Qualys, Inc. — Q1 2018 Form 10-Q
Reporting period: Three months ended March 31, 2018. Qualys provides cloud-based security and compliance subscriptions, generally sold on renewable annual terms. Figures below are in U.S. dollars; financial statement amounts are in millions unless otherwise stated.
Key financial results
| Metric | Q1 2018 | Q1 2017 | Change |
|---|---|---|---|
| Revenue | $64.9 | $53.1 | +22% |
| Gross profit / gross margin | $49.0 / 75% | $40.8 / 77% | Margin down 2 percentage points |
| Operating income / margin | $8.4 / 13% | $7.7 / 14% | Income up 10%; margin down about 1 point |
| Net income | $9.1 | $21.9 | Down 58% |
| Diluted EPS | $0.22 | $0.56 | Down 61% |
| Adjusted EBITDA (non-GAAP) | $24.6 / 38% of revenue | $16.8 / 32% | Up 46%; margin up 6 points |
| Operating cash flow | $43.0 | $32.4 | Up $10.6 |
Operating expenses were $40.6 million, or 62% of revenue, versus $33.2 million, or 63%. R&D rose 28% to $12.6 million; sales and marketing was nearly flat at $16.2 million; G&A increased 61% to $11.8 million. Stock-based compensation rose to $8.9 million from $4.3 million, including a $3.5 million increase in G&A stock compensation.
Liquidity, cash flow and obligations
- Cash, cash equivalents and short- and long-term investments totaled $393.9 million at March 31, 2018, including $7.8 million held by foreign subsidiaries. Cash and cash equivalents alone were $93.2 million.
- Current assets were $393.9 million and current liabilities were $171.1 million. Current deferred revenue was $147.7 million; noncurrent deferred revenue was $15.0 million.
- Operating cash flow of $43.0 million included a $14.5 million decrease in accounts receivable, primarily due to the timing of customer payments. Investing activities used $38.1 million, including $32.1 million net purchases of investments and $6.0 million of capital expenditures.
- The filing reports no conventional borrowings. Capital lease obligations had a present value of $2.8 million; operating lease commitments totaled $48.9 million. The new headquarters lease carries a stated $38.6 million commitment through April 2028.
- Management said available cash, investments and operating cash flow should fund operations for at least the next 12 months.
Changes versus the prior-year quarter
- Revenue increased $11.8 million, with $6.9 million of growth from U.S. customers and $4.9 million from foreign customers. Direct-channel revenue was $38.7 million and partner-channel revenue was $26.2 million. About 40% of revenue came through channel partners.
- VM-related solutions generated 74% of revenue, leaving the business materially dependent on that product group.
- Gross margin declined as cost of revenue grew 29%, faster than revenue growth, reflecting higher personnel, depreciation, acquired-technology amortization, licensing and data-center costs.
- Net income comparisons are heavily affected by tax: Q1 2017 included a $13.8 million tax benefit, while Q1 2018 had a $0.5 million tax provision. The effective tax rates were approximately (170.4)% and 5.3%, respectively.
- Operating cash flow increased, but the comparison also reflects different working-capital and tax-related items. Q1 2018 cash generation included the accounts-receivable reduction; Q1 2017 included a $22.6 million deferred-tax adjustment.
Outlook, accounting changes and notable items
- No numerical revenue or earnings guidance is provided in this filing. Management expects revenue growth from existing and new customers to continue and cites ongoing demand for its solutions. It also expects absolute spending to rise in R&D, sales and marketing, and G&A as it invests in products, infrastructure and growth.
- Qualys adopted ASC 606 on January 1, 2018 using the modified retrospective method. Revenue was not affected; certain commissions for new business and upsells are now capitalized and amortized over five years. Adoption increased opening retained earnings by $2.7 million. Q1 2018 commission expense would have been $0.5 million higher absent adoption, so reported expense and comparisons are affected by the accounting change.
- The board authorized a $100 million share-repurchase program in February. Qualys repurchased 21,288 shares for approximately $1.5 million during the quarter; $98.5 million remained authorized at March 31. The program has no expiration date and repurchases are not assured.
- On April 1, 2018, Qualys acquired certain assets of 1Mobility for $4.0 million in cash, of which $0.6 million is payable subject to agreement terms. The acquisition is to be accounted for as a business combination.
- A vendor began reviewing Qualys’s compliance with a technology license agreement during the quarter. Management intends to cooperate while defending its position and says amounts accrued are sufficient and potential losses beyond accruals are not significant.
- Other key risks include dependence on VM subscriptions and renewals, competition and pricing pressure, execution of product diversification, service or security disruptions, channel-partner reliance, foreign-exchange exposure, and privacy regulation. The EU GDPR was scheduled to take effect May 25, 2018. Management reported disclosure controls were effective and no material change in internal control over financial reporting.
Important facts for investors to verify
- Whether revenue growth, renewals and expansion sales continue, particularly given that VM-related solutions represented 74% of revenue.
- Whether gross-margin pressure and higher operating costs persist, and how much reported earnings are affected by stock-based compensation and commission capitalization.
- Whether operating cash flow remains strong without relying on favorable collections timing, and how cash and investment balances evolve alongside repurchases and capital spending.
- How the vendor license review, 1Mobility integration, and the new headquarters and data-center commitments develop.
- How the final accounting for the Tax Cuts and Jobs Act affects the effective tax rate; the filing says its analysis was ongoing.