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QUALYS, INC. - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations
[November 09, 2012]

QUALYS, INC. - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations


(Edgar Glimpses Via Acquire Media NewsEdge) This Quarterly Report on Form 10-Q, including this Management's Discussion and Analysis of Financial Condition and Results of Operations, should be read in conjunction with (1) our condensed consolidated financial statements (unaudited) and the related notes included elsewhere in this report, and (2) the audited consolidated financial statements and the related notes and management's discussion and analysis of financial condition and results of operations for the fiscal year ended December 31, 2011 included in the final prospectus for our initial public offering dated as of and filed with the SEC pursuant to Rule 424(b)(4) on September 27, 2012 (File No. 333-182027).



In addition to historical information, this Quarterly Report on Form 10-Q contains "forward-looking" statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, or the Exchange Act.

Forward-looking statements generally relate to future events or our future financial or operating performance. In some cases, it is possible to identify forward-looking statements because they contain words such as "anticipates," "believes," "contemplates," "continue," "could," "estimates," "expects," "future," "intends," "likely," "may," "plans," "potential," "predicts," "projects," "seek," "should," "target" or "will," or the negative of these words or other similar terms or expressions that concern our expectations, strategy, plans or intentions. We disclaim any obligation to update any forward-looking statements to reflect events or circumstances after the date of such statements.


Overview We are a pioneer and leading provider of cloud security and compliance solutions that enable organizations to identify security risks to their IT infrastructures, help protect their IT systems and applications from ever-evolving cyber attacks and achieve compliance with internal policies and external regulations. Our cloud solutions address the growing security and compliance complexities and risks that are amplified by the dissolving boundaries between internal and external IT infrastructures and web environments, the rapid adoption of cloud computing and the proliferation of geographically dispersed IT assets. Our integrated suite of security and compliance solutions delivered on our QualysGuard Cloud Platform enable our customers to identify their IT assets, collect and analyze large amounts of IT security data, discover and prioritize vulnerabilities, recommend remediation actions and verify the implementation of such actions. Organizations use our integrated suite of solutions delivered on our QualysGuard Cloud Platform to cost-effectively obtain a unified view of their security and compliance posture across globally-distributed IT infrastructures.

We were founded in December 1999 with a vision of transforming the way organizations secure and protect their IT infrastructure and applications and initially launched our first cloud solution, QualysGuard Vulnerability Management, in 2000. This solution has provided the substantial majority of our revenues to date. As this solution gained acceptance, we introduced new solutions to help customers manage increasing IT security and compliance requirements. In 2006, we added our PCI Compliance solution, and in 2008, we added our Policy Compliance solution. In 2009, we broadened the scope of our cloud services by adding Web Application Scanning. We continued our expansion in 2010, launching Malware Detection Service and Qualys SECURE Seal for automated protection of websites.

We provide our solutions through a software-as-a-service model, primarily with renewable annual subscriptions. These subscriptions require customers to pay a fee in order to access our cloud solutions. We invoice our customers for the entire subscription amount at the start of the subscription term, and the invoiced amounts are treated as deferred revenues and are recognized ratably over the term of each subscription. Historically, we have experienced significant revenue growth from existing customers as they renew and purchase additional subscriptions. Revenues from customers existing at or prior to September 30, 2011 grew $4.0 million to $59.6 million during the nine months ended September 30, 2012. We expect this trend to continue.

We market and sell our solutions to enterprises, government entities and to small and medium size businesses across a broad range of industries, including education, financial services, government, healthcare, insurance, manufacturing, media, retail, technology and utilities. As of September 30, 2012, we had over 6,000 customers in more than 100 countries, including a majority of each of the Forbes Global 100 and Fortune 100. In the nine months ended September 30, 2012 and 2011, approximately 68% and 69%, respectively, of our revenues were derived from customers in the United States. We sell our solutions to enterprises and government entities primarily through our field sales force and to small and medium-sized businesses through our inside sales force. We generate a significant portion of sales through our channel partners, including managed service providers, value-added resellers and consulting firms in the United States and internationally.

26-------------------------------------------------------------------------------- Table of Contents We have had strong revenue growth in the three and nine months ended September 30, 2012 compared to the same periods in 2011. Our revenues increased to $23.4 million in the three months ended September 30, 2012 from $19.4 million for the comparable period in 2011. Revenues reached $66.8 million for the nine months ended September 30, 2012, compared to $55.6 million in the nine months ended September 30, 2011, representing period-over-period increases of $4.0 million, and $11.2 million, or 21% and 20%, respectively. For the three months ended September 30, 2012, we had net income of $1.7 million compared to net income of $0.5 million for the three months ended September 30, 2011. For the nine months ended September 30, 2012, we had net income of $1.1 million compared to net income of $2.6 million for the nine months ended September 30, 2011.

On September 28, 2012, our common stock commenced trading on the NASDAQ Stock Market under the trading symbol "QLYS," and on October 3, 2012 we closed our initial public offering. In our initial public offering, we sold and issued 7,836,250 shares and certain selling stockholders sold an additional 875,000 shares. The net proceeds to us from the offering were approximately $87.5 million, after deducting underwriting discounts and commissions, and before deducting total estimated expenses in connection with this offering of approximately $2.5 million.

Key Metrics In addition to measures of financial performance presented in our condensed consolidated financial statements, we monitor the key metrics set forth below to help us evaluate growth trends, establish budgets, measure the effectiveness of our sales and marketing efforts, and assess operational efficiencies.

Four-Quarter Bookings We monitor Four-Quarter Bookings, a non-GAAP financial measure, which is calculated as revenues for the preceding four quarters plus the change in current deferred revenues for the same period. We believe this metric provides an additional tool for investors to use in assessing our business performance in a way that more fully reflects current business trends than reported revenues and reduces the variations in any particular quarter caused by customer subscription renewals. We believe Four-Quarter Bookings reflects the material sales trends for our business because it includes sales of subscriptions to new customers, as well as subscription renewals and upsells of additional subscriptions to existing customers. Since over 80% of our subscriptions are one year in length, we use current deferred revenues in this metric in order to focus on revenues to be generated over the next four quarters and to exclude the impact of multi-year subscriptions. Under our revenue recognition policy, we record subscription fees as deferred revenues and recognize revenues ratably over the subscription periods. For this reason, substantially all of our revenues for a period are typically generated from subscriptions commencing in prior periods. In addition, subscription renewals may vary during the year based on the date of our customers' original subscriptions, customer requests to modify subscription periods or other factors.

27-------------------------------------------------------------------------------- Table of Contents The following table presents the reconciliation of revenues to Four-Quarter Bookings for the four quarters ended September 30, 2012 and 2011.

Four Quarters Ended September 30, 2012 2011 (in thousands, except percentages) Revenues $ 87,416 $ 72,816 Deferred revenues, current Beginning of the Four-Quarter Period 40,413 34,370 Ending 51,693 40,413 Net change 11,280 6,043 Four-Quarter Bookings $ 98,696 $ 78,859 Percentage change from prior year period 25 % 22 % Adjusted EBITDA We monitor Adjusted EBITDA, a non-GAAP financial measure, to analyze our financial results and believe that it is useful to investors, as a supplement to U.S. GAAP measures, in evaluating our ongoing operational performance and enhancing an overall understanding of our past financial performance. We believe that Adjusted EBITDA helps illustrate underlying trends in our business that could otherwise be masked by the effect of the income or expenses that we exclude in Adjusted EBITDA. Furthermore, we use this measure to establish budgets and operational goals for managing our business and evaluating our performance. We also believe that Adjusted EBITDA provides an additional tool for investors to use in comparing our recurring core business operating results over multiple periods with other companies in our industry.

Adjusted EBITDA should not be considered in isolation from, or as a substitute for, financial information prepared in accordance with U.S. GAAP. We calculate Adjusted EBITDA as net income before (1) other (income) expense, net, which includes interest income, interest expense and other income and expense, (2) provision for income taxes, (3) depreciation and amortization of property and equipment, (4) amortization of intangible assets and (5) stock-based compensation.

The following table presents the reconciliation of net income to Adjusted EBITDA for the three and nine months ended September 30, 2012 and 2011.

Three Months Ended Nine Months Ended September 30, September 30, 2012 2011 2012 2011 (in thousands, except percentages) Net income $ 1,667 $ 452 $ 1,105 $ 2,605 Other (income) expense, net (23 ) 461 195 53 Provision for income taxes 77 81 77 291 Depreciation and amortization of property and equipment 1,739 1,121 5,066 3,466 Amortization of intangible assets 112 101 331 315 Stock-based compensation 1,027 550 2,583 1,512 Adjusted EBITDA $ 4,599 $ 2,766 $ 9,357 $ 8,242 Percentage of revenues 20 % 14 % 14 % 15 % 28-------------------------------------------------------------------------------- Table of Contents Limitations of Four-Quarter Bookings and Adjusted EBITDA Four-Quarter Bookings and Adjusted EBITDA, non-GAAP financial measures, have limitations as analytical tools, and should not be considered in isolation from or as a substitute for the measures presented in accordance with U.S. GAAP. Some of these limitations are: • Four-Quarter Bookings reflects the amount of revenues over a four-quarter period, plus the net change in the current portion of deferred revenues, while revenues are recognized ratably over the subscription periods; • Adjusted EBITDA does not reflect certain cash and non-cash charges that are recurring; • Adjusted EBITDA does not reflect income tax payments that reduce cash available to us; • Adjusted EBITDA excludes depreciation and amortization of property and equipment and, although these are non-cash charges, the assets being depreciated and amortized may have to be replaced in the future; and • Other companies, including companies in our industry, may calculate Four-Quarter Bookings or Adjusted EBITDA differently or not at all, which reduces their usefulness as a comparative measure.

Because of these limitations, Four-Quarter Bookings and Adjusted EBITDA should be considered alongside other financial performance measures, including revenues, net income and our financial results presented in accordance with U.S.

GAAP.

Key Components of Results of Operations Revenues We derive revenues from the sale of subscriptions to our security and compliance solutions, which are delivered on our cloud platform. We generate the substantial majority of our revenues through the sale of subscriptions to our QualysGuard Vulnerability Management solution, and we also have a growing number of customers who have purchased our additional solutions. Subscriptions to our solutions allow customers to access our cloud security and compliance solutions through a unified, web-based interface. Customers generally enter into one year renewable subscriptions. The subscription fee entitles the customer to an unlimited number of scans for a specified number of networked devices or web applications and, if requested by a customer as part of their subscription, a specified number of physical or virtual scanner appliances. Our physical and virtual scanner appliances are requested by certain customers as part of their subscriptions in order to scan IT infrastructures within their firewalls and do not function without, and are not sold separately from, subscriptions for our solutions. Customers are required to return physical scanner appliances if they do not renew their subscriptions.

We typically invoice our customers for the entire subscription amount at the start of the subscription term. Invoiced amounts are reflected on our consolidated balance sheet as accounts receivable or as cash when collected, and as deferred revenues until earned and recognized ratably over the subscription period. Accordingly, deferred revenues represents the amount billed to customers that has not yet been earned or recognized as revenues, pursuant to subscriptions entered into in current and prior periods.

Cost of Revenues Cost of revenues consists primarily of personnel expenses, comprised of salaries, benefits, performance-based compensation and stock-based compensation, for employees who operate our data centers and provide support services to our customers. Other expenses include depreciation of data center equipment and physical scanner appliances provided to certain customers as part of their subscriptions, expenses related to the use of third-party data centers, amortization of third-party technology licensing fees, fees paid to contractors who supplement or support our operations center personnel and overhead allocations. We expect to make significant capital investments to expand our data center operations, which will increase the cost of revenues in absolute dollars.

29-------------------------------------------------------------------------------- Table of Contents Operating Expenses Research and Development Research and development expenses consist primarily of personnel expenses, comprised of salaries, benefits, performance-based compensation and stock-based compensation, for our research and development teams. Other expenses include third-party contractor fees, amortization of intangibles related to prior acquisitions and overhead allocations. All research and development costs are expensed as incurred. We expect to continue to devote substantial resources to research and development in an effort to continuously improve our existing solutions as well as develop new solutions and expect that research and development expenses will increase in absolute dollars.

Sales and Marketing Sales and marketing expenses consist primarily of personnel expenses, comprised of salaries, benefits, sales commissions, performance-based compensation and stock-based compensation for our worldwide sales and marketing teams. Other expenses include marketing and promotional events, lead-generation marketing programs, public relations, travel and overhead allocations. All costs are expensed as incurred, including sales commissions. Sales commissions are expensed in the quarter in which the related order is received and are paid in the month subsequent to the end of that quarter, which results in increased expenses prior to the recognition of related revenues. Our new sales personnel are typically not immediately productive, and the resulting increase in sales and marketing expenses we incur when we add new personnel may not result in increased revenues if these new sales personnel fail to become productive. The timing of our hiring of sales personnel and the rate at which they generate incremental revenues may affect our future operating results. We expect that sales and marketing expenses will increase in absolute dollars.

General and Administrative General and administrative expenses consist primarily of personnel expenses, comprised of salaries, benefits, performance-based compensation and stock-based compensation, for our executive, finance and accounting, legal, human resources and internal information technology support teams as well as professional services fees and overhead allocations. We anticipate that we will incur additional expenses for personnel and for professional services, including auditing and legal services, insurance and other corporate governance-related expenses, including compliance with Section 404 of the Sarbanes-Oxley Act, related to operating as a public company. We expect that general and administrative expenses will increase in absolute dollars, especially in the near term, as we continue to add personnel to support our growth and operate as a public company.

Other Income (Expense), Net Our other income (expense), net consists primarily of interest expense associated with our capital leases and foreign exchange gains and losses, the majority of which result from fluctuations between the U.S. dollar and the Euro, British pound and Japanese yen.

Provision for Income Taxes Our provision for income taxes consists primarily of corporate income taxes resulting from profits generated in foreign jurisdictions by wholly-owned subsidiaries, along with state income taxes payable in the United States. The provision for income taxes also includes changes to unrecognized tax benefits related to uncertain tax positions.

Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the tax impact of timing differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carry-forwards. Deferred tax assets and liabilities are measured using statutory tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period when the statutory rate change is enacted into law.

30-------------------------------------------------------------------------------- Table of Contents We maintain a full valuation allowance on our U.S. federal and state deferred tax assets. Our cash tax expense is impacted by each jurisdiction's individual tax rates, laws on timing of recognition of income and deductions and availability of net operating losses and tax credits. Given the full valuation allowance and sensitivity of current cash taxes to local rules, our effective tax rate could fluctuate significantly on a quarterly basis and could be adversely affected by increases in non-deductible stock compensation or other non-deductible expenses and to the extent earnings are lower than anticipated in countries that have lower statutory rates and higher than anticipated in countries that have higher statutory rates. Our effective tax rate could also fluctuate due to a change in our earnings projections, by changes in the valuation of our deferred tax assets or liabilities, or by changes in tax laws, regulations, or accounting principles, as well as certain discrete items.

Results of Operations The following tables set forth selected condensed consolidated statements of operations data for each of the periods presented.

Three Months Ended Nine Months Ended September 30, September 30, 2012 2011 2012 2011 (in thousands) Consolidated Statements of Operations Data: Revenues $ 23,382 $ 19,375 $ 66,763 $ 55,560 Cost of revenues (1) 4,634 3,225 13,423 9,124 Gross profit 18,748 16,150 53,340 46,436 Operating expenses: Research and development (1) 5,076 4,922 15,325 14,680 Sales and marketing (1) 8,797 7,985 27,827 22,297 General and administrative (1) 3,154 2,249 8,811 6,510 Total operating expenses 17,027 15,156 51,963 43,487 Income from operations 1,721 994 1,377 2,949 Other income (expense), net 23 (461 ) (195 ) (53 ) Income before provision for income taxes 1,744 533 1,182 2,896 Provision for income taxes 77 81 77 291 Net income $ 1,667 $ 452 $ 1,105 $ 2,605 ____________________(1) Includes stock-based compensation as follows: Three Months Ended Nine Months Ended September 30, September 30, 2012 2011 2012 2011 (in thousands) Cost of revenues $ 68 $ 44 $ 195 $ 96 Research and development 167 118 484 340 Sales and marketing 349 163 856 397 General and administrative 443 225 1,048 679 Total stock-based compensation $ 1,027 $ 550 $ 2,583 $ 1,512 31-------------------------------------------------------------------------------- Table of Contents The following table sets forth selected condensed consolidated statements of operations data for each of the periods presented as a percentage of revenues.

Three Months Ended Nine Months Ended September 30, September 30, 2012 2011 2012 2011 Revenues 100 % 100 % 100 % 100 % Cost of revenues 20 17 20 16 Gross profit 80 83 80 84 Operating expenses: Research and development 22 25 23 26 Sales and marketing 38 41 42 40 General and administrative 13 12 13 13 Total operating expenses 73 78 78 79 Income from operations 7 5 2 5 Other income (expense), net - (2 ) - - Income before provision for income taxes 7 3 2 5 Provision for income taxes - 1 - - Net income 7 % 2 % 2 % 5 % Comparison of Three Months Ended September 30, 2012 and 2011 Revenues Three Months Ended September 30, Change 2012 2011 $ % (in thousands, except percentages) Revenues $ 23,382 $ 19,375 $ 4,007 21 % Revenues increased $4.0 million in the three months ended September 30, 2012 compared to the three months ended September 30, 2011, primarily due to the sale of additional solutions to existing customers and subscriptions to new customers. Of the total increase of $4.0 million, $2.9 million was from customers in the United States and the remaining $1.1 million was from customers in foreign countries. The growth in revenues reflects increased demand for our solutions.

32-------------------------------------------------------------------------------- Table of Contents Cost of Revenues Three Months Ended September 30, Change 2012 2011 $ % (in thousands, except percentages) Cost of revenues $ 4,634 $ 3,225 $ 1,409 44 % Percentage of revenues 20 % 17 % Gross profit percentage 80 % 83 % Cost of revenues increased $1.4 million in the three months ended September 30, 2012 compared to the three months ended September 30, 2011, primarily due to $0.6 million of higher depreciation expenses related to additional data center equipment, third-party software and physical scanner appliances deployed to customers, increased personnel expenses of $0.4 million, principally driven by the addition of employees in our operations team, and increased third-party software maintenance expense of $0.2 million. The decrease in gross profit percentage reflects the impact of increased investments to expand our data center infrastructure and to add capacity to deploy new solutions on our cloud platform.

Research and Development Expenses Three Months Ended September 30, Change 2012 2011 $ % (in thousands, except percentages) Research and development $ 5,076 $ 4,922 $ 154 3 % Percentage of revenues 22 % 25 % Research and development expenses were relatively constant in the three months ended September 30, 2012 and 2011, with slight increases due to the addition of employees as we continue to invest in enhancing our platform and developing new solutions.

Sales and Marketing Expenses Three Months Ended September 30, Change 2012 2011 $ % (in thousands, except percentages) Sales and marketing $ 8,797 $ 7,985 $ 812 10 % Percentage of revenues 38 % 41 % Sales and marketing expenses increased $0.8 million in the three months ended September 30, 2012 compared to the three months ended September 30, 2011, primarily due to an increase in personnel expenses of $1.2 million, principally driven by the addition of employees as we continue to expand our domestic and international sales and marketing efforts, and higher sales commissions as a result of higher bookings, partially offset by decreased marketing expenses of $0.4 million due to the timing of trade show and marketing activities in the third quarter of 2012.

33-------------------------------------------------------------------------------- Table of Contents General and Administrative Expenses Three Months Ended September 30, Change 2012 2011 $ % (in thousands, except percentages) General and administrative $ 3,154 $ 2,249 $ 905 40 % Percentage of revenues 13 % 12 % General and administrative expenses increased $0.9 million in the three months ended September 30, 2012 compared to the three months ended September 30, 2011, primarily due to an increase in personnel expenses of $0.4 million, principally driven by the addition of employees to support the growth of our business, an increase in stock-based compensation expense of $0.2 million, primarily for advisory board members, and an increase in professional services expenses of $0.2 million.

Other Income (Expense), Net Three Months Ended September 30, Change 2012 2011 $ % (in thousands, except percentages) Other income (expense), net $ 23 $ (461 ) $ 484 (105 )% Percentage of revenues - % 2 % Other income (expense), net increased $0.5 million in the three months ended September 30, 2012 compared to the three months ended September 30, 2011, primarily due to foreign exchange fluctuations in the Euro. The three months ended September 30, 2012 included $0.1 million of foreign currency exchange gains, compared to $0.4 million of foreign currency exchange losses in the three months ended September 30, 2011.

Provision for Income Taxes Three Months Ended September 30, Change 2012 2011 $ % (in thousands, except percentages) Provision for income taxes $ 77 $ 81 $ (4 ) (5 )% Percentage of revenues - % 1 % Provision for income taxes was unchanged in the three months ended September 30, 2012 compared to the three months ended September 30, 2011. Although pre-tax income was higher in the three months ended September 30, 2012, as we had a full valuation allowance in the United States, the provision for income taxes were primarily a result of foreign and state taxes and did not change significantly from the same quarter a year ago.

34-------------------------------------------------------------------------------- Table of Contents Comparison of Nine Months Ended September 30, 2012 and 2011 Revenues Nine Months Ended September 30, Change 2012 2011 $ % (in thousands, except percentages) Revenues $ 66,763 $ 55,560 $ 11,203 20 % Revenues increased $11.2 million in the nine months ended September 30, 2012 compared to the nine months ended September 30, 2011. Revenues from customers existing at or prior to September 30, 2011 grew $4.0 million to $59.6 million during the nine months ended September 30, 2012 due to increased subscriptions.

Subscriptions from new customers added in the twelve months ended September 30, 2012 contributed $7.2 million to the increase in revenues. Of the total increase of $11.2 million, $7.5 million was from customers in the United States and the remaining $3.7 million was from customers in foreign countries. The growth in revenues reflects increased demand for our solutions.

Cost of Revenues Nine Months Ended September 30, Change 2012 2011 $ % (in thousands, except percentages)Cost of revenues $ 13,423 $ 9,124 $ 4,299 47 % Percentage of revenues 20 % 16 % Gross profit percentage 80 % 84 % Cost of revenues increased $4.3 million in the nine months ended September 30, 2012 compared to the nine months ended September 30, 2011, primarily due to $1.6 million of higher depreciation expenses related to additional data center equipment, third-party software and physical scanner appliances deployed to customers, increased personnel expenses of $1.3 million, principally driven by the addition of employees in our operations team, and increased third-party software maintenance expense of $0.8 million. The decrease in gross profit percentage reflects the impact of increased investments to expand our data center infrastructure and to add capacity to deploy new solutions on our cloud platform.

Research and Development Expenses Nine Months Ended September 30, Change 2012 2011 $ % (in thousands, except percentages) Research and development $ 15,325 $ 14,680 $ 645 4 % Percentage of revenues 23 % 26 % Research and development expenses increased $0.6 million in the nine months ended September 30, 2012 compared to the nine months ended September 30, 2011, primarily due to an increase in personnel expenses of $0.7 million, principally driven by the addition of employees as we continue to invest in enhancing our platform and developing new solutions.

35-------------------------------------------------------------------------------- Table of Contents Sales and Marketing Expenses Nine Months Ended September 30, Change 2012 2011 $ % (in thousands, except percentages) Sales and marketing $ 27,827 $ 22,297 $ 5,530 25 % Percentage of revenues 42 % 40 % Sales and marketing expenses increased $5.5 million in the nine months ended September 30, 2012 compared to the nine months ended September 30, 2011, primarily due to an increase in personnel expenses of $4.2 million, principally driven by the addition of employees as we continue to expand our domestic and international sales and marketing efforts, and higher sales commissions as a result of higher bookings, increased travel and related expense of $0.6 million and increased professional services expenses of $0.2 million.

General and Administrative Expenses Nine Months Ended September 30, Change 2012 2011 $ % (in thousands, except percentages) General and administrative $ 8,811 $ 6,510 $ 2,301 35 % Percentage of revenues 13 % 13 % General and administrative expenses increased $2.3 million in the nine months ended September 30, 2012 compared to the nine months ended September 30, 2011, primarily due to an increase in personnel expenses of $1.1 million, principally driven by the addition of employees to support the growth of our business, an increase in stock-based compensation of $0.2 million, primarily for advisory board members, and an increase in professional services expenses of $0.5 million.

Other Income (Expense), Net Nine Months Ended September 30, Change 2012 2011 $ % (in thousands, except percentages) Other income (expense), net $ (195 ) $ (53 ) $ (142 ) 268 % Percentage of revenues - % - % Other income (expense), net decreased $(0.1) million in the nine months ended September 30, 2012 compared to the nine months ended September 30, 2011, primarily due to foreign exchange fluctuations in the Euro. The nine months ended September 30, 2012 included a nominal amount of foreign currency exchange losses, compared to $0.1 million of foreign currency exchange gains in the nine months ended September 30, 2011.

36-------------------------------------------------------------------------------- Table of Contents Provision for Income Taxes Nine Months Ended September 30, Change 2012 2011 $ % (in thousands, except percentages) Provision for income taxes $ 77 $ 291 $ (214 ) (74 )% Percentage of revenues - % - % Provision for income taxes decreased $(0.2) million in the nine months ended September 30, 2012 compared to the nine months ended September 30, 2011, primarily due to a reduction of the liability for uncertain tax positions of $0.3 million, resulting from closure of tax years in foreign jurisdictions during the nine months ended September 30, 2012, compared to a reduction of the liability for uncertain tax positions related to state taxes of $0.1 million in the nine months ended September 30, 2011.

Liquidity and Capital Resources Since our inception, we have financed our operations primarily through the proceeds from the issuance of our preferred stock, including $23.2 million invested by Philippe F. Courtot, our Chairman, President and Chief Executive Officer, and cash flows from operations. At September 30, 2012, our principal source of liquidity was cash of $25.8 million, including $2.2 million held outside of the United States by our foreign subsidiaries. We do not anticipate that we will need funds generated from foreign operations to fund our domestic operations. However, if we repatriate these funds, we could be subject to U.S.

income taxes on such amounts, less previously paid foreign income taxes.

We have experienced positive cash flows from operations during the nine months ended September 30, 2012 and 2011. We believe our existing cash and cash from operations will be sufficient to fund our operations for at least the next twelve months. We expect to spend approximately $20.0 million through December 31, 2013 for capital expenditures, primarily related to infrastructure to support the anticipated growth in our business. Our future capital requirements will depend on many factors, including our rate of revenue growth, the expansion of our sales and marketing activities, the timing and extent of our spending on research and development efforts, international expansion and investment in data centers. We may also seek to invest in or acquire complementary businesses or technologies.

On October 3, 2012, we closed our IPO and received net proceeds of approximately $87.5 million after deducting underwriting discounts and commissions, and before deducting total estimated expenses in connection with our IPO of approximately $2.5 million. To the extent that existing cash, cash from operations and net proceeds from our IPO are insufficient to fund our future activities, we may need to raise additional funding through debt and equity financing. Additional funds may not be available on favorable terms or at all.

37-------------------------------------------------------------------------------- Table of Contents Cash Flows The following summary of cash flows for the periods indicated has been derived from our condensed consolidated financial statements included elsewhere in this report: Nine Months Ended September 30, 2012 2011 (in thousands)Cash provided by operating activities $ 10,669 $ 11,287 Cash used in investing activities (8,104 ) (4,250 ) Cash used in financing activities (1,325 ) (54 ) Effect of exchange rate changes on cash 16 (128 ) Net increase in cash $ 1,256 $ 6,855 Cash Flows from Operating Activities In the nine months ended September 30, 2012, operating activities provided $10.7 million in cash related to an increase of $6.4 million in deferred revenues, attributable to increased collections from customers and an increase in subscriptions exceeding one year and net income of $1.1 million, adjusted by non-cash items including depreciation and amortization of $5.4 million and stock-based compensation of $2.6 million. These working capital increases were partially offset by an increase of $2.9 million in accounts receivable due to the overall growth of our business and a decrease of $2.1 million in accounts payable and accrued liabilities due to the timing of payments.

In the nine months ended September 30, 2011, operating activities provided $11.3 million in cash related to an increase of $4.7 million in deferred revenues, attributable to increased collections from customers and an increase in subscriptions exceeding one year and net income of $2.6 million, adjusted by non-cash items including depreciation and amortization of $3.8 million and stock-based compensation of $1.5 million. These sources of cash were partially offset by an increase of $2.0 million in accounts receivable due to the overall growth of our business and an increase of $1.3 million in prepaid expenses and other assets related to long-term maintenance contracts on third-party licensed technology.

Cash Flows from Investing Activities In the nine months ended September 30, 2012 and 2011, we used $8.1 million and $4.3 million, respectively, of cash for capital expenditures, including computer hardware and software for our data centers to support our growth and development, and to purchase physical scanner appliances provided to certain customers as part of their subscriptions.

Cash Flows from Financing Activities In the nine months ended September 30, 2012, cash used in financing activities of $1.3 million was primarily attributable to repayments on our capital lease obligations of $1.8 million, payment of consideration related to our Nemean acquisition of $1.0 million and cash paid for offering costs in connection with our IPO of $0.6 million. These cash outflows were partially offset by $2.0 million of proceeds from the exercise of stock options.

In the nine months ended September 30, 2011, cash used in financing activities of $0.1 million was primarily attributable to repayments on our capital leases of $1.2 million, partially offset by $1.0 million of proceeds from the exercise of stock options and warrants.

38-------------------------------------------------------------------------------- Table of Contents Line of Credit In March 2009, we entered into an equipment line of credit of $1.5 million. In March 2010, we amended this line of credit. The amount available for draws at the time of the amendment was increased by $0.8 million and was available through February 2011. In December 2010, we completed a second amendment to our line of credit. The amount available for draws at the time of the second amendment was increased by an additional $1.0 million and was available through February 2012. At September 30, 2012 and December 31, 2011, we had $0.3 million and $0.9 million, respectively, in outstanding borrowings under this line of credit, which are recorded in capital lease obligations in the condensed consolidated balance sheets. The remaining amount available for borrowings at December 31, 2011 was $0.9 million. Our line of credit expired in February 2012, and we are not able to draw any further funds from our line of credit.

Contractual Obligations Our principal commitments consist of obligations under our outstanding leases for office space and third-party data centers, capital lease and third-party software maintenance obligations. The following table summarizes our contractual cash obligations, including future interest payments, at September 30, 2012 and the effect such obligations are expected to have on our liquidity and cash flows in future periods: Payment Due by Period 2017 and Contractual Obligations Total Remainder of 2012 2013-2014 2015-2016 thereafter (in thousands) Operating lease obligations (1) $ 8,971 $ 526 $ 4,103 $ 2,889 $ 1,453 Capital lease obligations (2) 2,686 238 2,448 - - Maintenance obligations (3) 1,785 - 1,785 - - Total $ 13,442 $ 764 $ 8,336 $ 2,889 $ 1,453 (1) Operating lease obligations represent our obligations to make payments under the lease agreements for our facilities and office equipment leases. During the nine months ended September 30, 2012, we made regular payments on our operating lease obligations of $2.2 million.

(2) Capital lease obligations represent financing on computer equipment and software purchases. During the nine months ended September 30, 2012, we made regular payments on our capital lease obligations of $1.8 million.

(3) Maintenance obligations relate to third-party software licenses. During the nine months ended September 30, 2012, we made regular payments on our maintenance obligations of $0.8 million.

Off-Balance Sheet Arrangements During the periods presented, we did not have, nor do we currently have, any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities.

Recent Accounting Pronouncements See Note 1 to the unaudited condensed consolidated financial statements in Part I, Item 1 of this Quarterly Report on 10-Q for a discussion of recent accounting pronouncements.

Critical Accounting Policies and Estimates Our condensed consolidated financial statements are prepared in accordance with U.S. GAAP. The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, expenses and related disclosures. On an ongoing basis, we evaluate our estimates and assumptions. Our actual results may differ from these estimates under different assumptions or conditions.

We believe that of our significant accounting policies, which are described in the notes to our condensed consolidated financial statements, the accounting policies related to revenue recognition, goodwill and intangibles, income taxes and stock-based compensation involve the greatest degree of judgment and complexity and have the 39-------------------------------------------------------------------------------- greatest potential impact on our consolidated financial statements. A critical accounting policy is one that is material to the presentation of our consolidated financial statements and requires us to make difficult, subjective or complex judgments for uncertain matters that could have a material effect on our financial condition and results of operations. Accordingly, these are the policies we believe are the most critical to aid in fully understanding and evaluating our financial condition and results of operations. There have been no material changes to our critical accounting policies and estimates as compared to the critical accounting policies and estimates as described in our Prospectus dated September 27, 2012, filed with the SEC pursuant to Rule 424(b)(4).

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