Qualys, Inc.
Q2 2015 Earnings Call Transcript

Published: 4 Aug 2015

[Operator:]

Good day, everyone, and welcome to the Qualys Second Quarter 2015 Investor Conference Call. This call is being recorded. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions for asking a question will be given at that time. I would now like to turn the call over to Don McCauley, CFO of Qualys. Please go ahead, sir.

[Donald C. McCauley:]

Welcome to the Qualys second quarter 2015 investor conference call. I'm Don McCauley, CFO. I'm here with Philippe Courtot, our Chairman, President and CEO on this call. We would like to remind you that during the call, we expect to make forward-looking statements within the meaning of the Federal Securities laws. Forward-looking statements generally relate to future events or our future financial or operating performance. Forward-looking statements in this presentation include but are not limited to, the following list

[Philippe F. Courtot:]

Thank you, Don, and welcome to all of you. The second quarter of 2015 was an excellent quarter, which included a number of strategic product releases as well as continued growth and success across all aspects of our business. While Don will cover the financial details of our performance for the quarter, I would share with you why I think these are exciting times for Qualys on both a growth and strategic perspective. I would start up with an overview of key highlights that are driving the momentum in our business and discuss in more detail our new product releases. As I mentioned on last quarter's call, we launched our Qualys Cloud Agent platform at the RSA Conference in April. This is the disruptive expansion of our cloud security and compliance platform as it expands our offerings to provide real-time continuous security and compliance across all enterprise IT assets ranging from on-premise devices and mobile headphones to elastic cloud environment. In addition that this new technology liberates customers from the many challenges they face with conventional scanning solution such as scan time windows, credential management and batch reporting and allows them to build Continuous Monitoring programs more effectively. We are seeing significant interest from our customers and have an impressive number of trials underway. As a result, we anticipate a more rapid adoption than we have seen in the past for other new offerings. The product is now shipping for the Windows platform and will be available on Mac and Linux this month. We would be adding additional capabilities in the near future such as File Integrity Monitoring and Indication of Compromise detection capability. Now we're also making good progress with our new other solutions currently under development including the log management and analytics back end, as well the malware detection and prevention, both of which we expect to release in beta this year. Now, let me give you key highlights on the sale of our business. In the second quarter we added a number of important new accounts

[Donald C. McCauley:]

Thanks, Philippe. Again as previously mentioned our second quarter 2015 results were very good. Revenues grew in the second quarter to $39.9 million which represents 23% growth over the second quarter of 2014. Our current deferred revenue balance is $87.4 million as of June 30, 2015, which is 22% greater than the balance was one year ago. A quick review of some other revenue metrics, for the second quarter, the U.S. represented 70.5% of revenues compared to 70.0% a year ago. Also we drive 79% of second quarter revenues from subscriptions to our Vulnerability Management solution and that compares to 82% in the second quarter of last year. GAAP gross profit increased by 26% to $31.7 million in the second quarter of 2015 compared to $25.1 million in the prior year. GAAP gross margin was 79% for the second quarter of 2015 compared to 78% a year earlier. Non-GAAP gross margin was 80% for the second quarter of 2015 compared to 78% in the second quarter of last year. Adjusted EBITDA for the second quarter of 2015 increased by 81% to $13.1 million compared to $7.2 million a year earlier. Adjusted EBITDA as a percentage of revenues increased to 33% in the second quarter of 2015 compared with 22% in the same quarter of 2014. Net cash from operations in the first six months of 2015 increased by 68% to $25.6 million compared to $15.2 million in the first six months of 2014. Free cash flow this year increased by 74% to $15.0 million compared to $8.7 million in the first six months of last year. In the second quarter of 2015, capital expenditures were $4.3 million compared to $2.7 million in the second quarter last year. In the third quarter, we expect capital expenditures to be in the range of $4.5 million to $5.5 million as we expand our cloud infrastructure to support more customers and add more solutions and functionality to our platforms. Moving on to earnings per share. For the second quarter of 2015, GAAP EPS was $0.09 per diluted share versus $0.04 a year ago. Non-GAAP EPS was $0.16 per diluted share in the second quarter of 2015 compared to $0.11 in the second quarter of 2014. Now turning to our guidance, starting with revenues. For the third quarter we expect revenues to be in the range of $42 million to $42.5 million. At the midpoint this represents 23% growth over third quarter 2014 revenues. For the full year of 2015, our revenue guidance is unchanged as we expect revenues to be in the range of $165 million to $166.5 million. At the midpoint, this represents 24% growth over 2014 revenues. Now on to earnings per share. We expect GAAP EPS for the third quarter of 2015 to be in the range of $0.04 to $0.06 and non-GAAP EPS is expected to be in the range of $0.12 to $0.14. Our third quarter EPS estimates are based on approximately 38.9 million weighted average diluted shares outstanding. For the full year 2015 we continue to expect GAAP EPS to be in the range of $0.22 to $0.27 and non-GAAP EPS is expected to be in the range of $0.50 to $0.55. Our full year EPS estimates are based on approximately 38.6 million weighted average diluted shares outstanding. In summary, we remain very excited about the future of Qualys. We continue to work to drive growth within our current solutions and are seeing significant traction and interest with our new offerings such as our Cloud Agent Platform. Over time we expect to continue to leverage the power of the Qualys Cloud Platform to further drive shareholder value. Before we open up the call for Q&A, I'd just like to note for everyone that we will be holding our second Qualys Investor Day meeting on October 7. It will be held in Las Vegas on the afternoon before the Qualys Security Conference which is our annual user conference. That conference is being held on October 8 and 9. The Investor Meeting will include presentations from management focusing on our current platform and products as well as our exciting product pipeline for 2016 and beyond. Investors are also invited to attend our user conference which is a unique opportunity to connect with current and prospective customers and partners along with our engineers, as well as industry experts. With that Philippe and I would be happy to answer any of your questions. Operator?

[Operator:]

Thank you. And our first question comes from the line of Sterling Auty with JPMorgan. Your line is open. Please go ahead.

[Ken R. Talanian:]

Hi. This is actually Ken Talanian on for Sterling. Thank you for taking my question. I was wondering is the rollout of the Continuous Monitoring product causing any pause in Vulnerability Management as customers decide which product to go with?

[Philippe F. Courtot:]

Oh, not at all. This is Philippe speaking. Not at all. In fact it continues. The monitoring is a natural extension of our Vulnerability Management solution. What it does is that it allows now to have alert instead of just reports when you turn on the continuous security module which is an add-on. And what it does is that it allows you to essentially have alerts that you can directly integrate or plant to your incident response system. So they are totally complementary.

[Ken R. Talanian:]

Okay. And just another one, I was wondering looking at the 3Q guidance the growth looks a little bit shy at where the Street was and I was wondering if there's any FX in that estimate?

[Donald C. McCauley:]

Yeah, like every software company, we've had kind of FX headwinds this year and Q3 as it would be another quarter, would be under such a large difference between the rate of the euro a year ago and today but yes, there are some headwinds in Q3.

[Ken R. Talanian:]

Okay, great. Thank you, guys.

[Operator:]

Thank you. And the next question comes from the line of Philip Winslow with Credit Suisse. Your line is open. Philip Alan Winslow - Credit Suisse Securities (USA) LLC (Broker) Hi, guys. Thank you guys for taking my question. I'm wondering if you can just give some color on what you're seeing in the VM market. Obviously on the last call this was a big point of discussion. Sort of anything that you can point out this quarter versus where your head was 90 days ago? And also as you look at some of the newer products, maybe just some, if you can give some more color there as well as sort of now that we're half way through the year but just the trends that you're seeing versus the beginning of the year? Thanks.

[Philippe F. Courtot:]

So on the VM side, we see still the same. Qualys will continue essentially expanding our market penetration on the VM space and what we see is the fact that companies now are realizing more than ever that you have to really know the assets that you have, that you need to understand who owns them and as well as of course looking at their vulnerability. So today I think, this is the cornerstone of security and I think companies are understanding that very well. So what we see is that with our Cloud Agent, we see in fact further expansion of both our Vulnerability Management and as well as our Policy Compliance, because now we can go to the end point. One of the limitations of Qualys in the past was that we could not effectively address the security and compliance posture of the endpoint. Now with this agent, we can do that very effectively and this is essentially a continuation of the Vulnerability Management application. Philip Alan Winslow - Credit Suisse Securities (USA) LLC (Broker) Got it. Thanks guys.

[Operator:]

Thank you. The next question comes from the line of Steve Ashley with Robert W. Baird. Your line is open. Please go ahead.

[Steve M. Ashley:]

Thank you very much. I remember and I understand that you focus on trailing 12 months current billings. But if you were to look at the way that a lot of us folk out here look at quarterly billings, last quarter that number was up 29%. And I remember, Don, you saying you really didn't think that was representative of the trends in your business, that 29%. That comparable number this quarter is up like 19% or 20%. And I was just wondering if you had any comment on whether you thought that was representative of the growth rate of your business.

[Donald C. McCauley:]

Yeah, well just to – thanks, Steve – remind everyone that the point we were talking about here is that we felt that the opening deferred revenue balance at December 31 was on the light side because we saw a lot Q4 short period upsells from our customers which we kind of characterize as budget flush. And so that apparent one quarter bookings metric that you all calculate came out – my point was that it was overstated the kind of quarter that we had. I think sometimes it understates a little bit too. It's more in the ballpark this time, Steve.

[Steve M. Ashley:]

Okay. And then I was just wondering in terms of sales reps and hiring in general, if you could just update us on maybe head count and how the hiring process went in the period?

[Philippe F. Courtot:]

So in term of hiring. So we have done a few things. One, as you recall, we have a very highly leveraged model with the very strong partnership that we have, we added as I mentioned earlier AT&T and Solutionary. So we continue expanding our partnerships extremely well. In fact, we have beefed up our strategic alliance team. In term of our direct sales force we are expanding our head count. We have just essentially by the way hired a VP general manager for Europe. So we're adding middle management as well as EVPs for worldwide sales and we're absolutely actively recruiting and hiring. We have in fact quite a few offers which we have extended. And typically as you can see in the pattern of Qualys, we do most of our hiring in the second half of the year. And so we anticipate to maintain the 20 percentage to 25 percentage head count that we mentioned I think in the last earnings call that we are planning for the year. So we're continuing expanding and with all the new services that we have, this is really the time even for us to expand our sales force. We always have been careful of not expanding the sales force too early because at the end of day you end up with people which you pay a lot of money and they don't necessarily deliver. And so we have always had a balanced approach between the channel, between the direct sales force. And you see that in the high, really highly scalable model that we have been.

[Steve M. Ashley:]

Great. Thank you.

[Operator:]

Our next question comes from the line of Rob Owens with Pacific Crest. Your line is open. Please go ahead.

[Rob Owens:]

Great, and thanks for taking my question. Don, I think you may have partially answered this, but in and around the deferred revenue being down sequentially, I guess given the new products that you have, given how security spending appears to be picking up as we look at other companies' results, can you speak to that? Is Q2 – just I know seasonally this has always been kind of a one-off quarter or sometimes it's flat from deferred revenues, sometimes it's up a little bit, but what are the trends you're seeing there and is this the aberration that you saw Q4 to Q1 kind of playing out in Q2. Maybe help us understand that a little bit?

[Donald C. McCauley:]

Yeah, so Q2 is a pretty normal quarter, Rob, in terms of the pace of the quarter and the composition of it. Last year, deferred revenues were up just slightly. I think the year before they were down just slightly in Q2. So Q2 is usually about a flat quarter on deferred revenues just the way it works out. So nothing unusual. I think we're kind of seeing normal patterns in the business.

[Rob Owens:]

And then I think you answered Steve's kind of 20%. This is more the normalized growth rate, if you will. So does that mean once we get beyond expectations for this year, we should see some slowing, realizing you're not guiding to 2016 at this point, but it does take a while for that to transition out in the model, so if 29% was a little too hot and 20% is more like it, do we see things come down from the 23%, 24% that you're looking for this year?

[Donald C. McCauley:]

Well, we don't want to get ahead of ourselves guiding beyond this year but our pipelines are really strong. Philippe was talking about the number of new products that are hitting this year. So we're optimistic about the business but we're not getting ahead of ourselves guiding for next year yet

[Rob Owens:]

Fair enough.

[Philippe F. Courtot:]

Yeah. And the one thing that I would add, to what Don said here is that today we are doing very big upsell we thought we had (22

[Rob Owens:]

Great. And then, last one, if I may. Could you give a customer count; are you willing to give a customer count to close quarter?

[Donald C. McCauley:]

Yeah we update that once a year Rob, since it's not directly comparable for revenues but I'll tell you we're on the same kind of pace we were last year.

[Rob Owens:]

All right. Thanks, guys.

[Operator:]

Our next question comes from the line of Matt Hedberg with RBC Capital Markets. Your line is now open.

[Dan Bergstrom:]

Yeah. It's Dan Bergstrom for Matt Hedberg. Following up on Phil's question, just curious as how pricing is holding up in the core VM and then emerging products?

[Philippe F. Courtot:]

So pricing is holding very well. In fact, we have of course a long standing relationship with all of our customers. And we're winning a lot of deals. So I think there is – our competition in fact today hard essentially to compete with us against – on price and we're holding extremely well.

[Dan Bergstrom:]

Thanks. And then any changes in upsell trend this quarter. I know they're trending higher.

[Philippe F. Courtot:]

Same, same. We're doing – our business is not anymore as uniform as it used to be as I've mentioned earlier. So we do sometimes a very, very big upsell. And I speak about $0.5 million or $1 million upsell. So of course it's changing but upsells are generally speaking extremely strong. We see in adoption (25

[Dan Bergstrom:]

And then, Don, any large deals that came into the quarter much earlier or later than expected?

[Donald C. McCauley:]

No, we saw normal patterns this quarter.

[Dan Bergstrom:]

Thank you.

[Operator:]

Thank you. Our next question comes from the line of Michael Kim with Imperial Capital. Your line is open. Please go ahead.

[Michael Wonchoon Kim:]

Hi. Good afternoon, guys. Can you talk a little about the MSP channel? Are you starting to see some acceleration contribution from some of these partnerships and a little greater sales leverage? And do you see this going forward as an area where you anticipate expanding your focus?

[Philippe F. Courtot:]

Yeah, this has been a continuous trend. We have today quite a few MSSP partners. Today we can see now starting the Indian outsourcers, the HCL, Tata, Wipro, et cetera, are starting to bring business to us. So the trends have continued and again we're adding few more partners. Some are global; some are more local. So I think that the partnerships work very well because what we provide to our partners is the ability to essentially be in business without having any expenses really as long as they can immediately be capable of delivering Vulnerability Managed service, Policy Compliance services, web application security services and that's the very unique advantage that we have against the traditional enterprise software solutions where people have to be sold, they are not multi-tenants. But we still have a huge advantage here and are very natural fit for all these managed security service providers.

[Michael Wonchoon Kim:]

Great. And then just on Private Cloud Platform. Is this a deployment model that you're seeing preferred by the majority of the non-U.S. customers at this point and are you seeing more demand in the U.S. for Private Cloud?

[Philippe F. Courtot:]

So we are seeing more demand for the U.S. in Private Cloud with a very large organization, with the banks as we are now starting to get involved with them. We are also at the same time further virtualizing. I mentioned that we have been capable of totally virtualizing our platform which will deliver on the EC2 platform for Amazon themselves. So now we are essentially putting more efforts, so we could essentially distribute that platform, that Private Cloud Platform very easily. The Federal government is the natural customers for us in the U.S. and a very large company. We also have now our fully disconnected private cloud which we mentioned last quarter has been now delivered, accepted by Siemens, operational. And we are now focusing essentially now – with the Federal government where we are anticipating to (28

[Michael Wonchoon Kim:]

Great. Thank you very much.

[Operator:]

Our next question comes from the line of Rob Breza with Wunderlich Securities. Your line is open please go ahead.

[Rob Breza:]

Hi. Thanks for taking my questions. So just quickly, as you think about sales force and the capacity here and moving further out with the new additional products, do you feel like you're on pace with the added capacity given the dilution that comes from new products as existing sales force has to learn those products. How do you kind of balance that relative to your growth projections? Thanks.

[Philippe F. Courtot:]

Could you repeat the question? I'm not so sure that I understood the question.

[Rob Breza:]

The question is given the new product growth, how do you judge the capacity within the sales force to absorb the existing new products, maintain their focus on core VM and then yet drive 20% plus type growth for the industry?

[Philippe F. Courtot:]

Okay. Okay, very good question, thanks. So what we're doing is first of all what you have to understand is that what is again very unique with our model is that everything is centrally managed, everything is self updating. So you have all these different solutions out of the same platform. This is what (30

[Rob Breza:]

Thank you.

[Operator:]

Our next question comes from the line of Srini Nandury with Summit Research Partners. Your line is open please go ahead.

[Srini S. Nandury:]

Thank you Don and Philippe for taking my call. I appreciate this. I have a couple of questions on the guidance first and foremost thing, on the FX headwind seems to be pretty pronounced this quarter. Can you give us some color how much of a constant currency growth is for the next quarter?

[Donald C. McCauley:]

Well, the kind of headwinds we saw in the last quarter was about 1.7% on revenues and about 2.8% on deferred revenues. And in Q3 I think we expect a similar effect in Q3. And then it should just start to dissipate after that.

[Srini S. Nandury:]

Okay. I'm just trying to understand your – for modeling purposes on the AWS, you're assuming pretty much no revenue this year. Is that fair or is that – it looks like it's a little bit conservative?

[Philippe F. Courtot:]

What do you mean on the AWS?

[Srini S. Nandury:]

You guys are assuming no revenues from the AWS platform this year, is that what it is?

[Philippe F. Courtot:]

No, we are. No, no, no. With AWS, we have – Amazon is a Qualys customer. So it is of course big Qualys customer for their own needs. And then on the AWS platform, we have in fact – our customers are essentially for those who are using AWS. We have virtual images that also provides the scanning and the Vulnerability Management and the Web Application Scanning. So we don't today differentiate these revenues. They're essentially – it's another, if you prefer, (34

[Srini S. Nandury:]

Oh, I see, I see, okay, understood. Thank you so much for taking my call.

[Operator:]

Thank you. The next question comes from the line of Mike Cikos with Macquarie. Your line is open. Please go ahead. Mike Cikos - Macquarie Capital (USA), Inc. Hi, guys. I don't know if I missed it in your earlier comments regarding the sales reps. Typically, we get a number regarding how many new hires there have been or what's the total capacity at this point. Did you guys give us an update regarding the number of sales reps you finished the quarter with?

[Philippe F. Courtot:]

Nobody's given an update. So we finished the quarter, I think, at 139 people today, overall. Mike Cikos - Macquarie Capital (USA), Inc. Okay. And with the new sales reps that you are hiring or – has anything changed with the process, just regarding selling back into the existing customer base or where are the new hires going? Are they out hunting new customers or going back to the existing base and trying to up sell them with new solutions at this point?

[Philippe F. Courtot:]

It's a combination of both. We are expanding both our new business team, as well as our existing customer team because of course we are getting more and more customers and you need to service them. And as I'm sure you realize, serving a customer which is doing $1 million a year or $2 million a year, you don't need two people. So we have a significant leverage there with our renewal, as we call them, our renewal teams. Mike Cikos - Macquarie Capital (USA), Inc. Okay. And just one more question, if I could. Regarding the, call it, $0.05 of upside delivered in the second quarter. I was just interested in the EPS guidance that you guys maintain for full year. Just wondering where the incremental expenses will be coming in, in the second half?

[Philippe F. Courtot:]

That's essentially sales. We're expanding our sales force. And our product marketing team and our marketing efforts – we are essentially going to be much more active in turn with the new services as of course advertising them and doing some reach out campaigns so that's where the additional expenses are coming from. Mike Cikos - Macquarie Capital (USA), Inc. Okay. Thank you.

[Operator:]

Thank you. Our next question comes from the line of John Lucia with JMP Securities. Your line is open. Please go ahead.

[John A. Lucia:]

Hey, guys. Thanks for taking my questions. First question, you noted 60% of new customers have purchased more than one solution by the end of Q2. That's good when you compare it to the end of 2013 but that's only a 2% increase from 58% in Q1. A year ago I think the increases were more like 6% to 7% each quarter. So if you look at these metrics, it seems like cross-selling has slowed to a degree over the last six to nine months. My question is has the low hanging fruit been picked at this point and now cross-selling has become a little more difficult, or you're just going deeper with those existing customers? I just like to get more flavor on your expectations for cross-selling going forward?

[Philippe F. Courtot:]

No, I don't think this is – we see cross-selling still very strong. And in fact with all the new services that we're coming wtih, that will continue to increase. What is happening here, I believe, and that's something we may want to look into in more detail is because we have three businesses in Qualys. We have essentially the enterprise business. We have the mid-market business with Express as we call it. We have Qualys-centric product Qualys Express. And then we have Qualys SMB which is a company – a very small company. So there is much less upsell, if you prefer, in the SMB side of the market than there is of course in the large enterprise. So we have also the phenomena here of the mix of customers. And of course the larger customer base is more on the SMB side than it is on the enterprise. But on the enterprise side we are still very strong demand for most services.

[John A. Lucia:]

Okay. And then I have one follow-up. Last quarter, you guys talked about the VM business slowing to 19%. And it sounds like the growth remained at that level in Q2. Can we think of 19% as the new normal or would you expect the growth to decline or increase from these levels?

[Philippe F. Courtot:]

No, I personally believe that the the VM business is going to continue growing more. And this is because again as I mentioned earlier with our cloud agent, with our agents, with our cloud agents we can now go to the endpoint. And the endpoint is really where you have the volume. So this is where you have significant more endpoints that you have servers. And so we see today both for the VM and for the Policy Compliance we see that potential big lift from this cloud agent. Then again that's been very well accepted by our customers. And we see that these new services ramping up faster than we have ever seen in any new products.

[John A. Lucia:]

Okay, thank you.

[Operator:]

Thank you. I am showing no further questions at this time. I would like to turn the call back to Philippe Courtot for any further remarks.

[Philippe F. Courtot:]

Also, thank you, operator. Let me share with you another key milestone for Qualys. As I start speaking with you today from Black Hat, from the Black Hat conference in Las Vegas where we are launching and showcasing a revolutionary new service that we call Asset View that is IT and security teams real-time visibility and actionable data across millions of IT assets. And second, Asset View is based on our Cloud Agent Platform which was just discussed and we are providing it as a free service. So with Asset View, IT and security teams can deploy our Cloud Agent at low cost for doing assets inventory and to get a complete picture of the global IT assets and query them in real-time. In summary, with the launch of Asset View. IT and security teams can now answer the following question and on a global scale such as

[Operator:]

Ladies and gentlemen, thank you for participating in today's conference. This concludes today's program and you may all disconnect. Everyone have a great day.