Natasha Asar - Qualys, Inc. Philippe F. Courtot - Qualys, Inc. Melissa B. Fisher - Qualys, Inc..

Daniel Ives - Wedbush Securities Alex Henderson - Needham & Co. LLC Jackson E. Ader - JPMorgan Securities LLC Christopher Caleb Speros - Stifel, Nicolaus & Co., Inc. Erik Suppiger - JMP Securities LLC Howard S. Smith - First Analysis Securities Corp. Melissa Franchi - Morgan Stanley & Co. LLC Jonathan B. Ruykhaver - Robert W. Baird & Co. Patrick E.

Colville - Arete Research Services LLP.

Good day, everyone, and welcome to Qualys Third Quarter 2018 Earnings 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 Natasha Asar, Investor Relations. Please go ahead, ma'am..

Good afternoon and welcome to Qualys' third quarter 2018 earnings call. Joining me today to discuss our results are Philippe Courtot, our Chairman and CEO; and Melissa Fisher, our CFO.

Before we get started, I would like to remind you that our remarks today will include forward-looking statements that generally relate to future events or our future financial or operating performance. Actual results may differ materially from these statements.

Factors that could cause results to differ materially are set forth in today's press release and in our filings with the SEC, including our latest Form 10-Q and 10-K.

Any forward-looking statements that we make on this call are based on assumptions as of today and we undertake no obligation to update these statements as a result of new information or future events. During this call, we will present both GAAP and non-GAAP financial measures.

A reconciliation of GAAP to non-GAAP measures is included in today's earnings press release. As a reminder, the press release, prepared remarks and an accompanying investor presentation with supplemental information are available on our website. With that, I'd like to turn the call over to Philippe..

Thank you, Natasha, and welcome everyone to our Q3 earnings call. Melissa and I are pleased to report both continued revenue growth and profitability.

These results reflect our position as a leading cloud-based security and compliance platform unifying IT, security and compliance in a single-pane-of-glass view with two -second visibility across on-premises assets, endpoints, clouds and soon mobile, OT and IoT environments.

Such capabilities is the keystone of security as there is no security without visibility. To that effect, I invite all of you to watch a short video at www.qualys.com/visibility so you could experience it for yourself.

This unique competitive position was in fact reinforced when I met many of our European customers earlier in the month in Monaco at Les Assises de La Securite, the leading security conference in France.

They shared with me their view that they see Qualys as a strategic partner as they move to consolidate their current security and compliance stacks and accelerate their digital transformation in part because of GDPR as well as by the need to remain competitive.

As we continue delivering additional best-of-breed compliance and security solutions, application natively integrated within our Cloud Platform and expanding our offerings on public cloud platform such as Amazon AWS, Microsoft Azure, Google Cloud and soon IBM Security Connect, we believe that we naturally increase our stickiness and drastically reduce both cost and complexity for our customers.

This is underscored by the fact that we continue to innovate and deliver on our product roadmap.

And in Q3, we showcased the Passive Scanning Sensor, a new member of the Qualys sensor family that natively integrates network analysis functions, deep packet inspection and data correlation, into the Qualys Cloud Platform, delivering customers complete IT visibility at scale.

In combination with our existing data gathering sensors, specifically scanners and Cloud Agents, and our groundbreaking app for global IT Asset Inventory and CMDB synchronization, ITAM, these new capabilities enable us to offer our customers a single source of truth for all IT assets within hybrid environment, including on-premises assets, endpoints, clouds and soon again, mobile, OT and IoT environments.

And you will see that on the video I just mentioned. We now have more than 30 customers using our ITAM App for known assets in beta and expect to go GA in November. Our Passive Network Analysis for unknown assets will go into beta in November as well and is expected to go GA by year end.

We also announced a new Out-of-Band Configuration Assessment, Cloud App that allows customers to achieve complete visibility of all known IT infrastructure by pushing vulnerabilities and configuration data to the Qualys Cloud Platform from systems that are otherwise difficult or impossible to assess such as highly locked-down devices and on air-gapped networks.

Our expanded relationship with Microsoft and IBM are a testament to the tremendous value our Cloud Platform offers to customers.

This quarter, we added an integration into Microsoft's hybrid cloud, Azure Stack, which allows us to provide a single-pane view of the security and compliance posture of Microsoft Azure's infrastructure and user workloads, across Microsoft Azure as well as the Azure Stack.

We announced our release of monitoring and assessment for CIS, the Center for Internet Security, Inc., Microsoft Azure Foundation's Benchmark with our Cloud Security Assessment to enable our customers to build security into DevOps initiatives.

We also announced an expanded partnership with IBM whereby X-Force Red will deploy the Qualys Cloud Agent and Qualys Cloud Apps into client environments across the globe, providing a programmatic vulnerability management approach that leverages the breadth of Qualys' continuous visibility and the depth of the X-Force Red team to identify, prioritize and remediate clients' most critical vulnerability.

And finally, we were selected as a key partner for IBM's first open cloud platform, IBM Security Connect, to federate and analyze security data at scale. With IBM's open cloud platform, enterprises will be able to view their Qualys data across applications integrated with their network and other security solutions.

Adding to our product capabilities in October, we completed the acquisition of Layered Insight.

Layered Insight, based in the Bay Area, is a pioneer and global leader in container-native application protection, providing accurate insight into container images, adaptative analysis of running containers, and automated enforcement of the container environment.

By integrating Layered Insight's unique technology into the Qualys Container Security App will add the ability to provide dynamic analysis of running containers and automated enforcement of the container environment. Layered Insight's unique technology brings transparent orchestration to container security.

The ability to instrument images pushes automated deployment deep into the DevOps CI/CD pipeline, thus removing the resistance at deployment.

This instrumentation provides real-time visibility into containers at run-time, complementing our current capabilities of accessing container images in the build system for variabilities and configuration issues.

With this layered-in approach, there is no sidecar or privileged container needed by the solution, making it an ideal solution for Intelligent Edge and serverless Container-as-a-Service, CaaS, deployments like AWS Fargate, which are quickly becoming the future of containers like IaaS and PaaS quickly becoming the future of containers.

So, through the layered-in presence in the applications, the solution also provides protection, policy-based remediation and response capabilities that further simplify end-to-end container security. We expect quick integration into our Cloud Platform with general availability in Q2 2019.

In line with our accusations made to date, key employees have joined Qualys including Asif Awan as CTO of Container Security and John Kinsella as VP of Engineering, Container Security.

In summary, our acquisitions complement our organic innovation, expanding our Cloud Platform to provide more comprehensive security and compliance coverage on the application side, customer-owned web applications and providers-hosted SaaS web applications, and also providing visibility across all global IT assets including web applications, containers, APIs, OT, and IoT devices.

We continue to make good progress in penetrating the federal market. We were delighted to win a large multi-product deployment with DHS which was a competitive displacement. DHS has licensed Qualys' platform in support of the National Cybersecurity Assessment and Technical Services, NCATS, mission.

Qualys will be used in the DHS initiatives for protecting critical infrastructure and election security. Additionally, Cindy Stanton joined as VP of Product Marketing for both public sectors and cloud providers.

Cindy previously worked at Alert Logic and Verizon Business, and will leverage her experience to develop programs supporting federal agencies on their digital transformation and cloud security initiatives. Additionally, we continue to leverage the Cloud Platform as a distribution channel.

We announced the new comprehensive offering for consultants, consulting organizations and managed service providers, the Qualys Consulting Edition, enabling them to perform multiple ongoing vulnerability assessment, engagements and track these results from a single centralized and self-updating platform.

And we have seen a great response to the release of CloudView, CertView and the Qualys Community Edition, a successful lead-generation effort which serves to distribute our Qualys Cloud Platform to more users from which we can sell many additional solutions.

We have over 12,000 activations now, out of which almost 6,000 active users already, which is significant growth from the over 6,500 activations and 700 users we had at the end of Q2 2018. We're excited to host our customers and partners at our upcoming QSC user conference in Las Vegas on November 14 and 15.

We expect this user conference to be significant for our company as we believe that it will be evident that we have moved well beyond vulnerability management and, in fact, are bringing IT, security and compliance together across environments, drastically reducing the cost of deploying and maintaining traditional enterprise solutions and this is due to our cloud architecture.

At the conference, our Chief Product Officer, Sumedh Thakar, will showcase our new groundbreaking Global IT Asset Inventory solution, which again you can now preview at www.qualys.com/visibility.

And this is a solution which is always up to date with two-way synchronization with CMDBs and enables optimizations to regain full visibility across their on-premise, cloud, mobile, OT and IoT environments.

We will also showcase our new customizable dashboard that provides real-time analysis of your security and compliance posture in a single-pane view that identify in seconds assets that vulnerable to zero-day attacks or that has been compromised or are suspicious.

Finally, among other innovative solutions, we will also unveil and discuss our forthcoming patch management and mitigation solutions, a novel approach to container security, which I've mentioned earlier and how Qualys can help build security into your DevOps and digital transformation initiatives.

At the conference, our attendees will also have the opportunity to discuss and listen to customers which will share their experience and best practices. And you are, of course, welcome to attend that conference, which we combined with an Investor Day, and I will make some mention later on.

So, we are hosting a dedicated track for this community on November 15, which will include a demonstration of our newest application in the platform by our Chief Product Officer, Sumedh Thakar, a financial update by our Chief Financial Officer, Melissa Fisher, customer speakers and industry analysts.

Before I turn the call over to Melissa to discuss our financial results, I would like to welcome Patricia Hatter to our board. Patty brings unique experience as both buyer and seller of security and IT solutions, given her prior roles as both the CIO and SVP of Operations at McAfee, as well as the SVP of Services.

In addition, she also served as GM of Security & Software IT and CIO for Intel Security, and has also held a variety of leadership roles at Cisco and AT&T.

As we continue to expand the breadth of applications unifying IT, security and compliance, we expect to leverage her expertise as we increasingly sell our integrated Cloud Platform to CIOs and CISOs..

Thanks, Philippe and good afternoon. Before I start, I'd like to note that except for revenue, all financial figures are non-GAAP unless stated otherwise. As Philippe mentioned, our continued healthy financial results reflect our strong competitive position and continued platform adoption.

I'd like to share the following Q3 financial and operational highlights. Revenues for the third quarter of 2018 were $71.7 million which represents 20.5% growth over the same quarter last year.

Platform adoption continues to increase as a percentage of enterprise customers with three or more Qualys solutions rose to 39% this quarter, up from 30% a year ago, and the percentage of enterprise customers with four or more Qualys solutions rose to 20% this quarter, up from 14% a year ago.

Cloud Agent adoption accelerated with $13.9 million Cloud Agents purchased over the last 12 months, up from $8.1 million for the 12 months ending in Q2. Approximately, $5 million Cloud Agents were purchased by a Cloud Platform customer.

New products released since 2015 contributed approximately 23% of total bookings in the quarter, up from 14% in Q3 2017, driven by solid growth from both Cloud Agent and Threat Protection bookings. And we saw higher growth in the total number of orders from our SMB, SME and PCI customers.

This positive result did pull our historical year-over-year average deal size increase down to 5%. However, the average deal size for our enterprise customers grew 12% year-over-year. Our scalable model continues to drive industry-leading margins and generate significant cash flow.

We now expect full-year operating margins to increase approximately 250 basis points. Adjusted EBITDA for the third quarter of 2018 was $31.9 million, representing a 45% margin as compared to 40% for the same quarter last year.

For comparability purposes, Q3 adjusted EBITDA margin would still be 44% normalized for the impact of ASC 606, specifically the amortization of commissions. In addition to the efficiencies inherent in our highly profitable operational model, this quarter our R&D expense benefited from a catch-up in software capitalization.

Adjusted for this effect, R&D expense would have sequentially grown as we continue to invest in research and development, and in fact are delighted with our successful recruitment efforts in Pune. We generated strong operating cash flow for the third quarter of 2018 of $31.6 million, a slight decline of 4% year-over-year.

However year-to-date, cash flow has increased 21% versus the same period last year. We continue to invest the cash we generate from operations back into Qualys. In Q3, we spent $6.7 million on capital expenditures, including principal payments under capital lease obligations, and we used $27.2 million to repurchase 310,815 of our shares.

We remain confident in our financial model due to our strong competitive position and leading Cloud platform. As such, our board of directors has authorized an additional $100 million two-year open market share repurchase program, resulting in $153.5 million of current repurchase capacity.

This program will continue to minimize dilution to our shareholders. We have a strong current deferred revenue balance of $155.1 million as of September 30, 2018, 17% greater than the year ago. Current billings in Q3 were $75.4 million or 13% greater than a year ago.

Our Q3 current billings growth rate was negatively impacted by a large deal that we expect to close in Q4. Our business outlook remains healthy and we are maintaining the top end of our full-year 2018 revenue guidance, now in a range of $278.4 million to $279.2 million.

As we have consistently communicated, we do not manage to quarterly billings and are focused on the long-term growth of our business. We are also raising fiscal year 2018 non-GAAP EPS guidance to a range of $1.62 to $1.64. And for the fourth quarter, we expect capital expenditures to be in the range of $7.5 million to $8.5 million.

We feel very well-positioned given the unique nature of our integrated IT, security and compliance Cloud Platform as well as our new groundbreaking applications which you will see at QSC. With that, Philippe and I would be happy to answer any of your questions..

Our first question or comment comes from the line of Daniel Ives from Wedbush. Your line is open..

Thank you. So, my question is in regards to obviously you guys look like you are in position of strength going into to year end.

How are you in terms of thinking about things from an M&A perspective over the next year versus organic from a product perspective?.

So, this is Philippe. So, we continue on the same strategy.

If you recall, our strategy in term of M&A has been that we are – first of all, we wanted to really complete our Cloud Platform enough, so we could easily or more easily integrate additional technology, and what has been guiding us is identifying technology which either will accelerate the current engineering developments that we have or will accelerate our entrance into new markets.

And as you have seen, this is exactly what essentially that recent acquisition as – the two previous one as well as the acquisition now of Layered Insight, which allows us to move much, much faster into the very hot market which is container security.

So this being said, to answer your question, we believe that in 2019, it will be absolutely the same. We see quite significant opportunities today.

We've been, as I was mentioning earlier, very prudent in how much money do we pay because we see there has been an inflation fundamentally, far too much money being poured by the VCs into our space, we believe. I think the industry is entering into a consolidation phase, so we see a lot of opportunities.

So, we have the advantage of having a platform which will allow us to integrate more solutions pretty easily. And second, I mean, we have the cash as well. So, I think we're in a very good position. But, again, we're prudent. This is very deliberate. I used to say work is singular front (22:35).

And we see a good outlook for 2019 in terms of doing a few additional acquisitions..

Okay. And then, let me hear from Melissa. I mean look, expense controls is just phenomenal. I mean, especially relative to competitors, the way that they're spending. How – when you think about just kind of putting the pedal on the metal to just sales and marketing and R&D, especially just some of your big opportunities out there over the coming year.

Maybe if you could just – I know you're not giving guidance for 2019, would you anecdotally talk about that balance and how you're able to do that, especially with competitors spending money pretty significantly?.

Yes. Thanks, Dan. So first of all, we're obviously proud of our industry-leading margins but we feel like we are actually putting in significant efforts behind both those areas. To clarify or maybe repeat, as I mentioned, the R&D this quarter was sort of artificially depressed by this catch-up in software capitalization.

So as I said, we continue to invest in R&D and if we didn't have this catch-up this quarter, it actually would have sequentially grown. Sales and marketing is obviously just from a comps perspective impacted by ASC 606. So we continue to spend there.

Q4 is a big quarter for us in terms of sales and marketing because we have our annual user conference, and we continue to anticipate that we would continue to invest in 2019 as well..

Yes, and I'll probably add something. One thing which I think is very important here to understand, at the end of the day, it's the moderate stupid (24:22) fundamentally.

If you look at the way we have structured the company, we are totally cloud based since the very beginning and we understood that as long -- if you can have your customers renewing, you can live forever and if you can sell them additional services, you can grow forever, in a way and certainly more profitably than if you sell them enterprise software solutions.

So that has been the core – that's the core reason. Now, we have expanded our capability, again thanks to the platform, to continue having very low acquisition cost of customers through the free services that I just mentioned earlier. So, it doesn't cost us much to distribute a free service across the planet.

And of course, from there, the platform is already now in use and then we can upsell additional services to these customers that we essentially got through these free services. So the combination of sales and free services really help us to continue essentially maintain such a profitable model. It's all about the architecture of the model..

Awesome. Okay, congrats. Just a great quarter. Thanks..

Thank you..

Thanks, Dan..

Thank you. Our next question or comment comes from the line of Alex Henderson from Needham. Your line is open..

Thanks. I was hoping you could give us a little bit of sense of sale on the acquisition, what is the size of the nut that you're bringing in, in terms of cost? I assume that there's not much of any revenues attached to it. And on the R&D catch-up, it looks like that's a pretty good nut.

If I were to take the 2Q number on R&D and grow at 2% or 3% sequentially, is that the right way to think about where you'd be in the fourth quarter, if it wasn't for that? So in other words, $200,000 to $300,000 -- $400,000 versus 2Q?.

Yes. So, let me take the last question first. So on a non-GAAP basis, it's about $700,000. So I'll just give you the numbers, so you can do that for the modeling. And then obviously as I mentioned, that was a catch-up for the first three quarters, so that amount wouldn't continue going forward.

With regards to Layered Insight, I'll talk a little bit about the financials and then Philippe probably might want to add some color around the strategic nature because we feel like this acquisition is really – puts us at the forefront of container security when combined with our existing solution.

In terms of transaction details, so from an expense perspective, it's really not going to be material relative to our overall expense structure. The expenses for Q4 is baked into our guidance. The transaction price is $12 million.

And there's another $4 million paid -- tied to an earn-out another $4 million pay tied to employment of key employees through 2019..

Yes. And I will add to what Melissa said that they have a quite impressive, albeit small, numbers of customers like GE and you may have seen on the press release, a quote from GE, and a few others and they are very good prospect.

And in fact, I would say that three quarters of their customers are already Qualys customers, would always come to the fact that now we combine the superior – if you prefer assessment technology that Qualys has with their very unique architecture to be specific and that's what attracted this to us, brilliant team of people, small but absolutely brilliant.

They know what they're doing, and they have built really the right architecture for container security or for containers.

Instead of having a container managing other containers and as you know containers are ephemeral and the drift, they essentially have built a similar architecture to the one that we have, which is a kind of a sort of an agent that goes into the containers and that gives significant scalability, plus an enforcement point.

And so now, you can really start to speak about application protection and so forth and runtime. All that is real-time. So this – our two solution combines, it's a very, very powerful solution. And I'm sure we all know now containers are really taking the world by storm. This is a very strategic acquisition that we have made..

If I could, just one last quick question. The growth rate for the fourth quarter is kind of edged back under 20% after four quarters of pushing it over 20%.

And I was wondering if you could just give us a little bit of granularity around why that might be decelerating sequentially or year-over-year in that fourth quarter?.

Yes. So, Alex, we have a very healthy business. And Alex, as we mentioned earlier, if you remember, from a comparable perspective, we have tougher comps in the second half than the first half and actually in Q4 even more than Q3. So, the year ago growth number was 20% in Q4 versus 17% in Q3. So, that's what is impacting the growth rate..

Okay. Thank you..

Thank you. Our next question or comment from the line of Sterling Auty from JPMorgan. Your line is open..

Great. Thank you. Good evening, guys. This is actually Jackson Ader on for Sterling tonight..

Hi, Jackson..

And our question really revolves around the federal space. You guys have made it clear in a number of initiatives that you're going to try and head into the federal space outside of, Philippe, the large deals that you mentioned with DHS.

How would you say that that progress is tracking relative to your internal plans?.

Oh, I think we are absolutely delighted. As you know, we've been patient which is the one of the traits of Qualys, before deciding to finally enter the market because we thought the marketplace – we knew the marketplace was not ready for cloud. Now it is. So I think we are externally well positioned.

I mentioned that having DHS as our customers, now having selecting us and it was a competitive displacement. What they do appreciate here is the scale of Qualys, the quality, the fact that we deploy. And when you look at the federal market, it's -- of course it's absolutely all about scale. And today, of course, scale and cost.

So we have now – we have the scale. And I believe we're going to really become a significant -- a significant player in the federal space. This being said, it always takes time in the federal market because of the procurement. We established a very strong relationship with Calsoft, which is the premier distributor.

So while putting all the pieces together, we attracted Cindy Stanton, which now is essentially our VP of Product Marketing for Federal. So we are starting a lot of new initiatives. So, we are very, very happy, in fact with our presence at the federal market which we have done and there's more to come.

So – but is going to take time, so we don't anticipate significant revenues in 2019. As you know, our model, we take the revenue as we deliver the service. The orders in federal have more tendency to come around at the end of the fiscal year or the beginning of the other one. So in term of revenues, it is going to – this would be more in 2020.

However, we anticipate to have more in road in that marketplace which we would be very happy to report..

Sure. Okay. Understood. And then a quick follow-up, Melissa, on the CapEx side.

Anything to call out here in the fourth quarter, reason why CapEx is expected to pop up a little bit?.

Yes, it's really just a timing issue. We had expensed more in Q3 that didn't actually get paid, so it doesn't show up as CapEx in the cash flow statement until we get paid in Q4, which then shows up on the cash flow statement then. But we're still on track for – we had shared our full-year guidance CapEx of $28 million to $29 million..

All right. Thank you..

Thank you. Our next question or comment comes from the line of Gur Talpaz from Stifel. Your line is open..

Hi this is Chris Speros actually on for Gur.

I know they're still in beta, but can you talk about the initial feedback that you've received from customers concerning both the passive scanning tool and the asset inventory product?.

So this is a huge, huge positive response. In fact, this is absolutely a game changer. So you understand this is not something we've just been working recently. In fact, we saw the opportunity about 10 years ago. This is when we saw Goldman Sachs using the result of our scans to audit their CMDB, which was Tivoli.

But it took for us not only mastering that scan, but then the agent technology which give us the real time and absolutely the full inventory of everything that we – that the device has. Now, today, the missing piece was the passive scanning.

So today, we have essentially more than 30 beta users of one part which is the known asset, which is going to go GA in a couple of weeks. So now today, every word you can put to our agent, you have the complete view of your asset inventory in real-time essentially.

You synchronize that two ways with the CMDBs, and now today we're entering beta for the passive scanning which essentially will give us the unknown.

And so that's anything which connect to the network and you will see -- I always -- I encourage you to look at that video that we just published, that's again at www.qualys.com/visibility, log in to see the passive scanning discovering unknown devices and then we fingerprint them.

So essentially that's another huge task that we have undertaken, which is to fingerprinting all the devices on the planet, very similar to what Google did with their cars for essentially mapping the streets. So here we are mapping all these devices. And of course, we use to do that with machine learning.

So we have already a huge effort which has been undertaking. So when you combine all that together, we provide now the source of truth and what's very unique again with Qualys, it's not only on a few devices on your endpoint, it's on all of your on-premise servers, et cetera.

It's on your endpoint, it's on your cloud environment, on your containers, on your web application security. Early next year, with the mobile, with the launch of our mobile agent technology that we acquired from 1Mobility and during next year, it will be more and more OT and IT devices.

And all of that, we have the platform, we have index because of course you want to be able to analyze, correlate and, of course, report almost instantly. So we have now today indexed more than 620 billion data points on our elastic search clusters. We anticipate that, by year-end, we'll have essentially indexed close to 1 trillion.

So this is really heavy lifting and, again, it took us 10 years to get there. So we're very excited and so are our customers..

Great. And thanks for the color there. Multi-product customer growth was impressive in the quarter.

Are customers more willing to adopt multiple products at the initial point of sale or is this growth being sourced primarily from add-on sales?.

It's both, but I would say that, in general, we do see new customers taking on multiple products and initially more than we had historically..

Yes. And we believe also that the other interesting part with that global IT asset inventory is that this is also going to be, as I'm sure you realize, a kind of Trojan horse strategy to have our agent being everywhere.

And once we have our agent, of course, there is significantly additional services like file integrity monitoring, detection of indication of compromises, et cetera, that we can absolutely now deliver almost instantly. And that's again, the power of our platform.

So we see that ability to further penetrate with the agent, in the cloud, and as part of inventory. We're really building the nervous system, if you prefer. And the beauty of our solution is that, we help our customers and that's something that very few companies can do. And I would make another very important point after that.

We can help them consolidate the stack of their current solution, which are becoming very costly and almost ineffective. And so, that's one good thing for them. But also help them essentially build the security into the digital transformation.

So what we see today is that we're also moving into a new model of selling, and very few companies, I believe, can do at the same time an architectural change, so moving from an enterprise software solution to a cloud-based solution, but also doing a business model change.

We see today the Amazon, the Azure becoming extremely powerful platforms, essentially frictionless delivery of IT solutions. So we are very easily embedding our solution into them. So while envisioning an environment where you essentially will not even need that much sales people.

What you would need is people to essentially onboard to make sure that absolutely everything works; the customers understand what needs to be done. So I don't see our self increasing our sales force significantly with what I call these management sales guys, which cost you a fortune, enhance elephant.

It's all about frictionless, and I think we have the right platform, the right architecture, the right business model, the right sales force. This is a question that people say you're not spending enough in sales. No, it's all about essentially building, if you prefer, the new delivery model.

And that's, by the way, exactly what Amazon has done, when you look on the physical work, where they do essentially the procurement, the fulfillment, they deliver, they invoice you, et cetera. You put your goods on Amazon and so (39:31) they distribute that very effectively.

That's the way IT is going, which of course is not good news for a lot of companies, but I think is very good news for Qualys..

Great. Thanks for the color. Appreciate it..

Thank you. Our next question or comment comes from the line of Erik Suppiger from JMP Securities. Your line is open..

Thanks for taking the question. The Cloud Agent, I think you said that you had a service provider that took 5 million units, is that right? Can you talk a little bit about that deal? And then if we exclude that deal, I think you added about 800,000, which I think is consistent with the prior quarter.

Is that kind of the range that we could think of in terms of ongoing unit volumes on a quarterly basis?.

Yes, it's very difficult to predict. What you see here is the fact that now our agent is starting to be really adapted more and more into the cloud.

In fact, our agent is the ideal solutions to give you the global IT asset inventory wherever you can put the agent, but also it goes into the cloud and that's the beauty of our solution; it's a very, very small agent. So, you could see that adoption of our agents into this cloud environment and that's what it is.

So we're anticipating of course that we'll see more of those. So you have two dynamics here. One is the growth in the enterprise, if you prefer, moving more and more into the endpoint, and then you have the other dynamic, which is now cloud – the cloud.

And so, it's hard for us to give you any kind of – hard to model at this stage because you have two different dynamics here..

Okay. And then Melissa, you had talked about billings being depressed in the third quarter because you had a deal that slipped into Q4.

Can you give us a sense for what we might think of in terms of billings in Q4?.

Well, it obviously was meaningful, that's why we called it out. But I think I would point you back to our earlier remarks, so we have a healthy business and that's reflected by the fact that our full year revenue guidance is 21% for the year. And to what we talked about earlier, we have strong Cloud Agent adoption as well as multi-product adoption..

Yes, and I would add one thing also on the billings is that again aligned to what I mentioned earlier that now the cloud is really moving. So what we see also is that all these new cloud deals, if you prefer, that we are doing now are more moving into a consumption based model by the hour, by the node, monthly billings type.

So we see again that it doesn't change the revenues. Again, that's the beauty of our being 100% subscription based. But it does affect our billing. So we start to see looking forward that we're going to start to see these kind of a new consumption based model as you may know. Amazon is really pushing that very hard.

So all these cloud providers are going now into an hourly model or node per hour. And of course we are following that very naturally and that's the reason why I made the comment earlier that, unlike other companies, for us it doesn't change anything because it just affects the billings, it doesn't affect the revenues that much.

So we're in a very good position to do that business model change as well..

Right, and that's – as Philippe said, that's why billings would become even less relevant for us and why we still were able to outperform on revenues despite the lower billings growth rate because we're focused on managing revenues..

Okay.

When providers move more towards a consumption based model, does that change size of the deal opportunities to those providers?.

It will, because it's all about commercialization of the entire IT sector if you prefer. So yes, it will affect. However you're discussing here of again significantly less cost. In fact, you just have to be a little bit more – while building today an additional sales force as we speak, which essentially will not be customer based.

And the analogy that I give here is, when you look today when you go and buy and you go to an Apple store, you don't have a sales person there. Somebody is commissioned, you have a technical person which will inform you. And that's I think the way our entire industry is going. Everything being what we call transparent orchestration.

We've demonstrated that with Microsoft where you click, click, click. You don't have to install anything. It's already there. And then essentially what do you need in terms of the sales force, you need somebody to essentially onboard the customer, answer technical question and that's a sales force which is significantly less expensive.

And then by the way these new platforms, they do the invoicing, they do the – everything is already pre-fulfilled if you prefer. So you have significant velocity acceleration. So, while the price will go down, you have absolutely significantly more volume that you generate. And that's the way that technology has always done.

Remember the old good days of the PCs, which really make Microsoft extremely profitable. And for a long time because of course the PCs had more volume at a lower price but yet very profitable..

Very good. Thank you..

Thank you. Our next question or comment comes from the line of Howard Smith from First Analysis. Your line is open..

Yes. Thank you. Congratulations on continued solid results..

Thank you..

The first question has to do with kind of the CloudView, CertView community addition, the numbers you put out, it's clearly having the impact of getting people's attention and getting them to sign up.

Can you maybe qualitatively talk about the early signs of people actually becoming part of the ecosystem with other products through that lead gen effort?.

So we – no, it's a very good success everywhere. We are not publishing today much numbers about that. This is a culture relatively new for us. But what I can tell you is that we have been extremely surprised by the number of activations.

And so now it's also our challenge and that's why we're building that sales force as alluded to essentially onboard them, making sure that they use the service. And then at the appropriate time, because all these additional services are in the platform, you now start to upsell them.

But in that order, we are not here to interrupt the customers and try to immediately send them all the salespeople to upsell. We want them to be satisfied, they do what they need to do. And then of course, at their own rhythm, they can adopt all the new services which are already in the platform.

So we're putting a big effort today to essentially manage all of that and essentially building that new sales force I just talked about. And then in that case of course, we'll have -we believe we even would have additional – in fact, accelerated adoption. But we're very happy.

I mean this is absolutely -- again the cost of delivering these free services is absolutely nothing, it's pure engineers which have been the product. And of course we can disseminate that across the globe. So that's a very effective model..

Yes. And just following up on that effective and leverage on the sales and marketing, you talked about hiring some R&D folks and impact of the software amortization.

But on sales and marketing, are you on pace with your staffing levels kind of the budget at this point in the year?.

Yes. So we are very well in Europe, I think very happy with the European operation in sort of both the post-sales and the pre-sales. In the U.S., we are very good on the post-sales. We are looking at expanding our new business, if you prefer, teams. In fact, I mean the process of hiring an EVP for the Americas to essentially start selling.

And that's the purpose of that expanding our new business, selling to the CIO. With again, with that global IT asset inventory that now you can look for yourself. It takes you through a 13-minute video. You're going to be floored, when you look at what we have done here. This is all real, this is not mockups.

This is absolutely production grade, the solution. And then, now we can go and speak with the CIO, and essentially this is going to be the mission of our new sales force, of our new business sales force, and we're expanding it mainly in the U.S. because of course the marketplace is bigger. And in Europe, we're already essentially done.

We did also another change in our post-sales, if you prefer, model which was – so our customers are very happy. Now that we have very large customers, so we have now created kind of a slightly change in our technical account managers as we call them.

So we have created a new category, what we call Major Account Solution Architect, which now handle a few very large accounts, and these are accounts which are becoming multimillion dollar accounts. We see also we're becoming very strategic for them.

We see also the demand from these larger accounts who say we would like to take all of your applications. Give us – let's do a three, five year contract and we like for a fixed price to be able to deploy essentially all of your solutions.

And so, our answer to that demand has been, let's do the global IT asset inventory because when we do the global IT asset inventory, you will know exactly what you have. And then we can talk about deployment, about these and come up with a good business decision about okay you don't want to buy one product at a time.

You're standardized on our platform, so let's get a bigger deal..

That's great color and just real quick for Melissa.

Is there any FX impact that you would call out that's materially affecting kind of growth rates sequentially or year-over-year?.

No, nothing material..

Okay thanks..

We're also starting to look at hedging as well because again our model is the ideal model to hedge. So this is something we have not been doing in the past but now today Melissa is really looking seriously at that, which we'll never eliminate completely but at least would soften. And so that's something which we're going to be able to do very soon..

Great. Thank you..

Thank you. Our next question or comment comes from the line of Melissa Franchi from Morgan Stanley. Your line is open..

Okay. Thanks for taking my question. I wanted to follow up on the commentary on the billings slowdown. So I appreciate that it's becoming maybe less relevant as you're going to more pay as you go.

But if we think about the impact from the deal slippage and then the move to pay as you go, can you maybe parse out the magnitude of those two headwinds in the given quarter? If we look at 20% current billings growth in Q2 versus 13% this quarter, what were kind of – what were those impacts, to what degree were those impacts driving that slowdown?.

In fact, if you just -- when we mention, when we say that we do not manage the billings, essentially we don't fall on the trough of enterprise software which is at the end of the quarter, let's get the deal within the quarter and against concessions, pricing concession. We have always refused to do that.

And what happens then is that we could have sometimes some of these orders, instead of coming at the end of the quarter, okay, they come a little bit later because the procurement people are busy trying to take their pound of flesh on these enterprise software vendors. And so of course we don't have the priority.

And so you're speaking only of a few days or maybe a few weeks but not much. So it doesn't have a significant impact on the revenue side. As of course maybe a few days here and there, but it's not that significant in the grand scheme of things. And that has been our strategy since day one and we're being absolutely firm and solid.

We do not incentivize our sales force to precisely do that. Well, of course other companies do exactly the opposite and that's not the way we do it. So in terms of now the impact on the monthly billing, so this is – this is something which is new. Today is not really material at all and – but I – we see it coming.

The good news is that we believe again, because we become a consolidator on the enterprise, we see our traditional enterprise business becoming stronger and stronger and stronger in the next, if you prefer, few years, as we are now migrating into that new model.

So I don't think overall we're going to see much significant impact again on the revenues and we'll start to see the billings being again not on the quarterly basis, if you prefer, not meaningful as much as of course as they could be with other models.

Does that make sense?.

Yes, that's fair enough.

Just one follow-up question on the channel contribution, so the channel stays relatively stable at about 40% of the business and I'm just wondering if it's a priority to move this higher or are you comfortable with your channel relationships and the contribution that you have today?.

A very good question. No, we love in fact we're becoming significantly – the relationship with the channel, they love us. In the past, the channel they didn't like us because as you already know, you're just essentially competing against us because of course it's less professional services, less installation, today's exactly the opposite.

So we have a very good relationship with them. The reason why our channel business in dollars is not growing as significantly is because of the huge upsell that we do with our direct business and that compensate.

But if we look now in terms of the new business coming into Qualys, we could say that we could see that more of the new business is now coming from the channels. And so that's – but overall when you look at the dollars, it's not that significant.

At some point in time, we'll establish more and more relationship, we'll develop very strong relationship with IBM and others. We could see them starting to sell wonderful relationship with SecureWorks, or the PWCs, et cetera, the Accentures, all the Indian outsourcers do have absolutely fantastic channels.

And so the business of course – and we are there. And again, we are very differentiated because we don't do professional services, zero. And so we don't compete against our channel and it depends on the customers if they want to really come direct to Qualys or they want – they prefer to go to a partner. This is their decision; it's not ours.

Historically speaking, I've been there before. I've realized that typically you get about 25% of the enterprise market who absolutely wants to have a direct relationship, so you could say ultimately the model will go to a 25% direct and 75% channel. Then again, we let that happen. We don't push one solution versus the other one.

We just let life live, as I used to say..

Okay, sounds good. Thank you very much..

Thank you. Our next question or comment comes from the line of Jonathan Ruykhaver from RW Baird. Your line is open..

Good afternoon, Philippe and Melissa. Philippe, over the last year, you've expressed confidence around the opportunity with the endpoint agent, yet, it does sound like that adoption continues to be sluggish.

Can you just talk about some of the issues you're seeing around that opportunity and why adoption hasn't been stronger?.

First of all, I will not say sluggish at all..

Yes..

We have some fantastic deployments, 250,000 agents – 200,000 agents at the endpoints.

However, this being said, what makes that penetration essentially not as fast as I would like to, but we're also very confident that will accelerate, is the fact that today if you look at the poor companies, there have like nine agents on their endpoints; it's absolutely crazy.

And then you have of course ITs are not very inclined at putting another agent. That's what we believe that the global IT asset inventory is going to be absolutely a game changer because that's – who is the beneficiary of that? IT being the first one.

Security, of course, is a very beneficiary of that because, again, you cannot secure what you don't know. That's the big secret in our industry where we're putting a lot of things to try to protect. But if you don't know what you protect, you don't have very good effective defenses. So I think that will really help us continuing that penetration.

So I will not say sluggish. I would say it's a penetration. And again, we don't really push. We let things happen, but we're very happy with our progression on to the endpoint. And I think what is going to be another game changer is the – is essentially is the – is our mobile agent.

Why? Because we see a lot of our customers, we look at all the banks and all of these kind of tablets, et cetera, where they really, really need an agent. So that also will make our agent technology, if you prefer, becoming more pervasive. And that's essentially our strategy. I've done in my life five times ubiquity and that's what I believe today.

We are at the point that now, today, with a new class of agents, combined with the passive scanning that global IT asset inventory that now, we have what it means – what we need to really reach ubiquity. And that's really what I'm really pushing absolutely now. And again, I've done that four or five times, I don't even count anymore in my life..

I appreciate that color, Philippe. Impressive, the uptick in terms of new product contribution to bookings.

Can you talk about specific products driving that higher, especially maybe with some notable success if you're seeing it with products that may have been released more recently?.

So the number one still driver is the agent. That's the big one. However, this being said, we start to see the File Integrity Monitoring picking up, ThreatPROTECT. It's a very natural addition as well. So these are the one that we see. I'm absolutely convinced that we're going to see a significant adoption.

We have already quite a big adoption of our synchronization with ServiceNow and its coming, as well of course with the iTime (59:29) inventory, with the inventory behind, this is going to really make a lot of sense. So that I believe is going to be hot. Container security is absolutely crazy.

I mean there are (59:40) containers are changing the world and I think we're uniquely positioned today, so already our Container Security solution is moving. And I think with the addition of Layered Insight, we have another game changer here in Container Security. So this is going to be very hot. Our Web Application Scanning is doing well.

Still we are not having much traction with our web application firewall, which we should have now containerized because one of the issue is the deployment of it. So that's what limits – that's the resistance of the deployment; it's the fact that you've got to install it behind the load balances. It's a little bit complicated.

But I think once we containerize it, and that should come pretty soon, I think we'll have now the really good solution for web application security..

Great. Thank you very much..

Thank you. Our next question or comment comes from the line of Patrick Colville from Arete Research. Your line is open..

Hey, there. Thanks for taking my question. Can you just give me a bit more color on this 5 million agents which are purchased by a service provider? Just any context you could provide would be very useful..

It's difficult to give you any context here. This is a major cloud provider and – cloud platform, I should say. This is PaaS, not a cloud provider, it's a PaaS; it's a Platform as a Service. And so they are deploying more of Qualys and we expect they are going to deploy even more and the other ones as well.

But, as you know, they are not typically inclined to tell the world what they do. So we cannot unfortunately speak too much about..

Yes. We obviously see it as a testament, their investment with us, and using our Cloud Agent as significant which is why we wanted to call it out..

Yes, understood.

And then can I just ask about the competition? Just how you see trends with Tenable and Rapid7, please?.

Yes. So, those things very clear. Tenable, as you can see, they have very good growth. We don't see – it's like we are in different universe, fundamentally.

We are now starting to go into their universe with our Community Edition, with a new packaging that we did for consulting and starting to essentially compete against them there and in federal as well. So it's almost like we are in different universe, not really competing against each other.

So we're move now – we are looking at moving into their space. Now, as far as Rapid7 is concerned, it's like they have moved away. In a way, we always have competed with them in the midrange and then they have, essentially today, they are more into the Splunk turf trying to essentially provide more the analytics and kind of a platform.

So we still see them in the midmarket and we compete very effectively against them. They have also kind of a managed security service with them; they don't compete against us, but against our partners. So they are there. But I think we believe that as we continue delivering, especially that global IT asset inventory as a game changer.

And at the user conference, and I hope you could come, we're going to also unveil another major initiative that we're undergoing, that would speak essentially more to our customers and trying to make it that public. But essentially, embark our customers, which is always what Qualys has done, into a new adventure.

So now, today our big adventure, we took 10 years to get there with the global IT asset inventory. We're now moving into another big adventure continually pushing the boundaries of our platform..

Thank you so much..

Thank you..

Thank you. I'm showing no additional audio questions in the queue at this time. I would like to turn the conference back over to management for any closing remarks..

Okay. So thank you very much and thank you to you all for all these very good questions. So I would like again to encourage you to really listen to that video which takes, I think is about 13 minutes. You don't have to listen to the entire 13 minutes to get a gist of it. I think you will get that pretty quickly.

And also, I really would like to invite you again to our User Conference and Investor Day where you can speak with our customers. You're going to see a lot of the thing and really would give you the sense that really will be the true platform, that platform is really shaping up extremely well. So you could see that again for yourself.

So I hope to see you there. And again, thank you very much for your time and for your questions..

Ladies and gentlemen, thank you for participating in today's conference. This concludes the program. You may now disconnect. Everyone, have a wonderful day..