Good day, everyone and welcome to the Qualys Third Quarter 2019 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 Vinayak Rao, Vice President, Corporate Development and Investor Relations. Please go ahead, sir..

Good afternoon and welcome to Qualys’ third quarter 2019 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, investor presentation, and supplemental historical financial spreadsheet are available on our website. With that, I’d like to turn the call over to Philippe..

Thank you very much Vinay and welcome everyone to our Q3 earnings call. Melissa and I are pleased to report another solid quarter in terms of revenue growth and profitability. We are also very pleased to report strong growth in our paid Cloud Agent subscriptions, with almost 28 million now, 93% growth from prior year quarter.

As discussed before, our Cloud Agent is the technology platform for seven security, compliance and IT solutions available now namely Vulnerability Management, Policy Compliance, File Integrity Monitoring, Indication of Compromise, Patch Management, Asset Inventory and the upcoming Certificate Management and with more to come.

In terms of our newer solutions, we saw strong growth again this quarter from FIM and we continue to build a healthy pipeline in Patch Management and Container Security. At Black Hat this quarter, we launched our Global IT Asset Discovery and Inventory App as a free service.

We received very positive feedback from customers and industry luminaries because global IT asset inventory is one of the biggest challenges. If not the biggest challenge, for organizations, visibility is the cornerstone of security as you simply cannot secure what you do not know or see.

With our free service companies of all sizes can automatically build their global IT asset inventory across on-premises, endpoints, cloud, containers and now, mobile environments as well as identify in real-time everything that connects to their networks.

Only two and a half months after the launch, we have approximately 3,650 companies signed-up with over 500 new customers using the service. We have also been rolling out the free service to existing customers since last month and now have almost 300 existing customers using it.

As a result, our goal to make our Cloud Agents ubiquitous is now well on its way and allows us to make the subscription to our paid apps frictionless because no additional infrastructure is required.

Distributing such a free solution from our platform to generate meaningful demand of our paid apps is one of the key elements of our profitable growth, driving value for both our customers and shareholders.

Furthermore, this multi-product adoption naturally increases the stickiness of our platform and helps make us impenetrable to our competitors who do not offer the same breadth of solutions. This is underscored by the fact that the gross dollar retention rate of customers who have adopted four solutions or more stands at 99%.

We continue to invest in expanding the capabilities of our Cloud Platform and developing additional solutions and we will showcase significant new offerings at our upcoming QSC user conference in Las Vegas on November 20 and 21.

At the conference our attendees will have the opportunity to listen to industry experts such as Richard Clarke, author of The Fifth Domain and formerly a czar in the White House, Scott Crawford from 451 Research as well as Ramesh Chinta from Microsoft Azure who will discuss how Microsoft is building security into Azure, and of course of the roll that Qualys plays in it.

And Charles Henderson from IBM XForce Red who will talk about their efforts to automate pen testing and more quickly respond to eliminating vulnerabilities and they are a very big user of Qualys as well.

You will also hear fascinating presentations from our customers who will share their experiences and best practices, also their views on how their security needs are evolving and how mission critical Qualys is becoming for them.

Our President and Chief Product Officer, Sumedh, which we promoted recently and I would discuss that later, will unveil our next generation Vulnerability Management offering that brings it to its next level and showcase our forthcoming EDR and Data Lake / SIEM initiatives.

In addition, among other innovative solutions, we’ll discuss the forthcoming updates to our Container Security and the capabilities we have now of threat hunting with Qualys. And you could click; you go to our website and look at the agenda as well.

I would like to personally invite you to both our user conference and a dedicated institutional investor and analyst session that will occur during the conference on November 20.

This event will focus on how Qualys is driving sustainable growth and profitable growth and will include a demonstration of our newest application as well and with a Q&A session can select Qualys customers.

Finally, the expansion of our Cloud platform, which now delivers an impressive suite of security and compliance solutions, as well as our build out of operations in Pune, where we have more than 750 employees, was led by our Chief Product Officer, Sumedh Thakar. And I am delighted to announce his promotion to President and Chief Product Officer.

Sumedh started at Qualys in 2003 and through outstanding performance, now runs R&D, QA, Ops, Product Marketing and Customer Support and with his promotion, he would also run Worldwide Field Sales Operation. And as we continue to lay the foundation for our future growth, we also promoted Laurie MacCarthy to EVP Worldwide Field Operations.

Laurie joined Qualys in 2012 and was most recently VP Field Operations for the Americas. And Laurie came from one of our customers where she was running one of the activities of extremely good program vulnerability management program at CVS. In addition, we promoted Dilip Bachwani to SVP, Cloud Platform, Ops and Dev Ops.

Dilip joined Qualys in 2016 and was our VP of Dev Ops. And finally, we welcome the addition of Mustafa and I'm not sure if I know how to pronounce it correctly, Mahudhawala as our VP of Global Customer Service. And Mustafa is coming from Red Hat.

Our product and platform achievements and expansion of our management team lays the foundation for our continued progress to enable customers to consolidate their security, IT and compliance stacks while drastically reducing their spend. As importantly, it is core to the highly profitable recurring and growing revenue model we have built.

With that, I’ll turn the call over to Melissa to discuss our financial results..

Thanks, Philippe and good afternoon. Before I start, I'd like to note that, except for revenue, all financial figures are non-GAAP and growth rates are based on comparisons to the prior year period, unless stated otherwise.

We’re delighted with our increasing Cloud Agent subscriptions and multi-product adoption, which lays the foundation for future revenue growth and industry leading profitability. Our Q3 financial and operational highlights include, revenues for the third quarter of 2019 grew 15% to 82.7 million.

Platform adoption continued to increase as the percentage of enterprise customers with three or more Qualys solutions rose to 46% from 39% and the percentage of enterprise customers with four or more Qualys solutions increased to 26% from 20%.

Paid Cloud Agent subscriptions increased to 27.9 million over the last 12 months, up from 23.6 million for the 12 months ended in Q2 2019. 2 million additional Cloud Agents were purchased this quarter by a single cloud platform customer.

New products released since 2015 contributed approximately 33% of total bookings in the quarter, up from 23% and our average deal size continues to increase, growing 8%. Our scalable platform model continues to drive superior margins and generate significant cash Flow.

Adjusted EBITDA for the third quarter of 2019 was 39.2 million, representing a 47% margin versus 45%. We continued to increase our headcount sequentially and we benefited from attracting great talent in Pune as well as lower non-salary headcount costs and lower third-party expenses this quarter as compared to Q2 2019.

Q3 EPS grew 34% and we generated strong free cash flow for the third quarter of 2019 of 39.9 million and year-to-date, our free cash flow has increased 36% versus the same period last year.

In Q3, we continued to invest the cash we generate from operations back into Qualys including 5.8 million on capital expenditures, including principal payments under capital lease obligations and 49.8 million to repurchase 603,417 of our outstanding shares.

Our Board has authorized an additional two year 100 million open market share repurchase program; resulting in approximately 141 million in current share repurchase capacity. We remain confident in our model driven by our foundation of recurring revenues and expanding suite of applications.

Our current fiscal year 2019 revenue guidance is now a range of 321.2 million to 321.8 million. We are raising fiscal year 2019 non-GAAP EPS guidance from a range of $2.03 to $2.07 to a range of $2.28 to $2.30. We now expect to expand EBITDA margins this year and we expect our fiscal year 2019 EBITDA margin to be between 42.5% and 43%.

And for the fourth quarter, we expect capital expenditures to be in the range of 9 million to 10 million, which includes approximately 3.5 million for the first phase of the build out of a new Qualys office in Pune.

We are very excited by the robust early adoption of our free Global Asset Discovery and Inventory application, which makes it frictionless to enable many of our paid subscriptions. This provides us the opportunity to accelerate revenue growth as well as expand margins in the future.

As Philippe mentioned, we look forward to seeing many of you at the analyst and investor session at our upcoming QSC user conference in Las Vegas. With that, I’ll turn the call back to Philippe..

Thanks Melissa. In summary, and as Melissa said, we are really happy with the progress made in expanding our Cloud Platform and the increased adoption of our solutions by our existing enterprise and SME/SMB customer base as well as new customers.

And in addition again, just Melissa did, let me reiterate the invitation we are extending for you to attend both our user conference and the investor session. The investor session would also be webcasted for those who cannot attend in person, so they could listen it at their own leisure.

And please register on our website and peruse the agenda for one or both events. Melissa, Sumedh, Laurie and I all hope you would attend. With that, Melissa and I are happy to answer any of your questions..

[Operator Instructions] And our first question will come from line of Howard Smith from First Analysis. You may begin..

Yes, thank you for taking my question. Congratulations on the continued very profitable growth. First question has to do with the share buyback authorization and activity seemed a little bit stepped up in Q3.

And I'm just wondering is there any kind of policy shift in terms of how you and the board are thinking about using the cash or return to shareholders this way?.

Thanks Howard. I'll take that one. So as a framework our share repurchase program is – the objective is to minimize the delusion from grants given to employees and that has not changed that continues to be the same.

If you see, if you look at how we repurchase over the last couple of years, we end up being back loaded in the second half of the year because our window for repurchasing in the first half, especially the quarter will be announced year-end earnings end up being the shortest. So think of it a little bit more as a catch up..

Okay, great. That's helpful. And then Philippe, you spoke of the success of the kind of the asset inventory rollout.

Previous to that you had served you I think it's kind of a free offering that just in general, as you've rolled out a couple of these and see the results, how are you thinking about using free versions to support upsell and any tweaks you might be thinking of making going forward with those types of programs?.

Yeah, as opposed to said view which has more limited upsell. The global atheist in the venture is very strategic and on many forms is very strategic as we discussed and said previously because it gives that visibility that companies do not have. And that's absolutely something absolutely crucial.

And it's becoming very obvious that everybody needs to go that way. And what is very unique with Global IT inventory is that it expands across your entire environment. It just doesn't look at the windows servers or endpoints or cloud it goes across everything that you had in your environment.

And so then from there, there is significant upsell opportunity. You have the one which really are directly related to our Global IT inventory, which is for example, the ability now to look at your end of life assistance. So there's additional features about the kind of information that you can get to read that.

You do not get from the free asserted country. You can end discovery by the way and you can also now synchronize with the service now CNBB, so we become naturally the source of truth and these we see today very strong interest and we today probably have around 100 customers which are doing that already.

And then there's also – all the other upside which are related to the agent because the – what once you declare the Global IT inventory, you want to absolutely use the capabilities of our Cloud Agent because they give you a real time, which means anything that certainly changes on one device where you have put the agent or one asset immediately you know what that is, and that's exactly what you want.

Security has become an issue of both scales, it's always been an issue of accuracy and now is becoming absolutely an issue, essentially, of scale as well and real time, which is obviously things that requires a significant platform to be able to do that.

There is many, many, many upsell opportunity around that Cloud Agent and that's what we believe it is very strategic. And we see already that yes, it is very well received. As you know, we're only rolling out to our existing customers about a month ago.

The reason why we did that because we didn't want to have certainty all of our customers adopting it, so we're trickling and then having too much load too quickly on our platform, that their reception is fantastic and this will continue..

Right, thank you..

Thank you. And our next question comes from line of Dan Ives from Wedbush. You may begin..

Yeah, thank you. So can you just talk about in the market where you have some competitors that are starting to significantly expand their product portfolio and risk and some of the broader sort of five prone approaches and maybe kind of talk about that in terms of what you're seeing in the market? And from a product perspective, any changes. Thanks..

In terms of the – again of the competition, yes, everybody today realizes that there could be a platform and the platform cannot be an enterprise software platform. It has to be a cloud platform because the cloud platform gives you the scalability that you need.

So in that sense we're so well ahead of the market because I'm sure as you recall, we started the journey back in 1999. And we went through all the different variations of the cloud technology and we've been absolutely thanks to the big investment we made in Pune able to inject the most – the newest technology.

We have Elastic Search, we've Kafka, Cassandra and we're building valid scales that today we don't know anybody doing anything close to the scale that we do. We've today 28 million agents. But in reality, we also have architecture to hundreds of millions of agents, if not billions, of agents, so it's all about scale.

And yes, other companies are moving to that direction, but we believe that we're far ahead essentially of everybody else..

Thanks. Could you maybe just talk about especially in cloud with the Azure channel, obviously gaining more and more success, with the JET I win and just how you think about those market dynamics playing out and how that potentially bodes well for – how you guys are positioned, especially when it comes some of those Microsoft deals? Thanks..

Yeah. So that's another good question effectively. We always had believed if you recall some of the comment that I made, in fact, in 2009, I was already making that comment publicly. We also said that we need to be security to the cloud, we cannot continue bolting security on. In order to do that you need to have the right architecture.

This is exactly what our Cloud Agents are all about. All the major players all using our Cloud Agent today and millions of them to essentially ensure – have the visibility and ensure the security of their platform.

As I mentioned, I think either last earnings call or the one before, we've done something remarkable with Microsoft, whereby we've totally integrated our agent with the security center or by an Azure cluster with the security center Azure, whereby an Azure customers can essentially click on the link, go to the security center, click on the link, have the entire view of all of the assets they have on Azure, click on the second link and have the view of the security and compliance posture.

This is thanks to the Qualys if you prefer embedded agent there and then third, click on the third link which has nothing to do with us but only 100% with Microsoft created Playbook and the numediate [ph]. So security in this new environment have become click, click, click, nothing to install, nothing to update, it's all done for you.

What a big change? And then the only thing you do then is that you bring your policies because you are the one the customers who decide your policies. Do you want to ever [indiscernible] or not? Do you want this? Do you want that? And then of course, security is business. And that's where we see the future.

So of course, we're extremely well positioned. And now that we're totally integrated, of course, our agents with Microsoft, then of course, I was very happy to have heard that they want the July contract, because of course we naturally go. And by the way, as you know, our solution is not authorized.

So this is why we the way we saw the future happen and now we're so happy to see that the future is now..

Thank you. Our next question comes from the line of Chris Eberle from Nomura Instinet. You may begin..

Great, thanks. Hey guys. Nice job in the quarter.

Can you give us an indication of just – now that you have the free download of asset inventory in the market, just some early adoption what some of the attach rates look like for paying applications to that?.

Yeah, so in fact today – let me remind you the adoption of all of our customers the way they adopt. They always do a first proof of concept. And then they start to do the deployment. And all that takes some time. And as you know, with our model, we take the revenue as we deliver the service.

So we don't do like most of our competitors, which have a big chunk of perpetual license that they can – of course, that inflates if you prefer their goals. But these being said, we see today that even with these customers which have adopted, we've already starting to discuss with them about all the upsell capabilities that they have.

And so we have seen already customers trying now all these additional capabilities, all that are very good initial signs about what we've done. When you really look back, everything is integrated. So that means you don't have to install another application. You'll have to have another person managing it.

All of that can be done by the same team, which is currently managing the Qualys Solutions. So the answer is yes. We're very happy with it..

Got it, great, thank you..

And our next question comes from the line of Nick Yako from Cowen and Company. You may begin..

Great, thanks for taking my questions. You saw a mixed jump in the percent of bookings from new products in the quarter.

Any one or two products that you would highlight that were key drivers?.

Hi, Nick. Yeah, we're really delighted with that jump which was 33% in new solutions as a percent of bookings from 25% last quarter. It still remains mostly cut edge VM and policy compliance.

And remember, as we've discussed it's not a perfect metric because it does include the renewal portion of the policy compliance when someone renews from the original solution into a Cloud Agent enabled solution. And so we did see a high amount of renewal in that metric this quarter..

Yeah, Nick, we had some good traction there from the team, as well. We're starting to do the monitoring, which is the fine integrity monitoring..

Okay, great. And then building on an earlier question around cloud, earlier this week you announced the Global IT asset discovery app for the federal market, just curious what percent for the federal market.

And I'm curious, what percent of revenue does the federal government represent today, and now that the government is embracing cloud, how you think about that opportunity moving forward?.

Yeah, so in fact that has been our journey, trying to convince the government to apply the cloud. Our calculation was although you had a lot of people saying about these there's not much appetite. Finally it's changing. So today we have a very small percentage, I think today if you include states 3% round of our revenues of federal and state.

And if you break that down to federal it's probably about a part of it. And so we have very good customers and very savvy customers, they rave about what we are and now finally we're starting to essentially see the government ready to take. So we're going to make some investments now because again, we've always been balancing.

It's not worth trying to invest ahead of the game, but you don't want also to invest today either. So you have to time that as best as you can. So there we see an opportunity really with federal to really grow that market.

But again, we said it takes time, but I think – and that July contract is really I think this is going to be very interesting for us, but again, it needs to be deployed and on and on, so it would take some time in the federal government.

Today we're not seeing any significant revenues early next year, but I think now with the fiscal year being at the end of the year, so maybe we could get some nice additional thing. But today, we're not really counting that, but where we will make the investment in essentially beating up our federal team..

Thank you..

And our next question will come from the line of Matt Hedberg from RBC Capital Markets. You may begin..

Hey, it's Stan Bridges [ph] for Matt Hedberg. Thanks for taking our questions. On the go to market traditionally, you adopt new products through the platform, but at Black Hat and around the event around the Global IT asset discovery and inventory launch, there was a significant awareness and marketing campaign.

Very noticeable to us that attended, I think more of a start to market and engage CIOs.

Could you talk a little bit about that strategy and then – or any early engagements from that?.

Yeah, so that in fact absolutely because that's in fact the opportunity that we have today, so now what you're going to see is the second leg of our campaign. The first campaign as you rightly characterized it was an awareness campaign. This is where we are for you guys. And okay, so come and see it. Now we have enough adopters.

So we're now going to have our adopters speak, and they're going – and the second campaign we're preparing and they're the ones who are going to describe the benefits and what they have done and achieved, and you're going to see some of that about user conference, where we're going to have some of our users talking about it.

And you will also see an interesting panel to answer your question about the CIO. So we have a very interesting panel that now our President and Chief Product officer Sumedb will moderate.

Where we have in fact, Wendy Pfeiffer, which is the CEO of Nutanix, she's on our board now, which is also part of creating awareness to the CIO, in fact is going to be on the panel and she's going to review and give her view as a CIO of how do they see the evolution of security and web also some other very good representative of the company.

So I think we're just at the beginning of that, but there's different series of directions that we're continuing to take and you will see acceleration of our awareness effort toward the CIO and the CTO conference because one of the things I want to mention, the game in security is changing.

The theme of our user conference is security as a crossroad part two, why do they say part two is because part one is what is the last year about telling this is where we see the market is going. And part two will be the market is now there, what are the implications for the security industry.

So we'll go into more details and one of the implications is that – and we see that very clearly large companies which is which goes very well for us, is that now it's DevOps who's taking other. The security component as well as of course, additional cloud formation and so it's a very different mentality.

These are engineers, they don't do these big enterprise purchase, they want to make sure that your solution fits their need. And the big change is that you cannot go to them and describe your roadmap, they don't care about your roadmap. They want you to discuss with them about their roadmap.

So it's a totally different game, which is really happening to the industry. And again, this is what I predicted in 2009. But of course, it took significantly longer than I thought. I know why now, but we are well there now, big change is happening, and having a technical sales force, and a very strong engineering group that we have.

This really puts us very, very in – absolutely in a very wet position for that new era to come..

Thanks very prophetic nonetheless.

Maybe one for Melissa, Melissa, you indicated an FX headwind about 100 basis points each quarter here in the second half previously, any changes to that or incremental FX pressures to call out?.

Yeah, so it's roughly still the same, but we are expecting a little bit more in Q4 than we originally projected. But on the margin, it's still going to be roughly little less than 100 basis points headwind to the growth rate..

Thank you..

And our next question comes from the line of Gur Talpaz from Stifel. You may begin..

Okay. Thank you very much. Over the past few months, you talked about a pretty bad percentage in the first half [indiscernible] pretty significant markets so EBR, broader and some solutions.

Can you talk about the development path for these products? The comfort level that's pushing just seems to be pretty significant, how do you think you'll [ph] differentiate the two other solutions out there..

Yeah, so of course, so if you look at what Qualys is all about? So we are absolutely using internet technology for scale, accuracy and everything. And one of the reasons why I realized it took longer because I figured out finally and I said oh my god, I should have figured that out quite a few years ago.

But that registered a fueling digital transformation is the fact that the Google, the Facebook, et cetera have very similar to what IBM did when they invested a $1.5 billion in Linux many, many years ago. So they could essentially re-architect the environment in business that these companies they didn't want to depend upon enterprise software.

So they have to build search at a huge scale and that's where Alexa switched game now you have [indiscernible] and so forth.

I would assume that all this technology – and they present an open source why? Because I had the opportunity to discuss many, many years ago with Steve Mills, and say why you didn't acquire the Linux, which was a 50 people company at the time and you invested $1.5 billion? His answer was, because I didn't want to kill them.

And that's exactly the same thing. And it took me a long time to realize that, that the Google and company as I thought about it, however, they didn't want to put the significant technology enhancements too early because then they will have essentially an able competition, so it took them a certain time to bring that into up install.

But now today, oh my god, they're coming right and left. We will explode that containers would be there like even three years ago. Today they're taking the world by storm. We have or using containers in our platform and we have already replaced 70% of all dependency on the VMware virtual utilization layer [ph].

So we are builders of technology of scale like the Google, like the Amazon, like the – we're the same breed. So for us, essentially, when we move into that space, this new space like EDR, and anything that we do, whether it's the SIM, that's what is in our mind, goal, accuracy and elimination of false positives and false negatives.

So when I look at how are we going to compete in the SIM market, we're going to compete because we will have a better scale, we will have of course, significant bigger elimination of false positive which is a problem today that every SIM as and then of course, a better price because we're using newer technology which of course allows you to do more with less.

And same thing on the EDR market and of course we have the benefits, very unique benefits. Everything we do in a way through certain logic, whereby, because we capture the data that nobody does that of course, it puts us in a significant position to of course, now create that next generation if you prefer of SIM and even a PPR.

And of course, one of the interesting strategies is that if we can put our agents everywhere realized the telemetry that we're going to get. And already again with 28 million of them, they go everywhere. And that puts us in a very unique position. So the rest is all about scale.

That's what I mentioned earlier, that rev architected our backend not to under to millions or 10s of millions of agents but hundreds of millions, if not billions, of agents.

I hope that answered your question?.

Thank you very much. Maybe one follow-up for Melissa, putting on that.

You've been very capital efficient, when you look at your current level of spend do you think you have enough right now to support the development and the go to market event of these new initiatives?.

Yeah, thanks, Gur. We're very proud of our industry, the leading margins as well as our strong growth in cash flow of this quarter as well here today. As you can see from the implied guide for Q4, we do plan to continue to invest and these projects are part of that..

And I would like to admit also, if you look from a cost or profitability standpoint, on the engineering side the decisions we made in 2007 to go to India, now, today, we're just oh my god, that was the right decision because not only we can get the talent, huge pool of talent, but we also have a significant cost advantage by an order of magnitude.

So that's for the engineering. So we have the engineering power to really continue doing what we do and maintain of course, the margin that we haven't in fact seen as a percentage, our percentage of expensive engineering should certainly not grow, but you could read out this input you have the scale as well.

Now, on the go to market, the big advantage we have here is the model itself. The cost of distributing flip charts of Global ITS inventory is a sequel to nothing.

Where today to support that marketing efforts we're being what we call the pause the technical account representative in India, which are people, which we've young people we have from the technical schools. And then the other one, essentially onboarding people on these free services to make sure that there is a good experience from the get go.

And then after that, of course, now 70 we kind of sell these customers and again in a very, very not aggressive way, but essentially informing them of all the services they can have and get more value from it. And which is our model. So this is very efficient from a safe point.

And that signature whole model and for the customers is fantastic because everything's already in the platform, they don't have to install anything. They just have to be educated.

And the other investment we're starting to make is really to try to get more and this is something for example, frankly it's done very well, is all the libraries of training, of use cases.

So it becomes even easier and easier for customers to essentially implement if you prefer or deploy it's pretty easy, but then to configure and take advantage of all solution for their needs..

That's very helpful, thank you both..

Thank you. And our next question will come from the line of Melissa Franchi from Morgan Stanley. You may begin..

Thank you for taking my question. Melissa, I wanted to ask you about the guidance for Q4. You modestly lowered the high end of the FY '19 guidance, although it seems like things are going pretty well for you all. So I'm just wondering if you can talk about what's driving that and the puts and takes that's embedded in that outlook..

Yeah, sure, thanks Melissa. We had a very good quarter. We were delighted with the acceleration in Cloud Agent ads and the increase in multi-product adoption. We did take down the high end. It was driven by a couple of factors.

One is, as I earlier mentioned, the incremental FX headwind we expect to see as well as the fact that as we've discussed for leveraging our leadership position to match competitive pricing, where it makes sense because we have so much upsell opportunity in front of us..

Okay, I got it. And then just another follow-up for you, looking at billings growth, we did see a slowdown modestly, but current billings was better.

So can you maybe talk about what you saw for durations this quarter?.

Yeah, so if you're referring to the total billings, remember that includes that multi-year prepaid, but you don't manage to because we don't intend our sales force for that. We really let that be driven by our customers.

So in that specifically the multi-year prepaid, which affects the long-term deferred revenue, they had a bigger dollar value increase in the quarter a year ago then in this quarter.

In terms of the current billings, as we've talked about, we don't manage to it because there's multiple scenarios in which a renewal doesn't happen at the same time of the initial signing of the deal.

And so we point to the trajectory of our annual revenue guidance as the best proxy for business momentum, because certainly our current bookings inform our guidance there..

So let me add another thing that Melissa it's nice to have you back..

Thank you very much. And thank you, Melissa. Thanks..

Thank you. And our next question will come from the line of Alex Henderson from Needham & Company. You may begin..

Hi, this is Roger Boyd on for our Alex. Thanks for taking our questions. I was wondering if you could comment on what percent of customer base is using the Cloud Agent.

I think last quarter you said it was 20%? And then have you seen any incremental penetration from customers started off like deployment? Or is most of the growth coming from new customers trying out the Cloud Agent..

Yeah, so it's now in 22% of the customer base, there's still a significant opportunity, not only in the customers that don't have it, but also to discuss, we know that our customers who are using Cloud Agent are not fully deployed in their environments.

In terms of this quarter, where the buying was from? It kind of varies quarter-to-quarter, but actually, this quarter, the percent of bookings from new products such as I said, was mostly Cloud Agent, fractionally a bit higher in new than existing customers..

Got it makes sense. And then just maybe really quickly, is it fair to assume that the customers you're seeing pick up the free version of asset inventory tend to be the SMB customers or are you using enterprise customers try that as well..

No, it's all walks of life, I mean, because that's a universal problem. So for it's sort of in the enterprise, in fact – the enterprise in fact, today, bigger need than the low end of the market.

Because in the low end of the market, especially on the SMB, you get one guy, and maybe 50 PCs or 20 PCs and some coming, so they can do that still manually on spreadsheets, the enterprise cannot. The problem that the enterprise has is that they need – the enterprise today, the enterprises – the large enterprise is fundamentally changing.

The silos are crumbling, that's the message finally. Again, that's what probably would have happened 10 years ago, that is happening now. So the silos are very, very jealous of their tools.

So the window team, having their tool to do their own inventory under these under that and now today again, the silos are crumbling, everybody needs to accelerate digital transformation. So today we find that that visibility is starting to become very high on the mind of the CIOs.

And the sisters who do not really wants to still resist and continue with their own tools that they have and they're familiar with, that are getting more and more replaced. When you look at the tenure the average tenure of C sells today in the large enterprise is about 1.2 years.

So a huge movement and of course, they're obviously the one behind, changing things. On the mid-market, I think we see a very good adoption because they have bigger networks, more complexity. Even if I look at Qualys today you would be amazed at I give the demo, real time of our own inventory and we're using of course our own agents and discovery.

I couldn't have believed the complexity of the environment that we have with a company of 1,300 people. So for the SMEs, it's a much more something they want to be now. On the enterprise, they know, they've got to do it. But they've really got to go and you need to have the momentum and a good fund to start because the silos are resisting..

And just to add on to that – this program that Philippe said, we're seeing more of the enterprise customers using it and the existing, so about 40% of those using it just in a couple of months, and so on. So it's sort of an early still early data.

It's from the enterprise and it's closer to 10% in the new and that's because many of these existing enterprise customers already have Cloud Agent solutions, which we see as a very positive sign because once they then deploy the agent globally, for the purpose of free asset discovery and inventory, it's very easy for them to add on to these additional paid solutions, some of which they may be using in small amount.

Now they can turn it on for their full environments like we talked about with the opportunity to extend VM and policy compliance on the endpoints..

Great, thank you. I appreciate the color..

And our next question will come from the line of Sterling Auty from JPMorgan. You may begin..

Hi, this is Sahil on for Sterling. Thank you for taking my question.

So how was the EMEA business in the quarter given the macro backdrop?.

Yeah, very good, nothing really to report, still we have a very good penetration in Europe, as you know and what we seek adversity was in the pickup in Asia. I think today, the cloud now is starting to be more appealing to Asia, when it departs it's all about the I own my own premise.

Europe is doing very well and so is the US, so is – we see as kind of a slowdown in Brazil and in Latin America. That's about the only place where we see the real slow down..

Thank you. And I apologize if I had missed this in the prepared remarks, but do you give the split for vulnerability management in the quarter..

The vulnerability management family still continuous to be about 73% of the revenues..

Thank you. That's all from my side..

Thank you..

And next question will come from the line of Yun Kim from Rosenblatt Securities. You may begin..

Thank you. Congrats on another solid quarter. Just going back to the cloud fees adoption, it seems like that's going pretty well consistently for some time.

Can you just describe to us what kind of pricing uplift that you may be seeing for customers with cloud agents versus those who do not and if there is a meaningful pricing uplift what is driving that?.

Yeah. So it really depends on the nature of application that people use the Cloud Agents for because people don't purchase the Cloud Agent standalone.

So what we've talked about is if someone was a previous VM or policy compliance customer and then renewed or added on to a Cloud Agent for the purpose of doing those applications, they would pay in about an additional 20%.

For example, if they were subscribing to file integrity monitoring which is a solution enabled by the Cloud Agent, that's a much higher price solution. So it really depends on the nature of the solution that they're using..

Okay and does the new – I'm trying to better understand how the new asset inventory product; it seems like it should help drive the incremental Cloud Agent adoption right [indiscernible]?.

Yes, that's the second purpose. The first purpose is to give the much needed visibility that the company must have. And of course, the advantage for us is that of course, we now see the market with the Cloud Agent where then can access all of these other services that we have, all these other functionalities. Yes..

Got it, great, thank you so much..

And our next question will come from the line of or Patrick Colville from Arete Research. You may begin..

Thank you for taking my question and congrats on a solid set of results especially on the profitability. I mean just credible profitability, to be honest, really market leading.

Can you just talk through the puts and takes it possible on the gross margin side and then the operating margin side, just what happened in the quarter to kind of print such a strong performance..

Yeah, Patrick, so I repeat that we're very proud of our industry leading profitability. On the gross margin, we did have additional expenses related to data center capacity and software maintenance, but they were offset by an increased in mix in Pune, which we've talked about is really, we're getting a lot of our great engineering talent.

With regard to the other areas, we're really benefited from a number of factors. It was hiring in Pune, it was, lower net hiring than expected, lower non salary headcount costs things like vacation accrual, payroll taxes, as well as lower third party spend such as legal services, consulting and travel..

And can I ask about the buybacks because that was something that you briefly touched on earlier, but a pretty major change versus product orders. So if I've done my math right, its $50 million bought back in the third quarter, which is you had double the amount bought back in the whole of first half this year.

I mean is that something we should expect going forward collectively more aggressive on buybacks and to use the cash on the balance sheet to lower the share counts?.

Yeah, so great question. And, you know, we're delighted that we have the strong cash so that we can do this for our shareholders. Again, the objective is to minimize our dilution. And so that's, that's really our primary – what we're trying to achieve because we are preserving capacity for M&A, we continue to be actively looking in the market.

So I would not to guess that 50 million is indicative of what we're going to do every quarter. If you look at sort of the average of what we've been doing here, our broad has been authorizing $100 million. And so I think that's really more the way to think of it.

As I said, again, depending on the timing of when we're buying and the amount we can do in each quarter, it ends up varying..

Let me repeat two things I would say, one thing is that the quarter was a little bit not normal because we had a very small window the previous quarter. So in a way, it was a kind of a catch up. Because the goal in fact we have and this just came from discussion we had from our long-term investors when we discussed about capital allocation.

So essentially, firstly, to begin to say, what is your strategy of sales? First of all, let me get the cash. And then we have the cash we'll discuss about cash location and capital allocation.

And then of course, the number one requirement is literally – it's this exactly what it told us look for us if you could minimize the dilution because of course we continue looking for talent. And you know that talent, you need to incentivize them.

I personally prefer the option to the RSU because that's another discussion, and then if they say okay, so we – I said, let me think about and then maybe we discuss with the board and we say okay, we're going to essentially answer our long-term investors and we committed when we do that.

So it's not about pumping up the stock, it’s just about the goal is to essentially minimize the dilution that we do through the SBC and we are chocked into that.

Now today we gained some additional flexibility because in the past were limited also with limited of the windows and now today, we have expanded the capabilities to buy on the open market essentially that the authorized and that's about the only change that we made, but no change whatsoever in the underlining philosophy..

Well, great, thank you very much..

Thank you. And I'm not showing any further questions at this time. I'd like to turn the call back over to Vinayak for close your remarks..

Thank you all for attending our third quarter 2019 earnings call. We look forward to seeing you at Stifel's Midwest One-on-One Growth Conference in Chicago and Needham's Security Networking and Communications Conference in New York in November.

We'll also be at NASDAQ's Investor Conference in London, Wells Fargo's TMT Summit in Las Vegas and Cowen's Annual Networking & Cybersecurity Summit in New York in December. Thank you..

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect..