Earnings Review
Qualys (NASDAQ:QLYS) recently reported 1Q FY15 operating results. First quarter performance was mixed, with the company continuing to achieve strong growth, despite missing revenue estimates. On the whole, the top-line grew to $37.5m (+24% Y/Y), compared to $30.4m in the prior period, while diluted GAAP EPS turned positive, growing to $0.08 from a loss of $0.01 in the comparable period. In terms of analyst estimates, the company barely missed revenue estimates as mentioned earlier, while the bottom-line soundly beat expectations, with QLYS achieving diluted non-GAAP EPS of $0.15 compared with estimates of $0.11.
Strong 1Q performance
Top- and bottom-line performance aside, the company attributes the revenue miss to timing issues and lower than expected growth in Vulnerability Management ("VM"). VM continues to be extremely vital to the company as it contributes 80% to the top line. Despite missing estimates, the solution continues to show strong growth - VM grew 19% during the quarter, compared to a 20% growth rate in the comparable period. Due to the timing issues mentioned earlier, one cannot really conclude that the company's growth is slowing.
Some investors may worry that QLYS is really a one-product company, however, this assertion is actually false. The company continues to take measures to diversify its revenue streams (by introducing new offerings and upselling), evident from the fact that VM comprised of 79% of 1Q revenue compared to 83% in the prior period. I continue to expect growth rates within the 20% range for VM, along with the rest of the company's solutions.
Outlook remains strong, market penetration continues
In a prior article, I detailed the macro tailwinds supporting the company's growth - the industry is expected to grow at a CAGR of 48% throughout the remainder of the decade. The factors driving this growth remain intact, as executives globally increasingly place a higher emphasis on security. The industry continues to benefit from a growth spurt thanks to the high-profile breaches of Target (TGT), JPMorgan (JPM) and other institutions. Growth drivers are likely to remain intact - hardly a week goes by without some sort of data breach at a large institution. Just this week, the St. Louis Fed confirmed a cyber attack on its site.
As media outlets worldwide continue reporting on such incidents, it becomes harder for executives who currently employ minimal security initiatives to ignore the increasing importance of security. Likewise, it becomes more difficult for executives who have employed security solutions such as the ones QLYS provides to justify canceling such initiatives, allowing players within the industry to experience a certain degree of stability and customer stickiness in their revenue base.
The company continues its market penetration, attributing 1Q top-line growth to sales of subscriptions to new customers, subscription renewals as well as upsells. Renewals are a key metric to watch, given that a high figure would essentially endorse QLYS's value-add as well as imply a significant degree of customer stickiness. In the context of upselling, the company continues to succeed, with 58% of its customers using more than one QLYS solution, up from 54% at year-end 2014 and 30% at year-end 2013. Strong growth in upselling effectively proves the complementary nature of the company's solutions, and therefore I expect this metric to increase further in future quarters as the company continues to introduce new services and solutions.
New product offerings, strategic partnerships
QLYS released a number of new services during the quarter, most notably its Cloud Agent Platform ("CAP"). According to the company, CAP greatly simplifies VM as it eliminates the need for scanning windows and authenticated scans, while making security assessments dynamic. Further, it expands VM offerings to end-points which could not be reached via traditional scanning technologies. Thus, with an enhanced value-add, VM solution sales might even accelerate slightly in the following quarters and result in a profound impact on QLYS's top-line, considering that VM represents 80% of the company's revenues. QLYS's other new services are likely to sell well, given the company's track record for upselling.
The company has managed to expand its strategic partnerships to outsourcers including renowned companies such as Cognizant (CTSH) and Infosys (INFY). As mentioned in my earlier article on QLYS, these partnerships will continue to augment the company's global reach, allowing it to reach a greater number of customers.
Recent sell-off represents buying opportunity
Followers of QLYS would be aware that the stock fell 30% after earnings on weak guidance. In my opinion, the sell-off is unwarranted. Market participants might have treated QLYS's weak guidance and apparent slowing of VM solution sales too harshly - the company's outlook remains strong, considering its enhancements to its main offering and proven ability to upsell as detailed above. Baird apparently agrees with my assertion as they upgraded QLYS to outperform with a $50 price target. In addition, company insiders have bought into the sell-off. Although the company's core offering decelerated slightly, I remain confident that its growth potential remains intact. Therefore, I reiterate my bullish outlook on QLYS - my model below implies a price target of $56, or 45% upside from current levels.
