Qualys (QLYS) Q3'23 Earnings Update

Qualys is an IT, security and compliance solutions company that helps companies protect their systems and asset from cyber attacks. Their offerings are focused on monitoring, compliance and risk management. Qualys QLYS 0.00%↑ reported better-than-expected earnings and revenue for Q3’23 on November 2. The results for Q3’23 extended the cyber security company’s steady growth and strong profit margins. However, there’s a mixed picture in the near-term with regard to guidance that indicates a continued slowdown in topline growth.

The high-level numbers feature revenue of $142M (up 13.1% from the prior year), which compares to the consensus estimate of $141M. Non-GAAP EPS of $1.51 was up from 94 cents per shares in Q3’23 and consensus estimate of $1.14. There was a 15 cent tailwind from a change in tax estimates, which would’ve brought non-GAAP EPS to $1.36 and still been higher than the street’s estimate. The adjusted EBITDA margin of 48% was up 477 basis points from the prior year. Reported (unadjusted) EBITDA margins similarly improved by 176 basis points from Q3’23.

Looking ahead, Qualys guided Q4’23 revenue at $144.6 (up 10.5% YoY), slightly below the estimate of $145.2M. That would be the slowest quarterly growth ever for Qualys. It’s not a major change from the guidance given in August when FY2023 revenue was guided at $554M. It’s now $554.5 and another way to view that is some of the Q4’23 expected revenue was pulled into Q3’23. Despite the expected moderation in revenue growth, billings (via change in unearned revenue) looked stronger at 13.9% YoY. That’s the strongest billings growth rate since Q2’22 when growth rates slipped. Non-GAAP EPS, the other metric that management guides, is expected to be $1.23, which is 10 cents better than the consensus estimate.

During the Q2’23 earnings call, CEO Sumedh Thakar talked about the “tough period” with customers scrutinizing deals and delaying project start dates amid an uneven macro environment. During the Q3’23 CFO Joo Mi Kimm said the environment has “stabilized” with the full quote as follows:

In Q3, we started to see some indication of stabilization in the selling environment with customers confirming their prioritization of security within IT budgets but believe ongoing budget scrutiny will linger for the foreseeable future. Reflecting this sentiment, our gross retention rate has remained largely unchanged at approximately 90% but our net dollar expansion rate came in lower at 106%, down from 108% last quarter. While there continues to remain room for improvement from smaller customers, larger customers spending $25,000 or more with us grew 15%.

The interesting nugget here also is that net retention came down to 106% in a quarter that sales were ahead of expectations. Combined, it indicates Qualys had an easier time bringing on new business than expanding revenue at existing customers. The net dollar expansion is important for a cybersecurity company such as Qualys. They need to sign up customers with core offerings and upsell by having customers buy into the broader vision that Qualys can be a one-stop shop for cybersecurity products.

Also recall Qualys hired a new chief revenue officer in July and management said in August they would revisit planned initiatives push out investments by a few quarters. Kim reiterated that intention and indicated that margins were buoyed by the more modest investments made:

While we delayed some investments in response to the business climate and the arrival of our new CRO in July, we achieved greater operational efficiency through focused efforts on optimizing investments. This led to EBITDA margin exceeding our expectations in Q3 and further demonstrates our ability to maintain high operating leverage and remain capital efficient while continuing to innovate and invest in our long-term growth initiatives.

The above quote is also important in context of the slow down in revenue growth. The under-investment in sales and marketing is certainly part of the reason Qualys may only grow at 10.5% in Q4’23 and potentially early in 2024.

Shares of Qualys are trading ~10% higher on November 3 after the earnings report and the valuation multiples (such as 23X NTM EV/EBITDA and 3.1% FCF yield) are the near the historic average. However, those multiples look less appealing with Qualys growth in a trough. Combined, it indicates the stock is fair valued.

Disclosure: This is not advice to buy, sell or hold any stock referenced. Do your own due diligence. I have no position in any stock mentioned in this report. Like any financial analyst, doesn’t mean I’m not biased.