10-Q 1 rpdq3201710q.htm 10-Q Document

 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
 
FORM 10-Q
 
(Mark One)
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2017
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                      to                     
Commission File Number: 001-37496
 
 
RAPID7, INC.
(Exact Name of Registrant as Specified in its Charter)
 
Delaware
 
35-2423994
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)
 
 
 
100 Summer Street
Boston, MA
 
02110
(Address of principal executive offices)
 
(Zip Code)
Registrant’s telephone number, including area code: (617) 247-1717
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes      No  ☐
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes      No  ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and "emerging growth company" in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer
Accelerated filer
Non-accelerated filer
☐  (Do not check if a small reporting company)
Small reporting company
Emerging growth company
 
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ☐    No  
As of November 1, 2017, there were 43,881,140 shares of the registrant’s common stock, $0.01 par value per share, outstanding.
 




Table of Contents
 


i


PART I—FINANCIAL INFORMATION
Item 1.
Financial Statements.
RAPID7, INC.
Consolidated Balance Sheets (Unaudited)
(in thousands, except share and per share data)
 
 
 
September 30, 2017
 
December 31, 2016
Assets
 
 
 
 
Current assets:
 
 
 
 
Cash and cash equivalents
 
$
49,055

 
$
53,148

Short-term investments
 
34,825

 
18,779

Accounts receivable, net of allowance for doubtful accounts of $1,212 and $1,061 at September 30, 2017 and December 31, 2016, respectively
 
48,690

 
49,154

Prepaid expenses and other current assets
 
8,747

 
9,152

Total current assets
 
141,317

 
130,233

Long-term investments
 
1,110

 
20,162

Property and equipment, net
 
7,995

 
8,088

Goodwill
 
83,170

 
75,110

Intangible assets, net
 
17,208

 
8,946

Other assets
 
640

 
764

Total assets
 
$
251,440

 
$
243,303

Liabilities and Stockholders’ Equity
 
 
 
 
Current liabilities:
 
 
 
 
Accounts payable
 
$
3,567

 
$
4,012

Accrued expenses
 
23,737

 
23,499

Deferred revenue, current portion
 
133,117

 
116,903

Other current liabilities
 
1,394

 
1,195

Total current liabilities
 
161,815

 
145,609

Deferred revenue, non-current portion
 
55,526

 
52,160

Other long-term liabilities
 
2,333

 
3,496

Total liabilities
 
219,674

 
201,265

Stockholders’ equity:
 
 
 
 
Preferred stock, $0.01 par value per share; 10,000,000 shares authorized at September 30, 2017 and December 31, 2016; 0 shares issued at September 30, 2017 and December 31, 2016
 

 

Common stock, $0.01 par value per share; 100,000,000 shares authorized at September 30, 2017 and December 31, 2016; 44,337,203 and 43,018,737 shares issued at September 30, 2017 and December 31, 2016, respectively; 43,857,005 and 42,554,683 shares outstanding at September 30, 2017 and December 31, 2016, respectively
 
439

 
426

Treasury stock, at cost, 480,198 and 464,054 shares at September 30, 2017 and December 31, 2016, respectively
 
(4,645
)
 
(4,391
)
Additional paid-in-capital
 
457,904

 
435,360

Accumulated other comprehensive loss
 
(23
)
 
(19
)
Accumulated deficit
 
(421,909
)
 
(389,338
)
Total stockholders’ equity
 
31,766

 
42,038

Total liabilities and stockholders’ equity
 
$
251,440

 
$
243,303

The accompanying notes are an integral part of these unaudited consolidated financial statements.


1


RAPID7, INC.
Consolidated Statements of Operations (Unaudited)
(in thousands, except share and per share data)
 
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2017
 
2016
 
2017
 
2016
Revenue:
 
 
 
 
 
 
 
 
Products
 
$
29,626

 
$
23,108

 
$
82,736

 
$
64,709

Maintenance and support
 
11,654

 
9,694

 
33,794

 
27,037

Professional services
 
9,241

 
7,537

 
26,679

 
20,657

Total revenue
 
50,521

 
40,339

 
143,209

 
112,403

Cost of revenue:
 
 
 
 
 
 
 
 
Products
 
6,888

 
3,415

 
17,155

 
8,700

Maintenance and support
 
1,739

 
1,801

 
5,467

 
5,240

Professional services
 
5,740

 
4,822

 
17,088

 
14,103

Total cost of revenue
 
14,367

 
10,038

 
39,710

 
28,043

Total gross profit
 
36,154

 
30,301

 
103,499

 
84,360

Operating expenses:
 
 
 
 
 
 
 
 
Research and development
 
13,570

 
11,616

 
36,836

 
36,890

Sales and marketing
 
28,224

 
21,284

 
80,166

 
65,732

General and administrative
 
7,402

 
7,605

 
21,906

 
20,842

Total operating expenses
 
49,196

 
40,505

 
138,908

 
123,464

Loss from operations
 
(13,042
)
 
(10,204
)
 
(35,409
)
 
(39,104
)
Other income (expense), net:
 
 
 
 
 
 
 
 
Interest income (expense), net
 
198

 
44

 
585

 
55

Other income (expense), net
 
235

 
36

 
349

 
184

Loss before income taxes
 
(12,609
)
 
(10,124
)
 
(34,475
)
 
(38,865
)
Provision for (benefit from) income taxes
 
(2,325
)
 
70

 
(2,009
)
 
361

Net loss
 
$
(10,284
)
 
$
(10,194
)
 
$
(32,466
)
 
$
(39,226
)
Net loss per share, basic and diluted
 
$
(0.24
)
 
$
(0.25
)
 
$
(0.76
)
 
$
(0.96
)
Weighted-average common shares outstanding, basic and diluted
 
43,279,025

 
41,482,173

 
42,693,212

 
41,033,080

The accompanying notes are an integral part of these unaudited consolidated financial statements.


2


RAPID7, INC.
Consolidated Statements of Comprehensive Loss (Unaudited)
(in thousands)

 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2017
 
2016
 
2017
 
2016
 
 
 
 
 
 
 
 
 
Net loss
 
$
(10,284
)
 
$
(10,194
)
 
$
(32,466
)
 
$
(39,226
)
Other comprehensive loss:
 
 
 
 
 
 
 
 
Change in fair value of investments
 
23

 

 
(7
)
 

Adjustment for net losses realized and included in net loss
 

 

 
3

 

Total change in unrealized losses on investments
 
23

 

 
(4
)
 

Comprehensive loss
 
$
(10,261
)
 
$
(10,194
)
 
$
(32,470
)
 
$
(39,226
)

The accompanying notes are an integral part of these unaudited consolidated financial statements.



3


RAPID7, INC.
Consolidated Statements of Cash Flows (Unaudited)
(in thousands)
 
 
 
Nine Months Ended September 30,
 
 
2017
 
2016
Cash flows from operating activities:
 
 
 
 
Net loss
 
$
(32,466
)
 
$
(39,226
)
Adjustments to reconcile net loss to net cash provided by operating activities:
 
 
 
 
Depreciation and amortization
 
5,304

 
5,330

Stock-based compensation expense
 
14,738

 
13,337

Provision for doubtful accounts
 
509

 
504

Deferred income taxes
 
(2,632
)
 

Foreign currency re-measurement gain
 
(410
)
 
(166
)
Other non-cash expenses
 
214

 
168

Changes in operating assets and liabilities:
 
 
 
 
Accounts receivable
 
130

 
5,134

Prepaid expenses and other assets
 
601

 
(1,076
)
Accounts payable
 
(322
)
 
549

Accrued expenses
 
803

 
(1,607
)
Deferred revenue
 
19,580

 
18,948

Other liabilities
 
(965
)
 
166

Net cash provided by operating activities
 
5,084

 
2,061

Cash flows from investing activities:
 
 
 
 
Business acquisition, net of cash acquired
 
(14,717
)
 

Purchases of property and equipment
 
(3,506
)
 
(3,307
)
Capitalization of internal-use software costs
 
(756
)
 

Purchases of investments
 
(21,684
)
 

Sale and maturities of investments
 
24,522

 

Net cash used in investing activities
 
(16,141
)
 
(3,307
)
Cash flows from financing activities:
 
 
 
 
Deferred business acquisition payment
 
(796
)
 

Payments of capital lease obligations
 

 
(68
)
Taxes paid related to net share settlement of equity awards
 
(468
)
 
(3,826
)
Proceeds from employee stock purchase plan
 
2,914

 
3,724

Proceeds from stock option exercises
 
4,995

 
2,518

Net cash provided by financing activities
 
6,645

 
2,348

Effect of exchange rate changes on cash and cash equivalents
 
319

 
60

Net (decrease) increase in cash and cash equivalents
 
(4,093
)
 
1,162

Cash and cash equivalents, beginning of period
 
53,148

 
86,553

Cash and cash equivalents, end of period
 
$
49,055

 
$
87,715

Supplemental cash flow information:
 
 
 
 
Cash paid for income taxes
 
$
759

 
$
480

Cash paid for interest
 
$

 
$
1

The accompanying notes are an integral part of these unaudited consolidated financial statements.

4


RAPID7, INC.
Notes to Consolidated Financial Statements (Unaudited)
Note 1. Description of Business, Basis of Presentation and Consolidation and Significant Accounting Policies
Description of Business
Rapid7, Inc. and subsidiaries (“we,” “us” or “our”) is a leading provider of analytics for security and IT operations solutions that enable organizations to implement an active, analytics-driven approach to cyber security and IT operations.
Basis of Presentation and Consolidation
The accompanying unaudited consolidated financial statements have been prepared by us in accordance with accounting principles generally accepted in the United States of America (GAAP) as well as pursuant to the rules and regulations of the Securities and Exchange Commission (SEC) regarding interim financial reporting. Accordingly, certain information and note disclosures normally included in the financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such rules and regulations. These consolidated financial statements should be read in conjunction with the consolidated financial statements and related notes included in our Annual Report on Form 10-K for the year ended December 31, 2016 filed with the SEC on March 9, 2017.
The consolidated financial statements include our results of operations and those of our wholly-owned subsidiaries and reflect all adjustments (consisting solely of normal, recurring adjustments) which are, in the opinion of management, necessary for a fair statement of results for the interim periods presented. All intercompany transactions and balances have been eliminated in consolidation. The results of operations for the three and nine months ended September 30, 2017 are not necessarily indicative of the results to be expected for any future period or the entire fiscal year.

Significant Accounting Policies

There have been no significant changes to our significant accounting policies as of and for the three and nine months ended September 30, 2017, as compared to the significant accounting policies described in our Annual Report on Form 10-K for the year ended December 31, 2016.
Recent Accounting Pronouncements

In May 2017, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2017-09, Compensation-Stock Compensation (Topic 718): Scope of Modification Accounting, clarifying when a change to the terms or conditions of a share-based payment award must be accounted for as a modification. The ASU requires modification accounting if the fair value, vesting condition or the classification of the award is not the same immediately before and after a change to the terms and conditions of the award. The ASU will be effective for us on a prospective basis beginning on January 1, 2018, with early adoption permitted. This ASU is not expected to have an impact on our consolidated financial statements.
In October 2016, the FASB issued ASU 2016-16, Income Taxes (Topic 740): Intra-Entity Transfers of Assets Other Than Inventory. The ASU is intended to improve the accounting for the income tax consequences of intra-entity transfers of assets other than inventory. Current GAAP prohibits the recognition of current and deferred income taxes for an intra-entity asset transfer until the asset has been sold to an outside party. The ASU will allow an entity to recognize the income tax consequences of these transfers when the transfers occur. The ASU will be effective for us in the first quarter of 2018. We are currently evaluating the impact that the adoption of this ASU will have on our consolidated financial statements.
In March 2016, the FASB issued ASU 2016-09, Compensation-Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting. The ASU is intended to simplify several aspects of the accounting for share-based payment transactions, including the accounting for income taxes, forfeitures and statutory tax withholding requirements, as well as classification on the statement of cash flows. We adopted this ASU on January 1, 2017 and as a result, we have made an accounting policy election to account for forfeitures as they occur. This change has been applied on a modified retrospective basis, resulting in a cumulative-effect adjustment to increase accumulated deficit by $0.1 million as of January 1, 2017. The adoption of this ASU also requires excess tax benefits and tax deficiencies be recorded in the income statement as opposed to additional paid-in capital when the awards vest or are settled, and has been applied on a prospective basis. In connection with the adoption of this ASU, we recorded a cumulative-effect adjustment as of January 1, 2017 to increase gross deferred tax assets and the related valuation allowance against deferred tax assets by $3.4 million. The provisions related to classification of excess tax benefits in the statement of cash flows were adopted prospectively, and as such, the prior periods were not retrospectively adjusted.

5


In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842). The ASU requires companies to recognize on the balance sheet the assets and liabilities for the rights and obligations created by leased assets. The ASU will be effective for us in the first quarter of 2019, with early adoption permitted. We are currently evaluating the impact that the adoption of this ASU will have on our consolidated financial statements.
In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606). The ASU outlines a single, comprehensive model for accounting for revenue from contracts with customers and requires more detailed disclosure to enable users of financial statements to understand the nature, amount, timing and uncertainty of revenue and cash flows arising from such contracts. In August 2015, the FASB issued ASU 2015-14, which provides a one-year deferral in the effective date of ASU 2014-09. ASU 2014-09 will now be effective for us beginning January 1, 2018; however, early adoption will be permitted as of the original effective date. We plan to adopt ASU 2014-09 in the first quarter of 2018 and expect to adopt on a modified retrospective basis. Under this method of adoption, we would recognize the cumulative effect of initially applying the standard as an adjustment to the opening balance of retained earnings in the period of initial application. Comparative prior year periods would not be adjusted.
We are currently evaluating the potential impact of this standard on our financial position and results of operations. Based on our analysis performed to date, we expect recognition of total revenue related to our term software licenses, managed services, cloud-based subscriptions and stand-alone professional services to remain substantially unchanged. We expect that revenue related to the sale of our AppSpider perpetual software licenses will be recognized at the time of license delivery because software licenses are not dependent on the continued delivery of content subscriptions. We currently recognize revenue related to the sale of our AppSpider perpetual software licenses over the contractual period of maintenance and support due to the lack of vendor-specific objective evidence (VSOE) of selling price of the maintenance and support. We expect that revenue related to the sale of our Nexpose and Metasploit perpetual software licenses will be combined with their related content subscriptions as a single performance obligation when our contracts contain a material right with respect to renewal options. As a result, we expect to recognize the revenue related to the sale of Nexpose and Metasploit perpetual software licenses ratably over the customer's estimated economic life, rather than over the contractual period of maintenance and support.
In addition, under the new standard, for software licenses that are sold with professional services in a multiple-element arrangement, the professional services will likely represent a separate performance obligation and we will recognize revenue associated with the professional services as such services are performed. Revenue associated with professional services in a multiple-element arrangement is currently recognized ratably over the related contractual period of maintenance and support (typically one to three years) due to the lack of VSOE of selling price for the contractual elements. In addition, under the new standard, we expect the allocation of contract consideration for multiple-element arrangements to be on a relative fair value basis which may impact both the timing of income recognition and the presentation of revenue by class.
Further, under the new standard, we expect to capitalize certain direct and incremental commission costs to obtain a contract and amortize such costs over the customer's estimated economic life rather than expensing them as incurred in the period that the commissions are earned by our employees (which is typically upon signing of an arrangement).
Note 2. Fair Value Measurements
We measure certain financial assets and liabilities at fair value. Fair value is determined based upon the exit price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants, as determined by either the principal market or the most advantageous market. Inputs used in the valuation techniques to derive fair values are classified based on a three-level hierarchy, as follows:
Level 1: Observable inputs that reflect quoted prices (unadjusted) for identical assets or liabilities in active markets.
Level 2: Observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets with insufficient volume or infrequent transactions (less active markets); or model-derived valuations in which all significant inputs are observable or can be derived principally from or corroborated by observable market data for substantially the full term of the assets or liabilities.
Level 3: Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the asset or liability.
We consider an active market to be one in which transactions for the asset or liability occur with sufficient frequency and volume to provide pricing information on an ongoing basis, and consider an inactive market to be one in which there are infrequent or few transactions for the asset or liability, the prices are not current, or price quotations vary substantially either over time or among market makers.

6


The following table presents our financial assets and liabilities measured and recorded at fair value on a recurring basis using the above input categories:
 
 
 
As of September 30, 2017
 
 
Level 1
 
Level 2
 
Level 3
 
Total
 
 
(in thousands)
Description:
 
 
 
 
 
 
 
 
Assets:
 
 
 
 
 
 
 
 
Money market funds
 
$
3,076

 
$

 
$

 
$
3,076

U.S. government agencies
 
12,478

 

 

 
12,478

Commercial paper
 

 
6,729

 

 
6,729

Corporate bonds
 

 
15,455

 

 
15,455

Asset-backed securities
 

 
2,522

 

 
2,522

Total assets
 
$
15,554

 
$
24,706

 
$

 
$
40,260


 
 
As of December 31, 2016
 
 
Level 1
 
Level 2
 
Level 3
 
Total
 
 
(in thousands)
Description:
 
 
 
 
 
 
 
 
Assets:
 
 
 
 
 
 
 
 
Money market funds
 
$
10,085

 
$

 
$

 
$
10,085

U.S. government agencies
 
14,982

 

 

 
14,982

Commercial paper
 

 
8,078

 

 
8,078

Corporate bonds
 

 
10,314

 

 
10,314

Asset-backed securities
 

 
6,467

 

 
6,467

Total assets
 
$
25,067

 
$
24,859

 
$

 
$
49,926

We had no liabilities measured and recorded at fair value on a recurring basis as of September 30, 2017 or December 31, 2016.
Our investments, which are all classified as available-for-sale, consisted of the following:
 
 
As of September 30, 2017
 
 
Amortized Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Fair Value
 
 
(in thousands)
Description:
 
 
 
 
 
 
 
 
U.S. government agencies
 
$
12,494

 
$

 
$
(16
)
 
$
12,478

Commercial paper
 
6,729

 

 

 
6,729

Corporate bonds
 
15,463

 

 
(8
)
 
15,455

Asset-backed securities
 
2,521

 
1

 

 
2,522

Total assets
 
$
37,207

 
$
1

 
$
(24
)
 
$
37,184

Our available-for-sale investments as of September 30, 2017 includes $1.2 million of commercial paper investments which are classified as cash and cash equivalents as the original maturity was less than three months.

7


 
 
As of December 31, 2016
 
 
Amortized Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Fair Value
 
 
(in thousands)
Description:
 
 
 
 
 
 
 
 
U.S. government agencies
 
$
14,992

 
$
3

 
$
(13
)
 
$
14,982

Commercial paper
 
7,178

 

 

 
7,178

Corporate bonds
 
10,326

 
1

 
(13
)
 
10,314

Asset-backed securities
 
6,464

 
4

 
(1
)
 
6,467

Total assets
 
$
38,960

 
$
8

 
$
(27
)
 
$
38,941

For all of our investments for which the amortized cost basis was greater than the fair value at September 30, 2017 and December 31, 2016, we have concluded that there is no plan to sell the security nor is it more likely than not that we would be required to sell the security before its anticipated recovery. In making the determination as to whether the unrealized loss is other-than-temporary, we considered the length of time and extent the investment has been in an unrealized loss position, the financial condition and near-term prospects of the issuers, the issuers’ credit rating and the time to maturity.

Note 3. Business Combination
On July 12, 2017, we acquired Komand, Inc. (Komand), a security orchestration and automation company based in Boston, Massachusetts for total cash consideration of $14.8 million. We expensed the related acquisition costs of $0.2 million in general and administrative expense.
The following table summarizes the cash consideration paid for Komand and the preliminary allocation of purchase price to the estimated fair value of the assets acquired and liabilities assumed at the acquisition date (in thousands):
Cash consideration
$
14,781

 
 
Recognized amount of identifiable assets acquired and liabilities assumed:
 
Net working capital
(27
)
Deferred tax liability
(2,632
)
Intangible assets
9,380

Total identifiable net assets assumed
6,721

Goodwill
8,060

Total purchase price allocation
$
14,781

The fair value of identifiable intangible assets were based on valuations using a combination of the income and cost approach. The estimated fair value and useful life of identifiable intangible assets are as follows:
 
Amount
 
Weighted Average Amortization Life (years)
 
(in thousands)
 
 
Developed technology
$
9,380

 
5
Identifiable intangible assets
$
9,380

 
 
The excess of the purchase price over the tangible assets acquired, identifiable intangible asset acquired and assumed liabilities was recorded as goodwill. We believe that the amount of goodwill reflects the expected synergistic benefits of being able to leverage the integration of our existing product offerings and services with the products and technology acquired in connection with our acquisition of Komand and to be able to successfully market and sell these new products to our customer base. The goodwill was allocated to our one reporting unit. The acquired goodwill and intangible asset will not be deductible for tax purposes. Accordingly, a $2.6 million deferred tax benefit was recorded during the three months ended September 30, 2017 resulting from a partial release of our valuation allowance to account for the creation of a deferred tax liability for the developed technology intangible asset acquired which is not deductible for tax purposes.
These preliminary amounts are subject to subsequent adjustment as we obtain additional information to finalize certain components of working capital.

8


Following the acquisition, certain retained employees of Komand (i) received an aggregate of 295,600 restricted stock units which will vest over four years and (ii) shall be eligible for an aggregate of up to $5.0 million of incentive payments contingent on achievement of certain milestones within four years of the acquisition date. The vesting of the restricted stock units and eligibility to receive the incentive payments are each subject to the employee's continued service with us. Accordingly, compensation expense associated with the restricted stock units and incentive payments will be expensed as incurred in our post-acquisition financial statements.
Proforma results of operations have not been included, as the acquisition of Komand was not material to our results of operations for any periods presented.

Note 4. Property and Equipment
Property and equipment are recorded at cost and consist of the following:
 
 
As of
September 30, 2017
 
As of
December 31, 2016
 
 
(in thousands)
Computer equipment and software
 
$
15,024

 
$
12,844

Furniture and fixtures
 
3,629

 
3,131

Leasehold improvements
 
8,737

 
8,077

Total
 
27,390

 
24,052

Less accumulated depreciation
 
(19,395
)
 
(15,964
)
Property and equipment, net
 
$
7,995

 
$
8,088

Depreciation expense was $1.2 million and $1.1 million for the three months ended September 30, 2017 and 2016, respectively and $3.4 million for the nine months ended September 30, 2017 and 2016.
Note 5. Goodwill and Intangible Assets
Goodwill was $83.2 million and $75.1 million as of September 30, 2017 and December 31, 2016, respectively. The following table displays the changes in goodwill:
 
Amount
 
(in thousands)
Balance at December 31, 2016
$
75,110

Komand acquisition
8,060

Balance at September 30, 2017
$
83,170

The following table presents details of our intangible assets which include acquired identifiable intangible assets and capitalized internal-use software costs:
 
 
 
As of September 30, 2017
 
As of December 31, 2016
 
Weighted-
Average
Life (years)
 
Gross Carrying
Amount
 
Accumulated
Amortization
 
Net Book Value
 
Gross Carrying
Amount
 
Accumulated
Amortization
 
Net Book Value
 
 
 
(in thousands)
Intangible assets subject to amortization:
 
 
 
 
 
 
 
 
 
 
 
 
 
Developed technology
5.7
 
$
20,611

 
$
(4,848
)
 
$
15,763

 
$
11,231

 
$
(3,118
)
 
$
8,113

Customer relationships
6.7
 
1,000

 
(312
)
 
688

 
1,000

 
(197
)
 
803

Trade names
6.1
 
519

 
(507
)
 
12

 
519

 
(496
)
 
23

Non-compete agreements
2.0
 
40

 
(40
)
 

 
40

 
(33
)
 
7

Total acquired intangible assets
 
 
22,170

 
(5,707
)
 
16,463

 
12,790

 
(3,844
)
 
8,946

Internal-use software
 
 
756

 
(11
)
 
745

 

 

 

Total intangible assets
 
 
$
22,926

 
$
(5,718
)
 
$
17,208

 
$
12,790

 
$
(3,844
)
 
$
8,946


9


Amortization expense was $0.9 million and $0.8 million for the three months ended September 30, 2017 and 2016, respectively, and $1.9 million for the nine months ended September 30, 2017 and 2016.
Estimated future amortization expense of the acquired identifiable intangible assets and completed capitalized internal-use software costs as of September 30, 2017 is as follows (in thousands):
2017 (for the remaining three months)
$
970

2018
3,840

2019
3,813

2020
3,760

2021
3,208

2022 and thereafter
1,095

Total
$
16,686


The table above excludes the impact of $0.5 million of capitalized internal-use software costs for projects that have not been completed as of September 30, 2017, and therefore, we have not determined the useful life of the software, nor have all the costs associated with these projects been incurred.
Note 6. Stock-Based Compensation Expense
 
(a)
General
Stock-based compensation expense for restricted stock, restricted stock units, stock options and issuances of common stock pursuant to our employee stock purchase plan was classified in the accompanying consolidated statements of operations as follows:
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2017
 
2016
 
2017
 
2016
 
 
(in thousands)
Stock-based compensation expense:
 
 
 
 
 
 
 
 
Cost of revenue
 
$
305

 
$
166

 
$
815

 
$
445

Research and development
 
1,986

 
1,600

 
5,188

 
4,617

Sales and marketing
 
1,512

 
1,328

 
4,694

 
5,453

General and administrative
 
1,485

 
1,083

 
4,041

 
2,822

Total stock-based compensation expense
 
$
5,288

 
$
4,177

 
$
14,738

 
$
13,337

We recognize compensation cost of all awards on a straight-line basis over the applicable vesting period, which is generally four years.
(b)
Restricted Stock and Restricted Stock Units
Restricted stock and restricted stock unit activity during the nine months ended September 30, 2017 was as follows:
 
 
 
Restricted Stock
 
Restricted Stock Units
 
 
Shares
 
Weighted-Average
Grant Date
Fair Value
 
Shares
 
Weighted-Average
Grant Date
Fair Value
Unvested balance as of December 31, 2016
 
585,004

 
$
18.05

 
734,577

 
$
13.47

Granted
 

 

 
1,863,510

 
14.83

Vested
 
(292,210
)
 
17.36

 
(320,724
)
 
13.77

Forfeited
 
(14,093
)
 
23.01

 
(207,740
)
 
14.02

Unvested balance as of September 30, 2017
 
278,701

 
$
18.52

 
2,069,623

 
$
14.59

As of September 30, 2017, the unrecognized compensation expense related to our unvested restricted stock and restricted stock units expected to vest was $32.5 million. This unrecognized compensation expense will be recognized over an estimated weighted-average amortization period of 3.0 years.

10


During the nine months ended September 30, 2017, we repurchased 16,144 shares of our common stock in settlement of employee tax withholding obligations due upon the vesting of restricted stock.
(c)
Stock Options
Stock option activity during the nine months ended September 30, 2017 was as follows:
 
 
Shares
 
Weighted
Average
Exercise
Price
 
Weighted
Average
Remaining
Contractual Life
(in years)
 
Aggregate
Intrinsic
Value
(in thousands)
Outstanding as of December 31, 2016
 
4,580,375

 
$
8.20

 
 
 
 
Granted
 
1,274,238

 
13.41

 
 
 
 
Exercised
 
(785,550
)
 
6.38

 
 
 
$
8,598

Forfeited/cancelled
 
(290,813
)
 
12.73

 
 
 
 
Outstanding as of September 30, 2017
 
4,778,250

 
$
9.61

 
7.3
 
$
38,422

Vested and exercisable as of September 30, 2017
 
2,714,463

 
$
6.90

 
6.0
 
$
29,173

As of September 30, 2017, the unrecognized compensation expense related to our unvested stock options expected to vest was $12.0 million. This unrecognized compensation expense will be recognized over an estimated weighted-average amortization period of 2.7 years.
The total fair value of stock options vested in the nine months ended September 30, 2017 was $5.9 million. The weighted-average grant date fair value of stock options granted in the nine months ended September 30, 2017 was $6.66 per share.

(d)
Employee Stock Purchase Plan
Under the Rapid7, Inc. 2015 Employee Stock Purchase Plan (ESPP), employees may set aside up to 15% of their gross earnings, on an after-tax basis, to purchase our common shares at a discounted price, which is calculated at 85% of the lesser of: (i) the market value of our common stock at the beginning of each offering period and (ii) the market value of our common stock on the applicable purchase date.
On March 15, 2017, we issued 138,085 shares of common stock to employees for aggregate proceeds of $1.5 million. The purchase prices of the shares of common stock were $10.60 and $12.79 per share, which were discounted in accordance with the terms of the ESPP from the closing prices of our common stock on March 16, 2016 of $12.47 and on March 15, 2017 of $15.05, respectively.
On September 15, 2017, we issued 109,144 shares of common stock to employees for aggregate proceeds of $1.4 million. The purchase price of the shares of common stock was $12.96 per share, which was discounted in accordance with the terms of the ESPP from the closing price of our common stock on March 16, 2017 of $15.25.
Note 7. Net Loss per Share
The following table summarizes the computation of basic and diluted net loss per share of our common stock for the three and nine months ended September 30, 2017 and 2016:
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2017
 
2016
 
2017
 
2016
 
(in thousands, except share and per share data)
Numerator:
 
 
 
 
 
 
 
Net loss
$
(10,284
)
 
$
(10,194
)
 
$
(32,466
)
 
$
(39,226
)
Denominator:
 
 
 
 
 
 
 
Weighted-average common shares outstanding, basic and diluted
43,279,025

 
41,482,173

 
42,693,212

 
41,033,080

Net loss per share attributable to common stockholders, basic and diluted
$
(0.24
)
 
$
(0.25
)
 
$
(0.76
)
 
$
(0.96
)

11


The following potentially dilutive securities outstanding, prior to the use of the treasury stock method or if-converted method, have been excluded from the computation of diluted weighted-average shares outstanding for the respective periods below because they would have been anti-dilutive:
 
Three and Nine Months Ended September 30,
 
2017
 
2016
Options to purchase common stock
4,778,250

 
4,520,062

Unvested restricted stock
278,701

 
696,187

Unvested restricted stock units
2,069,623

 
657,427

Shares to be issued under ESPP
9,614

 
15,087

Total
7,136,188

 
5,888,763

Note 8. Commitments and Contingencies
 
(a)
Warranty
We provide limited product warranties. Historically, any payments made under these provisions have been immaterial.
(b)
Litigation and Claims
From time to time, we may be a party to litigation or subject to claims incident to the ordinary course of business. Although the results of litigation and claims cannot be predicted with certainty, we currently believe that the final outcome of these ordinary course matters will not have a material adverse effect on our business. Regardless of the outcome, litigation can have an adverse impact on us because of defense and settlement costs, diversion of management resources and other factors.
(c)
Indemnification Obligations
We agree to standard indemnification provisions in the ordinary course of business. Pursuant to these provisions, we agree to indemnify, hold harmless and reimburse the indemnified party for losses suffered or incurred by the indemnified party, generally our customers, in connection with any United States patent, copyright or other intellectual property infringement claim by any third party arising from the use of our products or services in accordance with the agreement or arising from our gross negligence, willful misconduct or violation of the law (provided that there is not gross or willful misconduct on the part of the other party) with respect to our products or services. The term of these indemnification provisions is generally perpetual from the time of execution of the agreement. We carry insurance that covers certain third-party claims relating to our services and limits our exposure. We have never incurred costs to defend lawsuits or settle claims related to these indemnification provisions.
As permitted under Delaware law, we have entered into indemnification agreements with our officers and directors, indemnifying them for certain events or occurrences while they serve as officers or directors of the company.
Note 9. Segment Information and Information about Geographic Areas
We operate in one segment. Our chief operating decision maker is our chief executive officer, who makes operating decisions, assesses performance and allocates resources on a consolidated basis.
Net revenues by geographic area presented based upon the location of the customer were as follows: 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2017
 
2016
 
2017
 
2016
 
(in thousands)
North America
$
42,966

 
$
34,538

 
$
121,177

 
$
96,957

Other
7,555

 
5,801

 
22,032

 
15,446

Total
$
50,521

 
$
40,339

 
$
143,209

 
$
112,403

Of the total net revenues generated in North America, 93% and 94% of the revenues were generated in the United States for the three months ended September 30, 2017 and 2016, respectively, and 93% and 96% of the revenues were generated in the United States for the nine months ended September 30, 2017 and 2016, respectively.
Property and equipment, net by geographic area was as follows:

12


 
 
As of September 30, 2017
 
As of December 31, 2016
 
(in thousands)
United States
$
6,646

 
$
7,063

Other
1,349

 
1,025

Total
$
7,995

 
$
8,088

Note 10. Related Party Transactions
In October 2015, McAfee LLC (formerly known as Intel Security) announced the end-of-sale for the McAfee Vulnerability Manager to customers and partners, effective January 11, 2016, with end-of-life to follow, and announced that we were named their exclusive vulnerability management partner. Under the terms of the commercial agreement, we incur partner referral fees as customers transition from McAfee Vulnerability Manager to Nexpose. During the three and nine months ended September 30, 2017, we recognized sales and marketing expense of $0.4 million and $2.3 million, respectively, related to partner referral fees payable to McAfee LLC. On February 6, 2017, Michael Berry, a member of our Board of Directors, became the Chief Financial Officer of McAfee LLC.
Note 11. Subsequent Event

In October 2017, we entered into a lease agreement for a new facility in Austin, Texas for approximately 26,000 square feet.  We expect to occupy the new office space in September 2018 and the lease term is 86 months.  Our total obligation for the rent is approximately $7.6 million over the term of the lease.  







13


Item 2.    Management's Discussion and Analysis of Financial Condition and Results of Operations.
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with (1) our consolidated financial statements and related notes appearing elsewhere in this Quarterly Report on Form 10-Q and (2) the audited consolidated financial statements and the related notes and management’s discussion and analysis of financial condition and results of operations for the fiscal year ended December 31, 2016 included in our Annual Report on Form 10-K, filed with the SEC on March 9, 2017.
This Quarterly Report on Form 10-Q contains “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, or the Securities Act, and Section 21E of the Securities Exchange Act of 1934, as amended, or the Exchange Act. These statements are often identified by the use of words such as “anticipate,” “believe,” “continue,” “could,” “estimate,” “expect,” “intend,” “may,” “plan,” “project,” “will,” “would” or the negative or plural of these words or similar expressions or variations. Such forward-looking statements are subject to a number of risks, uncertainties, assumptions and other factors that could cause actual results and the timing of certain events to differ materially from future results expressed or implied by the forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those identified herein, and those discussed in the section titled “Risk Factors,” set forth in Part II, Item 1A of this Quarterly Report on Form 10-Q and in our other SEC filings. You should not rely upon forward-looking statements as predictions of future events. Furthermore, such forward-looking statements speak only as of the date of this report. Except as required by law, we undertake no obligation to update any forward-looking statements to reflect events or circumstances after the date of such statements.
Overview
Rapid7 is a leading provider of analytics for security and IT operations that enable organizations to implement an active, analytics-driven approach to cyber security and IT operations. Our data and analytics platform was purpose-built for today’s increasingly complex and chaotic IT environment. We make it simple to collect and unify operational data from across the entire IT infrastructure, and our advanced analytics unlock the information required to securely operate, manage and develop today's sophisticated applications and services.
We combine our extensive experience in collecting disparate data, deep insight into attacker behaviors and techniques and our purpose-driven analytics to make sense of the wealth of data available to organizations about their IT environments and users. Our powerful and proprietary analytics enable organizations to contextualize and prioritize the threats facing their physical, virtual and cloud assets, including those posed by the behaviors of their users. Leveraging our IT data and analytics platform, our solutions enable organizations to strategically and dynamically manage their cyber security exposure and manage IT operations. Our solutions empower organizations to prevent attacks by providing visibility into vulnerabilities, and allow them to rapidly detect compromises, respond to breaches and correct the underlying causes of attacks. By providing a unified IT and security platform, with automated workflow, we enable IT and security to work together more effectively to develop, operate and secure their environment. For example, our platform and proprietary technologies were developed to help customers identify the weaknesses and exposures in their environment and are designed to enable them to detect and respond to breaches immediately. We help them troubleshoot performance issues across their infrastructure, applications and endpoints. Our platform approach enables organizations to collect data once and use it for ongoing unlimited use and access to solve the specific problems their organization faces, reducing the costs and overhead associated with relying on point solutions, and enabling workflow between organizations that must work together to resolve issues, reduce risk and increase resiliency.
We market and sell our products and professional services to global organizations of all sizes, including mid-market businesses, enterprises, non-profits, educational institutions and government agencies. Our customers span a wide variety of industries such as technology, energy, financial services, healthcare and life sciences, manufacturing, media and entertainment, retail, education, real estate, transportation, government and professional services. As of September 30, 2017, we had over 6,700 customers in 125 countries, including 39% of the Fortune 1000. Our revenue was not concentrated with any individual customer or group of customers, and no customer represented more than 2% of our revenue for the three or nine months ended September 30, 2017 or 2016.
We sell our products and services through direct inside and field sales teams and indirect channel partner relationships. Our global sales teams focus on both new customer acquisition and up-selling and cross-selling additional offerings to our existing customers. Our sales teams are organized by geography, consisting of the Americas; Europe, the Middle East and Africa; and Asia Pacific, or APAC, as well as by target organization size. Our inside sales team focuses on small and middle-market transactions, while larger or more complex transactions are generally handled by our globally distributed direct field sales teams. Our highly technical sales engineers help define customer use cases, manage solution evaluations and train channel partners.


14


Our Business Model
We have three offerings: (1) threat exposure management, which includes our Nexpose, InsightVM, Metasploit, AppSpider, InsightAppSec and Komand products, (2) incident detection and response, which includes our InsightIDR, Managed Detection and Response (formerly known as "Analytic Response"), InsightOps and Logentries products as well as our incident response services and (3) security advisory services.
We offer our products through a variety of delivery models to meet the needs of our diverse customer base, including:
 
Licensed software, including both term and perpetual licenses, and the sale of maintenance and support. Our Nexpose, Metasploit and AppSpider products are offered through perpetual or term software licenses, with a majority of our customers selecting a perpetual license. Our customers who purchase software licenses also purchase maintenance and support, which provides our customers with telephone and web-based support and ongoing bug fixes and repairs during the term of the maintenance and support agreement, and our customers who purchase our Nexpose and Metasploit products also purchase content subscriptions, which provide our customers with real-time access to the latest vulnerabilities and exploits. Our maintenance and support and content subscription agreements are typically for one to three-year terms. In addition, our Komand product offering is offered through term licenses.
 
Cloud-based subscriptions, which provide our software capabilities to our customers through cloud access and on a Software as a Service, or SaaS, basis. Our InsightIDR, InsightVM, InsightAppSec, Logentries and InsightOps products are offered on cloud-based subscriptions, generally with one to three-year terms.
Managed services, through which we operate our products and provide our capabilities on behalf of our customers. Our Managed Vulnerability Management (Nexpose), Managed Application Security (AppSpider) and Managed Detection and Response (InsightIDR) products are offered on a managed service basis, generally pursuant to one to three-year agreements.
We also offer various professional services across all of our offerings, including deployment and training services related to our software and cloud-based products, incident response services and security advisory services. Customers can purchase our professional services together with our product offerings or on a stand-alone basis pursuant to fixed fee or time-and-materials agreements.
An important component of our revenue growth strategy is to have our existing customers renew their agreements with us and purchase additional products from us. To assess our performance against this objective, we monitor the renewal rates of our existing customers. We calculate our renewal rate by dividing the dollar value of renewed customer agreements, including upsells and cross-sells of additional products, but excluding professional services and Logentries, in a trailing 12-month period by the dollar value of the corresponding customer agreements. We also calculate an expiring renewal rate that does not take into account any upsells or cross-sells. As a result of this methodology, we would not expect our expiring renewal rate to exceed 100%. Our renewal rate was 119% and 121% for the third quarter of 2017 and 2016, respectively, and our expiring renewal rate was 89% for the third quarter of 2017 and 2016. Our goal is to maintain what we believe are strong renewal rates, and work to increase them over time. However, our renewal rates may decline or fluctuate as a result of a number of factors, including customers’ satisfaction or dissatisfaction with our products and professional services, pricing, competitive offerings, economic conditions or overall changes in our customers’ spending levels.
We generate revenue from selling products, maintenance and support, and professional services. For the three months ended September 30, 2017 and 2016, 82% and 81% of our revenue, respectively, was derived from sales of products and associated maintenance and support, while the remaining 18% and 19%, respectively, was derived from the sale of professional services. For the nine months ended September 30, 2017 and 2016, 81% and 82% of our revenue, respectively, was derived from sales of products and associated maintenance and support, while the remaining 19% and 18%, respectively, was derived from the sale of professional services.
For the three months ended September 30, 2017 and 2016, recurring revenue, defined as revenue from term software licenses, content subscriptions, managed services, cloud-based subscriptions and maintenance and support, was 70.5% and 67.7%, respectively, of total revenue. For the nine months ended September 30, 2017 and 2016, recurring revenue was 69.8% and 67.4%, respectively, of total revenue. In prior years, we did not include term software licenses in the calculation of recurring revenue. As a result, for the three and nine months ended September 30, 2016, our recurring revenue was recast from 62.0%, as previously disclosed, to 67.7% and 67.4%, respectively.
For the three months ended September 30, 2017 and 2016, 86% and 85%, respectively, of our total revenue came from deferred revenue on the balance sheet at the beginning of the respective periods. For the nine months ended September 30, 2017 and 2016,

15


66% and 64%, respectively, of our total revenue came from deferred revenue on the balance sheet at the beginning of the respective periods. We have made adjustments to the historical calculation of revenue from deferred revenue and as a result, for the three and nine months ended September 30, 2016, our total revenue from deferred revenue was recast from 87% and 65%, respectively, as previously disclosed, to 85% and 64%, respectively. We generally bill customers and collect payment for both our products and services up front.
Other Business Metrics
We regularly monitor a number of financial and operating metrics in order to measure our current performance and estimate our future performance. Our other business metrics may be calculated in a manner different than similar other business metrics used by other companies.
 
 
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
 
2017
 
2016
 
2017
 
2016
 
 
(dollars in thousands)
Total revenue
 
$
50,521

 
$
40,339

 
$
143,209

 
$
112,403

Year-over-year growth
 
25.2
%
 
42.5
%
 
27.4
%
 
44.7
%
Calculated billings (non-GAAP)
 
$
58,735

 
$
44,881

 
$
162,789

 
$
131,350

Operating cash flow
 
$
5,744

 
$
1,790

 
$
5,084

 
$
2,061

 
 
 
As of September 30,
 
 
2017
 
2016
Deferred revenue
 
$
188,643

 
$
149,264

Number of customers
 
6,735

 
5,873

Total Revenue and Growth. We are focused on driving continued revenue growth through increased sales of our products and professional services to new and existing customers.
Calculated Billings (non-GAAP). Calculated billings is a non-GAAP measure that we define as total revenue recognized in accordance with generally accepted accounting principles, or GAAP, plus the change in deferred revenue from the beginning to the end of the period. We consider calculated billings to be a useful metric for management and investors, as a supplement to the corresponding GAAP measure of total revenue, because billings drive deferred revenue, which is an important indicator of the health and visibility of trends in our business, and represents a significant percentage of future revenue. We regularly monitor calculated billings because we believe the measure offers valuable information regarding the performance of our business and will help investors better understand the sales activity and performance of our business for a particular period. With the expansion of our subscription, cloud-based product offerings (InsightVM, InsightIDR, InsightAppSec, and InsightOps) on the Insight platform, we may realize a shortening of our average contract duration, which should be taken into consideration when evaluating calculated billings. Our use of calculated billings has limitations as an analytical tool and should not be considered in isolation or as a substitute for revenue recognition or revenue measurement, or an analysis of our results as reported under GAAP. Also, it is important to note that other companies, including companies in our industry, may not use calculated billings, may compute billings differently, may have different billing frequencies, or may use other financial measures to evaluate their performance, all of which could reduce the usefulness of calculated billings as a comparative measure.
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2017
 
2016
 
2017
 
2016
 
 
(in thousands)
Total revenue
 
$
50,521

 
$
40,339

 
$
143,209

 
$
112,403

Add: Deferred revenue, end of period
 
188,643

 
149,264

 
188,643

 
149,264

Less: Deferred revenue, beginning of period
 
180,429

 
144,722

 
169,063

 
130,317

Calculated billings
 
$
58,735

 
$
44,881

 
$
162,789

 
$
131,350


16


Operating Cash Flow. We monitor our operating cash flow as a measure of our overall business performance, which enables us to analyze our financial performance without the effects of certain non-cash items such as stock-based compensation expenses and depreciation and amortization. Additionally, operating cash flow takes into account the increase in deferred revenue as a result of increases in sales of products and services, which reflects the receipt of cash payment for products before they are recognized into revenue. Our operating cash flow is significantly impacted by the timing of commission and bonus payments, accounts payable payments and collections of accounts receivable.
Deferred Revenue. We believe that deferred revenue is an important metric as it provides visibility into the revenue to be recognized in future periods. Our deferred revenue consists of amounts that have been invoiced to customers but that have not yet been recognized as revenue. Our deferred revenue balance primarily consists of the portion of products, maintenance and support and professional services revenue that will be recognized ratably over the applicable maintenance and support contract period. Revenue from professional services that are sold on a stand-alone basis is recognized as those services are rendered.
Number of Customers. We believe that the size of our customer base is an indicator of our global market penetration and that our net customer additions are an indicator of the growth of our business. We define a customer as any entity that has (1) an active Rapid7 contract or a contract that expired within 90 days or less of the applicable measurement date; and for Logentries products, those customers with a contract value equal to or greater than $2,400 per year, or (2) purchased Rapid7 professional services within the 12 months preceding the applicable measurement date.

Non-GAAP Financial Results
To supplement our consolidated financial statements, which are prepared and presented in accordance with GAAP, we provide investors with certain non-GAAP financial measures, including non-GAAP gross profit, non-GAAP operating loss, non-GAAP net loss, and non-GAAP net loss per share, which we collectively refer to as non-GAAP financial measures. These non-GAAP financial measures exclude all or a combination of the following (as reflected in the following reconciliation tables): stock-based compensation expense, amortization of acquired intangible assets, certain acquisition-related expenses and certain non-recurring items. The presentation of the non-GAAP financial measures is not intended to be considered in isolation or as a substitute for, or superior to, the financial information prepared and presented in accordance with GAAP. We use these non-GAAP financial measures for financial and operational decision-making purposes and as a means to evaluate period-to-period comparisons, and use certain non-GAAP financial measures as performance measures under our executive bonus plan. We believe that these non-GAAP financial measures provide useful information about our operating results, enhance the overall understanding of past financial performance and future prospects and allow for greater transparency with respect to metrics used by our management in its financial and operational decision-making. While our non-GAAP financial measures are an important tool for financial and operational decision-making and for evaluating our own operating results over different periods of time, you should review the reconciliation of our non-GAAP financial measures to the comparable GAAP financial measures included below, and not rely on any single financial measure to evaluate our business.
We exclude stock-based compensation expense because of varying available valuation methodologies, subjective assumptions and the variety of equity instruments that can impact our non-cash expense. We believe that providing non-GAAP financial measures that exclude stock-based compensation expense allow for more meaningful comparisons between our operating results from period to period. We believe that excluding the impact of amortization of acquired intangible assets allows for more meaningful comparisons between operating results from period to period as the intangibles are valued at the time of acquisition and are amortized over several years after the acquisition. We also exclude the impact of certain costs directly related to acquisitions and asset impairments as these costs are unrelated to the current operations and neither comparable to the prior period nor predictive of future results, which we believe allows for a more meaningful comparison between the operating results from period to period. Accordingly, we believe that excluding these expenses provides investors and management with greater visibility into the underlying performance of our business operations, facilitates comparison of our results with other periods and may also facilitate comparison with the results of other companies in our industry.
Our non-GAAP financial measures may not provide information that is directly comparable to that provided by other companies in our industry, as other companies in our industry may calculate non-GAAP financial results differently, particularly related to non-recurring, unusual items. In addition, there are limitations in using non-GAAP financial measures because the non-GAAP financial measures are not prepared in accordance with GAAP, may be different from non-GAAP financial measures used by other companies and exclude expenses that may have a material impact upon our reported financial results. Further, stock-based compensation expense has been and will continue to be for the foreseeable future a significant recurring expense in our business and an important part of the compensation provided to our employees.
The following tables reconcile GAAP gross profit to non-GAAP gross profit in total and by revenue class for the three and nine months ended September 30, 2017 and 2016:

17


 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2017
 
2016
 
2017
 
2016
 
 
(in thousands)
GAAP total gross profit
 
$
36,154

 
$
30,301

 
$
103,499

 
$
84,360

Stock-based compensation expense
 
305

 
166

 
815

 
445

Amortization of acquired intangible assets
 
853

 
447

 
1,731

 
1,338

Non-GAAP total gross profit
 
$
37,312

 
$
30,914

 
$
106,045

 
$
86,143

 
 
 
 
 
 
 
 
 
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2017
 
2016
 
2017
 
2016
 
 
(in thousands)
GAAP gross profit – products
 
$
22,738

 
$
19,693

 
$
65,581

 
$
56,009

Stock-based compensation expense
 
92

 
11

 
242

 
42

Amortization of acquired intangible assets
 
853

 
447

 
1,731

 
1,338

Non-GAAP gross profit – products
 
$
23,683

 
$
20,151

 
$
67,554

 
$
57,389

 
 
 
 
 
 
 
 
 
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2017
 
2016
 
2017
 
2016
 
 
(in thousands)
GAAP gross profit – maintenance and support
 
$
9,915

 
$
7,893

 
$
28,327

 
$
21,797

Stock-based compensation expense
 
71

 
41

 
212

 
154

Non-GAAP gross profit – maintenance and support
 
$
9,986

 
$
7,934

 
$
28,539

 
$
21,951

 
 
 
 
 
 
 
 
 
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2017
 
2016
 
2017
 
2016
 
 
(in thousands)
GAAP gross profit – professional services
 
$
3,501

 
$
2,715

 
$
9,591

 
$
6,554

Stock-based compensation expense
 
142

 
114

 
361

 
249

Non-GAAP gross profit – professional services
 
$
3,643

 
$
2,829

 
$
9,952

 
$
6,803

The following table reconciles GAAP loss from operations to non-GAAP loss from operations for the three and nine months ended September 30, 2017 and 2016:
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2017
 
2016
 
2017
 
2016
 
 
(in thousands)
GAAP loss from operations
 
$
(13,042
)
 
$
(10,204
)
 
$
(35,409
)
 
$
(39,104
)
Stock-based compensation expense
 
5,288

 
4,177

 
14,738

 
13,337

Amortization of acquired intangible assets
 
894

 
769

 
1,863

 
1,935

Acquisition-related expenses
 
87

 

 
167

 

Non-GAAP loss from operations
 
$
(6,773
)
 
$
(5,258
)
 
$
(18,641
)
 
$
(23,832
)
The following table reconciles GAAP net loss to non-GAAP net loss for the three and nine months ended September 30, 2017 and 2016:

18


 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2017
 
2016
 
2017
 
2016
 
 
(in thousands, except share and per share data)
GAAP net loss
 
(10,284
)
 
(10,194
)
 
(32,466
)
 
(39,226
)
Stock-based compensation expense
 
5,288

 
4,177

 
14,738

 
13,337

Amortization of acquired intangible assets
 
894

 
769

 
1,863

 
1,935

Acquisition-related expenses
 
87

 

 
167

 

Release of valuation allowance, acquisition-related
 
(2,632
)
 

 
(2,632
)
 

Non-GAAP net loss
 
$
(6,647
)
 
$
(5,248
)
 
$
(18,330
)
 
$
(23,954
)
Non-GAAP net loss per share, basic and diluted
 
$
(0.15
)
 
$
(0.13
)
 
$
(0.43
)
 
$
(0.58
)
Weighted-average common shares outstanding, basic and diluted
 
43,279,025

 
41,482,173

 
42,693,212

 
41,033,080


Components of Results of Operations
Revenue
We generate revenue primarily from selling products, maintenance and support and professional services through a variety of delivery models to meet the needs of our diverse customer base. We generally bill customers and collect payment for both our products and services up front.
Products
We generate products revenue from the sale of (1) perpetual or term software licenses for our Nexpose, Metasploit and AppSpider products, term licenses for our product offering recently acquired from Komand, as well as associated content subscriptions for our Nexpose and Metasploit products, (2) managed services for our Nexpose, AppSpider and InsightIDR products and (3) cloud-based subscriptions for our InsightVM, InsightIDR, InsightAppSec, InsightOps, AppSpider and Logentries products. We also generate an immaterial amount of appliance revenue that is included in our products revenue and is associated with hardware sold as part of our Nexpose product to certain customers. Revenue for perpetual software licenses and related services that are sold along with the software license is deferred on our balance sheet and recognized as revenue on our consolidated statements of operations ratably over the contractual period of the maintenance and support, which is typically one to three years. Revenue for our managed services and cloud-based subscription offerings is recognized on our consolidated statements of operations ratably over the term of the managed service agreement or subscription, provided that all other revenue recognition criteria have been met.
Maintenance and Support
We generate maintenance and support revenue when customers purchase or renew agreements for maintenance and support of their Nexpose, Metasploit and AppSpider software licenses. Substantially all of our customers purchase an agreement for maintenance and support in connection with their purchase of a Nexpose, Metasploit or AppSpider software license. Revenue from maintenance and support is recognized ratably over the term of the applicable agreement.
Professional Services
We generate professional service revenue from the sale of deployment and training services related to our products, incident response services and security advisory services. Revenue from professional services sold together with our perpetual and term software licenses product offerings is recognized ratably over the term of the applicable agreement. Revenue from professional services sold on a stand-alone basis or with non-software products is recognized as those services are rendered.
Cost of Revenue
Our total cost of revenue consists of the costs of products, maintenance and support and professional services revenue.

19


Cost of Products
Cost of products consists of personnel and related costs for our content, managed service and cloud operations team, including salaries and other payroll related costs, bonuses, stock-based compensation and allocated overhead costs, which consist of IT, information security, recruiting, facilities and depreciation and are allocated based on relative headcount. Also included in cost of products are software license fees, hardware, cloud computing costs and internet connectivity expenses directly related to delivering our products, as well as amortization of certain intangible assets.
Cost of Maintenance and Support
Cost of maintenance and support consists of personnel and related costs for our support team, including salaries and other payroll related costs, bonuses, stock-based compensation and allocated overhead.
Cost of Professional Services
Cost of professional services consists of personnel and related costs for our professional services team, including salaries and other payroll related costs, bonuses, stock-based compensation, costs of contracted third-party vendors, travel and entertainment expenses and allocated overhead.
We expect our cost of revenue to increase on an absolute dollar basis as we continue to grow our revenue.
Gross Margin
Gross margin, or gross profit as a percentage of revenue, has been and will continue to be affected by a variety of factors, including the average sales price of our products and services, transaction volume growth, the mix of revenue between software licenses, cloud-based subscriptions, managed services and professional services and changes in cloud computing costs.
We expect our gross margins to decrease slightly as we expect revenue from our cloud-based subscriptions and managed services to increase as a percentage of total revenue, each of which generally have a lower gross margin than our software licenses.
Operating Expenses
Operating expenses consist of research and development, sales and marketing, and general and administrative expenses. Operating expenses include allocated overhead costs for depreciation, facilities, IT, information security and recruiting. Our allocated costs for IT include costs for compensation of IT personnel and costs associated with our IT infrastructure. All allocated overhead costs are allocated based on relative headcount.
Research and Development Expense
Research and development expense consists of personnel costs for our research and development team, including salaries and other payroll related costs, bonuses and stock-based compensation. Additional expenses include subcontracting, travel and entertainment, consulting and professional fees for third-party development resources as well as allocated overhead.
We expect research and development expense to increase on an absolute dollar basis in the near term as we continue to increase investments in our products and technology platform innovation, but to decrease as a percentage of total revenue.
Sales and Marketing Expense
Sales and marketing expense consists of personnel costs for our sales and marketing team, including salaries and other payroll related costs, commissions, bonuses and stock-based compensation. Additional expenses include marketing activities and promotional events, travel and entertainment, training costs, amortization of certain intangible assets and allocated overhead.
We expect sales and marketing expense to increase on an absolute dollar basis in the near term as we continue to increase investments to drive our revenue growth, but to decrease as a percentage of total revenue.
General and Administrative Expense
General and administrative expense consists of personnel costs for our administrative, legal, human resources, and finance and accounting teams, including salaries and other payroll related costs, bonuses and stock-based compensation. Additional expenses include travel and entertainment, subcontracting, professional fees, insurance, acquisition-related expenses, amortization of certain intangible assets and allocated overhead.

20


We expect general and administrative expense to increase on an absolute dollar basis in the near term as we continue to increase investments to support our growth, but to decrease as a percentage of total revenue.
Interest Income (Expense), Net
Interest income (expense), net consists primarily of interest income on our cash and cash equivalents and our short and long-term investments.
Other Income (Expense), Net
Other income (expense), net consists primarily of unrealized and realized gains and losses related to changes in foreign currency exchange rates and realized gains and losses on the sale of investments.
Provision for (Benefit from) Income Taxes
Provision for (benefit from) income taxes relates to U.S. federal and state, as well as certain foreign jurisdiction, income taxes. Historically, we have generated net losses in the U.S., U.K and Ireland and recorded a full valuation allowance against our U.S., U.K. and Ireland deferred tax assets. We expect to maintain a full valuation allowance on our U.S., Ireland and U.K. deferred tax assets in the near term. Realization of our U.S., Ireland and U.K. deferred tax assets depends upon future earnings, the timing and amount of which are uncertain.

Results of Operations
The following table sets forth our selected consolidated statements of operations data:
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2017
 
2016
 
2017
 
2016
 
(in thousands)
Consolidated Statement of Operations Data:
 
 
 
 
 
 
 
Revenue:
 
 
 
 
 
 
 
Products
$
29,626

 
$
23,108

 
$
82,736

 
$
64,709

Maintenance and support
11,654

 
9,694

 
33,794

 
27,037

Professional services
9,241

 
7,537

 
26,679

 
20,657

Total revenue
50,521

 
40,339

 
143,209

 
112,403

Cost of revenue:(1)
 
 
 
 
 
 
 
Products
6,888

 
3,415

 
17,155

 
8,700

Maintenance and support
1,739

 
1,801

 
5,467

 
5,240

Professional services
5,740

 
4,822

 
17,088

 
14,103

Total cost of revenue
14,367

 
10,038

 
39,710

 
28,043

Operating expenses:(1)
 
 
 
 
 
 
 
Research and development
13,570

 
11,616

 
36,836

 
36,890

Sales and marketing
28,224

 
21,284

 
80,166

 
65,732

General and administrative
7,402

 
7,605

 
21,906

 
20,842

Total operating expenses
49,196

 
40,505

 
138,908

 
123,464

Loss from operations
(13,042
)
 
(10,204
)
 
(35,409
)
 
(39,104
)
Interest income (expense), net
198

 
44

 
585

 
55

Other income (expense), net
235

 
36

 
349

 
184

Loss before income taxes
(12,609
)
 
(10,124
)
 
(34,475
)
 
(38,865
)
Provision for (benefit from) income taxes
(2,325
)
 
70

 
(2,009
)
 
361

Net loss
$
(10,284
)
 
$
(10,194
)
 
$
(32,466
)
 
$
(39,226
)
(1)
Cost of revenue and operating expenses include stock-based compensation expense and depreciation and amortization expense as follows:

21


 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2017
 
2016
 
2017
 
2016
 
(in thousands)
Stock-based compensation expense:
 
 
 
 
 
 
 
Cost of revenue
$
305

 
$
166

 
$
815

 
$
445

Research and development
1,986

 
1,600

 
5,188

 
4,617

Sales and marketing
1,512

 
1,328

 
4,694

 
5,453

General and administrative
1,485

 
1,083

 
4,041

 
2,822

Total stock-based compensation expense
$
5,288

 
$
4,177

 
$
14,738

 
$
13,337


 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2017
 
2016
 
2017
 
2016
 
(in thousands)
Depreciation and amortization expense:
 
 
 
 
 
 
 
Cost of revenue
1,067

 
648

 
2,387

 
1,916

Research and development
277

 
262

 
782

 
875

Sales and marketing
475

 
497

 
1,446

 
1,450

General and administrative
248

 
504

 
689

 
1,089

Total depreciation and amortization expense
$
2,067

 
$
1,911

 
$
5,304

 
$
5,330



22


The following table sets forth our selected consolidated statements of operations data expressed as a percentage of revenue:
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2017
 
2016
 
2017
 
2016
Consolidated Statement of Operations Data:
 
 
 
 
 
 
 
Revenue:
 
 
 
 
 
 
 
Products
58.6
 %
 
57.3
 %
 
57.8
 %
 
57.6
 %
Maintenance and support
23.1

 
24.0

 
23.6

 
24.0

Professional services
18.3

 
18.7

 
18.6

 
18.4

Total revenue
100.0

 
100.0

 
100.0

 
100.0

Cost of revenue:
 
 
 
 
 
 
 
Products
13.6

 
8.5

 
12.0

 
7.7

Maintenance and support
3.4

 
4.5

 
3.8

 
4.7

Professional services
11.4

 
11.9

 
11.9

 
12.5

Total cost of revenue
28.4

 
24.9

 
27.7

 
24.9

Operating expenses:
 
 
 
 
 
 
 
Research and development
26.9

 
28.8

 
25.7

 
32.8

Sales and marketing
55.9

 
52.8

 
56.0

 
58.5

General and administrative
14.6

 
18.8

 
15.3

 
18.5

Total operating expenses
97.4

 
100.4

 
97.0

 
109.8

Loss from operations
(25.8
)
 
(25.3
)
 
(24.7
)
 
(34.7
)
Interest income (expense), net
0.4

 
0.1

 
0.4

 

Other income (expense), net
0.5

 
0.1

 
0.2

 
0.1

Loss before income taxes
(24.9
)
 
(25.1
)
 
(24.1
)
 
(34.6
)
Provision for (benefit from) income taxes
(4.5
)
 
0.2

 
(1.4
)
 
0.3

Net loss
(20.4
)%
 
(25.3
)%
 
(22.7
)%
 
(34.9
)%
Comparison of the Three Months Ended September 30, 2017 and 2016
Revenue
 
Three Months Ended September 30,
 
Change
 
2017
 
2016
 
$
 
%
 
(dollars in thousands)
Revenue:
 
 
 
 
 
 
 
Products
$
29,626

 
$
23,108

 
$
6,518

 
28.2
%
Maintenance and support
11,654

 
9,694

 
1,960

 
20.2

Professional services
9,241

 
7,537

 
1,704

 
22.6

Total revenue
$
50,521

 
$
40,339

 
$
10,182

 
25.2
%
Total revenue increased by $10.2 million in the three months ended September 30, 2017 compared to the same period in 2016. The increase in revenue included a $4.2 million increase from new customers, upsells and cross-sells. The increase in new customers revenue included 862 new customers added since September 30, 2016 and a full fiscal quarter of revenue related to new customers added in the three months ended September 30, 2016. Revenue also increased in the three months ended September 30, 2017 compared to the same period in 2016 due to $6.0 million in additional revenue from existing customer renewals. The increase in total revenue in the three months ended September 30, 2017 compared to the same period in 2016 was comprised of $8.4 million generated from sales in North America and $1.8 million generated from sales from the rest of the world.

23


Cost of Revenue
 
Three Months Ended September 30,
 
Change
 
2017
 
2016
 
$
 
%
 
(dollars in thousands)
Cost of revenue:
 
 
 
 
 
 
 
Products
$
6,888

 
$
3,415

 
$
3,473

 
101.7
 %
Maintenance and support
1,739

 
1,801

 
(62
)
 
(3.4
)
Professional services
5,740

 
4,822

 
918

 
19.0

Total cost of revenue
$
14,367

 
$
10,038

 
$
4,329

 
43.1
 %
Gross margin %: