10-Q 1 rpdq1201910q.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 March 31, 2019
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 every Interactive Data File required to be submitted 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
x
Accelerated filer
¨
Non-accelerated filer
¨

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  
Securities registered pursuant to Section 12(b) of the Securities Exchange Act of 1934:
 
 
 
Title of each class
Trading symbol(s)
Name of each exchange on which registered
Common Stock, $0.01 par value per share
RPD
The Nasdaq Global Market
As of April 30, 2019, there were 48,202,433 shares of the registrant’s common stock, $0.01 par value per share, outstanding.
 




Table of Contents
 
 
 
 
 
 
Page
PART I.
 
Item 1.
 
 
 
 
 
 
Item 2.
Item 3.
Item 4.
PART II.
Item 1.
Item 1A.
Item 2.
Item 3.
Item 4.
Item 5.
Item 6.


i


PART I—FINANCIAL INFORMATION
Item 1.
Financial Statements.
RAPID7, INC.
Consolidated Balance Sheets (Unaudited)
(in thousands, except share and per share data)
 
 
 
March 31, 2019
 
December 31, 2018
Assets
 
 
 
 
Current assets:
 
 
 
 
Cash and cash equivalents
 
$
89,869

 
$
99,565

Short-term investments
 
161,600

 
159,210

Accounts receivable, net of allowance for doubtful accounts of $1,999 and $1,624 at March 31, 2019 and December 31, 2018, respectively
 
59,707

 
74,935

Deferred contract acquisition and fulfillment costs, current portion
 
12,994

 
12,321

Prepaid expenses and other current assets
 
15,773

 
9,746

Total current assets
 
339,943

 
355,777

Long-term investments
 
33,613

 
44,892

Property and equipment, net
 
32,771

 
17,523

Operating lease right-of-use assets
 
15,888

 

Deferred contract acquisition and fulfillment costs, non-current portion
 
28,054

 
27,634

Goodwill
 
88,420

 
88,420

Intangible assets, net
 
23,979

 
23,955

Other assets
 
1,238

 
1,168

Total assets
 
$
563,906

 
$
559,369

Liabilities and Stockholders’ Equity
 
 
 
 
Current liabilities:
 
 
 
 
Accounts payable
 
$
6,297

 
$
7,048

Accrued expenses
 
25,062

 
37,376

Operating lease liabilities, current portion
 
5,231

 

Deferred revenue, current portion
 
184,453

 
189,855

Other current liabilities
 
7,385

 
707

Total current liabilities
 
228,428

 
234,986

Convertible senior notes, net
 
177,198

 
174,688

Operating lease liabilities, non-current portion
 
16,394

 

Deferred revenue, non-current portion
 
52,014

 
58,716

Other long-term liabilities
 
1,021

 
3,660

Total liabilities
 
475,055

 
472,050

Stockholders’ equity:
 
 
 
 
Preferred stock, $0.01 par value per share; 10,000,000 shares authorized at March 31, 2019 and December 31, 2018; 0 shares issued at March 31, 2019 and December 31, 2018
 

 

Common stock, $0.01 par value per share; 100,000,000 shares authorized at March 31, 2019 and December 31, 2018; 48,644,450 and 48,087,257 shares issued at March 31, 2019 and December 31, 2018, respectively; 48,157,642 and 47,600,449 shares outstanding at March 31, 2019 and December 31, 2018, respectively
 
482

 
476

Treasury stock, at cost, 486,808 shares at March 31, 2019 and December 31, 2018
 
(4,764
)
 
(4,764
)
Additional paid-in-capital
 
569,229

 
556,223

Accumulated other comprehensive gain (loss)
 
162

 
(31
)
Accumulated deficit
 
(476,258
)
 
(464,585
)
Total stockholders’ equity
 
88,851

 
87,319

Total liabilities and stockholders’ equity
 
$
563,906

 
$
559,369

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 March 31,
 
 
2019
 
2018
Revenue:
 
 
 
 
Products
 
$
56,288

 
$
35,279

Maintenance and support
 
9,557

 
10,753

Professional services
 
7,340

 
8,483

Total revenue
 
73,185

 
54,515

Cost of revenue:
 
 
 
 
Products
 
12,485

 
8,436

Maintenance and support
 
1,884

 
1,849

Professional services
 
5,604

 
6,309

Total cost of revenue
 
19,973

 
16,594

Total gross profit
 
53,212

 
37,921

Operating expenses:
 
 
 
 
Research and development
 
17,865

 
16,722

Sales and marketing
 
35,138

 
29,052

General and administrative
 
9,953

 
8,732

Total operating expenses
 
62,956

 
54,506

Loss from operations
 
(9,744
)
 
(16,585
)
Other income (expense), net:
 
 
 
 
Interest income
 
1,731

 
243

Interest expense
 
(3,229
)
 
(2
)
Other income (expense), net
 
(206
)
 
78

Loss before income taxes
 
(11,448
)
 
(16,266
)
Provision for income taxes
 
225

 
95

Net loss
 
$
(11,673
)
 
$
(16,361
)
Net loss per share, basic and diluted
 
$
(0.24
)
 
$
(0.36
)
Weighted-average common shares outstanding, basic and diluted
 
47,827,939

 
45,210,250

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 March 31,
 
 
2019
 
2018
 
 
 
 
 
Net loss
 
$
(11,673
)
 
$
(16,361
)
Other comprehensive gain (loss):
 
 
 
 
Change in fair value of investments
 
193

 
(5
)
Total change in unrealized gain (loss) on investments
 
193

 
(5
)
Comprehensive loss
 
$
(11,480
)
 
$
(16,366
)

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



3


RAPID7, INC.
Consolidated Statements of Changes in Stockholders' Equity (Unaudited)
(in thousands)
 
Common stock
 
Treasury stock
 
Additional
paid-in-capital
 
Accumulated
other
comprehensive
gain (loss)
 
Accumulated
deficit
 
Total
stockholders’
equity
 
Shares
 
Amount
 
Shares
 
Amount
 
Balance, December 31, 2018
47,600

 
$
476

 
487

 
$
(4,764
)
 
$
556,223

 
$
(31
)
 
$
(464,585
)
 
$
87,319

Stock-based compensation expense

 

 

 

 
8,634

 

 

 
8,634

Issuance of common stock under Employee Stock Purchase Plan
111

 
1

 

 

 
2,633

 

 

 
2,634

Vesting of restricted stock units
244

 
3

 

 

 
(3
)
 

 

 

Shares withheld for employee taxes
(22
)
 

 

 

 
(980
)
 

 

 
(980
)
Issuance of common stock upon exercise of stock options
225

 
2

 

 

 
2,722

 

 

 
2,724

Net unrealized gain on investments

 

 

 

 

 
193

 

 
193

Net loss

 

 

 

 

 

 
(11,673
)
 
(11,673
)
Balance, March 31, 2019
48,158

 
$
482

 
487

 
$
(4,764
)
 
$
569,229

 
$
162

 
$
(476,258
)
 
$
88,851


 
Common stock
 
Treasury stock
 
Additional
paid-in-capital
 
Accumulated
other
comprehensive
gain (loss)
 
Accumulated
deficit
 
Total
stockholders’
equity
 
Shares
 
Amount
 
Shares
 
Amount
 
Balance, December 31, 2017
44,054

 
$
441

 
487

 
$
(4,764
)
 
$
463,428

 
$
(39
)
 
$
(434,913
)
 
$
24,153

Stock-based compensation expense

 

 

 

 
6,225

 

 

 
6,225

Cumulative effect adjustment for the adoption of ASC 606

 

 

 

 

 

 
25,873

 
25,873

Issuance of common stock related to follow-on public offering
1,500

 
15

 

 

 
30,892

 

 

 
30,907

Issuance of common stock under Employee Stock Purchase Plan
124

 
1

 

 

 
1,631

 

 

 
1,632

Vesting of restricted stock units
155

 
1

 

 

 
(1
)
 

 

 

Forfeiture of restricted stock awards
(3
)
 

 

 

 

 

 

 

Shares withheld for employee taxes
(20
)
 

 

 

 
(462
)
 

 

 
(462
)
Issuance of common stock upon exercise of stock options
389

 
4

 

 

 
1,956

 

 

 
1,960

Net unrealized loss on investments

 

 

 

 

 
(5
)
 

 
(5
)
Net loss

 

 

 

 

 

 
(16,361
)
 
(16,361
)
Balance, March 31, 2018
46,199

 
$
462

 
487

 
$
(4,764
)
 
$
503,669

 
$
(44
)
 
$
(425,401
)
 
$
73,922


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


4


RAPID7, INC.
Consolidated Statements of Cash Flows (Unaudited)
(in thousands)
 
 
 
Three Months Ended March 31,
 
 
2019
 
2018
Cash flows from operating activities:
 
 
 
 
Net loss
 
$
(11,673
)
 
$
(16,361
)
Adjustments to reconcile net loss to net cash (used in) provided by operating activities:
 
 
 
 
Depreciation and amortization
 
3,427

 
2,399

Amortization of debt discount and issuance costs
 
2,510

 

Stock-based compensation expense
 
8,634

 
6,225

Provision for doubtful accounts
 
437

 
156

Foreign currency re-measurement loss
 
249

 
147

Other non-cash (income) expense
 
(722
)
 
(52
)
Changes in operating assets and liabilities:
 
 
 
 
Accounts receivable
 
14,729

 
34,722

Deferred contract acquisition and fulfillment costs
 
(1,094
)
 
(1,713
)
Prepaid expenses and other assets
 
(5,940
)
 
(3,190
)
Accounts payable
 
66

 
3,219

Accrued expenses
 
(13,690
)
 
(11,317
)
Deferred revenue
 
(12,104
)
 
(6,495
)
Other liabilities
 
1,605

 
(444
)
Net cash (used in) provided by operating activities
 
(13,566
)
 
7,296

Cash flows from investing activities:
 
 
 
 
Purchases of property and equipment
 
(8,463
)
 
(2,147
)
Capitalization of internal-use software costs
 
(1,601
)
 
(693
)
Purchases of investments
 
(63,029
)
 
(4,460
)
Sales/maturities of investments
 
72,738

 
14,062

Net cash (used in) provided by investing activities
 
(355
)
 
6,762

Cash flows from financing activities:
 
 
 
 
Proceeds from follow-on public offering, net of offering costs of $608
 

 
31,231

Taxes paid related to net share settlement of equity awards
 
(979
)
 
(462
)
Proceeds from employee stock purchase plan
 
2,634

 
1,632

Proceeds from stock option exercises
 
2,718

 
1,961

Net cash provided by financing activities
 
4,373

 
34,362

Effect of exchange rate changes on cash, cash equivalents and restricted cash
 
(148
)
 
(36
)
Net (decrease) increase in cash, cash equivalents and restricted cash
 
(9,696
)
 
48,384

Cash, cash equivalents and restricted cash, beginning of period
 
99,565

 
51,762

Cash, cash equivalents and restricted cash, end of period
 
$
89,869

 
$
100,146

Supplemental cash flow information:
 
 
 
 
Cash paid for interest on convertible senior notes
 
$
1,342

 
$

Cash paid for income taxes, net of refunds
 
$
88

 
$
53

Non-cash investing activities:
 
 
 
 
Leasehold improvements acquired through tenant improvement allowance
 
$
7,313

 
$

Reconciliation of cash, cash equivalents and restricted cash:
 
 
 
 
Cash and cash equivalents
 
$
89,869

 
$
99,646

Restricted cash in other assets
 
$

 
$
500

Total cash, cash equivalents and restricted cash
 
$
89,869

 
$
100,146

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

5


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 advancing security with visibility, analytics, and automation delivered through our Insight cloud. Our solutions simplify the complex, allowing security teams to work more effectively with IT and development to reduce vulnerabilities, monitor for malicious behavior, investigate and shut down attacks, and automate routine tasks.
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, 2018 filed with the SEC on February 28, 2019.
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 months ended March 31, 2019 are not necessarily indicative of the results to be expected for any future period or the entire fiscal year.
Significant Accounting Policies
Our significant accounting policies are described in Note 2, Summary of Significant Accounting Policies, to the consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2018. There have been no material changes to the significant accounting policies during the three-month period ended March 31, 2019 other than those noted below.
Leases
Effective January 1, 2019, we adopted Financial Accounting Standards Board (FASB) Accounting Standards Update (ASU) 2016-02, Leases (Topic 842), as amended (ASC 842). In accordance with ASC 842, at the inception of an arrangement, we determine whether the arrangement is or contains a lease based on the unique facts and circumstances present and the classification of the lease. Most leases with a term greater than one year are recognized on the balance sheet as right-of-use (ROU) assets, lease liabilities and, if applicable, long-term lease liabilities. We have elected not to recognize on the balance sheet leases with terms of one year or less. For contracts with lease and non-lease components, we have elected not to allocate the contract consideration and to account for the lease and non-lease components as a single lease component.
Lease liabilities and their corresponding ROU assets are recorded based on the present value of lease payments over the expected lease term. The implicit rate within our operating leases are generally not determinable and therefore we use the incremental borrowing rate at the lease commencement date to determine the present value of lease payments. The determination of our incremental borrowing rate requires judgment. We determine our incremental borrowing rate for each lease using our estimated borrowing rate, adjusted for various factors including level of collateralization, term and currency to align with the terms of the lease. The operating lease ROU asset also includes any lease prepayments, offset by lease incentives. Certain of our leases include options to extend or terminate the lease. An option to extend the lease is considered in connection with determining the ROU asset and lease liability when it is reasonably certain we will exercise that option. An option to terminate is considered unless it is reasonably certain we will not exercise the option.
For periods prior to the adoption of ASC 842, we recorded rent expense on a straight-line basis over the term of the related lease. The difference between the straight-line rent expense and the payments made in accordance with the operating lease agreements were recognized as a deferred rent liability on the accompanying consolidated balance sheets.
Recent Accounting Pronouncements
Accounting Pronouncements Recently Adopted
In February 2016, FASB issued ASU 2016-02, Leases, which requires companies to recognize on the balance sheet the assets and liabilities for the rights and obligations created by the leased asset. The standard is effective for fiscal years, and interim periods

6


within those fiscal years, beginning after December 15, 2018. We adopted this standard effective January 1, 2019 using the modified retrospective approach for all leases entered into before the effective date. We also elected to implement the new standard at the adoption date with a cumulative-effect adjustment, if any, recognized to the opening balance of accumulative deficit in the period of adoption.
For comparability purposes, we will continue to comply with the previous disclosure requirements in accordance with the existing lease guidance for all periods presented in the year of adoption. We elected the package of practical expedients as permitted under the transition guidance, which allowed us: (1) to carry forward the historical lease classification; (2) not to reassess whether expired or existing contracts are or contain leases; and, (3) not to reassess the treatment of initial direct costs for existing leases. In addition, we elected an accounting policy to not recognize leases with an initial term of one year or less on the balance sheet.
Upon the adoption of this standard on January 1, 2019, we recognized a total lease liability of $21.3 million, representing the present value of the minimum rental payments remaining as of the adoption date and a right-of-use asset in the amount of $15.4 million. We did not have any finance leases (formerly referred to as capital leases prior to the adoption of ASC 842), therefore there was no change in accounting treatment required.
Accounting Pronouncements Not Yet Effective
In August 2018, the FASB issued Accounting Standards Update (ASU) 2018-15, Intangibles—Goodwill and Other—Internal-Use Software (Subtopic 350-40): Customer's Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That is a Service Contract, which aligns the requirements for capitalizing implementation costs in cloud computing arrangements with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software. The new standard will be effective for us in the first quarter of 2020, with early adoption permitted. Entities can choose to adopt the new guidance prospectively or retrospectively. We are currently in the process of evaluating the effects of this pronouncement on our consolidated financial statements.

In August 2018, the FASB issued ASU 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework—Changes to the Disclosure Requirements for Fair Value Measurement, which eliminates, modifies and adds disclosure requirements for fair value measurements. The new standard will be effective for us in the first quarter of 2020, with early adoption permitted. This ASU is not expected to have a material impact on our consolidated financial statements.
Note 2. Revenue from Contracts with Customers
We generate products revenue from the sale of (1) cloud-based subscriptions for our InsightIDR, InsightVM, InsightAppSec and InsightConnect products, (2) managed services offerings which utilize our products and (3) term or perpetual software licenses for our Nexpose, Metasploit, and AppSpider products, and associated content subscriptions for our Nexpose and Metasploit products. We also generate appliance revenue that is included in our products revenue and is associated with hardware sold with our Nexpose product to certain customers. We generate maintenance and support revenue associated with customers’ purchases of our software licenses for Nexpose, Metasploit and AppSpider. We generate professional service revenue from the sale of our deployment and training services related to our solutions, incident response services and security advisory services. Our deployment services educate and assist our customers on the best use and best practices to deploy our solutions.
In accordance with FASB ASU 2014-09, Revenue from Contracts with Customers (Topic 606) (ASC 606), revenue is recognized when a customer obtains control of promised products or services. The amount of revenue recognized reflects the consideration that we expect to be entitled to receive in exchange for these products or services. To achieve the core principle of this standard, we apply the following five steps:
1) Identify the contract with a customer
We consider the terms and conditions of the contracts and our customary business practices in identifying our contracts under ASC 606. We determine we have a contract with a customer when the contract is approved, we can identify each party’s rights regarding the services to be transferred, we can identify the payment terms for the services, and we have determined the customer has the ability and intent to pay and the contract has commercial substance. We apply judgment in determining the customer’s ability and intent to pay, which is based on a variety of factors, including the customer’s historical payment experience or, in the case of a new customer, credit and financial information pertaining to the customer.
2) Identify the performance obligations in the contract
Performance obligations promised in a contract are identified based on the products and services that will be transferred to the customer that are both capable of being distinct, whereby the customer can benefit from the product or service either on its own or together with other resources that are readily available from third parties or from us, and are distinct in the context of the contract, whereby the transfer of the products or services is separately identifiable from other promises in the contract.

7


3) Determine the transaction price
The transaction price is determined based on the consideration to which we expect to be entitled in exchange for transferring products or services to the customer. Variable consideration is included in the transaction price if, in our judgment, it is probable that no significant future reversal of cumulative revenue under the contract will occur.
In instances where the timing of revenue recognition differs from the timing of invoicing, we have determined our contracts generally do not include a significant financing component. The primary purpose of our invoicing terms is to provide customers with simplified and predictable ways of purchasing our products and services, not to receive financing from our customers or to provide customers with financing. Examples include invoicing at the beginning of a subscription term with revenue recognized ratably over the contract period.
4) Allocate the transaction price to performance obligations in the contract
If the contract contains a single performance obligation, the entire transaction price is allocated to the single performance obligation. Contracts that contain multiple performance obligations require an allocation of the transaction price to each performance obligation based on a relative standalone selling price (“SSP”).
5) Recognize revenue when or as we satisfy a performance obligation
Revenue is recognized at the time the related performance obligation is satisfied by transferring the promised product or service to a customer. Revenue is recognized when control of the products or services are transferred to our customers, in an amount that reflects the consideration that we expect to receive in exchange for those products or services.
The following table summarizes revenue from contracts with customers for the three months ended March 31, 2019 and 2018:
 
 
Three Months Ended March 31,
 
 
2019
 
2018
 
 
(in thousands)
Subscription revenue
 
$
46,969

 
$
28,710

Term and perpetual software licenses
 
8,676

 
5,619

Maintenance and support
 
9,557

 
10,753

Professional services
 
7,340

 
8,483

Other
 
643

 
950

Total revenue
 
$
73,185

 
$
54,515

The following table summarizes the revenue by region based on the shipping address of customers who have contracted to use our product or service for the three months ended March 31, 2019 and 2018:
 
 
Three Months Ended March 31,
 
 
2019

2018
 
 
(in thousands)
United States
 
$
59,940

 
$
44,210

All other
 
13,245

 
10,305

Total revenue
 
$
73,185

 
$
54,515


Subscription Revenue
Subscription revenue consists of revenue from our cloud-based subscription, managed services offerings and content subscriptions associated with our software licenses.

We generate cloud-based subscription revenue primarily from sales of subscriptions to access our cloud platform, together with related support services to our customers. These arrangements do not provide the customer with the right to take possession of our software operating on our cloud platform at any time. Instead, customers are granted continuous access to our cloud platform over the contractual period. Revenue is recognized over time on a ratable basis over the contract term beginning on the date that our service is made available to the customer. Our cloud-based subscription contracts generally have a term of one year which is billed in advance and non-cancellable.


8


Managed services offerings consist of fees generated when we operate our software and provide our capabilities on behalf of our customers. Revenue is recognized on a ratable basis over the contract term beginning on the date that our service is made available to the customer. Our managed services offerings generally have a term of one year which is billed in advance and non-cancellable.

Revenue related to our content subscriptions associated with our software licenses is recognized ratably over the contractual period.

Some of our customers have the option to purchase additional subscription and support services at a stated price. These options generally do not provide a material right as they are priced at our SSP.

Certain subscription contracts contain service level commitments, which entitle our customers to receive service credits and, in certain cases, refunds, if our services do not meet certain levels. These service credits and refunds represent variable consideration. We have historically not experienced any significant incidents affecting the defined levels of reliability and performance as required by our subscription contracts and accordingly, no estimated refunds have been considered in the allocation of the transaction price.
Term and Perpetual Software Licenses
For our perpetual software licenses where the utility to the customer is dependent on the continued delivery of content subscriptions, the content subscription renewal options result in a material right with respect to the perpetual software license. As a result, the revenue attributable to the perpetual software license is recognized ratably over the customer’s estimated economic life of five years, which represents a longer period of time in comparison to the initial contractual period of maintenance and support. The estimated economic life of five years represents the period which the customer is expected to benefit from the material right. We estimated this period of benefit by taking into consideration several factors, including the terms and conditions of our customer contracts and renewals and the expected useful life of our technology.
For our term software licenses where the utility to the customer is dependent on the continued delivery of content subscriptions, we recognize the license revenue over the contractual term of the arrangement as a material right does not exist.
For our term and perpetual software licenses which are not dependent on the continued delivery of content subscriptions, the license is considered distinct from the maintenance and support, and we therefore recognize revenue attributable to the license at the time of delivery.
Maintenance and Support
Maintenance and support services are sold with our perpetual and term software licenses. As maintenance and support services are distinct from the perpetual and term software license, revenue attributable to maintenance and support services is recognized ratably over the contractual period.
Professional Services
All of our professional services are considered distinct performance obligations when sold stand alone or with other products. These contracts generally have terms of one year or less. For the majority of these contracts, revenue is recognized over time based upon the proportion of work performed to date.
Other
Other revenue primarily includes revenue from delivery of appliances and other miscellaneous revenue.
Contracts with Multiple Performance Obligations
The majority of our contracts with customers contain multiple performance obligations. For these contracts, we account for individual performance obligations separately if they are considered distinct. The transaction price is allocated to the separate performance obligations on a relative SSP basis. We determine SSP based on our overall pricing objectives, taking into consideration market conditions and other factors, including the geographic locations of our customers and selling method (i.e., partner or direct).
Contract Balances
Contract liabilities consist of deferred revenue and include payments received in advance of performance under the contract. Such amounts are recognized as revenue over the contractual period consistent with the above methodology. For the three months ended March 31, 2019 and 2018, we recognized revenue of $64.6 million and $46.5 million, respectively, that was included in the

9


corresponding contract liability balance at the beginning of the periods presented. Deferred revenue that will be realized during the succeeding 12-month period is recorded as current, and the remaining deferred revenue is recorded as non-current.
We receive payments from customers based upon contractual billing schedules. Accounts receivable are recorded when the right to consideration becomes unconditional. Contract assets, or unbilled receivables, include amounts related to our contractual right to consideration for both completed and partially completed performance obligations that may not have been invoiced. As of March 31, 2019 and December 31, 2018, contract assets of $0.4 million and $0.8 million, respectively, are included in prepaid expenses and other current assets in our consolidated balance sheet.
Deferred Contract Acquisition and Fulfillment Costs
We capitalize commission expenses paid to internal sales personnel and partner referral fees that are incremental costs to obtaining customer contracts. These costs are recorded as deferred contract acquisition costs in the consolidated balance sheets. Costs to obtain a contract for a new customer, up-sell or cross-sell are amortized on a straight-line basis over an estimated period of benefit of five years as sales commissions on initial sales are not commensurate with sales commissions on contract renewals. We determined the estimated period of benefit by taking into consideration the contractual term and expected renewals of customer contracts, our technology and other factors, including the fact that commissions paid on renewals are not commensurate with commissions paid on initial sales transactions. We periodically review the carrying amount of deferred contract acquisition costs to determine whether events or changes in circumstances have occurred that could impact the period of benefit. Commissions paid relating to contract renewals are deferred and amortized on a straight-line basis over the related renewal period. Costs to obtain a contract for professional services arrangements are expensed as incurred in accordance with the practical expedient as the contractual period of our professional services arrangements are one year or less.
Amortization expense associated with deferred contract acquisition costs is recorded to sales and marketing expense in our consolidated statements of operations.
We capitalize costs incurred to fulfill our contracts that relate directly to the contract, are expected to generate resources that will be used to satisfy our performance obligations and are expected to be recovered through revenue generated under the contract. Contract fulfillment costs are amortized on a straight-line basis over the estimated period of benefit and recorded as cost of products in our consolidated statement of operations.
The following table summarizes the activity of the deferred contract acquisition and fulfillment costs for the three months ended March 31, 2019 and 2018:
 
 
Three Months Ended March 31,
 
 
2019
 
2018
 
 
(in thousands)
Beginning balance
 
$
39,955

 
$
27,165

Capitalization of contract acquisition and fulfillment costs
 
4,309

 
3,733

Amortization of deferred contract acquisition and fulfillment costs
 
(3,216
)
 
(2,020
)
Ending balance
 
$
41,048

 
$
28,878

Transaction price allocated to the remaining performance obligations
The following table includes estimated revenue expected to be recognized in the future related to performance obligations that are unsatisfied or partially unsatisfied as of March 31, 2019. The estimated revenues do not include unexercised contract renewals.
 
 
Remainder of 2019
 
2020
 
2021 and thereafter
 
 
(in thousands)
Subscription revenue
 
$
116,798

 
$
39,616

 
$
10,841

Term and perpetual software licenses
 
18,651

 
13,364

 
12,739

Maintenance and support
 
20,636

 
6,824

 
1,656

The amounts presented in the table above primarily consist of fixed fees which are typically recognized ratably as the performance obligation is satisfied.
As of March 31, 2019, the estimated revenue expected to be recognized in the future related to professional services is $10.2 million. We will recognize this revenue as the professional services are completed, which is expected to occur within the next 12 months or less.

10



Note 3. 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 we 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.
The following table presents our financial assets measured and recorded at fair value on a recurring basis using the above input categories:
 
 
As of March 31, 2019
 
 
Level 1
 
Level 2
 
Level 3
 
Total
 
 
(in thousands)
Description:
 
 
 
 
 
 
 
 
Assets:
 
 
 
 
 
 
 
 
Money market funds
 
$
34,303

 
$

 
$

 
$
34,303

U.S. government agencies
 
63,544

 

 

 
63,544

Commercial paper
 

 
45,948

 

 
45,948

Corporate bonds
 

 
54,880

 

 
54,880

Agency bonds
 

 
19,141

 

 
19,141

Asset-backed securities
 

 
11,700

 

 
11,700

Total assets
 
$
97,847

 
$
131,669

 
$

 
$
229,516

 
 
As of December 31, 2018
 
 
Level 1
 
Level 2
 
Level 3
 
Total
 
 
(in thousands)
Description:
 
 
 
 
 
 
 
 
Assets:
 
 
 
 
 
 
 
 
Money market funds
 
$
55,646

 
$

 
$

 
$
55,646

U.S. government agencies
 
74,481

 

 

 
74,481

Commercial paper
 

 
57,554

 

 
57,554

Corporate bonds
 

 
48,495

 

 
48,495

Agency bonds
 

 
19,087

 

 
19,087

Asset-backed securities
 

 
7,483

 

 
7,483

Total assets
 
$
130,127

 
$
132,619

 
$

 
$
262,746


As of March 31, 2019, the fair value of our 1.25% convertible senior notes due 2023, as further described in Note 6, Convertible Senior Notes and Capped Calls, was $313.4 million based upon quoted market prices. We consider the fair value of the Notes to be a Level 2 measurement due to limited trading activity of the Notes. We had no other liabilities measured and recorded at fair value on a recurring basis as of March 31, 2019 or December 31, 2018.

11


Our investments, which are all classified as available-for-sale, consisted of the following:
 
 
As of March 31, 2019
 
 
Amortized Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Fair Value
 
 
(in thousands)
Description:
 
 
 
 
 
 
 
 
U.S. government agencies
 
$
63,484

 
$
60

 
$

 
$
63,544

Commercial paper
 
45,947

 
1

 

 
45,948

Corporate bonds
 
54,816

 
69

 
(5
)
 
54,880

Agency bonds
 
19,108

 
33

 

 
19,141

Asset-backed securities
 
11,696

 
6

 
(2
)
 
11,700

Total assets
 
$
195,051

 
$
169

 
$
(7
)
 
$
195,213

 
 
As of December 31, 2018
 
 
Amortized Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Fair Value
 
 
(in thousands)
Description:
 
 
 
 
 
 
 
 
U.S. government agencies
 
$
71,480

 
$
20

 
$
(17
)
 
$
71,483

Commercial paper
 
57,554

 

 

 
57,554

Corporate bonds
 
48,532

 
15

 
(52
)
 
48,495

Agency bonds
 
19,077

 
16

 
(6
)
 
19,087

Asset-backed securities
 
7,490

 

 
(7
)
 
7,483

Total assets
 
$
204,133

 
$
51

 
$
(82
)
 
$
204,102

As of March 31, 2019 and December 31, 2018, our available-for-sale investments had maturities ranging from three months to two years.
Our available-for-sale investments as of December 31, 2018 included $3.0 million of U.S. Government agencies investments which are classified as cash and cash equivalents as the original maturity was less than three months.
For all of our investments for which the amortized cost basis was greater than the fair value at March 31, 2019 and December 31, 2018, 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 maturity. 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 4. Property and Equipment
Property and equipment are recorded at cost and consist of the following:
 
 
As of
March 31, 2019
 
As of
December 31, 2018
 
 
(in thousands)
Computer equipment and software
 
$
19,345

 
$
18,724

Furniture and fixtures(1)
 
6,651

 
5,580

Leasehold improvements (1)
 
34,853

 
19,437

Total
 
60,849

 
43,741

Less accumulated depreciation
 
(28,078
)
 
(26,218
)
Property and equipment, net
 
$
32,771

 
$
17,523

(1) As of March 31, 2019 and December 31, 2018, leasehold improvements included $19.0 million and $4.0 million, respectively, and as of March 31, 2019, furniture and fixtures included $1.1 million of construction-in progress primarily related to our new Boston, Massachusetts corporate headquarters facility.

12


Depreciation expense was $1.9 million and $1.4 million for the three months ended March 31, 2019 and 2018, respectively.
Note 5. Goodwill and Intangible Assets
Goodwill was $88.4 million as of March 31, 2019 and December 31, 2018.
The following table presents details of our intangible assets, which include acquired identifiable intangible assets and capitalized internal-use software costs:
 
 
 
As of March 31, 2019
 
As of December 31, 2018
 
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
5.5
 
$
29,771

 
$
(11,099
)
 
$
18,672

 
$
29,771

 
$
(9,741
)
 
$
20,030

Customer relationships
6.7
 
1,000

 
(543
)
 
457

 
1,000

 
(504
)
 
496

Trade names
6.1
 
519

 
(517
)
 
2

 
519

 
(516
)
 
3

Non-compete agreements
2.0
 
40

 
(40
)
 

 
40

 
(40
)
 

Total acquired intangible assets
 
 
31,330

 
(12,199
)
 
19,131

 
31,330

 
(10,801
)
 
20,529

Internal-use software
 
 
5,387

 
(539
)
 
4,848

 
3,786

 
(360
)
 
3,426

Total intangible assets
 
 
$
36,717

 
$
(12,738
)
 
$
23,979

 
$
35,116

 
$
(11,161
)
 
$
23,955

Amortization expense was $1.6 million and $1.0 million for the three months ended March 31, 2019 and 2018, respectively.
Estimated future amortization expense of the acquired identifiable intangible assets and completed capitalized internal-use software costs as of March 31, 2019 was as follows (in thousands):
2019 (for the remaining nine months)
$
4,721

2020
6,245

2021
5,450

2022
2,933

2023
1,450

2024 and thereafter

Total
$
20,799

The table above excludes the impact of $3.2 million of capitalized internal-use software costs for projects that have not been completed as of March 31, 2019, 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. Convertible Senior Notes and Capped Calls
In August 2018, we issued $200.0 million aggregate principal amount of convertible senior notes due August 1, 2023 and an additional $30.0 million aggregate principal amount of such notes pursuant to the exercise in full of the over-allotment options of the initial purchasers (collectively, the Notes). The Notes are our senior unsecured obligations and bear interest at a fixed rate of 1.25% per annum, payable semi-annually in arrears on February 1 and August 1 of each year, commencing on February 1, 2019. The Notes will mature on August 1, 2023, unless earlier converted, redeemed or repurchased. The Notes do not contain any financial covenants. The total net proceeds from the Notes offering, after deducting initial purchase discounts and estimated debt issuance costs was $223.1 million. The Notes are governed by an indenture between the Company, as issuer, and U.S. Bank National Association, as trustee (the Indenture).
Each $1,000 principal amount of the Notes is initially convertible into 24.0460 shares of our common stock, the Conversion Option, which is equivalent to an initial conversion price of approximately $41.59 per share, subject to adjustment upon the occurrence of specified events. The holders of the Notes may convert their Notes at their option at any time prior to the close of business on the business day immediately preceding February 1, 2023, only under the following circumstances: (1) during any calendar quarter commencing after the calendar quarter ending on December 31, 2018 (and only during such calendar quarter), if the last reported sale price of our common stock for at least 20 trading days (whether or not consecutive) during a period of 30 consecutive trading days ending on, and including, the last trading day of the immediately preceding calendar quarter is greater

13


than or equal to 130% of the conversion price of the Notes on each applicable trading day; (2) during the five business day period after any five consecutive trading day period (measurement period) in which the trading price (as defined in the Indenture) per $1,000 principal amount of the Notes for each trading day of the measurement period was less than 98% of the product of the last reported sale price of our common stock and the conversion rate of the Notes on each such trading day; (3)  if we call any or all of the Notes for redemption, at any time prior to the close of business on the scheduled trading day immediately preceding the redemption date; or (4) upon the occurrence of specified corporate events (as set forth in the Indenture). On or after February 1, 2023 until the close of business on the second scheduled trading day immediately preceding the maturity date, holders may convert their Notes at any time, regardless of the foregoing circumstances. Upon conversion, we will pay or deliver, as the case may be, cash, shares of our common stock or a combination of cash and shares of our common stock, at our election, in the manner and subject to the terms and conditions provided in the Indenture. We may not redeem the Notes prior to August 6, 2021. On or after August 6, 2021, we may redeem for cash all or any portion of the Notes, at our option, if the last reported sale price of our common stock has been at least 130% of the conversion price then in effect for at least 20 trading days (whether or not consecutive) during any 30 consecutive trading day period (including the last trading day of such period) ending on, and including the trading day immediately preceding, the date on which we provide the redemption notice at a redemption price equal to 100% principal amount of the Notes to be redeemed, plus accrued and unpaid interest to, but excluding, the redemption date. If we undergo a fundamental change (as set forth in the Indenture) at any time prior to the maturity date, holders of the Notes, will have the right, at their option, to require us to repurchase for cash all or any portion of their Notes at a repurchase price equal to 100% of the principal amount of the Notes to be repurchased, plus accrued and unpaid interest to, but excluding, the fundamental change repurchase date. In addition, following certain corporate events that occur prior to the maturity date or following our issuance of a notice of redemption, in each case as described in the Indenture, we will increase the conversion rate for a holder of the Notes who elects to convert its Notes in connection with such a corporate event or during the related redemption period in certain circumstances. During the three months ended March 31, 2019, none of the conditions allowing holders of the Notes to convert their Notes had been met. The Notes are therefore not convertible as of March 31, 2019 and are classified as long-term debt.
The foregoing description is qualified in its entirety by reference to the text of the Indenture and the Form of the Notes, which are filed as Exhibits 4.1 and 4.2 to this Quarterly Report on Form 10-Q.
In accounting for the transaction, the Notes have been separated into liability and equity components. The initial carrying amount of the liability component was calculated by measuring the fair value of a similar debt instrument that does not have an associated convertible feature. The initial carrying amount of the equity component representing the Conversion Option was $53.8 million and was determined by deducting the fair value of the liability component from the par value of the Notes. The equity component was recorded as an increase to additional paid-in capital and is not remeasured as long as it continues to meet the conditions for equity classification. The excess of the principal amount of the Notes over the initial carrying amount of the liability component, or the debt discount, is amortized to interest expense over the contractual term of the Notes at an effective interest rate of 7.37%.
In accounting for the debt issuance costs of $6.9 million related to the Notes, we allocated the total amount incurred to the liability and equity components of the Notes based on their relative values. Issuance costs attributable to the liability component were $5.3 million and will be amortized to interest expense using the effective interest method over the contractual term of the Notes. Issuance costs attributable to the equity component of $1.6 million were netted with the equity component in additional paid-in capital.
The net carrying amount of the liability component of the Notes was as follows:
 
 
As of
March 31, 2019
 
As of
December 31, 2018
 
 
(in thousands)
Principal
 
$
230,000

 
$
230,000

Unamortized debt discount
 
(48,050
)
 
(50,334
)
Unamortized issuance costs
 
(4,752
)
 
(4,978
)
Net carrying amount
 
$
177,198

 
$
174,688

The net carrying amount of the equity component as March 31, 2019 and December 31, 2018 was as follows (in thousands):
Debt discount for conversion option
 
$
53,820

Issuance costs
 
(1,626
)
Net carrying amount
 
$
52,194


14


Interest expense related to the Notes was as follows:
 
 
Three Months Ended March 31, 2019
 
 
(in thousands)
Contractual interest expense
 
$
719

Amortization of debt discount
 
2,284

Amortization of issuance costs
 
226

Total interest expense
 
$
3,229

In connection with the offering of the Notes, we entered into privately negotiated capped call transactions with certain counterparties, the (Capped Calls). The Capped Calls each have an initial strike price of $41.59 per share, subject to certain adjustments, which correspond to the initial conversion price of the Notes. The Capped Calls have initial cap prices of $63.98 per share, subject to certain adjustments. The Capped Calls are expected to offset potential dilution to our common stock upon conversion of the Notes, with such offset subject to a cap based on the cap price. The Capped Calls cover, subject to anti-dilution adjustments, approximately 5.5 million shares of our common stock. For accounting purposes, the Capped Calls are separate transactions, and not part of the terms of the Notes. The Capped Calls are recorded in stockholders' equity and are not accounted for as derivatives. Accordingly, the cost of $26.9 million incurred in connection with the Capped Calls was recorded as a reduction to additional paid-in capital.
The net impact to our stockholders' equity, included in additional paid-in capital, of the above components of the Notes was as follows (in thousands):
Conversion option
 
$
53,820

Purchase of capped calls
 
(26,910
)
Issuance costs
 
(1,626
)
Total
 
$
25,284

Note 7. Leases

Our leases primarily relate to office facilities that have remaining terms of up to ten years, some of which include one or more options to renew with renewal terms of up to five years and some of which include options to terminate the leases within the next three years. All of our leases are classified as operating leases.

The components of lease expense were as follows:
 
 
Three Months Ended
March 31, 2019
 
 
(in thousands)
Operating lease cost
 
$
1,967

Short-term lease costs
 
149

Variable lease costs
 
417

Total lease costs
 
$
2,533



15


Supplemental balance sheet information related to the operating leases was as follows:
 
 
As of
March 31, 2019
 
 
(in thousands, except lease term and discount rate)
Operating ROU assets
 
$
15,888

 
 
 
Operating lease liabilities, current portion
 
$
5,231

Operating lease liabilities, non-current portion
 
$
16,394

Total operating lease liabilities
 
$
21,625

 
 
 
Weighted average remaining lease term (in years) - operating leases
 
5.1

Weighted average discount rate - operating leases
 
7.4
%

Supplemental cash flow information related to leases was as follows:
 
 
Three Months Ended
March 31, 2019
 
 
(in thousands)
Cash paid for amounts included in the measurement of lease liabilities
 
$
1,928

ROU assets obtained in exchange for new lease obligations
 
$
1,866


Maturities of operating lease liabilities as of March 31, 2019 were as follows (in thousands):
2019 (for the remaining nine months)
$
5,382

2020
4,490

2021
4,125

2022
3,803

2023
3,600

2024 and thereafter
4,780

Total lease payments
$
26,180

Less: imputed interest
(4,555
)
Total
$
21,625


As of March 31, 2019, the operating lease for our future headquarters had not commenced and we did not have control of the leased space. We plan to take possession of the leased office space in the second quarter of 2019, at which time we will record a right-of-use asset and corresponding lease liability. Future lease payments related to this lease are $82.1 million and the lease payments are expected to commence in June 2019.

Under the prior lease accounting standard, as of December 31, 2018, the future minimum payments under non-cancellable leases, which included our future headquarters, were as follows (in thousands):
2019
$
9,899

2020
11,616

2021
10,933

2022
11,054

2023
11,136

Thereafter
53,648

Total
$
108,286

Note 8. Stock-Based Compensation Expense
(a)
General

16


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 March 31,
 
 
2019
 
2018
 
 
(in thousands)
Stock-based compensation expense:
 
 
 
 
Cost of revenue
 
$
573

 
$
374

Research and development
 
3,174

 
2,566

Sales and marketing
 
2,464

 
1,563

General and administrative
 
2,423

 
1,722

Total stock-based compensation expense
 
$
8,634

 
$
6,225

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 three months ended March 31, 2019 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, 2018
 
21,677

 
$
10.88

 
2,773,773

 
$
21.21

Granted
 

 

 
1,321,403

 
40.43

Vested
 
(16,255
)
 
10.88

 
(243,691
)
 
19.07

Forfeited
 

 

 
(98,979
)
 
23.61

Unvested balance as of March 31, 2019
 
5,422

 
$
10.88

 
3,752,506

 
$
28.05

As of March 31, 2019, the unrecognized compensation expense related to our unvested restricted stock and restricted stock units expected to vest was $107.1 million. This unrecognized compensation expense will be recognized over an estimated weighted-average amortization period of 3.0 years.
(c)
Stock Options
Stock option activity during the three months ended March 31, 2019 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, 2018
 
3,713,179

 
$
10.32

 
 
 
 
Granted
 

 

 
 
 
 
Exercised
 
(224,705
)
 
12.12

 
 
 
$
7,561

Forfeited/cancelled
 
(23,441
)
 
12.93

 
 
 
 
Outstanding as of March 31, 2019
 
3,465,033

 
$
10.18

 
5.9
 
$
140,086

Vested and exercisable as of March 31, 2019
 
2,613,931

 
$
8.82

 
5.3
 
$
109,244

As of March 31, 2019, the unrecognized compensation expense related to our unvested stock options expected to vest was $5.4 million. This unrecognized compensation expense will be recognized over an estimated weighted-average amortization period of 1.7 years.
The total fair value of stock options vested in the three months ended March 31, 2019 was $0.9 million.

17


(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 stock 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, 2018, we issued 123,607 shares of common stock to employees for aggregate proceeds of $1.6 million. The purchase prices of the shares were $12.96 and $14.78 per share, which were discounted in accordance with the terms of the ESPP from the closing prices of our common stock on March 16, 2017 of $15.25 and on September 18, 2017 of $17.39, respectively.
On September 14, 2018, we issued 96,108 shares of common stock to employees for aggregate proceeds of $2.0 million. The purchase prices of the shares were $21.96 and $14.78 per share, which were discounted in accordance with the terms of the ESPP from the closing prices of our common stock on March 16, 2018 of $25.84 and on September 18, 2017 of $17.39, respectively.
On March 15, 2019, we issued 110,822 shares of common stock to employees for aggregate proceeds of $2.6 million. The purchase prices of the shares were $30.46 and $21.96 per share, which were discounted in accordance with the terms of the ESPP from the closing prices of our common stock on September 17, 2018 of $35.84 and on March 16, 2018 of $25.84, respectively.
Note 9. 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 months ended March 31, 2019 and 2018:
 
Three Months Ended March 31,
 
2019
 
2018
 
(in thousands, except share and per share data)
Numerator:
 
 
 
Net loss
$
(11,673
)
 
$
(16,361
)
Denominator:
 
 
 
Weighted-average common shares outstanding, basic and diluted
47,827,939

 
45,210,250

Net loss per share attributable to common stockholders, basic and diluted
$
(0.24
)
 
$
(0.36
)
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 Months Ended March 31,
 
2019
 
2018
Options to purchase common stock
3,465,033

 
4,350,223

Unvested restricted stock
5,422

 
162,974

Unvested restricted stock units
3,752,506

 
3,507,173

Shares to be issued under ESPP
6,280

 
9,423

Total
7,229,241

 
8,029,793

Additionally, the 5.5 million shares underlying the conversion option of the Notes are not considered in the calculation of diluted net loss per share as the effect would be anti-dilutive. The Notes are not convertible as of March 31, 2019. We expect to settle the principal amount of the Notes in cash and therefore use the treasury stock method for calculating any potential dilutive effect of the conversion spread on diluted net income per share, if applicable. The conversion spread will have a dilutive impact on diluted net income per share when the average market price of our common stock for a given period of time exceeds the initial conversion price of $41.59 per share for the Notes.


18


Note 10. Commitments and Contingencies
 
(a)
Warranty
We provide limited product warranties. Historically, any payments made under these provisions have been immaterial.
(b)
Litigation and Claims
In October 2018, Finjan, Inc. (Finjan) filed a complaint against us and our wholly-owned subsidiary, Rapid7 LLC, in the United States District Court, District of Delaware, alleging patent infringement of seven patents held by them. In the complaint, Finjan sought unspecified damages, attorneys' fees and injunctive relief. We intend to vigorously contest Finjan's claims. This litigation is still in its early stages and the final outcome, including our liability, if any, with respect to Finjan's claims, is uncertain. 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.
In addition, from time to time, we are 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, financial condition or results of operations. 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 11. 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 March 31,
 
2019
 
2018
 
(in thousands)
North America
$
62,039

 
$
46,377

Other
11,146

 
8,138

Total
$
73,185

 
$
54,515

Of the total net revenues generated in North America, 97% and 95% of the revenues were generated in the United States for the three months ended March 31, 2019 and 2018, respectively.
Property and equipment, net by geographic area was as follows:
 
As of March 31, 2019
 
As of December 31, 2018
 
(in thousands)
United States
$
31,478

 
$
16,311

Other
1,293

 
1,212

Total
$
32,771

 
$
17,523



19


Note 12. Related Party Transactions

In October 2015, McAfee, LLC 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. On February 6, 2017, Michael Berry, a member of our board of directors, became the chief financial officer of Intel Security (McAfee). During the three months ended March 31, 2019, we did not make any payments for partner referral fees payable to McAfee LLC. As of March 31, 2019, we had $0.6 million of partner referral fees payable to McAfee, LLC recorded as accrued expenses on our consolidated balance sheet.
Note 13. Subsequent Event
On April 1, 2019, we acquired NetFort Technologies Limited (NetFort), a provider of end-to-end network traffic visibility and analytics across cloud, virtual and physical platforms for total cash consideration of $15.0 million. The acquisition will be accounted for under the acquisition method of accounting with the operations of the newly acquired entity included in our operating results from the date of acquisition. 

20


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, 2018 included in our Annual Report on Form 10-K, filed with the SEC on February 28, 2019.
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 and such forward-looking statements include, but are not limited to, statements with respect to our outlook; the impact of new accounting standards; deferred revenue; our transition to a subscription business model; our business strategy, plans and objectives for future operations; and our future financial and business performance. The events described in these 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 cyber security analytics and automation and a driving force behind the growing practice of Security Operations (SecOps). SecOps is the practice of aligning cyber security, information technology (IT), and development operations (DevOps) teams so that security becomes an integral part of these teams’ daily operations empowering organizations to innovate faster and more securely. As of March 31, 2019, over 7,900 organizations around the world trust Rapid7 to provide visibility, analytics and automation to help reduce risk, simplify cyber security complexity and deliver better security outcomes.

Organizations of all sizes are faced with a more sophisticated and motivated set of cyber attackers. Coupled with an increasingly complex IT environment and expanding attack surface, driven by ubiquitous connectivity, globalization, mobility and expansion to the cloud, security and IT teams are struggling to maintain adequate levels of cyber security, provide visibility to their management teams, and meet increasing regulatory requirements. At the same time, they must navigate a shortage of capable cyber security professionals.

Out of these challenges there is a growing need for cyber security, IT and DevOps teams to be better aligned and to work together to identify, manage and reduce risk and more nimbly adapt to emerging threats, without adding significant resources. This need is the foundation of the evolving SecOps movement. SecOps requires shared visibility into risk and priorities, and analytics and automation that enable IT, Security and DevOps to work together to achieve significantly higher levels of productivity and success. Rapid7 is providing solutions to power SecOps success.

Our mission is to advance security through technology and expertise that simplify the complexity of cyber security. We seek to remove friction from every aspect of customers’ businesses, making security achievable and allowing them to focus on their professional and organizational advancement.

We offer products across the four main pillars of SecOps:

Vulnerability Management: Our industry-leading Vulnerability Management solutions provide enterprises with comprehensive, yet prioritized, visibility into potential cyber risks across their traditional and modern IT environment. With built-in remediation workflows, automation, and validation, our solutions are designed to help ensure that risks can be easily mitigated and attack surfaces diminished.

Incident Detection and Response: Our Incident Detection and Response solutions are designed to enable organizations to rapidly detect and respond to cyber security incidents and breaches across physical, virtual and cloud assets. Equipped with user behavior analytics, attacker behavior analytics and deception technology, our Security Information and Event Management is designed to provide comprehensive network visibility and accelerate threat investigation and response.


21


Application Security: Our Application Security offering provides dynamic application security testing and run-time application security monitoring and protection solutions that are designed to continuously analyze web applications for security vulnerabilities and block many types of attack automatically.

Security Orchestration and Automation Response: Our Security Orchestration and Automation Response solutions allow operations teams to connect disparate solutions within their cyber security, IT and development operations and build automated workflows, without requiring code, to eliminate repetitive, manual and labor-intensive tasks, resulting in measurable time and cost savings.

To complement our SecOps products, we offer a range of managed services based on our software solutions and consulting services, including incident response services, security advisory services, and deployment and training.
We market and sell our products and professional services to organizations of all sizes globally, 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 March 31, 2019, we had 7,934 customers in 133 countries. 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 months ended March 31, 2019 or 2018.
We sell our products and professional services through direct inside and field sales teams and indirect channel partner relationships. Our sales teams focus on both new customer acquisition as well as 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, or EMEA; and Asia Pacific, or APAC, as well as by target organization size. Our highly technical sales engineers help define customer use cases, manage solution evaluations and train channel partners. In addition, we maintain a global channel partner network that complements our sales organization, particularly in EMEA, APAC and Latin America.
Recent Developments
On April 1, 2019, we acquired NetFort, a provider of end-to-end network traffic visibility and analytics across cloud, virtual and physical platforms for total cash consideration of $15.0 million.
Our Business Model
We have offerings in four key areas: (1) Vulnerability Management, (2) Incident Detection and Response, (3) Application Security and (4) Security Orchestration and Automation Response.
We offer our products through a variety of delivery models to meet the needs of our diverse customer base, including:
Cloud-based subscriptions, which provide our software capabilities to our customers through cloud access and on a Software as a Service basis. Our InsightVM, InsightIDR, InsightAppSec and InsightConnect products are offered as cloud-based subscriptions, generally with a one-year term.
Managed services, through which we operate our products and provide our capabilities on behalf of our customers. Our Managed Vulnerability Management, Managed Application Security and Managed Detection and Response products are offered on a managed service basis, generally pursuant to one-year agreements.
Licensed software, including both term and perpetual licenses, and the simultaneous sale of maintenance and support. Our Nexpose, Metasploit and AppSpider products are offered through term or perpetual software licenses. 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 them with real-time access to the latest vulnerabilities and exploits. Our maintenance and support and content subscription agreements are typically for one-year terms.
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

22


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, in a trailing 12-month period by the dollar value of the corresponding customer agreements. Our renewal rate was 120% for each of the three months ended March 31, 2019 and 2018. Our goal is to maintain what we believe are strong renewal rates. 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.
For the three months ended March 31, 2019 and 2018, recurring revenue, defined as revenue from term software licenses, content subscriptions, managed services, cloud-based subscriptions and maintenance and support, was 85% and 77%, respectively, of total revenue.
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
March 31,
 
 
2019
 
2018
 
 
(dollars in thousands)
Total revenue
 
$
73,185

 
$
54,515

Year-over-year growth (1)
 
34.2
%
 
20.5
%
Non-GAAP income (loss) from operations
 
$
577

 
$
(8,872
)
Operating cash flow
 
$
(13,566
)
 
$
7,296

(1) For the first quarter of 2018, we recognized revenue under ASC 606. For the first quarter of 2017, we recognized revenue under ASC 605 and therefore, the periods are not directly comparable.
 
 
As of March 31,
 
 
2019
 
2018
Number of customers
 
7,934

 
7,113

Annualized recurring revenue
 
$
268,194

 
$
177,792

Year-over-year growth
 
50.8
%
 
38.4
%
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.
Non-GAAP Income (Loss) from Operations. We monitor non-GAAP income (loss) from operations, a non-GAAP financial measure, to analyze our financial results. We believe non-GAAP income (loss) from operations is useful to investors, as a supplement to U.S. GAAP measures, in evaluating our ongoing operational performance and enhancing an overall understanding of our past financial performance and allowing for greater transparency with respect to metrics used by our management in its financial and operational decision-making. See Non-GAAP Financial Results below for further information on non-GAAP income (loss) from operations and a reconciliation of non-GAAP income (loss) from operations to the comparable GAAP financial measure.
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 impacted by the timing of commission and bonus payments, accounts payable payments and collections of accounts receivable.
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.
Annualized Recurring Revenue and Growth. Annualized Recurring Revenue (ARR) is defined as the annual value of all recurring revenue related to contracts in place at the end of the quarter. ARR should be viewed independently of revenue and

23


deferred revenue as ARR is an operating metric and is not intended to be combined with or replace these items. ARR is not a forecast of future revenue which can be impacted by contract start and end dates and renewal rates and does not include revenue reported as perpetual license or professional services revenue in our consolidated statement of operations.
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 income (loss) from operations, non-GAAP net income (loss), non-GAAP net income (loss) per share and adjusted EBITDA. 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 define non-GAAP gross profit, non-GAAP income (loss) from operations, non-GAAP net income (loss) and non-GAAP net income (loss) per share as the respective GAAP balances excluding the effect of stock-based compensation expense, amortization of acquired intangible assets, amortization of debt discount and issuance costs, and certain other items such as acquisition-related expenses, follow-on public offering costs and litigation-related expenses. Non-GAAP net income (loss) per basic and dilutive share is calculated as Non-GAAP net income (loss) divided by the weighted average shares used to compute net income (loss) per share, with the number of weighted average shares decreased to reflect the anti-dilutive impact of the capped call transactions entered into in connection with the 1.25% convertible senior note issued in August 2018.
We believe these non-GAAP financial measures are useful to investors in assessing our operating performance due to the following factors:
Stock-based compensation expense. 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 allows for more meaningful comparisons between our operating results from period to period.
Amortization of acquired intangible assets. 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 intangible assets are valued at the time of acquisition and are amortized over several years after the acquisition.
Amortization of debt discount and issuance costs. In August 2018, we issued $230 million of convertible senior notes, which bear interest at an annual fixed rate of 1.25%. The imputed interest rate of the convertible senior notes was approximately 7.37%. This is a result of the debt discount recorded for the conversion feature that is required to be separately accounted for as equity, and debt issuance costs, which reduce the carrying value of the convertible debt instrument. The debt discount is amortized as interest expense together with the issuance costs of the debt. The expense for the amortization of debt discount and debt issuance costs is a non-cash item, and we believe the exclusion of this interest expense provides a more useful comparison of our operational performance in different periods.
Litigation-related expenses. We exclude certain litigation-related expenses consisting of professional fees and related costs incurred by us related to significant litigation outside the ordinary course of business. We believe it is useful to exclude such expenses because we do not consider such amounts to be part of our ongoing operations.
Acquisition-related expenses and follow-on public offering costs. We exclude acquisition-related expenses and follow-on public offering costs as costs that are unrelated to the current operations and neither are comparable to the prior period nor predictive of future results.
Anti-dilutive impact of capped call transaction. In connection with the issuance of our convertible senior notes, we entered into capped call transactions to offset potential dilution from the embedded conversion feature in the notes. Although we cannot reflect the anti-dilutive impact of the capped call transactions under GAAP, we do reflect the anti-dilutive impact of the capped call transactions in non-GAAP net income (loss) per basic and diluted share to provide investors with useful information in evaluating the financial performance of the company on a per share basis.

24


We define adjusted EBITDA as net loss before (1) interest income, (2) interest expense, (3) other income (expense), net, (4) provision for income taxes, (5) depreciation expense, (6) amortization of intangible assets, (7) stock-based compensation expense, and (8) certain other items. We believe that the use of adjusted EBITDA is useful to investors and other users of our financial statements in evaluating our operating performance because it provides them with an additional tool to compare business performance across companies and across periods. Adjusted EBITDA should not be considered as a substitute for other measures of financial performance reported in accordance with GAAP. There are limitations to using this non-GAAP financial measure, including that other companies may calculate this measure differently than we do, that it does not reflect our capital expenditures or future requirements for capital expenditures and that it does not reflect changes in, or cash requirements for, our working capital and excludes some items that are cash based.
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 for the three months ended March 31, 2019 and 2018:
 
 
Three Months Ended March 31,
 
 
2019
 
2018
 
 
(in thousands)
GAAP total gross profit
 
$
53,212

 
$
37,921

Stock-based compensation expense
 
573

 
374

Amortization of acquired intangible assets
 
1,358

 
908

Non-GAAP total gross profit
 
$
55,143

 
$
39,203

 
 
 
 
 
 
 
Three Months Ended March 31,
 
 
2019
 
2018
 
 
(in thousands)
GAAP gross profit – products
 
$
43,803

 
$
26,843

Stock-based compensation expense
 
157

 
125

Amortization of acquired intangible assets
 
1,358

 
908

Non-GAAP gross profit – products
 
$
45,318

 
$
27,876

 
 
 
 
 
 
 
Three Months Ended March 31,
 
 
2019
 
2018
 
 
(in thousands)
GAAP gross profit – maintenance and support
 
$
7,673

 
$
8,904

Stock-based compensation expense
 
120

 
28

Non-GAAP gross profit – maintenance and support
 
$
7,793

 
$
8,932

 
 
 
 
 
 
 
Three Months Ended March 31,
 
 
2019
 
2018
 
 
(in thousands)
GAAP gross profit – professional services
 
$
1,736

 
$
2,174

Stock-based compensation expense
 
296

 
221

Non-GAAP gross profit – professional services
 
$
2,032

 
$
2,395


25


The following table reconciles GAAP loss from operations to non-GAAP income (loss) from operations for the three months ended March 31, 2019 and 2018:
 
 
Three Months Ended March 31,
 
 
2019
 
2018
 
 
(in thousands)
GAAP loss from operations
 
$
(9,744
)
 
$
(16,585
)
Stock-based compensation expense
 
8,634

 
6,225

Amortization of acquired intangible assets
 
1,397

 
948

Acquisition-related expenses
 
217

 

Follow-on public offering costs
 

 
140

Litigation-related expenses
 
73

 
400

Non-GAAP income (loss) from operations
 
$
577

 
$
(8,872
)
The following table reconciles GAAP net loss to non-GAAP net income (loss) for the three months ended March 31, 2019 and 2018:
 
 
Three Months Ended March 31,
 
 
2019
 
2018
 
 
(in thousands, except share and per share data)
GAAP net loss
 
$
(11,673
)
 
$
(16,361
)
Stock-based compensation expense
 
8,634

 
6,225

Amortization of acquired intangible assets
 
1,397

 
948

Acquisition-related expenses
 
217

 

Follow-on public offering costs
 

 
140

Litigation-related expenses
 
73

 
400

Amortization of debt discount and issuance costs
 
2,510

 

Non-GAAP net income (loss)
 
$
1,158

 
$
(8,648
)
 
 
 
 
 
Reconciliation of net income (loss) per share, basic:
 


 


GAAP net loss per share, basic
 
$
(0.24
)
 
$
(0.36
)
Non-GAAP adjustments to net loss
 
0.26

 
0.17

Non-GAAP net income (loss) per share, basic
 
$
0.02

 
$
(0.19
)
 
 
 
 
 
Reconciliation of net income (loss) per share, diluted:
 
 
 
 
GAAP net loss per share, diluted
 
$
(0.24
)
 
$
(0.36
)
Non-GAAP adjustments to net loss
 
0.26

 
0.17

Non-GAAP net income (loss) per share, diluted
 
$
0.02

 
$
(0.19
)
 
 
 
 
 
Weighted average shares used in GAAP per share calculation, basic and diluted
 
47,827,939

 
45,210,250

 
 
 
 
 
Weighted average shares used in non-GAAP per share calculation:
 
 
 
 
Basic
 
47,827,939

 
45,210,250

Diluted
 
51,184,402

 
45,210,250


26


The following table reconciles GAAP net loss to adjusted EBITDA for the three months ended March 31, 2019 and 2018:
 
 
Three Months Ended March 31,
 
 
2019
 
2018
Net loss
 
$
(11,673
)
 
$
(16,361
)
Interest income
 
(1,731
)
 
(243
)
Interest expense
 
3,229

 
2

Other (income) expense, net
 
206

 
(78
)
Provision for income taxes
 
225

 
95

Depreciation expense
 
1,850

 
1,383

Amortization of intangible assets
 
1,577

 
1,016

Stock-based compensation expense
 
8,634

 
6,225

Acquisition-related expenses
 
217

 

Follow-on public offering costs
 

 
140

Litigation-related expenses
 
73

 
400

Adjusted EBITDA
 
$
2,607

 
$
(7,421
)
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 at the beginning of a contractual period.
Products
We generate products revenue from the sale of (1) cloud-based subscriptions for our InsightVM, InsightIDR, InsightAppSec and InsightConnect products, (2) managed services offerings which utilize our products and (3) term or perpetual software licenses for our Nexpose, Metasploit and AppSpider products, as well as associated content subscriptions for our Nexpose and Metasploit products. We also generate appliance revenue that is included in our products revenue and is associated with hardware sold with our Nexpose product to certain customers.
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.
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.
Cost of Revenue
Our total cost of revenue consists of the costs of products, maintenance and support and professional services. Cost of revenue include overhead costs for depreciation, facilities, IT, information security, and recruiting. Our IT overhead costs include IT personnel compensation costs and costs associated with our IT infrastructure. All overhead costs are allocated based on relative headcount.
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. Also included in cost of products are software license fees, hardware, cloud computing costs and internet connectivity expenses directly related to delivering our products, amortization of contract fulfillment costs, as well as amortization of certain intangible assets including internally developed software.

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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 costs.
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 costs.
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 fluctuate over time depending on the factors described above.
Operating Expenses
Operating expenses consist of research and development, sales and marketing, and general and administrative expenses. Operating expenses include overhead costs for depreciation, facilities, IT, information security and recruiting. Our IT overhead costs include IT personnel compensation costs and costs associated with our IT infrastructure. All 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 travel and entertainment, consulting and professional fees for third-party development resources as well as allocated overhead costs.
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 remain relatively consistent 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, including amortization of deferred 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 costs.
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 executive, legal, human resources, and finance and accounting departments, including salaries and other payroll related costs, bonuses and stock-based compensation. Additional expenses include travel and entertainment, professional fees, litigation-related expenses, insurance, acquisition-related expenses, amortization of certain intangible assets and allocated overhead costs.
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 remain relatively consistent as a percentage of total revenue.
Interest Income
Interest income consists primarily of interest income on our cash and cash equivalents and our short and long-term investments.

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Interest Expense
Interest expense consists primarily of contractual interest expense, as well as amortization of debt discount and issuance costs related to our 1.25% convertible senior notes due 2023.
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.
Provision for Income Taxes
Provision for 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.

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Results of Operations
The following table sets forth our selected consolidated statements of operations data:
 
Three Months Ended March 31,
 
2019
 
2018
 
(in thousands)
Consolidated Statement of Operations Data:
 
 
 
Revenue:
 
 
 
Products
$
56,288

 
$
35,279

Maintenance and support
9,557

 
10,753

Professional services
7,340