10-Q 1 rpdq1201710q.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, 2017
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                      to                     
Commission File Number: 001-37496
 
 
RAPID7, INC.
(Exact Name of Registrant as Specified in its Charter)
 
Delaware
 
35-2423994
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)
 
 
 
100 Summer Street
Boston, MA
 
02110
(Address of principal executive offices)
 
(Zip Code)
Registrant’s telephone number, including area code: (617) 247-1717
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  ☒    No  ☐
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ☒    No  ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and "emerging growth company" in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer
Accelerated filer
Non-accelerated filer
☐  (Do not check if a small reporting company)
Small reporting company
Emerging growth company
 
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☒
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ☐    No  ☒
As of May 1, 2017, there were 42,858,692 shares of the registrant’s common stock, $0.01 par value per share, outstanding.
 




Table of Contents
 


i


PART I—FINANCIAL INFORMATION
Item 1.
Financial Statements.
RAPID7, INC.
Consolidated Balance Sheets (Unaudited)
(in thousands, except share and per share data)
 
 
 
March 31, 2017
 
December 31, 2016
Assets
 
 
 
 
Current assets:
 
 
 
 
Cash and cash equivalents
 
$
50,662

 
$
53,148

Short-term investments
 
28,561

 
18,779

Accounts receivable, net of allowance for doubtful accounts of $1,130 and $1,061 at March 31, 2017 and December 31, 2016, respectively
 
33,703

 
49,154

Prepaid expenses and other current assets
 
7,742

 
9,152

Total current assets
 
120,668

 
130,233

Long-term investments
 
16,803

 
20,162

Property and equipment, net
 
8,010

 
8,088

Goodwill
 
75,110

 
75,110

Intangible assets, net
 
8,460

 
8,946

Other assets
 
720

 
764

Total assets
 
$
229,771

 
$
243,303

Liabilities and Stockholders’ Equity
 
 
 
 
Current liabilities:
 
 
 
 
Accounts payable
 
$
3,495

 
$
4,012

Accrued expenses
 
16,346

 
23,499

Deferred revenue, current portion
 
116,564

 
116,903

Other current liabilities
 
1,239

 
1,195

Total current liabilities
 
137,644

 
145,609

Deferred revenue, non-current portion
 
51,083

 
52,160

Other long-term liabilities
 
3,187

 
3,496

Total liabilities
 
191,914

 
201,265

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

 

Common stock, $0.01 par value per share; 100,000,000 shares authorized at March 31, 2017 and December 31, 2016; 43,309,925 and 43,018,737 shares issued at March 31, 2017 and December 31, 2016, respectively; 42,840,896 and 42,554,683 shares outstanding at March 31, 2017 and December 31, 2016, respectively
 
428

 
426

Treasury stock, at cost, 469,029 and 464,054 shares at March 31, 2017 and December 31, 2016, respectively
 
(4,457
)
 
(4,391
)
Additional paid-in-capital
 
441,913

 
435,360

Accumulated other comprehensive loss
 
(39
)
 
(19
)
Accumulated deficit
 
(399,988
)
 
(389,338
)
Total stockholders’ equity
 
37,857

 
42,038

Total liabilities and stockholders’ equity
 
$
229,771

 
$
243,303

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


1


RAPID7, INC.
Consolidated Statements of Operations (Unaudited)
(in thousands, except share and per share data)
 
 
 
Three Months Ended March 31,
 
 
2017
 
2016
Revenue:
 
 
 
 
Products
 
$
25,942

 
$
20,145

Maintenance and support
 
10,802

 
8,381

Professional services
 
8,501

 
6,270

Total revenue
 
45,245

 
34,796

Cost of revenue:
 
 
 
 
Products
 
4,710

 
2,598

Maintenance and support
 
1,878

 
1,681

Professional services
 
5,676

 
4,433

Total cost of revenue
 
12,264

 
8,712

Total gross profit
 
32,981

 
26,084

Operating expenses:
 
 
 
 
Research and development
 
11,393

 
12,342

Sales and marketing
 
24,810

 
22,768

General and administrative
 
7,248

 
6,593

Total operating expenses
 
43,451

 
41,703

Loss from operations
 
(10,470
)
 
(15,619
)
Other income (expense), net:
 
 
 
 
Interest income (expense), net
 
169

 
(15
)
Other income (expense), net
 
(115
)
 
196

Loss before income taxes
 
(10,416
)
 
(15,438
)
Provision for income taxes
 
129

 
142

Net loss
 
$
(10,545
)
 
$
(15,580
)
Net loss per share, basic and diluted
 
$
(0.25
)
 
$
(0.38
)
Weighted-average common shares outstanding, basic and diluted
 
42,016,831

 
40,547,669

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,
 
 
2017
 
2016
 
 
 
 
 
Net loss
 
$
(10,545
)
 
$
(15,580
)
Other comprehensive loss:
 
 
 
 
Net unrealized loss on investments
 
(20
)
 

Comprehensive loss
 
$
(10,565
)
 
$
(15,580
)

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


3


RAPID7, INC.
Consolidated Statements of Cash Flows (Unaudited)
(in thousands)
 
 
 
Three Months Ended March 31,
 
 
2017
 
2016
Cash flows from operating activities:
 
 
 
 
Net loss
 
$
(10,545
)
 
$
(15,580
)
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
 
 
 
 
Depreciation and amortization
 
1,624

 
1,711

Stock-based compensation expense
 
4,279

 
5,519

Provision for doubtful accounts
 
316

 
124

Foreign currency re-measurement loss (gain)
 
44

 
(223
)
Other non-cash expenses
 
97

 
78

Changes in assets and liabilities:
 
 
 
 
Accounts receivable
 
15,182

 
14,048

Prepaid expenses and other assets
 
1,466

 
(716
)
Accounts payable
 
(244
)
 
(500
)
Accrued expenses
 
(7,216
)
 
(7,427
)
Deferred revenue
 
(1,416
)
 
1,540

Other liabilities
 
(266
)
 
(166
)
Net cash provided by (used in) operating activities
 
3,321

 
(1,592
)
Cash flows from investing activities:
 
 
 
 
Purchases of property and equipment
 
(1,335
)
 
(1,092
)
Purchases of investments
 
(7,401
)
 

Maturities of investments
 
900

 

Net cash used in investing activities
 
(7,836
)
 
(1,092
)
Cash flows from financing activities:
 
 
 
 
Payments of capital lease obligations
 

 
(68
)
Taxes paid related to net share settlement of equity awards
 
(169
)
 
(3,087
)
Proceeds from employee stock purchase plan
 
1,499

 
2,096

Proceeds from stock option exercises
 
775

 
547

Net cash provided by (used in) financing activities
 
2,105

 
(512
)
Effect of exchange rate changes on cash and cash equivalents
 
(76
)
 
151

Net decrease in cash and cash equivalents
 
(2,486
)
 
(3,045
)
Cash and cash equivalents, beginning of period
 
53,148

 
86,553

Cash and cash equivalents, end of period
 
$
50,662

 
$
83,508

Supplemental cash flow information:
 
 
 
 
Cash paid for income taxes
 
$
65

 
$
274

Cash paid for interest
 
$

 
$
1

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

4


RAPID7, INC.
Notes to Consolidated Financial Statements (Unaudited)
Note 1. Description of Business, Basis of Presentation and Consolidation and Significant Accounting Policies
Description of Business
Rapid7, Inc. and subsidiaries (“we,” “us” or “our”) is a leading provider of analytics for security and IT operations solutions that enable organizations to implement an active, analytics-driven approach to cyber security and IT operations.
Basis of Presentation and Consolidation
The accompanying unaudited consolidated financial statements have been prepared by us in accordance with accounting principles generally accepted in the United States of America (GAAP) as well as pursuant to the rules and regulations of the Securities and Exchange Commission (SEC) regarding interim financial reporting. Accordingly, certain information and note disclosures normally included in the financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such rules and regulations. These consolidated financial statements should be read in conjunction with the consolidated financial statements and related notes included in our Annual Report on Form 10-K for the year ended December 31, 2016 filed with the SEC on March 9, 2017.
The consolidated financial statements include our results of operations and those of our wholly-owned subsidiaries and reflect all adjustments (consisting solely of normal, recurring adjustments) which are, in the opinion of management, necessary for a fair statement of results for the interim periods presented. All intercompany transactions and balances have been eliminated in consolidation. The results of operations for the three months ended March 31, 2017 are not necessarily indicative of the results to be expected for any future period or the entire fiscal year.
Recent Accounting Pronouncements
In October 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2016-16, Income Taxes (Topic 740): Intra-Entity Transfers of Assets Other Than Inventory. The ASU is intended to improve the accounting for the income tax consequences of intra-entity transfers of assets other than inventory. Current GAAP prohibits the recognition of current and deferred income taxes for an intra-entity asset transfer until the asset has been sold to an outside party. The ASU will allow an entity to recognize the income tax consequences of these transfers when the transfers occur. The ASU will be effective for us in the first quarter of 2018. We are currently evaluating the impact that the adoption of this ASU will have on our consolidated financial statements.
In March 2016, the FASB issued ASU 2016-09, Compensation-Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting. The ASU is intended to simplify several aspects of the accounting for share-based payment transactions, including the accounting for income taxes, forfeitures and statutory tax withholding requirements, as well as classification on the statement of cash flows. We adopted this ASU on January 1, 2017 and as a result, we have made an accounting policy election to account for forfeitures as they occur. This change has been applied on a modified retrospective basis, resulting in a cumulative-effect adjustment to increase accumulated deficit by $0.1 million as of January 1, 2017. The adoption of this ASU also requires excess tax benefits and tax deficiencies be recorded in the income statement as opposed to additional paid-in capital when the awards vest or are settled, and has been applied on a prospective basis. In connection with the adoption of this ASU, we recorded a cumulative-effect adjustment as of January 1, 2017 to increase gross deferred tax assets and the related valuation allowance against deferred tax assets by $3.4 million. The provisions related to classification of excess tax benefits in the statement of cash flows were adopted prospectively, and as such, the prior periods were not retrospectively adjusted.
In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842). The ASU requires companies to recognize on the balance sheet the assets and liabilities for the rights and obligations created by leased assets. The ASU will be effective for us in the first quarter of 2019, with early adoption permitted. We are currently evaluating the impact that the adoption of this ASU will have on our consolidated financial statements.
In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606). The ASU outlines a single, comprehensive model for accounting for revenue from contracts with customers and requires more detailed disclosure to enable users of financial statements to understand the nature, amount, timing and uncertainty of revenue and cash flows arising from such contracts. In August 2015, the FASB issued ASU 2015-14, which provides a one year deferral in the effective date of ASU 2014-09. ASU 2014-09 will now be effective for us beginning January 1, 2018; however, early adoption will be permitted as of the original effective date. We plan to adopt ASU 2014-09 in the first quarter of 2018 and expect to adopt on a modified retrospective basis. Under this method of adoption, we would recognize the cumulative effect of initially applying the standard as an adjustment to

5


the opening balance of retained earnings in the period of initial application. Comparative prior year periods would not be adjusted. We are currently evaluating the potential impact of this standard on our financial position and results of operations. Based on our analysis performed to date, we expect recognition of total revenue related to our perpetual and term software licenses, managed services, cloud-based subscriptions and stand-alone professional services to remain substantially unchanged. However, under the new standard, for software licenses that are sold with professional services in a multiple-element arrangement, the professional services will likely represent a separate performance obligation and we will recognize revenue associated with the professional services as such services are performed. Revenue associated with professional services in a multiple-element arrangement is currently recognized ratably over the related contractual period of maintenance and support (typically one to three years) due to the lack of vendor-specific objective evidence (VSOE) of selling price for the contractual elements. In addition, under the new standard, we expect the allocation of contract consideration for multiple-element arrangements to be on a relative fair value basis which may impact the presentation of revenue by class. Additionally, under the new standard, we expect to capitalize direct and incremental certain commission costs to obtain a contract and amortize such costs over the customer's estimated economic life rather than expensing them as incurred in the period that the commissions are earned by our employees (which is typically upon signing of an arrangement).
Note 2. Fair Value Measurements
We measure certain financial assets and liabilities at fair value. Fair value is determined based upon the exit price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants, as determined by either the principal market or the most advantageous market. Inputs used in the valuation techniques to derive fair values are classified based on a three-level hierarchy, as follows:
Level 1: Observable inputs that reflect quoted prices (unadjusted) for identical assets or liabilities in active markets.
Level 2: Observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets with insufficient volume or infrequent transactions (less active markets); or model-derived valuations in which all significant inputs are observable or can be derived principally from or corroborated by observable market data for substantially the full term of the assets or liabilities.
Level 3: Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the asset or liability.
We consider an active market to be one in which transactions for the asset or liability occur with sufficient frequency and volume to provide pricing information on an ongoing basis, and consider an inactive market to be one in which there are infrequent or few transactions for the asset or liability, the prices are not current, or price quotations vary substantially either over time or among market makers.
The following table presents our financial assets and liabilities measured and recorded at fair value on a recurring basis using the above input categories:
 
 
 
As of March 31, 2017
 
 
Level 1
 
Level 2
 
Level 3
 
Total
 
 
(in thousands)
Description:
 
 
 
 
 
 
 
 
Assets:
 
 
 
 
 
 
 
 
Money market funds
 
$
4,632

 
$

 
$

 
$
4,632

U.S. Government agencies
 
14,973

 

 

 
14,973

Commercial paper
 

 
6,295

 

 
6,295

Corporate bonds
 

 
17,686

 

 
17,686

Asset-backed securities
 

 
6,410

 

 
6,410

Total assets
 
$
19,605

 
$
30,391

 
$

 
$
49,996



6


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

 
$

 
$

 
$
10,085

U.S. Government agencies
 
14,982

 

 

 
14,982

Commercial paper
 

 
8,078

 

 
8,078

Corporate bonds
 

 
10,314

 

 
10,314

Asset-backed securities
 

 
6,467

 

 
6,467

Total assets
 
$
25,067

 
$
24,859

 
$

 
$
49,926

We had no liabilities measured and recorded at fair value on a recurring basis as of March 31, 2017 or December 31, 2016.
Our investments, which are all classified as available-for-sale, consisted of the following:
 
 
As of March 31, 2017
 
 
Amortized Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Fair Value
 
 
(in thousands)
Description:
 
 
 
 
 
 
 
 
U.S. Government agencies
 
$
14,993

 
$

 
$
(20
)
 
$
14,973

Commercial paper
 
6,295

 

 

 
6,295

Corporate bonds
 
17,701

 
4

 
(19
)
 
17,686

Asset-backed securities
 
6,414

 

 
(4
)
 
6,410

Total assets
 
$
45,403

 
$
4

 
$
(43
)
 
$
45,364

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

 
$
3

 
$
(13
)
 
$
14,982

Commercial paper
 
7,178

 

 

 
7,178

Corporate bonds
 
10,326

 
1

 
(13
)
 
10,314

Asset-backed securities
 
6,464

 
4

 
(1
)
 
6,467

Total assets
 
$
38,960

 
$
8

 
$
(27
)
 
$
38,941

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

7



Note 3. Property and Equipment
Property and equipment are recorded at cost and consist of the following:
 
 
As of
March 31, 2017
 
As of
December 31, 2016
 
 
(in thousands)
Computer equipment and software
 
$
13,268

 
$
12,844

Furniture and fixtures
 
3,287

 
3,131

Leasehold improvements
 
8,557

 
8,077

Total
 
25,112

 
24,052

Less accumulated depreciation
 
(17,102
)
 
(15,964
)
Property and equipment, net
 
$
8,010

 
$
8,088

Depreciation expense was $1.1 million for the three months ended March 31, 2017 and 2016.
Note 4. Goodwill and Intangible Assets
Goodwill was $75.1 million as of March 31, 2017 and December 31, 2016.
Identifiable intangible assets consist of the following:
 
 
 
As of March 31, 2017
 
As of December 31, 2016
 
Weighted-
Average
Life (years)
 
Gross Carrying
Amount
 
Accumulated
Amortization
 
Net Book Value
 
Gross Carrying
Amount
 
Accumulated
Amortization
 
Net Book Value
 
 
 
(in thousands)
Intangible assets subject to amortization:
 
 
 
 
 
 
 
 
 
 
 
 
 
Developed technology
6.3
 
$
11,231

 
$
(3,557
)
 
$
7,674

 
$
11,231

 
$
(3,118
)
 
$
8,113

Customer relationships
6.7
 
1,000

 
(236
)
 
764

 
1,000

 
(197
)
 
803

Trade names
6.1
 
519

 
(499
)
 
20

 
519

 
(496
)
 
23

Non-compete agreements
2.0
 
40

 
(38
)
 
2

 
40

 
(33
)
 
7

Total intangible assets
 
 
$
12,790

 
$
(4,330
)
 
$
8,460

 
$
12,790

 
$
(3,844
)
 
$
8,946

Amortization expense was $0.5 million and $0.6 million for the three months ended March 31, 2017 and 2016, respectively.
Estimated future amortization expense of the acquired identifiable intangible assets as of March 31, 2017 is as follows (in thousands):
2017 (for the remaining nine months)
$
1,444

2018
1,886

2019
1,859

2020
1,837

2021
1,332

2022 and thereafter
102

Total
$
8,460

Note 5. Stock-Based Compensation Expense
 
(a)
General
Stock-based compensation expense for restricted stock, restricted stock units, stock options and issuances of common stock pursuant to our employee stock purchase plan was classified in the accompanying consolidated statements of operations as follows:

8


 
 
Three Months Ended March 31,
 
 
2017
 
2016
 
 
(in thousands)
Stock-based compensation expense:
 
 
 
 
Cost of revenue
 
$
202

 
$
137

Research and development
 
1,513

 
1,493

Sales and marketing
 
1,403

 
2,901

General and administrative
 
1,161

 
988

Total stock-based compensation expense
 
$
4,279

 
$
5,519

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, 2017 was as follows:
 
 
 
Restricted Stock
 
Restricted Stock Units
 
 
Shares
 
Weighted-Average
Grant Date
Fair Value
 
Shares
 
Weighted-Average
Grant Date
Fair Value
Unvested balance as of December 31, 2016
 
585,004

 
$
18.05

 
734,577

 
$
13.47

Granted
 

 

 
1,308,940

 
13.83

Vested
 
(78,441
)
 
19.05

 
(48,312
)
 
13.21

Forfeited
 
(860
)
 
23.01

 
(40,554
)
 
12.73

Unvested balance as of March 31, 2017
 
505,703

 
$
17.89

 
1,954,651

 
$
13.73

As of March 31, 2017, the unrecognized compensation expense related to our unvested restricted stock and restricted stock units expected to vest was $32.8 million. This unrecognized compensation expense will be recognized over an estimated weighted-average amortization period of 3.1 years.
During the three months ended March 31, 2017, we repurchased 4,975 shares of our common stock in settlement of employee tax withholding obligations due upon the vesting of restricted stock.
(c)
Stock Options
Stock option activity during the three months ended March 31, 2017 was as follows:
 
 
Shares
 
Weighted
Average
Exercise
Price
 
Weighted
Average
Remaining
Contractual Life
(in years)
 
Aggregate
Intrinsic
Value
(in thousands)
Outstanding as of December 31, 2016
 
4,580,375

 
$
8.20

 
 
 
 
Granted
 
1,138,566

 
12.93

 
 
 
 
Exercised
 
(120,479
)
 
6.43

 
 
 
$
1,000

Forfeited/cancelled
 
(97,442
)
 
12.10

 
 
 
 
Outstanding as of March 31, 2017
 
5,501,020

 
9.15

 
7.3
 
$
32,817

Vested and exercisable as of March 31, 2017
 
2,926,282

 
5.91

 
5.6
 
$
26,759

Vested and expected to vest as of March 31, 2017
 
5,501,020

 
9.15

 
7.3
 
$
32,817

As of March 31, 2017, the unrecognized compensation expense related to our unvested stock options expected to vest was $14.7 million. This unrecognized compensation expense will be recognized over an estimated weighted-average amortization period of 3.1 years.
The total fair value of stock options vested in the three months ended March 31, 2017 was $1.0 million. The weighted-average grant date fair value of stock options granted in the three months ended March 31, 2017 was $6.46 per share.

9



(d)
Employee Stock Purchase Plan
Under the Rapid7, Inc. 2015 Employee Stock Purchase Plan (ESPP), employees may set aside up to 15% of their gross earnings, on an after-tax basis, to purchase our common shares at a discounted price, which is calculated at 85% of the lesser of: (i) the market value of our common stock at the beginning of each offering period and (ii) the market value of our common stock on the applicable purchase date.
On March 15, 2017, we issued 138,085 shares of common stock to employees for aggregate proceeds of $1.5 million. The purchase prices of the shares of common stock were $10.60 and $12.79 per share, which were discounted in accordance with the terms of the ESPP from the closing prices of our common stock on March 16, 2016 of $12.47 and on March 15, 2017 of $15.05, respectively.
Note 6. 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, 2017 and 2016:
 
Three Months Ended March 31,
 
2017
 
2016
 
(in thousands, except share and per share data)
Numerator:
 
 
 
Net loss
$
(10,545
)
 
$
(15,580
)
Denominator:
 
 
 
Weighted-average common shares outstanding, basic and diluted
42,016,831

 
40,547,669

Net loss per share attributable to common stockholders, basic and diluted
$
(0.25
)
 
$
(0.38
)
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,
 
2017
 
2016
Options to purchase common stock
5,501,020

 
4,881,355

Unvested restricted stock
505,703

 
1,062,568

Unvested restricted stock units
1,954,651

 
498,300

Shares to be issued under ESPP
10,959

 
17,639

Total
7,972,333

 
6,459,862

Note 7. Commitments and Contingencies
 
(a)
Warranty
We provide limited product warranties. Historically, any payments made under these provisions have been immaterial.
(b)
Litigation and Claims
From time to time, we may be a party to litigation or subject to claims incident to the ordinary course of business. Although the results of litigation and claims cannot be predicted with certainty, we currently believe that the final outcome of these ordinary course matters will not have a material adverse effect on our business. Regardless of the outcome, litigation can have an adverse impact on us because of defense and settlement costs, diversion of management resources and other factors.
(c)
Indemnification Obligations
We agree to standard indemnification provisions in the ordinary course of business. Pursuant to these provisions, we agree to indemnify, hold harmless and reimburse the indemnified party for losses suffered or incurred by the indemnified party, generally our customers, in connection with any United States patent, copyright or other intellectual property infringement claim by any third party arising from the use of our products or services in accordance with

10


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 8. 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,
 
2017
 
2016
 
(in thousands)
North America
$
37,993

 
$
30,132

Other
7,252

 
4,664

Total
$
45,245

 
$
34,796

Of the total net revenues generated in North America, 94% and 97% of the revenues were generated in the United States for the three months ended March 31, 2017 and 2016, respectively.
Property and equipment, net by geographic area was as follows:
 
 
As of March 31, 2017
 
As of December 31, 2016
 
(in thousands)
United States
$
6,726

 
$
7,063

Other
1,284

 
1,025

Total
$
8,010

 
$
8,088

Note 9. Related Party Transactions
In October 2015, McAfee LLC (formerly known as Intel Security) announced the end-of-sale for the McAfee Vulnerability Manager to customers and partners, effective January 11, 2016, with end-of-life to follow, and announced that we were named their exclusive vulnerability management partner. Under the terms of the commercial agreement, we incur partner referral fees as customers transition from McAfee Vulnerability Manager to Nexpose. During the three months ended March 31, 2017, we recognized sales and marketing expense of $0.9 million related to partner referral fees paid to McAfee LLC. On February 6, 2017, Michael Berry, a member of our Board of Directors, became the Chief Financial Officer of McAfee LLC.

11


Item 2.    Management's Discussion and Analysis of Financial Condition and Results of Operations.
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with (1) our consolidated financial statements and related notes appearing elsewhere in this Quarterly Report on Form 10-Q and (2) the audited consolidated financial statements and the related notes and management’s discussion and analysis of financial condition and results of operations for the fiscal year ended December 31, 2016 included in our Annual Report on Form 10-K, filed with the SEC on March 9, 2017.
This Quarterly Report on Form 10-Q contains “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, or the Securities Act, and Section 21E of the Securities Exchange Act of 1934, as amended, or the Exchange Act. These statements are often identified by the use of words such as “anticipate,” “believe,” “continue,” “could,” “estimate,” “expect,” “intend,” “may,” “plan,” “project,” “will,” “would” or the negative or plural of these words or similar expressions or variations. Such forward-looking statements are subject to a number of risks, uncertainties, assumptions and other factors that could cause actual results and the timing of certain events to differ materially from future results expressed or implied by the forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those identified herein, and those discussed in the section titled “Risk Factors,” set forth in Part II, Item 1A of this Quarterly Report on Form 10-Q and in our other SEC filings. You should not rely upon forward-looking statements as predictions of future events. Furthermore, such forward-looking statements speak only as of the date of this report. Except as required by law, we undertake no obligation to update any forward-looking statements to reflect events or circumstances after the date of such statements.
Overview
Rapid7 is a leading provider of analytics for security and IT operations that enable organizations to implement an active, analytics-driven approach to cyber security and IT operations. Our data and analytics platform was purpose-built for today’s increasingly complex and chaotic IT environment. We make it simple to collect and unify operational data from across the entire IT infrastructure, and our advanced analytics unlock the information required to securely operate, manage and develop today's sophisticated applications and services.
We combine our extensive experience in collecting disparate data, deep insight into attacker behaviors and techniques and our purpose-driven analytics to make sense of the wealth of data available to organizations about their IT environments and users. Our powerful and proprietary analytics enable organizations to contextualize and prioritize the threats facing their physical, virtual and cloud assets, including those posed by the behaviors of their users. Leveraging our IT data and analytics platform, our solutions enable organizations to strategically and dynamically manage their cyber security exposure and manage IT operations. Our solutions empower organizations to prevent attacks by providing visibility into vulnerabilities, and allow them to rapidly detect compromises, respond to breaches and correct the underlying causes of attacks. By providing a unified IT and security platform, with automated workflow, we enable IT and security to work together more effectively to develop, operate and secure their environment. For example, our platform and proprietary technologies were developed to help customers identify the weaknesses and exposures in their environment and are designed to enable them to detect and respond to breaches immediately. We help them troubleshoot performance issues across their infrastructure, applications and endpoints. Our platform approach enables organizations to collect data once and use it for ongoing unlimited use and access to solve the specific problems their organization faces, reducing the costs and overhead associated with relying on point solutions, and enabling workflow between organizations that must work together to resolve issues, reduce risk and increase resiliency.
We market and sell our products and professional services to global organizations of all sizes, including mid-market businesses, enterprises, non-profits, educational institutions and government agencies. Our customers span a wide variety of industries such as technology, energy, financial services, healthcare and life sciences, manufacturing, media and entertainment, retail, education, real estate, transportation, government and professional services. As of March 31, 2017, we had over 6,300 customers in 122 countries, including 39% of the Fortune 1000. Our revenue was not concentrated with any individual customer or group of customers, and no customer represented more than 3% or 2% of our revenue for the three months ended March 31, 2017 and 2016, respectively.
We sell our products and services through direct inside and field sales teams and indirect channel partner relationships. Our global sales teams focus on both new customer acquisition and up-selling and cross-selling additional offerings to our existing customers. Our sales teams are organized by geography, consisting of the Americas; Europe, the Middle East and Africa; and Asia Pacific, or APAC, as well as by target organization size. Our inside sales team focuses on small and middle-market transactions, while larger or more complex transactions are generally handled by our globally distributed direct field sales teams. Our highly technical sales engineers help define customer use cases, manage solution evaluations and train channel partners.

12



Recent Developments
In April 2017, we announced the evolution of our Rapid7 Insight platform with the availability of two new solutions: InsightVM, for vulnerability management, and InsightAppSec, for application security testing. InsightVM builds upon our vulnerability management solution, Nexpose, by fully leveraging the abilities of the cloud to provide live answers to security professionals' most critical questions. InsightVM's live monitoring gathers continuous data to provide security professionals with increased visibility into the risk posed by their entire network footprint, including cloud, virtual and endpoints.
InsightAppSec, currently in beta, is designed to provide security professionals with the ability to assess modern web applications, while keeping pace with the industry’s newest applications. Enabled by the Rapid7 Insight platform, InsightAppSec streamlines results to provide more comprehensive visibility, instantaneously. With a focus on ease of use, InsightAppSec will feature more efficient scan creation, tuning, and scheduling. The solution, which advances the capabilities of Rapid7’s AppSpider, will feature a new workflow designed to provide more data and increased visibility into applications. InsightAppSec has a universal translator that automatically interprets the new technologies being used in today’s web and mobile applications.

Our Business Model
We have three offerings: (1) threat exposure management, which includes our Nexpose, InsightVM, Metasploit, AppSpider and InsightAppSec products, (2) incident detection and response, which includes our InsightIDR, Managed Detection and Response (formerly known as "Analytic Response"), InsightOps and Logentries products as well as our incident response services and (3) security advisory services.
We offer our products through a variety of delivery models to meet the needs of our diverse customer base, including:
 
Licensed software, including both term and perpetual licenses, and the simultaneous sale of maintenance and support. Our Nexpose, Metasploit and AppSpider products are offered through perpetual or term software licenses, with a substantial majority of our customers selecting a perpetual license. Our customers who purchase software licenses also purchase an agreement for maintenance and support, which provides our customers with telephone and web-based support and ongoing bug fixes and repairs during the term of the maintenance and support agreement, and our customers who purchase our Nexpose and Metasploit products also purchase content subscriptions, which provide our customers with real-time access to the latest vulnerabilities and exploits. Our maintenance and support and content subscription agreements are typically for one to three-year terms.
 
Cloud-based subscriptions, which provide our software capabilities to our customers through cloud access and on a Software as a Service, or SaaS, basis. Our InsightIDR, InsightVM, AppSpider, InsightAppSec, Logentries and InsightOps products are offered on a cloud-based subscription basis, generally with one to three-year terms.
Managed services, through which we operate our software and provide our capabilities on behalf of our customers. Our Managed Vulnerability Management (Nexpose), Managed Application Security (AppSpider) and Managed Detection and Response (Insight IDR) products are offered on a managed service basis, generally pursuant to one to three-year agreements.
We also offer various professional services across all of our offerings, including deployment and training services related to our Nexpose, Metasploit, AppSpider and InsightIDR software products, incident response services and security advisory services. Customers can purchase our professional services together with our product offerings or on a stand-alone basis pursuant to fixed fee or time-and-materials agreements.
An important component of our revenue growth strategy is to have our existing customers renew their agreements with us and purchase additional products from us. To assess our performance against this objective, we monitor the renewal rates of our existing customers. We calculate our renewal rate by dividing the dollar value of renewed customer agreements, including upsells and cross-sells of additional products, but excluding professional services, on a monthly basis in a trailing 12-month period by the dollar value of the corresponding expiring customer agreements. We also calculate an expiring renewal rate that does not take into account any upsells or cross-sells. As a result of this methodology, we would not expect our expiring renewal rate to exceed 100%. Our renewal rate was 120% and 126% for the three months ended March 31, 2017 and 2016, respectively, and our expiring revenue renewal rate was 88% and 89% for the three months ended March 31, 2017 and 2016, respectively. Our goal is to maintain what we believe are strong renewal rates, and work to increase them over time. However, our renewal rates may decline or fluctuate as a result of a number of factors, including customers’ satisfaction or dissatisfaction with our products and professional services, pricing, competitive offerings, economic conditions or overall reductions in our customers’ spending levels.

13


We generate revenue from selling products, maintenance and support, and professional services. For the three months ended March 31, 2017 and 2016, 81% and 82% of our revenue, respectively, was derived from sales of products and associated maintenance and support, while the remaining 19% and 18%, respectively, was derived from the sale of professional services.
For the three months ended March 31, 2017 and 2016, recurring revenue, defined as sales of term software licenses, content subscriptions, managed services, cloud-based subscriptions and maintenance and support, was 69% and 67%, respectively, of total revenue. In prior years, we did not include term software licenses in the calculation of recurring revenue. As a result, for the three months ended March 31, 2016, our recurring revenue was recast from 61%, as previously disclosed, to 67%.
For the three months ended March 31, 2017 and 2016, 89% and 86%, respectively, of our total revenue came from deferred revenue on the balance sheet at the beginning of the respective periods. We generally bill customers and collect payment for both our products and services up front.
Other Business Metrics
We regularly monitor a number of financial and operating metrics in order to measure our current performance and estimate our future performance. Our other business metrics may be calculated in a manner different than similar other business metrics used by other companies.
 
 
 
Three Months Ended
March 31,
 
 
2017
 
2016
 
 
(dollars in thousands)
Total revenue
 
$
45,245

 
$
34,796

Year-over-year growth
 
30.0
%
 
47.6
%
Calculated billings (non-GAAP)
 
43,829

 
36,336

Operating cash flow
 
$
3,321

 
$
(1,592
)
 
 
 
As of March 31,
 
 
2017
 
2016
Deferred revenue
 
$
167,647

 
$
131,857

Number of customers
 
6,350

 
5,360

Total Revenue and Growth. We are focused on driving continued revenue growth through increased sales of our products and professional services to new and existing customers.
Calculated Billings. Calculated billings is a key performance measure that we define as total revenue recognized in accordance with generally accepted accounting principles, or GAAP, plus the change in deferred revenue from the beginning to the end of the period. We consider calculated billings to be a useful metric for management and investors, as a supplement to the corresponding GAAP measure of total revenue, because billings drive deferred revenue, which is an important indicator of the health and visibility of trends in our business, and represents a significant percentage of future revenue. We regularly monitor calculated billings because we believe the measure offers valuable information regarding the performance of our business and will help investors better understand the sales activity and performance of our business for a particular period. Our use of calculated billings has limitations as an analytical tool and should not be considered in isolation or as a substitute for revenue recognition or revenue measurement, or an analysis of our results as reported under GAAP. Also, it is important to note that other companies, including companies in our industry, may not use calculated billings, may compute billings differently, may have different billing frequencies, or may use other financial measures to evaluate their performance, all of which could reduce the usefulness of calculated billings as a comparative measure.

14


 
 
Three Months Ended March 31,
 
 
2017
 
2016
 
 
(in thousands)
Total revenue
 
$
45,245

 
$
34,796

Add: Deferred revenue, end of period
 
167,647

 
131,857

Less: Deferred revenue, beginning of period
 
169,063

 
130,317

Calculated billings
 
$
43,829

 
$
36,336

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

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

15


performance of our business operations, facilitates comparison of our results with other periods and may also facilitate comparison with the results of other companies in our industry.
Our non-GAAP financial measures may not provide information that is directly comparable to that provided by other companies in our industry, as other companies in our industry may calculate non-GAAP financial results differently, particularly related to non-recurring, unusual items. In addition, there are limitations in using non-GAAP financial measures because the non-GAAP financial measures are not prepared in accordance with GAAP, may be different from non-GAAP financial measures used by other companies and exclude expenses that may have a material impact upon our reported financial results. Further, stock-based compensation expense has been and will continue to be for the foreseeable future a significant recurring expense in our business and an important part of the compensation provided to our employees.
The following tables reconcile GAAP gross profit to non-GAAP gross profit for the three months ended March 31, 2017 and 2016:
 
 
Three Months Ended March 31,
 
 
2017
 
2016
 
 
(in thousands)
GAAP total gross profit
 
$
32,981

 
$
26,084

Stock-based compensation expense
 
202

 
137

Amortization of intangible assets
 
439

 
446

Non-GAAP total gross profit
 
$
33,622

 
$
26,667

 
 
 
 
 
 
 
Three Months Ended March 31,
 
 
2017
 
2016
 
 
(in thousands)
GAAP gross profit – products
 
$
21,232

 
$
17,547

Stock-based compensation expense
 
60

 
18

Amortization of intangible assets
 
439

 
446

Non-GAAP gross profit – products
 
$
21,731

 
$
18,011

 
 
 
 
 
 
 
Three Months Ended March 31,
 
 
2017
 
2016
 
 
(in thousands)
GAAP gross profit – maintenance and support
 
$
8,924

 
$
6,700

Stock-based compensation expense
 
60

 
59

Non-GAAP gross profit – maintenance and support
 
$
8,984

 
$
6,759

 
 
 
 
 
 
 
Three Months Ended March 31,
 
 
2017
 
2016
 
 
(in thousands)
GAAP gross profit – professional services
 
$
2,825

 
$
1,837

Stock-based compensation expense
 
82

 
60

Non-GAAP gross profit – professional services
 
$
2,907

 
$
1,897


16


The following table reconciles GAAP loss from operations to non-GAAP loss from operations for the three months ended March 31, 2017 and 2016:
 
 
Three Months Ended March 31,
 
 
2017
 
2016
 
 
(in thousands)
GAAP loss from operations
 
$
(10,470
)
 
$
(15,619
)
Stock-based compensation expense
 
4,279

 
5,519

Amortization of intangible assets
 
486

 
583

Non-GAAP loss from operations
 
$
(5,705
)
 
$
(9,517
)
The following table reconciles GAAP net loss to non-GAAP net loss for the three months ended March 31, 2017 and 2016:
 
 
Three Months Ended March 31,
 
 
2017
 
2016
 
 
(in thousands, except share and per share data)
GAAP net loss
 
(10,545
)
 
(15,580
)
Stock-based compensation expense
 
4,279

 
5,519

Amortization of intangible assets
 
486

 
583

Non-GAAP net loss
 
$
(5,780
)
 
$
(9,478
)
Non-GAAP net loss per share, basic and diluted
 
$
(0.14
)
 
$
(0.23
)
Weighted-average common shares outstanding, basic and diluted
 
42,016,831

 
40,547,669


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

17


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

18


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 and operations as a public company, but to decrease as a percentage of total revenue.
Interest Income (Expense), Net
Interest income (expense), net consists primarily of interest income on our cash and cash equivalents and our short and long-term investments.
Other Income (Expense), Net
Other income (expense), net consists primarily of unrealized and realized gains and losses related to changes in foreign currency exchange rates.
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.

19


Results of Operations
The following table sets forth our selected consolidated statements of operations data:
 
Three Months Ended March 31,
 
2017
 
2016
 
(in thousands)
Consolidated Statement of Operations Data:
 
 
 
Revenue:
 
 
 
Products
$
25,942

 
$
20,145

Maintenance and support
10,802

 
8,381

Professional services
8,501

 
6,270

Total revenue
45,245

 
34,796

Cost of revenue:(1)
 
 
 
Products
4,710

 
2,598

Maintenance and support
1,878

 
1,681

Professional services
5,676

 
4,433

Total cost of revenue
12,264

 
8,712

Operating expenses:(1)
 
 
 
Research and development
11,393

 
12,342

Sales and marketing
24,810

 
22,768

General and administrative
7,248

 
6,593

Total operating expenses
43,451

 
41,703

Loss from operations
(10,470
)
 
(15,619
)
Interest income (expense), net
169

 
(15
)
Other income (expense), net
(115
)
 
196

Loss before income taxes
(10,416
)
 
(15,438
)
Provision for income taxes
129

 
142

Net loss
$
(10,545
)
 
$
(15,580
)
(1)
Cost of revenue and operating expenses include stock-based compensation expense and depreciation and amortization expense as follows:
 
Three Months Ended March 31,
 
2017
 
2016
 
(in thousands)
Stock-based compensation expense:
 
 
 
Cost of revenue
$
202

 
$
137

Research and development
1,513

 
1,493

Sales and marketing
1,403

 
2,901

General and administrative
1,161

 
988

Total stock-based compensation expense
$
4,279

 
$
5,519

 
Three Months Ended March 31,
 
2017
 
2016
 
(in thousands)
Depreciation and amortization expense:
 
 
 
Cost of revenue
$
661

 
$
628

Research and development
256

 
347

Sales and marketing
495

 
460

General and administrative
212

 
276

Total depreciation and amortization expense
$
1,624

 
$
1,711


20


The following table sets forth our selected consolidated statements of operations data expressed as a percentage of revenue:
 
Three Months Ended March 31,
 
2017
 
2016
Consolidated Statement of Operations Data:
 
 
 
Revenue:
 
 
 
Products
57.3
 %
 
57.9
 %
Maintenance and support
23.9

 
24.1

Professional services
18.8

 
18.0

Total revenue
100.0

 
100.0

Cost of revenue:
 
 
 
Products
10.4

 
7.5

Maintenance and support
4.2

 
4.8

Professional services
12.5

 
12.7

Total cost of revenue
27.1

 
25.0

Operating expenses:
 
 
 
Research and development
25.2

 
35.5

Sales and marketing
54.8

 
65.4

General and administrative
16.0

 
18.9

Total operating expenses
96.0

 
119.8

Loss from operations
(23.1
)
 
(44.8
)
Interest income (expense), net
0.4

 
(0.1
)
Other income (expense), net
(0.3
)
 
0.5

Loss before income taxes
(23.0
)
 
(44.4
)
Provision for income taxes
0.3

 
0.4

Net loss
(23.3
)%
 
(44.8
)%
Comparison of the Three Months Ended March 31, 2017 and 2016
Revenue
 
Three Months Ended March 31,
 
Change
 
2017
 
2016
 
$
 
%
 
(dollars in thousands)
Revenue:
 
 
 
 
 
 
 
Products
$
25,942

 
$
20,145

 
$
5,797

 
28.8
%
Maintenance and support
10,802

 
8,381

 
2,421

 
28.9

Professional services
8,501

 
6,270

 
2,231

 
35.6

Total revenue
$
45,245

 
$
34,796

 
$
10,449

 
30.0
%
Total revenue increased by $10.4 million in the three months ended March 31, 2017 compared to the same period in 2016. The increase in revenue was primarily attributable to a $6.5 million increase from new customers, including the 990 new customers added since March 31, 2016 and a full fiscal quarter of revenue related to new customers added in the three months ended March 31, 2016. Revenue also increased in the three months ended March 31, 2017 compared to the same period in 2016 due to $3.9 million in additional revenue from existing customers. The increase in total revenue in the three months ended March 31, 2017 compared to the same period in 2016 was comprised of $7.8 million generated from sales in North America and $2.6 million generated from sales from the rest of the world.

21


Cost of Revenue
 
Three Months Ended March 31,
 
Change
 
2017
 
2016
 
$
 
%
 
(dollars in thousands)
Cost of revenue:
 
 
 
 
 
 
 
Products
$
4,710

 
$
2,598

 
$
2,112

 
81.3
%
Maintenance and support
1,878

 
1,681

 
197

 
11.7
%
Professional services
5,676

 
4,433

 
1,243

 
28.0
%
Total cost of revenue
$
12,264

 
$
8,712

 
$
3,552

 
40.8
%
Gross margin %:
 
 
 
 
 
 
 
Products
81.8
%
 
87.1
%
 
 
 
 
Maintenance and support
82.6
%
 
79.9
%
 
 
 
 
Professional services
33.2
%
 
29.3
%
 
 
 
 
Total gross margin %
72.9
%
 
75.0
%
 
 
 
 
Total cost of revenue increased by $3.6 million in the three months ended March 31, 2017 compared to the same period in 2016, primarily due to a $2.1 million increase in personnel costs, resulting from an increase in headcount from 148 as of March 31, 2016 to 175 as of March 31, 2017, as well as the timing effect of when our headcount additions were hired in 2017 and 2016, to support our growing customer base. Our increase in total cost of revenue also included a $1.1 million increase in cloud computing costs, a $0.2 million increase in travel and entertainment expense and a $0.2 million increase in allocated overhead.
Total gross margin percentage decreased for the three months ended March 31, 2017 compared to the same period in 2016, primarily due to the decrease in gross margin for products, partially offset by the increase in gross margin for professional services and maintenance and support. The decrease in products gross margin for the three months ended March 31, 2017 was due to an increase in revenue from cloud-based subscriptions and managed services which have lower gross margins than our licensed software products. The increase in professional services gross margin for the three months ended March 31, 2017 was driven by higher utilization as well as a higher percentage of our services bookings coming from services that are sold on a standalone basis, which are recognized as revenue when delivered. The increase in maintenance and support gross margin for the three months ended March 31, 2017 was driven by our ability to scale as our revenue continues to grow.
Operating Expenses
Research and Development Expense
 
Three Months Ended March 31,
 
Change
 
2017
 
2016
 
$
 
%
 
(dollars in thousands)
Research and development
$
11,393

 
$
12,342

 
$
(949
)
 
(7.7
)%
% of revenue
25.2
%
 
35.5
%
 
 
 
 
Research and development expense decreased by $0.9 million in the three months ended March 31, 2017 compared to the same period in 2016, primarily due to a $1.2 million decrease in personnel costs and a decrease of $0.1 million in travel and entertainment expense, partially offset by an increase of $0.4 million in allocated overhead. The $1.2 million decrease in personnel costs was primarily due to a $0.4 million acquisition-related bonus recorded in the three months ended March 31, 2016 and $0.4 million of certain departmental costs in the three months ended March 31, 2016 that have been eliminated in 2017.

22



Sales and Marketing Expense
 
Three Months Ended March 31,
 
Change
 
2017
 
2016
 
$
 
%
 
(dollars in thousands)
Sales and marketing
$
24,810

 
$
22,768

 
$
2,042

 
9.0
%
% of revenue
54.8
%
 
65.4
%
 
 
 
 
Sales and marketing expense increased by $2.0 million in the three months ended March 31, 2017 compared to the same period in 2016, primarily due to a $0.8 million increase in marketing costs resulting from an increase in event marketing and general advertising, a $0.5 million increase in partner referral fees, a $0.5 million increase in allocated overhead, a $0.2 million increase in travel and entertainment expense and a $0.3 million increase in other costs. Partially offsetting the increase in sales and marketing expense was a $0.3 million decrease in personnel costs, which included a $1.5 million decrease in stock-based compensation expense related to the NTO and Logentries acquisitions, offset by a $1.2 million increase in salaries due to an increase in headcount from 341 as of March 31, 2016 to 366 as of March 31, 2017 as well as the timing effect of when our headcount additions were hired in 2017 and 2016 to drive additional sales of our products and services.
General and Administrative Expense 
 
Three Months Ended March 31,
 
Change
 
2017
 
2016
 
$
 
%
 
(dollars in thousands)
General and administrative
$
7,248

 
$
6,593

 
$
655

 
9.9
%
% of revenue
16.0
%
 
18.9
%
 
 
 
 
General and administrative expense increased by $0.7 million in the three months ended March 31, 2017 compared to the same period in 2016, primarily due to a $0.5 million increase in personnel costs as a result of an increase in headcount from 99 as of March 31, 2016 to 121 as of March 31, 2017 as well as the timing effect of when our headcount additions were hired in 2017 and 2016, in order to support our overall company growth. Included in the increase in personnel costs was a $0.2 million increase in stock-based compensation expense. Our increase in general and administrative expense also included a $0.2 million increase in other expense.
Interest Income (Expense), Net
 
Three Months Ended March 31,
 
Change
 
2017
 
2016
 
$
 
%
 
(dollars in thousands)
Interest income (expense), net
$
169

 
$
(15
)
 
$
184

 
NM
% of revenue
0.4
%
 
(0.1
)%
 
 
 
 
Interest income (expense), net increased by $0.2 million in the three months ended March 31, 2017 compared to the same period in 2016 primarily due to higher interest income as a result of our investments in higher-yield securities. In the three months ended March 31, 2016, we incurred net interest expense due to non-cash interest charges related to the accretion of the liability associated with deferred acquisition payments that exceeded interest income earned.
Other Income (Expense), Net
 
Three Months Ended March 31,
 
Change
 
2017
 
2016
 
$
 
%
 
(dollars in thousands)
Other income (expense), net
$
(115
)
 
$
196

 
$
(311
)
 
(158.7
)%
% of revenue
(0.3
)%
 
0.5
%
 
 
 
 
Other income (expense), net decreased by $0.3 million in the three months ended March 31, 2017 compared to the same period in 2016 primarily due to realized and unrealized foreign currency losses, specifically related to the Euro and British Pound.

23


Provision for Income Taxes
 
Three Months Ended March 31,
 
Change
 
2017
 
2016
 
$
 
%
 
(dollars in thousands)
Provision for income taxes
$
129

 
$
142

 
$
(13
)
 
(9.2
)%
% of revenue
0.3
%
 
0.4
%
 
 
 
 
Provision for income taxes decreased nominally in the three months ended March 31, 2017 compared to the same period in 2016.
Liquidity and Capital Resources
Our principal sources of liquidity are cash and cash equivalents, investments and our accounts receivable. In connection with our initial public offering, or IPO, and concurrent private placement in July 2015, we received aggregate net proceeds to us of $112.3 million, after deducting underwriting discounts and commissions of $8.3 million and offering expenses of $3.1 million. Prior to our IPO, we funded our operations primarily through issuances of common and redeemable convertible preferred stock and debt, including net proceeds of $93.4 million from the sale of shares of common and preferred stock. As of March 31, 2017, we had $50.7 million in cash and cash equivalents, $45.4 million in short- and long-term investments that have maturities ranging from 3 months to 2 years and an accumulated deficit of $400.0 million. Since our inception, we have generated significant losses and expect to continue to generate losses for the foreseeable future.
We believe that our existing cash and cash equivalents together with cash generated from our operations will be sufficient to meet our working capital expenditure requirements for at least the next 12 months. Our future capital requirements will depend on many factors, including our growth rate, the timing and extent of spending to support research and development efforts, the expansion of sales and marketing activities, particularly internationally, the introduction of new and enhanced products and professional service offerings and the cost of any future acquisitions of technology or businesses. In the event that additional financing is required from outside sources, we may be unable to raise the funds on acceptable terms, if at all. If we are unable to raise additional capital on terms satisfactory to us when we require it, our business, operating results and financial condition could be adversely affected.
The following table shows a summary of our cash flows for the three months ended March 31, 2017 and 2016:
 
 
 
Three Months Ended March 31,
 
 
2017
 
2016
 
 
(in thousands)
Cash and cash equivalents at beginning of period
 
$
53,148

 
$
86,553

Net cash provided by (used in) operating activities
 
3,321

 
(1,592
)
Net cash used in investing activities
 
(7,836
)
 
(1,092
)
Net cash provided by (used in) financing activities
 
2,105

 
(512
)
Effects of exchange rates on cash and cash equivalents
 
(76
)
 
151

Cash and cash equivalents at end of period
 
$
50,662

 
$
83,508

Uses of Funds
Our historical uses of cash have primarily consisted of cash used for operating activities such as expansion of our sales and marketing operations, research and development activities and other working capital needs, as well as cash used for business acquisitions and purchases of property and equipment.
Operating Activities
Operating activities provided $3.3 million of cash in the three months ended March 31, 2017. Cash provided by operating activities reflected our net loss of $10.5 million, offset by a decrease in our net operating assets and liabilities of $7.5 million and non-cash charges of $6.3 million related primarily to depreciation and amortization, stock-based compensation expense, provision for doubtful accounts and other non-cash charges. The decrease in our net operating assets and liabilities was primarily due to a $15.2 million decrease in accounts receivable driven by strong cash collections and a $1.5 million decrease in prepaid expenses and other assets, which each had a positive impact on operating cash flow. These factors were offset by a $7.2 million decrease in accrued expenses primarily as a result of the payout of annual bonuses and higher year-end commissions, a $1.4 million decrease

24


in deferred revenue, a $0.3 million decrease in accounts payable and a $0.3 million decrease in other liabilities, which each had a negative impact on operating cash flow.
Operating activities used $1.6 million of cash in the three months ended March 31, 2016, which reflected growth in revenue, offset by continuing investment in our operations. Cash used in operating activities reflected our net loss of $15.6 million, partially offset by a decrease in our net operating assets and liabilities of $6.8 million and non-cash charges of $7.2 million related to depreciation and amortization, stock-based compensation expense, provision for doubtful accounts and non-cash interest charges. The decrease in our net operating assets and liabilities was primarily due to a $14.1 million decrease in accounts receivable, which was the result of strong cash collections, and a $1.5 million increase in deferred revenue from sales of our products and services. These increases were offset by a $7.4 million decrease in accrued expenses, which was largely the result of annual bonus payments and increased commission payments, a $0.7 million increase in prepaid expenses and other assets, a $0.5 million decrease in accounts payable and a $0.2 million decrease in other liabilities.
Investing Activities
Investing activities used $7.8 million of cash in the three months ended March 31, 2017, consisting of $7.4 million used for purchases of investments, offset by $0.9 million of investment maturities, and $1.3 million in capital expenditures to purchase equipment and leasehold improvements.
Investing activities used $1.1 million of cash in the three months ended March 31, 2016, as a result of capital expenditures to purchase equipment.
Financing Activities
Financing activities provided $2.1 million of cash in the three months ended March 31, 2017, which consisted primarily of $1.5 million in proceeds from the issuance of common shares purchased by employees under the Rapid7, Inc. 2015 Employee Stock Purchase Plan, or ESPP, and $0.8 million in proceeds from the exercise of stock options, offset by $0.2 million in withholding taxes paid for the net share settlement of equity awards.
Financing activities used $0.5 million of cash in the three months ended March 31, 2016, which consisted primarily of $3.1 million in withholding taxes paid for the net share settlement of equity awards and $0.1 million in payments on capital lease obligations, partially offset by $2.1 million in proceeds from the issuance of common shares purchased by employees under the ESPP and $0.6 million in proceeds from the exercise of stock options.
Contractual Obligations and Commitments
As of March 31, 2017, there were no material changes in our contractual obligations and commitments from those disclosed in our Annual Report on Form 10-K for the year ended December 31, 2016 filed with the SEC on March 9, 2017.
Off-Balance Sheet Arrangements
We do not have any relationships with unconsolidated entities or financial partnerships, including entities sometimes referred to as structured finance or special purpose entities that were established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. We do not engage in off-balance sheet financing arrangements.
Recent Accounting Pronouncements
See Note 1 to the unaudited consolidated financial statements in Part I, Item 1 of this Quarterly Report on Form 10-Q for a discussion of recent accounting pronouncements.
Critical Accounting Policies and Estimates
Our consolidated financial statements are prepared in accordance with generally accepted accounting principles in the United States, or GAAP. The preparation of our consolidated financial statements requires us to make estimates, assumptions and judgments that affect the reported amounts of assets, liabilities, revenue, costs and expenses. We base our estimates and assumptions on historical experience and other factors that we believe to be reasonable under the circumstances. We evaluate our estimates and assumptions on an ongoing basis. Our actual results may differ from these estimates. There have been no material changes in our critical accounting policies from those disclosed in our Annual Report on Form 10-K for the year ended December 31, 2016 filed with the SEC on March 9, 2017.

25


Item 3.    Quantitative and Qualitative Disclosures About Market Risk.
Market risk represents the risk of loss that may impact our financial position due to adverse changes in financial market prices and rates. Our market risk exposure is primarily the result of fluctuations in interest rates and foreign exchange rates as well as to a lesser extent, inflation. In addition, we do not engage in trading activities involving non-exchange traded contracts. Therefore, we believe that we are not materially exposed to any financing, liquidity, market or credit risk that could arise if we had engaged in these relationships.
Foreign Currency Exchange Risk
Our results of operations and cash flows are subject to fluctuations due to changes in foreign currency exchange rates. Substantially all of our customers enter into contracts that are denominated in U.S. dollars. Our expenses are generally denominated in the currencies of the countries where our operations are located, which is primarily in the United States and to a lesser extent in the United Kingdom, other Euro-zone countries within mainland Europe, Canada, Hong Kong, Singapore and Australia. Our results of operations and cash flows are, therefore, subject to fluctuations due to changes in foreign currency exchange rates and may be adversely affected in the future due to changes in foreign currency exchange rates. The effect of a hypothetical 10% adverse change in foreign currency exchange rates on monetary assets and liabilities at March 31, 2017 would not be material to our financial condition or results of operations. To date, we have not engaged in any hedging strategies. As our international operations grow, we will continue to reassess our approach to manage our risk relating to fluctuations in foreign currency rates.
Interest Rate Risk
Our portfolio of cash and cash equivalents and short- and long-term investments is maintained in a variety of securities, including money market funds, commercial paper, corporate bonds, U.S. government agencies and asset-backed securities. Investments are classified as available-for-sale securities and carried at their fair market value with cumulative unrealized gains or losses recorded as a component of accumulated other comprehensive loss within stockholders' equity. A sharp rise in interest rates could have an adverse impact on the fair market value of certain securities in our portfolio. We do not currently hedge our interest rate exposure and do not enter into financial instruments for trading or speculative purposes.
As of March 31, 2017, we had cash and cash equivalents of $50.7 million, consisting of bank deposits and money market funds. We also had short- and long-term investments of $45.4 million, consisting of U.S. Government agencies, commercial paper, corporate bonds and asset-backed securities. Such interest-earning instruments carry a degree of interest rate risk. To date, fluctuations in interest income have not been significant. A hypothetical 10% change in interest rates during any of the periods presented would not have had a material impact on our financial statements.
Inflation Risk
We do not believe that inflation had a material effect on our business, financial condition or results of operations in the last three years. If our costs were to become subject to significant inflationary pressures, we may not be able to fully offset such higher costs through price increases. Our inability or failure to do so could harm our business, financial condition and results of operations.
Item 4.    Controls and Procedures.
Evaluation of Disclosure Controls and Procedures
We maintain "disclosure controls and procedures," as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act of 1934, as amended, means controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company's management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure.
Our management, with the participation of our Chief Executive Officer and our Chief Financial Officer, evaluated the effectiveness of the design and operations of our disclosure controls and procedures as of March 31, 2017. Based on the evaluation of our disclosure controls and procedures as of March 31, 2017, our chief executive officer and chief financial officer concluded that, as of such date, our disclosure controls and procedures were effective at the reasonable assurance level.
Inherent Limitations of Internal Controls
Our management, including our chief executive officer and chief financial officer, does not expect that our disclosure controls and procedures or our internal controls will prevent all errors and all fraud. A control system, no matter how well conceived and

26


operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision making can be faulty, and that breakdowns can occur because of a simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people or by management override of the control. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Over time, controls may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.
Changes in Internal Control over Financial Reporting
There was no change in our internal control over financial reporting identified in connection with the evaluation required by Rule 13a-15(d) and 15d-15(d) of the Exchange Act that occurred during the period covered by this Quarterly Report on Form 10-Q that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.


27


PART II—OTHER INFORMATION
Item 1.    Legal Proceedings.
From time to time, we may be a party to litigation or subject to claims incident to the ordinary course of business. Although the results of litigation and claims cannot be predicted with certainty, we currently believe that the final outcome of these ordinary course matters will not have a material adverse effect on our business. Regardless of the outcome, litigation can have an adverse impact on us because of defense and settlement costs, diversion of management resources and other factors.
Item 1A. Risk Factors.
Our operations and financial results are subject to various risks and uncertainties including those described below. You should consider carefully the risks and uncertainties described below, in addition to other information contained in this Quarterly Report on Form 10-Q as well as our other public filings with the Securities and Exchange Commission, or the SEC, including our Annual Report on Form 10-K for the year ended December 31, 2016, filed with the SEC on March 9, 2017. The risks and uncertainties described below are not the only ones we face. Additional risks and uncertainties that we are unaware of, or that we currently believe are not material, may also become important factors that adversely affect our business. If any of the following risks or others not specified below materialize, our business, financial condition and results of operations could be materially adversely affected. In that event, the trading price of our common stock could decline. 
Risks Related to Our Business and Industry
We are a rapidly growing company, which makes it difficult to evaluate our future prospects and may increase the risk that we will not be successful.
We are a rapidly growing company. Our ability to forecast our future operating results is subject to a number of uncertainties, including our ability to plan for and model future growth. We have encountered and will continue to encounter risks and uncertainties frequently experienced by growing companies in rapidly evolving industries. If our assumptions regarding these uncertainties, which we use to plan our business, are incorrect or change in reaction to changes in our markets, or if we do not address these risks successfully, our operating and financial results could differ materially from our expectations, our business could suffer and the trading price of our common stock may decline.
If we are unable to sustain our revenue growth rate, we may not achieve or maintain profitability in the future.
From the year ended December 31, 2012 to the year ended December 31, 2016, our revenue grew from $46.0 million to $157.4 million, which represents a compounded annual growth rate of approximately 36%. Although we have experienced rapid growth historically and currently have high renewal rates, we may not continue to grow as rapidly in the future and our renewal rates may decline. Any success that we may experience in the future will depend, in large part, on our ability to, among other things:
maintain and expand our customer base;
increase revenues from existing customers through increased or broader use of our products and professional services within their organizations;
improve the performance and capabilities of our products through research and development;
continue to develop our cloud-based solutions;
maintain the rate at which customers purchase our content subscriptions and maintenance and support;
continue to successfully expand our business domestically and internationally; and
successfully compete with other companies.
If we are unable to maintain consistent revenue or revenue growth, our stock price could be volatile, and it may be difficult to achieve and maintain profitability. You should not rely on our revenue for any prior quarterly or annual periods as any indication of our future revenue or revenue growth.
We have not been profitable historically and may not achieve or maintain profitability in the future.
We have posted a net loss in each year since inception, including net losses of $49.0 million, $49.9 million, $32.6 million, $10.5 million and $15.6 million in the years ended December 31, 2016, 2015 and 2014 and the three months ended March 31, 2017 and 2016, respectively. As of March 31, 2017, we had an accumulated deficit of $400.0 million. While we have experienced significant revenue growth in recent periods, we are not certain whether or when we will obtain a high enough volume of sales of our products

28


and professional services to sustain or increase our growth or achieve or maintain profitability in the future. We also expect our costs to increase in future periods, which could negatively affect our future operating results if our revenue does not increase. In particular, we expect to continue to expend financial and other resources on:
research and development related to our offerings, including investments in our research and development team;
sales and marketing, including a significant expansion of our sales organization, both domestically and internationally;
continued international expansion of our business;
expansion of our professional services organization; and
general and administrative expenses as we continue to implement and enhance our administrative, financial and operational systems, procedures and controls.
These investments may not result in increased revenue or growth in our business. If we are unable to increase our revenue at a rate sufficient to offset the expected increase in our costs, our business, financial position and results of operations will be harmed, and we may not be able to achieve or maintain profitability over the long term. Additionally, we may encounter unforeseen operating expenses, difficulties, complications, delays and other unknown factors that may result in losses in future periods. If our revenue growth does not meet our expectations in future periods, our financial performance may be harmed, and we may not achieve or maintain profitability in the future.
If our products or professional services fail to detect vulnerabilities or incorrectly detect vulnerabilities, or if our products contain undetected errors or defects, our brand and reputation could be harmed, which could have an adverse effect on our business and results of operations.
If our products or professional services fail to detect vulnerabilities in our customers’ cyber security infrastructure, or if our products or professional services fail to identify and respond to new and increasingly complex methods of cyber attacks, our business and reputation may suffer. There is no guarantee that our products or professional services will detect all vulnerabilities, especially in light of the rapidly changing security landscape to which we must respond. Additionally, our products may falsely detect vulnerabilities or threats that do not actually exist. For example, our Metasploit offering relies on information provided by an active community of security researchers who contribute new exploits, attacks and vulnerabilities. If the information from these third parties is inaccurate, the potential for false indications of security vulnerabilities increases. These false positives, while typical in the industry, may impair the perceived reliability of our offerings and may therefore adversely impact market acceptance of our products and professional services and could result in negative publicity, loss of customers and sales and increased costs to remedy any problem.
Our products may also contain undetected errors or defects when first introduced or as new versions are released. We have experienced these errors or defects in the past in connection with new products and product upgrades and we expect that these errors or defects will be found from time to time in the future in new or enhanced products after commercial release. Defects may cause our products to be vulnerable to attacks, cause them to fail to detect vulnerabilities, or temporarily interrupt customers’ networking traffic. Any errors, defects, disruptions in service or other performance problems with our products may damage our customers’ business and could hurt our reputation. If our products or professional services fail to detect vulnerabilities for any reason, we may incur significant costs, the attention of our key personnel could be diverted, our customers may delay or withhold payment to us or elect not to renew or other significant customer relations problems may arise. We may also be subject to liability claims for damages related to errors or defects in our products. A material liability claim or other occurrence that harms our reputation or decreases market acceptance of our products may harm our business and operating results.
An actual or perceived security breach or theft of the sensitive data of one of our customers, regardless of whether the breach is attributable to the failure of our products or professional services, could adversely affect the market’s perception of our offerings and subject us to legal claims.
The market for cyber security data and analytics is new and unproven and may not grow.
We believe our future success will depend in large part on the growth, if any, in the market for cyber security data and analytics. This market is nascent, and as such, it is difficult to predict important market trends, including the potential growth, if any. To date, the majority of enterprise spend on cyber security has been on threat protection products, such as network, endpoint and web security that are designed to stop threats from penetrating corporate networks. Organizations that use these security products may believe that their existing security solutions sufficiently protect access to their sensitive business data. Therefore, they may continue allocating their cyber security budgets to these products and may not adopt our products and professional services in addition to, or in lieu of, such traditional products. Further, sophisticated cyber attackers are skilled at adapting to new technologies and

29


developing new methods of gaining access to organizations’ sensitive business data, and changes in the nature of advanced cyber threats could result in a shift in IT budgets away from products and professional services such as ours. In addition, while recent high visibility attacks on prominent enterprises and governments have increased market awareness of the problem of cyber attacks, if cyber attacks were to decline, or enterprises or governments perceived that the general level of cyber attacks have declined, our ability to attract new customers and expand our sale to existing customers could be materially and adversely affected. If products and professional services such as ours are not viewed by organizations as necessary, or if customers do not recognize the benefit of our offerings as a critical layer of an effective cyber security strategy, our revenue may not grow as quickly as expected, or may decline, and the trading price of our stock could suffer. It is therefore difficult to predict how large the market will be for our solutions.
In addition, it is difficult to predict customer adoption and renewal rates, customer demand for our products and professional services, the size and growth rate of the market for cyber security data analytics, the entry of competitive products or the success of existing competitive products. Any expansion in our market depends on a number of factors, including the cost, performance and perceived value associated with our offerings and those of our competitors. If these offerings do not achieve widespread adoption or there is a reduction in demand for solutions in our market caused by a lack of customer acceptance, technological challenges, competing technologies and products, decreases in corporate spending, weakening economic conditions, or otherwise, it could result in reduced customer orders, early terminations, reduced renewal rates or decreased revenue, any of which would adversely affect our business operations and financial results. You should consider our business and prospects in light of the risks and difficulties we face in this new and unproven market.

If we are unable to successfully hire, train, manage and retain qualified personnel, especially those in sales and marketing and research and development, our business may suffer.
We continue to be substantially dependent on our sales force to obtain new customers and increase sales with existing customers. Our ability to successfully pursue our growth strategy will also depend on our ability to attract, motivate and retain our personnel, especially those in sales, marketing and research and development. We face intense competition for these employees from numerous technology, software and other companies, especially in certain geographic areas in which we operate, and we cannot ensure that we will be able to attract, motivate and/or retain sufficient qualified employees in the future. If we are unable to attract new employees and retain our current employees, we may not be able to adequately develop and maintain new products or professional services or market our existing products or professional services at the same levels as our competitors and we may, therefore, lose customers and market share. Our failure to attract and retain personnel, especially those in sales and marketing and research and development positions for which we have historically had a high turnover rate, could have an adverse effect on our ability to execute our business objectives and, as a result, our ability to compete could decrease, our operating results could suffer and our revenue could decrease. Even if we are able to identify and recruit a sufficient number of new hires, these new hires will require significant training before they achieve full productivity and they may not become productive as quickly as we would like or at all.
Our sales cycle may be unpredictable.
The timing of sales of our offerings is difficult to forecast because of the length and unpredictability of our sales cycle, particularly with large enterprises and with respect to certain of our products. We sell our products primarily to IT departments that are managing a growing set of user and compliance demands, which has increased the complexity of customer requirements to be met and confirmed during the sales cycle and prolonged our sales cycle. Further, the length of time that potential customers devote to their testing and evaluation, contract negotiation and budgeting processes varies significantly, depending on the size of the organization and nature of the product or professional service under consideration. In addition, we might devote substantial time and effort to a particular unsuccessful sales effort, and as a result, we could lose other sales opportunities or incur expenses that are not offset by an increase in revenue, which could harm our business.
Organizations may be reluctant to purchase cyber security data analytics offerings that are cloud-based due to the actual or perceived vulnerability of cloud solutions.
Some organizations have been reluctant to use cloud solutions for cyber security, such as our InsightIDR, InsightVM, AppSpider, InsightAppSec and Logentries products, because they have concerns regarding the risks associated with the reliability or security of the technology delivery model associated with this solution. If we or other cloud service providers experience security incidents, breaches of customer data, disruptions in service delivery or other problems, the market for cloud solutions may be negatively impacted, which could harm our business.

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Our quarterly operating results may vary from period to period, which could result in our failure to meet expectations with respect to operating results and cause the trading price of our stock to decline.
Our operating results, including the levels of our revenue, billings, cash flow and deferred revenue, have historically varied from period to period, and we expect that they will continue to do so as a result of a number of factors, many of which are outside of our control, including:
the level of demand for our products and professional services;
customer renewal rates and ability to attract new customers;
the extent to which customers purchase additional products, including content subscriptions and maintenance and support related to our Nexpose, Metasploit and AppSpider products, or professional services;
the ability to successfully grow our sales of InsightIDR, InsightVM and InsightAppSec;
the level of perceived threats to organizations’ cyber security;
network outages, security breaches, technical difficulties or interruptions with our products;
changes in the growth rate of the markets in which we compete;
variations in our billings and sales of our products and services due to seasonality and customer demand;
the announcement or adoption of new regulations and policy mandates or changes to existing regulations and policy mandates;
the timing and success of new product or professional service introductions by us or our competitors or any other changes in the competitive landscape of our industry, including consolidation among our competitors;
the introduction or adoption of new technologies that compete with our offerings;
the mix of our products and professional services sold during a period;
decisions by potential customers to purchase cyber security products or services from other vendors;
the amount and timing of operating costs and capital expenditures related to the operations and expansion of our business;
the timing of sales commissions relative to the recognition of revenue and the timing of revenue recognition generally;
price competition;
our ability to successfully manage and integrate any future acquisitions of businesses, including without limitation the amount and timing of expenses and potential future charges for impairment of goodwill from acquired companies;
our ability to increase, retain and incentivize the channel partners that market and sell our products and professional services;
our continued international expansion and associated exposure to changes in foreign currency exchange rates, including any fluctuations caused by uncertainties relating to Brexit;
the amount and timing of operating expenses related to the maintenance and expansion of our business, operations and infrastructure;
unforeseen litigation and intellectual property infringement;
the announcement or adoption of new regulations and policy mandates or changes to existing regulations and policy mandates;
the strength of regional, national and global economies;
the impact of natural disasters or manmade problems such as terrorism or war; and
future accounting pronouncements or changes in our accounting policies.
Each factor above or discussed elsewhere in this Quarterly Report on Form 10-Q or the cumulative effect of some of these factors may result in fluctuations in our operating results. This variability and unpredictability could result in our failure to meet expectations with respect to operating results, or those of securities analysts or investors, for a particular period. If we fail to meet or exceed expectations for our operating results for these or any other reasons, the market price of our stock could fall and we could face costly lawsuits, including securities class action suits.

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If we do not continue to innovate and offer products and professional services that address the dynamic threat landscape, we may not remain competitive, and our revenue and operating results could suffer.
The cyber security market is characterized by rapid technological advances, changes in customer requirements, frequent new product introductions and enhancements and evolving industry standards. Our success also depends, in part, upon our ability to anticipate industry evolution and introduce or acquire new products and professional services to keep pace with technological developments and market requirements both within our industry and in related industries. While we continue to invest significant resources in research and development in order to ensure that our products continue to address the cyber security risks that our customers face, the introduction of products and services embodying new technologies could render our existing products or services obsolete or less attractive to customers. In addition, developing new products and product enhancements is expensive and time consuming, and there is no assurance that such activities will result in significant cost savings, revenue or other expected benefits. If we spend significant time and effort on research and development and are unable to generate an adequate return on our investment, our business and results of operations may be materially and adversely affected. Further, we may not be able to successfully anticipate or adapt to changing technology or customer requirements or the dynamic threat landscape on a timely basis, in a way that sufficiently differentiates us from competing solutions such that customers choose to purchase our solutions. If any of our competitors implement new technologies before we are able to implement them or better anticipate the innovation opportunities in related industries, those competitors may be able to provide more effective or more cost-effective solutions than ours. In addition, we may experience technical problems and additional costs as we introduce new products and product enhancements, deploy future iterations of our products and integrate new products with existing customer systems. If any of these problems were to arise, our business, financial condition and results of operations could be adversely affected.
To date, we have derived a substantial majority of our revenue from customers using our threat exposure management offerings. If we are unable to renew or increase sales of our threat exposure management offerings, or if we are unable to increase sales of our other offerings, our business and operating results could be adversely affected.
Although we have recently introduced new products and professional services, we derive and expect to continue to derive a substantial majority of our revenue from customers using certain of our threat exposure management offerings, Nexpose and Metasploit. Greater than half of our revenue was attributable to Nexpose in each of our last three fiscal years. As a result, our operating results could suffer due to:
any decline in demand for our threat exposure management offerings;
failure of our threat exposure management offerings to detect vulnerabilities in our customers’ IT environments;
the introduction of products and technologies that serve as a replacement or substitute for, or represent an improvement over, our threat exposure management offerings;
technological innovations or new standards that our threat exposure management offerings do not address;
sensitivity to current or future prices offered by us or competing solutions; and
our inability to release enhanced versions of our threat exposure management offerings on a timely basis in response to the dynamic threat landscape.
Our inability to renew or increase sales of our threat exposure management offerings, including content subscriptions and maintenance and support, or a decline in prices of our threat exposure management offerings would harm our business and operating results more seriously than if we derived significant revenues from a variety of offerings. In addition, we have introduced several cloud-based subscription products, including InsightOps, InsightIDR, InsightVM and InsightAppSec products. These products are relatively new, and it is uncertain whether they will gain market acceptance. We are also investing heavily in the expansion of our security advisory services offerings, which we believe will help drive demand for our other products in addition to being a stand-alone service. Any factor adversely affecting sales of our products or professional services, including release cycles, market acceptance, competition, performance and reliability, reputation and economic and market conditions, could adversely affect our business and operating results.

Our business and growth depend substantially on customers renewing their content subscriptions and maintenance and support agreements with us. Any decline in our customer renewals could adversely affect our future operating results.
Our maintenance and support agreements are sold on a term basis. In addition, we also enter into content subscription agreements for our offerings. In order for us to improve our operating results, it is important that our existing customers renew their content subscription agreements, if applicable, and maintenance and support agreements when the initial contract term expires. Our customers have no obligation to renew their content subscription or maintenance and support agreements with us after the initial terms have expired. Our customers’ renewal rates may decline or fluctuate as a result of a number of factors, including their satisfaction or dissatisfaction with our new or current product offerings, our pricing, the effects of economic conditions, competitive

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offerings or alterations or reductions in our customers’ spending levels. If our customers do not renew their agreements with us or renew on terms less favorable to us, our revenues and results of operations may be adversely impacted.
If Metasploit were to be used by attackers to exploit vulnerabilities in the cyber security infrastructures of third parties, our reputation and business could be harmed.
Although Metasploit is a penetration testing tool that is intended to allow organizations to test the effectiveness of their cyber security programs, Metasploit has in the past and may in the future be used to exploit vulnerabilities in the cyber security infrastructures of third parties. While we have incorporated certain features into Metasploit to deter misuse, there is no guarantee that these controls will not be circumvented or that Metasploit will only be used defensively or for research purposes. Any actual or perceived security breach, malicious intrusion or theft of sensitive data in which Metasploit is believed to have been used could adversely affect perception of, and demand for, our offerings. Further, the identification of new exploits and vulnerabilities by the Metasploit community may enhance the knowledge base of cyber attackers or enable them to undertake new forms of attacks. If any of the foregoing were to occur, we could suffer negative publicity and loss of customers and sales, as well as possible legal claims.
We face intense competition in our market.
The market for cyber security solutions is highly fragmented, intensely competitive and constantly evolving. We compete with an array of established and emerging security software and services vendors. With the introduction of new technologies and market entrants, we expect the competitive environment to remain intense going forward. Our competitors include: vulnerability management and assessment vendors, including Qualys and Tenable Network Security; diversified security software and services vendors, including IBM and HP; legacy compliance and monitoring solutions such as SIEM, provided by vendors including LogRhythm, Alienvault and Sumo Logic; machine data analysis tools such as those provided by Splunk; security services specialists, including Mandiant (a subsidiary of FireEye); and providers of point solutions that compete with some of the features present in our solutions.
Some of our actual and potential competitors have advantages over us, such as longer operating histories, significantly greater financial, technical, marketing or other resources, stronger brand and business user recognition, larger and more mature intellectual property portfolios and broader global distribution and presence. In addition, our industry is evolving rapidly and is becoming increasingly competitive. Larger and more established companies may focus on cyber security and could directly compete with us. Smaller companies could also launch new products and services that we do not offer and that could gain market acceptance quickly.
Our competitors may be able to respond more quickly and effectively than we can to new or changing opportunities, technologies, standards or customer requirements. With the introduction of new technologies, the evolution of our offerings and new market entrants, we expect competition to intensify in the future. In addition, some of our larger competitors have substantially broader product offerings and can bundle competing products and services with other software offerings. As a result, customers may choose a bundled product offering from our competitors, even if individual products have more limited functionality than our solutions. These competitors may also offer their products at a lower price as part of this larger sale, which could increase pricing pressure on our offerings and cause the average sales price for our offerings to decline. These larger competitors are also often in a better position to withstand any significant reduction in capital spending, and will therefore not be as susceptible to economic downturns.
Furthermore, our current and potential competitors may establish cooperative relationships among themselves or with third parties that may further enhance their resources and product and services offerings in the markets we address. In addition, current or potential competitors may be acquired by third parties with greater available resources. As a result of such relationships and acquisitions, our current or potential competitors might be able to adapt more quickly to new technologies and customer needs, devote greater resources to the promotion or sale of their products and services, initiate or withstand substantial price competition, take advantage of other opportunities more readily or develop and expand their product and service offerings more quickly than we do. For all of these reasons, we may not be able to compete successfully against our current or future competitors, or we may be required to expend significant resources in order to remain competitive. If our competitors are more successful than we are in developing new product and service offerings or in attracting and retaining customers, our business, financial condition and results of operations could be adversely affected.
A component of our growth strategy is dependent on our continued international expansion, which adds complexity to our operations.
We market and sell our products and professional services throughout the world and have personnel in many parts of the world. For the three months ended March 31, 2017 and 2016, international operations generated 16% and 13% of our revenue, respectively.

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Our growth strategy is dependent, in part, on our continued international expansion. We expect to conduct a significant amount of our business with organizations that are located outside the United States, particularly in Europe and Asia. We cannot assure you that our expansion efforts into international markets will be successful in creating further demand for our products and professional services or in effectively selling our products and professional services in the international markets that we enter. Our current international operations and future initiatives will involve a variety of risks, including:
increased management, infrastructure and legal costs associated with having international operations;
reliance on channel partners;
trade and foreign exchange restrictions;
economic or political instability or uncertainty in foreign markets and around the world, such as related to the United Kingdom’s referendum in June 2016 in which voters approved an exit from the European Union, commonly referred to as “Brexit”;
foreign currency exchange rate fluctuations;
greater difficulty in enforcing contracts, accounts receivable collection and longer collection periods;
changes in regulatory requirements, including, but not limited to data privacy, data protection and data security regulations;
difficulties and costs of staffing and managing foreign operations;
the uncertainty and limitation of protection for intellectual property rights in some countries;
costs of compliance with foreign laws and regulations and the risks and costs of non-compliance with such laws and regulations;
costs of compliance with U.S. laws and regulations for foreign operations, including the Foreign Corrupt Practices Act, import and export control laws, tariffs, trade barriers, economic sanctions and other regulatory or contractual limitations on our ability to sell or provide our solutions in certain foreign markets, and the risks and costs of non-compliance;
heightened risks of unfair or corrupt business practices in certain geographies and of improper or fraudulent sales arrangements that may impact financial results and result in restatements of, and irregularities in, financial statements;
the potential for political unrest, acts of terrorism, hostilities or war;
management communication and integration problems resulting from cultural differences and geographic dispersion;
costs associated with language localization of our products; and
costs of compliance with multiple and possibly overlapping tax structures.
Our business, including the sales of our products and professional services by us and our channel partners, may be subject to foreign governmental regulations, which vary substantially from country to country and change from time to time. Our failure, or the failure by our channel partners, to comply with these regulations could adversely affect our business. Further, in many foreign countries it is common for others to engage in business practices that are prohibited by our internal policies and procedures or U.S. regulations applicable to us. Although we have implemented policies and procedures designed to comply with these laws and policies, there can be no assurance that our employees, contractors, channel partners and agents have complied, or will comply, with these laws and policies. Violations of laws or key control policies by our employees, contractors, channel partners or agents could result in delays in revenue recognition, financial reporting misstatements, fines, penalties or the prohibition of the importation or exportation of our products and could have a material adverse effect on our business and results of operations. If we are unable to successfully manage the challenges of international expansion and operations, our business and operating results could be adversely affected.
We are also monitoring developments related to Brexit, which could have significant implications for our business. Brexit could lead to economic and legal uncertainty, including significant volatility in global stock markets and currency exchange rates, and differing laws and regulations as the United Kingdom determines which European Union laws to replace or replicate. Any of these effects of Brexit, among others, could adversely affect our operations in the United Kingdom and our financial results.
As a cyber security provider, we are a target of cyber attacks that could adversely impact our reputation and operating results.
We sell cyber security and data analytics products. As a result, we have been and will be a target of cyber attacks designed to impede the performance of our products, penetrate our network security or the security of our cloud platform or our internal

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systems, or that of our customers, misappropriate proprietary information and/or cause interruptions to our services. For example, because Metasploit serves as an introduction to hacking for many individuals, a successful cyber attack on us may be perceived as a victory for the cyber attacker, thereby increasing the likelihood that we may be a target of cyber attacks, even absent financial motives. Further, if our systems are breached, attackers could learn critical information about how our products operate to help protect our customers’ IT infrastructures from cyber risk, thereby making our customers more vulnerable to cyber attacks. In addition, if actual or perceived breaches of our network security occur, they could adversely affect the market perception of our products, negatively affecting our reputation, and may expose us to the loss of our proprietary information or information belonging to our customers, investigations or litigation and possible liability, including injunctive relief and monetary damages. Such security breaches could also divert the efforts of our technical and management personnel. In addition, such security breaches could impair our ability to operate our business and provide products to our customers. If this happens, our reputation could be harmed, our revenue could decline and our business could suffer.
We are dependent on the continued services and performance of our senior management and other key employees, the loss of any of whom could adversely affect our business, operating results and financial condition.
Our future performance depends on the continued services and contributions of our senior management, particularly Corey Thomas, our President and Chief Executive Officer, and other key employees to execute on our business plan and to identify and pursue new opportunities and product innovations. We maintain key man insurance on Mr. Thomas, but do not do so for any of our other executive officers or key employees. From time to time, there may be changes in our senior management team resulting from the termination or departure of our executive officers and key employees. Our senior management and key employees are generally employed on an at-will basis, which means that they could terminate their employment with us at any time. The loss of the services of our senior management, particularly Mr. Thomas, or other key employees for any reason could significantly delay or prevent our development or the achievement of our strategic objectives and harm our business, financial condition and results of operations.
Our business and operations are experiencing rapid growth, and if we do not appropriately manage our future growth, or are unable to scale our systems and processes, our operating results may be negatively affected.
We are a rapidly growing company. To manage future growth effectively we will need to continue to improve and expand our internal information technology systems, financial infrastructure, and operating and administrative systems and controls, which we may not be able to do efficiently, in a timely manner or at all. Any future growth would add complexity to our organization and require effective coordination across our organization. Failure to manage any future growth effectively could result in increased costs, harm our results of operations and lead to customers or investors losing confidence in our internal systems and processes, which could harm our results of operations and stock price.
We recognize substantially all of our revenue ratably over the term of our agreements with customers and, as a result, downturns or upturns in sales may not be immediately reflected in our operating results.
We recognize substantially all of our revenue ratably over the terms of our agreements with customers, which generally occurs over a one to three-year period. As a result, a substantial portion of the revenue that we report in each period will be derived from the recognition of deferred revenue relating to agreements entered into during previous periods. Consequently, a decline in new sales or renewals in any one period may not be immediately reflected in our revenue results for that period. This decline, however, will negatively affect our revenue in future periods. Accordingly, the effect of significant downturns in sales and market acceptance of our products and potential changes in our rate of renewals may not be fully reflected in our results of operations until future periods. Our model also makes it difficult for us to rapidly increase our revenue through additional sales in any period, as revenue from new customers generally will be recognized over the term of the applicable agreement.
We also intend to increase our investment in research and development, sales and marketing, and general and administrative functions and other areas to grow our business. We are likely to recognize the costs associated with these increased investments earlier than some of the anticipated benefits and the return on these investments may be lower, or may develop more slowly, than we expect, which could adversely affect our operating results.
We may be unable to rapidly and efficiently adjust our cost structure in response to significant revenue declines, which could adversely affect our operating results.
Our brand, reputation and ability to attract, retain and serve our customers are dependent in part upon the reliable performance of our products and network infrastructure.
Our brand, reputation and ability to attract, retain and serve our customers are dependent in part upon the reliable performance of our products and network infrastructure. We have experienced, and may in the future experience, disruptions, outages and other

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performance problems due to a variety of factors, including infrastructure changes, human or software errors, capacity constraints and fraud or security attacks. In some instances, we may not be able to identify the cause or causes of these performance problems within an acceptable period of time.
We utilize third-party data centers located in Boston, Massachusetts, in addition to operating and maintaining certain elements of our own network infrastructure. We also utilize Amazon Web Services for our InsightIDR and Logentries infrastructure. Some elements of this complex system are operated by third parties that we do not control and that could require significant time to replace. We expect this dependence on third parties to continue. More specifically, certain of our products, in particular our Managed Vulnerability Management (Nexpose), InsightIDR, InsightVM, InsightAppSec and Logentries products, are hosted on Amazon Web Services, which provides us with computing and storage capacity. Interruptions in our systems or the third-party systems on which we rely, whether due to system failures, computer viruses, physical or electronic break-ins, or other factors, could affect the security or availability of our products, network infrastructure and website.
Prolonged delays or unforeseen difficulties in connection with adding capacity or upgrading our network architecture when required may cause our service quality to suffer. Problems with the reliability or security of our systems could harm our reputation. Damage to our reputation and the cost of remedying these problems could negatively affect our business, financial condition, and operating results.
Additionally, our existing data center facilities and third-party hosting providers have no obligations to renew their agreements with us on commercially reasonable terms or at all, and certain of the agreements governing these relationships may be terminated by either party at any time. If we are unable to maintain or renew our agreements with these providers on commercially reasonable terms or if in the future we add additional data center facilities or third-party hosting providers, we may experience costs or downtime as we transition our operations.
Any disruptions or other performance problems with our products could harm our reputation and business and may damage our customers’ businesses. Interruptions in our service delivery might reduce our revenue, cause us to issue credits to customers, subject us to potential liability and cause customers to not renew their purchases or our products.
If we fail to manage our operations infrastructure, our customers may experience service outages and/or delays.
Our future growth is dependent upon our ability to continue to meet the expanding needs of our customers and to attract new customers. As existing customers gain more experience with our products, they may broaden their reliance on our products, which will require that we expand our operations infrastructure. We also seek to maintain excess capacity in our operations infrastructure to facilitate the rapid provision of new customer deployments. In addition, we need to properly manage our technological operations infrastructure in order to support changes in hardware and software parameters and the evolution of our products, all of which require significant lead time. If we do not accurately predict our infrastructure requirements, our existing customers may experience service outages that may subject us to financial penalties, financial liabilities and customer losses. If our operations infrastructure fails to keep pace with increased sales, customers may experience delays as we seek to obtain additional capacity, which could adversely affect our reputation and our revenue.
If our products fail to help our customers achieve and maintain compliance with regulations and/or industry standards, our revenue and operating results could be harmed.
We generate a portion of our revenue from our threat exposure management offerings that help organizations achieve and maintain compliance with regulations and industry standards both domestically and internationally. For example, many of our customers subscribe to our threat exposure management offerings to help them comply with the security standards developed and maintained by the Payment Card Industry Security Standards Council, or the PCI Council, which apply to companies that process, transmit or store cardholder data. In addition, our threat exposure management offerings are used by customers in the health care industry to help them comply with numerous federal and state laws and regulations related to patient privacy. In particular, the Health Insurance Portability and Accountability Act of 1996, or HIPAA, and the 2009 Health Information Technology for Economic and Clinical Health Act include privacy standards that protect individual privacy by limiting the uses and disclosures of individually identifiable health information and implementing data security standards. The foregoing and other state, federal and international legal and regulatory regimes may affect our customers’ requirements for, and demand for, our products and professional services. Governments and industry organizations, such as the PCI Council, may also adopt new laws, regulations or requirements, or make changes to existing laws or regulations, that could impact the demand for, or value of, our products. If we are unable to adapt our products to changing legal and regulatory standards or other requirements in a timely manner, or if our products fail to assist with, or expedite, our customers’ cyber security defense and compliance efforts, our customers may lose confidence in our products and could switch to products offered by our competitors, or threaten or bring legal actions against us. In addition, if laws, regulations or standards related to data security, vulnerability management and other IT security and compliance requirements are relaxed or

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the penalties for non-compliance are changed in a manner that makes them less onerous, our customers may view government and industry regulatory compliance as less critical to their businesses, and our customers may be less willing to purchase our products. In any of these cases, our revenue and operating results could be harmed.
In addition, government and other customers may require our products to comply with certain privacy, security or other certifications and standards. If our products are late in achieving or fail to achieve or maintain compliance with these certifications and standards, or our competitors achieve compliance with these certifications and standards, we may be disqualified from selling our products to such customers, or may otherwise be at a competitive disadvantage, either of which would harm our business, results of operations, and financial condition.
If our customers are unable to implement our products successfully, customer perceptions of our offerings may be impaired or our reputation and brand may suffer.
Our products are deployed in a wide variety of IT environments, including large-scale, complex infrastructures. Some of our customers have experienced difficulties implementing our products in the past and may experience implementation difficulties in the future. If our customers are unable to implement our products successfully, customer perceptions of our offerings may be impaired or our reputation and brand may suffer.
In addition, in order for our products to achieve their functional potential, our products must effectively integrate into our customers’ IT infrastructures, which have different specifications, utilize varied protocol standards, deploy products from multiple different vendors and contain multiple layers of products that have been added over time. Our customers’ IT infrastructures are also dynamic, with a myriad of devices and endpoints entering and exiting the customers’ IT systems on a regular basis, and our products must be able to effectively adapt to and track these changes.
Any failure by our customers to appropriately implement our products or any failure of our products to effectively integrate and operate within our customers’ IT infrastructures could result in customer dissatisfaction, impact the perceived reliability of our products, result in negative press coverage, negatively affect our reputation and harm our financial results.
Future acquisitions could disrupt our business and harm our financial condition and operating results.
In order to remain competitive, we have in the past and may in the future seek to acquire additional businesses, products or technologies. The environment for acquisitions in our industry is very competitive and acquisition candidate purchase prices will likely exceed what we would prefer to pay. We also may not find suitable acquisition candidates, and acquisitions we complete may be unsuccessful.
Achieving the anticipated benefits of future acquisitions will depend in part upon whether we can integrate acquired operations, products and technology in a timely and cost-effective manner. The integration process of a new business or technology requires, among other things, coordination of administrative, sales and marketing, accounting and finance functions, and expansion of information and management systems. Integration of any future acquisition may prove to be difficult due to the necessity of coordinating geographically separate organizations and integrating personnel with disparate business backgrounds and accustomed to different corporate cultures. The acquisition and integration processes are complex, expensive and time consuming, and may cause an interruption of, or loss of momentum in, product development, sales activities and operations of both companies. Further, we may be unable to retain key personnel of an acquired company following the acquisition. If we are unable to effectively execute or integrate acquisitions, our business, financial condition and operating results could be adversely affected.
In addition, we may only be able to conduct limited due diligence on an acquired company’s operations, or may discover that the products or technology acquired were not as capable as we thought based upon the initial or limited due diligence. Following an acquisition, we may be subject to unforeseen liabilities arising from an acquired company’s past or present operations and these liabilities may be greater than the warranty and indemnity limitations that we negotiate. Any unforeseen liability that is greater than these warranty and indemnity limitations could have a negative impact on our financial condition.
If we are unable to maintain successful relationships with our channel partners, our business operations, financial results and growth prospects could be adversely affected.
Our success is dependent in part upon establishing and maintaining relationships with a variety of channel partners that we utilize to extend our geographic reach and market penetration. We anticipate that we will continue to rely on these partners in order to help facilitate sales of our offerings as part of larger purchases in the United States and to grow our business internationally. For 2016 and 2015, we derived approximately 37% and 39%, respectively, of our revenue from sales of products and professional services through channel partners, and the percentage of revenue derived from channel partners may increase in future periods.

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Our agreements with our channel partners are non-exclusive and do not prohibit them from working with our competitors or offering competing solutions, and some of our channel partners may have more established relationships with our competitors. If our channel partners choose to place greater emphasis on products of their own or those offered by our competitors or do not effectively market and sell our products and professional services, our ability to grow our business and sell our products and professional services, particularly in key international markets, may be adversely affected. In addition, our failure to recruit additional channel partners, or any reduction or delay in their sales of our products and professional services or conflicts between channel sales and our direct sales and marketing activities may harm our results of operations. Finally, even if we are successful, our relationships with channel partners may not result in greater customer usage of our products and professional services or increased revenue.
Failure to maintain high-quality customer support could have a material adverse effect on our business.
Once our products are deployed within our customers’ networks, our customers depend on our technical and other customer support services to resolve any issues relating to the implementation and maintenance of our products. If we do not effectively assist our customers in deploying our products, help our customers quickly resolve post-deployment issues or provide effective ongoing support, our ability to renew or sell additional products or professional services to existing customers would be adversely affected and our reputation with potential customers could be damaged. Further, to the extent that we are unsuccessful in hiring, training and retaining adequate technical and customer success personnel, our ability to provide adequate and timely support to our customers will be negatively impacted, and our customers’ satisfaction with our offerings will be adversely affected.
We rely on third-party software to operate certain functions of our business.
We rely on software vendors to operate certain critical functions of our business, including financial management and human resource management. If these services become unavailable due to extended outages or interruptions or because they are no longer available on commercially reasonable terms or prices, our expenses could increase, our ability to manage our finances could be interrupted and our processes for managing sales of our solutions and supporting our customers could be impaired until equivalent services, if available, are identified, obtained and integrated, all of which could harm our business.
We use third-party software and data that may be difficult to replace or that may cause errors or failures of our solutions, which could lead to lost customers or harm to our reputation and our operating results.
We license third-party software and security and compliance data from various third parties that are used in our solutions in order to deliver our offerings. In the future, this software or data may not be available to us on commercially reasonable terms, or at all. Any loss of the right to use any of this software or data could result in delays in the provisioning of our offerings until equivalent technology or data is either developed by us, or, if available, is identified, obtained and integrated, which could harm our business. In addition, any errors or defects in or failures of this third-party software could result in errors or defects in our products or cause our products to fail, which could harm our business and be costly to correct. Many of these providers attempt to impose limitations on their liability for such errors, defects or failures, and if enforceable, we may have additional liability to our customers or third-party providers that could harm our reputation and increase our operating costs.
We will need to maintain our relationships with third-party software and data providers, and to obtain software and data from such providers that do not contain errors or defects. Any failure to do so could adversely impact our ability to deliver effective solutions to our customers and could harm our operating results.
Our products contain third-party open source software components, and our failure to comply with the terms of the underlying open source software licenses could restrict our ability to sell our products.
Our products contain software licensed to us by third parties under so-called “open source” licenses, including the GNU General Public License, or GPL, the GNU Lesser General Public License, or LGPL, the BSD License, the Apache License and others. From time to time, there have been claims against companies that distribute or use open source software in their products and services, asserting that such open source software infringes the claimants’ intellectual property rights. We could be subject to suits by parties claiming that what we believe to be licensed open source software infringes their intellectual property rights. Use and distribution of open source software may entail greater risks than use of third-party commercial software, as open source licensors generally do not provide warranties or other contractual protections regarding infringement claims or the quality of the code. In addition, certain open source licenses require that source code for software programs that are subject to the license be made available to the public and that any modifications or derivative works to such open source software continue to be licensed under the same terms.

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Although we monitor our use of open source software in an effort both to comply with the terms of the applicable open source licenses and to avoid subjecting our products to conditions we do not intend, the terms of many open source licenses have not been interpreted by U.S. courts, and there is a risk that these licenses could be construed in a way that could impose unanticipated conditions or restrictions on our ability to commercialize our products. The terms of certain open source licenses require us to release the source code of our applications and to make our applications available under those open source licenses if we combine or distribute our applications with open source software in a certain manner. In the event that portions of our applications are determined to be subject to an open source license, we could be required to publicly release the affected portions of our source code, re-engineer all, or a portion of, those applications or otherwise be limited in the licensing of our applications. Disclosing our proprietary source code could allow our competitors to create similar products with lower development effort and time and ultimately, could result in a loss of sales for us. Disclosing the source code of our proprietary software could also make it easier for cyber attackers and other third parties to discover vulnerabilities in or to defeat the protections of our products, which could result in our products failing to provide our customers with the security they expect. Any of these events could have a material adverse effect on our business, operating results and financial condition.
Our technology alliance partnerships expose us to a range of business risks and uncertainties that could have a material adverse impact on our business and financial results.
We have entered, and intend to continue to enter, into technology alliance partnerships with third parties to support our future growth plans, including with certain of our actual or potential competitors. For example, through these technology alliance partnerships, we integrate with certain third-party application program interfaces, or APIs, which enhance our data collection capabilities in our customers’ IT environments. If these third parties no longer allow us to integrate with their APIs, or if we determine not to maintain these integrations, the functionality of our products may be reduced and our products may not be as marketable to certain potential customers. Technology alliance partnerships require significant coordination between the parties involved, particularly if a partner requires that we integrate its products with our products. Further, we have invested and will continue to invest significant time, money and resources to establish and maintain relationships with our technology alliance partners, but we have no assurance that any particular relationship will continue for any specific period of time, result in new offerings that we can effectively commercialize or result in enhancements to our existing offerings. In addition, while we believe that entering into technology alliance partnerships with certain of our actual or potential competitors is currently beneficial to our competitive position in the market, such partnerships may also give our competitors insight into our offerings that they may not otherwise have, thereby allowing them to compete more effectively against us.
The continued utility of Metasploit depends in part on the continued contributions from security researchers.
Our Metasploit product relies on information provided by an active community of security researchers who contribute new exploits, attacks and vulnerabilities. We expect that the continued contributions from these third parties will both enhance the robustness of Metasploit and also support our sales and marketing efforts. However, to the extent that the information provided by these third parties is inaccurate or malicious, the potential for false indications of security vulnerabilities and susceptibility to attack increases, which could adversely impact market acceptance of our products and professional services and could result in negative publicity, loss of customers and sales and increased costs to remedy any problem. Further, to the extent that our community of third parties is reduced in size or participants become less active, we may lose valuable insight into the dynamic threat landscape and our ability to quickly respond to new exploits, attacks and vulnerabilities may be reduced.
A portion of our revenue is generated by sales to government entities, which are subject to a number of challenges and risks.
Selling to government entities can be highly competitive, expensive and time consuming, and often requires significant upfront time and expense without any assurance that we will win a sale. Government demand and payment for our products and professional services may also be impacted by public sector budgetary cycles and funding authorizations, with funding reductions or delays adversely affecting public sector demand for our offerings. Government entities also have heightened sensitivity surrounding the purchase of cyber security solutions due to the critical importance of their IT infrastructures, the nature of the information contained within those infrastructures and the fact that they are highly-visible targets for cyber attacks. Accordingly, increasing sales of our products and professional services to government entities may be more challenging than selling to commercial organizations. Further, in the course of providing our products and professional services to government entities, our employees and those of our channel partners may be exposed to sensitive government information. Any failure by us or our channel partners to safeguard and maintain the confidentiality of such information could subject us to liability and reputational harm, which could materially and adversely affect our results of operations and financial performance.

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We are exposed to fluctuations in currency exchange rates, which could negatively affect our financial condition and results of operations.
Our reporting currency is the U.S. dollar and we generate a majority of our revenue in U.S. dollars. However, for the three months ended March 31, 2017 and 2016, we incurred approximately 16% and 11% of our expenses, respectively, outside of the United States in foreign currencies, primarily the pound sterling (GBP) and Euro, principally with respect to salaries and related personnel expenses associated with our sales and research and development operations. Additionally, for the three months ended March 31, 2017 and 2016, approximately 5% of our revenue was generated in foreign currencies. Accordingly, changes in exchange rates may have an adverse effect on our business, operating results and financial condition. The exchange rate between the U.S. dollar and foreign currencies has fluctuated substantially in recent years and may continue to fluctuate substantially in the future. To date, we have not engaged in any hedging strategies, and any such strategies, such as forward contracts, options and foreign exchange swaps related to transaction exposures that we may implement to mitigate this risk may not eliminate our exposure to foreign exchange fluctuations.
Changes in financial accounting standards may adversely impact our reported results of operations.
A change in accounting standards or practices, in particular with respect to revenue recognition, could harm our operating results and may even affect our reporting of transactions completed before the change is effective. New accounting pronouncements and varying interpretations of accounting pronouncements have occurred and may occur in the future. For example, in May 2014, the Financial Accounting Standards Board issued accounting standards update No. 2014-09 (Topic 606), Revenue from Contracts with Customers, which supersedes nearly all existing revenue recognition guidance under generally accepted accounting principles in the United States. We will be required to implement this new revenue standard, as amended by accounting standards update No. 2015-14, in the first quarter of fiscal 2018. While we are still evaluating the total impact of the new revenue standard, we believe the adoption of this new standard will have an impact on our consolidated financial statements, including the way we account for arrangements involving software licenses that are sold with professional services and recognize direct and incremental commission costs to obtain a contract. These and other changes to existing rules or the questioning of current practices may harm our operating results or the way we conduct our business.
We may require additional capital to support business growth, and this capital might not be available on acceptable terms, if at all.
We intend to continue to make investments to support our business growth and may require additional funds to respond to business challenges, including the need to develop new features or enhance our products, improve our operating infrastructure or acquire complementary businesses and technologies. Accordingly, we may need to engage in equity or debt financings to secure additional funds. If we raise additional funds through future issuances of equity or convertible debt securities, our existing stockholders could suffer significant dilution, and any new equity securities we issue could have rights, preferences and privileges superior to those of holders of our common stock. Any debt financing that we may secure in the future could involve restrictive covenants relating to our capital raising activities and other financial and operational matters, which may make it more difficult for us to obtain additional capital and to pursue business opportunities, including potential acquisitions. We may not be able to obtain additional financing on terms favorable to us, if at all. If we are unable to obtain adequate financing or financing on terms satisfactory to us when we require it, our ability to continue to support our business growth and to respond to business challenges could be significantly impaired, and our business may be adversely affected.
Risks Related to Government Regulation, Data Collection, Intellectual Property, Litigation and Catastrophic Events
We are subject to governmental export and import controls that could impair our ability to compete in international markets and/or subject us to liability if we are not in compliance with applicable laws.
Like other U.S.-based IT security products, our products are subject to U.S. export control and import laws and regulations, including the U.S. Export Administration Regulations and various economic and trade sanctions regulations administered by the U.S. Treasury Department’s Office of Foreign Assets Control. Exports of these products must be made in compliance with these laws and regulations. If we were to fail to comply with these laws and regulations, we and certain of our employees could be subject to substantial civil and criminal penalties, including fines for our company and responsible employees or managers, and, in extreme cases, incarceration of responsible employees and managers and the possible loss of export privileges. Complying with export control laws and regulations, including obtaining the necessary licenses or authorizations, for a particular sale may be time-consuming, is not guaranteed and may result in the delay or loss of sales opportunities. Changes in export or import laws and regulations, shifts in the enforcement or scope of existing laws and regulations, or changes in the countries, governments, persons, products or services targeted by such laws and regulations, could also result in decreased use of our products by, or in our decreased

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ability to export or sell our products to, existing or potential customers. A decreased use of our products or limitation on our ability to export or sell our products could adversely affect our business, financial condition and results of operations.
We also incorporate encryption technology into our products. These encryption products may be exported outside of the United States only with the required export authorizations, including by a license, a license exception or other appropriate government authorizations, including the filing of a product classification request. We previously deployed certain of our Metasploit products prior to obtaining the appropriate export authorizations. As such, we did not fully comply with applicable encryption controls in the U.S. Export Administration Regulations. Further, U.S. export control laws and economic sanctions prohibit the shipment of certain products and services to U.S. embargoed or sanctioned countries, governments or persons. Although we take precautions to prevent our products from being provided to those subject to U.S. sanctions, such measures may be circumvented. We are aware of previous exports in the form of downloads of certain of our Metasploit products by persons and organizations that appear to be located in countries that are the subject of U.S. embargoes, and by certain other persons and organizations without the requisite export authorizations. In September 2014, we initiated and filed a voluntary self-disclosure with the U.S. Department of Commerce’s Bureau of Industry and Security, or BIS, concerning our previous failure to obtain required authorizations for certain exports, as well as historical exports of free and trial software to embargoed countries. In March and August 2015, we filed supplements to the voluntary self-disclosure to BIS containing additional information regarding unauthorized exports. Also in March 2015, we filed a voluntary self-disclosure with the U.S. Department of Treasury’s Office of Foreign Assets Control, or OFAC, concerning exports of free and trial versions of our Metasploit products to embargoed countries, specifically Cuba, Iran, Sudan and Syria. As these transactions involved free downloads of our software, we did not derive any revenue from such transactions. On May 22, 2015, OFAC determined not to pursue a civil monetary penalty against us and issued us a Cautionary Letter to resolve our voluntary self-disclosure regarding the free downloads in embargoed countries. On January 12, 2017, BIS determined not to pursue a civil monetary penalty against us and issued us a warning letter to resolve our voluntary self-disclosure regarding our previous failure to obtain required authorizations for certain exports, as well as historical exports of free and trial software to embargoed countries.
In addition, various countries regulate the import and domestic use of certain encryption technology, including through import permitting and licensing requirements, and have enacted laws that could limit our ability to distribute our products or could limit our customers’ ability to implement our products in those countries.
Encryption products and the underlying technology may also be subject to export control restrictions. Governmental regulation of encryption technology and regulation of imports or exports of encryption products, or our failure to obtain required import or export approval for our products, when applicable, could harm our international sales and adversely affect our revenue. Compliance with applicable laws and regulations regarding the export and import of our products, including with respect to new products or changes in existing products, may create delays in the introduction of our products in international markets, prevent our customers with international operations from deploying our products globally or, in some cases, could prevent the export or import of our products to certain countries, governments, entities or persons altogether.
Finally, there are currently multinational efforts underway as part of the Wassenaar Arrangement on Export Controls for Conventional Arms and Dual-Use Goods and Technologies, or the Wassenaar Arrangement, to impose additional restrictions on certain cyber security products. Such controls have been implemented by many Wassenaar members, but are not currently in effect in the United States and may undergo substantial modification before becoming effective. To implement the controls under the Wassenaar Arrangement in the United States, BIS would have to amend the EAR. Such amendments could include changes that impose new licensing, approval and other requirements on our commercial Metasploit products and thereby put us at a disadvantage in competing for international sales. We are closely monitoring the potential implications of the Wassenaar Arrangement on the commercial versions of Metasploit, and are actively working with BIS and other U.S. government stakeholders in connection with the implementation of the controls under the Wassenaar Arrangement.
Failure to comply with governmental laws and regulations could harm our business.
Our business is subject to regulation by various federal, state, local and foreign governments. In certain jurisdictions, these regulatory requirements may be more stringent than those in the United States. Noncompliance with applicable regulations or requirements could subject us to investigations, sanctions, mandatory product recalls, enforcement actions, disgorgement of profits, fines, damages, civil and criminal penalties, injunctions or other collateral consequences. If any governmental sanctions are imposed, or if we do not prevail in any possible civil or criminal litigation, our business, results of operations, and financial condition could be materially adversely affected. In addition, responding to any action will likely result in a significant diversion of management’s attention and resources and an increase in professional fees. Enforcement actions and sanctions could harm our business, reputation, results of operations and financial condition.

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Because our products collect and store user and related information, domestic and international privacy and cyber security concerns, and other laws and regulations, could result in additional costs and liabilities to us or inhibit sales of our products.
We, and our customers, are subject to a number of domestic and international laws and regulations that apply to online services and the internet generally. These laws, rules and regulations address a range of issues including data privacy and cyber security, and restrictions or technological requirements regarding the collection, use, storage, protection, retention or transfer of data. The regulatory framework for online services, data privacy and cyber security issues worldwide can vary substantially from jurisdiction to jurisdiction, is rapidly evolving and is likely to remain uncertain for the foreseeable future. Many federal, state and foreign government bodies and agencies have adopted or are considering adopting laws, rules and regulations regarding the collection, use, storage and disclosure of information, web browsing and geolocation data collection, data analytics, cyber security and breach notification procedures. Interpretation of these laws, rules and regulations and their application to our products and professional services in the U.S. and foreign jurisdictions is ongoing and cannot be fully determined at this time.
In the United States, these include rules and regulations promulgated under the authority of the Federal Trade Commission, the Electronic Communications Privacy Act, Computer Fraud and Abuse Act, HIPAA, the Gramm Leach Bliley Act and state breach notification laws, as well as regulator enforcement positions and expectations reflected in federal and state regulatory actions, settlements, consent decrees and guidance documents. Internationally, virtually every jurisdiction in which we operate has established its own data security and privacy legal frameworks with which we, or our customers, must comply, including the Data Protection Directive 95/46/EC (“Directive”) established in the European Union (“EU”) and local EU Member State legislation implementing the Directive, such as the Data Protection Act in the UK. Further, many federal, state and foreign government bodies and agencies have introduced, and are currently considering, additional laws and regulations. If passed, we will likely incur additional expenses and costs associated with complying with such laws.
In addition, to facilitate the transfer of both customer and personnel data from the European Union to the United States, we signed up to the EU-U.S. Safe Harbor Framework, which required U.S.-based companies to provide assurance that they are adhering to relevant European standards for data protection. On October 6, 2015, the Court of Justice of the European Union, or CJEU, invalidated the EU-U.S. Safe Harbor Framework. In light of CJEU’s decision, we are reviewing our current operations to ensure that our EU-U.S. data transfers comply with EU data protection laws. The available legal basis for such transfers will depend on a number of factors, including, for example, the type of data and the European Economic Area country from which the data is being transferred, and may require that we obtain express consent from the customer or employee whose data is being transferred or include in our agreements with the applicable customer or European Economic Area employing entity the standard contractual clauses that have been approved by the EU Commission or adopt one of the other alternative mechanisms available in order to effect such transfers in compliance with the EU laws (although certain German regulators have expressed concerns in respect of the standard contractual clauses and the Irish DPA has commenced proceedings in the Irish High Court to seek a reference to the CJEU as to whether the standard contractual clauses can be used as a basis for data transfers to the U.S.). Our compliance actions may involve substantial time and expense; for example, if we enter into the standard contractual clauses with a customer, in some EU countries, including Belgium and Spain, executed clauses need to be lodged with or notified to the country’s data protection authority prior to the transfer of any data, and in other countries, including Austria, France, Ireland, Romania and Slovenia, the clauses need to be approved by the country’s data protection authority prior to use. Non-compliance could result in the EU data protection authorities imposing a number of different sanctions on us until we do, including fines and, ultimately, a prohibition on transfers.
In addition to government regulation, privacy advocates and industry groups may propose new and different self-regulatory standards that either legally or contractually apply to us. Because the interpretation and application of privacy and data protection laws are still uncertain, it is possible that these laws may be interpreted and applied in a manner that is inconsistent with our existing practices or the features of our products. We may also be subject to claims of liability or responsibility for the actions of third parties with whom we interact or upon whom we rely in relation to various services, including but not limited to vendors and business partners. If so, in addition to the possibility of fines, lawsuits and other claims, we could be required to fundamentally change our business activities and practices or modify our products, which could have an adverse effect on our business. Any inability to adequately address privacy concerns, even if unfounded, or comply with applicable privacy or data protection laws, regulations and policies, could result in additional cost and liability to us, damage our reputation, inhibit sales and adversely affect our business.
The costs of compliance with, and other burdens imposed by, the laws, rules, regulations and policies that are applicable to the businesses of our customers may limit the use and adoption of, and reduce the overall demand for, our software. Privacy or cyber security concerns, whether valid or not valid, may inhibit market adoption of our products particularly in certain industries and foreign countries.

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Further, there are active legislative discussions regarding the implementation of laws or regulations that could restrict the manner in which security research is conducted and that could restrict or possibly bar the conduct of penetration testing and the use of exploits, which are an essential component of our Metasploit product and our business strategy more generally. Our failure to comply with existing laws, rules or regulations, changes to existing laws or their interpretation, or the imposition of new laws, rules or regulations, could have a material and adverse impact on our business, results of operations, and financial condition.
Failure to protect our proprietary technology and intellectual property rights could substantially harm our business and operating results.
Our future success and competitive position depend in part on our ability to protect our intellectual property and proprietary technologies. To safeguard these rights, we rely on a combination of patent, trademark, copyright and trade secret laws and contractual protections in the United States and other jurisdictions, all of which provide only limited protection and may not now or in the future provide us with a competitive advantage.
We cannot assure you that any patents will issue from any patent applications, that patents that issue from such applications will give us the protection that we seek or that any such patents will not be challenged, invalidated, or circumvented. Any patents that may issue in the future from our pending or future patent applications may not provide sufficiently broad protection and may not be enforceable in actions against alleged infringers. We have registered the “Rapid7,” “Nexpose” and “Metasploit” names and logos in the United States and certain other countries. We have registrations and/or pending applications for additional marks in the United States and other countries; however, we cannot assure you that any future trademark registrations will be issued for pending or future applications or that any registered trademarks will be enforceable or provide adequate protection of our proprietary rights. We also license software from third parties for integration into our products, including open source software and other software available on commercially reasonable terms. We cannot assure you that such third parties will maintain such software or continue to make it available.
In order to protect our unpatented proprietary technologies and processes, we rely on trade secret laws and confidentiality agreements with our employees, consultants, channel partners, vendors and others. Despite our efforts to protect our proprietary technology and trade secrets, unauthorized parties may attempt to misappropriate, reverse engineer or otherwise obtain and use them. In addition, others may independently discover our trade secrets, in which case we would not be able to assert trade secret rights, or develop similar technologies and processes. Further, the contractual provisions that we enter into may not prevent unauthorized use or disclosure of our proprietary technology or intellectual property rights and may not provide an adequate remedy in the event of unauthorized use or disclosure of our proprietary technology or intellectual property rights. Moreover, policing unauthorized use of our technologies, trade secrets and intellectual property is difficult, expensive and time-consuming, particularly in foreign countries where the laws may not be as protective of intellectual property rights as those in the United States and where mechanisms for enforcement of intellectual property rights may be weak. We may be unable to determine the extent of any unauthorized use or infringement of our solutions, technologies or intellectual property rights.
From time to time, legal action by us may be necessary to enforce our patents and other intellectual property rights, to protect our trade secrets, to determine the validity and scope of the intellectual property rights of others or to defend against claims of infringement or invalidity. Such litigation could result in substantial costs and diversion of resources and could negatively affect our business, operating results and financial condition.
Assertions by third parties of infringement or other violations by us of their intellectual property rights, whether or not correct, could result in significant costs and harm our business and operating results.
Patent and other intellectual property disputes are common in our industry. We are currently involved in a lawsuit brought by a non-practicing entity alleging that we have infringed upon a now-expired patent held by such entity and we may, from time to time, be involved in other such disputes in the ordinary course of our business. Some companies, including some of our competitors, own large numbers of patents, copyrights and trademarks, which they may use to assert claims against us. Third parties have in the past and may in the future assert claims of infringement, misappropriation or other violations of intellectual property rights against us. They may also assert such claims against our customers or channel partners, whom we typically indemnify against claims that our solutions infringe, misappropriate or otherwise violate the intellectual property rights of third parties. As the numbers of products and competitors in our market increase and overlaps occur, claims of infringement, misappropriation and other violations of intellectual property rights may increase. Any claim of infringement, misappropriation or other violation of intellectual property rights by a third party, even those without merit, could cause us to incur substantial costs defending against the claim and could distract our management from our business.
The patent portfolios of our most significant competitors are larger than ours. This disparity may increase the risk that they may sue us for patent infringement and may limit our ability to counterclaim for patent infringement or settle through patent cross-

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licenses. In addition, future assertions of patent rights by third parties, and any resulting litigation, may involve patent holding companies or other adverse patent owners who have no relevant product revenues and against whom our own patents may therefore provide little or no deterrence or protection. There can be no assurance that we will not be found to infringe or otherwise violate any third-party intellectual property rights or to have done so in the past.
An adverse outcome of a dispute may require us to:
pay substantial damages, including treble damages, if we are found to have willfully infringed a third party’s patents or copyrights;
cease making, licensing or using solutions that are alleged to infringe or misappropriate the intellectual property of others;
expend additional development resources to attempt to redesign our solutions or otherwise develop non-infringing technology, which may not be successful;
enter into potentially unfavorable royalty or license agreements in order to obtain the right to use necessary technologies or intellectual property rights; and
indemnify our partners and other third parties.
In addition, royalty or licensing agreements, if required or desirable, may be unavailable on terms acceptable to us, or at all, and may require significant royalty payments and other expenditures. Some licenses may also be non-exclusive, and therefore, our competitors may have access to the same technology licensed to us. Any of the foregoing events could seriously harm our business, financial condition and results of operations.
Our intercompany relationships are subject to complex transfer pricing regulations, which may be challenged by taxing authorities.
We generally conduct our international operations through wholly-owned subsidiaries and report our taxable income in various jurisdictions worldwide based upon our business operations in those jurisdictions. In 2016, we completed the reorganization of our corporate structure and intercompany relationships to more closely align our corporate organization with the expansion of our international business activities. Although we anticipate achieving a reduction in our overall effective tax rate in the future as a result of this reorganized corporate structure, we may not realize any benefits. Our intercompany relationships are and will continue to be subject to complex transfer pricing regulations administered by taxing authorities in various jurisdictions. The relevant taxing authorities may disagree with our determinations as to the income and expenses attributable to specific jurisdictions. If such a disagreement were to occur, and our position were not sustained, we could be required to pay additional taxes, interest and penalties, which could result in one-time tax charges, higher effective tax rates, reduced cash flows and lower overall profitability of our operations. In addition, if the intended tax treatment of our reorganized corporate structure is not accepted by the applicable taxing authorities, changes in tax law negatively impact the structure or we do not operate our business consistent with the structure and applicable tax laws and regulations, we may fail to achieve any tax advantages as a result of the reorganized corporate structure, and our future operating results and financial condition may be negatively impacted.
Our ability to use net operating losses to offset future taxable income may be subject to certain limitations.
As of December 31, 2016, we had federal and state net operating loss carryforwards, or NOLs, of $93.8 million and $69.2 million, respectively, available to offset future taxable income, which expire in various years beginning in 2023 if not utilized. A lack of future taxable income would adversely affect our ability to utilize these NOLs before they expire. Under the provisions of the Internal Revenue Code of 1986, as amended, or the Internal Revenue Code, substantial changes in our ownership may limit the amount of pre-change NOLs that can be utilized annually in the future to offset taxable income. Section 382 of the Internal Revenue Code imposes limitations on a company’s ability to use NOLs if a company experiences a more-than-50-percent ownership change over a three-year testing period. Based upon our analysis as of December 31, 2016, we determined that although a small limitation on our historical NOLs exists, we do not expect this limitation to impair our ability to use our NOLs prior to expiration. However, if changes in our ownership occur in the future, our ability to use our NOLs may be further limited. For these reasons, we may not be able to utilize a material portion of the NOLs, even if we achieve profitability. If we are limited in our ability to use our NOLs in future years in which we have taxable income, we will pay more taxes than if we were able to fully utilize our NOLs. This could adversely affect our operating results and the market price of our common stock.

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The enactment of legislation implementing changes in the U.S. taxation of international business activities or the adoption of other tax reform policies could materially impact our financial position and results of operations.
Recent changes to U.S. tax laws, including limitations on the ability of taxpayers to claim and utilize foreign tax credits and the deferral of certain tax deductions until earnings outside of the United States are repatriated to the United States, as well as changes to U.S. tax laws that may be enacted in the future, could impact the tax treatment of our foreign earnings. Due to expansion of our international business activities, any changes in the U.S. taxation of such activities may increase our worldwide effective tax rate and adversely affect our financial condition and operating results. Additionally, changes in foreign tax laws, in particular with regard to UK tax policy, may adversely impact our worldwide tax rate.
Our operating results may be harmed if we are required to collect sales and use or other related taxes for our products and professional services in jurisdictions where we have not historically done so.
Taxing jurisdictions, including state, local and foreign taxing authorities, have differing rules and regulations governing sales and use or other taxes, and these rules and regulations are subject to varying interpretations that may change over time. In particular, significant judgment is required in evaluating our tax positions and our worldwide provision for taxes. While we believe that we are in material compliance with our obligations under applicable taxing regimes, one or more states, localities or countries may seek to impose additional sales or other tax collection obligations on us, including for past sales. It is possible that we could face sales tax audits and that such audits could result in tax-related liabilities for which we have not accrued. A successful assertion that we should be collecting additional sales or other taxes on our offerings in jurisdictions where we have not historically done so and do not accrue for sales taxes could result in substantial tax liabilities for past sales, discourage customers from purchasing our offerings or otherwise harm our business and operating results.
In addition, our tax obligations and effective tax rates could be adversely affected by changes in the relevant tax, accounting and other laws, regulations, principles and interpretations, including those relating to income tax nexus, by recognizing tax losses or lower than anticipated earnings in jurisdictions where we have lower statutory rates and higher than anticipated earnings in jurisdictions where we have higher statutory rates, by changes in foreign curr