10-Q 1 rpdq2201710q.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 June 30, 2017
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                      to                     
Commission File Number: 001-37496
 
 
RAPID7, INC.
(Exact Name of Registrant as Specified in its Charter)
 
Delaware
 
35-2423994
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)
 
 
 
100 Summer Street
Boston, MA
 
02110
(Address of principal executive offices)
 
(Zip Code)
Registrant’s telephone number, including area code: (617) 247-1717
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes      No  ☐
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes      No  ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and "emerging growth company" in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer
Accelerated filer
Non-accelerated filer
☐  (Do not check if a small reporting company)
Small reporting company
Emerging growth company
 
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ☐    No  
As of August 1, 2017, there were 43,550,301 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)
 
 
 
June 30, 2017
 
December 31, 2016
Assets
 
 
 
 
Current assets:
 
 
 
 
Cash and cash equivalents
 
$
53,068

 
$
53,148

Short-term investments
 
31,213

 
18,779

Accounts receivable, net of allowance for doubtful accounts of $1,240 and $1,061 at June 30, 2017 and December 31, 2016, respectively
 
47,560

 
49,154

Prepaid expenses and other current assets
 
8,892

 
9,152

Total current assets
 
140,733

 
130,233

Long-term investments
 
8,799

 
20,162

Property and equipment, net
 
8,287

 
8,088

Goodwill
 
75,110

 
75,110

Intangible assets, net
 
8,294

 
8,946

Other assets
 
630

 
764

Total assets
 
$
241,853

 
$
243,303

Liabilities and Stockholders’ Equity
 
 
 
 
Current liabilities:
 
 
 
 
Accounts payable
 
$
2,257

 
$
4,012

Accrued expenses
 
20,667

 
23,499

Deferred revenue, current portion
 
126,085

 
116,903

Other current liabilities
 
1,334

 
1,195

Total current liabilities
 
150,343

 
145,609

Deferred revenue, non-current portion
 
54,344

 
52,160

Other long-term liabilities
 
2,539

 
3,496

Total liabilities
 
207,226

 
201,265

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

 

Common stock, $0.01 par value per share; 100,000,000 shares authorized at June 30, 2017 and December 31, 2016; 44,005,649 and 43,018,737 shares issued at June 30, 2017 and December 31, 2016, respectively; 43,532,061 and 42,554,683 shares outstanding at June 30, 2017 and December 31, 2016, respectively
 
435

 
426

Treasury stock, at cost, 473,588 and 464,054 shares at June 30, 2017 and December 31, 2016, respectively
 
(4,531
)
 
(4,391
)
Additional paid-in-capital
 
450,394

 
435,360

Accumulated other comprehensive loss
 
(46
)
 
(19
)
Accumulated deficit
 
(411,625
)
 
(389,338
)
Total stockholders’ equity
 
34,627

 
42,038

Total liabilities and stockholders’ equity
 
$
241,853

 
$
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 June 30,
 
Six Months Ended June 30,
 
 
2017
 
2016
 
2017
 
2016
Revenue:
 
 
 
 
 
 
 
 
Products
 
$
27,168

 
$
21,456

 
$
53,110

 
$
41,601

Maintenance and support
 
11,338

 
8,962

 
22,140

 
17,343

Professional services
 
8,937

 
6,850

 
17,438

 
13,120

Total revenue
 
47,443

 
37,268

 
92,688

 
72,064

Cost of revenue:
 
 
 
 
 
 
 
 
Products
 
5,557

 
2,687

 
10,267

 
5,285

Maintenance and support
 
1,850

 
1,758

 
3,728

 
3,439

Professional services
 
5,672

 
4,848

 
11,348

 
9,281

Total cost of revenue
 
13,079

 
9,293

 
25,343

 
18,005

Total gross profit
 
34,364

 
27,975

 
67,345

 
54,059

Operating expenses:
 
 
 
 
 
 
 
 
Research and development
 
11,873

 
12,932

 
23,266

 
25,274

Sales and marketing
 
27,132

 
21,680

 
51,942

 
44,448

General and administrative
 
7,256

 
6,644

 
14,504

 
13,237

Total operating expenses
 
46,261

 
41,256

 
89,712

 
82,959

Loss from operations
 
(11,897
)
 
(13,281
)
 
(22,367
)
 
(28,900
)
Other income (expense), net:
 
 
 
 
 
 
 
 
Interest income (expense), net
 
218

 
26

 
387

 
11

Other income (expense), net
 
229

 
(48
)
 
114

 
148

Loss before income taxes
 
(11,450
)
 
(13,303
)
 
(21,866
)
 
(28,741
)
Provision for income taxes
 
187

 
149

 
316

 
291

Net loss
 
$
(11,637
)
 
$
(13,452
)
 
$
(22,182
)
 
$
(29,032
)
Net loss per share, basic and diluted
 
$
(0.27
)
 
$
(0.33
)
 
$
(0.52
)
 
$
(0.71
)
Weighted-average common shares outstanding, basic and diluted
 
42,681,287

 
41,063,613

 
42,395,450

 
40,805,641

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 June 30,
 
Six Months Ended June 30,
 
 
2017
 
2016
 
2017
 
2016
 
 
 
 
 
 
 
 
 
Net loss
 
$
(11,637
)
 
$
(13,452
)
 
$
(22,182
)
 
$
(29,032
)
Other comprehensive loss:
 
 
 
 
 
 
 
 
Change in fair value of investments
 
(10
)
 

 
(30
)
 

Adjustment for net losses realized and included in net loss
 
3

 

 
3

 

Total change in unrealized losses on investments
 
(7
)
 

 
(27
)
 

Comprehensive loss
 
$
(11,644
)
 
$
(13,452
)
 
$
(22,209
)
 
$
(29,032
)

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



3


RAPID7, INC.
Consolidated Statements of Cash Flows (Unaudited)
(in thousands)
 
 
 
Six Months Ended June 30,
 
 
2017
 
2016
Cash flows from operating activities:
 
 
 
 
Net loss
 
$
(22,182
)
 
$
(29,032
)
Adjustments to reconcile net loss to net cash (used in) provided by operating activities:
 
 
 
 
Depreciation and amortization
 
3,237

 
3,419

Stock-based compensation expense
 
9,450

 
9,160

Provision for doubtful accounts
 
478

 
394

Foreign currency re-measurement gain
 
(238
)
 
(119
)
Other non-cash expenses
 
175

 
130

Changes in assets and liabilities:
 
 
 
 
Accounts receivable
 
1,240

 
4,945

Prepaid expenses and other assets
 
412

 
(1,401
)
Accounts payable
 
(1,657
)
 
1,904

Accrued expenses
 
(2,122
)
 
(3,462
)
Deferred revenue
 
11,366

 
14,405

Other liabilities
 
(819
)
 
(72
)
Net cash (used in) provided by operating activities
 
(660
)
 
271

Cash flows from investing activities:
 
 
 
 
Purchases of property and equipment
 
(2,578
)
 
(1,842
)
Capitalization of internal-use software costs
 
(316
)
 

Purchases of investments
 
(15,828
)
 

Sale and maturities of investments
 
14,605

 

Net cash used in investing activities
 
(4,117
)
 
(1,842
)
Cash flows from financing activities:
 
 
 
 
Deferred business acquisition payment
 
(796
)
 

Payments of capital lease obligations
 

 
(68
)
Taxes paid related to net share settlement of equity awards
 
(261
)
 
(3,760
)
Proceeds from employee stock purchase plan
 
1,499

 
2,096

Proceeds from stock option exercises
 
4,111

 
1,431

Net cash provided by (used in) financing activities
 
4,553

 
(301
)
Effect of exchange rate changes on cash and cash equivalents
 
144

 
74

Net increase (decrease) in cash and cash equivalents
 
(80
)
 
(1,798
)
Cash and cash equivalents, beginning of period
 
53,148

 
86,553

Cash and cash equivalents, end of period
 
$
53,068

 
$
84,755

Supplemental cash flow information:
 
 
 
 
Cash paid for income taxes
 
$
623

 
$
334

Cash paid for interest
 
$

 
$
1

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

4


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

Significant Accounting Policies

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

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

5


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

6


The following table presents our financial assets and liabilities measured and recorded at fair value on a recurring basis using the above input categories:
 
 
 
As of June 30, 2017
 
 
Level 1
 
Level 2
 
Level 3
 
Total
 
 
(in thousands)
Description:
 
 
 
 
 
 
 
 
Assets:
 
 
 
 
 
 
 
 
Money market funds
 
$
10,095

 
$

 
$

 
$
10,095

U.S. government agencies
 
14,965

 

 

 
14,965

Commercial paper
 

 
4,479

 

 
4,479

Corporate bonds
 

 
15,721

 

 
15,721

Asset-backed securities
 

 
4,847

 

 
4,847

Total assets
 
$
25,060

 
$
25,047

 
$

 
$
50,107


 
 
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 June 30, 2017 or December 31, 2016.
Our investments, which are all classified as available-for-sale, consisted of the following:
 
 
As of June 30, 2017
 
 
Amortized Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Fair Value
 
 
(in thousands)
Description:
 
 
 
 
 
 
 
 
U.S. government agencies
 
$
14,993

 
$

 
$
(28
)
 
$
14,965

Commercial paper
 
4,479

 

 

 
4,479

Corporate bonds
 
15,736

 

 
(15
)
 
15,721

Asset-backed securities
 
4,850

 

 
(3
)
 
4,847

Total assets
 
$
40,058

 
$

 
$
(46
)
 
$
40,012


7


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

 
$
3

 
$
(13
)
 
$
14,982

Commercial paper
 
7,178

 

 

 
7,178

Corporate bonds
 
10,326

 
1

 
(13
)
 
10,314

Asset-backed securities
 
6,464

 
4

 
(1
)
 
6,467

Total assets
 
$
38,960

 
$
8

 
$
(27
)
 
$
38,941

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

Note 3. Property and Equipment
Property and equipment are recorded at cost and consist of the following:
 
 
As of
June 30, 2017
 
As of
December 31, 2016
 
 
(in thousands)
Computer equipment and software
 
$
14,189

 
$
12,844

Furniture and fixtures
 
3,614

 
3,131

Leasehold improvements
 
8,717

 
8,077

Total
 
26,520

 
24,052

Less accumulated depreciation
 
(18,233
)
 
(15,964
)
Property and equipment, net
 
$
8,287

 
$
8,088

Depreciation expense was $1.1 million for the three months ended June 30, 2017 and 2016 and $2.3 million and $2.2 million for the six months ended June 30, 2017 and 2016, respectively.
Note 4. Goodwill and Intangible Assets
Goodwill was $75.1 million as of June 30, 2017 and December 31, 2016.
The following table presents details of our intangible assets which include acquired identifiable intangible assets and capitalized internal-use software costs:
 
 
 
As of June 30, 2017
 
As of December 31, 2016
 
Weighted-
Average
Life (years)
 
Gross Carrying
Amount
 
Accumulated
Amortization
 
Net Book Value
 
Gross Carrying
Amount
 
Accumulated
Amortization
 
Net Book Value
 
 
 
(in thousands)
Intangible assets subject to amortization:
 
 
 
 
 
 
 
 
 
 
 
 
 
Developed technology
6.3
 
$
11,231

 
$
(3,995
)
 
$
7,236

 
$
11,231

 
$
(3,118
)
 
$
8,113

Customer relationships
6.7
 
1,000

 
(274
)
 
726

 
1,000

 
(197
)
 
803

Trade names
6.1
 
519

 
(503
)
 
16

 
519

 
(496
)
 
23

Non-compete agreements
2.0
 
40

 
(40
)
 

 
40

 
(33
)
 
7

Total acquired intangible assets
 
 
12,790

 
(4,812
)
 
7,978

 
12,790

 
(3,844
)
 
8,946

Internal-use software
 
 
316

 

 
316

 

 

 

Total intangible assets
 
 
$
13,106

 
$
(4,812
)
 
$
8,294

 
$
12,790

 
$
(3,844
)
 
$
8,946


8


Amortization expense was $0.5 million and $0.6 million for the three months ended June 30, 2017 and 2016, respectively, and $1.0 million and $1.2 million for the six months ended June 30, 2017 and 2016, respectively.
Estimated future amortization expense of the acquired identifiable intangible assets as of June 30, 2017 is as follows (in thousands):
2017 (for the remaining six months)
$
962

2018
1,886

2019
1,859

2020
1,837

2021
1,332

2022 and thereafter
102

Total
$
7,978


The costs associated with the development of internal-use software are not included in the table above, as the projects are currently in development. As such, we have not determined the useful life of the software, nor have all the costs associated with this project been incurred.
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:
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
 
2017
 
2016
 
2017
 
2016
 
 
(in thousands)
Stock-based compensation expense:
 
 
 
 
 
 
 
 
Cost of revenue
 
$
308

 
$
142

 
$
510

 
$
279

Research and development
 
1,689

 
1,524

 
3,202

 
3,017

Sales and marketing
 
1,779

 
1,224

 
3,182

 
4,125

General and administrative
 
1,395

 
751

 
2,556

 
1,739

Total stock-based compensation expense
 
$
5,171

 
$
3,641

 
$
9,450

 
$
9,160

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 six months ended June 30, 2017 was as follows:
 
 
 
Restricted Stock
 
Restricted Stock Units
 
 
Shares
 
Weighted-Average
Grant Date
Fair Value
 
Shares
 
Weighted-Average
Grant Date
Fair Value
Unvested balance as of December 31, 2016
 
585,004

 
$
18.05

 
734,577

 
$
13.47

Granted
 

 

 
1,423,010

 
14.11

Vested
 
(156,765
)
 
19.04

 
(200,416
)
 
13.72

Forfeited
 
(7,698
)
 
23.01

 
(78,441
)
 
13.62

Unvested balance as of June 30, 2017
 
420,541

 
$
17.59

 
1,878,730

 
$
13.92

As of June 30, 2017, the unrecognized compensation expense related to our unvested restricted stock and restricted stock units expected to vest was $30.6 million. This unrecognized compensation expense will be recognized over an estimated weighted-average amortization period of 3.0 years.

9


During the six months ended June 30, 2017, we repurchased 9,534 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 six months ended June 30, 2017 was as follows:
 
 
Shares
 
Weighted
Average
Exercise
Price
 
Weighted
Average
Remaining
Contractual Life
(in years)
 
Aggregate
Intrinsic
Value
(in thousands)
Outstanding as of December 31, 2016
 
4,580,375

 
$
8.20

 
 
 
 
Granted
 
1,266,238

 
13.38

 
 
 
 
Exercised
 
(670,533
)
 
6.13

 
 
 
$
7,572

Forfeited/cancelled
 
(134,812
)
 
12.41

 
 
 
 
Outstanding as of June 30, 2017
 
5,041,268

 
$
9.66

 
7.5
 
$
36,564

Vested and exercisable as of June 30, 2017
 
2,642,121

 
$
6.57

 
6.0
 
$
27,278

Vested and expected to vest as of June 30, 2017
 
4,544,979

 
$
9.27

 
7.1
 
$
34,726

As of June 30, 2017, the unrecognized compensation expense related to our unvested stock options expected to vest was $14.1 million. This unrecognized compensation expense will be recognized over an estimated weighted-average amortization period of 2.9 years.
The total fair value of stock options vested in the six months ended June 30, 2017 was $3.2 million. The weighted-average grant date fair value of stock options granted in the six months ended June 30, 2017 was $6.65 per share.

(d)
Employee Stock Purchase Plan
Under the Rapid7, Inc. 2015 Employee Stock Purchase Plan (ESPP), employees may set aside up to 15% of their gross earnings, on an after-tax basis, to purchase our common shares at a discounted price, which is calculated at 85% of the lesser of: (i) the market value of our common stock at the beginning of each offering period and (ii) the market value of our common stock on the applicable purchase date.
On March 15, 2017, we issued 138,085 shares of common stock to employees for aggregate proceeds of $1.5 million. The purchase prices of the shares of common stock were $10.60 and $12.79 per share, which were discounted in accordance with the terms of the ESPP from the closing prices of our common stock on March 16, 2016 of $12.47 and on March 15, 2017 of $15.05, respectively.
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 and six months ended June 30, 2017 and 2016:
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2017
 
2016
 
2017
 
2016
 
(in thousands, except share and per share data)
Numerator:
 
 
 
 
 
 
 
Net loss
$
(11,637
)
 
$
(13,452
)
 
$
(22,182
)
 
$
(29,032
)
Denominator:
 
 
 
 
 
 
 
Weighted-average common shares outstanding, basic and diluted
42,681,287

 
41,063,613

 
42,395,450

 
40,805,641

Net loss per share attributable to common stockholders, basic and diluted
$
(0.27
)
 
$
(0.33
)
 
$
(0.52
)
 
$
(0.71
)
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:

10


 
Three and Six Months Ended June 30,
 
2017
 
2016
Options to purchase common stock
5,041,268

 
4,766,320

Unvested restricted stock
420,541

 
811,681

Unvested restricted stock units
1,878,730

 
619,240

Shares to be issued under ESPP
76,647

 
103,471

Total
7,417,186

 
6,300,712

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 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 June 30,
 
Six Months Ended June 30,
 
2017
 
2016
 
2017
 
2016
 
(in thousands)
North America
$
40,218

 
$
32,287

 
$
78,211

 
$
62,419

Other
7,225

 
4,981

 
14,477

 
9,645

Total
$
47,443

 
$
37,268

 
$
92,688

 
$
72,064

Of the total net revenues generated in North America, 93% and 97% of the revenues were generated in the United States for the three months ended June 30, 2017 and 2016, respectively, and 93% and 97% of the revenues were generated in the United States for the six months ended June 30, 2017 and 2016, respectively.
Property and equipment, net by geographic area was as follows:
 

11


 
As of June 30, 2017
 
As of December 31, 2016
 
(in thousands)
United States
$
6,939

 
$
7,063

Other
1,348

 
1,025

Total
$
8,287

 
$
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 and six months ended June 30, 2017, we recognized sales and marketing expense of $0.9 million and $1.8 million, respectively, related to partner referral fees payable to McAfee LLC. On February 6, 2017, Michael Berry, a member of our Board of Directors, became the Chief Financial Officer of McAfee LLC.
Note 10. Subsequent Event
On July 12, 2017, we acquired Komand, Inc. (Komand), a security orchestration and automation company based in Boston, Massachusetts for total cash consideration of $14.8 million. In addition, certain retained employees of Komand (i) received an aggregate of 295,600 restricted stock units which will vest over four years and (ii) shall be eligible for an aggregate of up to $5.0 million of incentive payments contingent on achievement of certain milestones within four years of the acquisition; each restricted stock unit and incentive payment is subject to the employee's continued service. The acquisition will be accounted for under the acquisition method of accounting with the operations of the newly acquired entity included in our operating results from the date of acquisition.

12




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 June 30, 2017, we had over 6,500 customers in 123 countries, including 39% of the Fortune 1000. Our revenue was not concentrated with any individual customer or group of customers, and no customer represented more than 2% of our revenue for the three or six months ended June 30, 2017 or 2016.
We sell our products and services through direct inside and field sales teams and indirect channel partner relationships. Our global sales teams focus on both new customer acquisition and up-selling and cross-selling additional offerings to our existing customers. Our sales teams are organized by geography, consisting of the Americas; Europe, the Middle East and Africa; and Asia Pacific, or APAC, as well as by target organization size. Our inside sales team focuses on small and middle-market transactions, while larger or more complex transactions are generally handled by our globally distributed direct field sales teams. Our highly technical sales engineers help define customer use cases, manage solution evaluations and train channel partners.

13



Recent Developments
In July 2017, we acquired Komand, Inc. (Komand), a Boston, Massachusetts-based security orchestration and automation company, for total cash consideration of $14.8 million. Komand’s orchestration and automation technology will expand the Rapid7 Insight platform’s ability to empower lean security and IT teams to meaningfully increase productivity across their entire operation and reduce the time it takes to respond to an incident. With Komand technology, customers will have the ability to automatically identify risks, respond to incidents, and address issues significantly faster and with less human intervention.
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 sale of maintenance and support. Our Nexpose, Metasploit and AppSpider products are offered through perpetual or term software licenses, with a majority of our customers selecting a perpetual license. Our customers who purchase software licenses also purchase 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 (InsightIDR) products are offered on a managed service basis, generally pursuant to one to three-year agreements.
We also offer various professional services across all of our offerings, including deployment and training services related to our software and cloud-based products, incident response services and security advisory services. Customers can purchase our professional services together with our product offerings or on a stand-alone basis pursuant to fixed fee or time-and-materials agreements.
An important component of our revenue growth strategy is to have our existing customers renew their agreements with us and purchase additional products from us. To assess our performance against this objective, we monitor the renewal rates of our existing customers. We calculate our renewal rate by dividing the dollar value of renewed customer agreements, including upsells and cross-sells of additional products, but excluding professional services and Logentries, in a trailing 12-month period by the dollar value of the corresponding customer agreements. We also calculate an expiring renewal rate that does not take into account any upsells or cross-sells. As a result of this methodology, we would not expect our expiring renewal rate to exceed 100%. Our renewal rate was 119% and 126% for the second quarter of 2017 and 2016, respectively, and our expiring renewal rate was 88% and 89% for the second quarter of 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 changes in our customers’ spending levels.
We generate revenue from selling products, maintenance and support, and professional services. For the three months ended June 30, 2017 and 2016, 81% and 82% of our revenue, respectively, was derived from sales of products and associated maintenance and support, while the remaining 19% and 18%, respectively, was derived from the sale of professional services. For the six months ended June 30, 2017 and 2016, 81% and 82% of our revenue, respectively, was derived from sales of products and associated maintenance and support, while the remaining 19% and 18%, respectively, was derived from the sale of professional services.

14


For the three months ended June 30, 2017 and 2016, recurring revenue, defined as revenue from term software licenses, content subscriptions, managed services, cloud-based subscriptions and maintenance and support, was 70% and 67%, respectively, of total revenue. For the six months ended June 30, 2017 and 2016, recurring revenue 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 and six months ended June 30, 2016, our recurring revenue was recast from 62%, as previously disclosed, to 67%.
For the three months ended June 30, 2017 and 2016, 88% and 87%, respectively, of our total revenue came from deferred revenue on the balance sheet at the beginning of the respective periods. For the six months ended June 30, 2017 and 2016, 78% and 75%, 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
June 30,
 
Six Months Ended
June 30,
 
 
2017
 
2016
 
2017
 
2016
 
 
(dollars in thousands)
Total revenue
 
$
47,443

 
$
37,268

 
$
92,688

 
$
72,064

Year-over-year growth
 
27.3
%
 
44.5
%
 
28.6
%
 
46.0
%
Calculated billings (non-GAAP)
 
$
60,225

 
$
50,133

 
$
104,054

 
$
86,469

Operating cash flow
 
$
(3,981
)
 
$
1,863

 
$
(660
)
 
$
271

 
 
 
As of June 30,
 
 
2017
 
2016
Deferred revenue
 
$
180,429

 
$
144,722

Number of customers
 
6,559

 
5,628

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. With the expansion of our subscription, cloud-based product offerings (InsightVM, InsightIDR, InsightAppSec, and InsightOps) on the Insight platform, we may realize a shortening of our average contract duration, which should be taken into consideration when evaluating calculated billings. Our use of calculated billings has limitations as an analytical tool and should not be considered in isolation or as a substitute for revenue recognition or revenue measurement, or an analysis of our results as reported under GAAP. Also, it is important to note that other companies, including companies in our industry, may not use calculated billings, may compute billings differently, may have different billing frequencies, or may use other financial measures to evaluate their performance, all of which could reduce the usefulness of calculated billings as a comparative measure.

15


 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
 
2017
 
2016
 
2017
 
2016
 
 
(in thousands)
Total revenue
 
$
47,443

 
$
37,268

 
$
92,688

 
$
72,064

Add: Deferred revenue, end of period
 
180,429

 
144,722

 
180,429

 
144,722

Less: Deferred revenue, beginning of period
 
167,647

 
131,857

 
169,063

 
130,317

Calculated billings
 
$
60,225

 
$
50,133

 
$
104,054

 
$
86,469

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

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

16


performance of our business operations, facilitates comparison of our results with other periods and may also facilitate comparison with the results of other companies in our industry.
Our non-GAAP financial measures may not provide information that is directly comparable to that provided by other companies in our industry, as other companies in our industry may calculate non-GAAP financial results differently, particularly related to non-recurring, unusual items. In addition, there are limitations in using non-GAAP financial measures because the non-GAAP financial measures are not prepared in accordance with GAAP, may be different from non-GAAP financial measures used by other companies and exclude expenses that may have a material impact upon our reported financial results. Further, stock-based compensation expense has been and will continue to be for the foreseeable future a significant recurring expense in our business and an important part of the compensation provided to our employees.
The following tables reconcile GAAP gross profit to non-GAAP gross profit in total and by revenue class for the three and six months ended June 30, 2017 and 2016:
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
 
2017
 
2016
 
2017
 
2016
 
 
(in thousands)
GAAP total gross profit
 
$
34,364

 
$
27,975

 
$
67,345

 
$
54,059

Stock-based compensation expense
 
308

 
142

 
510

 
279

Amortization of acquired intangible assets
 
439

 
445

 
878

 
891

Non-GAAP total gross profit
 
$
35,111

 
$
28,562

 
$
68,733

 
$
55,229

 
 
 
 
 
 
 
 
 
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
 
2017
 
2016
 
2017
 
2016
 
 
(in thousands)
GAAP gross profit – products
 
$
21,611

 
$
18,769

 
$
42,843

 
$
36,316

Stock-based compensation expense
 
90

 
13

 
150

 
31

Amortization of acquired intangible assets
 
439

 
445

 
878

 
891

Non-GAAP gross profit – products
 
$
22,140

 
$
19,227

 
$
43,871

 
$
37,238

 
 
 
 
 
 
 
 
 
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
 
2017
 
2016
 
2017
 
2016
 
 
(in thousands)
GAAP gross profit – maintenance and support
 
$
9,488

 
$
7,204

 
$
18,412

 
$
13,904

Stock-based compensation expense
 
81

 
54

 
141

 
113

Non-GAAP gross profit – maintenance and support
 
$
9,569

 
$
7,258

 
$
18,553

 
$
14,017

 
 
 
 
 
 
 
 
 
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
 
2017
 
2016
 
2017
 
2016
 
 
(in thousands)
GAAP gross profit – professional services
 
$
3,265

 
$
2,002

 
$
6,090

 
$
3,839

Stock-based compensation expense
 
137

 
75

 
219

 
135

Non-GAAP gross profit – professional services
 
$
3,402

 
$
2,077

 
$
6,309

 
$
3,974


17


The following table reconciles GAAP loss from operations to non-GAAP loss from operations for the three and six months ended June 30, 2017 and 2016:
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
 
2017
 
2016
 
2017
 
2016
 
 
(in thousands)
GAAP loss from operations
 
$
(11,897
)
 
$
(13,281
)
 
$
(22,367
)
 
$
(28,900
)
Stock-based compensation expense
 
5,171

 
3,641

 
9,450

 
9,160

Amortization of acquired intangible assets
 
483

 
583

 
968

 
1,166

Acquisition-related expenses
 
80

 

 
80

 

Non-GAAP loss from operations
 
$
(6,163
)
 
$
(9,057
)
 
$
(11,869
)
 
$
(18,574
)
The following table reconciles GAAP net loss to non-GAAP net loss for the three and six months ended June 30, 2017 and 2016:
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
 
2017
 
2016
 
2017
 
2016
 
 
(in thousands, except share and per share data)
GAAP net loss
 
(11,637
)
 
(13,452
)
 
(22,182
)
 
(29,032
)
Stock-based compensation expense
 
5,171

 
3,641

 
9,450

 
9,160

Amortization of acquired intangible assets
 
483

 
583

 
968

 
1,166

Acquisition-related expenses
 
80

 

 
80

 

Non-GAAP net loss
 
$
(5,903
)
 
$
(9,228
)
 
$
(11,684
)
 
$
(18,706
)
Non-GAAP net loss per share, basic and diluted
 
$
(0.14
)
 
$
(0.22
)
 
$
(0.28
)
 
$
(0.46
)
Weighted-average common shares outstanding, basic and diluted
 
42,681,287

 
41,063,613

 
42,395,450

 
40,805,641


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 InsightVM, InsightIDR, InsightAppSec, InsightOps, AppSpider and Logentries products. We also generate an immaterial amount of appliance revenue that is included in our products revenue and is associated with hardware sold as part of our Nexpose product to certain customers. Revenue for perpetual software licenses and related services that are sold along with the software license is deferred on our balance sheet and recognized as revenue on our consolidated statements of operations ratably over the contractual period of the maintenance and support, which is typically one to three years. Revenue for our managed services and cloud-based subscription offerings is recognized on our consolidated statements of operations ratably over the term of the managed service agreement or subscription, provided that all other revenue recognition criteria have been met.
Maintenance and Support
We generate maintenance and support revenue when customers purchase or renew agreements for maintenance and support of their Nexpose, Metasploit and AppSpider software licenses. Substantially all of our customers purchase an agreement for maintenance and support in connection with their purchase of a Nexpose, Metasploit or AppSpider software license. Revenue from maintenance and support is recognized ratably over the term of the applicable agreement.
Professional Services

18


We generate professional service revenue from the sale of deployment and training services related to our products, incident response services and security advisory services. Revenue from professional services sold together with our perpetual and term software licenses product offerings is recognized ratably over the term of the applicable agreement. Revenue from professional services sold on a stand-alone basis or with non-software products is recognized as those services are rendered.
Cost of Revenue
Our total cost of revenue consists of the costs of products, maintenance and support and professional services revenue.
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, the mix of revenue between software licenses, cloud-based subscriptions, managed services and professional services and changes in cloud computing costs.
We expect our gross margins to decrease slightly as we expect revenue from our cloud-based subscriptions to increase as a percentage of total revenue and our cloud-based subscriptions generally have a lower gross margin than our software licenses.
Operating Expenses
Operating expenses consist of research and development, sales and marketing, and general and administrative expenses. Operating expenses include allocated overhead costs for depreciation, facilities, IT, information security and recruiting. Our allocated costs for IT include costs for compensation of IT personnel and costs associated with our IT infrastructure. All 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.

19


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.
We expect general and administrative expense to increase on an absolute dollar basis in the near term as we continue to increase investments to support our growth, but to decrease as a percentage of total revenue.
Interest Income (Expense), Net
Interest income (expense), net consists primarily of interest income on our cash and cash equivalents and our short and long-term investments.
Other Income (Expense), Net
Other income (expense), net consists primarily of unrealized and realized gains and losses related to changes in foreign currency exchange rates and realized gains and losses on the sale of investments.
Provision for 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.

20


Results of Operations
The following table sets forth our selected consolidated statements of operations data:
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2017
 
2016
 
2017
 
2016
 
(in thousands)
Consolidated Statement of Operations Data:
 
 
 
 
 
 
 
Revenue:
 
 
 
 
 
 
 
Products
$
27,168

 
$
21,456

 
$
53,110

 
$
41,601

Maintenance and support
11,338

 
8,962

 
22,140

 
17,343

Professional services
8,937

 
6,850

 
17,438

 
13,120

Total revenue
47,443

 
37,268

 
92,688

 
72,064

Cost of revenue:(1)
 
 
 
 
 
 
 
Products
5,557

 
2,687

 
10,267

 
5,285

Maintenance and support
1,850

 
1,758

 
3,728

 
3,439

Professional services
5,672

 
4,848

 
11,348

 
9,281

Total cost of revenue
13,079

 
9,293

 
25,343

 
18,005

Operating expenses:(1)
 
 
 
 
 
 
 
Research and development
11,873

 
12,932

 
23,266

 
25,274

Sales and marketing
27,132

 
21,680

 
51,942

 
44,448

General and administrative
7,256

 
6,644

 
14,504

 
13,237

Total operating expenses
46,261

 
41,256

 
89,712

 
82,959

Loss from operations
(11,897
)
 
(13,281
)
 
(22,367
)
 
(28,900
)
Interest income (expense), net
218

 
26

 
387

 
11

Other income (expense), net
229

 
(48
)
 
114

 
148

Loss before income taxes
(11,450
)
 
(13,303
)
 
(21,866
)
 
(28,741
)
Provision for income taxes
187

 
149

 
316

 
291

Net loss
$
(11,637
)
 
$
(13,452
)
 
$
(22,182
)
 
$
(29,032
)
(1)
Cost of revenue and operating expenses include stock-based compensation expense and depreciation and amortization expense as follows:
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2017
 
2016
 
2017
 
2016
 
(in thousands)
Stock-based compensation expense:
 
 
 
 
 
 
 
Cost of revenue
$
308

 
$
142

 
$
510

 
$
279

Research and development
1,689

 
1,524

 
3,202

 
3,017

Sales and marketing
1,779

 
1,224

 
3,182

 
4,125

General and administrative
1,395

 
751

 
2,556

 
1,739

Total stock-based compensation expense
$
5,171

 
$
3,641

 
$
9,450

 
$
9,160


 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2017
 
2016
 
2017
 
2016
 
(in thousands)
Depreciation and amortization expense:
 
 
 
 
 
 
 
Cost of revenue
$
658

 
$
640

 
$
1,319

 
$
1,268

Research and development
249

 
266

 
505

 
613

Sales and marketing
477

 
493

 
972

 
953

General and administrative
229

 
309

 
441

 
585

Total depreciation and amortization expense
$
1,613

 
$
1,708

 
$
3,237

 
$
3,419



21


The following table sets forth our selected consolidated statements of operations data expressed as a percentage of revenue:
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2017
 
2016
 
2017
 
2016
Consolidated Statement of Operations Data:
 
 
 
 
 
 
 
Revenue:
 
 
 
 
 
 
 
Products
57.3
 %
 
57.6
 %
 
57.3
 %
 
57.7
 %
Maintenance and support
23.9

 
24.0

 
23.9

 
24.1

Professional services
18.8

 
18.4

 
18.8

 
18.2

Total revenue
100.0

 
100.0

 
100.0

 
100.0

Cost of revenue:
 
 
 
 
 
 
 
Products
11.7

 
7.2

 
11.1

 
7.3

Maintenance and support
3.9

 
4.7

 
4.0

 
4.8

Professional services
12.0

 
13.0

 
12.2

 
12.9

Total cost of revenue
27.6

 
24.9

 
27.3

 
25.0

Operating expenses:
 
 
 
 
 
 
 
Research and development
25.0

 
34.7

 
25.1

 
35.1

Sales and marketing
57.2

 
58.2

 
56.0

 
61.7

General and administrative
15.3

 
17.8

 
15.7

 
18.3

Total operating expenses
97.5

 
110.7

 
96.8

 
115.1

Loss from operations
(25.1
)
 
(35.6
)
 
(24.1
)
 
(40.1
)
Interest income (expense), net
0.5

 

 
0.4

 

Other income (expense), net
0.5

 
(0.1
)
 
0.1

 
0.2

Loss before income taxes
(24.1
)
 
(35.7
)
 
(23.6
)
 
(39.9
)
Provision for income taxes
0.4

 
0.4

 
0.3

 
0.4

Net loss
(24.5
)%
 
(36.1
)%
 
(23.9
)%
 
(40.3
)%
Comparison of the Three Months Ended June 30, 2017 and 2016
Revenue
 
Three Months Ended June 30,
 
Change
 
2017
 
2016
 
$
 
%
 
(dollars in thousands)
Revenue:
 
 
 
 
 
 
 
Products
$
27,168

 
$
21,456

 
$
5,712

 
26.6
%
Maintenance and support
11,338

 
8,962

 
2,376

 
26.5

Professional services
8,937

 
6,850

 
2,087

 
30.5

Total revenue
$
47,443

 
$
37,268

 
$
10,175

 
27.3
%
Total revenue increased by $10.2 million in the three months ended June 30, 2017 compared to the same period in 2016. The increase in revenue included a $5.1 million increase from new customers, including the 931 new customers added since June 30, 2016 and a full fiscal quarter of revenue related to new customers added in the three months ended June 30, 2016.  Revenue also increased in the three months ended June 30, 2017 compared to the same period in 2016 due to $5.1 million in additional revenue from existing customers. The increase in total revenue in the three months ended June 30, 2017 compared to the same period in 2016 was comprised of $7.9 million generated from sales in North America and $2.3 million generated from sales from the rest of the world.

22


Cost of Revenue
 
Three Months Ended June 30,
 
Change
 
2017
 
2016
 
$
 
%
 
(dollars in thousands)
Cost of revenue:
 
 
 
 
 
 
 
Products
$
5,557

 
$
2,687

 
$
2,870

 
106.8
%
Maintenance and support
1,850

 
1,758

 
92

 
5.2

Professional services
5,672

 
4,848

 
824

 
17.0

Total cost of revenue
$
13,079

 
$
9,293

 
$
3,786

 
40.7
%
Gross margin %:
 
 
 
 
 
 
 
Products
79.5
%
 
87.5
%
 
 
 
 
Maintenance and support
83.7

 
80.4

 
 
 
 
Professional services
36.5

 
29.2

 
 
 
 
Total gross margin %
72.4
%
 
75.1
%
 
 
 
 
Total cost of revenue increased by $3.8 million in the three months ended June 30, 2017 compared to the same period in 2016, primarily due to a $2.2 million increase in personnel costs, inclusive of $0.2 million of stock-based compensation expense, resulting from an increase in headcount from 156 as of June 30, 2016 to 200 as of June 30, 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 $1.7 million increase in cloud computing costs related to growing cloud-based subscription revenue, a $0.6 million increase in allocated overhead driven largely by an increase in IT and facilities costs and a $0.1 million increase in travel and entertainment expense, partially offset by a decrease of $0.8 million of third-party professional service consulting costs.
Total gross margin percentage decreased for the three months ended June 30, 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 June 30, 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 maintenance and support gross margin for the three months ended June 30, 2017 was driven by our ability to scale as our revenue continues to grow. The increase in professional services gross margin for the three months ended June 30, 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.
Operating Expenses
Research and Development Expense
 
Three Months Ended June 30,
 
Change
 
2017
 
2016
 
$
 
%
 
(dollars in thousands)
Research and development
$
11,873

 
$
12,932

 
$
(1,059
)
 
(8.2
)%
% of revenue
25.0
%
 
34.7
%
 
 
 
 
Research and development expense decreased by $1.1 million in the three months ended June 30, 2017 compared to the same period in 2016, primarily due to a $1.2 million decrease in personnel costs, partially offset by an increase of $0.1 million in allocated overhead driven largely by an increase in IT and facilities costs. The $1.2 million decrease in personnel costs was primarily due to a $0.6 million acquisition-related bonus recorded in the three months ended June 30, 2016 and $0.3 million of certain departmental costs in the three months ended June 30, 2016 that have been eliminated in 2017. In addition, $0.3 million of personnel costs that were capitalized as internal-use software costs in the three months ended June 30, 2017.

23