Business Context and Reporting Period
Rapid7, Inc. provides cybersecurity analytics, vulnerability management, incident detection and response, application security, security orchestration and automation, managed services, and consulting through its Insight Platform. This Form 10-K covers the fiscal year ended December 31, 2018, with quarterly information for the three months ended December 31, 2018.
- More than 7,800 customers in 131 countries at year-end, including 53% of Fortune 100 organizations.
- 1,246 full-time employees at December 31, 2018.
- Recurring revenue represented 81% of 2018 revenue under ASC 606, compared with 70% of 2017 revenue under ASC 605.
Financial Performance and Position
| Metric | FY 2018 | FY 2017 | Change |
|---|---|---|---|
| Total revenue | $244.1 million | $200.9 million | 21.5% increase |
| Gross profit | $173.0 million | $144.0 million | 20.1% increase |
| Gross margin | 70.9% | 71.7% | Down 0.8 percentage points |
| Loss from operations | $(53.0) million | $(48.8) million | Loss increased |
| Net loss | $(55.5) million | $(45.5) million | Loss increased |
| Net loss per share | $(1.20) | $(1.06) | Loss per share increased |
| Operating cash flow | $6.1 million | $13.3 million | Decreased $7.2 million |
| Adjusted EBITDA | $(13.4) million | $(21.5) million | Improved $8.0 million |
Revenue consisted of $168.6 million of products, $42.2 million of maintenance and support, and $33.3 million of professional services. Products revenue increased 44.4%, while maintenance and support declined 8.7% and professional services declined 12.2%.
- Annualized recurring revenue was $251.8 million, up 52.7% from $164.9 million in 2017.
- Customer count increased to 7,808 from 7,030.
- Reported renewal rate was 120%; the expiring renewal rate was 90%.
- Stock-based compensation was $27.6 million, up from $19.5 million.
- Cash and cash equivalents were $99.6 million, supplemented by $204.1 million of short- and long-term investments.
- Total deferred revenue was $248.6 million, compared with $224.5 million at December 31, 2017.
- Total assets were $559.4 million and total stockholders’ equity was $87.3 million.
Fourth-Quarter 2018 Results
| Metric | Q4 2018 | Q4 2017 |
|---|---|---|
| Revenue | $68.8 million | $57.7 million |
| Gross profit | $49.5 million | $43.4 million |
| Loss from operations | $(10.8) million | $(13.4) million |
| Net loss | $(13.0) million | $(13.0) million |
Material Changes Versus the Prior Comparable Period
- Rapid7 adopted ASC 606 on January 1, 2018 using the modified retrospective method. Prior periods were not recast, limiting direct comparability.
- ASC 606 reduced 2018 reported revenue by approximately $11.8 million versus the pro forma ASC 605 presentation, while reducing sales and marketing expense by approximately $12.9 million through capitalization of qualifying contract acquisition costs.
- Deferred contract acquisition and fulfillment costs increased to $40.0 million at year-end, including $22.8 million of 2018 capitalization.
- The company issued $230.0 million principal amount of 1.25% convertible senior notes due 2023, receiving $223.1 million of net proceeds. It used $26.9 million to purchase capped calls intended to offset potential dilution.
- Rapid7 completed a January 2018 offering that generated $30.9 million of net proceeds from the issuance of 1.5 million primary shares.
- The company acquired tCell.io, Inc. in October 2018 for $15.4 million in cash, adding application threat defense and monitoring technology.
- Gross margin declined primarily because cloud subscriptions and managed services generally carry lower margins than licensed software, and because of higher cloud-computing costs.
- Operating losses remained substantial, but non-GAAP operating loss and adjusted EBITDA improved due in part to revenue growth and operating leverage.
Cash Flow, Debt, Liquidity, and Commitments
- Operating activities generated $6.1 million of cash, compared with $13.3 million in 2017. Deferred revenue contributed $22.9 million, while deferred contract acquisition and fulfillment costs used $12.8 million.
- Investing activities used $193.7 million, primarily reflecting $233.4 million of investment purchases, $14.5 million for the tCell acquisition, and $12.8 million of capital expenditures.
- Financing activities generated $236.2 million, primarily from the convertible notes and common-stock offering.
- The convertible notes had a $174.7 million net carrying value at year-end and a $233.0 million estimated fair value. Principal of $230.0 million is due in 2023, with scheduled contractual interest of $14.3 million through maturity.
- Total contractual obligations were $444.8 million, including $108.3 million of operating lease commitments and $92.2 million of non-cancellable purchase obligations.
- Management stated that cash, investments, and expected operating cash flow should satisfy working-capital and capital-expenditure requirements for at least the next 12 months.
Outlook, Commentary, Risks, and Unusual Items
The filing does not provide a specific quantitative 2019 revenue or earnings outlook. Management expects continued investment in research and development, sales and marketing, international expansion, infrastructure, customer success, and potential strategic acquisitions. The company expects to remain loss-making for the foreseeable future.
- Key growth initiatives include expanding the customer base, upselling and cross-selling, improving renewals, expanding channel partnerships, international growth, product development, and strategic M&A.
- Material risks include intense competition, dependence on vulnerability-management products, renewal and customer-expansion risk, cloud-service outages, cybersecurity breaches, product defects or false positives, reliance on third-party infrastructure and software, and difficulty scaling operations.
- Regulatory risks include GDPR and other privacy rules, export controls affecting cybersecurity products and encryption technology, changing compliance requirements, and potential tax or transfer-pricing disputes.
- Finjan, Inc. filed a patent-infringement complaint in October 2018 alleging infringement of seven patents and seeking unspecified damages, legal fees, and injunctive relief. The outcome was uncertain at filing.
- A Massachusetts wage-and-hour class action was settled in the fourth quarter of 2018 for $0.6 million.
- The company entered into a new Boston headquarters lease expected to commence June 1, 2019 and expire in November 2029.
- ASC 842 lease accounting was expected to materially increase reported assets and liabilities beginning in the first quarter of 2019.
- On February 24, 2019, after year-end, Corey Thomas was appointed board chair, Benjamin Nye became lead independent director, and Andrew Burton was promoted to president and chief operating officer.
Investor Verification Checklist
- Reconcile 2018 revenue and margins under ASC 606 with the pro forma ASC 605 figures before assessing organic growth.
- Evaluate whether ARR growth and the 120% renewal rate are supported by sustainable customer expansion, renewals, upsells, and cross-sells.
- Assess the effect of cloud-computing costs and the increasing subscription mix on future gross margins and cash flow.
- Review liquidity relative to the $230.0 million convertible-note maturity, lease commitments, purchase obligations, and ongoing operating losses.
- Monitor potential dilution from the convertible notes, including the $41.59 conversion price and approximately 5.5 million underlying shares.
- Track the Finjan patent litigation, the tCell integration, and any related acquisition or impairment charges.
- Verify the impact of ASC 842 adoption on the balance sheet and covenant or liquidity analysis.
- Consider the recurring $27.6 million stock-based compensation expense when comparing GAAP and non-GAAP profitability.