Rapid7, Inc. — Form 10-Q Summary
Business context and reporting period
Rapid7 provides cybersecurity data and analytics solutions, including threat exposure management, incident detection and response, and security advisory services. The filing covers the three and nine months ended September 30, 2015. Rapid7 had 4,423 customers in more than 90 countries, including 35% of the Fortune 1000, and operated as one reportable segment.
Financial results and key metrics
| Metric | Q3 2015 | Q3 2014 | 9M 2015 | 9M 2014 |
|---|---|---|---|---|
| Revenue | $28.3 million | $20.3 million | $77.7 million | $54.9 million |
| Revenue growth | 39.3% | 31.6% | 41.4% | 25.9% |
| Gross profit | $21.2 million | $15.7 million | $57.4 million | $42.2 million |
| GAAP gross margin | 75.1% | 77.1% | 73.9% | 76.8% |
| Loss from operations | $(10.5) million | $(5.9) million | $(25.7) million | $(21.1) million |
| GAAP net loss | $(11.8) million | $(7.0) million | $(28.8) million | $(23.6) million |
| Net loss attributable to common stockholders | $(26.0) million | $5.5 million | $(78.0) million | $(38.8) million |
| Operating cash flow | $2.3 million | $(0.9) million | $(2.0) million | $(5.4) million |
- Q3 revenue included $16.2 million from products, $7.0 million from maintenance and support, and $5.1 million from professional services. Nine-month revenue was $44.5 million, $19.1 million, and $14.1 million, respectively.
- Recurring revenue represented 62% of total revenue in both Q3 and the first nine months of 2015. Deferred revenue was $110.2 million at September 30, 2015, compared with $72.3 million at September 30, 2014.
- Q3 operating margin was approximately negative 37.0%; nine-month operating margin was approximately negative 33.1%. Q3 net margin was approximately negative 41.8% on a GAAP basis.
- Non-GAAP operating loss was $7.8 million in Q3 and $20.6 million for the first nine months. Non-GAAP net loss was $9.1 million in Q3 and $23.7 million for the first nine months.
- Cash was $124.0 million at September 30, 2015, compared with $36.8 million at December 31, 2014. Management stated that existing cash and expected operating cash generation should fund working-capital and expenditure requirements for at least the next 12 months.
- Rapid7 had no term loan outstanding at September 30, 2015. It repaid $18.0 million of principal and related fees and interest totaling $18.7 million in July 2015, and terminated its unused line of credit in August.
- Stockholders’ equity was $52.5 million at September 30, 2015, versus a deficit of $246.9 million at December 31, 2014, primarily reflecting the IPO and conversion of all preferred stock.
Material changes versus the prior comparable period
- Revenue increased 39.3% in Q3 and 41.4% for the first nine months. Q3 growth was driven primarily by $7.0 million of additional revenue recognized from beginning deferred revenue, with additional contributions from existing and new customers.
- Professional services was the fastest-growing revenue category, increasing 75.4% in Q3 and 94.2% year to date, principally from higher demand for security advisory services.
- Gross margin declined because of revenue mix, particularly the larger contribution from lower-margin professional services. Professional-services gross margin was 20.0% in Q3 versus 15.8% in the prior-year quarter.
- Operating expenses increased 46.8% in Q3 and 31.3% year to date. Research and development, sales and marketing, and general and administrative expenses rose as Rapid7 expanded headcount and invested in growth, product development, international operations, and public-company infrastructure.
- Customer count increased from 3,354 at September 30, 2014 to 4,423 at September 30, 2015. The Q3 renewal rate improved to 122% from 109%; the expiring renewal rate improved to 88% from 85%.
- Operating cash flow improved year over year but remained negative for the first nine months. The improvement was supported by a $25.1 million increase in deferred revenue, partly offset by a $6.7 million increase in accounts receivable.
- On July 22, 2015, Rapid7 completed its IPO and concurrent private placement, generating aggregate net proceeds of approximately $112.3 million. All outstanding preferred stock converted into common stock, and the company recorded a $14.2 million beneficial conversion charge related to the IPO participation payment.
Outlook, commentary, risks, contingencies, and unusual items
- The filing does not provide quantitative quarterly or annual revenue, margin, earnings, or cash-flow guidance. Management expects absolute research and development, sales and marketing, and general and administrative expenses to increase in the near term, while expecting those expenses to decline as percentages of revenue over time.
- Rapid7 expects gross margins to fluctuate based on product and services mix, pricing, transaction volume, and revenue composition. The company expects to continue generating losses for the foreseeable future and maintained a full valuation allowance against U.S. deferred tax assets.
- On October 13, 2015, after quarter end, Rapid7 acquired Logentries for approximately $68.0 million. Consideration included $36.2 million of cash, 1,252,657 common shares, assumed options, and 942,388 restricted shares granted to retained employees. The acquisition is expected to expand cloud-based log management and search capabilities.
- Rapid7 acquired NT OBJECTives in April 2015 for approximately $6.1 million, recording $4.6 million of goodwill and $2.1 million of identifiable intangible assets. The company also entered into a 42-month lease amendment for approximately 20,000 additional square feet, with $3.4 million of base-rent obligations.
- Unusual Q3 items included a $14.2 million beneficial conversion charge, $0.5 million of impaired capitalized product-development costs, $0.6 million of Logentries acquisition-related expenses, and $0.8 million of interest expense from writing off unamortized debt discount upon term-loan termination.
- Material risks include continued operating losses, dependence on sustained revenue growth and customer renewals, intense cybersecurity competition, product defects or failure to detect vulnerabilities, cyberattacks, reliance on third-party hosting and software providers, international and foreign-exchange exposure, and integration risks from acquisitions.
- Rapid7 disclosed an ongoing patent lawsuit brought by a non-practicing entity. Management did not expect currently known claims to have a material adverse effect, but adverse intellectual-property outcomes could result in damages, licensing costs, redesigns, or restrictions on product use.
- The company’s voluntary disclosure to the U.S. Bureau of Industry and Security regarding certain unauthorized exports remained under review and could result in monetary or other penalties. OFAC issued a Cautionary Letter and did not pursue a civil monetary penalty regarding related free downloads to embargoed countries.
- Following the October 2015 invalidation of the EU-U.S. Safe Harbor Framework, Rapid7 was reviewing alternative legal mechanisms for European data transfers. Failure to implement an acceptable mechanism could result in increased costs, fines, or transfer restrictions.
Important facts for investors to verify
- Verify the effect of the Logentries acquisition on post-quarter cash, share count, goodwill, intangible assets, operating expenses, and future revenue.
- Assess whether revenue growth and renewal rates can be sustained as growth increasingly depends on deferred-revenue recognition and expanded professional services.
- Monitor the path toward profitability and positive operating cash flow, including the effect of continued hiring, stock-based compensation, acquisition spending, and public-company costs.
- Review the composition and aging of deferred revenue and accounts receivable, as well as the company’s ability to convert deferred revenue into cash and recognized revenue.
- Evaluate potential exposure from the BIS export matter, EU data-transfer compliance, intellectual-property litigation, indemnification obligations, and other regulatory claims.
- Consider dilution from outstanding options, restricted shares, Logentries consideration, acquisition-related awards, and potential future equity financing.