Rapid7, Inc. — Q3 2019 Form 10-Q Summary
Business Context and Reporting Period
Rapid7 provides cybersecurity analytics and automation through its Insight cloud, including vulnerability management, incident detection and response, application security, security orchestration and automation response, managed services, software licenses and professional services. The filing covers the three and nine months ended September 30, 2019, compared with the corresponding 2018 periods. Rapid7 reported 8,625 customers in 143 countries and operated as one reporting segment.
Financial Performance and Key Metrics
| Metric | Q3 2019 | Q3 2018 | 9M 2019 | 9M 2018 |
|---|---|---|---|---|
| Total revenue | $83.2 million | $62.4 million | $235.3 million | $175.3 million |
| Year-over-year revenue growth | 33.3% | 23.4% | 34.2% | 22.4% |
| Gross profit | $59.5 million | $44.6 million | $169.5 million | $123.5 million |
| GAAP gross margin | 71.6% | 71.4% | 72.0% | 70.5% |
| Loss from operations | $(11.8) million | $(11.3) million | $(33.7) million | $(42.2) million |
| GAAP net loss | $(14.4) million | $(11.8) million | $(39.5) million | $(42.5) million |
| GAAP net loss per share | $(0.29) | $(0.25) | $(0.82) | $(0.92) |
| Non-GAAP operating income | $0.5 million | $(2.8) million | $1.6 million | $(17.7) million |
| Adjusted EBITDA | $3.4 million | $(1.1) million | $8.8 million | $(12.8) million |
| Operating cash flow | $1.8 million | $(4.1) million | $(9.2) million | $(5.9) million |
Products revenue increased 53.5% year over year in Q3 and 58.1% for the nine-month period, driven primarily by subscription growth. Maintenance and support revenue declined 13.5% in Q3 and 12.1% year to date as customers transitioned from Nexpose to subscription-based InsightVM. Professional services revenue declined 15.7% in Q3 and 19.0% year to date.
Recurring revenue represented 88% of Q3 revenue and 87% of nine-month revenue, compared with 82% and 79%, respectively, in the prior-year periods. Annualized recurring revenue was $310.2 million at September 30, 2019, up 42.7% year over year. The reported renewal rate was 111%, compared with 118% in Q3 2018. Customer count increased 17% year over year.
Operating expenses were $71.3 million in Q3 and $203.2 million for the first nine months, reflecting continued investment in research and development, sales and marketing, facilities and personnel. Stock-based compensation was $10.4 million in Q3 and $29.5 million year to date, compared with $7.4 million and $21.0 million in the comparable periods.
Liquidity, Debt and Balance Sheet
- Cash and cash equivalents were $114.9 million at September 30, 2019, compared with $99.6 million at December 31, 2018.
- Short- and long-term investments totaled $142.8 million, compared with $204.1 million at year-end 2018.
- Total liquidity from cash, cash equivalents and investments was approximately $257.7 million.
- Rapid7 had $230.0 million principal amount of 1.25% convertible senior notes due 2023; the carrying amount was $182.5 million and quoted fair value was $298.1 million.
- The notes were not convertible as of September 30, 2019 and contain no financial covenants. The related capped calls cover approximately 5.5 million shares and are intended to offset potential dilution, subject to a cap.
- Total operating lease liabilities were $79.7 million, including the new Boston headquarters lease. Additional future lease payments were approximately $35.0 million for an expansion expected to commence in 2021 and $10.1 million for a Belfast facility expected to commence in 2020.
- Management stated that existing cash, investments and expected operating cash flows should be sufficient to meet working capital and capital expenditure requirements for at least the next 12 months, while also noting continuing operating losses and possible future financing needs.
Material Changes Versus the Prior Comparable Period
- Revenue growth accelerated to 33.3% in Q3 and 34.2% year to date, with the mix shifting substantially toward subscription-based products.
- Gross margin improved by 20 basis points in Q3 and 150 basis points year to date, primarily from scaling subscription and managed-service offerings.
- GAAP operating and net losses remained substantial, although non-GAAP operating income and adjusted EBITDA turned positive in both Q3 and the nine-month period.
- Interest expense increased materially because of the convertible notes, reaching $3.4 million in Q3 and $9.9 million year to date, versus $1.7 million and $1.7 million in the prior periods.
- Operating cash flow declined to a $9.2 million use year to date despite lower GAAP net loss, primarily reflecting working-capital changes, including lower deferred revenue and higher prepaid and contract acquisition costs.
- Rapid7 acquired NetFort Technologies Limited on April 1, 2019 for $16.1 million in cash, recording $9.4 million of goodwill and $6.1 million of developed technology intangible assets.
- The company completed its new Boston headquarters in July 2019, contributing to higher property and equipment and lease-related assets and liabilities.
- Rapid7 adopted ASC 842 lease accounting on January 1, 2019, recognizing lease liabilities and right-of-use assets on the balance sheet.
Outlook, Commentary, Risks and Unusual Items
The filing does not provide a clear numerical quarterly or full-year revenue, profitability or cash-flow guidance figure. Management expects continued investment in research and development, sales and marketing, general and administrative functions and international expansion. Management also expects cost of revenue and operating expenses to increase in absolute dollars, with sales and marketing expected to decline as a percentage of revenue over time.
- Rapid7 expects to remain unprofitable for the foreseeable future and has an accumulated deficit of $504.1 million.
- The business is exposed to renewal-rate fluctuations, customer adoption and expansion, sales-cycle timing, competition, pricing pressure and the uncertain development of the SecOps market.
- Cybersecurity product failures, false positives, service outages, data breaches or misuse of Metasploit could damage reputation, result in liability and reduce renewals or sales.
- Privacy, data-security, export-control and cybersecurity regulations, including GDPR and the then-upcoming California Consumer Privacy Act, could increase compliance costs or restrict operations.
- Rapid7 faces foreign-exchange exposure and has not used hedging strategies; Q3 and year-to-date results included foreign-currency losses.
- Finjan, Inc. has alleged infringement of seven patents in litigation pending in Delaware. The company intends to contest the claims, but the outcome and potential liability are uncertain.
- Significant recurring non-GAAP adjustments include stock-based compensation, amortization of acquired intangibles, convertible-note discount amortization, acquisition-related costs and litigation expenses. Stock-based compensation and debt discount amortization are recurring or economically meaningful and should not be ignored when assessing profitability.
Most Important Facts for Investors to Verify
- Whether subscription growth, ARR growth and customer expansion can offset declines in maintenance and support and professional services.
- Whether the 111% renewal rate stabilizes or declines further from the prior-year 118% level.
- Whether gross-margin improvement continues as cloud infrastructure, personnel and facility costs rise.
- Whether Rapid7 can convert non-GAAP profitability into sustained positive GAAP earnings and operating cash flow.
- The cash requirements and potential dilution associated with the $230.0 million convertible notes, including conversion, repurchase and capped-call terms.
- The final purchase-price allocation and integration performance of NetFort, including the carrying value of goodwill and acquired technology.
- The potential financial and operational impact of the Finjan patent litigation and other intellectual-property claims.
- The cost and utilization implications of the Boston headquarters, Belfast facility and planned Boston expansion leases.