Rapid7, Inc. — Form 10-Q Summary
Business context and reporting period
Rapid7 provides security and IT analytics and automation solutions, including vulnerability management, incident detection and response, SIEM, application security, log analytics, managed services and professional services. The filing covers the three and six months ended June 30, 2018. The company reported more than 7,200 customers in 127 countries and operated as one reportable segment.
Rapid7 adopted ASC 606, Revenue from Contracts with Customers, on January 1, 2018 using the modified retrospective method. Because 2018 results reflect ASC 606 while 2017 results generally reflect ASC 605, reported periods are not directly comparable.
Key financial metrics
| Metric | Three months ended June 30, 2018 | Six months ended June 30, 2018 |
|---|---|---|
| Revenue | $58.4 million | $113.0 million |
| Year-over-year revenue growth | 23.2% | 21.9% |
| Gross profit | $41.0 million | $79.0 million |
| Gross margin | 70.2% | 69.9% |
| Loss from operations | $(14.3) million | $(30.9) million |
| Net loss | $(14.3) million | $(30.7) million |
| Net loss per diluted share | $(0.31) | $(0.67) |
| Operating cash flow | $(9.1) million | $(1.8) million |
| Adjusted EBITDA | $(4.2) million | $(11.7) million |
Products revenue increased 43.7% year over year to $39.0 million in the second quarter and 39.9% to $74.3 million for the first six months. Maintenance and support revenue declined 6.4% in the quarter and 3.5% year to date, while professional services revenue declined 1.7% and 1.0%, respectively.
Recurring revenue represented 79% of second-quarter revenue and 78% of year-to-date revenue under ASC 606, compared with 70% and 69% in the comparable 2017 periods. Annualized recurring revenue was $198.6 million at June 30, 2018, up 44.3% year over year. The renewal rate was 122%, and the expiring renewal rate was 89%, for the quarter.
At June 30, 2018, cash and cash equivalents were $100.7 million, and short- and long-term investments were $17.9 million. Total cash, cash equivalents and restricted cash were $101.2 million. Total liabilities were $254.2 million, primarily consisting of $224.4 million of current and non-current deferred revenue. The filing does not disclose outstanding interest-bearing debt. Stockholders' equity was $69.5 million, and accumulated deficit was $439.7 million.
Material changes versus the prior comparable period
- Second-quarter revenue increased $11.0 million, or 23.2%, and six-month revenue increased $20.3 million, or 21.9%.
- Growth was driven primarily by existing customers and higher product and subscription activity. Management attributed $13.3 million of quarterly growth and $23.6 million of year-to-date growth to existing customers.
- ASC 606 reduced reported revenue by approximately $3.1 million in the quarter and $6.8 million year to date compared with the prior accounting model. ASC 606 also reduced sales and marketing expense through capitalization of qualifying commissions.
- Gross margin declined from 72.4% to 70.2% in the quarter and from 72.7% to 69.9% year to date, primarily because of a greater mix of cloud subscriptions and managed services, lower reported revenue under ASC 606, higher cloud costs and increased amortization.
- Research and development expense rose 35.5% in the quarter and 41.0% year to date, reflecting increased headcount and investment in products and infrastructure.
- Sales and marketing expense increased 14.8% in the quarter and 15.9% year to date, although it declined as a percentage of revenue from 57.2% to 53.3% in the quarter and from 56.0% to 53.3% year to date.
- Net loss widened from $11.6 million to $14.3 million in the quarter and from $22.2 million to $30.7 million year to date. Stock-based compensation increased to $7.4 million in the quarter and $13.6 million year to date.
- Operating cash flow deteriorated to $(9.1) million in the quarter and $(1.8) million year to date, compared with $(4.0) million and $(0.7) million, respectively, in 2017.
- Cash increased substantially due to $30.9 million of net proceeds from a January 2018 public offering, $4.7 million from option exercises and $1.6 million from the employee stock purchase plan.
Accounting, outlook, risks and unusual items
ASC 606 resulted in $31.7 million of deferred contract acquisition and fulfillment costs at June 30, 2018. The company capitalizes qualifying commissions and certain fulfillment costs, generally amortizing them over an estimated five-year benefit period. Adoption increased opening stockholders' equity through the related balance-sheet adjustments but reduced reported current-period revenue relative to the former accounting model.
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. The company expects continued losses for the foreseeable future and may require additional financing to support growth, acquisitions or increased investment.
No quantitative financial guidance is presented in the filing text. Management expects research and development, sales and marketing, and general and administrative expenses to increase in absolute dollars, while sales and marketing and general and administrative expenses are expected to decline as percentages of revenue. Gross margins are expected to fluctuate based on revenue mix, pricing, transaction volume and cloud-computing costs.
The company recorded $0.4 million of litigation-related expense in the first quarter and increased its litigation accrual to $0.6 million for a Massachusetts wage-and-hour class action; the settlement agreement was entered into in July 2018. The filing states that ordinary-course litigation is not currently expected to have a material adverse effect, although outcomes cannot be predicted with certainty.
Key risks include continued operating losses, dependence on revenue growth and renewals, execution of the transition to a subscription-based model, intense competition, cybersecurity and service outages, product defects or false positives, dependence on cloud and other third-party providers, international and foreign-exchange exposure, privacy and data-protection regulation including GDPR, intellectual-property claims, channel-partner dependence and the need for additional capital. The company also expects a material increase in assets and liabilities when it adopts ASC 842 lease accounting in the first quarter of 2019.
Management concluded that disclosure controls and procedures were effective as of June 30, 2018. The filing reports no material changes to internal control over financial reporting.
Investor verification checklist
- Reconcile growth and margin trends under ASC 606 with the ASC 605 pro forma disclosures before comparing 2018 with 2017.
- Assess whether annualized recurring revenue growth, the 122% renewal rate and the 89% expiring renewal rate are sustainable.
- Monitor the effect of cloud subscriptions and managed services on gross margin and cash generation.
- Evaluate the pace of operating expense growth, stock-based compensation and the path toward profitability.
- Review liquidity needs given recurring operating cash outflows, accumulated deficit and the possibility of future equity or debt financing.
- Follow the Massachusetts wage-and-hour settlement and any other litigation or claims.
- Assess the future balance-sheet effect of ASC 842 and the continued capitalization and amortization of contract acquisition costs.