Rapid7, Inc. — Form 10-Q Summary
Business context and reporting period
Rapid7 provides security operations, vulnerability management, incident detection and response, IT analytics and automation, managed services, and professional services. The filing covers the quarter and nine months ended September 30, 2018. Rapid7 reported approximately 7,400 customers in 127 countries, including 52% of the Fortune 100, with no individual customer representing more than 2% of revenue.
Rapid7 adopted ASC 606, Revenue from Contracts with Customers, on January 1, 2018 using the modified retrospective method. Accordingly, 2018 revenue and expense results are not directly comparable with 2017 results reported under ASC 605.
Key financial metrics
| Metric | Q3 2018 | Q3 2017 | 9M 2018 | 9M 2017 |
|---|---|---|---|---|
| Revenue | $62.4 million | $50.5 million | $175.3 million | $143.2 million |
| Revenue growth | 23.4% | 25.2% | 22.4% | 27.4% |
| Gross profit | $44.6 million | $36.2 million | $123.5 million | $103.5 million |
| Gross margin | 71.4% | 71.6% | 70.5% | 72.3% |
| Operating loss | $(11.3) million | $(13.0) million | $(42.2) million | $(35.4) million |
| Net loss | $(11.8) million | $(10.3) million | $(42.5) million | $(32.5) million |
| Net loss per share | $(0.25) | $(0.24) | $(0.92) | $(0.76) |
| Operating cash flow | $(4.1) million | $5.7 million | $(5.9) million | $5.1 million |
| Adjusted EBITDA | $(1.1) million | $(5.6) million | $(12.8) million | $(15.2) million |
Q3 revenue consisted of products of $43.8 million, maintenance and support of $10.6 million, and professional services of $7.9 million. Subscription revenue was $35.9 million for the quarter and $96.0 million for the nine-month period. Annualized recurring revenue was $217.4 million as of September 30, 2018, up 46.2% year over year, and the customer count was 7,399, up from 6,735.
Recurring revenue represented 82% of Q3 revenue and 79% of nine-month revenue under ASC 606. The renewal rate was 120% for Q3, compared with 119% in the prior-year quarter; the expiring renewal rate was 90%, compared with 89%.
Liquidity, cash flow and debt
- Cash and cash equivalents were $131.2 million at September 30, 2018, compared with $51.6 million at December 31, 2017.
- Short- and long-term investments totaled $179.9 million, producing cash, cash equivalents and investments of approximately $311.1 million.
- Rapid7 issued $230.0 million of 1.25% convertible senior notes due August 1, 2023, receiving net proceeds of approximately $223.1 million. The notes had a net carrying amount of $172.2 million at quarter-end and a quoted fair value of $255.3 million.
- The notes have an initial conversion price of approximately $41.59 per share and are potentially convertible into approximately 5.5 million shares. Capped calls costing $26.9 million cover approximately 5.5 million shares and are intended to offset potential dilution, subject to a cap price of $63.98 per share.
- Rapid7 completed a January 2018 public offering of 1.5 million newly issued shares for net proceeds of $30.9 million.
- Operating activities used $5.9 million during the first nine months, while investing activities used $150.3 million, primarily for investment purchases, capital expenditures and internal-use software. Financing activities provided $236.0 million, primarily from the convertible notes and equity offering.
- Management stated that existing cash, investments and expected operating cash flows should be sufficient to meet working-capital and expenditure requirements for at least the next 12 months.
Material changes versus the prior comparable period
- Q3 revenue increased 23.4%, driven primarily by products revenue, which increased 47.9%. Maintenance and support declined 8.9% and professional services declined 14.3%.
- Nine-month revenue increased 22.4%, but growth was slower than the 27.4% reported in the prior-year period.
- Gross margin declined by 20 basis points in Q3 and 180 basis points for the nine-month period. Management cited greater mix of cloud subscriptions and managed services, which carry lower margins than licensed software, as well as ASC 606 effects.
- Operating loss improved in Q3 despite higher operating expenses, but the nine-month operating loss widened because research and development, sales and marketing, and general and administrative expenses grew faster than gross profit.
- Stock-based compensation increased to $7.4 million in Q3 and $21.0 million for the nine-month period, compared with $5.3 million and $14.7 million, respectively, in the prior-year periods.
- Interest expense increased substantially following the convertible note issuance, including $1.2 million of debt-discount amortization and $0.1 million of issuance-cost amortization during Q3 and the nine-month period.
- ASC 606 reduced reported 2018 revenue by approximately $3.1 million in Q3 and $10.0 million for the nine-month period compared with pro forma presentation under ASC 605. It also resulted in capitalization of contract acquisition and fulfillment costs; the balance was $33.6 million at September 30.
Outlook, commentary, risks and unusual items
Management expects continued investment in research and development, sales and marketing, international expansion, infrastructure and professional services. It expects operating expenses to increase in absolute dollars, while sales and marketing and general and administrative expenses are expected to decline as a percentage of revenue over time. The filing does not provide a clear numerical quarterly or annual revenue, earnings, or cash-flow guidance figure.
- Rapid7 announced the upcoming availability of InsightConnect and additional automation functionality in InsightVM and InsightIDR. Global rollout began in October 2018 and was expected to continue through early 2019.
- On October 15, 2018, Rapid7 acquired tCell.io for $14.4 million in cash and issued 112,924 restricted stock units to certain retained employees and contractors. The acquisition was not included in the reported quarter-end results.
- Rapid7 settled a Massachusetts wage-and-hour class action, with a $0.6 million accrual at September 30, 2018.
- In October 2018, Finjan filed a patent-infringement complaint involving seven patents and sought unspecified damages, attorneys’ fees and injunctive relief. The filing states that the litigation is in its early stages and that the outcome is uncertain.
- Rapid7 has incurred losses since inception, had an accumulated deficit of $451.6 million, and expects losses to continue for the foreseeable future.
- Key risks include dependence on continued revenue growth and renewals, transition to a subscription model, competitive pressure, cloud-service reliability, cybersecurity incidents, product defects or missed vulnerabilities, privacy and regulatory compliance, international and foreign-exchange exposure, acquisition integration, litigation, and the ability to service or refinance convertible debt.
- Rapid7 expects adoption of the new lease standard in the first quarter of 2019 to materially increase reported assets and liabilities for operating leases.
- Disclosure controls and procedures were assessed as effective at the reasonable-assurance level as of September 30, 2018.
Most important facts for investors to verify
- Whether ARR growth and renewal rates remain strong as Rapid7 continues shifting from perpetual licenses toward subscriptions and cloud services.
- Whether revenue growth can offset rising research and development, sales and marketing, infrastructure, stock-based compensation and debt-related costs.
- The sustainability of negative operating cash flow and the expected timing of operating profitability.
- The impact of ASC 606 on reported revenue, deferred revenue, capitalized commissions, future amortization and comparability with historical periods.
- The potential dilution, cash-settlement requirements and liquidity implications of the 2023 convertible notes, including the effectiveness and limits of the capped calls.
- The integration, financial contribution and potential additional costs of the tCell acquisition.
- The outcome and potential exposure from the Finjan patent litigation and other legal or regulatory matters.
- Whether gross margins stabilize or decline further as subscription and managed-service revenue becomes a larger portion of the business.