Rapid7, Inc. 2020 Q3 Form 10-Q Summary
Business context and reporting period
Rapid7 provides cybersecurity products and professional services through its Insight Platform, covering vulnerability risk management, incident detection and response, application security, cloud security, and security orchestration and automation. The filing covers the three and nine months ended September 30, 2020, compared with the corresponding 2019 periods. Rapid7 reported 9,347 customers in 130 countries as of September 30, 2020, including 48% of the Fortune 100.
Financial performance and liquidity
| Metric | Q3 2020 | Q3 2019 | YTD 2020 | YTD 2019 |
|---|---|---|---|---|
| Total revenue | $105.1 million | $83.2 million | $298.3 million | $235.3 million |
| Year-over-year growth | 26.4% | 33.3% | 26.8% | 34.2% |
| Gross profit | $74.0 million | $59.5 million | $210.5 million | $169.5 million |
| Gross margin | 70.5% | 71.6% | 70.6% | 72.0% |
| Loss from operations | $(17.9) million | $(11.8) million | $(53.5) million | $(33.7) million |
| Net loss | $(25.5) million | $(14.4) million | $(69.9) million | $(39.5) million |
| Net loss per share | $(0.50) | $(0.29) | $(1.38) | $(0.82) |
| Operating cash flow | $11.1 million | $1.8 million | $4.3 million | $(9.2) million |
- Products revenue increased 28.9% in Q3 and 29.6% year to date, while professional services revenue declined 2.4% in Q3 and 3.0% year to date.
- Subscription revenue was $78.7 million in Q3 and $220.1 million year to date. Recurring revenue represented 91% of total revenue in both periods.
- Annualized recurring revenue was $398.7 million, up 28.5% year over year. Customer count increased 8% year over year, while renewal rate declined to 103% from 111% in Q3 2019.
- Non-GAAP income from operations was $2.4 million in Q3 and $2.8 million year to date, compared with $0.5 million and $1.6 million, respectively, in the prior-year periods. Adjusted EBITDA was $5.8 million in Q3 and $12.6 million year to date.
- Cash, cash equivalents and restricted cash totaled $239.7 million at September 30, 2020. Short- and long-term investments totaled $92.0 million, providing approximately $331.7 million of cash and investments before debt.
- Net cash provided by operating activities was $4.3 million year to date. Investing activities used $90.5 million, including $125.8 million for the DivvyCloud acquisition. Financing activities provided $202.3 million, primarily from the issuance of the 2025 convertible notes.
- Convertible senior notes had aggregate principal of $460.0 million and a net carrying amount of $373.3 million. The 2023 Notes had a 1.25% coupon and the 2025 Notes had a 2.25% coupon. No borrowings were outstanding under the $50.0 million revolving credit facility.
- Operating lease liabilities totaled $87.4 million. The company had an accumulated deficit of $588.4 million.
Material changes versus the prior comparable period
- Revenue growth remained strong but decelerated from the prior year, while gross margin declined due primarily to a greater mix of cloud subscriptions and managed services, which have lower margins than licensed software.
- Operating expenses increased 29.0% in Q3 and 29.9% year to date, led by research and development, sales and marketing, and general and administrative investment. Operating loss margins worsened to 17.0% in Q3 from 14.1% and to 17.9% year to date from 14.3%.
- Interest expense increased to $7.3 million in Q3 and $16.7 million year to date, primarily due to the 2025 Notes and related debt discount and issuance-cost amortization.
- Stock-based compensation increased to $17.1 million in Q3 and $46.9 million year to date, compared with $10.4 million and $29.5 million, respectively, in the prior-year periods.
- Rapid7 acquired DivvyCloud on May 1, 2020 for aggregate consideration of $137.8 million, including $130.8 million paid in cash. The acquisition added $115.9 million of goodwill and $21.2 million of identifiable intangible assets. DivvyCloud contributed $3.4 million of revenue and $11.1 million of net loss year to date after acquisition.
- Rapid7 issued $230.0 million principal amount of 2025 convertible senior notes and purchased $27.3 million of related capped calls. The 2023 Notes became conditionally convertible from October 1 through December 31, 2020; no conversion notices had been received through issuance of the financial statements.
- Operating cash flow improved from a $9.2 million use to $4.3 million provided, largely because of higher non-cash charges and improved collections, although deferred revenue declined by $10.5 million year to date.
Guidance, outlook, management commentary, risks and unusual items
- Management slowed hiring and reduced discretionary spending in response to COVID-19, while benefiting from lower travel and virtual-event costs. It expects the pandemic and related economic slowdown to negatively affect performance during 2020 and beyond.
- The filing states that ARR at the end of Q3 was lower than initially anticipated because customers pulled back spending amid economic uncertainty. Professional services revenue also declined as customers delayed or rescheduled services.
- No clear numerical revenue or earnings guidance for the full year is provided in the filing text. Management expects continued losses for the foreseeable future but believes available cash, investments, operating cash flow and revolver capacity will cover working capital and capital requirements for at least the next 12 months.
- Material commitments include additional AWS purchase obligations of $105.0 million for 2021 through 2023 and operating lease payments of $114.3 million before imputed interest.
- Rapid7 is defending a patent-infringement lawsuit brought by Finjan seeking unspecified damages, attorneys’ fees and injunctive relief. The outcome is uncertain; litigation-related expenses were $0.7 million in Q3 and $1.6 million year to date.
- Key risks include COVID-19-related reductions in customer spending and renewals, slowing ARR growth, continued GAAP losses, substantial convertible debt, potential cash settlement or dilution upon note conversion, DivvyCloud integration, cybersecurity and service-outage risks, dependence on AWS and other third parties, data-privacy regulation, foreign-exchange exposure, competition, and intellectual-property litigation.
- The company began using foreign-currency forward contracts as cash-flow hedges during Q3. Outstanding forward contracts had a notional value of $8.9 million and a fair-value liability of $0.1 million.
- Disclosure controls and procedures were deemed effective at the reasonable assurance level as of September 30, 2020, with no reported material change in internal control over financial reporting.
Most important facts for investors to verify
- Whether recurring revenue, ARR growth and renewal rates stabilize or continue to decelerate as COVID-19 and broader economic pressures persist.
- Whether the shift toward cloud subscriptions and managed services produces sustainable growth while allowing gross margins to recover.
- The pace at which Rapid7 converts revenue growth into positive GAAP operating income and consistently positive operating cash flow, excluding substantial stock-based compensation and other non-cash adjustments.
- DivvyCloud’s post-acquisition growth, profitability contribution, integration progress and potential goodwill or intangible-asset impairment exposure.
- The timing and form of any conversion or settlement of the 2023 and 2025 Notes, including liquidity needs, dilution and capped-call effectiveness.
- The status and potential financial exposure of the Finjan litigation and other intellectual-property claims.
- The effect of AWS commitments, lease obligations, customer payment behavior and deferred-revenue trends on future liquidity.