Form 10-K
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-K

 

 

(Mark One)

 

x

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2015

OR

 

¨

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE TRANSITION PERIOD FROM                      TO                     

Commission File Number 001-37496

 

 

RAPID7, INC.

(Exact name of registrant as specified in its Charter)

 

 

 

Delaware   35-2423994

( State or other jurisdiction of

incorporation or organization)

  (I.R.S. Employer
Identification No.)

100 Summer Street

Boston, MA

  02110
(Address of principal executive offices)   (Zip Code)

Registrant’s telephone number, including area code: (617) 247-1717

 

 

Securities registered pursuant to Section 12(b) of the Act: Common Stock, Par Value $0.01 Per Share; Common Stock traded on the NASDAQ Global Market

Securities registered pursuant to Section 12(g) of the Act: None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. YES ¨ NO x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act. YES ¨ NO x

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES x NO ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). YES x NO ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definition of “large accelerated filer”, “accelerated filer”, and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer

 

¨

  

Accelerated filer

 

¨

Non-accelerated filer

 

x  (Do not check if a small reporting company)

  

Small reporting company

 

¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). YES ¨ NO x

As of June 30, 2015, the last business day of the registrant’s most recently completed second quarter, there was no established public market for the registrant’s common stock. The registrant’s common stock began trading on The NASDAQ Global Market on July 17, 2015. The number of shares of registrant’s Common Stock outstanding as of March 1, 2016 was 41,608,564.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the registrant’s definitive Proxy Statement for its 2016 Annual Meeting of Stockholders to be filed with the Securities and Exchange Commission pursuant to Regulation 14A not later than 120 days after the end of the fiscal year covered by this Annual Report on Form 10-K are incorporated by reference in Part III, Items 10-14 of this Annual Report on Form 10-K.

 

 

 


Table of Contents

Table of Contents

 

                Page        

PART I

     

Item 1.

   Business      2   

Item 1A.

   Risk Factors      22   

Item 1B.

   Unresolved Staff Comments      48   

Item 2.

   Properties      48   

Item 3.

   Legal Proceedings      48   

Item 4.

   Mine Safety Disclosures      48   

PART II

     

Item 5.

   Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities      49   

Item 6.

   Selected Financial Data      51   

Item 7.

   Management’s Discussion and Analysis of Financial Condition and Results of Operations      54   

Item 7A.

   Quantitative and Qualitative Disclosures About Market Risk      79   

Item 8.

   Financial Statements and Supplementary Data      80   

Item 9.

   Changes in and Disagreements With Accountants on Accounting and Financial Disclosure      110   

Item 9A.

   Controls and Procedures      110   

Item 9B.

   Other Information      111   

PART III

     

Item 10.

   Directors, Executive Officers and Corporate Governance      112   

Item 11.

   Executive Compensation      112   

Item 12.

   Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters      112   

Item 13.

   Certain Relationships and Related Transactions, and Director Independence      112   

Item 14.

   Principal Accounting Fees and Services      112   

PART IV

     

Item 15.

   Exhibits, Financial Statement Schedules      113   

 

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PART I

Forward-Looking Statements

This Annual Report on Form 10-K, including the sections entitled “Business,” “Risk Factors,” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” contains forward-looking statements that involve risks and uncertainties, as well as assumptions that, if they never materialize or prove incorrect, could cause our results to differ materially from those expressed or implied by such forward-looking statements. Statements that are not purely historical are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Forward-looking statements are often identified by the use of words such as, but not limited to, “anticipate,” “believe,” “can,” “continue,” “could,” “estimate,” “expect,” “intend,” “may,” “plan,” “project,” “seek,” “should,” “target,” “will,” “would” and similar expressions or variations intended to identify forward-looking statements. These forward-looking statements include, but are not limited to, statements concerning the following:

• our ability to continue to add new customers, maintain existing customers and sell new products and professional services to new and existing customers;

• the effects of increased competition as well as innovations by new and existing competitors in our market;

• our ability to adapt to technological change and effectively enhance, innovate and scale our solutions;

• our ability to effectively manage or sustain our growth and to attain and sustain profitability;

• our ability to diversify our sources of revenue;

• potential acquisitions and integration of complementary business and technologies;

• our expected use of proceeds;

• our ability to maintain, or strengthen awareness of, our brand;

• perceived or actual security, integrity, reliability, quality or compatibility problems with our solutions, including related to security breaches in our customers; systems, unscheduled downtime or outages;

• statements regarding future revenue, hiring plans, expenses, capital expenditures, capital requirements and stock performance;

• our ability to attract and retain qualified employees and key personnel and further expand our overall headcount;

• our ability to grow, both domestically and internationally;

• our ability to stay abreast of new or modified laws and regulations that currently apply or become applicable to our business both in the United States and internationally including laws and regulations related to export compliance;

• our ability to maintain, protect and enhance our intellectual property;

• costs associated with defending intellectual property infringement and other claims; and

• the future trading prices of our common stock and the impact of securities analysts’ reports on these prices.

These statements represent the beliefs and assumptions of our management based on information currently available to us. Such forward-looking statements are subject to risks, uncertainties and other important factors that could cause actual results and the timing of certain events to differ materially from future results expressed or implied by such forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those identified below, and those discussed in the section titled “Risk Factors”

 

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included under Part I, Item 1A. Furthermore, such forward-looking statements speak only as of the date of this report. Except as required by law, we undertake no obligation to update any forward-looking statements to reflect events or circumstances that occur after the date of this report.

Item 1. Business.

Overview

Rapid7 is a leading provider of security data and analytics solutions that enable organizations to implement an active, analytics-driven approach to cyber security. Our security data and analytics platform was purpose built for today’s increasingly complex and chaotic IT environment. We combine our extensive experience in security data and analytics and deep insight into attacker behaviors and techniques to make sense of the wealth of data available to organizations about their IT environments and users. There has been an explosion of increasingly sophisticated cyber attacks as the proliferation of mobile devices, cloud-based applications and solutions relying on user credentials has eliminated the boundaries that previously defined an organization’s network perimeter and expanded the threat surface that organizations must now defend. Our powerful and proprietary analytics enable organizations to contextualize and prioritize the threats facing their physical, virtual and cloud assets, including those posed by the behaviors of their users. Leveraging our security data and analytics platform, our solutions enable organizations to strategically and dynamically manage their cyber security exposure. Our solutions empower organizations to prevent and contain attacks by providing visibility into vulnerabilities and to rapidly detect compromises, respond to breaches and correct the underlying causes of attacks. This balanced and analytics-focused approach ultimately better secures organizations’ environments and reduces the likelihood of, and risks associated with, cyber attacks. We believe our technology and solutions revolutionize the practice of cyber security and are central and critical to implementing a modern security program.

With our security data and analytics platform, which we refer to as the Rapid7 Insight Platform, at our core, we are pioneering active, analytics-driven solutions to cyber security that enable organizations to find and eliminate critical weaknesses and detect attacks in their IT environments. Our threat exposure management offerings include our industry-leading vulnerability management, web application security testing and attack simulation products, which we enhance with deep security analytics capabilities to quickly deliver contextual risk prioritization, critical threat awareness and impactful remediation guidance. Similarly, we added analytics and automation to traditional manual penetration testing to be able to deliver robust ongoing attack simulation solutions that provide organizations with visibility into real world threats. By providing and combining analytics and actionable insights related to both an organization’s attack surface and the dynamic threat landscape, our security data and analytics platform enables organizations to manage their threat exposure above and beyond traditional vulnerability management products on the market.

Further leveraging our data collection, analytics and attacker knowledge, we introduced our incident detection and response solutions to provide organizations with the ability to rapidly detect and respond to cyber security incidents and breaches. We believe that the traditional approach to detecting and responding to incidents using Security Information and Event Management, or SIEM, Intrusion Detection System, or IDS, and Intrusion Prevention System, or IPS, technologies, among others, is not entirely effective. These technologies can burden an organization with unmanageable volumes of alerts as well as false positives. Our solutions use a variety of analytics to help identify cyber threats to an organization and provide IT security teams with the ability to easily build incident timelines for faster investigations and more efficient resolution, as well as enabling search across the organization’s data from our Insight Platform. Proprietary behavioral and pattern-recognition analytics are central to this capability, which functions in part by automatically mapping an organization’s assets and users relative to the threat landscape, such that aberrant and risky user-specific and asset-specific behaviors are rapidly identified, escalated for investigation and prioritized by threat level. To complement our incident detection product, we offer a range of services. These include our recently introduced analytic response service, which provides our customers with a managed service for threat detection and response, and our incident response professional services through which we provide critical access to our security experts and experience to

 

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organizations that have identified a serious security incident, enabling them to accelerate incident response and containment. We also offer security advisory services that help organizations develop a holistic approach to their cyber security programs, test their incident response preparedness and advance their cyber security program maturity. All of our products are designed with an intuitive user interface, focused on ease-of-use and fast time-to-value for our customers.

The Rapid7 Security Data and Analytics Evolution

 

LOGO

Cyber security has become a strategic imperative for organizations globally, driven by increased focus by boards of directors and senior management in the wake of numerous high profile breaches and data thefts. Organizations are increasingly at risk of being compromised, with organizations reporting a 38% increase in security incidents detected and a 56% increase in the theft of “hard” intellectual property in 2015 over the prior year, according to a report by PricewaterhouseCoopers LLP, or PWC. There are three converging macro drivers that are changing the cyber security landscape for organizations and driving the increase in cyber breaches. First, mobile and connected devices, cloud-based applications and more open and interconnected networks have increased IT complexity, expanding the exploitable attack surface across an organization and resulting in more sources of potential vulnerability. Second, there has been a dramatic change in the tools available to cyber attackers. Attackers can now purchase, at very low cost, highly effective and easy-to-use software that is designed to circumvent traditional prevention-based tools, thereby lowering the bar for nearly anyone to launch advanced cyber attacks. Third, the economic motives for attackers are more compelling, with new, vibrant markets providing attackers an efficient and effective way to monetize stolen customer information and employee data.

The confluence of these factors has rendered the old model of “block and protect” prevention-based cyber security programs ineffective. These traditional “block and protect” approaches to cyber security typically rely disproportionately on network perimeter protection tools such as firewalls and antivirus software to stop attackers. However, as the network perimeter rapidly disappears, the effectiveness of these legacy solutions diminishes greatly. In addition, prevention-centric models are often passive and implemented with a “deploy and forget” mentality, lacking a holistic cyber security strategy. While these approaches can alert IT security professionals to potentially suspicious activity, the data generated is often raw and in “machine form,” making it difficult for an organization to develop actionable insights that reflect a real-time understanding of the organization’s assets, user behavior and the dynamic threat landscape that it faces. Developing these insights has historically been complex and resource intensive, requiring security expertise, data scientists and analytical modeling skills, which many organizations lack. Further, preventative solutions are generally not able to identify or deter attacks that involve modern attack techniques such as the use of stolen or weak credentials, which have been the primary cyber threat action by attackers for five years in a row, according to the 2015 Verizon Data Breach Investigations Report. Organizations have also historically struggled to identify attacks in their early

 

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stages, with nearly 33% of attacks taking more than a month and up to a year to discover, according to the 2015 Verizon Data Breach Investigations Report. The decreasing effectiveness of a traditional prevention-focused approach to cyber security is causing a significant shift to a new model that uses an active, analytics-driven approach to reduce and manage risks to the organization. This new model disrupts the historical focus on “block and protect” solutions and balances organizations’ investments in prevention, detection and correction to reduce the likelihood of, and risks associated with, cyber attacks. Effective implementation of this new model demands data and analytics to assess the effectiveness of tools and programs, identify attacker behaviors and prioritize and remediate exposures. Rapid7 empowers organizations to better secure their dynamic IT environments by providing the security data and analytics that are at the core of a holistic and active, analytics-driven approach to cyber security. Given the shift to the new cyber security model and the needs of organizations to address their security issues, we estimate that the market opportunity for security data and analytics is $14.4 billion in 2016.

As of December 31, 2015, we had more than 5,100 customers, including 37% of the organizations in the Fortune 1000. We have experienced strong revenue growth with revenue increasing from $31.0 million in 2011 to $110.5 million in 2015, representing a 37% compound annual growth rate. We have strong visibility to our revenue as 53% of the revenue recognized in 2015 was recorded on our balance sheet as deferred revenue as of December 31, 2014 and 82% of the revenue recognized in the fourth quarter of 2015 was recorded on our balance sheet as deferred revenue as of September 30, 2015. We incurred a net loss of $49.9 million in 2015 as we continued what we believe is a disciplined path of investing for growth given our large market opportunity.

Recent Developments

On October 13, 2015, we acquired RevelOps, Inc. (d/b/a Logentries), a provider of machine data search technology. With the addition of Logentries’ cloud-based log management and search capabilities, we enable information security teams to solve a broader range of security challenges, investigate incidents and more efficiently achieve their compliance requirements. We acquired Logentries for a total consideration of $67.9 million.

In February 2016, we announced InsightIDR, our new Insight Platform offering that integrates our recently acquired Logentries machine data search technology, enabling organizations to go from compromise to containment quickly and also meet their operational compliance needs. InsightIDR is a cloud-based offering that seeks to provide comprehensive incident detection and response and will be available in the first quarter of 2016. Our InsightIDR offering combines behavior analytics and search with contextual data collection to help detect some of the stealthiest attacks. InsightIDR directly addresses the gaps found in many of today’s detection technologies, including SIEMs and IPSs and is powered by our Insight Platform, which simplifies and combines data collection, analytics, and search technology. The combination of these technologies can enable not only effective detection but also efficient investigation, so that organizations can rapidly go from compromise to containment. InsightIDR puts the organization’s data at the IT security analyst’s fingertips so an organization can improve investigation times often at lower costs than with traditional solutions on the market.

 

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Industry Background

Industry Overview

Cyber security is a critical focus area for executives, boards of directors and IT security professionals at organizations globally. Security breaches are becoming more common, higher profile and have increasingly negative consequences for organizations. In response, organizations are enlarging cyber security budgets in order to thwart potential attacks and minimize the risks associated with those attacks. IT security professionals face a rapidly evolving and dynamic threat landscape and an increasingly fragmented mosaic of security technology vendors offering point solutions to prevent specific threats and protect against specific attack vectors. Forced to make choices and allocate cyber security budgets with limited information, IT security professionals are often left feeling overwhelmed. At the same time, threats continue to escalate due to three converging macro drivers that are changing the practice of cyber security:

Increasingly Complex IT Environment is Expanding Organizations’ Attack Surfaces

The transformation of the IT environment is being driven by the proliferation of mobile and other connected devices, cloud-based applications and the increasing empowerment of business users. IT departments are required to deliver more applications faster, often in the cloud, in order to meet growing user demands for innovation and productivity tools. As a result, it has become increasingly difficult for IT departments to secure the increasing number of systems against the growing number of known security vulnerabilities. For example, in 2014, many organizations were affected by the exploitation of widespread vulnerabilities such as “Heartbleed” and “Shellshock,” with many IT departments unprepared and under-resourced as they attempted to understand the impact of these vulnerabilities and then quickly operationalize a remediation effort to minimize the risks and exposures to their organizations.

Increasing user empowerment has also led to an increase in the number of applications and devices and the amount of data that individual users can access with their credentials, which further expands the attack surface of an organization exposed to potential cyber criminals. According to the 2015 Verizon Data Breach Investigations Report, compromised credentials have been the number one cyber threat action by attackers for five years in a row. Users can be the subject of targeted phishing attacks, where an attacker masquerades as a trustworthy entity in an electronic communication in order to gain control of a user’s device and/or credentials. These credentials can then be used to access the enterprise and its network more broadly, as well as give the attacker access to cloud-based software and applications, where they may gain access to even more protected data. Through 2015, more than 75 percent of mobile applications will fail basic security tests, according to Gartner, Inc. or Gartner. Firewalls and other traditional prevention-based techniques are less capable of protecting this complex and expanded attack surface, leaving IT security professionals overwhelmed by new threats and looking for new technologies and ways to respond.

Weaponized Malware Evades Traditional Prevention-Based Tools and Expands the Cyber-Attacker Universe

The historical threat landscape used to be defined by amateur cyber criminals launching attacks for fame or mischief. Those attacks caused relatively little damage and could often be detected and prevented by signature-based security solutions. However, today there are sophisticated software toolkits and malware that can be used to launch a cyber attack, which are readily available online for free or at a low cost. These toolkits are specifically designed to circumvent the preventative security measures typically put in place by organizations, allowing cyber criminals with rudimentary IT knowledge to launch sophisticated attacks on enterprise users and networks. With this weaponized software, cyber attacks are no longer just the domain of advanced attackers, and the number of security breaches is rapidly increasing. According to PWC, the total number of security incidents detected by enterprises increased by 38% in 2015. The motivations of cyber criminals are highly varied and include not only mischief but the desire to embarrass organizations, promote specific social issues, feed national interests, support terrorism and make money – all of which could be pursued with today’s weaponized software and which could make nearly every organization a potential target.

 

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A Vibrant Cyber-Crime Economy Further Incents Cyber Attackers

The dependence of organizations on information technology and the sensitive and valuable nature of digitally stored data have raised the stakes for cyber attackers, with financial gain becoming a primary motive for many attackers. Economic incentives for attackers continue to become more compelling, as new and vibrant black markets for stolen data, including credit card information, email account information and healthcare information, enable attackers to efficiently and effectively monetize stolen information. This more recent dynamic has led to a proliferation of data from successful attacks being offered for sale by cyber criminals, and the formation of a lucrative and growing underground economy. According to a 2014 report by the RAND Corporation, hacker black markets are growing in size and complexity and in certain respects can be more profitable than the illegal drug trade because worldwide distribution is accomplished electronically such that resource requirements are negligible.

Enterprise Security Shifting from Passive “Block and Protect” to Actively-Managed Security Programs

As a result of the above trends in the cyber security landscape, IT teams are increasingly faced with unwieldy chaos as they are challenged to deliver solutions that increase user and employee productivity while ensuring overall organizational integrity and security. This challenge can be overwhelming for IT security professionals as they seek to protect their organizations against increasingly frequent, damaging and costly breaches. A new model for cyber security is needed and organizations are shifting from the traditional “block and protect” prevention-centric strategies to actively-managed security programs for the following reasons:

Passive, Prevention-Based Security Infrastructure is Inadequate

Organizations have traditionally taken a passive approach to cyber security, relying on deploying “block and protect” security tools aimed at thwarting attackers at the perimeter of the network. “Block and protect” security tools include firewalls, intrusion prevention, identity and access management, endpoint security and network access controls, among others. To address newly discovered vulnerabilities and security threats, IT security professionals traditionally added new prevention-centric devices and technologies to their existing tools, with little consideration for overall management or ecosystem optimization. On the other hand, sophisticated software-enabled technologies and techniques are increasingly used by cyber criminals to evade prevention-based security solutions. Additionally, the explosion of cloud-based applications and mobile devices accessing enterprise data are blurring the previously rigid lines that once defined enterprise network boundaries. Without these boundaries, prevention-based tools are easily circumvented by attackers.

Equally problematic for today’s organizations, traditional “block and protect” solutions are ineffective against cyber attacks using compromised user credentials. Traditional security protocols rely on procedures to grant individual users only the specific security privileges that they require, but such reliance fails when users’ credentials are stolen or compromised. The risks and exposures are further increased because many users have administrator-level credentials on their devices to maximize their productivity, but these credentials are relatively easily stolen and can be exploited by attackers in order to gain access to an organization’s network, assets and information. Use of stolen credentials in cyber attacks is becoming a significant issue with 90% of respondents to the Rapid7 2015 Incident Detection & Response Survey stating that they are worried about compromised credentials. Furthermore, according to the 2015 Verizon Data Breach Investigations Report, compromised credentials have been the number one threat action for five years in a row.

 

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Organizations Must Move to an Active, Data and Analytics-Driven Approach

In light of high profile and costly security breaches, IT security professionals are increasingly focused on developing comprehensive security programs to better protect their organizations against attacks. While prevention-based approaches can alert IT security professionals to potentially suspicious activity, the data is typically delivered through an overwhelming number of alerts and is often raw and in “machine form,” making it difficult for an organization to develop actionable insights that reflect a real-time understanding of the organization’s assets, user behavior and the dynamic threat landscape that it faces. Developing these insights has historically been complex and resource intensive, requiring security expertise, data scientists and analytical modeling skills, which many organizations lack. By contrast, active, analytics-driven security approaches require more than just the deployment of technology to prevent breaches. To improve the overall effectiveness of an organization’s cyber security program, an actively-managed approach focuses on analytics and an understanding of risks and threats in context, and facilitates the allocation of security budgets to the specific tools that enable the organization to process and analyze significant amounts of data in real time to quickly identify, understand and react to attacks and breaches as they occur. Through security data and analytics, organizations can recognize behavior patterns associated with breaches, even if the attack vector is completely novel. The organization can then develop and improve its cyber security programs in order to reduce its exposures and better detect and respond to compromises using a holistic approach across the following overall vectors of a security program:

 

   

Prevention. Identifying, prioritizing, addressing and reducing risks in a manner that reflects each organization’s unique IT infrastructure as well as the dynamic and evolving threat landscape.

 

   

Detection. Analyzing an organization’s attack surface along with user and attacker behaviors to quickly identify security breaches and facilitate a timely and effective response to cyber attacks.

 

   

Correction. Implementing techniques to remediate high-priority risks both tactically and at the program level.

The following graphic illustrates the shift that we believe is occurring with respect to how organizations manage their cyber security programs:

Shift to Analytics-Driven, Risk-Based Approach to Cyber Security

 

LOGO

Analytics provides the critical context and prioritization to underlying security data to facilitate effective, informed and proactive decisions that allow for the systemic and dynamic management of security programs across each of these areas. An active, analytics-driven security program can prevent attacks through increased

 

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visibility into vulnerabilities, rapidly detecting and responding to compromises and correcting the underlying causes of attacks. This balanced and analytics-focused approach ultimately secures organizations’ environments and reduces both the likelihood of, and risks associated with, cyber attacks better than a traditional “block and protect” security strategy.

Our Market Opportunity

According to Gartner, advanced targeted attacks make prevention-centric strategies obsolete. Securing enterprises in 2020 will require a shift to information- and people-centric security strategies, combined with pervasive internal monitoring and sharing of security intelligence. Accordingly, we believe that our market opportunity is large and growing and will be positively impacted by the ongoing shift in security spending from a traditional, passive, “block and protect” approach to an active, analytics-driven approach to cyber security. Gartner, Inc. estimates that by 2020, 60% of enterprise information security budgets will be allocated for rapid detection and response approaches – up from less than 20% in 2015.

Our estimate, based on International Data Corporation data, is that the overall market for security data and analytics is a $14.4 billion opportunity in 2016. Included in our estimates are all or a portion of the markets for Vulnerability Management, SIEM, Policy and Compliance, Network Intrusion Detection and Prevention, Endpoint Security Suites and Security Services. We believe that our market opportunity will grow as organizations continue to move away from technologies such as SIEM and Network Intrusion Detection, which can burden an organization with alerts and false positives and may be inadequate in today’s environment.

Benefits of Our Solutions

We are a leading provider of security data and analytics solutions that enable organizations to implement an active, analytics-driven approach to cyber security. Key benefits of our solutions include:

Decreased Risk of Security Breach. Our technology platform and solutions provide IT security professionals with a complete view of their dynamic attack surface and automatically assess an organization’s vulnerabilities relative to the evolving threat landscape. We provide robust and relevant analytics and insight into attacker behaviors and techniques so that IT security professionals are able to identify and prioritize risks effectively to reduce risks and ultimately create a more secure IT environment for their organization. Our data and analytics are coupled with our deep search technology that allows IT organizations the ability to deeply investigate risks such that they can be contained and remediated quickly.

Enhanced Attack Preparedness. Our solutions allow our customers to test their defenses by simulating real-world attacks on their IT environments, using the same techniques and exploits as attackers. Our attack simulation solutions leverage our security data and analytics expertise as well as the insights from our community of thousands of active Metasploit users who provide us with real-time, real-world insight into attacker behavior across the global IT attack surface. By using the same techniques as attackers and simulating real-world attacks on IT environments, we enable our customers to uncover critical gaps in their preventative measures and identify shortcomings in their incident detection and response capabilities.

Fast, Effective and Confident Intrusion Response. Our product and service offerings can help mitigate the impact of a breach by automatically identifying the root cause of a breach and providing clear and actionable insight into effective mitigation and correction. Our technology automatically monitors each user and IT asset within an organization without the need to build and maintain complicated detection rules or data queries or deploy collection agents. Rather than sending numerous alerts and alarms that become an onslaught of overwhelming and unintelligible data, our solutions provide timely, prioritized and clear analysis and instructions to IT security professionals so that they can quickly, confidently and effectively respond to cyber security breaches. Furthermore, we couple our detection technology with our deep search capabilities, which can improve the time from compromise to containment. Complementing our products, when an organization is breached, our

 

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incident response professionals leverage our deep security expertise to help guide customers through critical breach response tactics and implementation of mitigation strategies. This comprehensive approach to incident detection and response can help our customers manage the evolving threat landscape.

A Continually Relevant and Effective Security Program. We serve as a trusted security advisor to our customers, providing both products and professional services that enable organizations to implement an active, analytics-driven approach to cyber security. Our solutions are continually relevant as they evolve with, and react to, the dynamic threat landscape. Guided by our holistic approach balancing prevention, detection and correction solutions, we provide strategic, technology-agnostic guidance tailored to an organization’s security maturity and optimized to an organization’s IT environment.

Our Competitive Strengths

We have developed the following key competitive advantages that we believe will allow us to maintain a leadership position in the market for security data and analytics:

Automated Data Collection from the Endpoint to the Cloud. We have deep technology expertise in cyber security data collection from 16 years of experience in vulnerability management. Our Insight Platform provides robust data collection capabilities across multiple data sources, from endpoint information, to user behaviors, to cloud activity. As an organization’s infrastructure evolves and expands, additional data sources are quickly and efficiently integrated into our platform. Further, our Insight Platform uses flexible collection methods as it does not require the use of agents for data collection, although it can leverage agents when needed. This allows our platform to amass data from multiple sources quickly and without significant customer installation expertise, while providing greater visibility to IT security professionals. We believe that the simplicity of integrating our products into a customer’s IT environment is a key competitive differentiator for us, as it provides a significant advantage for IT security professionals who may otherwise be unable to collect and process the necessary data from across their organization.

Customer-Specific Security Analytics. We understand the cyber security risks specific to each of our customer’s organizations and IT environments. Our technology platform collects and organizes data from each customer’s unique IT environment, which allows us to systemically and automatically profile the key risks specific to each customer. By utilizing our powerful, proprietary analytics to assess and understand the context and relationships around users, IT assets and cyber threats within a customer’s environment, we can provide our customers with specific, actionable insights specific to their environments.

Robust and Relevant Knowledge of Attacker Activity. Our database of more than 70,000 known vulnerabilities is continuously expanding through the efforts of our internal security experts and the broader Metasploit community. Our ties to the security research community through our Metasploit framework, an open source project with an active community of contributors and users that was downloaded over 100,000 times in 2015, provides us with real-time insight into new attacks and exploits. The size and accuracy of our exploit database and the speed at which our threat exposure management offerings are updated provides significant value to IT security professionals looking to secure their networks in a dynamic and evolving threat environment. We also have a team of experienced security researchers who support our knowledge and security insights through threat intelligence research and attacker modeling.

Intuitive Product Design Focused on Speed to Insight. Our solutions are designed for ease-of-use by IT security professionals. Our underlying technology platform can easily become part of our customers’ operational fabric without requiring internal expertise in systems integration, data science or data scripting. Our solutions are designed to abstract the powerful underlying capabilities of our security data and analytics platform so that users interact with a simple, elegant interface. We believe that this clean user interface and intuitive design of our products differentiate Rapid7 products from the competition and enables our customers to develop actionable insights quickly and with limited training. We believe that our solutions are resource efficient for our customers and provide them with a fast time-to-value, which makes it easy for organizations to understand the benefits of an active, analytics-driven approach to cyber security.

 

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Deep Security Domain Expertise Across Technology, Operations and People. We leverage our deep domain expertise in security data and analytics to better serve our customers, who frequently have limited ability to carry deep expertise in-house. We offer security advisory services to help customers assess the quality of their security programs and implement changes to make them more effective and cost efficient. We also offer incident detection and response services to help customers find and respond to attacks and compromises that they may be missing on their own. Ultimately, we serve as a trusted security advisor to our customers, encompassing a powerful combination of technology, services and operations expertise to support our customers’ success in managing their cyber security exposure. We believe that this differentiates our offerings, resulting in strong customer retention and our ability to expand our share of our customers’ security spending over time.

User Behavior Analytics. We believe that our user-centric approach to analytics is a key differentiator of our technology platform and offerings. Our software solutions automatically create a behavior profile for each user in a customer’s IT environment. We compare these profiles against dynamic attacker behavior profiles to distinguish normal user behavior from suspicious behavior and incorporate additional data about how systems are likely to respond when under real-world attack. Within our technology platform, our prioritization engine triangulates on the most important data to determine potentially compromised user credentials and reduce false signals and alerts. In addition, our ability to provide rapid context around users and assets involved in an incident can significantly reduce investigation time, enabling organizations to more quickly respond to, contain and mitigate breaches. These powerful user-centric analytics allow IT security professionals to make informed and proactive decisions.

Fast and Accessible Search Capabilities. We believe that our ability to enable fast search through an organization’s data can enable IT security professionals to better investigate and operationalize data to quickly identify the root cause of issues. Our solutions allow IT security professionals to collect both structured and unstructured machine data and to obtain rapid access to their data. These capabilities, along with real time and easily accessible search across raw logs for known patterns with intuitive search queries, can enable IT security professionals to access their data for operational purposes.

Our Growth Strategy

Our mission is to deliver security data and analytics that revolutionize the practice of cyber security. Key elements of our growth strategy include:

Drive New Customer Additions. We believe that most organizations with IT infrastructure would benefit from our products and services, regardless of size or industry, and we have a significant opportunity to increase our penetration across these organizations. In particular, we are focused on further penetrating large enterprises and middle-market businesses. We have principally sold our products and services through our direct inside sales team and recently augmented our sales capabilities with a direct field sales team. In 2015, we made a significant investment in our sales organization, growing our headcount by 39% and our total net number of customers by 1,399, or 37%. We intend to continue to invest in building our global sales and go-to-market organizations. See “Our Customers” for additional information regarding our markets.

Increase Customer Economics and Success. Our customer base includes more than 5,100 customers, as of December 31, 2015. We believe that these customers provide us with a significant opportunity to drive incremental sales by both selling larger volumes of the offerings that a customer is already purchasing from us and cross selling other offerings from our portfolio to these customers. For example, customers acquired in 2011 have spent, in the aggregate, 2.9 times their initial 2011 spend with us through 2015, which we believe reflects both our strong renewal rates and our ability to drive upsells and cross-sells since our license agreements with a majority of these customers are perpetual in nature. We believe that we currently only capture a percentage of the total cyber security budgets of our enterprise customers and we believe that they will increase their spending with us as they continue to shift their programs to security data and analytics-centric strategies. We have a dedicated customer success team focused on engagement and education to drive customer loyalty and increased purchases of our solutions.

 

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Continue to Expand Internationally. In 2015, we generated 13% of our revenue from customers outside of North America, while 54% of the total cyber security market is outside of North America, according to a February 2014 report by Frost & Sullivan. We believe that cyber attacks are increasingly global in nature and that organizations globally are increasingly shifting to an active, data and analytics-driven approach to cyber security. We plan to continue to increase our international sales, service and support organizations to target additional sales across Europe and Asia and will also continue to expand our number of channel partners internationally.

Continue to Innovate with Our Products and Technology Platform. We plan to build upon our current performance and technology leadership in security data and analytics to enhance our technology platform and product capabilities. For example, in early 2016 we announced InsightIDR, our comprehensive incident detection and response solution that can enable organizations to go from compromise to containment quickly and also meet their operational compliance needs. This new solution integrates our recently acquired Logentries machine data search technology. InsightIDR builds on our Insight Platform, and our deep understanding of attacker behavior, to provide organizations with actionable insights into security incidents.

Serve as the Hub for Cyber Security. Our robust and comprehensive data collection capabilities, deep understanding of the attacker, analytics-driven approach and industry leadership through our Metasploit community position us to fundamentally change the way that organizations approach cyber security. Moreover, our technology platform was developed with open application program interfaces, or APIs, to allow other developers to access the security data that we collect and the powerful analytics that we provide. We expect to continue to offer new analytics-based solutions for cyber security operations and that third-party application developers will continue to leverage our data collection and analytics capabilities.

Our Security Data and Analytics Platform

Our Insight Platform is at the core of our security data and analytics product offerings. The platform was built using our extensive experience in collecting and analyzing data to enable our customers to create and manage active, analytics-driven cyber security programs. There are two fundamental and competitively differentiating capabilities of our technology platform: (1) the breadth and depth of data that we collect and (2) the powerful analytics, and resulting correlation and context that we apply to the data. Our robust data collection architecture supports gathering a wide swath of organizational and environmental data from endpoints to the cloud, including key data about user-specific behavior. Further, by using agentless data collection architecture, we can provide IT security professionals with seamless integration and automatic visibility into their dynamic and rapidly-expanding attack surfaces. By utilizing our powerful, proprietary analytics to assess and understand the context and relationships around users, IT assets and cyber threats within a customer’s environment, we can provide our customers with specific, actionable insights.

 

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The Rapid7 Security Data and Analytics Platform

 

LOGO

Our Insight Platform was architected from inception to be secure, reliable, scalable and extensible, enabling both us and third-party developers to create and add new applications that leverage our powerful data collection and analytics competencies. The design and development of our Insight Platform includes the following key attributes:

Holistic Dataset for Managing Cyber Security. Our Insight Platform collects information from multiple sources to provide a holistic view across an organization’s ecosystem from network and endpoint data, to enterprise cloud data, to user information. We collect data from the following sources: cyber security assets such as firewalls, intrusion detection systems, or IDS, intrusion prevention systems, or IPS, identity and access management, or IAM, and security information and event management, or SIEM; users; endpoints such as computers, mobile and connected devices and servers; applications; cloud activity; IT environment permissions, policies and controls; and third parties, such as cloud-based email and business productivity solution providers.

Robust Platform and Customer Data Security. Our Insight Platform was designed to provide a secure environment for both our data and that of our customers. We deploy a variety of technologies and industry-leading practices such as physical and logical customer data segregation, network segmentation, audited and monitored access level controls, data anonymization and separated development-staging-production environments to help ensure that the data collected from a customer’s environment remains proprietary and secure, including encrypting data when appropriate. Further, we regularly run penetration tests of our platform.

Both Agentless and Endpoint Agent Based Architecture with Automated Analytics. We have designed our solutions to be easy to deploy with minimal manual input from our customers. We developed our platform utilizing a flexible approach that employs both agentless data collection and our own internally-developed endpoint agent-based data collection technology, which enables rapid and seamless integration of our products into our customers’ IT environments and provides IT security professionals with instant visibility into their dynamic and rapidly-expanding attack surfaces. Our customers can use the approach that best meets their needs. Proprietary analytics are embedded in our solutions and are continuously curated based on the latest security research such that organizations are not required to develop customized detection rules or write scripts to yield actionable insights.

Enterprise-Grade Scalability. Our technology platform provides a high level of horizontal scalability. We leverage on premise deployment models and Amazon Web Services, or AWS, to achieve a high degree of redundancy, fault tolerance and cost-effective operations. We are currently deployed in two AWS regions, with plans to add additional geographies. Our automated deployment technologies enable us to add new AWS

 

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instances or additional services rapidly. Within our platform, we use a variety of SQL and NoSQL technologies to enable broad scalability, while keeping each customer’s data entirely separate. Our infrastructure architecture is designed to process large amounts of data and easily incorporate new data sources, including on premise, cloud and mobile. Our platform is designed to support customers with large numbers of users or with geographically dispersed environments, and we have scaled to meet the needs of customers with over 2.0 million active assets and 50,000 active users.

Extensible Modern Platform. Our technology platform provides a rich set of APIs and services that enable customers, partners and developers to import and export data and utilize our analytics capabilities. This allows us to easily integrate with other security tools in the customer’s environment and also enables customers to build bespoke applications and analysis on top of the data that we gather.

Our Products and Services

We offer products and professional services that leverage our security data and Insight Platform. We typically engage with customers based on their current needs determined in large part by what is occurring in their IT environments, within their industries and the initiatives of their senior management and boards of directors. We offer three broad solution groups: threat exposure management, incident detection and response and security advisory services. An organization that has just detected that it has been breached, for example, may initially purchase our incident detection and response products and services whereas a customer with a new chief information security officer looking to gain insight into the organization’s security environment may initially purchase our threat exposure management solutions, and a customer whose board of directors has mandated a security review may initially purchase our security advisory services.

Our threat exposure management solutions reflect our evolution and enhancement of traditional vulnerability management tools to encompass a broader set of data, including real-world threat information, and analytics that facilitate systematic remediation. By providing IT security professionals with a complete view of their changing attack surface and an automated way to assess the evolving threat landscape, our customers can implement a data and analytics-driven cyber security program to minimize high-priority risks.

Our incident detection and response solutions offer customers a combination of product-based analytics as well as expert services to help detect attackers and respond to attacks once they are discovered. In addition, in October 2015, we acquired Logentries, a provider of machine data search technology. With the addition of Logentries’ cloud-based log management and search capabilities, we enable information security teams to solve a broader range of security challenges, investigate incidents and more efficiently achieve their compliance requirements.

We offer our products through a combination of perpetual and term software licenses, cloud-based subscriptions and managed services offerings. All of our products have been designed with an intuitive user interface, focused on ease-of-use and fast time-to-value for our customers.

Our security advisory services help organizations implement and manage an analytics-driven security approach by looking strategically and holistically at their security programs and providing them with advice related to prevention, detection and correction. We believe that our professional services drive incremental customer adoption and usage of our products.

 

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Rapid7’s Products and Services Offerings

 

LOGO

Threat Exposure Management

Our threat exposure management solutions help organizations systematically and dynamically manage cyber vulnerabilities, allowing them to understand their exposures and prevent attacks through insights into their IT environments. In building our threat exposure management offerings, we brought security data and analytics capabilities to our core competencies around vulnerability management to drive insights into customer exposures, management and remediation. Our threat exposure management offerings are available to customers through perpetual and term software licenses with content subscriptions that provide our customers with real-time access to the latest vulnerabilities and exploits, and also as a managed service. Additionally, we provide deployment support and training.

Our threat exposure management offerings include:

Nexpose

Nexpose enables customers to assess and remediate their overall exposure to cyber risk across their increasingly complex IT environments. This includes analyzing vulnerabilities, detecting security misconfigurations and determining the effectiveness of controls across an IT environment. The key features of Nexpose include: automatic vulnerability updates; exception management, which allows organizations to track when risk is knowingly introduced into the IT environment; executive remediation and security testing reporting; interactive charting; scan scheduling and alerting; RealContext classification, which allows organizations to apply business context to threats including by identifying where sensitive data is stored; web application, virtual, unified vulnerability, perimeter and discovery scanning; policy compliance and management, including with standards such as PCI and HIPAA; report and scan customization; Open API and third-party integrations; advanced report templates and uploading; dynamic discovery; user role customization; integrated vulnerability validation; controls effectiveness testing; and prioritized guidance based on customized threat models. We offer five editions of Nexpose including Ultimate, Enterprise, Consultant, Express and Community, each of which has varying combinations of features and is geared to the requirements of different organizations, based on size and need.

Metasploit

Metasploit is an industry-leading penetration testing software, developed on an open source framework. Metasploit can be used to safely simulate attacks on an organization’s network in order to uncover vulnerabilities before they are exploited by cyber attackers and assess the effectiveness of an organization’s existing defenses, security controls and mitigation efforts. The key features of Metasploit include: wizards for standard baseline audits; task chains for automated custom workflows; modules for discrete tasks, such as network segmentation

 

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testing; dynamic payloads, designed to evade leading antivirus solutions; closed-loop vulnerability validation to prioritize remediation; phishing awareness management and spear phishing; web-based interface; and integrations via remote APIs. We sell two editions of Metasploit: Metasploit Pro is our advanced penetration testing and security program solution targeted at penetration testers and IT security teams and Metasploit Express is our baseline penetration testing product targeted at IT generalists. Metasploit Pro integrates with Nexpose to enable IT security professionals to prioritize remediation efforts and understand the impact of an attack before it happens. We also offer a free community version of Metasploit for small companies and students, as well as the open source framework, which is geared toward developers and security researchers.

AppSpider

AppSpider is a comprehensive dynamic application security testing solution that continuously analyzes web applications for security vulnerabilities and enhances organizations’ ability to effectively reduce IT security risk. The key features of AppSpider include: a universal translator to enable IT security professionals to analyze complex applications, including rich internet applications built using AJAX or GWT and web services such as REST and JSON; customized attack simulation capabilities that allow IT security professionals to automatically test complex business workflows such as shopping carts; scanning automation; live vulnerability reports and attack replay, which allows IT security professionals to replay vulnerabilities in real time in order to verify that vulnerabilities are exploitable and that successful remediation has occurred; continuous site monitoring, which detects changes in application ecosystems and triggers a re-scan according to configurable settings; and integration with protection technologies to automatically generate web application firewalls, or WAFs, custom rules that help to protect vulnerable applications while the vulnerabilities are being remediated. AppSpider supports most leading WAFs, including F5, Sourcefire and Imperva. AppSpider is offered through perpetual and term software licenses, on a cloud-based subscription basis or as a managed service.

Incident Detection and Response

Our incident detection and response solutions help IT security professionals detect and respond quickly and effectively to cyber attacks. These solutions leverage our unique understanding of the attacker and our proprietary risk-driven behavioral analysis to detect attacks. Our incident detection products are available to customers as a cloud-based subscription or as a managed service. We also provide incident response services to support our product offerings and provide customers with critical support and expertise in the wake of a breach.

Our incident detection and response offerings include:

InsightUBA

InsightUBA (formerly known as UserInsight) is a cloud-based offering that enables customers to detect intruders quickly, reducing the probability that an incident becomes a breach. The product leverages our Insight Platform to quickly and easily collect data from across an organization’s IT environment, including network data, endpoint data and information from mobile and other connected devices and cloud services. InsightUBA uses heuristic and behavioral analysis to create a behavioral profile for each user that can be used to identify anomalous activity, such as lateral movement across the network, which may suggest that an attacker is present. InsightUBA is designed to identify attacks such as those launched with compromised credentials as well as the use of common attack tools that other monitoring tools can miss. Once an incident has been identified, InsightUBA allows IT security professionals to perform a rapid and targeted review of relevant security data, going back months or years, so that a streamlined and effective response plan can be implemented quickly and efficiently.

InsightIDR

InsightIDR is a recently announced cloud based offering for comprehensive incident detection and response which will be available in the first quarter of 2016. InsightIDR combines behavior analytics and search with contextual data collection to help detect some of the stealthiest attacks. InsightIDR directly addresses the gaps

 

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found in many of today’s detection technologies, including SIEMs and IPSs and is powered by our Insight Platform, which simplifies and combines data collection, analytics, and search technology. The combination of these technologies can enable not only effective detection but also efficient investigation, so that organizations can rapidly go from compromise to containment. InsightIDR puts an organization’s data at the IT security analyst’s fingertips so an organization can improve investigation times, often at lower cost than with traditional solutions on the market.

Analytic Response

Analytic Response is a managed service that provides customers with threat detection by identifying known threats, certain unknown threats and intruder movement from the endpoint to the cloud. The service combines threat insight with sophisticated user and attacker behavior analytics and is monitored and managed by our security analysts, with experience in identifying dynamic threats and containing incidents to protect organizations. When a breach is identified with our Analytic Response services, our analysts pivot to incident response, providing security teams with detailed, easy-to-follow remediation step tailored to the environment.

Incident Response Services

Our incident response services give our customers access to our industry-leading security experts and experience, enabling customers to accelerate incident investigation and containment. Our incident response professionals collaborate with an organization’s in-house IT security professionals on all stages of incident response from analysis and detection through containment, remediation and cleanup.

Machine Data and Search

As part of our incident detection and response solutions, our machine data and search offering enables IT professionals to centralize, search and monitor their log data in order to investigate anomalies, troubleshoot issues and conduct root cause analysis. This offering can be used for application debugging and performance monitoring, infrastructure monitoring and trouble-shooting, and log aggregation and reporting for compliance.

Our machine data and search offering is:

Logentries

Logentries’ technology, acquired in October 2015, provides a powerful cloud-based solution for collecting, searching, visualizing and analyzing machine data and logs. Built-in tagging, alerting and reporting make it easy for customers to maintain a proactive view of their environment and identify anomalous events. Logentries’ scalable, cost-effective architecture enables organizations to store and search structured, semi-structured and unstructured data in real time.

Security Advisory Services

Our security advisory services help customers transform their organizations’ security programs to be relevant, actionable and sustainable through a data and analytics-driven cyber security program. Our security advisory services offerings include Cyber Security Maturity Assessment, Incident Response Program Development, Security Program Development, Security Assessment, Security Awareness Training and Threat Modeling. Customers can take control of their organizations’ security with help from our seasoned security professionals who have deep experience building and managing security programs, with expertise in vulnerability management, fraud detection, threat intelligence and incident response.

Our security advisory services enhance our ability to serve as a trusted advisor in assisting organizations to think proactively about IT security and implement strategic, analytics-driven security strategies. We believe that our role as trusted advisor helps drive customer success and loyalty and further usage of our products.

 

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Our Customers

Our customer base has grown from approximately 1,750 customers at the end of 2011 to more than 5,100 customers as of December 31, 2015, in 99 countries, including 37% of the organizations in the Fortune 1000. We define a customer as any entity that has 1) an active Rapid7 contract or a contract that expired within 90 days or less of the applicable measurement date, 2) purchased Rapid7 professional services within the 12 months preceding the applicable measurement date or 3) an active subscription to our Logentries product with a contract value equal to or greater than $2,400 per year. We provide products and services to customers of varying sizes, including enterprises, non-profit organizations, educational institutions and government agencies. 58% of our revenue in 2015 was generated by large enterprises, which we define as organizations that have either annual revenue greater than $1.0 billion or more than 2,500 employees, and the balance was generated by middle-market businesses. Our customers span a wide variety of industries including technology, energy, financial services, healthcare and life sciences, manufacturing, media and entertainment, retail, education, real estate, transportation, government and professional services, with customers in the technology industry representing our largest industry in 2015 at 14% of our revenue. We believe that our business has low revenue exposure to individual customers. While our top five customers by revenue in 2015 were each party to multi-year aggregate deals with us ranging in value from $0.8 million to $2.8 million, each of these customers individually accounted for less than 1% of our total 2015 revenue, with 2015 revenue for each of these individual customers being between $0.6 million and $0.7 million.

Rapid7’s Community

Our online community provides us with a rapidly growing network of active users and influencers who promote the usage of our software, identify cyber risks and provide technical support to each other. Our community includes paid customers of our software, users of our free community edition and open source Metasploit framework and security researchers and contributors to our Metasploit framework, which is used to simulate attacks and test an organization’s defenses against real-world threats.

The Metasploit project has an active community of contributors and users and was downloaded over 100,000 times in 2015. This online security community provides us with a robust and rapidly growing network of active users and influencers who promote the usage of our software. Security researchers contribute modules to the Metasploit framework that serve as a resource about real-world attacker techniques. The community also provides us with near real-time visibility into new cyber attacks as they occur and a deep understanding of attacker behaviors. In December 2015, the Metasploit framework ranked in the top-ten out of over 110,000 active ruby projects based on the number of projects with at least one fork, according to GitHub.

We also operate a global scanning project that scans approximately 3.7 billion assets across the internet each week and makes the raw data available to the public for research, decision making and vulnerability prioritization.

Technology Alliance Partnerships

Our security data and analytics platform has the ability to leverage a broad partner ecosystem with over 75 technology platform integrations as of December 31, 2015. We allow other developers to access the security data that we collect and the powerful analytics that we provide. We also built our platform with the ability to leverage APIs and data collection from other technologies. This allows us to integrate with other IT and security technologies that our customer may already have in place in three primary ways.

 

   

Data Collaboration. Our data collaboration integrations provide two-way data sharing to enhance our platform value. For example, we can ingest data from an existing SIEM technology and also share our analysis of user behavior activity with the SIEM technology.

 

   

Data Workflow. Our data workflow integrations enable IT security integration to streamline the process of correction and improve efficiencies. For example, we make remediation data from our platform available to IT ticketing systems in order to drive operational efficiencies and tracking of IT performance.

 

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Data Ingestion. Our data ingestion integrations enhance our analytical capabilities by funneling increased volumes of security data to our platform. For example, we ingest firewall data into our platform, which allows us to better understand user activity in the context of attacks.

We believe that these integrations with our technology alliance partners enhance the value of our platform to our customers.

Sales and Marketing

Our sales and marketing organizations collaborate to create brand preference, efficiently and effectively generate leads, build a strong sales pipeline and cultivate customer relationships to help drive revenue growth. Our go-to- market strategy consists of a strong thought-leadership program, digital marketing engine and a diversified sales organization designed to efficiently sell to organizations of all sizes.

Sales

We sell our products and services through direct inside and field sales team and indirect channel partner relationships. Our global sales teams focus on both new customer acquisition and up-selling and cross-selling additional and new offerings, respectively, to our existing customers. Our sales teams are organized by geography, consisting of the Americas; Europe, the Middle East and Africa, or EMEA; and Asia Pacific, or APAC, as well as by target organization size. Our inside sales team focuses on small and middle-market transactions, while larger or more complex transactions are generally handled by our globally distributed direct field sales teams. Our highly trained sales engineers help define customer use cases, manage solution evaluations and train channel partners.

We maintain a global channel partner network that complements our sales organization. Our channel partner network expands our geographic sales reach by providing language support and broader distribution capabilities, particularly in key markets such as EMEA, APAC and Latin America. Our channel partners also provide us with additional leverage by assisting in closing customer transactions as part of larger security purchases, sourcing new prospects and securing maintenance renewals. Our sales force works directly with, and are involved in sales to, substantially all of the end customers of our channel partners and we sometimes engage a channel partner solely to assist with finalizing a purchase, for example, in the event a customer is working on broader software initiatives with that channel partner.

We intend to continue investing in our international sales organization to continue to drive market penetration. We also have a dedicated sales teams focused on government and education customers, which covers U.S. federal, state and local government, as well as educational entities.

Marketing

We focus our marketing efforts on increasing the strength of the Rapid7 brand, communicating product advantages and business benefits, generating leads for our sales force and channel partners and driving product adoption. We deliver targeted content to demonstrate our thought leadership in security and use digital advertising methods to drive downloads of our free community and trial software, which deliver opportunities to our sales organization. We engage with existing customers to provide community-based education and awareness and to promote expanded use of our software within these customers. We work with our own researchers, as well as the broader security community, to share important information about vulnerabilities and threats. We share that research through our active online community, social media and traditional public relations. In addition, we host regional and national events to engage both customers and prospects, deliver product training and foster community collaboration.

Sales and marketing expense totaled $67.4 million, $49.0 million and $31.8 million for 2015, 2014 and 2013, respectively.

 

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Research and Development

We invest substantial resources in research and development to enhance our core technology platform and products, develop new end market-specific solutions and applications, and conduct product and quality assurance testing. Our technical and engineering team monitors and tests our products on a regular basis, and we maintain a regular release process to refine, update, and enhance our existing products. We also have a team of experienced security researchers who work to keep us abreast of the latest developments in the cyber security landscape. Our research and development teams are distributed globally and are located in our offices in Cambridge, Austin, Los Angeles, Toronto, Dublin and Belfast providing us with a broad, worldwide reach to engineering talent. Research and development expense totaled $38.7 million, $25.6 million and $21.4 million for 2015, 2014 and 2013, respectively.

Our Competition

The market for cyber security solutions is highly fragmented, intensely competitive and constantly evolving. We compete with an array of established and emerging security software and services vendors. With the introduction of new technologies and market entrants, we expect the competitive environment to remain intense going forward. Our competitors include: vulnerability management and assessment vendors, including Qualys and Tenable Network Security; diversified security software and services vendors, including IBM and HP; legacy compliance and monitoring solutions such as SIEM, including those provided by LogRhythm and Alienvault; security services specialists, including Mandiant (a subsidiary of FireEye); and providers of point solutions that compete with some of the features present in our solutions.

We compete on the basis of a number of factors, including:

 

   

product functionality;

 

   

breadth of offerings;

 

   

performance;

 

   

brand name, reputation and customer satisfaction;

 

   

ease of implementation, use and maintenance;

 

   

total cost of ownership; and

 

   

scalability, reliability and security.

We believe that we compete favorably with respect to all of these factors and that we are well positioned as a leading provider of cyber security and data analytics products and professional services.

Intellectual Property

Our future success and competitive position depend in part on our ability to protect our intellectual property and proprietary technologies. To safeguard these rights, we rely on a combination of patent, trademark, copyright and trade secret laws and contractual protections in the United States and other jurisdictions.

As of December 31, 2015, we had five issued patents and 17 patent applications pending in the United States relating to our products. We cannot assure you that any patents will issue from any patent applications, that patents that issue from such applications will give us the protection that we seek or that any such patents will not be challenged, invalidated, or circumvented. Any patents that may issue in the future from our pending or future patent applications may not provide sufficiently broad protection and may not be enforceable in actions against alleged infringers.

 

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We have registered the “Rapid7,” “Nexpose” and “Metasploit” names and logos in the United States and certain other countries. We have registrations and/or pending applications for additional marks in the United States and other countries; however, we cannot assure you that any future trademark registrations will be issued for pending or future applications or that any registered trademarks will be enforceable or provide adequate protection of our proprietary rights.

We also license software from third parties for integration into our offerings, including open source software and other software available on commercially reasonable terms. We cannot assure you that such third parties will maintain such software or continue to make it available.

We are the registered holder of a variety of domestic and international domain names that include rapid7.com and metasploit.com, as well as similar variations on those names.

In order to protect our unpatented proprietary technologies and processes, we rely on trade secret laws and confidentiality agreements with our employees, consultants, channel partners, vendors and others. Despite our efforts to protect our proprietary technology and trade secrets, unauthorized parties may attempt to misappropriate, reverse engineer or otherwise obtain and use them. In addition, others may independently discover our trade secrets, in which case we would not be able to assert trade secret rights, or develop similar technologies and processes. Further, the contractual provisions that we enter into may not prevent unauthorized use or disclosure of our proprietary technology or intellectual property rights and may not provide an adequate remedy in the event of unauthorized use or disclosure of our proprietary technology or intellectual property rights.

If we become more successful, we believe that competitors will be more likely to try to develop solutions and services that are similar to ours and that may infringe our proprietary rights. It may also be more likely that competitors or other third parties will claim that our platform and products infringe their proprietary rights.

Patent and other intellectual property disputes are common in our industry and we have been involved in such disputes from time to time in the ordinary course of our business. Some companies, including some of our competitors, own large numbers of patents, copyrights and trademarks, which they may use to assert claims against us. Third parties may in the future assert claims of infringement, misappropriation or other violations of intellectual property rights against us. They may also assert such claims against our customers or channel partners whom we typically indemnify against claims that our solutions infringe, misappropriate or otherwise violate the intellectual property rights of third parties. As the numbers of products and competitors in our market increase and overlaps occur, claims of infringement, misappropriation and other violations of intellectual property rights may increase. Any claim of infringement, misappropriation or other violation of intellectual property rights by a third party, even those without merit, could cause us to incur substantial costs defending against the claim and could distract our management from our business.

Government Regulation

Like other U.S.-based IT security products, our products are subject to U.S. export control laws and regulations, specifically the Export Administration Regulations, or EAR, U.S. economic and trade sanctions regulations, and applicable foreign government import, export, and use requirements. Certain of our products are subject to encryption controls under the EAR due to the nature of the product and/or its use or incorporation of encryption functionality. Under the encryption controls in the EAR, applicable products may only be exported outside of the United States with required export authorizations, including by a license, a license exception or other appropriate government authorizations. To qualify for this authorization, developers of encryption products are generally required to file an encryption registration, and in some cases subject their encryption product to a one-time technical review. In addition to the restrictions under the EAR, U.S. export control laws and economic sanctions prohibit the export of certain products and services to countries, governments, entities or persons subject to U.S. embargoes or trade sanctions.

 

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We believe that we have completed the necessary technical reviews of the products and services that we currently export, but new products that we acquire or develop may require technical review before we can export them. In addition, some of our products are subject to an export license requirement when shipped to certain foreign government end users. We would need to apply for these individual licenses on a case-by-case basis, the acceptance and granting of which may be issued at the discretion of the U.S. Department of Commerce.

We previously deployed certain of our products prior to obtaining the required export authorizations under the EAR. In addition, we are aware of exports of certain of our software products to persons and organizations in countries that are the subject of U.S. embargoes. We initiated and filed a voluntary self-disclosure with the U.S. Department of Commerce’s Bureau of Industry and Security, or BIS, in September 2014 regarding our previous failure to obtain required export authorizations under the EAR for these historical downloads, as well as exports to embargoed countries, namely Cuba, Iran, Sudan and Syria. We filed a supplement to the voluntary disclosure to BIS in March 2015 with additional information regarding unauthorized apparent historical exports of software to certain foreign government end users. Also in March 2015, we filed a voluntary self-disclosure with the U.S. Department of Treasury’s Office of Foreign Assets Control, or OFAC, concerning exports of free and trial versions of software to Cuba, Iran, Sudan and Syria. As these transactions involved free downloads of our software, we did not derive any revenue from such transactions. On May 22, 2015, OFAC determined not to pursue a civil monetary penalty against us and issued us a Cautionary Letter to resolve our voluntary self- disclosure regarding the free downloads in embargoed countries. The voluntary self-disclosure submitted to BIS currently remains under review and we are fully cooperating with BIS. We have also been improving our procedures for screening transactions to ensure compliance with U.S. export control and trade sanctions laws and have restricted the ability of individuals or entities outside of the United States and Canada to download our free Metasploit products absent pre-screening.

In addition, there is currently a multinational effort underway as part of the Wassenaar Arrangement on Export Controls for Conventional Arms and Dual-Use Goods and Technologies, or the Wassenaar Arrangement, to impose additional restrictions on specified intrusion software, which may encompass our commercial Metasploit products. These controls are not currently in effect in the United States and may undergo substantial modification before becoming effective. To implement the controls under the Wassenaar Arrangement in the United States, BIS would have to amend the EAR. Such amendments could include changes that impose new licensing, approval and other requirements on our commercial Metasploit products and thereby put us at a disadvantage in competing for international sales. We are closely monitoring the potential implications of the Wassenaar Arrangement on the commercial versions of Metasploit, and are actively working with BIS and other U.S. government stakeholders in connection with the implementation of the controls under the Wassenaar Arrangement.

Employees

As of December 31, 2015, we had 756 full-time employees, including 140 in product delivery and support, 314 in sales and marketing, 205 in research and development and 97 in general and administrative. As of December 31, 2015, we had 576 full-time employees in the United States and 180 full-time employees internationally. None of our U.S. employees are covered by collective bargaining agreements. We believe our employee relations are good and we have not experienced any work stoppages.

Corporate Information

We were initially incorporated in July 2000 in Delaware. Rapid7 LLC, a limited liability company organized under the laws of the Commonwealth of Massachusetts, was formed in January 2004. In August 2004, pursuant to an exchange agreement among Rapid7 LLC and the stockholders of Rapid7, Inc., the stockholders exchanged their shares in Rapid7, Inc. for equity interests in Rapid7 LLC, after which Rapid7, Inc. was dissolved. In August 2008, Rapid7 LLC was merged with and into Rapid7 LLC, a newly-formed Delaware limited liability company. Rapid7, Inc. was reincorporated in Delaware in October 2011. In a series of transactions in November 2011, equity holders of Rapid7 LLC exchanged their equity interests in Rapid7 LLC for capital stock in Rapid7, Inc. and Rapid7 LLC became a wholly-owned subsidiary of Rapid7, Inc.

 

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Our principal executive offices are located at 100 Summer Street, Boston, Massachusetts. Our telephone number is (617) 247-1717. Our website address is www.rapid7.com. The information contained on, or that can be accessed through, our website is not incorporated by reference into this Annual Report on Form 10-K.

“Rapid7,” the Rapid7 logo, and other trademarks or service marks of Rapid7, Inc. appearing in this Annual Report on Form 10-K are the property of Rapid7, Inc. This Annual Report on Form 10-K contains additional trade names, trademarks and service marks of others, which are the property of their respective owners. Solely for convenience, trademarks and trade names referred to in this Annual Report on Form 10-K may appear without the ® or TM symbols.

Geographic Information

For a description of our revenue and long-lived assets by geographic location, see Note 15 of the Notes to our Consolidated Financial Statements included in this Annual Report on Form 10-K.

Available Information

Our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to reports filed pursuant to Sections 13(a) and 15(d) of the Securities Exchange Act of 1934, as amended, are made available free of charge on or through our website at www.investors.rapid7.com as soon as reasonably practicable after such reports are filed with, or furnished to, the SEC. The SEC also maintains a website, www.sec.gov, which contains reports and other information regarding issuers that file electronically with the SEC. The public may read and copy any files with the SEC Public Reference Room at 100 F Street, NE, Washington, DC 20549. The public may obtain information on the operation of the Public Reference Room by calling 1-800-SEC-0330. We are not, however, including the information contained on our website, or information that may be accessed through links on our website, as part of, or incorporating such information by reference into, this Annual Report on Form 10-K.

Item 1A. Risk Factors.

Our operations and financial results are subject to various risks and uncertainties including those described below. You should consider carefully the risks and uncertainties described below, in addition to other information contained in this Annual Report on Form 10-K as well as our other public filings with the Securities and Exchange Commission, including our consolidated financial statements and related notes. The risks and uncertainties described below are not the only ones we face. Additional risks and uncertainties that we are unaware of, or that we currently believe are not material, may also become important factors that adversely affect our business. If any of the following risks or others not specified below materialize, our business, financial condition and results of operations could be materially adversely affected. In that case, the trading price of our common stock could decline.

Risks Related to Our Business and Industry

We are a rapidly growing company, which makes it difficult to evaluate our future prospects and may increase the risk that we will not be successful.

We are a rapidly growing company. Our ability to forecast our future operating results is subject to a number of uncertainties, including our ability to plan for and model future growth. We have encountered and will continue to encounter risks and uncertainties frequently experienced by growing companies in rapidly evolving industries. If our assumptions regarding these uncertainties, which we use to plan our business, are incorrect or change in reaction to changes in our markets, or if we do not address these risks successfully, our operating and financial results could differ materially from our expectations, our business could suffer and the trading price of our common stock may decline.

 

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If we are unable to sustain our revenue growth rate, we may not achieve or maintain profitability in the future.

From the year ended December 31, 2011 to the year ended December 31, 2015, our revenue grew from $31.0 million to $110.5 million, which represents a compounded annual growth rate of approximately 37%. Although we have experienced rapid growth historically and currently have high renewal rates, we may not continue to grow as rapidly in the future and our renewal rates may decline. Any success that we may experience in the future will depend, in large part, on our ability to, among other things:

 

   

maintain and expand our customer base;

 

   

increase revenues from existing customers through increased or broader use of our products and professional services within their organizations;

 

   

improve the performance and capabilities of our products through research and development;

 

   

continue to develop our cloud-based solutions;

 

   

maintain the rate at which customers purchase our content subscriptions and maintenance and support;

 

   

continue to successfully expand our business domestically and internationally; and

 

   

successfully compete with other companies.

If we are unable to maintain consistent revenue or revenue growth, our stock price could be volatile, and it may be difficult to achieve and maintain profitability. You should not rely on our revenue for any prior quarterly or annual periods as any indication of our future revenue or revenue growth.

We have not been profitable historically and may not achieve or maintain profitability in the future.

We have posted a net loss in each year since inception, including net losses of $49.9 million in 2015, $32.6 million in 2014 and $18.9 million in 2013. As of December 31, 2015, we had an accumulated deficit of $340.3 million. While we have experienced significant revenue growth in recent periods, we are not certain whether or when we will obtain a high enough volume of sales of our products and professional services to sustain or increase our growth or achieve or maintain profitability in the future. We also expect our costs to increase in future periods, which could negatively affect our future operating results if our revenue does not increase. In particular, we expect to continue to expend substantial financial and other resources on:

 

   

research and development related to our offerings, including investments in our research and development team;

 

   

sales and marketing, including a significant expansion of our sales organization, both domestically and internationally;

 

   

continued international expansion of our business;

 

   

expansion of our professional services organization; and

 

   

general administration expenses, including legal and accounting expenses related to being a public company.

These investments may not result in increased revenue or growth in our business. If we are unable to increase our revenue at a rate sufficient to offset the expected increase in our costs, our business, financial position and results of operations will be harmed, and we may not be able to achieve or maintain profitability over the long term. Additionally, we may encounter unforeseen operating expenses, difficulties, complications, delays and other unknown factors that may result in losses in future periods. If our revenue growth does not meet our expectations in future periods, our financial performance may be harmed, and we may not achieve or maintain profitability in the future.

 

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If our products or professional services fail to detect vulnerabilities or incorrectly detect vulnerabilities, or if our products contain undetected errors or defects, our brand and reputation could be harmed, which could have an adverse effect on our business and results of operations.

If our products or professional services fail to detect vulnerabilities in our customers’ cyber security infrastructure, or if our products or professional services fail to identify and respond to new and increasingly complex methods of cyber attacks, our business and reputation may suffer. There is no guarantee that our products or professional services will detect all vulnerabilities, especially in light of the rapidly changing security landscape to which we must respond. Additionally, our products may falsely detect vulnerabilities or threats that do not actually exist. For example, our Metasploit offering relies on information provided by an active community of security researchers who contribute new exploits, attacks and vulnerabilities. If the information from these third parties is inaccurate, the potential for false indications of security vulnerabilities increases. These false positives, while typical in the industry, may impair the perceived reliability of our offerings and may therefore adversely impact market acceptance of our products and professional services and could result in negative publicity, loss of customers and sales and increased costs to remedy any problem.

Our products may also contain undetected errors or defects when first introduced or as new versions are released. We have experienced these errors or defects in the past in connection with new products and product upgrades and we expect that these errors or defects will be found from time to time in the future in new or enhanced products after commercial release. Defects may cause our products to be vulnerable to attacks, cause them to fail to detect vulnerabilities, or temporarily interrupt customers’ networking traffic. Any errors, defects, disruptions in service or other performance problems with our products may damage our customers’ business and could hurt our reputation. If our products or professional services fail to detect vulnerabilities for any reason, we may incur significant costs, the attention of our key personnel could be diverted, our customers may delay or withhold payment to us or elect not to renew or other significant customer relations problems may arise. We may also be subject to liability claims for damages related to errors or defects in our products. A material liability claim or other occurrence that harms our reputation or decreases market acceptance of our products may harm our business and operating results.

An actual or perceived security breach or theft of the sensitive data of one of our customers, regardless of whether the breach is attributable to the failure of our products or professional services, could adversely affect the market’s perception of our offerings and subject us to legal claims.

We face intense competition in our market.

The market for cyber security solutions is highly fragmented, intensely competitive and constantly evolving. We compete with an array of established and emerging security software and services vendors. With the introduction of new technologies and market entrants, we expect the competitive environment to remain intense going forward. Our competitors include: vulnerability management and assessment vendors, including Qualys and Tenable Network Security; diversified security software and services vendors, including IBM and HP; legacy compliance and monitoring solutions such as SIEM, including those provided by LogRhythm and Alienvault; security services specialists, including Mandiant (a subsidiary of FireEye); and providers of point solutions that compete with some of the features present in our solutions.

Some of our actual and potential competitors have advantages over us, such as longer operating histories, significantly greater financial, technical, marketing or other resources, stronger brand and business user recognition, larger intellectual property portfolios and broader global distribution and presence. In addition, our industry is evolving rapidly and is becoming increasingly competitive. Larger and more established companies may focus on cyber security and could directly compete with us. Smaller companies could also launch new products and services that we do not offer and that could gain market acceptance quickly.

Our competitors may be able to respond more quickly and effectively than we can to new or changing opportunities, technologies, standards or customer requirements. With the introduction of new technologies, the

 

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evolution of our offerings and new market entrants, we expect competition to intensify in the future. In addition, some of our larger competitors have substantially broader product offerings and can bundle competing products and services with other software offerings. As a result, customers may choose a bundled product offering from our competitors, even if individual products have more limited functionality than our solutions. These competitors may also offer their products at a lower price as part of this larger sale, which could increase pricing pressure on our offerings and cause the average sales price for our offerings to decline. These larger competitors are also often in a better position to withstand any significant reduction in capital spending, and will therefore not be as susceptible to economic downturns.

Furthermore, our current and potential competitors may establish cooperative relationships among themselves or with third parties that may further enhance their resources and product and services offerings in the markets we address. In addition, current or potential competitors may be acquired by third parties with greater available resources. As a result of such relationships and acquisitions, our current or potential competitors might be able to adapt more quickly to new technologies and customer needs, devote greater resources to the promotion or sale of their products and services, initiate or withstand substantial price competition, take advantage of other opportunities more readily or develop and expand their product and service offerings more quickly than we do. For all of these reasons, we may not be able to compete successfully against our current or future competitors.

The market for our products and professional services is new and unproven and may not grow.

We believe our future success will depend in large part on the growth, if any, in the market for cyber security data and analytics. This market is nascent, and as such, it is difficult to predict important market trends, including the potential growth, if any. To date, the majority of enterprise spend on cyber security has been on threat protection products, such as network, endpoint and web security that are designed to stop threats from penetrating corporate networks. Organizations that use these security products may believe that their existing security solutions sufficiently protect access to their sensitive business data. Therefore, they may continue allocating their cyber security budgets to these products and may not adopt our products and professional services in addition to, or in lieu of, such traditional products. Further, sophisticated cyber attackers are skilled at adapting to new technologies and developing new methods of gaining access to organizations’ sensitive business data, and changes in the nature of advanced cyber threats could result in a shift in IT budgets away from products and professional services such as ours. In addition, while recent high visibility attacks on prominent enterprises and governments have increased market awareness of the problem of cyber attacks, if cyber attacks were to decline, or enterprises or governments perceived that the general level of cyber attacks have declined, our ability to attract new customers and expand our sale to existing customers could be materially and adversely affected. If products and professional services such as ours are not viewed by organizations as necessary, or if customers do not recognize the benefit of our offerings as a critical layer of an effective cyber security strategy, our revenue may not grow as quickly as expected, or may decline, and the trading price of our stock could suffer. It is therefore difficult to predict how large the market will be for our solutions.

In addition, it is difficult to predict customer adoption and renewal rates, customer demand for our products and professional services, the size and growth rate of the market for cyber security data analytics, the entry of competitive products or the success of existing competitive products. Any expansion in our market depends on a number of factors, including the cost, performance and perceived value associated with our offerings and those of our competitors. If these offerings do not achieve widespread adoption or there is a reduction in demand for solutions in our market caused by a lack of customer acceptance, technological challenges, competing technologies and products, decreases in corporate spending, weakening economic conditions, or otherwise, it could result in reduced customer orders, early terminations, reduced renewal rates or decreased revenue, any of which would adversely affect our business operations and financial results. You should consider our business and prospects in light of the risks and difficulties we encounter in this new and unproven market.

 

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Forecasts of our market and market growth may prove to be inaccurate, and even if the markets in which we compete achieve the forecasted growth, there can be no assurance that our business will grow at similar rates, or at all.

Growth forecasts included in this Annual Report on Form 10-K relating to our market opportunity and the expected growth in the market for information and data security analytics are subject to significant uncertainty and are based on assumptions and estimates which may prove to be inaccurate. Even if these markets meet our size estimates and experience the forecasted growth, we may not grow our business at similar rates, or at all. Our growth is subject to many factors, including our success in implementing our business strategy, which is subject to many risks and uncertainties. Accordingly, the forecasts of market growth included in this Annual Report on Form 10-K should not be taken as indicative of our future growth.

Organizations may be reluctant to purchase cyber security data analytics offerings that are cloud-based due to the actual or perceived vulnerability of cloud solutions.

Some organizations have been reluctant to use cloud solutions for cyber security, such as InsightUBA (formerly known as UserInsight) and Logentries, because they have concerns regarding the risks associated with the reliability or security of the technology delivery model associated with this solution. If we or other cloud service providers experience security incidents, breaches of customer data, disruptions in service delivery or other problems, the market for cloud solutions as a whole may be negatively impacted.

If we do not continue to innovate and offer products and professional services that address the dynamic threat landscape, we may not remain competitive, and our revenue and operating results could suffer.

The cyber security market is characterized by rapid technological advances, changes in customer requirements, frequent new product introductions and enhancements and evolving industry standards. Our success also depends on continued innovation to provide features that make our products and professional services responsive to the dynamic threat landscape. While we continue to invest significant resources in research and development in order to ensure that our products continue to address the cyber security risks that our customers face, the introduction of products and services embodying new technologies could render our existing products or services obsolete or less attractive to customers. In addition, developing new products and product enhancements is expensive and time consuming, and there is no assurance that such activities will result in significant cost savings, revenue or other expected benefits. If we spend significant time and effort on research and development and are unable to generate an adequate return on our investment, our business and results of operations may be materially and adversely affected. Further, we may not be able to successfully anticipate or adapt to changing technology or customer requirements or the dynamic threat landscape on a timely basis, or at all.

To date, we have derived a substantial majority of our revenue from customers using our threat exposure management offerings. If we are unable to renew or increase sales of our threat exposure management offerings, or if we are unable to increase sales of our other offerings, our business and operating results could be adversely affected.

Although we have recently introduced new products and professional services, we derive and expect to continue to derive a substantial majority of our revenue from customers using certain of our threat exposure management offerings, Nexpose and Metasploit. Greater than one-half of our revenue was attributable to Nexpose in each of the last three years. As a result, our operating results could suffer due to:

 

   

any decline in demand for our threat exposure management offerings;

 

   

failure of our threat exposure management offerings to detect vulnerabilities in our customers’ IT environments;

 

   

the introduction of products and technologies that serve as a replacement or substitute for, or represent an improvement over, our threat exposure management offerings;

 

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technological innovations or new standards that our threat exposure management offerings do not address;

 

   

sensitivity to current or future prices offered by us or competing solutions; and

 

   

our inability to release enhanced versions of our threat exposure management offerings on a timely basis in response to the dynamic threat landscape.

Our inability to renew or increase sales of our threat exposure management offerings, including content subscriptions and maintenance and support, or a decline in prices of our threat exposure management offerings would harm our business and operating results more seriously than if we derived significant revenues from a variety of offerings. For example, our sales and marketing of our Analytic Response, InsightUBA and InsightIDR products for user behavior analytics and incident detection and response, respectively, is relatively new, and it is uncertain whether these products will gain market acceptance. We are also investing heavily in the expansion of our security advisory services offerings, which we believe will help drive demand for our other products in addition to being a stand-alone service. Any factor adversely affecting sales of our products or professional services, including release cycles, market acceptance, competition, performance and reliability, reputation and economic and market conditions, could adversely affect our business and operating results.

If Metasploit were to be used by attackers to exploit vulnerabilities in the cyber security infrastructures of third parties, our reputation and business could be harmed.

Although Metasploit is a penetration testing tool that is intended to allow organizations to test the effectiveness of their cyber security programs, Metasploit has in the past and may in the future be used to exploit vulnerabilities in the cyber security infrastructures of third parties. While we have incorporated certain features into Metasploit to deter misuse, there is no guarantee that these controls will not be circumvented or that Metasploit will only be used defensively or for research purposes, and any actual or perceived security breach, malicious intrusion or theft of sensitive data in which Metasploit is believed to have been used could adversely affect perception of, and demand for, our offerings. Further, the identification of new exploits and vulnerabilities by the Metasploit community may enhance the knowledge base of cyber attackers or enable them to undertake new forms of attacks. If any of the foregoing were to occur, we could suffer negative publicity and loss of customers and sales, as well as possible legal claims.

A component of our growth strategy is dependent on our continued international expansion, which adds complexity to our operations.

We market and sell our products and professional services throughout the world and have personnel in many parts of the world. For the year ended December 31, 2015, international operations generated 13% of our revenue. Our growth strategy is dependent, in part, on our continued international expansion. We expect to conduct a significant amount of our business with organizations that are located outside the United States, particularly in Europe and Asia. We cannot assure you that our expansion efforts into international markets will be successful in creating further demand for our products and professional services outside of the United States or in effectively selling our products and professional services in the international markets that we enter. Our current international operations and future initiatives will involve a variety of risks, including:

 

   

foreign currency exchange fluctuations;

 

   

trade and foreign exchange restrictions;

 

   

economic or political instability in foreign markets;

 

   

greater difficulty in enforcing contracts, accounts receivable collection and longer collection periods;

 

   

changes in regulatory requirements, including, but not limited to data privacy, data protection and data security regulations;

 

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difficulties and costs of staffing and managing foreign operations;

 

   

the uncertainty and limitation of protection for intellectual property rights in some countries;

 

   

costs of compliance with foreign laws and regulations and the risks and costs of non-compliance with such laws and regulations;

 

   

costs of compliance with U.S. laws and regulations for foreign operations, including the Foreign Corrupt Practices Act, import and export control laws, tariffs, trade barriers, economic sanctions and other regulatory or contractual limitations on our ability to sell or provide our solutions in certain foreign markets, and the risks and costs of non-compliance;

 

   

heightened risks of unfair or corrupt business practices in certain geographies and of improper or fraudulent sales arrangements that may impact financial results and result in restatements of, and irregularities in, financial statements;

 

   

the potential for political unrest, acts of terrorism, hostilities or war;

 

   

management communication and integration problems resulting from cultural differences and geographic dispersion;

 

   

costs associated with language localization of our products; and

 

   

costs of compliance with multiple and possibly overlapping tax structures.

Our business, including the sales of our products and professional services by us and our channel partners, may be subject to foreign governmental regulations, which vary substantially from country to country and change from time to time. Our failure, or the failure by our channel partners, to comply with these regulations could adversely affect our business. Further, in many foreign countries it is common for others to engage in business practices that are prohibited by our internal policies and procedures or U.S. regulations applicable to us. Although we have implemented policies and procedures designed to comply with these laws and policies, there can be no assurance that our employees, contractors, channel partners and agents have complied, or will comply, with these laws and policies. Violations of laws or key control policies by our employees, contractors, channel partners or agents could result in delays in revenue recognition, financial reporting misstatements, fines, penalties or the prohibition of the importation or exportation of our products and could have a material adverse effect on our business and results of operations. If we are unable to successfully manage the challenges of international expansion and operations, our business and operating results could be adversely affected.

As a cyber security provider, we are a target of cyber attacks that could adversely impact our reputation and operating results.

We sell cyber security and data analytics products. As a result, we have been and will be a target of cyber attacks designed to impede the performance of our products, penetrate our network security or the security of our cloud platform or our internal systems, or that of our customers, misappropriate proprietary information and/or cause interruptions to our services. For example, because Metasploit serves as an introduction to hacking for many individuals, a successful cyber attack on us may be perceived as a victory for the cyber attacker, thereby increasing the likelihood that we may be a target of cyber attacks, even absent financial motives. Further, if our systems are breached, attackers could learn critical information about how our products operate to help protect our customers’ IT infrastructures from cyber risk, thereby making our customers more vulnerable to cyber attacks. In addition, if actual or perceived breaches of our network security occur, they could adversely affect the market perception of our products, negatively affecting our reputation, and may expose us to the loss of our proprietary information or information belonging to our customers, investigations or litigation and possible liability, including injunctive relief and monetary damages. Such security breaches could also divert the efforts of our technical and management personnel. In addition, such security breaches could impair our ability to operate our business and provide products to our customers. If this happens, our reputation could be harmed, our revenue could decline and our business could suffer.

 

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We are dependent on the continued services and performance of our senior management and other key employees, as well as on our ability to successfully hire, train, manage and retain qualified personnel, especially those in sales and marketing and research and development.

Our future performance depends on the continued services and contributions of our senior management, particularly Corey Thomas, our President and Chief Executive Officer, and other key employees to execute on our business plan and to identify and pursue new opportunities and product innovations. We maintain key man insurance on Mr. Thomas, but do not do so for any of our other executive officers or key employees. From time to time, there may be changes in our senior management team resulting from the termination or departure of our executive officers and key employees. Our senior management and key employees are generally employed on an at-will basis, which means that they could terminate their employment with us at any time. The loss of the services of our senior management, particularly Mr. Thomas, or other key employees for any reason could significantly delay or prevent our development or the achievement of our strategic objectives and harm our business, financial condition and results of operations.

Our ability to successfully pursue our growth strategy will also depend on our ability to attract, motivate and retain our personnel, especially those in sales and marketing and research and development. We face intense competition for these employees from numerous technology, software and other companies, especially in certain geographic areas in which we operate, and we cannot ensure that we will be able to attract, motivate and/or retain additional qualified employees in the future. If we are unable to attract new employees and retain our current employees, we may not be able to adequately develop and maintain new products or professional services or market our existing products or professional services at the same levels as our competitors and we may, therefore, lose customers and market share. Our failure to attract and retain personnel, especially those in sales and marketing and research and development positions for which we have historically had a high turnover rate, could have an adverse effect on our ability to execute our business objectives and, as a result, our ability to compete could decrease, our operating results could suffer and our revenue could decrease. Even if we are able to identify and recruit a sufficient number of new hires, these new hires will require significant training before they achieve full productivity and they may not become productive as quickly as we would like or at all.

Our business and operations are experiencing rapid growth, and if we do not appropriately manage our future growth, or are unable to scale our systems and processes, our operating results may be negatively affected.

We are a rapidly growing company. To manage future growth effectively, and as we continue to transition to the requirements of being a public company, we will need to continue to improve and expand our internal information technology systems, financial infrastructure, and operating and administrative systems and controls, which we may not be able to do efficiently, in a timely manner or at all. Any future growth would add complexity to our organization and require effective coordination across our organization. Failure to manage any future growth effectively could result in increased costs, harm our results of operations and lead to investors losing confidence in our internal systems and processes.

Our quarterly operating results may vary from period to period, which could result in our failure to meet expectations with respect to operating results and cause the trading price of our stock to decline.

Our operating results have historically varied from period to period, and we expect that they will continue to do so as a result of a number of factors, many of which are outside of our control, including:

 

   

the level of demand for our products and professional services;

 

   

customer renewal rates;

 

   

the extent to which customers purchase additional products, including content subscriptions and maintenance and support related to our Nexpose, Metasploit and AppSpider products, or professional services;

 

   

the level of perceived threats to organizations’ cyber security;

 

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network outages, security breaches, technical difficulties or interruptions with our products;

 

   

changes in the growth rate of the markets in which we compete;

 

   

the announcement or adoption of new regulations and policy mandates or changes to existing regulations and policy mandates;

 

   

the timing and success of new product or professional service introductions by us or our competitors or any other changes in the competitive landscape of our industry, including consolidation among our competitors;

 

   

the introduction or adoption of new technologies that compete with our offerings;

 

   

the mix of our products and professional services sold during a period;

 

   

decisions by potential customers to purchase cyber security products or services from other vendors;

 

   

the amount and timing of operating costs and capital expenditures related to the operations and expansion of our business;

 

   

the timing of sales commissions relative to the recognition of revenue and the timing of revenue recognition generally;

 

   

price competition;

 

   

our ability to successfully manage any future acquisitions of businesses, including without limitation the timing of expenses and potential future charges for impairment of goodwill from acquired companies;

 

   

our ability to increase, retain and incentivize the channel partners that market and sell our products and professional services;

 

   

our continued international expansion and associated exposure to changes in foreign currency exchange rates;

 

   

the amount and timing of operating expenses related to the maintenance and expansion of our business, operations and infrastructure;

 

   

unforeseen litigation and intellectual property infringement;

 

   

the announcement or adoption of new regulations and policy mandates or changes to existing regulations and policy mandates;

 

   

the strength of regional, national and global economies;

 

   

the impact of natural disasters or manmade problems such as terrorism; and

 

   

future accounting pronouncements or changes in our accounting policies.

Each factor above or discussed elsewhere in this Annual Report on Form 10-K or the cumulative effect of some of these factors may result in fluctuations in our operating results. This variability and unpredictability could result in our failure to meet expectations with respect to operating results, or those of securities analysts or investors, for a particular period. If we fail to meet or exceed expectations for our operating results for these or any other reasons, the market price of our stock could fall and we could face costly lawsuits, including securities class action suits.

We recognize substantially all of our revenue ratably over the term of our agreements with customers and, as a result, downturns or upturns in sales may not be immediately reflected in our operating results.

We recognize substantially all of our revenue ratably over the terms of our agreements with customers, which generally occurs over a one to three-year period. As a result, a substantial portion of the revenue that we report in

 

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each period will be derived from the recognition of deferred revenue relating to agreements entered into during previous periods. Consequently, a decline in new sales or renewals in any one period may not be immediately reflected in our revenue results for that period. This decline, however, will negatively affect our revenue in future periods. Accordingly, the effect of significant downturns in sales and market acceptance of our products and potential changes in our rate of renewals may not be fully reflected in our results of operations until future periods. Our model also makes it difficult for us to rapidly increase our revenue through additional sales in any period, as revenue from new customers generally will be recognized over the term of the applicable agreement.

We also intend to increase our investment in research and development, sales and marketing, and general and administrative functions and other areas to grow our business. We are likely to recognize the costs associated with these increased investments earlier than some of the anticipated benefits and the return on these investments may be lower, or may develop more slowly, than we expect, which could adversely affect our operating results.

We may be unable to rapidly and efficiently adjust our cost structure in response to significant revenue declines, which could adversely affect our operating results.

Our brand, reputation and ability to attract, retain and serve our customers are dependent in part upon the reliable performance of our products and network infrastructure.

Our brand, reputation and ability to attract, retain and serve our customers are dependent in part upon the reliable performance of our products and network infrastructure. We have experienced, and may in the future experience, disruptions, outages and other performance problems due to a variety of factors, including infrastructure changes, human or software errors, capacity constraints and fraud or security attacks. In some instances, we may not be able to identify the cause or causes of these performance problems within an acceptable period of time.

We utilize third-party data centers located in Boston, Massachusetts, in addition to operating and maintaining certain elements of our own network infrastructure. We also utilize Amazon Web Services for our InsightIDR, InsightUBA and Logentries infrastructure. Some elements of this complex system are operated by third parties that we do not control and that could require significant time to replace. We expect this dependence on third parties to continue. More specifically, certain of our products, in particular our Nexpose managed service, InsightIDR, InsightUBA and Logentries products, are hosted on Amazon Web Services, which provides us with computing and storage capacity. Interruptions in our systems or the third-party systems on which we rely, whether due to system failures, computer viruses, physical or electronic break-ins, or other factors, could affect the security or availability of our products, network infrastructure and website.

Prolonged delays or unforeseen difficulties in connection with adding capacity or upgrading our network architecture when required may cause our service quality to suffer. Problems with the reliability or security of our systems could harm our reputation. Damage to our reputation and the cost of remedying these problems could negatively affect our business, financial condition, and operating results.

Additionally, our existing data center facilities and third-party hosting providers have no obligations to renew their agreements with us on commercially reasonable terms or at all, and certain of the agreements governing these relationships may be terminated by either party at any time. If we are unable to maintain or renew our agreements with these providers on commercially reasonable terms or if in the future we add additional data center facilities or third-party hosting providers, we may experience costs or downtime as we transition our operations.

Any disruptions or other performance problems with our products could harm our reputation and business and may damage our customers’ businesses. Interruptions in our service delivery might reduce our revenue, cause us to issue credits to customers, subject us to potential liability and cause customers to not renew their purchases or our products.

 

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If we fail to manage our operations infrastructure, our customers may experience service outages and/or delays.

Our future growth is dependent upon our ability to continue to meet the expanding needs of our customers and to attract new customers. As existing customers gain more experience with our products, they may broaden their reliance on our products, which will require that we expand our operations infrastructure. We also seek to maintain excess capacity in our operations infrastructure to facilitate the rapid provision of new customer deployments. In addition, we need to properly manage our technological operations infrastructure in order to support changes in hardware and software parameters and the evolution of our products, all of which require significant lead time. If we do not accurately predict our infrastructure requirements, our existing customers may experience service outages that may subject us to financial penalties, financial liabilities and customer losses. If our operations infrastructure fails to keep pace with increased sales, customers may experience delays as we seek to obtain additional capacity, which could adversely affect our reputation and our revenue.

If our products fail to help our customers achieve and maintain compliance with regulations and/or industry standards, our revenue and operating results could be harmed.

We generate a portion of our revenue from our threat exposure management offerings that help organizations achieve and maintain compliance with regulations and industry standards both domestically and internationally. For example, many of our customers subscribe to our threat exposure management offerings to help them comply with the security standards developed and maintained by the Payment Card Industry Security Standards Council, or the PCI Council, which apply to companies that process, transmit or store cardholder data. In addition, our threat exposure management offerings are used by customers in the health care industry to help them comply with numerous federal and state laws and regulations related to patient privacy. In particular, the Health Insurance Portability and Accountability Act of 1996, or HIPAA, and the 2009 Health Information Technology for Economic and Clinical Health Act include privacy standards that protect individual privacy by limiting the uses and disclosures of individually identifiable health information and implementing data security standards. The foregoing and other state, federal and international legal and regulatory regimes may affect our customers’ requirements for, and demand for, our products and professional services. Governments and industry organizations, such as the PCI Council, may also adopt new laws, regulations or requirements, or make changes to existing laws or regulations, that could impact the demand for, or value of, our products. If we are unable to adapt our products to changing legal and regulatory standards or other requirements in a timely manner, or if our products fail to assist with, or expedite, our customers’ cyber security defense and compliance efforts, our customers may lose confidence in our products and could switch to products offered by our competitors, or threaten or bring legal actions against us. In addition, if laws, regulations or standards related to data security, vulnerability management and other IT security and compliance requirements are relaxed or the penalties for non-compliance are changed in a manner that makes them less onerous, our customers may view government and industry regulatory compliance as less critical to their businesses, and our customers may be less willing to purchase our products. In any of these cases, our revenue and operating results could be harmed.

In addition, government and other customers may require our products to comply with certain privacy, security or other certifications and standards. If our products are late in achieving or fail to achieve or maintain compliance with these certifications and standards, or our competitors achieve compliance with these certifications and standards, we may be disqualified from selling our products to such customers, or may otherwise be at a competitive disadvantage, either of which would harm our business, results of operations, and financial condition.

If our customers are unable to implement our products successfully, customer perceptions of our offerings may be impaired or our reputation and brand may suffer.

Our products are deployed in a wide variety of IT environments, including large-scale, complex infrastructures. Some of our customers have experienced difficulties implementing our products in the past and may experience

 

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implementation difficulties in the future. If our customers are unable to implement our products successfully, customer perceptions of our offerings may be impaired or our reputation and brand may suffer.

In addition, in order for our products to achieve their functional potential, our products must effectively integrate into our customers’ IT infrastructures, which have different specifications, utilize varied protocol standards, deploy products from multiple different vendors and contain multiple layers of products that have been added over time. Our customers’ IT infrastructures are also dynamic, with a myriad of devices and endpoints entering and exiting the customers’ IT systems on a regular basis, and our products must be able to effectively adapt to and track these changes.

Any failure by our customers to appropriately implement our products or any failure of our products to effectively integrate and operate within our customers’ IT infrastructures could result in customer dissatisfaction, impact the perceived reliability of our products, result in negative press coverage, negatively affect our reputation and harm our financial results.

The continued utility of Metasploit depends in part on the continued contributions from security researchers.

Our Metasploit product relies on information provided by an active community of security researchers who contribute new exploits, attacks and vulnerabilities. We expect that the continued contributions from these third parties will both enhance the robustness of Metasploit and also support our sales and marketing efforts. However, to the extent that the information provided by these third parties is inaccurate or malicious, the potential for false indications of security vulnerabilities and susceptibility to attack increases, which could adversely impact market acceptance of our products and professional services and could result in negative publicity, loss of customers and sales and increased costs to remedy any problem. Further, to the extent that our community of third parties is reduced in size or participants become less active, we may lose valuable insight into the dynamic threat landscape and our ability to quickly respond to new exploits, attacks and vulnerabilities may be reduced.

Recent and future acquisitions could disrupt our business and harm our financial condition and operating results.

In order to remain competitive, we have in the past and may in the future seek to acquire additional businesses, products or technologies. The environment for acquisitions in our industry is very competitive and acquisition candidate purchase prices will likely exceed what we would prefer to pay. We also may not find suitable acquisition candidates, and acquisitions we complete may be unsuccessful.

Achieving the anticipated benefits of future acquisitions will depend in part upon whether we can integrate acquired operations, products and technology in a timely and cost-effective manner. For example, in October 2015, we acquired RevelOps, Inc. (d/b/a Logentries). The Logentries acquisition is intended to provide us with machine data search, forensics, and compliance capabilities that complement and build upon our current offerings. The integration process of a new business or technology, such as Logentries, requires, among other things, coordination of administrative, sales and marketing, accounting and finance functions, and expansion of information and management systems. Integration of Logentries or any future acquisition may prove to be difficult due to the necessity of coordinating geographically separate organizations and integrating personnel with disparate business backgrounds and accustomed to different corporate cultures. The acquisition and integration processes are complex, expensive and time consuming, and may cause an interruption of, or loss of momentum in, product development and sales activities and operations of both companies. Further, we may be unable to retain key personnel of an acquired company following the acquisition, including certain employees which we acquired in connection with our acquisition of Logentries. If we are unable to effectively execute acquisitions, our business, financial condition and operating results could be adversely affected.

In addition, we may only be able to conduct limited due diligence on an acquired company’s operations. Following an acquisition, we may be subject to unforeseen liabilities arising from an acquired company’s past or

 

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present operations and these liabilities may be greater than the warranty and indemnity limitations that we negotiate. Any unforeseen liability that is greater than these warranty and indemnity limitations could have a negative impact on our financial condition.

We rely on third-party channel partners to generate a substantial amount of our revenue.

Our success is dependent in part upon establishing and maintaining relationships with a variety of channel partners that we utilize to extend our geographic reach and market penetration. We anticipate that we will continue to rely on these partners in order to help facilitate sales of our offerings as part of larger purchases in the United States and to grow our business internationally. For 2015, 2014 and 2013, we derived approximately 39%, 41% and 38% respectively, of our revenue from sales of products and professional services through channel partners, and the percentage of revenue derived from channel partners may increase in future periods. Our agreements with our channel partners are non-exclusive and do not prohibit them from working with our competitors or offering competing solutions, and some of our channel partners may have more established relationships with our competitors. If our channel partners choose to place greater emphasis on products of their own or those offered by our competitors or do not effectively market and sell our products and professional services, our ability to grow our business and sell our products and professional services, particularly in key international markets, may be adversely affected. In addition, our failure to recruit additional channel partners, or any reduction or delay in their sales of our products and professional services or conflicts between channel sales and our direct sales and marketing activities may harm our results of operations. Finally, even if we are successful, our relationships with channel partners may not result in greater customer usage of our products and professional services or increased revenue.

Failure to maintain high-quality customer support could have a material adverse effect on our business.

Once our products are deployed within our customers’ networks, our customers depend on our technical and other customer support services to resolve any issues relating to the implementation and maintenance of our products. If we do not effectively assist our customers in deploying our products, help our customers quickly resolve post-deployment issues or provide effective ongoing support, our ability to renew or sell additional products or professional services to existing customers would be adversely affected and our reputation with potential customers could be damaged. Further, to the extent that we are unsuccessful in hiring, training and retaining adequate technical and customer success personnel, our ability to provide adequate and timely support to our customers will be negatively impacted, and our customers’ satisfaction with our offerings will be adversely affected.

We rely on third-party software to operate certain functions of our business.

We rely on software vendors to operate certain critical functions of our business, including financial management and human resource management. If these services become unavailable due to extended outages or interruptions or because they are no longer available on commercially reasonable terms or prices, our expenses could increase, our ability to manage our finances could be interrupted and our processes for managing sales of our solutions and supporting our customers could be impaired until equivalent services, if available, are identified, obtained and integrated, all of which could harm our business.

We use third-party software and data that may be difficult to replace or that may cause errors or failures of our solutions, which could lead to lost customers or harm to our reputation and our operating results.

We license third-party software and security and compliance data from various third parties that are used in our solutions in order to deliver our offerings. In the future, this software or data may not be available to us on commercially reasonable terms, or at all. Any loss of the right to use any of this software or data could result in delays in the provisioning of our offerings until equivalent technology or data is either developed by us, or, if available, is identified, obtained and integrated, which could harm our business. In addition, any errors or defects in or failures of this third-party software could result in errors or defects in our products or cause our products to

 

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fail, which could harm our business and be costly to correct. Many of these providers attempt to impose limitations on their liability for such errors, defects or failures, and if enforceable, we may have additional liability to our customers or third-party providers that could harm our reputation and increase our operating costs.

We will need to maintain our relationships with third-party software and data providers, and to obtain software and data from such providers that do not contain errors or defects. Any failure to do so could adversely impact our ability to deliver effective solutions to our customers and could harm our operating results.

Our products contain third-party open source software components, and our failure to comply with the terms of the underlying open source software licenses could restrict our ability to sell our products.

Our products contain software licensed to us by third parties under so-called “open source” licenses, including the GNU General Public License, or GPL, the GNU Lesser General Public License, or LGPL, the BSD License, the Apache License and others. From time to time, there have been claims against companies that distribute or use open source software in their products and services, asserting that such open source software infringes the claimants’ intellectual property rights. We could be subject to suits by parties claiming that what we believe to be licensed open source software infringes their intellectual property rights. Use and distribution of open source software may entail greater risks than use of third-party commercial software, as open source licensors generally do not provide warranties or other contractual protections regarding infringement claims or the quality of the code. In addition, certain open source licenses require that source code for software programs that are subject to the license be made available to the public and that any modifications or derivative works to such open source software continue to be licensed under the same terms.

Although we monitor our use of open source software in an effort both to comply with the terms of the applicable open source licenses and to avoid subjecting our products to conditions we do not intend, the terms of many open source licenses have not been interpreted by U.S. courts, and there is a risk that these licenses could be construed in a way that could impose unanticipated conditions or restrictions on our ability to commercialize our products. The terms of certain open source licenses require us to release the source code of our applications and to make our applications available under those open source licenses if we combine or distribute our applications with open source software in a certain manner. In the event that portions of our applications are determined to be subject to an open source license, we could be required to publicly release the affected portions of our source code, re-engineer all, or a portion of, those applications or otherwise be limited in the licensing of our applications. Disclosing our proprietary source code could allow our competitors to create similar products with lower development effort and time and ultimately, could result in a loss of sales for us. Disclosing the source code of our proprietary software could also make it easier for cyber attackers and other third parties to discover vulnerabilities in or to defeat the protections of our products, which could result in our products failing to provide our customers with the security they expect. Any of these events could have a material adverse effect on our business, operating results and financial condition.

Our technology alliance partnerships expose us to a range of business risks and uncertainties that could have a material adverse impact on our business and financial results.

We have entered, and intend to continue to enter, into technology alliance partnerships with third parties to support our future growth plans, including with certain of our actual or potential competitors. For example, through these technology alliance partnerships, we integrate with certain third-party application program interfaces, or APIs, which enhance our data collection capabilities in our customers’ IT environments. If these third parties no longer allow us to integrate with their APIs, or if we determine not to maintain these integrations, the functionality of our products may be reduced and our products may not be as marketable to certain potential customers. Technology alliance partnerships require significant coordination between the parties involved, particularly if a partner requires that we integrate its products with our products. Further, we have invested and will continue to invest significant time, money and resources to establish and maintain relationships with our technology alliance partners, but we have no assurance that any particular relationship will continue for any

 

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specific period of time, result in new offerings that we can effectively commercialize or result in enhancements to our existing offerings. In addition, while we believe that entering into technology alliance partnerships with certain of our actual or potential competitors is currently beneficial to our competitive position in the market, such partnerships may also give our competitors insight into our offerings that they may not otherwise have, thereby allowing them to compete more effectively against us.

Our sales cycle may be unpredictable.

The timing of sales of our offerings is difficult to forecast because of the length and unpredictability of our sales cycle, particularly with large enterprises and with respect to certain of our products, such as InsightUBA. We sell our products primarily to IT departments that are managing a growing set of user and compliance demands, which has increased the complexity of customer requirements to be met and confirmed during the sales cycle and prolonged our sales cycle. Further, the length of time that potential customers devote to their testing and evaluation, contract negotiation and budgeting processes varies significantly, depending on the size of the organization and nature of the product or professional service under consideration. For example, the length of the sales cycle for our threat exposure management offerings typically ranges from one to six months, while sales of our InsightUBA product can exceed twelve months because input from an organization’s senior management is often required before a sale of these products are consummated and because InsightUBA has only been broadly commercially available since 2014. In addition, we might devote substantial time and effort to a particular unsuccessful sales effort, and as a result, we could lose other sales opportunities or incur expenses that are not offset by an increase in revenue, which could harm our business.

A portion of our revenue is generated by sales to government entities, which are subject to a number of challenges and risks.

Selling to government entities can be highly competitive, expensive and time consuming, and often requires significant upfront time and expense without any assurance that we will win a sale. Government demand and payment for our products and professional services may also be impacted by public sector budgetary cycles and funding authorizations, with funding reductions or delays adversely affecting public sector demand for our offerings. Government entities also have heightened sensitivity surrounding the purchase of cyber security solutions due to the critical importance of their IT infrastructures, the nature of the information contained within those infrastructures and the fact that they are highly-visible targets for cyber attacks. Accordingly, increasing sales of our products and professional services to government entities may be more challenging than selling to commercial organizations. Further, in the course of providing our products and professional services to government entities, our employees and those of our channel partners may be exposed to sensitive government information. Any failure by us or our channel partners to safeguard and maintain the confidentiality of such information could subject us to liability and reputational harm, which could materially and adversely affect our results of operations and financial performance.

We are exposed to fluctuations in currency exchange rates, which could negatively affect our financial condition and results of operations.

Our reporting currency is the U.S. dollar and we generate a majority of our revenue in U.S. dollars. However, for the year ended December 31, 2015, we incurred approximately 15% of our expenses outside of the United States in foreign currencies, primarily the pound sterling (GBP), principally with respect to salaries and related personnel expenses associated with our sales and research and development operations. Additionally, for the year ended December 31, 2015, approximately 5% of our revenue was generated in foreign currencies. Accordingly, changes in exchange rates may have an adverse effect on our business, operating results and financial condition. The exchange rate between the U.S. dollar and foreign currencies has fluctuated substantially in recent years and may continue to fluctuate substantially in the future. The results of our operations may be adversely affected by foreign exchange fluctuations. To date, we have not engaged in any hedging strategies, and any such strategies,

 

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such as forward contracts, options and foreign exchange swaps related to transaction exposures that we may implement to mitigate this risk may not eliminate our exposure to foreign exchange fluctuations.

Changes in financial accounting standards may cause an adverse impact our reported results of operations.

A change in accounting standards or practices, particular with respect to revenue recognition, could harm our operating results and may even affect our reporting of transactions completed before the change is effective. New accounting pronouncements and varying interpretations of accounting pronouncements have occurred and may occur in the future. Changes to existing rules or the questioning of current practices may harm our operating results or the way we conduct our business.

Our business is subject to the risks of earthquakes, fire, power outages, floods and other catastrophic events, and to interruption by manmade problems such as terrorism.

A significant natural disaster, such as an earthquake, fire or a flood, or a significant power outage could have a material adverse impact on our business, operating results and financial condition. In addition, natural disasters could affect our channel partners’ ability to perform services for us on a timely basis. In the event we or our channel partners are hindered by any of the events discussed above, our ability to provide our products or professional services to customers could be delayed.

In addition, our facilities and those of our third-party data centers and hosting providers are vulnerable to damage or interruption from human error, intentional bad acts, pandemics, earthquakes, hurricanes, floods, fires, war, terrorist attacks, power losses, hardware failures, systems failures, telecommunications failures and similar events. The occurrence of a natural disaster, power failure or an act of terrorism, vandalism or other misconduct, a decision by a third party to close a facility on which we rely without adequate notice, or other unanticipated problems could result in lengthy interruptions in provision or delivery of our products, potentially leaving our customers vulnerable to cyber attacks. The occurrence of any of the foregoing events could damage our systems and hardware or could cause them to fail completely, and our insurance may not cover such events or may be insufficient to compensate us for the potentially significant losses, including the potential harm to the future growth of our business, that may result from interruptions in our service as a result of system failures.

All of the aforementioned risks may be exacerbated if our disaster recovery plans or the disaster recovery plans established for our third-party data centers and hosting providers prove to be inadequate. To the extent that any of the above results in delayed or reduced customer sales, our business, financial condition and results of operations could be adversely affected.

We may require additional capital to support business growth, and this capital might not be available on acceptable terms, if at all.

We intend to continue to make investments to support our business growth and may require additional funds to respond to business challenges, including the need to develop new features or enhance our products, improve our operating infrastructure or acquire complementary businesses and technologies. Accordingly, we may need to engage in equity or debt financings to secure additional funds. If we raise additional funds through future issuances of equity or convertible debt securities, our existing stockholders could suffer significant dilution, and any new equity securities we issue could have rights, preferences and privileges superior to those of holders of our common stock. Any debt financing that we may secure in the future could involve restrictive covenants relating to our capital raising activities and other financial and operational matters, which may make it more difficult for us to obtain additional capital and to pursue business opportunities, including potential acquisitions. We may not be able to obtain additional financing on terms favorable to us, if at all. If we are unable to obtain adequate financing or financing on terms satisfactory to us when we require it, our ability to continue to support our business growth and to respond to business challenges could be significantly impaired, and our business may be adversely affected.

 

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Risks Related to Government Regulation, Data Collection, Intellectual Property and Litigation

Failure to comply with governmental laws and regulations could harm our business.

Our business is subject to regulation by various federal, state, local and foreign governments. In certain jurisdictions, these regulatory requirements may be more stringent than those in the United States. Noncompliance with applicable regulations or requirements could subject us to investigations, sanctions, mandatory product recalls, enforcement actions, disgorgement of profits, fines, damages, civil and criminal penalties, injunctions or other collateral consequences. If any governmental sanctions are imposed, or if we do not prevail in any possible civil or criminal litigation, our business, results of operations, and financial condition could be materially adversely affected. In addition, responding to any action will likely result in a significant diversion of management’s attention and resources and an increase in professional fees. Enforcement actions and sanctions could harm our business, reputation, results of operations and financial condition.

We are subject to governmental export and import controls that could impair our ability to compete in international markets and/or subject us to liability if we are not in compliance with applicable laws.

Like other U.S.-based IT security products, our products are subject to U.S. export control and import laws and regulations, including the U.S. Export Administration Regulations and various economic and trade sanctions regulations administered by the U.S. Treasury Department’s Office of Foreign Assets Control. Exports of these products must be made in compliance with these laws and regulations. If we were to fail to comply with these laws and regulations, we and certain of our employees could be subject to substantial civil and criminal penalties, including fines for our company and responsible employees or managers, and, in extreme cases, incarceration of responsible employees and managers and the possible loss of export privileges. Complying with export control laws and regulations, including obtaining the necessary licenses or authorizations, for a particular sale may be time-consuming, is not guaranteed and may result in the delay or loss of sales opportunities. Changes in export or import laws and regulations, shifts in the enforcement or scope of existing laws and regulations, or changes in the countries, governments, persons, products or services targeted by such laws and regulations, could also result in decreased use of our products by, or in our decreased ability to export or sell our products to, existing or potential customers. A decreased use of our products or limitation on our ability to export or sell our products could adversely affect our business, financial condition and results of operations.

We also incorporate encryption technology into our products. These encryption products may be exported outside of the United States only with the required export authorizations, including by a license, a license exception or other appropriate government authorizations, including the filing of an encryption registration or product classification request. We previously deployed certain of our Metasploit products prior to obtaining the appropriate export authorizations. As such, we did not fully comply with applicable encryption controls in the U.S. Export Administration Regulations. Further, U.S. export control laws and economic sanctions prohibit the shipment of certain products and services to U.S. embargoed or sanctioned countries, governments or persons. Although we take precautions to prevent our products from being provided to those subject to U.S. sanctions, such measures may be circumvented. We are aware of previous exports in the form of downloads of certain of our Metasploit products by persons and organizations that appear to be located in countries that are the subject of U.S. embargoes, and by certain other persons and organizations without the requisite export authorizations. In September 2014, we initiated and filed a voluntary self-disclosure with the U.S. Department of Commerce’s Bureau of Industry and Security, or BIS, concerning our previous failure to obtain required authorizations for certain exports, as well as historical exports of free and trial software to embargoed countries. In March and August 2015, we filed supplements to the voluntary self-disclosure to BIS containing additional information regarding unauthorized exports. Also in March 2015, we filed a voluntary self-disclosure with the U.S. Department of Treasury’s Office of Foreign Assets Control, or OFAC, concerning exports of free and trial versions of our Metasploit products to embargoed countries, specifically Cuba, Iran, Sudan and Syria. As these transactions involved free downloads of our software, we did not derive any revenue from such transactions. On May 22, 2015, OFAC determined not to pursue a civil monetary penalty against us and issued us a Cautionary Letter to resolve our voluntary self-disclosure regarding the free downloads in embargoed countries. The

 

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voluntary self-disclosure submitted to BIS currently remains under review, and we are cooperating with BIS. It is possible that the matters discussed in the BIS voluntary self-disclosure could result in monetary penalties or other penalties being assessed against us.

In addition, various countries regulate the import and domestic use of certain encryption technology, including through import permitting and licensing requirements, and have enacted laws that could limit our ability to distribute our products or could limit our customers’ ability to implement our products in those countries.

Encryption products and the underlying technology may also be subject to export control restrictions. Governmental regulation of encryption technology and regulation of imports or exports of encryption products, or our failure to obtain required import or export approval for our products, when applicable, could harm our international sales and adversely affect our revenue. Compliance with applicable laws and regulations regarding the export and import of our products, including with respect to new products or changes in existing products, may create delays in the introduction of our products in international markets, prevent our customers with international operations from deploying our products globally or, in some cases, could prevent the export or import of our products to certain countries, governments, entities or persons altogether.

Finally, there are currently multinational efforts underway as part of the Wassenaar Arrangement on Export Controls for Conventional Arms and Dual-Use Goods and Technologies, or the Wassenaar Arrangement, to impose additional restrictions on certain cyber security products. These controls are not currently in effect in the United States and may undergo substantial modification before becoming effective. To implement the controls under the Wassenaar Arrangement in the United States, BIS would have to amend the EAR. Such amendments could include changes that impose new licensing, approval and other requirements on our commercial Metasploit products and thereby put us at a disadvantage in competing for international sales. We are closely monitoring the potential implications of the Wassenaar Arrangement on the commercial versions of Metasploit, and are actively working with BIS and other U.S. government stakeholders in connection with the implementation of the controls under the Wassenaar Arrangement.

Because our products collect and store user and related information, domestic and international privacy and cyber security concerns, and other laws and regulations, could result in additional costs and liabilities to us or inhibit sales of our products.

We, and our customers, are subject to a number of domestic and international laws and regulations that apply to online services and the internet generally. These laws, rules and regulations address a range of issues including data privacy and cyber security, and restrictions or technological requirements regarding the collection, use, storage, protection, retention or transfer of data. The regulatory framework for online services, data privacy and cyber security issues worldwide can vary substantially from jurisdiction to jurisdiction, is rapidly evolving and is likely to remain uncertain for the foreseeable future. Many federal, state and foreign government bodies and agencies have adopted or are considering adopting laws, rules and regulations regarding the collection, use, storage and disclosure of information, web browsing and geolocation data collection, data analytics, cyber security and breach notification procedures. Interpretation of these laws, rules and regulations and their application to our products and professional services in the U.S. and foreign jurisdictions is ongoing and cannot be fully determined at this time.

In the United States, these include rules and regulations promulgated under the authority of the Federal Trade Commission, the Electronic Communications Privacy Act, Computer Fraud and Abuse Act, HIPAA, the Gramm Leach Bliley Act and state breach notification laws, as well as regulator enforcement positions and expectations reflected in federal and state regulatory actions, settlements, consent decrees and guidance documents. Internationally, virtually every jurisdiction in which we operate has established its own data security and privacy legal frameworks with which we, or our customers, must comply, including the Data Protection Directive established in the European Union and the Federal Data Protection Act recently implemented in Germany.

 

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Further, many federal, state and foreign government bodies and agencies have introduced, and are currently considering, additional laws and regulations. If passed, we will likely incur additional expenses and costs associated with complying with such laws.

In addition, to facilitate the transfer of both customer and personnel data from the European Union to the United States, we signed up to the EU-U.S. Safe Harbor Framework, which required U.S.-based companies to provide assurance that they are adhering to relevant European standards for data protection. On October 6, 2015, the Court of Justice of the European Union, or CJEU, invalidated the EU-U.S. Safe Harbor Framework. In light of CJEU’s decision, we are reviewing our current operations to ensure that our EU-U.S. data transfers comply with EU data protection laws. The available legal basis for such transfers will depend on a number of factors, including, for example, the type of data and the European Economic Area country from which the data is being transferred, and may require that we obtain consent from the customer or employee whose data is being transferred or include in our agreements with the applicable customer or European Economic Area employing entity the standard contractual clauses that have been approved by the EU Commission. These actions may involve substantial time and expense; for example, if we enter into the standard contractual clauses with a customer, in some EU countries, including Belgium and Spain, executed clauses need to be lodged with or notified to the country’s data protection authority prior to the transfer of any data, and in other countries, including Austria, France, Ireland, Romania and Slovenia, the clauses need to be approved by the country’s data protection authority prior to use. The Article 29 Working Party, a body comprising representatives from data protection authorities of all the EU countries that works to harmonize the application of data protection rules throughout the EU, indicated after the CJEU’s ruling on October 6, 2015 that it would allow a grace period until the end of January 2016 to implement alternatives. On February 2, 2016, the EU Commission announced that it had reached agreement with the United States regarding a replacement regime for EU-U.S. transfers referred to as the Privacy Shield. It is anticipated that the Privacy Shield will be ratified by the EU in the next three to four months. We are reviewing all of the transfer options currently available and working to secure an alternative legal means to support our data transfers. However, as we have not yet put in place an alternative framework, the EU data protection authorities could impose a number of different sanctions on us until we do, including fines and, ultimately, a prohibition on transfers.

In addition to government regulation, privacy advocates and industry groups may propose new and different self-regulatory standards that either legally or contractually apply to us. Because the interpretation and application of privacy and data protection laws are still uncertain, it is possible that these laws may be interpreted and applied in a manner that is inconsistent with our existing practices or the features of our products. We may also be subject to claims of liability or responsibility for the actions of third parties with whom we interact or upon whom we rely in relation to various services, including but not limited to vendors and business partners. If so, in addition to the possibility of fines, lawsuits and other claims, we could be required to fundamentally change our business activities and practices or modify our products, which could have an adverse effect on our business. Any inability to adequately address privacy concerns, even if unfounded, or comply with applicable privacy or data protection laws, regulations and policies, could result in additional cost and liability to us, damage our reputation, inhibit sales and adversely affect our business.

The costs of compliance with, and other burdens imposed by, the laws, rules, regulations and policies that are applicable to the businesses of our customers may limit the use and adoption of, and reduce the overall demand for, our software. Privacy or cyber security concerns, whether valid or not valid, may inhibit market adoption of our products particularly in certain industries and foreign countries.

Further, there are active legislative discussions regarding the implementation of laws or regulations that could restrict the manner in which security research is conducted and that could restrict or possibly bar the conduct of penetration testing and the use of exploits, which are an essential component of our Metasploit product and our business strategy more generally. Our failure to comply with existing laws, rules or regulations, changes to existing laws or their interpretation, or the imposition of new laws, rules or regulations, could have a material and adverse impact on our business, results of operations, and financial condition.

 

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Failure to protect our proprietary technology and intellectual property rights could substantially harm our business and operating results.

Our future success and competitive position depend in part on our ability to protect our intellectual property and proprietary technologies. To safeguard these rights, we rely on a combination of patent, trademark, copyright and trade secret laws and contractual protections in the United States and other jurisdictions, all of which provide only limited protection and may not now or in the future provide us with a competitive advantage.

As of December 31, 2015, we had five issued patents and 17 patent applications pending in the United States relating to our products. We cannot assure you that any patents will issue from any patent applications, that patents that issue from such applications will give us the protection that we seek or that any such patents will not be challenged, invalidated, or circumvented. Any patents that may issue in the future from our pending or future patent applications may not provide sufficiently broad protection and may not be enforceable in actions against alleged infringers. We have registered the “Rapid7,” “Nexpose” and “Metasploit” names and logos in the United States and certain other countries. We have registrations and/or pending applications for additional marks in the United States and other countries; however, we cannot assure you that any future trademark registrations will be issued for pending or future applications or that any registered trademarks will be enforceable or provide adequate protection of our proprietary rights. We also license software from third parties for integration into our products, including open source software and other software available on commercially reasonable terms. We cannot assure you that such third parties will maintain such software or continue to make it available.

In order to protect our unpatented proprietary technologies and processes, we rely on trade secret laws and confidentiality agreements with our employees, consultants, channel partners, vendors and others. Despite our efforts to protect our proprietary technology and trade secrets, unauthorized parties may attempt to misappropriate, reverse engineer or otherwise obtain and use them. In addition, others may independently discover our trade secrets, in which case we would not be able to assert trade secret rights, or develop similar technologies and processes. Further, the contractual provisions that we enter into may not prevent unauthorized use or disclosure of our proprietary technology or intellectual property rights and may not provide an adequate remedy in the event of unauthorized use or disclosure of our proprietary technology or intellectual property rights. Moreover, policing unauthorized use of our technologies, trade secrets and intellectual property is difficult, expensive and time-consuming, particularly in foreign countries where the laws may not be as protective of intellectual property rights as those in the United States and where mechanisms for enforcement of intellectual property rights may be weak. We may be unable to determine the extent of any unauthorized use or infringement of our solutions, technologies or intellectual property rights.

From time to time, legal action by us may be necessary to enforce our patents and other intellectual property rights, to protect our trade secrets, to determine the validity and scope of the intellectual property rights of others or to defend against claims of infringement or invalidity. Such litigation could result in substantial costs and diversion of resources and could negatively affect our business, operating results and financial condition.

Assertions by third parties of infringement or other violations by us of their intellectual property rights, whether or not correct, could result in significant costs and harm our business and operating results.

Patent and other intellectual property disputes are common in our industry. We are currently involved in a lawsuit brought by a non-practicing entity alleging that we have infringed upon a now-expired patent held by such entity and we may, from time to time, be involved in other such disputes in the ordinary course of our business. Some companies, including some of our competitors, own large numbers of patents, copyrights and trademarks, which they may use to assert claims against us. Third parties have in the past and may in the future assert claims of infringement, misappropriation or other violations of intellectual property rights against us. They may also assert such claims against our customers or channel partners, whom we typically indemnify against claims that our solutions infringe, misappropriate or otherwise violate the intellectual property rights of third parties. As the numbers of products and competitors in our market increase and overlaps occur, claims of infringement, misappropriation and other violations of intellectual property rights may increase. Any claim of

 

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infringement, misappropriation or other violation of intellectual property rights by a third party, even those without merit, could cause us to incur substantial costs defending against the claim and could distract our management from our business.

The patent portfolios of our most significant competitors are larger than ours. This disparity may increase the risk that they may sue us for patent infringement and may limit our ability to counterclaim for patent infringement or settle through patent cross-licenses. In addition, future assertions of patent rights by third parties, and any resulting litigation, may involve patent holding companies or other adverse patent owners who have no relevant product revenues and against whom our own patents may therefore provide little or no deterrence or protection. There can be no assurance that we will not be found to infringe or otherwise violate any third-party intellectual property rights or to have done so in the past.

An adverse outcome of a dispute may require us to:

 

   

pay substantial damages, including treble damages, if we are found to have willfully infringed a third party’s patents or copyrights;

 

   

cease making, licensing or using solutions that are alleged to infringe or misappropriate the intellectual property of others;

 

   

expend additional development resources to attempt to redesign our solutions or otherwise develop non-infringing technology, which may not be successful;

 

   

enter into potentially unfavorable royalty or license agreements in order to obtain the right to use necessary technologies or intellectual property rights; and

 

   

indemnify our partners and other third parties.

In addition, royalty or licensing agreements, if required or desirable, may be unavailable on terms acceptable to us, or at all, and may require significant royalty payments and other expenditures. Some licenses may also be non-exclusive, and therefore, our competitors may have access to the same technology licensed to us. Any of the foregoing events could seriously harm our business, financial condition and results of operations.

Our operating results may be harmed if we are required to collect sales and use or other related taxes for our products and professional services in jurisdictions where we have not historically done so.

Taxing jurisdictions, including state, local and foreign taxing authorities, have differing rules and regulations governing sales and use or other taxes, and these rules and regulations are subject to varying interpretations that may change over time. In particular, significant judgment is required in evaluating our tax positions and our worldwide provision for taxes. While we believe that we are in material compliance with our obligations under applicable taxing regimes, one or more states, localities or countries may seek to impose additional sales or other tax collection obligations on us, including for past sales. It is possible that we could face sales tax audits and that such audits could result in tax-related liabilities for which we have not accrued. For example, we are currently subject to audits by the Commonwealth of Massachusetts. A successful assertion that we should be collecting additional sales or other taxes on our offerings in jurisdictions where we have not historically done so and do not accrue for sales taxes could result in substantial tax liabilities for past sales, discourage customers from purchasing our offerings or otherwise harm our business and operating results.

In addition, our tax obligations and effective tax rates could be adversely affected by changes in the relevant tax, accounting and other laws, regulations, principles and interpretations, including those relating to income tax nexus, by recognizing tax losses or lower than anticipated earnings in jurisdictions where we have lower statutory rates and higher than anticipated earnings in jurisdictions where we have higher statutory rates, by changes in foreign currency exchange rates, or by changes in the valuation of our deferred tax assets and liabilities. Although we believe our tax estimates are reasonable, the final determination of any tax audits or litigation could be materially different from our historical tax provisions and accruals, which could have a material adverse effect on our operating results or cash flows in the period or periods for which a determination is made.

 

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Our intercompany relationships are subject to complex transfer pricing regulations, which may be challenged by taxing authorities.

We generally conduct our international operations through wholly-owned subsidiaries and report our taxable income in various jurisdictions worldwide based upon our business operations in those jurisdictions. Our intercompany relationships are and will continue to be subject to complex transfer pricing regulations administered by taxing authorities in various jurisdictions. The relevant taxing authorities may disagree with our determinations as to the income and expenses attributable to specific jurisdictions. If such a disagreement were to occur, and our position were not sustained, we could be required to pay additional taxes, interest and penalties, which could result in one-time tax charges, higher effective tax rates, reduced cash flows and lower overall profitability of our operations.

Our ability to use net operating losses to offset future taxable income may be subject to certain limitations.

As of December 31, 2015, we had federal and state net operating loss carryforwards, or NOLs, of $99.5 million and $71.2 million, respectively, available to offset future taxable income, which expire in various years beginning in 2023 if not utilized. A lack of future taxable income would adversely affect our ability to utilize these NOLs before they expire. Under the provisions of the Internal Revenue Code of 1986, as amended, or the Internal Revenue Code, substantial changes in our ownership may limit the amount of pre-change NOLs that can be utilized annually in the future to offset taxable income. Section 382 of the Internal Revenue Code imposes limitations on a company’s ability to use NOLs if a company experiences a more-than-50-percent ownership change over a three-year testing period. Based upon our analysis as of December 31, 2015, we determined that although a small limitation on our historical NOLs exists, we do not expect this limitation to impair our ability to use our NOLs prior to expiration. However, if changes in our ownership occur in the future, our ability to use our NOLs may be further limited. For these reasons, we may not be able to utilize a material portion of the NOLs, even if we achieve profitability. If we are limited in our ability to use our NOLs in future years in which we have taxable income, we will pay more taxes than if we were able to fully utilize our NOLs. This could adversely affect our operating results and the market price of our common stock.

The enactment of legislation implementing changes in the U.S. taxation of international business activities or the adoption of other tax reform policies could materially impact our financial position and results of operations.

Recent changes to U.S. tax laws, including limitations on the ability of taxpayers to claim and utilize foreign tax credits and the deferral of certain tax deductions until earnings outside of the United States are repatriated to the United States, as well as changes to U.S. tax laws that may be enacted in the future, could impact the tax treatment of our foreign earnings. Due to expansion of our international business activities, any changes in the U.S. taxation of such activities may increase our worldwide effective tax rate and adversely affect our financial condition and operating results.

Risk Related to our Common Stock

The market price of our common stock has been and is likely to continue to be volatile.

The market price of our common stock may be highly volatile and may fluctuate substantially as a result of a variety of factors, some of which are related in complex ways. Since shares of our common stock were sold in our initial public offering, or IPO, in July 2015 at a price of $16.00 per share, our stock price has ranged from an intraday low of $9.05 to an intraday high of $27.45. Factors that may affect the market price of our common stock include:

 

   

actual or anticipated fluctuations in our financial condition and operating results;

 

   

variance in our financial performance from expectations of securities analysts;

 

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changes in the prices of our products and professional services;

 

   

changes in our projected operating and financial results;

 

   

changes in laws or regulations applicable to our products or professional services;

 

   

announcements by us or our competitors of significant business developments, acquisitions or new offerings;

 

   

our involvement in any litigation;

 

   

our sale of our common stock or other securities in the future;

 

   

changes in senior management or key personnel;

 

   

trading volume of our common stock;

 

   

changes in the anticipated future size and growth rate of our market; and

 

   

general economic, regulatory and market conditions.

Recently, the stock markets have experienced extreme price and volume fluctuations that have affected and continue to affect the market prices of equity securities of many companies. These fluctuations have often been unrelated or disproportionate to the operating performance of those companies. Broad market and industry fluctuations, as well as general economic, political, regulatory and market conditions, may negatively impact the market price of our common stock. In the past, companies that have experienced volatility in the market price of their securities have been subject to securities class action litigation. We may be the target of this type of litigation in the future, which could result in substantial costs and divert our management’s attention.

An active public trading market for our common stock may not be sustained.

Prior to the completion of our IPO in July 2015, no public market for our common stock existed. Although our common stock is listed on The NASDAQ Global Market, we cannot assure you that an active public trading market for our common stock will continue to develop or be sustained. If an active market for our common stock does not continue to develop or is not sustained, it may be difficult for investors in our common stock to sell shares without depressing the market price for the shares or to sell the shares at all. An inactive market may also impair our ability to raise capital to continue to fund operations by selling shares and may impair our ability to acquire other companies or technologies by using our shares as consideration.

If securities or industry analysts do not publish research or reports about our business, or publish negative reports about our business, our stock price and trading volume could decline.

The trading market for our common stock will depend, in part, on the research and reports that securities or industry analysts publish about us or our business. We do not have any control over these analysts. If our financial performance fails to meet analyst estimates or one or more of the analysts who cover us downgrade our shares or change their opinion of our shares, our share price would likely decline. If one or more of these analysts cease coverage of our company or fail to regularly publish reports on us, we could lose visibility in the financial markets, which could cause our share price or trading volume to decline.

We do not intend to pay dividends for the foreseeable future and, as a result, your ability to achieve a return on your investment will depend on appreciation in the price of our common stock.

We have never declared or paid any cash dividends on our common stock and do not intend to pay any cash dividends in the foreseeable future. We anticipate that we will retain all of our future earnings for use in the development of our business and for general corporate purposes. Any determination to pay dividends in the future will be at the discretion of our board of directors. Accordingly, investors must rely on sales of their common stock after price appreciation, which may never occur, as the only way to realize any future gains on their investments.

 

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Concentration of ownership among our existing directors, executive officers and holders of 5% or more of our outstanding common stock may prevent minority investors from influencing significant corporate decisions.

As of December 31, 2015, our directors, executive officers and holders of more than 5% of our common stock, some of whom are represented on our board of directors, together with their affiliates, beneficially owned 61% of the voting power of our outstanding capital stock. As a result, these stockholders will be able to determine the outcome of matters submitted to our stockholders for approval. This concentration of ownership by itself may have the effect of delaying, deferring or preventing a change in control of the company, impeding a merger, consolidation, takeover or other business combination involving us, or discouraging a potential acquirer from making a tender offer or otherwise attempting to obtain control, which in turn, could materially and adversely affect the market price of our common stock.

We may invest or spend the proceeds of our IPO in ways with which you may not agree or in ways which may not yield a return.

We anticipate that the remaining net proceeds from our IPO will be used for working capital and other general corporate purposes. We may also use a portion of the remaining net proceeds to acquire complementary businesses, products or technologies. However, we do not have any agreements or commitments for any acquisitions at this time. Our management will have considerable discretion in the application of the net proceeds, and you will not have the opportunity to assess whether the proceeds are being used effectively. The net proceeds may be invested with a view towards long-term benefits for our stockholders and this may not increase our operating results or market value. The failure by our management to apply these funds effectively may adversely affect the return on your investment.

Future sales of our common stock in the public market could cause our share price to decline.

As of December 31, 2015, 41,540,400 shares of our common stock were issued and outstanding. Sales of a substantial number of shares of our common stock in the public market, or the perception that these sales might occur, could depress the market price of our common stock and could impair our ability to raise capital through the sale of additional equity securities. The majority of these shares were acquired prior to our IPO and were subject to lock-up agreements prohibiting holders of these shares from selling any of their shares for a period of 180 days following our IPO. These lock-up agreements have expired and, as a result, a substantial number of our shares are now generally freely tradable, subject, in the case of sales by our affiliates, to the volume limitations and other provisions of Rule 144 under the Securities Act. If holders of these shares sell, or indicate an intent to sell, substantial amounts of our common stock in the public market, the trading price of our common stock could decline significantly.

Additionally, stockholders holding approximately 71% of our common stock outstanding have the right, subject to various conditions and limitations, to request we include their shares of our common stock in registration statements we may file relating to our securities. If the offer and sale of these shares are registered, they will be freely tradable without restriction under the Securities Act. Shares of common stock sold under such registration statements can be freely sold in the public market. In the event such registration rights are exercised and a large number of shares of common stock are sold in the public market, such sales could reduce the trading price of our common stock.

We have filed registration statements on Form S-8 under the Securities Act to register the total number of shares of our common stock that may be issued under our equity incentive plans. In addition, in the future, we may issue common stock or other securities if we need to raise additional capital. The number of new shares of our common stock issued in connection with raising additional capital could constitute a material portion of our then-outstanding shares of our common stock.

 

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We are an “emerging growth company” and we cannot be certain if the reduced disclosure requirements applicable to emerging growth companies will make our common stock less attractive to investors.

We are an “emerging growth company,” as defined in the JOBS Act. For as long as we qualify as an emerging growth company, we intend to take advantage of certain exemptions from various reporting requirements that are applicable to other public companies that are not “emerging growth companies” including, but not limited to, the auditor attestation requirements of Section 404 of the Sarbanes-Oxley Act, reduced disclosure obligations regarding executive compensation in our periodic reports and proxy statements, and exemptions from the requirements of holding a nonbinding advisory vote on executive compensation and stockholder approval of any golden parachute payments not previously approved. We cannot predict if investors will find our common stock less attractive because we will rely on these exemptions and provide reduced disclosure. If some investors find our common stock less attractive as a result, there may be a less active trading market for our common stock and our stock price may be more volatile.

We have and will continue to incur increased costs as a result of being a public company.

As a newly public company, and particularly after we are no longer an “emerging growth company,” we have incurred and we will continue to incur significant legal, accounting and other expenses that we did not incur as a private company. The Sarbanes-Oxley Act, the Dodd-Frank Wall Street Reform and Consumer Protection Act, the listing requirements of the NASDAQ Stock Market and other applicable securities rules and regulations impose various requirements on public companies. We expect that compliance with these requirements will continue to increase certain of our expenses and make some activities more time-consuming than they have been in the past when we were a private company. Such additional costs going forward could negatively affect our financial results.

We are obligated to develop and maintain proper and effective internal controls over financial reporting and any failure to maintain the adequacy of these internal controls may adversely affect investor confidence in our company and, as a result, the value of our common stock.

We are required, pursuant to Section 404 of the Sarbanes-Oxley Act, or Section 404, to furnish a report by management on, among other things, the effectiveness of our internal control over financial reporting for the first fiscal year beginning after the effective date of our IPO. This assessment will need to include disclosure of any material weaknesses identified by our management in our internal control over financial reporting. Our independent registered public accounting firm will not be required to attest to the effectiveness of our internal control over financial reporting until our first annual report required to be filed with the SEC following the date we no longer qualify as an “emerging growth company,” as defined in the JOBS Act. We will be required to disclose significant changes made in our internal control procedures on a quarterly basis.

We have commenced the costly and challenging process of compiling the system and processing documentation necessary to perform the evaluation needed to comply with Section 404, and we may not be able to complete our evaluation, testing and any required remediation in a timely fashion. Our compliance with Section 404 will require that we incur substantial accounting expense and expend significant management efforts. We currently do not have an internal audit group, and we will need to hire additional accounting and financial staff with appropriate public company experience and technical accounting knowledge and compile the system and process documentation necessary to perform the evaluation needed to comply with Section 404.

During the evaluation and testing process of our internal controls, if we identify one or more material weaknesses in our internal control over financial reporting, we will be unable to assert that our internal control over financial reporting is effective. We cannot assure you that there will not be material weaknesses or significant deficiencies in our internal control over financial reporting in the future. Any failure to maintain internal control over financial reporting could severely inhibit our ability to accurately report our financial condition or results of operations. If we are unable to conclude that our internal control over financial reporting is effective, or if our

 

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independent registered public accounting firm determines we have a material weakness or significant deficiency in our internal control over financial reporting, we could lose investor confidence in the accuracy and completeness of our financial reports, the market price of our common stock could decline, and we could be subject to sanctions or investigations by the NASDAQ Stock Market, the SEC or other regulatory authorities. Failure to remedy any material weakness in our internal control over financial reporting, or to implement or maintain other effective control systems required of public companies, could also restrict our future access to the capital markets.

Anti-takeover provisions in our charter documents and under Delaware law could make an acquisition of us more difficult, limit attempts by our stockholders to replace or remove our current management and limit the market price of our common stock.

Provisions in our amended and restated certificate of incorporation and amended and restated bylaws may have the effect of delaying or preventing a change in control or changes in our management. Among other things, our amended and restated certificate of incorporation and amended and restated bylaws include provisions that:

 

   

authorize our board of directors to issue preferred stock without further stockholder action and with voting liquidation, dividend and other rights superior to our common stock;

 

   

require that any action to be taken by our stockholders be effected at a duly called annual or special meeting and not by written consent, and limit the ability of our stockholders to call special meetings;

 

   

establish an advance notice procedure for stockholder proposals to be brought before an annual meeting, including proposed nominations of persons for director nominees;

 

   

establish that our board of directors is divided into three classes, with directors in each class serving three-year staggered terms;

 

   

require the approval of holders of two-thirds of the shares entitled to vote at an election of directors to adopt, amend or repeal our amended and restated bylaws or amend or repeal the provisions of our amended and restated certificate of incorporation regarding the election and removal of directors and the ability of stockholders to take action by written consent or call a special meeting;

 

   

prohibit cumulative voting in the election of directors; and

 

   

provide that vacancies on our board of directors may be filled only by a majority of directors then in office, even though less than a quorum.

These provisions may frustrate or prevent any attempts by our stockholders to replace or remove our current management by making it more difficult for stockholders to replace members of our board of directors, who are responsible for appointing the members of our management. In addition, because we are incorporated in Delaware, we are governed by the provisions of Section 203 of the Delaware General Corporation Law, which generally prohibits a Delaware corporation from engaging in any of a broad range of business combinations with any “interested” stockholder for a period of three years following the date on which the stockholder became an “interested” stockholder. Any of the foregoing provisions could limit could limit the opportunity for our stockholders to receive a premium for their shares of our common stock, and could also affect the price that some investors are willing to pay for our common stock.

Our amended and restated certificate of incorporation designates the Court of Chancery of the State of Delaware as the exclusive forum for certain litigation that may be initiated by our stockholders, which could limit our stockholders’ ability to obtain a favorable judicial forum for disputes with us.

Pursuant to our amended and restated certificate of incorporation, unless we consent in writing to the selection of an alternative forum, the Court of Chancery of the State of Delaware is the sole and exclusive forum for (1) any derivative action or proceeding brought on our behalf, (2) any action asserting a claim of breach of a fiduciary

 

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duty owed by any of our directors, officers or other employees to us or our stockholders, (3) any action asserting a claim arising pursuant to any provision of the Delaware General Corporation Law, our amended and restated certificate of incorporation or our amended and restated bylaws or (4) any action asserting a claim governed by the internal affairs doctrine. Our amended and restated certificate of incorporation further provides that any person or entity purchasing or otherwise acquiring any interest in shares of our common stock is deemed to have notice of and consented to the foregoing provision. The forum selection clause in our amended and restated certificate of incorporation may limit our stockholders’ ability to obtain a favorable judicial forum for disputes with us.

Item 1B. Unresolved Staff Comments.

None.

Item 2. Properties.

Our corporate headquarters occupy approximately 68,000 square feet in Boston, Massachusetts under an operating lease that expires in August 2019. We have additional U.S. offices including Los Angeles, California; Cambridge, Massachusetts; Austin, Texas; and Alexandria, Virginia. We also lease various international offices including Toronto, Canada; Reading, United Kingdom; Belfast, Northern Ireland; Dublin, Ireland; and Singapore.

We believe that our current facilities are suitable and adequate to meet our current needs. We intend to add new facilities or expand existing facilities as we add employees, and we believe that suitable additional or substitute space will be available as needed to accommodate any such expansion of our operations.

Item 3. Legal Proceedings.

From time to time we may become involved in legal proceedings or be subject to claims arising in the ordinary course of our business. We are not presently a party to any legal proceedings that, if determined adversely to us, would individually or taken together have a material adverse effect on our business, operating results, financial condition or cash flows. Regardless of the outcome, litigation can have an adverse impact on us because of defense and settlement costs, diversion of management resources and other factors.

Item 4. Mine Safety Disclosures.

Not applicable.

 

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PART II

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.

Market Information

Our common stock, has been listed on the NASDAQ Global Market under the symbol “RPD” since July 17, 2015. Prior to that date, there was no public trading market for our common stock. Our initial public offering was priced at $16.00 per share on July 16, 2015.

The following table sets forth the reported high and low sales prices of our common stock for the periods indicated, as regularly quoted on the NASDAQ Global Market:

 

             High                      Low          

Third Quarter (from July 17, 2015 to September 30, 2015)

   $         27.45           $         16.50       

Fourth Quarter

   $ 24.76           $ 14.75       

As of December 31, 2015, there were 293 holders of record of our common stock. Because many of our shares are held by brokers and other institutions on behalf of stockholders, we are unable to estimate the total number of stockholders represented by these record holders.

Dividends

We have never declared or paid, and do not anticipate declaring or paying in the foreseeable future, any cash dividends on our common stock. Any future determination as to the declaration and payment of dividends, if any, will be at the discretion of our board of directors, subject to applicable laws, and will depend on then existing conditions, including our financial condition, operating results, contractual restrictions, capital requirements, business prospects, and other factors our board of directors may deem relevant.

Stock Performance Graph

The following shall not be deemed incorporated by reference into any of our other filings under the Securities Exchange Act of 1934, as amended, or the Securities Act of 1933, as amended, except to the extent we specifically incorporate it by reference into such filings.

 

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The following graph shows a comparison from July 17, 2015 (the date our common stock commenced trading on the NASDAQ Global Market) through December 31, 2015 of the cumulative total return for an investment of $100 in our common stock, the NASDAQ Global Market and the NASDAQ Computer Index. Data for the NASDAQ Global Market and the NASDAQ Computer Index assume reinvestment of dividends.

The comparisons in the graph below are based upon historical data and are not indicative of, nor intended to forecast, future performance of our common stock.

 

LOGO

 

    July 17,
    2015    
    July 31,
    2015    
    August 31,
2015
    September 30,
2015
    October 31,
2015
    November 30,
2015
    December 31,
2015
 

Rapid7, Inc.

  $     100.00      $ 90.90      $ 83.43      $ 89.99      $ 81.33      $ 67.76      $ 59.85   

NASDAQ Global Market Composite

    100.00        101.46        91.33        81.04        83.74        88.58        84.85   

NASDAQ Computer

    100.00        101.75        96.09        95.06        106.07        108.13        105.11   

Recent Sale of Unregistered Securities

From January 1, 2015 through July 17, 2015, the date of the filing of our registration statement on Form S-8 (File No. 333-205716), we issued and sold an aggregate of 296,230 shares of our common stock to our employees and former employees upon the exercise of stock option awards under our equity plans, at exercise prices ranging from $0.30 to $10.88 per share, for aggregate proceeds of $1.1 million.

From January 1, 2015 through July 17, 2015, the date of the filing of our registration statement on Form S-8 (File No. 333-205716), and pursuant the terms of our 2011 Stock Option and Grant Plan, we granted to (1) our employees and directors stock option awards to purchase an aggregate of 940,903 shares of our common stock, at an exercise prices ranging from $9.77 to $10.88 per share and (2) 416,117 shares of restricted common stock to certain retained employees of NT OBJECTives, Inc., or NTO, at a price of $10.88 per share.

The offers, sales and issuances of the securities described in the preceding paragraphs were deemed to be exempt from registration under Rule 701 promulgated under the Securities Act, or Rule 701, in that the transactions were by an issuer not involving any public offering or under Section 4(a)(2) of the Securities Act or under compensatory benefit plans and contracts relating to compensation as provided under Rule 701. The recipients of such securities were our employees, directors or consultants and received the securities under our equity incentive plans. Appropriate legends were affixed to the securities issued in these transactions.

On April 30, 2015, we issued 9,091 shares of common stock to one accredited investor who was a security holder of NTO as partial consideration for the acquisition of NTO.

On July 22, 2015, concurrently with the closing of our initial public offering, or IPO, we issued and sold to entities affiliated with Technology Crossover Ventures 312,500 shares of our common stock in a private placement at a price equal to the IPO price of $16.00 per share, resulting in net proceeds to us of $5.0 million.

 

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On October 13, 2015 we issued 1,252,627 shares of common stock as part of the purchase consideration to acquire Logentries.

The offers, sales and issuances of the securities described in the preceding paragraphs were deemed to be exempt from registration under Section 4(a)(2) of the Securities Act, or Rule 506 of Regulation D promulgated thereunder as a transaction by an issuer not involving a public offering or Regulation S promulgated under the Securities Act. The recipients of securities in these transactions acquired the securities for investment only and not with a view to or for sale in connection with any distribution thereof. Appropriate legends were affixed to the securities issued in these transactions. Each of the recipients of securities in these transactions was either an accredited investor within the meaning of Rule 501 of Regulation D under the Securities Act or had adequate access, through employment, business or other relationships, to information about us.

Use of Proceeds from Public Offering of Common Stock

On July 22, 2015, we closed our initial public offering, or IPO, of 7,417,500 shares of common stock at an offering price of $16.00 per share, including 967,500 shares pursuant to the underwriters’ option to purchase additional shares, resulting in gross proceeds of approximately $118.7 million. All of the shares issued and sold in our IPO were registered under the Securities Act pursuant to a registration statement on Form S-1 (File No. 333-204874), which was declared effective by the SEC on July 16, 2015. Morgan Stanley & Co. LLC, Barclays Capital Inc., Pacific Crest Securities, a division of KeyBanc Capital Markets Inc., William Blair & Company, L.L.C., Raymond James & Associates, Inc. and Cowen and Company, LLC acted as underwriters for the offering. The offering commenced on July 6, 2015 and did not terminate before all of the securities registered in the registration statement were sold.

The net proceeds to us, after deducting underwriting discounts and commission of $8.3 million and offering expenses of $3.1 million, were $107.3 million. No offering expenses were paid directly or indirectly to any of our directors or officers (or their associates) or persons owning ten percent or more of any class of our equity securities or to any other affiliates. We have invested a portion of the net offering proceeds into money market securities. There has been no material change in the planned use of proceeds from our IPO from those disclosed in the final prospectus for our IPO dated as of on July 16, 2015 and filed with the SEC pursuant to Rule 424(b)(4); provided, that we used $36.2 million in cash to acquire 100% of the outstanding capital stock of RevelOps, Inc.

As of December 31, 2015, all expenses incurred in connection with our IPO had been paid.

Purchase of Equity Securities by the Issuer and Affiliated Purchasers

None.

Securities Authorized for Issuance Under Equity Compensation Plans

Information about securities authorized for issuance under our equity compensation plan is incorporated herein by reference to Item 12 of Part III of this Annual Report on Form 10-K.

Item 6. Selected Financial Data.

The following selected historical financial data should be read in conjunction with Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and our consolidated financial statements and the related notes appearing in Item 8, “Financial Statements and Supplementary Data,” of this Annual Report on Form 10-K to fully understand the factors that may affect the comparability of the information presented below.

The selected consolidated financial data in this section are not intended to replace the consolidated financial statements and are qualified in their entirety by the consolidated financial statements and related notes included elsewhere in this Annual Report on Form 10-K.

 

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The following selected consolidated statements of operations data for the years ended December 31, 2015, 2014, and 2013, and the consolidated balance sheet data as of December 31, 2015 and 2014, have been derived from our audited consolidated financial statements included elsewhere in this Annual Report on Form 10-K. The consolidated statements of operations data for the year ended December 31, 2012 and 2011 and the consolidated balance sheet data as of December 31, 2013, 2012 and 2011 have been derived from our audited consolidated financial statements not included in this Annual Report on Form 10-K.

 

       Year Ended December 31,  
       2015     2014     2013     2012     2011  
       (in thousands, except share and per share data)  

Consolidated Statement of Operations Data:

            

Revenue:

            

Products

     $ 63,407      $ 47,030      $ 38,633      $ 29,414      $ 19,332   

Maintenance and support

       26,903        19,016        14,017        9,727        6,711   

Professional services

       20,216        10,834        7,380        6,903        4,909   
    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total revenue

       110,526        76,880        60,030        46,044        30,952   

Cost of revenue(1):

            

Products

       6,921        4,557        4,048        1,691        1,260   

Maintenance and support

       6,002        4,495        3,388        2,069        1,546   

Professional services

       16,321        9,420        5,442        4,462        3,201   
    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total cost of revenue

       29,244        18,472        12,878        8,222        6,007   

Operating expenses(1):

            

Research and development

       38,746        25,570        21,411        17,820        11,579   

Sales and marketing

       67,365        49,007        31,779        23,278        19,648   

General and administrative

       21,731        12,972        12,586        9,436        5,468   
    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expense

       127,842        87,549        65,776        50,534        36,695   
    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Loss from operations

       (46,560)        (29,141)        (18,624)        (12,712)        (11,750)   

Interest income (expense), net

       (2,523)        (2,802)        (122)        (71)        (288)   

Other income (expense), net

       (278)        (305)        43        (29)        (47)   
    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Loss before income taxes

       (49,361)        (32,248)        (18,703)        (12,812)        (12,085)   

Provision for (benefit from) income taxes

       496        379        170        (418)        22   
    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net loss

       (49,857)        (32,627)        (18,873)        (12,394)        (12,107)   

Accretion of preferred stock to redemption value(2)

       (35,061)        (52,336)        (33,553)        (25,606)        (12,006)   

Beneficial conversion feature relating to IPO participation payment

       (14,161)                               
    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net loss attributable to common stockholders

     $ (99,079)      $ (84,963)      $ (52,426)      $ (38,000)      $ (24,113)   
    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net loss per share attributable to common stockholders, basic and diluted

     $ (4.00)      $ (6.65)      $ (4.18)      $ (3.09)      $ (1.96)   
    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Weighted-average common shares outstanding, basic and diluted

       24,740,480        12,770,916        12,549,266        12,308,428        12,274,938   

 

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  (1)

Includes stock-based compensation expense and depreciation and amortization expense as follows:

 

    Year Ended December 31,  
              2015                         2014                         2013                         2012                         2011            
    (in thousands)  

Stock-based compensation expense:

         

Cost of revenue

    $             532        $             167        $               67        $               61        $             100   

Research and development

    5,010        499        426        375        236   

Sales and marketing

    3,139        496        249        293        100   

General and administrative

    2,004        997        1,305        991        33   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total stock-based compensation expense

    $        10,685        $          2,159        $          2,047        $          1,720        $             469   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Depreciation and amortization expense:

         

Cost of revenue

    $          1,890        $          1,275        $          1,107        $             547        $             282   

Research and development

    1,138        1,093        649        406        229   

Sales and marketing

    1,617        1,396        675        444        338   

General and administrative

    707        376        200        132        66   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total depreciation and amortization expense

    $          5,352        $          4,140        $          2,631        $          1,529        $             915   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

  (2)

See Note 12 to our consolidated financial statements appearing in Item 8 for further details on the calculation of accretion of preferred stock to redemption value and basic and diluted net loss per share attributable to common stockholders.

 

    As of December 31,  
              2015                         2014                         2013                         2012                         2011            
    (in thousands)  

Consolidated Balance Sheet Data:

         

Cash

  $ 86,553      $ 36,823      $ 20,612      $ 7,667      $ 21,255   

Working capital, excluding deferred revenue

    109,015        50,359        28,206        12,655        21,744   

Total assets

    230,561        86,966        59,855        41,782        37,676   

Total deferred revenue

    130,317        85,056        59,855        44,728        28,261   

Total debt

           16,871        16,318        18        96   

Total liabilities

    162,486        122,230        92,432        58,797        43,017   

Redeemable convertible preferred stock

           211,598        128,444        94,891        69,343   

Total stockholders’ equity (deficit)

    68,075        (246,862)        (161,021)        (111,906)        (74,684)   

 

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and related notes appearing elsewhere in this Annual Report on Form 10-K. In addition to historical financial information, the following discussion contains forward-looking statements that reflect our plans, estimates and beliefs. Our actual results could differ materially from those contained in or implied by any forward-looking statements. Factors that could cause or contribute to these differences include those under “Risk Factors” included in Part I, Item 1A or in other parts of this Annual Report on Form 10-K.

Overview

Rapid7 is a leading provider of security data and analytics solutions that enable organizations to implement an active, analytics-driven approach to cyber security. Our security data and analytics platform was purpose built for today’s increasingly complex and chaotic IT environment. We combine our extensive experience in security data and analytics and deep insight into attacker behaviors and techniques to make sense of the wealth of data available to organizations about their IT environments and users. There has been an explosion of increasingly sophisticated cyber attacks as the proliferation of mobile devices, cloud-based applications and solutions relying on user credentials has eliminated the boundaries that previously defined an organization’s network perimeter and expanded the threat surface that organizations must now defend. Our powerful and proprietary analytics enable organizations to contextualize and prioritize the threats facing their physical, virtual and cloud assets, including those posed by the behaviors of their users. Leveraging our security data and analytics platform, our solutions enable organizations to strategically and dynamically manage their cyber security exposure. Our solutions empower organizations to prevent attacks by providing visibility into vulnerabilities and to rapidly detect compromises, respond to breaches and correct the underlying causes of attacks. This balanced and analytics-focused approach ultimately better secures organizations’ environments and reduces the likelihood of, and risks associated with, cyber attacks. We believe our technology and solutions revolutionize the practice of cyber security and are central and critical to implementing a modern security program.

We primarily market and sell our products and professional services to global organizations of all sizes, including mid-market businesses, enterprises, non-profits, educational institutions and government agencies. Our customers span a wide variety of industries such as technology, energy, financial services, healthcare and life sciences, manufacturing, media and entertainment, retail, education, real estate, transportation, government and professional services. As of December 31, 2015, we had over 5,100 customers in 99 countries, including 37% of the Fortune 1000. Our revenue was not concentrated with any individual customer or group of customers, and no customer represented more than 1% of our revenue in 2015, 2014 or 2013.

We sell our products and services through direct inside and field sales team and indirect channel partner relationships. Our sales teams are organized by geography as well as by target organization size. Our global channel partner network complements our sales organization, working closely with our sales teams to extend our geographic reach and to close sales of our offerings as part of larger purchases, particularly in key markets such as Europe, the Middle East and Africa, Asia Pacific and Latin America.

Recent Developments

On October 13, 2015, we acquired RevelOps, Inc. (d/b/a Logentries), a provider of machine data search technology. With the addition of Logentries’ cloud-based log management and search capabilities, we will enable information security teams to solve a broader range of security challenges, investigate incidents and more efficiently achieve their compliance requirements. We acquired Logentries for a total consideration of approximately $67.9 million.

In February 2016, we announced InsightIDR, our new Insight Platform offering that integrates our recently acquired Logentries machine data search technology, enabling organizations to go from compromise to containment quickly and also meet their operational compliance needs. InsightIDR is a cloud-based offering that seeks to provide comprehensive incident detection and response and will be available in the first quarter of 2016.

 

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Our InsightIDR offering combines behavior analytics and search with contextual data collection to help detect some of the stealthiest attacks. InsightIDR directly addresses the gaps found in many of today’s detection technologies, including SIEMs and IPSs and is powered by our Insight Platform, which simplifies and combines data collection, analytics, and search technology. The combination of these technologies can enable not only effective detection but also efficient investigation, so that organizations can rapidly go from compromise to containment. InsightIDR puts the organization’s data at the IT security analyst’s fingertips so an organization can improve investigation times often at lower costs than with traditional solutions on the market.

Our Business Model

We have three offerings: (1) threat exposure management, which includes our Nexpose, Metasploit and AppSpider products, (2) incident detection and response, which includes our InsightUBA (formerly known as UserInsight), Analytic Response, and Logentries products, our recently announced InsightIDR product and our incident response services and (3) security advisory services. Our customers typically engage with us based on their current security and IT organizational needs, whether to address a current breach or to help them mature their security programs. An organization that has just detected that it has been breached, for example, may initially purchase our incident detection and response products and services, whereas a customer with a new chief information security officer looking to gain insight into the organization’s security environment may initially purchase our threat exposure management solutions, and a customer whose board has mandated a security review may initially purchase our security advisory services.

We generate revenue from selling products, maintenance and support, and professional services. In 2015, 2014 and 2013, 82%, 86% and 88% of our revenue, respectively, was derived from sales of products and associated maintenance and support, while the remaining 18%, 14% and 12%, respectively, was derived from the sale of professional services. In 2015, 2014 and 2013, 62%, 62% and 58% of our total revenue, respectively, was derived from sales of content subscriptions, managed services, cloud-based subscriptions and maintenance and support, which we refer to as recurring revenue. We generally bill customers and collect payment for both our products and services up front.

We offer our products through a variety of delivery models to meet the needs of our diverse customer base, including:

 

   

Licensed software, including both term and perpetual licenses, and the simultaneous sale of maintenance and support. With the purchase of software licenses, we also offer content subscriptions that provide our customers with real-time access to the latest vulnerabilities and exploits, which are critical for customers in today’s rapidly evolving IT environment and threat landscape.

 

   

Cloud-based subscriptions, where our software capabilities are provided to our customers through cloud access and on a SaaS basis.

 

   

Managed services, where we operate our software and provide our capabilities on behalf of our customers.

Licensed Software

Our Nexpose, Metasploit and AppSpider products are offered through perpetual or term software licenses, with a substantial majority of our customers selecting a perpetual license. Substantially all customers who purchase software licenses also purchase an agreement for maintenance and support, which generally represents approximately 15% of the software list price per year and provides our customers with telephone and web-based support and ongoing bug fixes and repairs during the term of the maintenance and support agreement.

Importantly, generally all customers also purchase vulnerability and exploit content subscriptions at the time of their software purchase, which generally represents approximately 20% of the software list price per year. These

 

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content subscriptions are critical to keeping our customers’ security programs current by providing them with real-time access to the latest vulnerabilities and exploits over time, and differentiate our threat exposure management offerings from typical vulnerability assessment tools.

Our maintenance and support and content subscription agreements are typically for one to three-year terms.

Cloud-Based Subscriptions

Our InsightUBA, AppSpider and Logentries products are offered on a cloud-based subscription basis, generally with one to three-year terms. Our recently announced InsightIDR product will also be offered on a cloud-based subscription basis.

Managed Services

Our Nexpose, AppSpider, Analytic Response and InsightUBA products are offered on a managed service basis, generally pursuant to one to three-year agreements.

Professional Services

We offer different forms of professional services across all of our offerings, including deployment and training services related to our Nexpose, Metasploit, AppSpider and InsightUBA software products, our recently announced InsightIDR product, incident response services and security advisory services. Customers can purchase our professional services together with our product offerings or on a stand-alone basis pursuant to fixed fee or time-and-materials agreements.

Key Factors Affecting Our Performance

Our historical financial performance has been, and we expect our financial performance in the future to be, primarily driven by the following factors:

Market Adoption. We believe our future success will depend in large part on the growth in the market for cyber security data and analytics. To date, the majority of enterprise spend on cyber security has been on threat prevention-centric products, such as network, endpoint and web security that are designed to stop threats from penetrating organizations’ networks. Although organizations have not historically had a specific portion of their IT and security budgets allocated for security data and analytics products beyond traditional “block and protect” and compliance-oriented spending categories, we believe that organizations are shifting their cyber security spending to a risk-based approach as they recognize that it is not possible to completely prevent attacks, and that they should instead focus more on managing risk and mitigating breaches as they occur. Further, Gartner, Inc. estimates that by 2020, 60% of enterprise information security budgets will be allocated for rapid detection and response approaches – up from less than 20% in 2015. We believe that we are well positioned to capitalize on this expected shift. The degree to which prospective customers recognize the need for security data and analytics solutions that enable organizations to implement an active, analytics driven approach to cyber security, and subsequently allocate budget dollars for our products and professional services, will drive our ability to acquire new customers and increase sales to existing customers, which, in turn, will affect our future financial performance.

Add New Customers. We believe that our ability to add new customers is a key indicator of our increasing market adoption and future revenue potential. Our customer count grew by 37% from 2014 to 2015 and from 2013 to 2014. In 2015, 55% of our sales orders, excluding renewals, were with new customers. We are intensely focused on continuing to grow our customer base. We have continuously enhanced our technology platform and product offerings with a focus on pioneering active, analytics-driven solutions to cyber security, and we have expanded both our domestic and international sales force to drive new customer acquisition. However, our ability to continue to grow our customer base is dependent upon our ability to compete within the increasingly competitive markets in which we participate.

 

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Maintain Strong Renewal Rates. An important component of our revenue growth strategy is to have our existing customers renew their agreements with us and purchase additional products from us. To assess our performance against this objective, we monitor the renewal rates of our existing customers. We calculate our renewal rate by dividing the dollar value of renewed customer agreements, including upsells and cross-sells of additional products, but excluding professional services, on a monthly basis in a trailing 12-month period by the dollar value of the corresponding expiring customer agreements, and then determining the average for the applicable period. We also calculate an expiring revenue renewal rate that does not take into account any upsells or cross-sells. As a result of this methodology, we would not expect our expiring revenue renewal rate to exceed 100%. We believe that we have strong renewal rates. Our renewal rate was 126% in 2015 and 111% in 2014 and our expiring revenue renewal rate was 88% in 2015 and 85% in 2014. Our goal is to maintain, and work to increase, our renewal rates over time. However, our renewal rates may decline or fluctuate as a result of a number of factors, including customers’ satisfaction or dissatisfaction with our products and professional services, pricing, economic conditions or overall reductions in our customers’ spending levels.

Increase Sales to Existing Customers. We believe that our current customer base provides us with a significant opportunity to drive incremental sales. We focus on generating more revenue from the products and services that they already purchase from us as they grow and deploy our solutions across other areas of their organizations. We are also focused on cross-selling other products and services in our portfolio to our existing customers. In most cases, customers initially engage with us within a single solution category, threat exposure management, incident detection and response or security advisory services, based on their immediate IT security needs and the maturity of their security program. Once we are in a customer’s IT environment, we are able to gain insight into the robustness of its security programs and vulnerabilities, which allows us to educate the customer about how our other products and professional services can enhance its cyber security posture. In 2015, 45% of our new sales orders, excluding renewals, were from existing customers. Our ability to increase sales to existing customers will depend on a number of factors, including customers’ satisfaction or dissatisfaction with our products and professional services, pricing, economic conditions or overall reductions in our customers’ spending levels.

Invest in Growth. We will continue to focus on long-term revenue growth. We believe that our market opportunity is large and we will continue to invest significantly in sales and marketing to grow our customer base, both domestically and internationally. We also expect to continue to invest in research and development to further enhance our Insight Platform and continue to develop cyber security solutions as evidenced by our recent announcement of InsightIDR, a new incident detection and response offering that enables security professionals to more quickly detect and investigate security incidents.

Key Metrics

We monitor the following key metrics to help us measure and evaluate the effectiveness of our operations:

 

     Year Ended December 31,  
     2015      2014      2013  
     (dollars in thousands)  

Total revenue

   $     110,526       $     76,880       $     60,030   

Year-over-year growth

     43.8%         28.1%         30.4%   

Operating cash flow

   $ (1,907    $ (3,356    $ (613

Deferred revenue

   $ 130,317       $ 85,056       $ 59,855   

Number of customers

     5,132         3,733         2,733   

Total Revenue and Growth. We are focused on driving continued revenue growth through increased sales of our products and professional services to new and existing customers.

 

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Operating Cash Flow. We monitor our operating cash flow as a measure of our overall business performance, which enables us to analyze our financial performance without the effects of certain non-cash items such as stock-based compensation expenses and depreciation and amortization. Additionally, operating cash flow takes into account the increase in deferred revenue as a result of increases in sales of products and services, which reflects the receipt of cash payment for products before they are recognized into revenue. Our operating cash flow is significantly impacted by changes in deferred revenue, timing of commission and bonus payments and collections of accounts receivable.

Deferred Revenue. We believe that deferred revenue is an important metric as it provides visibility into the revenue to be recognized in future periods. Our deferred revenue consists of amounts that have been invoiced to customers but that have not yet been recognized as revenue. Our deferred revenue balance consists of the portion of products, maintenance and support and professional services revenue that will be recognized ratably over the applicable maintenance and support contract period. Revenue from professional services that are sold on a stand-alone basis is recognized as those services are rendered.

Number of Customers. We believe that the size of our customer base is an indicator of our global market penetration and that our net customer additions are an indicator of the growth of our business. We define a customer as any entity that has 1) an active Rapid7 contract or a contract that expired within 90 days or less of the applicable measurement date, 2) purchased Rapid7 professional services within the 12 months preceding the applicable measurement date or 3) an active subscription to our Logentries product with a contract value equal to or greater than $2,400 per year.

Non-GAAP Financial Results

To supplement our consolidated financial statements, which are prepared and presented in accordance with generally accepted accounting principles in the United States, or GAAP, we provide investors with certain non-GAAP financial measures, including non-GAAP gross profit, non-GAAP operating loss and non-GAAP net loss, which we collectively refer to as non-GAAP financial measures. These non-GAAP financial measures exclude all or a combination of the following (as reflected in the following reconciliation tables): stock-based compensation expense, amortization of acquired intangible assets, acquisition related expenses and impairment of long-lived assets. The presentation of the non-GAAP financial measures is not intended to be considered in isolation or as a substitute for, or superior to, the financial information prepared and presented in accordance with GAAP. We use these non-GAAP financial measures for financial and operational decision-making purposes and as a means to evaluate period-to-period comparisons. We believe that these non-GAAP financial measures provide useful information about our operating results, enhance the overall understanding of past financial performance and future prospects and allow for greater transparency with respect to metrics used by our management in its financial and operational decision making. While our non-GAAP financial measures are an important tool for financial and operational decision making and for evaluating our own operating results over different periods of time, you should consider our non-GAAP financial measures alongside our GAAP financial results.

We exclude stock-based compensation expense because of varying available valuation methodologies, subjective assumptions and the variety of equity instruments that can impact our non-cash expense. We believe that providing non-GAAP financial measures that exclude stock-based compensation expense allow for more meaningful comparisons between our operating results from period to period. We believe that excluding the impact of amortization of intangible assets allows for more meaningful comparisons between operating results from period to period as the intangibles are valued at the time of acquisition and are amortized over a period of several years after the acquisition. We also exclude the impact of costs directly related to acquisitions and asset impairments as these costs are unrelated to the current operations and neither comparable to the prior period nor predictive of future results, which we believe allows for a more meaningful comparison between the operating results from period to period. Accordingly, we believe that excluding these expenses provides investors and

 

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management with greater visibility of the underlying performance of our business operations, facilitates comparison of our results with other periods and may also facilitate comparison with the results of other companies in our industry.

There are limitations in using non-GAAP financial measures because the non-GAAP financial measures are not prepared in accordance with GAAP, may be different from non-GAAP financial measures used by other companies and exclude expenses that may have a material impact upon our reported financial results. Further, stock-based compensation expense has been and will continue to be for the foreseeable future a significant recurring expense in our business and an important part of the compensation provided to our employees.

The following tables reconcile GAAP gross profit to non-GAAP gross profit for the years ended 2015, 2014 and 2013:

 

       Year Ended December 31,  
               2015                      2014                      2013          
       (in thousands)  

GAAP total gross profit

     $       81,282       $           58,408       $           47,152   

Stock-based compensation expense

       532         167         67   

Amortization of intangible assets

       1,212         869         909   
    

 

 

    

 

 

    

 

 

 

Non-GAAP total gross profit

     $ 83,026       $ 59,444       $ 48,128   
    

 

 

    

 

 

    

 

 

 

 

     Year Ended December 31,  
             2015                      2014                      2013          
     (in thousands)  

GAAP gross profit – products and maintenance and support

   $         77,387       $         56,994       $         45,214   

Stock-based compensation expense

     281         13         14   

Amortization of intangible assets

     1,212         869         909   
  

 

 

    

 

 

    

 

 

 

Non-GAAP gross profit – products and maintenance and support

   $ 78,880       $ 57,876       $ 46,137   
  

 

 

    

 

 

    

 

 

 

 

       Year Ended December 31,  
               2015                      2014                      2013          
       (in thousands)  

GAAP gross profit – professional services

     $         3,895       $             1,414       $             1,938   

Stock-based compensation expense

       251         154         53   
    

 

 

    

 

 

    

 

 

 

Non-GAAP gross profit – professional services

     $ 4,146       $ 1,568       $ 1,991   
    

 

 

    

 

 

    

 

 

 

 

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The following table reconciles GAAP loss from operations to non-GAAP loss from operations for the years ended 2015, 2014 and 2013:

 

       Year Ended December 31,  
               2015                     2014                     2013          
       (in thousands)  

GAAP loss from operations

     $ (46,560   $ (29,141   $ (18,624

Stock-based compensation expense

       10,685        2,159        2,047   

Amortization of intangible assets

       1,286        869        909   

Acquisition related expenses

       1,342                 

Impairment of long-lived assets

       483                 
    

 

 

   

 

 

   

 

 

 

Non-GAAP loss from operations

     $ (32,764   $ (26,113   $ (15,668
    

 

 

   

 

 

   

 

 

 

The following tables reconciles GAAP net loss attributable to common stockholders to non-GAAP net loss for the years ended 2015, 2014 and 2013:

 

       Year Ended December 31,  
               2015                     2014                     2013          
       (in thousands, except share and per share data)  

GAAP net loss attributable to common stockholders

     $ (99,079   $ (84,963   $ (52,426

Accretion of preferred stock to redemption value

       35,061        52,336        33,553   

Beneficial conversion charge relating to IPO participation payment

       14,161                 
    

 

 

   

 

 

   

 

 

 

GAAP net loss

       (49,857     (32,627     (18,873

Stock-based compensation expense

       10,685        2,159        2,047   

Amortization of intangible assets

       1,286        869        909   

Acquisition related expenses

       1,342                 

Impairment of long-lived assets

       483                 
    

 

 

   

 

 

   

 

 

 

Non-GAAP net loss

     $ (36,061   $ (29,599   $ (15,917
    

 

 

   

 

 

   

 

 

 

Non-GAAP net loss per share, basic and diluted

     $ (1.46   $ (2.32   $ (1.27
    

 

 

   

 

 

   

 

 

 

Weighted-average common shares outstanding, basic and diluted

       24,740,480        12,770,916        12,549,266   
    

 

 

   

 

 

   

 

 

 

Components of Results of Operations

Revenue

We generate revenue primarily from selling products, maintenance and support and professional services through a variety of delivery models to meet the needs of our diverse customer base. We generally bill customers and collect payment for both our products and services up front.

Products

We generate products revenue from the sale of (1) perpetual or term software licenses and associated content subscriptions for our Nexpose, Metasploit and AppSpider products, (2) managed services for our Nexpose, AppSpider, Analytic Response and InsightUBA products and (3) cloud-based subscriptions for our InsightUBA, AppSpider and Logentries products. We also generate an immaterial amount of appliance revenue that is included in our products revenue and that is associated with hardware sold as part of our Nexpose product to certain customers. Revenue for software licenses and any other products and services that are sold along with the

 

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software license is deferred on our balance sheet and recognized as revenue on the consolidated statements of operations ratably over the contractual period of the maintenance and support, which is typically one to three years.

Maintenance and Support

We generate maintenance and support revenue when customers purchase or renew agreements for maintenance and support of their Nexpose, Metasploit and AppSpider deployments. Substantially all customers purchase an agreement for maintenance and support in connection with their purchase of a Nexpose or Metasploit software license. Revenue from maintenance and support is typically recognized ratably over the term of the applicable agreement.

Professional Services

We generate professional service revenue from the sale of deployment and training services related to our products, incident response services and security advisory services. Revenue from professional services sold together with our other offerings is recognized ratably over the term of the applicable agreement. Revenue from professional services sold on a stand-alone basis is recognized as those services are rendered.

Cost of Revenue

Our total cost of revenue consists of the costs of products, maintenance and support and professional services revenue.

Cost of Products

Cost of products consists of personnel and related costs for our content and cloud operations team, including salaries, benefits, bonuses, payroll taxes, stock-based compensation and allocated overhead costs, which consist of IT, information security, recruiting, facilities and depreciation and are allocated based on relative headcount. Also included in cost of products are software license fees, hardware, Amazon Web Services (AWS) cloud computing costs and internet connectivity expenses directly related to delivering our products, as well as amortization of intangible assets.

Cost of Maintenance and Support

Cost of maintenance and support consists of personnel and related costs for our support team, including salaries, benefits, bonuses, payroll taxes, stock-based compensation and allocated overhead.

Cost of Professional Services

Cost of professional services consists of personnel and related costs for our professional services team, including salaries, benefits, bonuses, payroll taxes, stock-based compensation, costs of contracted third-party vendors, travel and entertainment expenses and allocated overhead.

We expect our cost of revenue to increase on an absolute dollar basis in the near term as we continue to grow our revenue.

Gross Margin

Gross margin, or gross profit as a percentage of revenue, has been and will continue to be affected by a variety of factors, including the average sales price of our products and services, transaction volume growth and the mix of revenue among products and services. We expect our gross margins to fluctuate over time depending on the factors described above.

 

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Operating Expenses

Operating expenses consist of research and development, sales and marketing, and general and administrative expenses. Operating expenses include allocated overhead costs for depreciation of equipment, facilities, IT, information security and recruiting. Allocated costs for facilities consist of leasehold improvements and rent. Our allocated costs for IT include costs for compensation of IT personnel and costs associated with our IT infrastructure. All such costs are allocated based on relative headcount.

Research and Development Expense

Research and development expense consists of personnel costs for our research and development team, including salaries, bonuses, stock-based compensation and other related costs. Additional expenses include subcontracting, consulting and professional fees for third-party development resources as well as allocated overhead.

We expect research and development expense to increase on an absolute dollar basis in the near term as we continue to increase investments in our products and technology platform innovation, but to decrease as a percentage of total revenue.

Sales and Marketing Expense

Sales and marketing expense consists of personnel costs for our sales and marketing team, including salaries, commissions, bonuses, stock-based compensation and other related costs. Additional expenses include marketing activities and promotional events, travel and entertainment, training costs, amortization of certain intangible assets and allocated overhead.

We expect sales and marketing expense to increase on an absolute dollar basis in the near term as we continue to increase investments to drive our revenue growth, but to decrease as a percentage of total revenue.

General and Administrative Expense

General and administrative expense consists of personnel costs for our administrative, legal, human resources, and finance and accounting teams, including salaries, bonuses, stock-based compensation and other related costs. Additional expenses include travel and entertainment, subcontracting, professional fees, insurance, acquisition related expenses, amortization of certain intangible assets and allocated overhead, as well as changes in the fair market value of the contingent consideration liability associated with acquisitions, which are subject to revaluation.

We expect general and administrative expense to increase on an absolute dollar basis in the near term as we continue to increase investments to support our growth and as a result of our becoming a public company, but to decrease as a percentage of total revenue.

Interest Income (Expense), Net

Interest income (expense), net consists of interest incurred on our term loan obligation and related discount amortization offset by interest income on our cash balances.

Other Income (Expense), Net

Other income (expense), net consists primarily of unrealized and realized gains and losses related to changes in foreign currency exchange rates.

 

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Provision for Income Taxes

Provision for income taxes relates primarily to U.S. federal and state, as well as certain foreign jurisdiction, income taxes. We have generated net losses in all periods to date and recorded a full valuation allowance against our U.S. and Ireland deferred tax assets. We expect to maintain a full valuation allowance on our U.S. and Ireland deferred tax assets in the near term. Realization of any of our deferred tax assets depends upon future earnings, the timing and amount of which are uncertain.

Results of Operations

 

       Year Ended December 31,  
                   2015                              2014                              2013              
       (in thousands)  

Consolidated Statement of Operations Data:

          

Revenue:

          

Products

     $ 63,407       $ 47,030       $ 38,633   

Maintenance and support

       26,903         19,016         14,017   

Professional services

       20,216         10,834         7,380   
    

 

 

    

 

 

    

 

 

 

Total revenue

       110,526         76,880         60,030   

Cost of revenue:(1)

          

Products

       6,921         4,557         4,048   

Maintenance and support

       6,002         4,495         3,388   

Professional services

       16,321         9,420         5,442   
    

 

 

    

 

 

    

 

 

 

Total cost of revenue

       29,244         18,472         12,878   

Operating expenses:(1)

          

Research and development

       38,746         25,570         21,411   

Sales and marketing

       67,365         49,007         31,779   

General and administrative

       21,731         12,972         12,586   
    

 

 

    

 

 

    

 

 

 

Total operating expenses

       127,842         87,549         65,776   
    

 

 

    

 

 

    

 

 

 

Loss from operations

       (46,560)         (29,141)         (18,624)   

Interest income (expense), net

       (2,523)         (2,802)         (122)   

Other income (expense), net

       (278)         (305)         43   
    

 

 

    

 

 

    

 

 

 

Loss before income taxes

       (49,361)         (32,248)         (18,703)   

Provision for income taxes

       496         379         170   
    

 

 

    

 

 

    

 

 

 

Net loss

       (49,857)         (32,627)         (18,873)   

Accretion of preferred stock to redemption value

       (35,061)         (52,336)         (33,553)   

Beneficial conversion charge relating to IPO participation payment

       (14,161)                   
    

 

 

    

 

 

    

 

 

 

Net loss attributable to common stockholders

     $ (99,079)       $ (84,963)       $ (52,426)   
    

 

 

    

 

 

    

 

 

 

 

  (1) 

Cost of revenue and operating expenses include stock-based compensation expense and depreciation and amortization expense as follows:

 

       Year Ended December 31,  
               2015                      2014                      2013          
       (in thousands)  

Stock-based compensation expense:

          

Cost of revenue

     $ 532       $ 167       $ 67   

Research and development

       5,010         499         426   

Sales and marketing

       3,139         496         249   

General and administrative

       2,004         997         1,305   
    

 

 

    

 

 

    

 

 

 

Total stock-based compensation expense

     $ 10,685       $ 2,159       $ 2,047   
    

 

 

    

 

 

    

 

 

 

 

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    Year Ended December 31,  
            2015                     2014                     2013          
    (in thousands)  

Depreciation and amortization expense:

     

Cost of revenue

  $                1,890      $                1,275      $               1,107   

Research and development

    1,138        1,093        649   

Sales and marketing

    1,617        1,396        675   

General and administrative

    707        376        200   
 

 

 

   

 

 

   

 

 

 

Total depreciation and amortization expense

  $ 5,352      $ 4,140      $ 2,631   
 

 

 

   

 

 

   

 

 

 

The following table sets forth our consolidated statements of operations data expressed as a percentage of revenue:

 

       Year Ended December 31,  
           2015              2014              2013      

Consolidated Statement of Operations Data:

          

Revenue:

          

Products

       57.4%         61.2%         64.4%   

Maintenance and support

       24.3         24.7         23.3   

Professional services

       18.3         14.1         12.3   
    

 

 

    

 

 

    

 

 

 

Total revenue

       100.0         100.0         100.0   

Cost of revenue:

          

Products

       6.3         5.9         6.7   

Maintenance and support

       5.4         5.8         5.6   

Professional services

       14.8         12.3         9.1   
    

 

 

    

 

 

    

 

 

 

Total cost of revenue

       26.5         24.0         21.4   

Operating expenses:

          

Research and development

       35.1         33.3         35.7   

Sales and marketing

       60.9         63.7         52.9   

General and administrative

       19.7         16.9         21.0   
    

 

 

    

 

 

    

 

 

 

Total operating expenses

       115.7         113.9         109.6   
    

 

 

    

 

 

    

 

 

 

Loss from operations

       (42.2)         (37.9)         (31.0)   

Interest income (expense), net

       (2.3)         (3.6)         (0.2)   

Other income (expense), net

       (0.2)         (0.4)         0.1   
    

 

 

    

 

 

    

 

 

 

Loss before income taxes

       (44.7)         (41.9)         (31.1)   

Provision for income taxes

       0.4         0.5         0.3   
    

 

 

    

 

 

    

 

 

 

Net loss

       (45.1)         (42.4)         (31.4)   

Accretion of preferred stock to redemption value

       (31.7)         (68.1)         (55.9)   

Beneficial conversion charge relating to IPO participation payment

       (12.8)                   
    

 

 

    

 

 

    

 

 

 

Net loss attributable to common stockholders

       (89.6)%         (110.5)%         (87.3)%   
    

 

 

    

 

 

    

 

 

 

 

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Year Ended December 31, 2015 Compared to the Year Ended December 31, 2014

Revenue

 

     Year Ended
December 31,
    Change  
           2015                 2014                   $                   %        
     (dollars in thousands)  

Revenue:

        

Products

     $    63,407        $  47,030        $  16,377        34.8

Maintenance and support

     26,903        19,016        7,887        41.5   

Professional services

     20,216        10,834        9,382        86.6   
  

 

 

   

 

 

   

 

 

   

Total revenue

     $  110,526        $  76,880        $  33,646        43.8
  

 

 

   

 

 

   

 

 

   

Total revenue increased by $33.6 million in 2015 compared to 2014 primarily due to an increase of $17.8 million in revenue recognized from our deferred revenue balance. The remaining increase was the result of increased purchases of additional products and services of $8.9 million by our existing customers and $6.9 million from increased sales to new customers. The increase in total revenue in 2015 was comprised of $29.0 million from North America and $4.6 million from the rest of the world. We added 1,399 net new customers in 2015, bringing our total customer count to 5,123 as of December 31, 2015, as compared to adding 1,000 net new customers in 2014, resulting in a total customer count of 3,733 as of December 31, 2014. Products revenue and maintenance and support revenue increased by $16.3 million and $7.9 million, respectively, primarily due to the same contributors that drove our increase in total revenue. Professional services revenue increased by $9.4 million primarily due to increased demand for security advisory services.

Cost of Revenue

 

     Year Ended
December 31,
    Change  
             2015                     2014                     $                     %          
     (dollars in thousands)  

Cost of revenue:

        

Products

   $ 6,921      $ 4,557      $ 2,364        51.9

Maintenance and support

     6,002        4,495        1,507        33.5   

Professional services

     16,321        9,420        6,901        73.3   
  

 

 

   

 

 

   

 

 

   

Total cost of revenue

   $ 29,244      $ 18,472      $ 10,772        58.3
  

 

 

   

 

 

   

 

 

   

Gross margin %:

        

Products

     89.1     90.3    

Maintenance and support

     77.7        76.4       

Professional services

     19.3        13.1       
  

 

 

   

 

 

     

Total gross margin %

     73.5     76.0    
  

 

 

   

 

 

     

Total cost of revenue increased by $10.8 million in 2015 compared to 2014 due to a $7.1 million increase in personnel costs, primarily as a result of our increase in headcount from 104 as of December 31, 2014 to 140 as of December 31, 2015 to support our growing customer base. Our increase in total cost of revenue also included a $1.8 million increase in allocated overhead, a $1.1 million increase in hardware and AWS cloud computing costs, a $0.5 million increase in travel and entertainment expenses and a $0.3 million increase in amortization expense. The same factors were the primary contributors to the increases in products, maintenance and support and professional services cost of revenue.

Total gross margin percentage decreased due to our revenue mix.

 

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Operating Expenses

Research and Development Expense

 

    Year Ended
December 31,
    Change  
            2015                     2014                     $                     %          
    (dollars in thousands)  

Research and development

   $    38,746            $    25,570         $    13,176        51.5%   

% of revenue

    35.1%          33.3%       

Research and development expense increased by $13.2 million in 2015 compared to 2014 primarily due to a $10.9 million increase in personnel costs resulting from an increase in headcount from 114 as of December 31, 2014 to 205 as of December 31, 2015 to support our product innovation. Included in the increase in personnel cost was a $4.5 million increase in stock-based compensation expense and $3.1 million of additional cost attributable to the Logentries and NTO acquisitions. Our increase in research and development expense also included a $1.3 million increase in allocated overhead primarily due to IT related costs to support our growing headcount, a $0.5 million charge for the write off of capitalized product development costs due to changes in future product development plans, a $0.3 million increase in travel and entertainment expense and a $0.2 million increase in professional fees.

Sales and Marketing Expense

 

     Year Ended
December 31,
    Change  
             2015                     2014                     $                     %          
     (dollars in thousands)  

Sales and marketing

    $       67,365         $       49,007            $     18,358        37.5%   

% of revenue

     60.9%        63.7%       

Sales and marketing expense increased by $18.4 million in 2015 compared to 2014 primarily due to a $13.4 million increase in personnel costs, resulting from an increase in headcount from 227 as of December 31, 2014 to 314 as of December 31, 2015 to drive additional sales of our products and services and higher commissions expense as a result of increased customer orders. Included in the increase in personnel cost was a $2.6 million increase in stock-based compensation expense and $2.5 million of additional personnel costs attributable to the Logentries and NTO acquisitions. Our increase in sales and marketing expense also included a $2.9 million increase in allocated overhead primarily due to IT related costs to support our growing headcount, a $1.7 million increase in marketing programs, driven largely by our customer conferences and increased advertising, and a $0.4 million increase in travel and entertainment expense.

General and Administrative Expense

 

     Year Ended
December 31,
    Change  
             2015                     2014                     $                     %          
     (dollars in thousands)  

General and administrative

    $     21,731           $     12,972         $      8,759            67.5%       

% of revenue

     19.7%          16.9%       

General and administrative expense increased by $8.8 million in 2015 compared to 2014 primarily due to a $3.8 million increase in professional fees. The increase in professional fees was the result of costs indirectly related to our IPO, costs related to operating as a public company and $1.3 million of NTO and Logentries acquisition related expenses. Our increase in general and administrative expense also included a $3.4 million increase in personnel costs as a result of an increase in headcount from 66 as of December 31, 2014 to 97 as of

 

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December 31, 2015 to support our overall company growth as well as operation as a public company. Included in the increase in personnel costs was a $1.0 million increase in stock-based compensation expense and $0.4 million of additional costs attributable to the acquisition of Logentries and NTO. We also had an increase of $1.3 million in allocated overhead primarily due to IT related costs to support our growing headcount and a $0.3 million increase in travel and entertainment expense.

Interest Income (Expense), Net

 

     Year Ended
December 31,
    Change  
             2015                     2014                         $                             %              
     (dollars in thousands)  

Interest income (expense), net

   $ (2,523   $ (2,802   $ 279        10.0

% of revenue

     (2.3 )%      (3.6 )%     

Interest income (expense), net increased by $0.3 million in 2015 compared to 2014 primarily due to the decreased interest expense on our term loan of $1.0 million, partially offset by an increase in debt discount amortization of $0.6 million. The increase of debt discount amortization and decrease in interest expense was due to the repayment in full and termination of our term loan in July 2015.

Other Income (Expense), Net

 

    Year Ended
December 31,
    Change  
            2015                     2014                         $                             %              
    (dollars in thousands)  

Other income (expense), net

  $ (278   $ (305   $ 27        (8.9 )% 

% of revenue

    (0.2 )%      (0.4 )%     

Other income (expense), net increased nominally in 2015 compared to 2014 primarily due to realized and unrealized foreign currency gains and losses.

Provision for Income Taxes

 

     Year Ended
December 31,
    Change  
             2015                     2014                         $                             %              
     (dollars in thousands)  

Provision for income taxes

   $ 496      $ 379      $ 117        30.9

% of revenue

     0.4     0.5    

Provision for income taxes increased by $0.1 million in 2015 compared to 2014 primarily due to increased foreign taxes resulting from growth of our international operations.

 

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Year Ended December 31, 2014 Compared to the Year Ended December 31, 2013

Revenue

 

    Year Ended
December 31,
    Change  
    2014     2013     $             %          
    (dollars in thousands)  

Revenue:

       

Products

  $       47,030      $       38,633      $ 8,397        21.7%   

Maintenance and support

    19,016        14,017        4,999        35.7      

Professional services

    10,834        7,380        3,454        46.8      
 

 

 

   

 

 

   

 

 

   

Total revenue

  $ 76,880      $ 60,030      $   6,850        28.1%   
 

 

 

   

 

 

   

 

 

   

Total revenue increased by $16.9 million in 2014 compared to 2013 primarily due to an increase of $8.5 million recognized from our deferred revenue balance. The remaining increase was the result of a net increase of $5.2 million from sales to existing customers and $3.2 million from sales to new customers. We added 1,000 net new customers globally in 2014 compared to 2013. The increase in total revenue in 2014 was comprised of $13.6 million from North America and $3.3 million from the rest of the world. Products revenue and maintenance and support revenue increased by $8.4 million and $5.0 million, respectively, primarily due to the same contributors that drove our increase in total revenue. Professional services revenue increased by $3.5 million primarily due to increased demand for deployment, training and security assessment services.

Cost of Revenue

 

     Year Ended
December 31,
    Change  
     2014     2013     $           %        
     (dollars in thousands)  

Cost of revenue:

        

Products

   $ 4,557         $ 4,048         $ 509        12.6%   

Maintenance and support

     4,495           3,388           1,107        32.7      

Professional services

     9,420           5,442           3,978        73.1      
  

 

 

   

 

 

   

 

 

   

Total cost of revenue

   $     18,472         $     12,878         $       5,594        43.4%   
  

 

 

   

 

 

   

 

 

   

Gross margin %:

        

Products

     90.3%        89.5%       

Maintenance and support

     76.4           75.8          

Professional services

     13.1           26.3          
  

 

 

   

 

 

     

Total gross margin %

     76.0%        78.5%       
  

 

 

   

 

 

     

Total cost of revenue increased by $5.6 million in 2014 compared to 2013 primarily due to a $4.4 million increase in personnel costs and a $0.6 million increase in overhead allocations, both as a result of our increase in headcount from 67 as of December 31, 2013 to 104 as of December 31, 2014 to support our growing customer base. Our increase in total cost of revenue also included a $0.5 million increase in travel and entertainment expenses and a $0.1 million increase in hardware and hosting costs. The same factors were the primary contributors to the increases in products, maintenance and support and professional services cost of revenue.

Gross margin percentage decreased slightly as we continued our investment in growing our professional services team to help promote adoption of our analytics-driven approach to cyber security.

 

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Operating Expenses

Research and Development Expense

 

    Year Ended
December 31,
    Change  
    2014     2013     $     %  
    (dollars in thousands)  

Research and development

  $     25,570          $     21,411         $       4,159               19.4%   

% of revenue

    33.3%         35.7%       

Research and development expense increased by $4.2 million in 2014 compared to 2013 primarily due to a $3.4 million increase in personnel costs and a $0.6 million increase in allocated overhead, both as a result of our increase in headcount from 100 as of December 31, 2013 to 114 as of December 31, 2014 to support our product innovation. Our increase in research and development expense also included a $0.1 million increase in travel and entertainment expenses and $0.1 million increase in professional fees. In 2014, we expanded our research and development presence to Belfast, United Kingdom.

Sales and Marketing Expense

 

       Year Ended
December 31,
    Change  
       2014     2013     $     %  
       (dollars in thousands)  

Sales and marketing

     $       49,007         $       31,779          $     17,228              54.2%   

% of revenue

       63.7%        52.9%       

Sales and marketing expense increased by $17.2 million in 2014 compared to 2013 primarily due to a $14.2 million increase in personnel costs, including sales commissions, and a $2.6 million increase in allocated overhead, both as a result of our increase in headcount from 173 as of December 31, 2013 to 227 as of December 31, 2014 to drive additional sales of our products and services. In 2014, we invested in lead generation activities as well as trade shows and security regional events to strengthen awareness and educate the IT community about our offerings. Our increase in sales and marketing expense also included a $0.6 million increase in travel and entertainment costs as a result of our increased headcount, partially offset by a $0.2 million decrease in professional fees.

General and Administrative Expense

 

       Year Ended
December 31,
    Change  
       2014     2013     $     %  
       (dollars in thousands)  

General and administrative

     $     12,972          $     12,586         $           386             3.1%     

% of revenue

       16.9%         21.0%       

General and administrative expense increased by $0.4 million in 2014 compared to 2013 primarily due to a $1.4 million increase in personnel costs as a result of our increase in headcount from 58 as of December 31, 2013 to 66 as of December 31, 2014 to support our overall company growth as well as our preparation to operate as a public company, partially offset by a $0.6 million decrease in professional fees and a $0.1 million decrease in allocated overhead.

 

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Interest Income (Expense), Net

 

     Year Ended
December 31,
    Change  
     2014     2013     $     %  
     (dollars in thousands)  

Interest income (expense), net

    $   (2,802)           $     (122)          $       (2,680)               NM         

% of revenue

     (3.6)%         (0.2)%        

Interest income (expense), net increased by $2.7 million in 2014 compared to 2013 due to interest expense and discount amortization related to our term loan entered into in December 2013.

Other Income (Expense), Net

 

    Year Ended
December 31,
    Change  
    2014     2013     $     %  
    (dollars in thousands)  

Other income (expense), net

   $       (305)          $             43           $     (348)                  NM       

% of revenue

    (0.4)%         0.1%        

Other income (expense), net changed from de minimis income in 2013 to expense of $0.3 million in 2014 primarily due to unrealized and realized foreign currency fluctuations, specifically in European currencies.

Provision for Income Taxes

 

     Year Ended
December 31,
    Change  
     2014     2013     $     %  
     (dollars in thousands)  

Provision for income taxes

    $          379          $          170          $       209               122.9%   

% of revenue

     0.5%        0.3%       

Provision for income taxes increased by $0.2 million in 2014 compared to 2013 due to our increased operations in foreign jurisdictions where we are subject to income taxes on profits arising from our intercompany transfer pricing arrangements.

Liquidity and Capital Resources

Our principal sources of liquidity are cash and our accounts receivable. In connection with our IPO and concurrent private placement, we received aggregate net proceeds to us of $112.3 million, after deducting underwriting discounts and commissions related to our IPO of $8.3 million and offering expenses of $3.1 million. Prior to our IPO, we funded our operations primarily through issuances of common and redeemable convertible preferred stock and debt, including net proceeds of $93.4 million from the sale of shares of common and preferred stock. As of December 31, 2015, we had $86.6 million in cash and an accumulated deficit of $340.3 million. We have generated significant losses since inception and expect to continue to generate losses for the foreseeable future.

We believe that our existing cash balance together with cash generated from our operations will be sufficient to meet our working capital expenditure requirements for at least the next 12 months. Our future capital requirements will depend on many factors, including our growth rate, the timing and extent of spending to support research and development efforts, the expansion of sales and marketing activities, particularly

 

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internationally, and the introduction of new and enhanced products and professional service offerings. In the event that additional financing is required from outside sources, we may be unable to raise the funds on acceptable terms, if at all. If we are unable to raise additional capital when desired, our business, operating results and financial condition could be adversely affected.

The following table shows a summary of our cash flows for the years ended December 31, 2015, 2014 and 2013:

 

    Year Ended December 31,  
    2015     2014     2013  
    (in thousands)  

Cash at beginning of period

   $ 36,823         $ 20,612         $ 7,667    

Net cash used in operating activities

    (1,907)        (3,356)        (613)    

Net cash used in investing activities

    (42,947)        (7,082)        (2,778)   

Net cash provided by financing activities

    94,786         26,669         16,322    

Effects of exchange rates on cash

    (202)         (20)         14    
 

 

 

   

 

 

   

 

 

 

Cash at end of period

   $       86,553         $       36,823         $       20,612    
 

 

 

   

 

 

   

 

 

 

Uses of Funds

Our historical uses of cash have primarily consisted of cash used for operating activities such as expansion of our sales and marketing operations, research and development activities and other working capital needs, as well as cash used for business acquisitions.

Operating Activities

Operating activities used $1.9 million in cash in 2015, which reflected continued growth in revenue, offset by continuing investment in our operations. Cash used in operating activities reflected our net loss of $49.9 million, partially offset by our net decrease in operating assets and liabilities of $29.0 million and non-cash charges of $19.0 million related to depreciation and amortization, stock-based compensation, provision for doubtful accounts and other non-cash charges such as amortization of debt discount, impairment of long-lived assets and non-cash interest expense. The decrease in our net operating assets and liabilities was primarily due to a $44.8 million increase in deferred revenue from sales of our products and services and a $6.7 million increase in accrued expenses, partially offset by a $18.4 million increase in accounts receivable, a $2.3 million decrease in accounts payable and a $1.8 million increase in prepaid expenses and other assets.

Operating activities used $3.4 million of cash in 2014, which reflected growth in revenue, offset by continuing investment in our operations. Cash used in operating activities reflected our net loss of $32.6 million, offset by our net increase in operating assets and liabilities of $21.6 million and non-cash charges of $7.6 million related to depreciation and amortization, stock-based compensation and provision for doubtful accounts. The increase in our net operating assets and liabilities was primarily due to a $25.2 million increase in deferred revenue from sales of our products and services, a $3.5 million increase in accrued expense, a $2.2 million increase in other liabilities and a $0.6 million increase in accounts payable, partially offset by an increase of $7.1 million in accounts receivable and an increase of $2.2 million in prepaid expenses.

Operating activities used $0.6 million in cash in 2013, which reflected growth in revenue. Cash used in operating activities reflected our net loss of $18.9 million, offset by our increase in operating assets and liabilities of $13.0 million and non-cash charges of $5.2 million related to depreciation and amortization, stock-based compensation, provision for doubtful accounts and deferred income taxes. The increase in our net operating assets and liabilities was primarily due to a $15.1 million increase in deferred revenue from sales of our products and services, a $1.1 million increase in accounts payable due to the growth of our business and a $3.0 million increase in accrued expense as a result of headcount growth, partially offset by a $4.0 million increase in accounts receivable and a $3.1 million payment of contingent consideration.

 

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Investing Activities

Investing activities used $42.9 million in cash in 2015, primarily for the acquisition of Logentries and NTO with respect to $35.5 million and $3.3 million, respectively. Additionally, $4.1 million was used to purchase property and equipment.

Investing activities used $7.1 million in cash in 2014 and $2.8 million in cash in 2013, primarily for capital expenditures to purchase property and equipment, principally related to leasehold improvements for our new corporate headquarters.

Financing Activities

Financing activities provided $94.8 million in 2015, which consisted of net proceeds from our IPO and concurrent private placement of $112.3 million and proceeds from stock option exercises of $1.3 million, partially offset by the repayment of our term loan and related termination payment of $18.5 million and payments on capital lease obligations of $0.3 million.

Financing activities provided $26.7 million in cash in 2014, which consisted primarily of $30.8 million in net proceeds from the issuance of shares of Series D redeemable convertible preferred stock and $0.5 million in proceeds from exercises of stock options, partially offset by $3.5 million in repurchases of common stock, $0.8 million in payments of contingent consideration related to acquisitions and $0.3 million in payments on capital lease obligations.

Financing activities provided $16.3 million in cash in 2013, which consisted primarily of $18.0 million in proceeds from our term loan and $0.3 million in proceeds from exercises of stock options, partially offset by $1.5 million in payments of contingent consideration related to acquisitions and $0.3 million in payments on capital lease obligations.

Contractual Obligations and Commitments

The following table summarizes our commitments to settle contractual obligations as of December 31, 2015:

 

    Less than
1 Year
     1 to 3
Years
     3 to 5
Years
     More than
5 Years
     Total  
    (in thousands)  

Capital leases

   $ 70                $        $ —         $ —                $ 70    

Operating leases

    4,901                 8,682         2,532          —                 16,115    
 

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

  Total

   $       4,971                $     8,682        $     2,532         $             —                $     16,185    
 

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

The commitment amounts in the table above are associated with agreements that are enforceable and legally binding and that specify all significant terms, including fixed or minimum services to be used, fixed, minimum or variable price provisions and the approximate timing of the actions under the agreements. The table does not include obligations under agreements that we can cancel without a significant penalty.

We lease our office facilities under non-cancellable operating leases. As of December 31, 2015, we have leases that expire at various dates through 2020.

Off-Balance Sheet Arrangements

We do not have any relationships with unconsolidated entities or financial partnerships, including entities sometimes referred to as structured finance or special purpose entities that were established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. We do not engage

 

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in off-balance sheet financing arrangements. In addition, we do not engage in trading activities involving non-exchange traded contracts. We therefore believe that we are not materially exposed to any financing, liquidity, market or credit risk that could arise if we had engaged in these relationships.

Critical Accounting Policies

Our consolidated financial statements are prepared in accordance with generally accepted accounting principles in the United States, or GAAP. The preparation of our consolidated financial statements requires us to make estimates, assumptions and judgments that affect the reported amounts of assets, liabilities, revenue, costs and expenses. We base our estimates and assumptions on historical experience and other factors that we believe to be reasonable under the circumstances. We evaluate our estimates and assumptions on an ongoing basis. Our actual results may differ from these estimates. Our most critical accounting policies are summarized below. See Note 2 to our consolidated financial statements included in this Annual Report on Form 10-K for a description of our other significant accounting policies.

Revenue Recognition

We generate revenue primarily from selling products, maintenance and support, and professional services through a variety of delivery models. We generally bill customers and collect payment for both our products and services up front.

We generate products revenue from the sale of (1) perpetual or term software licenses and associated content subscriptions for our Nexpose and Metasploit products, (2) managed services for our Nexpose, AppSpider, Analytic Response and InsightUBA products and (3) cloud-based subscriptions for our, InsightUBA, Logentries and AppSpider products. We also generate an immaterial amount of appliance revenue that is included in our products revenue and that is associated with hardware sold as part of our Nexpose product to certain customers. We generate maintenance and support revenue associated with customers’ purchases of our software licenses for Nexpose and Metasploit. We generate professional service revenue from the sale of our deployment and training services related to our solutions, incident response services and security advisory services.

Revenue is only recognized when all of the following criteria are met:

 

   

Persuasive evidence of an arrangement exists. Binding agreements or purchase orders are generally evidence of an arrangement.

 

   

Delivery has occurred. Delivery occurs (1) upon delivery of the software license key or when the customer has access to the software product or (2) when we perform the services.

 

   

The sales price is fixed or determinable. Fees are considered fixed and determinable when the fees are contractually agreed upon with the customer.

 

   

Collectability is probable. Collectability is deemed probable based on review of a number of factors, including creditworthiness and customer payment history. If collectability is not reasonably assured, revenue is deferred until collection becomes reasonably assured, which is generally upon the receipt of payment.

Substantially all of our software licenses are sold in multiple-element arrangements that include maintenance and support, content subscriptions, cloud-based subscriptions, professional services and/or managed services. All of these elements are considered to be software elements other than cloud-based subscriptions, which are non-software elements, and managed services, which can be either software elements or non-software elements. Non-software elements included in multiple-element arrangements consist of a single deliverable that has stand-alone value and that represents a single unit of accounting. We have determined that we do not have vendor-specific

 

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objective evidence, or VSOE, of the selling price for the elements comprising these multiple-element arrangements as our software licenses are generally not sold on a stand-alone basis and we purposefully employ variable pricing for our offerings in order to meet customer purchase requirements along the multiple price points of the demand curve.

When all of the elements of a multiple-element arrangement are software elements, the revenue for software licenses and any other products and services that are sold along with the license is generally deferred on our balance sheet and recognized as revenue on our consolidated statements of operations ratably over the contractual period of the maintenance and support, typically one to three years, which is longer than the period over which the professional services are performed. Revenue recognition begins upon delivery of the software license, assuming that all other criteria for revenue recognition have been met.

When a multiple-element arrangement includes both software elements and non-software elements, the total arrangement consideration is first allocated between the software elements and the non-software elements based on the selling price hierarchy, which includes (1) VSOE, if available, (2) third-party evidence, or TPE, if VSOE is not available or (3) best estimate of selling price, or BESP, if neither VSOE nor TPE is available. We have not been able to establish a selling price for any element using VSOE or TPE. We determine BESP by considering our overall pricing objectives and market conditions. Significant pricing practices taken into consideration include our discounting practices, the size and volume of our transactions, our price lists, our go-to-market strategy, historical standalone sales and contract prices. The determination of BESP is made in consultation with, and is approved by, our management. Our multiple-element arrangements can include a single non-software element, in which case the portion of the consideration allocated to the non-software element is recognized ratably over the service period of the non-software element, assuming all other criteria for revenue recognition have been met. The portion of the consideration allocated to software elements is recognized as described above.

With respect to our managed services and cloud-based subscription offerings sold on a stand-alone basis, we recognize revenue ratably over the term of the managed service agreement or subscription, assuming that the other criteria for revenue recognition are met.

We recognize revenue from professional services sold on a stand-alone basis as those services are rendered.

For purposes of disclosing revenue by class, we allocate the arrangement consideration for multiple-element software arrangements among the individual elements utilizing BESP, as we do not have VSOE or TPE, of selling price for any of the elements.

Stock-Based Compensation

We measure and recognize compensation expense for all stock options and restricted stock awards, or RSAs, based on the estimated fair value of the award on the grant date. The fair value is recognized as expense, net of estimated forfeitures, over the requisite service period, which is generally the vesting period of the respective award, on a straight-line basis when the only condition to vesting is continued service. If vesting is subject to a market or performance condition, recognition is based on the derived service period of the award. Expense for awards with performance conditions is estimated and adjusted on a quarterly basis based upon the assessment of the probability that the performance condition will be met.

We use the Black-Scholes option pricing model to estimate the fair value of stock option awards. The Black-Scholes option pricing model requires management to make a number of other assumptions, including the expected life of the option, the volatility of the underlying stock, the risk-free interest rate and expected dividends. The assumptions used in our Black-Scholes option-pricing model represent management’s best estimates at the time of grant. These estimates are complex, involve a number of variables, uncertainties and assumptions and the application of management’s judgment, as they are inherently subjective. If any assumptions change, our stock-based compensation expense could be materially different in the future.

 

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These assumptions are estimated as follows:

 

   

Fair Value of Common Stock. Prior to our IPO, we estimated the fair value of common stock. See “Common and Preferred Stock Valuations” below. For stock options granted subsequent to our IPO, the fair value of common stock is based on the closing market price of our common stock on the date of grant.

 

   

Expected Term. The expected term represents the period that our stock options are expected to be outstanding. We calculated the expected term using the simplified method based on the average of each option’s vesting term and the contractual period during which the option can be exercised, which is typically 10 years following the date of grant.

 

   

Expected Volatility. The expected volatility is based on the historical stock volatility of several of our comparable publicly traded companies over a period of time equal to the expected term of the options, as we have limited trading history to use the volatility of our own common stock.

 

   

Risk-Free Interest Rate. The risk-free interest rate was based on an average of the five and seven-year U.S. Treasury zero-coupon issues for each option grant date with maturities approximately equal to the option’s expected term.

 

   

Expected Dividend Yield. We have not paid dividends on our common stock nor do we expect to pay dividends in the foreseeable future.

The fair value of RSAs is based on the closing market price of our common stock on the NASDAQ Global Market on the date of grant.

We estimate the fair value of the rights to acquire stock under our 2015 Employee Stock Purchase Plan, or ESPP, using the Black-Scholes option pricing formula. Our ESPP provides for a twelve-month offering period which contains two purchase periods of approximately six months in duration. We use our peer group volatility data in the valuation of ESPP shares. We recognize such compensation expense on a straight-line basis over the employee’s requisite service period.

Common and Preferred Stock Valuations

Given the absence of an active market for our common stock prior to our IPO, our board of directors was required to estimate the fair market value of our common stock on each grant date and considered, among other things, valuations of our common stock prepared by unrelated third-party valuation firms in accordance with the guidance provided by the American Institute of Certified Public Accountants 2004 Practice Aid, Valuation of Privately-Held-Company Equity Securities Issued as Compensation, or the Practice Aid. Our board of directors exercised reasonable judgment and considered a number of objective and subjective factors to determine the best estimate of the fair market value of our common stock, including:

 

   

contemporaneous third-party valuations of our common stock;

 

   

the prices, rights, preferences and privileges of our preferred stock relative to the common stock;

 

   

our business, financial condition and results of operations, including related industry trends affecting our operations;

 

   

the likelihood of achieving a liquidity event, such as an initial public offering or sale of our company, given prevailing market conditions;

 

   

the lack of marketability of our common stock;

 

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the market performance of comparable publicly traded technology companies; and

 

   

the United States and global economic and capital market conditions and outlook.

In valuing our common stock, our board of directors determined the equity value of our business generally using a combination of the income approach and the market approach valuation methods.

The income approach estimates value based on the expectation of future cash flows that a company will generate, such as cash earnings, cost savings, tax deductions and the proceeds from disposition. These future cash flows are discounted to their present values using a discount rate derived based on an analysis of the cost of capital of comparable publicly traded companies in similar lines of business, as of each valuation date, and is adjusted to reflect the risks inherent in our cash flows.

The market approach estimates the fair value of a company by applying market multiples of comparable publicly traded companies in a similar line of business. The market multiples are based on relevant metrics implied by the price that investors have paid for the equity of publicly traded companies. Given our significant focus on investing in and growing our business, we primarily utilized the revenue multiple when performing valuation assessments under the market approach. When considering which companies to include as our comparable industry peer companies, we focused on U.S.-based publicly traded companies that were broadly comparable to us based on consideration of industry, market and line of business. From the comparable companies, a representative market value multiple was determined and applied to our operating results to estimate the value of our company. The market value multiple was determined based on consideration of multiples of revenue to each of the comparable companies’ last twelve-month revenue and the forecasted future twelve-month revenue. In addition, the market approach considers merger and acquisition transactions involving companies similar to the company’s business being valued. Multiples of revenue are calculated for these transactions and then applied to the business being valued, after reduction by an appropriate discount.

Historically, our enterprise value was determined using a weighted average combination of the income approach and the market approach. Once an equity value was determined, we utilized a hybrid of the option pricing method, or OPM, and probability-weighted expected return method, or PWERM, to allocate the overall value of equity to the various share classes.

The OPM treats common stock and convertible preferred stock as call options on a company’s enterprise value with exercise prices based on the liquidation preferences of the convertible preferred stock. Under this method, the common stock only has value if the funds available for distribution to stockholders exceed the value of the liquidation preference at the time of an assumed liquidity event. The value assigned to the common stock is the remaining value after the convertible preferred stock is liquidated. The OPM prices the call option using the Black-Scholes model. The OPM is used when the range of possible future outcomes is difficult to predict.

The PWERM relies on a forward-looking analysis to predict the possible future value of a company. Under this method, discrete future outcomes, including an initial public offering, or IPO, and non-IPO scenarios, are weighted based on the estimated the probability of each scenario. The PWERM is used when discrete future outcomes can be predicted with reasonable certainty based on a probability distribution.

The hybrid method is generally preferred for a company expecting a liquidity event in the near future but where, due to market or other factors, the liquidity event is uncertain. In the application of the hybrid method, we relied on the PWERM to allocate the value of equity under a near-term liquidity scenario and the OPM to allocate the value of equity under a long-term liquidity scenario. The projected equity value relied upon in the PWERM scenario was based on (1) guideline IPO transactions involving companies that were considered broadly comparable to us and (2) our expectation of the pre-money valuation that we needed to achieve to consider an IPO as a viable exit strategy. The projected equity value relied upon in the OPM was based on a weighted average indication of the value using the discounted cash flow method, which is an income approach, and the guideline public company method, which is a market approach.

 

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In addition, we determined the fair value of our preferred stock as of each reporting period using the guidance prescribed by the Practice Aid, which was consistent with the way we had valued our common stock.

Income Taxes

Income taxes are accounted for using the asset and liability method. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective income tax bases, and operating loss and tax credit carryforwards. Valuation allowances are provided when we determine that it is more likely than not that all of, or a portion of, deferred tax assets will not be utilized in the future.

We account for unrecognized tax benefits using a more-likely-than-not threshold for financial statement recognition and measurement of tax positions taken or expected to be taken in a tax return.

Significant judgment is required in determining any valuation allowance recorded against deferred tax assets. In assessing the need for a valuation allowance, we consider all available evidence, including past operating results, estimates of future taxable income and the feasibility of tax planning strategies. In the event that we change our determination as to the amount of deferred tax assets that can be realized, we will adjust our valuation allowance with a corresponding impact to the provision for income taxes in the period in which such determination is made.

Estimates of future taxable income are based on assumptions that are consistent with our plans. Assumptions represent management’s best estimates and involve inherent uncertainties and the application of management’s judgment. Should actual amounts differ from our estimates, the amount of our tax expense and liabilities could be materially impacted.

Goodwill and Other Intangible Assets

Goodwill is an asset representing the future economic benefits arising from other assets acquired in a business combination that are not individually identified and separately recognized. We allocate the cost of an acquired entity to the assets acquired and liabilities assumed based on their estimated fair values at the date of acquisition. The excess of the purchase price for acquisitions over the fair value of the net assets acquired, including other intangible assets, is recorded as goodwill. Goodwill is not amortized but is tested for impairment at least annually or more frequently when events or circumstances occur that indicate that it is more likely than not that an impairment has occurred.

For our goodwill impairment analysis, we operate with a single reporting unit. We test goodwill for impairment on the last day of each fiscal year and whenever events or changes in circumstances indicate that the carrying amount of this asset may exceed its fair value. To test goodwill impairment, we perform the two-step goodwill impairment test to identify potential goodwill impairment. The two step impairment test begins with an estimation of the fair value of a reporting unit. Goodwill impairment exists when a reporting unit’s carrying value of goodwill exceeds its implied fair value. Significant judgment is applied when goodwill is assessed for impairment. In performing the first step of the goodwill impairment testing and measurement process, we compare our entity-wide estimated fair value to net book value to identify potential impairment. Management estimates the entity-wide fair value utilizing a weighted-average of the income approach using discounted cash flows, guideline public company and guideline transaction methods. If the fair value of the reporting unit is less than the book value, the second step is performed to determine if goodwill is impaired. If we determine through the impairment evaluation process that goodwill has been impaired, an impairment charge would be recorded in our consolidated statements of operations. There has been no impairment of goodwill for any periods presented. In addition, based on the results of our impairment test, our reporting unit was not at risk of having its carrying value, including goodwill, exceed its fair value.

Other intangible assets acquired in a business combination are recognized at fair value using generally accepted valuation methods appropriate for the type of intangible asset and reported separately from goodwill. Intangible assets with definite lives are amortized over the estimated useful lives and are tested for impairment when events

 

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or circumstances occur that indicate that it is more likely than not that an impairment has occurred. We test other intangible assets with definite lives for impairment by comparing the carrying amount to the sum of the net undiscounted cash flows expected to be generated by the asset whenever events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable. If the carrying amount of the asset exceeds its net undiscounted cash flows, then an impairment loss is recognized for the amount by which the carrying amount exceeds its fair value. There has been no impairment of other intangible assets for any periods presented.

Recent Accounting Pronouncements

In February 2016, the Financial Accounting Standards Board, or FASB, issued Accounting Standards Update, or ASU, 2016-02, Leases (Topic 842). The ASU requires companies to recognize on the balance sheet the assets and liabilities for the rights and obligations created by leased assets. The ASU will be effective for us in the first quarter of 2019, with early adoption permitted. We are currently evaluating the impact that the adoption of this ASU will have on our consolidated financial statements.

In November 2015, the FASB issued ASU 2015-17, Income Taxes (Topic 740) – Balance Sheet Classification of Deferred Taxes. The ASU requires that deferred tax liabilities and assets be classified as noncurrent in a classified balance sheet simplifying current GAAP, which requires an entity to separate deferred tax liabilities and assets into current and noncurrent amounts in the balance sheet. The ASU will be effective for us in the first quarter of 2017, and may be applied prospectively or retrospectively at our election. We do not expect that the adoption of this ASU will have a significant impact on our consolidated financial statements.

In September 2015, the FASB issued ASU 2015-16, Business Combinations (Topic 805) – Simplifying the Accounting for Measurement-Period Adjustments. The ASU requires that an acquirer recognize adjustments to provisional amounts that are identified during the measurement period in the reporting period in which the adjustment amounts are determined. The ASU requires that the acquirer record, in the same period’s financial statements, the effect on earnings of changes in depreciation, amortization, or other income effects, if any, as a result of the change to the provisional amounts, calculated as if the accounting had been completed at the acquisition date. The ASU requires an entity to present separately on the face of the income statement or disclose in the notes the portion of the amount recorded in current-period earnings by line item that would have been recorded in previous reporting periods if the adjustment to the provisional amounts had been recognized as of the acquisition date. The ASU will be effective for us in the first quarter of 2016. We do not expect that the adoption of this ASU will have a significant impact on our consolidated financial statements.

In April 2015, the FASB issued ASU 2015-05, Intangibles -Goodwill and Other – Internal Use Software (Subtopic 350-40): Customer’s Accounting for Fees Paid in a Cloud Computing Arrangement, which provides guidance on accounting for fees paid in a cloud computing arrangement. Under the ASU, if a cloud computing arrangement includes a software license, the software license element should be accounted for consistent with the purchase of other software licenses. If the cloud computing arrangement does not include a software license, it should be accounted for as a service contract. The ASU will be effective for us in the first quarter of 2016 and may be applied either prospectively or retrospectively. We do not expect that the adoption of this ASU will have a significant impact on our consolidated financial statements.

In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606). The ASU outlines a single, comprehensive model for accounting for revenue from contracts with customers and requires more detailed disclosure to enable users of financial statements to understand the nature, amount, timing and uncertainty of revenue and cash flows arising from such contracts. In August 2015, the FASB issued ASU 2015-14, which provides a one year deferral in the effective date of ASU 2014-09. ASU 2014-09 will now be effective for us beginning January 1, 2018; however, early adoption will be permitted as of the original effective date. The new standard may be applied retrospectively to each prior period presented or prospectively with the cumulative effect recognized on the date of adoption. We are currently evaluating the impact that the standard will have on our consolidated financial statements.

 

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Item 7A. Quantitative and Qualitative Disclosures About Market Risk.

Interest Rate Risk

We are exposed to interest rate risk in the ordinary course of our business. Our cash is held in readily available checking and money market accounts. Due to the short-term nature of our checking and money market accounts, we believe that we do not have any material exposure to changes in the fair value of our cash balances as a result of changes in interest rates. Declines in interest rates, however, would reduce future interest income. We had cash of $86.6 million as of December 31, 2015 and hold this cash for working capital purposes.

During the years ended December 31, 2015 and 2014, the effect of a hypothetical 10% increase or decrease in overall interest rates would not have had a material impact on our interest income.

Foreign Currency Exchange Risk

Our results of operations and cash flows are subject to fluctuations due to changes in foreign currency exchange rates. Substantially all of our customers enter into contracts that are denominated in U.S. dollars. Our expenses are generally denominated in the currencies of the countries where our operations are located, which is primarily in the United States and to a lesser extent in the United Kingdom, other Euro-zone countries within mainland Europe, Hong Kong, Canada, Singapore and Australia. Our results of operations and cash flows are, therefore, subject to fluctuations due to changes in foreign currency exchange rates and may be adversely affected in the future due to changes in foreign currency exchange rates. The effect of a hypothetical 10% change in foreign currency exchanges rates applicable to our business would not have a material impact on our historical consolidated financial statements. To date, we have not engaged in any hedging strategies. As our international operations grow, we will continue to reassess our approach to manage our risk relating to fluctuations in foreign currency rates.

Inflation Risk

We do not believe that inflation had a material effect on our business, financial condition or results of operations in the last three years. If our costs were to become subject to significant inflationary pressures, we may not be able to fully offset such higher costs through price increases. Our inability or failure to do so could harm our business, financial condition and results of operations.

JOBS Act Transition Period

In April 2012, the Jumpstart Our Business Startups Act of 2012, or the JOBS Act, was enacted. Section 107 of the JOBS Act provides that an “emerging growth company” can take advantage of the extended transition period provided in Section 7(a)(2)(B) of the Securities Act for complying with new or revised accounting standards. Thus, an emerging growth company can delay the adoption of certain accounting standards until those standards would otherwise apply to private companies. We have irrevocably elected not to avail ourselves of this extended transition period and, as a result, we will adopt new or revised accounting standards on the relevant dates on which adoption of such standards is required for other public companies.

We are relying on other exemptions and reduced reporting requirements provided by the JOBS Act. Subject to certain conditions, as an emerging growth company, we may rely on certain of these exemptions, including without limitation, (i) providing an auditor’s attestation report on our system of internal controls over financial reporting pursuant to Section 404(b) of the Sarbanes-Oxley Act and (ii) complying with any requirement that may be adopted by the Public Company Accounting Oversight Board regarding mandatory audit firm rotation or a supplement to the auditor’s report providing additional information about the audit and the financial statements, known as the auditor discussion and analysis. We will remain an emerging growth company until the earlier to occur of (1) the last day of the fiscal year (a) following the fifth anniversary of the completion of this offering, (b) in which we have total annual gross revenues of at least $1.0 billion or (c) in which we are deemed to be a “large accelerated filer” under the rules of the U.S. Securities and Exchange Commission, which means the

market value of our common stock that is held by non-affiliates exceeds $700 million as of the prior June 30th, and (2) the date on which we have issued more than $1.0 billion in non-convertible debt during the prior three-year period.

 

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Item 8. Financial Statements and Supplementary Data.

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

 

Consolidated Financial Statements:

    

Report of Independent Registered Public Accounting Firm

       81   

Consolidated Balance Sheets

       82   

Consolidated Statements of Operations

       83   

Consolidated Statements of Changes in Redeemable Convertible Preferred Stock and Stockholders’ Equity (Deficit)

       84   

Consolidated Statements of Cash Flows

       85   

Notes to Consolidated Financial Statements

       86   

 

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Board of Directors and Stockholders

Rapid7, Inc.:

We have audited the accompanying consolidated balance sheets of Rapid7, Inc. and subsidiaries as of December 31, 2015 and 2014, and the related consolidated statements of operations, changes in redeemable convertible preferred stock and stockholders’ equity (deficit), and cash flows for each of the years in the three-year period ended December 31, 2015. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Rapid7, Inc. and subsidiaries as of December 31, 2015 and 2014, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2015, in conformity with U.S. generally accepted accounting principles.

/s/ KPMG LLP

Boston, Massachusetts

March 10, 2016

 

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RAPID7, INC.

CONSOLIDATED BALANCE SHEETS

(in thousands, except share and per share data)

 

      December 31, 2015         December 31, 2014    

Assets

   

Current assets:

   

Cash

    $                 86,553        $                 36,823   

Accounts receivables, net

    44,164        25,412   

Prepaid expenses and other current assets

    6,148        4,209   
 

 

 

   

 

 

 

Total current assets

    136,865        66,444   

Property and equipment, net

    7,532        7,922   

Goodwill

    74,565        11,265   

Intangible assets, net

    11,385        1,156   

Other assets

    214        179   
 

 

 

   

 

 

 

Total assets

    $               230,561        $                 86,966   
 

 

 

   

 

 

 

Liabilities, Redeemable Convertible Preferred Stock and Stockholders’ Equity (Deficit)

   

Current liabilities:

   

Accounts payable

    2,038        3,536   

Accrued expenses

    24,707        11,907   

Deferred revenue, current portion

    87,917        58,164   

Other current liabilities

    1,105        642   
 

 

 

   

 

 

 

Total current liabilities

    115,767        74,249   

Deferred revenue, non-current portion

    42,400        26,892   

Term loan payable, net of unamortized debt discount

           16,871   

Other long-term liabilities

    4,319        4,218   
 

 

 

   

 

 

 

Total liabilities

    162,486        122,230   

Commitments and contingencies

   

Redeemable convertible preferred stock:

   

Series A redeemable convertible preferred stock, $0.01 par value per share; 0 and 6,303,033 shares authorized, issued and outstanding at December 31, 2015 and 2014, respectively; aggregate liquidation value of $0 and $9,252 at December 31, 2015 and 2014, respectively

           68,892   

Series B redeemable convertible preferred stock, $0.01 par value per share; 0 and 519,269 shares authorized, issued and outstanding at December 31, 2015 and 2014, respectively; aggregate liquidation value of $0 and $880 at December 31, 2015 and 2014, respectively

           5,681   

Series C redeemable convertible preferred stock, $0.01 par value per share; 0 and 6,873,797 shares authorized, issued and outstanding at December 31, 2015 and 2014, respectively; aggregate liquidation value of $0 and $59,829 at December 31, 2015 and 2014, respectively

           80,286   

Series D redeemable convertible preferred stock, $0.01 par value per share; 0 and 2,696,504 shares authorized at December 31, 2015 and 2014, respectively; 0 and 2,686,516 shares issued and outstanding at December 31, 2015 and 2014, respectively; aggregate liquidation value of $0 and $31,143 at December 31, 2015 and 2014, respectively

           56,739   

Stockholders’ equity (deficit):

   

Preferred stock, $0.01 par value per share; 10,000,000 and 0 shares authorized at December 31, 2015 and 2014, respectively; 0 shares issued at December 31, 2015 and 2014

             

Common stock, $0.01 par value; 100,000,000 and 35,700,000 shares authorized at December 31, 2015 and 2014, respectively; 41,942,026 and 12,964,721 shares issued at December 31, 2015 and 2014, respectively; 41,540,400 and 12,563,095 shares outstanding at December 31, 2015 and 2014, respectively

    415        126   

Additional paid-in-capital

    411,524          

Accumulated deficit

    (340,338)        (243,462)   

Treasury stock, at cost, 401,626 shares at December 31, 2015 and 2014

    (3,526)        (3,526)   
 

 

 

   

 

 

 

Total stockholders’ equity (deficit)

    68,075        (246,862)   
 

 

 

   

 

 

 

Total liabilities, redeemable convertible preferred stock and stockholders’ equity (deficit)

    $               230,561        $               86,966   
 

 

 

   

 

 

 

See accompanying notes to consolidated financial statements.

 

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RAPID7, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except share and per share data)

 

    Year Ended December 31,  
                2015                             2014                             2013              

Revenue:

     

Products

    $          63,407        $          47,030        $          38,633   

Maintenance and support

    26,903        19,016        14,017   

Professional services

    20,216        10,834        7,380   
 

 

 

   

 

 

   

 

 

 

Total revenue

    110,526        76,880        60,030   

Cost of revenue:

     

Products

    6,921        4,557        4,048   

Maintenance and support

    6,002        4,495        3,388   

Professional services

    16,321        9,420        5,442   
 

 

 

   

 

 

   

 

 

 

Total cost of revenue

    29,244        18,472        12,878   
 

 

 

   

 

 

   

 

 

 

Total gross profit

    81,282        58,408        47,152   
 

 

 

   

 

 

   

 

 

 

Operating expenses:

     

Research and development

    38,746        25,570        21,411   

Sales and marketing

    67,365        49,007        31,779   

General and administrative

    21,731        12,972        12,586   
 

 

 

   

 

 

   

 

 

 

Total operating expenses

    127,842        87,549        65,776   
 

 

 

   

 

 

   

 

 

 

Loss from operations

    (46,560)        (29,141)        (18,624)   

Other income (expense), net:

     

Interest income (expense), net

    (2,523)        (2,802)        (122)   

Other income (expense), net

    (278)        (305)        43   
 

 

 

   

 

 

   

 

 

 

Loss before income taxes

    (49,361)        (32,248)        (18,703)   

Provision for income taxes

    496        379        170   
 

 

 

   

 

 

   

 

 

 

Net loss

    (49,857)        (32,627)        (18,873)   

Accretion of preferred stock to redemption value

    (35,061)        (52,336)        (33,553)   

Beneficial conversion charge relating to IPO participation payment

    (14,161)                 
 

 

 

   

 

 

   

 

 

 

Net loss attributable to common stockholders

    $        (99,079)        $        (84,963)        $        (52,426)   
 

 

 

   

 

 

   

 

 

 

Net loss per share attributable to common stockholders, basic and diluted

    $            (4.00)        $            (6.65)        $            (4.18)   
 

 

 

   

 

 

   

 

 

 

Weighted-average common shares outstanding, basic and diluted

    24,740,480        12,770,916        12,549,266   
 

 

 

   

 

 

   

 

 

 

See accompanying notes to consolidated financial statements.

 

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RAPID7, INC.

CONSOLIDATED STATEMENTS OF CHANGES IN REDEEMABLE CONVERTIBLE PREFERRED STOCK AND STOCKHOLDERS’

EQUITY (DEFICIT)

(in thousands, except share data)

 

    Series A
redeemable convertible
preferred stock
    Series B
redeemable convertible
preferred stock
    Series C
redeemable convertible
preferred stock
    Series D
redeemable convertible
preferred stock
        Common stock     Additional
paid-in
capital
    Accumulated
deficit
    Treasury stock     Total
stockholders’
equity (deficit)
 
    Shares     Amount     Shares     Amount     Shares     Amount     Shares     Amount         Shares     Amount         Shares     Amount    

Balance, December 31, 2012

    6,303,033      $ 34,793        519,269      $ 2,908        6,873,797      $ 57,190             $            12,533,527      $   125      $      $ (112,031)             $      $ (111,906)   

Stock-based compensation expense

                                                                              2,047                             2,047   

Accretion of preferred stock to redemption value

           20,169               1,630               11,754                                        (3,308)        (30,245)                      (33,553)   

Issuance of common stock warrants

                                                                              1,007                             1,007   

Issuance of common stock upon exercise of stock options, net of stock withheld for taxes

                                                                229,994        3        254                             257   

Net loss

                                                                                     (18,873)                      (18,873)   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

       

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance, December 31, 2013

    6,303,033      $ 54,962        519,269      $ 4,538        6,873,797      $ 68,944             $            12,763,521      $ 128      $      $ (161,149)             $      $  (161,021)   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

       

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Stock-based compensation expense

                                                                              2,159                             2,159   

Accretion of preferred stock to redemption value

           13,930               1,143               11,342               25,921                          (2,650)        (49,686)                      (52,336)   

Issuance of Series D redeemable convertible preferred stock, net of issuance costs

                                              2,686,516        30,818                                                        

Issuance of common stock upon exercise of stock options

                                                                201,200        2        487                             489   

Purchase of common stock

                                                                (401,626)        (4)        4               401,626        (3,526)        (3,526)   

Net loss

                                                                                     (32,627)                      (32,627)   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

       

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance, December 31, 2014

    6,303,033      $ 68,892        519,269      $ 5,681        6,873,797      $ 80,286        2,686,516      $ 56,739            12,563,095      $ 126      $      $ (243,462)        401,626      $ (3,526)      $ (246,862)   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

       

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Stock-based compensation expense

                                                                              10,685                             10,685   

Accretion of preferred stock to redemption value

           14,308               1,173               10,929               8,651                          (2,203)        (32,858)                      (35,061)   

Conversion of preferred stock to common stock

    (6,303,033)        (83,200)        (519,269)        (6,854)        (6,873,797)        (91,215)        (2,686,516)        (65,390)            16,382,615        164        246,495                             246,659   

IPO participation payment and beneficial conversion charge

                                                                1,939,990        19        14,142        (14,161)                        

Issuance of common stock in relation to IPO and concurrent private placement, net of offering costs

                                                                7,730,000        77        112,198                             112,275   

Issuance of common stock and options associated with acquisitions

                                                                1,261,718        13        31,962                             31,975   

Issuance of restricted stock

                                                                1,358,505        13        (13)                               

Shares withheld for employee taxes

                                                                (134,296)        (1)        (3,086)                             (3,087)   

Issuance of common stock upon exercise of stock options and warrants

                                                                438,773        4        1,344                             1,348   

Net loss

                                                                                     (49,857)                      (49,857)   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

       

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance, December 31, 2015

         $             $             $             $            41,540,400      $ 415      $    411,524      $  (340,338)        401,626      $  (3,526)      $ 68,075   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

       

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

See accompanying notes to consolidated financial statements.

 

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RAPID7, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

 

    Year Ended December 31,  
                2015                             2014                             2013              

Cash flows from operating activities:

     

Net loss

  $ (49,857)      $ (32,627)      $ (18,873)   

Adjustments to reconcile net loss to net cash used in operating activities:

     

Depreciation and amortization

    5,352        4,140        2,631   

Amortization of debt discount

    1,129        553          

Non-cash interest expense

    209                 

Stock-based compensation expense

    10,685        2,159        2,047   

Provision for doubtful accounts

    828        581        460   

Impairment of long-lived assets

    483                 

Deferred income taxes

    119        196        111   

Foreign currency re-measurement loss

    153                 

Changes in assets and liabilities:

     

Accounts receivables

    (18,370)        (7,127)        (4,012)   

Prepaid expenses and other assets

    (1,787)        (2,165)        28   

Accounts payable

    (2,302)        567        1,064   

Accrued expenses

    6,702        3,534        2,971   

Deferred revenue

    44,868        25,200        15,126   

Contingent consideration

           (560)        (3,081)   

Other liabilities

    (119)        2,193        915   
 

 

 

   

 

 

   

 

 

 

Net cash used in operating activities

    (1,907)        (3,356)        (613)   
 

 

 

   

 

 

   

 

 

 

Cash flows from investing activities:

     

Business acquisitions, net of cash acquired

    (38,811)                 

Purchases of property and equipment

    (4,136)        (7,082)        (2,778)   
 

 

 

   

 

 

   

 

 

 

Net cash used in investing activities

    (42,947)        (7,082)        (2,778)   
 

 

 

   

 

 

   

 

 

 

Cash flows from financing activities:

     

Proceeds from initial public offering and concurrent private placement, net of offering costs of $3,097

    112,275                 

Proceeds from issuance of Series D redeemable convertible preferred stock, net

           30,818          

Borrowings from term loan

                  18,000   

Borrowings from line of credit

                  5,000   

Repayments on line of credit

                  (5,000)   

Repayments of term loan and related termination fee

    (18,540)                 

Payments of contingent consideration related to business acquisitions

           (856)        (1,500)   

Payments of debt and equity issuance costs

                  (135)   

Repurchase of common and preferred stock

           (3,526)          

Payments of capital lease obligations

    (253)        (256)        (300)   

Proceeds from stock option exercises

    1,304        489        257   
 

 

 

   

 

 

   

 

 

 

Net cash provided by financing activities

    94,786        26,669        16,322   
 

 

 

   

 

 

   

 

 

 

Effect of exchange rate changes on cash

    (202)        (20)        14   
 

 

 

   

 

 

   

 

 

 

Net increase in cash

    49,730        16,211        12,945   

Cash, beginning of period

    36,823        20,612        7,667   
 

 

 

   

 

 

   

 

 

 

Cash, end of period

  $ 86,553      $ 36,823      $ 20,612   
 

 

 

   

 

 

   

 

 

 

Supplemental cash flow information:

     

Cash paid for income taxes

  $ 341      $ 62      $ 34   

Cash paid for interest

  $ 1,427      $ 2,095      $ 96   

Non-cash investing and financing activities:

     

Common stock issued for acquisitions

  $ 27,481      $      $   

Vested stock options issued for acquisition

  $ 4,494      $      $   

See accompanying notes to consolidated financial statements.

 

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RAPID7, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

(1)

Nature of the Business

Rapid7, Inc. and subsidiaries (“we,” “us” or “our”) is a leading provider of security data and analytics solutions that enable organizations to implement an active, analytics-driven approach to cyber security. Our solutions empower organizations to prevent attacks by providing visibility into vulnerabilities and to rapidly detect compromises, respond to breaches and correct the underlying causes of attacks.

 

(2)

Summary of Significant Accounting Policies

 

  (a)

Basis of Presentation

The accompanying consolidated financial statements include our results of operations and those of our wholly-owned subsidiaries. All intercompany transactions and balances have been eliminated in consolidation. The accompanying consolidated financial statements have been prepared on the basis of generally accepted accounting principles in the United States of America (U.S. GAAP).

 

  (b)

Use of Estimates

The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates, judgments and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses, together with amounts disclosed in the accompanying notes to the financial statements. Actual results could differ from those estimates. Significant items subject to such estimates and assumptions include revenue recognition, stock-based compensation, income taxes and goodwill and other intangible assets. We base our estimates on historical experience and also on assumptions that we believe are reasonable. Changes in facts or circumstances may cause us to change our assumptions and estimates in future periods and it is possible that actual results could differ from our current or revised future estimates.

 

  (c)

Translation of Foreign Currencies

The functional currency of our foreign subsidiaries is the U.S. dollar. We translate all monetary assets and liabilities denominated in foreign currencies into U.S. dollars using the exchange rates in effect at the balance sheet dates and other assets and liabilities using historical exchange rates. Foreign currency denominated revenue and expenses have been re-measured using the average exchange rates in effect during each period. Foreign currency transactional and re-measurement gains and losses are included in other income (expense), net. In 2015, we recorded foreign currency transactional losses and foreign currency re-measurement losses of $0.1 million and $0.2 million, respectively. Foreign currency transactional and re-measurement gain and losses were not significant in 2014 or 2013.

 

  (d)

Revenue Recognition

We generate revenue primarily from selling products, maintenance and support, and professional services through a variety of delivery models. We generally bill customers and collect payment for both our products and services up front.

We generate products revenue from the sale of (1) perpetual or term software licenses and associated content subscriptions for our Nexpose and Metasploit products, (2) managed services for our Nexpose, AppSpider, Analytic Response and InsightUBA products and (3) cloud-based subscriptions for our, InsightUBA, Logentries and AppSpider products. We also generate an immaterial amount of appliance revenue that is included in our products revenue and that is associated with hardware sold as part of our Nexpose product to certain customers. We generate maintenance and support revenue associated with customers’ purchases of our software licenses for Nexpose and Metasploit. We generate professional service revenue from the sale of our deployment and training services related to our solutions, incident response services and security advisory services.

 

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Revenue is only recognized when all of the following criteria are met:

 

   

Persuasive evidence of an arrangement exists. Binding agreements or purchase orders are generally evidence of an arrangement.

 

   

Delivery has occurred. Delivery occurs (1) upon delivery of the software license key or when the customer has access to the software product or (2) when we perform the services.

 

   

The sales price is fixed or determinable. Fees are considered fixed and determinable when the fees are contractually agreed upon with the customer.

 

   

Collectability is probable. Collectability is deemed probable based on review of a number of factors, including creditworthiness and customer payment history. If collectability is not reasonably assured, revenue is deferred until collection becomes reasonably assured, which is generally upon the receipt of payment.

Substantially all of our software licenses are sold in multiple-element arrangements that include maintenance and support, content subscriptions, cloud-based subscriptions, professional services and/or managed services. All of these elements are considered to be software elements other than cloud-based subscriptions, which are non-software elements, and managed services, which can be either software elements or non-software elements. Non-software elements included in multiple-element arrangements consist of a single deliverable that has stand-alone value and that represents a single unit of accounting. We have determined that we do not have vendor-specific objective evidence, or VSOE, of the selling price for the elements comprising these multiple-element arrangements as our software licenses are generally not sold on a stand-alone basis and we purposefully employ variable pricing for our offerings in order to meet customer purchase requirements along the multiple price points of the demand curve.

When all of the elements of a multiple-element arrangement are software elements, the revenue for software licenses and any other products and services that are sold along with the license is generally deferred on our balance sheet and recognized as revenue on our consolidated statements of operations ratably over the contractual period of the maintenance and support, typically one to three years, which is longer than the period over which the professional services are performed. Revenue recognition begins upon delivery of the software license, assuming that all other criteria for revenue recognition have been met.

When a multiple-element arrangement includes both software elements and non-software elements, the total arrangement consideration is first allocated between the software elements and the non-software elements based on the selling price hierarchy, which includes (1) VSOE, if available, (2) third-party evidence, or TPE, if VSOE is not available or (3) best estimate of selling price, or BESP, if neither VSOE nor TPE is available. We have not been able to establish a selling price for any element using VSOE or TPE. We determine BESP by considering our overall pricing objectives and market conditions. Significant pricing practices taken into consideration include our discounting practices, the size and volume of our transactions, our price lists, our go-to-market strategy, historical standalone sales and contract prices. The determination of BESP is made in consultation with, and is approved by, our management. Our multiple-element arrangements can include a single non-software element, in which case the portion of the consideration allocated to the non-software element is recognized ratably over the service period of the non-software element, assuming all other criteria for revenue recognition have been met. The portion of the consideration allocated to software elements is recognized as described above.

With respect to our managed services and cloud-based subscription offerings sold on a stand-alone basis, we recognize revenue ratably over the term of the managed service agreement or subscription, assuming that the other criteria for revenue recognition are met.

 

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We recognize revenue from professional services sold on a stand-alone basis as those services are rendered.

For purposes of disclosing revenue by class, we allocate the arrangement consideration for multiple-element software arrangements among the individual elements utilizing BESP, as we do not have VSOE or TPE, of selling price for any of the elements.

 

  (e)

Deferred Revenue

Deferred revenue consists of amounts that have been invoiced but that have not been recognized as revenue. Deferred revenue that will be realized during the succeeding 12-month period is recorded as current, and the remaining deferred revenue is recorded as non-current.

 

  (f)

Accounts Receivable and Allowance for Doubtful Accounts

Accounts receivable are recorded at the invoiced amount, net of allowances for doubtful accounts. Management regularly reviews the adequacy of the allowance for doubtful accounts by considering the age of outstanding invoices, the customer’s expected ability to pay and the collection history, when applicable, to determine whether an allowance is appropriate. Accounts receivable are charged against the allowance for doubtful accounts after all means of collection have been exhausted and the potential for recovery is considered remote. Additions to the allowance for doubtful accounts are recorded in general and administrative expense in the consolidated statement of operations. We do not have any off balance sheet credit exposure related to our customers. The following table displays the changes in our allowance for doubtful accounts:

 

    Amount  
      (in thousands)    

Balance at December 31, 2012

  $ 460   

Additions

    460   

Less write-offs, net of recoveries

    (209)   
 

 

 

 

Balance at December 31, 2013

    711   

Additions

    581   

Less write-offs, net of recoveries

    (1,016)   
 

 

 

 

Balance at December 31, 2014

    276   

Additions

    828   

Less write-offs, net of recoveries

    (374)   
 

 

 

 

Balance at December 31, 2015

  $ 730   
 

 

 

 

 

  (g)

Concentration of Credit Risk

Financial instruments that potentially expose us to concentrations of credit risk consist primarily of accounts receivable. We provide credit to customers in the normal course of business. Collateral is not required for accounts receivable, but ongoing credit evaluations of customers’ financial condition are performed. We maintain reserves for potential credit losses. No single customer accounted for 10% or more of our total revenues in 2015, 2014 or 2013 or accounts receivable as of December 31, 2015 and 2014.

We maintain our cash in bank deposit and checking accounts with major financial institutions, which at times may exceed U.S. federally insured limits. We have not experienced any losses in such accounts and believe that we are not exposed to any significant risk.

 

  (h)

Fair Value Measurements

We utilize valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs to the extent possible. We determine fair value based on assumptions that market

 

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participants would use in pricing an asset or liability in the principal or most advantageous market. When considering market participant assumptions in fair value measurements, the following fair value hierarchy distinguishes between observable and unobservable inputs, which are categorized in one of the following levels:

 

   

Level 1 Inputs: Unadjusted quoted prices in active markets for identical assets or liabilities accessible to the reporting entity at the measurement date.

 

   

Level 2 Inputs: Other than quoted prices included in Level 1 inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the asset or liability.

 

   

Level 3 Inputs: Unobservable inputs for the asset or liability used to measure fair value to the extent that observable inputs are not available, thereby allowing for situations in which there is little, if any, market activity for the asset or liability at measurement date.

 

  (i)

Property and Equipment

Property and equipment are recorded at cost and depreciated over their estimated useful lives using the straight-line method. Leasehold improvements are amortized over the shorter of the lease term or the estimated useful life of the related asset. All other asset categories are depreciated over three to five years. Upon sale, the cost of assets disposed and the related accumulated depreciation are removed from the accounts and any resulting gain or loss is recognized in the consolidated statements of operations. Repairs and maintenance costs are expensed as incurred.

 

  (j)

Capitalized Software Costs

We capitalize certain costs related to software acquired for internal use and software developed for sale.

With respect to software acquired for internal use, we capitalize qualifying software costs, which include software license fees and third-party implementation and related costs. Total unamortized capitalized costs relating to software acquired for internal use as of December 31, 2015 and 2014 were $0.6 million and $0.3 million, respectively.

With respect to software developed for sale, we expense costs incurred in research and development until technological feasibility has been established for the product. Once technological feasibility is established, all software costs are capitalized until the product is available for general release. As of December 31, 2015 and 2014, total unamortized capitalized costs relating to software developed for sale was $0 and $0.5 million, respectively. In 2015, we wrote off the $0.5 million capitalized product development costs due to changes in future product development plans. This impairment charge was recorded in research and development expense within our consolidated statements of operations.

 

  (k)

Long-Lived Assets

We review the carrying value of our long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying value of these assets may not be recoverable. When such events or changes in circumstances occur, recoverability of these assets is measured by a comparison of the carrying value of an asset to the future net undiscounted cash flows directly associated with the asset. If assets are considered to be impaired, the impairment recognized is the amount by which the carrying value exceeds the fair value of the asset. We use a discounted cash flow approach or other methods, if appropriate, to assess fair value.

 

  (l)

Goodwill and Other Intangible Assets

Goodwill is an asset representing the future economic benefits arising from other assets acquired in a business combination that are not individually identified and separately recognized. We allocate the cost of an acquired entity to the assets acquired and liabilities assumed based on their estimated fair values at the date of acquisition. The excess of the purchase price for acquisitions over the fair value

 

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of the net assets acquired, including other intangible assets, is recorded as goodwill. Goodwill is not amortized but is tested for impairment at least annually or more frequently when events or circumstances occur that indicate that it is more likely than not that an impairment has occurred.

For our goodwill impairment analysis, we operate with a single reporting unit. We test goodwill for impairment on the last day of each fiscal year and whenever events or changes in circumstances indicate that the carrying amount of this asset may exceed its fair value. To test goodwill impairment, we perform the two-step goodwill impairment test to identify potential goodwill impairment. The two step impairment test begins with an estimation of the fair value of a reporting unit. Goodwill impairment exists when a reporting unit’s carrying value of goodwill exceeds its implied fair value. Significant judgment is applied when goodwill is assessed for impairment. In performing the first step of the goodwill impairment testing and measurement process, we compare our entity-wide estimated fair value to net book value to identify potential impairment. Management estimates the entity-wide fair value utilizing a weighted-average of the income approach using discounted cash flows, guideline public company and guideline transaction methods. If the fair value of the reporting unit is less than the book value, the second step is performed to determine if goodwill is impaired. If we determine through the impairment evaluation process that goodwill has been impaired, an impairment charge would be recorded in our consolidated statements of operations. There has been no impairment of goodwill for any periods presented. In addition, based on the results of our impairment test, our reporting unit was not at risk of having its carrying value, including goodwill, exceed its fair value.

Other intangible assets acquired in a business combination are recognized at fair value using generally accepted valuation methods appropriate for the type of intangible asset and reported separately from goodwill. Intangible assets with definite lives are amortized over the estimated useful lives and are tested for impairment when events or circumstances occur that indicate that it is more likely than not that an impairment has occurred. We test other intangible assets with definite lives for impairment by comparing the carrying amount to the sum of the net undiscounted cash flows expected to be generated by the asset whenever events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable. If the carrying amount of the asset exceeds its net undiscounted cash flows, then an impairment loss is recognized for the amount by which the carrying amount exceeds its fair value. There has been no impairment of other intangible assets for any periods presented.

 

  (m)

Stock-Based Compensation

We measure and recognize compensation expense for all stock options and restricted stock awards (RSAs) based on the estimated fair value of the award on the grant date. The fair value is recognized as expense, net of estimated forfeitures, over the requisite service period, which is generally the vesting period of the respective award, on a straight-line basis when the only condition to vesting is continued service. If vesting is subject to a market or performance condition, recognition is based on the derived service period of the award. Expense for awards with performance conditions is estimated and adjusted on a quarterly basis based upon the assessment of the probability that the performance condition will be met.

 

  (n)

Advertising

Advertising costs are expensed as incurred, and are recorded in sales and marketing expense in our consolidated statement of operations. We incurred $4.3 million, $3.2 million and $1.7 million in advertising expense in 2015, 2014 and 2013, respectively.

 

  (o)

Income Taxes

Income taxes are accounted for using the asset and liability method. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective

 

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income tax bases, and operating loss and tax credit carryforwards. Valuation allowances are provided when we determine that it is more likely than not that all of, or a portion of, deferred tax assets will not be utilized in the future.

We account for unrecognized tax benefits using a more-likely-than-not threshold for financial statement recognition and measurement of tax positions taken or expected to be taken in a tax return.

 

  (p)

Sales Commissions

Sales commissions are recognized in the period that the commissions are earned by our employees, which is typically upon signing of an arrangement. Under our sales commission policy, the amount of sales commissions expense attributable to the sales arrangement signed in the period is recognized fully in that period; however, the revenue from the sales arrangement is generally recognized ratably over the contractual period of the applicable agreement.

 

  (q)

Net Loss per Share Attributable to Common Stockholders

Basic net loss per share attributable to common stockholders is computed by dividing our net loss attributable to common stockholders by the weighted-average number of common shares used in the loss per share calculation during the period. Diluted net loss per share attributable to common stockholders is computed by giving effect to all potentially dilutive securities, including stock options, restricted stock awards, warrants and redeemable convertible preferred stock. Basic and diluted net loss per share attributable to common stockholders was the same for all periods presented as the inclusion of all potentially dilutive securities outstanding was anti-dilutive.

 

  (r)

Recent Accounting Pronouncements

In February 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2016-02, Leases (Topic 842). The ASU requires companies to recognize on the balance sheet the assets and liabilities for the rights and obligations created by leased assets. The ASU will be effective for us in the first quarter of 2019, with early adoption permitted. We are currently evaluating the impact that the adoption of this ASU will have on our consolidated financial statements.

In November 2015, the FASB issued ASU 2015-17, Income Taxes (Topic 740) – Balance Sheet Classification of Deferred Taxes. The ASU requires that deferred tax liabilities and assets be classified as noncurrent in a classified balance sheet simplifying current GAAP, which requires an entity to separate deferred tax liabilities and assets into current and noncurrent amounts in the balance sheet. The ASU will be effective for us in the first quarter of 2017, and may be applied prospectively or retrospectively at our election. We do not expect that the adoption of this ASU will have a significant impact on our consolidated financial statements.

In September 2015, the FASB issued ASU 2015-16, Business Combinations (Topic 805) – Simplifying the Accounting for Measurement-Period Adjustments. The ASU requires that an acquirer recognize adjustments to provisional amounts that are identified during the measurement period in the reporting period in which the adjustment amounts are determined. The ASU requires that the acquirer record, in the same period’s financial statements, the effect on earnings of changes in depreciation, amortization, or other income effects, if any, as a result of the change to the provisional amounts, calculated as if the accounting had been completed at the acquisition date. The ASU requires an entity to present separately on the face of the income statement or disclose in the notes the portion of the amount recorded in current-period earnings by line item that would have been recorded in previous reporting periods if the adjustment to the provisional amounts had been recognized as of the acquisition date. The ASU will be effective for us in the first quarter of 2016. We do not expect that the adoption of this ASU will have a significant impact on our consolidated financial statements.

 

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In April 2015, the FASB issued ASU 2015-05, Intangibles -Goodwill and Other – Internal Use Software (Subtopic 350-40): Customer’s Accounting for Fees Paid in a Cloud Computing Arrangement, which provides guidance on accounting for fees paid in a cloud computing arrangement. Under the ASU, if a cloud computing arrangement includes a software license, the software license element should be accounted for consistent with the purchase of other software licenses. If the cloud computing arrangement does not include a software license, it should be accounted for as a service contract. The ASU will be effective for us in the first quarter of 2016 and may be applied either prospectively or retrospectively. We do not expect that the adoption of this ASU will have a significant impact on our consolidated financial statements.

In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606). The ASU outlines a single, comprehensive model for accounting for revenue from contracts with customers and requires more detailed disclosure to enable users of financial statements to understand the nature, amount, timing and uncertainty of revenue and cash flows arising from such contracts. In August 2015, the FASB issued ASU 2015-14, which provides a one year deferral in the effective date of ASU 2014-09. ASU 2014-09 will now be effective for us beginning January 1, 2018; however, early adoption will be permitted as of the original effective date. The new standard may be applied retrospectively to each prior period presented or prospectively with the cumulative effect recognized on the date of adoption. We are currently evaluating the impact that the standard will have on our consolidated financial statements.

 

(3)

Business Combinations

Acquisition of RevelOps, Inc.

On October 13, 2015, we acquired 100% of the outstanding equity of RevelOps, Inc. (d/b/a Logentries) for total consideration of $67.9 million. We made an initial payment of $36.2 million in cash, issued 1,252,627 shares of our common stock with an aggregate fair value of $27.4 million, inclusive of a discount from the quoted market price due to certain trading restrictions associated with the shares, and issued vested replacement options with respect to 221,759 shares of our common stock to certain continuing employees with an aggregate value of $4.5 million upon the closing of the acquisition. As a partial offset to the initial cash payment, we estimate we will receive $0.2 million related to the final working capital adjustment for the acquisition. The fair value of the vested replacement options included in the purchase price was based on the fair value of the vested Logentries options on the acquisition date. The excess fair value when comparing the fair value of the new vested replacement options and the vested Logentries options of $0.3 million was expensed immediately in the post-combination financial statements of the combined entity. We expensed the related acquisition costs of $0.9 million in general and administrative expense.

The following table summarizes the consideration paid for Logentries and the preliminary allocation of purchase price to the estimated fair value of the assets acquired and liabilities assumed based on their fair values on the acquisition date (in thousands):

 

Consideration:

 

Cash

  $             36,212   

Common stock

    27,382   

Vested replacement options

    4,494   

Net working capital receivable

    (150)   
 

 

 

 

Total purchase price allocation

  $ 67,938   
 

 

 

 

 

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Recognized amounts of identifiable assets acquired and liabilities assumed:

 

Cash

    $       745   

Accounts receivable

    526   

Prepaid expenses and other current assets

    297   

Intangible assets

    9,425   

Other non-current assets

    155   

Accounts payable

    (512)   

Accrued expenses

    (1,048)   

Deferred revenue

    (360)   
 

 

 

 

Total identifiable net assets assumed

    9,228   

Goodwill

    58,710   
 

 

 

 

Total purchase price allocation

    $  67,938   
 

 

 

 

The fair values of identifiable intangible assets were based on valuations using the income approach. The estimated fair values and useful lives of the identifiable intangible assets are as follows:

 

             Amount              Weighted average
amortization
            life (years)             
 
     (in thousands)         

Developed technology

     $          8,300         6   

Customer relationships

     900         7   

Trade name

     225         1   
  

 

 

    

Identifiable intangible assets

     $          9,425      
  

 

 

    

The excess of the purchase price over the tangible assets acquired, identifiable intangible assets acquired and assumed liabilities was recorded as goodwill. We believe that the goodwill is related to the expected synergistic benefits of us being able to leverage the integration of our existing products and services with the acquired products to both Logentries’ and our customer bases. The goodwill was allocated to our one reporting unit. The acquired goodwill will not be deductible for tax purposes. These preliminary amounts are subject to subsequent adjustment as we obtain additional information to finalize certain components of working capital.

Following the acquisition, we granted to certain retained employees of Logentries RSAs with respect to an aggregate of 942,388 restricted shares of our common stock, which will vest subject to continued service. These RSAs will be accounted for as stock-based compensation expense over the required service periods based on the grant date fair value.

Pro Forma Financial Information

The unaudited pro forma financial information in the table below summarizes the combined results of our operations and Logentries, on a pro forma basis, as though we had acquired Logentries on January 1, 2014. The unaudited pro forma financial information for all periods presented also includes the effects of business combination accounting resulting from the acquisition, including amortization expense from acquired intangibles assets, reversal of acquisition related expenses and the stock-compensation expense recorded to retain certain employees.

 

             Year Ended December 31,          
             2015                      2014          
     (in thousands)  

Total revenue

     $      112,870         $        77,891   

Net loss

     (61,192)         (49,813)   

 

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Acquisition of NT OBJECTives, Inc.

On April 30, 2015, we acquired 100% of the outstanding equity of NT OBJECTives, Inc. (NTO), a web application security testing company, expanding the web application testing capabilities of our threat exposure management offering. We acquired NTO for total consideration of $6.1 million. We made an initial payment of $3.4 million in cash, issued 9,091 shares of our common stock with a fair value of $0.1 million, are obligated to pay $0.1 million in cash for the settlement of a working capital adjustment and are obligated to make two additional payments of $1.5 million each, less the amount of any indemnity claims, on the first and second anniversary dates of the closing. The net present value of these two additional payments, or $2.5 million, is included in the total purchase consideration paid. We expensed the related acquisition costs of $0.4 million in general and administrative expense.

The following table summarizes the consideration paid for NTO and the preliminary allocation of purchase price to the estimated fair value of the assets acquired and liabilities assumed at the acquisition date (in thousands):

 

Consideration:

  

Cash

   $       3,404   

Common stock

     99   

Net working capital liability

     56   

Net present value of deferred cash payments

     2,535   
  

 

 

 

Fair value of total consideration transferred

   $ 6,094