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EX-32.2 - EXHIBIT 32.2 - Rapid7, Inc.q1201810-qexx322.htm
EX-32.1 - EXHIBIT 32.1 - Rapid7, Inc.q1201810-qexx321.htm
EX-31.2 - EXHIBIT 31.2 - Rapid7, Inc.q1201810-qexx312.htm
EX-31.1 - EXHIBIT 31.1 - Rapid7, Inc.q1201810-qexx311.htm

 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
 
FORM 10-Q
 
(Mark One)
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2018
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
 
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      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      No  ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and "emerging growth company" in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer
Accelerated filer
Non-accelerated filer
☐  (Do not check if a small reporting company)
Small reporting company
Emerging growth company
 
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ☐    No  
As of May 1, 2018, there were 46,231,891 shares of the registrant’s common stock, $0.01 par value per share, outstanding.
 




Table of Contents
 


i


PART I—FINANCIAL INFORMATION
Item 1.
Financial Statements.
RAPID7, INC.
Consolidated Balance Sheets (Unaudited)
(in thousands, except share and per share data)
 
 
 
March 31, 2018
 
December 31, 2017
Assets
 
 
 
 
Current assets:
 
 
 
 
Cash and cash equivalents
 
$
99,646

 
$
51,562

Short-term investments
 
29,630

 
39,178

Accounts receivable, net of allowance for doubtful accounts of $1,407 and $1,478 at March 31, 2018 and December 31, 2017, respectively
 
38,718

 
73,661

Deferred contract acquisition and fulfillment costs, current portion
 
8,583

 

Prepaid expenses and other current assets
 
12,232

 
8,877

Total current assets
 
188,809

 
173,278

Long-term investments
 
1,096

 
1,102

Property and equipment, net
 
9,238

 
8,589

Goodwill
 
83,164

 
83,164

Intangible assets, net
 
16,316

 
16,640

Deferred contract acquisition and fulfillment costs, non-current portion
 
20,295

 

Other assets
 
1,552

 
1,363

Total assets
 
$
320,470

 
$
284,136

Liabilities and Stockholders’ Equity
 
 
 
 
Current liabilities:
 
 
 
 
Accounts payable
 
$
5,669

 
$
2,240

Accrued expenses
 
18,372

 
29,728

Deferred revenue, current portion
 
140,448

 
155,811

Other current liabilities
 
1,702

 
1,706

Total current liabilities
 
166,191

 
189,485

Deferred revenue, non-current portion
 
78,450

 
68,689

Other long-term liabilities
 
1,907

 
1,809

Total liabilities
 
246,548

 
259,983

Stockholders’ equity:
 
 
 
 
Preferred stock, $0.01 par value per share; 10,000,000 shares authorized at March 31, 2018 and December 31, 2017; 0 shares issued at March 31, 2018 and December 31, 2017
 

 

Common stock, $0.01 par value per share; 100,000,000 shares authorized at March 31, 2018 and December 31, 2017; 46,685,380 and 44,540,544 shares issued at March 31, 2018 and December 31, 2017, respectively; 46,198,572 and 44,053,736 shares outstanding at March 31, 2018 and December 31, 2017, respectively
 
462

 
441

Treasury stock, at cost, 486,808 shares at March 31, 2018 and December 31, 2017
 
(4,764
)
 
(4,764
)
Additional paid-in-capital
 
503,669

 
463,428

Accumulated other comprehensive loss
 
(44
)
 
(39
)
Accumulated deficit
 
(425,401
)
 
(434,913
)
Total stockholders’ equity
 
73,922

 
24,153

Total liabilities and stockholders’ equity
 
$
320,470

 
$
284,136

The accompanying notes are an integral part of these unaudited consolidated financial statements.

1


RAPID7, INC.
Consolidated Statements of Operations (Unaudited)
(in thousands, except share and per share data)
 
 
 
Three Months Ended March 31,
 
 
2018
 
2017
Revenue:
 
 
 
 
Products
 
$
35,279

 
$
25,942

Maintenance and support
 
10,753

 
10,802

Professional services
 
8,483

 
8,501

Total revenue
 
54,515

 
45,245

Cost of revenue:
 
 
 
 
Products
 
8,436

 
4,710

Maintenance and support
 
1,849

 
1,878

Professional services
 
6,309

 
5,676

Total cost of revenue
 
16,594

 
12,264

Total gross profit
 
37,921

 
32,981

Operating expenses:
 
 
 
 
Research and development
 
16,722

 
11,393

Sales and marketing
 
29,052

 
24,810

General and administrative
 
8,732

 
7,248

Total operating expenses
 
54,506

 
43,451

Loss from operations
 
(16,585
)
 
(10,470
)
Other income (expense), net:
 
 
 
 
Interest income (expense), net
 
241

 
169

Other income (expense), net
 
78

 
(115
)
Loss before income taxes
 
(16,266
)
 
(10,416
)
Provision for income taxes
 
95

 
129

Net loss
 
$
(16,361
)
 
$
(10,545
)
Net loss per share, basic and diluted
 
$
(0.36
)
 
$
(0.25
)
Weighted-average common shares outstanding, basic and diluted
 
45,210,250

 
42,016,831

The accompanying notes are an integral part of these unaudited consolidated financial statements.


2


RAPID7, INC.
Consolidated Statements of Comprehensive Loss (Unaudited)
(in thousands)

 
 
Three Months Ended March 31,
 
 
2018
 
2017
 
 
 
 
 
Net loss
 
$
(16,361
)
 
$
(10,545
)
Other comprehensive loss:
 
 
 
 
Change in fair value of investments
 
(5
)
 
(20
)
Total change in unrealized losses on investments
 
(5
)
 
(20
)
Comprehensive loss
 
$
(16,366
)
 
$
(10,565
)

The accompanying notes are an integral part of these unaudited consolidated financial statements.



3


RAPID7, INC.
Consolidated Statements of Cash Flows (Unaudited)
(in thousands)
 
 
 
Three Months Ended March 31,
 
 
2018
 
2017
Cash flows from operating activities:
 
 
 
 
Net loss
 
$
(16,361
)
 
$
(10,545
)
Adjustments to reconcile net loss to net cash provided by operating activities:
 

 
 
Depreciation and amortization
 
2,399

 
1,624

Stock-based compensation expense
 
6,225

 
4,279

Provision for doubtful accounts
 
156

 
316

Foreign currency re-measurement loss
 
147

 
44

Other non-cash (income) expense
 
(52
)
 
97

Changes in operating assets and liabilities:
 

 
 
Accounts receivable
 
34,722

 
15,182

Deferred contract acquisition and fulfillment costs
 
(1,713
)
 

Prepaid expenses and other assets
 
(3,190
)
 
1,466

Accounts payable
 
3,219

 
(244
)
Accrued expenses
 
(11,317
)
 
(7,216
)
Deferred revenue
 
(6,495
)
 
(1,416
)
Other liabilities
 
(444
)
 
(266
)
Net cash provided by operating activities
 
7,296

 
3,321

Cash flows from investing activities:
 
 
 
 
Purchases of property and equipment
 
(2,147
)
 
(1,335
)
Capitalization of internal-use software costs
 
(693
)
 

Purchases of investments
 
(4,460
)
 
(7,401
)
Sale and maturities of investments
 
14,062

 
900

Net cash provided by (used in) investing activities
 
6,762

 
(7,836
)
Cash flows from financing activities:
 
 
 
 
Proceeds from secondary public offering, net of offering costs paid of $284
 
31,231

 

Taxes paid related to net share settlement of equity awards
 
(462
)
 
(169
)
Proceeds from employee stock purchase plan
 
1,632

 
1,499

Proceeds from stock option exercises
 
1,961

 
775

Net cash provided by financing activities
 
34,362

 
2,105

Effect of exchange rate changes on cash, cash equivalents and restricted cash
 
(36
)
 
(76
)
Net increase (decrease) in cash, cash equivalents and restricted cash
 
48,384

 
(2,486
)
Cash, cash equivalents and restricted cash, beginning of period
 
51,762

 
53,148

Cash, cash equivalents and restricted cash, end of period
 
$
100,146

 
$
50,662

Supplemental cash flow information:
 
 
 
 
Cash paid for income taxes
 
$
53

 
$
65

Reconciliation of cash, cash equivalents and restricted cash:
 
 
 
 
Cash and cash equivalents
 
$
99,646

 
$
50,662

Restricted cash in other assets
 
500

 

Total cash, cash equivalents and restricted cash
 
$
100,146

 
$
50,662

The accompanying notes are an integral part of these unaudited consolidated financial statements.

4


RAPID7, INC.
Notes to Consolidated Financial Statements (Unaudited)
Note 1. Description of Business, Basis of Presentation and Consolidation and Significant Accounting Policies
Description of Business
Rapid7, Inc. and subsidiaries ("we", "us" or "our") is trusted by IT and security professionals around the world to manage risk, simplify modern IT complexity, and drive innovation. Our analytics help transform today's vast amount of security and IT data into the answers needed to securely develop and operate sophisticated IT networks and applications.
Basis of Presentation and Consolidation
The accompanying unaudited consolidated financial statements have been prepared by us in accordance with accounting principles generally accepted in the United States of America (GAAP), as well as pursuant to the rules and regulations of the Securities and Exchange Commission (SEC), regarding interim financial reporting. Accordingly, certain information and note disclosures normally included in the financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such rules and regulations. These consolidated financial statements should be read in conjunction with the consolidated financial statements and related notes included in our Annual Report on Form 10-K for the year ended December 31, 2017 filed with the SEC on March 8, 2018.
The consolidated financial statements include our results of operations and those of our wholly-owned subsidiaries and reflect all adjustments (consisting solely of normal, recurring adjustments) which are, in the opinion of management, necessary for a fair statement of results for the interim periods presented. All intercompany transactions and balances have been eliminated in consolidation. The results of operations for the three months ended March 31, 2018 are not necessarily indicative of the results to be expected for any future period or the entire fiscal year.
Significant Accounting Policies
For a more complete discussion of our significant accounting policies and other information, the consolidated financial statements and notes thereto should be read in conjunction with the consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2017. As of January 1, 2018, we adopted Accounting Standards Update (ASU) No. 2014-09, Revenue from Contracts with Customers (Topic 606) (ASU 2014-09), which with its amendments is collectively known as ASC 606. See Accounting Pronouncements Recently Adopted below and Note 2, Revenue from Contract with Customers, for a discussion of the impact of the adoption of this standard, which we are adopting using the modified retrospective transition method, and changes in our accounting policies related to revenue recognition and accounting for costs to obtain and fulfill a customer contract.
Recent Accounting Pronouncements
Accounting Pronouncements Recently Adopted
In December 2017, the SEC issued Staff Accounting Bulletin 118 (SAB 118), which provides guidance for companies analyzing their accounting for the income tax effects of the Tax Cuts and Jobs Act of 2017 (Tax Act). SAB 118 provides that a company may report provisional amounts based on reasonable estimates. The provisional estimates are then subject to adjustment during a measurement period up to one year and should be accounted for as a prospective change. We continue to evaluate our transition tax obligation and expect to finalize our conclusion by the end of fiscal 2018. The provisional amounts recorded are based on our current interpretation and understanding of the Tax Act signed into law in December 2017, are judgmental and may change as we receive additional clarification and implementation guidance. Changes to these provisional amounts could result in additional charges or credits in future reporting periods.
In May 2017, the Financial Accounting Standards Board (FASB), issued Accounting Standards Update (ASU) 2017-09, Compensation-Stock Compensation (Topic 718): Scope of Modification Accounting, clarifying when a change to the terms or conditions of a share-based payment award must be accounted for as a modification. The ASU required modification accounting if the fair value, vesting condition or the classification of the award is not the same immediately before and after a change to the terms and conditions of the award. We adopted this standard on a prospective basis on January 1, 2018. There was no impact to our consolidated financial statements as a result of the adoption.
In November 2016, the FASB issued ASU 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash, which provided guidance on the treatment of restricted cash in the statements of cash flows. Amounts generally described as restricted cash and restricted cash equivalents should be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. We adopted this standard in the first quarter of 2018 utilizing the

5


retrospective transition method. The presentation of restricted cash in the consolidated statements of cash flows was adjusted as a result of adopting this new standard.
In October 2016, the FASB issued ASU 2016-16, Income Taxes (Topic 740): Intra-Entity Transfers of Assets Other Than Inventory. The ASU is intended to improve the accounting for the income tax consequences of intra-entity transfers of assets other than inventory. Current GAAP prohibits the recognition of current and deferred income taxes for an intra-entity asset transfer until the asset has been sold to an outside party. The ASU will allow an entity to recognize the income tax consequences of these transfers when the transfers occur. We adopted this standard on January 1, 2018 and there was no impact to our consolidated financial statements as a result of the adoption.
In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606) (ASU 2014-09), which replaced the revenue recognition requirements in FASB ASC Topic 605, Revenue Recognition (ASC 605). The new revenue standard 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. The new revenue standard provides a five-step analysis of transactions to determine when and how revenue is recognized. The core principle is that a company should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods and services.
We adopted ASC 606 on January 1, 2018 using the modified retrospective method. Under this method of adoption, we recognized the cumulative effect of initially applying the new revenue standard as an adjustment to the opening balance of accumulated deficit. Comparative prior year periods were not adjusted.


6


As a result of applying the modified retrospective method to adopt ASC 606, the following adjustments were made to the consolidated balance sheet as of January 1, 2018:
 
 
As Reported
 
Adjustments
 
Adjusted under ASC 606
 
 
December 31, 2017
 
Term and Perpetual License
 
Professional Services
 
Other
 
Costs to Obtain or Fulfill a Contract
 
January 1, 2018
 
 
(in thousands)
Cash and cash equivalents
 
$
51,562

 
$

 
$

 
$

 
$

 
$
51,562

Short-term investments
 
39,178

 

 

 

 

 
39,178

Accounts receivable, net
 
73,661

 

 

 

 

 
73,661

Deferred contract acquisition and fulfillment costs, current portion
 

 

 

 

 
7,844

 
7,844

Prepaid expenses and other current assets
 
8,877

 

 
30

 

 

 
8,907

Long-term investments
 
1,102

 

 

 

 

 
1,102

Property and equipment, net
 
8,589

 

 

 

 

 
8,589

Goodwill
 
83,164

 

 

 

 

 
83,164

Intangible assets, net
 
16,640

 

 

 

 

 
16,640

Deferred contract acquisition and fulfillment costs, non-current portion
 

 

 

 

 
19,321

 
19,321

Other assets
 
1,363

 

 

 

 

 
1,363

Total assets
 
$
284,136

 
$

 
$
30

 
$

 
$
27,165

 
$
311,331

Accounts payable
 
$
2,240

 
$

 
$

 
$

 
$

 
$
2,240

Accrued expenses
 
29,728

 

 

 

 

 
29,728

Deferred revenue, current portion
 
155,811

 
(10,912
)
 
(1,523
)
 
(1,356
)
 

 
142,020

Other current liabilities
 
1,706

 

 

 

 

 
1,706

Deferred revenue, non-current portion
 
68,689

 
17,647

 
(2,624
)
 
(339
)
 

 
83,373

Other long-term liabilities
 
1,809

 

 

 

 
429

 
2,238

Total liabilities
 
259,983

 
6,735

 
(4,147
)
 
(1,695
)
 
429

 
261,305

Common stock
 
441

 

 

 

 

 
441

Treasury stock
 
(4,764
)
 

 

 

 

 
(4,764
)
Additional paid-in-capital
 
463,428

 

 

 

 

 
463,428

Accumulated other comprehensive loss
 
(39
)
 

 

 

 

 
(39
)
Accumulated deficit
 
(434,913
)
 
(6,735
)
 
4,177

 
1,695

 
26,736

 
(409,040
)
Total stockholders’ equity
 
24,153

 
(6,735
)
 
4,177

 
1,695

 
26,736

 
50,026

Total liabilities and stockholders’ equity
 
$
284,136

 
$

 
$
30

 
$

 
$
27,165

 
$
311,331


Term and Perpetual Licenses
Prior to the adoption of ASC 606, we recognized revenue for our term and perpetual licenses over the contractual period of maintenance and support due to the lack of vendor-specific objective evidence (VSOE) of selling price of maintenance and support. Under ASC 606, for our term and perpetual licenses which are not dependent on the continued delivery of content subscriptions, revenue is recognized at the time of delivery. For our perpetual licenses where the utility to the customer is dependent on the continued delivery of content subscriptions, the content subscription renewal option results in a material right with respect to the perpetual license. As a result, revenue related to the sale of these perpetual licenses is recognized ratably over the customer's estimated economic life of 5 years. The net impact of these changes resulted in a $6.7 million adjustment to accumulated deficit with an associated increase to deferred revenue.

Professional Services
Under ASC 605, professional services which were sold with term or perpetual licenses were recognized ratably over the contractual period of maintenance and support. Under ASC 606, these services are deemed distinct performance obligations and therefore recognized as the services are performed. The net impact of these changes resulted in a $4.2 million adjustment to accumulated deficit with an associated decrease to deferred revenue.


7


Costs to Obtain or Fulfill a Contract
Prior to the adoption of ASC 606, we expensed sales commissions in the period that they were earned by our employees (which was typically upon signing of an arrangement). Under ASC 606, the direct and incremental costs to obtain contracts with customers, including sales commissions, are deferred and recognized over a period of benefit that we have determined to be 5 years. In addition, under ASC 606, contract fulfillment costs associated with certain of our product offerings are deferred and amortized over the estimated period of benefit. Prior to the adoption of ASC 606, such costs were expensed as incurred. The net impact of these changes resulted in a $27.2 million increase in deferred contract acquisition and fulfillment costs and an adjustment to accumulated deficit.

Income Taxes
Deferred tax liabilities increased by $0.4 million due to the temporary differences between the accounting and tax carrying values of capitalized costs to obtain or fulfill a contract created as a result of the adoption of ASC 606. In addition, the increase in deferred revenue generated additional deferred tax assets. As we fully reserve our deferred tax assets in the jurisdictions impacted by the increase in deferred revenue, this impact was offset by a corresponding increase to our valuation allowance.

Refer to Note 2, Revenue from Contracts with Customers, for additional information including further discussion on the impact of the adoption of ASC 606 and changes in accounting policies relating to revenue recognition and accounting for costs to obtain or fulfill a customer contract.
Accounting Pronouncements Not Yet Effective
In February 2016, the FASB issued 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. Although we have not finalized our process of evaluating the impact of adoption of the ASU on our consolidated financial statements, we expect there will be a material increase to assets and liabilities related to the recognition of new right-of-use assets and lease liabilities on our balance sheet for leases currently classified as operating leases.
Note 2. Revenue from Contracts with Customers
Effective January 1, 2018, we adopted ASC 606 under the modified retrospective transition method.  This method was applied to contracts that were not complete as of the date of initial application. The following is a summary of new and/or revised significant accounting policies affected by our adoption of ASC 606, which relate primarily to revenue and cost recognition. Refer to Note 2, Summary of Significant Accounting Policies, in our Annual Report on Form 10-K for the year ended December 31, 2017 for the policies in effect for revenue and cost recognition prior to January 1, 2018 and for all other significant accounting policies. For further information regarding the adoption of ASC 606, see Note 1, Accounting Pronouncements Recently Adopted.
We generate products revenue from the sale of (1) term or perpetual software licenses for our Nexpose, Metasploit, AppSpider and Komand products, and associated content subscriptions for our Nexpose and Metasploit products, (2) cloud-based subscriptions for our InsightIDR, InsightVM, InsightAppSec, Logentries and InsightOps products and (3) managed services offerings which utilize either our InsightVM, AppSpider or InsightIDR products. We also generate an immaterial amount of appliance revenue that is included in our products revenue. We generate maintenance and support revenue associated with customers’ purchases of our software licenses for Nexpose, Metasploit, AppSpider and Komand. 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. Our deployment services educate and assist our customers on the best use and best practices to deploy our solutions.
In accordance with ASC 606, revenue is recognized when a customer obtains control of promised products or services. The amount of revenue recognized reflects the consideration that we expect to be entitled to receive in exchange for these products or services. To achieve the core principle of this standard, we apply the following five steps:
1) Identify the contract with a customer
We consider the terms and conditions of the contracts and our customary business practices in identifying our contracts under ASC 606. We determine we have a contract with a customer when the contract is approved, we can identify each party’s rights regarding the services to be transferred, we can identify the payment terms for the services, and we have determined the customer has the ability and intent to pay and the contract has commercial substance. We apply judgment in determining the customer’s ability and intent to pay, which is based on a variety of factors, including the customer’s historical payment experience or, in the case of a new customer, credit and financial information pertaining to the customer.

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2) Identify the performance obligations in the contract
Performance obligations promised in a contract are identified based on the products and services that will be transferred to the customer that are both capable of being distinct, whereby the customer can benefit from the product or service either on its own or together with other resources that are readily available from third parties or from us, and are distinct in the context of the contract, whereby the transfer of the products or services is separately identifiable from other promises in the contract.
3) Determine the transaction price
The transaction price is determined based on the consideration to which we expect to be entitled in exchange for transferring products or services to the customer. Variable consideration is included in the transaction price if, in our judgment, it is probable that no significant future reversal of cumulative revenue under the contract will occur.
In instances where the timing of revenue recognition differs from the timing of invoicing, we have determined our contracts generally do not include a significant financing component. The primary purpose of our invoicing terms is to provide customers with simplified and predictable ways of purchasing our products and services, not to receive financing from our customers or to provide customers with financing. Examples include invoicing at the beginning of a subscription term with revenue recognized ratably over the contract period.
4) Allocate the transaction price to performance obligations in the contract
If the contract contains a single performance obligation, the entire transaction price is allocated to the single performance obligation. Contracts that contain multiple performance obligations require an allocation of the transaction price to each performance obligation based on a relative standalone selling price (“SSP”).
5) Recognize revenue when or as we satisfy a performance obligation
Revenue is recognized at the time the related performance obligation is satisfied by transferring the promised product or service to a customer. Revenue is recognized when control of the products or services are transferred to our customers, in an amount that reflects the consideration that we expect to receive in exchange for those products or services.
The following table summarizes revenue from contracts with customers for the three months ended March 31, 2018 (in thousands):
Subscription revenue
 
$
28,710

Term and perpetual software licenses
 
5,619

Maintenance and support
 
10,753

Professional services
 
8,483

Other
 
950

Total revenue
 
$
54,515

The following table summarizes the revenue by region based on the shipping address of customers who have contracted to use our product or service for the three months ended March 31, 2018 (in thousands):
United States
 
$
44,210

All other
 
10,305

Total revenue
 
$
54,515


Subscription Revenue
Subscription revenue consists of revenue from our cloud-based subscription, managed services offerings and content subscriptions associated with our software licenses. We generate cloud-based subscription revenue primarily from sales of subscriptions to access our cloud platform, together with related support services to our customers. These arrangements do not provide the customer with the right to take possession of our software operating on our cloud platform at any time. Instead, customers are granted continuous access to our cloud platform over the contractual period. Revenue is recognized over time on a ratable basis over the contract term beginning on the date that our service is made available to the customer. Our cloud-based subscription contracts generally have terms of 1 to 3 years which are billed in advance and non-cancelable. Managed services offerings consist of fees generated when we operate our software and provide our capabilities on behalf of our customers. Revenue is recognized on a ratable basis over the contract term beginning on the date that our service is made available to the customer. Our managed services offerings generally have terms of 1 to 3 years which are billed in advance and non-cancelable. Revenue related to our content subscriptions associated with our software licenses is recognized ratably over the contractual period. Some of our customers have the option to purchase additional subscription and support services at a stated price. These options generally do not provide a material right as they are priced at our SSP.

9



Certain subscription contracts contain service level commitments, which entitle our customers to receive service credits and, in certain cases, refunds, if our services do not meet certain levels. These service credits and refunds represent variable consideration. We have historically not experienced any significant incidents affecting the defined levels of reliability and performance as required by our subscription contracts and accordingly, no estimated refunds have been considered in the allocation of the transaction price.
Term and Perpetual Software Licenses
For our perpetual software licenses where the utility to the customer is dependent on the continued delivery of content subscriptions, the content subscription renewal options result in a material right with respect to the perpetual software license. As a result, the revenue attributable to the perpetual software license is recognized ratably over the customer’s estimated economic life of 5 years, which represents a longer period of time in comparison to the initial contractual period of maintenance and support. The estimated economic life of 5 years represents the period which the customer is expected to benefit from the material right. We estimated this period of benefit by taking into consideration several factors, including the terms and conditions of our customer contracts and renewals and the expected useful life of our technology.
For our term software licenses where the utility to the customer is dependent on the continued delivery of content subscriptions, we recognize the license revenue over the contractual term of the arrangement as a material right does not exist.
For our term and perpetual software licenses which are not dependent on the continued delivery of content subscriptions, the license is considered distinct from the maintenance and support, and we therefore recognize revenue attributable to the license at the time of delivery.
Maintenance and Support
Maintenance and support services are sold with our perpetual and term software licenses. As maintenance and support services are distinct from the perpetual and term software license, revenue attributable to maintenance and support services is recognized ratably over the contractual period.
Professional Services
All of our professional services are considered distinct performance obligations when sold stand alone or with other products. These contracts generally have terms of one year or less. For the majority of these contracts, revenue is recognized over time based upon the proportion of work performed to date.
Other
Other revenue primarily includes revenue from delivery of appliances and other miscellaneous revenue .
Contracts with Multiple Performance Obligations
The majority of our contracts with customers contain multiple performance obligations. For these contracts, we account for individual performance obligations separately if they are considered distinct. The transaction price is allocated to the separate performance obligations on a relative SSP basis. We determine SSP based on our overall pricing objectives, taking into consideration market conditions and other factors, including the geographic locations of our customers and selling method (i.e., partner or direct).
Contract Balances
Contract liabilities consist of deferred revenue and include payments received in advance of performance under the contract. Such amounts are recognized as revenue over the contractual period consistent with the above methodology. For the three months ended March 31, 2018, we recognized revenue of $46.5 million that was included in the corresponding contract liability balance at the beginning of the period presented.
We receive payments from customers based upon contractual billing schedules. Accounts receivable are recorded when the right to consideration becomes unconditional. Contract assets, or unbilled receivables, include amounts related to our contractual right to consideration for both completed and partially completed performance obligations that may not have been invoiced. As of January 1, 2018 and March 31, 2018, contract assets of $0.3 million and $0.5 million, respectively, are included in prepaid expenses and other current assets in our consolidated balance sheet.


10


Costs to Obtain or Fulfill a Contract
We capitalize commission expenses paid to internal sales personnel and partner referral fees that are incremental to obtaining customer contracts. These costs are recorded as deferred contract acquisition costs in the consolidated balance sheets. Costs to obtain a contract for a new customer, up-sell or cross-sell are amortized on a straight-line basis over an estimated period of benefit of 5 years. We determined the estimated period of benefit by taking into consideration the contractual term and expected renewals of customer contracts, our technology and other factors, including the fact that commissions paid on renewals are not commensurate with commissions paid on initial sales transactions. We periodically review the carrying amount of deferred contract acquisition costs to determine whether events or changes in circumstances have occurred that could impact the period of benefit.
Commissions paid relating to contract renewals are deferred and amortized on a straight-line basis over the related renewal period. Costs to obtain a contract for professional services arrangements are expensed as incurred in accordance with the practical expedient as the contractual period of our professional services arrangements are one year or less.
Amortization expense associated with deferred contract acquisition costs is recorded to sales and marketing expense in the accompanying consolidated statements of operations.
We capitalize costs incurred to fulfill our contracts that relate directly to the contract, are expected to generate resources that will be used to satisfy our performance obligations and are expected to be recovered through revenue generated under the contract. Contract fulfillment costs are amortized on a straight-line basis over the estimated period of benefit and recorded as cost of products in our consolidated statement of operations.
The following table summarizes the activity of the deferred contract acquisition and fulfillment costs:
 
 
Three Months Ended March 31, 2018
 
 
(in thousands)
Beginning balance
 
$
27,165

Capitalization of contract acquisition and fulfillment costs
 
3,733

Amortization of deferred contract acquisition and fulfillment costs
 
(2,020
)
Ending balance
 
$
28,878

Transaction price allocated to the remaining performance obligations
The following table includes estimated revenue expected to be recognized in the future related to performance obligations that are unsatisfied or partially unsatisfied as of March 31, 2018. The estimated revenues do not include unexercised contract renewals.
 
 
Remainder of 2018
 
2019
 
2020 and thereafter
 
 
(in thousands)
Subscription revenue
 
$
67,921

 
$
36,817

 
$
18,468

Software licenses
 
11,665

 
12,344

 
21,030

Maintenance and support
 
25,398

 
11,369

 
4,348

The amounts presented in the table above primarily consist of fixed fees which are typically recognized ratably as the performance obligation is satisfied.
As of March 31, 2018, the estimated revenue expected to be recognized in the future related to professional services is $13.7 million. We will recognize this revenue as the professional services are completed, which is expected to occur within the next 12 months or less.
Transition Disclosures
In accordance with the modified retrospective method transition requirements, we will present the financial statement line items impacted and adjusted to compare to presentation under ASC 605 for each of the interim and annual periods during the first year of adoption of ASC 606.

11


The following tables summarize the impact as of and for the three months ended March 31, 2018.
 
 
As of March 31, 2018
Balance Sheet
 
As Reported under ASC 606
 
Proforma as if ASC 605 was in effect
 
 
(in thousands)
Cash and cash equivalents
 
$
99,646

 
$
99,646

Short-term investments
 
29,630

 
29,630

Accounts receivable, net
 
38,718

 
38,718

Deferred contract acquisition and fulfillment costs, current portion
 
8,583

 

Prepaid expenses and other current assets
 
12,232

 
11,949

Long-term investments
 
1,096

 
1,096

Property and equipment, net
 
9,238

 
9,238

Goodwill
 
83,164

 
83,164

Intangible assets, net
 
16,316

 
16,316

Deferred contract acquisition and fulfillment costs, non-current portion
 
20,295

 

Other assets
 
1,552

 
1,552

Total assets
 
$
320,470

 
$
291,309

 
 
 
 
 
Accounts payable
 
$
5,669

 
$
5,669

Accrued expenses
 
18,372

 
18,372

Deferred revenue, current portion
 
140,448

 
152,336

Other current liabilities
 
1,702

 
1,702

Deferred revenue, non-current portion
 
78,450

 
61,730

Other long-term liabilities
 
1,907

 
1,478

Total liabilities
 
246,548

 
241,287

Common stock
 
462

 
462

Treasury stock
 
(4,764
)
 
(4,764
)
Additional paid-in-capital
 
503,669

 
503,669

Accumulated other comprehensive loss
 
(44
)
 
(44
)
Accumulated deficit
 
(425,401
)
 
(449,301
)
Total stockholders’ equity
 
73,922

 
50,022

Total liabilities and stockholders’ equity
 
$
320,470

 
$
291,309

Total reported assets were $29.2 million greater than the proforma balance sheet, which assumes the previous guidance remained in effect as of March 31, 2018, largely due to deferred contract acquisition costs of $28.9 million.
Total reported liabilities were $5.3 million greater than the proforma balance sheet primarily due to changes in deferred revenue and deferred tax liabilities.

12


 
 
Three Months Ended March 31, 2018
Statement of Operations
 
As Reported under ASC 606
 
Proforma as if ASC 605 was in effect
 
 
(in thousands, except share and per share data)
Revenue:
 
 
 
 
Products
 
$
35,279

 
$
37,766

Maintenance and support
 
10,753

 
11,682

Professional services
 
8,483

 
8,753

Total revenue
 
54,515

 
58,201

Cost of revenue:
 
 
 
 
Products
 
8,436

 
8,464

Maintenance and support
 
1,849

 
1,849

Professional services
 
6,309

 
6,303

Total cost of revenue
 
16,594

 
16,616

Total gross profit
 
37,921

 
41,585

Operating expenses:
 
 
 
 
Research and development
 
16,722

 
16,722

Sales and marketing
 
29,052

 
30,743

General and administrative
 
8,732

 
8,732

Total operating expenses
 
54,506

 
56,197

Loss from operations
 
(16,585
)
 
(14,612
)
Other income (expense), net:
 

 
 
Interest income (expense), net
 
241

 
241

Other income (expense), net
 
78

 
78

Loss before income taxes
 
(16,266
)
 
(14,293
)
Provision for income taxes
 
95

 
95

Net loss
 
$
(16,361
)
 
$
(14,388
)
Net loss per share, basic and diluted
 
$
(0.36
)
 
$
(0.32
)
Weighted-average common shares outstanding, basic and diluted
 
45,210,250

 
45,210,250

The following summarizes the significant changes on the consolidated statement of operations for the three months ended March 31, 2018 as a result of the adoption of ASC 606 on January 1, 2018 compared to if we had continued to recognize revenue under ASC 605:
Products revenue decreased $2.5 million under ASC 606 primarily due to perpetual licenses revenue which are dependent on the continued delivery of content subscriptions and the change in the allocation of contract consideration to a relative fair value method under ASC 606 from residual method under ASC 605. As a result of the allocation change, more contract consideration is allocated to license revenue under ASC 606. Given the utility of certain of our perpetual license products are dependent on the continued delivery of content subscriptions, the content subscription renewal option results in a material right with respect to the perpetual license. As a result, revenue allocated to the perpetual license is recognized ratably over the customer's estimated economic life of 5 years rather than over the contractual period of maintenance and support, typically one to three years.
Maintenance and support revenue decreased $0.9 million under ASC 606 primarily due to the change in the allocation of contract consideration to the relative fair value method under ASC 606 from the residual method under ASC 605. As a result of the allocation change, more contract consideration is allocated to license revenue under ASC 606.
Professional services revenue decreased $0.3 million under ASC 606. Under ASC 606, the professional services represent distinct performance obligations and therefore are recognized as such services are performed. Under ASC 605, professional services sold together with term or perpetual licenses were recognized ratably over the contractual period of maintenance and support.

13


Sales and marketing expense decreased $1.7 million under ASC 606 primarily due to the capitalization of commissions considered direct and incremental costs to obtain a contract in the three months ended March 31, 2018 partially offset by amortization of capitalized commissions recorded as part of the cumulative effect adjustment upon adoption of ASC 606.
 
 
Three Months Ended March 31, 2018
Statement of Cash Flows
 
As Reported under ASC 606
 
Proforma as if ASC 605 was in effect
 
 
(in thousands)
Net loss
 
$
(16,361
)
 
$
(14,388
)
Adjustments to reconcile net loss to net cash provided by operating activities
 
8,875

 
8,875

Changes in operating assets and liabilities:
 
 
 
 
Accounts receivable
 
34,722

 
34,722

Deferred contract acquisition and fulfillment costs
 
(1,713
)
 

Prepaid expenses and other assets
 
(3,190
)
 
(2,936
)
Accounts payable
 
3,219

 
3,219

Accrued expenses
 
(11,317
)
 
(11,317
)
Deferred revenue
 
(6,495
)
 
(10,435
)
Other liabilities
 
(444
)
 
(444
)
Net cash provided by operating activities
 
7,296

 
7,296

The adoption of ASC 606 resulted in offsetting changes in operating assets and liabilities and had no impact on net cash flow from operations.
Note 3. Fair Value Measurements
We measure certain financial assets and liabilities at fair value. Fair value is determined based upon the exit price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants, as determined by either the principal market or the most advantageous market. Inputs used in the valuation techniques to derive fair values are classified based on a three-level hierarchy, as follows:
Level 1: Observable inputs that reflect quoted prices (unadjusted) for identical assets or liabilities in active markets.
Level 2: Observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets with insufficient volume or infrequent transactions (less active markets); or model-derived valuations in which all significant inputs are observable or can be derived principally from or corroborated by observable market data for substantially the full term of the assets or liabilities.
Level 3: Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the asset or liability.
We consider an active market to be one in which transactions for the asset or liability occur with sufficient frequency and volume to provide pricing information on an ongoing basis, and we consider an inactive market to be one in which there are infrequent or few transactions for the asset or liability, the prices are not current, or price quotations vary substantially either over time or among market makers.

14


The following table presents our financial assets and liabilities measured and recorded at fair value on a recurring basis using the above input categories:
 
 
As of March 31, 2018
 
 
Level 1
 
Level 2
 
Level 3
 
Total
 
 
(in thousands)
Description:
 
 
 
 
 
 
 
 
Assets:
 
 
 
 
 
 
 
 
Money market funds
 
$
7,368

 
$

 
$

 
$
7,368

U.S. government agencies
 
9,378

 

 

 
9,378

Commercial paper
 

 
12,657

 

 
12,657

Corporate bonds
 

 
11,137

 

 
11,137

Total assets
 
$
16,746

 
$
23,794

 
$

 
$
40,540

 
 
As of December 31, 2017
 
 
Level 1
 
Level 2
 
Level 3
 
Total
 
 
(in thousands)
Description:
 
 
 
 
 
 
 
 
Assets:
 
 
 
 
 
 
 
 
Money market funds
 
$
95

 
$

 
$

 
$
95

U.S. government agencies
 
11,869

 

 

 
11,869

Commercial paper
 

 
12,942

 

 
12,942

Corporate bonds
 

 
12,964

 

 
12,964

Asset-backed securities
 

 
2,505

 

 
2,505

Total assets
 
$
11,964

 
$
28,411

 
$

 
$
40,375

We had no liabilities measured and recorded at fair value on a recurring basis as of March 31, 2018 or December 31, 2017.
Our investments, which are all classified as available-for-sale, consisted of the following:
 
 
As of March 31, 2018
 
 
Amortized Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Fair Value
 
 
(in thousands)
Description:
 
 
 
 
 
 
 
 
U.S. government agencies
 
$
9,385

 
$

 
$
(7
)
 
$
9,378

Commercial paper
 
10,211

 

 

 
10,211

Corporate bonds
 
11,174

 

 
(37
)
 
11,137

Total assets
 
$
30,770

 
$

 
$
(44
)
 
$
30,726

Our available-for-sale investments as of March 31, 2018 includes $2.4 million of commercial paper investments which are classified as cash and cash equivalents as the original maturity was less than three months.
 
 
As of December 31, 2017
 
 
Amortized Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Fair Value
 
 
(in thousands)
Description:
 
 
 
 
 
 
 
 
U.S. government agencies
 
$
11,880

 
$

 
$
(11
)
 
$
11,869

Commercial paper
 
12,942

 

 

 
12,942

Corporate bonds
 
12,991

 

 
(27
)
 
12,964

Asset-backed securities
 
2,506

 

 
(1
)
 
2,505

Total assets
 
$
40,319

 
$

 
$
(39
)
 
$
40,280


15


As of March 31, 2018 and December 31, 2017, our available-for-sale investments had maturities ranging from three months to two years.
For all of our investments for which the amortized cost basis was greater than the fair value at March 31, 2018 and December 31, 2017, we have concluded that there is no plan to sell the security nor is it more likely than not that we would be required to sell the security before its anticipated recovery. In making the determination as to whether the unrealized loss is other-than-temporary, we considered the length of time and extent the investment has been in an unrealized loss position, the financial condition and near-term prospects of the issuers, the issuers’ credit rating and the time to maturity.
Note 4. Property and Equipment
Property and equipment are recorded at cost and consist of the following:
 
 
As of
March 31, 2018
 
As of
December 31, 2017
 
 
(in thousands)
Computer equipment and software
 
$
18,002

 
$
16,205

Furniture and fixtures
 
3,965

 
4,034

Leasehold improvements
 
9,374

 
9,079

Total
 
31,341

 
29,318

Less accumulated depreciation
 
(22,103
)
 
(20,729
)
Property and equipment, net
 
$
9,238

 
$
8,589

Depreciation expense was $1.4 million and $1.1 million for the three months ended March 31, 2018 and 2017, respectively.
Note 5. Goodwill and Intangible Assets
Goodwill was $83.2 million as of March 31, 2018 and December 31, 2017.
The following table presents details of our intangible assets, which include acquired identifiable intangible assets and capitalized internal-use software costs:
 
 
 
As of March 31, 2018
 
As of December 31, 2017
 
Weighted-
Average
Life (years)
 
Gross Carrying
Amount
 
Accumulated
Amortization
 
Net Book Value
 
Gross Carrying
Amount
 
Accumulated
Amortization
 
Net Book Value
 
 
 
(in thousands)
Intangible assets subject to amortization:
 
 
 
 
 
 
 
 
 
 
 
 
 
Developed technology
5.7
 
$
20,611

 
$
(6,664
)
 
$
13,947

 
$
20,611

 
$
(5,756
)
 
$
14,855

Customer relationships
6.7
 
1,000

 
(389
)
 
611

 
1,000

 
(351
)
 
649

Trade names
6.1
 
519

 
(512
)
 
7

 
519

 
(510
)
 
9

Non-compete agreements
2.0
 
40

 
(40
)
 

 
40

 
(40
)
 

Total acquired intangible assets
 
 
22,170

 
(7,605
)
 
14,565

 
22,170

 
(6,657
)
 
15,513

Internal-use software
 
 
1,855

 
(104
)
 
1,751

 
1,162

 
(35
)
 
1,127

Total intangible assets
 
 
$
24,025

 
$
(7,709
)
 
$
16,316

 
$
23,332

 
$
(6,692
)
 
$
16,640

Amortization expense was $1.0 million and $0.5 million for the three months ended March 31, 2018 and 2017, respectively.

16


Estimated future amortization expense of the acquired identifiable intangible assets and completed capitalized internal-use software costs as of March 31, 2018 is as follows (in thousands):
2018 (for the remaining nine months)
$
3,074

2019
4,081

2020
4,023

2021
3,226

2022
1,095

2023 and thereafter

Total
$
15,499

The table above excludes the impact of $0.8 million of capitalized internal-use software costs for projects that have not been completed as of March 31, 2018, and therefore, we have not determined the useful life of the software, nor have all the costs associated with these projects been incurred.
Note 6. Stockholders' Equity
On January 30, 2018, we completed a public offering of 5,950,000 shares of our common stock, of which 1,500,000 shares of common stock were sold by us and 4,450,000 shares of common stock were sold by certain existing stockholders, at an offering price of $22.00 per share, including 770,000 shares pursuant to the underwriters' option to purchase additional shares from the selling stockholders. Our net proceeds from the offering were $30.9 million, after deducting underwriting discounts and commissions and our offering expenses. We did not receive any of the proceeds from the sale of shares by the selling stockholders.
Note 7. Stock-Based Compensation Expense
(a)
General
Stock-based compensation expense for restricted stock, restricted stock units, stock options and issuances of common stock pursuant to our employee stock purchase plan was classified in the accompanying consolidated statements of operations as follows:
 
 
Three Months Ended March 31,
 
 
2018
 
2017
 
 
(in thousands)
Stock-based compensation expense:
 
 
 
 
Cost of revenue
 
$
374

 
$
202

Research and development
 
2,566

 
1,513

Sales and marketing
 
1,563

 
1,403

General and administrative
 
1,722

 
1,161

Total stock-based compensation expense
 
$
6,225

 
$
4,279

We recognize compensation cost of all awards on a straight-line basis over the applicable vesting period, which is generally four years.

17


(b)
Restricted Stock and Restricted Stock Units
Restricted stock and restricted stock unit activity during the three months ended March 31, 2018 was as follows:
 
 
Restricted Stock
 
Restricted Stock Units
 
 
Shares
 
Weighted-Average
Grant Date
Fair Value
 
Shares
 
Weighted-Average
Grant Date
Fair Value
Unvested balance as of December 31, 2017
 
210,083

 
$
18.00

 
1,988,509

 
$
14.77

Granted
 

 

 
1,758,777

 
23.71

Vested
 
(47,109
)
 
18.82

 
(155,431
)
 
13.57

Forfeited
 

 

 
(84,682
)
 
18.34

Unvested balance as of March 31, 2018
 
162,974

 
$
17.76

 
3,507,173

 
$
19.22

As of March 31, 2018, the unrecognized compensation expense related to our unvested restricted stock and restricted stock units expected to vest was $65.5 million. This unrecognized compensation expense will be recognized over an estimated weighted-average amortization period of 3.2 years.
(c)
Stock Options
Stock option activity during the three months ended March 31, 2018 was as follows:
 
 
Shares
 
Weighted
Average
Exercise
Price
 
Weighted
Average
Remaining
Contractual Life
(in years)
 
Aggregate
Intrinsic
Value
(in thousands)
Outstanding as of December 31, 2017
 
4,684,954

 
$
9.68

 
 
 
 
Granted
 
97,850

 
24.14

 
 
 
 
Exercised
 
(388,786
)
 
5.04

 
 
 
$
7,345

Forfeited/cancelled
 
(43,795
)
 
16.18

 
 
 
 
Outstanding as of March 31, 2018
 
4,350,223

 
$
10.35

 
7.0
 
$
66,227

Vested and exercisable as of March 31, 2018
 
2,629,325

 
$
7.99

 
6.0
 
$
46,236

As of March 31, 2018, the unrecognized compensation expense related to our unvested stock options expected to vest was $10.3 million. This unrecognized compensation expense will be recognized over an estimated weighted-average amortization period of 2.3 years.
The total fair value of stock options vested in the three months ended March 31, 2018 was $7.0 million. The weighted-average grant date fair value of stock options granted in the three months ended March 31, 2018 was $11.73 per share.
(d)
Employee Stock Purchase Plan
Under the Rapid7, Inc. 2015 Employee Stock Purchase Plan (ESPP), employees may set aside up to 15% of their gross earnings, on an after-tax basis, to purchase our common stock at a discounted price, which is calculated at 85% of the lesser of: (i) the market value of our common stock at the beginning of each offering period and (ii) the market value of our common stock on the applicable purchase date.
On March 15, 2017, we issued 138,085 shares of common stock to employees for aggregate proceeds of $1.5 million. The purchase prices of the shares of common stock were $10.60 and $12.79 per share, which were discounted in accordance with the terms of the ESPP from the closing prices of our common stock on March 16, 2016 of $12.47 and on March 15, 2017 of $15.05, respectively.
On March 15, 2018, we issued 123,607 shares of common stock to employees for aggregate proceeds of $1.6 million. The purchase prices of the shares were $12.96 and $14.78 per share, which were discounted in accordance with the terms of the ESPP from the closing prices of our common stock on March 16, 2017 of $15.25 and on September 18, 2017 of $17.39, respectively.


18


Note 8. Net Loss per Share
The following table summarizes the computation of basic and diluted net loss per share of our common stock for the three months ended March 31, 2018 and 2017:
 
Three Months Ended March 31,
 
2018
 
2017
 
(in thousands, except share and per share data)
Numerator:
 
 
 
Net loss
$
(16,361
)
 
$
(10,545
)
Denominator:
 
 
 
Weighted-average common shares outstanding, basic and diluted
45,210,250

 
42,016,831

Net loss per share attributable to common stockholders, basic and diluted
$
(0.36
)
 
$
(0.25
)
The following potentially dilutive securities outstanding, prior to the use of the treasury stock method or if-converted method, have been excluded from the computation of diluted weighted-average shares outstanding for the respective periods below because they would have been anti-dilutive:
 
Three Months Ended March 31,
 
2018
 
2017
Options to purchase common stock
4,350,223

 
5,501,020

Unvested restricted stock
162,974

 
505,703

Unvested restricted stock units
3,507,173

 
1,954,651

Shares to be issued under ESPP
9,423

 
10,959

Total
8,029,793

 
7,972,333

Note 9. Commitments and Contingencies
 
(a)
Warranty
We provide limited product warranties. Historically, any payments made under these provisions have been immaterial.
(b)
Litigation and Claims
From time to time, we may be a party to litigation or subject to claims incident to the ordinary course of business. Although the results of litigation and claims cannot be predicted with certainty, we currently believe that the final outcome of these ordinary course matters will not have a material adverse effect on our business. 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.
In November 2016, Rapid7 LLC and two of our then executive officers were named as defendants in a class action lawsuit which alleged violations of certain Massachusetts wage and hour laws. In the three months ended March 31, 2018, we increased our litigation accrual by $0.4 million to $0.6 million which reflects the preliminary settlement amount discussed between the parties in April 2018.
(c)
Indemnification Obligations
We agree to standard indemnification provisions in the ordinary course of business. Pursuant to these provisions, we agree to indemnify, hold harmless and reimburse the indemnified party for losses suffered or incurred by the indemnified party, generally our customers, in connection with any United States patent, copyright or other intellectual property infringement claim by any third party arising from the use of our products or services in accordance with the agreement or arising from our gross negligence, willful misconduct or violation of the law (provided that there is not gross or willful misconduct on the part of the other party) with respect to our products or services. The term of these indemnification provisions is generally perpetual from the time of execution of the agreement. We carry insurance that covers certain third-party claims relating to our services and limits our exposure. We have never incurred costs to defend lawsuits or settle claims related to these indemnification provisions.

19


As permitted under Delaware law, we have entered into indemnification agreements with our officers and directors, indemnifying them for certain events or occurrences while they serve as officers or directors of the company.
Note 10. Segment Information and Information about Geographic Areas
We operate in one segment. Our chief operating decision maker is our Chief Executive Officer, who makes operating decisions, assesses performance and allocates resources on a consolidated basis.
Net revenues by geographic area presented based upon the location of the customer were as follows: 
 
Three Months Ended March 31,
 
2018
 
2017
 
(in thousands)
North America
$
46,377

 
$
37,993

Other
8,138

 
7,252

Total
$
54,515

 
$
45,245

Of the total net revenues generated in North America, 95% and 94% of the revenues were generated in the United States for the three months ended March 31, 2018 and 2017, respectively.
Property and equipment, net by geographic area was as follows:
 
As of March 31, 2018
 
As of December 31, 2017
 
(in thousands)
United States
$
7,876

 
$
7,182

Other
1,362

 
1,407

Total
$
9,238

 
$
8,589

Note 11. Related Party Transactions
In October 2015, McAfee LLC (formerly known as Intel Security) announced the end-of-sale for the McAfee Vulnerability Manager to customers and partners, effective January 11, 2016, with end-of-life to follow, and announced that we were named their exclusive vulnerability management partner. Under the terms of the commercial agreement, we incur partner referral fees as customers transition from McAfee Vulnerability Manager to Nexpose. During the three months ended March 31, 2018, we recognized sales and marketing expense of $0.2 million related to partner referral fees payable to McAfee LLC. On February 6, 2017, Michael Berry, a member of our Board of Directors, became the Chief Financial Officer of McAfee LLC.

20


Item 2.    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 (1) our consolidated financial statements and related notes appearing elsewhere in this Quarterly Report on Form 10-Q and (2) the audited consolidated financial statements and the related notes and Management’s Discussion and Analysis of Financial Condition and Results of Operations for the fiscal year ended December 31, 2017 included in our Annual Report on Form 10-K, filed with the SEC on March 8, 2018.
This Quarterly Report on Form 10-Q contains “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, or the Securities Act, and Section 21E of the Securities Exchange Act of 1934, as amended, or the Exchange Act. These statements are often identified by the use of words such as “anticipate,” “believe,” “continue,” “could,” “estimate,” “expect,” “intend,” “may,” “plan,” “project,” “will,” “would” or the negative or plural of these words or similar expressions or variations. Such forward-looking statements are subject to a number of risks, uncertainties, assumptions and other factors that could cause actual results and the timing of certain events to differ materially from future results expressed or implied by the forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those identified herein, and those discussed in the section titled “Risk Factors,” set forth in Part II, Item 1A of this Quarterly Report on Form 10-Q and in our other SEC filings. You should not rely upon forward-looking statements as predictions of future events. 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 after the date of such statements.
Overview
Organizations of all sizes are faced with a more sophisticated and motivated set of cyber attackers. Coupled with an increasingly complex IT environment and expanding attack surface, which is driven by mobility and a shift to the cloud, security and IT teams are struggling to maintain adequate levels of cyber security, provide visibility to their management teams, and meet increasing regulatory requirements. At the same time, they must navigate a shortage of capable cyber security professionals. Out of these challenges, the concept of Security Operations, or SecOps, is emerging. SecOps is a movement that recognizes that Security and IT Operations must work together to deliver better security and more nimbly adapt to emerging threats, without adding significant resources. SecOps requires solutions that provide visibility, analytics and automation that enable IT, Security and DevOps to work together to achieve significantly higher levels of productivity and success.
Rapid7 is a leading provider of security and IT analytics and automation solutions for SecOps, and is trusted by professionals around the world to provide visibility, analytics and automation to help manage risk, simplify IT complexity and drive innovation. Our solutions, which include vulnerability management, incident detection and response, security information and event management, or SIEM, application security testing, log analytics, and security orchestration and automation, all focus on the critical needs of enterprises for greater visibility into their environments, analytics that provide context to complex data, and automation that enables SecOps teams to scale and more efficiently to address critical security and IT tasks.
We combine our extensive experience in collecting data from an ever-expanding IT environment, our deep insight into attacker behaviors and techniques, and our powerful and proprietary analytics to provide solutions that can quickly and efficiently identify and prioritize risks and active threats in an enterprise’s IT environment. Our broad data collection capabilities encompass endpoints, servers, applications, users, cloud-based assets, client devices, network activity, log data and information from third-party applications. We also provide workflows and automations that can enable and accelerate remediation of these risks and active threats. We have designed our solutions to be easy to deploy and use for security and IT teams of all sizes.
We offer analytic solutions across the following three core areas of SecOps:
Our Vulnerability Management offerings include our industry-leading vulnerability management, web application security testing and attack simulation products. These solutions provide enterprises with comprehensive, yet prioritized, visibility into potential cyber risks across their IT environment. We have also added remediation workflows to help ensure that these risks can be easily mitigated.
Our Incident Detection and Response solutions are designed to enable organizations to rapidly detect and respond to cyber security incidents and breaches across physical, virtual and cloud assets, including those associated with the behaviors of their users. These solutions combine the collection of massive amounts of data with our core analytics and machine-learning-driven user behavioral analytics to simplify the task of identifying and responding to potential breaches.
Our IT Analytics and Automation solutions are designed to allow operations teams to quickly gain visibility into their IT environment and facilitate automated workflows to eliminate repetitive, manual and labor-intensive tasks.

21


Finally, to complement our SecOps products, we offer a range of managed services based on our software solutions and professional services, including incident response services, security advisory services, and deployment and training.
We 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 March 31, 2018, we had over 7,100 customers in 128 countries, including 55% of the Fortune 100. Our revenue was not concentrated with any individual customer or group of customers, and no customer represented more than 2% and 3% of our revenue for the three months ended March 31, 2018 and 2017, respectively.
We sell our products and professional services through direct inside and field sales teams and indirect channel partner relationships. Our global sales teams focus on both new customer acquisition as well as up-selling and cross-selling additional offerings 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 primarily focuses on small and middle-market enterprises, while Fortune 500 enterprises are generally handled by our globally distributed direct field sales teams. Our highly technical sales engineers help define customer use cases, manage solution evaluations and train channel partners.
Our Business Model
We have offerings in three key areas: (1) Vulnerability Management, which includes our InsightVM, Nexpose, InsightAppSec, AppSpider and Metasploit products, (2) Incident Detection and Response, which includes our InsightIDR and Managed Detection and Response products as well as our incident response services and (3) IT Analytics and Automation Solutions, which includes our Logentries, InsightOps and Komand products.
We offer our products through a variety of delivery models to meet the needs of our diverse customer base, including:
Cloud-based subscriptions, which provide our software capabilities to our customers through cloud access and on a Software as a Service basis. Our InsightIDR, InsightVM, InsightAppSec, Logentries and InsightOps products are offered as cloud-based subscriptions, generally with one to three-year terms.
Managed services, through which we operate our products and provide our capabilities on behalf of our customers. Our Managed Vulnerability Management (InsightVM), Managed Application Security (AppSpider) and Managed Detection and Response (InsightIDR) products are offered on a managed service basis, generally pursuant to one to three-year agreements.
Licensed software, including both term and perpetual licenses, and the simultaneous sale of maintenance and support. Our Nexpose, Metasploit and AppSpider products are offered through term or perpetual software licenses. Our customers who purchase software licenses also purchase maintenance and support, which provides our customers with telephone and web-based support and ongoing bug fixes and repairs during the term of the maintenance and support agreement, and our customers who purchase our Nexpose and Metasploit products also purchase content subscriptions, which provide them with real-time access to the latest vulnerabilities and exploits. Our maintenance and support and content subscription agreements are typically for one to three-year terms. In addition, our Komand product is offered through term licenses.
We also offer various professional services across all of our offerings, including deployment and training services related to our software and cloud-based products, 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.
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 and Logentries, in a trailing 12-month period by the dollar value of the corresponding customer agreements. We also calculate an expiring 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 renewal rate to exceed 100%. Our renewal rate was 120% for the three months ended March 31, 2018 and 2017 and our expiring renewal rate was 89% and 88% for the three months ended March 31, 2018 and 2017, respectively. Our goal is to maintain what we believe are strong renewal rates, and work to increase them 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, competitive offerings, economic conditions or overall changes in our customers’ spending levels.

22


We generate revenue from selling products, maintenance and support, and professional services. For the three months ended March 31, 2018 and 2017, 84% and 81% of our revenue, respectively, was derived from sales of products and associated maintenance and support, while the remaining 16% and 19%, respectively, was derived from the sale of professional services.
For the three months ended March 31, 2018, recurring revenue, defined as revenue from term software licenses, content subscriptions, managed services, cloud-based subscriptions and maintenance and support, was 77% of total revenue under ASC 606 and 75% of total revenue under ASC 605. For the three months ended March 31, 2017 recurring revenue was 69% of total revenue.
For the three months ended March 31, 2018, 85% of total revenue under ASC 606 and 89% of total revenue under ASC 605, respectively, came from deferred revenue on the balance sheet at the beginning of the respective period. For the three months ended March 31, 2017, 89% of our total revenue came from deferred revenue on the balance sheet at the beginning of the respective period.
During the three months ended March 31, 2018, we recognized revenue based on the ASU 2014-09, Revenue from Contracts with Customers (Topic 606), however revenue for the three months ended March 31, 2017 was recognized based on ASC 605. Therefore, the periods are not directly comparable. For additional information on the impact of the new accounting standard on our revenue, see Note 2, Revenue from Contracts with Customers, in the notes to the consolidated financial statements.
Other Business Metrics
We regularly monitor a number of financial and operating metrics in order to measure our current performance and estimate our future performance. Our other business metrics may be calculated in a manner different than similar other business metrics used by other companies.
 
 
Three Months Ended
March 31,
 
 
2018
 
2017
 
 
(dollars in thousands)
Total revenue
 
$
54,515

 
$
45,245

Year-over-year growth
 
20.5
%
 
30.0
%
Annualized recurring revenue (non-GAAP)
 
$
177,792

 
$
128,441

Year-over-year growth
 
38.1
%
 
33.7
%
Operating cash flow
 
$
7,296

 
$
3,321

 
 
As of March 31,
 
 
2018
 
2017
Number of customers
 
7,113

 
6,350

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.
Annualized Recurring Revenue (ARR) and Growth. ARR is a non-GAAP measure that we define as the annual value of all recurring revenue related to contracts in place at the end of the period. ARR should be viewed independently of revenue and deferred revenue as ARR is a performance metric and is not intended to be combined with any of these items.
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 the timing of commission and bonus payments, accounts payable payments and collections of accounts receivable.
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; and for Logentries products, those customers with a contract value equal to or greater than $2,400 per year, or (2) purchased Rapid7 professional services within the 12 months preceding the applicable measurement date.

23


Non-GAAP Financial Results
To supplement our consolidated financial statements, which are prepared and presented in accordance with GAAP, we provide investors with certain non-GAAP financial measures, including non-GAAP gross profit, non-GAAP operating loss, non-GAAP net loss, non-GAAP net loss per share, and ARR 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, and certain non-recurring items such as secondary public offering costs and litigation related expenses. 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, and use certain non-GAAP financial measures as performance measures under our executive bonus plan. 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 review the reconciliation of our non-GAAP financial measures to the comparable GAAP financial measures included below, and not rely on any single financial measure to evaluate our business.
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 acquired 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 several years after the acquisition. We also exclude certain non-recurring items such as secondary public offering costs and litigation-related expenses 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 management with greater visibility into 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.
Our non-GAAP financial measures may not provide information that is directly comparable to that provided by other companies in our industry, as other companies in our industry may calculate non-GAAP financial results differently, particularly related to non-recurring, unusual items. In addition, 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.

24


The following tables reconcile GAAP gross profit to non-GAAP gross profit for the three months ended March 31, 2018 and 2017:
 
 
Three Months Ended March 31,
 
 
2018
 
2017
 
 
(in thousands)
GAAP total gross profit
 
$
37,921

 
$
32,981

Stock-based compensation expense
 
374

 
202

Amortization of acquired intangible assets
 
908

 
439

Non-GAAP total gross profit
 
$
39,203

 
$
33,622

 
 
 
 
 
 
 
Three Months Ended March 31,
 
 
2018
 
2017
 
 
(in thousands)
GAAP gross profit – products
 
$
26,843

 
$
21,232

Stock-based compensation expense
 
125

 
60

Amortization of acquired intangible assets
 
908

 
439

Non-GAAP gross profit – products
 
$
27,876

 
$
21,731

 
 
 
 
 
 
 
Three Months Ended March 31,
 
 
2018
 
2017
 
 
(in thousands)
GAAP gross profit – maintenance and support
 
$
8,904

 
$
8,924

Stock-based compensation expense
 
28

 
60

Non-GAAP gross profit – maintenance and support
 
$
8,932

 
$
8,984

 
 
 
 
 
 
 
Three Months Ended March 31,
 
 
2018
 
2017
 
 
(in thousands)
GAAP gross profit – professional services
 
$
2,174

 
$
2,825

Stock-based compensation expense
 
221

 
82

Non-GAAP gross profit – professional services
 
$
2,395

 
$
2,907

The following table reconciles GAAP loss from operations to non-GAAP loss from operations for the three months ended March 31, 2018 and 2017:
 
 
Three Months Ended March 31,
 
 
2018
 
2017
 
 
(in thousands)
GAAP loss from operations
 
$
(16,585
)
 
$
(10,470
)
Stock-based compensation expense
 
6,225

 
4,279

Amortization of acquired intangible assets
 
948

 
486

Secondary public offering costs
 
140

 

Litigation-related expenses
 
400

 

Non-GAAP loss from operations
 
$
(8,872
)
 
$
(5,705
)

25


The following table reconciles GAAP net loss to non-GAAP net loss for the three months ended March 31, 2018 and 2017:
 
 
Three Months Ended March 31,
 
 
2018
 
2017
 
 
(in thousands, except share and per share data)
GAAP net loss
 
$
(16,361
)
 
$
(10,545
)
Stock-based compensation expense
 
6,225

 
4,279

Amortization of acquired intangible assets
 
948

 
486

Secondary public offering costs
 
140

 

Litigation-related expenses
 
400

 

Non-GAAP net loss
 
$
(8,648
)
 
$
(5,780
)
Non-GAAP net loss per share, basic and diluted
 
$
(0.19
)
 
$
(0.14
)
Weighted-average common shares outstanding, basic and diluted
 
45,210,250

 
42,016,831

Adoption of Revenue from Contracts with Customers (Topic 606)
In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606) (ASU 2014-09), which replaced the revenue recognition requirements in FASB ASC Topic 605, Revenue Recognition (ASC 605). The new revenue standard 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. The new revenue standard provides a five-step analysis of transactions to determine when and how revenue is recognized. The core principle is that a company should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods and services.
We adopted ASC 606 effective on January 1, 2018 using the modified retrospective method. Under this method of adoption, we recognized the cumulative effect of initially applying the new revenue standard as an adjustment to the opening balance of accumulated deficit. See Note 2, Revenue from Contracts with Customers, in the notes to our consolidated financial statements included in this Quarterly Report on Form 10-Q for additional discussion of the impact of the adoption of ASC 606 and changes in accounting policies relating to revenue recognition and accounting for costs to obtain and fulfill a customer contract.
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.
Products
We generate products revenue from the sale of (1) term or perpetual software licenses for our Nexpose, Metasploit and AppSpider products, term licenses for our Komand product offering, as well as associated content subscriptions for our Nexpose and Metasploit products, (2) managed services offerings which utilize either our InsightVM, AppSpider or InsightIDR products and (3) cloud-based subscriptions for our InsightVM, InsightIDR, InsightAppSec, InsightOps, AppSpider and Logentries products. We also generate an immaterial amount of appliance revenue that is included in our products revenue and is associated with hardware sold with our Nexpose product to certain customers.
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 software licenses. Substantially all of our customers purchase an agreement for maintenance and support in connection with their purchase of a Nexpose, Metasploit or AppSpider software license.
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.
Cost of Revenue

26


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, managed service and cloud operations team, including salaries and other payroll related costs, bonuses, 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, cloud computing costs and internet connectivity expenses directly related to delivering our products, amortization of contract fulfillment costs, as well as amortization of certain intangible assets including internally developed software.
Cost of Maintenance and Support
Cost of maintenance and support consists of personnel and related costs for our support team, including salaries and other payroll related costs, bonuses, 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 and other payroll related costs, bonuses, 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 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, the mix of revenue between software licenses, cloud-based subscriptions, managed services and professional services and changes in cloud computing costs. We expect our gross margins to fluctuate over time depending on the factors described above.
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, facilities, IT, information security and recruiting. Our allocated costs for IT include costs for compensation of IT personnel and costs associated with our IT infrastructure. All allocated overhead 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 and other payroll related costs, bonuses and stock-based compensation. Additional expenses include travel and entertainment, 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 remain consistent 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 and other payroll related costs, commissions, bonuses and stock-based compensation. 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 legal, human resources, and finance and accounting departments, including salaries and other payroll related costs, bonuses and stock-based compensation. Additional expenses include travel and entertainment, professional fees, litigation expenses, insurance, secondary public offering expenses, amortization of certain intangible assets and allocated overhead.

27


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, but to decrease as a percentage of total revenue.
Interest Income (Expense), Net
Interest income (expense), net consists primarily of interest income on our cash and cash equivalents and our short and long-term investments.
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 and realized gains and losses on the sale of investments.
Provision for Income Taxes
Provision for income taxes relates to U.S. federal and state, as well as certain foreign jurisdiction, income taxes. Historically, we have generated net losses in the U.S., U.K and Ireland and recorded a full valuation allowance against our U.S., U.K. and Ireland deferred tax assets. We expect to maintain a full valuation allowance on our U.S., Ireland and U.K. deferred tax assets in the near term. Realization of our U.S., Ireland and U.K. deferred tax assets depends upon future earnings, the timing and amount of which are uncertain.
Results of Operations
The following table sets forth our selected consolidated statements of operations data:
 
Three Months Ended March 31,
 
2018
 
2017
 
(in thousands)
Consolidated Statement of Operations Data:
 
 
 
Revenue:
 
 
 
Products
$
35,279

 
$
25,942

Maintenance and support
10,753

 
10,802

Professional services
8,483

 
8,501

Total revenue
54,515

 
45,245

Cost of revenue:(1)
 
 
 
Products
8,436

 
4,710

Maintenance and support
1,849

 
1,878

Professional services
6,309

 
5,676

Total cost of revenue
16,594

 
12,264

Operating expenses:(1)
 
 
 
Research and development
16,722

 
11,393

Sales and marketing
29,052

 
24,810

General and administrative
8,732

 
7,248

Total operating expenses
54,506

 
43,451

Loss from operations
(16,585
)
 
(10,470
)
Interest income (expense), net
241

 
169

Other income (expense), net
78

 
(115
)
Loss before income taxes
(16,266
)
 
(10,416
)
Provision for income taxes
95

 
129

Net loss
$
(16,361
)
 
$
(10,545
)

28


(1)
Cost of revenue and operating expenses include stock-based compensation expense and depreciation and amortization expense as follows:
 
Three Months Ended March 31,
 
2018
 
2017
 
(in thousands)
Stock-based compensation expense:
 
 
 
Cost of revenue
$
374

 
$
202

Research and development
2,566

 
1,513

Sales and marketing
1,563

 
1,403

General and administrative
1,722

 
1,161

Total stock-based compensation expense
$
6,225

 
$
4,279

 
Three Months Ended March 31,
 
2018
 
2017
 
(in thousands)
Depreciation and amortization expense:
 
 
 
Cost of revenue
1,237

 
661

Research and development
288

 
256

Sales and marketing
593

 
494

General and administrative
281

 
213

Total depreciation and amortization expense
$
2,399

 
$
1,624

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