Rapid7, Inc. (NASDAQ:RPD) Q3 2023 Earnings Call Transcript

Rapid7, Inc. (NASDAQ:RPD) Q3 2023 Earnings Call Transcript November 1, 2023

Operator: Good afternoon. My name is Rob, and I will be your conference operator today. At this time, I would like to welcome everyone to the Rapid7 Third Quarter 2023 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. [Operator Instructions] Thank you. Elizabeth Chwalk, Director of Investor Relations, you may begin your conference.

Elizabeth Chwalk: Thank you, operator and good afternoon everyone. We appreciate you joining us today to discuss Rapid7’s third quarter 2023 financial and operating results in addition to our financial outlook for the fourth quarter and full fiscal year 2023. With me on the call today are Corey Thomas, our CEO; and Tim Adams, our CFO. We have distributed our earnings press release over the wire and it is now posted on our website at investors.rapid7.com along with the updated company presentation and financial metrics file. This call is being broadcast live via webcast and following the call, an audio replay will be available at investors.rapid7.com. During this call, we may make statements related to our business that are considered forward-looking under Federal Securities laws.

These statements are made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995 and include statements related to the company’s positioning, strategy, business plans, restructuring plans, financial guidance for the fourth quarter and full year 2023, financial goals for the full year 2024, and the assumptions underlying such goals and guidance. These forward-looking statements are based on our current expectations and beliefs and on information currently available to us. Actual outcomes and results may differ materially from the future results expressed or implied in these statements due to a number of risks and uncertainties, including those contained in our most recent quarterly report on Form 10-Q filed on August 9th, 2023, and in the subsequent reports that we filed with the SEC.

The information provided on this conference call should be considered in light of such risks. Actual results and the timing of events may differ materially from the results or timing predicted or implied by such forward-looking statements, and reported results should not be considered as an indication of future performance. Rapid7 does not assume any obligation to update the information presented on this conference call, except to the extent required by applicable law. Our commentary today will primarily be in non-GAAP terms and reconciliations between our historical GAAP and non-GAAP results can be found in today’s earnings press release and on our website at investors.rapid7.com. At times in our prepared remarks or in responses to your questions, we may offer incremental metrics to provide greater insight into the dynamics of our business or our quarterly results.

Please be advised that this additional detail may be one-time in nature, and we may or may not update these metrics in the future. With that, I’d like to turn the call over to our CEO, Corey Thomas. Corey?

Corey Thomas: Good afternoon everyone and thank you for joining us today on our third quarter 2023 earnings call. Rapid7 ended the third quarter with $777 million in ARR or 14% over the prior year, while delivering revenue and operating income above our guided ranges. During the third quarter, we continued to see strong demand for integrated security operations solutions across our Insight platform. Our value proposition is resonating with mainstream enterprise customers, particularly with our consolidated offerings. Over 40% of new ARR in the third quarter was from either a threat or cloud risk complete deal, validating our strategic focus around supporting the modern or extended SOC with integrated best-of-breed capabilities across risk management and threat detection.

As we sell more of our platform together, we see deal sizes getting larger as ASPs have steadily increased all year. Overall, we saw a customer spending environment that was in line with our expectations and remained stable during the third quarter and into October. Amid the worsening consequences for cybersecurity incidents and the persistent challenge of proactively securing IT environment in an efficient manner, we consistently hear a set of beans from conversations with customers. There is need for integrated cloud security offerings with InsightOps as well as a desire to upgrade to cloud-native detection response programs and automation and integrated expertise are often critical differentiators in choosing technology partners. While security team leaders are prioritizing spending around these areas, the budget environment remains complex.

Consistent with the last 12 months, we continue to see higher levels of approval during extended procurement cycles. The good news is that our sellers have become more adept in navigating this environment and there is still urgency from customers on projects around cloud security and detection response, the anchors of our successful risk and threat management offerings. Our critical role as a strategic partner to SecOps team is reflected in the growing number of long-term commitments we’re seeing from customers. Our total weighted average contract length in the quarter was up 20% over the prior year, which speaks to the value and confidence our customers have in Rapid7 as a long-term technology partner. Turning now to the restructuring we announced alongside our Q2 earnings results in August.

Our efforts to streamline the business are mostly complete and we are progressing on our areas of strategic reinvestment. I am proud of how well our Rapid7 team has responded to the changes as we have worked to optimize our organization and underlying cost structure over the past few months. Collectively, our strategic alignment is benefiting profitability, as we expected, and we continue to expect the full year 2023 operating margin to expand over 750 basis points from the prior year and to generate free cash flows of approximately $80 million. Regarding our customers, we had an intentional focus during the latter half of the third quarter on ensuring continuity and strong overall customer experience as we executed our transition plan. Our customer-facing teams were heavily focused on spending more time engaging with and messaging to existing customers and prospects with less relative focus on scaling incremental pipeline.

The result is that our changes were widely well received by customers, driving strong conversion rates that fueled solid overall ARR growth in the quarter. Now, that we are largely through these changes, our teams are incrementally more focused on engaging broadly to drive strong and improving pipeline momentum as we exit the year. And we believe we remain well positioned to achieve our fourth quarter objectives. Regarding reinvestment into our strategic areas of focus. We’re accelerating our leadership in the extended side as well as further scaling our ability to offer expertise alongside our technology. While it’s still early, we are progressing well in both areas, and I’ll give you tangible examples of the positive traction we’re seeing in the business.

We continue to see strong demand for our integrated consolidation solutions to support the extended SOC and we continue to innovate by adding end-to-end capabilities to expand our value proposition to mainstream in the process. In October, we announced the general availability of multilayered endpoint protection for our managed detection and response customers. By offering integrated next-gen antivirus alongside digital forensics and incident response capabilities, onto our Insight agent, we are elevating the breadth and holistic visibility of our extended detection and response. We saw a meaningful gap in the market for customers with legacy endpoint solutions that are focused on affordable, highly effective solutions. Our expanded offerings will now enable these MGR customers to benefit from reduced endpoint security cost and complexity within their SOC, while freeing up additional budget dollars by consolidating onto our Insight platform.

We also continue to see traction cross-selling across our integrated platform of solutions. A good example of this is in the third quarter was a deal with a midsized fintech company owned by a large private equity firm. This customer became a Rapid7 vulnerability management customer in 2022, and earlier this year, extended their enterprise risk visibility with our cloud security offering. They will start again in the third quarter to explore our managed threat complete offering after facing additional resource constraints and regulatory requirements. With transferred dollars that weren’t part of their initial budget and after a competitive process, the customer chose Rapid7 for our ability to detect and respond to threats across their entire security environment and throughout each phase of the DNR life cycle.

With our Insight agent already deployed, the customer is able to implement our robust monitoring capabilities within days of their purchase, allowing a quick return on their security budget dollars. Our ARR with the customer more than tripled to the high six figures over the course of 18 months, highlighting the urgency and the value resource-constrained enterprises place on best-in-suite solutions within strategic areas of security operations. We’re also scaling our ability to offer integrated expertise alongside our SecOps solutions by accelerating our strategic managed services partnerships. I am pleased to announce that we signed a partnership deal in the third quarter with a nationwide leader in communication services, who chose Rapid7 technology as the foundation for their managed detection and response offering.

It was a highly competitive process and our new partner needed a single provider to help their customers manage security across their entire network, endpoint server and cloud infrastructure while helping to contain and disrupt ongoing security breaches. This partnership will combine our best-in-class threat detection and response platform and global SOC presence to help small, medium and large enterprise customers better manage an ever-evolving and challenging cyber threat landscape. Over time, we’ll have the opportunity to expand our partnership to sell other Rapid7 solutions to their substantial customer base. We’re excited about this partnership and our ability to leverage similar partnerships in the future as we scale our ability to offer integrated expertise to more customers.

Rapid7 remains focused on being the leading provider of integrated security solutions for the extended SOC by providing risk and threat management within the context of overall security, alongside expertise tailored to the needs of each customer. We are pleased with our third quarter results and continue to march forward towards our goals. When we updated our ARR guidance in August, alongside the announcement of our restructuring and strategic realignment, we established a high confidence range to account for modest degrees of disruption in the business. As we make progress, we’ve seen performance track within our range of expectations. Given larger deal cycles as well as the heavy concentration of large deals in the fourth quarter, we believe it is prudent to reiterate our full year ARR guidance of $800 million to $805 million.

All-in-all, we are pleased with our third quarter results and the early progress we are making as we work to reaccelerate growth by reinvesting into strategic areas of strong customer demand within our business. We were able to outperform on our operating income target in the third quarter and to flow through that upside to our full year guidance range. This speaks to the benefit of our new streamlined cost structure, which will allow us to become a more profitable growth company. We expect to generate approximately $80 million of free cash flow this year and then double that figure to at least $160 million next year in 2024. With that, thank you for joining us on the call today. I will now turn the call over to our CFO, Tim Adams, to share additional detail on our financial results and outlook.

Tim?

Tim Adams: Thank you, Corey. Good afternoon to everyone on today’s call and thank you for joining us. Before I turn to the results, a quick reminder that except for revenue, all financial results we will discuss today are non-GAAP financial measures, unless otherwise stated. Additionally, reconciliations between our GAAP and non-GAAP results can be found in our earnings press release. Rapid7 ended the third quarter of 2023 with $777 million in ARR, growing 14% over the prior year on solid demand for our consolidated offerings across risk management and threat complete. Customers continue to gravitate towards our integrated solutions anchored in detection and response in cloud security, which made up over 40% of new ARR in the third quarter.

Our value proposition is resonating with customers as we see ASPs continue to climb and our average contracts get longer. We saw relatively balanced contributions from new and existing customers in the third quarter. ARR per customer grew 7% over the prior year to $6,100, and we ended the quarter with over 11,400 total customers, reflecting 6% growth over the prior year. Third quarter revenue of $199 million represented growth of 13% year-over-year, exceeding the high end of our guidance range. Product revenue grew 14% year-over-year to $190 million as customers continue to prioritize budget dollars around projects in our areas of strategic focus, both around the extended SOC and the ability to offer integrated expertise. International revenue made up 22% of total revenue, while North American represented 78%.

Moving on to operating and profitability measures for the quarter. Product gross margin was 77%, in line with the prior year, and total gross margin was 75%. Operating expenses reflect the changes to our cost structure that we implemented in August. Sales and marketing represented 34% of revenue in the quarter, down from 38% in the prior year. R&D and G&A expenses were 16% and 6% of revenue, respectively, compared to 20% and 8% in the third quarter of last year. Overall, higher revenue and a leaner cost structure drove higher-than-expected operating income of $37 million in the quarter. Our adjusted EBITDA was $43 million in the third quarter and diluted net income per share was $0.50. Before we turn to the balance sheet and cash flow statement, I want to mention certain items from the third quarter income statement that do not affect our non-GAAP results.

We incurred a total of $24 million in restructuring and real estate impairment charges in the quarter, in line with our expectations. We also booked a non-cash induced conversion expense of $54 million in the quarter as a result of the required accounting treatment related to the partial repurchase of our 2025 convertible notes. We ended the third quarter with cash, cash equivalents, and investments of $373 million. We took proactive steps during the quarter to strengthen our balance sheet and to take advantage of favorable market conditions. The increase in cash and equivalents from the second quarter reflects the proceeds from our convertible notes offering in September, partially offset by the previously mentioned partial repurchase of our 2025 notes.

This was primarily a liability management effort, allowing us to enter into a new convert with more favorable terms and extended the maturity date of a portion of our debt structure. Operating cash flow was $4 million and reflects timing of the restructuring payments, which were concentrated in the third quarter, as expected. It also reflects a working capital headwind related to the timing of cash collections. We have already seen strong collections early in the fourth quarter, and we’ll continue to manage these working capital dynamics closely. Moving on to our outlook for the remainder of 2023. As Corey mentioned, we are maintaining our full year ARR outlook range of $800 million to $805 million or approximately 12% to 13% growth over the prior year.

As our strategic realignment is tracking in line with our range of expectations, we feel confident about maintaining the existing range for the full year. We are raising our full year revenue guidance to $773 million to $775 million, representing 13% growth. This reflects product revenue outperformance in the third quarter, partially offset by slightly lower services revenue forecast for the full year as we actively deemphasize some lower-value professional services coming out of our restructuring. We are also raising the midpoint of our full year operating income guidance by $7 million to reflect our strong third quarter performance. This brings our full year operating income guidance to $94 million to $96 million, representing roughly 12% full year operating margin and over 750 basis points of improvement from the prior year.

Non-GAAP net income per share is expected to be $1.26 to $1.29 based on an anticipated 72.1 million diluted weighted average shares outstanding. We are reiterating our free cash flow guidance of approximately $80 million for the full year. As implied by our full year guidance for the fourth quarter of 2023, we expect revenue in the range of $200 million to $202 million and operating income between $33 million and $35 million, which represents an operating margin of approximately 17%. Non-GAAP net income per share for the fourth quarter is expected to be $0.47 to $0.49 based on an anticipated 73.8 million diluted weighted average shares outstanding. With that, thank you for joining us on the call today, and we will now open the call for questions.

Operator?

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Q&A Session

Operator: [Operator Instructions] And your first question comes from the line of Matt Hedberg from RBC Capital Markets. Your line is open.

Matt Hedberg: Great. Thanks for taking my questions. Corey, great to see the results and demand commentary and the benefits of the restructuring going on here. I’m curious, you noted in your prepared remarks that you’re working to reaccelerate growth. I guess, I’m wondering, when we think about sales and marketing or products or whatever it might be, what do you think are some of the most important aspects of what you guys are doing to control some of that reacceleration even despite ongoing economic uncertainty?

Corey Thomas: Yes. Thanks Matt. It’s a good question. So, I think there’s two fundamentals. This one, you have to be in the right markets that have the right demand drivers. I think we’re there. If you think about what we’re doing in the extended SOC, customers are struggling with the cost of complexity of managing their tech service in this environment. And so we are leaning into that and continuing to reallocate investment into that area of focus. That’s a long-term investment area that involves cloud, and we’re also delivering expertise. But of course, we’re actually focused on that. We have been. We think we have a good leg up. We think we’re competitively differentiated. But it’s a long-term investment area and again, we’re rotating more of our investment to those areas over time.

Now, I would say the point on that one is going to be also the one that goes to go to market is, look, we can actually grow faster. Our big focus right now is growing efficiently, though. And so this is a focus of making sure we have durable growth and efficient growth because as we actually look forward, we know that we can actually in the right areas, the right spaces. We know we actually are set it up for the right products in services, we have to make sure that we actually have the efficient growth that we’re actually looking for and that spend is going to come over time. So, we are, I would say, being methodical, being very thoughtful. We are going to be spending the reinvestment, but it’s going to be to extend it into the cloud. continuing to actually work with partners to deliver augmented services.

As I talked about with the large national provider and one of the deals that we actually just did, you’ll see more of that. But it’s also a big focus on extending our sales and marketing engine, but actually doing that both through partners, but doing that efficiently ourselves. And that’s what you’ll see us make investments over the course of both this year, but more importantly, we’ll make an investments over the course of 2024. But that’s kind of how we think about growth. We’re focused on efficiency now and then adding growth that actually gives long-term growth potential, but actually doing it in a way that makes sure that we actually stay very disciplined, very lean and very efficient.

Matt Hedberg: Super helpful. Thanks Corey.

Corey Thomas: Thank you.

Operator: Your next question comes from the line of Adam Tindle from Raymond James. Your line is open.

Adam Tindle: Okay. Thanks. Good afternoon. Corey, I just wanted to start, you mentioned how the pipeline was impacted from Q3 from making sure existing customers were okay, which makes total sense and probably a good move I guess the question would be, how do you shift the salesforce to focus? How did you shift them to focus on existing? And how do you pivot them to focus on new pipelines, some of the things you can do from incentives. And Tim, if you wanted to maybe as a follow-up to this, I know that, that can have a lagged impact on revenue growth, that deceleration in pipeline. Wondering how we should think about that in light of moving forward in 2024 growth, we’re exiting, I think, at single-digit growth in Q4. Wondering if that’s maybe an indicator of what to expect in 2024. Why or why not? Thank you.

Corey Thomas: Yes. So, I’ll tackle that. So, I’ll tackle it first. So, one, on the — as we actually think about sort of guidance, I would just say, listen, the biggest factor there was, as you said, we were very focused on executing the cost structure alignment and make sure we take care of customers. We actually just had very direct discussions with our team about what the priorities were. The priorities to make sure we’re servicing our customers well, make sure that we were converting existing deals. We saw and just continue to see very, very strong conversion rates overall. And we continue to see that we were actually adding more consolidation pipeline. So, we had as more consolidation pipe — those are bigger deals. They actually have longer sales cycles.

So, you ask what the short-term effect was, theoretically, less pipe for Q4. That’s something we’re very comfortable with because, again, our big near-term focus was the cost structure. Now, longer term, we’re very focused on continuing to build strategic pipe, which we’re seeing in the consolidation efforts. We’re doing two things around that. we’re making sure that our sales team is well equipped and selling it. And I would just say we’re seeing the benefits of that now. Yes, that actually have some benefits in 2024. But the other part of it is, as I talked about on the last call, we did drive lots of efficiency, not in our direct sellers, but in our overall go-to-market engine. And we expect to actually add more of the — more of the pipe and demand generation capabilities over time, but we are very, very disciplined about adding that in a way that is lean and that is efficient.

And I think that sets up for a good long-term dynamic, but that’s the focus that we actually have right now.

Tim Adams: Yes. And then, Adam, it’s Tim too. The second part of your question regarding 2024, we are right in the middle of our budgeting process for next year. So, it would be premature for us to make any comments about growth for next year. But I’ll reemphasize what Corey said, we’re very focused on efficient growth and generating strong free cash flow. So, we’ve shared with you guys last quarter that we anticipate roughly $160 million of free cash flow next year. And we still feel very good about that number. And look, we had some hard actions that we had to take back in August with the restructuring and the realignment of the company. But I do think that sets us up very well for next year that we’ve rationalized the cost structure. So, very focused on efficient growth, and we’ll have more to say about next year on the Q4 call.

Adam Tindle: Makes sense. Thank you very much.

Operator: Your next question comes from the line of Matt Saltzman from Morgan Stanley. Your line is open.

Matt Saltzman: Great. Thanks for taking the question. So, just looking at total customer growth, it’s kind of trended in this mid-single-digit range for several quarters now. I appreciate you guys don’t specifically guide to or disclose gross logo retention. But I’m just curious if you can speak qualitatively about the trends on gross logo retention over the last 12 months and maybe the last six months?

Corey Thomas: Yes, I mean, I will talk at a high level, as you say, we don’t disclose it. I think last year, we talked to were exiting last year seeing some pressure in that area in Europe. And what I would just say is that this year, we’ve seen the improvement that we actually have expected to see. So, we feel good about our retention overall. It’s just say on balance, if you look at last year compared to this year, we feel that it’s trending positively, and we feel good about the direction and the setup going forward. And in fact, as we think about sort of efficient growth, a big part of that is really focused in to make sure you’re taking care of your customers first. That’s the allotment for the customer value, it does a lot in for us. And we feel good about the trends that we’re seeing in the business.