Rapid7, Inc. - Quarter Report: 2015 June (Form 10-Q)

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-Q

(Mark One)

For the quarterly period ended June 30, 2015

OR

For the transition period from                      to                     

Commission File Number: 001-37496

RAPID7, INC.

(Exact Name of Registrant as Specified in its Charter)

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  x

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 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  x

As of July 31, 2015, there were 39,340,839 shares of the registrant’s common stock, $0.01 par value per share, outstanding.

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PART I—FINANCIAL INFORMATION

RAPID7, INC.

Consolidated Balance Sheets (Unaudited)

(in thousands, except share and per share data)

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

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RAPID7, INC.

Consolidated Statements of Operations (Unaudited)

(in thousands, except share and per share data)

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

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RAPID7, INC.

Consolidated Statements of Cash Flows (Unaudited)

(in thousands)

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

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RAPID7, INC.

Notes to Consolidated Financial Statements (Unaudited)

Note 1. Description of Business and Basis of Presentation and Consolidation

Description of Business

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

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 (U.S. 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 U.S. 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 final prospectus for our initial public offering (IPO) dated as of July 16, 2015 and filed with the SEC pursuant to Rule 424(b)(4) under the Securities Act of 1933, as amended.

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 and six months ended June 30, 2015 are not necessarily indicative of the results to be expected for any future period or the entire fiscal year.

Unaudited Pro Forma Balance Sheet as of June 30, 2015

On July 22, 2015, we closed our IPO in which we sold and issued 7,417,500 shares of common stock (see note 10). Upon closing of the IPO, all of the redeemable convertible preferred stock outstanding automatically converted into 18,322,605 shares of common stock, which included 1,939,990 of additional shares of common stock issued upon conversion of our Series D preferred stock (Series D IPO Participation Payment). In addition, concurrently with the closing of our IPO, we issued 312,500 shares of common stock to entities affiliated with Technology Crossover Ventures in a private placement, for net proceeds of $5.0 million. The pro forma stockholders’ equity, as set forth on the pro forma June 30, 2015 consolidated balance sheet, has been adjusted to reflect the assumed: (i) conversion of our preferred stock into common stock and related beneficial conversion charge of $14.2 million associated with the Series D IPO Participation Payment, (ii) the sale and issuance of 7,417,500 shares of common stock and the receipt of net proceeds upon the closing of the IPO and (iii) the sale and issuance of 312,500 shares of common stock and the receipt of the net proceeds upon the closing of the private placement issuance.

The unaudited pro forma net loss per share for the three and six months ended June 30, 2015 assumes: (i) the conversion of all outstanding shares of redeemable convertible preferred stock into an aggregate of 18,322,605 shares of common stock as of January 1, 2015, (ii) the sale and issuance of 7,417,500 shares of common stock upon the closing of the IPO as of January 1, 2015 and (iii) the sale and issuance of 312,500 shares of common stock to entities affiliated with Technology Crossover Ventures in a the private placement as of January 1, 2015. The amount recorded to reflect the beneficial conversion charge as a result of the Series D IPO Participation Payment has been included and the amounts recorded to reflect the accretion of preferred stock to redemption value on the redeemable convertible preferred stock have been added back to arrive at pro forma net loss attributable to common stockholders and pro forma net loss per share attributable to common stockholders.

We believe that the unaudited pro forma balance sheet, pro forma net loss attributable to common stockholders and pro forma net loss per share attributable to common stockholders provides meaningful information to investors, such as measures of equity, net loss and net loss per share that are comparable to what will be reported by us in our consolidated financial statements for the periods subsequent to and including July 22, 2015.

Recent Accounting Pronouncements

In May 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2014-09, Revenue from Contracts with Customers (Topic 606). This guidance outlines a single, comprehensive model for accounting for revenue from contracts with customers and requires more detailed disclosure to enable users of financial statements to understand the nature, amount, timing and uncertainty of revenue and cash flows arising from such contracts. In July 2015, the FASB elected to defer the effective date of ASU 2014-09. ASU 2014-09 will be effective for fiscal years, and interim periods within those years, beginning after December 15, 2017, but entities will be permitted to early adopt the standard as of the original effective date. The new standard may be applied prospectively to each prior period presented or retrospectively with the cumulative effect recognized on the date of adoption. We are currently evaluating the impact that the standard will have on our consolidated financial statements.

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RAPID7, INC.

Notes to Consolidated Financial Statements (Unaudited)

Note 2. Business Combinations

On April 30, 2015, we acquired 100% of the outstanding equity of NT OBJECTives, Inc. (NTO). We acquired NTO to expand our web application security offerings. We acquired NTO for total consideration of $6.0 million. We made an initial payment of $3.4 million in cash and issued $0.1 million (9,091 shares) of our common stock upon the closing of the acquisition and are obligated to make two additional payments of $1.5 million each, less the amount of any indemnity claims and net working capital adjustments, on the first and second anniversary dates of the closing. The net present value of these two additional payments, or $2.5 million, is included in the total purchase consideration paid. We expensed the related acquisition costs of $0.4 million in general and administrative expense.

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

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

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

Revenues for NTO were immaterial and the net loss for NTO was $1.2 million from the acquisition date through June 30, 2015. Pro forma results of operations have not been included, as the acquisition of NTO was not material to our results of operations for any periods presented.

In May 2015, we entered into loan agreements with certain retained employees of NTO. The terms of these agreements require the employees to pay us the total amount borrowed, with accrued interest at 1.7% per annum, within 18 months of the agreement date. The loan agreements are secured by restricted stock awards granted to the employees. The aggregate amount of these loans was $0.5 million and is classified as other assets on the consolidated balance sheet.

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RAPID7, INC.

Notes to Consolidated Financial Statements (Unaudited)

Note 3. Property and Equipment

Property and equipment are recorded at cost. Property and equipment consists of the following:

Depreciation expense was $1.0 million and $0.9 million for the three months ended June 30, 2015 and 2014, respectively, and $1.9 million and $1.6 million for the six months ended June 30, 2015 and 2014, respectively.

Note 4. Goodwill and Other Intangible Assets

The changes in the carrying amount of goodwill for the six months ended June 30, 2015 are as follows (in thousands):

Identifiable intangible assets consist of the following:

Amortization expense was approximately $0.3 million and $0.2 million for the three months ended June 30, 2015 and 2014, respectively, and $0.5 million and $0.4 million for the six months ended June 30, 2015 and 2014, respectively.

Estimated future amortization expense of the acquired identifiable intangible assets as of June 30, 2015 is as follows (in thousands):

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RAPID7, INC.

Notes to Consolidated Financial Statements (Unaudited)

Note 5. Stock-Based Compensation Expense

The stock-based compensation expense for restricted stock and stock options was classified in the accompanying consolidated statements of operations as follows:

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

Restricted stock activity during the six months ended June 30, 2015 was as follows:

As of June 30, 2015, the unrecognized compensation cost related to 338,962 shares of unvested restricted stock expected to vest was $3.7 million. This unrecognized compensation will be recognized over an estimated weighted-average amortization period of 3.8 years.

Stock option activity during the six months ended June 30, 2015 was as follows:

As of June 30, 2015, the unrecognized compensation cost related to 1,776,328 unvested stock options expected to vest was $6.2 million. This unrecognized compensation will be recognized over an estimated weighted-average amortization period of 2.9 years.

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RAPID7, INC.

Notes to Consolidated Financial Statements (Unaudited)

The total fair value of stock options vested in the six months ended June 30, 2015 was $1.3 million. The weighted-average grant date fair value of stock options granted in the six months ended June 30, 2015 was $4.51 per share.

The weighted-average remaining contractual life of options outstanding as of June 30, 2015 and options exercisable as of June 30, 2015 was 7.9 years and 7.2 years, respectively.

Note 6. 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 and six months ended June 30, 2015 and 2014:

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RAPID7, INC.

Notes to Consolidated Financial Statements (Unaudited)

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:

Pro Forma Net Loss Per Share

Note 7. Commitments and Contingencies

We provide limited product warranties. Historically, any payments made under these provisions have been immaterial.

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RAPID7, INC.

Notes to Consolidated Financial Statements (Unaudited)

From time to time, in the normal course of business, various claims are made by customers or other third parties against us, or such claims may be pending or threatened. When we believe that an adverse outcome from such a claim is both probable and estimable, a reserve for the estimated liability is recorded.

We do not expect any liabilities from claims to have a material adverse effect on our financial position or results of operations.

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.

Note 8. 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. All of our principal operations and decision-making functions are located in the United States.

Net revenues by geographic area presented based upon the location of the customer are as follows:

Of the net revenues generated in North America, 96% were generated in the United States in the three and six months ended June 30, 2015, and 97% were generated in the United States in the three and six months ended June 30, 2014.

As of June 30, 2015 and December 31, 2014, substantially all of our property and equipment was located within the United States.

Note 9. Related Party Transactions

In July 2015, entities affiliated with Technology Crossover Ventures purchased $5.0 million of our common stock (312,500 shares) in a private placement concurrent with the completion of our IPO at a price per share equal to the IPO price. Entities affiliated with Technology Crossover Ventures are holders of more than 5% of our capital stock and Timothy McAdam, a member of our board of directors, is affiliated with such entities.

Note 10. Subsequent Events

On July 22, 2015, we closed our IPO of 7,417,500 shares of common stock at an offering price of $16.00 per share, including 967,500 shares pursuant to the underwriters’ option to purchase additional shares, resulting in net proceeds of approximately $107.4 million, after deducting underwriting discounts and commissions of $8.3 million and offering expenses of approximately $3.0 million. Upon the closing of the IPO, all of our outstanding preferred stock automatically converted into 18,322,605 shares of common stock, which included 1,939,990 additional shares of common stock issued upon conversion of our Series D preferred stock.

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

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RAPID7, INC.

Notes to Consolidated Financial Statements (Unaudited)

Additionally, in connection with the closing of our IPO, we filed an amended and restated certificate of incorporation with the Secretary of State of the State of Delaware that amended and restated in its entirety our certificate of incorporation to, among other things (i) increase the total number of shares of our common stock that we are authorized to issue to 100,000,000 and (ii) eliminate all references to the various series of preferred stock that were previously authorized (including certain protective measures held by the various series of preferred stock), except for the reference to 10,000,000 shares of undesignated preferred stock that may be issued, and with terms to be set, by our board of directors.

On July 23, 2015, we repaid our term loan with Silicon Valley Bank. The aggregate amount paid was $18.7 million, which included the full principal amount of $18.0 million, the termination payment of $0.5 million and $0.2 million of accrued interest. Upon the repayment and termination of the term loan, we recorded a $0.9 million charge to interest expense for the unamortized portion of the debt discount. On August 5, 2015, we also terminated our line of credit with Silicon Valley Bank, under which there was no outstanding balance.

On August 17, 2015, we entered into an amendment to our lease agreement for our principal executive offices in Boston, Massachusetts for approximately 20,000 additional square feet. We expect to occupy the additional office space in March 2016 and the term of the lease is 42 months. Our total obligation for the base rent of the additional square footage is approximately $3.4 million over the term of the lease.

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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, 2014 included in the final prospectus for our initial public offering dated as of July 16, 2015 and filed with the SEC pursuant to Rule 424(b)(4) (File No. 333-204874).

This Quarterly Report on Form 10-Q contains “forward-looking statements” within the meaning of Section 27A of 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

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

We primarily market and sell our products and professional services to global organizations of all sizes, including mid-market businesses, enterprises, non-profits, educational institutions and government agencies. Our customers span a wide variety of industries such as energy, financial services, healthcare and life sciences, manufacturing, media and entertainment, retail, professional services and technology. As of June 30, 2015, we had over 4,150 customers in more than 90 countries, including 34% of the Fortune 1000. Our revenue was not concentrated with any individual customer or group of customers, and no customer represented more than 2% of our revenue in the three or six months ended June 30, 2015 and 2014.

We sell our products and services through our direct inside sales team, a direct field sales team established and significantly expanded in 2014 and indirect channel partner relationships. Our sales teams are organized by geography as well as by target organization size. Our global channel partner network complements our sales organization, working closely with our sales teams to extend our geographic reach and to close sales of our offerings as part of larger purchases, particularly in key markets such as Europe, the Middle East and Africa, Asia Pacific and Latin America.

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Recent Developments

In July 2015, we closed our initial public offering, or IPO, of 7,417,500 shares of common stock at an offering price of $16.00 per share, including 967,500 shares pursuant to the underwriters’ option to purchase additional shares, resulting in net proceeds to us of approximately $107.4 million, after deducting underwriting discounts and commissions of $8.3 million and offering expenses of approximately $3.0 million. Concurrent with the closing of our IPO, we issued and sold to entities affiliated with Technology Crossover Ventures 312,500 shares of our common stock in a private placement at a price equal to the IPO price of $16.00 per share, resulting in net proceeds to us of $5.0 million.

Our Business Model

We have three offerings: (1) threat exposure management, which includes our Nexpose, Metasploit and AppSpider products, (2) incident detection and response, which includes our UserInsight product and our incident response services and (3) security advisory services.

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

We also offer different forms of professional services across all of our offerings, including deployment and training services related to our Nexpose, Metasploit, AppSpider and UserInsight software 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, on a monthly basis in a trailing 12-month period by the dollar value of the corresponding expiring customer agreements, and then determining the average for the applicable period. We also calculate an expiring 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%. We believe that we have strong renewal rates. Our renewal rate was 115% and 108% for the second quarter of 2015 and 2014, respectively, and our expiring renewal rate was 87% and 85% for the second quarter of 2015 and 2014, respectively. Our goal is to maintain, and work to increase, our renewal rates over time. However, our renewal rates may decline or fluctuate as a result of a number of factors, including customers’ satisfaction or dissatisfaction with our products and professional services, pricing, economic conditions or overall reductions in our customers’ spending levels.

We generate revenue from selling products, maintenance and support, and professional services. For the three months ended June 30, 2015 and 2014, 81% and 87% of our revenue, respectively, was derived from sales of products and associated maintenance and support, while the remaining 19% and 13%, respectively, was derived from the sale of professional services. For the six months ended June 30, 2015 and 2014, 82% and 87% of our revenue, respectively, was derived from sales of products and associated maintenance and support, while the remaining 18% and 13%, respectively, was derived from the sale of professional services.

For the three and six months ended June 30, 2015, 61% of our total revenue was derived from sales of content subscriptions, managed services, cloud-based subscriptions and maintenance and support, which we refer to as recurring revenue. For the three and six months ended June 30, 2014, 62% of our total revenue was derived from recurring revenue. We generally bill customers and collect payment for both our products and services up front.

For the three months ended June 30, 2015 and 2014, approximately 83% and 82%, respectively, of our total revenue came from deferred revenue on the balance sheet at the beginning of the respective periods. For the six months ended June 30, 2015 and 2014, approximately 75% and 73%, respectively, of our total revenue came from deferred revenue on the balance sheet at the beginning of the respective periods.

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Key Metrics

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

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.

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

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

Number of Customers. We believe that the size of our customer base is an indicator of our global market penetration and that our net customer additions are an indicator of the growth of our business.

Non-GAAP Financial Results

To supplement our consolidated financial statements, which are prepared and presented in accordance with generally accepted accounting principles in the United States, or GAAP, we provide investors with certain non-GAAP financial measures, including non-GAAP gross profit, non-GAAP operating loss and non-GAAP net loss, which we collectively refer to as non-GAAP financial measures. These non-GAAP financial measures exclude all or a combination of the following (as reflected in the following reconciliation tables): stock-based compensation expense, amortization of acquired intangible assets and acquisition 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. We believe that these non-GAAP financial measures provide useful information about our operating results, enhance the overall understanding of past financial performance and future prospects and allow for greater transparency with respect to metrics used by our management in its financial and operational decision making. While our non-GAAP financial measures are an important tool for financial and operational decision making and for evaluating our own operating results over different periods of time, you should consider our non-GAAP financial measures alongside our GAAP financial results.

We exclude stock-based compensation expense because of varying available valuation methodologies, subjective assumptions and the variety of equity instruments that can impact our non-cash expense. We believe that providing non-GAAP financial measures that exclude stock-based compensation expense allow for more meaningful comparisons between our operating results from period to period. We believe that excluding the impact of amortization of intangible assets allows for more meaningful comparisons between operating results from period to period as the intangibles are valued at the time of acquisition and are amortized over a period of several years after the acquisition. We also believe that excluding the impact of costs directly related to acquisitions as these costs are

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unrelated to the current operations and neither comparable to the prior period nor predictive of future results and allows for a more meaningful comparisons between the operating results from period to period. Accordingly, we believe that excluding these expenses provides investors and management with greater visibility of the underlying performance of our business operations, facilitates comparison of our results with other periods and may also facilitate comparison with the results of other companies in our industry.

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

The following table reconciles GAAP gross profit to non-GAAP gross profit for the three and six months ended June 30, 2015 and 2014:

The following table reconciles GAAP loss from operations to non-GAAP loss from operations for the three and six months ended June 30, 2015 and 2014:

The following table reconciles GAAP net loss attributable to common shareholders to non-GAAP net loss for the three and six months ended June 30, 2015 and 2014:

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Components of Results of Operations

Revenue

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

Products

We generate products revenue from the sale of (1) perpetual or term software licenses and associated content subscriptions for our Nexpose, Metasploit and AppSpider products, (2) managed services for our Nexpose, AppSpider and UserInsight products and (3) cloud-based subscriptions for our UserInsight and AppSpider products. We also generate an immaterial amount of appliance revenue that is included in our products revenue and that is associated with hardware sold as part of our Nexpose product to certain customers. Revenue for software licenses and any other products and services that are sold along with the software license is deferred on our balance sheet and recognized as revenue on the consolidated statements of operations ratably over the contractual period of the maintenance and support, which is typically one to three years.

Maintenance and Support

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

Professional Services

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

Cost of Revenue

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

Cost of Products

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

Cost of Maintenance and Support

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

Cost of Professional Services

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

We expect our cost of revenue to increase on an absolute dollar basis in the near term as we continue to grow our revenue, but to remain relatively consistent as a percentage of total revenue.

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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, the mix of products sold, transaction volume growth and the mix of revenue among products and services. We expect our gross margins to fluctuate over time depending on the factors described above.

Operating Expenses

Operating expenses consist of research and development, sales and marketing, and general and administrative expenses.

Research and Development Expense

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

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

Sales and Marketing Expense

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

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

General and Administrative Expense

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

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

Interest Income (Expense), Net

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

Other Income (Expense), Net

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

Provision for Income Taxes

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

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Results of Operations

The following table sets forth our selected consolidated statements of operations data:

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

Comparison of the Three Months Ended June 30, 2015 and 2014

Revenue