What changed in this filing

/stocks — the workspaceLOADING

Item 7. Management’s Discussion and Analysis

2021-02-26 compared with 2020-02-28 · 150 added, 287 removed, 444 unchanged (50% of the section changed)

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Factors that could cause or contribute to these differences include those under “Risk Factors” included in Part I, Item 1A or in other parts of this Annual Report on Form 10-K.

Rapid7 is a leading cyber security solutions provider, on a mission to make successful security tools and practices accessible to all.

Rapid7 Insight Platform technology, expert services, and thought-leading research enables over 9,000 customers to improve their security programs so that they can safely advance and innovate.

In the nearly 20 years that Rapid7 has been in business, security companies and trends have come and gone, while broader technology innovation continues to advance rapidly.

Rapid7 is advancing security with visibility, analytics, and automation delivered through our Insight Platform.

Our solutions simplify the complex, allowing security teams to work more effectively with IT and development to reduce vulnerabilities, monitor for misconfigurations and malicious behavior, investigate and shut down attacks, and automate routine tasks.

In the 20 years that Rapid7 has been in business, security companies and trends have come and gone, while broader technology innovation continues to advance rapidly.

Every company is now a technology company, and rampant innovation inevitably creates security risk.

The migration of businesses to the cloud and ubiquitous connected devices present security teams with an increasingly complex, ever-changing, and unpredictable attack surface.

The migration of businesses to the cloud, more distributed workforces and ubiquitous connected devices present security teams with an increasingly complex, ever-changing, and unpredictable attack surface.

We believe as cybersecurity challenges continue to rise exponentially, two key factors can prevent organizations from effectively managing their growing security exposure.

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These two factors compound the difficulties that resource-constrained organizations face when attempting to minimize their security exposure, meet security compliance regulations and provide visibility to their leadership.

The expanding divide between risk created through innovation and risk managed by security teams is called the Security Achievement Gap.

We call the expanding divide between risk created through innovation and risk effectively managed by security teams the Security Achievement Gap.

We believe Rapid7 is uniquely positioned to improve how customer security challenges are addressed.

Our solutions simplify the complex, allowing teams to more effectively reduce vulnerabilities, monitor malicious behavior, investigate and shut down attacks, and automate routine tasks.

All of our solutions and services are built with and supported by the expertise of our dedicated team of security researchers and consultants, who bring knowledge of attacker behavior and emerging vulnerabilities directly to customers.

We also continue to invest in further simplifying our technology to improve usability, lowering the barrier to managing security for teams and organizations who lack resources.

We also continue to invest in further simplifying our technology to improve usability, lowering the barrier for teams and organizations who lack resources to manage their security posture.

While our security technology is the foundation of our mission to make successful security accessible to all, technology alone will not solve today’s cybersecurity challenges.

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Our revenue was not concentrated with any individual customer and no customer represented more than 1% of our revenue in 2020, 2019 or 2018.

We sell our products and professional services through direct inside and field sales teams and indirect channel partner relationships.

Our 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 (EMEA);

and Asia Pacific (APAC), as well as by target organization size.

Our highly technical sales engineers help define customer use cases, manage solution evaluations and train channel partners.

In addition, we maintain a global channel partner network that complements our sales organization, particularly in EMEA, APAC and Latin America.

Recent Developments

Acquisition of Alcide.IO Ltd.

On January 28, 2021, we acquired Alcide.IO Ltd., a leading provider of Kubernetes security for a total purchase price of approximately $50 million in cash, subject to certain adjustments.

COVID-19 Response

Rapid7 remains focused on supporting its customers, partners, employees and communities during the COVID-19 pandemic.

The impact of COVID-19 on the global economy and on our business continues to be a fluid situation.

We responded quickly to adopt a virtual sales strategy to enable most of our employees to work productively from home, continued our focus on customers and new customers and worked to guard the health and safety of our team, support our customers and partners, mitigate risk, and maximize our financial performance.

We are focused on ensuring continuity for our customers and partners.

During 2020, we slowed hiring and reduced discretionary spending from what was initially anticipated at the beginning of the

fiscal year 2020.

In addition, we continue to realize savings that naturally accrue from less travel and virtual rather than in-person events.

The continuing COVID-19 pandemic is expected to result in a sustained global slowdown of economic activity that is likely to decrease demand for a broad variety of goods and services, including from our customers.

Our operational and financial performance were negatively impacted by the slowdown in activity associated with the COVID-19 pandemic for the year ending December 31, 2020 and we expect that to continue going forward.

The extent of the impact of the COVID-19 on our operational and financial performance will depend on certain developments, including the duration and spread of the disease, its impact on industry events, and its effect on our customers, partners, suppliers and vendors and other parties with whom we do business, all of which are uncertain and cannot be predicted at this time.

To the extent possible, we are conducting business as usual, with necessary or advisable modifications to employee travel, employee work locations, and cancellation of Rapid7 in-person marketing events.

We will continue to actively monitor the at times rapidly evolving situation related to COVID-19 and may take further actions that alter our business operations, including those that may be required by federal, foreign, state or local authorities, or that we determine are in the best interests of our employees, customers, partners, suppliers, vendors and stockholders.

At this point, the extent to which the COVID-19 pandemic may impact our business, results of operations and financial condition is uncertain.

Furthermore, due to our subscription model, the effect of the COVID-19 pandemic may not be fully reflected in our results of operations until future periods.

Our Business Model

We have offerings in four key areas:

(1) Vulnerability Risk Management, (2) Incident Detection and Response, (3) Application Security and (4) Security Orchestration and Automation Response.

We have offerings in five key areas:

(1) Vulnerability Risk Management, (2) Incident Detection and Response, (3) Application Security and (4) Cloud Security and (5) Security Orchestration and Automation Response.

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

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• Cloud-based subscriptions, which provide our software capabilities to our customers through cloud access and on a Software as a Service basis.

• Cloud-based subscriptions, which provide our software capabilities to our customers through cloud access and on a subscription basis.

Our InsightIDR, InsightVM, InsightAppSec and InsightConnect products are offered as cloud-based subscriptions, generally with a one-year term.

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• 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 Nexpose, Metasploit, AppSpider and DivvyCloud 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-year terms.

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.

Our renewal rate was 108%, 119% and 116% in 2019, 2018 and 2017, respectively.

For the years ended December 31, 2018 and 2017, our renewal rate was adjusted from the previously disclosed 120% and 122%, respectively, to 119% and 116%, respectively, based on a reclassification of certain upsells and cross-sells.

Our goal is to maintain strong renewal rates and continue to increase the 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, competitive offerings, economic conditions or overall changes in our customers’ spending levels.

In 2020, 2019 and 2018 recurring revenue, defined as revenue from term software licenses, content subscriptions, managed services, cloud-based subscriptions and maintenance and support, was 90%, 87% and 81%, respectively, of total revenue.

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

Our renewal rate was 103%, 108% and 119% for the quarters ended December 31, 2020, 2019 and 2018, respectively.

For the quarter ended December 31, 2018, our renewal rate was adjusted from the previously disclosed 120% to 119%, based on a reclassification of certain upsells and cross-sells.

We monitor the following key metrics to help us measure and evaluate the effectiveness of our operations and as a means to evaluate period-to-period comparisons.

We believe that both management and investors benefit from referring to these key metrics as supplemental information in assessing our performance and when planning, forecasting, and analyzing future periods.

These key metrics also facilitate management's internal comparisons to our historical performance as well as comparisons to certain competitors' operating results.

We believe these key metrics are useful to investors both because they allow for greater transparency with respect to key metrics used by management in its financial and operational decision-making and also because they are used by institutional investors and the analyst community to help evaluate the health of our business:

Year Ended December 31,

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Year-over-year growth 25.9 % 33.9 % 21.5 %

33.9 % 21.5 % 27.6 %

Non-GAAP income (loss) from operations $ 2,032 $ 2,404 $ (26,273)

Operating cash flow $ 4,887 $ (1,420) $ 6,066

(1) For 2018, we recognized revenue under ASC 606.

For 2017, we recognized revenue under ASC 605 and therefore, the periods are not directly comparable.

As of December 31,

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Year-over-year growth 27.8 % 34.5 %

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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.

We monitor total revenue and believe it is useful to investors as a measure of the overall success of our business.

Non-GAAP Income (Loss) from Operations .

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Operating Cash Flow .

We monitor our operating cash flow as a measure of our overall business performance, which enables us to analyze our financial performance without the effects of certain non-cash items such as stock-based compensation expenses and depreciation and amortization.

We monitor our operating cash flow and believe it is a useful to investors 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.

During 2019, as we continued to shift from a perpetual license business model to a subscription business model, our average contract lengths declined which decreased our annual billings and, as a result, our cash flow from operations was negatively impacted.

Number of Customers .

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ARR is not a forecast of future revenue, which can be impacted by contract start and end dates and renewal rates and does not include revenue reported as perpetual license or professional services revenue in our consolidated statement of operations.

We use ARR and believe it is useful to investors as a measure of the overall success of our business.

Non-GAAP Financial Results

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We define non-GAAP gross profit, non-GAAP income (loss) from operations, non-GAAP net income (loss) and non-GAAP net income (loss) per share as the respective GAAP balances excluding the effect of stock-based compensation expense, amortization of acquired intangible assets, amortization of debt discount and issuance costs, and certain other items such as acquisition-related expenses, follow-on public offering costs and litigation-related expenses.

Non-GAAP net income (loss) per basic and dilutive share is calculated as Non-GAAP net income (loss) divided by the weighted average shares used to compute net income (loss) per share, with the number of weighted average shares decreased to reflect the anti-dilutive impact of the capped call transactions (Capped Calls) entered into in connection with the 1.25% convertible senior note issued in August 2018 (Notes).

Non-GAAP net income (loss) per basic and diluted share is calculated as Non-GAAP net income (loss) divided by the weighted average shares used to compute net income (loss) per share, with the number of weighted average shares decreased to reflect the anti-dilutive impact of the capped call transactions entered into in connection with our convertible senior notes.

We believe these non-GAAP financial measures are useful to investors in assessing our operating performance due to the following factors:

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• Stock-based compensation expense.

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• Amortization of debt discount and issuance costs.

In August 2018, we issued $230 million of convertible senior notes, which bear interest at an annual fixed rate of 1.25%.

The imputed interest rate of the convertible senior notes was approximately 7.37%.

This is a result of the debt discount recorded for the conversion feature that is required to be separately accounted for as equity, and debt issuance costs, which reduce the carrying value of the convertible debt instrument.

The debt discount is amortized as interest expense together with the issuance costs of the debt.

The expense for the amortization of debt discount and debt issuance costs is a non-cash item, and we believe the exclusion of this interest expense provides a more useful comparison of our operational performance in different periods.

The expense for the amortization of debt discount and debt issuance costs related to our convertible senior notes and revolving credit facility is a non-cash item and we believe the exclusion of this interest expense provides a more useful comparison of our operational performance in different periods.

• Litigation-related expenses.

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• Anti-dilutive impact of capped call transaction.

In connection with the issuance of our convertible senior notes, we entered into capped call transactions to offset potential dilution from the embedded conversion feature in the notes.

Although we cannot reflect the anti-dilutive impact of the capped call transactions under GAAP, we do reflect the anti-dilutive impact of the capped call transactions in non-GAAP net income (loss) per basic and diluted share to provide investors with useful information in evaluating our financial performance on a per share basis.

We define adjusted EBITDA as net loss before (1) interest income, (2) interest expense, (3) other income (expense), net, (4) provision for (benefit from) income taxes, (5) depreciation expense, (6) amortization of intangible assets, (7) stock-based compensation expense, and (8) certain other items.

Our capped calls transactions are intended to offset potential dilution from the conversion features in our convertible senior notes.

Although we cannot reflect the anti-dilutive impact of the capped call transactions under GAAP, we do reflect the anti-dilutive impact of the capped call transactions in non-GAAP net income (loss) per diluted share to provide investors with useful information in evaluating our financial performance on a per share basis.

We define adjusted EBITDA as net loss before (1) interest income, (2) interest expense, (3) other income (expense), net, (4) provision for income taxes, (5) depreciation expense, (6) amortization of intangible assets, (7) stock-based compensation expense, and (8) certain other items.

We believe that the use of adjusted EBITDA is useful to investors and other users of our financial statements in evaluating our operating performance because it provides them with an additional tool to compare business performance across companies and across periods.

Adjusted EBITDA should not be considered as a substitute for other measures of financial performance reported in accordance with GAAP.

There are limitations to using this non-GAAP financial measure, including that other companies may calculate this measure differently than we do, that it does not reflect our capital expenditures or future requirements for capital expenditures and that it does not reflect changes in, or cash requirements for, our working capital and excludes some items that are cash based.

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.

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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.

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The following tables reconcile GAAP gross profit to non-GAAP gross profit for the years ended December 31, 2020, 2019 and 2018:

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(in thousands)

GAAP gross profit – maintenance and support $ 28,283 $ 34,545 $ 38,777

Stock-based compensation expense 616 233 247

Non-GAAP gross profit – maintenance and support $ 28,899 $ 34,778 $ 39,024

Year Ended December 31,

2019 2018 2017

(in thousands)

GAAP gross profit – professional services $ 3,911 $ 6,083 $ 9,702

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The following table reconciles GAAP net loss to non-GAAP net income (loss) for the years ended December 31, 2020, 2019 and 2018:

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Year Ended December 31,

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Release of valuation allowance, acquisition-related — (761) —

Tax adjustment for the impact of tax reform — — (352)

Amortization of debt discount and issuance costs 17,518 10,513 3,831

Non-GAAP net income (loss) $ 4,306 $ (19,057) $ (25,933)

Reconciliation of net income (loss) per share, basic:

Non-GAAP net (loss) income $ (5,200) $ 4,306 $ (19,057)

Reconciliation of net (loss) income per share, basic:

GAAP net loss per share, basic $ (1.94) $ (1.10) $ (1.20)

Non-GAAP adjustments to net loss $ 1.84 $ 1.19 $ 0.79

Non-GAAP net income (loss) per share, basic $ 0.09 $ (0.41) $ (0.60)

Reconciliation of net income (loss) per share, diluted:

Non-GAAP net (loss) income per share, basic $ (0.10) $ 0.09 $ (0.41)

Reconciliation of net (loss) income per share, diluted:

GAAP net loss per share, diluted $ (1.94) $ (1.10) $ (1.20)

Non-GAAP adjustments to net loss $ 1.84 $ 1.18 $ 0.79

Non-GAAP net income (loss) per share, diluted $ 0.08 $ (0.41) $ (0.60)

Non-GAAP net (loss) income per share, diluted $ (0.10) $ 0.08 $ (0.41)

Weighted-average common shares used in GAAP per share calculation, basic 51,036,824 48,731,791 46,456,825

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Other (income) expense, net 81 433 336

Provision for (benefit from) income taxes 42 466 (2,236)

Provision for income taxes 1,986 42 466

Depreciation expense 11,036 8,963 6,486

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Components of Results of Operations

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.

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We generate products revenue from the sale of (1) cloud-based subscriptions for our InsightIDR, InsightVM, InsightAppSec and InsightConnect products, (2) managed services offerings which utilize our products and (3) 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.

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.

We generate revenue primarily from selling products and professional services through a variety of delivery models to meet the needs of our diverse customer base.

We generate products revenue from the sale of (1) cloud-based subscriptions, (2) managed services offerings, which utilize our products and (3) term or perpetual software licenses for our products, as well as associated content subscriptions.

We also generate revenue when customers purchase or renew agreements for maintenance and support of their software licenses.

Substantially all of our customers purchase an agreement for maintenance and support in connection with their purchase of a software license.

Professional Services

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Cost of Revenue

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

Cost of revenue include overhead costs for depreciation, facilities, IT, information security, and recruiting.

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

Cost of revenue includes overhead costs for depreciation, facilities, IT, information security, and recruiting.

Our IT overhead costs include IT personnel compensation costs and costs associated with our IT infrastructure.

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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.

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 costs.

Cost of products consists of personnel and related costs for our content, support, managed service and cloud operations teams, including salaries and other payroll related costs, bonuses, stock-based compensation and allocated overhead costs.

Also included in cost of products are software license fees, 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 Professional Services

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All overhead costs are allocated based on relative headcount.

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Research and Development Expense

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Additional expenses include travel and entertainment, consulting and professional fees for third-party development resources as well as allocated overhead costs.

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 relatively consistent as a percentage of total revenue.

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 and to increase slightly 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, including amortization of deferred commissions, bonuses and stock-based compensation.

Additional expenses include marketing activities and promotional events, industry conferences, travel and entertainment, training costs, amortization of certain intangible assets and allocated overhead costs.

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 remain relatively consistent as a percentage of total revenue.

Additional expenses include marketing activities and promotional events, travel and entertainment, training costs, amortization of certain intangible assets and allocated overhead costs.

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

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Interest Expense

Interest expense consists primarily of contractual interest expense, as well as amortization of debt discount and issuance costs related to our 1.25% convertible senior notes due 2023.

Interest expense consists primarily of contractual interest expense, as well as amortization of debt discount and issuance costs related to our convertible senior notes and revolving credit facility.

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.

Provision for (Benefit from) Income Taxes

Provision for (benefit from) 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.

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Provision for Income Taxes

Provision for income taxes consists of income taxes in foreign jurisdictions where we conduct business, withholding taxes, and state income taxes in the United States.

We maintain a full valuation allowance for domestic and certain foreign deferred tax assets, including net operating loss carryforwards and tax credits.

Based on our history of losses, we expect to maintain this full valuation allowance for the foreseeable future as it is more likely than not that some or all of those deferred tax assets may not be realized.

Results of Operations

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Products $ 382,922 $ 297,897 $ 210,794

Maintenance and support 36,778 42,223 46,268

Professional services 28,564 29,050 33,297

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Products 96,864 68,179 47,488

Maintenance and support 8,495 7,678 7,491

Professional services 24,653 22,967 23,595

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Loss before income taxes (96,863) (53,803) (55,079)

Provision for (benefit from) income taxes 42 466 (2,236)

Provision for income taxes 1,986 42 466

Net loss (98,849) (53,845) (55,545)

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Total depreciation and amortization expense $ 22,631 $ 16,528 $ 11,097

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

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Products 93.1 % 91.1 % 86.4 %

Maintenance and support 11.2 17.3 23.0

Professional services 6.9 8.9 13.6

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Products 23.5 20.9 19.4

Maintenance and support 2.6 3.1 3.7

Professional services 6.0 7.0 9.7

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Loss before income taxes (23.5) (16.5) (22.6)

Provision for (benefit from) income taxes — 0.2 (1.1)

Provision for income taxes 0.5 — 0.2

Net loss (24.0) % (16.5) % (22.8) %

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Products $ 382,922 $ 297,897 $ 85,025 28.5 %

Maintenance and support 36,778 42,223 (5,445) (12.9)

Professional services 28,564 29,050 (486) (1.7)

Total revenue $ 411,486 $ 326,947 $ 84,539 25.9 %

Total revenue increased by $82.9 million in 2019 compared to 2018.

The increase in revenue consisted of a $19.0 million increase in revenue from new customers and $63.9 million increase in revenue from existing customers.

The $63.9 million increase in revenue from existing customers was due to an increase in revenue from renewals, upsells and cross-sells as a result of the continued growth of our customer base.

Revenue from new customers represents the revenue recognized from the customer's initial purchase.

All renewals, upsells and cross-sells are considered revenue from existing customers.

Total revenue increased by $84.5 million in 2020 compared to 2019 which included $6.3 million of revenue attributable to the DivvyCloud acquisition in May 2020.

The remainder of the increase in revenue was primarily from existing customers as a result of the continued growth of our customer base.

Revenue from renewals, upsells and cross-sells are considered revenue from existing customers.

The increase in total revenue in 2020 was comprised of $68.1 million generated from sales in North America and $16.4 million generated from sales from the rest of the world.

The $5.4 million decrease in maintenance and support revenue in 2019 compared to 2018 was primarily due to the continued transition of our Nexpose customers to our subscription-based InsightVM product.

Therefore, we believe it is more useful to combine products and maintenance and support revenue together, which collectively grew 41% year-over-year.

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million decrease in professional services revenue in 2019 compared to 2018 was primarily due to a reduction in professional services bookings resulting from our continued shift to selling more strategic professional services.

Cost of Revenue

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Products $ 96,864 $ 68,179 $ 28,685 42.1 %

Maintenance and support 8,495 7,678 817 10.6

Professional services 24,653 22,967 1,686 7.3

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Products 74.7 % 77.1 %

Maintenance and support 76.9 81.8

Professional services 13.7 20.9

Total gross margin % 70.5 % 72.1 %

Total cost of revenue increased by $20.1 million in 2019 compared to 2018, primarily due to $10.8 million increase in cloud computing costs related to growing cloud-based subscription revenue, a $3.4 million increase in allocated overhead driven largely by an increase in IT and facilities costs, primarily as a result of our increased office space, and a $3.0 million increase in personnel costs, inclusive of a $0.9 million increase in stock-based compensation expense, as a result of an increase in headcount to support our growing customer base.

Our increase in total cost of revenue also included a $2.3 million increase in amortization of intangible assets primarily due our acquisition of NetFort in April 2019 and tCell in October 2018, and a $0.6 million increase in amortization expense for capitalized internally-developed software.

Total gross margin percentage increased in 2019 compared to 2018.

The increase in products gross margin was due to the continued increase in our subscription-based and managed services product gross margins as we continue to grow and scale these offerings.

The decrease in maintenance and support gross margin was primarily a result of a continued transition of our Nexpose customers to our subscription-based InsightVM product.

The decrease in professional services gross margin was primarily due to a reduction in professional services revenue.

Total cost of revenue increased by $30.4 million in 2020 compared to 2019, primarily due to a $14.3 million increase in personnel costs, inclusive of a $1.7 million increase in stock-based compensation expense, resulting from an increase in headcount to support our growing customer base, and a $11.4 million increase in cloud computing costs related to growing cloud-based subscription revenue.

The $14.3 million increase in personnel costs included $1.2 million of additional costs attributable to the employees acquired in the DivvyCloud acquisition in May 2020.

Our increase in total cost of revenue also included a $2.6 million increase in allocated overhead driven largely by an increase in IT and facilities costs, a $2.4 million increase in amortization expense for acquired intangible assets and a $1.4 million increase in amortization expense for capitalized internally-developed software.

These increases were partially offset by a $1.7 million decrease in other expenses.

Total gross margin percentage decreased in 2020 compared to 2019.

The decrease in products gross margin was primarily due to an increase in revenue from cloud-based subscriptions and managed services, which have lower gross margins than our licensed software products.

The decrease in professional services gross margin was primarily due to a reduction in professional services revenue as customers delayed scheduling the delivery of services in response to the COVID-19 pandemic.

Operating Expenses

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% of revenue 26.4 % 24.3 %

Research and development expense increased by $11.6 million in 2019 compared to 2018 primarily due to a $9.5 million increase in personnel costs and a $4.4 million increase in allocated overhead driven largely by an increase in IT and facilities costs, primarily as a result of our increased office space.

These increases were partially offset by a $0.5 million write-off of a capitalized internal-use software project in the prior year, a $0.4 million decrease in third-party cloud infrastructure costs, a $0.3 million increase in research and development tax credits, a $0.3 million decrease in travel expenses and a $0.8 million decrease in other expenses.

The $9.5 million increase in personnel costs was primarily due to a $7.5 million increase in salaries and related costs driven by growth in headcount and a $4.8 million increase in stock-based compensation expense, partially offset by a $2.8 million increase in personnel costs that were capitalized as internal-use software costs.

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Research and development expense increased by $29.2 million in 2020 compared to 2019, primarily due to a $22.9 million increase in personnel costs, a $5.1 million increase in allocated overhead driven by costs related to our global kick-off meeting and an increase in IT and facilities costs, and a $1.7 million increase in third-party infrastructure costs.

These increases were partially offset by a $0.5 million decrease in other expenses.

The $22.9 million increase in personnel costs was primarily due to a $14.1 million increase in salaries and related costs driven by growth in headcount, including $5.3 million in additional salaries and related costs attributable to the employees acquired in the acquisition of DivvyCloud in May 2020, and a $8.8 million increase in stock-based compensation expense, including $4.2 million of stock-based compensation expense related to RSUs issued to retained employees and common stock to be issued to the founders as part of the acquisition of DivvyCloud.

Sales and Marketing Expense

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% of revenue 47.6 % 48.2 %

Sales and marketing expense increased by $34.4 million in 2019 compared to 2018 primarily due to a $13.5 million increase in personnel costs, inclusive of a $4.3 million increase in stock-based compensation expense, as a result of an increase in headcount to drive additional sales.

Our increase in sales and marketing expense also included a $8.9 million increase in allocated overhead driven largely by an increase in IT and facilities costs, primarily as a result of our increased office space, a $6.0 million increase in commission expense, a $3.6 million increase in marketing and advertising costs, a $0.6 million increase in travel expenses and a $1.8 million increase in other expenses.

Sales and marketing expense increased by $38.3 million in 2020 compared to 2019, primarily due to a $26.8 million increase in personnel costs, a $6.5 million increase in commission expense, a $5.0 million increase in allocated overhead driven by costs related to our global kick-off meeting as well as an increase in IT and facilities costs, a $4.0 million increase in marketing and

advertising costs and a $0.9 million increase in other expenses.

The $26.8 million increase in personnel costs was primarily due a $21.9 million increase in salaries and related costs driven by growth in headcount, including $6.1 million of additional costs attributable to the employees acquired in the DivvyCloud acquisition in May 2020, and a $4.9 million increase in stock-based compensation expense, including $1.5 million in stock-based compensation expense related to RSUs issued to DivvyCloud retained employees.

These increases were partially offset by a $4.9 million decrease in travel and entertainment expenses as a result of reduced travel due to the COVID-19 pandemic.

General and Administrative Expense

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% of revenue 14.5 % 13.7 %

General and administrative expense increased by $9.7 million in 2019 compared to 2018 primarily due to a $5.3 million increase in personnel costs, inclusive of a $3.0 million increase in stock-based compensation expense, as a result of an increase in headcount to support our overall company growth, a $1.6 million increase in professional fees primarily due to acquisition and litigation-related expenses and other professional consulting fees, a $1.5 million increase in bad debt expense, a $0.5 million increase in allocated overhead driven largely by an increase in facilities costs, primarily as a result of our increased office space, and a $1.3 million increase in other expenses.

General and administrative expense increased by $14.8 million in 2020 compared to 2019, primarily due to a $10.7 million increase in personnel costs due to an increase in headcount, inclusive of a $7.8 million increase in stock-based compensation expense, a $2.1 million increase in professional fees primarily due to litigation and acquisition-related expenses and other professional consulting fees, a $0.6 million increase in allocated overhead driven by costs related to our global kick-off meeting as well as an increase in IT costs, a $0.6 million increase in other office expenses and a $0.8 million increase in other expenses.

Interest Income

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% of revenue 0.4 % 1.8 %

Interest income increased by $2.8 million in 2019 compared to 2018 primarily due to higher interest income as a result of an increase in cash and cash equivalents and investments due to the issuance of the Notes in August 2018.

Interest income decreased by $4.6 million in 2020 compared to 2019 primarily due to a decrease in interest rates.

Interest Expense

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% of revenue (5.9) % (4.1) %

Interest expense increased by $8.5 million in 2019 compared to 2018 primarily due to contractual interest and amortization of debt discount and issuance costs related to the issuance of the Notes.

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Interest expense increased by $10.7 million in 2020 compared to 2019 primarily due to contractual interest and amortization of debt discount and issuance costs related to the 2025 Notes issued in May 2020.

Other Income (Expense), Net

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% of revenue — % (0.1) %

Other income (expense), net reflected a $0.1 million increase in expense in 2019 compared to 2018 due to realized and unrealized foreign currency losses, primarily related to the euro and British pound sterling.

Other income (expense), net reflected a $0.4 million decrease in expense in 2020 compared to 2019 due to realized and unrealized foreign currency gains and losses, primarily related to the euro and British pound sterling.

Provision for Income Taxes

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% of revenue 0.5 % — %

Provision for income taxes decreased by $0.4 million in 2019 compared to 2018 primarily due to a $0.8 million deferred tax benefit in 2019, partially offset by a $0.2 million release of a tax reserve in the prior year and a one-time $0.2 million tax benefit recognized as a result of tax reform in 2018.

Provision for income taxes increased by $1.9 million in 2020 compared to 2019 primarily due to a $1.1 million increase in foreign income and withholding taxes and a $0.8 million deferred tax benefit in 2019.

The $0.8 million deferred tax benefit resulted from a partial release of our valuation allowance to account for the creation of a deferred tax liability for the developed technology intangible asset acquired in the acquisition of NetFort, which is not deductible for tax purposes.

Year Ended December 31, 2019 Compared to the Year Ended December 31, 2018

We adopted ASC 606 effective January 1, 2018 using the modified retrospective method.

Under this method of adoption, we recognized the cumulative effect as of January 1, 2018.

Comparable periods were not adjusted and therefore periods below are not directly comparable.

See Note 2, to our consolidated financial statements included in this Annual Report on Form 10-K for additional discussion of the impact of the adoption of this new accounting guidance.

December 31, Change

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(dollars in thousands)

Products $ 168,571 $ 116,748 $ 51,823 44.4 %

Maintenance and support 42,223 46,268 (4,045) (8.7)

$ 297,897 $ 210,794 $ 87,103 41.3 %

Professional services 29,050 33,297 (4,247) (12.8)

Total revenue $ 326,947 $ 244,091 $ 82,856 33.9 %

(1) Prior to the fiscal year beginning January 1, 2020, we presented revenue on our consolidated statement of operations as products, maintenance and support and professional services revenue.

For the year ended December 31, 2020, we combined products and maintenance and support revenue as products revenue on our consolidated statement of operations as our customers continue to migrate from our on-premise products to our SaaS Insight Platform.

Given this continued migration, we believe it is more relevant to categorize maintenance and support revenue together as products revenue.

Prior periods have been adjusted to conform with this presentation.

Total revenue increased by $82.9 million in 2019 compared to 2018.

The increase in revenue included a $4.6 million increase from new customers and $50.4 million increase in revenue from existing customers.

The increase in revenue consisted of a $19.0 million increase in revenue from new customers and $63.9 million increase in revenue from existing customers.

The $63.9 million increase in revenue from existing customers was due to an increase in revenue from renewals, upsells and cross-sells as a result of the continued growth of our customer base.

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All renewals, upsells and cross-sells are considered revenue from existing customers.

The revenue increase was partially offset by a $11.8 million decrease in revenue as a result of the adoption of ASC 606.

The increase in total revenue in 2019 was comprised of $66.8 million generated from sales in North America and $16.1 million generated from sales from the rest of the world.

The revenue increase generated from sales in North America and rest of world was partially offset by a $8.9 million decrease in revenue in North America and a $2.9 million decrease in revenue in the rest of the world due to the adoption of ASC 606.

The $4.0 million decrease in maintenance and support revenue in 2018 compared to 2017 was primarily due to a $3.5 million reduction in revenue as a result of the adoption of ASC 606.

The $4.6 million decrease in professional services revenue in 2018

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compared to 2017 was primarily due to a $1.7 million reduction in revenue as a result of the adoption of ASC 606 and a reduction in professional services bookings which drove the performance of less services.

The $4.2 million decrease in professional services revenue in 2019 compared to 2018 was primarily due to a reduction in professional services bookings resulting from our continued shift to selling more strategic professional services.

Cost of Revenue

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Products $ 68,179 $ 47,488 $ 20,691 43.6 %

Maintenance and support 7,678 7,491 187 2.5

Professional services 22,967 23,595 (628) (2.7)

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Products 77.1 % 77.5 %

Maintenance and support 81.8 83.8

Professional services 20.9 29.1

Total gross margin % 72.1 % 70.9 %

Total cost of revenue increased by $14.2 million in 2018 compared to 2017, primarily due to $6.9 million increase in cloud computing costs related to growing cloud-based subscription revenue, as well as a $5.0 million increase in personnel costs, inclusive of a $0.6 million increase in stock-based compensation expense, as a result of an increase in headcount to support our growing customer base.

Our increase in total cost of revenue also included a $1.6 million increase in allocated overhead driven largely by IT and facilities costs, a $1.3 million increase in amortization of intangible assets primarily due our acquisition of Komand in July 2017 and tCell in October 2018, a $0.4 million increase in amortization expense for capitalized internally-developed software, and a $0.3 million increase in other costs.

These increases were partially offset by a $1.0 million decrease in third-party professional service consulting costs and a $0.3 million decrease in travel and entertainment expenses.

Total cost of revenue was not materially impacted by the adoption of ASC 606.

Total gross margin percentage decreased in 2018 compared to 2017.

The decrease in products gross margin was due to an increase in revenue from cloud-based subscriptions and managed services, which have lower gross margins than our licensed software products, in addition to a reduction in products revenue of $6.6 million as a result of the adoption of ASC 606.

The decrease in maintenance and support gross margin was primarily due to a reduction of maintenance and support revenue of $3.5 million as a result of the adoption of ASC 606.

largely by an increase in IT and facilities costs, primarily as a result of our increased office space, and a $3.0 million increase in personnel costs, inclusive of a $0.9 million increase in stock-based compensation expense, as a result of an increase in headcount to support our growing customer base.

Total gross margin percentage increased in 2019 compared to 2018.

The decrease in products gross margin was due to the continued transition of our Nexpose customers to our subscription-based InsightVM product.

The decrease in professional services gross margin was primarily due to a reduction in professional services revenue.

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% of revenue 24.3 % 27.8 %

Research and development expense increased by $16.8 million in 2018 compared to 2017 primarily due to a $11.3 million increase in personnel costs, a $2.2 million increase in allocated overhead driven largely by an increase in IT and facilities costs, a $1.6 million increase in third-party cloud infrastructure costs related to development of new and future offerings, a $0.6 million increase for a global developers conference, a $0.6 million increase in travel and entertainment expenses and a $0.5 million increase due to the write-off of a capitalized internal-use software project.

The $11.3 million increase in personnel costs was primarily due to a $8.8 million increase in salaries and related costs driven by growth in headcount, a $1.0 million increase in acquisition-related bonuses, and a $3.6 million increase in stock-based compensation expense, partially offset by a $2.1 million increase in personnel costs that were capitalized as internal-use software costs.

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Sales and Marketing Expense

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% of revenue 48.2 % 50.5 %

Sales and marketing expense increased by $11.7 million in 2018 compared to 2017 primarily due to a $21.5 million increase in personnel costs and commissions, inclusive of a $1.8 million increase in stock-based compensation expense, as a result of an increase in headcount to drive additional sales.

Our increase in sales and marketing expense also included a $3.9 million increase in allocated overhead driven largely by an increase in IT and facilities costs, a $0.8 million increase in marketing and advertising costs, a $0.5 million in professional consulting fees, a $0.3 million increase in travel and entertainment expense and a $0.2 million increase in other expenses.

These increases were partially offset by a $0.6 million decrease in event marketing expense related to a user conference which was held in the prior year and a $2.0 million decrease in partner referral fees.

In addition, the sales and marketing expense increase was partially offset by a $12.9 million decrease in personnel costs as a result of capitalized commission costs net of amortization expense due to the adoption of ASC 606.

General and Administrative Expense

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% of revenue 13.7 % 14.3 %

General and administrative expense increased by $4.7 million in 2018 compared to 2017 primarily due to a $2.9 million increase in personnel costs, inclusive of a $2.0 million increase in stock-based compensation expense, as a result of an increase in headcount to support our overall company growth, $0.6 million of litigation-related expenses, a $0.6 million increase in allocated overhead, driven largely by an increase in IT and facilities costs, $0.2 million in secondary public offering expenses, $0.1 million in professional fees and a $0.3 million increase in other expenses.

Interest Income

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% of revenue 1.8 % 1.3 %

Interest income increased by $2.4 million in 2018 compared to 2017 primarily due to higher interest income as a result of the increase in value of investments as well as higher interest rates.

Interest Expense

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(dollars in thousands)

Interest expense $ (4,934) $ (87) $ (4,847) NM

Interest expense $ (13,389) $ (4,934) $ (8,455) 171.4 %

% of revenue (4.1) % (2.0) %

Interest expense increased by $8.5 million in 2019 compared to 2018 primarily due to contractual interest and amortization of debt discount and issuance costs related to the issuance of the Notes.

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Other Income (Expense), Net

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% of revenue (0.1) % (0.1) %

Other income (expense), net reflected a $0.6 million increase in expense in 2018 compared to 2017 due to realized and unrealized foreign currency losses exceeding gains, primarily related to the euro and British pound sterling.

Provision for (benefit from) Income Taxes

Provision for Income Taxes

December 31, Change

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(dollars in thousands)

Provision for (benefit from) income taxes $ 466 $ (2,236) $ 2,702 NM

Provision for income taxes $ 42 $ 466 $ (424) NM

% of revenue — % 0.2 %

Provision for income taxes increased by $2.7 million to an expense of $0.5 million in 2018 compared to a $2.2 million benefit in 2017.

The increase was primarily due to a $2.6 million deferred tax benefit in the prior year.

The deferred tax benefit resulted from the partial release of our valuation allowance to account for the creation of a deferred tax liability for the developed technology intangible asset acquired in the acquisition of Komand which was not deductible for tax purposes.

Liquidity and Capital Resources

As of December 31, 2019, we had $123.4 million in cash and cash equivalents, $139.0 million of short- and long-term investments that have maturities ranging from 3 months to 2 years and an accumulated deficit of $518.4 million.

Since our inception, we have generated significant losses and expect to continue to generate losses for the foreseeable future.

Our principal sources of liquidity are cash and cash equivalents and investments, cash flow from operations, equity financing transactions, and issuance of convertible senior notes.

To date, we have financed our operations primarily through private and public equity financings, issuance of convertible senior notes and through cash generated by operating activities.

We believe that our existing cash and cash equivalents and our short and long-term investments together with cash generated from our operations will be sufficient to meet our working capital expenditure requirements for at least the next 12 months.

Our future capital requirements will depend on many factors, including our growth rate, the timing and extent of spending to support research and development efforts, the expansion of sales and marketing activities, particularly internationally, the introduction of new and enhanced products and professional service offerings and the cost of any future acquisitions of technology or businesses.

As of December 31, 2020, we had $173.6 million in cash and cash equivalents, $149.0 million of short- and long-term investments that have maturities ranging from 1 to 16 months.

Since our inception, we have generated significant losses and expect to continue to generate losses for the foreseeable future and as of December 31, 2020 have an accumulated deficit of $617.3 million.

Our principal sources of liquidity are cash and cash equivalents, short and long-term investments and our Credit and Security Agreement (Credit Agreement).

To date, we have financed our operations primarily through private and public equity financings and issuance of convertible senior notes and through cash generated by operating activities.

We believe that our existing cash and cash equivalents, our short and long-term investments and our available borrowings under our Credit Agreement will be sufficient to meet our working capital expenditure requirements for at least the next 12 months.

Our future capital requirements will depend on many factors, including our growth rate, the timing and extent of spending to support research and development efforts, the expansion of sales and marketing activities, particularly internationally, the introduction of new and enhanced products and service offerings and the cost of any future acquisitions of technology or

In the event that additional financing is required from outside sources, we may be unable to raise the funds on acceptable terms, if at all.

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Cash, cash equivalents and restricted cash at beginning of period $ 123,413 $ 99,565 $ 51,762

Net cash (used in) provided by operating activities (1,420) 6,066 13,286

Net cash provided by (used in) investing activities 16,811 (193,733) (22,221)

Net cash provided by (used in) operating activities 4,887 (1,420) 6,066

Net cash (used in) provided by investing activities (156,287) 16,811 (193,733)

Net cash provided by financing activities 200,925 8,788 236,164

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Cash, cash equivalents and restricted cash at end of period $ 173,617 $ 123,413 $ 99,565

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Uses of Funds

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Operating Activities

Operating activities provided $4.9 million of cash in 2020, which reflects our continued growth in revenue offset by continued investments in our operations and impact of the timing of working capital items.

Cash used in operating activities reflected our net loss of $98.8 million and an increase in our net operating assets and liabilities of $3.5 million, offset by $106.7 million of non-cash charges related primarily to depreciation and amortization, stock-based compensation expense, amortization of debt discount and debt issuance costs, provision for doubtful accounts, deferred income taxes and other non-cash charges.

The increase in our net operating assets and liabilities was primarily due to a $24.4 million increase in accounts receivable, a $13.4 million increase in deferred contract acquisition and fulfillment costs, a $8.9 million increase in prepaid expenses and other assets, a $2.4 million decrease in accounts payable and a $0.4 million decrease in other liabilities, which each had a negative impact on operating cash flow.

These factors were partially offset by a $37.4 million increase in deferred revenue from sales of our products and services and a $8.6 million increase in accrued expenses, which each had a positive impact on operating cash flow.

Operating activities used $1.4 million of cash in 2019, which reflects our continued growth in revenue offset by continued investments in our operations and impact of the timing of working capital items.

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These factors were offset by a $12.8 million increase in deferred contract acquisition and fulfillment costs, a $1.7 million increase in accounts receivable and a $0.3 million increase in prepaid expenses and other assets, which each had a negative impact on operating cash flow.

Operating activities provided $13.3 million of cash in 2017.

Cash provided by operating activities reflected our net loss of $45.5 million, offset by a decrease in our net operating assets and liabilities of $33.7 million and non-cash charges of $25.1 million related primarily to depreciation and amortization, stock-based compensation expense, provision for doubtful accounts, deferred income taxes and other non-cash charges.

The decrease in our net operating assets and liabilities was primarily due to a $55.4 million increase in deferred revenue from sales of our products and services, and a $6.8 million increase in accrued expenses, which both had a positive impact on operating cash flow.

These factors were offset by a $25.2 million increase in accounts receivable, a $2.3 million decrease in accounts payable and a $1.0 million decrease in other liabilities, which each had a negative impact on operating cash flow.

Investing Activities

Investing activities provided $16.8 million of cash in 2019, consisting of $215.0 million of investment sales and maturities, offset by $148.1 million for purchases of investments, $29.4 million in capital expenditures to purchase leasehold improvements and furniture and fixtures, primarily related to office space build-outs including our new corporate headquarters and computer equipment, $14.6 million of cash paid for the acquisition of NetFort and $6.1 million for capitalization of internal-use software costs.

Investing activities used $193.7 million of cash in 2018, consisting of $233.4 million for purchases of investments, offset by $70.3 million of investment sales and maturities, $14.5 million of cash paid for the acquisition of tCell, $12.8 million in capital expenditures to purchase computer equipment and leasehold improvements and $3.3 million for the capitalization of internal-use software costs.

Investing activities used $22.4 million of cash in 2017, consisting of $14.7 million of cash paid for the acquisition of Komand, $4.8 million in capital expenditures to purchase computer equipment and leasehold improvements and $1.2 million for the capitalization of internal-use software costs, $35.2 million used for purchases of investments less $33.7 million of investment sales and maturities and $0.2 million increase in restricted cash.

Investing activities used $156.3 million of cash in 2020, consisting of $125.8 million of cash paid for the acquisition of DivvyCloud, net of cash acquired of $5.0 million, $13.8 million in capital expenditures to purchase leasehold improvements,

furniture and fixtures and computer equipment, $10.6 million for purchases of investments, net of sales and maturities, and $6.1 million for capitalization of internal-use software costs.

Investing activities provided $16.8 million of cash in 2019, consisting of $66.9 million for investment sales and maturities, net of purchases, $29.4 million in capital expenditures to purchase leasehold improvements and furniture and fixtures, primarily related to office space build-outs including our new corporate headquarters and computer equipment, $14.6 million of cash paid for the acquisition of NetFort and $6.1 million for capitalization of internal-use software costs.

Investing activities used $193.7 million of cash in 2018, consisting of $163.1 million for purchases of investments, net of sales and maturities, $14.5 million of cash paid for the acquisition of tCell, $12.8 million in capital expenditures to purchase computer equipment and leasehold improvements and $3.3 million for the capitalization of internal-use software costs.

Financing Activities

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2015 Employee Stock Purchase Plan (ESPP), partially offset by $6.9 million in withholding taxes paid for the net share settlement of equity awards.

Financing activities provided $200.9 million of cash in 2020, which consisted primarily of $222.8 million in proceeds from the issuance of the 2025 Notes, net of issuance costs paid of $7.2 million, $7.8 million in proceeds from the exercise of stock options and $7.1 million in proceeds from the issuance of common stock purchased by employees under the Rapid7, Inc.

2015 Employee Stock Purchase Plan (ESPP), partially offset by $27.3 million for the purchase of 2025 Capped Calls, $8.9 million in withholding taxes paid for the net share settlement of equity awards, $0.4 million of payments of debt issuance costs and $0.2 million of deferred consideration payments.

Financing activities provided $8.8 million of cash in 2019, which consisted primarily of $10.2 million in proceeds from the exercise of stock options and $5.5 million in proceeds from the issuance of common stock purchased by employees under the ESPP, partially offset by $6.9 million in withholding taxes paid for the net share settlement of equity awards.

Financing activities provided $236.2 million of cash in 2018, which consisted primarily of $223.1 million in net proceeds from the issuance of the 2023 Notes, $30.9 million in net proceeds from a secondary public offering in January 2018, $7.6 million in proceeds from the exercise of stock options and $3.6 million in proceeds from the issuance of common stock purchased by employees under the ESPP, partially offset by $26.9 million for the purchase of 2023 Capped Calls related to the 2023 Notes and $2.1 million in withholding taxes paid for the net share settlement of equity awards.

Financing activities provided $7.3 million of cash in 2017, which consisted primarily of $5.8 million in proceeds from the exercise of stock options, and $2.9 million in proceeds from the issuance of common stock purchased by employees under the ESPP, partially offset by a $0.7 million payment related to the deferred acquisition consideration associated with our acquisition of NT Objectives, Inc.

in 2015 and $0.7 million in withholding taxes paid for the net share settlement of equity awards.

Contractual Obligations and Commitments

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Certain of our operating leases require real estate taxes, common area maintenance and insurance payments, which are expensed when incurred and not included in the commitments table noted above.

The non-cancellable purchase obligations in the table above include cloud infrastructure services, including with Amazon Web Services (AWS), software subscriptions and the build-out of our new corporate headquarters.

In January 2020, we amended our contract with AWS which increased our total purchase obligation by $15.0 million, $40.0 million and $50.0 million in 2021, 2022 and 2023, respectively, for a total additional $105.0 million from the amounts that are included in the table above.

As of December 31, 2019, we had a total of $8.0 million in letters of credit outstanding as collateral for certain office space leases and corporate credit card programs.

These irrevocable letters of credit, which are not included in the table of contractual obligations above, are unsecured and are expected to remain in effect until 2020.

We intend to renew certain of these letters of credit annually over the term of the office space leases or corporate credit card programs.

The non-cancellable purchase obligations in the table above include cloud infrastructure services, including with Amazon Web Services (AWS) and software subscriptions.

Off-Balance Sheet Arrangements

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We therefore believe that we are not materially exposed to any financing, liquidity, market or credit risk that could arise if we had engaged in these relationships.

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Critical Accounting Policies

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Our actual results may differ from these estimates.

Our most critical accounting policies are summarized below.

See Note 2, Summary of Significant Accounting Policies , in the Notes to our Consolidated Financial Statements included in this Annual Report on Form 10-K for a description of our other significant accounting policies.

Our significant accounting policies, including those considered to be critical accounting policies are summarized in Note 2, Summary of Significant Accounting Policies , in the Notes to our Consolidated Financial Statements included in this Annual Report on Form 10-K.

The following critical accounting policies reflect significant judgments and estimates used in the preparation of our consolidated financial statements:

• Revenue recognition;

We generate products revenue from the sale of (1) cloud-based subscriptions for our InsightIDR, InsightVM, InsightAppSec, and InsightConnect products, (2) managed services offerings which utilize our products and (3) term or perpetual software licenses for our Nexpose, Metasploit and AppSpider products, and associated content subscriptions for our Nexpose and Metasploit products.

We also generate 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 and AppSpider.

We generate professional service revenue from the sale of our deployment and training services related to our solutions, incident response services, penetration testing and security advisory services.

Our deployment services educate and assist our customers on the best use and best practices to deploy our solutions.

We adopted ASC 606 on January 1, 2018 using the modified retrospective method.

The adoption of ASC 606 resulted in a cumulative adjustment to increase our accumulated deficit as of January 1, 2018.

Comparative prior periods were not adjusted.

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.

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.

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.

Sales through our channel network of distributors and resellers are generally discounted as compared to the price that we would sell to an end user.

Revenue for sales through our channel network is recorded net of any distributor or reseller margin.

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.

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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.

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 annual or multi-year contractual terms which are billed in advance of the annual subscription period and are non-cancellable.

• 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 annual or multi-year contractual terms which are billed in advance of the annual subscription period and are non-cancellable.

• 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.

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 five years, which represents a longer period of time in comparison to the initial contractual period of maintenance and support.

The estimated economic life of five 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.

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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 arrangements, revenue is recognized over time based upon the proportion of work performed to date.

Other revenue primarily includes revenue from delivery of appliances and other miscellaneous revenue.

Contracts with Multiple Performance Obligations

• Deferred contract acquisition and fulfillment costs;

• Business combinations

Revenue Recognition

We generate revenue primarily from:

(1) subscription revenue from the sale of cloud-based subscriptions, managed services and content subscriptions associated with our software licenses, (2) term and perpetual software licenses, (3) maintenance and support associated with the purchase of software licenses and (4) professional services from the sale of our deployment and training services related to our solutions, incident response services, penetration testing and security advisory services.

The majority of our contracts with customers contain multiple performance obligations.

For these contracts, we account for individual performance obligations separately if they are distinct.

The transaction price is allocated to the separate performance obligations on a relative SSP basis.

The transaction price is allocated to the separate performance obligations on a relative standalone selling price (SSP) basis.

We determine SSP of our products and services based on our overall pricing objectives using all information reasonably available to us, taking into consideration market conditions and other factors, including the geographic locations of our customers, negotiated discounts from price lists and selling method (i.e., partner or direct).

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Once SSP is established it is applied consistently to all transactions involving that product or service utilizing a portfolio approach.

ASC 605 Revenue Accounting Policy

For periods prior to January 1, 2018, revenue was recognized in accordance with ASC 605.

Under ASC 605, revenue was recognized when all of the following criteria were met:

(1) Persuasive evidence of an arrangement existed, (2) delivery had occurred, (3) the sales price was fixed or determinable and (4) collectability was probable.

Substantially all of our software licenses were sold in multiple-element arrangements that included maintenance and support and content subscriptions, and in addition could include cloud-based subscriptions, professional services and/or managed services.

All of these elements were considered to be software elements other than cloud-based subscriptions and managed services which were non-software elements.

Non-software elements included in multiple-element arrangements consist of a single deliverable that had stand-alone value and represented a single unit of accounting.

We determined that we did not have vendor-specific objective evidence (VSOE), of the selling price for the elements comprising these multiple-element arrangements as our software licenses were generally not sold on a stand-alone basis and we purposefully employed variable pricing for our offerings in order to meet customer purchase requirements along the multiple price points of the demand curve.

When all of the elements of a multiple-element arrangement were software elements, the revenue for software licenses and any other products and services that were sold along with the license was generally deferred on our balance sheet and recognized as revenue on our consolidated statements of operations ratably over the contractual period of the maintenance and support, typically one to three years, which was longer than the period over which the professional services were performed.

Revenue recognition began upon delivery of the software license, assuming that all other criteria for revenue recognition had been met.

When a multiple-element arrangement included both software elements and non-software elements, the total arrangement consideration was first allocated between the software elements and the non-software elements based on the selling price hierarchy, which included (1) VSOE, if available, (2) third-party evidence (TPE), if VSOE was not available or (3) best estimate of selling price (BESP), if neither VSOE nor TPE was available.

We were not able to establish a selling price for any element using VSOE or TPE.

We determined BESP by considering our overall pricing objectives and market conditions.

Significant pricing practices taken into consideration included our discounting practices, the size and volume of our transactions, our price lists, historical standalone sales and contract prices.

The determination of BESP was made in consultation with, and was approved by, our management.

The portion of the consideration allocated to the non-software elements was recognized ratably over the service period of the non-software elements, assuming all other criteria for revenue recognition had been met.

The portion of the consideration allocated to software elements was recognized as described above.

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

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

Deferred Contract Acquisition and Fulfillment Costs

We adopted ASC 606 on January 1, 2018 using the modified retrospective method.

The adoption of ASC 606 resulted in a cumulative adjustment to increase our accumulated deficit as of January 1, 2018.

Comparative prior periods were not adjusted.

In accordance with ASC 606, we capitalize commission expenses paid to internal sales personnel and partner referral fees that are incremental costs to obtaining customer contracts.

These costs are recorded as deferred contract acquisition costs on the consolidated balance sheets.

We capitalize commission expenses paid to internal sales personnel and partner referral fees that are incremental costs to obtaining customer contracts.

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 five years as sales commissions on initial sales are not commensurate with sales commissions on contract renewals.

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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 our 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.

For periods prior to January 1, 2018, under ASC 605, sales commissions were recognized in the period that the commissions were earned by our employees, which was typically upon signing of an arrangement.

Business Combinations

We account for business combinations by recognizing the fair value of acquired assets and liabilities.

The excess of the purchase price for acquisitions over the fair value of the net assets acquired, including other intangible assets, is recorded as goodwill.

Determining the fair value of assets and liabilities assumed requires management to make significant estimates and assumptions, especially with respect to intangible assets.

While we use our best estimates and assumptions as part of the

purchase price allocation to accurately value assets acquired and liabilities assumed at the acquisition date, our estimates are inherently uncertain and subject to refinement.

Recent Accounting Pronouncements

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Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.

What changed 10-K

Item 7. Management’s Discussion and Analysis