Rapid7, Inc. 10-K

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations. The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and related notes appearing elsewhere in this Annual Report on Form 10-K. In addition to historical financial information, the following discussion contains forward-looking statements that reflect our plans, estimates and beliefs. Our actual results could differ materially from those contained in or implied by any forward-looking statements. Factors that could cause or contribute to these differences include those under “Risk Factors” included in Part I, Item 1A or in other parts of this Annual Report on Form 10-K. Overview Rapid7 is 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, 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. First, the tools to manage complex security problems are often equally complicated to use. Second, there is a scarcity of cybersecurity professionals who are qualified to successfully manage these sophisticated tools. 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. 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. 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 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. Our ongoing commitment to researching and partnering with the technology community helps to curb new security risks born through innovation. We are also investing in under-served, at risk communities, like non-profits and hospitals, to better understand their needs and make security technology and services accessible. By continuously improving our technology, stemming the creation of risk in the community, and making security more usable and accessible, Rapid7 aims to close the Security Achievement Gap. We market and sell our products and professional services to organizations of all sizes globally, including mid-market businesses, enterprises, non-profits, educational institutions and government agencies. Our customers span a wide variety of industries such as technology, energy, financial services, healthcare and life sciences, manufacturing, media and entertainment, retail, education, real estate, transportation, government and professional services. As of December 31, 2020, we had over 9,700 customers in 144 countries, including 46% of the Fortune 100. Our revenue was not concentrated with any individual customer and no customer represented more than 1% of our revenue in 2020, 2019 or 2018. 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 42 Table of Contents 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 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: • 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. • Managed services, through which we operate our products and provide our capabilities on behalf of our customers. Our Managed Vulnerability Management, Managed Application Security and Managed Detection and Response products are offered on a managed service basis, generally pursuant to one-year agreements. • Licensed software, including both term and perpetual licenses, and the simultaneous sale of maintenance and support. 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, penetration testing 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. 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 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 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. 43 Table of Contents Key Metrics 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, 2020 2019 2018 (dollars in thousands) Total revenue $ 411,486 $ 326,947 $ 244,091 Year-over-year growth 25.9 % 33.9 % 21.5 % Non-GAAP income (loss) from operations $ 2,032 $ 2,404 $ (26,273) Operating cash flow $ 4,887 $ (1,420) $ 6,066 As of December 31, 2020 2019 (dollars in thousands) Number of customers 9,736 9,022 Year-over-year growth 7.9 % 15.5 % Annualized recurring revenue (ARR) $ 432,946 $ 338,714 Year-over-year growth 27.8 % 34.5 % 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 . We monitor non-GAAP income (loss) from operations, a non-GAAP financial measure, to analyze our financial results. We believe non-GAAP income (loss) from operations is useful to investors, as a supplement to U.S. GAAP measures, in evaluating our ongoing operational performance and enhancing an overall understanding of our past financial performance and allow for greater transparency with respect to metrics used by our management in its financial and operational decision-making. See Non-GAAP Financial Results for further information on non-GAAP income (loss) from operations and a reconciliation of non-GAAP income (loss) from operations to the comparable GAAP financial measure. Operating Cash Flow . 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. Number of Customers . We believe that the size of our customer base is an indicator of our global market penetration and that our net customer additions are an indicator of the growth of our business. We define a customer as any entity that has (1) an active Rapid7 contract or a contract that expired within 90 days or less of the applicable measurement date; and for Logentries products, those customers with a contract value equal to or greater than $2,400 per year, or (2) purchased Rapid7 professional services within the 12 months preceding the applicable measurement date. Annualized Recurring Revenue and Growth. Annualized Recurring Revenue (ARR) is defined as the annual value of all recurring revenue related to contracts in place at the end of the quarter. ARR should be viewed independently of revenue and deferred revenue as ARR is an operating metric and is not intended to be combined with or replace these items. 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. 44 Table of Contents Non-GAAP Financial Results To supplement our consolidated financial statements, which are prepared and presented in accordance with GAAP, we provide investors with certain non-GAAP financial measures, including non-GAAP gross profit, non-GAAP income (loss) from operations, non-GAAP net income (loss), non-GAAP net income (loss) per share and adjusted EBITDA. The presentation of the non-GAAP financial measures is not intended to be considered in isolation or as a substitute for, or superior to, the financial information prepared and presented in accordance with GAAP. We use these non-GAAP financial measures for financial and operational decision-making purposes and as a means to evaluate period-to-period comparisons, and use certain non-GAAP financial measures as performance measures under our executive bonus plan. We believe that these non-GAAP financial measures provide useful information about our operating results, enhance the overall understanding of past financial performance and future prospects and allow for greater transparency with respect to metrics used by our management in its financial and operational decision-making. While our non-GAAP financial measures are an important tool for financial and operational decision-making and for evaluating our own operating results over different periods of time, you should review the reconciliation of our non-GAAP financial measures to the comparable GAAP financial measures included below, and not rely on any single financial measure to evaluate our business. We 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 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: • Stock-based compensation expense. 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 allows for more meaningful comparisons between our operating results from period to period. • Amortization of acquired intangible assets. We believe that excluding the impact of amortization of acquired intangible assets allows for more meaningful comparisons between operating results from period to period as the intangible assets are valued at the time of acquisition and are amortized over several years after the acquisition. • Amortization of debt discount and issuance costs. 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. We exclude certain litigation-related expenses consisting of professional fees and related costs incurred by us related to significant litigation outside the ordinary course of business. We believe it is useful to exclude such expenses because we do not consider such amounts to be part of our ongoing operations. • Acquisition-related expenses and follow-on public offering costs. We exclude acquisition-related expenses and follow-on public offering costs as costs that are unrelated to the current operations and neither are comparable to the prior period nor predictive of future results. • Anti-dilutive impact of capped call transaction. 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. 45 Table of Contents Our non-GAAP financial measures may not provide information that is directly comparable to that provided by other companies in our industry, as other companies in our industry may calculate non-GAAP financial results differently, particularly related to non-recurring, unusual items. In addition, there are limitations in using non-GAAP financial measures because the non-GAAP financial measures are not prepared in accordance with GAAP, may be different from non-GAAP financial measures used by other companies and exclude expenses that may have a material impact upon our reported financial results. Further, stock-based compensation expense has been and will continue to be for the foreseeable future a significant recurring expense in our business and an important part of the compensation provided to our employees. The following tables reconcile GAAP gross profit to non-GAAP gross profit for the years ended December 31, 2020, 2019 and 2018: Year Ended December 31, 2020 2019 2018 (in thousands) GAAP total gross profit $ 289,969 $ 235,801 $ 173,008 Stock-based compensation expense 4,298 2,580 1,692 Amortization of acquired intangible assets 8,700 6,339 3,985 Non-GAAP total gross profit $ 302,967 $ 244,720 $ 178,685 Year Ended December 31, 2020 2019 2018 (in thousands) GAAP gross profit – products $ 286,058 $ 229,718 $ 163,306 Stock-based compensation expense 2,740 1,405 726 Amortization of acquired intangible assets 8,700 6,339 3,985 Non-GAAP gross profit – products $ 297,498 $ 237,462 $ 168,017 Year Ended December 31, 2020 2019 2018 (in thousands) GAAP gross profit – professional services $ 3,911 $ 6,083 $ 9,702 Stock-based compensation expense 1,558 1,175 966 Non-GAAP gross profit – professional services $ 5,469 $ 7,258 $ 10,668 The following table reconciles GAAP loss from operations to non-GAAP income (loss) from operations for the years ended December 31, 2020, 2019 and 2018: Year Ended December 31, 2020 2019 2018 (in thousands) GAAP loss from operations $ (74,099) $ (45,995) $ (53,038) Stock-based compensation expense 63,888 40,664 27,593 Amortization of acquired intangible assets 9,138 6,479 4,144 Acquisition-related expenses 1,343 514 115 Follow-on public offering costs — — 205 Litigation-related expenses 1,762 742 600 Non-GAAP income (loss) from operations $ 2,032 $ 2,404 $ (20,381) 46 Table of Contents The following table reconciles GAAP net loss to non-GAAP net income (loss) for the years ended December 31, 2020, 2019 and 2018: Year Ended December 31, 2020 2019 2018 (in thousands, except share and per share data) GAAP net loss $ (98,849) $ (53,845) $ (55,545) Stock-based compensation expense 63,888 40,664 27,593 Amortization of acquired intangible assets 9,138 6,479 4,144 Acquisition-related expenses 1,343 514 115 Follow-on public offering costs — — 205 Litigation-related expenses 1,762 742 600 Release of valuation allowance, acquisition-related — (761) — Amortization of debt discount and issuance costs 17,518 10,513 3,831 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 (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 (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 Weighted average shares used in non-GAAP per share calculation: Basic 51,036,824 48,731,791 46,456,825 Diluted 51,036,824 52,058,103 46,456,825 The following table reconciles GAAP net loss to adjusted EBITDA for the years ended December 31, 2020, 2019 and 2018: Year Ended December 31, 2020 2019 2018 (in thousands) Net loss $ (98,849) $ (53,845) $ (55,545) Interest income (1,454) (6,014) (3,229) Interest expense 24,137 13,389 4,934 Other (income) expense, net 81 433 336 Provision for income taxes 1,986 42 466 Depreciation expense 11,036 8,963 6,486 Amortization of intangible assets 11,595 7,565 4,611 Stock-based compensation expense 63,888 40,664 27,593 Acquisition-related expenses 1,343 514 115 Follow-on public offering costs — — 205 Litigation-related expenses 1,762 742 600 Adjusted EBITDA $ 15,525 $ 12,453 $ (13,428) 47 Table of Contents Components of Results of Operations Revenue 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. Products 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 We generate professional service revenue from the sale of deployment and training services related to our products, incident response services and security advisory services. Cost of Revenue 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. All overhead costs are allocated based on relative headcount. Cost of Products 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 Cost of professional services consists of personnel and related costs for our professional services team, including salaries and other payroll related costs, bonuses, stock-based compensation, costs of contracted third-party vendors, travel and entertainment expenses and allocated overhead costs. We expect our cost of revenue to increase on an absolute dollar basis as we continue to grow our revenue. Gross Margin Gross margin, or gross profit as a percentage of revenue, has been and will continue to be affected by a variety of factors, including the average sales price of our products and services, transaction volume growth, the mix of revenue between software licenses, cloud-based subscriptions, managed services and professional services and changes in cloud computing costs. We expect our gross margins to fluctuate over time depending on the factors described above. Operating Expenses Operating expenses consist of research and development, sales and marketing, and general and administrative expenses. Operating expenses include 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. All overhead costs are allocated based on relative headcount. Research and Development Expense Research and development expense consists of personnel costs for our research and development team, including salaries and other payroll related costs, bonuses and stock-based compensation. Additional expenses include travel and entertainment, consulting and professional fees for third-party development resources as well as allocated overhead 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 and to increase slightly as a percentage of total revenue. 48 Table of Contents 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, 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 General and administrative expense consists of personnel costs for our executive, legal, human resources, and finance and accounting departments, including salaries and other payroll related costs, bonuses and stock-based compensation. Additional expenses include travel and entertainment, professional fees, litigation-related expenses, insurance, acquisition-related expenses, amortization of certain intangible assets and allocated overhead costs. We expect general and administrative expense to increase on an absolute dollar basis in the near term as we continue to increase investments to support our growth, but to remain relatively consistent as a percentage of total revenue. Interest Income Interest income consists primarily of interest income on our cash and cash equivalents and our short and long-term investments. Interest Expense 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 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. 49 Table of Contents Results of Operations Year Ended December 31, 2020 2019 2018 (in thousands) Consolidated Statement of Operations Data: Revenue: Products $ 382,922 $ 297,897 $ 210,794 Professional services 28,564 29,050 33,297 Total revenue 411,486 326,947 244,091 Cost of revenue: (1) Products 96,864 68,179 47,488 Professional services 24,653 22,967 23,595 Total cost of revenue 121,517 91,146 71,083 Operating expenses: (1) Research and development 108,568 79,364 67,743 Sales and marketing 195,981 157,722 123,310 General and administrative 59,519 44,710 34,993 Total operating expenses 364,068 281,796 226,046 Loss from operations (74,099) (45,995) (53,038) Interest income 1,454 6,014 3,229 Interest expense (24,137) (13,389) (4,934) Other income (expense), net (81) (433) (336) Loss before income taxes (96,863) (53,803) (55,079) Provision for income taxes 1,986 42 466 Net loss (98,849) (53,845) (55,545) (1) Cost of revenue and operating expenses include stock-based compensation expense and depreciation and amortization expense as follows: Year Ended December 31, 2020 2019 2018 (in thousands) Stock-based compensation expense: Cost of revenue $ 4,298 $ 2,580 $ 1,692 Research and development 24,423 15,670 10,822 Sales and marketing 16,826 11,883 7,569 General and administrative 18,341 10,531 7,510 Total stock-based compensation expense $ 63,888 $ 40,664 $ 27,593 Year Ended December 31, 2020 2019 2018 (in thousands) Depreciation and amortization expense: Cost of revenue $ 13,218 $ 9,110 $ 5,673 Research and development 2,844 2,083 1,336 Sales and marketing 4,779 3,971 2,783 General and administrative 1,790 1,364 1,305 Total depreciation and amortization expense $ 22,631 $ 16,528 $ 11,097 50 Table of Contents The following table sets forth our consolidated statements of operations data expressed as a percentage of revenue: Year Ended December 31, 2020 2019 2018 Consolidated Statement of Operations Data: Revenue: Products 93.1 % 91.1 % 86.4 % Professional services 6.9 8.9 13.6 Total revenue 100.0 100.0 100.0 Cost of revenue: Products 23.5 20.9 19.4 Professional services 6.0 7.0 9.7 Total cost of revenue 29.5 27.9 29.1 Operating expenses: Research and development 26.4 24.3 27.8 Sales and marketing 47.6 48.2 50.5 General and administrative 14.5 13.7 14.3 Total operating expenses 88.5 86.2 92.6 Loss from operations (18.0) (14.1) (21.7) Interest income 0.4 1.8 1.3 Interest expense (5.9) (4.1) (2.0) Other income (expense), net — (0.1) (0.1) Loss before income taxes (23.5) (16.5) (22.6) Provision for income taxes 0.5 — 0.2 Net loss (24.0) % (16.5) % (22.8) % Year Ended December 31, 2020 Compared to the Year Ended December 31, 2019 Revenue Year Ended December 31, Change 2020 2019 $ % (dollars in thousands) Revenue: Products $ 382,922 $ 297,897 $ 85,025 28.5 % Professional services 28,564 29,050 (486) (1.7) Total revenue $ 411,486 $ 326,947 $ 84,539 25.9 % 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. 51 Table of Contents Cost of Revenue Year Ended December 31, Change 2020 2019 $ % (dollars in thousands) Cost of revenue: Products $ 96,864 $ 68,179 $ 28,685 42.1 % Professional services 24,653 22,967 1,686 7.3 Total cost of revenue $ 121,517 $ 91,146 $ 30,371 33.3 % Gross margin %: Products 74.7 % 77.1 % Professional services 13.7 20.9 Total gross margin % 70.5 % 72.1 % 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 Research and Development Expense Year Ended December 31, Change 2020 2019 $ % (dollars in thousands) Research and development $ 108,568 $ 79,364 $ 29,204 36.8 % % of revenue 26.4 % 24.3 % 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 Year Ended December 31, Change 2020 2019 $ % (dollars in thousands) Sales and marketing $ 195,981 $ 157,722 $ 38,259 24.3 % % of revenue 47.6 % 48.2 % 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 52 Table of Contents 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 Year Ended December 31, Change 2020 2019 $ % (dollars in thousands) General and administrative $ 59,519 $ 44,710 $ 14,809 33.1 % % of revenue 14.5 % 13.7 % 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 Year Ended December 31, Change 2020 2019 $ % (dollars in thousands) Interest income $ 1,454 $ 6,014 $ (4,560) (75.8) % % of revenue 0.4 % 1.8 % Interest income decreased by $4.6 million in 2020 compared to 2019 primarily due to a decrease in interest rates. Interest Expense Year Ended December 31, Change 2020 2019 $ % (dollars in thousands) Interest expense $ (24,137) $ (13,389) $ (10,748) 80.3 % % of revenue (5.9) % (4.1) % 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 Year Ended December 31, Change 2020 2019 $ % (dollars in thousands) Other income (expense), net $ (81) $ (433) $ 352 (81.3) % % of revenue — % (0.1) % 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. 53 Table of Contents Provision for Income Taxes Year Ended December 31, Change 2020 2019 $ % (dollars in thousands) Provision for income taxes $ 1,986 $ 42 $ 1,944 NM % of revenue 0.5 % — % 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 Revenue Year Ended December 31, Change 2019 2018 $ % (dollars in thousands) Revenue: Products (1) $ 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 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. 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 $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 Year Ended December 31, Change 2019 2018 $ % (dollars in thousands) Cost of revenue: Products $ 68,179 $ 47,488 $ 20,691 43.6 % Professional services 22,967 23,595 (628) (2.7) Total cost of revenue $ 91,146 $ 71,083 $ 20,063 28.2 % Gross margin %: Products 77.1 % 77.5 % Professional services 20.9 29.1 Total gross margin % 72.1 % 70.9 % 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 54 Table of Contents 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 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. Operating Expenses Research and Development Expense Year Ended December 31, Change 2019 2018 $ % (dollars in thousands) Research and development $ 79,364 $ 67,743 $ 11,621 17.2 % % of revenue 24.3 % 27.8 % 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. Sales and Marketing Expense Year Ended December 31, Change 2019 2018 $ % (dollars in thousands) Sales and marketing $ 157,722 $ 123,310 $ 34,412 27.9 % % of revenue 48.2 % 50.5 % 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. General and Administrative Expense Year Ended December 31, Change 2019 2018 $ % (dollars in thousands) General and administrative $ 44,710 $ 34,993 $ 9,717 27.8 % % of revenue 13.7 % 14.3 % 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. 55 Table of Contents Interest Income Year Ended December 31, Change 2019 2018 $ % (dollars in thousands) Interest income $ 6,014 $ 3,229 $ 2,785 86.2 % % of revenue 1.8 % 1.3 % 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 Expense Year Ended December 31, Change 2019 2018 $ % (dollars in thousands) 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. Other Income (Expense), Net Year Ended December 31, Change 2019 2018 $ % (dollars in thousands) Other income (expense), net $ (433) $ (336) $ (97) 28.9 % % of revenue (0.1) % (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. Provision for Income Taxes Year Ended December 31, Change 2019 2018 $ % (dollars in thousands) Provision for income taxes $ 42 $ 466 $ (424) NM % of revenue — % 0.2 % 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. 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. Liquidity and Capital Resources 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 56 Table of Contents businesses. In the event that additional financing is required from outside sources, we may be unable to raise the funds on acceptable terms, if at all. If we are unable to raise additional capital on terms satisfactory to us when we require it, our business, operating results and financial condition could be adversely affected. The following table shows a summary of our cash flows for the years ended December 31, 2020, 2019 and 2018: Year Ended December 31, 2020 2019 2018 (in thousands) Cash, cash equivalents and restricted cash at beginning of period $ 123,413 $ 99,565 $ 51,762 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 Effects of exchange rates on cash, cash equivalents and restricted cash 679 (331) (694) Cash, cash equivalents and restricted cash at end of period $ 173,617 $ 123,413 $ 99,565 Uses of Funds Our historical uses of cash have primarily consisted of cash used for operating activities such as expansion of our sales and marketing operations, research and development activities and other working capital needs, as well as cash used for investing activities such as business acquisitions and purchases of property and equipment. 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. Cash used in operating activities reflected our net loss of $53.8 million and an increase in our net operating assets and liabilities of $15.2 million, offset by non-cash charges of $67.6 million related primarily to depreciation and amortization, stock-based compensation expense, amortization of debt discount and debt issuance costs, provision for doubtful accounts and other non-cash charges. The increase in our net operating assets and liabilities was primarily due to a $14.8 million increase in accounts receivable, $13.7 million increase in prepaid expenses and other assets and a $11.3 million increase in deferred contract acquisition and fulfillment costs, which each had a negative impact on operating cash flow. These factors were partially offset by a $18.7 million increase in deferred revenue from sales of our products and services, a $4.7 million increase in accrued expenses, a $1.1 million increase in other liabilities, and a $0.1 million increase in accounts payable, which each had a positive impact on operating cash flow. Operating activities provided $6.1 million of cash in 2018. Cash provided by operating activities reflected our net loss of $55.5 million, offset by a decrease in our net operating assets and liabilities of $18.2 million and non-cash charges of $43.4 million related primarily to depreciation and amortization, stock-based compensation expense, amortization of debt discount and issuance costs, provision for doubtful accounts, and other non-cash charges. The decrease in our net operating assets and liabilities was primarily due to a $18.7 million increase in deferred revenue from sales of our products and services, a $6.0 million increase in accrued expenses, a $3.7 million increase in accounts payable, and a $0.4 million increase in other liabilities, which each had a positive impact on operating cash flow. 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. Investing Activities 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, 57 Table of Contents 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 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. Contractual Obligations and Commitments The following table summarizes our commitments to settle contractual obligations as of December 31, 2020: Less than 1 Year 1 to 3 Years 3 to 5 Years More than 5 Years Total (in thousands) Convertible senior notes principal $ — $ 230,000 $ 230,000 $ — $ 460,000 Convertible senior notes interest 8,050 21,275 2,588 — 31,913 Operating leases 15,035 41,528 34,031 20,480 111,074 Non-cancellable purchase obligations 45,545 92,727 77 — 138,349 Total $ 68,630 $ 385,530 $ 266,696 $ 20,480 $ 741,336 The commitment amounts in the table above are associated with agreements that are enforceable and legally binding. The table does not include obligations under agreements that we can cancel without a significant penalty. We lease our office facilities under non-cancellable operating leases. As of December 31, 2020, we have leases that expire at various dates through 2030. 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) and software subscriptions. Off-Balance Sheet Arrangements We do not have any relationships with unconsolidated entities or financial partnerships, including entities sometimes referred to as structured finance or special purpose entities that were established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. We do not engage in off-balance sheet financing arrangements. In addition, we do not engage in trading activities involving non-exchange traded contracts. We therefore believe that we are not materially exposed to any financing, liquidity, market or credit risk that could arise if we had engaged in these relationships. 58 Table of Contents Critical Accounting Policies Our consolidated financial statements are prepared in accordance with generally accepted accounting principles in the United States (GAAP). The preparation of our consolidated financial statements requires us to make estimates, assumptions and judgments that affect the reported amounts of assets, liabilities, revenue, costs and expenses. We base our estimates and assumptions on historical experience and other factors that we believe to be reasonable under the circumstances. We evaluate our estimates and assumptions on an ongoing basis. Our actual results may differ from these estimates. Our 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; • Deferred contract acquisition and fulfillment costs; and • 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 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). When available, we use directly observable stand-alone transactions to determine SSP. When not regularly sold on a stand-alone basis, we estimate SSP for our products and services utilizing historical sales data, including discounts from list price. The historical data is aggregated and analyzed by geographic location and selling method to establish a median or average price. Once SSP is established it is applied consistently to all transactions involving that product or service utilizing a portfolio approach. Deferred Contract Acquisition and Fulfillment Costs 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. We determined the estimated period of benefit by taking into consideration the contractual term and expected renewals of customer contracts, our technology and other factors, including the fact that commissions paid on renewals are not commensurate with commissions paid on initial sales transactions. We periodically review the carrying amount of deferred contract acquisition costs to determine whether events or changes in circumstances have occurred that could impact the period of benefit. Commissions paid relating to contract renewals are deferred and amortized on a straight-line basis over the related renewal period. Costs to obtain a contract for professional services arrangements are expensed as incurred in accordance with the practical expedient as the contractual period of our professional services arrangements are one year or less. 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 59 Table of Contents 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 See Note 2, Summary of Significant Accounting Policies , in the Notes to our Consolidated Financial Statements in Item 8 of Part II of this Annual Report on Form 10-K for a description of recent accounting pronouncements and our expectation of their impact, if any, on our results of operations and financial conditions.