Rapid7, Inc. 10-K

Item 8. Financial Statements and Supplementary Data. INDEX TO CONSOLIDATED FINANCIAL STATEMENTS Consolidated Financial Statements: Report of Independent Registered Public Accounting Firm 62 Consolidated Balance Sheets 64 Consolidated Statements of Operations 65 Consolidated Statements of Comprehensive Loss 66 Consolidated Statements of Changes Stockholders' Equity 67 Consolidated Statements of Cash Flows 68 Notes to Consolidated Financial Statements 69 61 Table of Contents REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Stockholders and Board of Directors Rapid7, Inc.: Opinions on the Consolidated Financial Statements and Internal Control Over Financial Reporting We have audited the accompanying consolidated balance sheets of Rapid7, Inc. and subsidiaries (the Company) as of December 31, 2020 and 2019, the related consolidated statements of operations, comprehensive loss, changes in stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2020, and the related notes (collectively, the consolidated financial statements). We also have audited the Company’s internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2020 and 2019, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2020, in conformity with U.S. generally accepted accounting principles. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2020 based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Change in Accounting Principle As discussed in Note 2 to the consolidated financial statements, the Company has changed its method of accounting for leases as of January 1, 2019 due to the adoption of Accounting Standards Update 2016-02, Leases (Topic 842). Basis for Opinions The Company’s management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s consolidated financial statements and an opinion on the Company’s internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the consolidated financial statements included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions. Definition and Limitations of Internal Control Over Financial Reporting A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the 62 Table of Contents company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Critical Audit Matter The critical audit matter communicated below is a matter arising from the current period audit of the consolidated financial statements that was communicated or required to be communicated to the audit committee and that: (1) relates to accounts or disclosures that are material to the consolidated financial statements and (2) involved our especially challenging, subjective, or complex judgment. The communication of a critical audit matter does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates. Evaluation of standalone selling prices of revenue performance obligations As discussed in Note 2 to the consolidated financial statements, the Company recognized products revenue of $382.9 million and professional services revenue of $28.6 million for the year ended December 31, 2020. The Company allocates value to each distinct performance obligation on a relative standalone selling price basis. The Company determines standalone selling price based on pricing objectives, taking into consideration market conditions and other factors, including the geographic locations of customers, negotiated discounts from price lists and selling method. We identified the evaluation of standalone selling prices for the Company’s products and services as a critical audit matter. Subjective auditor judgment was involved in evaluating the Company’s assumptions regarding market conditions and pricing practices, including historical sales data and discounts from list price, where there was no direct observable data available. The following are primary procedures we performed to address this critical audit matter. We evaluated the design and tested the operating effectiveness of certain internal controls in the Company’s revenue process, including controls over the determination of standalone selling prices, and the assumptions described above. We evaluated the Company’s estimated standalone selling prices, including their compliance with the Company’s accounting policy, by assessing available, relevant external information and comparing the estimated standalone selling prices to internal historical disaggregated sales data, including discounts from list price, by geographic location and selling method. We selected certain customer agreements and read contract source documents to assess the relevance and reliability of the historical sales data used by the Company to estimate standalone selling prices, and tested the mathematical accuracy of the median or average discount from list price for the products and services. /s/ KPMG LLP We have served as the Company's auditor since 2013. Boston, Massachusetts February 26, 2021 63 Table of Contents RAPID7, INC. CONSOLIDATED BALANCE SHEETS (in thousands, except share and per share data) December 31, 2020 December 31, 2019 Assets Current assets: Cash and cash equivalents $ 173,617 $ 123,413 Short-term investments 138,839 116,158 Accounts receivable, net of allowance for doubtful accounts of $ 3,251 and $ 1,829 at December 31, 2020 and 2019, respectively 111,599 87,927 Deferred contract acquisition and fulfillment costs, current portion 21,536 17,047 Prepaid expenses and other current assets 27,844 20,051 Total current assets 473,435 364,596 Long-term investments 10,124 22,887 Property and equipment, net 53,114 50,670 Operating lease right-of-use assets 67,178 60,984 Deferred contract acquisition and fulfillment costs, non-current portion 43,103 34,213 Goodwill 213,601 97,866 Intangible assets, net 44,296 28,561 Other assets 8,271 5,136 Total assets $ 913,122 $ 664,913 Liabilities and Stockholders’ Equity Current liabilities: Accounts payable $ 3,860 $ 6,836 Accrued expenses 61,677 41,021 Operating lease liabilities, current portion 9,612 7,179 Deferred revenue, current portion 278,585 231,518 Other current liabilities — 119 Total current liabilities 353,734 286,673 Convertible senior notes, net 378,586 185,200 Operating lease liabilities, non-current portion 75,737 72,294 Deferred revenue, non-current portion 31,365 36,226 Other long-term liabilities 2,164 1,352 Total liabilities 841,586 581,745 Stockholders’ equity: Preferred stock, $ 0.01 par value per share; 10,000,000 shares authorized at December 31, 2020 and 2019; 0 shares issued and outstanding at December 31, 2020 and 2019 — — Common stock, $ 0.01 par value per share; 100,000,000 shares authorized at December 31, 2020 and 2019; 52,712,084 and 50,397,922 shares issued at December 31, 2020 and 2019, respectively; 52,225,276 and 49,911,114 shares outstanding at December 31, 2020 and 2019, respectively 522 499 Treasury stock, at cost, 486,808 shares at December 31, 2020 and 2019 ( 4,764 ) ( 4,764 ) Additional paid-in-capital 692,603 605,650 Accumulated other comprehensive loss 454 213 Accumulated deficit ( 617,279 ) ( 518,430 ) Total stockholders’ equity 71,536 83,168 Total liabilities and stockholders’ equity $ 913,122 $ 664,913 See accompanying notes to consolidated financial statements. 64 Table of Contents RAPID7, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (in thousands, except share and per share data) Year Ended December 31, 2020 2019 2018 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: 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 Total gross profit 289,969 235,801 173,008 Operating expenses: 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 ) Other income (expense), net: 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 ) Net loss per share, basic and diluted $ ( 1.94 ) $ ( 1.10 ) $ ( 1.20 ) Weighted-average common shares outstanding, basic and diluted 51,036,824 48,731,791 46,456,825 See accompanying notes to consolidated financial statements. 65 Table of Contents RAPID7, INC. CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS (in thousands) Year Ended December 31, 2020 2019 2018 Net loss $ ( 98,849 ) $ ( 53,845 ) $ ( 55,545 ) Other comprehensive income (loss): Change in fair value of investments ( 170 ) 244 8 Adjustment for net losses realized and included in net loss ( 21 ) — — Total change in unrealized gains (losses) on investments ( 191 ) 244 8 Change in unrealized gains on cash flow hedges 432 — — Total other comprehensive income 241 244 8 Comprehensive loss $ ( 98,608 ) $ ( 53,601 ) $ ( 55,537 ) See accompanying notes to consolidated financial statements. 66 Table of Contents RAPID7, INC. CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY (in thousands) Common stock Treasury stock Additional paid-in-capital Accumulated other comprehensive loss Accumulated deficit Total stockholders’ equity Shares Amount Shares Amount Balance, December 31, 2017 44,054 $ 441 487 $ ( 4,764 ) $ 463,428 $ ( 39 ) $ ( 434,913 ) $ 24,153 Stock-based compensation expense — — — — 27,593 — — 27,593 Cumulative-effect adjustment for the adoption of ASC 606 — — — — — — 25,873 25,873 Equity component of convertible senior notes, net — — — — 52,194 — — 52,194 Purchase of capped calls related to convertible senior notes — — — — ( 26,910 ) — — ( 26,910 ) Issuance of common stock related to secondary offering 1,500 15 — — 30,892 — — 30,907 Issuance of common stock under employee stock purchase plan 219 2 — — 3,635 — — 3,637 Vesting of restricted stock units 973 10 — — ( 10 ) — — — Forfeiture of restricted stock awards ( 3 ) — — — — — — — Shares withheld for employee taxes ( 88 ) ( 1 ) — — ( 2,196 ) — — ( 2,197 ) Issuance of common stock upon exercise of stock options 945 9 — — 7,597 — — 7,606 Other comprehensive income — — — — — 8 — 8 Net loss — — — — — — ( 55,545 ) ( 55,545 ) Balance, December 31, 2018 47,600 $ 476 487 $ ( 4,764 ) $ 556,223 $ ( 31 ) $ ( 464,585 ) $ 87,319 Stock-based compensation expense — — — — 40,664 — — 40,664 Issuance of common stock under employee stock purchase plan 185 2 — — 5,519 — — 5,521 Vesting of restricted stock units 1,292 13 — — ( 13 ) — — — Shares withheld for employee taxes ( 134 ) ( 2 ) — — ( 6,950 ) — — ( 6,952 ) Issuance of common stock upon exercise of stock options 968 10 — — 10,207 — — 10,217 Other comprehensive income — — — — — 244 — 244 Net loss — — — — — — ( 53,845 ) ( 53,845 ) Balance, December 31, 2019 49,911 $ 499 487 $ ( 4,764 ) $ 605,650 $ 213 $ ( 518,430 ) $ 83,168 Stock-based compensation expense — — — — 61,419 — — 61,419 Issuance of common stock under employee stock purchase plan 233 2 — — 7,080 — — 7,082 Vesting of restricted stock units 1,451 15 — — ( 15 ) — — — Shares withheld for employee taxes ( 154 ) ( 2 ) — — ( 8,919 ) — — ( 8,921 ) Issuance of common stock upon exercise of stock options 784 8 — — 7,811 — — 7,819 Equity component of convertible senior notes, net — — — — 46,832 — — 46,832 Purchase of capped called related to convertible senior notes — — — — ( 27,255 ) — — ( 27,255 ) Other comprehensive income — — — — — 241 — 241 Net loss — — — — — — ( 98,849 ) ( 98,849 ) Balance, December 31, 2020 52,225 $ 522 487 $ ( 4,764 ) $ 692,603 $ 454 $ ( 617,279 ) $ 71,536 See accompanying notes to consolidated financial statements. 67 Table of Contents RAPID7, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands) Year Ended December 31, 2020 2019 2018 Cash flows from operating activities: Net loss $ ( 98,849 ) $ ( 53,845 ) $ ( 55,545 ) Adjustments to reconcile net loss to net cash provided by (used in) operating activities: Depreciation and amortization 22,631 16,528 11,097 Amortization of debt discount and issuance costs 17,518 10,513 3,831 Stock-based compensation expense 63,888 40,664 27,593 Provision for doubtful accounts 1,997 2,241 740 Deferred income taxes 737 ( 645 ) ( 69 ) Foreign currency re-measurement loss 263 255 757 Other non-cash items 168 ( 1,889 ) ( 506 ) Changes in assets and liabilities: Accounts receivable ( 24,380 ) ( 14,800 ) ( 1,685 ) Deferred contract acquisition and fulfillment costs ( 13,379 ) ( 11,306 ) ( 12,790 ) Prepaid expenses and other assets ( 8,956 ) ( 13,691 ) ( 287 ) Accounts payable ( 2,394 ) 92 3,675 Accrued expenses 8,640 4,759 6,018 Deferred revenue 37,428 18,686 22,870 Other liabilities ( 425 ) 1,018 367 Net cash provided by (used in) operating activities 4,887 ( 1,420 ) 6,066 Cash flows from investing activities: Business acquisitions, net of cash acquired ( 125,826 ) ( 14,607 ) ( 14,460 ) Purchases of property and equipment ( 13,802 ) ( 29,428 ) ( 12,813 ) Capitalization of internal-use software ( 6,130 ) ( 6,087 ) ( 3,265 ) Purchases of investments ( 177,053 ) ( 148,047 ) ( 233,421 ) Sales and maturities of investments 166,524 214,980 70,226 Net cash (used in) provided by investing activities ( 156,287 ) 16,811 ( 193,733 ) Cash flows from financing activities: Proceeds from issuance of convertible senior notes, net of issuance costs of $ 7,201 and $ 6,879 for the years ended December 31, 2020 and 2018, respectively 222,799 — 223,121 Purchase of capped calls related to convertible senior notes ( 27,255 ) — ( 26,910 ) Proceeds from follow-on public offering, net of offering costs of $ 608 — — 30,907 Deferred business acquisition payment ( 150 ) — — Payment of debt issuance costs ( 440 ) — — Taxes paid related to net share settlement of equity awards ( 8,921 ) ( 6,952 ) ( 2,197 ) Proceeds from employee stock purchase plan 7,082 5,521 3,637 Proceeds from stock option exercises 7,810 10,219 7,606 Net cash provided by financing activities 200,925 8,788 236,164 Effect of exchange rate changes on cash and cash equivalents 679 ( 331 ) ( 694 ) Net increase in cash and cash equivalents 50,204 23,848 47,803 Cash and cash equivalents, beginning of period 123,413 99,565 51,762 Cash and cash equivalents, end of period $ 173,617 $ 123,413 $ 99,565 Supplemental cash flow information: Cash paid for interest on convertible senior notes $ 5,463 $ 2,779 $ — Cash paid for income taxes, net of refunds $ 312 $ 400 $ 188 Non-cash investing activities: Leasehold improvements acquired through tenant improvement allowance $ — $ 14,016 $ — See accompanying notes to consolidated financial statements. 68 Table of Contents RAPID7, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (1) Nature of the Business Rapid7, Inc. and subsidiaries (“we,” “us” or “our”) is advancing security with visibility, analytics, and automation delivered through our Insight cloud. Our solutions simplify the complex, allowing security teams to work more effectively with IT and development to reduce vulnerabilities, monitor for malicious behavior, investigate and shut down attacks, and automate routine tasks. (2) Summary of Significant Accounting Policies (a) Basis of Presentation and Consolidation The accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (GAAP). The consolidated financial statements include our results of operations and those of our wholly-owned subsidiaries. All intercompany transactions and balances have been eliminated in consolidation. (b) Use of Estimates The preparation of consolidated financial statements in conformity with GAAP requires management to make estimates, judgments and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. The management estimates include, but are not limited to the determination of the estimated economic life of perpetual licenses for revenue recognition, the determination of standalone selling prices in revenue transactions with multiple performance obligations, the estimated period of benefit for deferred contract acquisition and fulfillment costs, the useful lives and recoverability of long-lived assets, the valuation of allowance for doubtful accounts, the valuation of stock-based compensation, the fair value of assets acquired and liabilities assumed in business combinations, the incremental borrowing rate for operating leases, the fair value of the debt component of convertible senior notes and the valuation for deferred tax assets. We base our estimates on historical experience and on various other assumptions that we believe are reasonable. Actual results could differ from those estimates. The 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 for the year ended December 31, 2020 was negatively impacted by the slowdown in activity associated with the COVID-19 pandemic and we expect that to continue going forward. Estimates and assumptions about future events and their effects cannot be determined with certainty and therefore require the exercise of judgment. As of the date of issuance of these financial statements, we are not aware of any specific event or circumstance that would require us to update our estimates, assumptions and judgments or revise the carrying value of our assets or liabilities. These estimates may change as new events occur and additional information is obtained and will be recognized in the consolidated financial statements as soon as they become known. Actual results could differ from those estimates and any such differences may be material to our financial statements. (c) Reclassification Prior to the fiscal year beginning January 1, 2020, we have 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 have 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 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. 69 Table of Contents (d) 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. We recognize revenue 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. 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. 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. 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. 70 Table of Contents • 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. 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. 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 Other revenue primarily includes revenue from delivery of appliances and other miscellaneous revenue. Contracts with Multiple Performance Obligations The majority of our contracts with customers contain multiple performance obligations. For these contracts, we account for individual performance obligations separately if they are 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 71 Table of Contents 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 including that product or service utilizing a portfolio approach. Contract Balances Contract liabilities consist of deferred revenue and include payments received in advance of performance under the contract. Such amounts are recognized as revenue over the contractual period consistent with the above methodology. For the year ended December 31, 2020, we recognized revenue of $ 225.7 million that was included in the corresponding contract liability balance at the beginning of the period presented. Deferred revenue that will be realized during the succeeding 12-month period is recorded as current, and the remaining deferred revenue is recorded as non-current. We receive payments from customers based upon contractual billing schedules. Accounts receivable are recorded when the right to consideration becomes unconditional. Unbilled receivables include amounts related to our contractual right to consideration for both completed and partially completed performance obligations that have not been invoiced. If the right to consideration is based on satisfaction of another performance obligation in the contract other than the passage of time, we would record a contract asset. As of December 31, 2020 and 2019, unbilled receivables of $ 1.2 million and $ 0.8 million, respectively, are included in prepaid expenses and other current assets in our consolidated balance sheet. As of December 31, 2020 and 2019, we have no contract assets recorded on our consolidated balance sheet. (e) Cash and Cash Equivalents We consider all highly liquid instruments with original maturities of three months or less at the date of purchase to be cash equivalents. Cash and cash equivalents are recorded at cost, which approximates fair value. (f) Investments Our investments consist of commercial paper, corporate bonds, agency bonds, U.S. Government agencies and asset-backed securities. We classify our investments as available-for-sale and record these investments at fair value. When the fair value of an investment declines below its amortized cost basis, any portion of that decline attributable to credit losses, to the extent expected to be nonrecoverable before the sale of the security, is recognized in our consolidated statements of operations. When the fair value of the investment declines below its amortized cost basis due to changes in interest rates, such amounts are recorded in accumulated other comprehensive income (loss), and are recognized in our consolidated statement of operations only if we sell or intend to sell the security before recovery of its cost basis. Realized gains and losses are determined based on the specific identification method, and are reflected in our consolidated statements of operations. Investments with an original maturity of greater than three months at the date of purchase and less than one year from the date of the balance sheet are classified as short-term and those with maturities of more than one year from the date of the balance sheet are classified as long-term in the consolidated balance sheet. We do not invest in any securities with contractual maturities greater than 24 months. (g) Accounts Receivable and Allowance for Doubtful Accounts Accounts receivable are recorded at the invoiced amount, net of allowances for doubtful accounts for any potential uncollectible amounts. We maintain an allowance for doubtful accounts for estimated credit losses resulting from the inability of our customers to make required payments. Management regularly reviews the adequacy of the allowance based upon historical collection experience, the age of the receivable, an evaluation of each customer's expected ability to pay and current and future economic and market conditions. Accounts receivable are charged against the allowance for doubtful accounts after all means of collection have been exhausted and the potential for recovery is considered remote. Additions to the allowance for doubtful accounts are recorded in general and administrative expense in the consolidated statement of operations. We do not have any off-balance sheet credit exposure related to our customers. The following table displays the changes in our allowance for doubtful accounts: 72 Table of Contents Amount (in thousands) Balance at December 31, 2017 $ 1,478 Additions, net of recoveries 740 Less write-offs ( 594 ) Balance at December 31, 2018 1,624 Additions, net of recoveries 2,241 Less write-offs ( 2,036 ) Balance at December 31, 2019 1,829 Additions, net of recoveries 1,997 Less write-offs ( 575 ) Balance at December 31, 2020 $ 3,251 (h) Concentration of Credit Risk Financial instruments that potentially expose us to concentrations of credit risk consist primarily of cash and cash equivalents, accounts receivable, short-term and long-term investments and derivative financial instruments. Management believes that the financial institutions that hold our investments are financially sound and, accordingly, are subject to minimal credit risk. Deposits held with banks may exceed the amount of insurance provided on such deposits. We provide credit to customers in the normal course of business. Collateral is not required for accounts receivable, but ongoing credit evaluations of customers’ financial condition are performed. We maintain reserves for potential credit losses. No single customer, including channel partners, accounted for 10% or more of our total revenues in 2020, 2019 or 2018 or accounts receivable as of December 31, 2020 or 2019. Our derivative financial instruments expose us to credit risk to the extent that the counterparties may be unable to meet the terms of the arrangement. We mitigate this credit risk by transacting with major financial institutions with high credit ratings. (i) 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. These costs are recorded as deferred contract acquisition costs on the consolidated balance sheets. Costs to obtain a contract for a new customer, up-sell or cross-sell are amortized on a straight-line basis over an estimated period of benefit of 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. 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. 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. 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. 73 Table of Contents (j) Property and Equipment Property and equipment are recorded at cost and depreciated over their estimated useful lives using the straight-line method. The following table presents the useful lives of our property and equipment: Useful Lives Computer equipment and software 3 years Furniture and fixtures 3 - 5 years Leasehold improvements Shorter of the useful life of the asset or the lease term Repairs and maintenance costs are expensed as incurred. (k) Software Development Costs Software development costs associated with the development of products for sale are recorded to research and development expense until technological feasibility has been established for the product. Once technological feasibility is established, all software costs are capitalized until the product is available for release to customers. To date, the software development costs have not been capitalized as the cost incurred and time between technological feasibility and product release was insignificant. As such, these costs are expensed as incurred and recognized in research and development expenses in our consolidated statements of operations. Costs related to software developed, acquired or modified for internal use are capitalized. Costs incurred during the preliminary planning and evaluation stage of the project and during the post implementation stages of the project are expensed as incurred. Costs incurred during the application development stage of the project are capitalized. These capitalized costs consist of internal compensation related costs and external direct costs. Costs related to software developed for internal use are amortized over an useful life of 3 years. We capitalized $ 6.1 million, $ 6.1 million and $ 3.3 million of costs related to software developed for internal use in the years ended December 31, 2020, 2019 and 2018, respectively. (l) Leases We determine whether an arrangement is or contains a lease at inception based on the unique facts and circumstances present. We evaluate the classification of a lease at inception and, as necessary, at modification. Operating leases are recognized on the consolidated balance sheet as right-of-use (ROU) assets, lease liabilities and, if applicable, long-term lease liabilities. Operating lease ROU assets and liabilities are recognized at the present value of future lease payments at the lease commencement date. The implicit rate within our operating leases are generally not determinable and therefore we use the incremental borrowing rate at the lease commencement date to determine the present value of lease payments. The determination of our incremental borrowing rate requires judgment. We determine our incremental borrowing rate for each lease using our estimated borrowing rate, adjusted for various factors including level of collateralization, term and currency to align with the terms of the lease. The operating lease ROU asset also includes any lease prepayments and initial direct costs, offset by lease incentives. Certain of our leases include options to extend or terminate the lease. An option to extend the lease is considered in connection with determining the ROU asset and lease liability when it is reasonably certain we will exercise that option. An option to terminate is considered unless it is reasonably certain we will not exercise the option. We have elected not to recognize on the balance sheet leases with terms of one year or less. For contracts with lease and non-lease components, we have elected not to allocate the contract consideration and to account for the lease and non-lease components as a single lease component. (m) Impairment of Long-Lived Assets We evaluate our long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying value of these assets may not be recoverable. When such events or changes in circumstances occur, recoverability of these assets is measured by a comparison of the carrying value of the assets to the future net undiscounted cash flows directly associated with the assets. If such assets are considered to be impaired, the impairment recognized is the amount by which the carrying value exceeds the fair value of the assets. For the year ended December 31, 2020, there was no impairment of our long-lived assets. 74 Table of Contents (n) 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. During the measurement period, which may be up to one year from the acquisition date, we may record adjustments to the fair value of these assets acquired and liabilities assumed with the corresponding offset to goodwill. Upon the conclusion of the final determination of the fair value of assets acquired or liabilities assumed any subsequent adjustments are recorded to the consolidated statements of operations. Acquisition-related transaction costs are expensed as incurred. (o) Goodwill Goodwill is an asset representing the future economic benefits arising from other assets acquired in a business combination that are not individually identified and separately recognized. Goodwill is not amortized but is tested for impairment at least annually or more frequently when events or circumstances occur that indicate that it is more likely than not that an impairment has occurred. We perform an annual goodwill impairment test on the last day of each fiscal year and whenever events or changes in circumstances indicate that the carrying amount of this asset may exceed its fair value. For our goodwill impairment analysis, we operate with a single reporting unit. To test goodwill impairment, we perform a single-step goodwill impairment test to identify potential goodwill impairment. The single-step impairment test begins with an estimation of the fair value of a reporting unit. Goodwill impairment exists when the net assets of a reporting unit exceed its fair value. In performing the single step of the goodwill impairment testing and measurement process, we estimated the fair value of our single reporting unit using our market capitalization. Based upon our assessment performed as of December 31, 2020, we concluded the fair value of our single reporting unit exceeded its' carrying value and there was no impairment of goodwill. (p) Foreign Currency The functional currency of our foreign subsidiaries is the U.S. dollar. We translate all monetary assets and liabilities denominated in foreign currencies into U.S. dollars using the exchange rates in effect at the balance sheet dates and non-monetary assets and liabilities using historical exchange rates. Foreign currency denominated expenses are re-measured using the average exchange rates for the period. Foreign currency transaction and re-measurement gains and losses are included in other income (expense), net. In 2020, 2019 and 2018, foreign currency transactional gains (losses) and foreign currency re-measurement gains (losses) were not material. (q) Derivative and Hedging Activities As a global business, we are exposed to currency exchange rate risk. Although the majority of our revenue is denominated in U.S. dollars, a portion of our operating expenses are denominated in foreign currencies, making them subject to fluctuations in foreign currency exchange rates. We enter into foreign currency derivative contracts, which we designate as cash flow hedges, to manage the foreign currency exchange risk associated with these expenses. Derivative financial instruments are recorded at fair value and reported as either an asset or liability on our consolidated balance sheets. Gains or losses related to our cash flow hedges are recorded as a component of accumulated other comprehensive income (loss) in our consolidated balance sheets and are reclassified into the financial statement line item associated with the underlying hedged transaction in our consolidated statement of operations when the underlying hedged transaction is recognized in our consolidated statement of operations. If it becomes probable that the hedged transaction will not occur, the cumulative unrealized gain or loss is reclassified immediately from accumulated other comprehensive income (loss) into the financial statement line item associated with the underlying hedged transaction in our consolidated statement of operations. Derivatives designated as cash flow hedges are classified in our consolidated statements of cash flow in the same manner as the underlying hedged transaction, primarily within cash flow from operating activities. 75 Table of Contents (r) Stock-Based Compensation Stock-based compensation expense related to our stock options, restricted stock units (RSUs), performance-based restricted stock units (PSUs) and purchase rights issued under our 2015 Employee Stock Purchase Plan (ESPP) is calculated based on the estimated fair value of the award on the grant date. The fair values of RSUs and PSUs are based on the value of our common stock on the date of grant. The fair values of stock options and ESPP purchase rights are estimated on the grant date using the Black-Scholes option pricing model which requires management to make a number of assumptions, including the expected life of the option, the volatility of the underlying stock, the risk-free interest rate and expected dividends. The assumptions used in our Black-Scholes option-pricing model represent management’s best estimates at the time of grant. These estimates involve a number of variables, uncertainties and assumptions and the application of management’s judgment, as they are inherently subjective. If any assumptions change, our stock-based compensation expense could be materially different in the future. The fair value is recognized as expense on a straight-line basis over the requisite service period, which is generally the vesting period of the respective award. The actual number of PSUs earned and eligible to vest are determined based on the performance conditions defined when the awards are granted. We recognize share-based compensation expense for the PSUs on a straight-line basis over the requisite service period for each separately vesting portion of the award when it is probable that the performance conditions will be achieved. We reassess the probability of vesting at each reporting period for awards with performance conditions and adjust stock-based compensation cost based on its probability assessment. We recognize forfeitures as they occur and do not estimate a forfeiture rate when calculating the stock-based compensation expense. (s) Advertising Advertising costs are expensed as incurred, and are recorded in sales and marketing expense in our consolidated statement of operations. We incurred $ 16.4 million, $ 12.8 million and $ 8.9 million in advertising expense in 2020, 2019 and 2018, respectively. (t) Income Taxes Income taxes are accounted for using the asset and liability method. Under this method, deferred tax assets and liabilities are recognized for differences between the consolidated financial statements carrying amounts of assets and liabilities and their respective income tax bases, and operating loss and tax credit carryforwards using enacted tax rates expected to apply to taxable income in the years in which the differences are expected to reverse. Deferred tax assets are reduced by a valuation allowance if it is more likely than not that some or all of the deferred tax assets will not be realized. Significant judgment is required in determining any valuation allowance recorded against deferred tax assets. In assessing the need for a valuation allowance, we consider all available evidence, including past operating results, estimates of future taxable income, and the feasibility of tax planning strategies. In the event that we change our determination as to the amount of deferred tax assets that can be realized, we will adjust our valuation allowance with a corresponding impact to the provision for income taxes in the period in which such determination is made. We recognize tax benefits from uncertain tax positions if it is more likely than not that the tax position will be sustained on examination by the taxing authorities based on the technical merits of the position. Interest and penalties associated with such uncertain tax positions are classified as a component of income tax expense. (u) Net Loss per Share We calculate basic net loss per share by dividing our net loss by the weighted-average number of common shares outstanding during the period. Diluted net loss per share is computed by giving effect to all potentially dilutive securities, including stock options, RSUs, PSUs, the impact of our ESPP and the impact of the conversion spread of our convertible senior notes (Notes). Basic and diluted net loss per share was the same for all periods presented as the inclusion of all potentially dilutive securities outstanding was anti-dilutive. (v) Recent Accounting Pronouncements Accounting Pronouncements Recently Adopted In August 2018, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2018-15, Intangibles—Goodwill and Other—Internal-Use Software (Subtopic 350-40): Customer's 76 Table of Contents Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That is a Service Contract, which aligns the requirements for capitalizing implementation costs in cloud computing arrangements with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software. We adopted this standard on January 1, 2020 using the prospective adoption approach. The impact to our consolidated financial statements as a result of the adoption was not material. In August 2018, the FASB issued ASU 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework—Changes to the Disclosure Requirements for Fair Value Measurement , which eliminates, modifies and adds disclosure requirements for fair value measurements. We adopted this standard on January 1, 2020 and there was no impact to our consolidated financial statements as a result of the adoption. In June 2016, the FASB issued ASU 2016-13, Measurement of Credit Losses on Financial Instruments , which introduced a new methodology for accounting for credit losses on financial instruments. The standard establishes a new forward looking expected loss model that requires entities to estimate current expected credit losses on accounts receivable and other financial instruments by using all practical and relevant information. We adopted this standard in the first quarter of 2020. The impact to our consolidated financial statements as a result of the adoption was not material. Accounting Pronouncements Not Yet Effective In August 2020, the FASB issued ASU 2020-06, Debt—Debt with Conversion and Other Options (Subtopic 470-20) and Derivatives and Hedging—Contracts in Entity’s Own Equity (Subtopic 815-40): Accounting for Convertible Instruments and Contracts in an Entity’s Own Equity , which simplify the accounting for certain financial instruments with characteristics of liabilities and equity, including convertible instruments and contracts on an entity’s own equity. The standard eliminates beneficial conversion feature and cash conversion models resulting in more convertible instruments being accounted for as a single unit; and simplifies classification of debt on the balance sheet and earnings per share calculation. The standard is effective for us in the first quarter of fiscal 2022 and can be adopted on a full or modified retrospective basis. We plan to adopt this standard in the first quarter of 2021 under the modified retrospective basis. Adopting this guidance will reduce non-cash interest expense, and thereby increase net income, in our consolidated financial statements. Additionally, the treasury stock method for calculating earnings per share will no longer be allowed for convertible debt instruments whose principal amount may be settled using shares. Rather, the if-converted method will be required. Application of the “if converted” method may reduce our reported diluted earnings per share. In March 2020, the FASB issued ASU 2020-04, Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting , which provides temporary optional expedients and exceptions to GAAP guidance on contract modifications to ease the financial reporting burdens related to the expected market transition from the London Interbank Offered Rate (LIBOR) to alternative reference rates. We may elect to apply the amendments prospectively through December 31, 2022. The impact to our consolidated financial statements from the adoption of this standard is expected to be immaterial. In December 2019, the FASB issued ASU 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes . This standard is intended to simplify various aspects related to accounting for income taxes by removing certain exceptions to the general principles in Topic 740 and clarifying certain aspects of the current guidance to promote consistency among reporting entities. The new standard will be effective for us in the first quarter of 2021. Most amendments within this ASU are required to be applied on a prospective basis, while certain amendments must be applied on a retrospective or modified retrospective basis. We do not expect the adoption of this guidance to have a material impact on our consolidated financial statements. 77 Table of Contents (3) Revenue from Contracts with Customers The following table summarizes revenue from contracts with customers for the years ended December 31, 2020, 2019 and 2018: Year Ended December 31, 2020 2019 2018 (in thousands) Subscription revenue $ 304,737 $ 220,589 $ 137,442 Term and perpetual software licenses 45,959 38,931 28,200 Maintenance and support 31,567 36,778 42,223 Professional services 28,564 29,050 33,297 Other 659 1,599 2,929 Total revenue $ 411,486 $ 326,947 $ 244,091 The following table summarizes the revenue by region based on the shipping address of customers who have contracted to use our product or service for the years ended December 31, 2020, 2019 and 2018: Year Ended December 31, 2020 2019 2018 (in thousands) United States $ 329,753 $ 264,852 $ 199,852 All other 81,733 62,095 44,239 Total revenue $ 411,486 $ 326,947 $ 244,091 Transaction Price Allocated to the Remaining Performance Obligations The following table includes estimated revenue expected to be recognized in the future related to performance obligations that are unsatisfied or partially unsatisfied as of December 31, 2020. The estimated revenues do not include unexercised contract renewals. Next Twelve Months Thereafter (in thousands) Subscription revenue $ 242,115 $ 64,433 Term and perpetual software licenses 33,041 12,851 Maintenance and support 18,011 4,222 The amounts presented in the table above primarily consist of fixed fees which are typically recognized ratably as the performance obligation is satisfied. As of December 31, 2020, the estimated revenue expected to be recognized in the future related to performance obligations that are unsatisfied or partially unsatisfied associated with professional services was $ 15.3 million. We will recognize this revenue as the professional services are completed, which is expected to occur within the next 12 months or less. (4) Business Combinations DivvyCloud Corporation On May 1, 2020, we acquired Divvy Cloud Corporation (DivvyCloud), a Cloud Security Posture Management (CSPM) company, for a purchase price with an aggregate fair value of $ 137.8 million. The purchase consideration consisted of $ 130.8 million in cash paid at closing, $ 7.4 million in deferred cash payments and $ 0.1 million in working capital and other purchase price adjustments. The deferred cash payments will be held by us to satisfy indemnification obligations and certain post-closing purchase price adjustments. The deferred cash payments for post-closing purchase price adjustments was payable three months from the acquisition date in the amount of $ 0.2 million and the remaining $ 7.2 million is payable on the fifteenth month anniversary of the acquisition date. We have determined the fair value of the deferred cash payments was $ 6.9 million as of the acquisition date. During the third quarter of 2020, we made a $ 0.2 million payment for the first deferred cash payment and final working capital and other purchase price adjustments. Table of Contents In addition, in connection with the acquisition, we will issue an aggregate of 200,596 shares of Rapid7’s common stock to the founders of DivvyCloud in three equal annual installments beginning on the first anniversary of the closing date. The 200,596 shares of common stock were accounted for as stock-based compensation expense as continued service was required. The fair value of the 200,596 shares of common stock was $ 8.9 million. In the year ended December 31, 2020, we recorded $ 1.1 million of acquisition-related costs in general and administrative expense. The following table summarizes the preliminary allocation of purchase price to the estimated fair value of the assets acquired and liabilities assumed at the acquisition date (in thousands): Consideration: Cash $ 130,865 Deferred cash consideration 6,917 Fair value of total consideration transferred $ 137,782 Recognized amount of identifiable assets acquired and liabilities assumed: Cash and cash equivalents 5,039 Operating lease right-of-use assets 3,320 Other assets 2,206 Deferred revenue ( 4,779 ) Operating lease liabilities ( 3,297 ) Other liabilities ( 1,642 ) Intangible assets 21,200 Total identifiable net assets assumed 22,047 Goodwill 115,735 Net purchase price $ 137,782 The fair value of identifiable intangible assets was based on valuations using the income approach. The estimated fair value and useful life of identifiable intangible assets are as follows: Amount Weighted Average Amortization Life (in thousands) (in years) Developed technology $ 18,600 6 Customer relationships 1,700 6 Trade name 900 5 Total identifiable intangible assets $ 21,200 The excess of the purchase price over the tangible assets acquired, identifiable intangible assets acquired and assumed liabilities was recorded as goodwill. We believe the goodwill is attributable to expanded product offerings resulting from the integration of the technology acquired with our existing product offerings and increased opportunities to successfully market and sell these new products and features to our customer base. The goodwill was allocated to our one reporting unit. The acquired goodwill and intangible assets were not deductible for tax purposes. These preliminary amounts are subject to subsequent adjustment as we obtain additional information to finalize certain components of working capital. Following the acquisition, we granted to certain retained employees of DivvyCloud restricted stock units (RSUs) for an aggregate of 153,643 shares of our common stock, which will vest over three years subject to continued service. In addition, we granted certain retained employees of DivvyCloud performance-based restricted stock units (PSUs) for an aggregate of 109,760 shares of our common stock, which will vest over a maximum of three years based upon achievement of certain performance conditions and continued service. The RSUs and PSUs are expensed as stock-based compensation expense over the required service periods, assuming the service and performance conditions are achieved. 79 Table of Contents Our revenue and net loss attributable to the DivvyCloud business for the year ended December 31, 2020 was $ 6.3 million and $ 18.5 million, respectively. Pro Forma Financial Information The unaudited pro forma financial information in the table below summarizes the combined results of our operations and DivvyCloud, on a pro forma basis, as though we had acquired DivvyCloud on January 1, 2019. The unaudited pro forma financial information for all periods presented also includes the effects of business combination accounting resulting from the acquisition, including an adjustment to revenue for the deferred revenue fair value adjustment, amortization expense from acquired intangibles assets, reversal of acquisition-related expenses and the stock-compensation expense recorded to retain certain employees. Year Ended December 31, 2020 2019 (in thousands) Revenue $ 416,999 $ 332,392 Net loss $ ( 102,766 ) $ ( 78,258 ) NetFort Technologies Limited On April 1, 2019, we acquired NetFort Technologies Limited (NetFort), a provider of end-to-end network traffic visibility and analytics across cloud, virtual and physical platforms for a purchase price of $ 16.1 million. The $ 16.1 million purchase price was funded with cash. We expensed the related acquisition costs of $ 0.5 million in general and administrative expense. The assets acquired and liabilities assumed were recorded at their estimated fair values as of the acquisition date. The excess of the purchase price over the assets acquired and liabilities assumed was recorded as goodwill. The fair value of net assets acquired, goodwill and intangible assets were $ 0.6 million, $ 9.4 million and $ 6.1 million, respectively. The goodwill was allocated to our one reporting unit. The acquired goodwill and intangible asset will not be deductible for tax purposes. Accordingly, a $ 0.8 million deferred tax benefit was recorded resulting 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. Following the acquisition, certain retained employees and non-employee contractors of NetFort received an aggregate of 123,623 RSUs, which vest over a maximum of three years . The vesting of the RSUs is subject to the employee's continued service with us. Accordingly, the compensation expense associated with the RSUs is expensed as incurred in our post-acquisition financial statements. tCell.io, Inc. On October 15, 2018, we acquired tCell.io, Inc. (tCell) for total cash consideration of $ 15.4 million. The assets acquired and liabilities assumed were recorded at their estimated fair values as of the acquisition date. The excess of the purchase price over the assets acquired and liabilities assumed was recorded as goodwill. The fair value of net assets acquired, goodwill and intangible assets were $ 0.9 million, $ 5.3 million and $ 9.2 million, respectively. The goodwill was allocated to our one reporting unit. The acquired goodwill and intangible asset were not deductible for tax purposes. 80 Table of Contents (5) Investments Our investments, which are all classified as available-for-sale, consisted of the following: As of December 31, 2020 Amortized Cost Gross Unrealized Gains Gross Unrealized Losses Fair Value (in thousands) Description: U.S. Government agencies $ 83,596 $ 3 $ ( 12 ) $ 83,587 Corporate bonds 24,162 31 ( 1 ) 24,192 Commercial paper 34,766 — — 34,766 Agency bonds 3,998 1 — 3,999 Asset-backed securities 2,419 — — 2,419 Total $ 148,941 $ 35 $ ( 13 ) $ 148,963 As of December 31, 2019 Amortized Cost Gross Unrealized Gains Gross Unrealized Losses Fair Value (in thousands) Description: U.S. Government agencies $ 36,880 $ 99 $ — $ 36,979 Commercial paper 19,965 1 — 19,966 Corporate bonds 60,803 77 ( 2 ) 60,878 Agency bonds 12,198 44 — 12,242 Asset-backed securities 8,986 1 ( 7 ) 8,980 Total $ 138,832 $ 222 $ ( 9 ) $ 139,045 As of December 31, 2020 and 2019, our available-for-sale investments had maturities ranging from 1 to 16 months and from 3 months to 2 years, respectively . For all of our investments for which the amortized cost basis was greater than the fair value at December 31, 2020 and 2019, we have concluded that there is no plan to sell the security nor is it more likely than not that we would be required to sell the security before its anticipated recovery. In making the determination as to whether the unrealized loss is other-than-temporary, we considered the length of time and extent the investment has been in an unrealized loss position, the financial condition and near-term prospects of the issuers, the issuers’ credit rating and the time to maturity. (6) Fair Value Measurements We measure certain financial assets and liabilities at fair value. Fair value is determined based upon the exit price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants, as determined by either the principal market or the most advantageous market. Inputs used in the valuation techniques to derive fair values are classified based on a three-level hierarchy, as follows: • Level 1 : Observable inputs that reflect quoted prices (unadjusted) for identical assets or liabilities in active markets. • Level 2 : Observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets with insufficient volume or infrequent transactions (less active markets); or model-derived valuations in which all significant inputs are observable or can be derived principally from or corroborated by observable market data for substantially the full term of the assets or liabilities. • Level 3 : Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the asset or liability. We consider an active market to be one in which transactions for the asset or liability occur with sufficient frequency and volume to provide pricing information on an ongoing basis, and consider an inactive market to be one in which 81 Table of Contents there are infrequent or few transactions for the asset or liability, the prices are not current, or price quotations vary substantially either over time or among market makers. The following table presents our financial assets measured and recorded at fair value on a recurring basis using the above input categories: As of December 31, 2020 Level 1 Level 2 Level 3 Total (in thousands) Description: Assets: Money market funds $ 152,570 $ — $ — $ 152,570 U.S. Government agencies 83,587 — — 83,587 Commercial paper — 34,766 — 34,766 Corporate bonds — 24,192 — 24,192 Agency bonds — 3,999 — 3,999 Asset-backed securities — 2,419 — 2,419 Foreign currency forward contracts designated as cash flow hedges — 432 — 432 Total assets $ 236,157 $ 65,808 $ — $ 301,965 As of December 31, 2019 Level 1 Level 2 Level 3 Total (in thousands) Description: Assets: Money market funds $ 106,781 $ — $ — $ 106,781 Corporate bonds — 60,878 — 60,878 U.S. Government agencies 36,979 — — 36,979 Commercial paper — 19,966 — 19,966 Agency bonds — 12,242 — 12,242 Asset-backed securities — 8,980 — 8,980 Total assets $ 143,760 $ 102,066 $ — $ 245,826 As of December 31, 2020, the fair value of our 1.25 % and 2.25 % convertible senior notes due 2023 and 2025, respectively, as further described in Note 11, Debt, was $ 501.8 million and $ 373.3 million, respectively, based upon quoted market prices. We consider the fair value of the notes to be a Level 2 measurement due to limited trading activity of the notes. We had no financial liabilities measured and recorded at fair value on a recurring basis as of December 31, 2020 and 2019. (7) Property and Equipment Property and equipment are recorded at cost and consist of the following: As of December 31, 2020 2019 (in thousands) Computer equipment and software $ 13,438 $ 13,106 Furniture and fixtures 9,655 7,522 Leasehold improvements 50,336 44,050 Total 73,429 64,678 Less accumulated depreciation ( 20,315 ) ( 14,008 ) Property and equipment, net $ 53,114 $ 50,670 In 2020, we disposed of $ 3.6 million, $ 0.7 million and $ 0.4 million of computer equipment and software, leasehold improvements and furniture and fixtures, respectively, of fully depreciated assets which were no longer in use. 82 Table of Contents We recorded depreciation expense of $ 11.0 million, $ 9.0 million and $ 6.5 million in 2020, 2019 and 2018, respectively. (8) Goodwill and Intangible Assets Goodwill was $ 213.6 million and $ 97.9 million as of December 31, 2020 and 2019, respectively. There were no goodwill impairment charges in 2020, 2019 or 2018. The following table displays the changes in the gross carrying amount of goodwill: Amount (in thousands) Balance at December 31, 2018 $ 88,420 NetFort acquisition 9,446 Balance at December 31, 2019 $ 97,866 DivvyCloud acquisition 115,735 Balance at December 31, 2020 $ 213,601 The following table presents details of our intangible assets which include acquired identifiable intangible assets and capitalized internal-use software costs: Weighted- Average Estimated Useful Life (years) As of December 31, 2020 As of December 31, 2019 Gross Carrying Amount Accumulated Amortization Net Book Value Gross Carrying Amount Accumulated Amortization Net Book Value (in thousands) Intangible assets subject to amortization: Developed technology 5.6 $ 54,455 $ ( 24,780 ) $ 29,675 $ 35,855 $ ( 16,080 ) $ 19,775 Customer relationships 6.3 2,700 ( 958 ) 1,742 1,000 ( 641 ) 359 Trade names 5.4 1,419 ( 639 ) 780 519 ( 519 ) — Non-compete agreements 2.0 40 ( 40 ) — 40 ( 40 ) — Total acquired intangible assets 3.0 58,614 ( 26,417 ) 32,197 37,414 ( 17,280 ) 20,134 Internal-use software 16,002 ( 3,903 ) 12,099 9,873 ( 1,446 ) 8,427 Total intangible assets $ 74,616 $ ( 30,320 ) $ 44,296 $ 47,287 $ ( 18,726 ) $ 28,561 Intangible assets are expensed on a straight-line basis over the useful life of the asset. We recorded amortization expense of $ 11.6 million, $ 7.5 million and $ 4.6 million in 2020, 2019 and 2018, respectively. Estimated future amortization expense of the acquired identifiable intangible assets and completed capitalized internal-use software costs as of December 31, 2020 is as follows (in thousands): 2021 $ 13,039 2022 10,168 2023 7,283 2024 3,868 2025 3,443 2026 and thereafter 1,128 Total $ 38,929 The table above excludes the impact of $ 5.4 million of capitalized internal-use software costs for projects that have not been completed as of December 31, 2020, and therefore, we have not determined the useful life of the software, nor have all the costs associated with these projects been incurred. 83 Table of Contents (9) Deferred Contract Acquisition and Fulfillment Costs The following table summarizes the activity of the deferred contract acquisition and fulfillment costs for the years ended December 31, 2020 and 2019: Year Ended December 31, 2020 2019 (in thousands) Beginning balance $ 51,260 $ 39,955 Capitalization of contract acquisition and fulfillment costs 33,525 26,109 Amortization of deferred contract acquisition and fulfillment costs ( 20,146 ) ( 14,804 ) Ending balance $ 64,639 $ 51,260 (10) Derivatives and Hedging Activities To mitigate our exposure to foreign currency fluctuations resulting from certain expenses denominated in certain foreign currencies, we enter into forward contracts that are designated as cash flow hedging instruments. These forward contracts have contractual maturities of twelve months or less, and as of December 31, 2020, outstanding forward contracts had a total notional value of $ 12.5 million. The notional value represents the gross amount of foreign currency that will be bought or sold upon maturity of the forward contract. During the year ended December 31, 2020, all cash flow hedges were considered effective. The fair values of outstanding derivative instruments were as follows (in thousands): Consolidated Balance Sheet Location As of December 31, 2020 Derivative assets: Foreign currency forward contracts designated as cash flow hedges Prepaid expenses and other current assets $ 432 Total derivative assets $ 432 During the year ended December 31, 2020, amounts reclassified from accumulated other comprehensive income (loss) on our consolidated balance sheet to the financial statement line item associated with the underlying hedged transaction on our consolidated statement of operations for our cash flow hedges were not material. (11) Debt Convertible Senior Notes In August 2018, we issued $ 230.0 million aggregate principal amount of convertible senior notes due August 1, 2023 (the 2023 Notes) and in May 2020, we issued $ 230.0 million aggregate principal amount of convertible senior notes due May 1, 2025 (the 2025 Notes) (collectively, the Notes). The 2023 Notes bear interest at a fixed rate of 1.25 % per annum, payable semi-annually in arrears on February 1 and August 1 of each year. The 2025 Notes bear interest at a fixed rate of 2.25 % per annum, payable semi-annually in arrears on May 1 and November 1 of each year, commencing on November 1, 2020. The 2023 Notes and the 2025 Notes mature on August 1, 2023 and May 1, 2025, respectively unless earlier converted, redeemed or repurchased. The 2023 Notes and 2025 Notes are senior unsecured obligations, do not contain any financial covenants and are governed by an indenture between the Company, as issuer, and U.S. Bank National Association, as trustee (the 2023 Indenture and the 2025 Indenture, respectively). The total net proceeds from the 2023 Notes and the 2025 Notes offerings, after deducting initial purchase discounts and estimated debt issuance costs, were $ 223.1 million and $ 222.8 million, respectively. Terms of the 2023 Notes and the 2025 Notes The holders of the Notes may convert their respective Notes at their option at any time prior to the close of business on the business day immediately preceding their respective convertible dates only under the following circumstances: • during any calendar quarter commencing after the calendar quarter ending on December 31, 2018 for the 2023 Notes and September 30, 2020 for the 2025 Notes (and only during such calendar quarter), if the last reported sale price of our common stock for at least 20 trading days (whether or not consecutive) during a period of 30 consecutive trading days ending on, and including, the last trading day of the immediately 84 Table of Contents preceding calendar quarter is greater than or equal to 130 % of the conversion price of the respective Notes on each applicable trading day; • during the five business day period after any five consecutive trading day period (measurement period) in which the trading price (as defined in the Indenture) per $1,000 principal amount of the applicable series of Notes for each trading day of the measurement period was less than 98 % of the product of the last reported sale price of our common stock and the conversion rate of the respective Notes on each such trading day; • if we call any or all of the respective Notes for redemption, at any time prior to the close of business on the scheduled trading day immediately preceding the respective redemption date; or • upon the occurrence of specified corporate events (as set forth in the Indenture). During the three months ended December 31, 2020, the conversion feature of the 2023 Notes was triggered as the last reported price of our common stock was more than or equal to 130 % of the conversion price for at least 20 trading days in the period of 30 consecutive trading days ending on, and including, the last trading day of the immediately preceding calendar quarter, and therefore the 2023 Notes are currently convertible, in whole or in part, at the option of the holders from January 1, 2021 through March 31, 2021. Whether the 2023 Notes will be convertible following such period will depend on the continued satisfaction of this condition or another conversion condition in the future. We had not received any conversion notices through the issuance date of our consolidated financial statements. Since we may elect to repay the 2023 Notes in cash, shares of our common stock, or a combination of both, we have continued to classify the 2023 Notes as long-term debt on our consolidated balance sheet as of December 31, 2020. As of December 31, 2020, the 2025 Notes are not convertible at the option of the holder. The following table presents details of the Notes (number of shares in millions): Initial Conversion Price per $1,000 Principal Initial Conversion Price Initial Number of Shares 2023 Notes 24.0460 $ 41.59 5.5 2025 Notes 16.3875 $ 61.02 3.8 The holders may convert the 2023 Notes and 2025 Notes at any time on or after February 1, 2023 and November 1, 2024, respectively, until the close of business on the second scheduled trading day immediately preceding the maturity date, regardless of the foregoing circumstances. Upon conversion, we will pay or deliver, as the case may be, cash, shares of our common stock or a combination of cash and shares of our common stock, at our election, in the manner and subject to the terms and conditions provided in the Indenture. If we undergo a fundamental change (as set forth in the Indentures) at any time prior to the maturity date, holders of the Notes will have the right, at their option, to require us to repurchase for cash all or any portion of their Notes at a repurchase price equal to 100 % of the principal amount of the Notes to be repurchased, plus accrued and unpaid interest to, but excluding, the fundamental change repurchase date. In addition, following certain corporate events that occur prior to the maturity date or following our issuance of a notice of redemption, in each case as described in the Indentures, we will increase the conversion rate for a holder of the Notes who elects to convert its Notes in connection with such a corporate event or during the related redemption period in certain circumstances. We may not redeem the 2023 Notes or 2025 Notes prior to August 6, 2021 and May 6, 2023 (Redemption Dates), respectively. On or after the respective Redemption Dates, we may redeem for cash all or any portion of the 2023 Notes or 2025 Notes, at our option, if the last reported sale price of our common stock has been at least 130 % of the conversion price then in effect for at least 20 trading days (whether or not consecutive) during any 30 consecutive trading day period (including the last trading day of such period) ending on, and including the trading day immediately preceding, the date on which we provide the redemption notice at a redemption price equal to 100 % principal amount of the 2023 Notes or 2025 Notes to be redeemed, plus accrued and unpaid interest to, but excluding, the redemption date. Accounting for the 2023 Notes and the 2025 Notes In accounting for the transactions, the 2023 Notes and the 2025 Notes have been separated into liability and equity components. The initial carrying amounts of the liability components were calculated by measuring the fair value of similar debt instruments that do not have an associated convertible feature. The initial carrying amounts of the equity components representing the option to convert the Notes was $ 53.8 million and $ 48.3 million for the 2023 Notes and the 2025 Notes, respectively, and were determined by deducting the fair values of the liability components from the par value of the 2023 Notes and 2025 Notes. The equity components were recorded as an increase to additional paid-in capital and are not remeasured as long as they continue to meet the conditions for equity classification. The excess of 85 Table of Contents the principal amount of the 2023 Notes and the 2025 Notes over their respective carrying amount of the liability component, or debt discount, are amortized to interest expense using the effective interest method over the contractual terms of the respective Notes. In accounting for the debt issuance costs of $ 6.9 million and $ 7.2 million related to the 2023 Notes and the 2025 Notes, respectively, we allocated the total amount incurred to the liability and equity components of the 2023 Notes and 2025 Notes based on their relative values. Issuance costs attributable to the liability component were $ 5.3 million and $ 5.7 million, for the 2023 Notes and the 2025 Notes, respectively, and will be amortized to interest expense using the effective interest method over the contractual term of the 2023 Notes and 2025 Notes, respectively. Issuance costs attributable to the equity component of $ 1.6 million and $ 1.5 million for the 2023 Notes and the 2025 Notes, respectively, were netted with the equity component in additional paid-in capital. The effective interest rates for the 2023 Notes and the 2025 Notes were 7.36 % and 7.85 %, respectively. The net carrying amount of the liability components of the 2023 Notes and the 2025 Notes were as follows (in thousands): As of December 31, 2020 As of December 31, 2019 2023 Notes 2025 Notes Total 2023 Notes Principal $ 230,000 $ 230,000 $ 460,000 $ 230,000 Unamortized debt discount ( 30,425 ) ( 42,930 ) ( 73,355 ) ( 40,768 ) Unamortized issuance costs ( 3,009 ) ( 5,050 ) ( 8,059 ) ( 4,032 ) Net carrying amount $ 196,566 $ 182,020 $ 378,586 $ 185,200 The net carrying amount of the equity component as of December 31, 2020 and 2019 (for the 2023 Notes only) was as follows (in thousands): 2023 Notes 2025 Notes Total Debt discount for conversion option $ 53,820 $ 48,346 $ 102,166 Issuance costs ( 1,626 ) ( 1,514 ) ( 3,140 ) Net carrying amount $ 52,194 $ 46,832 $ 99,026 Interest expense related to the 2023 Notes and the 2025 Notes was as follows (in thousands): Year Ended December 31, 2020 Year Ended December 31, 2019 2023 Notes 2025 Notes Total 2023 Notes 2025 Notes Total Contractual interest expense $ 2,875 $ 3,450 $ 6,325 $ 2,875 $ — $ 2,875 Amortization of debt discount 10,342 5,417 15,759 9,567 — 9,567 Amortization of issuance costs 1,023 637 1,660 946 — 946 Total interest expense $ 14,240 $ 9,504 $ 23,744 $ 13,388 $ — $ 13,388 The future payments of the principal and contractual interest related to the Notes as of December 31, 2020 are as follows (in thousands): Principal Interest Total 2021 $ — $ 8,050 $ 8,050 2022 — 8,050 8,050 2023 230,000 8,050 238,050 2024 — 5,175 5,175 2025 230,000 2,588 232,588 Total $ 460,000 $ 31,913 $ 491,913 Capped Calls In connection with the offering of the 2023 Notes and the 2025 Notes, we entered into privately negotiated capped call transactions with certain counterparties (the 2023 Capped Calls and 2025 Capped Calls). The initial strike prices for the 2023 Capped Calls and the 2025 Capped Calls are $ 41.59 and $ 61.02 per share, respectively, subject to certain adjustments, which correspond to the initial conversion price of the 2023 Notes and the 2025 Notes. The initial cap prices for the 2023 Capped Calls and the 2025 Capped Calls are $ 63.98 and $ 93.88 per share, respectively, subject to 86 Table of Contents certain adjustments. The 2023 Capped Calls and the 2025 Capped Calls are expected to offset potential dilution to our common stock upon conversion of the respective 2023 Notes or the 2025 Notes, with such offset subject to a cap based on the cap price. The 2023 Capped Calls and the 2025 Capped Calls cover, subject to anti-dilution adjustments, approximately 5.5 million and 3.8 million shares of our common stock, respectively. For accounting purposes, the 2023 Capped Calls and the 2025 Capped Calls are separate transactions, and not part of the terms of the 2023 Notes and the 2025 Notes. The 2023 Capped Calls and the 2025 Capped Calls are recorded in stockholders' equity and are not accounted for as derivatives. Accordingly, the cost of $ 26.9 million and $ 27.3 million, respectively, for the 2023 Capped Calls and 2025 Capped Calls was recorded as a reduction to additional paid-in capital. The net impact to our stockholders' equity, included in additional paid-in capital, of the above components of the 2023 Notes and the 2025 Notes was as follows (in thousands): 2023 Notes 2025 Notes Conversion option $ 53,820 $ 48,346 Purchase of capped calls ( 26,910 ) ( 27,255 ) Issuance costs ( 1,626 ) ( 1,514 ) Total $ 25,284 $ 19,577 Credit Agreement On April 23, 2020, we entered into a Credit and Security Agreement (the Credit Agreement), with KeyBank National Association that provides for a $ 30.0 million revolving credit facility, with a letter of credit sublimit of $ 15.0 million and an accordion feature under which we can increase the credit facility to up to $ 70.0 million. We incurred fees of $ 0.4 million in connection with entering into the Credit Agreement. The fees are recorded in other current assets on the consolidated balance sheet and are amortized on a straight-line basis over the contractual term of the arrangement. The commitment fee of 0.2 % per annum on the unused portion of the credit facility is expensed as incurred and included within interest expense on the consolidated statement of operations. The Credit Agreement matures on April 23, 2023 and contains certain financial covenants including a requirement that we maintain specified minimum recurring revenue and liquidity amounts. In May 2020, we utilized the accordion feature to increase the credit facility to $ 50.0 million. The borrowings under the Credit Agreement bear interest, at our option, at a rate equal to either the London Interbank Offered Rate (LIBOR) rate (subject to a 1.00 % floor), plus an applicable margin equal to 2.50 % per annum or the alternate base rate (subject to a floor), plus an applicable margin equal to 0 % per annum. As of December 31, 2020, we did not have any outstanding borrowings and we were in compliance with all covenants under the Credit Agreement. As of December 31, 2020, we had a total of $ 8.1 million in letters of credit outstanding as collateral for certain office space leases and corporate credit card programs which reduce the amount of borrowing available under our Credit Agreement. (12) Leases Our leases primarily relate to office facilities that have remaining terms of up to 9.9 years, some of which include one or more options to renew with renewal terms of up to 5 years and some of which include options to terminate the leases within the next 6.7 years. All of our leases are classified as operating leases. The components of lease expense were as follows: Year Ended December 31, 2020 2019 (in thousands) Operating lease costs $ 14,881 $ 11,299 Short-term lease costs 1,033 1,140 Variable lease costs 4,870 3,388 Total lease costs $ 20,784 $ 15,827 87 Table of Contents Supplemental balance sheet information related to the operating leases was as follows: As of December 31, 2020 2019 (in thousands, except lease term and discount rate) Operating ROU assets $ 67,178 $ 60,984 Operating lease liabilities, current portion $ 9,612 $ 7,179 Operating lease liabilities, non-current portion 75,737 72,294 Total operating lease liabilities $ 85,349 $ 79,473 Weighted average remaining lease terms (in years) - operating leases 7.9 8.7 Weighted average discount rate - operating leases 7.7 % 7.6 % Supplemental cash flow information related to leases was as follows: As of December 31, 2020 2019 (in thousands) Cash paid for amounts included in the measurement of lease liabilities $ 16,159 $ 11,720 ROU assets obtained in exchange for new lease obligations $ 15,838 $ 65,873 Maturities of operating lease liabilities as of December 31, 2020 were as follows (in thousands): 2021 $ 15,035 2022 13,887 2023 14,177 2024 13,464 2025 12,552 Thereafter 41,958 Total lease payments $ 111,073 Less: imputed interest ( 25,724 ) Total $ 85,349 (13) Stock-Based Compensation ( a) General In connection with our IPO, our board of directors resolved not to make future grants under our 2011 Stock Option and Grant Plan (the 2011 Plan). The 2011 Plan will continue to govern outstanding awards granted thereunder. The 2011 Plan provided for the grant of qualified incentive stock options and nonqualified stock options or other awards such as restricted stock awards (RSAs) to our employees, officers, directors and outside consultants. In July 2015, our board of directors adopted and our stockholders approved our 2015 Equity Incentive Plan (the 2015 Plan). We initially reserved 800,000 shares of our common stock for the issuance of awards under the 2015 Plan plus the number of shares of common stock reserved for issuance under the 2011 Plan at the time the 2015 Plan became effective. The 2015 Plan also provides that (i) any shares subject to awards granted under the 2011 Plan that would have otherwise returned to the 2011 Plan (such as upon the expiration or termination of a stock award prior to vesting) will be added to, and available for issuance under, the 2015 Plan and (ii) the number of shares reserved and available for issuance under the 2015 Plan automatically increases each January 1, beginning on January 1, 2016, by 4 % of the outstanding number of shares of our common stock on the immediately preceding December 31 (known as the “evergreen” provision) or such lesser number of shares as determined by our board of directors. Additionally, on October 8, 2015, our board Table of Contents of directors amended, effective as of the acquisition of Logentries, the 2015 Plan to reserve an additional 1,500,000 shares of our common stock for issuance of inducement awards. In February 2020, March 2019, March 2018, March 2017 and March 2016, we registered the increase in the number of shares authorized to be issued under the 2015 Plan by 1,996,444 , 1,904,017 1,762,149 , 1,702,187 and 1,661,616 shares, respectively, which represents the amount automatically added pursuant to the annual evergreen provision contained therein. As of December 31, 2020, the shares of common stock authorized to be issued under the 2015 Plan totaled 15,788,542 and there were 2,305,220 shares of common stock available for grant. We recognize stock-based compensation expense for all awards on a straight-line basis over the applicable vesting period, which is generally four years . Stock-based compensation expense for restricted stock, restricted stock units (RSUs), performance-based restricted stock units (PSUs), stock options and purchase rights issued under our employee stock purchase plan was classified in the accompanying consolidated statements of operations 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 In the first quarter of 2020, our Compensation Committee adopted and approved the performance goals, targets and payout formulas for 2020 under our bonus plans, including permitting our executive officers and other employees the opportunity to receive payment of their earned bonuses for fiscal year 2020 in the form of common stock (in lieu of cash). For the year ended December 31, 2020, we recognized stock-based compensation expense related to such bonuses in the amount of $ 2.5 million, based on the performance attainment of the pre-established corporate financial objectives as of December 31, 2020. For all employees, including executive officers, who elected to receive their 2020 bonuses in the form of common stock (in lieu of cash), the payouts are expected to be made in the form of fully vested stock awards in the first quarter of 2021 pursuant to our 2015 Equity Incentive Plan, as amended. The number of shares underlying such awards shall be determined by dividing the dollar value of the actual bonus award payment by the closing price per share of our common stock on the date of grant. (b) Restricted Stock, Restricted Stock Units and Performance-Based Restricted Stock Units Restricted stock, restricted stock unit and performance-based restricted stock unit activity during 2020, 2019 and 2018 was as follows: 89 Table of Contents Restricted Stock RSUs and PSUs Shares Weighted- Average Grant Date Fair Value Shares Weighted- Average Grant Date Fair Value Unvested balance as of December 31, 2017 210,083 $ 18.00 1,988,509 $ 14.77 Granted — — 2,099,394 25.19 Vested ( 187,706 ) 18.80 ( 973,443 ) 17.41 Forfeited ( 700 ) 23.01 ( 340,687 ) 18.96 Unvested balance as of December 31, 2018 21,677 10.88 2,773,773 21.21 Granted — — 1,740,299 43.34 Vested ( 21,677 ) 10.88 ( 1,291,932 ) 24.42 Forfeited — — ( 285,216 ) 26.14 Unvested balance as of December 31, 2019 — — 2,936,924 32.43 Granted — — 1,725,531 57.57 Vested — — ( 1,451,618 ) 33.66 Forfeited — — ( 268,923 ) 40.56 Unvested balance as of December 31, 2020 — $ — 2,941,914 $ 45.86 As of December 31, 2020, the unrecognized compensation cost related to shares of unvested RSUs and PSUs expected to vest was $ 121.9 million. This unrecognized compensation will be recognized over an estimated weighted-average amortization period of 2.3 years. (c) Stock Options The following table summarizes information about stock option activity during the reporting periods: Shares Weighted Average Exercise Price Weighted Average Remaining Contractual Life (in years) Aggregate Intrinsic Value (in thousands) Outstanding as of December 31, 2017 4,684,954 $ 9.68 Granted 107,850 24.44 Exercised ( 944,658 ) 8.05 $ 19,982 Forfeited/cancelled ( 134,967 ) 15.20 Outstanding as of December 31, 2018 3,713,179 10.32 Granted — — Exercised ( 968,057 ) 10.55 $ 39,526 Forfeited/cancelled ( 9,730 ) 13.53 Outstanding as of December 31, 2019 2,735,392 10.10 Granted — — Exercised ( 783,645 ) 9.98 $ 39,095 Forfeited/cancelled ( 18,734 ) 17.87 Outstanding as of December 31, 2020 1,933,013 $ 10.07 4.05 $ 154,816 Vested and exercisable as of December 31, 2020 1,844,721 $ 9.75 3.94 $ 148,339 As of December 31, 2020, the unrecognized compensation cost related to our unvested stock options expected to vest was $ 0.5 million. This unrecognized compensation will be recognized over an estimated weighted-average amortization period of 0.5 years. The total fair value of stock options vested in 2020, 2019 and 2018 was $ 2.2 million, $ 3.7 million and $ 5.1 million, respectively. The weighted-average grant date fair value per share of stock options granted in 2018 was $ 11.86 per share. 90 Table of Contents (d) Employee Stock Purchase Plan On July 17, 2015, we filed a registration statement on Form S-8 with the Securities and Exchange Commission registering 800,000 shares of our common stock reserved under our 2015 Employee Stock Purchase Plan (ESPP). In February 2020, February 2019, March 2018, March 2017 and March 2016, we increased the number of shares to be authorized under the ESPP by 499,111 , 476,004 , 440,537 , 425,547 and 415,404 shares, respectively, which represents the amount automatically added pursuant to the annual evergreen provision of the ESPP. As of December 31, 2020, the shares of common stock authorized to be issued under the ESPP totaled 3,056,603 and there were 1,824,947 shares of common stock available for grant. Under the ESPP, employees may set aside up to 15 % of their gross earnings, on an after-tax basis, to purchase our common shares at a discounted price, which is calculated at 85 % of the lesser of: (i) the market value of our common stock at the beginning of each offering period and (ii) the market value of our common stock on the applicable purchase date. The fair value of shares issued under our ESPP are estimated on the grant date using the Black-Scholes option pricing model. The expected term represents the term from the first day of the offering period to the purchase dates within each offering period. The expected volatility is based on the historical volatilities of our own common stock. The risk-free interest rate is based on U.S. Treasury zero-coupon securities with maturities consistent with the estimated expected term. We have not paid dividends on our common stock nor do we expect to pay dividends in the foreseeable future. The following table reflects the assumptions used in the Black-Scholes option pricing model to calculate the expense related to the ESPP: Year Ended December 31, 2020 2019 2018 Expected term (in years) 0.5 - 1.0 0.5 - 1.0 0.5 - 1.0 Expected volatility 47 - 53 % 44 - 55 % 37 % Risk-free interest rate 0.1 – 0.3 % 1.9 – 2.5 % 2.0 – 2.6 % Expected dividend yield — — — Grant date fair value per share $ 9.63 – 22.30 $ 14.17 – 17.94 $ 6.62 – 10.95 On March 15, 2018, we issued 123,607 shares of common stock to employees, with purchase prices of $ 12.96 and $ 14.78 per share, for aggregate proceeds of $ 1.6 million. On September 14, 2018, we issued 96,108 shares of common stock to employees, with purchase prices of $ 21.96 and $ 14.78 per share, for aggregate proceeds of $ 2.0 million. On March 15, 2019, we issued 110,822 shares of common stock to employees, with purchase prices of $ 30.46 and $ 21.96 per share, for aggregate proceeds of $ 2.6 million. On September 13, 2019, we issued 74,221 shares of common stock to employees, with purchase prices of $ 30.46 and $ 42.22 per share, for aggregate proceeds of $ 2.9 million. On March 15, 2020, we issued 101,806 shares of common stock to employees, with a purchase price of $ 32.87 per share, for aggregate proceeds of $ 3.3 million. On September 15, 2020, we issued 131,585 shares of common stock to employees, with a purchase price of the shares was $ 28.39 per share, for aggregate proceeds of $ 3.7 million. (14) Income Taxes Loss before income taxes included in the consolidated statements of operations was as follows: Year Ended December 31, 2020 2019 2018 (in thousands) United States $ ( 72,846 ) $ ( 41,111 ) $ ( 39,754 ) Foreign ( 24,017 ) ( 12,692 ) ( 15,325 ) Loss before income taxes $ ( 96,863 ) $ ( 53,803 ) $ ( 55,079 ) 91 Table of Contents Income tax expense included in the consolidated statements of operations was as follows: Year Ended December 31, 2020 2019 2018 (in thousands) Current: Federal $ 8 $ 260 $ 124 State and local 122 109 126 Foreign 1,149 255 228 Total current tax expense 1,279 624 478 Deferred: Federal 9 9 ( 285 ) State and local 2 2 16 Foreign 696 ( 593 ) 257 Total deferred tax expense (benefit) 707 ( 582 ) ( 12 ) Income tax expense $ 1,986 $ 42 $ 466 The reconciliation of the federal statutory rate of 21% to the effective income tax rate for the years ended December 31, 2020, 2019 and 2018 was as follows: Year Ended December 31, 2020 2019 2018 Federal statutory rate 21.0 % 21.0 % 21.0 % State taxes, net of federal benefit ( 0.1 ) ( 0.2 ) ( 0.2 ) Permanent differences ( 4.0 ) ( 2.8 ) 0.2 Stock-based compensation 12.1 22.3 9.3 Federal research and development credit 1.1 1.3 1.2 Foreign rate differential ( 1.4 ) ( 1.4 ) ( 1.1 ) Change in valuation allowance ( 30.0 ) ( 41.0 ) ( 32.8 ) Other ( 0.8 ) 0.7 1.5 Effective income tax rate ( 2.1 ) % ( 0.1 ) % ( 0.9 ) % 92 Table of Contents Net deferred tax assets and liabilities, as set forth in the table below, reflect the impact of temporary differences between the amounts of assets and liabilities recorded for financial statement purposes and such amounts measured in accordance with tax laws: As of December 31, 2020 2019 (in thousands) Deferred tax assets: Accruals and reserves $ 1,272 $ 323 Net operating loss carryforwards 117,478 85,969 Deferred revenue 7,951 14,401 Depreciation 3,330 2,335 Research and development credits 6,201 4,665 Operating lease liabilities 20,967 19,657 Stock-based compensation 4,755 3,806 Tax credits 1,148 1,181 Other 2,105 61 Gross deferred tax assets 165,207 132,398 Valuation allowance ( 110,350 ) ( 94,581 ) Total deferred tax assets 54,857 37,817 Deferred tax liabilities: Intangible assets ( 5,717 ) ( 2,249 ) Operating lease ROU assets ( 16,233 ) ( 14,792 ) Convertible senior notes ( 17,961 ) ( 9,959 ) Deferred contract acquisition and fulfillment costs ( 15,908 ) ( 11,565 ) Other ( 543 ) ( 20 ) Total deferred tax liabilities ( 56,362 ) ( 38,585 ) Net deferred tax liabilities $ ( 1,505 ) $ ( 768 ) As of December 31, 2020, we have evaluated the need for a valuation allowance on deferred tax assets. In assessing whether the deferred tax assets are realized, management considered whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. Due to our history of generating losses in the United States, the United Kingdom and Ireland, we continue to record a full valuation allowance against our deferred tax assets in these jurisdictions. If we achieve future profitability, a significant portion of these deferred tax assets could be available to offset future income taxes. The valuation allowance increased by $ 15.8 million for the year ended December 31, 2020, primarily due to additional operating losses generated during the year. We plan to permanently reinvest the undistributed earnings of our foreign subsidiaries. If we repatriate these earnings, we may be required to pay U.S. state and local taxes, as well as foreign withholding taxes. As of December 31, 2020, we had federal and state net operating loss carryforwards of $ 376.7 million and $ 290.2 million, respectively. Of our federal net operating losses, $ 257.2 million will carry forward indefinitely. The remaining federal and state net operating loss carryforwards expire at various dates beginning in 2021. As of December 31, 2020, we had foreign net operating loss carryforwards of $ 157.8 million that can be carried forward indefinitely. We also had federal, state and international research and development credit carryforwards of $ 4.0 million, $ 1.9 million and $ 0.3 million as of December 31, 2020, respectively. These credit carryforwards expire at various dates beginning in 2023. We are currently subject to the annual limitation under Sections 382 and 383 of the Internal Revenue Code. We will not be precluded from realizing the net operating loss carryforwards and tax credits but may be limited in the amount we could utilize in any given tax year in the event that the federal and state taxable income exceeds the limitation imposed by Section 382. The amount of the annual limitation is determined based on our value immediately prior to the ownership change. Subsequent ownership changes may further affect the limitation in future years. We file income tax returns in all jurisdictions in which we operate. In the normal course of business, we are subject to examination by federal, state, and foreign tax authorities, where applicable. The statute of limitations for these jurisdictions is generally three to seven years. However, to the extent we utilize net operating losses or other similar 93 Table of Contents carryforward attributes such as credits, the statute remains open to the extent of the net operating losses or credits that are utilized. We have no tax returns under examination as of December 31, 2020. As of December 31, 2020 and 2019, we had no reserves for unrecognized tax benefits. (15) Net Loss Per Share The following table summarizes the computation of basic and diluted net loss per share of our common stock for 2020, 2019 and 2018: Year Ended December 31, 2020 2019 2018 (in thousands, except share and per share data) Numerator: Net loss $ ( 98,849 ) $ ( 53,845 ) $ ( 55,545 ) Denominator: Weighted-average common shares outstanding, basic and diluted 51,036,824 48,731,791 46,456,825 Net loss per share, basic and diluted $ ( 1.94 ) $ ( 1.10 ) $ ( 1.20 ) The shares underlying the conversion options in the 2023 Notes and the 2025 Notes were not considered in the calculation of diluted net loss per share as the effect would have been anti-dilutive. Based on the initial conversion prices, the entire outstanding principal amount of the 2023 Notes and the 2025 Notes as of December 31, 2020 would have been convertible into approximately 5.5 million and 3.8 million shares, respectively. We expect to settle the principal amount of the 2023 Notes and the 2025 Notes in cash. As a result, only the amount by which the conversion value exceeds the aggregate principal amount of the 2023 Notes and the 2025 Notes is considered in the diluted earnings per share computation under the treasury stock method. The conversion spread has a dilutive impact on diluted net income per share when the average market price of our common stock for a given period of time exceeds the initial conversion prices of $ 41.59 per share for the 2023 Notes and $ 61.02 per share for the 2025 Notes. In connection with the issuance of the 2023 Notes and the 2025 Notes, we entered into 2023 Capped Calls and 2025 Capped Calls, which were not included for the purpose of calculating the number of diluted shares outstanding, as their effect would have been anti-dilutive. During the three months ended December 31, 2020, the conversion feature of the 2023 Notes was triggered as the last reported price of our common stock was more than or equal to 130 % of the conversion price for at least 20 trading days in the period of 30 consecutive trading days ending on, and including, the last trading day of the immediately preceding calendar quarter, and therefore the Notes are currently convertible, in whole or in part, at the option of the holders. We had not received any conversion notices through the issuance date of our audited consolidated financial statements. For disclosure purposes, we have calculated the potentially dilutive effect of the conversion spread, which is included in the table below. The following potentially dilutive securities outstanding, prior to the use of the treasury stock method, have been excluded from the computation of diluted weighted-average shares outstanding for the respective periods below because they would have been anti-dilutive: Year Ended December 31, 2020 2019 2018 Options to purchase common stock 1,933,013 2,705,458 3,713,179 Unvested restricted stock — — 21,677 Unvested restricted stock units 2,941,914 2,936,924 2,773,773 Shares to be issued under ESPP 101,658 53,167 74,634 Convertible senior notes 9,299,432 5,530,176 5,530,176 Total 14,276,017 11,225,725 12,113,439 (16) Commitments and Contingencies (a) Purchase Obligations As of December 31, 2020, we have non-cancellable firm purchase commitments relating to cloud infrastructure services, including with Amazon Web Services (AWS), and software subscriptions. 94 Table of Contents The following table presents details of the future non-cancellable purchase commitments under these agreements as of December 31, 2020 (in thousands): 2021 $ 45,545 2022 42,017 2023 50,649 2024 61 2025 77 Total $ 138,349 (b) Warranty We provide limited product warranties. Historically, any payments made under these provisions have been immaterial. (c) Litigation and Claims In October 2018, Finjan, Inc. (Finjan) filed a complaint against us and our wholly-owned subsidiary, Rapid7 LLC, in the United States District Court, District of Delaware, alleging patent infringement of seven patents held by them. In the complaint, Finjan sought unspecified damages, attorneys' fees and injunctive relief. We intend to vigorously contest Finjan's claims. The final outcome, including our liability, if any, with respect to Finjan's claims, is uncertain. Regardless of the outcome, litigation can have an adverse impact on us because of defense and settlement costs, diversion of management resources and other factors. In addition, from time to time, we may be a party to litigation or subject to claims incident to the ordinary course of business. Although the results of litigation and claims cannot be predicted with certainty, we currently believe that the final outcome of these ordinary course matters will not have a material adverse effect on our business. Regardless of the outcome, litigation can have an adverse impact on us because of defense and settlement costs, diversion of management resources and other factors. (d) Indemnification Obligations We agree to standard indemnification provisions in the ordinary course of business. Pursuant to these provisions, we agree to indemnify, hold harmless and reimburse the indemnified party for losses suffered or incurred by the indemnified party, generally our customers, in connection with any United States patent, copyright or other intellectual property infringement claim by any third party arising from the use of our products or services in accordance with the agreement or arising from our gross negligence, willful misconduct or violation of the law (provided that there is not gross or willful misconduct on the part of the other party) with respect to our products or services. The term of these indemnification provisions is generally perpetual from the time of execution of the agreement. We carry insurance that covers certain third-party claims relating to our services and limits our exposure. We have never incurred costs to defend lawsuits or settle claims related to these indemnification provisions. As permitted under Delaware law, we have entered into indemnification agreements with our officers and directors, indemnifying them for certain events or occurrences while they serve as officers or directors of the company. (17) Employee Benefit Plan In December 2008, we established a discretionary 401(k) plan in which all full-time U.S. employees above the age 18 are eligible to participate after they have been employed for us for 90 days following the applicable date of hire. Matching contributions to the 401(k) plan can be made at our discretion. In 2020, 2019 and 2018, we made discretionary contributions of $ 2.9 million, $ 2.8 million and $ 2.0 million, respectively, to the plan. (18) Segment Information and Information about Geographic Areas We operate in one segment. Our chief operating decision maker is our Chief Executive Officer, who makes operating decisions, assesses performance and allocates resources on a consolidated basis. 95 Table of Contents Net revenues by geographic area presented based upon the location of the customer are as follows: Year Ended December 31, 2020 2019 2018 (in thousands) United States $ 329,753 $ 264,852 $ 199,852 Other 81,733 62,095 44,239 Total $ 411,486 $ 326,947 $ 244,091 Property and equipment, net by geographic area as of December 31, 2020 and 2019 is presented in the table below: As of December 31, 2020 2019 (in thousands) United States $ 40,101 $ 42,570 Other 13,013 8,100 Total $ 53,114 $ 50,670 (19) Subsequent Event 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. Supplementary Data The following table sets forth our unaudited quarterly consolidated statements of operations data for each of the eight quarters presented. We have prepared the quarterly financial data on the same basis as the audited consolidated financial statements included in this Annual Report on Form 10-K. In our opinion, the quarterly financial data reflects all adjustments, consisting only of normal recurring adjustment that we consider necessary for a fair presentation of this data. This quarterly financial data should be read in conjunction with our consolidated financial statements and related notes included elsewhere in this Annual Report on Form 10-K. Our historical results are not necessarily indicative of the results to be expected in the future. Three Months Ended December 31, 2020 September 30, 2020 June 30, 2020 March 31, 2020 December 31, 2019 September 30, 2019 June 30, 2019 March 31, 2019 (in thousands, unaudited) Consolidated Statements of Operations Data: Revenue: Products $ 104,384 $ 98,559 $ 92,430 $ 87,549 $ 82,997 $ 76,476 $ 72,579 $ 65,845 Professional services 8,775 6,516 6,482 6,791 8,651 6,679 6,380 7,340 Total revenue 113,159 105,075 98,912 94,340 91,648 83,155 78,959 73,185 Cost of revenue: Products 27,295 25,196 23,118 21,256 19,470 17,703 16,637 14,369 Professional services 6,399 5,832 5,963 6,458 5,892 5,927 5,544 5,604 Total cost of revenue 33,694 31,028 29,081 27,714 25,362 23,630 22,181 19,973 Operating expenses: Research and development 29,737 28,509 26,120 24,202 21,719 20,154 19,626 17,865 Sales and marketing 54,429 48,448 44,959 48,145 44,508 39,904 38,172 35,138 General and administrative 15,930 15,006 14,484 14,099 12,374 11,223 11,160 9,953 Total operating expense 100,096 91,963 85,563 86,446 78,601 71,281 68,958 62,956 Loss from operations (20,631) (17,916) (15,732) (19,820) (12,315) (11,756) (12,180) (9,744) Interest income 111 87 208 1,048 1,253 1,448 1,582 1,731 Interest expense (7,429) (7,328) (5,917) (3,462) (3,449) (3,399) (3,312) (3,229) Other income (expense), net 12 143 210 (447) 294 (492) (29) (206) Loss before income taxes (27,937) (25,014) (21,231) (22,681) (14,217) (14,199) (13,939) (11,448) Provision for (benefit from) income taxes 981 527 235 243 129 207 (519) 225 Net loss $ (28,918) $ (25,541) $ (21,466) $ (22,924) $ (14,346) $ (14,406) $ (13,420) $ (11,673) 96 Table of Contents Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure. None.