Good day, ladies and gentlemen and welcome to the Q3 2018 Rapid7 Earnings Conference Call. [Operator Instructions] As a reminder, today’s conference is being recorded. I would now like to discuss today’s conference call, Mr. Jeff Bray.

Thank you, operator and good afternoon everyone. We appreciate you joining us to discuss Rapid7’s Q3 2018 financial and operating results in addition to our financial outlook for the fourth quarter and full fiscal year 2018. I am Jeff Bray. I am here today with Corey Thomas, our President and CEO and Jeff Kalowski, our CFO. We distributed our Q3 2018 earnings press release over the wires. It is now posted on our website at investors.rapid7.com. We have also posted our updated company presentation and financial metrics file on our Investor Relations website. This call is being webcast and can be accessed at investors.rapid7.com. The webcast of this call will be archived and a telephone replay will be available until November 13, 2018. We would like to bring the following to your attention. The date of this call is November 6, 2018. Our discussion today contains forward-looking statements about events and circumstances that have not yet occurred, including without limitations, statements regarding our objectives for future operations and future financial and business performance. These forward-looking statements are based on our current expectations and beliefs on information currently available to us. Statements containing words such as anticipate, believe, continue, estimate, expect, intend, may, will and other similar statements are intended to identify such forward-looking statements. Actual outcomes and results may differ materially from the expectations contained in these statements due to a number of risks and uncertainties, including those contained in the Risk Factors section of our most recent quarterly report on Form 10-Q filed with the Securities and Exchange Commission on August 7, 2018 and subsequent reports that we filed with the Securities and Exchange Commission. The information provided on this conference call should be considered in light of such risks. Actual results and the timing of certain events may…

Thank you, Jeff and good afternoon everyone. Thank you all for joining us today on our third quarter 2018 earnings call. I am pleased to announce that Rapid7 had a great third quarter, reflecting strong performance across the world and across our product offerings. We are exceeding our growth goals while demonstrating greater operating leverage. In Q3 2018, we exceeded the high-end of our guidance with revenue and operating profit. Our total revenue under ASC 605 grew by 30% year-over-year. Our focus on ARR bookings has increased our recurring revenue, which for the first time, accounted for over 80% of our total revenue in the third quarter. Our ARR accelerated for the fifth quarter in a row, growing 46% year-over-year. We demonstrated operating leverage and we are making good progress towards our goal to be profitable in 2019 on a non-GAAP basis. Our strong results were driven by consistent execution by our go-to-market teams and continued product innovation. Our sales teams executed very well and have embraced selling subscriptions driving higher ARR. Our customers increasingly recognize the need for SecOps and specifically the value delivered by our cloud-based products. Our focus on innovation and our platform approach is driving adoption within and across product lines. During the third quarter, we added to our already broad set of market leading solutions, launching InsightConnect, which builds on our Komand acquisition from last year. As security teams try to balance increasing workloads with limited resources, complex ecosystems and rising threats, our customers are seeking solutions to streamline their processes to reduce risk and help them quickly respond to issues. InsightConnect, which is one of the first cloud native security orchestration automation and response solutions is designed to seamlessly integrate with the myriad of security, development, and IT systems that customers have today, including…

Thanks, Corey and good afternoon everyone. Before I begin discussing our strong results for the third quarter of 2018, I want to remind everyone that as of January 1 of this year, we adopted ASC 606 on a modified retrospective basis and therefore we have been reporting each quarter’s results in 2018 under both ASC 606 and ASC 605. We have included all of these details in our earnings press release today. When discussing our year-over-year growth rates and other key trends in our business, we will be comparing our results on an ASC 605 basis as we don’t have prior year operating results under 606 and a comparison would not be meaningful. We are pleased with our strong performance in the third quarter, which beat our guidance on all key metrics and was highlighted by accelerating ARR growth of 46% year-over-year, an increase of recurring revenue to over 80% of total revenue and meaningful operating leverage. First, I will briefly discuss our results on an ASC 605 basis. Total revenue for the third quarter 2018 was $65.5 million, an increase of 30% year-over-year, well ahead of our guidance. Recurring revenue was 81% of total revenue the third quarter of 2018, up from 71% in Q3 2017, representing a growth rate of 48%. Looking at the business geographically, in Q3, North America comprised 85% of revenue, growing 29% year-over-year. Rest of world revenue increased 33% year-over-year and contributed 15% of total revenue in the third quarter. On an ASC 605 basis, non-GAAP operating loss was $1.5 million, also meaningfully better than our guidance on a non-GAAP loss of $6.6 million to $5.2 million and adjusted EBITDA was positive $0.2 million for the third quarter compared to a loss of $5.6 million in the prior year period. Our non-GAAP operating margin…

[Operator Instructions] Our first question comes from Saket Kalia with Barclays Capital.

Hi, guys. Thanks for taking my questions here and congrats all around. Congrats Jeff in the new role. Congrats Neeraj on the new role as well.

Thanks, Saket.

First, maybe for you, Corey, I thought one of the important metrics in the quarter even though it’s a small increase, but just maybe psychologically is that expiring renewal rate, getting a nine handle on it. And so the question is how much of that in your view is from perhaps a more enterprise heavy customer base versus the perhaps naturally higher renewal rates that come from subscription in your view?

Yes, it’s a great observation. As you know, it’s been steadily increasing. The dominant effect actually was that our platform customers have a much higher renewal rate overall than our non-platform customers. So, as more and more of our customers move to the platform and as our recurring and subscription revenue accelerates, we are actually seeing much higher renewal rates on our platform customers than others. And that’s driving it higher in an environment by the way where we are introducing lots of new products and newer products tend to have lower renewal rates than mature products. And so it’s something we are quite pleased with even as we continue to actually add new products overall to the platform.

Got it. That’s helpful. Jeff Kalowski, for my follow-up for you, we have talked about sort of professional services revenue and bookings being lower as we have sort of transitioned more to the ARR focus. The question is where do you think that professional services line maybe bottoms, whether that’s as a percentage of revenue as a minimum dollar amount per year per quarter, how do you think about professional services in the context of the model sort of longer term?

Yes. So Saket, clearly it’s been slowing down this quarter. And as we said earlier, with the comp plan focus and our sales force driving more ARR that has certainly had effect and it’s been a favorable change. Secondly, we also decided to focus on more higher strategic services and I will point out that those higher strategic services engagements are higher margin, which with our margins going down it’s more due to some excess capacity. However, it’s too early to really say where the trough is. It will be a lower percentage of the total revenues, but I think what – at this point, let’s close out the year. We have got another quarter to go and on our February call, we will give better guidance on where we think that will go in 2019.

Got it. Very helpful. Thanks, guys.

Our next question comes from Rob Owens with KeyBanc Capital Markets.

Great and thanks for taking my question. I guess, first and foremost, as you guys have meaningfully expanded your product portfolio, what has the channel response been? As you get into some more of the traditional type of SIEM and endpoint categories, has this helped channel or is there more complexity given kind of the broader suite approach coupled with more of a subscription model, just curious at this point what the channel leverage looks like?

So I would say our demand from the channel has actually grown and continues to grow. And I think that’s more a reflection of the channel sees, long-term opportunities with Rapid7. I think we are still in the early innings of our expansion into the channel. Now, we are really focused on which channel partners have the right capability, but it’s clear that we actually have accelerating growth. We have built a broader portfolio and especially if you look at our Komand technology, that provides a vast amount of opportunity for our channel partners to actually make money on our platform. And channel partners are recognizing that. So both the inbound interest that we have from channel partners and our discussions with them make it very, very clear that we have lots of expansion opportunity with the channel and I think we are in a great position at this point, but it’s still early innings.

And number two, I would love some of your thoughts just in general around InsightVM and I know there is a lot of speculation that maybe VM slows next year as other categories in security take precedence, what do you think relative to your opportunity for InsightVM as you look at ‘19 and clearly the other parts of your portfolio are going to be growing faster, but just kind of a general outlook for VM as we enter next year?

Yes. So the first thing is that the VM market is doing incredibly well. We see that it’s an incredibly healthy market overall. And frankly, it’s much healthier than we expect or anticipate if you think about the plans that we shared at our past Analyst Day. What we see is that the demand for visibility in general has lots of legs well into the future because people environments are complex, they are changing and they want to know what do I have, what’s the risk of what I have and what’s happening in my environment, how do I best optimize and respond to the changes in my environment and how do I make myself more efficient. But visibility is a core part of SecOps and we see continued demand for that. As far as vulnerability management as it goes forward in the future, I think the underlying baseline of the aspect of visibility it provides continues to be a core demand driver. As I have said, it’s well ahead of what we expected in our models and so if it continues to be strong that’s great. We have strong upside to the plan, but we are really focused on overall visibility and how that translates to people’s security operations.

Thanks Corey.

Thank you.

Our next question comes from Gur Talpaz with Stifel.

Great. Thanks for taking my questions and congratulations on the results here. So if we look at the growth in ARR, congrats again on the acceleration there, how should we think about the underlying fundamental drivers of that expansion, meaning is it asset expansion within VM, is it adoption of IDR or AppSec, all of the above, how would you sort of categorize the different components that have driven that relative acceleration?

So it truly has been broad based. We see it across our portfolio. We see it across the customer expansion. We talked in the call about the ARR per customer expanding, so we are clearly seeing strength within our customer base. We see it in the new customers that we are adding. We talked about adding 10% growth in our customer base, but that really is a tale of two stories where we have services only customers that are more tactical and more transactional is contracting and we have much higher expansion in our strategic SecOps product customers. And so it very much is broad based growth across all of those different dimensions that is leading to the higher ARR growth. But I do want to be clear is that one of the underpinnings is we have very strong performance in the core vulnerability management market, even as we actually are aggressively expanding into the other parts of the SecOps market and opportunity.

That’s helpful. And then speaking of the expansion, the other opportunities, with the launch of InsightConnect, I know it’s early days, but can you talk about, one, the initial customer response, but perhaps more importantly can you talk about how InsightConnect compares relative to sort of the standalone SOAR platforms that exist out there and the relative advantages you have through integrated platform? Thank you.

Absolutely. So first and foremost, as you may recall, we actually accelerated the launch of InsightConnect based on customer feedback. We had originally told you that it would be some time in 2019, but we made it through our first incubation cycle much quicker than we expected, both as a result of great engineering work, but also great customer feedback and go to market team engagement work with our customers. So I would say the feedback so far, it’s very early, has been extraordinarily positive. On your second point as far as the differentiation, we really think of the differentiation in two parts over time. The first part, which we think is important is we think that the SOAR market and security orchestration automation market is a mainstream market. This is a prime use case that has really is going to have productivity improvements and impacts for customers both large and small and we are really focused on a solution that actually makes it extraordinarily easy and simple for customers of all sizes and skill sets to get the benefits of those productivities. So the ease of use and the built-in integration is of course the key focus and a long-term differentiator. And that’s true in a standalone case. The additional benefit that we actually have baked it into our platform is that we have quite a large customer base and those customers get great experiences right out of the box that allows them to get faster productivity and get experience with security orchestration and automation on a product platform that they are used to come forth and already are baking in an increasing amount of their IT and security infrastructure.

Thank you. Our next question comes from Matt Hedberg with RBC Capital Markets.

Hey, good afternoon guys. Thanks for taking my questions. International continues to do well and it’s an area of focus for you guys, I am curious and as you think about heading into next year, when you think about the opportunity internationally, how do you think about additional investments there and from a broad adoption perspective, where is that market relative to the U.S., especially as your platform expands beyond VM?

Yes. If you look at our percentage of revenue basis, it’s still under 20%. We think it has massive expansion opportunities. If you look at it, we really started looking at it on a per ARR basis as we go forward and you continue to see it actually continue to climb up year-by-year as a percentage of ARR and as a percentage of revenue, but definitely as a percentage of ARR. As we actually add more cloud instances around the world, you all know the geopolitical backdrop. More and more countries want to have an instance in their own territories and we have been adding more instances around the world. We added the Australia instance this year. We expect that dynamic to continue to happen and we think we have lots of upside there. And one of the things we continue to see is that the overall international market is behind the U.S. market in terms of security spend. And we think that’s changing. You definitely see that in Europe where we are seeing strong and healthy performance, but we expect that continued to change overall and we expect the international market to grow faster than the U.S. market in general.

That’s great. And then maybe a follow-up on the prior question on Connect, can you help us with how that’s priced and if a customer, I mean with the pre-built integration with VM and IDR, it seems like it’s going to be a natural up-sell, if you think about like what that could mean on a per customer ARR basis, any sense on kind of what the uplift would be there?

Yes. And so I would say it’s too early. It’s priced on a per workflow basis because that’s the natural way and that’s the least friction way for customers to price it. And we think that this has one of those viral effects that can lower the cost of our sales and marketing over time is because if you think about it, if customers have a great experience with a couple of workflows, the expansion of workflows is quite natural. And so one of the things that we are paying attention to is sort of like what’s the average workflows per customer and how does that evolve over time. And we in fact are seeding our workflows in our InsightVM and InsightIDR solutions and we think the feedback on that, at least from some early conversations has been positive. But it’s too early to tell what the average workflows per customer will be overall.

That’s great. Thanks for that guys. Congrats on the results.

Thank you so much.

Our next question comes from Michael Turits with Raymond James.

Hey guys. This is Eric Heath on for Michael. Congrats on the quarter. And then a question for you Corey, just a follow-up on Rob’s question earlier, could you elaborate on your penetration of VM with the existing customers and then further to that, can you talk about some of the puts and takes of why customers are choosing to expand their visibility or maybe they are hesitant in expanding their coverage, just curious on your thoughts on that?

Yes. We haven’t seen hesitancy in expanding, so I think the backdrop you are asking is we are clearly growing our new customers and that’s working well there. But you are also highlighting the fact that regardless of cross-sell, we are actually growing the up-sell into customers’ accounts and customers are actually getting more VM visibility with us. And that is an extraordinarily healthy dynamic. I think that’s driven by two factors. One, they actually have more assets and more types of assets that they need visibility into, whether that’s cloud assets, whether that’s IoT assets in the future, there is more and more assets that they are looking for visibility into. The second thing is that VM customers have historically been under-penetrated. Now, the environment is changing because they are adding more assets, but we think across our customer base, we still have substantial room to actually grow the up-sell and cross-sell. Part of the reason that we can do this though, is that we are still adding new customers to the platform. And so of course, that customer is capped at 100% of their asset and we have been growing the assets of our customers, but we continue to add new customers into our customer base that are starting off at lower levels and then they grow and expand over time. And so that actually creates a positive dynamic for us in the overall VM market and gives us more sustainability on the up-sell dynamics.

Got it. And then a question for Jeff, if I may. I know you guys are moving away from billings as a metric, but could you provide any color on some of the moving pieces for the deceleration in current billings on a 605 basis?

Well, we don’t have any comparative data from the prior year if you are trying to look at the change in short-term billings by taking the revenue plus the change in current deferred because it’s really not meaningful. If you look historically, we are losing the perpetual value of the 1 year portion, which makes it look like it’s slowing down and also the decline in services, which is generally all billed up front also effects the change in current billings. So that’s one factor affecting the change, but that’s why we talk about ARR. That’s really the most important metric, not billings. And as we said earlier, we don’t guide to billings for a couple of reasons. One is that we are going through the transition to subscription and it’s not meaningful year-over-year and really the focus is on ARR.

And then just one last one if I may is there a run-rate on R&D for tCell?

No, they have low teens in the number of employees plus their OpEx. So that’s where they are right now in terms of employees.

Okay, thank you.

Our next question comes from Alex Henderson with Needham.

Hi, good afternoon. This is Dan Park on for Alex. Thanks for taking my questions. So as you continue to broaden the Insight platforms and incorporate more SecOps features, is this helping to drive more competitive displacement opportunities versus other VM centric vendors? Clearly, there is plenty to go around with three of the major players all growing at a 20% plus clip and also have you seen a meaningful change in overall competition?

There is no meaningful change in overall competition. I think the market has great dynamics. I think there is a large market that can support a number of different winners. We don’t focus that heavily on the competition in the VM market overall. I would say that displacement is one of the things that we do primarily when customers are looking to operationalize security and they love our platform story. And they love the story of what we are bringing and how we’re tying it all together and driving productivity for the organization. But we don’t have a strategy that says we have to grow by going out and taking from others. Ours really comes from customers who are looking to operationalize their security, customers that value productivity enhancements and that want the full visibility that we have and we are focused on those customers that have the most lifetime customer value for us. And occasionally, those customers are displacing other vendors but that’s not a focus of our growth.

And as a follow-up, how big of a nut do you expect a step up in OpEx to be with the R&D from tCell and the systems improvement initiatives called out in Q4? Is this expected to continue for a few quarters or is it really just a one-time impact?

Well, what we said is that we shifted some expenses that did not hit in Q3 into Q4 with respect to next year’s growth. What we said is that our OpEx is not having a material effect to the full year in OpEx and revenue in 2018. We will provide a better update when we give guidance in February for the year, the overall year.

Yes. And I will provide some of the color behind it. So one, as we actually said in our script, we are not changing our profile that we actually expect as we go forward. The other thing that I would highlight is that because our ARR is higher and because our go-to-market engine and more importantly, our customer engine is working faster and better than expected, we actually have increasing confidence in the long-term leverage of the overall model. And the systems investments that we are making specifically in subscription management, specifically in some of our back-end systems really are all about driving long-term efficiency and increasing the sustainable profitability level over time.

Okay, great. Thanks for the clarification.

Thank you.

Our next question comes from Jonathan Ho with William Blair.

Hi, good afternoon. I just wanted to start with tCell, can you talk a little bit about what you are adding with tCell that you didn’t have before with your AppSec capabilities?

Yes, that’s great. So the backdrop or the context as we enter is that cloud-based applications are a new standard and a new norm of the type of applications that we are experiencing. If you think about the last 20 years, most of the applications were built and designed on premise and we know we have this substantial growth of SaaS and cloud-based applications that by the way is not just the traditional technology companies, it’s companies of all sizes and scales that are making applications. So you have this massive application proliferation of cloud-based applications. We have one of the leading technologies on the dynamic testing. So how do you actually test the applications about how they perform real-time from a security perspective? What tCell allows us to do though is it allows us to actually monitor those applications real-time from an embedded perspective to actually look, are they being attacked, are they being compromised, and then shift that monitoring to protecting those applications real-time. It’s part of our continuing strategy to actually really turn application security into a long-term massive growth pillar and opportunity. And the underlying fundamentals, is there is lots of new cloud-based applications that are on the market and that will be on the market and this is a market that has incredibly positive competitive dynamics. And we think that we are going to be positioned with continued investment to be a leader overall in this market.

Got it. And then just as a follow-up as you start to see more platform sales, are you starting to see maybe customers look at your products and not lead with the VM sales. So, potentially multiple tips of the spear that you maybe didn’t have in the past. I just wanted to get a sense of whether there is any potential there on the non-VM side?

I mean, absolutely and that’s frankly expanding. We originally thought that it would be sell VM first and then sell the other products. Then IDR proved that half of the sales were to net new customers that didn’t have a VM solution so we proved that we could do it. Increasingly now, our sales team has the luxury of just going in and saying, hey, what’s your biggest problem? And then if it’s application security, we can solve that. If it’s vulnerability management, we can solve that. If it’s monitoring instance action response, we can solve that or if you have one of our competitors’ VM solutions and another competitor’s SIEM solution and you really want to take that data and then use the automation workflow, we can go in and help you get better productivity off the existing data solutions we have. We’ll do a great job for you and then you’ll be more likely to move over time. Increasingly, we have the capability to go in and just say, what’s your problem or how do we add the most value and that drives long-term go-to-market and sales productivity, because we don’t have to force the conversation. We can just start with the point and greatest pain.

Thank you. Our next question comes from Gregg Moskowitz with Cowen & Company.

Okay, thank you and congratulations guys on a good quarter. I had a follow-up on InsightConnect. My understanding is that InsightVM and IDR do include some more basic automation functionality. So if you could elaborate on that and how much appeal you think InsightConnect offers to those customers of yours going forward? That will be helpful.

Yes, absolutely. So one of the things that we look at when we do expansion and especially acquisitions is that it should be a great large TAM expansion in its own right, but it’s also to differentiate our existing products and offerings first as competitors in the market. And InsightConnect is a perfect example of that. So, we talked earlier about how it actually compared favorably and what the overall dynamics in security orchestration and automation were, but it also does an amazing job of differentiating our solutions. One of the biggest complaints that people have – I will use the vulnerability management market, for example – in vulnerability management is that it’s great. You provide visibility, you provide understanding. I know what to do. I don’t have the capacity to go actually remediate and fix all of these issues. And so we embedded and included in there at actually no cost automation scenarios that allow people to actually connect to their patch management and their configuration management systems and automatically translate from vulnerability management to automatically updating their systems to improve the productivity of the overall IT and security teams. Again, vulnerability management, I have issues. I want to automatically contain vulnerabilities in my environment so I can patch them automatically integrates into the network infrastructure that allows automatic containment or orchestrated containment. That allows our customers to be more productive on our solutions than they are on competitive solutions. And again, customers prefer us because of our operation focus and the productivity that we drive to in our teams. If you take IDR, again it’s great to actually know that you have an incident. It’s great to investigate an incident, but the entire SIEM market has been lacking the ability to really respond to the incident. That’s been an outsourced affair and what we are doing with automation, with our InsightConnect product, is we are tying the analytics and the investigation to the response operations allowing you to automatically contain and limit the damage by tying both security and IT together. So what that means is that if I find an issue with a user, I can automatically integrate with identity and access management system. If I find an issue with the device, I can automatically contain that device on my network. Again, part of our value proposition with our security operations overall stack is that it allows different teams across both development, security and IT to work together more efficiently. And what we have included in our products from an automation perspective is just one example of that. And our expectation is that as people get experienced with that, they will continue to expand their footprint and workflows over time.

That’s really helpful, Corey. I appreciate the color and all the detail on that. And then just as a follow-up, you did mention earlier that you are starting to see more traction in retail and hospitality as those customers realize they need a more secure infrastructure and I am wondering if there is anything that you are putting in place to emphasize your go to market focus on these industries or is this just a function of seeing more pull from those customers? Thanks.

Yes. When we see more pull from customers, we actually take that into account in our go to market plan and our territory assignments. And so we shift our focus about how we plan and allocate our go to market resources, be it from a market perspective or from a sales lease source allocation perspective as we see different opportunities.

Alright, terrific. Thank you.

Our next question comes from Melissa Franchi with Morgan Stanley.

Hi. Thank you for taking my question. I wanted to follow-up on the tCell commentary. Corey, should we anticipate that tCell will eventually become its own product on the Insight platform or is it largely going to be developed into InsightAppSec. And then just very broadly, if you could just maybe give us an update of how InsightAppSec is progressing relative to your expectations, it’s a product that we haven’t heard too much about recently, so would love to get an update?

I would say InsightAppSec in general is well ahead of our expectations. The market is stronger. Our position is stronger and we are very optimistic about the overall application security market in general. I would say on the packaging, it’s too early to tell. We are very disciplined when we acquire technology about putting them through our incubation engine, which really figures out what’s the optimal go to market pricing package positioning and messaging that drives the most adoption and the most efficient customer acquisition for that particular product category. So you will see us with a single or a set of application security offerings, because it’s a big market for us. But we are really focused on how do we minimize customer friction and how we maximize customer lifetime value in this fast growing market.

Yes. And Melissa, I will just add that the revenue is accelerating much faster than our overall growth rate both in the ARR and in revenue. It’s doing very well.

And then lastly, it’s just a market that’s under-penetrated in general and that we are under-penetrated in. So we have great growth prospects in this market. I also say we would really like competitive dynamics overall in the cloud based application security market.

Got it. Okay. And then a follow-up for Jeff, Jeff this year, we have obviously seen a divergence between ARR growth, billings and revenue growth and obviously that’s from the subscription transition and contract duration changes, as we are looking into FY ‘19, I know you are not guiding, but how should we think about the relative relationship between those top line metrics and how to think about relative growth between those?

Yes. So if you look at our overall ARR growth, what we are saying is this year we are going to be over 40% and our recurring revenue today is about over 80% of the total. And we are saying that the ARR will grow 30% over the course of the next 2 years. So if you take our recurring revenue and you assume that that will grow 30% into next year and you apply a factor for services and the perpetual revenue is roughly $3 million in the quarter, that’s going to decline slightly into next year, you can sort of get directionally to where the revenue will be for next year.

That’s very helpful. Thank you.

And I am not showing any further questions at this time. I would like to turn the call back over to our host.

Thank you all for joining us for this quarter’s call. I appreciate your time and we look forward to talking to you next time.

Ladies and gentlemen, this does conclude today’s presentation. You may now disconnect and have a wonderful day.