Rapid7 Q3 2023 Earnings Call Transcript

Quartr
Provided by Quartr
November 1, 2023

There are 16 speakers on the call.

Operator

Good afternoon. My name is Rob, and I will be your conference operator today. At this time, I would like to welcome everyone to the Rapid7 Third Quarter 2023 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer session.

Operator

Thank you. Elizabeth Schwach, Director of Investor Relations, you may begin your conference.

Speaker 1

Thank you, operator, and good afternoon, everyone. We appreciate you joining us today to discuss Rapid7's Q3 2023 financial and operating results Investor Relations in addition to our financial outlook for the Q4 and full fiscal year 2023. With me on the call today are Corey Thomas, Consumer Financial Officer, our CEO and Tim Adams, our CFO. We have distributed our earnings press release over the wire and it is now posted on our Web site at investors. Rapid7.com, along with the updated company presentation and financial metrics file.

Speaker 1

Investor Relations. This call is being broadcast live via webcast and following the call, an audio replay will be available at investors. Rapid7.com. During this call, we may make statements related to our business that are considered forward looking under federal securities laws. These statements are made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995 and include statements related to the company's positioning, strategy, business plans, restructuring plans, financial guidance for the Q4 and full year 2023, Financial goals for the full year 2024 and the assumptions underlying such goals and guidance.

Speaker 1

These forward looking statements are based on our current expectations and beliefs and on information currently available to us. Actual outcomes and results may differ materially from the future results press or implied in these statements due to a number of risks and uncertainties, including those contained in our most recent quarterly Report on Form 10 Q filed on August 9, 2023, and in the subsequent reports that we file with the SEC. Investor Relations. The information provided on this conference call should be considered in light of such risks. Actual results and the timing of certain events may differ materially from the results or timing predicted or implied by such forward looking statements and reported results should not be considered as an indication of future performance.

Speaker 1

7 does not assume any obligation to update the information presented on this conference call, except to the extent required by applicable law. Investor Relations. Our commentary today will primarily be in non GAAP terms and reconciliations between our historical GAAP and non GAAP results can be found in today's earnings press release and on our website at investors. Rapid7.com. At times, in our prepared remarks or in responses to your questions, we may offer incremental metrics to provide greater insight into the dynamics of our business for our quarterly results.

Speaker 1

Please be advised that this additional detail may be one time in nature Investor Relations Officer and we may or may not update these metrics in the future. With that, I'd like to turn the call over to our CEO, Corey Thomas. Corey?

Speaker 2

Good afternoon, everyone, and thank you for joining us today on our Q3 2023 earnings call. Rapid7 ended the 3rd quarter with $777,000,000 in ARR, 0.14% over the prior year, While delivering revenue and operating income above our guided ranges. During the Q3, we continued to see strong demand for Integrated Security Operations Solutions across our Insight platform. Our value proposition is resonating with mainstream enterprise customers, particularly with our consolidated offerings. Over 40% of new ARR in the Q3 was from either a threat or cloud risk complete deal, and Exchange Commission.

Speaker 2

We are executing our strategic focus around supporting the modern or extended SOC with integrated best of breed capabilities Across Risk Management and Threat Detection. As we sell more of our platform together, we see deal sizes getting larger as ASPs have steadily increase all year. Overall, we saw a customer spending environment that was in line with our expectations and remained stable Q3 and into October. Amid the worsening consequences for cybersecurity incidents and the persistent challenge of proactively securing IT environments in an efficient manner. We consistently hear a set of themes from conversations with customers.

Speaker 2

There is need for integrated cloud security offerings with InsectOps as well as a desire to upgrade to cloud native detection response programs and Automation and integrated expertise are often critical differentiators in choosing technology partners. While security team leaders are prioritizing spending around these areas, the budget environment remains complex. Consumer with the last 12 months, we continue to see higher levels of approval during extended procurement cycles. The good news is that our sellers have become more adept in navigating this environment and there is still urgency from customers on projects around cloud security and Detection and Response, the anchors of our successful risk and threat management offerings. Our critical role as a strategic partner to SecOps teams is reflected in the growing number of long term commitments we're seeing from customers.

Speaker 2

Our total weighted average contract length in the quarter was up 20% over the prior year, which speaks to the value and confidence our customers have and Rapid7 as a long term technology partner. Turning now restructuring we announced alongside our Q2 earnings results in August. Our efforts to streamline the business are mostly complete and we are progressing on our areas of strategic reinvestment. I am proud of how well our Rapid7 team has responded to the changes as we have worked to optimize our organization and underlying cost structure over the past few months. Collectively, our strategic alignment is benefiting profitability as we expected and we continue to expect the full year 2023 operating margin to span over 7.50 basis points from the prior year and to generate free cash flows of approximately $80,000,000 Regarding our customers, we had an intentional focus during the latter half of the third quarter on ensuring continuity and strong overall customer experience as we executed our transition plan.

Speaker 2

Our customer facing teams were heavily focused on spending more time Engaging with and Messaging to Existing Customers and Prospects with less relative focus on scaling incremental pipeline. The result is that our changes were widely well received by customers, driving strong conversion rates that fueled solid overall ARR growth quarter. Now that we are largely through these changes, our teams are incrementally more focused Investor Relations team on engaging broadly to drive strong and improving pipeline momentum as we exit the year. And we believe we remain well positioned to achieve our Q4 objectives. Regarding reinvestment into our strategic areas of focus, we're accelerating our leadership in the extended stock as well as further scaling our ability to offer expertise alongside our technology.

Speaker 2

While it's still early, we are progressing well in both areas, and I'll give you tangible examples of the positive traction we're seeing in the business. We continue to see strong demand for our integrated consolidation solutions to support the extended stock. And we continue to innovate by adding end to end capabilities to expand our value proposition to mainstream inter process. In October, we announced the general availability of multilayered endpoint protection for our managed detection and response customers. By offering integrated next gen antivirus alongside digital forensics and incident response capabilities On to our Insight Agent, we are elevating the breadth and holistic visibility of our extended detection and response.

Speaker 2

We saw a meaningful gap in the market for customers with legacy endpoint solutions that are focused on affordable, highly effective solutions. Our expanded offerings will now enable these MDR customers to benefit from reduced endpoint security cost and complexity within their SOC, while freeing up additional budget dollars by consolidating onto our Insight platform. We also continue to see traction Cross selling across our integrated platform of solutions. A good example of this is in the 3rd quarter was a deal with a midsized FinTech Company owned by a large private equity firm. This customer became a Rapid7 vulnerability management customer in 2022 and earlier this year extended their enterprise risk visibility with our cloud security offering.

Speaker 2

They reached out again in the 3rd quarter to explore our Managed Direct Complete offering after facing additional resource constraints and regulatory requirements. With transfer dollars that weren't part of their initial budget and after a competitive process, the customer chose Rapid7 for our ability to detect and respond to threats and Exchange Commission across their entire security environment and throughout each phase of the DNR lifecycle. With our Insight Agent already deploy the customer is able to implement our robust monitoring capabilities within days of their purchase, allowing a quick return on their security budget dollars. Our ARR with the customer more than tripled to the high 6 figures over the course of 18 months, highlighting the urgency and the value resource constrained enterprises place on best in suite solutions within strategic areas of security operations. We're also scaling our ability to offer integrated expertise alongside our SecOps solutions by accelerating our strategic managed services partnerships.

Speaker 2

I am pleased to announce that we signed a partnership deal in the 3rd quarter with a nationwide leader in communication services who chose Rapid7 Technology as the foundation for their managed detection and response offering. It was a highly competitive process and our new partner needed a single provider to help their customers manage security across their entire network, Endpoint Server and Cloud Infrastructure, while helping to contain and disrupt ongoing security breaches. This partnership will combine our best in class threat detection and response platform and global stock presence to help small, medium and large enterprise customers better manage an ever evolving and challenging cyber threat landscape. Service. Over time, we'll have the opportunity to expand our partnership to sell other Rapid7 solutions to their substantial customer base.

Speaker 2

Service. We're excited about this partnership and our ability to leverage similar partnerships in the future as we scale our ability to offer integrated expertise to more customers. Cyber remains focused on being the leading provider of integrated security solutions for the extended SOC by providing risk and threat management within the context of overall security, alongside expertise tailored to the needs of each customer. We are pleased with our Q3 results and continue to march forward towards our goals. When we updated our ARR guidance in August, Alongside the announcement of our restructuring and strategic realignment, we established a high confidence range to account for modest degrees of disruption in the business.

Speaker 3

Investor Relations. As we make

Speaker 4

progress, we've seen performance track within our range of expectations.

Speaker 2

Given larger deal cycles, as well as the heavy concentration of large deals in the Q4, we believe it is prudent to reiterate our full year ARR guidance $800,000,000 to $805,000,000 All in all, we are pleased with our 3rd quarter results and early progress we are making as we work to reaccelerate growth by reinvesting into strategic areas of strong customer demand within our business. We were able to outperform on our operating income targets in the Q3 and to flow through that upside to our full year guidance range. Investor Relations. This speaks to the benefit of our new streamlined cost structure, which will allow us to become a more profitable growth company. We expect to generate approximately $80,000,000 of free cash flow this year and then double that figure to at least $160,000,000 next year in 2024.

Speaker 2

With that, thank you for joining us on the call today. I will now turn the call over to our CFO, Tim Adams to share additional detail on our financial results and outlook. Tim?

Speaker 5

Thank you, Corey. Good afternoon to everyone on today's call and thank you for joining us. Before I turn to the results, a quick reminder that except for revenue, all financial results we will discuss today are non GAAP financial measures, Investor Relations, unless otherwise stated. Additionally, reconciliations between our GAAP and non GAAP results can be found in our earnings press release. Rapid7 ended the Q3 of 2023 with $777,000,000 in ARR, Growing 14% over the prior year on solid demand for our consolidated offerings across risk management and threat complete.

Speaker 5

Customer continue to gravitate towards our integrated solutions anchored in detection and response and cloud security, Retail, which made up over 40% of new ARR in the 3rd quarter. Our value proposition is resonating with customers as we see ASPs continue to climb and our average contracts get longer. We saw relatively balanced contributions from new and existing customers in the Q3. ARR per customer grew 7% over the prior year to $68,100 and we ended the quarter with over 11,400 total customers, Conference Call, reflecting 6% growth over the prior year. 3rd quarter revenue of $199,000,000 represented growth of 13% year over year, exceeding the high end of our guidance range.

Speaker 5

Product revenue grew 14% year over year $190,000,000 as customers continue to prioritize budget dollars around projects in our areas of strategic focus, both around the extended SOC and the ability to offer integrated expertise. International revenue made up 22% of total revenue, while North American represented 78%. Moving on to operating and profitability measures for the quarter. Product gross margin was 77%, in line with the prior year and total gross margin was 75%. Operating expenses reflect the changes to our cost structure that we implemented in August.

Speaker 5

Sales and marketing represented 34% of revenue in the quarter, down from 38% in the prior year. R and D and G and A expenses were 16% and 6% of revenue respectively compared to 20% 8% in the Q3 of last year. Overall higher revenue and a leaner cost structure drove higher than expected operating income of $37,000,000 in the quarter. Our adjusted EBITDA was $43,000,000 in the 3rd quarter and diluted net income per share was $0.50 Before we turn to the balance sheet and cash flow statement, I want to mention certain items from the Q3 income statement that do not affect our non GAAP results. We incurred a total of $24,000,000 in restructuring and real estate impairment charges in the quarter in line with our expectations.

Speaker 5

We also booked a non cash induced conversion expense of $54,000,000 in the quarter Investor Relations as a result of the required accounting treatment related to the partial repurchase of our 2025 convertible notes. We ended the Q3 with cash, cash equivalents and investments of $373,000,000 We took proactive steps during the quarter to strengthen our balance sheet and to take advantage of favorable market conditions. The increase in cash and equivalents from the 2nd quarter reflects the proceeds from our convertible notes offering in September, Partnership, partially offset by the previously mentioned partial repurchase of our 2025 notes. This was primarily a liability management effort Allowing us to enter into a new convert with more favorable terms and extend it to maturity date of a portion of our debt structure. Operating cash flow was $4,000,000 and reflects timing of the restructuring payments, which were concentrated in the 3rd quarter as expected.

Speaker 5

It also reflects a working capital headwind related to the timing of cash collections. We have already seen strong collections early in the Q4 and we'll continue to manage these working capital dynamics closely. Moving on to our outlook for the remainder of 2023. As Corey mentioned, we are maintaining our full year ARR outlook range of $800,000,000 to $805,000,000 or approximately 12% to 13% growth over the prior year. As our strategic realignment is tracking in line with our range of expectations, We feel confident about maintaining the existing range for the full year.

Speaker 5

We are raising our full year revenue guidance to 7 $73,000,000 to $775,000,000 representing 13% growth. This reflects product revenue out performance in the Q3, partially offset by slightly lower services revenue forecast for the full year, as we actively deemphasize some lower value professional services coming out of our restructuring. We are also raising the midpoint of our full year operating income guidance by $7,000,000 to reflect our strong third quarter performance. This brings our full year operating income guidance to $94,000,000 to $96,000,000 representing roughly 12% full year operating margin and over 7.50 basis points of improvement from the prior year. Non GAAP net income per share is expected to be $1.26 to $1.29 Investor Relations and Company based on an anticipated 72,100,000 diluted weighted average shares outstanding.

Speaker 5

We are reiterating our free cash flow guidance of approximately $80,000,000 for the full year. Investor Relations. As implied by our full year guidance for the Q4 of 2023, we expect revenue in the range of $200,000,000 to $202,000,000 and operating income between $33,000,000 $35,000,000 which represents an operating margin of approximately 17%. Non GAAP net income per share for the Q4 is expected to be $0.47 to $0.49 Investor Relations and Company. With that, Thank you for joining us on the call today, and we will now open the call for questions.

Speaker 5

Operator?

Operator

And your first question comes from the line of Matt Hedberg from RBC Capital Markets. Your line

Speaker 6

Great. Thanks for taking my questions. Corey, great to see the results and the demand commentary and the benefits of the restructuring going on here. I'm curious, you noted in your prepared remarks that you're working to reaccelerate growth. I guess I'm wondering, we think about sales and marketing or products or whatever it might be.

Speaker 6

What do you think are some of the most important aspects of what you guys are doing to control some of that reacceleration even despite ongoing economic uncertainty?

Speaker 7

Yes. Thanks, Matt. It's a good question. So I think there's 2 fundamentals. There's 1, you have to be in the right markets and have the right demand drivers.

Speaker 7

I think we're there. If you think about what we're doing and the Extended SOC. Customers are struggling with the cost of complexity of managing their tax service in this environment. And so we are leaning into that and continuing to reallocate investment into that area of focus. That's a long term investment area that involves cloud, involves delivering expertise.

Speaker 7

But of course, we're actually focused on that. We have been. We think we have a good leg up. We think we're competitively differentiated. But it's a long term investment area.

Speaker 7

And again, we're rotating more of our investment to those areas over time. Now I would say the point on that one is going to be also the one that goes to go to market is, look, we can actually grow faster. Our big focus right now is growing And so this is a focus of making sure we have durable growth and efficient growth because as we actually look forward, We know that we can act share in the right areas, right spaces. We know we actually are setting up for the right products and services. We have to make sure that we actually have the efficient growth that we're actually looking for.

Speaker 7

And that spend is going to come over time. So we are, I would say, being methodical, being very thoughtful. We are going to spend in the reinvestment, but it's going to be to extend it into the cloud, continuing to actually work with partners to deliver augmented services, as I've talked about, with the large national provider and one of the deals that we actually just did, you'll see more of that. But it's also a big focus on extending our sales and marketing engine, but Actually doing that both through partners, but doing that efficiently ourselves. And that's where you'll see us make investments over the course of both this year, but more importantly, we'll make investments over the course of 2024.

Speaker 7

But that's not how we think about growth. We're focused on efficiency now and then adding growth that actually gives long term growth potential, but Actually doing it in a way that makes sure that we actually stay very disciplined, very lean and very efficient.

Operator

Your next question comes from the line of Adam Tindle from Raymond James. Your line is open.

Speaker 8

Okay. Thanks. Good afternoon. Corey, I just wanted to start, you mentioned how the pipeline was impacted from Q3 from making sure existing customers were okay, which makes total sense and probably a good move. I guess the question would be, how do you shift the sales force to focus?

Speaker 8

How did you shift them to focus on existing and how do you pivot them to focus on new pipeline, some of the things you can do from incentives. And Tim, if you wanted to maybe as a follow-up to this, I know that that can have a lagged impact on revenue growth, that deceleration in pipeline. Wondering how we should think about that in light of Moving forward in 2024 growth, we're exiting, I think, at single digit growth in Q4. Wondering if that's maybe an indicator of what to expect in 2024, why or why not? Thank you.

Speaker 7

Yes. So I'll tackle that. So I'll tackle it first. So one, on As we actually think about sort of our guidance, I would just say, listen, the biggest factor there was, as you said, we were very focused on executing the cost structure Alignment and make sure we take care of customers. We actually just had very direct discussion with our team about what the priorities were.

Speaker 7

The priorities were to make sure we're servicing our customers well, Adding more consolidation pipe in. So we had pipe as more consolidation pipe. Those are bigger deals. They actually have longer sales cycles. So yes, while the short term effect Was theoretically less pipe for Q4.

Speaker 7

That's something we're very comfortable with because again, our big near term focus was the cost structure. Now longer term, we're very focused on continuing to build strategic pipe, which we're seeing in the consolidation efforts. We're doing 2 things around that. We're making sure that our sales team is well equipped in selling it. And I would just say we're seeing the benefits of that now.

Speaker 7

Yes, it actually has benefits in 2024. But the other part of it is, as I talked about in the last call, we did drop lots of efficiency, not in our direct sellers, but in our overall go to market engine. And we expect to actually add more of the pipe and demand generation capabilities over time. We are being very, very disciplined about adding that in a way that is lean and that is efficient. And I think that sets up for a good long term dynamic, But that's the focus that we actually have right now.

Speaker 9

Yes. And then Adam, it's Tim. The second part of your question regarding 2024, We are right in the middle of our budgeting process for next year, so it would be premature for us to make any comments about growth for next year. But I'll reemphasize what Corey said. We're very focused on efficient growth and generating strong free cash flow.

Speaker 9

So we've shared with you guys last quarter that we anticipate roughly $160,000,000 of free cash flow next year, and we still feel very good about that number. And look, we had some hard actions that we had to take back in August with the restructuring and the realignment of the company. But I do think that sets us up very well for next year that we've rationalized the cost structure. So very focused on efficient growth and we'll have more to say about next year on the Q4 call.

Speaker 8

Makes sense. Thank you very

Operator

much. Your next question comes from the line of Matt Saltzman from Morgan Stanley. Your line is open.

Speaker 3

Great. Thanks for taking the question. So just looking at total customer growth, it's kind of trended in this mid single digit range for several quarters now. I appreciate you guys don't specifically guide to or disclose gross logo retention. But I'm just curious if you can speak qualitatively about the trends on gross loan retention over the last 12 months, maybe the last 6 months.

Speaker 7

Yes. I mean, I will talk at a high level. As you say, we don't disclose it. I think last year, we We talked to who actually last year seeing some pressure in that area in Europe. And what I would just say is that this year, we've seen the improvement that we actually have expected to see.

Speaker 7

So we feel good about our retention overall. And so I'll just say on balance, if you look at last year compared to this year, we feel that it's trending positively. We feel good about the direction of the setup going forward. And in fact, as we think about sort of efficient growth, a big part of that is really focusing to Make sure you're taking care of your customers first. That's the alignment for the customer value, that's the alignment for us.

Speaker 7

And we feel good about the trends that we're seeing in the business.

Speaker 10

Great. Thank you.

Speaker 7

Thank you.

Operator

Your next question comes from the line of Fatima Boolani from Citi. Your line is open.

Speaker 11

Good afternoon. Thank you for taking my questions. Corey, I wanted to revisit some of the pipeline commentary you talked about. Very clear that the focus was very, very intentional on keeping existing customers happy and growing the wallet share there. But it sounds like there There are going to be some pivots into building new pipe and incremental demand generation on the new logo front.

Speaker 11

And I just wanted to make Sure, I understood or picked up on that information correctly. And so really what are some of the things that you're going to be putting in place to be able to maybe reaccelerate some of that new customer and new logo acquisition momentum and Growth initiatives.

Speaker 7

Great question. And by the way, welcome back. Look, I think that there's on the question of pipe overall there's 2 dynamics that are really key to focus on. 1, we're actually doing a great job of building strategic pipe. And so and I've talked about this before.

Speaker 7

One of the interesting things is, as we actually build That's a positive thing. We're converting those things well. And that's more of a timing thing. So I think that we have more visibility into the outlook as we actually go forward. The second thing that I think you're alluding to and hitting on, which is actually also important, is we're focused not just on how do we actually build pipe, but we're focusing on What's the efficiency and what's the cost to build in pipe?

Speaker 7

So we're not treating all things the same. So I'll give you a perfect example of that is we have a very intentional focus about How do we actually build pipe through partners in the ecosystem and through MSSPs? You saw an example on that on one of the marquee deals that actually named on the call. Going through partners and especially MSSP partners, but more broadly the channel, we have a very, very tight focus on that and we think we can do that efficiently rate targeted set of partners. That's one example.

Speaker 7

But again, if you're in the right demand areas, then you can sort of like fine ways to actually build pipe. And we are focused, I would say, more now on the cost and the efficiency of the pipe that we build and the overall engine Actually just driving growth as fast as possible. We will grow. Again, our tight focus is on long term growth, but it's not on trying to get the fastest time to actually that growth is actually making sure it's both durable, sustainable, but also actually has the right cost structure around it.

Speaker 9

Corey, the only thing I would add is, I think we both commented in our prepared remarks just on the strength of the packages, Threat Complete, Cloud Risk Complete, now over 40% of new ARR. And we've seen that grow nicely every quarter. So that's another tailwind of momentum I think we have with our sellers, both new and existing customers. Absolutely.

Speaker 7

Thank you again. Great question.

Operator

Your next question comes from the line of Jonathan Ho from William Blair. Your line is open.

Speaker 4

Hi, this is General Reiden with for Johnson. Thanks for taking our question. So your solutions are targeting modern SOC efforts. In terms of SOC spending, are you seeing customers start to shift how they approach traditional apps, apps like SIEM and other solutions to save money or improve security and how might that relate to Rapid7's value proposition? Thanks.

Speaker 7

Yes, we're seeing a big shift. One is if you think about the traditional SOC, it was primarily focused on collecting log files in the on premise environment and Monitoring the On Premise Environment. What we're doing when we think about the extended SOC is actually focusing on the overall attack surface, which is not just the on premise environment. It's the cloud, it's the applications. And so what we're helping customers do is, 1, collect all the data to monitor the full attack surface.

Speaker 7

But that also adds a massive volume of data. And So we're focused on both the productivity, but also augmenting either with our sales or with partners the expertise and the talent to actually manage the volume of data from that larger attack surface. Customers are absolutely shifting their focus from traditional SIEMs that focus in logs on premise To say how do I cover my full attack surface, but they're also looking at how do I do that efficiently, because if you look at the trends that are happening right now, Customers are not able to add as many security professionals as they would like. And therefore, they're really, really focused on the efficiency and partners that

Operator

Your next question comes from the line of Brian Essex from JPMorgan. Your line is open.

Speaker 12

Hi. This is Sheryl with B. Dave on for Bryan Essex. Thank you for taking the question. It was great to see you reiterate the doubling of free cash flow in 2024.

Speaker 12

If you can let us know like what level of confidence do you have in it and what are the primary levers you're looking to deliver on that cash flow and how much control do you have over them?

Speaker 7

Yes, we have very high confidence on the $160,000,000 of free cash flow. I would what I would say is that we have a lot of controls and levers in the overall business. We've taken a very thoughtful approach to planning that looked at growth rates, plus or minus the growth rates of this year. And so we're very thoughtful about like what how do we actually deliver that free cash flow across a wide range of scenarios. We have the levers in the business.

Speaker 7

That's also a big part of why we're actually as we're doing reinvestments. We're doing the reinvestments steadily, not all in one go, because that also gives us levers to actually make sure that our reinvestments are timed up well to the performance that we expect to see. So I would say we have a lot of visibility, we have a lot of controls, but most importantly, our entire company is fairly committed and we have a good structure from today to deliver on that.

Speaker 12

Great. Thank you.

Speaker 7

Thank you.

Operator

Your next question comes from the line of Eric Heath from KeyBanc Capital Markets. Your line is

Speaker 10

open. Hey, thanks for taking the question and Corey and Sam, good execution and tough environment. So Just to follow-up on some of the kind of macro kind of guidance questions. Just curious what's kind of embedded in your guidance for 4Q in terms of conversion rates because It seems like maybe you had some relatively high conversion rates this quarter. So I was curious if you're extrapling that out.

Speaker 10

And also any color on the macro or expectations on budget flush? And If you had any commentary on linearity so far this quarter, that would be great too.

Speaker 7

Yes. I may have missed something. So I'll cover those and Tim will cover for me if I actually missed something. What I would say is we've seen, I would say, improved conversion rates this year, not just across 1 quarter, but it's been a consistent theme that's actually picked up. So we expect consistency more than anything else.

Speaker 7

And I would just say on that one, I think the early start to the quarter indicates consistency and the consistency that we expect in the overall conversion rates. The other piece of it is, no, we're not out over our skis from our perspective on expecting a budget flush. We did not factor a budget flush in for this quarter. I don't see any indicators that would indicate a budget flush right now. If we do, that's great.

Speaker 7

But there was no reason to actually factor a budget flush into our expectations and how we think about the overall guidance.

Operator

Day. And your next question comes from the line of Mike Walkley from Canaccord Genuity. Your line is open.

Speaker 13

Hey, guys. Good afternoon. It's Daniel on for Mike. Thanks for taking the question. So could you just provide maybe some color on how the productivity of your sales reps are changing, now that they have a few quarters' worth of experience, really exclusively selling via consolidated offerings.

Speaker 13

Also, just given your focus on improving profitability and cash flows, do you think the level of investments is sufficient to continue to grow longer term? Thanks.

Speaker 7

Yes, two great questions. So on productivity, what I would say is that through Q3, where we expected the productivity to actually be for our direct sellers. We are building larger deals in the pipe, Which has some time and impact on the sales cycle. So you have a mix shift in the size of the deals in pipe. I provided a little bit of qualitative data on that in my prepared remarks.

Speaker 7

So that's more of a timing issue, but we think that washes out. So what I would say is we see very healthy productivity trends and we expect, I would say, reasonable consistent levels of productivity to actually come up next year. And so we're happy with the trends and the outlook on the productivity. Your second question was, I forgot

Speaker 9

With our focus on profitability, are we still investing at the right levels to continue?

Speaker 7

Yes. So yes, look, I think but just to be clear, I take a very focused view on, I would say, mid long term growth. I'm not trying to actually really drive short term acceleration. And So the way to think about that is that we're doing heavy investments in product and services. When I talk about services, I'm talking about like us and our ecosystem and making sure we can augment our customers.

Speaker 7

We're investing heavily there. We're going to keep investing heavily there because if you think about what drives long term growth is we have to be the preferred provider for the extended stock. We're committed to doing that. We're putting lots of resources in the products and services, and we're very intentional about that. And those are investments that we're making now, but it's also investments that we're going to be steadily onboarding and Day over the course of the next year.

Speaker 7

And so that's an ongoing plan. The second part of that is the investments in sales and marketing. And while I say it's we're very focused. We're really looking at our engine and we will be adding resources. We're going to be adding capacity, but we're making sure the engine is efficient in this environment.

Speaker 7

We are taking a more partner focused approach and aligned approach in this environment. And so again, if you look out, We think in the midterm, we actually are going to have a very, very good growth engine, but it's not something that we're rushing on the sales and market investments to actually try to hit a quarter by quarter target.

Speaker 9

Yes, Corey. And I think as look analysts pencil out what numbers for the full year may look like for sales and marketing. It is we think it's the right amount, but it's still a healthy investment this year.

Speaker 7

Yes. Yes.

Speaker 9

Harries into next year.

Speaker 7

Yes. The investments that we made this year actually helped setup for next year. But again, it is a we are taking a more methodical approach on how we actually allocate net investments in the sales and market.

Speaker 13

Great. Thank you so much for the color.

Operator

Your next question comes from the line of Trevor Rambo from BTIG. Your line is open.

Speaker 14

Hi. Thanks for taking the question. This is Trevor on for Gray Powell. I was just I just want to ask, how are you seeing customers react to the latest breach increase in breach headlines? And do you expect it to drive an increase in activity for the company?

Speaker 14

And then lastly, do you see any product categories that benefit more than one another?

Speaker 7

Yes. So first, we tend to be pretty focused on not trying not to sell into news headlines just because that creates some weird incentives. It also hurts customers' trust over time. That said, it is a backdrop that's happening. So look, here's how I'll describe the backdrop at a most fundamental level is that CISOs, especially with some of the SEC's recent actions as it relates to SolarWinds and other things, Clearly very focused on security and their personal accountability.

Speaker 7

And so they have security as a top priority. And I still think we have a significant backlog of security projects and resources that are needed. The funding environment that CISOs are going into is tight. And so the reconciliation of that demand backlog, pressure CECL space and the speed and the velocity of the budgets they're getting is an underlying tension that underplays all the stuff that we actually see with the deal cycles and all the other things. I think if you actually zoom out, that backlog of projects absolutely has to get resolved over time.

Speaker 7

So I think we actually have a healthy demand driver, healthy demand market. Again, I love the place that Rapid7 sits with the extended SOC, with the focus on the attack surface, looking across the entire environment from the on prem and endpoint to the cloud. I think we're set up well. But I would just say the budget environment for CISOs is going to play out as a budget environment in place for CISOs. Our goal is to set ourselves up to be a great partner and to provide a great ecosystem as they have money, as they have funds to suddenly only have them.

Speaker 7

And this is why I think our methodical long term approach will pay dividends.

Speaker 9

There was maybe one last piece of that question, just does it benefit any products in particular or not?

Speaker 7

I would

Speaker 9

just go back The packages, the way we fund it.

Speaker 7

Yes, consolidation. Absolutely, Tim, that's a great point. It provides leverage and scale, being able to actually say that I can actually Management Attack surface from the endpoint to the on prem to the cloud. It actually provides an economic value, which helps the CISOs do their job. It Allows them, if they choose to do it with us or our partner, augment with expertise.

Speaker 7

And so it provides an economic value, at the same time, it addresses core security concerns.

Speaker 14

Great. Thanks for the color there.

Speaker 7

Thank you. Thank you.

Operator

Your next question comes from the line of Rob Galvin from Stifel. Your line is open.

Speaker 3

Hi, this is Rob on for Brad. Thanks for taking the question. The international growth of 16% and 22% of revenue appears to be trending well. And I'm wondering if the offshore talent mix shift from the restructuring discuss last quarter had any impact on this growth or if the offshore talent mix shift was more focused on operating cost efficiencies. Thanks.

Speaker 7

Yes. So I think it's a great question. I would not say it's a primary driver of growth. This is actually too early. Well, I would say that we did have some catch up work to do to make sure that the distribution of our global service and support ecosystem what's properly allocated around the world to make sure that the workloads matter.

Speaker 7

The other thing is just the reality of cyber attacks is more of the attackers operate in time zones that are not the time zones of the U. S. And so as we actually make sure that our teams are operating around the clock, It's important to actually have people that are operating in the same time zones, not just our customers, but also the time zones that attackers are actually operating in. I think we will see more benefits and confidence because our teams, both in Europe and in Asia, are now able to actually talk more aggressively and directly about the ability to actually get local resources and commitment and availability. So we think that, that will be a positive thing as we actually go forward.

Speaker 7

But I would just say it's too early for that to actually have shown up in these Q3 specific results.

Speaker 2

Great. Thank you.

Speaker 7

Thank you.

Operator

Your next question comes from the line of Alex Henderson from Needham. Your line is

Speaker 15

run. Great. Thanks so much.

Speaker 14

I was hoping you could talk

Speaker 15

a little bit about the partnership expansion programs and particularly the MSP that you noted in your call. How material do you think that will be as we look out into 2020 4 in 2025. Can it add 3%, 4%, 5% to your top line growth rate? And While you're at it, would you mind just looking at the Splunk acquisition by Cisco, does that have any positive impact on you as a result of that consolidation. Thanks.

Speaker 7

Yes. That's 2 great questions. So on the first one, what I would say is that It will be incrementally positive, I think, in 2024. We did one big one. I think we'll do some more.

Speaker 7

We've had some smaller ones actually prior to this. So I think it will be incrementally positive in 2024. The bigger they are, I would just say, the longer the ramp cycle is. So I just want to be clear, it's just like you are These are big organizations and you actually have to you turn the gears of the organizations. So I would say some incremental movement in 2024, but I think it really picks up in 2025 and 2026.

Speaker 7

We like this consolidated focus yes, with the breadth partners, I'm going to be clear. We have a wire partner, but having a few bigger, very focused partners that really move the dial, I think it's important, but these are big sophisticated organizations with lots of customers. So the effort and investment is well worth it, We're going to be investing heavily with our partner, but it is also lots of sort of like investment and lots and some work that they do is actually make this broadly available. So we expect to see the benefits over multiple years, but we do expect to have, I would say, incremental positivity in 2024, but I would say really picking up in 2025 when you start Some of these larger organizations and how they actually operate. And then on the Splunk, that's a good question.

Speaker 7

Look, I have a lot of respect for Cisco, for Splunk. And so there's nothing specific about that or those teams or those organizations. What I would say is that when you actually have changes or disruptions in the market and you have, that's always an opportunity. And I would say, especially in this environment where People are budget concerned, where they are talent concerned. I think it's an opportunity.

Speaker 7

Now Cisco has a lot of things and they have a probably a great consolidation story. I think us being very focused on the extended stock and the extended attack surface. I think we're fairly unique in what we can actually offer here. And so I think that anytime any competitor in the market has things that actually cause them to focus or shift focus, that's an opportunity for us. So I think from that perspective, yes, it's an opportunity, but that's it, I have a lot of respect for the competitors in the market here.

Speaker 15

Great. Thanks. And I would note that they both were downsizing, so that helps too. Thanks.

Speaker 13

Thank you.

Speaker 10

And we

Operator

have reached the end of our question and answer period. I will now turn the call back over to our CEO, Corey Thomas, for some final closing remarks.

Speaker 7

Thank you all for joining us today on our call, and I wish you all a good rest of the year. Thank you.

Operator

This concludes today's conference call. Thank you for your participation. You may now disconnect.

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Earnings Conference Call
Rapid7 Q3 2023
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