Rapid7 Q2 2023 Earnings Call Transcript

Quartr
Provided by Quartr
August 8, 2023

There are 15 speakers on the call.

Operator

Thank you for standing by. My name is Jessica, and I will be your conference operator today. At this time, I would like to welcome everyone to the Rapid7 Second Quarter Earnings 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

The Q and A session. I would now like to turn the call over to Sunil Shah, VP of Investor Relations. Call. Please go ahead.

Speaker 1

Thank you, operator, and good afternoon, everyone. We appreciate you joining us today to discuss Rapid7's Q2 2023 financial and operating results, in addition to our financial outlook for the Q3 and full fiscal year 2023. With me on the call today are Corey Thomas, our CEO and Tim Adams, our CFO. We have distributed our earnings press release over the wire and it is now posted on our This call is being broadcast live via webcast, and following the call, an audio replay will be available at investors. Rapid7.com.

Speaker 1

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 includes statements related to the company's positioning, strategy, business plans, restructuring plan, financial guidance for the Q3 and full year 2023, financial goals for full year 2024, Any assumptions underlying such goals and guidance. 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 expressed or implied in these statements due to a number of risks and uncertainties, Including those contained in our most recent quarterly report on Form 10Q filed on May 10, 2023, and in the subsequent reports that we filed with the SEC. The information provided on this conference call should be considered in light of such risks.

Speaker 1

Actual results and the timing of certain events may differ materially from the results or timing predicted presented on this conference call, except to the extent required by applicable law. Our commentary today will primarily be in non GAAP terms 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 and in response to your questions, we may offer incremental metrics to provide greater insight into the dynamics of our business or our quarterly results. Please be advised that this additional detail may be one time in nature, and we may or may not update these metrics in the future.

Speaker 1

With that, I'd like to turn the call over to our CEO, Corey Thomas. Corey?

Speaker 2

Thank you, Sunil, and welcome to everyone joining us on today's Q2 2023 earnings call. I would like to start by acknowledging the plan we announced today To restructure and optimize our organization by reducing Rapid7's employee base by roughly 18%. While it was an extremely difficult decision, we believe this step is critical to build on the momentum we're seeing in security operations And to position us to be a more profitable growth company in 2024 and beyond. I will discuss more details Let's start with our 2nd quarter results. I'm pleased to report that Rapid7 ended the 2nd quarter With $751,000,000 in ARR, point 14% over the prior year and delivered revenue and operating income with our consolidation offerings.

Speaker 2

Customers are gravitating towards our holistic security operations stack, particularly ThreatComplete, which unifies risk and threat management into a single integrated offering. The performance of our packages once again exceeded our expectations As over 1 third of new ARR in the 2nd quarter was driven by either a threat or cloud risk complete deal as customers look to increase the effectiveness an efficiency of their security programs by consolidating their vendor footprint. A great example of this consolidation With a 6 figure ARR deal in the 2nd quarter with an existing InsightVM customer that was looking to replace a legacy SIEM solution managed by MSSP. Building on our established VM relationship, Rapid7 was uniquely able to provide the customer a comprehensive security solution. And our best in class technology, coupled with the expertise of our SOC analysts, was amplified by the value proposition from our Managed Threat Complete offering.

Speaker 2

We competed against many large players in the extended detection response space, and the customer chose Rapid7 This customer is indicative of the current environment where customers are upgrading and consolidating providers While looking for better quality services and experiences. Customer spending dynamics in the Q2 were broadly in line with our expectations, With ongoing macro sensitivity influencing customer budgets, we've optimized our sales efforts around this new normal By leaning into customers' needs for more cohesive, efficient solutions that are aligned with their resource constraints. Our strategic focus around SecOps consolidation continues to gain momentum and we are driving focused innovation across our core products and capabilities to accelerate customer value. We are particularly focused on integrating a frictionless cloud security experience into risk management programs for mainstream buyers. A great proof point is our recently introduced executive risk view, a new capability that gives security practitioners unified visibility to risk across all combinations of on premise, cloud and hybrid environments.

Speaker 2

Executive RiskVue's ability to holistically assess risk and track security program effectiveness is a complete differentiator For us across VM and cloud security. It's also an example of our unique ability to add value for customers By leveraging the breadth of our Insight platform, our expertise in helping customers secure their cloud and hybrid environment is illustrated 6 figure competitive win in the Q2 with an enterprise manufacturing company. As an existing customer, They had built out a strong risk management program for their traditional environment with Rapid7's vulnerability management and AppSec solutions. Despite a flat budget this year, the CECL security teams needed to extend risk visibility and management into their growing cloud footprint. After an extensive POC, Rapid7's cloud security capabilities set us apart from other well known players for multiple reasons.

Speaker 2

Our ability to provide unified visibility to risk across the full environment, the integration and ease of use of our platform, And our ability to offer extensive automation, including automated remediation. Ultimately, these product differentiators combined What the budget predictability and value proposition from our cloud risk complete offering led the customer to consolidate this part of their SecOps stack on the Rapid7 Insight platform. Turning now to our strategic areas of focus as we enter the second half of twenty twenty three and look forward. We remain anchored on our core customer mission to make the best security operations technologies accessible to all. Let me share with you how we're optimizing to execute against this mission through our focus on the modern SOC.

Speaker 2

With the industry undergoing a customer driven shift to consolidated security platforms, the early success around our integrated SecOps strategy is evident As our consolidation offerings track ahead of expectations, looking ahead, we see an evolving set of critical customer dynamics in this space. 1st, we have noticed a customer shift from cloud security as a specialized function to cloud security As an integrated capability within security and SecOps teams. We view this as a massive demand driver for integrated SecOps And think that we have a significant opportunity to be the leader in delivering integrated risk and threat management across on prem, cloud and external attack surfaces. 2nd, as the threat landscape continues to grow in complexity, customers are showing more demand than ever integrated expertise to support them in effectively managing their security technologies. The convergence of these key trends, security consolidation, integrated cloud security and expertise driven outcomes are the foundation of what we view as the new modern SOC.

Speaker 2

Rapid7's focus is to be the leading provider of integrated security solutions for the modern SOC, by providing risk and threat management within the context of overall security, delivered as a service alongside expertise tailored to the needs of each customer. Let me walk you through 3 distinct opportunities for Rapid7 to support the modern side and why we believe that we are optimally positioned to win. 1, customers continue to upgrade from legacy log centric detection to cloud native detection and response programs. With over $300,000,000 of our ARR in detection response, with a growth at over 25%, it is clear that customer demand is strong and we have established both the scale and product leadership to win this opportunity. 2, customers can no longer treat their risk and threat functions as distinct.

Speaker 2

The modern SOC manages threats as a function of risk and vice versa. With our integrated best of breed capabilities across risk management and threat detection In both cloud and traditional environments, we are uniquely positioned to deliver this integrated experience to mainstream buyers. And 3, customers are increasingly reliant upon both greater levels of automation and integrated expertise alongside their technology. Having built best in class service augmentation with our global SOC presence, we see massive potential to drive high margin managed services Both through existing offerings and investing in accelerating our strategic managed service partnerships. With that context, let's talk about the strategic decision we announced today to restructure our organization and reorient our cost structure And how that positions us to better execute against our strategy.

Speaker 2

We recently completed a deep analysis of our cost structure through the lens of accelerating our investments Deliver the most comprehensive modern stock offering for our customers. Earlier today, we announced plans to reduce our global workforce by approximately 18% And to consolidate our global facility footprint. There are 2 clear outcomes from this reorientation. First, it is clear that we have an opportunity to run leaner as a business. About half of our plan changes are efficiency related cuts That we expect to flow directly to the bottom line.

Speaker 2

These include streamlining management layers, reduction of role overlap, and optimizing our own and offshore talent mix. 2nd, we have a compelling opportunity With a vast amount of our product expansion now behind us, we can reallocate and accelerate investment in capabilities and services that Customers are purchasing around the modern sock, including our managed service partnerships. We expect these changes We'll meaningfully optimize our cost structure while enhancing future product capabilities and delivering a higher quality customer experience. Ultimately, these changes position us to drive strong and more profitable growth over time by aligning our investments with our customers' long term SecOps needs, While at the same time establishing a strong free cash flow support for our business. Tim will guide you through more specific financial details later on the call.

Speaker 2

But at a high level, net of the investments we're making in strategic focus areas, we expect these measures to substantially expand our profitability profile While driving significant progress towards our midterm rule of 40 objective. Looking ahead to 2024, We believe these actions position us to deliver at least $160,000,000 in free cash flow in 2024, Doubling from our current 2023 guidance of $80,000,000 Given the investment levers in our business, We have confidence in our ability to scale free cash flow in 2024. While it's premature to set any revenue or ARR growth targets for 2024, This free cash flow expectation does not assume improvement in the macroeconomic environment, and we're confident we can execute to this target even if our top line growth to be sustained at this year's levels. Shifting our focus back to 2023, I'm pleased with the progress our team has made during the first half of twenty twenty three, laying the groundwork for us to drive ongoing customer impact With our integrated SecOps strategy, including executing to our first half growth targets. Looking to the back half of twenty twenty three, We continue to see line of sight to our original full year ARR guidance range.

Speaker 2

With that said, we believe it is prudent to establish a high confidence expectation range That accounts for a modest degree of disruption over the next 3 to 6 months as we implement the strategic realignment. As a result, we're reducing our full year ARR guidance by approximately 2% at the midpoint to account for potential disruption. This is coupled with a significant ramp in our operating margin expectations, which we will now expect to improve by approximately 700 basis points over the prior year. Tim will share more specifics on this in his comments. In summary, we continue to focus on the highest value, most impactful areas of our business on behalf of customers.

Speaker 2

While the changes we announced today are difficult, we have a compelling opportunity to position ourselves to deliver stronger, more profitable growth and we remain committed as ever to our enduring goals, help customers securely transition to the cloud, expand the capabilities and value of our Insight platform and balance strategic investments in durable growth with expanding profitability. Thank you all for joining us today. I will now turn the call over to our CFO, Tim Adams, to share additional detail on our financial results and outlook. Tim? Thank you, Corey, and good afternoon to everyone on today's call.

Speaker 2

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, unless otherwise stated. Additionally, reconciliations between our GAAP and non GAAP results can be found in our earnings press release. Rapid7 ended Q2 of 2023 with $751,000,000 in ARR, Consistent with our expectations and growing 14% over the prior year, reflecting continued demand for our Insight platform With the strongest growth contribution coming from the high priority areas of detection and response and cloud security. We continue to see threat and cloud risk complete offerings tracking ahead of our expectations at over 1 third of new ARR in the 2nd quarter.

Speaker 2

With the benefit coming from both landing new customers and driving upgrades and expansion within our base. We also saw balanced contributions from new and existing customers in our overall business during the quarter, With ARR per customer that grew 7% year over year to $66,500 As existing customers leverage more capabilities on our platform, we saw a nice improvement in total net customer adds, Ending the 2nd quarter with nearly 11,300 customers, representing growth of 6% year over year. 2nd quarter revenue of $190,000,000 grew 14% over the prior year And exceeded the high end of our guidance range. Product revenue grew 14% year over year to $182,000,000 And was better than expected on favorable linearity in the quarter. International revenue grew 17% over the prior year And represented 21% of total revenue, while North America revenue grew 13% year over year.

Speaker 2

Now turning to our operating and profitability measures for the quarter. Product gross margin was 76% in the 2nd quarter And overall gross margin was 74%, both in line with our expectations. Sales and marketing expenses represented 39% of revenue in the quarter, down from 41% in the prior year. R and D expenses were 21% of revenue, unchanged from the prior year, and G and A expenses were 7% of revenue compared to 8% Higher revenue combined with slower hiring in the quarter drove stronger than anticipated Operating income of $13,000,000 in the 2nd quarter. Our adjusted EBITDA was $19,000,000 in the quarter And diluted net income per share was $0.18 better than our guided range on higher operating income.

Speaker 2

There are 2 additional items from the Q2 I want to mention that are non cash and do not affect our non GAAP results. 1st, our GAAP net income reflects a $13,000,000 non cash charge related to a capped call transaction from our 2023 convertible bonds. These bonds were retired as part of a refinancing nearly 2 years ago, But the associated capped calls require us to record a mark to market adjustment at the end of the second quarter. This Cap Call transaction was settled in early August, resulting in a cash receipt of slightly over $17,000,000 2nd, as part of the restructuring plan, we will be consolidating our global real estate footprint. Moving to the balance sheet and cash flow statement.

Speaker 2

We ended the 2nd quarter with cash, cash equivalents and investments Of $296,000,000 This is before the $17,000,000 we collected in August related to the CapCall transaction on our 2023 convertible bonds. Operating cash flow was $31,000,000 and we generated $26,000,000 of free cash flow in the 2nd quarter, driven by stronger profitability and more favorable collection trends. Now turning to our outlook for the remainder of the year. The restructuring plan we announced today Is a focused effort to align our organization and our investments around the areas of business that are driving the most value for our customers. This was not a decision we made lightly, and we believe these actions will enable stronger and more profitable growth We expect to incur charges of approximately $24,000,000 to $32,000,000 related to the restructuring plan throughout the 3rd and 4th quarters of 2023, Of which the majority are expected to be cash expenditures and weighted towards the Q3.

Speaker 2

We also expect to incur $3,000,000 to $4,000,000 in non cash impairment charges from the consolidation of our real estate footprint and non GAAP net income results. Though the cash expenditures will be reflected in our operating cash flow and free cash flow. As such, the cash benefit of reduced headcount will be offset by the associated severance related cash charges. As a result, we are maintaining our expectation of approximately $80,000,000 in free cash flow for the full year. As Corey mentioned, we are updating our full year ARR outlook range to $800,000,000 to $805,000,000 at the midpoint, which despite healthy year to date momentum in our business, we believe is appropriate to account for modest disruption risk in the business as we make these important strategic changes.

Speaker 2

We are adjusting our total revenue guidance for the full year to $771,000,000 to $775,000,000 or roughly 13% growth. The The $3,000,000 reduction at the midpoint is wholly driven by lower professional services revenue tied specifically to our restructuring cost actions, which we now expect should be approximately flat compared to last year. We are raising our full year operating income guidance to a range of $86,000,000 to $90,000,000 Which represents approximately 700 basis points of operating margin expansion over the prior year. We expect full year net income per share to be in the range of $1.23 to $1.29 Turning to quarterly guidance. For the Q3 of 2023, we expect revenue in the range of 196 $198,000,000 which represents growth of roughly 12% year over year.

Speaker 2

We expect operating income for the 3rd quarter in the range of $29,000,000 to $31,000,000 And non GAAP net income per share of $0.41 to $0.44 which is based on 71,700,000 diluted Weighted average shares outstanding. As we look out at next year, we expect to generate at least $160,000,000 free cash flow in 2024, doubling from our current 2023 guidance of $80,000,000 We feel good about our results year to date and about our ability to pursue the strategic opportunities ahead of us

Operator

to the Our first question comes from the line of Matt Hedberg with RBC. Matt, go ahead.

Speaker 2

Great, great guys. Thanks for taking my question. So just one, let's see. So I just wanted to maybe get a better perspective on the full year guide. I mean, obviously, the Q2 results were good.

Speaker 2

I just want to be clear. Is the full year reduction just a function of the restructuring? Or is it That you're seeing macro you're assuming macro trends deteriorate, just maybe a little finer point on sort of the assumptions on the 2% reduction would be super helpful. Thank you.

Speaker 3

Very reasonable question, Matt. So the first thing is that we were really focused on looking at our cost structure, both this year, but more importantly as we went into 2024. And we decided that if we were going to have the right cost structure going into 'twenty four, this was the right time to actually make these changes. Now secondary impact is we have to really assess What's the risk of these changes in the business? As you know, we had a back end loaded year.

Speaker 3

What I would say is foundationally, we were trending well towards what we be But when we think about the amount of change that we're doing with the 18% reduction in a back end loaded year, we want to make sure that we Gave a guidance range. That was a very high confidence guidance range. So that was a primary driver of the change in the guidance.

Speaker 4

Thank you. Great.

Operator

Thank you. Your next question comes from the line of Saket Kalia with Barclays. Saket, go ahead.

Speaker 5

Okay, great. Hey guys, thanks for taking my question here. I'll keep it to one as well. Corey, maybe for you, You talked about using this restructuring as a way to also reallocate resources. I mean, clearly, there's a profitability benefit, But also as a way to reallocate resources to the areas where customers are seeing the most value.

Speaker 5

I was wondering if you could just go one level deeper into that. What product areas do you think are maybe going to get a little bit of increased investment? Where do you think you can get a little bit more profitability? Tell us how you thought about that.

Speaker 3

That's a good question. In fact, one of the things that we actually saw is we were seeing extraordinarily strong healthy performance conversion rates in certain parts of our business So with the package strategy that we actually laid out, we had to make sure that our entire organization was aligned around that. And frankly, it just wasn't. And that gave us this gives us an opportunity to actually get the alignment right. The areas specifically Saket, to your very good question, It's really I think about 3 core areas that we're really going to focus on.

Speaker 3

One is what we think about as the modern SOC is customers are looking to upgrade their SOCs to Drive Efficiency. They need both great technology. Yes, it's also consolidation play, but they also need expertise on demand. And so if you look at the investments that we're making, we're really bringing the modern side together, which people have to actually monitor their traditional environments, but they also have to really monitor their cloud environments the the Frankly, the packages are actually going ahead of what we actually laid out. But there's opportunity to actually build a deeper, more integrated solution and to fully take that to market in a very compelling way.

Speaker 3

And I would say we're seeing some of the benefits of that, but we plan to accelerate the benefits. The second thing which I actually alluded to in the previous statement was the Accelerating our investment to continue in cloud. Cloud is at its early evolution, its early innings. The most important thing now is it's actually going from a niche thing where you actually have separate things And as more customers focus on complex integrated environments, it needs to be a mainstream thing. Our goal is to be a leader in mainstream security operations Where people are able to actually both monitor risk and threats across their traditional environments and their cloud environments and that to be a seamless experience.

Speaker 3

We have great traction and great progress. But look, it's a competitive market. We're not resting on our laurels. And we actually are reallocating and refocusing our investment in that area. And then the last area I would just say is more than anything a realignment focus area is that as we've actually executed our strategy quite well on broadening our product portfolio, We've just actually had different experiences for different buyers of different products and services.

Speaker 3

And so we're streamlining and aligning that. That frankly is both an efficiency benefit, but it's a better customer experience, for our customers. So those are the areas of major focus that we have. Thank you for the question, Saket.

Operator

Thank you. Your next question comes from the line of Eric He with KeyBanc Capital Markets. Eric. Go ahead.

Speaker 6

Hey, great. Thank you. I'll ask 2 questions, if I may. Just first, I mean, Corey, can you help us just give us an understanding on kind of the type of growth profile you're setting yourself up for in 2024 following this restructuring plan? And then one follow-up, if I may.

Speaker 3

Yes. No, so I can answer that one pretty quickly. So it's way too premature to actually talk about the growth profile that you referred, mostly because I am not at all qualified to talk about what the economy is going to be like in 2024. And so we'll update you on that later. I think the important thing to think about when talking about the performance profile We knew we wanted to actually strengthen our free cash flow.

Speaker 3

We want to establish a strong foundation there. And so what we did was really pressure tested the growth profile to make sure that it was going to be resilient, I mean, the free cash flow that it would actually hit our free cash flow aspirations and targets In a range of different scenarios. So we have a lot of confidence in regards to what I will tell you too is that we're making investments in the business such that as the economy normalizes, whenever that happens, We should actually see growth accelerate from where we expected to be this year. But again, it's too early to actually talk about what's going to happen in the economy. But we're definitely making the investments Actually, yes, get more free cash flow and efficiency, but we plan to be a competitive grower in the market.

Speaker 3

And as the economy normalizes, our absolute focus is making sure that we're actually growing stronger than what we're seeing at this level today.

Speaker 6

Okay. Thanks. And then just on your comments about cloud, could you just be Maybe be a little bit more specific on where you'd like to invest in cloud security. Does this mean more kind of aggressively in the CNAP space? Is that how I should think about it?

Speaker 6

And then just If you had any color on kind of how big the cloud security business is at the moment, that'd be great color as well.

Speaker 3

Yes. So we see the traction in cloud. We didn't release specific numbers on it. What I would just say as a high level for cloud is we're actually seeing great traction. In fact, the traction has accelerated, which is part of our confidence in investing it.

Speaker 3

There's 2 different areas that I think. We actually have core capabilities and strength and cloud vulnerability management, cloud vulnerability assessment, And CSPM and Cloud Automation today. And we have a good position in other areas. There's 2 things I would say. 1, it's a continuing investment in overall cloud security to make sure that we have the leadership position there.

Speaker 3

And so there's some aspects of CNAP absolutely will be investing in. But the other one is that cloud is still early stages. It's not, like how do you think about securing AI in the cloud? And so it's also a non static. It's a highly dynamic market.

Speaker 3

And we also want to make sure we have the investment capacity to make sure that we actually are leaning into the investment. Because with Cloud, you actually have to be leaning into the investment to stay relevant. The The last thing I'd say is that we do see a big advantage in the traction that we've seen is customers are looking to manage cloud in the of other things that they're doing in their environment. So I would say we see a major differentiator in integrated security operations management That includes cloud in the context of the traditional environment and allows people to manage their overall security footprint cost effectively. We think that as the market goes mainstream, that's a massive opportunity.

Speaker 3

And that will be one of our drivers to your previous question that actually helps us continue to actually accelerate growth as the economy normalizes.

Speaker 4

Thank you.

Operator

Thank you. Your next question comes from the line of Matt Saltzman with Morgan Stanley. Matt, go ahead.

Speaker 7

Hey, team. Thanks for taking the question. Corey, just a start quick one for you. When you think about the competitive landscape for Rapid7, I would assume things have certainly shifted, particularly as you brought in the product portfolio and Really honed in on these bundled go to market motion. So I'm curious in the RFP process, if you're seeing A broadening of the vendors that you're competing with and just kind of any commentary that you can give around win rates.

Speaker 7

I know it's still relatively early in terms of the bundles being in the market, but anything you can give us around win rates against kind of new competitors would be really helpful.

Speaker 3

Yes, it's a good one. So Look, I think the biggest nuke where we have the most at bats is going to be clearly in the modern sock space. That's the evolution of the SIEM market. We also have a consolidation play. And you will see a range of different competitors.

Speaker 3

You see the traditional SIM players, you see some of the MDR players, You have a range of competitors. What I would say is that we're actually having a lot of traction and momentum. That's part of why we're continuing to double down in that business in that space. The conversion rates are high, the growth rates are good, it's at scale business, it's extraordinarily healthy. We're seeing lots of ability to attach around that business.

Speaker 3

And so part of what we're doing is really oriented around that modern soft and how we've been clouded. So that's the first thing. And so our win rates Are actually consistent and growing and high and we feel very good. We're actually having with Managed Direct Complete, I would just say record conversion rates And that offering, which is a proxy, for win rates, although we haven't publicly disclosed the win rates. The second thing I would just highlight is, You know, there's 2 ways to think about the cloud space is the integrated.

Speaker 3

Our strategy right now, because this cloud space is both competitive and expensive, We knock it off the ballpark if we actually do an effective job of upgrading our vulnerability management installed base, Which is substantial base and sticky. That's the motion that we really got focused on this year and that's the purpose of CRC. And we're doing an extraordinary job Right now with a very recent start and actually start to upgrade that CRC base. It's early. We have that vulnerability management base.

Speaker 3

But we are not going out specifically trying to actually land lots of net new cloud customers because this is not the most efficient motion for us right now. We see our early momentum over the next couple of years as really upselling and upgrading our vulnerability management and Solbase to Cloud Risk Complete. You start to see evidence of that. I think I've talked about on the story. The pipeline ability is there.

Speaker 3

The conversion rates are there. We're managing to do that. But that's the strategy and focus areas that we actually have there. Now inevitably, I think that you're alluding to, as we continue to actually build on that cloud momentum, we'll absolutely see more cloud competitors and it's a hyper competitive market We'll tackle that as that comes. But to be clear, is that you talked about accelerating growth.

Speaker 3

We knock it off the ballpark by just upgrading our vulnerability management install base. And that's what we've sort of currently put into focus.

Operator

Thank you. Your next question comes from the line of Brad Reback with Stifel. Brad, go ahead.

Speaker 2

Great. Thanks very much. Corey, 18% is a really large number. So as you manage the business going forward, how do you prevent, I'll call it morale breakage. And then how do we think about how long it'll take to reinvest those savings back into the business?

Speaker 2

Thanks.

Speaker 3

Alright. 1, you're quite right. 18% is large. Of course, we don't do this lightly. So let me just talk about, How we actually thought about this.

Speaker 3

So the first thing is that from our employees, I think that we're able to say to our employees today is while we don't control it, Incrementalism is not helpful to anyone. There's lots of companies that have had to do this multiple times. And so we actually just had a bias about, Hey, let's go deeper and actually do this once, if we're going to have to do it. So that's one thing that we actually focus on. The second thing is that we definitely like all companies had inefficiencies.

Speaker 3

We start by tackling inefficiencies. The inefficiencies are absolutely a smaller number. But part of what we actually saw in the momentum is we actually have parts of our business They're actually growing quite healthy, have incredible stickiness, are showing great signs of the expansion and anchoring ability. And we did not have all of our team and resources aligned around that for obvious reasons, if you think about the legacy of the business. And so when you think about You're going to do something like a RIF or restructuring, you could just tackle the efficiencies.

Speaker 3

You can go shallow, Which actually causes more pain to employees over the longer term frame. You could actually go a little bit different in an effort to actually do it once. We think that's the best for employees so they actually have some visibility and confidence as they go forward. The thing that gives me the most confidence and the thing that I've heard from most of our employees that they're excited about Is that second part of actually making a hard decision to do some of the realignment that allows us to focus on the areas that people See the momentum because our employees see where we actually have momentum and us put a line in the sand and say we will actually be investing behind these opportunities Is a confidence builder, for lots of our employees who are actually looking at the opportunity in the market. So that's our decision.

Speaker 3

Make sure that for employees, we actually do this once, with everything that we actually know is possible, making sure that they are being invested in tackling the big opportunities that we're already getting progress on. And that's the type of thing that we think actually motivates and excites the employees that are actually moving forward with us.

Speaker 8

Corey, just on the second part of Brad's question about the timeliness of the reinvestment. We're going to be very thoughtful and very deliberate in terms of what we do. But Brad, you would expect to see some of that the in the back half of this year and certainly carrying into next year. But again, we're very confident with that improvement in free cash flow doubling year over year to the $160,000,000 that Cory mentioned earlier for next year.

Speaker 4

Thank you for the question.

Operator

Thank you. Your next question comes from the line of Joel Fishbein with Truist Securities. Joel, go ahead.

Speaker 9

Thanks. Just a quick follow-up on Brad's question and then one about acquisitions. You guys are reaching a point where you have easier comps going forward. And I just if you've thought about How this may impact in terms of go to market or talk about any impact to your go to market Feed on the Street salespeople that did the restructuring might have. I know there's not focus there.

Speaker 9

And then also just as a follow-up to that, how the restructuring or Focus on free cash flow might impact your acquisition strategy going forward. Thanks.

Speaker 3

Yes, no, it's 2 very good questions. So the first Is that we made every effort to make sure that we actually minimize customer impact in the short term. And in the mid term, it's Very positive. They're actually customer impact. We're actually rotating more people to be frontline customer facing and engaged.

Speaker 3

One way to simple way to think about the restructuring is that, it's very mild impact on our quota carrying people, Our frontline support people in terms of the number of net people in the organizations that are doing customer facing stuff. There is a lot of impact in some of the overhead that's built up in lines, the management layers, the efficiency. And so that is an impact. To your point, I think part of what we actually had to look at is we have a lot of positive signals. I mean the momentum in the business is good.

Speaker 3

We had a good Q2. We built good pipe. We've seen great conversion rates. But what we really wanted to balance that with is making sure that we actually take proper care to actually, man, it's a risk that comes from a change of this order of magnitude and size. And so part of that is making sure that we're deeply focused on making sure we try to minimize customer, Any customer friction that can come along with this, have good communication.

Speaker 3

Part of this is also why we actually reduced the guidance range to actually make sure That our team is focused on building a long term healthy business. But again, there's some unknowns in there as you actually go through a change in a relatively tight window. So that's the setup that we actually have around that. I think that we're quite set up well to actually manage our customers engagement only over the short term, But in the near term, we actually think it will be quite successful. And then you have a second question, remember, Tim?

Speaker 8

It was on the M and A side.

Speaker 3

On the free cash On the M and A side, I think there's what 2 obvious points is that 1, generating more free cash flow gives us a more range of flexibilities of options About how to do that. Of course, we'll actually look at what's the best benefit for long term shareholders. And so that's going to be a focus here. It just gives us a lot more flexibility and a lot more options to how we manage the business, which is why I had a really, really big focus with Tim and the rest of our leadership team On establishing a much stronger foundation of free cash flow as we're going forward because it allows us a lot more options. When we do M and A, I mean, I can never say we'd never do anything.

Speaker 3

We have a significant bias for tech and team things that are strategically aligned and oriented. That tends to be where we actually like to play and where we actually like to focus on in M and A. But I would think about the free cash flow is just giving us a lot more capacity and options How do we actually generate value in the business? Thank you.

Operator

Thank you. Your next question comes from the line of Srinik Patari with Robert Baird. Srinik, go ahead.

Speaker 10

Hey, thanks for taking my question. So, yeah, Corey, it's good to see that your Threat and Cloud Risk Complete offerings are tracking ahead of their expectations and It's hit over 1 third of your new ARR and overall better than expected kind of favorable linearity in the quarter. From international revenue standpoint, it seems like it again grew quite strongly about 13%. Can you provide some your time provide some geographical color around both the favorable linearity as well as the overall retention rates sequentially from last quarter. I really appreciate

Speaker 3

it. Yes, I'll tag team that with Tim. So the first thing I would just say is we're seeing Last year was pressured in the international, especially EMEA, Tim talked about retention last year. I would say we've seen a very healthy stabilization in a good place to actually continue growth in health from here. And so we feel very good about what's happening in international teams.

Speaker 3

We feel very good about the execution and leadership. We think we're set up well as we actually go forward. But a lot of that is just its improvements over last year, which we had a rough 'twenty two When it came to international and so you saw stabilization and now you're starting to see some improvements of the fundamentals going forward.

Speaker 8

So Tim? Yes. No, I would just add, Cory, certainly a big opportunity Still internationally, the growth rate has been better, higher than what we've seen in North America. Still a huge TAM over there, a big opportunity. And to your point,

Speaker 4

Thank you for the question.

Operator

Thank you. Your next question comes from the line of Jonathan Ho with William Blair. Jonathan, go ahead.

Speaker 5

Hi there. Good afternoon. I wanted to see if I could get a little bit of additional detail on the MSP opportunity that you referenced and just like why is the MSP opportunity a little bit more attractive than in prior periods? How does the restructuring maybe impact that as well? Thank you.

Speaker 3

No, it's a great question. So we've been talking a little bit for a while about partnership, the partnership focus, but also the big opportunity around MSSVs. Look, the way that we see it, Customers overwhelmingly need both technology and services. As people try to tackle fear of complex security environment, There's just not enough talent, enough expertise. We have to scale with a strategy of both technology that's great, well integrated and good service experience.

Speaker 3

Rapid7 does some of this, but we have no aspirations to actually do all of it. 2, we actually think MSPs are great partners. And so part of what we're doing in the efficiency and the streamlining is not just internally aligning our teams. We're actually leaning heavily into a partner strategy Actually for partners that actually provide value to customers to be investing more in those partners, co selling more with those partners, investing in integrated technology solutions support services with those partners. But we are rotating our orientation to be, look, partners have actually grown well with our business.

Speaker 3

We have key partners that going quite well, but you'll see even more of that in the future. We have some great demand with some very key strategic partners That we've already shown momentum with this year. And we see a lot of opportunity to actually partner with key folks in the ecosystem going forward. And so that's a big focus. But at the end of the day, customers need great technology.

Speaker 3

Yes, it needs to be integrated, but they also need service augmentation. And our strategy is to actually do that not just ourselves, but helpfully in contact with our partners.

Speaker 4

Thank you, Jonathan.

Operator

Thank you. Your next question comes from the line of Gregg Moskowitz. Greg, go ahead.

Speaker 11

Yes. Hey, guys. This is Mike on for Greg here. Just two quick ones. So firstly, just wondering, were there any changes quarter in average sales cycles, average deal sizes or duration as compared with the Q1.

Speaker 11

And just second, What sort of ASP uplift did you see for ThreatComplete and Cloud Risk Complete this quarter? Thanks.

Speaker 3

Yes, I would say no change from Q1. If you think about Q4, Q1, Q2, it's been what we've seen. It's a pressured economic environment. Things take a little bit longer, But it's a stable trend is what I would actually see. Look, yeah, I just want to be clear.

Speaker 3

Our demand outlook is healthy and stable. It's just you have the you have a environment where customers are under a little bit of pressure and we have to be thoughtful about how that pressure manifested. We're also seeing things convert. We're seeing lots of health. And so we feel very good about the stapleness of the demand environment so far.

Speaker 3

Things can always change, but we feel very good about what we actually saw in Q2 And what that pertains for as we actually move forward. On your second question is that the outlook that we saw on the packages We're still double. It's roughly 2x. We feel good about that. We do have to get we have to do a job of managing more deals that could have that have higher ASPs in there.

Speaker 3

And that's also a panel take consideration when we think about guidance and other things. But again, it's roughly 2x and that's been a positive trend in the business.

Operator

Thank you. Your next question comes from the line of Gray Powell with BTIG. Gray, go

Speaker 2

ahead. Okay, great. Thanks for taking the question. Yes, maybe just one on my side. I want to make sure I had a stat I think you called out detection and response at over $300,000,000 in ARR, with 25% growth.

Speaker 2

That's great to hear. I know you're not disclosing vulnerability management revenue anymore, but is it safe to say that that's still growing in line Or maybe better than the overall VM market. Just how should we think about that mix? Thanks.

Speaker 3

Yes. So one, if you I'll answer Two questions. 1, at the heart of it, when you think about competitiveness from a usage and adoption, we believe and we're seeing healthy traction in usage and adoption Vulnerability Management and New Customer Adoption Vulnerability Management Solutions. It gets a bit apples and oranges because this is the challenge when you actually have allocations. As you do more platform sales, more solution sales, more packages.

Speaker 3

And so then you're actually attributing and what I would just say there is that it really doesn't make sense to actually Do the allocation base because again, it's just more of an allocation base from a revenue perspective. So the way that we actually are really measuring this, Well, this year, which again is sort of started off a bit more challenge, but we're seeing the right ramp and the right trends and the right trajectory. But as we actually go forward So we expect us to grow better than the overall vulnerability management market in the medium term, because we actually have a better overall Growth profile and opportunity. Yes, we have to actually get through these near term changes. Yes, the economy is in flux some ways.

Speaker 3

But we think we have a very healthy setup for that. And that's the main thing versus actually talking about like how do you actually allocate dollars to specific line items.

Speaker 4

Thanks for the question.

Operator

Thank you. Your next question comes from the line of Roger Boyd with UBS. Roger, go ahead.

Speaker 12

Great. Thanks for taking the question. Corey, I'd love to go back on MSSPs for a second. A lot of your competitors in VM, cloud, SIEM, etcetera are also Emphasizing the growth opportunities they see in this channel. I'm wondering if

Speaker 4

you could just talk about the competitive environment there with MSPs and what makes Rapid7 a better partner versus the competitors. That'd be great. Thanks.

Speaker 3

Yes. I think there's one, I appreciate the opportunity to answer the question. So The first thing is when you think about MSSPs, let's just talk about what they need as a sign. So one, not all people will be successful You're seeing a lot of movement in the market where almost every, I would say, channel partner, Tech company, VAR, even lots of tech companies are doing more managed services. And just to be clear, that's what customers need.

Speaker 3

So let's just understand that like this is an area of core customer need. Now let's talk about why Rapid7 is ideally positioned and why we're having lots of momentum and in fact why we're putting even more investment in this area. We are not interested in commodity low value managed services that do a poor job of security for customers. We want to have world class services that are good. We're also not interested in low margin businesses.

Speaker 3

And so what we've actually had to really focus on over time in Rapid7 is how do you actually build an integrated platform? So the first thing I'll say on differentiation Very few people in the market actually offer integrated solution that spans all security operations, which is what lots of these partners are looking for. So if you think about our solution, it gives them a compelling solution that allows them to compete in detection response, the overall cloud security space, the traditional vulnerability and management space, The risk and compliance space. And even now with some of our partnerships and some of our enhancements with Minerva, the endpoint space. It gives them the ability to go to customers with a holistic solution.

Speaker 3

That's critical and that's what actually, partners support. The second thing that partners need though Is they don't want they don't want poor margins. And so what we've actually built in is heavy automation for ourselves. Again, we looked at ourselves as a lighthouse customer. We have highly competitive, highly attractive, managed service and MDR solutions that have a high win rate, But also 1 at very, very high gross margins.

Speaker 3

And so when you think about competitive positions, we have a comprehensive solution with a lot of automation intelligence They can be running at high gross margins and we set ourselves up to actually partner well with those service providers. This is why we actually have lots of demand. This is why we actually have competitive advantage That's also why we're accelerating our investments in those partnerships because yes, it's a little bit disruptive in the short term, but it gives us long term scale in the business that's incredibly important to us.

Operator

Thank you. Your next question comes from the line of Alex Henderson with Needham. Alex, your line is open.

Speaker 13

Great. Just start off with a clarification. You said your demand trends are stable And you are comfortable, but I was hoping you could just tell us is your pipeline as robust coming out of the June quarter as It was, say, coming out of the Q1 or out of the end of the year. You said that there's no change in that trajectory as we go into the restructuring. So the Change in revenue is only a function of the destabilization, not a pipeline issue.

Speaker 13

Could you talk a little bit about the linearity during the quarter? Was there any fall off in orders or closure rates late in the quarter that we should be aware of? Thanks.

Speaker 3

No. Super fair quality questions, Alex, considering the amount of things that we announced today. So the first thing I would just say is our overall pipeline is actually stable to up and our conversion rates are improved coming out of the quarter. So we actually feel very good about the conversion rates. We feel good about the pipeline coming out.

Speaker 3

So again, the trends in the business are healthy from that perspective. To put a fine point on, because I think the fair question you're asking is like, A, how much of the guide down is the structural changes in risk management? And how much of the guide down is sort of like just trends that you actually saw. And so just to be very specific about that Is that it is about the structural risk management. And look, here's what it comes down to is we actually have a good opportunity.

Speaker 3

The year was already back end loaded. We saw good trends. We actually don't we don't want to be overly precise about an 18% cut and what the implications of that are. So the question that we actually exited after we decided sort of like how to set up for 2024, how to set up the free cash flow is what's inappropriate from a guidance perspective, Knowing that we're actually going to be going through changes. I would say Alex is there's no precision that you can actually do to say like, I'll take a 1,000,000 I'll take a 1,000,000 too.

Speaker 3

We said listen, We want to actually give a number that even with the changes with the major outcomes and knowing by the way that in every quarter I'll answer your other questions. But let me just answer your other question. Your other question was We saw great and consistent conversion rates throughout the quarter. Nothing fell off in the last week. In fact, we have had another consistent period of very strong closes on the bank.

Speaker 3

That said is some things actually close, some things push and that's what we expected. But in a year that's already back end loaded where you can Have things pushed and still close. What we didn't want to do was be over precise about what the impact of a change of this magnitude was. And so we actually asked the opposite question. It says, all right, what's the range of outcomes if actually some things go well, some things don't, some things take longer, some things push And we actually want to have a high confidence guidance range.

Speaker 3

That was a primary driver of guidance that we actually saw.

Speaker 2

Did I

Speaker 3

answer all that?

Speaker 13

Great. Just one last question, if I could stick it in. The timing of these restructurings given the announcement here is in August, Is most of the cost improvement then going to start kicking in, in the Q4 and into 2024 Or do you get some of it in the current quarter?

Speaker 8

Yes. Alex, you'll get a little bit in the Q3. The majority of the team, the 18% is happening right now this week. You'll have some folks that are transitioning through the balance of the year, But then you get the full quarter impact in Q4 and then of course for next year as well, which you see in the free cash flow guide for next year.

Speaker 3

Thank you, Alex.

Operator

Thank you. Your next question comes from the line of Rob Owens with Piper Sandler. Rob, go ahead.

Speaker 14

Hey, thanks for taking my question. This is Ethan on for Rob. I wanted to ask about net new customer additions. They looked pretty strong here, Both on a sequential basis and a year over year basis. So I was kind of hoping you could add some more color there.

Speaker 14

Where did you see strength? Was it with the new packages? With the MDR services. Just curious if there was anything to call out there and why there's such a stark improvement. Thank you.

Speaker 3

Yes. It was a little bit And probably from what we had commented on around really rotating our focus on expanding the customer's office. What I would say and I want to just remind you is that We started with the focus first on the packages. And we follow on motion and training and enabling was about how do we actually Engage deeper and sell more into our installed base. So that motion really got started in Q2.

Speaker 3

So I would expect the trend to change over time. But Probably was a little bit imprecise in the timing on the last call, because that motion was starting. So I still expect us to see In fact, we saw a little bit more, but I would expect to see a skew towards expansion in the installed base over the next year. But we did actually that was a follow on motion from the package motion that we actually did to start the year. And then to answer your core question, it was pretty broad based across regions, products and territories.

Speaker 3

So I can't really localize it to one thing. What I would just say is that the our sales team has a lot of confidence and a lot of momentum. I would say we're focusing heavy on expansion as we actually go forward. But that may rotate over at a slower pace is the way that I'll take away from this quarter.

Speaker 4

Thank you for the question.

Operator

All right. Thank you. Your final question comes from the line of Brian Essex with JPMorgan. Brian, go ahead.

Speaker 2

Hey, Grace. Thanks for taking the question. And Cory, I just want to follow on to that actually last topic. Echo my congrats on some healthy net new ads here from a customer perspective. Just want to get a sense of anything you can provide us for attach rates within the installed base, how much running room do you have to go to kind of upgrade existing customers with adoption of packages?

Speaker 2

And are you seeing anything in your pipeline that's yielding greater confidence in sales productivity from a selling the platform perspective?

Speaker 3

Yeah. So what I actually think we have a massive amount of runway. Part of what we actually are saw and sometimes use words like restructuring, you miss like the realignment and optimization pieces. But a big opportunity that we actually see is that look, for better or for worse, it actually worked. But we actually Spent the last couple of years both doing innovation that made us relevant.

Speaker 3

We have relevant offerings today in areas. Yes, there's continuing work to do, but we actually set ourselves up for relevance make sure that we're in growth markets as we actually go forward. And we had to actually do that by selling into areas that frankly Vulnerability Management did not buy us lots of tailwinds. When you think about the SIEM market, when you think about text and response, when you think about NBR, when you think about automation, when you think about cloud, Is, you know, there's a setup there, but we have to get traction. We have traction and we actually have momentum.

Speaker 3

A part of what we're doing in this restructuring is a lot of realignment. We have not honed our engine to actually really focus on expansion in the installed base. And that's an opportunity that's in front of us. So a big part of what we actually did our baseline and we did our research, when we look at best practices and benchmarks is We actually have a lot of ground that we can actually gain that's relatively straightforward for a company of our size when it comes from the internal operationalization of how we actually expand and operationalize in our installed base. And we're applying that.

Speaker 3

It's not rocket science, but it's applicable. But now is the right time to actually do that because we actually have established critical mass. Keep in mind, most companies when they add new product extensions never get critical mass. We actually have critical mass in growth areas. And this is a good place to really focus about how do we expand in the installed base.

Speaker 3

And most of that opportunity is in front of us. Again, at over $500,000 ARR per customer, and still being sub 100 ks ARR per customer and having historically, frankly, immature processes around expansion, not a lot of focus. Focus, maturing our processes, focusing on our alignment, our pricing and packaging. Those are the areas that we're focusing on To drive that expansion in the installed base and that is a big part of the restructuring alignment. Yes.

Speaker 8

Corey, and to your point, you see it in that ARR per customer continues to grow, which has been very healthy, but there's so much room to grow from the mid-60s into the 100,000 numbers. Yes, absolutely. A lot of headroom to go.

Speaker 4

Thank you for the question, Brian.

Speaker 3

All right. I think that that is all the questions that we actually have today. Look, I know this was a lot to cover. I'm deeply appreciative of everyone's time and attention and I hope all of you have a great evening.

Operator

Ladies and gentlemen, that concludes today's call. Thank you all for joining. You may now disconnect.

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Earnings Conference Call
Rapid7 Q2 2023
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