8/6/2024

speaker
Operator
Operator

Thank you for standing by. I'd like to welcome everyone to the Rapid7 second quarter 2024 earnings call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. If you'd like to ask a question during this time, simply press star and the number one on your telephone keypad. If you'd like to withdraw your questions, Press star one again. Thank you. I would now like to turn the call over to Elizabeth Schwach, Director of Investor Relations at Rapid7. Please go ahead.

speaker
Elizabeth Schwach
Director of Investor Relations

Thank you, Operator, and good afternoon, everyone. We appreciate you joining us today to discuss Rapid7's second quarter 2024 financial and operating results, in addition to our financial outlook for the third quarter and full fiscal year 2024. 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 website at investors.rapid7.com, along with the updated company presentation and financial metrics file. 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 law. 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, and financial guidance for the third quarter and full year 2024 and the 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 10-Q, filed on May 8, 2024, our most recent annual report on Form 10-K on February 26, 2024, and in the subsequent reports that we file with the SEC. The information provided on this conference call should be considered in light of such risks. Actual results on 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. Rapid7 does not assume any obligation to update the information presented on this conference call except to the extent required by applicable law. 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, and our prepared comments are in responses 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. With that, I'd like to turn the call over to our CEO, Corey Thomas. Corey?

speaker
Corey Thomas
CEO

Hello, and welcome to everyone joining us on our second quarter 2024 earnings call. As previewed a few weeks ago, Rapid7 ended the second quarter with $816 million of ARR, which is in line with our expectations and represents 9% growth over the prior year. Growth was led by our threat detection response business as customers continue to prioritize their ability to efficiently monitor security data across their full environment while extending their teams with our deep security expertise. The strongest demand was for our consolidated threat complete offerings, which drove over 40% of new ARR in the quarter. As we progress through the second quarter, the underlying market dynamics we've highlighted as tailwinds to our business continue to support our broad strategic plan. Computer practice trainers are increasingly struggling to manage visibility into their complete IT environment. Current market offerings don't tackle these challenges effectively or economically, with the latter factor being particularly difficult for mainstream enterprises. As we continue to advance key investments around innovation this year, these are the core customer challenges we remain focused on solving. Rapid7 is investing to build the strongest security operations ecosystem for mainstream enterprises, supported by a leading data platform for contextualizing risk across fragmented, complex environments. Over the past year, we've been strategically reorienting our company towards an integrated data platform focusing on the highest value workloads in cloud and detection response and building out a more efficient go-to-market motion. We firmly believe that providing visibility across a customer's risk environment by integrating traditional vulnerability management with a broad set of cloud security solutions and pairing that with a world-class DNR stock efficacy in one place gives customers a more effective solution and overall better security outcomes at the price value they're seeking. Our strategic plan is to capture this opportunity while optimizing our business for better long-term growth. In order to meet these strategic objectives, we started this year by sharing our intentional and targeted efforts around three key areas. Detection of spots innovation, our partner ecosystem, and mainstream cloud security adoption. We've spoken to these critical areas on the last few earning calls, and today I'm pleased to update you on the progress we made in each and every last one of them. Our first area of focus is innovation to deliver world-class detection response experience to our customers. Rapid7 has taken a deliberate approach in this market over the last few years, and we continue to invest in extending our capabilities with a committed focus on delivering the integrations, features, and usability that resonates most with mainstream enterprise customers. This overarching approach supports the steady growth we're seeing today in the following ways. The escalated frequency of ransomware attacks is driving security teams to favor solutions that monitor their full IT environments. We continue to focus investments towards expanding the breadth of alert coverage on our platform, which improves our ability to monitor and manage more third-party security data on our platform and sets Rapid7 apart from our peers in SIEM and the XDR space. Rapid7 also stands out against point vendors that lack broad expertise and capabilities across security operations. Our ability to offer an integrated platform to solve adjacent security concerns like full visibility into hybrid attack service delivers better security outcomes and more compelling economic value. And lastly, we are one of the few detection and response platforms that gives customers a seamless extension of their own security teams by using our managed services and the extensive expertise that comes along with it, we continue to invest in the efficiency and scale of our stock, including leveraging AI and analytics to make these teams more effective. Our second key area of focus this year is our partner ecosystem, which continues to increase in importance as we scale and prioritize efficient demand generation. Investing in our growing services and partner ecosystem to increase our capacity for service delivery as well as provide a strong source of efficient demand generation will help us deliver more sustainable and profitable growth. Sales pipeline generated across our strategic partners grew 15% year over year in the second quarter, which was an acceleration from Q1. Our team is seeing traction broadly as we continue to emphasize our MSSP partnerships, key channel relationships, and increasingly engage with customers in marketplaces like AWS. Our Comcast business partnership is progressing nicely and will serve as a steady driver of scale for our detection and response business. Customer buying behavior continues to shift towards the hyperscaler marketplaces, and our ability to support this has doubled the volume of deals that we have closed year-to-date on AWS marketplaces. Furthermore, we're gaining mindshare and momentum with our top channel partners, which is helping to support stronger pipeline growth and remains a growth opportunity for Rapid7. Our last key area, and the one that I'm most excited about today, is our focus on leading mainstream cloud security adoption. To give some context to the unique challenges and opportunities in this space, it's helpful to remember that many security teams don't exactly know what their IT environments look like. While this knowledge is foundational to protecting those environments, mastery of the customer type surface is limited by data collection, which tends to be expensive and challenging. especially as it relates to securing cloud security environments. Because there are multiple sources of data to integrate, we are lowering the barrier to visibility by allowing customers to secure their attack surface by integrating diverse sets of security data, including network identity and cloud telemetry, together on the Rapid7 command platform. This leads me to the announcement you may have heard and seen yesterday. We introduced our new command platform in Black Hat. Fully integrated platform extends our traditional insight capabilities by allowing customers to integrate more of their critical security data in one place, whether that data comes from Apex 7 or other providers, giving security operations teams greater visibility that they can trust. Our flagship exposure command offering aims to provide integrated risk visibility across the full attack surface at optimal cost effectiveness. This single unified view can help customers understand What does my complete environment look like and what are my biggest exposures is the core of our new exposure command offering. The hybrid attack surface clarity offered by exposure command across both traditional and cloud environments is now built into our vulnerability management and improved suite of robust CNAP capabilities for an integrated threat-based approach to risk reduction. Exposure command is boistered by our recent acquisition of Noetic, which provides an integrated, high-confidence view of assets across the attack surface. We believe that the Noetic technology and their top-notch team will be crucial pieces of Rapid7's broader offering, and we're thrilled to have them on board. Starting officially this week, the Rapid7 team will be executed on the following opportunities for our company and our customers related to Exposure Command. First, the opportunity to drive meaningful expansion from our existing Insight VM base to Exposure Command. with frictionless upsell offers for customers looking to unlock better attack service visibility and expand into the cloud. Second, we expect this new platform offering can enhance retention, not only through Exposure Command, but by offering additional attack surface management functionality as part of the existing VM offering at a minimal uplift. Third, Exposure Command adds a second flagship land offering with disruptive market pricing to position us strongly in competitive deals and to help us expand the market to new mainstream customers. We believe there are many underserved mainstream customers that lack visibility into their broader environments, in part due to the complexity and cost structure for existing CNAP offers. And finally, we believe accelerating cloud security adoption via exposure command will further support DNR growth. As customers know well, you can't effectively monitor and respond to threats without visibility into your attack surface. and having visibility into your full environment is a driver for greater urgency around monitoring and responding to threats. As we look ahead, we believe that the long-term investments we are prioritizing this year in the three critical areas I just described, supporting the ,, building our partner ecosystem, and accelerating mainstream cloud adoption, will ultimately deliver the best security outcomes and the strongest economic value for our customers. We remain steadfast. and our commitment to enhancing value for our shareholders, and we are working to capture upside and opportunity through our focused strategic plan. We're currently in the market with our two flagship offerings, exposure command and detection response, to address the highest priority areas of spending within security operations. We continue to innovate on our underlying product capabilities and improve our land and expand motions to meet customers' needs in the existing market. We're confident that our recently streamlined leadership organization focused on profitability and efficient growth and a clear strategy to provide leading security operations platform to mainstream enterprise customers will support long-term growth for Rapid7. 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.

speaker
Tim Adams
CFO

Tim? Thank you, Corey, and good afternoon to everyone on today's call. Thank you for taking the time to join us today. Before I turn to our 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 the second quarter of 2024 with $816 million in ARR, consistent with our expectations and growing 9% over the prior year. Our Q2 ending ARR result reflects continued strength in our detection and response business, particularly for our threat complete offerings. As Corey shared, this consolidated offering drove over 40% of new ARR in the quarter. and underscores the customer demand we are seeing for broad, effective, well-integrated solutions at compelling price points. Trends in the rest of the business during the second quarter were in line with our expectations as we worked towards the launch of our exposure command, our new integrated risk management offering. ARR growth in the second quarter was weighted towards our sales expansion, as ARR per customer grew 7% over the prior year to $71,000, while our total customer base grew 2% year over year to end the quarter with nearly 11,500 customers. We continue to see growth in our higher value platform customers that is partially offset by a decline in lower value non-platform customers. Second quarter revenue of $208 million grew 9% over the prior year and exceeded our guided range. Recurring product subscription revenue grew 10% over the prior year to $200 million, which was better than expected on favorable linearity in the quarter. Professional services revenue declined sequentially as we continued to actively deemphasize certain lower value services. Our revenue mix continues to shift towards international, which grew 19% year over year, and now represents 23% of total revenue. I'll turn now to our operating and profitability measures for the second quarter. Profit gross margin was 76% in the quarter, and total gross margin was 74%, both of which are in line sequentially and with the prior year. Sales and marketing and R&D expenses were 33% and 15% of revenue, respectively, compared to 39% and 21% in the prior year. G&A expense was in line with the prior year at 7% of revenue. Operating income of $39 million was above our guided range and represented a roughly 19% operating margin, approximately 12% higher than the second quarter of last year. Adjusted EBITDA was $45 million in the quarter and net income per diluted share was 58 cents. Moving to our balance sheet and cash flow. We ended the second quarter with cash, cash equivalents and investments of $494 million compared to $464 million at the end of the first quarter. We generated $29 million of free cash flow in the quarter up from the $28 million we reported last quarter. This brings us to our guidance for the remainder of the year. We continue to expect full year ending ARR to be in the range of $850 million to $860 million, which represents growth of 6% to 7% over the prior year. Our second quarter was broadly in line with our expectations, and as we look out at the rest of the year, our assumptions for the second half have not meaningfully changed since we updated guidance in May. While the demand environment continues to be choppy, we expect relative stability and customer spending trends to continue. And while we expect improving pipeline momentum exiting the year, only a modest contribution from exposure command is assumed in the fourth quarter. And lastly, we continue to expect that our detection and response business will remain healthy. Similar to the comments we made last quarter, given the ramp of ARR in the second half of the year and the timing of our recent exposure command launch, I would like to share some directional commentary on our ARR expectations for the third quarter. We expect a high single-digit sequential increase in millions of net new ARR dollars, similar to the increase in the second quarter. We are raising and narrowing our full-year revenue range to $833 to $837 million, representing growth of 7 to 8%. up from the $830 to $836 million. On profitability, we are maintaining the midpoint and narrowing our full-year operating income range to $152 to $156 million. Our updated operating income range is the result of better expense control in the second quarter that is offset by new incremental costs in the second half of the year related to the NOETIC acquisition, as well as higher advisory and legal fees. We expect full year net income per share in the range of 215 to 220 based on an estimated 74.7 million diluted weighted average shares outstanding. Our full year expectation for free cash flow is now 150 to $160 million. While we remain strongly committed to expanding profitability and continue to see a reasonable path to our original target of $160 million, our updated range reflects the new incremental costs in the second half of the year related to noetic and higher advisory and legal fees. Moving to quarterly guidance. For the third quarter of 2024, we expect total revenue in the range of $209 million to $211 million. representing growth of 5% to 6% over the prior year. We expect non-GAAP operating income in the second quarter in the range of $36 to $38 million, and non-GAAP net income per share of $0.50 to $0.53, which is based on 74.9 million diluted weighted average shares outstanding. Thank you for taking the time to join us on the call today, and with that, we will open the call for questions. Operator?

speaker
Operator
Operator

Thank you. As a reminder, if you'd like to ask a question, please press star one on your telephone keypad. Your first question comes from the line of Matt Hedberg from RBC. Line is open.

speaker
Matt Hedberg

Great. Thanks for taking my questions, guys. Corey, Nice to see the stability in the results. I guess, you know, I wanted to drill down a little bit on some of the go-to-market changes that you talked about a month or so ago. You know, maybe just a little bit more of the rationale there and, you know, how do you think about that, you know, potentially impacting second half performance?

speaker
Corey Thomas
CEO

Yeah, no, thanks. It's a great question, Matt. So the primary drivers we're gearing up for the evolution of our go-to-market motion as we really focus on both the command and exposure command You know, a big part of that is upgrading our VM customers to our new command platform, which we think is going to be more relevant to the future than traditional vulnerability management. And we had a high urgency around that. We had three established leaders who have a strong track record. strong tenure with the company that were ready to actually take over sort of like integrated roles across each of the regions. The second part of it is I've been spending the last several years really focused on our product and R&D. And I really wanted to actually sort of like spend more direct time with our sales leaders as we were actually making this as we were making this transition. And as we were looking to accelerate the business going forward.

speaker
Matt Hedberg

Got it. That makes a lot of sense. And I guess somewhat related to the second question, in your prepared remarks, you called out sales pipeline from partners grew nicely. And I think you called out sort of MSP and AWS and maybe a couple others. How does that, as you think about the evolving go-to-market motion, how important are partners going to be, especially with new product rollouts and just broader distribution from that sense of

speaker
Corey Thomas
CEO

Look, I think it's critical. You know, if you just take a step back, remember we have like two big things that we're really focusing on. It's one, making sure and making the transition to make sure that our products and our services are relevant for the next five years, not the past five years. We've had a lot of focus on the product strategy around detection response, managed detection response, and now sort of like integrated exposure command with our new attack surface management offering. And so we've been highly focused there overall. But the second part is how do we actually set ourselves up for a efficient growth as we actually go forward. And as you know, we have to make some sort of like hard but important decisions to actually look and say, like, how do we become the growth oriented security operations company over the next five years? And we saw partners as critical to that. We think we're making good traction there. We're still in the middle of the transition there, but we're seeing the things pointed in the right way. Partners like our offering. We're increasing our investment. We're increasing our service around it. We think it's good for partners. It's good for our customers. But we think that these two big things that we've been actually doing, ensuring our product strategy is right for the next five years, which is really a long-term orientation, and ensuring that our go-to-market strategy has the most leverage for both our customers and the company, are two big things we're doing, and partners are key to that.

speaker
Rapid7

Thanks a lot, Corey. Best of luck. Thanks, Matt. Appreciate it.

speaker
Operator
Operator

Your next question. Sorry, I apologize. Your next question comes from the line of Fatima Bulani from Citi. Line is open.

speaker
Fatima Bulani

Hi, good afternoon. This is Joel on for Fatima. Thanks for taking our questions. So maybe just the first one to follow up on the GTM conversation. So in relation to some of the GTM and sales org changes from earlier this year, Could you just talk about how sales productivity and attrition levels have tended relative to your internal expectations? And then also from that perspective, what's embedded in your guidance for the year?

speaker
Corey Thomas
CEO

Yeah. So on the I assume you're talking about the sales people themselves. We've seen very healthy retention of the sales force. It's in line with our expectations overall and where we expect from the Salesforce maturity. I can tell you that our sales team is extraordinarily excited by the new command launch and the new products that we actually have coming into the market. I haven't seen this much momentum in a long time. That's boistering some of the retention in an overall, I would just say, challenging high level macro environment. We're seeing lots of excitement and momentum as we enter the second half of the year from our sales team.

speaker
Fatima Bulani

And then maybe just to follow up for you, Corey, on the CRC v2, any shareable anecdotes from customers and maybe how early momentum is tracking relative to your expectations?

speaker
Corey Thomas
CEO

Yeah, so the biggest difference between, so we launched our new command platform and you can think about the, you know, the insight platform was a rapid seven platform that actually offered a common set of products on a common platform. The command platform is an all security data platform that includes both Rapid7 data, but critically, customers want to actually see all of their security data about their attack surface, and they don't want to have to be the system integrator on that. The problem that we actually solve with the command platform and with exposure command is we provide the lowest cost, highest efficacy view of the overall attack surface. while actually integrating all the security telemetry across the ecosystem overall. And so that's the primary drive and purpose of the command platform overall. And with that set up, I would just say that we're actually seeing a lot of early interest. Now, it's too early to tell, but I'll tell you, we saw, you know, pre-launch the pipeline build after we introduced our sales. It's been the highest of any launch that I've seen in Rapid 7's history. We've already got the first set of deals in when, you know, that was sort of like because it was addressing a real customer need. That said, is that we're pretty pragmatic about the expectations for this year. Our primary goal this year is to build pipe so that we're set up for a sort of right reacceleration next year. But if sales cycles come in, that's great. But it's not something we're factoring into our overall plans.

speaker
Fatima Bulani

Got it. Thank you.

speaker
Corey Thomas
CEO

Thank you.

speaker
Operator
Operator

Thank you. The next question comes from the line of Jonathan Ho from William Blair. The line is open.

speaker
Jonathan Ho

Hi there. Can you hear me okay? Yes.

speaker
Gartner

Good afternoon. Just wanted to get a sense for how you're thinking about this command platform upsell and perhaps, you know, how you're seeing the market change, you know, whether there's any shifts in terms of, you know, customer spending behaviors that are maybe moving more towards the CTEM or tax service management value proposition.

speaker
Corey Thomas
CEO

Yeah, it's a great question. Look, we've been worried about this for a while. We started investing, as you know, several years ago. We've been accelerating the investment. That was a big part of the restructuring that we did last year. Because what we really want to position ourselves up was to position ourselves for future customer needs and not customer needs to invest. Right now, customers biggest challenge is that you ask almost any customer, they do not have a clear understanding of their overall attack surface. And vulnerability management has done a decent job, but it's still sort of providing a silo of data about parts of the attack surface, but it provides it with a lack of context. What we heard from lots of customers is they wanted to actually have a high confidence view of their overall attack surface. They wanted to actually integrate the data from all of their security telemetry, not just from one vendor. That's the flaw in many asset inventory systems. And they actually wanted to lower the cost of actually the ability to get an understanding to the overall attack surface, which is one of the challenges that you have on the cloud side. And so we are seeing a shift to CTAM or I think Gartner calls it the exposure management space. It's not just sort of packaging vulnerability management together and cloud together. It's the ability to make sure you have end-to-end visibility across the environment. But just as important where we put lots of investment, where we actually combine our innovations with Noetic's innovation, is the ability to integrate all that data in. to actually have the highest confidence view of the state of the overall attack surface at any moment in time and then to be able to integrate all that different data in and be able to drive in investigate respond prioritize across all the data across all the attack surface So far in early discussions, that's providing real value to customers in ways that traditional vulnerability management didn't, which was just another data source that customers didn't have to spend a lot of time and people to actually go figure out, like, all right, how do I relate that data to other data in the environment?

speaker
Gartner

Fantastic. Thank you.

speaker
Corey Thomas
CEO

Thanks, John.

speaker
Operator
Operator

Thank you. The next question comes from the line of Joel Fishbane from Truist Securities. Your line is open.

speaker
Joel Fishbane

Thank you. Thanks for taking the question. Congrats on the command platform launch. Corey, for you, I just would love a little bit more color on, and I know it's early days, pricing, packaging, and go-to-market for the command platform. And what will it actually include and not include? That would be really helpful. Thank you.

speaker
Corey Thomas
CEO

Yeah. So while it's early days, what I would just say is that, look, similar to what we did in DNR, our goal is to actually make the ability to have 100% visibility with confidence into customers' environments affordable and achievable. So it will be an uplift, but it's a relatively, I think, reasonable uplift for existing vulnerability management customers. We think that if we actually do that, it will not just improve sort of like in our expansion growth. It also lock customers in for longer and make them stickier because we're solving a bigger, better problem. The second thing that it actually gives us by taking that approach is when customers better understand what their attack surface is, it turns out that there's more to monitor, and we can actually monetize it with our detection and response offerings. So you can expect it to be a small uplift from the incremental vulnerability management perspective, but we really are pricing this to actually give customers complete visibility into their overall attack surface. And then from there, we actually have several different offerings on top of that that we can actually monetize. But it all starts on the basis of every customer has 100% confidence and understanding of their attack surface. Thank you. Thank you.

speaker
Operator
Operator

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

speaker
Alex Henderson

Yeah. Before I throw a question at you, I just wanted to clarify something. Did you say your pipeline was up 15% for the company as a whole, or was that just the VAR channel?

speaker
Corey Thomas
CEO

That was our overall partner ecosystem was up 15%. The commentary on the company is just that we have seen pipelines stabilize and improving, but we want to see that improvement continue as we build up momentum for next year. Okay.

speaker
Alex Henderson

So if I were to look at the two major products that you've got now, what you're calling your two foundational platforms, if I was a new customer, say, in the June quarter of next year and I acquired – these two product lines simultaneously for, you know, a reasonable-sized company, what would be the relative sizing of the two acquired properties? Would one be larger than the other? Is the, you know, exposure command product larger or smaller than the detection and response platform?

speaker
Corey Thomas
CEO

Yeah, you're just talking about raw pricing. Is that correct? I just want to make sure I understand the question.

speaker
Alex Henderson

Yeah, just roughly, you know, if a new customer, say, a thousand employees, which is larger.

speaker
Corey Thomas
CEO

Yeah, so the way I think about it is that surface command is designed to sort of be very low cost and give you complete coverage of the environment. And so people can actually integrate the data across the environment. Exposure command combines the integration capabilities of surface command with all of the raw sort of like capabilities. So think about it will be disruptive against traditional cloud pricing, but it's meant to actually really drive adoption. So it's meant to be affordable and drive overall coverage in the environment. And then there's lots of the way to think about is detection response is going to be at a premium price point. And frankly, it's going to be more customizable to customers needs. And we really get our monetization into detection response space. because that's critical. And we have a wide range of price points from technology only to manage service with partners, to manage service with us, to customer learning. But we have a wider range of price points with detection and response. And that's also super strategic for customers. And part of why we take the disruptive approach on surface command and exposure command is because the more people understand their attack surface, the easier it is for us to monitor and secure that attack surface with the customers.

speaker
Alex Henderson

So should we be thinking about this as somewhat of a loss leader, you know, entry product that then allows you to upsell the detection and response platform and therefore is a much smaller contribution to revenues but does drive the overall business proposition over time? Is that the right way to think about what we're doing?

speaker
Corey Thomas
CEO

The way that I would think about it is it will actually be a contributor. We expect it to be a contributor to growth, but I would say it's probably a smaller contributor to growth and detection response. But it's still a net positive contributor to growth, just to be clear. And I think that disruptive sort of like packaging and pricing doesn't interrupt that. It does set up for higher expansion and growth in the detection response business. That's true. But we're not pricing it where it's a negative to growth. It is accretive to growth. We expect it to be accretive to growth. But we expect detection and response to be a larger growth driver. That's true. Thanks. Thank you so much.

speaker
Operator
Operator

Thank you. Next question comes from the line of Joshua Tenton from Wolf Research. Your line's open.

speaker
Joshua Tenton

Hey, guys. Thanks for taking my question. Can you hear me? Yes, we can hear you, Josh. Yeah, look, I just have one for me, and I guess, you know, I heard the prepared remarks, especially around the guidance, but just maybe help us get a little confidence around, you know, your confidence interval on the implied second half net new ARR. I understand you guys talked to, like, strength and consolidated offerings, which is 40% of net new ARR, you know, this quarter. we're talking about pretty small numbers for net new ARR in the first half versus what implied in the second half. And it kind of feels like the rest of the business needs to pick up to kind of hit the numbers you're talking to. So just maybe help us gain a little bit more confidence around, you know, your guys' decision to leave the full year, to reiterate the full year ARR outlook today.

speaker
Corey Thomas
CEO

That's great. So if you really look at it, while you're right on the first year, I have got it's really Q1 was just like sort of like really poor in terms of it. Our big question that we actually had was really stabilizing Q2 and having a stable outlook for Q3. We feel very good about that. In addition, Q4, we have just more longer term deals in there. So we have a little bit more in the bank going into Q4. But really what you're talking about. is getting back up to a little bit above a flat year-over-year net ARR from last year. And we feel good about that trend line. I mean, frankly, from the Q1 spot to the Q2, just even though it was a small number, getting that momentum back and having that outlook be stable for Q3 was the trend that we were actually looking to actually get on. And that puts us, I think, in the guidance range. And actually, we feel comfortable about landing in the guidance range right now.

speaker
Corey

Yeah, Corey, in your prepared comments, you talked about the strength in the partner pipeline build up 15%, which year over year, which was up from Q1. So we are seeing the momentum on that side. And we know that Q4 has historically always been a strong quarter for us. And we anticipate that again this year.

speaker
Corey Thomas
CEO

But even that, we expected it to be relatively stable from last year. And we've seen enough momentum and build for that.

speaker
Joshua Tenton

Thank you. A very quick follow-up. Sure. On my end, can you guys, maybe just broadly speaking, actually not broadly speaking, just in general, I don't know if you give an update. I don't remember exactly when you give it to you, but can you just help us understand like the strength you're seeing or like what the run rate is or just an update on the IDR business? Has that kind of been a shining light for you guys over the last two quarters?

speaker
Corey Thomas
CEO

Yeah, IDR is much higher in the preference stack, and it's been the biggest contributor of overall growth this year. And we see the demand there. And in fact, you know, we are working to expand our IDR services because we see customers looking for us to actually do more from a detection response perspective. So we see that as something that's high in the value stack. Customers are looking to help both on the technology side and on the managed service side from us and our partners. And so we see that as a big opportunity, frankly, not just now, but over the next several years.

speaker
Corey

Yeah, Corey, we didn't break it out this quarter, and maybe we have in the past, but we both said in our prepared comments, it's really been an anchor for us, a very strong, positive anchor, and it grew very nicely in the quarter. Yeah. Thank you.

speaker
Joshua Tenton

Thank you, guys. Much appreciated.

speaker
Corey

Thanks, Josh.

speaker
Operator
Operator

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

speaker
Brian Essex

Hi, this is Charlotte Bedeck. I'm for Brian Essex. Thank you for taking the question. I know you gave some color in the prepared remarks, but could you expand a little bit about the platform customer account versus your total customer account and how that's trending? If you're seeing better traction in the enterprise, that can be different aspects like that. That'd be really helpful. Thank you.

speaker
Corey Thomas
CEO

Yeah, I think in the past we've broken out platform versus traditional. Look, we continue to see fall off of our small dollar transactional customers. Our platform customers grew faster than that. And so you can think about like mid single digits in terms of that, which was, I would just say, in line with expectations and healthy. We always want to grow customers, but we're happy that the growth is coming on the platform side. We think that sets up for better long term growth.

speaker
Corey

Yeah, Corey, and it was up sequentially and year over year on the platform side, and it's aligned share of the customer base, and it's performing well. Perfect.

speaker
Corey Thomas
CEO

Thank you.

speaker
Brian Essex

Great. Great. Thank you.

speaker
Operator
Operator

Thanks. Thank you. Your next question comes from the line of Rob Owens of Piper Sandler. The line is open.

speaker
Jonathan Ho

Great. Thanks for taking my question. This is Ethan on for Rob. Corey, I just wanted to ask on the VM space as a whole. Do you see some of the headwinds in growth that you're seeing here, you and other your peers are seeing as kind of cyclical or more secular longer term? Thanks.

speaker
Corey Thomas
CEO

Yeah. So, look, I think the biggest thing is we've been worried and focused and building our platform for a little while because we've seen the pressure that in the strategic value that vulnerability management was going to have. And so we really have taken an intentional approach to actually shift our value stack up first with detection response. And now with our CTM or overall exposure command offering. to solve a more strategic problem for customers. Because at the end of the day, it's about the customer. And vulnerability management solves a problem, but that problem is becoming less and less strategic for customers. I think that's the pressure that you're seeing in the market. It's one that we've been sort of like worried about and focused on for a little while. So while I think that's true, I think vulnerability management itself is still critical. And that's why we see it as an important capability of our solution. But it's a capability of the solution. It's not a standalone solution as we see it, and we think standalone solutions will continue to see pressure, but we do think that if you're solving the broader visibility, risk, understanding of the attack surface problem, then we actually think that's something that customers are going to find valuable. We're seeing good early momentum, but it's too early to tell the pace of that, but we are seeing very good early traction there.

speaker
Jonathan Ho

Great. Appreciate the call.

speaker
Corey Thomas
CEO

Thank you.

speaker
Operator
Operator

Thank you. The next question comes from the line of an anonymous caller from Morgan Stanley. Line is open.

speaker
spk19

Hi, this is Oscar Saavedra on for Hansa Parwala from Morgan Stanley. Thank you for taking my question. I want to dig in a little on your commentary on pipeline generation by partners. Nice to see that it was up 15%. Last quarter, I know you mentioned, you indicated that the contributions from the new focus was not yet making up the contribution laws from what you de-emphasized. I was just wondering if you can comment on how that trend of this quarter, to what extent that gap was closed compared to last quarter. And as we look ahead, how should we think about maybe the timeline for that to sort of break even? Thank you.

speaker
Corey Thomas
CEO

Yeah, as part of the some of the changes that we actually made is something I'm paying a lot of attention to. What I would say is that we saw it stabilize and grow better than it has in a while in the quarter. But we do are looking to actually manage it to grow faster. Now, the partner stuff takes time. And I would just say that that's a core sort of like part of the transition period. But we feel that we're on the right trajectory enough so that we're actually increasing our investment allocation. to the partner ecosystem um because we're seeing the yield and the results there and really what we're focusing on is you know how do we of course make sure that we actually are executing um against this year's targets but also how do we actually build that momentum as we actually go into next year and so i'll just say it's trending the right way of course like everybody else we want to see more sooner um and we're managing our investments thoughtfully on that path but we're seeing the right direction um we're just looking to actually get more out of it faster

speaker
spk19

Got it. Thank you.

speaker
Corey Thomas
CEO

Thank you very much.

speaker
Operator
Operator

Thank you. The next question comes from the line of Mark Cash of Raymond James. The line is open.

speaker
Mark Cash

Hi, yeah, thank you. This is Mark on for Adam. So, Corey, if I could start with you, you know, some exciting change in the product front happening. You know, while there's this move to regional go-to-market structure and not replacing COO roles, So are those changes related or is the move to a regional sales structure something that's already being worked on and why move to that structure?

speaker
Corey Thomas
CEO

Yeah, the changes to actually the regional sales structure already should be worked on. We have been looking at how to, within the region, align the land, expand, retain businesses, drive not just efficiency, but especially since we have a more partner-centric business, to make sure that we actually had more alignment there. So that work was already underway, and our previous chief commercial officer actually did lots of the homework working with the regional sales leaders. to actually help bring that plan forward and to make it a reality there. But the reason for it was not just an efficiency thing, it was also an execution about how do we actually make sure that we're actually upgrading our install base to the new command platform in a timely fashion while working with and expanding our partner ecosystem.

speaker
Mark Cash

Okay, thank you for that. And Corey, if I could ask, I'm sorry, maybe actually for Tim, if you don't mind, I guess, you know, generate 150 to 160 million of free cash flow this year, substantial margin improvement year over year. So how are you now thinking about rank ordering the use of cash that you have this more durable savings of cash coming to the business?

speaker
Corey

Yeah, in terms of more of a capital structure use of cash. So first priority is to make sure we always have enough cash to run the business, which has never been a problem. You know, I would call that, you know, a couple hundred million that you would leave on the balance sheet. Corey and I have talked very publicly of, you know, one acquisition per year to at least have the room to do that. Similar to the acquisition, you know, we welcome the Noetic team to Rapid7. And that is a tech and team, a smaller size deal. So I would call all of that priority number one. And then priority number two is we're very mindful of the debt stack that we have. And we have plenty of time to manage that accordingly.

speaker
Operator
Operator

but ultimately to uh to repay the debt so i'd put it in that order priority thank you thank you our next question comes from the line of michael romanelli from misa hall line is open yeah

speaker
spk17

Yeah. Hey, guys. This is Mike on for Greg. Maybe two for me. I guess just, you know, firstly, from your perspective, have you seen any change in customer behavior since the CrowdStrike IT outage very recently and then just on average discounting rates? So I guess what do they look like in 2Q? You know, were there any changes sequentially? Thanks.

speaker
Corey Thomas
CEO

Look, the CrowdStrike items was a big deal for our customers and for the security industry in general. It took a lot of time. Lots of people put heroic efforts in to get their businesses back online while they were staying secure. We have overlapping customers and we were trying to make sure that we supported our customers. And so I think people are sort of like, while systems are back online, I think that took a lot out of security teams. And so I think that was probably the bigger pressure point. I think it's too early to know anything else, but I just know security teams and IT teams put in Herculean efforts An idea really matters, and they should be appreciated. Your second question, remind me what it was again? Just on relative discounting. Oh, relative discounting. I don't think we saw anything material on the relative discounting level. No real change. Yeah. Thank you very much.

speaker
Operator
Operator

Operator, any more questions? Yep. Apologize. Thank you. Yep. Our next question comes from the line of Kingsley crane lines open.

speaker
Rapid7

I think you're taking the question. So in light of some of your peers focusing on profitability, I wanted to double click on product gross margins. How much room do you feel you have to expand product gross margins over time is 80% a reasonable goal? Or do you expect most future margin improvements to be from sales and marketing, for example?

speaker
Corey Thomas
CEO

You know, it's a really good question. I would say the one, look, I think customers get a vote here. And I will say that customers are also looking for more assistance and enablement. So I think right now we have confidence that we can grow margins overall. We have the flexibility to actually, you know, grow it at the gross margin line from operating expenses. But customers are looking for more help and assistance. Now, I think part of the reason that we actually have room on the gross margin line is really two things. One, we are geared up more partners and managed services partners, which actually help with that. And our team is investing in AI, which actually has the benefit of helping our customers get more coverage and support. While also allowing us to expand our margin profile. And so we haven't fixed the model. We don't want to sacrifice our ability to support customers, engage with customers. But right now, we have very high confidence that we can expand our overall margin as a company while accelerating growth. But it's going to actually, sorry, the overall demand level of customer service, which has been going up hugely where customers want to have Rapid7 and its partners help them more with their security programs, that's going to be offset by AI and the ability for us to continue to ramp partners.

speaker
Rapid7

Great question. Thank you. Well, that's really helpful. And just one more. So I want to think through geodynamics. We've seen some challenges in the States. for a lot of security companies. You've added almost as much net new revenue last year in international as you did in the States. So I just want to talk more about what you're seeing in the U.S. market in particular and what you're hearing from customers.

speaker
Corey Thomas
CEO

Thanks. So there's two things. customers are still under lots of budget pressures. So I just want to be clear that that has not gone away. Customers are trying to figure out how to address security and frankly, how to do it in a tighter budget envelope overall. But we see most customers trying to really address security and they're trying to address the budget envelope overall. That hasn't changed. What they're focusing on is the most critical security problems, and that's why we've had this urgency to really drive and make sure the problems that we solve are the most meaningful problems that we can possibly solve in the security stack. That's why you've seen us aggress so heavily in long-term product service and technology. because that's the moment to do it so that we're actually doing a more important job for customers overall. But most customers are struggling with this. How do I actually make sure that I'm adjusting my business budget needs while also making sure I'm securing our business? And that's not going away. And we see that in North America, too, just like most security companies.

speaker
Rapid7

Very helpful. Thank you. Thank you.

speaker
Operator
Operator

Thank you. Our next question comes from the line of Brad Reback from Stifle. The line is open.

speaker
Brad Reback

Great. Thanks very much. Corey, as we look out to next year, can you envision a scenario where total customer count is actually down?

speaker
Corey Thomas
CEO

Look, you can't look. In this world, you can never say never. I would just say that our strategy right now is to focus on quality of customers. And I think that, like, if you look at our strategic platform customers, if you look at what we're doing with the command platform, I have high confidence that the command platform customers will be up. I have high confidence that the strategic customers will be up. I would just say we're less concerned about some of the historical transactional business, and that creates noise. And so... On the overall customer count, who knows? But I'll just say on the things that actually matter, we have very high confidence that that'll continue to improve. And we're expecting to see healthy transition and healthy adoption of our overall command platform.

speaker
Corey

Yeah, and the platforms. customers, Corey, as we mentioned earlier, continue to grow sequentially. It has, absolutely.

speaker
Corey Thomas
CEO

But that's why I tell them the total customer count is just that there's some things that we're managing and some things that we're not. I think one of the things that, you know, us and the team were talking about is just how to provide over time more consistent transparency to the things that matter. But I would just say on the things that matter, we feel very good about our ability to grow that customer cycle.

speaker
Brad Reback

That's great. Just one follow-up on that. Any reason you wouldn't start providing the absolute platform customer count going forward?

speaker
Corey Thomas
CEO

Yeah. So right now our team's looking, you know, every year we go through the cycle of looking at like what's the right thing to provide. I know that amongst a bunch of other things are in consideration about what we actually share and provide going forward. Look, our goal is to provide the most meaningful insight to our investors. And I know that Elizabeth and the team are working through that right now. So I can't make any commitments now, but they work through that every year. And I know they're looking to do it again now as we get ready to enter next year.

speaker
Brad Reback

Perfect. Thanks very much.

speaker
Corey Thomas
CEO

Thank you.

speaker
Operator
Operator

Thank you. Our next question comes from the line of Schneider-Rod from Baird. The line is open.

speaker
spk14

Hi, this is Zach Schneider on for Shrenik at Baird. Thanks for taking the question. I just wanted to ask about upselling to existing customers and specifically how you plan on sustaining its momentum in the face of budget constraints and elongated sales cycles. If you could talk to any specific initiatives that are being implemented to enhance customer engagement and drive higher upsells, And additionally, how you're addressing customer concerns regarding pricing and ROI. Thanks.

speaker
Corey Thomas
CEO

Yeah, so absolutely. Look, we have what I think is a very high ROI story. We solve a big problem for, I would just say, relatively modest and reasonable incremental spending costs. And we think that that formulation has the impact of making it easier for customers to say yes, making it easier to actually secure existing renewals, because we're piloting lots of incremental value to customers for what's a relatively modest incremental price point. And so we're taking that out to all of our customers. Again, the initial feedback has been good, but we're in the early stages of taking that strategy out to customers. We're doing it across all of our sales teams. And I think we're set up well for success there. But again, we want to make it really, really compelling. And that's why we did not pick, like others, a purely monetization strategy, which is about the company. We picked how do we solve the biggest possible customer problem at the most reasonable economics. And we think that's a strategy that's going to be attractive.

speaker
spk14

Great. Thank you.

speaker
Corey Thomas
CEO

Thank you.

speaker
Operator
Operator

Thank you. Our next question comes from the line of Trevor Rambo. of BTIG. The line is open.

speaker
spk06

Hi, this is Trevor on for GrayPAL. Thanks for taking my question, and congrats on some nice results. So maybe dovetailing off a question before, but what needs to happen for ARR growth to improve back to double digits over the next year or so in terms of growth? What levers do you guys have at your disposal to get there? Is that something more of an exposure command gaining traction? And when should we think about that becoming a possibility at this point?

speaker
Corey Thomas
CEO

Yeah, so look, we clearly are focused. While it's too early to comment specifically next year, I will comment on the leverage because that's a very reasonable question there. Look, the leverage we have is we have latent demand and detection response that we just have to actually, our team is doing some work to expand the offerings and the coverage where customers are asking us for stuff. And we just have to expand our offerings. It's not rocket science there, but our team is working through that. And we think that allows us to address more of the overall detection response market as we actually go forward. The one that we've actually talked about is the command platform exposure command. We actually think that allows us to actually really participate in the higher value stack, similar to the cloud, similar to the attack surface management, where customers are actually spending money versus traditional vulnerability management, which just isn't as big a budget priority. So now we're actually playing in the area where customers actually have priority and they're looking to spend money and we're providing a good overall value proposition. And then in addition to that, we actually have a couple add-ons that were introduced to the Indian StyleBase. Now, all of that has to tee up with the continuing investments that we're actually making in the partner ecosystem that actually drives scale and the rationalization that we're actually doing around the alignment across the business. But if you look at that right product strategy around detection response, which we're expanding that business, you're going to hear more about that later. The exposure command, which allows us to be more strategic in the risk and visibility space. We're executing that. We have good momentum there. Partner, continue to make investments. And frankly, we're going to be accelerating those investments over time. We're seeing good traction there. And then we're really focused on equipment to enable our team. We have a good team there, and I think that they're set up well. Those are the things that can actually drive traction as we actually go into next year. It's early, but we're actually seeing this set up good. But we have to actually, first and foremost, we have to start by continuing to actually leverage the healthy pipeline trends that we actually saw, where it stabilized and upticked in Q2. And we have to actually really accelerate that and build that. But those are the things that actually drive as we go forward.

speaker
spk06

Great. Thank you. Thank you.

speaker
Operator
Operator

Thank you. Our last question comes from the line of Rudy Kessinger of DA Davidson. The line is open.

speaker
Rudy Kessinger

Hey, thanks for squeezing me in, guys. I want to come back to just this implied net new ARR in the second half. I mean, it's four times as much net new ARR basically implied in the second half versus the first half at the midpoint of the ARR outlook. I know you've given a few comments. Marketplace pipeline up 15%. You know, they get 4X the net new ARR. So just can you give some commentary on the overall pipeline for the second half relative to the first half? Is there any other assumptions in the outlook such as maybe improved gross retention that might be helping drive some of the sequential improvements here? Or just any other color you could provide would be very helpful.

speaker
Corey Thomas
CEO

Yeah, two quick things. One, it's a primarily a Q1 dynamic, not the linearity X and Q2. I would just point out that you talk about 4X in the second half. It was 7X and Q2. And so when you have a Q1 that we actually had, the numbers don't make any sense. You know, you couldn't have actually said 7X and Q2 was going to make it or 8X and Q2 was going to make any sense either. And so really, it's the traction and the it's the rate. of improvement, and we're back on a healthy rate of improvement. So yes, Q1 was bad, but I think we actually normalized and stabilized things in Q2 and we're set up well. And then to get to your core of your question, which is actually really good, is that we didn't leave the guidance range the same just to leave it the same. We actually took a very detailed look at our pipeline, and we believe that from the pipeline and the data and everything that we actually see today, that we're going to be in the guidance range that we actually indicated. But those are the two considerations that I'll just share. Thanks for the question.

speaker
Rudy Kessinger

Yeah. OK. And then just as a quick follow up, if I could just. Go ahead, please. Just on the new logo side. Yeah. On the new logo side, I saw, you know, it flipped back to positive quarter of a quarter, I guess. Just any comments on, you know, new logo bookings in Q2 relative to expectations?

speaker
Corey Thomas
CEO

So I would just say it was within expectations. Look, Q2 was a quarter that we expected to normalize. We saw normalization. I would not say it was a home run quarter. I would just say that Q1 was a bad quarter. Q2, we expected to actually get back to business and normalize it. It normalized. We saw very healthy traction and normalized traction on the platform side. We gave the number up mid single digits. We saw the... It's getting back to positive net overall customer growth. And that's kind of where we expect it to be in a healthy, normalized environment and the setup. So we actually it was what we expected and what we needed to do to actually set up for us to be where we want to be as we actually exit the year. The primary thing that I'm focused on right now is, of course, the introducing the product to our customers, the new products to our customers and building pipeline, not just for the back half of the year, but as we go forward. All right, thank you very much. And Operator, were there any other questions?

speaker
Operator
Operator

There are no more questions.

speaker
Corey Thomas
CEO

All right. With that, I want to thank everyone. I know that there's lots of stuff going on, but I really appreciate the questions and the support. I think we're in an exciting time. We've been executing our product strategy. We're taking that out to our customers and we've been intentionally focused on investments. They're going to set us up for the next several years, not the past three years. So I appreciate everyone's time and attention. Thank you all. Thank you.

speaker
Operator
Operator

ladies and gentlemen that concludes today's conference call thank you all for joining you may now disconnect

Disclaimer

This conference call transcript was computer generated and almost certianly contains errors. This transcript is provided for information purposes only.EarningsCall, LLC makes no representation about the accuracy of the aforementioned transcript, and you are cautioned not to place undue reliance on the information provided by the transcript.

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