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Rapid7 Inc. (NASDAQ:RPD) Q3 2023 Earnings Conference Call November 1, 2023 4:30 PM ET

Company Participants

Elizabeth Chwalk – Director, IR

Corey Thomas – Chairman and CEO

Tim Adams – CFO

Conference Call Participants

Matt Hedberg – RBC Capital Markets

Adam Tindle – Raymond James

Matt Saltzman – Morgan Stanley

Fatima Boolani – Citi

John Weidemoyer – William Blair

Eric Heath – KeyBanc Capital Markets

Trevor Rambo – BTIG

Rob Galvin – Stifel

Alex Henderson – Needham

Operator

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

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

Elizabeth Chwalk

Thank you, operator and good afternoon everyone. We appreciate you joining us today to discuss Rapid7’s third quarter 2023 financial and operating results in addition to our financial outlook for the fourth quarter 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 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 laws. These statements are made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995 and include statements related to the company’s positioning, strategy, business plans, restructuring plans, financial guidance for the fourth quarter and full year 2023, financial goals for the 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 August 9th, 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.

Actual results and the timing of 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 in our prepared remarks or in responses to your questions, we may offer incremental metrics to provide greater insight into the dynamics of our business 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?

Corey Thomas

Good afternoon everyone and thank you for joining us today on our third quarter 2023 earnings call. Rapid7 ended the third quarter with $777 million in ARR or 14% over the prior year, while delivering revenue and operating income above our guided ranges.

During the third quarter, we continued to see strong demand for integrated security operations solutions across our Insight platform. Our value proposition is resonating with mainstream enterprise customers, particularly with our consolidated offerings.

Over 40% of new ARR in the third quarter was from either a threat or cloud risk complete deal, validating our strategic focus around supporting the modern or extended SOC with integrated best-of-breed capabilities across risk management and threat detection. As we sell more of our platform together, we see deal sizes getting larger as ASPs have steadily increased all year.

Overall, we saw a customer spending environment that was in line with our expectations and remained stable during the third quarter and into October. Amid the worsening consequences for cybersecurity incidents and the persistent challenge of proactively securing IT environment in an efficient manner, we consistently hear a set of beans from conversations with customers.

There is need for integrated cloud security offerings with InsightOps as well as a desire to upgrade to cloud-native detection response programs and automation and integrated expertise are often critical differentiators in choosing technology partners.

While security team leaders are prioritizing spending around these areas, the budget environment remains complex. Consistent with the last 12 months, we continue to see higher levels of approval during extended procurement cycles.

The good news is that our sellers have become more adept in navigating this environment and there is still urgency from customers on projects around cloud security and detection response, the anchors of our successful risk and threat management offerings.

Our critical role as a strategic partner to SecOps team is reflected in the growing number of long-term commitments we’re seeing from customers. Our total weighted average contract length in the quarter was up 20% over the prior year, which speaks to the value and confidence our customers have in Rapid7 as a long-term technology partner.

Turning now to the restructuring we announced alongside our Q2 earnings results in August. Our efforts to streamline the business are mostly complete and we are progressing on our areas of strategic reinvestment. I am proud of how well our Rapid7 team has responded to the changes as we have worked to optimize our organization and underlying cost structure over the past few months.

Collectively, our strategic alignment is benefiting profitability, as we expected, and we continue to expect the full year 2023 operating margin to expand over 750 basis points from the prior year and to generate free cash flows of approximately $80 million.

Regarding our customers, we had an intentional focus during the latter half of the third quarter on ensuring continuity and strong overall customer experience as we executed our transition plan.

Our customer-facing teams were heavily focused on spending more time engaging with and messaging to existing customers and prospects with less relative focus on scaling incremental pipeline. The result is that our changes were widely well received by customers, driving strong conversion rates that fueled solid overall ARR growth in the quarter.

Now, that we are largely through these changes, our teams are incrementally more focused on engaging broadly to drive strong and improving pipeline momentum as we exit the year. And we believe we remain well positioned to achieve our fourth quarter objectives.

Regarding reinvestment into our strategic areas of focus. We’re accelerating our leadership in the extended side as well as further scaling our ability to offer expertise alongside our technology. While it’s still early, we are progressing well in both areas, and I’ll give you tangible examples of the positive traction we’re seeing in the business.

We continue to see strong demand for our integrated consolidation solutions to support the extended SOC and we continue to innovate by adding end-to-end capabilities to expand our value proposition to mainstream in the process. In October, we announced the general availability of multilayered endpoint protection for our managed detection and response customers.

By offering integrated next-gen antivirus alongside digital forensics and incident response capabilities, onto our Insight agent, we are elevating the breadth and holistic visibility of our extended detection and response. We saw a meaningful gap in the market for customers with legacy endpoint solutions that are focused on affordable, highly effective solutions.

Our expanded offerings will now enable these MGR customers to benefit from reduced endpoint security cost and complexity within their SOC, while freeing up additional budget dollars by consolidating onto our Insight platform.

We also continue to see traction cross-selling across our integrated platform of solutions. A good example of this is in the third quarter was a deal with a midsized fintech company owned by a large private equity firm.

This customer became a Rapid7 vulnerability management customer in 2022, and earlier this year, extended their enterprise risk visibility with our cloud security offering. They will start again in the third quarter to explore our managed threat complete offering after facing additional resource constraints and regulatory requirements.

With transferred dollars that weren’t part of their initial budget and after a competitive process, the customer chose Rapid7 for our ability to detect and respond to threats across their entire security environment and throughout each phase of the DNR life cycle.

With our Insight agent already deployed, the customer is able to implement our robust monitoring capabilities within days of their purchase, allowing a quick return on their security budget dollars.

Our ARR with the customer more than tripled to the high six figures over the course of 18 months, highlighting the urgency and the value resource-constrained enterprises place on best-in-suite solutions within strategic areas of security operations.

We’re also scaling our ability to offer integrated expertise alongside our SecOps solutions by accelerating our strategic managed services partnerships. I am pleased to announce that we signed a partnership deal in the third quarter with a nationwide leader in communication services, who chose Rapid7 technology as the foundation for their managed detection and response offering.

It was a highly competitive process and our new partner needed a single provider to help their customers manage security across their entire network, endpoint server and cloud infrastructure while helping to contain and disrupt ongoing security breaches.

This partnership will combine our best-in-class threat detection and response platform and global SOC presence to help small, medium and large enterprise customers better manage an ever-evolving and challenging cyber threat landscape.

Over time, we’ll have the opportunity to expand our partnership to sell other Rapid7 solutions to their substantial customer base. We’re excited about this partnership and our ability to leverage similar partnerships in the future as we scale our ability to offer integrated expertise to more customers.

Rapid7 remains focused on being the leading provider of integrated security solutions for the extended SOC by providing risk and threat management within the context of overall security, alongside expertise tailored to the needs of each customer. We are pleased with our third quarter results and continue to march forward towards our goals.

When we updated our ARR guidance in August, alongside the announcement of our restructuring and strategic realignment, we established a high confidence range to account for modest degrees of disruption in the business. As we make progress, we’ve seen performance track within our range of expectations.

Given larger deal cycles as well as the heavy concentration of large deals in the fourth quarter, we believe it is prudent to reiterate our full year ARR guidance of $800 million to $805 million.

All-in-all, we are pleased with our third quarter results and the early progress we are making as we work to reaccelerate growth by reinvesting into strategic areas of strong customer demand within our business.

We were able to outperform on our operating income target in the third quarter and to flow through that upside to our full year guidance range. This speaks to the benefit of our new streamlined cost structure, which will allow us to become a more profitable growth company. We expect to generate approximately $80 million of free cash flow this year and then double that figure to at least $160 million next year in 2024.

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

Tim Adams

Thank you, Corey. Good afternoon to everyone on today’s call and thank you for joining us.

Before I turn to the results, a quick reminder that except for revenue, all financial results we will discuss today are non-GAAP financial measures, unless otherwise stated. Additionally, reconciliations between our GAAP and non-GAAP results can be found in our earnings press release.

Rapid7 ended the third quarter of 2023 with $777 million in ARR, growing 14% over the prior year on solid demand for our consolidated offerings across risk management and threat complete.

Customers continue to gravitate towards our integrated solutions anchored in detection and response in cloud security, which made up over 40% of new ARR in the third quarter. Our value proposition is resonating with customers as we see ASPs continue to climb and our average contracts get longer.

We saw relatively balanced contributions from new and existing customers in the third quarter. ARR per customer grew 7% over the prior year to $6,100, and we ended the quarter with over 11,400 total customers, reflecting 6% growth over the prior year.

Third quarter revenue of $199 million represented growth of 13% year-over-year, exceeding the high end of our guidance range. Product revenue grew 14% year-over-year to $190 million as customers continue to prioritize budget dollars around projects in our areas of strategic focus, both around the extended SOC and the ability to offer integrated expertise. International revenue made up 22% of total revenue, while North American represented 78%.

Moving on to operating and profitability measures for the quarter. Product gross margin was 77%, in line with the prior year, and total gross margin was 75%. Operating expenses reflect the changes to our cost structure that we implemented in August. Sales and marketing represented 34% of revenue in the quarter, down from 38% in the prior year.

R&D and G&A expenses were 16% and 6% of revenue, respectively, compared to 20% and 8% in the third quarter of last year. Overall, higher revenue and a leaner cost structure drove higher-than-expected operating income of $37 million in the quarter. Our adjusted EBITDA was $43 million in the third quarter and diluted net income per share was $0.50.

Before we turn to the balance sheet and cash flow statement, I want to mention certain items from the third quarter income statement that do not affect our non-GAAP results. We incurred a total of $24 million in restructuring and real estate impairment charges in the quarter, in line with our expectations.

We also booked a non-cash induced conversion expense of $54 million in the quarter as a result of the required accounting treatment related to the partial repurchase of our 2025 convertible notes.

We ended the third quarter with cash, cash equivalents, and investments of $373 million. We took proactive steps during the quarter to strengthen our balance sheet and to take advantage of favorable market conditions.

The increase in cash and equivalents from the second quarter reflects the proceeds from our convertible notes offering in September, partially offset by the previously mentioned partial repurchase of our 2025 notes. This was primarily a liability management effort, allowing us to enter into a new convert with more favorable terms and extended the maturity date of a portion of our debt structure.

Operating cash flow was $4 million and reflects timing of the restructuring payments, which were concentrated in the third quarter, as expected. It also reflects a working capital headwind related to the timing of cash collections. We have already seen strong collections early in the fourth quarter, and we’ll continue to manage these working capital dynamics closely.

Moving on to our outlook for the remainder of 2023. As Corey mentioned, we are maintaining our full year ARR outlook range of $800 million to $805 million or approximately 12% to 13% growth over the prior year. As our strategic realignment is tracking in line with our range of expectations, we feel confident about maintaining the existing range for the full year.

We are raising our full year revenue guidance to $773 million to $775 million, representing 13% growth. This reflects product revenue outperformance in the third quarter, partially offset by slightly lower services revenue forecast for the full year as we actively deemphasize some lower-value professional services coming out of our restructuring.

We are also raising the midpoint of our full year operating income guidance by $7 million to reflect our strong third quarter performance. This brings our full year operating income guidance to $94 million to $96 million, representing roughly 12% full year operating margin and over 750 basis points of improvement from the prior year.

Non-GAAP net income per share is expected to be $1.26 to $1.29 based on an anticipated 72.1 million diluted weighted average shares outstanding. We are reiterating our free cash flow guidance of approximately $80 million for the full year.

As implied by our full year guidance for the fourth quarter of 2023, we expect revenue in the range of $200 million to $202 million and operating income between $33 million and $35 million, which represents an operating margin of approximately 17%.

Non-GAAP net income per share for the fourth quarter is expected to be $0.47 to $0.49 based on an anticipated 73.8 million diluted weighted average shares outstanding.

With that, thank you for joining us on the call today, and we will now open the call for questions. Operator?

Question-and-Answer Session

Operator

[Operator Instructions]

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

Matt Hedberg

Great. Thanks for taking my questions. Corey, great to see the results and demand commentary and the benefits of the restructuring going on here. I’m curious, you noted in your prepared remarks that you’re working to reaccelerate growth. I guess, I’m wondering, when we think about sales and marketing or products or whatever it might be, what do you think are some of the most important aspects of what you guys are doing to control some of that reacceleration even despite ongoing economic uncertainty?

Corey Thomas

Yes. Thanks Matt. It’s a good question. So, I think there’s two fundamentals. This one, you have to be in the right markets that have the right demand drivers. I think we’re there. If you think about what we’re doing in the extended SOC, customers are struggling with the cost of complexity of managing their tech service in this environment. And so we are leaning into that and continuing to reallocate investment into that area of focus. That’s a long-term investment area that involves cloud, and we’re also delivering expertise.

But of course, we’re actually focused on that. We have been. We think we have a good leg up. We think we’re competitively differentiated. But it’s a long-term investment area and again, we’re rotating more of our investment to those areas over time.

Now, I would say the point on that one is going to be also the one that goes to go to market is, look, we can actually grow faster. Our big focus right now is growing efficiently, though. And so this is a focus of making sure we have durable growth and efficient growth because as we actually look forward, we know that we can actually in the right areas, the right spaces.

We know we actually are set it up for the right products in services, we have to make sure that we actually have the efficient growth that we’re actually looking for and that spend is going to come over time.

So, we are, I would say, being methodical, being very thoughtful. We are going to be spending the reinvestment, but it’s going to be to extend it into the cloud. continuing to actually work with partners to deliver augmented services. As I talked about with the large national provider and one of the deals that we actually just did, you’ll see more of that.

But it’s also a big focus on extending our sales and marketing engine, but actually doing that both through partners, but doing that efficiently ourselves. And that’s what you’ll see us make investments over the course of both this year, but more importantly, we’ll make an investments over the course of 2024.

But that’s kind of how we think about growth. We’re focused on efficiency now and then adding growth that actually gives long-term growth potential, but actually doing it in a way that makes sure that we actually stay very disciplined, very lean and very efficient.

Matt Hedberg

Super helpful. Thanks Corey.

Corey Thomas

Thank you.

Operator

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

Adam Tindle

Okay. Thanks. Good afternoon. Corey, I just wanted to start, you mentioned how the pipeline was impacted from Q3 from making sure existing customers were okay, which makes total sense and probably a good move I guess the question would be, how do you shift the salesforce to focus? How did you shift them to focus on existing? And how do you pivot them to focus on new pipelines, some of the things you can do from incentives.

And Tim, if you wanted to maybe as a follow-up to this, I know that, that can have a lagged impact on revenue growth, that deceleration in pipeline. Wondering how we should think about that in light of moving forward in 2024 growth, we’re exiting, I think, at single-digit growth in Q4. Wondering if that’s maybe an indicator of what to expect in 2024. Why or why not? Thank you.

Corey Thomas

Yes. So, I’ll tackle that. So, I’ll tackle it first. So, one, on the — as we actually think about sort of guidance, I would just say, listen, the biggest factor there was, as you said, we were very focused on executing the cost structure alignment and make sure we take care of customers.

We actually just had very direct discussions with our team about what the priorities were. The priorities to make sure we’re servicing our customers well, make sure that we were converting existing deals.

We saw and just continue to see very, very strong conversion rates overall. And we continue to see that we were actually adding more consolidation pipeline. So, we had as more consolidation pipe — those are bigger deals. They actually have longer sales cycles.

So, you ask what the short-term effect was, theoretically, less pipe for Q4. That’s something we’re very comfortable with because, again, our big near-term focus was the cost structure.

Now, longer term, we’re very focused on continuing to build strategic pipe, which we’re seeing in the consolidation efforts. We’re doing two things around that. we’re making sure that our sales team is well equipped and selling it. And I would just say we’re seeing the benefits of that now. Yes, that actually have some benefits in 2024.

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

Tim Adams

Yes. And then, Adam, it’s Tim too. The second part of your question regarding 2024, we are right in the middle of our budgeting process for next year. So, it would be premature for us to make any comments about growth for next year.

But I’ll reemphasize what Corey said, we’re very focused on efficient growth and generating strong free cash flow. So, we’ve shared with you guys last quarter that we anticipate roughly $160 million of free cash flow next year.

And we still feel very good about that number. And look, we had some hard actions that we had to take back in August with the restructuring and the realignment of the company. But I do think that sets us up very well for next year that we’ve rationalized the cost structure. So, very focused on efficient growth, and we’ll have more to say about next year on the Q4 call.

Adam Tindle

Makes sense. Thank you very much.

Operator

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

Matt Saltzman

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

Corey Thomas

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

So, we feel good about our retention overall. It’s just say on balance, if you look at last year compared to this year, we feel that it’s trending positively, and we feel good about the direction and the setup going forward.

And in fact, as we think about sort of efficient growth, a big part of that is really focused in to make sure you’re taking care of your customers first. That’s the allotment for the customer value, it does a lot in for us. And we feel good about the trends that we’re seeing in the business.

Matt Saltzman

Great. Thank you.

Corey Thomas

Thank you.

Operator

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

Fatima Boolani

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

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

Corey Thomas

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

One of the interesting things is as we actually build as we build more consolidation pipe, those things are bigger deals and they follow the same sales cycles as the bigger deals. That’s a positive thing. We’re converting those things well. And that’s more of a timing thing. So, I think that we have more visibility into the outlook as we actually go forward.

The second thing that I think you’re alluding to in hitting on, which is actually also important, is we’re focused not just on how do we actually build pipe, but we’re focusing on, what’s the efficiency and what’s the cost to build in pipe. So, we’re not treating all things the same.

So, I’ll give you a perfect example of that is we have a very intention to focus about how do we actually build pipe through partners in the ecosystem and through MSPs. You saw an example of that on one of the marquee deals that actually named on the call, going through partners and especially MSSP partners, but more broadly, the channel. We have a very, very tight focus on that, and we think we can do that efficiently through a targeted set of partners, that’s 1 example.

But again, if you’re in the right demand areas, then you can actually sort of like in ways to actually build pipe, and we are focused, I would say, more now on the cost and the efficiency of the pipe that we build and the overall engine that just actually just driving growth as fast as possible. We will grow.

Again, our tight focus is on long-term growth. but it’s not on trying to get the fastest time to actually that growth is actually making sure it’s both durable, sustainable, but also actually has the right cost structure around it.

Tim Adams

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

Corey Thomas

Absolutely. Thank you again. Great question.

Operator

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

John Weidemoyer

Hi, this is John Weidemoyer for Jonathan. Thanks for taking our question. So, your solutions are targeting modern SOC efforts in terms of SOC spending, are you seeing customers start to shift how they approach traditional apps like SIEM and other solutions to save muddy or improve security? And how might that relate to Rapid7’s value proposition.

Corey Thomas

Yes, we’re seeing a big shift. One is if you think about the traditional stock, it was primarily focused on collecting log files in the on-premise environment and monitoring the on-premise environment. what we’re doing when we think about the extended stock is actually focusing on the overall attack surface, which is not just on Tetris environment. It’s the cloud. It’s the applications.

And so what we’re helping customers do is, one, collect all the data to monitor the full attack surface. But that also adds a massive volume of data. And so we’re focused on both the productivity but also augmenting either with our sales or with partners the expertise and the talent to actually manage the volume of data from that larger attack surface.

Customers are absolutely shifting their focus from traditional SIEMs and focus in malls on-premise to say, how do I cover my full attack surface, but then also looking at how do I do that efficiently.

Because if you look at the trends that are happening right now, customers are not able to add as many security professionals as they would like. And therefore, they’re really, really focused on the efficiency and partners that can deliver efficiency in their agent, and that’s our focus on our extended SOC. Thank you for your question.

Operator

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

Unidentified Analyst

Hi, this is [indiscernible] on for Brian Essex. Thank you for taking the questions. It was great to see you reiterate the doubling of free cash flow in 2024. If you can let us know like what level of confidence do you have in it? And what are the primary levers you’re looking to deliver that cash flow and how much control do you have over them?

Corey Thomas

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

We have the levers in the business. That’s also a big part of why we’re actually as we’re doing reinvestments. We’re doing the reinvestment steadily, not all in 1 go, because that also gives us levers to actually make sure that our reinvestments are timed up well to the performance that we expect to see.

So, I say we have a lot of visibility. We have a lot of controls. But most importantly, our entire company is fairly committed, and we have a good structure from today to deliver on that.

Unidentified Analyst

Great. Thank you.

Corey Thomas

Thank you.

Operator

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

Eric Heath

Hey, thanks for taking the question and Corey and Tim, good execution in tough environment. So, just to follow-up on some of the kind of macro kind of guidance questions. Just curious what’s kind of embedded in your guidance for 4Q in terms of conversion rates because — it seems like maybe you had some relatively high conversion rates this quarter.

So, just curious if you’re extrapolating that out. And also any color on the macro or expectations on the budget flush. And if you had any commentary on the linearity so far this quarter, that would be great, too.

Corey Thomas

Yes, I may miss something. So, I’ll cover those and Tim will cover for me if I actually miss something. So, what I would say is we’ve seen, I would say, improved conversion rates this year, not just across the one quarter, but it’s been a consistent dean that’s actually picked up. So, we expect consistency more than anything else. And I would just say on that one, I think the early start to the quarter indicates consistency and the consistency that we expect in the overall conversion rates.

The other piece of it is, no, we’re not out over our skis from our perspective on expecting a budget flush. We did not factor a budget flush in for this quarter. I don’t see any indicators that would indicate a budget flush right now. If we do, that’s great, but there was no reason to actually factor a budget flush into our expectations and how we think about the overall guidance.

Eric Heath

Thanks.

Corey Thomas

Thank you.

Operator

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

Unidentified Analyst

Hey guys, good afternoon. It’s Daniel on for Mike. Thanks for taking the question. So, could you just provide maybe some color on how the productivity of your sales reps are changing now that they have a few quarters’ worth of experience, really exclusively selling via consolidated offerings. Also, just given your focus on improving profitability and cash flows, do you think the level of investments is sufficient to continue to grow longer term? Thanks.

Corey Thomas

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

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

Tim Adams

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

Corey Thomas

Yes. So, yes, look, I think — but just to be clear is I take a very focused view on, I would say, mid long-term growth. I’m not super — I’m not trying to actually really drive short-term acceleration. And so the way to think about that is that we’re doing heavy investments in products and services.

When I talk about services, I’m talking about like us and our ecosystem and making sure we can augment our customers. We’re investing heavily there. We’re going to keep investing heavily there because if you think about what drives long-term growth is we have to be the preferred provider for the extended SOC. We’re committed to doing that.

We’re putting lots of resources in the products and services. And we’re very intentional about that. And those are investments that we’re making now, but it’s also investments that we’re going to be steadily onboarded and increasing over the course of the next year. And so that’s our ongoing plan.

The second part of that is the investment in sales and marketing. And while I say we’re very focused, we’re really looking at our engine, and we will be adding resources.

We’re going to be adding capacity, but we’re making sure the engine is efficient in this environment. We are taking a more partner-focused approach and aligned approach in this environment.

And so again, if you look out, we think in the midterm, we’re actually are going to have a very, very good growth engine, but it’s not something that we’re rushing on the sales and marketing investments. to actually try to hit a quarter-by-quarter target.

Tim Adams

Yes, Corey. And I think as look analysts pencil out what numbers for the full year may look like for sales and marketing, it is — we think it’s the right amount, but it’s still a healthy investment that carries into next year.

Corey Thomas

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

Unidentified Analyst

Great. Thanks so much for the color.

Operator

[Operator Instructions] Your next question comes from the line of Trevor Rambo from BTIG. Your line is open.

Trevor Rambo

Hi, thanks for taking the question. This is Trevor on for Gray Powell. I was just — I just want to ask, how are you seeing customers react in latest breach an increase in breach headlines. And do you expect it to drive an increase in activity for the company? And then lastly, do you see any product categories that are benefit more than one another? Thanks.

Corey Thomas

Yes. So, first, we tend to be pretty focused on not trying to not to sell into news headlines just because that creates some weird incentives. It also hurts customers’ trust over time. That said, it is a backdrop that’s happening.

So, look, here’s how I just at the backdrop at the most fundamental level, is that CISOs, especially with some of the SEC’s recent actions as it relates to solar winds and other things, are clearly very focused on security and their personal accountability. And so they have security as a top priority. And I still think we have a significant backlog of security projects and resources that are needed.

The funding environment the CISO are going into is tight. And so the reconciliation of that demand backlog, the pressure CISO space, and the speed and the velocity of the budgets they’re getting is an underlying tension that underplays all the stuff that we actually see what the deal cycles and all the other things.

I think if you actually assume out that backlog of projects absolutely has to get resolved over time. So I think we actually have a healthy demand driver, healthy demand market.

Again, I love the place that Rapid7 sits with the extended SOC, with the focus on the attack surface looking across the entire environment from the on-prem and endpoint to the cloud, I think we’re set up well. But I would just say the budget environment for CISOs is going to play out as a budget environment place for CISO.

Our goal is to set ourselves up to be a great partner and to brought a great ecosystem as they have money, as they have funds to steadily only them. And this is where I think our methodical long-term approach will pay dividends.

Tim Adams

So, there was maybe one last piece of that question. Just does it benefit any products in particular I just go back to the packages, the way we fund.

Corey Thomas

Yes. Consolidation — absolutely, Tim, that’s a great point, is it provides leverage and scale, being able to actually say that I can actually manage my attack surface from the endpoint and on-prem to the cloud.

It actually provides an economic value, which helps the CISOs do their job. It allows them if they choose to do it with us or our partner, augment with expertise. And so it provides an economic value, at the same time, it addresses core security concerns.

Trevor Rambo

Great. Thanks for the color.

Corey Thomas

Thank you.

Operator

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

Rob Galvin

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

Corey Thomas

Yes. So, I think it’s a great question. I would not say it’s a primary driver of growth because it’s actually too earlier. What I would say is that we did have some catch-up work to do to make sure that the distribution of our global service and support ecosystem was properly allocated around the world to make sure that the workloads better.

The other thing is just the reality of cyberattacks is more of the attackers operate in time zones that are not the time zones of the US. And so as we actually make sure that our teams are operating around the clock, it’s important to actually have people that are operating in the same time zones, not just our customers, but also the time zones that attacker is actually operating in.

I think we will see more benefits and confidence because our teams both in Europe and in Asia are now able to actually talk more aggressively and directly about the ability to actually get local resources and commitment and availability. So, we think that, that will be a positive thing as we actually go forward. But I would just say it’s too early for that to actually have shown up in the Q3 specific results.

Rob Galvin

Great. Thank you.

Corey Thomas

Thank you.

Operator

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

Alex Henderson

Great. Thanks so much. I was hoping you could talk a little bit about the partnership expansion programs, particularly the MSP that you noted in your call. How material do you think that will be as we look out into 2024 and 2025. Can it add 3%, 4%, 5% to your topline growth rate? And while you’re at it, would you mind just looking at the Splunk acquisition by Cisco, does that have any positive impact on you as a result of that consolidation? Thank you.

Corey Thomas

Yes. Two great questions. So, on the first one, what I would say is that it will be incrementally positive, I think in 2024. We did 1 big one. I think we’ll do some more. We’ve had some smaller ones actually prior to this. So I think it will be incrementally positive in 2024.

The bigger they are, I would just say, the longer the ramp cycle is. So, I just want to be clear, it’s just like your — these are big organizations, and you actually have to — you turn the gears of the organizations. So, I would say some incremental movement in 2024, but I think it really picks up in 2025 and 2026. And we like this consolidated focus on partnering, yes, with the breadth partners going to be clear. We have a war partner post.

But having a few bigger, very focused partners that really move the dial, I think, it’s important. But these are big sophisticated organizations with lots of customers. So, the effort and investment is well worth it. And we’re going to be investing heavily with our partner, but it is also lots of sort of like investment in lots and some work that they do is to actually make this broadly available.

So, we expect to see the benefits over multiple years. But we do expect to have, I would say, incremental positivity in 2024, but I would say really picking up in 2025 when you start looking at some of these larger organizations and how they actually operate.

And then on the [Indiscernible] question, look, I have a lot of respect for Cisco, for Splunk. And so there’s nothing specific about that or those teams and those organizations. What I would say is that when you actually have changes or disruptions to the market and you have — that’s always an opportunity.

And I would say, especially in this environment where people are budget concerned, where there are talent concern, I think it’s an opportunity. Now, it’s just caused a lot of vans and they have probably a great consolidation story. But I think very spacious on the extended stock and the extended attack surface. I think we’re fairly unique in what we can actually offer here.

And so I think that any time any competitor in the market has things that actually cause them to focus or shift focus, that’s an opportunity for us. And so I think from that perspective, yes, it’s an opportunity. But that’s an oval of respect for the competitors in the market here.

Alex Henderson

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

Corey Thomas

Thank you.

Operator

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

Corey Thomas

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

Tim Adams

Thank you.

Operator

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