SECUREWORKS CORP. This management's discussion and analysis is based upon the financial statements of Secureworks which have been prepared in accordance with accounting principles generally accepted inthe United States , or GAAP, and should be read in conjunction with our audited financial statements and related notes for the year endedJanuary 28, 2022 included in Part II, Item 8 of our Annual Report on Form 10-K for the fiscal year endedJanuary 28, 2022 filed with theSEC onMarch 23, 2022 , which we refer to as the Annual Report. In addition to historical financial information, the following discussion contains forward-looking statements that reflect our plans, estimates, beliefs, expected future responses to and effects of the COVID-19 pandemic, the Ukrainian/Russian conflict, inflation concerns and other characterizations of future events or circumstances. Our actual results could differ materially from those discussed or implied in our forward-looking statements. Factors that could cause or contribute to these differences include those discussed in "Risk Factors" in Part I, Item 1A of our Annual Report. Our fiscal year is the 52- or 53-week period ending on the Friday closest toJanuary 31 . We refer to the fiscal year endingFebruary 3, 2023 and the fiscal year endedJanuary 28, 2022 as fiscal 2023 and fiscal 2022, respectively. Fiscal 2023 has 53 weeks and fiscal 2022 has 52 weeks. In fiscal 2023, each quarter has 13 weeks, except for the fourth quarter, which will have 14 weeks. Unless otherwise indicated, all changes identified for the current-period results represent comparisons to results for the prior corresponding fiscal periods. Effective beginning with the three months endedJuly 30, 2021 , we decided to separately present Net revenue and Costs of revenue recognized from Subscription and Professional services offerings, respectively, in the Condensed Consolidated Statement of Operations and within management's discussion and analysis. Historically, these amounts were presented within the Net revenue and Cost of revenue line items, respectively. We concluded that the discrete presentation of these revenue streams provides a more meaningful representation of the nature of the revenues generated by our service offerings. Certain prior year amounts have been conformed to the current year presentation.
All percentage amounts and ratios presented in this management's discussion and analysis were calculated using the underlying data in thousands.
Except where the context otherwise requires or where otherwise indicated, (1) all references to "Secureworks," "we," "us," "our" and "our Company" in this management's discussion and analysis refer toSecureWorks Corp. and our subsidiaries on a consolidated basis, (2) all references to "Dell" refer toDell Inc. and its subsidiaries on a consolidated basis and (3) all references to "Dell Technologies" refer toDell Technologies Inc. , the ultimate parent company ofDell Inc. Overview We are a leading global cybersecurity provider of technology-driven solutions singularly focused on protecting our customers by outpacing and outmaneuvering the adversary. Our vision is to be the essential cybersecurity company for a digitally connected world by providing the software platform of choice to deliver our holistic approach to security at scale for our customers to achieve their best security outcomes. We combine considerable experience from securing thousands of customers, machine-learning capabilities in our software platform, and actionable insights from our team of elite researchers, analysts and consultants to create a powerful network effect that provides increasingly strong protection for our customers. We know from our experience that security based on "point" products operating in silos is not sufficient to outpace the adversary at scale. Through our vendor-inclusive approach, we create integrated and comprehensive solutions by proactively managing the collection of point products deployed by our customers to address specific security issues and provide solutions to fortify gaps in their defenses.
By aggregating and analyzing data from sources around the world, we offer solutions that enable organizations to:
•prevent security breaches,
•detect malicious activity,
•respond rapidly when a security breach occurs, and
•identify emerging threats.
We believe a platform that supports innovation and collaboration enables the
power of the security community to outmaneuver the adversary. Leveraging our
extensive security expertise and knowledge, we utilize unique insights to build
an integrated security platform that fuels efficient and effective security
operations for customers and partners.
The integrated approach we have pioneered enables us to deliver a broad
portfolio of security solutions to organizations of varying size and complexity.
We seek to provide the right level of security for each customer's particular
situation, which evolves as the customer's organization grows and changes over
time. Our flexible and scalable solutions support the evolving
20
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needs of the largest, most sophisticated enterprises, as well as small and
medium-sized businesses and
We offer our customers:
•software-as-a-service, or SaaS, solutions,
•managed security services, and
•professional services, including incident response services and security risk consulting.
Our solutions leverage the proprietary technologies, security operations workflows, extensive expertise and knowledge of the tactics, techniques and procedures of the adversary that we have developed over more than two decades. As key elements of our strategy, we seek to:
•be the cloud-native security software platform of choice,
•broaden our reach with security service providers to deliver our security software platform globally, and
•empower the global security community to beat the adversary at scale.
We offer an integrated suite of technology-driven security solutions enabled by our Taegis software platform or Counter Threat Platform and our team of highly-skilled security experts. Our technology-driven security solutions offer an innovative approach to prevent, detect and respond to cybersecurity breaches. The platforms collect, aggregate, correlate and analyze billions of events daily from our extensive customer base utilizing sophisticated algorithms to detect malicious activity and deliver security countermeasures, dynamic intelligence and valuable context regarding the intentions and actions of cyber adversaries. Through our Taegis solutions and managed security services, which are sold on a subscription basis, we provide global visibility and insight into malicious activity, enabling our customers to detect, respond to and effectively remediate threats quickly. Our proprietary Taegis software platform, which we launched in fiscal 2020, was purpose-built as a cloud-native software platform that combines the power of machine-learning with security analytics and threat intelligence to unify detection and response across endpoint, network and cloud environments for better security outcomes and simpler security operations. The Taegis software platform is a core element for our SaaS solutions, which leverage workflows designed from our extensive security operations expertise and our integrated orchestration and automation capabilities to increase the speed of response actions. We expanded our Taegis SaaS applications with Vulnerability, Detection and Response, or VDR during fiscal 2021 with our acquisition ofDelve Laboratories Inc. Taegis Extended Detection and Response, or XDR, VDR and Managed Detection and Response, or ManagedXDR are the first in a suite of software-driven applications and solutions that Secureworks plans to release driven by our Taegis software platform. In addition to our Taegis solutions and managed security services, we also offer a variety of professional services, which include incident response and security and risk consulting, to accelerate adoption of our software solutions. We advise customers on a broad range of security and risk-related matters through both project-based and long-term contracts in addition to our Taegis solutions and managed security services. COVID-19 InDecember 2019 , a novel strain of the coronavirus, COVID-19, was reported in mainlandChina . TheWorld Health Organization declared the outbreak to constitute a "pandemic" onMarch 11, 2020 . This led to a significant disruption of normal business operations globally, as businesses, including Secureworks, implemented modifications to protect employees by restricting travel and directing employees to work-from-home, in some instances as required by federal, state and local authorities. While we instituted a global work-from-home policy beginning inMarch 2020 , we did not incur significant disruptions in our business operations or a material impact on our results of operations, financial condition, liquidity or capital resources for the three months endedApril 29, 2022 . We have experienced a limited reduction in customer demand for our solutions that we believe is attributable to COVID-19, which may impact our results in future periods. We continue to actively monitor the impacts and potential impacts of the COVID-19 pandemic in all aspects of our business. The extent of the impact of COVID-19 on our future operational and financial performance will depend on various developments, including the duration and spread of variations of the virus, effectiveness and acceptance of vaccines deployed to contain the virus, impact on our employees, customers and vendors, impact on our customers' liquidity and our volume of sales, and length of our sales cycles, none of which can be predicted with certainty. The pandemic might further curtail customer spending, lead to delayed or deferred purchasing decisions, lengthen sales cycles and result in delays in receiving customer or partner payments. These effects, individually or in the aggregate, could have a material negative impact on our future results of operations and financial condition. Due to our subscription-based business model, any such effects of COVID-19 may not be fully reflected in our results of operations until future periods. 21 --------------------------------------------------------------------------------
Key Factors Affecting Our Performance
We believe that our future success will depend on many factors, including the adoption of our Taegis solutions by organizations, continued investment in our technology and threat intelligence research, our introduction of new solutions, our ability to increase sales of our solutions to new and existing customers and our ability to attract and retain top talent. Although these areas present significant opportunities, they also present risks that we must manage to ensure our future success. We operate in an intensely competitive industry and face, among other competitive challenges, pricing pressures within the information security market as a result of action by our larger competitors to reduce the prices of their security prevention, detection and response solutions, as well as the prices of their managed security services. We must continue to manage our investments in an efficient manner and effectively execute our strategy to succeed. If we are unable to address these challenges, our business could be adversely affected.
The key factors affecting our performance include the following:
Transition to Taegis Solutions. Commencing in fiscal 2021, we began transitioning customers away from non-strategic other managed security subscription services to Taegis subscription solutions. In line with this transition strategy, we informed customers early in the fourth quarter of fiscal 2022 that many of our other managed security subscription services would no longer be available for purchase effective as of the beginning of fiscal 2023, as many of those services offer a natural transition to our Taegis platform. Renewals associated with many of our existing other managed security subscription services are not expected to extend beyond the end of fiscal 2023. Although we believe this business transition will enable us to offer security services with higher profit margins, we will continue to incur substantial costs in connection with the transition and, during the transition period, we could lose competitive bids to other cybersecurity solutions providers for the sale of such services. Adoption of Technology-Driven Solution Strategy. The evolving landscape of applications, modes of communication and IT architectures makes it increasingly challenging for organizations of all sizes to protect their critical business assets, including proprietary information, from cyber threats. New technologies heighten security risks by increasing the number of ways a threat actor can attack a target, by giving users greater access to important business networks and information and by facilitating the transfer of control of underlying applications and infrastructure to third-party vendors. An effective cyber defense strategy requires the coordinated deployment of multiple products and solutions tailored to an organization's specific security needs. Our integrated suite of solutions, including our new Taegis offerings, is designed to facilitate the successful implementation of such a strategy, but continuous investment in, and adaptation of, our technology will be required as the threat landscape continues to evolve rapidly. The degree to which prospective and current customers recognize the mission-critical nature of our technology-driven information security solutions, and subsequently allocate budget dollars to our solutions, will affect our future financial results. Investment in OurTechnology and Threat Intelligence Research . Our software platforms constitute the core of our technology-driven security solutions. They provide our customers with an integrated perspective and intelligence regarding their network environments and security threats. Our software platforms are augmented by our Counter Threat Unit research team, which conducts exclusive research into threat actors, uncovers new attack techniques, analyzes emerging threats and evaluates the risks posed to our customers. Our performance is significantly dependent on the investments we make in our research and development efforts, and on our ability to be at the forefront of threat intelligence research, and to adapt these software platforms to new technologies as well as to changes in existing technologies. This is an area in which we will continue to invest, while leveraging a flexible staffing model to align with solutions development. We believe that investment in our Taegis software platform and solutions will contribute to long-term revenue growth, but such investment may continue to adversely affect our prospects for near-term profitability. Introduction of New Security Solutions. Our performance is significantly dependent on our ability to continue to innovate and introduce new information security solutions, such as our Taegis solutions, that protect our customers from an expanding array of cybersecurity threats. We continue to invest in solutions innovation and leadership, including by hiring top technical talent and focusing on core technology innovation. In addition, we will continue to evaluate and utilize third-party proprietary technologies, where appropriate, for the continuous development of complementary offerings. We cannot be certain that we will realize increased revenue from our solutions development initiatives. We believe that our investment in solutions development will contribute to long-term revenue growth, but such investment may continue to adversely affect our prospects for near-term profitability. 22 -------------------------------------------------------------------------------- Investments in Expanding Our Customer Base and Deepening Our Customer Relationships. To support future sales, we will need to continue to devote resources to the development of our global sales force. We have made and plan to continue to make significant investments in expanding our go-to-market efforts with direct sales, channel partners and marketing. Any investments we make in our sales and marketing operations will occur before we realize any benefits from such investments. The investments we have made, or intend to make, to strengthen our sales and marketing efforts may not result in an increase in revenue or an improvement in our results of operations. Although we believe our investment in sales and marketing will help us improve our results of operations in the long term, the resulting increase in operating expenses attributable to these sales and marketing functions may continue to affect our profitability in the near term. The continued growth of our business also depends in part on our ability to sell additional solutions to our existing customers. As our customers realize the benefits of the solutions they previously purchased, our portfolio of solutions provides us with a significant opportunity to expand these relationships. Investment in Our People. The difficulty in providing effective information security is exacerbated by the highly competitive environment for identifying, hiring and retaining qualified information security professionals. Our technology leadership, brand, exclusive focus on information security, customer-first culture, and robust training and development program have enabled us to attract and retain highly talented professionals with a passion for building a career in the information security industry. These professionals are led by a highly experienced and tenured management team with extensive IT security expertise and a record of developing successful new technologies and solutions to help protect our customers. We will continue to invest in attracting and retaining top talent to support and enhance our information security offerings.
Key Operating Metrics
Commencing in fiscal 2021, we began transitioning our subscription customers to our Taegis solutions from our non-strategic, lower margin other managed security subscription services. This transition has resulted in a decline in both our total customer base and total annual recurring revenue. Despite these declines, our gross profit has remained relatively stable and our gross margins have increased. We believe the transition of our subscription business to our Taegis solutions is resulting in a higher value, higher margin business. As part of our ongoing transition, early in the fourth quarter of fiscal 2022, we announced that many of our other managed security subscription services would no longer be available for purchase effective as of the beginning of fiscal 2023, as many of those services offer a natural transition to our Taegis platforms. Renewals associated with many of our existing other managed security subscription services are not expected to extend beyond the end of fiscal 2023. The transition has resulted in the growth of our Taegis portfolio of technology-driven information security solutions offered to customers of all sizes and across all industries. We have achieved this organic growth by re-solutioning existing customers to our Taegis offerings, which generate more average revenue per customer, and through continued expansion in volume and breadth of the Taegis solutions we deploy. The transformation of our Taegis subscription-based model has required ongoing investment in our business, which has contributed to higher net losses. We believe these investments are critical to our long-term success, although they may continue to impact our prospects for near-term profitability.
Relevant key operating metrics are presented below as of the dates indicated and for the fiscal periods then ended.
April 29, 2022 April 30, 2021
Managed security subscription customer base 2,100 3,300
Taegis subscription customer base 1,400 500
Total subscription customer base 3,300 3,600
Total customer base 4,800 5,300
Managed security annual recurring revenue (in millions) $ 189.1 $ 349.1
Taegis annual recurring revenue (in millions) 180.3 72.4
Total annual recurring revenue (in millions) $
369.4
Managed security average subscription revenue per customer (in $
88.4$ 105.4 thousands ) Taegis average subscription revenue per customer (in thousands)$ 129.8 $ 143.3 Total average subscription revenue per customer (in thousands)$ 112.1 $ 116.1 Net revenue retention rate 94 % 98 % Taegis Subscription Customer Base and Managed Security Subscription Customer Base. We define our Taegis subscription customer base and managed security subscription customer base as the number of customerswho have a subscription agreement for that respective offering as of a particular date. Some customers may have subscription agreements for both security offerings to address their current security needs. 23 -------------------------------------------------------------------------------- Total Subscription Customer Base. We define our total subscription customer base as the number of unique customerswho have a subscription agreement for our Taegis solutions and/or managed security services as of a particular date. We believe that growing our existing customer base and our ability to grow our average subscription revenue per customer represent significant future revenue opportunities for us. Total Customer Base. We define total customer base as the number of customers that subscribe to our Taegis SaaS applications and managed security services and customers that buy professional and other services from us, as of a particular date. Total Annual Recurring Revenue. We define total annual recurring revenue as of the measurement date. Changes to recurring revenue may result from the expansion of our offerings and sales of additional solutions to our existing customers, as well as the timing of customer renewals. Total Average Subscription Revenue Per Customer. Total average subscription revenue per customer is primarily related to the persistence of cyber threats and the results of our sales and marketing efforts to increase the awareness of our solutions. Our customer composition of both enterprise and small and medium sized businesses provides us with an opportunity to expand our professional services revenue. As ofApril 29, 2022 andApril 30, 2021 , approximately 55% and 64%, respectively, of our professional services customers subscribed to our Taegis solutions or managed security services. Net Revenue Retention Rate. Net revenue retention rate is an important measure of our success in retaining and growing revenue from our subscription-based customers. To calculate our revenue retention rate for any period, we compare the annual recurring revenue of our subscription-based customers at the beginning of the fiscal year (base recurring revenue) to the same measure from that same cohort of customers at the end of the fiscal year (retained recurring revenue). By dividing the retained recurring revenue by the base recurring revenue, we measure our success in retaining and growing installed revenue from the specific cohort of customers we served at the beginning of the period. Our calculation includes the positive revenue impacts of selling and installing additional solutions to this cohort of customers and the negative revenue impacts of customer or service attrition during the period. The calculation, however, does not include the positive impact on revenue from sales of solutions to any customers acquired during the period. Our net revenue retention rates may increase or decline from period to period as a result of various factors, including the timing of solutions installations and customer renewal rates. 24 --------------------------------------------------------------------------------
Non-GAAP Financial Measures
We use supplemental measures of our performance, which are derived from our financial information, but which are not presented in our financial statements prepared in accordance with generally accepted accounting principles inthe United States of America , referred to as GAAP. Non-GAAP financial measures presented in this management's discussion and analysis include non-GAAP subscription cost of revenue, non-GAAP professional services cost of revenue, non-GAAP gross profit, non-GAAP subscription gross profit, non-GAAP professional services gross profit, non-GAAP gross margin, non-GAAP subscription gross margin, non-GAAP professional services gross margin, non-GAAP operating expenses, non-GAAP research and development expenses, non-GAAP sales and marketing expenses, non-GAAP general and administrative expenses, non-GAAP operating income (loss), non-GAAP net income, non-GAAP earnings per share and adjusted EBITDA. We use non-GAAP financial measures to supplement financial information presented on a GAAP basis. We believe these non-GAAP financial measures provide useful information to help evaluate our operating results by facilitating an enhanced understanding of our operating performance and enabling more meaningful period-to-period comparisons. There are limitations to the use of the non-GAAP financial measures presented in this management's discussion and analysis. Our non-GAAP financial measures may not be comparable to similarly titled measures of other companies. Other companies, including companies in our industry, may calculate non-GAAP financial measures differently than we do, limiting the usefulness of those measures for comparative purposes. The non-GAAP financial measures we present, as defined by us, exclude the items described in the reconciliation below. As the excluded items can have a material impact on earnings, our management compensates for this limitation by relying primarily on GAAP results and using non-GAAP financial measures supplementally. The non-GAAP financial measures are not meant to be considered as indicators of performance in isolation from or as a substitute for revenue, gross profit, research and development expenses, sales and marketing expenses, general and administrative expenses, operating income (loss), net income (loss), earnings (loss) per share in accordance with GAAP and should be read only in conjunction with financial information presented on a GAAP basis.
Reconciliation of Non-GAAP Financial Measures
The table below presents a reconciliation of each non-GAAP financial measure to its most directly comparable GAAP financial measure. We encourage you to review the reconciliations in conjunction with the presentation of the non-GAAP financial measures for each of the periods presented. In future fiscal periods, we may exclude such items and may incur income and expenses similar to these excluded items. Accordingly, the exclusion of these items and other similar items in our non-GAAP presentation should not be interpreted as implying that these items are non-recurring, infrequent or unusual.
The following is a summary of the items excluded from the most comparable GAAP financial measures to calculate our non-GAAP financial measures:
•Amortization of Intangible Assets. Amortization of intangible assets consists of amortization associated with external software development costs capitalized and acquired customer relationships and technology. In connection with the acquisition ofDell byDell Technologies in fiscal 2014 and our acquisition of Delve in fiscal 2021, our tangible and intangible assets and liabilities associated with customer relationships and technology were accounted for and recognized at fair value on the related transaction date. •Stock-based Compensation Expense. Non-cash stock-based compensation expense relates to both theDell Technologies and Secureworks equity plans. We exclude such expense when assessing the effectiveness of our operating performance since stock-based compensation does not necessarily correlate with the underlying operating performance of the business. •Aggregate Adjustment for Income Taxes. The aggregate adjustment for income taxes is the estimated combined income tax effect for the adjustments mentioned above. The tax effects are determined based on the tax jurisdictions where the above items were incurred. 25 --------------------------------------------------------------------------------
Three Months Ended
April 29, 2022 April 30, 2021
(in thousands)
GAAP net revenue(1) $ 121,015 $ 139,463
GAAP subscription cost of revenue $ 32,826 $ 37,425
Amortization of intangibles (4,265) (3,819)
Stock-based compensation expense (123) (103)
Non-GAAP subscription cost of revenue $ 28,438 $ 33,503
GAAP professional services cost of revenue $ 16,609 $ 19,782
Stock-based compensation expense (387) (196)
Non-GAAP professional services cost of revenue $ 16,222 $ 19,586
GAAP gross profit $ 71,580 $ 82,256
Amortization of intangibles 4,265 3,819
Stock-based compensation expense 510 299
Non-GAAP gross profit $ 76,355 $ 86,374
GAAP research and development expenses $ 33,331 $ 28,152
Stock-based compensation expense (2,743) (1,098)
Non-GAAP research and development expenses $ 30,588 $ 27,054
GAAP sales and marketing expenses $ 39,245 $ 36,405
Stock-based compensation expense (1,638) (732)
Non-GAAP sales and marketing expenses $ 37,607 $ 35,673
GAAP general and administrative expenses $ 25,360 $ 25,555
Amortization of intangibles (3,524) (3,524)
Stock-based compensation expense (4,235) (3,906)
Non-GAAP general and administrative expenses $ 17,601 $ 18,125
GAAP operating loss $ (26,356) $ (7,856)
Amortization of intangibles 7,789 7,343
Stock-based compensation expense 9,126 6,035
Non-GAAP operating (loss) income $ (9,441) $ 5,522
GAAP net loss $ (21,598) $ (6,390)
Amortization of intangibles 7,789 7,343
Stock-based compensation expense 9,126 6,035
Aggregate adjustment for income taxes (2,920) (2,997)
Non-GAAP net (loss) income $ (7,603) $ 3,991
GAAP loss per share $ (0.26) $ (0.08)
Amortization of intangibles 0.09 0.09
Stock-based compensation expense 0.11 0.07
Aggregate adjustment for income taxes (0.03) (0.04)
Non-GAAP (loss) earning per share * $ (0.09) $ 0.05
* Sum of reconciling items may differ from total due to rounding of individual components
GAAP net loss $ (21,598) $ (6,390)
Interest and other, net 697 907
Income tax benefit (5,455) (2,373)
Depreciation and amortization 9,383 9,918
Stock-based compensation expense 9,126 6,035
Adjusted EBITDA $ (7,847) $ 8,097
(1) Historically the Company has presented non-GAAP net revenue as a financial
measure. There are no such adjustments that give rise to non-GAAP net revenue
for either of the periods presented. GAAP net revenue is inclusive of both
subscription and professional services revenue.
26
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Our Relationship with
OnApril 27, 2016 , we completed our IPO. Upon the closing of our IPO,Dell Technologies owned, indirectly throughDell Inc. andDell Inc.'s subsidiaries, all shares of our outstanding Class B common stock, which as ofApril 29, 2022 represented approximately 82.5% of our total outstanding shares of common stock and approximately 97.9% of the combined voting power of both classes of our outstanding common stock. As a majority-owned subsidiary ofDell , we receive fromDell various corporate services in the ordinary course of business, including finance, tax, human resources, legal, insurance, IT, procurement and facilities related services. The costs of these services have been charged in accordance with a shared services agreement that went into effect onAugust 1, 2015 , the effective date of our carve-out fromDell . For more information regarding the allocated costs and related party transactions, see "Notes to Condensed Consolidated Financial Statements-Note 10-Related Party Transactions" in our condensed consolidated financial statements included in this report. During the periods presented in the consolidated financial statements included in this report, Secureworks did not file separate federal tax returns, as Secureworks was generally included in the tax grouping of otherDell entities within the respective entity's tax jurisdiction. The income tax benefit has been calculated using the separate return method, modified to apply the benefits for loss approach. Under the benefits for loss approach, net operating losses or other tax attributes are characterized as realized or as realizable by Secureworks when those attributes are utilized or expected to be utilized by other members of theDell consolidated group. For more information, see "Notes to Condensed Consolidated Financial Statements -Note 9-Income and Other Taxes" in our condensed consolidated financial statements included in this report. Additionally, we participate in various commercial arrangements withDell , under which, for example, we provide information security solutions to third-party customers with whichDell has contracted to provide our solutions, procure hardware, software and services fromDell , and sell our solutions throughDell inthe United States and some international jurisdictions. In connection with our IPO, effectiveAugust 1, 2015 , we entered into agreements withDell that govern these commercial arrangements. These agreements generally were initially effective for up to one to three years and include extension and cancellation options. To the extent that we choose to, or are required to, transition away from the corporate services currently provided byDell , we may incur additional non-recurring transition costs to establish our own stand-alone corporate functions. For more information regarding the allocated costs and related party transactions, see "Notes to Condensed Consolidated Financial Statements-Note 10-Related Party Transactions" in our condensed consolidated financial statements included in this report. 27 --------------------------------------------------------------------------------
Components of Results of Operations
Revenue
We generate revenue from the sales of our subscriptions and professional services.
•Subscription Revenue. Subscription revenue primarily consists of subscription fees derived from our Taegis solutions and managed security services. Taegis subscription-based revenue currently includes two applications, Extended Detection and Response, or XDR, and Vulnerability Detection and Response, or VDR, along with the add-on managed service to supplement the XDR SaaS application, referred to as Managed Detection and Response, or ManagedXDR. Managed security service subscription-based arrangements typically include a suite of security services, up-front installation fees and maintenance, and also may include the provision of an associated hardware appliance. Our subscription contracts typically range from one to three years and, as ofApril 29, 2022 , averaged approximately two years in duration. The revenue and any related costs for these deliverables are recognized ratably over the contract term, beginning on the date on which service is made available to customers. •Professional Services Revenue. Professional services revenue consists primarily of incident response solutions and security and risk consulting. Professional services engagements are typically purchased as fixed-fee and retainer-based contracts. Professional services customers typically purchase solutions pursuant to customized contracts that are shorter in duration. Revenue from these engagements is recognized under the proportional performance method of accounting. Revenue from time and materials-based contracts is recognized as costs are incurred at amounts represented by the agreed-upon billing rates. In general, these contracts have terms of less than one year. The fees we charge for our solutions vary based on a number of factors, including the solutions selected, the number of customer devices covered by the selected solutions, and the level of management we provide for the solutions. In the first quarter of fiscal 2023, approximately 78% of our revenue was derived from subscription-based arrangements, attributable to Taegis solutions and managed security services, while approximately 22% was derived from professional services engagements. As we respond to the evolving needs of our customers, the relative mix of subscription-based solutions and professional services we provide our customers may fluctuate. International revenue, which we define as revenue contracted through non-U.S. entities, represented approximately 34% and 32% of our total net revenue in the first quarters of fiscal 2023 and fiscal 2022, respectively. Although our international customers are located primarily in theUnited Kingdom ,Japan ,Australia andCanada , we provided our Taegis solutions or managed security services to customers across 78 countries as ofApril 29, 2022 . Over all of the periods presented in this report, our pricing strategy for our various offerings was relatively consistent, and accordingly did not significantly affect our revenue growth. However, we may adjust our pricing to remain competitive and support our strategic initiatives.
Cost of Revenue
Our cost of revenue consists of costs incurred to provide subscription and professional services.
•Cost of Subscription Revenue. Cost of subscription revenue consists primarily of personnel-related expenses associated with maintaining our platforms and delivering managed services to our subscription customers, as well as hosting costs for these platforms. Personnel-related expenses consist primarily of salaries, benefits and performance-based compensation. Also included in cost of subscription revenue are amortization of equipment and costs associated with hardware utilized as part of providing subscription services, amortization of technology licensing fees, amortization of intangible assets, amortization of external software development costs capitalized, maintenance fees and overhead allocations. As our business grows, the cost of subscription revenue associated with our solutions may fluctuate. •Cost of Professional Services. Cost of professional services revenue consists primarily of personnel-related expenses, such as salaries, benefits and performance-based compensation. Also included in cost of professional services revenue are fees paid to contractorswho supplement or support our solutions, maintenance fees and overhead allocations. As our business grows, the cost of professional services revenue associated with our solutions may fluctuate. 28 --------------------------------------------------------------------------------
Gross Profit and Margin
Gross margin, or gross profit as a percentage of revenue, has been and will continue to be affected by a variety of factors, including the mix between our existing solutions, introduction of new solutions, personnel-related costs and cloud hosting costs. We expect our gross margins to fluctuate depending on these factors, but we expect them to increase over time with expected growth and higher mix of Taegis subscription solutions revenue compared to managed security services and professional services revenue. As we balance revenue growth and continue to invest in initiatives to drive the efficiency of our business, however, we expect gross margin as a percentage of total revenue to continue to fluctuate from period to period.
Operating Costs and Expenses
Our operating costs and expenses consist of research and development expenses, sales and marketing expenses and general and administrative expenses.
•Research and Development, or R&D, Expenses. Research and development expenses include compensation and related expenses for the continued development of our solutions offerings, including a portion of expenses related to our threat research team, which focuses on the identification of system vulnerabilities, data forensics and malware analysis. R&D expenses also encompass expenses related to the development of prototypes of new solutions offerings and allocated overhead. Our customer solutions have generally been developed internally. We operate in a competitive and highly technical industry. Therefore, to maintain and extend our technology leadership, we intend to continue to invest in our R&D efforts by hiring more personnel to enhance our existing security solutions and to add complementary solutions. •Sales and Marketing, or S&M, Expenses. Sales and marketing expenses include salaries, sales commissions and performance-based compensation benefits and related expenses for our S&M personnel, travel and entertainment, marketing and advertising programs (including lead generation), customer advocacy events, and other brand-building expenses, as well as allocated overhead. As we continue to grow our business, both domestically and internationally, we will invest in our sales capability, which will increase our sales and marketing expenses in absolute dollars. •General and Administrative, or G&A, Expenses. General and administrative expenses include primarily the costs of human resources and recruiting, finance and accounting, legal support, information management and information security systems, facilities management, corporate development and other administrative functions, and are partially offset by allocations of information technology and facilities costs to other functions.
Interest and Other, Net
Interest and other, net consists primarily of the effect of exchange rates on our foreign currency-denominated asset and liability balances and interest income earned on our cash and cash equivalents. All foreign currency transaction adjustments are recorded as foreign currency gains (losses) in the Consolidated Statements of Operations. To date, we have had minimal interest income.
Income Tax Benefit
Our effective tax benefit rate was 20.2% and 27.1% for the three months endedApril 29, 2022 andApril 30, 2021 , respectively. The change in effective tax rate between the periods was primarily attributable to the impact of certain adjustments related to the vesting of stock-based compensation awards and the recognition of additional benefits relating to research and development credits. We calculate a provision for income taxes using the asset and liability method, under which deferred tax assets and liabilities are recognized by identifying the temporary differences arising from the different treatment of items for tax and accounting purposes. We provide valuation allowances for deferred tax assets, where appropriate. We fileU.S. federal returns on a consolidated basis withDell and we expect to continue doing so until such time (if any) as we are deconsolidated for tax purposes with respect to theDell consolidated group. According to the terms of the tax matters agreement betweenDell Technologies and Secureworks that went into effect onAugust 1, 2015 ,Dell Technologies will reimburse us for any amounts by which our tax assets reduce the amount of tax liability owed by theDell group on an unconsolidated basis. For a further discussion of income tax matters, see "Notes to Condensed Consolidated Financial Statements-Note 9-Income and Other Taxes" in our condensed consolidated financial statements included in this report. 29 --------------------------------------------------------------------------------
Results of Operations
Three months ended
The following tables summarize our key performance indicators for the three
months ended
Three Months Ended
April 29, 2022 April 30, 2021
% of % % of
$ Revenue Change $ Revenue
(in thousands, except percentages)
Net revenue:
Subscription $ 94,413 78.0 % (9.3) % $ 104,070 74.6 %
Professional Services 26,602 22.0 % (24.8) % 35,393 25.4 %
Total net revenue $ 121,015 100.0 % (13.2) % $ 139,463 100.0 %
Cost of revenue:
Subscription $ 32,826 27.1 % (12.3) % $ 37,425 26.8 %
Professional Services 16,609 13.7 % (16.0) % 19,782 14.2 %
Total cost of revenue $ 49,435 40.9 % (13.6) % $ 57,207 41.0 %
Total gross profit $ 71,580 59.1 % (13.0) % $ 82,256 59.0 %
Operating expenses:
Research and development $ 33,331 27.5 % 18.4 % $ 28,152 20.2 %
Sales and marketing 39,245 32.4 % 7.8 % 36,405 26.1 %
General and administrative 25,360 21.0 % (0.8) % 25,555 18.3 %
Total operating expenses $ 97,936 80.9 % 8.7 % $ 90,112 64.6 %
Operating loss $ (26,356) (21.8) % 235.5 % $ (7,856) (5.6) %
Net loss $ (21,598) (17.8) % 238.0 % $ (6,390) (4.6) %
Other Financial Information (1)
GAAP net revenue:
Subscription $ 94,413 78.0 % (9.3) % $ 104,070 74.6 %
Professional Services 26,602 22.0 % (24.8) % 35,393 25.4 %
Total GAAP net revenue $ 121,015 100.0 % (13.2) % $ 139,463 100.0 %
Non-GAAP cost of revenue:
Non-GAAP Subscription $ 28,438 23.5 % (15.1) % $ 33,503 24.0 %
Non-GAAP Professional Services 16,222 13.4 % (17.2) % 19,586 14.0 %
Total Non-GAAP cost of revenue $ 44,660 36.9 % (15.9) % $ 53,089 38.1 %
Non-GAAP gross profit $ 76,355 63.1 % (11.6) % $ 86,374 61.9 %
Non-GAAP operating expenses:
Non-GAAP research and development $ 30,588 25.3 % 13.1 % $ 27,054 19.4 %
Non-GAAP sales and marketing 37,607 31.1 % 5.4 % 35,673 25.6 %
Non-GAAP general and administrative 17,601 14.5 % (2.9) % 18,125 13.0 %
Non-GAAP operating expenses $ 85,796 70.9 % 6.1 % $ 80,852 58.0 %
Non-GAAP operating (loss) income $ (9,441) (7.8) % (271.0) % $ 5,522 4.0 %
Non-GAAP net (loss) income $ (7,603) (6.3) % (290.5) % $ 3,991 2.9 %
Adjusted EBITDA $ (7,847) (6.5) % (196.9) % $ 8,097 5.8 %
_____________________
(1) See "Non-GAAP Financial Measures" and "Reconciliation of Non-GAAP Financial
Measures" for more information about these non-GAAP financial measures,
including our reasons for including the measures, material limitations with
respect to the usefulness of the measures, and a reconciliation of each non-GAAP
financial measure to the most directly comparable GAAP financial measure.
Non-GAAP financial measures as a percentage of revenue are calculated based on
total GAAP net revenue.
30
--------------------------------------------------------------------------------Revenue
The following table presents information regarding our revenue for the three
months ended
Three Months Ended
April 29, 2022 April 30, 2021 Change
$ % of Revenue $ % of Revenue Change %
(in thousands, except percentages)
Net revenue:
Taegis Subscription Solutions $ 37,216 30.8 % $ 13,960 10.0 % $ 23,256 166.6 %
Managed Security Services 57,197 47.3 % 90,110 64.6 % (32,913) (36.5) %
Total Subscription revenue $ 94,413 78.0 % $ 104,070 74.6 % $ (9,657) (9.3) %
Professional services 26,602 22.0 % 35,393 25.4 % (8,791) (24.8) %
Total net revenue $ 121,015 100.0 % $ 139,463 100.0 % $ (18,448) (13.2) %
Subscription Revenue. For the three months ended April 29, 2022 , subscription
revenue decreased $9.7 million or 9.3%. The revenue decrease reflects our
continued focus on reducing non-strategic service offerings and prioritizing the
growth of our Taegis subscription solutions, which includes reselling Taegis
offerings to our current managed security services customer base.
Professional Services Revenue. For the three months ended April 29, 2022 ,
professional services revenue decreased $8.8 million or 24.8%. The revenue
decrease reflects both our focus on reducing non-strategic professional service
offerings and an overall decrease of billable hours from the first quarter of
fiscal 2021.
Revenue for certain services provided to or on behalf of
We primarily generate revenue from sales inthe United States . However, for the three months endedApril 29, 2022 , international revenue, which we define as revenue contracted through non-U.S. entities, totaled$40.6 million and represented 34.0% of our total revenue, compared to 32% of total revenue for the prior corresponding period. Currently, our international customers are primarily located inAustralia ,United Kingdom ,Japan andCanada . We are focused on continuing to grow our international customer base in future periods. 31 --------------------------------------------------------------------------------
Cost of Revenue
The following table presents information regarding our cost of revenue for the
three months ended
Three Months Ended
April 29, 2022 April 30, 2021 Change
$ % of Revenue $ % of Revenue $ %
(in thousands, except percentages)
Cost of revenue:
Subscription $ 32,826 27.1 % $ 37,425 26.8 % $ (4,599) (12.3) %
Professional Services 16,609 13.7 % 19,782 14.2 % (3,173) (16.0) %
Total cost of revenue $ 49,435 40.9 % $ 57,207 41.0 % $ (7,772) (13.6) %
Other Financial Information
Non-GAAP cost of revenue:
Non-GAAP Subscription $ 28,438 23.5 % $ 33,503 24.0 % $ (5,065) (15.1) %
Non-GAAP Professional Services 16,222 13.4 % 19,586 14.0 % (3,364) (17.2) %
Total Non-GAAP cost of revenue(1) $ 44,660 36.9 % $ 53,089 38.1 % $ (8,429) (15.9) %
(1) See "Non-GAAP Financial Measures" and "Reconciliation of Non-GAAP Financial
Measures" for a reconciliation of each non-GAAP financial measure to the most
directly comparable GAAP financial measure.
Subscription Cost of Revenue. For the three months ended April 29, 2022 ,
subscription cost of revenue decreased $4.6 million , or 12.3%. As a percentage
of revenue, subscription cost of revenue increased 30 basis points to 27.1%. On
a non-GAAP basis, subscription cost of revenue as a percentage of revenue
decreased 50 basis points to 23.5%. The decrease in subscription cost of revenue
was primarily attributable to lower employee-related expenses.
Professional Services Cost of Revenue. For the three months ended April 29,
2022 , professional services cost of revenue decreased $3.2 million , or 16.0%. As
a percentage of revenue, professional services cost of revenue decreased 50
basis points to 13.7%. On a non-GAAP basis, professional services cost of
revenue as a percentage of revenue decreased 60 basis points to 13.4%. The
decrease in professional services cost of revenue was primarily attributable to
lower employee-related expenses associated with the reduction of non-strategic
professional services offerings.
32
--------------------------------------------------------------------------------Gross Profit and Gross Margin
The following table presents information regarding our gross profit and gross
margin for the three months ended
Three Months Ended
April 29, 2022 April 30, 2021 Change
$ $ $ %
(in thousands, except percentages)
Gross Profit:
Subscription $ 61,587 $ 66,645 $ (5,058) (7.6) %
Professional Services 9,993 15,611 (5,618) (36.0) %
Total Gross Profit $ 71,580 $ 82,256 $ (10,676) (13.0) %
Gross Margin:
Subscription 65.2 % 64.0 % 1.2 %
Professional Services 37.6 % 44.1 % (6.5) %
Total Gross Margin 59.1 % 59.0 % 0.1 %
Other Financial Information
Non-GAAP Gross Profit:
Non-GAAP Subscription $ 65,975 $ 70,567 $ (4,592) (6.5) %
Non-GAAP Professional Services 10,380 15,807 (5,427) (34.3) %
Total Non-GAAP Gross Profit(1) $ 76,355 $ 86,374 $ (10,019) (11.6) %
Non-GAAP Gross Margin:
Non-GAAP Subscription 69.9 % 67.8 % 2.1 %
Non-GAAP Professional Services 39.0 % 44.7 % (5.7) %
Total Non-GAAP Gross Margin 63.1 % 61.9 % 1.2 %
(1) See "Non-GAAP Financial Measures" and "Reconciliation of Non-GAAP Financial
Measures" for a reconciliation of each non-GAAP financial measure to the most
directly comparable GAAP financial measure.
Subscription Gross Margin. Subscription gross margin increased 1.2% for the
three months ended
Subscription gross margin on a GAAP basis includes amortization of intangible
assets and stock-based compensation expense. On a non-GAAP basis, excluding
these adjustments, gross margin increased 2.1% for the three months ended
Professional Services Gross Margin. Professional services gross margin decreased 6.5% for the three months endedApril 29, 2022 primarily due to the decrease in professional services revenue.
Professional services gross margin on a GAAP basis includes stock-based
compensation expense. On a non-GAAP basis, excluding that adjustment, gross
margin decreased 5.7% for the three months ended
33
--------------------------------------------------------------------------------Operating Expenses
The following table presents information regarding our operating expenses during
the three months ended
Three Months Ended
April 29, 2022 April 30, 2021
% of % % of
$ Revenue Change $ Revenue
(in thousands, except percentages)
Operating expenses:
Research and development $ 33,331 27.5 % 18.4 % $ 28,152 20.2 %
Sales and marketing 39,245 32.4 % 7.8 % 36,405 26.1 %
General and administrative 25,360 21.0 % (0.8) % 25,555 18.3 %
Total operating expenses $ 97,936 80.9 % 8.7 % $ 90,112 64.6 %
Other Financial Information
Non-GAAP research and development $ 30,588 25.3 % 13.1 % $ 27,054 19.4 %
Non-GAAP sales and marketing 37,607 31.1 % 5.4 % 35,673 25.6 %
Non-GAAP general and administrative 17,601 14.5 % (2.9) % 18,125 13.0 %
Non-GAAP operating expenses (1) $ 85,796 70.9 % 6.1 % $ 80,852 58.0 %
(1) See "Non-GAAP Financial Measures" and "Reconciliation of Non-GAAP Financial Measures" for a reconciliation of each non-GAAP financial measure to the most directly comparable GAAP financial measure.
Research and Development Expenses. R&D expenses increased$5.2 million , or 18.4%, for the three months endedApril 29, 2022 . As a percentage of revenue, R&D expenses increased 730 basis points to 27.5% for the three months endedApril 29, 2022 . On a non-GAAP basis, R&D expenses as a percentage of revenue increased 590 basis points to 25.3% for the three months endedApril 29, 2022 . The increase in R&D expenses was primarily attributable to increased compensation and benefits resulting from the addition of R&D personnel associated with the continued development of our Taegis solutions. Sales and Marketing Expenses. S&M expenses increased$2.8 million , or 7.8%, for the three months endedApril 29, 2022 . As a percentage of revenue, S&M expenses increased 630 basis points to 32.4% for the three months endedApril 29, 2022 . On a non-GAAP basis, S&M expenses as a percentage of revenue increased 550 basis points to 31.1% for the three months endedApril 29, 2022 . The increase in S&M expenses was primarily attributable to both increased marketing expenses and headcount growth in the sales team, the effect of which was partially offset by a decrease in commission expenses. General and Administrative Expenses. G&A expenses decreased$0.2 million , or 0.8%, for the three months endedApril 29, 2022 . As a percentage of revenue, G&A expenses increased 270 basis points to 21.0% for the three months endedApril 29, 2022 . On a non-GAAP basis, G&A expenses as a percentage of revenue increased 150 basis points to 14.5% for the three months endedApril 29, 2022 . The slight decrease in G&A expenses were primarily attributable to lower employee-related expenses, professional services and consulting-related costs, which were partially offset by a higher allocation of shared expenses. 34 --------------------------------------------------------------------------------
Operating Loss
Our operating loss was$26.4 million and$7.9 million for the three months endedApril 29, 2022 andApril 30, 2021 , respectively. As a percentage of revenue, our operating loss was 21.8% for the three months endedApril 29, 2022 and 5.6% for the three months endedApril 30, 2021 . The increase in our operating loss was primarily attributable to our decreased gross profit and increased operating expenses as we continue to invest in the business to drive growth. Operating loss on a GAAP basis includes amortization of intangible assets and stock-based compensation expense. On a non-GAAP basis, excluding these adjustments for amortization of intangible assets and stock-based compensation expense, our non-GAAP operating loss was$9.4 million for the three months endedApril 29, 2022 compared to operating income of$5.5 million for the three months endedApril 30, 2021 . Interest and Other, Net Interest and other, net represented net expense of$0.7 million and$0.9 million for the three months endedApril 29, 2022 andApril 30, 2021 , respectively. The change primarily reflected the effects of foreign currency transactions and related exchange rate fluctuations.
Income Tax Expense (Benefit)
Our income tax benefit was$5.5 million , or 20.2%, and$2.4 million , or 27.1%, of our pre-tax loss during the three months endedApril 29, 2022 andApril 30, 2021 , respectively. The change in the effective tax benefit rate was primarily attributable to the impact of certain discrete adjustments related to the vesting of stock-based compensation awards in the current quarter and the recognition of additional benefits related to research and development credits.
Net Income (Loss)
Our net loss of$21.6 million increased$15.2 million , or 238.0%, for the three months endedApril 29, 2022 . Net loss on a non-GAAP basis was$7.6 million compared to non-GAAP net income of$4.0 million the three months endedApril 30, 2021 . The changes on both a GAAP and non-GAAP basis were attributable to lower revenue from our continued focus on reducing non-strategic service offerings and increased operating expenses, the effect of which was offset in part by the higher income tax benefit recognized in the current quarter. 35 --------------------------------------------------------------------------------
Liquidity and Capital Commitments
Overview
We believe that our cash and cash equivalents will provide us with sufficient liquidity to meet our material cash requirements, including to fund our business and meet our obligations for at least 12 months from the filing date of this report and for the foreseeable future thereafter. Our future capital requirements will depend on many factors, including our rate of revenue growth, the rate of expansion of our workforce, the timing and extent of our expansion into new markets, the timing of introductions of new functionality and enhancements to our solutions, potential acquisitions of complementary businesses and technologies, continuing market acceptance of our solutions, and general economic and market conditions. We may need to raise additional capital or incur indebtedness to continue to fund our operations in the future or to fund our needs for less predictable strategic initiatives, such as acquisitions. In addition to our$30 million revolving credit facility fromDell , described below, sources of financing may include arrangements with unaffiliated third parties, depending on the availability of capital, the cost of funds and lender collateral requirements
Selected Measures of Liquidity and Capital Resources
As of
Selected measures of our liquidity and capital resources are as follows:
April 29,
2022 January 28, 2022
(in thousands)
Cash and cash equivalents $ 186,220 $ 220,655
Revolving Credit Facility
SecureWorks, Inc. , our wholly-owned subsidiary, is party to a revolving credit agreement with a wholly-owned subsidiary ofDell Inc. under which we have obtained a$30 million senior unsecured revolving credit facility. Under the facility, up to$30 million principal amount of borrowings may be outstanding at any time. The maximum amount of borrowings may be increased by up to an additional$30 million by mutual agreement of the lender and borrower. The proceeds from loans made under the facility may be used for general corporate purposes. The facility is not guaranteed by us or our subsidiaries. There was no outstanding balance under the facility as ofApril 29, 2022 orJanuary 28, 2022 , and we did not borrow any amounts under the facility during any period covered by this report. EffectiveMarch 23, 2022 , the facility was amended and restated to extend the maturity date toMarch 23, 2023 and to modify the annual rate at which interest accrues to the applicable LIBOR plus 1.23%. The unused portion of the facility is subject to a commitment fee of 0.35%, which is due upon expiration of the facility. For more information regarding the facility, see "Notes to Condensed Consolidated Financial Statements-Note 5-Debt" in our condensed consolidated financial statements included in this report. 36
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