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 endedFebruary 1, 2019 included in Part II, Item 8 of our Annual Report on Form 10-K as filed with theSEC onMarch 28, 2019 , 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 and beliefs. 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 endingJanuary 31, 2020 and the fiscal year endedFebruary 1, 2019 as fiscal 2020 and fiscal 2019, respectively. Fiscal 2020 and fiscal 2019 each have 52 weeks, and each quarter has 13 weeks. All percentage amounts and ratios presented in this management's discussion and analysis were calculated using the underlying data in thousands. Unless otherwise indicated, all changes identified for the current-period results represent comparisons to results for the prior corresponding fiscal periods. 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 provider of technology-driven information security solutions singularly focused on protecting our customers from cyber attacks. We combine visibility from thousands of customers, machine learning and automation from our proprietary technology and actionable insights from our team of elite researchers and analysts to create a powerful network effect that provides increasingly strong protection for our customers. By aggregating and analyzing data from various sources around the world, we prevent security breaches, detect malicious activity in real time, respond rapidly and predict emerging threats. Our mission is to unlock the value of our customers' security investments by simplifying their complex security operations and amplifying their defenses. Through our vendor-neutral 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 supplemental solutions where gaps exist in our customers' defenses. We provide the right level of security for each customer's unique situation, which evolves as the customer's organization grows and changes. We have pioneered an integrated approach that delivers a broad portfolio of information security solutions to organizations of varying size and complexity. Our flexible and scalable solutions support the evolving needs of the largest, most sophisticated enterprises staffed with in-house security experts, as well as small and medium-sized businesses and government agencies with limited in-house capabilities and resources. Our solutions enable organizations to: • prevent security breaches by fortifying their cyber defenses,
• detect malicious activity,
• respond rapidly to security breaches, and
• predict emerging threats.
Our solutions leverage the proprietary technologies, processes and extensive expertise and knowledge of the tactics, techniques, and procedures of the adversary that we have developed over more than 20 years. Key elements of our strategy include: • maintain and extend our technology leadership,
• expand and diversify our customer base,
• deepen our existing customer relationships, and
• attract and retain top talent.
Our technology-driven information security solutions offer an innovative approach to prevent, detect, respond to and predict cybersecurity breaches. Through our managed security solutions, which are laregely sold on a subscription basis, we provide global visibility and insight into malicious activity, enabling our customers to detect and effectively remediate threats quickly.
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In the first quarter of fiscal 2020, the Company launched its first software as
a service application, Red Cloak Threat Detection and Response (TDR), which
gives customers visibility across their entire environment, applies advanced
analytics developed using machine and deep learning on diverse data from a wide
range of sources, and leverages workflows designed using the Company's 20 years
of security operations expertise and integrated orchestration and automation
capabilities that increase the speed of response actions. Threat intelligence,
which is typically deployed as part of our managed security solutions, delivers
early warnings of vulnerabilities and threats along with actionable information
to help prevent any adverse impact. In addition to these solutions, we also
offer a variety of professional services, which include security and risk
consulting and incident response. Through security and risk consulting, we
advise customers on a broad range of security and risk-related matters. Incident
response minimizes the impact and duration of security breaches through
proactive customer preparation, rapid containment and thorough event analysis
followed by effective remediation. We continuously evaluate potential
investments and acquisitions of businesses, services and technologies that could
complement our existing offerings. We have a single organization responsible for
the delivery of our security solutions, which enables us to respond quickly to
our customers' evolving needs and help them secure themselves against cyber
attacks.
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 third quarter of fiscal 2020, approximately 77% of our revenue was derived
from subscription-based solutions, attributable to managed security contracts,
while approximately 23% 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.
Key Operating Metrics
In recent years, we have experienced broad growth across our portfolio of
technology-driven information security solutions being provided to all sizes of
customers. We have achieved much of this growth by providing solutions to large
enterprise customers, which generate substantially more average revenue than our
small and medium-sized business, or SMB, customers and by continually expanding
the volume and breadth of the security solutions that we provide to all
customers. This has resulted in steady growth in our average revenue per
customer. This growth has required continuous investment in our business,
resulting in net losses. We believe these investments are critical to our
success, although they may continue to impact our profitability.
We believe the operating metrics described below provide further insight into
the long-term value of our subscription agreements and our ability to maintain
and grow our customer relationships. Relevant key operating metrics are
presented below as of the dates indicated and for the quarterly periods then
ended:
November 1, 2019 November 2, 2018
Subscription customer base 4,100 4,300
Total customer base 4,988 4,840
Monthly recurring revenue (in millions) $ 36.9 $ 35.1
Annual recurring revenue (in millions) $ 442.8 $ 421.7
Average subscription revenue per customer (in thousands) $ 107.8 $ 99.3
Revenue retention rate 99 % 91 %
Subscription Customer Base. We define our subscription customer base as the number of customers who subscribe to our managed security solutions 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 our total customer base as the number of customers that, as of a particular date, subscribe to our managed security solutions or buy professional and other services from us.
Annual and Monthly Recurring Revenue. We define recurring revenue as the value
of our subscription contracts as of a particular date. Because we use recurring
revenue as a leading indicator of future annual revenue, we include operational
backlog. We define operational backlog as the recurring revenue associated with
pending contracts, which are contracts that have been sold but for which the
service period has not yet commenced. Our increase in recurring revenue has been
driven primarily by our continuing ability to expand our offerings and sell
additional solutions to existing customers, as well as by larger subscription
contracts to our enterprise customers. Overall, we expect both annual and
monthly recurring revenue to continue to grow as we retain and expand our
customer base, and as our customers extend the use of our solutions over time.
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Average Subscription Revenue Per Customer. The increase in our 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. Additionally, our customer composition of both
enterprise and SMB companies provides us with an opportunity to expand our
professional services revenue.
Revenue Retention Rate. Our 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 monthly recurring revenue excluding operational backlog of our
subscription-based customer base at the beginning of the fiscal year, which we
call our base recurring revenue, to the monthly recurring revenue excluding
operational backlog from that same cohort of customers at the end of the period,
which we call our 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.
However, the calculation does not include the positive impact on revenue from
sales of solutions to any customers acquired during the period. Our revenue
retention rates may decline or increase from period to period as a result of
several factors, including the timing of solution installations and customer
renewal rates.
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 GAAP. Non-GAAP financial measures presented in this
management's discussion and analysis include non-GAAP revenue, non-GAAP gross
margin, 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 (loss), non-GAAP earnings (loss) 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.
In particular, we have excluded the impact of certain purchase accounting
adjustments related to a change in the basis of deferred revenue for the
acquisition of Dell by Dell Technologies in fiscal 2014. We believe it is useful
to exclude such purchase accounting adjustments related to the foregoing
transactions as this deferred revenue generally results from multi-year service
contracts under which deferred revenue is established upon sale and revenue is
recognized over the term of the contract. Pursuant to the fair value provisions
applicable to the accounting for business combinations, GAAP requires this
deferred revenue to be recorded at its fair value, which is typically less than
the book value. In presenting non-GAAP earnings, we add back the reduction in
revenue that results from this revaluation on the expectation that a significant
majority of these service contracts will be renewed in the future and therefore
the revaluation is not helpful in predicting our ongoing revenue trends. We
believe that this non-GAAP financial adjustment is useful to investors because
it allows investors to (1) evaluate the effectiveness of the methodology and
information used by management in its financial and operational decision-making,
and (2) compare past and future reports of financial results of our Company as
the revenue reduction related to acquired deferred revenue will not recur when
related service contracts are renewed in future periods.
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.
Non-GAAP revenue, non-GAAP gross margin, 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
(loss) and non-GAAP earnings (loss) per share, 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 margin, research and development expenses, sales and marketing expenses,
general and administrative expenses, operating income (loss) or net income
(loss) prepared in accordance with GAAP, and should be read only in conjunction
with financial information presented on a GAAP basis.
22
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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 of customer relationships and acquired
technology. In connection with the acquisition of
Technologies in fiscal 2014, all of our tangible and intangible assets and
liabilities were accounted for and recognized at fair value on the
transaction date. Accordingly, amortization of intangible assets consists
of amortization associated with intangible assets recognized in connection
with this transaction.
• Stock-based Compensation Expense. Non-cash stock-based compensation
relates to both the
exclude such expenses 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.
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Three Months Ended Nine Months Ended
November 1, November 2, 2018 November 1, 2019 November 2, 2018
2019
(in thousands) (in thousands)
GAAP and non-GAAP revenue $ 141,332 $ 133,060 $ 410,779 $ 387,999
GAAP gross margin $ 79,764 $ 70,927 $ 222,775 $ 202,788
Amortization of intangibles 3,559 3,410 10,529 10,231
Stock-based compensation expense 353 224 1,009 768
Non-GAAP gross margin $ 83,676 $ 74,561
GAAP research and development expenses
$ 71,600 $ 65,921 Stock-based compensation expense (996 ) (933 ) (3,157 ) (2,970 ) Non-GAAP research and development expenses$ 23,099 $ 20,181
$ 68,443 $ 62,951
GAAP sales and marketing expenses
$ 116,966 $ 105,964 Stock-based compensation expense (691 ) (800 ) (2,389 ) (2,141 )
Non-GAAP sales and marketing expenses
GAAP general and administrative expenses$ 25,078 $ 21,619 $ 73,862 $ 69,235 Amortization of intangibles (3,524 ) (3,524 ) (10,571 ) (10,571 ) Stock-based compensation expense (3,052 ) (2,876 ) (9,062 ) (8,596 ) Non-GAAP general and administrative expenses$ 18,502 $ 15,219 $ 54,229 $ 50,068 GAAP operating income (loss)$ (10,135 ) $ (6,579 )$ (39,653 ) $ (38,332 ) Amortization of intangibles 7,083 6,934 21,100 20,802 Stock-based compensation expense 5,092 4,833 15,617 14,475
Non-GAAP operating income (loss)
$ (2,936 ) $ (3,055 ) GAAP net income (loss)$ (7,908 ) $ (3,735 )$ (26,438 ) $ (27,323 ) Amortization of intangibles 7,083 6,934 21,100 20,802 Stock-based compensation expense 5,092 4,833 15,617 14,475 Aggregate adjustment for income taxes (3,438 ) (2,801 ) (11,997 ) (8,130 ) Non-GAAP net income (loss)$ 829 $ 5,231 $ (1,718 ) $ (176 )
GAAP earnings (loss) per share
$ (0.33 ) $ (0.34 ) Amortization of intangibles 0.09 0.09 0.26 0.26 Stock-based compensation expense 0.06 0.06 0.19 0.18 Aggregate adjustment for income taxes (0.04 ) (0.03 ) (0.15 ) (0.10 ) Non-GAAP earnings (loss) per share *$ 0.01 $ 0.06 $ (0.02 ) $ - * Sum of reconciling items may differ from total due to rounding of individual components GAAP net income (loss)$ (7,908 ) $ (3,735 )$ (26,438 ) $ (27,323 ) Interest and other, net 1,257 (1,074 ) (961 ) (2,582 ) Income tax benefit (3,484 ) (1,770 ) (12,254 ) (8,427 ) Depreciation and amortization 10,869 10,360 32,017 30,872 Stock-based compensation expense 5,092 4,833 15,617 14,475 Adjusted EBITDA$ 5,826 $ 8,614 $ 7,981 $ 7,015 24
-------------------------------------------------------------------------------- Our Relationship withDell andDell Technologies OnApril 27, 2016 , we completed our IPO. Upon the closing of our IPO,Dell Technologies owned, indirectly throughDell Inc. andDell Inc.'s subsidiaries, no shares of our outstanding Class A common stock and all shares of our outstanding Class B common stock, which as ofNovember 1, 2019 represented approximately 86.2% of our total outstanding shares of common stock and approximately 98.4% 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 11-Related Party Transactions" in our condensed consolidated financial statements included in this report. During the periods presented in the condensed consolidated financial statements included in this report, Secureworks did not file separate federal tax returns, as Secureworks generally was 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 expect to be utilized by other members of theDell consolidated group. For more information, see "Notes to Condensed Consolidated Financial Statements -Note 10-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 11-Related Party Transactions" in our condensed consolidated financial statements included in this report. Components of Results of Operations Revenue We sell managed security solutions and threat intelligence solutions on a subscription basis and various professional services, including security and risk consulting and incident response solutions. Our managed security subscription contracts typically range from one to three years and, as ofNovember 1, 2019 , averaged 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 customers typically purchase solutions pursuant to customized contracts that are shorter in duration. In general, these contracts have terms of less than one year. Professional services consist primarily of fixed-fee and retainer-based contracts. 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. 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 third quarter of fiscal 2020, approximately 77% of our revenue was derived from subscription-based solutions, attributable to managed security contracts, while approximately 23% 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 25% of our total net revenue in the third quarter of fiscal 2020 and 23% of our total net revenue in the third quarter of fiscal 2019. Although our international customers are located primarily in theUnited Kingdom ,Japan , andCanada , we provided managed security solutions to customers across 49 countries as ofNovember 1, 2019 . 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. 25 -------------------------------------------------------------------------------- During the second quarter of fiscal 2019, a significant portion of our contract withBank of America, N.A ., a large customer, was amended and extended for two more years. During the term of the extended contract, the mix of services is different from the mix in prior periods, with higher gross margin, although the total value of services is lower than in prior periods. Gross Margin We operate in a challenging business environment, where the complexity and number of cyber attacks are constantly increasing. Accordingly, initiatives to drive the efficiency of our Counter Threat Platform and the continued training and development of our employees are critical to our long-term success. Gross margin has been and will continue to be affected by these factors as well as others, including the mix of solutions sold, the mix between large and small customers, timing of revenue recognition and the extent to which we expand our counter threat operations centers. Cost of revenue consists primarily of personnel expenses, including salaries, benefits and performance-based compensation for employees who maintain our Counter Threat Platform and provide solutions to our customers, as well as perform other critical functions. Also included in cost of revenue are amortization of equipment and costs associated with hardware provided to customers as part of their subscription services, amortization of technology licensing fees, amortization of intangible assets, fees paid to contractors who supplement or support our solutions, maintenance fees and overhead allocations. As our business grows, the cost of revenue associated with our solutions may fluctuate. We operate in a high-growth industry and have experienced significant revenue growth since our inception. Accordingly, we expect our gross margin to increase in absolute dollars. We continue to invest in initiatives to drive the efficiency of our business to increase gross margin as a percentage of total revenue. However, as we balance revenue growth and efficiency initiatives, gross margin as a percentage of total revenue may 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 Condensed Consolidated Statements of Operations. To date, we have had minimal interest income. Income Tax Benefit Our effective tax benefit rate was 30.6% and 32.2% for the three months endedNovember 1, 2019 andNovember 2, 2018 , respectively, and 31.7% and 23.6% for the nine months endedNovember 1, 2019 andNovember 2, 2018 , respectively. The change in the Company's effective income tax rate for the three and nine months endedNovember 1, 2019 compared with the three and nine months endedNovember 2, 2018 was primarily attributable to the impact of the intra-period allocation of certain permanent items and international tax expenses as well as discrete adjustments related to stock-based compensation expense. 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 26 -------------------------------------------------------------------------------- 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 10-Income and Other Taxes" in our condensed consolidated financial statements included in this report. Results of Operations
The following tables summarize our key performance indicators for the three and
nine months ended
Three Months Ended
November 1, 2019 November 2, 2018
% of % % of
$ Revenue Change $ Revenue
(in thousands, except percentages)
Net revenue $ 141,332 100.0 % 6.2 % $ 133,060 100.0 %
Cost of revenue $ 61,568 43.6 % (0.9 )% $ 62,133 46.7 %
Total gross margin $ 79,764 56.4 % 12.5 % $ 70,927 53.3 %
Operating expenses $ 89,899 63.6 % 16.0 % $ 77,506 58.2 %
Operating income (loss) $ (10,135 ) (7.2 )% 54.1 % $ (6,579 ) (4.9 )%
Net income (loss) $ (7,908 ) (5.6 )% 111.7 % $ (3,735 ) (2.8 )%
Other Financial Information (1)
Non-GAAP net revenue $ 141,332 100.0 % 6.2 % $ 133,060 100.0 %
Non-GAAP cost of revenue $ 57,656 40.8 % (1.4 )% $ 58,499 44.0 %
Non-GAAP gross margin $ 83,676 59.2 % 12.2 % $ 74,561 56.0 %
Non-GAAP operating expenses $ 81,636 57.8 % 17.7 % $ 69,373 52.1 %
Non-GAAP operating income (loss) $ 2,040 1.4 % (60.7 )% $ 5,188 3.9 %
Non-GAAP net income (loss) $ 829 0.6 % (84.2 )% $ 5,231 3.9 %
Adjusted EBITDA $ 5,826 4.1 % (32.4 )% $ 8,614 6.5 %
Nine Months Ended
November 1, 2019 November 2, 2018
% of % % of
$ Revenue Change $ Revenue
(in thousands, except percentages)
Net revenue $ 410,779 100.0 % 5.9 % $ 387,999 100.0 %
Cost of revenue $ 188,004 45.8 % 1.5 % $ 185,211 47.7 %
Total gross margin $ 222,775 54.2 % 9.9 % $ 202,788 52.3 %
Operating expenses $ 262,428 63.9 % 8.8 % $ 241,120 62.1 %
Operating income (loss) $ (39,653 ) (9.7 )% 3.4 % $ (38,332 ) (9.9 )%
Net income (loss) $ (26,438 ) (6.4 )% (3.2 )% $ (27,323 ) (7.0 )%
Other Financial Information (1)
Non-GAAP net revenue $ 410,779 100.0 % 5.9 % $ 387,999 100.0 %
Non-GAAP cost of revenue $ 176,466 43.0 % 1.3 % $ 174,212 44.9 %
Non-GAAP gross margin $ 234,313 57.0 % 9.6 % $ 213,787 55.1 %
Non-GAAP operating expenses $ 237,249 57.8 % 9.4 % $ 216,842 55.9 %
Non-GAAP operating loss $ (2,936 ) (0.7 )% (3.9 )% $ (3,055 ) (0.8 )%
Non-GAAP net loss $ (1,718 ) (0.4 )% 876.1 % $ (176 ) - %
Adjusted EBITDA $ 7,981 1.9 % 13.8 % $ 7,015 1.8 %
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(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 non-GAAP revenue.
Three and nine months endedNovember 1, 2019 compared to the three and nine months endedNovember 2, 2018 Revenue Net revenue, which we refer to as revenue, increased$8.3 million , or 6.2%, and$22.8 million , or 5.9%, for the three and nine months endedNovember 1, 2019 . The revenue increase resulted primarily from revenue generated by our subscription-based solutions. Revenue attributable to our subscription-based solutions represented approximately 77% and 76% of total revenue for the three and nine months endedNovember 1, 2019 , respectively. Our existing customers continued to increase their contracted subscriptions for our solutions, with average revenue per customer increasing 9% year over year. Revenue for certain services provided to or on behalf ofDell under our commercial agreements withDell totaled approximately$10.6 million and$19.4 million for the three and nine months endedNovember 1, 2019 , respectively, and$3.8 million and$13.9 million for the three and nine months endedNovember 2, 2018 , respectively. For more information regarding the commercial agreements, see "Notes to Condensed Consolidated Financial Statements-Note 11-Related Party Transactions" in our condensed consolidated financial statements included in this report. We primarily generate revenue from sales inthe United States . However, for the three months endedNovember 1, 2019 , international revenue, which we define as revenue contracted through non-U.S. entities, increased to$35.1 million , or 17.9%, from the three months endedNovember 2, 2018 . Currently, our international customers are primarily located in theUnited Kingdom ,Japan , andCanada . We are focused on continuing to grow our international customer base in future periods. Gross Margin Our total gross margin increased$8.8 million , or 12.5%, and$20.0 million , or 9.9%, for the three and nine months endedNovember 1, 2019 , respectively. As a percentage of revenue, our gross margin increased 310 basis points to 56.4% and 190 basis points to 54.2% for the three and nine months endedNovember 1, 2019 , respectively. 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$9.1 million , or 12.2%, and$20.5 million , or 9.6%, for the three and nine months endedNovember 1, 2019 , respectively. As a percentage of revenue, our non-GAAP gross margin increased 320 basis points to 59.2% and 190 basis points to 57.0% for three and nine months endedNovember 1, 2019 , respectively. The increase in gross margin as a percentage of revenue on both a GAAP and non-GAAP basis during the three and nine months endedNovember 1, 2019 was primarily attributable to improvement in our subscription-based solutions margins as we continue to focus on delivering comprehensive higher-value security solutions and driving scale and operational efficiencies. Growth in revenue from Safeguard and Response solutions sold throughDell , which have higher margins, also contributed to the increase in gross margins. Operating Expenses
The following table presents information regarding our operating expenses during
the three and nine months ended
28
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Three Months Ended
November 1, 2019 November 2, 2018
% of % % of
Dollars Revenue Change Dollars Revenue
(in thousands, except percentages)
Operating expenses:
Research and development $ 24,095 17.0 % 14.1 % $ 21,114 15.9 %
Sales and marketing 40,726 28.8 % 17.1 % 34,773 26.1 %
General and administrative 25,078 17.7 % 16.0 % 21,619 16.2 %
Total operating expenses $ 89,899 63.6 % 16.0 % $ 77,506 58.2 %
Other Financial Information
Non-GAAP research and development $ 23,099 16.3 % 14.5 % $ 20,181 15.2 %
Non-GAAP sales and marketing 40,035 28.3 % 17.8 % 33,973 25.5 %
Non-GAAP general and administrative 18,502 13.1 % 21.6 % 15,219 11.4 %
Non-GAAP operating expenses (1) $ 81,636 57.8 % 17.7 % $ 69,373 52.1 %
Nine Months Ended
November 1, 2019 November 2, 2018
% of % % of
Dollars Revenue Change Dollars Revenue
(in thousands, except percentages)
Operating expenses:
Research and development $ 71,600 17.4 % 8.6 % $ 65,921 17.0 %
Sales and marketing 116,966 28.5 % 10.4 % 105,964 27.3 %
General and administrative 73,862 18.0 % 6.7 % 69,235 17.8 %
Total operating expenses $ 262,428 63.9 % 8.8 % $ 241,120 62.1 %
Other Financial Information
Non-GAAP research and development $ 68,443 16.7 % 8.7 % $ 62,951 16.2 %
Non-GAAP sales and marketing 114,577 27.9 % 10.4 % 103,823 26.8 %
Non-GAAP general and administrative 54,229 13.2 % 8.3 %
50,068 12.9 %
Non-GAAP operating expenses (1)
(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$3.0 million , or 14.1%, and$5.7 million , or 8.6%, for the three and nine months endedNovember 1, 2019 , respectively. As a percentage of revenue, R&D expenses increased 110 basis points to 17.0% and 40 basis points to 17.4% for the three and nine months endedNovember 1, 2019 , respectively. On a non-GAAP basis, R&D expenses as a percentage of revenue increased 110 basis points to 16.3% and 50 basis points to 16.7% for the three and nine months endedNovember 1, 2019 , respectively. The increase in R&D expenses was primarily attributable to increased compensation and benefits, and other technology related costs for the continued development of our solutions offerings, including the development of a new security analytics platform and software applications. Sales and Marketing Expenses. S&M expenses increased$6.0 million , or 17.1%, and$11.0 million , or 10.4%, for the three and nine months endedNovember 1, 2019 , respectively. As a percentage of revenue, S&M expenses increased 270 basis points to 28.8% and 120 basis points to 28.5% for the three and nine months endedNovember 1, 2019 , respectively. On a non-GAAP basis, S&M expenses as a percentage of revenue increased 280 basis points to 28.3% and 110 basis points to 27.9% for the three and nine months endedNovember 1, 2019 , respectively. The increases in S&M expenses were primarily attributable to 29 -------------------------------------------------------------------------------- sales cost associated with the new offerings launched in the first quarter of fiscal 2020 in partnership withDell . In addition, commission expense increased due to the reduction in the period over which deferred commission costs are recognized. General and Administrative Expenses. G&A expenses increased$3.5 million , or 16.0%, and$4.6 million , or 6.7%, for the three and nine months endedNovember 1, 2019 , respectively. As a percentage of revenue, G&A expenses increased 150 basis points to 17.7% and increased 20 basis points to 18.0% for the three and nine months endedNovember 1, 2019 , respectively. On a non-GAAP basis, G&A expenses as a percentage of revenue increased 170 basis points to 13.1% and increased 30 basis points to 13.2% for the three and nine months endedNovember 1, 2019 , respectively. The increase in G&A expenses were primarily attributable to an increase in compensation and benefits, sales tax expense, as well as higher facilities-related costs. Operating Income (Loss) Our GAAP operating loss was$(10.1) million and$(39.7) million for the three and nine months endedNovember 1, 2019 , respectively. As a percentage of revenue, our operating loss increased to (7.2)% and decreased to (9.7)% for the three and nine months endedNovember 1, 2019 , respectively. The increase in our GAAP operating loss on a dollar basis was primarily attributable to increased operating expenses as we continue to invest in the business to drive growth. Operating loss on a GAAP basis includes amortization of intangible assets and stock-based compensation expense. The changes in our non-GAAP operating income and non-GAAP operating loss as a percentage of revenue during the three and nine months endedNovember 1, 2019 were attributable to the same drivers as above. Interest and Other Income (Expense), Net Our interest and other income (expense), net was$(1.3) million and$1.0 million of income for the three and nine months endedNovember 1, 2019 , respectively, compared with$1.1 million and$2.6 million , respectively, for the prior year periods. The changes primarily reflected the effects of foreign currency transactions and related exchange rate fluctuations. Income Tax Benefit Our income tax benefit was$3.5 million , or 30.6%, and$12.3 million , or 31.7%, of our pre-tax loss during the three and nine months endedNovember 1, 2019 , respectively, and$1.8 million , or 32.2%, and$8.4 million , or 23.6%, during the three and nine months endedNovember 2, 2018 , respectively. The changes in the effective tax benefit rate were primarily attributable to the impact of certain discrete adjustments related to the vesting of stock-based compensation units in the current periods. Net Income (Loss) Our net loss of$(7.9) million increased$4.2 million , or 111.7%, for the three months endedNovember 1, 2019 . For the nine months endedNovember 1, 2019 , our net loss of$(26.4) million decreased$0.9 million , or 3.2%. Net income on a non-GAAP basis was$0.8 million , which represented a decrease of$4.4 million , from the three months endedNovember 2, 2018 . On a non-GAAP basis for the nine months endedNovember 1, 2019 , our net loss was$(1.7) million , which represented an increase of$1.5 million , from the nine months endedNovember 2, 2018 . The changes in net loss were attributable to our operating results, which reflected higher business investment, the impacts of foreign currency fluctuations, partially offset by the higher income tax benefit recognized in the current periods. Liquidity and Capital Commitments Overview We believe that our cash and cash equivalents together with our accounts receivable will provide us with sufficient liquidity to fund our business and meet our obligations for at least 12 months. 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 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 ofNovember 1, 2019 , our principal sources of liquidity consisted of cash and cash equivalents of$138.8 million and accounts receivable of$118.4 million . Selected measures of our liquidity and capital resources are as follows: 30 -------------------------------------------------------------------------------- November 1, 2019 February 1, 2019 (in thousands) Cash and cash equivalents$ 138,788 $ 129,592 Accounts receivable, net$ 118,396 $ 141,344 We invoice our customers based on a variety of billing schedules. During the nine months endedNovember 1, 2019 , on average, approximately 57% of our recurring revenue was billed in advance and approximately 43% was billed on either a monthly or a quarterly basis. Invoiced accounts receivable generally are collected over a period of 30 to 120 days. The decrease in accounts receivable as ofNovember 1, 2019 , reflected increased collection activity, partially offset by an increase in revenue. We regularly monitor our accounts receivable for collectability, particularly in markets where economic conditions remain uncertain, and continue to take actions to reduce our exposure to credit losses. As ofNovember 1, 2019 andFebruary 1, 2019 , the allowance for doubtful accounts was$5.7 million and$6.2 million , respectively. The decrease in the allowance for doubtful accounts was due to overall improvement in our longer-aged receivables balances. Based on our assessment, we believe we are adequately reserved for credit risk. Revolving Credit FacilitySecureWorks, Inc. , our wholly-owned subsidiary, has a revolving credit agreement with a wholly-owned subsidiary ofDell Inc. under which we have a$30 million senior unsecured revolving credit facility. EffectiveMarch 26, 2019 , the facility was amended and restated to extend the maturity date toMarch 26, 2020 and to increase the annual rate at which interest accrues to the applicable London Interbank Offered Rate plus 1.50%. 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$30 million by mutual agreement of the lender and borrower. The proceeds from loans made under the facility may be used for general corporate purposes. The facility is not guaranteed by us or our subsidiaries. There was no outstanding balance under the facility as ofNovember 1, 2019 orFebruary 1, 2019 . The unused portion of the facility is subject to a commitment fee of 0.35%, which is due upon expiration of the facility. For additional information about the facility, see "Notes to Condensed Consolidated Financial Statements-Note 5-Debt" in our condensed consolidated financial statements included in this report. Cash Flows The following table presents information concerning our cash flows during the nine months endedNovember 1, 2019 andNovember 2, 2018 . Nine Months Ended November 1, 2019 November 2, 2018 (in thousands) Net change in cash from: Operating activities$ 35,852 $ 26,039 Investing activities (12,082 ) (6,974 ) Financing activities (14,574 ) (4,825 )
Change in cash and cash equivalents $ 9,196
Operating Activities - Cash provided by operating activities totaled$35.9 million and$26.0 million for the nine months endedNovember 1, 2019 andNovember 2, 2018 , respectively. The improvement in our operating cash flows was primarily driven by the decrease in our net accounts receivable balance due to improved collection rates, partially offset by our net transactions withDell . We expect that our future transactions withDell will be a source of cash over time as we anticipate that our charges toDell will continue to exceedDell's charges to us, although the timing of charges and settlements may vary from period to period. Investing Activities - Cash used in investing activities totaled$12.1 million and$7.0 million for the nine months endedNovember 1, 2019 andNovember 2, 2018 , respectively. For the periods presented, investing activities consisted primarily of capital expenditures for property and equipment to support our data center and facility infrastructure as well as certain capitalized cost related to the development of our new security software application. Financing Activities - Cash flows used in financing activities totaled$14.6 million and$4.8 million for the nine months endedNovember 1, 2019 andNovember 2, 2018 , respectively. The usage in the nine months endedNovember 1, 2019 reflected 31 -------------------------------------------------------------------------------- employee tax withholding payments of$8.2 million on restricted stock awards paid by us, and our repurchase of$6.4 million of our Class A common stock pursuant to our stock repurchase program. The usage in the nine months endedNovember 2, 2018 reflected employee tax withholding payments of$2.2 million on restricted stock awards paid by us and payments of long-term financing arrangements of$1.6 million , including an intercompany obligation of$1.1 million with aDell subsidiary, and our repurchase of$1.1 million of our Class A common stock pursuant to our stock repurchase program. Off-Balance Sheet Arrangements As ofNovember 1, 2019 , we were not subject to any obligations pursuant to any off-balance sheet arrangements that have or are reasonably likely to have a material effect on our financial condition, results of operations or liquidity. Critical Accounting Policies The unaudited condensed consolidated financial statements included elsewhere in this report have been prepared in accordance with GAAP for interim financial information and the requirements of theSEC . Accordingly, they do not include all of the information and disclosures required by GAAP for a complete financial statement presentation. The year-end condensed balance sheet data was derived from audited financial statements, but does not include all disclosures required by GAAP. In the opinion of management, all adjustments consisting of normal recurring accruals and disclosures considered necessary for a fair interim presentation have been included. All inter-company accounts and transactions have been eliminated in consolidation. As described in "Notes to Condensed Consolidated Financial Statements-Note 1-Description of the Business and Basis of Presentation," we have adopted the new lease accounting guidance set forth in ASC 842. Management assessed the critical accounting policies as disclosed in our Annual Report and determined that, other than the change in recognition of right-of-use assets and lease liabilities, there were no changes to our critical accounting policies or our estimates associated with those policies during the three and nine months endedNovember 1, 2019 . Recently Issued Accounting Pronouncements See "Notes to Condensed Consolidated Financial Statements-Note 1-Description of the Business and Basis of Presentation" in our condensed consolidated financial statements included in this report for a description of recently issued accounting pronouncements and our expectation of their impact, if any, on our financial statements. Item 3. Quantitative and Qualitative Disclosures About Market Risk Our results of operations and cash flows have been and will continue to be subject to fluctuations because of changes in foreign currency exchange rates, particularly changes in exchange rates between theU.S. dollar and the Euro, the British Pound, the Romanian Leu and the Canadian Dollar, the currencies of countries where we currently have our most significant international operations. Our expenses in international locations are generally denominated in the currencies of the countries in which our operations are located. As our international operations grow, we may begin to use foreign exchange forward contracts to partially mitigate the impact of fluctuations in net monetary assets denominated in foreign currencies. Item 4. Controls and Procedures Limitations on Effectiveness of Disclosure Controls and Procedures In designing and evaluating our disclosure controls and procedures, as defined below underSEC rules, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. In addition, the design of disclosure controls and procedures must reflect the fact that there are resource constraints and that management is required to apply its judgment in evaluating the benefits of possible controls and procedures relative to their costs. Evaluation of Disclosure Controls and Procedures Disclosure controls and procedures (as defined in Rules 13a15(e) and 15d15(e) under the Securities Exchange of 1934, or Exchange Act) are designed to ensure that information required to be disclosed in reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified inSEC rules and forms and that such information is accumulated and communicated to management, including the chief executive officer and the chief financial officer, to allow timely decisions regarding required disclosures. In connection with the preparation of this report, our management, under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures as ofNovember 1, 2019 . Based on that evaluation, our management has concluded that our disclosure controls and procedures were effective as ofNovember 1, 2019 . 32
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Changes in Internal Control over Financial Reporting Internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Internal control over financial reporting includes those policies and procedures which (a) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of assets, (b) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, (c) provide reasonable assurance that receipts and expenditures are being made only in accordance with appropriate authorization of management and the board of directors, and (d) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of assets that could have a material effect on the financial statements. There were no changes in our internal control over financial reporting that occurred during the quarter endedNovember 1, 2019 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
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