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 consolidated financial statements and related notes included in this 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." Our fiscal year is the 52- or 53-week period ending on the Friday nearestJanuary 31 . We refer to our fiscal years endedJanuary 31, 2020 ,February 1, 2019 andFebruary 2, 2018 , as fiscal 2020, fiscal 2019 and fiscal 2018, respectively. Fiscal 2020, fiscal 2019 and fiscal 2018 each included 52 weeks. All percentage amounts and ratios presented in this management's discussion and analysis were calculated using the underlying data in thousands. The following discussion focuses on our fiscal 2020 and fiscal 2019 financial condition and results of operations, including comparisons of the years endedJanuary 31, 2020 andFebruary 1, 2019 . For discussion and analysis related to our financial condition and results of operations for fiscal 2018, including comparisons of the years endedFebruary 1, 2019 andFebruary 2, 2018 , refer to Part II, Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K for fiscal 2019, which was filed with theSecurities and Exchange Commission onMarch 28, 2019 . Except where the context otherwise requires or where otherwise indicated, 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, all references to "Dell" refer toDell Inc. and its subsidiaries on a consolidated basis and 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 deep expertise from service to 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 vision is to be the essential cybersecurity company for a digitally connected world. 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 seek to 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 21 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.
47
-------------------------------------------------------------------------------- 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 largely sold on a subscription basis, we provide global visibility and insight into malicious activity, enabling our customers to detect and effectively remediate threats quickly. In fiscal 2020, we launched our first software-as-a-service application, Red Cloak Threat Detection and Response (TDR) and related Managed Detection and Response (MDR) powered by Red Cloak. This application 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 our 21 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 services, which includes security and risk consulting and incident response to accelerate adoption of our capabilities. 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 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. 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 has led to a significant disruption of normal business operations globally, as businesses, including Secureworks, have needed to implement modifications to employee travel, employee work locations and employee productivity, in some instances as required by federal, state and local authorities. The extent of the impact of COVID-19 on our future operational and financial performance will depend on various future developments, including the duration and spread of the outbreak, impact on our employees, impact on our customers, effect on our sales cycles or costs, and effect on our vendors, all of which are uncertain and cannot be predicted, but which could have a material adverse effect on our business, results of operations or financial condition. At this point, the extent to which COVID-19 may impact our financial condition or results of operations is uncertain. Due to our subscription-based business model, the effect of COVID-19 may not be fully reflected in our results of operations until future periods, if at all. FromApril 2009 toJanuary 31, 2020 , the number of events processed by our technology platform increased from five billion to as many as 320 billion events per day. This significant growth has required continual investment in our business. We believe these investments are critical to our success, although they may continue to impact our near-term profitability.
Key Factors Affecting Our Performance
We believe that our future success will depend on many factors, including the adoption of our 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. For additional information about these risks, refer to "Risk Factors" in this report. We operate in a highly 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 monitoring, detection and prevention products, as well as their managed security solutions. We must continue to efficiently manage our investments and effectively execute our strategy to succeed. If we are unable to address these challenges, our business could be adversely affected. 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 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. 48
-------------------------------------------------------------------------------- Investment in OurTechnology and Threat Intelligence Research . Our technology platform constitutes the core of our technology-driven information security solutions. It provides our customers with an integrated perspective and intelligence regarding their network environments and security threats. The platform is 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 our platform 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 platform will contribute to long-term revenue growth, but it may continue to adversely affect our near-term profitability. Introduction of New Information Security Solutions. Our performance is significantly dependent on our ability to continue to innovate and introduce new information security solutions that protect our customers from an expanding array of cybersecurity threats. We continue to invest in solutions innovation and leadership, including 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 it may continue to adversely affect our near-term profitability. 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 adversely 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. 49
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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. Execution of this strategy 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 annual periods then ended: January 31, 2020 February 1, 2019 February 2, 2018 Subscription customer base 4,100 4,200 4,400 Total customer base 5,200 4,700 5,000 Monthly recurring revenue (in millions) $ 36.5 $ 36.2 $ 35.3 Annual recurring revenue (in millions) $ 437.5 $ 434.1 $ 423.0 Average subscription revenue per customer (in thousands) $ 107.8 $ 103.3 $ 95.6 Revenue retention rate 95 % 89 % 96 % 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 subscribe to our managed security solutions as well as customers that buy professional and other services from us, as of a particular date. 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. Average Subscription Revenue Per Customer. 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. As ofJanuary 31, 2020 ,February 1, 2019 , andFebruary 2, 2018 , approximately 60%, 50%, and 44%, respectively, of our professional services customers subscribed to our managed security solutions. 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 solutions installations and customer renewal rates. 50
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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 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 ofDell byDell 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), non-GAAP earnings (loss) per share and adjusted EBITDA, 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.
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: • Impact of Purchase Accounting. The impact of purchase accounting consists primarily of purchase accounting adjustments related to a change in the basis of deferred revenue related to the acquisition ofDell byDell Technologies in fiscal 2014.
• 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. 51
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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
expense relates to both the
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.
• Impact of Tax Cuts and Jobs Act. The impact of the Tax Cuts and Jobs Act
relates to final tax provision impacts of complying with theU.S. tax reform that was enacted inDecember 2017 , as recorded in fiscal 2020 and fiscal 2019, as well as the provisional tax benefit of$27.0 million that was recorded in the fourth quarter of fiscal 2018. For additional information, see "Notes to Consolidated Financial Statements-Note 11-Income and Other Taxes" in our consolidated financial statements included in this report.
• Aggregate Adjustment for Income Taxes. The aggregate adjustment for income
taxes is the estimated combined income tax effect for the adjustments
mentioned above. The tax effects are determined based on the tax jurisdictions where the above items were incurred. Fiscal Year Ended January 31, February 1, February 2, 2020 2019 2018 GAAP revenue$ 552,765 $ 518,709 $ 467,930 Impact of purchase accounting - - 584 Non-GAAP revenue$ 552,765 $ 518,709 $ 468,514 GAAP gross margin$ 299,969 $ 272,592 $ 242,846 Amortization of intangibles 14,089 13,642 13,642 Impact of purchase accounting - - 624 Stock-based compensation expense 1,206 780 891 Non-GAAP gross margin$ 315,264 $
287,014
GAAP research and development expenses$ 94,964 $ 87,608 $ 80,164 Stock-based compensation expense (4,280 ) (4,133 ) (3,261 ) Non-GAAP research and development expenses$ 90,684 $
83,475
GAAP sales and marketing expenses$ 157,674 $ 141,818 $ 139,937 Stock-based compensation expense (1,694 ) (2,652 ) (735 ) Non-GAAP sales and marketing expenses$ 155,980 $
139,166
GAAP general and administrative expenses$ 99,505 $ 91,898 $ 92,726 Amortization of intangibles (14,094 ) (14,094 ) (14,095 ) Impact of purchase accounting - - (1,025 ) Stock-based compensation expense (12,368 ) (11,805 ) (8,903 ) Non-GAAP general and administrative expenses$ 73,043 $ 65,999 $ 68,703 GAAP operating income (loss)$ (52,174 ) $ (48,732 ) $ (69,981 ) Amortization of intangibles 28,183 27,736 27,737 Impact of purchase accounting - - 1,649 Stock-based compensation expense 19,548 19,370 13,790 Non-GAAP operating income (loss)$ (4,443 ) $ (1,626 ) $ (26,805 ) 52
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GAAP net income (loss)$ (31,666 ) $ (39,101 ) $ (10,417 ) Amortization of intangibles 28,183 27,736 27,737 Impact of purchase accounting - - 1,649 Stock-based compensation expense 19,548 19,370 13,790 Impact of Tax Cuts and Jobs Act (1,191 ) 4,325 (34,993 ) Aggregate adjustment for income taxes (14,688 ) (10,978 ) (15,129 ) Non-GAAP net income (loss) $ 186
GAAP earnings (loss) per share$ (0.39 ) $ (0.48 ) $ (0.13 ) Amortization of intangibles 0.35 0.34 0.35 Impact of purchase accounting - - 0.02 Stock-based compensation expense 0.24 0.24 0.17 Impact of Tax Cuts and Jobs Act (0.01 ) 0.05 (0.44 ) Aggregate adjustment for income taxes (0.18 ) (0.13 ) (0.19 ) Non-GAAP earnings (loss) per share * $ -
GAAP net income (loss)$ (31,666 ) $ (39,101 ) $ (10,417 ) Interest and other, net (850 ) (2,778 ) 2,735 Income tax benefit (19,658 ) (6,853 ) (62,299 ) Depreciation and amortization 42,932 41,207 42,171 Stock-based compensation expense 19,548 19,370 13,790 Impact of purchase accounting - - 584 Adjusted EBITDA$ 10,306
Our Relationship with
On
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 Consolidated Financial Statements-Note 13-Related Party Transactions" in our 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 Consolidated Financial Statements-Note 11-Income and Other Taxes" in our 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 53
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provided by
Components of Results of Operations
Revenue
We sell managed security and threat intelligence solutions on a subscription basis and various professional services, including security and risk consulting and incident response solutions. Our managed security contracts typically range from one to three years and, as ofJanuary 31, 2020 , 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 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 fiscal 2020, approximately 76% of our revenue was derived from subscription-based arrangements, attributable to managed security solutions, while approximately 24% 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%, 22% and 16% of our total net revenue in fiscal 2020, fiscal 2019 and fiscal 2018, respectively. Although our international customers are located primarily in theUnited Kingdom ,Japan andCanada , we provide managed security solutions to customers across 52 countries as ofJanuary 31, 2020 . 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. 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 utilized as part of providing 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. 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. 54
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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 Expense (Benefit)
Our effective tax benefit rate was 38.3%, 14.9% and 85.7% for the fiscal years endedJanuary 31, 2020 ,February 1, 2019 andFebruary 2, 2018 , respectively. The change in effective tax rate from fiscal 2019 to fiscal 2020 was primarily attributable to the impact of certain discrete adjustments related to the vesting of stock-based compensation units, certain provisions from the Tax Cuts and Jobs Act, 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 us 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 Consolidated Financial Statements-Note 11-Income and Other Taxes" in our consolidated financial statements included in this report. 55
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Results of Operations
Fiscal 2020 Compared to Fiscal 2019
The following table summarizes our key performance indicators for the fiscal
years ended
Fiscal Year Ended January 31, 2020 February 1, 2019 % of % % of $ Revenue Change $ Revenue (in thousands, except percentages) Net revenue$ 552,765 100.0 % 6.6 %$ 518,709 100.0 % Cost of revenue$ 252,796 45.7 % 2.7 %$ 246,117 47.4 % Total gross margin$ 299,969 54.3 % 10.0 %$ 272,592 52.6 % Operating expenses$ 352,143 63.7 % 9.6 %$ 321,324 61.9 % Operating loss$ (52,174 ) (9.4 )% 7.1 %$ (48,732 ) (9.4 )% Net loss$ (31,666 ) (5.7 )% (19.0 )%$ (39,101 ) (7.5 )% Other Financial Information (1) Non-GAAP revenue$ 552,765 100.0 % 6.6 %$ 518,709 100.0 % Non-GAAP gross margin$ 315,264 57.0 % 9.8 %$ 287,014 55.3 % Non-GAAP operating expenses$ 319,707 57.8 % 10.8 %$ 288,640 55.6 % Non-GAAP operating loss$ (4,443 ) (0.8 )% 173.2 %$ (1,626 ) (0.3 )% Non-GAAP net income$ 186 - % (86.2 )%$ 1,352 0.3 % Adjusted EBITDA$ 10,306 1.9 % (13.0 )%$ 11,845 2.3 % _____________________
(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.
Revenue
Net revenue, which we refer to as revenue, increased$34.1 million , or 6.6%, in fiscal 2020, compared with fiscal 2019. The revenue increase resulted primarily from revenue generated by subscription-based solutions. Revenue attributable to our subscription-based solutions represented approximately 76% of revenue in fiscal 2020 and fiscal 2019. Our existing customers continued to increase their contracted subscriptions for our solutions, with our retention rate increasing 6% in fiscal 2020. Revenue for certain services provided to or on behalf ofDell under our commercial agreements withDell totaled approximately$27.2 million and$16.6 million for fiscal 2020 and 2019, respectively. For more information regarding the commercial agreements, see "Notes to Consolidated Financial Statements-Note 13-Related Party Transactions" in our consolidated financial statements included in this report. We primarily generate revenue from sales inthe United States . However, for fiscal 2020, international revenue, which we define as revenue contracted through non-U.S. entities, increased to$140.3 million , or 21.9%. 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. 56
-------------------------------------------------------------------------------- Gross Margin Our total gross margin increased$27.4 million , or 10.0%, in fiscal 2020, compared with fiscal 2019. As a percentage of revenue, our gross margin percentage increased 170 basis points to 54.3% in fiscal 2020. Gross margin on a GAAP basis includes amortization of intangible assets, purchase accounting adjustments and stock-based compensation expense. On a non-GAAP basis, excluding these adjustments, gross margin increased$28.3 million , or 9.8%, in fiscal 2020. As a percentage of revenue, our non-GAAP gross margin increased 170 basis points to 57.0% in fiscal 2020. The increase in gross margin as a percentage of revenue on a GAAP and non-GAAP basis during the fiscal year was mainly attributable to improvement in our subscription-based solutions margins as we continue to focus on delivering comprehensive higher-value security solutions and driving scale and operational efficiencies. Growth in revenue from Safeguard and Response solutions sold throughDell , which have higher margins, also contributed to the increase in gross margin.
Operating Expenses
The following table presents information regarding our operating expenses during
the fiscal years ended
Fiscal Year Ended January 31, 2020 February 1, 2019 % of % % of Dollars Revenue Change Dollars Revenue (in thousands, except percentages) Operating expenses: Research and development$ 94,964 17.2 % 8.4 %$ 87,608 16.9 % Sales and marketing 157,674 28.5 % 11.2 % 141,818 27.3 % General and administrative 99,505 18.0 % 8.3 % 91,898 17.7 % Total operating expenses$ 352,143 63.7 % 9.6 %$ 321,324 61.9 % Other Financial Information Non-GAAP research and development$ 90,684 16.4 % 8.6 %$ 83,475 16.1 % Non-GAAP sales and marketing 155,980 28.2 % 12.1 % 139,166 26.8 % Non-GAAP general and administrative 73,043 13.2 % 10.7 %
65,999 12.7 %
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$7.4 million , or 8.4%, in fiscal 2020. As a percentage of revenue, on a GAAP basis, R&D expenses increased 30 basis points to 17.2% in fiscal 2020. As a percentage of revenue, on a non-GAAP basis, R&D expenses increased 30 basis points to 16.4% in fiscal 2020. The increases were primarily attributable to increased compensation and benefits associated with additional development resources, and other technology related cost for the continued development of our solutions, including the development of a new security analytics platform and software application. Sales and Marketing Expenses. S&M expenses increased$15.9 million , or 11.2%, in fiscal 2020. As a percentage of revenue, S&M expenses increased 120 basis points to 28.5% in fiscal 2020. On a non-GAAP basis, S&M expenses as a percentage of revenue increased 140 basis points to 28.2% for fiscal 2020. The increases in S&M expenses as a percentage of revenue were primarily attributable to sales costs associated with 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$7.6 million , or 8.3%, in fiscal 2020. As a percentage of revenue, G&A expenses increased 30 basis points to 18.0% in fiscal 2020. On a non-GAAP basis, G&A expenses as a percentage of revenue increased 50 basis points to 13.2% in fiscal 2020. The increases in G&A expenses as a percentage of revenue were primarily attributable to compensation and benefits, sales tax expense, and higher facilities-related costs. 57
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Operating Loss
Our operating loss was$52 million for fiscal 2020 compared to$49 million for fiscal 2019. As a percentage of revenue, our operating loss was 9.4% in both fiscal 2020 and fiscal 2019. The increase in our operating loss 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, purchase accounting adjustments and stock-based compensation expense. The increases in our non-GAAP operating loss on a dollar basis and as a percentage of revenue were primarily attributable to the same drivers as above. Interest and Other, Net
Interest and other income was
Income Tax Expense (Benefit)
Our income tax benefit was$19.7 million , or 38.3%, and$6.9 million , or 14.9%, of our pre-tax loss in fiscal 2020 and fiscal 2019, respectively. The changes in the effective tax benefit rate were primarily attributable to the impact of certain discrete adjustments related to the vesting of stock-based compensation units, certain provisions from the Tax Cuts and Jobs Act and the research and development tax credit. Net Income (Loss) Our net loss of$(31.7) million decreased$7.4 million , or 19.0%, in fiscal 2020. The decrease in our net loss was attributable to the increased tax benefit in fiscal 2020 compared with fiscal 2019 related to the Tax Cuts and Jobs Act, which more than offset lower operating results. Net income on a non-GAAP basis was$0.2 million , which represents a decrease of$1.2 million , or 86.2%, from fiscal 2019. Overall, the decrease in non-GAAP net income was primarily due to the impacts of the operating losses discussed above. Liquidity, Capital Commitments and Contractual Cash Obligations 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, as well as 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 ofJanuary 31, 2020 , our principal sources of liquidity consisted of cash and cash equivalents of$181.8 million and accounts receivable of$111.8 million . Our cash and cash equivalents balance as ofJanuary 31, 2020 included$100.5 million invested in money market funds pending their use in our business.
Selected measures of our liquidity and capital resources are as follows:
January 31, February 1, 2020 2019 (in thousands) Cash and cash equivalents$ 181,838 $ 129,592 Accounts receivable, net$ 111,798 $ 141,344 58
-------------------------------------------------------------------------------- We invoice our customers based on a variety of billing schedules. During fiscal 2020, on average, 58% of our recurring revenue was billed in advance and approximately 42% was billed on either a monthly or a quarterly basis. Invoiced accounts receivable are generally collected over a period of 30 to 120 days. The decrease in accounts receivable as ofJanuary 31, 2020 compared withFebruary 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 ofJanuary 31, 2020 andFebruary 1, 2019 , the allowance for doubtful accounts was$5.1 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 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$30 million by mutual agreement of the lender and borrower. The proceeds from loans made under the facility may be used for general corporate purposes. The facility is not guaranteed by us or our subsidiaries. There was no outstanding balance under the facility as ofJanuary 31, 2020 . Effective as ofMarch 26, 2020 , the facility agreement was amended and restated to extend the maturity date toMarch 26, 2021 and to modify the annual rate at which interest accrues. Each loan made under the amended and restated credit facility will accrue interest at an annual rate equal to the applicableLondon interbank offered rate plus 1.30%. Amounts under the facility may be borrowed, repaid and reborrowed from time to time during the term of the facility. The borrower will be required to repay in full all of the loans outstanding, including all accrued interest, and the facility will terminate upon a change of control of us or following a transaction in whichSecureWorks, Inc. ceases to be a direct or indirect wholly-owned subsidiary of our company. The credit agreement contains customary representations, warranties, covenants and events of default. The unused portion of the facility is subject to a commitment fee of 0.35%, which is due upon expiration of the facility. Cash Flows Fiscal Year Ended January 31, February 1, 2020 2019 (in thousands) Net change in cash from: Operating activities$ 78,839 $ 57,199 Investing activities (12,590 ) (10,200 ) Financing activities (14,003 ) (18,946 )
Change in cash and cash equivalents
• Operating Activities - Cash provided by operating activities was
million and
improvement in our operating cash flows was primarily driven by the decrease
in our net accounts receivable due to improved collection rates, partially
offset by our net transactions with
transactions with
that our charges to
although the timing of charges and settlements may vary period to period.
• Investing Activities - Cash used in investing activities totaled
million and
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 costs related to the
development of our new security software application.
• Financing Activities - Cash used in financing activities was
and
fiscal 2020 reflected employee tax withholding payments of
associated with the vesting of stock compensation grants and our repurchase
of
program re-authorized during fiscal 2020 and payment of a long-term financing
arrangement of
million from stock options exercised during fiscal 2020. The usage in fiscal
2019 reflected our repurchase of
pursuant to our stock repurchase program authorized during fiscal 2019, payments of long-term financing arrangements of$3.2 million , including related 59
-------------------------------------------------------------------------------- party obligations with aDell subsidiary of$2.2 million , and employee tax withholding payments of$2.2 million associated with the vesting of stock compensation grants. For information about our stock repurchase program, see "Notes to Consolidated Financial Statements-Note 9-Stockholders' Equity" in our consolidated financial statements included in this report. Contractual Cash Obligations
Contractual cash obligations are summarized in the following table:
Payments Due by Fiscal
Year
(in thousands) Less than 1 year 1-3 years 3-5 years Thereafter Total Operating leases $ 5,017$ 12,285 $ 9,918 $ 7,648 $ 34,868 Purchase obligations 3,645 2,048 - - 5,693 Credit facilities and other(1) - 500 - - 500 Total $ 8,662$ 14,833 $ 9,918 $ 7,648 $ 41,061
(1) Other reflects purchase obligations of annual maintenance services for
hardware systems for internal use financed from a related party. See also
"Notes to Consolidated Financial Statements-Note 13-
Transactions" in our consolidated financial statements included in this
report.
For information about leases and purchase obligations, see "Notes to Consolidated Financial Statements-Note 8-Leases" and "Notes to Consolidated Financial Statements-Note 7-Commitments and Contingencies" in our consolidated financial statements included in this report.
Off-Balance Sheet Arrangements
As of
Critical Accounting Policies and Estimates
We prepare our financial statements in conformity with GAAP, which requires certain estimates, assumptions and judgments to be made that may affect our consolidated financial statements. Accounting policies that have a significant impact on our results are described in "Notes to Consolidated Financial Statements-Note 2-Significant Accounting Policies" in our consolidated financial statements included in this report. The accounting policies discussed in this section are those that we consider to be the most critical. We consider an accounting policy to be critical if the policy is subject to a material level of judgment and if changes in those judgments are reasonably likely to materially impact our results. Revenue Recognition. Secureworks derives revenue primarily from two sources: (1) subscription revenue related to managed security and threat intelligence solutions; and (2) professional services, including security and risk consulting and incident response solutions. Subscription-based arrangements typically include security solutions, up-front installation fees and maintenance, and also may include the provision of an associated hardware appliance. The Company uses its hardware appliances in providing security solutions required to access the Company's technology platform. The arrangements that require hardware do not typically convey ownership of the appliance to the customer. Moreover, any related installation fees are non-refundable and are also incapable of being distinct within the context of the arrangement. Therefore, the Company has determined that these arrangements constitute a single performance obligation for which the revenue and any related costs are recognized over the term of the arrangement ratably, which reflects the Company's performance in transferring control of the services to the customer. Amounts that have been invoiced, but for which the above revenue recognition criteria have not been met, are included in deferred revenue. Professional services consist primarily of fixed-fee and retainer-based contracts. Revenue from these engagements is recognized using an input method over the contract term. Secureworks reports revenue net of any revenue-based taxes assessed by governmental authorities that are imposed on, and concurrently with, specific revenue-producing transactions. We recognize revenue when all of the following criteria are met: 60
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• Identification of the contract, or contracts, with a customer-A contract
with a customer exists when (i) we enter into an enforceable contract with
a customer, (ii) the contract has commercial substance and the parties are
committed to perform, and (iii) payment terms can be identified and
collection of substantially all consideration to which we will be entitled
in exchange for goods or services that will be transferred is deemed
probable based on the customer's intent and ability to pay. Contracts
entered into for professional services and subscription-based solutions
near or at the same time are generally not combined as a single contract
for accounting purposes, since neither the pricing nor the services are interrelated.
• Identification of the performance obligations in the contract-Performance
obligations promised in a contract are identified based on the goods or
services that will be transferred to the customer that are both (i)
capable of being distinct, whereby the customer can benefit from the goods
or service either on its own or together with other resources that are
readily available from third parties or from us, and (ii) distinct in the
context of the contract, whereby the transfer of the goods or services is
separately identifiable from other promises in the contract. When promised
goods or services are incapable of being distinct, we account for them as
a combined performance obligation. With regard to a typical contract for subscription-based solutions, the performance obligation represents a series of distinct services that will be accounted for as a single performance obligation. In a typical professional services contract, Secureworks has a separate performance obligation associated with each
service. We are generally acting as a principal in each subscription-based
and professional services arrangement and, thus, recognize revenue on a gross basis. • Determination of the transaction price-The total transaction price is
primarily fixed in nature as the consideration is tied to the specific
services purchased by the customer, which constitutes a series for
delivery of the solutions over the duration of the contract. For
professional services contracts, variable consideration exists in the form
of rescheduling penalties and expense reimbursements; no estimation is
required at contract inception, since variable consideration is allocated
to the applicable period.
• Allocation of the transaction price to the performance obligations in the
contract-We allocate the transaction price to each performance obligation
based on the performance obligation's standalone selling price. Standalone
selling price is determined by considering all information available to us, such as historical selling prices of the performance obligation, geographic location, overall strategic pricing objective, market conditions and internally approved pricing guidelines related to the performance obligations.
• Recognition of revenue when, or as, the Company satisfies performance
obligation-We recognize revenue over time using a time-elapsed output
method to measure progress (i.e., ratable recognition) for the
subscription-based performance obligation over the contract term. For any
upgraded installation services, which we have determined represent a
performance obligation separate from its subscription-based arrangements,
revenue is recognized over time using hours elapsed over the service term
as an appropriate method to measure progress. For the performance
obligation pertaining to professional services arrangements, we recognize
revenue over time using an input method based on time (hours or days) incurred to measure progress over the contract term. Intangible Assets Including Goodwill. Identifiable intangible assets with finite lives are amortized on a straight-line basis over their estimated useful lives. Finite-lived intangible assets are reviewed for impairment on a quarterly basis, or as potential triggering events are identified.Goodwill and indefinite-lived intangible assets are tested for impairment on an annual basis in the third fiscal quarter, or sooner if an indicator of impairment occurs. To determine whether goodwill and indefinite-lived intangible assets are impaired, we first assess certain qualitative factors. Based on this assessment, if it is determined that the fair value of the goodwill or indefinite-lived intangible asset is less than its carrying amount, we perform the quantitative analysis of the impairment test. The goodwill impairment test consists of a two-step process, if necessary. The first step is to compare the fair value of the reporting unit to its carrying value, including goodwill. We typically use a discounted cash flow model to determine the fair value of the reporting unit. The assumptions used in the model are consistent with those which we believe hypothetical marketplace participants would use. If the fair value of the reporting unit is less than its carrying value, the second step of the impairment test must be performed in order to determine the amount of the impairment loss, if any. The second step compares the implied fair value of the reporting unit's goodwill with the carrying amount of that goodwill. If the carrying amount of the reporting unit's goodwill exceeds its implied fair value, an impairment charge is recognized in an amount equal to that excess. The loss recognized cannot exceed the carrying amount of goodwill. We have determined that we have a single goodwill reporting unit, and, accordingly, for the quantitative analysis, we compare the fair value of this goodwill reporting unit to its carrying value. For indefinite-lived assets, other than goodwill, if the carrying amount determined through the quantitative analysis exceeds the fair value, an impairment charge is recognized in an amount equal to that excess. 61
-------------------------------------------------------------------------------- Based on the qualitative assessment performed during fiscal 2020, we determined that it was not more likely than not that the fair value of the Secureworks reporting unit was less than its carrying amount and therefore, no impairment of goodwill or indefinite-lived intangible asset existed at our test date ofNovember 1, 2019 . Subsequently, no events occurred through ourJanuary 31, 2020 year end that would indicate an impairment exists. Stock-Based Compensation. Our compensation programs include grants under theSecureWorks Corp. 2016 Long-Term Incentive Plan and, prior to the IPO date, grants under share-based payment plans ofDell Technologies Inc. , orDell Technologies . Under the plans, we and, prior to the IPO date,Dell Technologies have granted stock options, restricted stock awards and restricted stock units. Compensation expense related to stock-based transactions is measured and recognized in the financial statements based on fair value. Fair value for restricted stock awards and restricted stock units under our plan is based on the closing price of our Class A common stock as reported on the Nasdaq Global Select Market on the day of the grant. The fair value of each option award is estimated on the grant date using the Black-Scholes option-pricing model and a single option award approach. This model requires that at the date of grant we determine the fair value of the underlying common stock, the expected term of the award, the expected volatility, risk-free interest rates and expected dividend yield. The annual grant of restricted stock and restricted stock units issued during the fiscal year endedJanuary 31, 2020 vest over an average service period of three years and approximately 50% of such awards are subject to performance conditions. Stock-based compensation expense, regarding service-based awards, is adjusted for forfeitures, and recognized using a straight-line basis over the requisite service periods of the awards, which is generally three to four years. Stock-based compensation expense, regarding performance awards, is adjusted for forfeitures and performance criteria, and recognized on a graded vesting basis. We estimate a forfeiture rate, based on an analysis of actual historical forfeitures, to calculate stock-based compensation expense. Loss Contingencies. We are subject to the possibility of various losses arising in the ordinary course of business. We consider the likelihood of loss or impairment of an asset or the incurrence of a liability, as well as our ability to reasonably estimate the amount of loss, in determining loss contingencies. An estimated loss contingency is accrued when it is probable that an asset has been impaired or a liability has been incurred and the amount of loss can reasonably be estimated. We regularly evaluate current information available to us to determine whether such accruals should be adjusted and whether new accruals are required.
Recently Issued Accounting Pronouncements
Information about recently issued accounting pronouncements is presented in "Notes to Consolidated Financial Statements-Note 2-Significant Accounting Policies" in our consolidated financial statements included in this report.
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