SECUREWORKS CORP. This management's discussion and analysis is based upon the financial statements of Secureworks which have been prepared in accordance with accounting principles generally accepted inthe United States , or GAAP, and should be read in conjunction with our audited financial statements and related notes for the year endedJanuary 31, 2020 included in Part II, Item 8 of our Annual Report on Form 10-K as filed with theSEC onMarch 27, 2020 , which we refer to as the Annual Report. In addition to historical financial information, the following discussion contains forward-looking statements that reflect our plans, estimates, beliefs, expected future responses to and effects of the COVID-19 pandemic and other characterizations of future events or circumstances. Our actual results could differ materially from those discussed or implied in our forward-looking statements. Factors that could cause or contribute to these differences include those discussed in "Risk Factors" in Part I, Item 1A of our Annual Report. Our fiscal year is the 52- or 53-week period ending on the Friday closest toJanuary 31 . We refer to the fiscal year endingJanuary 29, 2021 and the fiscal year endedJanuary 31, 2020 as fiscal 2021 and fiscal 2020, respectively. Fiscal 2021 and fiscal 2020 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 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 cyber security 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. 21 -------------------------------------------------------------------------------- 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 provides 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 include 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. FromApril 2009 toOctober 30, 2020 , the number of events processed by our technology platform increased from five billion to as many as 350 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. 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 2021, approximately 76% of our revenue was derived from subscription-based solutions, attributable to managed security contracts, 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. Acquisition ofDelve Laboratories We seek to make strategic acquisitions of other companies to supplement our internal growth. OnSeptember 21, 2020 , we acquired all of the outstanding shares ofDelve Laboratories, Inc. ("Delve") for$15.1 million , net of cash acquired. Delve provides comprehensive vulnerability assessment solutions through its automated vulnerability platform. Delve's SaaS solution is powered by artificial intelligence and machine learning to provide customers with more accurate and actionable data about the highest risk vulnerabilities across their network, endpoints and cloud. We plan to integrate the vulnerability discovery and prioritization technology into new offerings within our cloud-based portfolio, including our Red Cloak Platform and TDR application, expanding visibility and insights for users. COVID-19 InDecember 2019 , a novel strain of the coronavirus, COVID-19, was reported in mainlandChina . TheWorld Health Organization declared the outbreak to constitute a "pandemic" onMarch 11, 2020 . This led to a significant disruption of normal business operations globally, as businesses, including Secureworks, have implemented modifications to protect employees by restricting travel and directing employees to work-from-home, in some instances as required by federal, state and local authorities. While we instituted a global work-from-home policy beginning inMarch 2020 , we did not incur significant disruptions in our business operations or a material impact on our results of operations, financial condition, liquidity or capital resources during the three and nine endedOctober 30, 2020 . We have experienced a limited reduction in customer demand for our solutions that we believe is attributable to COVID-19, which may impact on our results in future periods. Although we are unable to predict the extent and severity of all impacts of COVID-19, the pandemic might further curtail customer spending, lead to delayed or deferred purchasing decisions, lengthen sales cycles and result in delays in receiving customer or partner payments. These effects, individually or in the aggregate, could have a material negative impact on our future results of operations and financial condition. In light of these considerations, we continue to actively monitor the impacts and potential impacts of the COVID-19 pandemic in all aspects of our business. The extent of the impact of COVID-19 on our future operational and financial performance will depend on various developments, including the duration and spread of the virus, impact on our employees, customers and vendors, impact on our customers' liquidity, volume of sales, and length of our sales cycles, all of which remain uncertain and cannot be predicted, but which could have a material negative effect on our business, results of operations or financial 22 -------------------------------------------------------------------------------- condition. 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. Key Operating Metrics In recent years, we have experienced broad growth across our portfolio of technology-driven information security solutions provided to customers of all sizes. 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 quarterly periods then ended: October 30, 2020 November 1, 2019 Subscription customer base 3,900 4,100 Total customer base 5,200 5,000 Monthly recurring revenue (in millions) $ 36.9 $ 36.9 Annual recurring revenue (in millions)$ 442.7 $ 442.8 Average subscription revenue per customer (in thousands)$ 113.2 $ 107.8 Net revenue retention rate 95 % 99 % Subscription Customer Base. We define our subscription customer base as the number of customerswho subscribe to our managed security solutions as of a particular date. We believe that growing our 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 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 entered into 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. 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. For each of the nine months endedOctober 30, 2020 andNovember 1, 2019 , approximately 66% and 68%, respectively, of our professional services customers subscribed to our managed security solutions. Net Revenue Retention Rate. Our net revenue retention rate is an important measure of our success in retaining and growing revenue from our subscription-based customers. To calculate our net 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. The calculation, however, does not include the positive impact on revenue from sales of solutions to any customers acquired during the period. Our net revenue retention rates may decline or increase from period to period as a result of several factors, including the timing of solution installations and customer renewal rates. 23 -------------------------------------------------------------------------------- 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. There are limitations to the use of the non-GAAP financial measures presented in this management's discussion and analysis. Our non-GAAP financial measures may not be comparable to similarly titled measures of other companies. Other companies, including companies in our industry, may calculate non-GAAP financial measures differently than we do, limiting the usefulness of those measures for comparative purposes. The non-GAAP financial measures we present, as defined by us, exclude the items described in the reconciliation below. As the excluded items can have a material impact on earnings, our management compensates for this limitation by relying primarily on GAAP results and using non-GAAP financial measures supplementally. The non-GAAP financial measures are not meant to be considered as indicators of performance in isolation from or as a substitute for revenue, gross 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 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 ofDell byDell Technologies in fiscal 2014 and the Delve Acquisition in fiscal 2021, 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 these transactions. •Stock-based Compensation Expense. Non-cash stock-based compensation relates to both theDell Technologies and Secureworks equity plans. We 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. 24 --------------------------------------------------------------------------------
Three Months Ended Nine Months Ended
October 30, November 1, October 30, November 1,
2020 2019 2020 2019
(in thousands) (in thousands)GAAP and non-GAAP revenue$ 141,641 $ 141,332 $ 421,298 $ 410,779 GAAP gross margin$ 82,028 $ 79,764 $ 238,876 $ 222,775 Amortization of intangibles 3,646 3,559 10,754 10,529 Stock-based compensation expense 255 353 1,008 1,009 Non-GAAP gross margin$ 85,929 $ 83,676 $ 250,638 $ 234,313 GAAP research and development expenses$ 27,608 $ 24,095 $ 75,790 $ 71,600 Stock-based compensation expense (793) (996) (3,181) (3,157)
Non-GAAP research and development expenses
GAAP sales and marketing expenses$ 34,810 $ 40,726 $ 107,886 $ 116,966 Stock-based compensation expense (1,072) (691) (2,695) (2,389) Non-GAAP sales and marketing expenses$ 33,738 $
40,035
GAAP general and administrative expenses$ 24,508 $ 25,078 $ 73,824 $ 73,862 Amortization of intangibles (3,524) (3,524) (10,571) (10,571) Stock-based compensation expense (3,961) (3,052) (10,791) (9,062) Non-GAAP general and administrative expenses$ 17,023 $ 18,502 $ 52,462 $ 54,229 GAAP operating loss$ (4,898) $ (10,135) $ (18,624) $ (39,653) Amortization of intangibles 7,170 7,083 21,325 21,100 Stock-based compensation expense 6,081 5,092 17,675 15,617 Non-GAAP operating income (loss)$ 8,353 $ 2,040 $ 20,376 $ (2,936) GAAP net loss$ (3,608) $ (7,908) $ (12,371) $ (26,438) Amortization of intangibles 7,170 7,083 21,325 21,100 Stock-based compensation expense 6,081 5,092 17,675 15,617 Aggregate adjustment for income taxes (2,917) (3,438) (8,998) (11,997) Non-GAAP net income (loss)$ 6,726 $ 829 $ 17,631 $ (1,718) GAAP loss per share$ (0.04) $ (0.10) $ (0.15) $ (0.33) Amortization of intangibles 0.09 0.09 0.26 0.26 Stock-based compensation expense 0.08 0.06 0.22 0.19 Aggregate adjustment for income taxes (0.04) (0.04) (0.11) (0.15) Non-GAAP earnings (loss) per share *$ 0.08 $ 0.01 $ 0.22 $ (0.02) * Sum of reconciling items may differ from total due to rounding of individual components GAAP net loss$ (3,608) $ (7,908) $ (12,371) $ (26,438) Interest and other, net 79 1,257 (944) (961) Income tax benefit (1,369) (3,484) (5,309) (12,254) Depreciation and amortization 10,106 10,869 30,978 32,017 Stock-based compensation expense 6,081 5,092 17,675 15,617 Adjusted EBITDA$ 11,289 $ 5,826 $ 30,029 $ 7,981 25
-------------------------------------------------------------------------------- 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 ofOctober 30, 2020 represented approximately 85.1% of our total outstanding shares of common stock and approximately 98.3% 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 12-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 because Secureworks was generally included in the tax grouping of otherDell entities within the respective entity's tax jurisdiction. The income tax benefit has been calculated using the separate return method, modified to apply the benefits for loss approach. Under the benefits for loss approach, net operating losses or other tax attributes are characterized as realized or as realizable by Secureworks when those attributes are utilized or expected to be utilized by other members of theDell consolidated group. For more information, see "Notes to Condensed Consolidated Financial Statements -Note 11-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 12-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 ofOctober 30, 2020 , 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 2021, 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 31% of our total net revenue in the third quarter of fiscal 2021 and 25% of our total net revenue in the third quarter of fiscal 2020. Although our international customers are located primarily in theUnited Kingdom ,Japan , andCanada , we provided managed security solutions to customers across 57 countries as ofOctober 30, 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. 26 -------------------------------------------------------------------------------- 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 employeeswho maintain our Counter Threat Platform, provide solutions to our customers, and 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 contractorswho 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, internal 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 27.5% and 30.0% for the three and nine months endedOctober 30, 2020 , respectively, and 30.6% and 31.7% for the three and nine months endedNovember 1, 2019 , respectively. The change in the Company's effective income tax rate between the periods was primarily attributable to both the improvement of loss before income taxes and the impact of discrete adjustments related to stock-based compensation expense of approximately$0.3 million and$0.8 million for the three and nine months endedOctober 30, 2020 , respectively, and$0.5 million and$2.6 million for the three and nine months endedNovember 1, 2019 , respectively. 27 --------------------------------------------------------------------------------
Results of Operations
The following tables summarize our key performance indicators for the three and
nine months ended
Three Months Ended
October 30, 2020 November 1, 2019
% of % % of
$ Revenue Change $ Revenue
(in thousands, except percentages)
Net revenue $ 141,641 100.0 % 0.2 % $ 141,332 100.0 %
Cost of revenue $ 59,613 42.1 % (3.2) % $ 61,568 43.6 %
Total gross margin $ 82,028 57.9 % 2.8 % $ 79,764 56.4 %
Operating expenses $ 86,926 61.4 % (3.3) % $ 89,899 63.6 %
Operating loss $ (4,898) (3.5) % (51.7) % $ (10,135) (7.2) %
Net loss $ (3,608) (2.5) % (54.4) % $ (7,908) (5.6) %
Other Financial Information (1)
Non-GAAP net revenue $ 141,641 100.0 % 0.2 % $ 141,332 100.0 %
Non-GAAP cost of revenue $ 55,712 39.3 % (3.4) % $ 57,656 40.8 %
Non-GAAP gross margin $ 85,929 60.7 % 2.7 % $ 83,676 59.2 %
Non-GAAP operating expenses $ 77,576 54.8 % (5.0) % $ 81,636 57.8 %
Non-GAAP operating income $ 8,353 5.9 % 309.5 % $ 2,040 1.4 %
Non-GAAP net income $ 6,726 4.7 % 711.3 % $ 829 0.6 %
Adjusted EBITDA $ 11,289 8.0 % 93.8 % $ 5,826 4.1 %
Nine Months Ended
October 30, 2020 November 1, 2019
%
$ % of Revenue Change $ % of Revenue
(in thousands, except percentages)
Net revenue $ 421,298 100.0 % 2.6 % $ 410,779 100.0 %
Cost of revenue $ 182,422 43.3 % (3.0) % $ 188,004 45.8 %
Total gross margin $ 238,876 56.7 % 7.2 % $ 222,775 54.2 %
Operating expenses $ 257,500 61.1 % (1.9) % $ 262,428 63.9 %
Operating loss $ (18,624) (4.4) % (53.0) % $ (39,653) (9.7) %
Net loss $ (12,371) (2.9) % (53.2) % $ (26,438) (6.4) %
Other Financial Information (1)
Non-GAAP net revenue $ 421,298 100.0 % 2.6 % $ 410,779 100.0 %
Non-GAAP cost of revenue $ 170,660 40.5 % (3.3) % $ 176,466 43.0 %
Non-GAAP gross margin $ 250,638 59.5 % 7.0 % $ 234,313 57.0 %
Non-GAAP operating expenses $ 230,262 54.7 % (2.9) % $ 237,249 57.8 %
Non-GAAP operating income (loss) $ 20,376 4.8 % (794.0) % $ (2,936) (0.7) %
Non-GAAP net income (loss) $ 17,631 4.2 % (1126.3) % $ (1,718) (0.4) %
Adjusted EBITDA $ 30,029 7.1 % 276.3 % $ 7,981 1.9 %
____________________
(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.
28-------------------------------------------------------------------------------- Three and nine months endedOctober 30, 2020 compared to the three and nine months endedNovember 1, 2019 Revenue Net revenue, which we refer to as revenue, increased$0.3 million , or 0.2%, and$10.5 million , or 2.6%, for the three and nine months endedOctober 30, 2020 , respectively. The revenue increase resulted primarily from revenue generated by our subscription-based solutions, which represented approximately 76.4% and 76.2% of total revenue for the three and nine months endedOctober 30, 2020 . Our existing customers continued to increase their contracted subscriptions for our solutions, with average revenue per customer increasing 5% year over year. Revenue for certain services provided to or on behalf ofDell under our commercial agreements withDell totaled approximately$4.3 million and$14.9 million for the three and nine months endedOctober 30, 2020 , respectively, and$10.6 million and$19.4 million for the three and nine months endedNovember 1, 2019 , respectively. For more information regarding these commercial agreements, see "Notes to Condensed Consolidated Financial Statements-Note 12-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 endedOctober 30, 2020 , international revenue, which we define as revenue contracted through non-U.S. entities, increased to$43.2 million , or 23.3%, from the three months endedNovember 1, 2019 . 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 Gross margin on a GAAP basis includes amortization of intangible assets and stock-based compensation expense. Our total gross margin increased$2.3 million , or 2.8%, and$16.1 million , or 7.2%, for the three and nine months endedOctober 30, 2020 , respectively. As a percentage of revenue, our gross margin increased 150 basis points to 57.9% and 250 basis points to 56.7% for the three and nine months endedOctober 30, 2020 , respectively. On a non-GAAP basis, excluding amortization of intangible assets and stock-based compensation expense, gross margin increased$2.3 million , or 2.7%, and$16.3 million , or 7.0%, for the three and nine months endedOctober 30, 2020 , respectively. As a percentage of revenue, our non-GAAP gross margin increased 150 basis points to 60.7% and 250 basis points to 59.5% for three and nine months endedOctober 30, 2020 , respectively. The increases in gross margin as a percentage of revenue on both a GAAP and non-GAAP basis during the three and nine months endedOctober 30, 2020 was primarily attributable to improvement in our subscription-based solutions margins as we continue to focus on delivering comprehensive higher-value security solutions and driving scale and operational efficiencies, and a decrease in travel-related costs, which we attribute to the COVID-19 pandemic. Operating Expenses The following table presents information regarding our operating expenses during the three and nine months endedOctober 30, 2020 andNovember 1, 2019 . Three Months Ended October 30, 2020 November 1, 2019 % of % % of Dollars Revenue Change Dollars Revenue (in thousands, except percentages) Operating expenses: Research and development$ 27,608 19.5 % 14.6 %$ 24,095 17.0 % Sales and marketing 34,810 24.6 % (14.5) % 40,726 28.8 % General and administrative 24,508 17.3 % (2.3) % 25,078 17.7 % Total operating expenses$ 86,926 61.4 % (3.3) %$ 89,899 63.6 % Other Financial Information Non-GAAP research and development$ 26,815 18.9 % 16.1 %$ 23,099 16.3 % Non-GAAP sales and marketing 33,738 23.8 % (15.7) % 40,035 28.3 % Non-GAAP general and administrative 17,023 12.0 % (8.0) % 18,502 13.1 % Non-GAAP operating expenses (1)$ 77,576 54.8 % (5.0) %$ 81,636 57.8 % 29 --------------------------------------------------------------------------------
Nine Months Ended
October 30, 2020 November 1, 2019
Dollars % of Revenue % Change Dollars % of Revenue
(in thousands, except percentages)Operating expenses: Research and development$ 75,790 18.0 % 5.9 %$ 71,600 17.4 % Sales and marketing 107,886 25.6 % (7.8) % 116,966 28.5 % General and administrative 73,824 17.5 % (0.1) % 73,862 18.0 % Total operating expenses$ 257,500 61.1 % (1.9) %$ 262,428 63.9 % Other Financial Information Non-GAAP research and development$ 72,609 17.2 % 6.1 %$ 68,443 16.7 % Non-GAAP sales and marketing 105,191 25.0 % (8.2) % 114,577 27.9 % Non-GAAP general and administrative 52,462 12.5 % (3.3) % 54,229 13.2 % Non-GAAP operating expenses (1)$ 230,262 54.7 % (2.9) %$ 237,249 57.8 %
(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. For the three months endedOctober 30, 2020 , R&D expenses increased$3.5 million , or 14.6%. As a percentage of revenue, R&D expenses increased 250 basis points to 19.5%. On a non-GAAP basis, R&D expenses as a percentage of revenue increased 260 basis points to 18.9%. The increase in R&D expenses was primarily attributable to an increase in compensation and benefits resulting from the addition of R&D personnel associated with the continued development of our solutions, including our new security analytics platform and software applications. For the nine months endedOctober 30, 2020 , R&D expenses increased$4.2 million , or 5.9%. As a percentage of revenue, R&D expenses increased 60 basis points to 18.0%. On a non-GAAP basis, R&D expenses as a percentage of revenue increased 50 basis points to 17.2%. The increase in R&D expenses was primarily attributable to increased compensation and benefits resulting from the addition of R&D personnel associated with the continued development of our solutions, including our new security analytics platform and software applications. Sales and Marketing Expenses. For the three months endedOctober 30, 2020 , S&M expenses decreased$5.9 million , or 14.5%. As a percentage of revenue, S&M expenses decreased 420 basis points to 24.6%. On a non-GAAP basis, S&M expenses as a percentage of revenue decreased 450 basis points to 23.8%. The decrease in S&M expenses was primarily attributable to lower travel-related costs associated with increased remote activities as a result of COVID-19 and a reduction of sales cost associated with our Safeguard offerings in partnership withDell . For the nine months endedOctober 30, 2020 , S&M expenses decreased$9.1 million , or 7.8%. As a percentage of revenue, S&M expenses decreased 290 basis points to 25.6%. On a non-GAAP basis, S&M expenses as a percentage of revenue decreased 290 basis points to 25.0%. The decrease in S&M expenses was primarily attributable to lower travel-related costs associated with increased remote activities as a result of COVID-19 and a reduction of sales cost associated with our Safeguard offerings in partnership withDell . General and Administrative Expenses. For the three months endedOctober 30, 2020 , G&A expenses decreased$0.6 million , or 2.3%. As a percentage of revenue, G&A expenses decreased 40 basis points to 17.3% . On a non-GAAP basis, G&A expenses as a percentage of revenue decreased 110 basis points to 12.0%. The decrease in G&A expenses was primarily attributable to lower employee and travel-related costs. For the nine months endedOctober 30, 2020 , G&A expenses decreased$38.0 thousand , or 0.1%. As a percentage of revenue, G&A expenses decreased 50 basis points to 17.5%. On a non-GAAP basis, G&A expenses as a percentage of revenue decreased 70 basis points to 12.5%. The decrease in G&A expenses was primarily attributable to lower employee and facilities-related costs, which was offset by professional services and consulting related costs incurred in fiscal 2021. 30 -------------------------------------------------------------------------------- Operating Income (Loss) Our operating loss for the three months endedOctober 30, 2020 andNovember 1, 2019 was$(4.9) million and$(10.1) million , respectively. As a percentage of revenue, our operating loss was (3.5)% and (7.2)% for the three months endedOctober 30, 2020 andNovember 1, 2019 , respectively. The decrease in our operating loss was primarily due to increased gross margin and lower operating expenses as previously described. Our operating loss for the nine months endedOctober 30, 2020 andNovember 1, 2019 was$(18.6) million and$(39.7) million , respectively. As a percentage of revenue, our operating loss was (4.4)% and (9.7)% for the nine months endedOctober 30, 2020 andNovember 1, 2019 , respectively. The decrease in our operating loss was primarily due to increased gross margin as previously described. Operating income on a GAAP basis includes amortization of intangible assets and stock-based compensation expense. On a non-GAAP basis, excluding these adjustments, our non-GAAP operating income was$8.4 million and$20.4 million for the three and nine months endedOctober 30, 2020 , respectively, compared to non-GAAP operating income of$2.0 million and a non-GAAP operating loss of$(2.9) million for the three and nine months endedNovember 1, 2019 , respectively. Interest and Other, Net Our interest and other, net was$(0.1) million and$0.9 million for the three and nine months endedOctober 30, 2020 , respectively, compared with$(1.3) million and$1.0 million for the three and nine months endedNovember 1, 2019 , respectively. The changes primarily reflected the effects of foreign currency transactions and related exchange rate fluctuations. Income Tax Benefit Our income tax benefit was$1.4 million , or 27.5%, and$5.3 million , or 30.0%, of our pre-tax loss during the three and nine months endedOctober 30, 2020 , respectively, and$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. The changes in the effective tax benefit rate were primarily attributable to both the improvement of loss before income taxes and the impact of certain discrete adjustments related to stock-based compensation expense of approximately$0.3 million and$0.8 million for the three and nine months endedOctober 30, 2020 , respectively, and$0.5 million and$2.6 million for the three and nine months endedNovember 1, 2019 , respectively. Net Income (Loss) Our net loss of$(3.6) million decreased$4.3 million , or 54.4%, for the three months endedOctober 30, 2020 . For the nine months endedOctober 30, 2020 , our net loss of$(12.4) million decreased$14.1 million , or 53.2%. Net income on a non-GAAP basis for the three months endedOctober 30, 2020 was$6.7 million compared to non-GAAP net income of$0.8 million for the three months endedNovember 1, 2019 , and$17.6 million for the nine months endedOctober 30, 2020 compared to a non-GAAP loss of$(1.7) million for the nine months endedNovember 1, 2019 . The changes on both a GAAP and non-GAAP basis were attributable to our improved operating results offset in part by the lower income tax benefit recognized in the current period. 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. Cash from operations could be affected by various risks and uncertainties, including, but not limited to, the effects of COVID-19 and other risks and uncertainties described under "Risk Factors" in Part I, Item 1A of our Annual Report. 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, the expansion of sales and marketing activities, potential acquisitions of complementary businesses and technologies, continuing market acceptance of our solutions, general economic and market conditions, as well as macroeconomic events such as COVID-19. 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 future strategic initiatives, such as acquisitions. In addition to our$30 million revolving credit facility fromDell , described below, sources of financing may include arrangements with unaffiliated third parties, depending on the availability of capital, the cost of funds and lender collateral requirements. 31
-------------------------------------------------------------------------------- Selected Measures of Liquidity and Capital Resources As ofOctober 30, 2020 , our principal sources of liquidity consisted of cash and cash equivalents and accounts receivable. Selected measures of our liquidity and capital resources are as follows: October 30, January 31, 2020 2020 (in thousands) Cash and cash equivalents$ 188,048 $ 181,838 Accounts receivable, net$ 107,907 $ 111,798 We invoice our customers based on a variety of billing schedules. During the nine months endedOctober 30, 2020 , 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 in advance. Invoiced accounts receivable are generally collected over a period of 30 to 120 days. The decrease in accounts receivable as ofOctober 30, 2020 reflected increased collection activity. 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 ofOctober 30, 2020 andJanuary 31, 2020 , the allowance for doubtful accounts was$5.3 million and$5.1 million , respectively. Based upon our assessment, we believe we are adequately reserved for credit risk. Revolving Credit FacilitySecureWorks, 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$30 million by mutual agreement of the lender and borrower. The proceeds from loans made under the facility may be used for general corporate purposes. The facility is not guaranteed by us or our subsidiaries. There was no outstanding balance under the facility as ofOctober 30, 2020 orJanuary 31, 2020 . The facility has a maturity date ofMarch 26, 2021 and interest on borrowings accrues at the applicable London Interbank Offered Rate plus 1.30%. Amounts under the facility may be borrowed, repaid and reborrowed from time to time during the term of the facility. The borrower will be required to repay in full all of the loans outstanding, including all accrued interest, and the facility will terminate upon a change of control of us or following a transaction in whichSecureWorks, Inc. ceases to be a direct or indirect wholly-owned subsidiary of our Company. The credit agreement contains customary representations, warranties, covenants and events of default. The unused portion of the facility is subject to a commitment fee of 0.35%, which is due upon expiration of the facility. Cash Flows The following table presents information concerning our cash flows for the nine months endedOctober 30, 2020 andNovember 1, 2019 . Nine Months Ended October 30, November 1, 2020 2019 (in thousands) Net change in cash from: Operating activities$ 28,434 $ 35,852 Investing activities (17,262)
(12,082)
Financing activities (4,962) (14,574)
Change in cash and cash equivalents $ 6,210 $ 9,196
Operating Activities - Cash provided by operating activities totaled $28.4
million and $35.9 million for the nine months ended October 30, 2020 and
November 1, 2019 , respectively. The decrease in cash provided by operating
activities is primarily driven by the establishment of consistent customer
collection rates year over year and a decline in deferred revenue. Both items
were partially offset by our net transactions with Dell . We expect that our
future transactions with Dell will be a source of cash over time as we
anticipate that our charges to Dell will continue to exceed Dell's charges to
us, although the timing of charges and settlements may vary from period to
period.
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Investing Activities - Cash used in investing activities totaled $17.3 million
and $12.1 million for the nine months ended October 30, 2020 and November 1,
2019 , respectively. The use of cash flows for the nine months ended October 30,
2020 reflected our acquisition of Delve for $15.1 million , net of cash acquired,
and capital expenditures of $2.2 million . The use of cash flows for the nine
months ended November 1, 2019 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 totaled $5.0 million
and $14.6 million for the nine months ended October 30, 2020 and November 1,
2019 , respectively. The use of cash flows for the nine months ended October 30,
2020 reflected employee tax withholding payments paid by us of $5.0 million on
restricted stock awards. The use of cash flows for the nine months ended
November 1, 2019 reflected employee tax withholding payments of $8.2 million
paid by us on employee restricted stock awards and our repurchase of $6.4
million of our Class A common stock pursuant to our stock repurchase program,
which expired by its terms on May 1, 2020 .
Off-Balance Sheet Arrangements
As of October 30, 2020 , 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 the SEC . 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 "in our condensed
consolidated financial statements included in this report, we have adopted the
new accounting guidance set forth in ASC 350, ASC 326, and ASC 848.
Additionally, management assessed the critical accounting policies as disclosed
in our Annual Report and incorporated the Company's method of accounting with
respect to business combinations as a result of our acquisition of Delve during
the three months ended October 30, 2020 , as described in "Notes to Condensed
Consolidated Financial Statements-Note 2-Business Combinations " in our
condensed consolidated financial statements included in this report.
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 the U.S. dollar and the Euro, the
British Pound, the Romanian Leu, Japanese Yen, 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 under SEC 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 cost.
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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 ofOctober 30, 2020 . Based on that evaluation, our management has concluded that our disclosure controls and procedures were effective as ofOctober 30, 2020 . 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 endedOctober 30, 2020 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
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