UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
| (Mark One) | |||||||||||
| ☑ | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | ||||||||||
For the quarterly period ended July 29, 2022
| or | |||||||||||
| ☐ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | ||||||||||
For the transition period from to | |||||||||||
Commission File Number: 001-37748
SecureWorks Corp.
(Exact name of registrant as specified in its charter)
Delaware | 27-0463349 | ||||||||||||||||||||||||||||
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) | ||||||||||||||||||||||||||||
One Concourse Parkway NE | |||||||||||||||||||||||||||||
Suite 500 | |||||||||||||||||||||||||||||
Atlanta, | Georgia | 30328 | |||||||||||||||||||||||||||
(Address of principal executive offices) | (Zip Code) | ||||||||||||||||||||||||||||
(Registrant’s telephone number, including area code): (404) 327-6339
Not Applicable
(Former name, former address and former fiscal year, if changed since last report)
Securities registered pursuant to Section 12(b) of the Act:
| Title of each class | Trading Symbol(s) | Name of each exchange on which registered | ||||||
| Class A Common Stock, | SCWX | The Nasdaq Stock Market LLC | ||||||
| par value $0.01 per share | (Nasdaq Global Select Market) | |||||||
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☑ No ☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☑ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of "large accelerated filer," "accelerated filer," "smaller reporting company," and "emerging growth company" in Rule 12b-2 of the Exchange Act.
| Large accelerated filer | ☐ | Accelerated filer | ☑ | |||||||||||
| Non-accelerated filer | ☐ | Smaller reporting company | ☐ | |||||||||||
| Emerging growth company | ☐ | |||||||||||||
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☑
As of August 26, 2022, there were 84,970,379 shares of the registrant's common stock outstanding, consisting of 14,970,379 outstanding shares of Class A common stock and 70,000,000 outstanding shares of Class B common stock.
| TABLE OF CONTENTS | ||||||||||||||
| ITEM | PAGE | |||||||||||||
Except where the content otherwise requires or where otherwise indicated, all references in this report to "Secureworks," "we," "us," "our" and "our Company" to refer to SecureWorks Corp. and our subsidiaries on a consolidated basis.
Part I. Financial Information
Item 1. Financial Statements
SECUREWORKS CORP.
CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL POSITION (Unaudited)
(in thousands, except for per share data)
| July 29, 2022 | January 28, 2022 | ||||||||||
| ASSETS | |||||||||||
| Current assets: | |||||||||||
| Cash and cash equivalents | $ | 167,487 | $ | 220,655 | |||||||
Accounts receivable, net of allowances of $3,120 and $3,510, respectively | 71,339 | 86,231 | |||||||||
| Inventories, net | 475 | 505 | |||||||||
| Other current assets | 27,283 | 26,040 | |||||||||
| Total current assets | 266,584 | 333,431 | |||||||||
| Property and equipment, net | 6,150 | 8,426 | |||||||||
| Operating lease right-of-use assets, net | 15,236 | 17,441 | |||||||||
| Goodwill | 425,878 | 425,926 | |||||||||
| Intangible assets, net | 121,144 | 133,732 | |||||||||
| Other non-current assets | 65,589 | 68,346 | |||||||||
| Total assets | $ | 900,581 | $ | 987,302 | |||||||
| LIABILITIES AND STOCKHOLDERS' EQUITY | |||||||||||
| Current liabilities: | |||||||||||
| Accounts payable | $ | 20,883 | $ | 15,062 | |||||||
| Accrued and other current liabilities | 64,622 | 88,122 | |||||||||
| Short-term deferred revenue | 151,026 | 163,304 | |||||||||
| Total current liabilities | 236,531 | 266,488 | |||||||||
| Long-term deferred revenue | 8,881 | 12,764 | |||||||||
| Operating lease liabilities, non-current | 14,346 | 16,869 | |||||||||
| Other non-current liabilities | 33,230 | 43,124 | |||||||||
| Total liabilities | 292,988 | 339,245 | |||||||||
Commitments and contingencies (Note 6) | |||||||||||
| Stockholders' equity: | |||||||||||
Preferred stock - $0.01 par value: 200,000 shares authorized; — shares issued | — | — | |||||||||
Common stock - Class A of $0.01 par value: 2,500,000 shares authorized; 14,970 and 14,282 shares issued and outstanding, at July 29, 2022 and January 28, 2022, respectively. | 150 | 143 | |||||||||
Common stock - Class B of $0.01 par value: 500,000 shares authorized; 70,000 shares issued and outstanding | 700 | 700 | |||||||||
| Additional paid in capital | 949,248 | 939,404 | |||||||||
| Accumulated deficit | (315,939) | (269,622) | |||||||||
| Accumulated other comprehensive loss | (6,670) | (2,672) | |||||||||
Treasury stock, at cost - 1,257 and 1,257 shares, respectively | (19,896) | (19,896) | |||||||||
| Total stockholders' equity | 607,593 | 648,057 | |||||||||
| Total liabilities and stockholders' equity | $ | 900,581 | $ | 987,302 | |||||||
The accompanying notes are an integral part of these condensed consolidated financial statements.
3
SECUREWORKS CORP.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)
(in thousands, except per share data)
| Three Months Ended | Six Months Ended | ||||||||||||||||||||||
| July 29, 2022 | July 30, 2021 | July 29, 2022 | July 30, 2021 | ||||||||||||||||||||
| Net revenue: | |||||||||||||||||||||||
| Subscription | $ | 90,322 | $ | 102,426 | $ | 184,735 | $ | 206,496 | |||||||||||||||
| Professional services | 25,860 | 31,746 | 52,462 | 67,139 | |||||||||||||||||||
| Total net revenue | 116,182 | 134,172 | 237,197 | 273,635 | |||||||||||||||||||
| Cost of revenue: | |||||||||||||||||||||||
| Subscription | 34,060 | 37,058 | 66,886 | 74,730 | |||||||||||||||||||
| Professional services | 15,519 | 19,425 | 32,128 | 38,960 | |||||||||||||||||||
| Total cost of revenue | 49,579 | 56,483 | 99,014 | 113,690 | |||||||||||||||||||
| Gross profit | 66,603 | 77,689 | 138,183 | 159,945 | |||||||||||||||||||
| Operating expenses: | |||||||||||||||||||||||
| Research and development | 33,638 | 30,417 | 66,969 | 58,569 | |||||||||||||||||||
| Sales and marketing | 40,940 | 34,685 | 80,185 | 71,090 | |||||||||||||||||||
| General and administrative | 24,274 | 26,488 | 49,634 | 52,043 | |||||||||||||||||||
| Total operating expenses | 98,852 | 91,590 | 196,788 | 181,702 | |||||||||||||||||||
| Operating loss | (32,249) | (13,901) | (58,605) | (21,757) | |||||||||||||||||||
| Interest and other, net | 131 | (601) | (566) | (1,508) | |||||||||||||||||||
| Loss before income taxes | (32,118) | (14,502) | (59,171) | (23,265) | |||||||||||||||||||
| Income tax benefit | (7,399) | (2,739) | (12,854) | (5,112) | |||||||||||||||||||
| Net loss | $ | (24,719) | $ | (11,763) | $ | (46,317) | $ | (18,153) | |||||||||||||||
| Loss per common share (basic and diluted) | $ | (0.29) | $ | (0.14) | $ | (0.55) | $ | (0.22) | |||||||||||||||
| Weighted-average common shares outstanding (basic and diluted) | 84,483 | 82,979 | 84,123 | 82,482 | |||||||||||||||||||
The accompanying notes are an integral part of these condensed consolidated financial statements.
4
SECUREWORKS CORP.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS (Unaudited)
(in thousands)
| Three Months Ended | Six Months Ended | ||||||||||||||||||||||
| July 29, 2022 | July 30, 2021 | July 29, 2022 | July 30, 2021 | ||||||||||||||||||||
| Net loss | $ | (24,719) | $ | (11,763) | $ | (46,317) | $ | (18,153) | |||||||||||||||
| Foreign currency translation adjustments, net of tax | (1,158) | (378) | (3,998) | 86 | |||||||||||||||||||
| Comprehensive loss | $ | (25,877) | $ | (12,141) | $ | (50,315) | $ | (18,067) | |||||||||||||||
The accompanying notes are an integral part of these condensed consolidated financial statements.
5
SECUREWORKS CORP.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
(in thousands)
| Six Months Ended | |||||||||||
| July 29, 2022 | July 30, 2021 | ||||||||||
| Cash flows from operating activities: | |||||||||||
| Net loss | $ | (46,317) | $ | (18,153) | |||||||
| Adjustments to reconcile net loss to net cash used in operating activities: | |||||||||||
| Depreciation and amortization | 18,515 | 19,863 | |||||||||
| Amortization of right of use asset | 1,932 | 2,098 | |||||||||
| Amortization of costs capitalized to obtain revenue contracts | 8,985 | 9,912 | |||||||||
| Amortization of costs capitalized to fulfill revenue contracts | 2,565 | 2,738 | |||||||||
| Stock-based compensation expense | 17,938 | 13,615 | |||||||||
| Effects of exchange rate changes on monetary assets and liabilities denominated in foreign currencies | 516 | 1,344 | |||||||||
| Income tax benefit | (12,854) | (5,112) | |||||||||
| Provision for credit losses | (102) | 448 | |||||||||
| Changes in assets and liabilities: | |||||||||||
| Accounts receivable | 14,329 | 9,532 | |||||||||
| Net transactions with Dell | (592) | (8,903) | |||||||||
| Inventories | 30 | (67) | |||||||||
| Other assets | (6,933) | (8,232) | |||||||||
| Accounts payable | 5,685 | (1,293) | |||||||||
| Deferred revenue | (17,165) | (2,912) | |||||||||
| Operating leases, net | (2,801) | (2,970) | |||||||||
| Accrued and other liabilities | (25,145) | (25,185) | |||||||||
| Net cash used in operating activities | (41,414) | (13,277) | |||||||||
| Cash flows from investing activities: | |||||||||||
| Capital expenditures | (827) | (1,033) | |||||||||
| Software development costs | (2,840) | (3,218) | |||||||||
| Net cash used in investing activities | (3,667) | (4,251) | |||||||||
| Cash flows from financing activities: | |||||||||||
| Taxes paid on vested restricted shares | (8,087) | (9,945) | |||||||||
| Proceeds from stock option exercises | — | 4,134 | |||||||||
| Net cash used in financing activities | (8,087) | (5,811) | |||||||||
| Net decrease in cash and cash equivalents | (53,168) | (23,339) | |||||||||
| Cash and cash equivalents at beginning of the period | 220,655 | 220,300 | |||||||||
| Cash and cash equivalents at end of the period | $ | 167,487 | $ | 196,961 | |||||||
The accompanying notes are an integral part of these condensed consolidated financial statements.
6
SECUREWORKS CORP.
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (Unaudited)
(in thousands, except per share data)
| Three Months Ended July 29, 2022 | Common Stock - Class A | Common Stock - Class B | ||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Outstanding Shares | Amount | Outstanding Shares | Amount | Additional Paid in Capital | Accumulated Deficit | Accumulated Other Comprehensive (Loss) Income | Treasury Stock | Total Stockholders' Equity | ||||||||||||||||||||||||||||||||||||||||||||||||
| Balances, April 29, 2022 | 14,859 | $ | 149 | 70,000 | $ | 700 | $ | 941,082 | $ | (291,220) | $ | (5,512) | $ | (19,896) | $ | 625,303 | ||||||||||||||||||||||||||||||||||||||||
| Net loss | — | — | — | — | — | (24,719) | — | — | (24,719) | |||||||||||||||||||||||||||||||||||||||||||||||
| Other comprehensive income | — | — | — | — | — | — | (1,158) | — | (1,158) | |||||||||||||||||||||||||||||||||||||||||||||||
| Vesting of restricted stock units | 168 | 2 | — | — | (2) | — | — | — | — | |||||||||||||||||||||||||||||||||||||||||||||||
| Common stock withheld as payment for withholding taxes upon the vesting of restricted shares | (57) | (1) | — | — | (645) | — | — | — | (645) | |||||||||||||||||||||||||||||||||||||||||||||||
| Stock-based compensation | — | — | — | — | 8,812 | — | — | — | 8,812 | |||||||||||||||||||||||||||||||||||||||||||||||
| Balances, July 29, 2022 | 14,970 | $ | 150 | 70,000 | $ | 700 | $ | 949,248 | $ | (315,939) | $ | (6,670) | $ | (19,896) | $ | 607,593 | ||||||||||||||||||||||||||||||||||||||||
| Six Months Ended July 29, 2022 | Common Stock - Class A | Common Stock - Class B | ||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Outstanding Shares | Amount | Outstanding Shares | Amount | Additional Paid in Capital | Accumulated Deficit | Accumulated Other Comprehensive (Loss) Income | Treasury Stock | Total Stockholders' Equity | ||||||||||||||||||||||||||||||||||||||||||||||||
| Balances, January 28, 2022 | 14,282 | $ | 143 | 70,000 | $ | 700 | $ | 939,404 | $ | (269,622) | $ | (2,672) | $ | (19,896) | $ | 648,057 | ||||||||||||||||||||||||||||||||||||||||
| Net loss | — | — | — | — | — | (46,317) | — | — | (46,317) | |||||||||||||||||||||||||||||||||||||||||||||||
| Other comprehensive loss | — | — | — | — | — | — | (3,998) | — | (3,998) | |||||||||||||||||||||||||||||||||||||||||||||||
| Vesting of restricted stock units | 1,381 | 14 | — | — | (14) | — | — | — | — | |||||||||||||||||||||||||||||||||||||||||||||||
| Common stock withheld as payment for withholding taxes upon the vesting of restricted shares | (693) | (7) | — | — | (8,080) | — | — | — | (8,087) | |||||||||||||||||||||||||||||||||||||||||||||||
| Stock-based compensation | — | — | — | — | 17,938 | — | — | — | 17,938 | |||||||||||||||||||||||||||||||||||||||||||||||
| Balances, July 29, 2022 | 14,970 | $ | 150 | 70,000 | $ | 700 | $ | 949,248 | $ | (315,939) | $ | (6,670) | $ | (19,896) | $ | 607,593 | ||||||||||||||||||||||||||||||||||||||||
The accompanying notes are an integral part of these condensed consolidated financial statements.
7
SECUREWORKS CORP.
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (Unaudited)
(in thousands, except per share data)
| Three Months Ended July 30, 2021 | Common Stock - Class A | Common Stock - Class B | ||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Outstanding Shares | Amount | Outstanding Shares | Amount | Additional Paid in Capital | Accumulated Deficit | Accumulated Other Comprehensive (Loss) Income | Treasury Stock | Total Stockholders' Equity | ||||||||||||||||||||||||||||||||||||||||||||||||
| Balances, April 30, 2021 | 13,550 | $ | 135 | 70,000 | $ | 700 | $ | 916,527 | $ | (236,221) | $ | (196) | $ | (19,896) | $ | 661,049 | ||||||||||||||||||||||||||||||||||||||||
| Net loss | — | — | — | — | — | (11,763) | — | — | (11,763) | |||||||||||||||||||||||||||||||||||||||||||||||
| Other comprehensive loss | — | — | — | — | — | — | (378) | — | (378) | |||||||||||||||||||||||||||||||||||||||||||||||
| Vesting of restricted stock units | 57 | 1 | — | — | (1) | — | — | — | — | |||||||||||||||||||||||||||||||||||||||||||||||
| Exercise of stock options | 1,417 | 14 | — | — | 4,120 | — | — | — | 4,134 | |||||||||||||||||||||||||||||||||||||||||||||||
| Common stock withheld as payment for withholding taxes upon the vesting of restricted shares | (932) | (9) | — | — | (3,095) | — | — | — | (3,104) | |||||||||||||||||||||||||||||||||||||||||||||||
| Stock-based compensation | — | — | — | — | 7,580 | — | — | — | 7,580 | |||||||||||||||||||||||||||||||||||||||||||||||
| Balances, July 30, 2021 | 14,092 | $ | 141 | 70,000 | $ | 700 | $ | 925,131 | $ | (247,984) | $ | (574) | $ | (19,896) | $ | 657,518 | ||||||||||||||||||||||||||||||||||||||||
| Six Months Ended July 30, 2021 | Common Stock - Class A | Common Stock - Class B | ||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Outstanding Shares | Amount | Outstanding Shares | Amount | Additional Paid in Capital | Accumulated Deficit | Accumulated Other Comprehensive (Loss) Income | Treasury Stock | Total Stockholders' Equity | ||||||||||||||||||||||||||||||||||||||||||||||||
| Balances, January 29, 2021 | 12,450 | $ | 124 | 70,000 | $ | 700 | $ | 917,344 | $ | (229,831) | $ | (660) | $ | (19,896) | $ | 667,781 | ||||||||||||||||||||||||||||||||||||||||
| Net loss | — | — | — | — | — | (18,153) | — | — | (18,153) | |||||||||||||||||||||||||||||||||||||||||||||||
| Other comprehensive income | — | — | — | — | — | — | 86 | — | 86 | |||||||||||||||||||||||||||||||||||||||||||||||
| Vesting of restricted stock units | 1,197 | 12 | — | — | (12) | — | — | — | — | |||||||||||||||||||||||||||||||||||||||||||||||
| Exercise of stock options | 1,417 | 14 | 4,120 | 4,134 | ||||||||||||||||||||||||||||||||||||||||||||||||||||
| Grant of restricted stock awards | 485 | 5 | — | — | (5) | — | — | — | — | |||||||||||||||||||||||||||||||||||||||||||||||
| Common stock withheld as payment for withholding taxes upon the vesting of restricted shares | (1,457) | (14) | — | — | (9,931) | — | — | — | (9,945) | |||||||||||||||||||||||||||||||||||||||||||||||
| Stock-based compensation | — | — | — | — | 13,615 | — | — | — | 13,615 | |||||||||||||||||||||||||||||||||||||||||||||||
| Balances, July 30, 2021 | 14,092 | $ | 141 | 70,000 | $ | 700 | $ | 925,131 | $ | (247,984) | $ | (574) | $ | (19,896) | $ | 657,518 | ||||||||||||||||||||||||||||||||||||||||
The accompanying notes are an integral part of these condensed consolidated financial statements.
8
NOTE 1 — DESCRIPTION OF THE BUSINESS AND BASIS OF PRESENTATION
Description of the Business
SecureWorks Corp. (individually and collectively with its consolidated subsidiaries, “Secureworks” or the “Company”) is a leading global cybersecurity provider of technology-driven solutions singularly focused on protecting the Company’s customers by outpacing and outmaneuvering adversaries.
On April 27, 2016, the Company completed its initial public offering (“IPO”). Upon the closing of the IPO, Dell Technologies Inc. (“Dell Technologies”) owned, indirectly through Dell Inc. and Dell Inc.’s subsidiaries (Dell Inc., individually and collectively with its consolidated subsidiaries, “Dell”), all shares of the Company’s outstanding Class B common stock, which as of July 29, 2022 represented approximately 82.4% of the Company's total outstanding shares of common stock and approximately 97.9% of the combined voting power of both classes of the Company's outstanding common stock.
The Company has one primary business activity, which is to provide customers with technology-driven cybersecurity solutions. The Company’s chief operating decision-maker, who is the Chief Executive Officer, makes operating decisions, assesses performance and allocates resources on a consolidated basis. There are no segment managers who are held accountable for operations and operating results below the consolidated unit level. Accordingly, Secureworks operates its business as a single reportable segment.
Basis of Presentation and Consolidation
The Company’s condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP”). The preparation of financial statements in accordance with GAAP requires management to make assumptions and estimations that affect the amounts reported in the Company’s financial statements and notes. The inputs into certain of the Company’s assumptions and estimations considered the economic implications of the coronavirus 2019 (“COVID-19”) pandemic, the Ukraine/Russia conflict and inflation concerns on the Company’s critical and significant accounting estimates. The condensed consolidated financial statements include assets, liabilities, revenue and expenses of all majority-owned subsidiaries. Intercompany transactions and balances are eliminated in consolidation.
For the periods presented, Dell has provided various corporate services to the Company in the ordinary course of business, including finance, tax, human resources, legal, insurance, IT, procurement and facilities-related services. The cost of these services is charged in accordance with a shared services agreement that went into effect on August 1, 2015. For more information regarding the related party transactions, see "Note 10—Related Party Transactions."
During the periods presented in the financial statements, Secureworks did not file separate federal tax returns, as the Company is generally included in the tax grouping of other Dell 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 this 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 the Dell consolidated group. See "Note 9—Income and Other Taxes" for more information.
Fiscal Year
The Company’s fiscal year is the 52- or 53-week period ending on the Friday closest to January 31. The Company refers to the fiscal year ending February 3, 2023 and the fiscal year ended January 28, 2022 as fiscal 2023 and fiscal 2022, respectively. Fiscal 2023 has 53 weeks and fiscal 2022 had 52 weeks. In fiscal 2023, each quarter has 13 weeks, except for the fourth quarter, which will have 14 weeks. Unless otherwise indicated, all changes identified for the current-period results represent comparisons to results for the prior corresponding fiscal periods.
9
SECUREWORKS CORP.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Use of Estimates
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting periods. Estimates are revised as additional information becomes available. In the Condensed Consolidated Statements of Operations, estimates are used when accounting for revenue arrangements, determining the cost of revenue, allocating cost and estimating the impact of contingencies. In the Condensed Consolidated Statements of Financial Position, estimates are used in determining the valuation and recoverability of assets, such as accounts receivables, inventories, fixed assets, capitalized software, goodwill and other identifiable intangible assets. Estimates are also used in determining the reported amounts of liabilities, such as taxes payable and the impact of contingencies. All estimates also impact the Condensed Consolidated Statements of Operations. Actual results could differ from these estimates due to risks and uncertainties, including uncertainty in the current economic environment due to the COVID-19 pandemic, the Ukraine/Russia conflict and impacts of inflation. The Company considered the potential impact of the COVID-19 pandemic and current economic and geopolitical uncertainty on its estimates and assumptions and determined there was not a material impact to the Company's condensed consolidated financial statements as of and for the three and six months ended July 29, 2022. As the COVID-19 pandemic and current economic environment continue to develop, many of the Company's estimates could require increased judgment and be subject to a higher degree of variability and volatility. As a result, the Company's estimates may change materially in future periods.
Recently Adopted Accounting Pronouncements
Business Combinations – The Company has adopted Accounting Standard Update (“ASU”) 2021-08, “Business Combinations (Topic 805): Accounting for Contract Assets and Contract Liabilities from Contracts with Customers.” The guidance requires contract assets and contract liabilities (i.e., deferred revenue) acquired in a business combination to be recognized and measured by the acquirer on the acquisition date in accordance with ASC 606, “Revenue from Contracts with Customers.” ASU 2021-08 was effective for the Company beginning on January 29, 2022. There was no impact to the Company’s condensed consolidated financial statements as a result of adoption of this standard update.
Summary of Significant Accounting Policies
There have been no significant changes to the Company’s significant accounting policies as of and for the three and six months ended July 29, 2022, as compared to the significant accounting policies described in the Company's Annual Report on Form 10-K for the fiscal year ended January 28, 2022.
NOTE 2 — LOSS PER SHARE
Loss per share is calculated by dividing net loss for the periods presented by the respective weighted-average number of common shares outstanding, and excludes any dilutive effects of share-based awards that may be anti-dilutive. Diluted net loss per common share is computed by giving effect to all potentially dilutive common shares, including common stock issuable upon the exercise of stock options and unvested restricted common stock and restricted stock units. The Company applies the two-class method to calculate earnings per share. Because the Class A common stock and the Class B common stock share the same rights in dividends and earnings, earnings per share (basic and diluted) are the same for both classes of common stock. Since losses were incurred in all periods presented, all potential common shares were determined to be anti-dilutive.
The following table sets forth the computation of loss per common share (in thousands, except per share amounts):
| Three Months Ended | Six Months Ended | ||||||||||||||||||||||
| July 29, 2022 | July 30, 2021 | July 29, 2022 | July 30, 2021 | ||||||||||||||||||||
| Numerator: | |||||||||||||||||||||||
| Net loss | $ | (24,719) | $ | (11,763) | $ | (46,317) | $ | (18,153) | |||||||||||||||
| Denominator: | |||||||||||||||||||||||
| Weighted-average number of shares outstanding: | |||||||||||||||||||||||
| Basic and Diluted | 84,483 | 82,979 | 84,123 | 82,482 | |||||||||||||||||||
| Loss per common share: | |||||||||||||||||||||||
| Basic and Diluted | $ | (0.29) | $ | (0.14) | $ | (0.55) | $ | (0.22) | |||||||||||||||
| Weighted-average anti-dilutive stock options, non-vested restricted stock and restricted stock units | 6,057 | 4,873 | 5,980 | 5,449 | |||||||||||||||||||
10
SECUREWORKS CORP.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE 3 — CONTRACT BALANCES AND CONTRACT COSTS
The Company derives revenue primarily from subscription revenue and professional services. Subscription revenue is derived from (i) Taegis software-as-a-service (“SaaS”) security platform and (ii) managed security services. Taegis offerings currently include two applications, Extended Detection and Response (“XDR”) and Vulnerability Detection and Response (“VDR”), along with the add-on managed service to supplement the XDR SaaS application, referred to as Managed Detection and Response (“ManagedXDR”). Subscription-based managed security service arrangements typically include a suite of security services, up-front installation fees and maintenance, and they also may include the provision of an associated hardware appliance. Professional services typically include incident response and security and risk consulting solutions.
The following table presents revenue by service type (in thousands):
| Three Months Ended | Six Months Ended | |||||||||||||||||||||||||
| July 29, 2022 | July 30, 2021 | July 29, 2022 | July 30, 2021 | |||||||||||||||||||||||
| Net revenue: | ||||||||||||||||||||||||||
| Taegis Subscription Solutions | $ | 42,809 | $ | 18,503 | $ | 80,025 | $ | 32,463 | ||||||||||||||||||
| Managed Security Services | 47,513 | 83,923 | $ | 104,710 | $ | 174,033 | ||||||||||||||||||||
| Total Subscription revenue | $ | 90,322 | $ | 102,426 | 184,735 | 206,496 | ||||||||||||||||||||
| Professional Services | 25,860 | 31,746 | 52,462 | 67,139 | ||||||||||||||||||||||
| Total net revenue | $ | 116,182 | $ | 134,172 | $ | 237,197 | $ | 273,635 | ||||||||||||||||||
Promises to provide the Company’s subscription-based solutions related to SaaS applications are accounted for as separate performance obligations and managed security services are accounted for as a single performance obligation. Our subscription-based solutions have an average contract term of approximately two years as of July 29, 2022. Performance obligations related to the Company’s security and risk consulting professional service contracts are separate obligations associated with each service. Although the Company has many multi-year customer relationships for its various professional service solutions, the arrangement is typically structured as a separate performance obligation over the contract period and recognized over a duration of less than one year.
The deferred revenue balance does not represent the total contract value of annual or multi-year, non-cancelable subscription agreements. The Company invoices its customers based on a variety of billing schedules. During the six months ended July 29, 2022, on average, approximately 62% of the Company's recurring revenue was billed annually in advance and approximately 38% was billed on either a monthly or quarterly basis in advance. In addition, many of the Company’s professional services engagements are billed in advance of service commencement. The deferred revenue balance is influenced by several factors, including seasonality, the compounding effects of renewals, invoice duration and invoice timing.
Changes to the Company's deferred revenue during the six months ended July 29, 2022 and July 30, 2021 are as follows (in thousands):
As of January 28, 2022 | Upfront payments received and billings during the six months ended July 29, 2022 | Revenue recognized during the six months ended July 29, 2022 | As of July 29, 2022 | |||||||||||||||||||||||
| Deferred revenue | $ | 176,068 | $ | 143,991 | $ | (160,151) | $ | 159,908 | ||||||||||||||||||
As of January 29, 2021 | Upfront payments received and billings during the six months ended July 30, 2021 | Revenue recognized during the six months ended July 30, 2021 | As of July 30, 2021 | |||||||||||||||||||||||
| Deferred revenue | $ | 178,027 | $ | 176,529 | $ | (179,137) | $ | 175,419 | ||||||||||||||||||
11
SECUREWORKS CORP.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Remaining Performance Obligation
The remaining performance obligation represents the transaction price allocated to contracted revenue that has not yet been recognized, which includes deferred revenue and non-cancellable contracts that will be invoiced and recognized as revenue in future periods. The remaining performance obligation consists of two elements: (i) the value of remaining services to be provided through the contract term for customers whose services have been activated (“active”); and (ii) the value of subscription-based solutions contracted with customers that have not yet been installed (“backlog”). Backlog is not recorded in revenue, deferred revenue or elsewhere in the consolidated financial statements until the Company establishes a contractual right to invoice, at which point backlog is recorded as revenue or deferred revenue, as appropriate. The Company applies the practical expedient in ASC paragraph 606-10-50-14(a) and does not disclose information about remaining performance obligations that are part of a contract that has an original expected duration of one year or less.
The Company expects that the amount of backlog relative to the total value of its contracts will change from year to year due to several factors, including the amount invoiced at the beginning of the contract term, the timing and duration of the Company’s customer agreements, varying invoicing cycles of agreements and changes in customer financial circumstances. Accordingly, fluctuations in backlog are not always a reliable indicator of future revenues.
As of July 29, 2022, the Company expects to recognize remaining performance obligations as follows (in thousands):
| Total | Expected to be recognized in the next 12 months | Expected to be recognized in 12-24 months | Expected to be recognized in 24-36 months | Expected to be recognized thereafter | ||||||||||||||||||||||||||||
| Performance obligation - active | $ | 259,274 | $ | 137,977 | $ | 86,236 | $ | 34,228 | $ | 833 | ||||||||||||||||||||||
| Performance obligation - backlog | 11,732 | 3,932 | 3,902 | 3,831 | 67 | |||||||||||||||||||||||||||
| Total | $ | 271,006 | $ | 141,909 | $ | 90,138 | $ | 38,059 | $ | 900 | ||||||||||||||||||||||
Deferred Commissions and Fulfillment Costs
The Company capitalizes a significant portion of its commission expense and related fringe benefits earned by its sales personnel. Additionally, the Company capitalizes certain costs to install and activate hardware and software used in its managed security services, primarily related to a portion of the compensation for the personnel who perform the installation activities. These deferred costs are amortized on a systematic basis that is consistent with the transfer to the customer of the goods or services to which the assets relate.
Changes in the balance of total deferred commission and total deferred fulfillment costs during the six months ended July 29, 2022 and July 30, 2021 are as follows (in thousands):
As of January 28, 2022 | Amount capitalized | Amount recognized | As of July 29, 2022 | |||||||||||||||||||||||
| Deferred commissions | $ | 53,978 | $ | 4,994 | $ | (8,985) | $ | 49,987 | ||||||||||||||||||
| Deferred fulfillment costs | 7,597 | 210 | (2,565) | 5,242 | ||||||||||||||||||||||
As of January 29, 2021 | Amount capitalized | Amount recognized | As of July 30, 2021 | |||||||||||||||||||||||
| Deferred commissions | $ | 57,888 | $ | 7,516 | $ | (9,912) | $ | 55,492 | ||||||||||||||||||
| Deferred fulfillment costs | 11,009 | 1,039 | (2,700) | 9,348 | ||||||||||||||||||||||
During the fourth quarter of fiscal 2022, Secureworks announced the end-of-sale for a number of managed security service offerings effective the first day of fiscal 2023. The Company evaluated these deferred costs as part of a broader asset group for impairment and potential changes to their estimated lives. The Company did not record any impairment losses on the deferred commissions or deferred fulfillment costs and did not identify any material changes to the expense recognition pattern during the six months ended July 29, 2022 or July 30, 2021.
12
SECUREWORKS CORP.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE 4 — GOODWILL AND INTANGIBLE ASSETS
Goodwill relates to the acquisition of Dell by Dell Technologies and represents the excess of the purchase price attributable to Secureworks over the fair value of the assets acquired and liabilities assumed, as well as subsequent business combinations completed by the Company. Goodwill decreased $48 thousand due to foreign currency translation for the six months ended July 29, 2022, compared to January 28, 2022. Goodwill totaled $425.9 million as of July 29, 2022 and January 28, 2022.
Goodwill and indefinite-lived intangible assets are tested for impairment on an annual basis during the third fiscal quarter of each fiscal year, or earlier if an indicator of impairment occurs. The Company completed the most recent annual impairment test in the third quarter of fiscal 2022 by performing a “Step 0” qualitative assessment of goodwill at the reporting unit level, as well as the Company’s indefinite-lived trade name asset at the individual asset level. The Company has one reporting unit. The qualitative assessment includes the Company’s consideration of the relevant events and circumstances that would affect the Company’s single reporting unit and indefinite-lived assets, including macroeconomic, industry and market conditions, the Company’s overall financial performance, and trends in the market price of the Company’s Class A common stock. After assessing the totality of these events and circumstances, the Company determined it was not more-likely-than not that the fair value of the reporting unit and indefinite-lived intangible asset was less than their respective carrying values as of the annual impairment date. Further, no triggering events have transpired since the performance of the qualitative assessment that would indicate a potential impairment occurred during the period through July 29, 2022.
Intangible Assets
The Company's intangible assets as of July 29, 2022 and January 28, 2022 were as follows:
| July 29, 2022 | January 28, 2022 | |||||||||||||||||||||||||||||||||||||
| Gross | Accumulated Amortization | Net | Gross | Accumulated Amortization | Net | |||||||||||||||||||||||||||||||||
| (in thousands) | ||||||||||||||||||||||||||||||||||||||
| Customer relationships | $ | 189,518 | $ | (126,482) | $ | 63,036 | $ | 189,518 | $ | (119,435) | $ | 70,083 | ||||||||||||||||||||||||||
| Acquired Technology | 141,784 | (121,275) | 20,509 | 141,784 | (113,937) | 27,847 | ||||||||||||||||||||||||||||||||
| Developed Technology | 10,963 | (3,482) | 7,481 | 8,123 | (2,439) | 5,684 | ||||||||||||||||||||||||||||||||
| Finite-lived intangible assets | 342,265 | (251,239) | 91,026 | 339,425 | (235,811) | 103,614 | ||||||||||||||||||||||||||||||||
| Trade name | 30,118 | — | 30,118 | 30,118 | — | 30,118 | ||||||||||||||||||||||||||||||||
| Total intangible assets | $ | 372,383 | $ | (251,239) | $ | 121,144 | $ | 369,543 | $ | (235,811) | $ | 133,732 | ||||||||||||||||||||||||||
Amortization expense related to finite-lived intangible assets was approximately $7.6 million and $15.4 million for the three and six months ended July 29, 2022, respectively, and $7.6 million and $14.9 million for the three and six months ended July 30, 2021, respectively. Amortization expense is included within cost of revenue and general and administrative expense in the Condensed Consolidated Statements of Operations. There were no impairment charges related to intangible assets during the three and six months ended July 29, 2022 or July 30, 2021.
13
SECUREWORKS CORP.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE 5 — DEBT
Revolving Credit Facility
SecureWorks, Inc., a wholly-owned subsidiary of SecureWorks Corp., is a party to a revolving credit agreement with a wholly-owned subsidiary of Dell Inc. under which the Company obtained a $30 million senior, unsecured revolving credit facility. Effective March 23, 2022, the revolving credit agreement was amended and restated to extend the maturity date from March 25, 2022 to March 23, 2023 and to decrease the annual rate at which interest accrues to the applicable London Interbank Offered Rate (“LIBOR”) plus 1.23%. Under the amended terms, if LIBOR is no longer published on a current basis and such circumstances are unlikely to be temporary, the facility will be amended to replace LIBOR with an alternate benchmark rate. The amended and restated revolving credit agreement otherwise has terms substantially similar to those of the facility before the amendment and restatement.
Under the facility, up to $30 million principal amount of borrowings may be outstanding at any time. Amounts under the facility may be borrowed, repaid, and reborrowed from time to time during the term of the facility. The proceeds from loans made under the facility may be used for general corporate purposes. 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. There was no outstanding balance under the credit facility as of July 29, 2022 or January 28, 2022, and there were no amounts borrowed under the credit facility during the three and six months ended July 29, 2022 or July 30, 2021.
The maximum amount of borrowings may be increased by up to an additional $30 million by mutual agreement of the lender and borrower. 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 SecureWorks Corp. or following a transaction in which SecureWorks, Inc. ceases to be a direct or indirect wholly-owned subsidiary of SecureWorks Corp. The facility is not guaranteed by SecureWorks Corp. or its subsidiaries.
14
SECUREWORKS CORP.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE 6 — COMMITMENTS AND CONTINGENCIES
Legal Contingencies— From time to time, the Company is involved in claims and legal proceedings that arise in the ordinary course of business. The Company accrues a liability when it believes that it is both probable that a liability has been incurred and that it can reasonably estimate the amount of the loss. The Company reviews the status of such matters at least quarterly and adjusts its liabilities as necessary to reflect ongoing negotiations, settlements, rulings, advice of legal counsel and other relevant information. Whether the outcome of any claim, suit, assessment, investigation or legal proceeding, individually or collectively, could have a material adverse effect on the Company’s business, financial condition, results of operations or cash flows will depend on a number of factors, including the nature, timing and amount of any associated expenses, amounts paid in settlement, damages or other remedies or consequences. To the extent new information is obtained and the Company’s views on the probable outcomes of claims, suits, assessments, investigations or legal proceedings change, changes in accrued liabilities would be recorded in the period in which such a determination is made. As of July 29, 2022, the Company does not believe that there were any such matters that, individually or in the aggregate, would have a material adverse effect on its business, financial condition, results of operations or cash flows.
Customer-based Taxation Contingencies—Various government entities (“taxing authorities”) require the Company to bill its customers for the taxes they owe based on the services they purchase from the Company. The application of the rules of each taxing authority concerning which services are subject to each tax and how those services should be taxed involves the application of judgment. Taxing authorities periodically perform audits to verify compliance and include all periods that remain open under applicable statutes, which generally range from to four years. These audits could result in significant assessments of past taxes, fines and interest if the Company were found to be non-compliant. During the course of an audit, a taxing authority may question the Company’s application of its rules in a manner that, if the Company were not successful in substantiating its position, could result in a significant financial impact to the Company. In the course of preparing its financial statements and disclosures, the Company considers whether information exists that would warrant disclosure or an accrual with respect to such a contingency.
As of July 29, 2022, the Company is under audit with various state taxing authorities in which rulings related to the taxability of certain of its services are pending. The Company has recorded an estimated liability in the amount of $8.7 million related to such matters, of which $0.2 million was accrued during the three months ended July 29, 2022. As of July 29, 2022, $1.6 million of the estimated liability is no longer subject to appeal and $7.1 million remains in appeal. The Company will continue to appeal these rulings, but should the Company not prevail, it could be subject to obligations to pay additional taxes together with associated penalties and interest for the audited tax period, as well as additional taxes for periods subsequent to the tax audit period, including penalties and interest. While Dell does provide an indemnification for certain state tax issues for tax periods prior to August 1, 2015, such indemnification would not cover a material portion of the current estimated liability.
Indemnifications—In the ordinary course of business, the Company enters into contractual arrangements under which it agrees to indemnify its customers from certain losses incurred by the customer as to third-party claims relating to the services performed on behalf of the Company or for certain losses incurred by the customer as to third-party claims arising from certain events as defined within the particular contract. Such indemnification obligations may not be subject to maximum loss clauses. Historically, payments related to these indemnifications have been immaterial.
Concentrations—The Company sells solutions to customers of all sizes primarily through its sales organization, supplemented by sales through partners. During the three and six months ended July 29, 2022 and July 30, 2021, the Company had no customer that represented 10% or more of its net revenue.
15
SECUREWORKS CORP.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE 7 — LEASES
The Company recorded operating lease cost for facilities of approximately $1.3 million and $2.6 million for the three and six months ended July 29, 2022, respectively, and $1.3 million and $2.7 million for the three and six months ended July 30, 2021, respectively. Operating lease cost include expenses in connection with variable lease costs of $0.1 million and $0.2 million for the three and six months ended July 29, 2022, respectively, and $64 thousand and $0.1 million for the three and six months ended July 30, 2021, respectively, which primarily consisted of utilities and common area charges.
The Company recorded operating lease cost of equipment leases of approximately $30 thousand and $47 thousand for the three and six months ended July 29, 2022, respectively, and $0.1 million and $0.3 million for the three and six months ended July 30, 2021, respectively. Equipment lease costs included short-term lease costs of $14 thousand and $15 thousand for the three and six months ended July 29, 2022 respectively, and $0.1 million and $0.2 million for the three and six months ended July 30, 2021, respectively. Lease expense for equipment was included in cost of revenues.
Cash paid for amounts included in the measurement of operating lease liabilities was $1.5 million and $3.2 million during the three and six months ended July 29, 2022, respectively, and $1.7 million and $3.6 million for the three and six months ended July 30, 2021, respectively.
Weighted-average information associated with the measurement of the Company’s remaining operating lease obligations is as follows:
| July 29, 2022 | ||||||||
| Weighted-average remaining lease term | 4.1 years | |||||||
| Weighted-average discount rate | 5.38 | % | ||||||
The following table summarizes the maturity of the Company's operating lease liabilities as of July 29, 2022 (in thousands):
| Fiscal Years Ending | July 29, 2022 | |||||||
| 2023 | $ | 2,861 | ||||||
| 2024 | 5,668 | |||||||
| 2025 | 5,095 | |||||||
| 2026 | 4,526 | |||||||
| 2027 | 4,088 | |||||||
| Thereafter | — | |||||||
| Total operating lease payments | $ | 22,238 | ||||||
| Less imputed interest | 2,325 | |||||||
| Total operating lease liabilities | $ | 19,913 | ||||||
The Company's leases have remaining lease terms of 2 months to 4.4 years, inclusive of renewal or termination options that the Company is reasonably certain to exercise.
16
SECUREWORKS CORP.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE 8 — STOCK-BASED COMPENSATION AND OTHER LONG-TERM PERFORMANCE INCENTIVES
The SecureWorks Corp. 2016 Long-Term Incentive Plan (the "2016 Plan") provides for the grant of options, stock appreciation rights, restricted stock, restricted stock units, deferred stock units, unrestricted stock, dividend equivalent rights, other equity-based awards, and cash bonus awards. Awards may be granted under the 2016 Plan to individuals who are employees, officers, or non-employee directors of the Company or any of its affiliates, consultants and advisors who perform services for the Company or any of its affiliates, and any other individual whose participation in the 2016 Plan is determined to be in the best interests of the Company by the compensation committee of the board of directors.
Under the 2016 Plan, the Company granted 332,376 and 3,982,900 restricted stock units during the three and six months ended July 29, 2022, respectively, and 509,839 and 2,358,802 restricted stock units during the three and six months ended July 30, 2021, respectively. The Company granted no restricted stock awards during the three and six months ended July 29, 2022. During the three and six months ended July 30, 2021, the Company granted 0 and 466,644 restricted stock awards, respectively. The annual restricted stock unit and restricted stock awards granted during these periods vest over a three-year period. Approximately 17% and 29% of such awards granted during the six months ended July 29, 2022 and July 30, 2021, respectively, are subject to performance conditions. All restricted stock units granted during the three months ended April 30, 2021 were subject to stockholder approval at the Company’s 2021 annual meeting held on June 21, 2021 of an amendment to the 2016 Plan to increase the number of shares of Class A common stock issuable under the plan by 5,000,000 shares. Such stockholder approval was obtained and those awards were deemed granted and outstanding for accounting purposes during the three months ended July 30, 2021.
The Company grants long-term cash awards to certain employees under the 2016 Plan. A portion of the cash awards issued prior to fiscal 2021 were subject to various performance conditions and vest in equal annual installments over a three-year period. The Company granted no cash awards during the three and six months ended July 29, 2022, compared to $1.5 million and $9.0 million of cash awards granted during the three and six months ended July 30, 2021, respectively, that vest in equal installments over a three-year period. The Company recognized $1.1 million and $2.5 million of related compensation expense for the three and six months ended July 29, 2022, respectively, and $1.6 million and $3.2 million of related compensation expense for the three and six months ended July 30, 2021, respectively.
17
SECUREWORKS CORP.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE 9 — INCOME AND OTHER TAXES
The Company’s loss before income taxes and income tax benefit (in thousands) and effective income tax rate for the three and six months ended July 29, 2022 and July 30, 2021 was as follows (in thousands, except percentages):
| Three Months Ended | Six Months Ended | ||||||||||||||||||||||
| July 29, 2022 | July 30, 2021 | July 29, 2022 | July 30, 2021 | ||||||||||||||||||||
| Loss before income taxes | $ | (32,118) | $ | (14,502) | $ | (59,171) | $ | (23,265) | |||||||||||||||
| Income tax benefit | $ | (7,399) | $ | (2,739) | $ | (12,854) | $ | (5,112) | |||||||||||||||
| Effective tax rate | 23.0 | % | 18.9 | % | 21.7 | % | 22.0 | % | |||||||||||||||
During the periods presented in the accompanying Condensed Consolidated Statements of Financial Position, the Company did not file separate federal tax returns as the Company generally was included in the tax grouping of other Dell 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 by the Company when those attributes are utilized by other members of the Dell consolidated group.
Effective for tax years beginning on or after January 1, 2022, the Tax Cuts and Jobs Act of 2017 eliminated the option to deduct research and development (“R&D”) expenses in the year incurred and instead requires taxpayers to capitalize R&D expenses, including software development cost, and subsequently amortize such expenses over five years for R&D activities conducted in the United States and over fifteen years for R&D activities conducted outside of the United States. If Section 174 of the Internal Revenue Code is not modified, repealed or deferred to a future date by the United States Congress, then the Company will have taxable income in the near-term delaying Dell’s utilization of the Company’s net operating losses to future years.
The Company's effective tax benefit rate was 23.0% and 21.7% for the three and six months ended July 29, 2022, respectively, and 18.9% and 22.0% for the three and six months ended July 30, 2021, respectively. The change in the Company's effective income tax rate between the periods was primarily attributable to the impact of certain discrete adjustments related to stock-based compensation expense of approximately $0.1 million and $0.6 million for the three and six months ended July 29, 2022, respectively, and $0.4 million and $0.1 million for the three and six months ended July 30, 2021, respectively. The change related specifically to the impact of the vesting of certain equity awards for which the fair value on the vesting date was lower than the fair value for both the three and six month periods ended July 29, 2022 and July 30, 2021 on the date the equity awards were originally granted. The change in fair value, which is measured by the price of the Class A common stock as reported on the Nasdaq Global Select Market, resulted in a lower actual tax deduction for both the three and six month periods ended July 29, 2022 and July 30, 2021 than the amounts deducted for financial reporting purposes.
As of July 29, 2022 and January 28, 2022, the Company had $5.5 million and $5.5 million, respectively, of deferred tax assets related to net operating loss carryforwards for state tax returns that are not included with those of other Dell entities. These net operating loss carryforwards began expiring in the fiscal year ended January 28, 2022. Due to the uncertainty surrounding the realization of these net operating loss carryforwards, the Company has provided valuation allowances for the full amount as of July 29, 2022 and January 28, 2022. Because the Company is included in the tax filings of other Dell entities, management has determined that it will be able to realize the remainder of its deferred tax assets. If the Company's tax provision had been prepared using the separate return method, the unaudited pro forma pre-tax loss, tax benefit and net loss for the six months ended July 29, 2022 would have been $59.2 million, $5.3 million and $53.9 million, respectively, as a result of the recognition of a valuation allowance that would have been recorded on a significant amount of deferred tax assets as well as certain attributes from the Tax Cuts and Jobs Act of 2017 that would be lost if not utilized by the Dell consolidated group.
Net deferred tax balances are included in other non-current assets and other non-current liabilities in the Condensed Consolidated Statements of Financial Position.
As of July 29, 2022 and January 28, 2022, the Company had a net operating loss receivable from Dell of $14.1 million and $10.7 million, respectively. The Company had $4.3 million and $4.2 million of unrecognized tax benefits as of July 29, 2022 and January 28, 2022, respectively.
18
SECUREWORKS CORP.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE 10 — RELATED PARTY TRANSACTIONS
Allocated Expenses
For the periods presented, Dell has provided various corporate services to Secureworks in the ordinary course of business. The costs of services provided to Secureworks by Dell are governed by a shared services agreement between Secureworks and Dell Inc. The total amounts of the charges under the shared services agreement with Dell were $0.9 million and $1.9 million for the three and six months ended July 29, 2022, respectively, and $0.9 million and $1.9 million for the three and six months ended July 30, 2021, respectively. Management believes that the basis on which the expenses have been allocated is a reasonable reflection of the utilization of services provided to or the benefit received by the Company during the periods presented.
Related Party Arrangements
For the periods presented, related party transactions and activities involving Dell Inc. and its wholly-owned subsidiaries were not always consummated on terms equivalent to those that would prevail in an arm's-length transaction where conditions of competitive, free-market dealing may exist.
The Company purchases computer equipment for internal use from Dell Inc. and its subsidiaries that is capitalized within property and equipment in the Condensed Consolidated Statements of Financial Position. Purchases of computer equipment from Dell and EMC Corporation, a wholly-owned subsidiary of Dell that provides enterprise software and storage ("EMC"), totaled $0.2 million and $0.4 million for the three and six months ended July 29, 2022, respectively, and $0.1 million and $0.3 million for the three and six months ended July 30, 2021, respectively.
EMC previously maintained a majority ownership interest in VMware, Inc. ("VMware"), a company that provides cloud and virtualization software and services. The Company's purchases of annual maintenance services, software licenses and hardware systems for internal use from Dell, EMC and VMware totaled $0.2 million and $0.5 million for the three and six months ended July 29, 2022, respectively and $0.5 million and $1.1 million for the three and six months ended July 30, 2021, respectively. On November 1, 2021, Dell Technologies completed its spin-off of all shares of common stock of VMware that were beneficially owned by Dell Technologies and its subsidiaries, including EMC, to Dell Technologies’ stockholders. As a result of the spin-off transaction, the businesses of VMware were separated from the remaining businesses of Dell Technologies, although Michael S. Dell, the Chairman, Chief Executive Officer and majority stockholder of Dell Technologies, continues to serve as Chairman of the Board of VMware.
The Company recognized revenue related to solutions provided to VMware that totaled $0.1 million and $0.3 million for the three and six months ended July 29, 2022, respectively, and $0.2 million and $0.3 million for the three and six months ended July 30, 2021, respectively. In October 2019, VMware acquired Carbon Black Inc., a security business with which the Company had an existing commercial relationship. Purchases by the Company of solutions from Carbon Black totaled $0.4 million and $1.7 million for the three and six months ended July 29, 2022, respectively, and $1.5 million and $2.6 million for the three and six months ended July 30, 2021, respectively.
The Company also recognized revenue related to solutions provided to significant beneficial owners of Secureworks common stock, which include Mr. Dell and affiliates of Mr. Dell. The revenues recognized by the Company from solutions provided to Mr. Dell, MSD Capital, L.P. (a firm founded for the purposes of managing investments of Mr. Dell and his family), DFI Resources LLC, an entity affiliated with Mr. Dell, and the Michael and Susan Dell Foundation totaled $0.1 million and $0.2 million for the three and six months ended July 29, 2022, respectively, and $51 thousand and $0.1 million for the three and six months ended July 30, 2021, respectively.
The Company provides solutions to certain customers whose contractual relationships have historically been with Dell rather than Secureworks, although the Company has the primary responsibility to provide the services. Effective August 1, 2015, in connection with the IPO, many of such customer contracts were transferred from Dell to the Company, forming a direct contractual relationship between the Company and the end customer. For customers whose contracts have not yet been transferred or whose contracts were subsequently originated through Dell under a reseller agreement, the Company recognized revenues of approximately $14.4 million and $30.6 million for the three and six months ended July 29, 2022, respectively, and $15.2 million and $30.2 million for the three and six months ended July 30, 2021, respectively. In addition, as of July 29, 2022, the Company had approximately $0.5 million of contingent obligations to Dell related to outstanding performance bonds for certain customer contracts which Dell issued on behalf of the Company. These contingent obligations are not recognized as liabilities on the Company’s financial statements.
As the Company’s customer and on behalf of certain of its own customers, Dell also purchases solutions from the Company. The Company recognized revenues from such purchases of approximately $1.2 million and $2.8 million for the three and six months ended July 29, 2022, respectively, and $2.9 million and $6.2 million for the three and six months ended July 30, 2021, respectively.
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SECUREWORKS CORP.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
As a result of the foregoing related party arrangements, the Company has recorded the following related party balances in the Condensed Consolidated Statements of Financial Position as of July 29, 2022 and January 28, 2022 (in thousands).
| July 29, 2022 | January 28, 2022 | |||||||||||||
| Related party payable (in accrued and other current liabilities) | $ | 3,977 | $ | 3,088 | ||||||||||
| Accounts receivable from customers under reseller agreements with Dell (in accounts receivable, net) | $ | 7,437 | $ | 7,700 | ||||||||||
| Net operating loss tax sharing receivable under agreement with Dell (payable in accrued and other and receivable in other current assets) | $ | 14,145 | $ | 10,693 | ||||||||||
NOTE 11 — FAIR VALUE MEASUREMENTS
The Company measures fair value within the guidance of the three-level valuation hierarchy. This hierarchy is based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date. The categorization of a measurement within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement. The three levels are defined as follows:
•Level 1 - Quoted market prices in active markets for identical assets or liabilities
•Level 2 - Other observable market-based inputs or unobservable inputs that are corroborated by market data
•Level 3 - Significant unobservable inputs
Assets and Liabilities Measured at Fair Value on a Recurring Basis
The assets and liabilities of the Company that are measured at fair value on a recurring basis using the respective input levels as of July 29, 2022 and January 28, 2022 were as follows (in thousands):
| July 29, 2022 | January 28, 2022 | ||||||||||||||||
| Level 1 | Level 1 | ||||||||||||||||
| Cash equivalents - Money Market Funds | $ | 60,956 | $ | 115,846 | |||||||||||||
Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis
The carrying amounts of the Company's accounts receivable, accounts payable and accrued expenses approximate their respective fair value due to their short-term nature.
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Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
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 in the United States, or GAAP, and should be read in conjunction with our audited financial statements and related notes for the year ended January 28, 2022 included in Part II, Item 8 of our Annual Report on Form 10-K for the fiscal year ended January 28, 2022 filed with the SEC on March 23, 2022, which we refer to as the Annual Report. In addition to historical financial information, the following discussion contains forward-looking statements that reflect our plans, estimates, beliefs, expected future responses to and effects of the COVID-19 pandemic, the Ukraine/Russia conflict, inflation concerns and other characterizations of future events or circumstances. Our actual results could differ materially from those discussed or implied in our forward-looking statements. Factors that could cause or contribute to these differences include those discussed in "Risk Factors" in Part I, Item 1A of our Annual Report.
Our fiscal year is the 52- or 53-week period ending on the Friday closest to January 31. We refer to the fiscal year ending February 3, 2023 and the fiscal year ended January 28, 2022 as fiscal 2023 and fiscal 2022, respectively. Fiscal 2023 has 53 weeks and fiscal 2022 had 52 weeks. In fiscal 2023, each quarter has 13 weeks, except for the fourth quarter, which will have 14 weeks. Unless otherwise indicated, all changes identified for the current-period results represent comparisons to results for the prior corresponding fiscal periods.
All percentage amounts and ratios presented in this management’s discussion and analysis were calculated using the underlying data in thousands.
Except where the context otherwise requires or where otherwise indicated, (1) all references to "Secureworks," "we," "us," "our" and "our Company" in this management's discussion and analysis refer to SecureWorks Corp. and our subsidiaries on a consolidated basis, (2) all references to "Dell" refer to Dell Inc. and its subsidiaries on a consolidated basis and (3) all references to "Dell Technologies" refer to Dell Technologies Inc., the ultimate parent company of Dell Inc.
Overview
We are a leading global cybersecurity provider of technology-driven solutions singularly focused on protecting our customers by outpacing and outmaneuvering the adversary.
Our vision is to be the essential cybersecurity company for a digitally connected world by providing the security platform of choice to deliver our holistic approach to security at scale for our customers to achieve their best security outcomes. We combine considerable experience from securing thousands of customers, processing billions of customer events with our machine-learning capabilities in our security platform, and actionable insights from our team of elite researchers, analysts and consultants to create a powerful network effect that provides increasingly strong protection for our customers.
We know from our experience that security based on “point” products operating in silos is not sufficient to outpace the adversary at scale. Through our vendor-inclusive approach, we create integrated and comprehensive solutions by proactively managing the collection of point products deployed by our customers to address specific security issues and provide solutions to reduce their cybersecurity risk.
By aggregating and analyzing data from sources around the world, we offer solutions that enable organizations to:
•prevent security breaches,
•detect malicious activity,
•respond rapidly when a security breach occurs, and
•identify emerging threats.
We believe a platform that supports innovation and collaboration enables the power of the security community to collectively outmaneuver the adversary. Leveraging our extensive security expertise and knowledge, we utilize unique insights to build an integrated security platform that fuels efficient and effective security operations for customers and partners.
The integrated approach we have pioneered enables us to deliver a broad portfolio of security solutions to organizations of varying size and complexity. We seek to provide the right level of security for each customer's particular situation, which evolves as the customer’s organization grows and changes over time. Our flexible and scalable solutions support the evolving needs of the largest, most sophisticated enterprises, as well as small and medium-sized businesses and U.S. state and local government agencies with limited in-house capabilities and resources.
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We offer our customers:
•software-as-a-service, or SaaS, solutions,
•managed security services, and
•professional services, including incident response services and security risk consulting.
Our solutions leverage the proprietary technologies, security operations workflows, extensive expertise and knowledge of the tactics, techniques and procedures of the adversary that we have developed over more than two decades. As key elements of our strategy, we seek to:
•be the cloud-native SaaS security platform of choice,
•broaden our reach with security service providers to deliver our security platform globally,
•utilize our data assets to maximize the performance of our solutions, and
•empower the global security community to beat the adversary at scale.
We offer an integrated suite of technology-driven security solutions enabled by our Taegis software platform or Counter Threat Platform and our team of highly-skilled security experts. Our technology-driven security solutions offer an innovative approach to prevent, detect and respond to cybersecurity breaches. The platforms collect, aggregate, correlate and analyze billions of events daily from our extensive customer base utilizing sophisticated algorithms to detect malicious activity and deliver security countermeasures, dynamic intelligence and valuable context regarding the intentions and actions of cyber adversaries. Through our Taegis solutions and managed security services, which are sold on a subscription basis, we provide global visibility and insight into malicious activity, enabling our customers to detect, respond to and effectively remediate threats quickly.
Our proprietary Taegis security platform, which we launched in fiscal 2020, was purpose-built as a cloud-native software platform that combines the power of machine-learning with security analytics and threat intelligence to unify detection and response across endpoint, network and cloud environments for better security outcomes and simpler security operations. The Taegis security platform is a core element for our SaaS solutions, which leverage workflows designed from our extensive security operations expertise and our integrated orchestration and automation capabilities to increase the speed of response actions. We expanded our Taegis SaaS applications with Vulnerability, Detection and Response, or VDR, during fiscal 2021 with our acquisition of Delve Laboratories Inc.
Taegis Extended Detection and Response, or XDR, VDR and Managed Detection and Response, or ManagedXDR, are the first in a suite of software-driven applications and solutions that Secureworks plans to release driven by our Taegis security platform.
In addition to our Taegis solutions and managed security services, we also offer a variety of professional services, which include incident response and security and risk consulting, to accelerate adoption of our software solutions. We advise customers on a broad range of security and risk-related matters through both project-based and long-term contracts in addition to our Taegis solutions and managed security services.
COVID-19
In December 2019, a novel strain of the coronavirus, COVID-19, was reported in mainland China. The World Health Organization declared the outbreak to constitute a “pandemic” on March 11, 2020. This led to a significant disruption of normal business operations globally, as businesses, including Secureworks, implemented modifications to protect employees by restricting travel and directing employees to work-from-home, in some instances as required by federal, state and local authorities. While we instituted a global work-from-home policy beginning in March 2020, we did not incur significant disruptions in our business operations or a material impact on our results of operations, financial condition, liquidity or capital resources for the three and six months ended July 29, 2022. We have experienced a limited reduction in customer demand for our solutions that we believe is attributable to COVID-19, which may impact our results in future periods.
We continue to actively monitor the impacts and potential impacts of the COVID-19 pandemic in all aspects of our business. The extent of the impact of COVID-19 on our future operational and financial performance will depend on various developments, including the duration and spread of variations of the virus, effectiveness and acceptance of vaccines deployed to contain the virus, impact on our employees, customers and vendors, impact on our customers’ liquidity and our volume of sales, and length of our sales cycles, none of which can be predicted with certainty. The pandemic might further curtail customer spending, lead to delayed or deferred purchasing decisions, lengthen sales cycles and result in delays in receiving customer or partner payments. These effects, individually or in the aggregate, could have a material negative impact on our future results of operations and financial condition. Due to our subscription-based business model, any such effects of COVID-19 may not be fully reflected in our results of operations until future periods.
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Key Factors Affecting Our Performance
We believe that our future success will depend on many factors, including the adoption of our Taegis solutions by organizations, continued investment in our technology and threat intelligence research, our introduction of new solutions, our ability to increase sales of our solutions to new and existing customers and our ability to attract and retain top talent. Although these areas present significant opportunities, they also present risks that we must manage to ensure our future success. We operate in an intensely competitive industry and face, among other competitive challenges, pricing pressures within the information security market as a result of action by our larger competitors to reduce the prices of their security prevention, detection and response solutions, as well as the prices of their managed security services. We must continue to manage our investments in an efficient manner and effectively execute our strategy to succeed. If we are unable to address these challenges, our business could be adversely affected.
The key factors affecting our performance include the following:
Transition to Taegis Solutions. Commencing in fiscal 2021, we began transitioning customers away from non-strategic other managed security subscription services to Taegis subscription solutions. In line with this transition strategy, we informed customers early in the fourth quarter of fiscal 2022 that many of our other managed security subscription services would no longer be available for purchase effective as of the beginning of fiscal 2023, as many of those services offer a natural transition to our Taegis platform. Renewals associated with many of our existing other managed security subscription services are not expected to extend beyond the end of fiscal 2023. Although we believe this business transition will enable us to offer security services with higher profit margins, we will continue to incur substantial costs in connection with the transition and, during the transition period, we could lose competitive bids to other cybersecurity solutions providers for the sale of such services.
Adoption of Technology-Driven Solution Strategy. The evolving landscape of applications, modes of communication and IT architectures makes it increasingly challenging for organizations of all sizes to protect their critical business assets, including proprietary information, from cyber threats. New technologies heighten security risks by increasing the number of ways a threat actor can attack a target, by giving users greater access to important business networks and information and by facilitating the transfer of control of underlying applications and infrastructure to third-party vendors. An effective cyber defense strategy requires the coordinated deployment of multiple products and solutions tailored to an organization’s specific security needs. Our integrated suite of solutions, including our new Taegis offerings, is designed to facilitate the successful implementation of such a strategy, but continuous investment in, and adaptation of, our technology will be required as the threat landscape continues to evolve rapidly. The degree to which prospective and current customers recognize the mission-critical nature of our technology-driven information security solutions, and subsequently allocate budget dollars to our solutions, will affect our future financial results.
Investment in Our Technology and Threat Intelligence Research. Our software platforms constitute the core of our technology-driven security solutions. They provide our customers with an integrated perspective and intelligence regarding their network environments and security threats. Our software platforms are augmented by our Counter Threat Unit research team, which conducts exclusive research into threat actors, uncovers new attack techniques, analyzes emerging threats and evaluates the risks posed to our customers. Our performance is significantly dependent on the investments we make in our research and development efforts and on our ability to be at the forefront of threat intelligence research and adapt these software platforms to new technologies as well as to changes in existing technologies. This is an area in which we will continue to invest, while leveraging a flexible staffing model to align with solutions development. We believe that investment in our Taegis security platform and solutions will contribute to long-term revenue growth, but such investment may continue to adversely affect our prospects for near-term profitability.
Introduction of New Security Solutions. Our performance is significantly dependent on our ability to continue to innovate and introduce new information security solutions, such as our Taegis solutions, that protect our customers from an expanding array of cybersecurity threats. We continue to invest in solutions innovation and leadership, including by hiring top technical talent and focusing on core technology innovation. In addition, we will continue to evaluate and utilize third-party proprietary technologies, where appropriate, for the continuous development of complementary offerings. We cannot be certain that we will realize increased revenue from our solutions development initiatives. We believe that our investment in solutions development will contribute to long-term revenue growth, but such investment may continue to adversely affect our prospects for near-term profitability.
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Investments in Expanding Our Customer Base and Deepening Our Customer Relationships. To support future sales, we will need to continue to devote resources to the development of our global sales force. We have made and plan to continue to make significant investments in expanding our go-to-market efforts with direct sales, channel partners and marketing. Any investments we make in our sales and marketing operations will occur before we realize any benefits from such investments. The investments we have made, or intend to make, to strengthen our sales and marketing efforts may not result in an increase in revenue or an improvement in our results of operations. Although we believe our investment in sales and marketing will help us improve our results of operations in the long term, the resulting increase in operating expenses attributable to these sales and marketing functions may continue to affect our profitability in the near term. The continued growth of our business also depends in part on our ability to sell additional solutions to our existing customers. As our customers realize the benefits of the solutions they previously purchased, our portfolio of solutions provides us with a significant opportunity to expand these relationships.
Investment in Our People. The difficulty in providing effective information security is exacerbated by the highly competitive environment for identifying, hiring and retaining qualified information security professionals. Our technology leadership, brand, exclusive focus on information security, customer-first culture, and robust training and development program have enabled us to attract and retain highly talented professionals with a passion for building a career in the information security industry. These professionals are led by a highly experienced and tenured management team with extensive IT security expertise and a record of developing successful new technologies and solutions to help protect our customers. We will continue to invest in attracting and retaining top talent to support and enhance our information security offerings.
Key Operating Metrics
Commencing in fiscal 2021, we began transitioning our subscription customers to our Taegis solutions from our non-strategic, lower margin other managed security subscription services. This transition has resulted in a decline in both our total customer base and total annual recurring revenue. Despite these declines, our gross profit has remained relatively stable and our gross margins have increased. We believe the transition of our subscription business to our Taegis solutions is resulting in a higher value, higher margin business. As part of our ongoing transition, early in the fourth quarter of fiscal 2022, we announced that many of our other managed security subscription services would no longer be available for purchase effective as of the beginning of fiscal 2023, as many of those services offer a natural transition to our Taegis platforms. Renewals associated with many of our existing other managed security subscription services are not expected to extend beyond the end of fiscal 2023.
The transition has resulted in the growth of our Taegis portfolio of technology-driven information security solutions offered to customers of all sizes and across all industries. We have achieved this organic growth by re-solutioning existing customers to our Taegis offerings, which generate more average revenue per customer, and through continued expansion in volume and breadth of the Taegis solutions we deploy. The transformation of our Taegis subscription-based model has required ongoing investment in our business, which has contributed to higher net losses. We believe these investments are critical to our long-term success, although they may continue to impact our prospects for near-term profitability.
Relevant key operating metrics are presented below as of the dates indicated and for the fiscal periods then ended.
| July 29, 2022 | July 30, 2021 | ||||||||||
| Managed security subscription customer base | 1,900 | 3,100 | |||||||||
| Taegis subscription customer base | 1,500 | 700 | |||||||||
| Total subscription customer base | 3,100 | 3,600 | |||||||||
| Total customer base | 4,700 | 5,200 | |||||||||
| Managed security annual recurring revenue (in millions) | $ | 159.1 | $ | 314.4 | |||||||
| Taegis annual recurring revenue (in millions) | 201.2 | 100.6 | |||||||||
| Total annual recurring revenue (in millions) | $ | 360.2 | $ | 415.0 | |||||||
| Managed security average subscription revenue per customer (in thousands) | $ | 84.8 | $ | 101.8 | |||||||
| Taegis average subscription revenue per customer (in thousands) | $ | 136.4 | $ | 148.6 | |||||||
| Total average subscription revenue per customer (in thousands) | $ | 114.7 | $ | 116.5 | |||||||
| Net revenue retention rate | 90 | % | 95 | % | |||||||
Taegis Subscription Customer Base and Managed Security Subscription Customer Base. We define our Taegis subscription customer base and managed security subscription customer base as the number of customers who have a subscription agreement for that respective offering as of a particular date. Some customers may have subscription agreements for both security offerings to address their current security needs.
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Total Subscription Customer Base. We define our total subscription customer base as the number of unique customers who have a subscription agreement for our Taegis solutions and/or managed security services as of a particular date. We believe that growing our existing customer base and our ability to grow our average subscription revenue per customer represent significant future revenue opportunities for us.
Total Customer Base. We define total customer base as the number of customers that subscribe to our Taegis SaaS applications and managed security services and customers that buy professional and other services from us, as of a particular date.
Total Annual Recurring Revenue. We define total annual recurring revenue as of the measurement date. Changes to recurring revenue may result from the expansion of our offerings and sales of additional solutions to our existing customers, as well as the timing of customer renewals.
Total Average Subscription Revenue Per Customer. Total average subscription revenue per customer is primarily related to the persistence of cyber threats and the results of our sales and marketing efforts to increase the awareness of our solutions. Our customer composition of both enterprise and small and medium sized businesses provides us with an opportunity to expand our professional services revenue. As of July 29, 2022 and July 30, 2021, approximately 53% and 61%, respectively, of our professional services customers subscribed to our Taegis solutions or managed security services.
Net Revenue Retention Rate. Net revenue retention rate is an important measure of our success in retaining and growing revenue from our subscription-based customers. To calculate our revenue retention rate for any period, we compare the annual recurring revenue of our subscription-based customers at the beginning of the fiscal year (base recurring revenue) to the same measure from that same cohort of customers at the end of the fiscal year (retained recurring revenue). By dividing the retained recurring revenue by the base recurring revenue, we measure our success in retaining and growing installed revenue from the specific cohort of customers we served at the beginning of the period. Our calculation includes the positive revenue impacts of selling and installing additional solutions to this cohort of customers and the negative revenue impacts of customer or service attrition during the period. The calculation, however, does not include the positive impact on revenue from sales of solutions to any customers acquired during the period. Our net revenue retention rates may increase or decline from period to period as a result of various factors, including the timing of solutions installations and customer renewal rates.
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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 in the United States of America, referred to as GAAP. Non-GAAP financial measures presented in this management’s discussion and analysis include non-GAAP cost of revenue, non-GAAP subscription cost of revenue, non-GAAP professional services cost of revenue, non-GAAP gross profit, non-GAAP subscription gross profit, non-GAAP professional services gross profit, non-GAAP gross margin, non-GAAP subscription gross margin, non-GAAP professional services gross margin, non-GAAP operating expenses, non-GAAP research and development expenses, non-GAAP sales and marketing expenses, non-GAAP general and administrative expenses, non-GAAP operating income (loss), non-GAAP net (loss) income, non-GAAP (loss) earnings per share and adjusted EBITDA. We use non-GAAP financial measures to supplement financial information presented on a GAAP basis. We believe these non-GAAP financial measures provide useful information to help evaluate our operating results by facilitating an enhanced understanding of our operating performance and enabling more meaningful period-to-period comparisons.
There are limitations to the use of the non-GAAP financial measures presented in this management’s discussion and analysis. Our non-GAAP financial measures may not be comparable to similarly titled measures of other companies. Other companies, including companies in our industry, may calculate non-GAAP financial measures differently than we do, limiting the usefulness of those measures for comparative purposes.
The non-GAAP financial measures we present, as defined by us, exclude the items described in the reconciliation below. As the excluded items can have a material impact on earnings, our management compensates for this limitation by relying primarily on GAAP results and using non-GAAP financial measures supplementally. The non-GAAP financial measures are not meant to be considered as indicators of performance in isolation from or as a substitute for revenue, gross profit, subscription cost of revenue, professional services cost of revenue, operating expense, research and development expenses, sales and marketing expenses, general and administrative expenses, operating income (loss), net income (loss), earnings (loss) per share in accordance with GAAP and should be read only in conjunction with financial information presented on a GAAP basis.
Reconciliation of Non-GAAP Financial Measures
The table below presents a reconciliation of each non-GAAP financial measure to its most directly comparable GAAP financial measure. We encourage you to review the reconciliations in conjunction with the presentation of the non-GAAP financial measures for each of the periods presented. In future fiscal periods, we may exclude such items and may incur income and expenses similar to these excluded items. Accordingly, the exclusion of these items and other similar items in our non-GAAP presentation should not be interpreted as implying that these items are non-recurring, infrequent or unusual.
The following is a summary of the items excluded from the most comparable GAAP financial measures to calculate our non-GAAP financial measures:
•Amortization of Intangible Assets. Amortization of intangible assets consists of amortization associated with external software development costs capitalized and acquired customer relationships and technology. In connection with the acquisition of Dell by Dell Technologies in fiscal 2014 and our acquisition of Delve Laboratories Inc. in fiscal 2021, our tangible and intangible assets and liabilities associated with customer relationships and technology were accounted for and recognized at fair value on the related transaction date.
•Stock-based Compensation Expense. Non-cash stock-based compensation expense relates to Secureworks' equity plan. We exclude such expense when assessing the effectiveness of our operating performance since stock-based compensation does not necessarily correlate with the underlying operating performance of the business.
•Aggregate Adjustment for Income Taxes. The aggregate adjustment for income taxes is the estimated combined income tax effect for the adjustments mentioned above. The tax effects are determined based on the tax jurisdictions where the above items were incurred.
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| Three Months Ended | Six Months Ended | ||||||||||||||||||||||
| July 29, 2022 | July 30, 2021 | July 29, 2022 | July 30, 2021 | ||||||||||||||||||||
| (in thousands, except per share data) | |||||||||||||||||||||||
GAAP net revenue(1) | $ | 116,182 | $ | 134,172 | $ | 237,197 | $ | 273,635 | |||||||||||||||
| GAAP subscription cost of revenue | $ | 34,060 | $ | 37,058 | $ | 66,886 | $ | 74,730 | |||||||||||||||
| Amortization of intangibles | (4,115) | (4,044) | (8,380) | (7,863) | |||||||||||||||||||
| Stock-based compensation expense | (167) | (15) | (290) | (117) | |||||||||||||||||||
| Non-GAAP subscription cost of revenue | $ | 29,778 | $ | 32,999 | $ | 58,216 | $ | 66,750 | |||||||||||||||
| GAAP professional services cost of revenue | $ | 15,519 | $ | 19,425 | $ | 32,128 | $ | 38,960 | |||||||||||||||
| Stock-based compensation expense | (345) | (176) | (732) | (372) | |||||||||||||||||||
| Non-GAAP professional services cost of revenue | $ | 15,174 | $ | 19,249 | $ | 31,396 | $ | 38,588 | |||||||||||||||
| GAAP gross profit | $ | 66,603 | $ | 77,689 | $ | 138,183 | $ | 159,945 | |||||||||||||||
| Amortization of intangibles | 4,115 | 4,044 | 8,380 | 7,863 | |||||||||||||||||||
| Stock-based compensation expense | 511 | 190 | 1,021 | 489 | |||||||||||||||||||
| Non-GAAP gross profit | $ | 71,229 | $ | 81,923 | $ | 147,584 | $ | 168,297 | |||||||||||||||
| GAAP research and development expenses | $ | 33,638 | $ | 30,417 | $ | 66,969 | $ | 58,569 | |||||||||||||||
| Stock-based compensation expense | (2,640) | (1,542) | (5,383) | (2,640) | |||||||||||||||||||
| Non-GAAP research and development expenses | $ | 30,998 | $ | 28,875 | $ | 61,586 | $ | 55,929 | |||||||||||||||
| GAAP sales and marketing expenses | $ | 40,940 | $ | 34,685 | $ | 80,185 | $ | 71,090 | |||||||||||||||
| Stock-based compensation expense | (1,627) | (1,016) | (3,265) | (1,748) | |||||||||||||||||||
| Non-GAAP sales and marketing expenses | $ | 39,313 | $ | 33,669 | $ | 76,920 | $ | 69,342 | |||||||||||||||
| GAAP general and administrative expenses | $ | 24,274 | $ | 26,488 | $ | 49,634 | $ | 52,043 | |||||||||||||||
| Amortization of intangibles | (3,523) | (3,523) | (7,047) | (7,047) | |||||||||||||||||||
| Stock-based compensation expense | (4,034) | (4,832) | (8,269) | (8,738) | |||||||||||||||||||
| Non-GAAP general and administrative expenses | $ | 16,717 | $ | 18,133 | $ | 34,318 | $ | 36,258 | |||||||||||||||
| GAAP operating loss | $ | (32,249) | $ | (13,901) | $ | (58,605) | $ | (21,757) | |||||||||||||||
| Amortization of intangibles | 7,638 | 7,567 | 15,427 | 14,910 | |||||||||||||||||||
| Stock-based compensation expense | 8,812 | 7,580 | 17,938 | 13,615 | |||||||||||||||||||
| Non-GAAP operating (loss) income | $ | (15,799) | $ | 1,246 | $ | (25,240) | $ | 6,768 | |||||||||||||||
| GAAP net loss | $ | (24,719) | $ | (11,763) | $ | (46,317) | $ | (18,153) | |||||||||||||||
| Amortization of intangibles | 7,638 | 7,567 | 15,427 | 14,910 | |||||||||||||||||||
| Stock-based compensation expense | 8,812 | 7,580 | 17,938 | 13,615 | |||||||||||||||||||
| Aggregate adjustment for income taxes | (3,024) | (2,463) | (5,944) | (5,460) | |||||||||||||||||||
| Non-GAAP net (loss) income | $ | (11,293) | $ | 921 | $ | (18,896) | $ | 4,912 | |||||||||||||||
| GAAP loss per share | $ | (0.29) | $ | (0.14) | $ | (0.55) | $ | (0.22) | |||||||||||||||
| Amortization of intangibles | 0.09 | 0.09 | 0.18 | 0.18 | |||||||||||||||||||
| Stock-based compensation expense | 0.10 | 0.09 | 0.21 | 0.16 | |||||||||||||||||||
| Aggregate adjustment for income taxes | (0.04) | (0.03) | (0.07) | (0.07) | |||||||||||||||||||
| Non-GAAP (loss) earnings per share * | $ | (0.13) | $ | 0.01 | $ | (0.22) | $ | 0.06 | |||||||||||||||
| * Sum of reconciling items may differ from total due to rounding of individual components | |||||||||||||||||||||||
| GAAP net loss | $ | (24,719) | $ | (11,763) | $ | (46,317) | $ | (18,153) | |||||||||||||||
| Interest and other, net | (131) | 601 | 566 | 1,508 | |||||||||||||||||||
| Income tax benefit | (7,399) | (2,739) | (12,854) | (5,112) | |||||||||||||||||||
| Depreciation and amortization | 9,132 | 9,945 | 18,515 | 19,863 | |||||||||||||||||||
| Stock-based compensation expense | 8,812 | 7,580 | 17,938 | 13,615 | |||||||||||||||||||
| Adjusted EBITDA | $ | (14,305) | $ | 3,624 | $ | (22,152) | $ | 11,721 | |||||||||||||||
(1) Historically the Company has presented non-GAAP net revenue as a financial measure. There are no such adjustments that give rise to non-GAAP net revenue for any of the periods presented. GAAP net revenue is inclusive of both subscription and professional services revenue.
27
Our Relationship with Dell and Dell Technologies
On April 27, 2016, we completed our IPO. Upon the closing of our IPO, Dell Technologies owned, indirectly through Dell Inc. and Dell Inc.’s subsidiaries, all shares of our outstanding Class B common stock, which as of July 29, 2022 represented approximately 82.4% of our total outstanding shares of common stock and approximately 97.9% of the combined voting power of both classes of our outstanding common stock.
As a majority-owned subsidiary of Dell, we receive from Dell 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 on August 1, 2015, the effective date of our carve-out from Dell. For more information regarding the allocated costs and related party transactions, see "Notes to Condensed Consolidated Financial Statements—Note 10—Related Party Transactions" in our condensed consolidated financial statements included in this report.
During the periods presented in the consolidated financial statements included in this report, Secureworks did not file separate federal tax returns, as Secureworks was generally included in the tax grouping of other Dell 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 the Dell consolidated group. For more information, see "Notes to Condensed Consolidated Financial Statements —Note 9—Income and Other Taxes" in our condensed consolidated financial statements included in this report.
Additionally, we participate in various commercial arrangements with Dell, under which, for example, we provide information security solutions to third-party customers with which Dell has contracted to provide our solutions, procure hardware, software and services from Dell, and sell our solutions through Dell in the United States and some international jurisdictions. In connection with our IPO, effective August 1, 2015, we entered into agreements with Dell 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 by Dell, we may incur additional non-recurring transition costs to establish our own stand-alone corporate functions. For more information regarding the allocated costs and related party transactions, see "Notes to Condensed Consolidated Financial Statements—Note 10—Related Party Transactions" in our condensed consolidated financial statements included in this report.
28
Components of Results of Operations
Revenue
We generate revenue from the sales of our subscriptions and professional services.
•Subscription Revenue. Subscription revenue primarily consists of subscription fees derived from our Taegis solutions and managed security services. Taegis subscription-based revenue currently includes two applications, Extended Detection and Response, or XDR, and Vulnerability Detection and Response, or VDR, along with the add-on managed service to supplement the XDR SaaS application, referred to as Managed Detection and Response, or ManagedXDR. Managed security service subscription-based arrangements typically include a suite of security services, up-front installation fees and maintenance, and also may include the provision of an associated hardware appliance. Our subscription contracts typically range from one to three years and, as of July 29, 2022, averaged approximately two years in duration. The revenue and any related costs for these deliverables are recognized ratably over the contractual term, beginning on the date on which service is made available to customers.
•Professional Services Revenue. Professional services revenue consists primarily of incident response solutions and security and risk consulting. Professional services engagements are typically purchased as fixed-fee and retainer-based contracts. Professional services customers typically purchase solutions pursuant to customized contracts that are shorter in duration. Revenue from these engagements is recognized under the proportional performance method of accounting. Revenue from time and materials-based contracts is recognized as costs are incurred at amounts represented by the agreed-upon billing rates. In general, these contracts have terms of less than one year.
The fees we charge for our solutions vary based on a number of factors, including the solutions selected, the number of customer devices covered by the selected solutions, and the level of management we provide for the solutions. In the second quarter of fiscal 2023, approximately 78% of our revenue was derived from subscription-based arrangements, attributable to Taegis solutions and managed security services, while approximately 22% was derived from professional services engagements. As we respond to the evolving needs of our customers, the relative mix of subscription-based solutions and professional services we provide our customers may fluctuate. International revenue, which we define as revenue contracted through non-U.S. entities, represented approximately 33% of our total net revenue in the second quarters of both fiscal 2023 and fiscal 2022. Although our international customers are located primarily in the United Kingdom, Japan, Australia and Canada, we provided our Taegis solutions or managed security services to customers across 77 countries as of July 29, 2022.
Over all of the periods presented in this report, our pricing strategy for our various offerings was relatively consistent, and accordingly did not significantly affect our revenue growth. However, we may adjust our pricing to remain competitive and support our strategic initiatives.
Cost of Revenue
Our cost of revenue consists of costs incurred to provide subscription and professional services.
•Cost of Subscription Revenue. Cost of subscription revenue consists primarily of personnel-related expenses associated with maintaining our platforms and delivering managed services to our subscription customers, as well as hosting costs for these platforms. Personnel-related expenses consist primarily of salaries, benefits and performance-based compensation. Also included in cost of subscription revenue are amortization of equipment and costs associated with hardware utilized as part of providing subscription services, amortization of technology licensing fees, amortization of intangible assets, amortization of external software development costs capitalized, maintenance fees and overhead allocations. As our business grows, the cost of subscription revenue associated with our solutions may fluctuate.
•Cost of Professional Services. Cost of professional services revenue consists primarily of personnel-related expenses, such as salaries, benefits and performance-based compensation. Also included in cost of professional services revenue are fees paid to contractors who supplement or support our solutions, maintenance fees and overhead allocations. As our business grows, the cost of professional services revenue associated with our solutions may fluctuate.
Gross Profit and Margin
Gross margin, or gross profit as a percentage of revenue, has been and will continue to be affected by a variety of factors, including the mix between our existing solutions, introduction of new solutions, personnel-related costs and cloud hosting costs. We expect our gross margins to fluctuate depending on these factors, but we expect them to increase over time with expected growth and higher mix of Taegis subscription solutions revenue compared to managed security services and professional services revenue. As we balance revenue growth and continue to invest in initiatives to drive the efficiency of our business, however, we expect gross margin as a percentage of total revenue to continue to fluctuate from period to period.
29
Operating Costs and Expenses
Our operating costs and expenses consist of research and development expenses, sales and marketing expenses and general and administrative expenses.
•Research and Development, or R&D, Expenses. Research and development expenses include compensation and related expenses for the continued development of our solutions offerings, including a portion of expenses related to our threat research team, which focuses on the identification of system vulnerabilities, data forensics and malware analysis. R&D expenses also encompass expenses related to the development of prototypes of new solutions offerings and allocated overhead. Our customer solutions have generally been developed internally. We operate in a competitive and highly technical industry. Therefore, to maintain and extend our technology leadership, we intend to continue to invest in our R&D efforts by hiring more personnel to enhance our existing security solutions and to add complementary solutions.
•Sales and Marketing, or S&M, Expenses. Sales and marketing expenses include salaries, sales commissions and performance-based compensation benefits and related expenses for our S&M personnel, travel and entertainment, marketing and advertising programs (including lead generation), customer advocacy events, and other brand-building expenses, as well as allocated overhead. As we continue to grow our business, both domestically and internationally, we will invest in our sales capability, which will increase our sales and marketing expenses in absolute dollars.
•General and Administrative, or G&A, Expenses. General and administrative expenses include primarily the costs of human resources and recruiting, finance and accounting, legal support, information management and information security systems, facilities management, corporate development and other administrative functions, and are partially offset by allocations of information technology and facilities costs to other functions.
Interest and Other, Net
Interest and other, net consists primarily of the effect of exchange rates on our foreign currency-denominated asset and liability balances and interest income earned on our cash and cash equivalents. All foreign currency transaction adjustments are recorded as foreign currency gains (losses) in the Consolidated Statements of Operations. To date, we have had minimal interest income.
Income Tax Benefit
Our effective tax benefit rate was 23.0% and 21.7% for the three and six months ended July 29, 2022, respectively, and 18.9% and 22.0% for the three and six months ended July 30, 2021, respectively. The change in effective tax rate between the periods was primarily attributable to the impact of certain adjustments related to the vesting of stock-based compensation awards and the recognition of additional benefits relating to research and development credits.
We calculate a provision for income taxes using the asset and liability method, under which deferred tax assets and liabilities are recognized by identifying the temporary differences arising from the different treatment of items for tax and accounting purposes. We provide valuation allowances for deferred tax assets, where appropriate. We file U.S. federal returns on a consolidated basis with Dell and we expect to continue doing so until such time (if any) as we are deconsolidated for tax purposes with respect to the Dell consolidated group. According to the terms of the tax matters agreement between Dell Technologies and Secureworks that went into effect on August 1, 2015, Dell Technologies will reimburse us for any amounts by which our tax assets reduce the amount of tax liability owed by the Dell group on an unconsolidated basis. For a further discussion of income tax matters, see “Notes to Condensed Consolidated Financial Statements—Note 9—Income and Other Taxes" in our condensed consolidated financial statements included in this report.
30
Results of Operations
Three and six months ended July 29, 2022 compared to the three and six months ended July 30, 2021
The following tables summarize our key performance indicators for the three and six months ended July 29, 2022 and July 30, 2021.
| Three Months Ended | Six Months Ended | |||||||||||||||||||||||||||||||||||||||||||||||||
| July 29, 2022 | July 30, 2021 | July 29, 2022 | July 30, 2021 | |||||||||||||||||||||||||||||||||||||||||||||||
| $ | % of Revenue | $ | % of Revenue | $ | % of Revenue | $ | % of Revenue | |||||||||||||||||||||||||||||||||||||||||||
| (in thousands, except percentages) | ||||||||||||||||||||||||||||||||||||||||||||||||||
| Net revenue: | ||||||||||||||||||||||||||||||||||||||||||||||||||
| Subscription | $ | 90,322 | 77.7 | % | $ | 102,426 | 76.3 | % | $ | 184,735 | 77.9 | % | $ | 206,496 | 75.5 | % | ||||||||||||||||||||||||||||||||||
| Professional Services | 25,860 | 22.3 | % | 31,746 | 23.7 | % | 52,462 | 22.1 | % | 67,139 | 24.5 | % | ||||||||||||||||||||||||||||||||||||||
| Total net revenue | $ | 116,182 | 100.0 | % | $ | 134,172 | 100.0 | % | $ | 237,197 | 100.0 | % | $ | 273,635 | 100.0 | % | ||||||||||||||||||||||||||||||||||
| Cost of revenue: | ||||||||||||||||||||||||||||||||||||||||||||||||||
| Subscription | $ | 34,060 | 37.7 | % | $ | 37,058 | 36.2 | % | $ | 66,886 | 36.2 | % | $ | 74,730 | 36.2 | % | ||||||||||||||||||||||||||||||||||
| Professional Services | 15,519 | 60.0 | % | 19,425 | 61.2 | % | 32,128 | 61.2 | % | 38,960 | 58.0 | % | ||||||||||||||||||||||||||||||||||||||
| Total cost of revenue | $ | 49,579 | 42.7 | % | $ | 56,483 | 42.1 | % | $ | 99,014 | 41.7 | % | $ | 113,690 | 41.5 | % | ||||||||||||||||||||||||||||||||||
| Total gross profit | $ | 66,603 | 57.3 | % | $ | 77,689 | 57.9 | % | $ | 138,183 | 58.3 | % | $ | 159,945 | 58.5 | % | ||||||||||||||||||||||||||||||||||
| Operating expenses: | ||||||||||||||||||||||||||||||||||||||||||||||||||
| Research and development | $ | 33,638 | 29.0 | % | $ | 30,417 | 22.7 | % | $ | 66,969 | 28.2 | % | $ | 58,569 | 21.4 | % | ||||||||||||||||||||||||||||||||||
| Sales and marketing | 40,940 | 35.2 | % | 34,685 | 25.9 | % | 80,185 | 33.8 | % | 71,090 | 26.0 | % | ||||||||||||||||||||||||||||||||||||||
| General and administrative | 24,274 | 20.9 | % | 26,488 | 19.7 | % | 49,634 | 20.9 | % | 52,043 | 19.0 | % | ||||||||||||||||||||||||||||||||||||||
| Total operating expenses | $ | 98,852 | 85.1 | % | $ | 91,590 | 68.3 | % | $ | 196,788 | 83.0 | % | $ | 181,702 | 66.4 | % | ||||||||||||||||||||||||||||||||||
| Operating loss | $ | (32,249) | (27.8) | % | $ | (13,901) | (10.4) | % | $ | (58,605) | (24.7) | % | $ | (21,757) | (7.9) | % | ||||||||||||||||||||||||||||||||||
| Net loss | $ | (24,719) | (21.3) | % | $ | (11,763) | (8.8) | % | $ | (46,317) | (19.5) | % | $ | (18,153) | (6.6) | % | ||||||||||||||||||||||||||||||||||
Other Financial Information (1) | ||||||||||||||||||||||||||||||||||||||||||||||||||
| Non-GAAP cost of revenue: | ||||||||||||||||||||||||||||||||||||||||||||||||||
| Non-GAAP Subscription | $ | 29,778 | 33.0 | % | $ | 32,999 | 32.2 | % | $ | 58,216 | 31.5 | % | $ | 66,750 | 32.3 | % | ||||||||||||||||||||||||||||||||||
| Non-GAAP Professional Services | 15,174 | 58.7 | % | 19,249 | 60.6 | % | 31,396 | 59.8 | % | 38,588 | 57.5 | % | ||||||||||||||||||||||||||||||||||||||
| Total Non-GAAP cost of revenue | $ | 44,953 | 38.7 | % | $ | 52,249 | 38.9 | % | $ | 89,613 | 37.8 | % | $ | 105,338 | 38.5 | % | ||||||||||||||||||||||||||||||||||
| Non-GAAP gross profit | $ | 71,229 | 61.3 | % | $ | 81,923 | 61.1 | % | $ | 147,584 | 62.2 | % | $ | 168,297 | 61.5 | % | ||||||||||||||||||||||||||||||||||
| Non-GAAP operating expenses: | ||||||||||||||||||||||||||||||||||||||||||||||||||
| Non-GAAP research and development | $ | 30,998 | 26.7 | % | $ | 28,875 | 21.5 | % | $ | 61,586 | 26.0 | % | $ | 55,929 | 20.4 | % | ||||||||||||||||||||||||||||||||||
| Non-GAAP sales and marketing | 39,313 | 33.8 | % | 33,669 | 25.1 | % | 76,920 | 32.4 | % | 69,342 | 25.3 | % | ||||||||||||||||||||||||||||||||||||||
| Non-GAAP general and administrative | 16,717 | 14.4 | % | 18,133 | 13.5 | % | 34,318 | 14.5 | % | 36,258 | 13.3 | % | ||||||||||||||||||||||||||||||||||||||
| Non-GAAP operating expenses | $ | 87,028 | 74.9 | % | $ | 80,677 | 60.1 | % | $ | 172,824 | 72.9 | % | $ | 161,529 | 59.0 | % | ||||||||||||||||||||||||||||||||||
| Non-GAAP operating (loss) income | $ | (15,799) | (13.6) | % | $ | 1,246 | 1.0 | % | $ | (25,240) | (10.6) | % | $ | 6,768 | 2.5 | % | ||||||||||||||||||||||||||||||||||
| Non-GAAP net (loss) income | $ | (11,293) | (9.7) | % | $ | 921 | 0.7 | % | $ | (18,896) | (8.0) | % | $ | 4,912 | 1.8 | % | ||||||||||||||||||||||||||||||||||
| Adjusted EBITDA | $ | (14,305) | (12.3) | % | $ | 3,624 | 2.7 | % | $ | (22,152) | (9.3) | % | $ | 11,721 | 4.3 | % | ||||||||||||||||||||||||||||||||||
_____________________
(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 total GAAP net revenue, except for non-GAAP subscription cost of revenue and non-GAAP professional services cost of revenue measures, which are calculated based on GAAP subscription net revenue and GAAP professional services net revenue, respectively.
31
Revenue
The following table presents information regarding our net revenue for the three and six months ended July 29, 2022 and July 30, 2021.
| Three Months Ended | Change | Six Months Ended | Change | ||||||||||||||||||||||||||||||||||||||||||||
| July 29, 2022 | July 30, 2021 | $ | % | July 29, 2022 | July 30, 2021 | $ | % | ||||||||||||||||||||||||||||||||||||||||
| (in thousands, except percentages) | |||||||||||||||||||||||||||||||||||||||||||||||
| Net revenue: | |||||||||||||||||||||||||||||||||||||||||||||||
| Taegis Subscription Solutions | $ | 42,809 | $ | 18,503 | $ | 24,306 | 131.4 | % | $ | 80,025 | $ | 32,463 | $ | 47,562 | 146.5 | % | |||||||||||||||||||||||||||||||
| Managed Security Services | 47,513 | 83,923 | (36,410) | (43.4) | % | 104,710 | 174,033 | (69,323) | (39.8) | % | |||||||||||||||||||||||||||||||||||||
| Total Subscription revenue | $ | 90,322 | $ | 102,426 | $ | (12,104) | (11.8) | % | $ | 184,735 | $ | 206,496 | $ | (21,761) | (10.5) | % | |||||||||||||||||||||||||||||||
| Professional services | 25,860 | 31,746 | (5,886) | (18.5) | % | 52,462 | 67,139 | (14,677) | (21.9) | % | |||||||||||||||||||||||||||||||||||||
| Total net revenue | $ | 116,182 | $ | 134,172 | $ | (17,990) | (13.4) | % | $ | 237,197 | $ | 273,635 | $ | (36,438) | (13.3) | % | |||||||||||||||||||||||||||||||
Subscription Revenue. For the three and six months ended July 29, 2022, subscription revenue decreased $12.1 million, or 11.8%, and $21.8 million, or 10.5%, respectively. The revenue decrease reflects our continued focus on reducing non-strategic service offerings and prioritizing the growth of our Taegis subscription solutions, which includes reselling Taegis offerings to our current managed security services customer base.
Professional Services Revenue. For the three and six months ended July 29, 2022, professional services revenue decreased $5.9 million, or 18.5%, and $14.7 million or 21.9%, respectively. The revenue decrease reflects both our focus on reducing non-strategic professional service offerings and an overall decrease of billable hours from the fiscal 2022 periods.
Revenue for certain services provided to or on behalf of Dell under our commercial agreements with Dell totaled approximately $1.2 million and $2.8 million for the three and six months ended July 29, 2022, respectively, and $2.9 million and $6.2 million for the three and six months ended July 30, 2021, respectively. Of the revenue derived from Dell, subscription revenue represented approximately 26% for the three and six months ended July 29, 2022, and 39% and 42% for the three and six months ended July 30, 2021, respectively. For more information regarding the commercial agreements, see "Notes to Condensed Consolidated Financial Statements—Note 10—Related Party Transactions" in our condensed consolidated financial statements included in this report.
We primarily generate revenue from sales in the United States. However, for the three and six months ended July 29, 2022, international revenue, which we define as revenue contracted through non-U.S. entities, totaled $38.8 million and $79.3 million, respectively, and represented 33% of our total revenue in both periods. For the three and six months ended July 30, 2021, international revenue totaled $44.5 million and $89.4 million and represented 33% and 32% of total revenue, respectively. Currently, our international customers are primarily located in Australia, United Kingdom, Japan and Canada. We are focused on continuing to grow our international customer base in future periods.
32
Cost of Revenue
The following table presents information regarding our cost of revenue for the three and six months ended July 29, 2022 and July 30, 2021.
| Three Months Ended | Change | Six Months Ended | Change | ||||||||||||||||||||||||||||||||||||||||||||
| July 29, 2022 | July 30, 2021 | $ | % | July 29, 2022 | July 30, 2021 | $ | % | ||||||||||||||||||||||||||||||||||||||||
| (in thousands, except percentages) | |||||||||||||||||||||||||||||||||||||||||||||||
| Cost of revenue: | |||||||||||||||||||||||||||||||||||||||||||||||
| Subscription | $ | 34,060 | $ | 37,058 | $ | (2,998) | (8.1) | % | $ | 66,886 | $ | 74,730 | $ | (7,844) | (10.5) | % | |||||||||||||||||||||||||||||||
| Professional Services | 15,519 | 19,425 | (3,906) | (20.1) | % | 32,128 | 38,960 | (6,832) | (17.5) | % | |||||||||||||||||||||||||||||||||||||
| Total cost of revenue | $ | 49,579 | $ | 56,483 | $ | (6,904) | (12.2) | % | $ | 99,014 | $ | 113,690 | $ | (14,676) | (12.9) | % | |||||||||||||||||||||||||||||||
| Other Financial Information | |||||||||||||||||||||||||||||||||||||||||||||||
| Non-GAAP cost of revenue: | |||||||||||||||||||||||||||||||||||||||||||||||
| Non-GAAP Subscription | $ | 29,778 | $ | 32,999 | $ | (3,221) | (9.8) | % | $ | 58,216 | $ | 66,750 | $ | (8,534) | (12.8) | % | |||||||||||||||||||||||||||||||
| Non-GAAP Professional Services | 15,174 | 19,249 | (4,075) | (21.2) | % | 31,396 | 38,588 | (7,192) | (18.6) | % | |||||||||||||||||||||||||||||||||||||
Total Non-GAAP cost of revenue(1) | $ | 44,953 | $ | 52,249 | $ | (7,296) | (14.0) | % | $ | 89,613 | $ | 105,338 | $ | (15,725) | (14.9) | % | |||||||||||||||||||||||||||||||
(1) See "Non-GAAP Financial Measures" and "Reconciliation of Non-GAAP Financial Measures" for a reconciliation of each non-GAAP financial measure to the most directly comparable GAAP financial measure.
Subscription Cost of Revenue. For the three months ended July 29, 2022, subscription cost of revenue decreased $3.0 million, or 8.1%. As a percentage of revenue, subscription cost of revenue increased 150 basis points to 37.7%. On a non-GAAP basis, subscription cost of revenue as a percentage of revenue increased 80 basis points to 33.0%. The decrease in subscription cost of revenue was primarily attributable to lower employee-related expenses.
For the six months ended July 29, 2022, subscription cost of revenue decreased $7.8 million, or 10.5%. As a percentage of revenue, subscription cost of revenue decreased — basis points to 36.2%. On a non-GAAP basis, subscription cost of revenue as a percentage of revenue decreased 80 basis points to 31.5%. The decrease in subscription cost of revenue was primarily attributable to lower employee-related expenses.
Professional Services Cost of Revenue. For the three months ended July 29, 2022, professional services cost of revenue decreased $3.9 million, or 20.1%. As a percentage of revenue, professional services cost of revenue decreased 120 basis points to 60.0%. On a non-GAAP basis, professional services cost of revenue as a percentage of revenue decreased 190 basis points to 58.7%. The decrease in professional services cost of revenue was primarily attributable to lower employee-related expenses associated with the reduction of non-strategic professional services offerings.
For the six months ended July 29, 2022, professional services cost of revenue decreased $6.8 million, or 17.5%. As a percentage of revenue, professional services cost of revenue increased 320 basis points to 61.2%. On a non-GAAP basis, professional services cost of revenue as a percentage of revenue increased 230 basis points to 59.8%. The decrease in professional services cost of revenue was primarily attributable to lower employee-related expenses associated with the reduction of non-strategic professional service offerings.
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Gross Profit and Gross Margin
The following table presents information regarding our gross profit and gross margin for the three and six months ended July 29, 2022 and July 30, 2021.
| Three Months Ended | Change | Six Months Ended | Change | ||||||||||||||||||||||||||||||||||||||||||||
| July 29, 2022 | July 30, 2021 | $ | % | July 29, 2022 | July 30, 2021 | $ | % | ||||||||||||||||||||||||||||||||||||||||
| (in thousands, except percentages) | |||||||||||||||||||||||||||||||||||||||||||||||
| Gross Profit: | |||||||||||||||||||||||||||||||||||||||||||||||
| Subscription | $ | 56,262 | $ | 65,368 | $ | (9,106) | (13.9) | % | $ | 117,849 | $ | 131,766 | $ | (13,917) | (10.6) | % | |||||||||||||||||||||||||||||||
| Professional Services | 10,341 | 12,321 | (1,980) | (16.1) | % | 20,334 | 28,179 | (7,845) | (27.8) | % | |||||||||||||||||||||||||||||||||||||
| Total Gross Profit | $ | 66,603 | $ | 77,689 | $ | (11,086) | (14.3) | % | $ | 138,183 | $ | 159,945 | $ | (21,762) | (13.6) | % | |||||||||||||||||||||||||||||||
| Gross Margin: | |||||||||||||||||||||||||||||||||||||||||||||||
| Subscription | 62.3 | % | 63.8 | % | (1.5) | % | 63.8 | % | 63.8 | % | — | % | |||||||||||||||||||||||||||||||||||
| Professional Services | 40.0 | % | 38.8 | % | 1.2 | % | 38.8 | % | 42.0 | % | (3.2) | % | |||||||||||||||||||||||||||||||||||
| Total Gross Margin | 57.3 | % | 57.9 | % | (0.6) | % | 58.3 | % | 58.5 | % | (0.2) | % | |||||||||||||||||||||||||||||||||||
| Other Financial Information | |||||||||||||||||||||||||||||||||||||||||||||||
| Non-GAAP Gross Profit: | |||||||||||||||||||||||||||||||||||||||||||||||
| Non-GAAP Subscription | $ | 60,544 | $ | 69,427 | $ | (8,883) | (12.8) | % | $ | 126,519 | $ | 139,746 | $ | (13,227) | |||||||||||||||||||||||||||||||||
| Non-GAAP Professional Services | 10,686 | 12,497 | (1,811) | (14.5) | % | 21,066 | 28,551 | (7,485) | |||||||||||||||||||||||||||||||||||||||
Total Non-GAAP Gross Profit(1) | $ | 71,229 | $ | 81,923 | $ | (10,694) | (13.1) | % | $ | 147,584 | $ | 168,297 | $ | (20,713) | |||||||||||||||||||||||||||||||||
| Non-GAAP Gross Margin: | |||||||||||||||||||||||||||||||||||||||||||||||
| Non-GAAP Subscription | 67.0 | % | 67.8 | % | (0.8) | % | 68.5 | % | 67.7 | % | 0.8 | % | |||||||||||||||||||||||||||||||||||
| Non-GAAP Professional Services | 41.3 | % | 39.4 | % | 1.9 | % | 40.2 | % | 42.5 | % | (2.3) | % | |||||||||||||||||||||||||||||||||||
| Total Non-GAAP Gross Margin | 61.3 | % | 61.1 | % | 0.2 | % | 62.2 | % | 61.5 | % | 0.7 | % | |||||||||||||||||||||||||||||||||||
(1) See "Non-GAAP Financial Measures" and "Reconciliation of Non-GAAP Financial Measures" for a reconciliation of each non-GAAP financial measure to the most directly comparable GAAP financial measure.
Subscription Gross Margin. Subscription gross margin decreased 1.5% for the three months ended July 29, 2022 and remained unchanged for the six months ended July 29, 2022. We expect subscription gross margin to fluctuate from period to period as we continue to prioritize the growth and delivery of comprehensive higher-value security offerings with our Taegis subscription solutions, while driving scale and operational efficiencies associated with reducing our non-strategic managed security service offerings.
Subscription gross margin on a GAAP basis includes amortization of intangible assets and stock-based compensation expense. On a non-GAAP basis, excluding these adjustments, gross margin decreased 0.8% for the three months ended July 29, 2022. For the six months ended July 29, 2022, gross margin increased 0.8%.
Professional Services Gross Margin. Professional services gross margin increased 1.2% for the three months ended July 29, 2022. For the six months ended July 29, 2022, gross margin decreased 3.2%. We expect professional services gross margin to fluctuate due to the timing of the revenue and related expense reductions associated with the reduction of our non-strategic professional services offerings.
Professional services gross margin on a GAAP basis includes stock-based compensation expense. On a non-GAAP basis, excluding that adjustment, gross margin increased 1.9% for the three months ended July 29, 2022. For the six months ended July 29, 2022, non-GAAP professional services gross margin decreased 2.3%.
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Operating Expenses
The following table presents information regarding our operating expenses during the three and six months ended July 29, 2022 and July 30, 2021.
| Three Months Ended | Change | Six Months Ended | Change | ||||||||||||||||||||||||||||||||||||||||||||
| July 29, 2022 | July 30, 2021 | $ | % | July 29, 2022 | July 30, 2021 | $ | % | ||||||||||||||||||||||||||||||||||||||||
| (in thousands, except percentages) | |||||||||||||||||||||||||||||||||||||||||||||||
| Operating expenses: | |||||||||||||||||||||||||||||||||||||||||||||||
| Research and development | $ | 33,638 | $ | 30,417 | $ | 3,221 | 10.6 | % | $ | 66,969 | $ | 58,569 | $ | 8,400 | 14.3 | % | |||||||||||||||||||||||||||||||
| Sales and marketing | 40,940 | 34,685 | 6,255 | 18.0 | % | 80,185 | 71,090 | 9,095 | 12.8 | % | |||||||||||||||||||||||||||||||||||||
| General and administrative | 24,274 | 26,488 | (2,214) | (8.4) | % | 49,634 | 52,043 | (2,409) | (4.6) | % | |||||||||||||||||||||||||||||||||||||
| Total operating expenses | $ | 98,852 | $ | 91,590 | $ | 7,262 | 7.9 | % | $ | 196,788 | $ | 181,702 | $ | 15,086 | 8.3 | % | |||||||||||||||||||||||||||||||
| Other Financial Information | |||||||||||||||||||||||||||||||||||||||||||||||
| Non-GAAP research and development | $ | 30,998 | $ | 28,875 | $ | 2,123 | 7.4 | % | $ | 61,586 | $ | 55,929 | $ | 5,657 | 10.1 | % | |||||||||||||||||||||||||||||||
| Non-GAAP sales and marketing | 39,313 | 33,669 | 5,644 | 16.8 | % | 76,920 | 69,342 | 7,578 | 10.9 | % | |||||||||||||||||||||||||||||||||||||
| Non-GAAP general and administrative | 16,717 | 18,133 | (1,416) | (7.8) | % | 34,318 | 36,258 | (1,940) | (5.4) | % | |||||||||||||||||||||||||||||||||||||
Non-GAAP operating expenses (1) | $ | 87,028 | $ | 80,677 | $ | 6,351 | 7.9 | % | $ | 172,824 | $ | 161,529 | $ | 11,295 | 7.0 | % | |||||||||||||||||||||||||||||||
(1) See "Non-GAAP Financial Measures" and "Reconciliation of Non-GAAP Financial Measures" for a reconciliation of each non-GAAP financial measure to the most directly comparable GAAP financial measure.
Research and Development Expenses. For the three months ended July 29, 2022, R&D expenses increased $3.2 million, or 10.6%. As a percentage of revenue, R&D expenses increased 630 basis points to 29.0%, and on a non-GAAP basis, R&D expenses as a percentage of revenue increased 520 basis points to 26.7%. The increase in R&D expenses was primarily attributable to higher employee-related expenses associated with R&D personnel resulting from the continued development of our Taegis solutions.
For the six months ended July 29, 2022, R&D expenses increased $8.4 million, or 14.3%. As a percentage of revenue, R&D expenses increased 680 basis points to 28.2% and on a non-GAAP basis, R&D expenses as a percentage of revenue increased 560 basis points to 26.0%. The increase in R&D expenses was primarily attributable to higher employee-related expenses associated with R&D personnel resulting from the continued development of our Taegis solutions.
Sales and Marketing Expenses. For the three months ended July 29, 2022, S&M expenses increased $6.3 million, or 18.0%. As a percentage of revenue, S&M expenses increased 930 basis points to 35.2%, and on a non-GAAP basis, S&M expenses as a percentage of revenue increased 870 basis points to 33.8%. The increase in S&M expenses was primarily attributable to costs incurred in connection with our Taegis marketing campaigns and headcount growth, the effect of which was partially offset by a decrease in commission expenses.
For the six months ended July 29, 2022, S&M expenses increased $9.1 million, or 12.8%. As a percentage of revenue, S&M expenses increased 780 basis points to 33.8%, and on a non-GAAP basis, S&M expenses as a percentage of revenue increased 710 basis points to 32.4%. The increase in S&M expenses was primarily attributable to costs incurred in connection with our Taegis marketing campaigns and headcount growth, the effect of which was partially offset by a decrease in commission expenses.
General and Administrative Expenses. For the three months ended July 29, 2022, G&A expenses decreased $2.2 million, or 8.4%. As a percentage of revenue, G&A expenses increased 120 basis points to 20.9%, and on a non-GAAP basis, G&A expenses as a percentage of revenue increased 90 basis points to 14.4%. The decrease in G&A expenses were primarily attributable to lower employee-related expenses, professional services and consulting-related costs, which were partially offset by a higher allocation of shared expenses.
For the six months ended July 29, 2022, G&A expenses decreased $2.4 million, or 4.6%. As a percentage of revenue, G&A expenses increased 190 basis points to 20.9%. On a non-GAAP basis, G&A expenses as a percentage of revenue increased 120 basis points to 14.5%. The decrease in G&A expenses were primarily attributable to lower employee-related expenses, professional services and consulting-related costs, which were partially offset by a higher allocation of shared expenses.
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Operating Loss
Our operating loss for the three months ended July 29, 2022 and July 30, 2021 was $32.2 million and $13.9 million, respectively. As a percentage of revenue, our operating loss was 27.8% and 10.4% for the three months ended July 29, 2022 and July 30, 2021, respectively. The increase in our operating loss was primarily attributable to our decreased gross profit and increased operating expenses as we continue to invest in the business to drive growth.
Our operating loss for the six months ended July 29, 2022 and July 30, 2021 was $58.6 million and $21.8 million, respectively. As a percentage of revenue, our operating loss was 24.7% and 7.9% for the six months ended July 29, 2022 and July 30, 2021, respectively. The increase in our operating loss was primarily attributable to our decreased gross profit and increased operating expenses as we continue to invest in the business to drive growth.
Operating loss on a GAAP basis includes amortization of intangible assets and stock-based compensation expense. On a non-GAAP basis, excluding these adjustments for amortization of intangible assets and stock-based compensation expense, our non-GAAP operating loss was $15.8 million and $25.2 million for the three and six months ended July 29, 2022, respectively, compared to operating income of $1.2 million and $6.8 million for the three and six months ended July 30, 2021, respectively.
Interest and Other, Net
Interest and other, net represented income of $0.1 million for the three months ended July 29, 2022 and net expense of $0.6 million for the six months ended July 29, 2022, compared with net expense of $0.6 million and $1.5 million for the three and six months ended July 30, 2021, respectively. The change primarily reflected the effects of foreign currency transactions and related exchange rate fluctuations.
Income Tax Expense (Benefit)
Our income tax benefit was $7.4 million, or 23.0%, and $12.9 million, or 21.7%, of our pre-tax loss during the three and six months ended July 29, 2022, respectively, and $2.7 million, or 18.9%, and $5.1 million, or 22.0%, of our pre-tax loss during the three and six months ended July 30, 2021, respectively. The change in the effective tax benefit rate was primarily attributable to the impact of certain discrete adjustments related to the vesting of stock-based compensation awards in the current quarter and the recognition of additional benefits related to research and development credits.
Net Income (Loss)
Our net loss of $24.7 million increased $13.0 million, or 110.1%, for the three months ended July 29, 2022 compared to the three months ended July 30, 2021. Our net loss of $46.3 million increased $28.2 million, or 155.1%, for the six months ended July 29, 2022 compared to the six months ended July 30, 2021. Net loss on a non-GAAP basis for the three months ended July 29, 2022 was $11.3 million compared to non-GAAP net income of $0.9 million for the three months ended July 30, 2021. For the six months ended July 29, 2022, Non-GAAP net loss was $18.9 million compared to non-GAAP net income of $4.9 million for the six months ended July 30, 2021. The changes on both a GAAP and non-GAAP basis were attributable to lower revenue from our continued focus on reducing non-strategic service offerings and to our increased operating expenses, the effect of which was offset in part by the higher income tax benefit recognized in the current quarter.
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Liquidity and Capital Commitments
Overview
We believe that our cash and cash equivalents will provide us with sufficient liquidity to meet our material cash requirements, including to fund our business and meet our obligations for at least 12 months from the filing date of this report and for the foreseeable future thereafter. Our future capital requirements will depend on many factors, including our rate of revenue growth, the rate of expansion of our workforce, the timing and extent of our expansion into new markets, the timing of introductions of new functionality and enhancements to our solutions, potential acquisitions of complementary businesses and technologies, continuing market acceptance of our solutions, and general economic and market conditions. We may need to raise additional capital or incur indebtedness to continue to fund our operations in the future or to fund our needs for less predictable strategic initiatives, such as acquisitions. In addition to our $30 million revolving credit facility from Dell, 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
Our principal sources of liquidity, consisting of cash and cash equivalents, are set forth below as of the dates indicated.
| July 29, 2022 | January 28, 2022 | ||||||||||
| (in thousands) | |||||||||||
| Cash and cash equivalents | $ | 167,487 | $ | 220,655 | |||||||
Revolving Credit Facility
SecureWorks, Inc., our wholly-owned subsidiary, is party to a revolving credit agreement with a wholly-owned subsidiary of Dell 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 of July 29, 2022 or January 28, 2022, and we did not borrow any amounts under the facility during any period covered by this report. Effective March 23, 2022, the facility was amended and restated to extend the maturity date to March 23, 2023 and to modify the annual rate at which interest accrues to the applicable LIBOR plus 1.23%. The unused portion of the facility is subject to a commitment fee of 0.35%, which is due upon expiration of the facility. For more information regarding the facility, see "Notes to Condensed Consolidated Financial Statements—Note 5—Debt" in our condensed consolidated financial statements included in this report.
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Cash Flows
| Six Months Ended | ||||||||||||||
| July 29, 2022 | July 30, 2021 | |||||||||||||
| (in thousands) | ||||||||||||||
| Net change in cash from: | ||||||||||||||
| Operating activities | $ | (41,414) | $ | (13,277) | ||||||||||
| Investing activities | (3,667) | (4,251) | ||||||||||||
| Financing activities | (8,087) | (5,811) | ||||||||||||
| Change in cash and cash equivalents | $ | (53,168) | $ | (23,339) | ||||||||||
Operating Activities — Cash used in operating activities totaled $41.4 million and $13.3 million for the six months ended July 29, 2022 and July 30, 2021, respectively. The increased use of our operating cash was primarily driven by our strategic investment in the business focused on marketing and research and development initiatives regarding our Taegis offerings.
Investing Activities — Cash used in investing activities totaled $3.7 million and $4.3 million for the six months ended July 29, 2022 and July 30, 2021, respectively. Investing activities consisted primarily of capitalized expenses related to the development of our Taegis software platform and SaaS applications, which decreased slightly for the six months ended July 29, 2022 from the same period in fiscal 2021.
Financing Activities — Cash used in financing activities totaled $8.1 million and $5.8 million for the six months ended July 29, 2022 and July 30, 2021, respectively. The use of cash flows for the six months ended July 29, 2022 reflected employee tax withholding payments of $8.1 million on restricted stock awards paid by us. The use of cash flows for the six months ended July 30, 2021 reflected such employee tax withholding payments of $9.9 million, offset in part by $4.1 million of proceeds from stock option exercises.
Off-Balance Sheet Arrangements
As of July 29, 2022, 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 consolidated financial statements included in this report, management assessed the critical accounting policies as disclosed in our Annual Report and determined that there were no changes to our critical accounting policies or our estimates associated with those policies during the three and six months ended July 29, 2022.
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.
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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 global inflation and foreign currency exchange rates, particularly changes in exchange rates between the U.S. dollar and the Euro, the British Pound, the Romanian Leu, the Japanese Yen, the Australian Dollar 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.
Evaluation of Disclosure Controls and Procedures
Disclosure controls and procedures (as defined in Rules 13a‑15(e) and 15d‑15(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 in SEC 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 of July 29, 2022. Based on that evaluation, our management has concluded that our disclosure controls and procedures were effective as of July 29, 2022.
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 ended July 29, 2022 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
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Part II. Other Information
Item 1A. Risk Factors
We have discussed risks affecting us under "Risk Factors" in Part I, Item 1A of our Annual Report on Form 10-K for the fiscal year ended January 28, 2022 filed with the SEC on March 23, 2022. The risks described in our Annual Report are not the only risks facing us. There are additional risks and uncertainties not currently known to us or that we currently deem to be immaterial that may also materially adversely affect our business, financial condition or operating results.
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Item 6. Exhibits
Secureworks hereby files or furnishes the following exhibits:
| Exhibit No. | Description | |||||||
| 10.1* | ||||||||
| 31.1 | ||||||||
| 31.2 | ||||||||
| 32.1 | ||||||||
| 101.INS | Inline XBRL Instance Document - the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document. | |||||||
| 101.SCH | Inline XBRL Taxonomy Extension Schema Document. Filed herewith. | |||||||
| 101.CAL | Inline XBRL Taxonomy Extension Calculation Linkbase Document. Filed herewith. | |||||||
| 101.DEF | Inline XBRL Taxonomy Extension Definition Linkbase Document. Filed herewith. | |||||||
| 101.LAB | Inline XBRL Taxonomy Extension Label Linkbase Document. Filed herewith. | |||||||
| 101.PRE | Inline XBRL Taxonomy Extension Presentation Linkbase Document. Filed herewith. | |||||||
| 104 | Cover Page Interactive Data File (the cover page XBRL tags are embedded within the Inline XBRL document, which is contained in Exhibit 101). | |||||||
| ________ | ||||||||
* Certain identified portions of this exhibit have been omitted in accordance with Item 601(b)(10)(iv) of Regulation S-K.
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SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
| SecureWorks Corp. | ||||||||
| By: | /s/ Paul M. Parrish | |||||||
| Paul M. Parrish | ||||||||
| Chief Financial Officer | ||||||||
| (Duly Authorized Officer) | ||||||||
Date: September 1, 2022
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