SecureWorks Corp.

All lines have been placed on mute to prevent any background noise. A supplemental slide presentation to accompany the prepared remarks can be found on the company's website. After the speaker's remarks, there will be a question and answer session. If you would like to ask a question during this time, simply press star followed by the number one on your telephone keypad. If you would like to withdraw your question, please press star then two. Thank you. At this time, I would like to turn the call over to Kevin Toomey, SecureWorks Vice President of Investor Relations. So, Mr. Toomey, you may begin your conference.

Thank you, Operator. Good morning, and welcome to SecureWorks' second quarter fiscal 2024 earnings call. Joining me today are Wendy Thomas, our Chief Executive Officer, and Valpana Wegner, our Chief Financial Officer. During this call, unless otherwise indicated, we will reference non-GAAP financial measures You will find the reconciliations between these GAAP and non-GAAP financial measures in the press release and presentation posted on the website earlier today. Finally, I'd like to remind you that all statements made during this call that relate to future results and events are forward-looking statements based on current expectations. Actual results and events could differ materially from those projected due to a number of risks and uncertainties. which are discussed in our press release, web deck, and SEC filings, which you can also find on the investor relations website at investors.secureworks.com. We assume no obligation to update our forward-looking statements. With that, I'll turn the call over to SecureWorks CEO, Wendy Thomas.

Thank you, Kevin, and welcome, everyone. I'm pleased to share that we delivered on our financial commitments in the second quarter, and executed on several key strategic milestones. We also took actions to align our cost structure to our go-forward SAS business, lying the foundations for profitability in fiscal 25. CAGIS annual recurring revenue, or ARR, was $276 million at the end of the second quarter, and CAGIS revenue grew 55% year-over-year to $66 million in the quarter. To put those numbers into context, that puts us in the top three in terms of global market share for managed detection and response out of more than 50 tracked companies as published by Gartner. The majority of organizations find it challenging to outpace growing cyber risk without the technology and expertise SecureWorks and its partners bring to managing detection and response operations. Our platform design and productization strategy positions us to leverage MDR as the leading edge to drive adoption of our Tagus XDR platform, differentiating our managed XDR approach from others in the market. This, with our multiple partner-led go-to-market paths that broaden our reach and coverage, enable us to capitalize on a large and expanding market opportunity. The Tagus platform was uniquely designed to address the security challenges of our customers and partners in several ways. First, Tagis is open without compromise. This means Tagis provides customers real choice around security controls, such as endpoint, cloud, identity, and network, and more importantly, pivots with customer technology choices over time. And as market recognition of our XDR platform grows, I'm pleased to share what we were named a leader in the recent 2023 Frost & Sullivan XDR Radar Report earning the top innovation spot in the open XDR category. Second, CAGIS provides superior detection, separating the signal from the noise. And with our fixed per-end point pricing, we incent customers to share the full breadth of their security telemetry with us. This translates into enhanced detection performance for our customers, and alleviates the need for them to compromise security for the purpose of minimizing the volume-based pricing that many XDR vendors charge. And as our partner ecosystem expands, the depth and breadth of the telemetry we ingest makes Tagus even more powerful. Third, Tagus provides unmatched response with integrated proprietary orchestration and automation capabilities, a growing set of response playbooks, and access to unlimited incident response. What this means for our customers is an industry-leading return on investment with superior security outcomes. I'll turn now to a couple of market observations and then provide an update on our go-to-market results. First, consistent with the reports of others in the industry, we continue to experience longer sales cycles than a year ago. These are largely driven by longer customer decision-making cycle times, primarily a result of increased layers of deal review. In this environment of heightened fiscal responsibility, technology budget decisions more often reach the highest levels of the organization. We do not see indicators of this changing in the near term. Second, we're encouraged to see more prospects actively planning for XDR adoption as market awareness grows and customers, who have already adopted Tagus XDR, laying out roadmaps for security vendor consolidation. With native security controls, embedded orchestration, and a minimum of one year storage included, Tagus XDR makes it possible for customers to realize better security for less money with fewer vendors. Let me share some customer examples of how Tagus is resonating in the market. Last quarter, we won a leading utility infrastructure company, where the team had invested in a variety of security controls in recent years in response to a security posture assessment. But the results weren't what they were hoping for. Their team was overwhelmed with low fidelity alerts from a variety of costly and unconnected security controls and in the face of rising cyber risk to their business. This customer was seeking valid detections and a streamlined approach to investigations and remediation. and they had a mandate to scale their existing investment in their SOC team. They saw the power of Tejas XDR to work across their existing investments with a path to streamline those investments as contracts come up for renewal. And importantly, they immediately benefited from fewer higher fidelity detections with full threat context and response recommendations. They have shared with us and other prospects how powerful and reassuring it has been to have rapid access to security experts via chat in 90 seconds or less, a unique feature for subscribers to our XDR software. Another great win this quarter was an expansion with a current customer, a $6 billion multinational consumer goods manufacturing company that saw the power of Tagus in improving their security operations in Europe and decided to extend Tagus to the rest of their organization. Cages enable them to implement a global governance model across their corporate headquarters and regional security teams across all major continents of the world. The ease of deployment and the ability to seamlessly manage operations across a follow-the-sun SOC model, as well as predictable pricing, were the key drivers for this customer to expand their relationship with SecureWorks as their global security platform partner. I'd like to share a few highlights on how we are expanding our partner ecosystem through our multiple go-to-market channels, including MSSPs that sell and deliver Tagus-powered security services under their brands, solution providers that sell Tagus with SecureWorks-delivered services in targeted markets, cyber risk partners who can reduce breach exposure for their customers by leveraging our portfolio of solutions, and technology alliance partners who create seamless protection for our joint customers. We made great progress in our MSSP partner program this quarter, a large and growing market opportunity for us. Partners are choosing to build their MCR business on TAGIS based on the compelling return on investment opportunity and positive TAGIS customer feedback. While these relationships have a long sales cycle, we're seeing the beginning stages of pipeline conversion with our MSSP partners, as indicated by our new partnership with EY. EY recently announced their intelligent extended detection and response service powered by SecureWorks Tagus XDR. Tagus is uniquely positioned to be the platform of choice for MSSPs to run their security operations with maximum effectiveness and efficiency, creating better outcomes for their customers, and grow their business profitably. Turning to solution providers. We've expanded our partner first motion since our launch in North America last December, having executed on our plan to extend the program to the Middle East, the United Kingdom, and to Europe. We remain confident that these partners are an important path to market as customers value the advisory role that solution providers play in recommending trusted solutions and easing the procurement process. With any new sales motion, instead of relationships like this, it takes time to ramp. Under the leadership of our new CRO, who started this past quarter, we are deepening our relationships with the partner community globally and refining the sales motions to capitalize on the partner-led opportunity. Year-to-date, more than 60% of global TAGIS new acquisition business was closed with a partner. We are also expanding our technology alliance relationships. We remain committed to cementing new partnerships with market leading technologies to create seamless security visibility and superior security outcomes for our customers enabled by the open XDR approach of Cages. For example, we recently announced a partnership with Akamai, a global cloud services leader, integrating their leading zero trust network access solution into Cages. Embedding the data and intelligence to scale secure access is fundamental in an era of work anywhere. which is driving an identity to become the new perimeter. Moving to an update on product development, this quarter we expanded our platform capabilities to improve alert triage with an automated rule-based process for creating and updating investigations, directly benefiting our customers by minimizing the time between detection and executing a response. This also drives scale by reducing the workload for MDR analysts. This is just one example of our investments in automation this year that have yielded a significant reduction in the time to complete investigations, supporting more rapid response, and driving our highest customer satisfaction ratings in this area to date. If you recall in the first quarter, we discussed two new offerings to unify the way companies prevent, detect, and respond to threats across both IT and OT or operational technology environments. During the second quarter, we launched Tagus integrations with two leaders in OT monitoring, Clarity and Dragos, which can be managed via the Tagus UI in the context of a customer's entire attack surface. These new partnerships provide more visibility, threat detection and response for traditionally siloed IT and OT environments, while improving the search, event analysis and response experience in Tagus. We are seeing strong interest in our OT offering as we are well positioned to address the rising risk of breach from converged OT and IT environments in the industrial space. Before I hand the call over to Alpana to walk through our financial results, let me shift gears and talk about our path to profitable growth. Our competitive advantages are resonating in the market and demand for our solutions is increasing. The depth and breadth of our partnership ecosystem provide diverse vectors for growth well into the future. I am pleased with the progress our team has made since the launch of our partner-first go-to-market motion. But with broader sales cycle elongation, the conversion to the top line is taking longer than we initially projected. In addition, our other MSS business lines are sunsetting faster, which is a positive for the business in the long term. However, it is creating a near-term headwind on our total revenue this year. As such, we are revising our full-year revenue and ARR guidance to reflect these shifts in timing. We are delivering and remain committed to improving adjusted EBITDA while investing in the highest quality solutions and security outcomes for our customers and partners to retain our market leadership position. I want to thank our customers and partners for joining forces with us, and my thanks to our teammates for their hard work and commitment to the SecureWorks mission of securing human progress. I also want to welcome Alpana Wegner to her first SecureWorks earnings call since joining us in June. I look forward to working closely with her as we drive growth and scale into our business. With that, I'll turn the call over to Alpana to walk through our financial results and guidance.

Thanks, Wendy. Good morning, everyone. I'm excited to join SecureWorks at a time where the business is pivoting to a financial model that has highly recurring revenue and supports scalability and profitability. I'll start with the highlights of our Q2 financial results, and then I will provide expectations for Q3 in the remainder of the year. Total revenue for the quarter was $93 million, above the high end of our guidance of $90 to $92 million, driven primarily by higher professional services revenue. Our TAGES business performed in line with our expectations in the quarter. TAGES subscription revenue was $66 million, up 6% sequentially and 55% year-over-year. TAGES ARR increased 37% year-over-year to $276 million, now representing more than 90% of our total ARR. Average revenue per TAGES customer health at $135,000 and remains a premium to both the industry average and to our historical other MSS average, underscoring the value that TAGES provides our customers. Total gross margin expanded 70 basis points sequentially to 70.7% this quarter and showed an improvement of 520 basis points versus second quarter a year ago demonstrating the scale opportunity within the Tejas business. Adjusted EBITDA loss was 10.3 million compared to a 14.3 million loss in the prior year period, reflecting our actions to lower operating costs and to expand the gross margin of our Tejas business. Turning to the balance sheet and capital allocation, we ended the second quarter with a strong balance sheet with 65 million of cash, no debt, and an undrawn credit facility. We used $28 million of cash from operations compared with $17 million used in the prior year period, which primarily reflects the timing of cash receipts and the timing of net transactions with Dell. We recently expanded and extended our existing revolving line of credit to a $50 million facility with a maturity and repayment period of March 2026, providing us with longer-term additional liquidity. Before moving to guidance, I would like to provide additional details on the restructuring activity we announced last month, which further aligned our cost structure to our highly scalable TAGIS-centric business model. The annualized impact of the cost reductions in total are expected to be $50 million. As we previously shared, the other MSS and non-strategic services business are rolling off at a faster pace than originally projected, and accordingly, we have been actively managing the related costs out. After taking into effect the reductions we announced last month, we estimate approximately 10 million on an annualized basis of duplicative, fixed, and transition-related costs remaining in the business, with a split of 80-20 across cost of revenue and operating expenses. We expect these costs to roll off as we complete the end of life in the first half of fiscal 25. The remainder of the cost reductions were in operating expenses. We identified opportunities across G&A, R&D, and sales and marketing to streamline, simplify, and align to our SAS model, including efficiencies from our partner-first go-to-market. We recognized 14 million of restructuring costs in Q2, 11 of which will be paid in cash outflows, with the majority being in second half of fiscal 24. Now turning to our guidance. Our revenue and our ARR outlook for the remainder of the year is shaped by two primary factors. The first is we expect to continue to wind down our other MSS business at a faster pace than previously anticipated. And the second, as Wendy mentioned earlier, while we are building strong solution provider relationships and growing pipeline, the ramp time for our ARR and professional services has elongated. For the third quarter of fiscal 24, we expect total revenue of between $88 to $90 million and non-GAAP net loss per share of $0.05 to $0.07. For the full year, we now expect pages ARR to end between $285 and $300 million, which at the midpoint is a 12% year-over-year growth. We continue to expect other MSS ARR to represent 5% or less of total ARR, and TAGIS revenue between 264 to 268 million, and total revenue between 360 to 368 million. Our outlook on profitability takes into consideration the recent restructuring activities. We continue to expect TAGIS gross margins to be 70% or better adjusted EBITDA to be between negative 31 to 37 million, and adjusted EBITDA in the fourth quarter near breakeven, and EBITDA profitability in fiscal 25. We expect full-year non-GAAP ETS loss to be between 36 cents and 41 cents, and we expect net cash used in operating activities to be between 70 and 80 million. This change reflects the timing of the cash outlay related to restriction costs I just covered, as well as the reduction of $5 million in tax benefit realization and $8 million related to estate sales tax settlement. We also expect CapEx of $6 to $8 million. In closing, I'm pleased we delivered against our financial commitments in the second quarter. We believe our differentiated platform pages, our extensive security expertise, the multiple go-to-market paths we have underway, and our actions in fiscal 24 will drive our business to sustainable, profitable growth next year. Thank you for joining us on the call today. Wendy will now rejoin us as we begin Q&A. Operator, can you please introduce the first question?

Thank you. The first question comes from Mike Kiles of Needham.

Hey, thanks, Dean, for getting me on here. I'm really looking forward to working with you, Alpana. I think this is our first time having you on for a company call now. I guess my first question would be for Wendy. And one of the things I'm trying to figure out when I look at slide four, for example, it shows that the TAGIS customer count has has been at 2,000 now. I think this is the third consecutive quarter. So my question is, I guess, what is SecureWorks doing to help drive net new logos to the TAGIS platform, and when can we expect to start seeing that show through on the customer count?

Sure, and good morning. You're doing well. What we have in our TAGES logo count is a rounded number, so you don't see some of the movement in that necessarily each quarter. But we, customer count this quarter was fairly consistent with what you see in the ARR line. As our business model is shifting in terms of a couple of things. One, our platform was designed for a target market that is both a little more upmarket, and you see that in our average revenue per customer of 134,000 versus some of our, the rest of the competitors in the market in terms of that average, as well as to target managed services providers who, in our customer count, the end customer count doesn't show up there. It's one MSP partner. So, we tend to focus in on the as much as anything in terms of that revenue opportunity. And then clearly, as we're making the, the partnership as well, and I saw the announcement we've expanded into into Europe in the Middle East this quarter, and having signed those partners to launch launch in those markets, we see growing demand and pipeline from the partners that we've launched in North America. and expect to see that same ramp with those partners as well. So it's just this go-to-market shift and expansion opportunity that will drive that growth going forward.

Great. Thanks for that, Wendy. And I guess just a follow-up. I know we're talking about the sales cycles here. I guess my question is, did we actually see sales cycles elongate if we're looking at this most recent quarter versus quarter to quarter? versus the previous quarter. I know that we've seen extension on a year-to-year basis, but just wanted to see if there was any incremental elongation on a sequential basis. And I guess just a follow-up for Alpana as well. Just given, call it $65 million in cash on the sheet exiting the quarter and the expectation for continued usage over the remainder of the year with the updated guidance, Can you give us a sense for, I guess, your cushion, what you're comfortable with on the sheet before maybe you start tapping into the revolver? You have just anything that would be beneficial. Thank you, guys.

Okay. I'll take the first part and hand off to Alpana. So, the good news is security is clearly still a high priority for customers. What we don't see is customers saying no. The demand is there. Our pipeline is increasing and it's growing in terms of the mix with partners as we expand that partner ecosystem. So, what we do see is that there is just this era right now when every organization is looking to operate at a heightened level of fiscal management. And so, we do see more layers of deal review, additional layers, if you will. And we did see that elongate in 2Q versus versus first quarter as well as year over year. So it's just an opportunity for organizations to make sure that when they make this investment, they're doing so with a full understanding of the opportunity, the roadmap for future savings, and that they have a partner that they trust to be in this with them as more than a vendor, but truly someone who is engaged in evolving with their business. And I think that's one of the unique things given our reputation and brand and how we operate with our existing customers who provide tremendous references for us. That is the strength of turning that pipeline into ARR. Yeah, and good morning, Mike.

This is Alpana. It's nice to speak with you this morning and look forward to talking further with you. As it relates to the question on cash, yeah, as you noted, we ended the quarter with $65 million on the balance sheet. From my perspective, I think of our use of cash tracking pretty closely from a trend perspective with what we're looking from an outlook perspective on the shift in trajectory with EBITDA. And so as we see EBITDA improving with the guide of a break even in Q4 of this year, I would say that you should expect to see our cash flow trending in the same direction. with cash flow generation coming next year. And so from your, you know, your question on the revolver, it's nice to have. We're very happy with where that's at, having it at $50 million in a three-year term now with the most recent amendment, but I don't see a need in the near term, you know, from an operating cash flow perspective, needing to tap into it anytime in the near term.

Terrific. Thank you for all the color, guys. I'll turn it over to my colleagues. I appreciate it.

Thank you. Thank you. Thank you.

As a reminder, it is Star 1 if you'd like to ask a question. Your next question comes from the line of Hamza Foghala of Morgan Stanley.

Hi. Good morning. Thank you so much for taking my question. Wendy, just maybe a first one for you to follow up on the last question. Just on the overall demand environment, Would you say that you're starting to see some stability? Are things getting maybe slightly worse? Any sort of green shoots that you see in terms of broader security demand trends on your end?

Sure. Good morning. From our end, we do see, as I mentioned, demand and pipeline increasing. So we do see good shoots there and not the kind of not spending at all on security that we saw probably, what, a year and a half ago where people really took a pause. So that part is positive, absolutely. The second part for us is that XDR and MDR are still markets that are in ramping adoption, if you will. And I would say that the market awareness of and understanding of MDR for certain and now XDR is growing so that it's kind of become an area of why aren't you making a plan for this kind of transition off of a legacy SIEM or really a people-led security operation. And so we view that as another positive trend for our business versus obviously very mature security product markets that are in a different space now.

Got it. And maybe just one quick follow-up, Hanna. I'm sorry if I missed it, but was there any color indication on when we would see a return to sort of revenue growth again?

We are not currently guiding to fiscal 25, but what we are providing is the outlook from a profitability and a cash flow perspective for 25 is there. What I would say is our continued focus on growth is front and center. There's no deceleration in terms of our focus on it. And we're continuing to strategically look at taking the demand that we're seeing in the pipeline and how we look to convert that faster. And I would say, you know, the end of life that we've announced on our other MSS line, we still see that progressing on track. If not, you know, as we've mentioned, it's accelerating. And so, as we come to a close and kind of get that top line overhang behind us in the first half of next year, you know, we would certainly expect the top line to return to growth. If you look at the TAGIS line on its own, it is growing, and so that would be an indicator as well as to where we see the future.

Thank you so much.

Thank you. Thank you. As a reminder, if you'd like to ask any further questions, please press star then 1 on your telephone key.

There are no further questions at this time.

Mr. Toomey, I turn the call back over to you.

Okay, thank you. That wraps the Q&A and today's call. A replay of this webcast will be available on our investor relations page at secureworks.com, along with our supplemental web deck and additional financial tables.

Thank you, everyone, for joining us today.

Thank you. Thank you all for joining today's call. I can confirm Today's call has now concluded.

You may now disconnect and enjoy the rest of your day.