Rebecca Gardy - Head, IR Michael Cote - President and CEO Wayne Jackson - CFO.

Sterling Auty - JP Morgan Gabriela Borges - Goldman Sachs Jonathan Ho - William Blair Saket Kalia - Barclays Capital Walter Pritchard - Citi Melissa Franchi - Morgan Stanley Matt Swanson - RBC Capital Markets Fatima Boolani - UBS Gur Talpaz - Stifel Rob Owens - KeyBanc Capital Markets.

Good morning and welcome to the Secureworks Third Quarter Fiscal 2018 Financial Results Conference Call. Following prepared remarks, we will conduct a question-and-answer session. [Operator Instructions] At this time, all participants are in a listen-only mode. We are webcasting this call live on the Secureworks Investor Relations website.

After the completion of the call, a recording of the call will be made available on the same site. Now, I will turn the call over to Rebecca Gardy, Head of Investor Relations. Ms. Gardy, you may begin..

Thank you, Gregina. Good morning, everyone, and thank you for joining us today to review Secureworks’ financial results for the third quarter of fiscal 2018. This call is being recorded. This call is also being broadcast live over the internet and can be accessed on the Investor Relations section of Secureworks website at investors.Secureworks.com.

The webcast will be archived at the same location for one year. This morning, Secureworks issued a press release announcing results for its fiscal quarter ended November 3, 2017 and you can access this press release on the Investor Relations section of the Secureworks website.

During this call, management will make forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.

These forward-looking statements include, but are not limited to, guidance with respect to GAAP and non-GAAP revenue and net loss per share as well as adjusted earnings before interest, taxes, depreciation and amortization.

Our forward-looking statements involve risks and uncertainties that could cause actual results to differ materially from those anticipated by these statements.

You can find a description of these risks and uncertainties in this morning’s earnings press release and in the Company’s annual report in Form 10-K for the year ended February 3, 2017, which is available on our Investor Relations website as well as on the Securities and Exchange Commission’s website.

Additional information also will be set forth in the Company’s quarterly report on Form 10-Q for the quarter ended November 3, 2017, and in its other SEC filings. All forward-looking statements made on this call are based on assumptions that we believe to be reasonable as of this date, December 6, 2017.

We undertake no obligation to update our forward-looking statements after this call as a result of new information or future events. Some of the financial measures we use on this call are expressed on a non-GAAP basis.

These non-GAAP measures exclude stock-based compensation, the impact of purchase accounting, amortization of intangibles and the related tax effect of these items. We have provided reconciliations of the non-GAAP financial measures to GAAP financial measures in today’s earnings press release available on our website.

Non-GAAP measures are not intended to be considered in isolation from, a substitute for, or superior to our GAAP results, and we encourage you to consider all measures when analyzing Secureworks’ performance. With us on today’s call are Michael Cote, President and Chief Executive Officer of Secureworks and Wayne Jackson, Chief Financial Officer.

Following their prepared remarks, we will take your questions. We would appreciate you limiting your initial questions to two so that we may allow as many of you to ask questions as possible in our allotted time.

In the event you have additional questions that are not covered by others, please feel free to re-queue and we will do our very best to come back to you. Thank you for your cooperation on this. And now, I would like to turn over the call to Mr. Cote..

Thank you, Rebecca. And thank you, everyone, for joining us this morning on our third quarter fiscal 2018 earnings call. This quarter, we continued to see positive results with revenue growing 10% to $118 million and gross margin continuing to expand as we realize scale in our delivery model.

In addition, our adjusted EBITDA loss improved for the second consecutive quarter, narrowing to $4 million. Our monthly recurring revenue grew 8% year-over-year to $33.4 million, our largest quarterly increase in MRR in two years, demonstrating that our sales changes are taking hold.

The growth in MRR included a meaningful contribution from our new solutions such as Advanced Endpoint Threat Protection or AETP, which was launched mid-third quarter and has already resulted in over $1 million in new sales. We had a solid quarter overall and we are on track to finish in line with our prior revenue and EPS expectations for the year.

As I did on our last quarter’s earnings call. I will share a few additional metrics as we continue to execute on our go-to-market strategy. We saw a 27% sequential increase in the total value of closed deals greater than $1 million. Although, the absolute number of deals in this group remained essentially flat.

We are making progress in North America especially with enterprise clients where year-over-year, sales increased over 20%. And our sales momentum in EMEA and APJ continued to accelerate this quarter as our sales execution continued to improve and our sellers in those regions become more tangent.

[Ph] Both regions saw record sales quarters with Japan in particular more than doubling over last year. Our revenue retention rate for each of the first three quarters last year was greater than 100%. Although, our revenue retention rate improved sequentially this quarter, during the past four quarters, it has been between 96% and 99%.

In addition, although our sales productivities improved in each of the last two quarters, we are not yet at the productivity levels we expect in North America. We have a clear path forward to continue to grow sales and improve revenue retention. As announced earlier in October, I’m in the midst of a search for a new Chief Revenue Officer.

I’m excited about the caliber of the candidates, both internal and external. Our interim leaders are highly respected and experience individuals that are well-known to clients in their respective territories and did a nice job closing out the third quarter.

We have a deep bench of tenured sellers and the changes we have discussed in prior quarters; talent, coverage and quality of sale are yielding results. We are a client-centric company and our client success is paramount. We have three key priorities in this area; excellence, engagement and continuous innovation.

One of the hallmarks of our Company is our passion to provide excellence and the value we deliver to our clients as we protect them in today’s digitally connected world. We strive to be the best security partner and we consistently seek to raise the bar by delivering solutions with the highest level of quality.

We are measuring client satisfaction on a regular cadence and are consistently looking for ways to elevate our gain. Our sole focus is making our clients as successful as possible in realizing value from our solutions.

Earlier this year, we started a client success organization to ensure deep engagement with each of our clients so that they remain at the center of everything we do. The security industry is constantly evolving as adversaries change their tactics, techniques and procedures.

The commitment to continuous innovation is thereby imperative as it ensures our solutions are providing the most value to our clients as they combat adversaries across their security environments; my prior comment on our success with AETP is one example.

This quarter, research and development expenses were approximately 16% of revenue, bringing our year-to-date investments to over $56 million. These dollars have been deployed in the broad areas to fuel technology innovation with near-term benefit such orchestration and remediation and cloud solutions.

We also carve out a portion of our R&D spend for initiatives with long-term -- longer term horizons. We developed our Counter Threat Platform by automating the delivery of our detection through algorithms and machine learning based solutions.

As a natural next step, we are extending automation and to response by programmatically validating, prioritizing, containing and eradicating threat activity.

The rapid growth in our subscription based Managed Detection and Response or MDR and advanced remediation solutions further build the case to progress into orchestration as we see strong market demand. We have automated several playbooks from our extensive library and are testing them against real world use cases.

As we continue to automate more of our playbooks, our clients will see a marked reduction in the complexity of repeated tasks and an increase in the speed of the response to threat events. We designed our Cloud Guardian portfolio to help organizations take full advantage of cloud computing benefits in a secure way.

This portfolio provides end-to-end solutions and covers all stages of cloud deployment from initial evaluation and architecture to ongoing assessments and monitoring as well as direct remediation. An example of one of our latest solutions is the cloud security configuration manager.

With a few clicks, clients can apply and enforce best practices to their existing cloud accounts and feel confident that the security hygiene of their accounts will be optimized. Another example is a significant growth we have seen in our solutions to secure Office 365 environments.

In our innovation roadmap, we will be further developing our capabilities to rapidly and properly detect malicious activity, respond on behalf of our clients or to provide information, enabling them to easily respond and to deploy this information to prevent attacks that can be prevented, and predict future threat activity.

I’m excited and optimistic about the future and we have several projects on the horizon to tackle complex challenges faced by our clients. Recognizing the quickening pace of machine intelligence and cyber security, we have dedicated a portion of our current and future R&D spend to accelerate the next generation of our Counter Threat Platform.

We are prototyping a new platform that would allow for the rapid creation of high-value security applications like machine learning and analytics across diverse data sources. This new design meets our clients’ needs for greater control over data access including where data resides.

Our top goal every day is to protect our clients, and we remain committed to aggressively addressing the market and emerging trends. I will now turn it over to Wayne to talk about our performance in the third quarter in more detail.

Wayne?.

Thanks, Mike, and good morning, everyone. Today, I will review our third quarter performance and share our outlook for the fourth quarter and full year fiscal 2018. All financial information discussed is non-GAAP and growth rates are compared to the prior year periods unless otherwise stated.

For the third quarter, revenue grew 9.6% to a $117.7 million as a result of steady growth in our subscription business and strong performance in our security risk consulting business. Revenue outside the U.S. grew to 17% of total revenue for the quarter, up from 13% last year.

The overall percent split for the revenue between MSS and SRC remained at approximately 80-20. Monthly recurring revenue or MRR was $33.4 million, an increase of 8.4% over the third quarter last year and a 3.4% increase sequentially. Our average annual subscription revenue per client was 90,000 this quarter, a 6% increase over the prior year.

In the third quarter, we began to see benefits of our sales investments through growth in the value of contracts sold. A few examples of seven-digit contracts sold this quarter include a three-year contract with a U.S.

based global industrial manufacturer for a suite of solutions which provides comprehensive managed detection and response; a three-year contract with a medium-sized regional bank in North America that includes advanced endpoint and network threat detection and prevention; and finally, a one -year contract with an automotive parts manufacturer to drive detection capabilities to their next generation firewall solutions.

This was our first $1 million plus booking in Japan. Revenue retention in the period was 97% versus 96% in the second quarter as installations offset non-renewing contracts. Though improved versus last quarter, we continued to experience overall renewal rates lower than historical averages.

Our third quarter gross margin was 55.7%, an increase of 230 basis points compared to last year and 100 basis points over the prior quarter. This margin expansion came from profitable growth in our subscription solutions and reflects continued scale derived from our delivery model.

For the third quarter, operating expenses totaled $73.2 million compared to $61.7 million last year. Research and development expenses have remained relatively consistent over the last four quarters at approximately 16% of revenue as we invest in innovative technologies to meet our clients’ evolving needs.

Sales and marketing expenses this quarter were approximately 31.8% of revenue, up from 27.4% last year and compared to 32.0% in the second quarter, as we continue to invest in our sales and go-to-market strategy.

General and administrative expenses were 14.5% of revenue, compared to 15% last year and 13.1% in the second quarter, which included a one-time benefit for jobs tax credit. Our operating loss was $7.6 million for the quarter and adjusted EBITDA loss was $4.2 million or 3.5% of revenue versus 1.7% a year ago and 3.9% last quarter.

The increase in adjusted EBITDA loss was primarily driven by increased investments in our businesses, which was partially offset by higher gross margins. In addition, the third quarter includes a $1.7 million benefit from a decrease in performance-based compensation expense.

Our net loss for the quarter widened to $5.2 million from $1.2 million last year, primarily due to increased sales investments. Based on 80.355 million shares outstanding, net loss per share was $0.06. Turning to the balance sheet, we had cash and cash equivalents of $100 million at the end of the third quarter.

Our net accounts receivable totaled $137 million at the end of the quarter. The increase in AR for the third quarter was primarily attributable to the timing of our billings and collections as a result of the Company’s conversion in this quarter, system conversion in this quarter, as well as our continued revenue growth.

Cash flow provided by operations for the quarter was $5.2 million, primarily as a result of the collection of tax receivable this quarter, offset by the increase in accounts receivable. Before turning to guidance, I want to remind you last year’s fourth quarter contains 14 weeks.

The upcoming fourth quarter will have 13 weeks, affecting year-over-year comparisons. Now, on to guidance. Our financial guidance takes into account our financial performance through the first three quarters of the fiscal year and the type of forward-looking information that Rebecca referred to earlier.

For the fourth quarter of fiscal 2018, we expect GAAP and non-GAAP revenue to be in the range of $117 million to $118 million and we expect non-GAAP net loss per share to be in the range of $0.08 to $0.09 based on approximately 80.362 million weighted average shares outstanding.

For fiscal year 2018, we expect GAAP revenue to be in the range of $464 million to $465 million and in the range of $465 million to $466 million on a non-GAAP basis. We expect our GAAP net loss to be in the range of $51 million to $52 million and our adjusted EBITDA loss to be in the range of $22 million to $23 million.

Lastly, based on approximately 80.28 million weighted average shares outstanding, we expect net loss per share to be in the range of $0.64 and $0.65 and non-GAAP net loss per share to be in the range of $0.29 to $0.30. We expect our total capital expenditures will be approximately $18 million for the full year.

Based on our year-to-date sales performance, our revenue retention rates and visibility and expected sales in the fourth quarter, we are narrowing our guidance for MRR to be in the range of $34.4 million to $35.0 million at the end of the fourth quarter of fiscal 2018. Before I finish, let me address ASC 606.

We currently expect to adopt this accounting standard and its amendments using the full retrospective option, beginning in the first quarter of fiscal 2019. We will disclose additional information regarding the adoption during our year-end earnings call. I will now return the call to Mike for closing remarks..

Thanks, Wayne. This quarter’s solid performance shows we are making headway on our plan to accelerate our growth trajectory. Change of this magnitude is not easy and takes time. While we have made a lot of progress this quarter, we are not where we want to be, especially in light of this year’s investments in the business.

We have a clear path forward and we will execute against our plans to accelerate growth while officially deploying resources. I look forward to providing further details on our progress next quarter.

Before I turn it over to the operator for questions, I want to express my gratitude for the hard work and dedication our team members put in everyday to keep our clients safe in a digitally connected world.

I would also like to thank our clients for allowing Secureworks to serve as their trusted cyber security partner and our other stakeholders for their continued support. I hope you have a happy holiday season. Operator, if you now open the line for questions, we will be happy to take them..

[Operator Instructions] We will take our first question from the line of Sterling Auty with JP Morgan. Please go ahead..

Yes, thanks. Hi, guys.

Mike, just kind of curious, with the departure of the Chief Revenue Office, did that actually have impact in North America, because you mentioned the productivity not being where you would like it?.

So, Sterling, thanks. Good morning. I would say that we -- as I mentioned in my prepared remarks, the existing team did a great job closing the quarter out. And I was pleased to report we ended the progress. Clearly, a change of Chief Revenue Officer in the midst is going to have some impact.

And we are more kind of cautiously optimistic about what the future will hold. So, we are in pretty shape.

I will -- while I’m on the Chief Revenue Officer, I will say that I have been pleasantly surprised with the number and quality of individuals who have shown interest in the position, and I am working diligently as one would expect, to work through this and hope to be able to have an announcement in the near future..

And then, the one follow-up would be as you’re going through that hiring process, made some changes to the sales organization already, would you expect that whoever comes in would just kind of continue the path that you’ve got or will you allow them to make additional changes which may take quarters to feel the full benefit?.

So, thanks for the question, Sterling. A couple of ways I would answer that. Number one, we have not lost any of the new management team members and the new leadership that has been brought, particularly in North America.

And I believe that most of that team who I mentioned did a really good job in closing out the third quarter and getting us on a path going forward, the conversations I have been having with the leading candidates for the Chief Revenue Officer position has centered around the changes that we made earlier in the year and we’ve put in place through the year.

I will clearly allow this individual to latitude for things that they want to do in running the organization. But, I am happy to say that most of the folks that I talked to would agree with the process and changes that we’ve made, and quite frankly would like to just continue to accelerate that down on a go forward basis..

Your next question comes from the line of Gabriela Borges with Goldman Sachs. Please go ahead..

Great. Thank you. Good morning. Thanks for taking my question. Maybe just to start on the 4Q EBITDA guidance and the 4Q MRR guidance. I want to touch two things. The first is on MRR, slightly lower at the midpoint relative to where you thought you’d be, coming into the year. Mike, you touched a little bit just now on the CRO transition.

Any other factors that are impacting the MRR outlook for 4Q? And then, I’ll ask the follow-up on EBITDA..

Okay. Yes. Thank you, Gabriela, I would -- so, I’d summarize it this way. Q3 was a strong quarter, as I mentioned, in terms of the value of the contracts we signed and in particular some of the largest contracts. And we made progress in North America in the enterprise deals that we signed and productivity across our sales organization.

The MRR growth in Q3 was the best that we’ve seen in two years. Having said that, I think, we’re trying to -- I would say, I’m pleased but not satisfied. And even though it was a solid quarter, we’re trying to be -- have a cautious outlook on our future.

And I think, we need to get to the point, as I mentioned with Sterling’s question, to solidify the CRO position and the sales leadership, as we move forward..

That’s helpful. And the follow-up is, coming into 2018, the expectation had been investments would be a little bit higher this year; there were some things that you wanted to accomplish from a sales organization standpoint.

As we now close out the fiscal year, could you maybe just level set us on when you think you might be back at breakeven EBITDA? Thanks..

Hi, Gabriela, this is Wayne. Thanks for the question. So, we had talked in earlier this year about getting EBITDA positive on a quarterly basis sometime in fiscal 2019; that was in Q1, I think as we made the investments in the sales and marketing initiatives. We still believe and we still expect to become EBITDA positive in the future.

And I’d like to defer answering that question directly until we get to the end of Q4. As Mike said, we made great progress in the sales and marketing. We’re seeing the investments pay off. And we know that the path to profitability is very important to us. I’d like to defer that till we give our earnings guidance next year..

Understood, thanks for the color..

Your next question comes from the line of Jonathan Ho with William Blair. Please go ahead..

Good morning. I just wanted to start with the gross margins.

Can you talk a little bit about sort of the cost savings that you were able to drive? And maybe how we should think about the gross margins going forward?.

Hi, Jonathan, it’s Wayne. Thanks for the question. So, gross margin has improved year-over-year, as we talk about 230 basis points. The way we look at gross margin is -- and it went up a 100 basis points sequentially. We’re still focused on long-term gross margin expansion; it’s still there as we talked about before.

We have seen the return on the investments on the technology side. This quarter, we’re seeing, and Mike talked about the success we’re having in EMEA and APJ or really rest of the world. We’re seeing those margins in those regions expand as the revenue -- as the sales and then revenue increases; that was part of the plan as well.

And then, the third area that I keep referring to is basic blocking and tackling on the things we do from an operations perspective to deliver our solutions. We continue to see opportunities there as we close out this year and head into next year. So, it’s still the same three areas.

Long-term, we still -- we’re focused on continued margin expansion -- gross margin expansion..

Just to touch on what Wayne said or to add a little color. I think it goes back, Jonathan, all the way to the IPO road show where we had said, we made initial investments going into the IPO for the long-term growth of the business.

And as Wayne mentioned, we’ve seen accelerated growth outside North America and some of the automation things that we put in place in North America, we continue to and would expect over time to continue see those yield benefits..

And then, with regard to the sales restructuring process, can you maybe help us understand what inning we’re in, in terms of that improvement process? And just aside from the CRO issues, maybe, why has North America lagged some relative to your expectation?.

So, let me do -- let me address your question in the three focus areas of talent, coverage and quality of sales. Because I think that’s really the key areas. In talent, I would say, we’ve done a very good job, and it’s been the largest focus area of getting the right people in the right positions, particularly in North America.

And it ties almost into coverage. So, I’ll put those two together, right, closer to where their clients are, where our clients are and working the relationships there. So, on the talent and coverage perspective, I would say, we’re in the later innings of the game, to put it into a baseball game.

The quality of sale perspective, I would say, we’re probably still in the 3rd, 4th, 5th inning, middle innings. As we’re working through, we expect -- the first part of the year, bringing the right people on board, ensuring that our people are in the right places and getting their relationships with the clients.

And we’ve done a lot of that at this point. And we’re now spending a lot of our time on the sales -- things of value proposition, consistency and quality of the way we’re going into the sales organizations.

And again, as I mentioned, Jeff and Ian, and Ryan have done a really good job in leading our sales organization and ensuring that we did not miss a step as we closed out Q3. And I think it’s now continuing to drive this execution into the early part of next year..

Your next question comes from the line of Saket Kalia with Barclays Capital. Please go ahead..

Hey, Mike, maybe just start with you. I think we called out a 6% increase in average subscription per client, which is great.

Is that coming from customers signing on for more offerings in that preliminary engagement or is perhaps that the mix of enterprise a little bit higher, which is taking that measure up? How do you think about the drivers for that 6% increase in subscription per client?.

So, this is Wayne. Just to make sure we understand your question.

You’re talk about our average revenue -- subscription revenue per client up 6% to $90,000 this quarter?.

Yes. That’s right Wayne. .

Okay. What drives that is pretty much the enterprise clients, which is one reason we’ve pivoted to focusing on that over the last several quarters..

So, it would be a combination of -- I mentioned that we had the overall contract value deals over $1 million is up 27%. So, it’s some bigger deals. And we -- it’s some increased cross-sell to some of the new solutions we have into our existing client base..

Got it. Maybe for my follow-up for you Mike, just more higher level kind of anecdotal.

Can you just talk about where customers and where the market is in terms of feeling more comfortable with outsourcing more security functions versus handling more of that security in-house?.

So, Saket, I think it’s a great question and actually it’s been a bit of a fascinating quarter when you go back and think about, if you will, Equifax and Uber, which weren’t necessarily -- I think they came out after our quarter ended but during this same reporting period, and then the continued impact from GDPR.

So, I think there’s a lot of questions in view from senior management getting engaged in what’s going in and ensuring that there is a return on the spend of security, meaning from my perspective, a reduction in risk for clients. And I think that we have found the world falls into two buckets.

There are those executives who basically believe that they can do it better themselves and there are those within their closed university or world, and there’s others that believe that there is value associated with working with partners, particular partner that has global experience and a lot of global clients.

And from anecdotal perspective, our sales pipe looks good and healthy. We are getting a lot of opportunities from larger organizations who are looking, in particular, for the analytics and intellectual property and the algorithms, machine learning and health and trying to combat the threats.

But, I would caveat that with saying they also want to play roles.

And when we talk about outsourcing, I would say, it’s more of a co-sourcing type relationship because quite frankly those clients that we partner with know their networks and their infrastructures better than we could, unless it’s a small to medium-sized business where it’s something that’s easier for us to -- kind of very simple network..

Your next question comes from the line of Walter Pritchard with Citi. Please go ahead..

Hi, thanks. Two questions. First for Mike. On the renewal rate, can you talk about where those clients are going that are now renewing? I assume your gross renewal rate is lower than the 96, 97 you are talking about.

Where do those clients end up, can you give us a little bit more detail there?.

Yes, I actually -- so, Walter, thank you because it’s a great question. Let me clarify that it’s not client necessarily leaving Secureworks. It’s often where they may be reducing their spend with us that reduces the client -- the revenue retention rate.

So, in another words, if we are doing a $100 of work with a client, they may say we longer want to involve in this part of our network and we would like to shift it over to a different place from the network, if you will, to the endpoint.

So, most of the majority of the reduction in revenue retention rate relates to, if you will, solution churn over moving from one solution to another, not client churn. In fact, I think in our largest clients, say the top 50, we have not lost any this year..

Great. And then, for Wayne. Just on the -- we saw that deferred revenue was down pretty materially, probably the most material reduction you’ve seen in deferred. I think you warned us even as going back pre-IPO, not to expect -- that billing was a sort of meaningful metric.

But, what drove that? I think it was $9 million reduction in deferred sequentially..

Hi, Walter. Good morning. Thanks for the question. So, I will lead in or caveat by saying our deferred revenue is still lumpy; it varies from quarter-to-quarter. Part of that is, we still have about 50% of our contracts that are prepaid or billed on an annual basis.

So that introduces the unpredictable -- or the lumpiness; it’s not unpredictable, the lumpiness. I will share one level of detail since the number was larger this quarter. And that is, at the end of the second quarter -- I mentioned in our prepared remarks that we had a system conversion that impacted our accounts receivable balance.

We anticipated of course that system conversion. So, we did pre-bill some -- or sent out invoices pre-bill at the end of Q2, which of course drove our deferred balance higher. And so, that impacted that balance. And then, we didn’t have that same kind of pre-billing at the end of Q3. A lot more detail I don’t want to get into.

But since it was a higher number, I thought, I’d spend a moment on it..

Your next question comes from the line of Melissa Franchi with Morgan Stanley. Please go ahead..

Okay. Thanks for taking my question. I just wanted to follow up on Walter’s previous question on the renewal rates or the retention rate. Mike, can you maybe just detail what common catalysts for customers to downsize their Secureworks deployment..

Melissa, thank you. This is Mike Cote. As I sort of think through -- I’m trying to think if there’s a common answer to that question that goes consistently across.

Because we -- in many cases, we’ll often meet with our clients to help rescope, based upon where the hackers are going, and look and say, we need to move the spend that you have on detection alert across your servers, they’re in a certain part of your network and it’ll be a more productive spend to reduce your risk greater, if we move it for example to the endpoints where the hackers are currently focusing them.

But, if I looked at it, I would say -- remember, our retention rate went up, so we saw a positive movement this quarter versus second quarter.

But if I looked at it through the year, I would say that the biggest implications are probably where clients are moving and reducing some of their spend around monitoring parts of their network and increasing the spend on endpoint would probably be the biggest issue I’d see at a broad brush.

But, if you want we can, in a follow-up call, get you a little more details. So that’s probably the biggest thing we’ve seen. And again, most of the change in the reduction when we look at -- let me back up.

When we look at our revenue retention for the year, the way it’s calculated is we look at the book of business from our clients at the beginning of the year and the recurring revenue we have with them. And at the end of each quarter, whatever clients are still with us, we look at the revenue that those clients have with us.

So, it’s the reduction of what gets taken out, less, and then we’ll get that back in as cross sells. Most of the reduction relates to solutions, not to clients. And clearly, the bigger impact, what’s been fairly consistent is the SMB side of the house. The bigger impact has been fluctuation in the large enterprise side..

Okay. That’s helpful. And then, I just wanted to follow up on AETP and just wondering if you could maybe give us an update on how that performs in the quarter relative to your expectations.

And when do you think some of these newer solutions, like AETP, will start to become meaningful enough to start to impact some of the top line metrics, like MRR?.

Well, as I mentioned in the prepared remarks, our newer solutions have a meaningful impact on MRR and the increase we had in MRR, which is the largest increase that we had in few years. AETP came out of the gate very strong with as I mentioned, $1 million, after being released mid-Q3.

So, we were pretty pleased with how quickly it’s come running out of the gate. The hope and cautious optimism is that that growth accelerates as we continue to go into Q4 and fiscal 2019.

The other one that I mentioned is really our MDR where we’re -- MDR and I’ll say advanced remediation where effectively now we are using automations and individual to dig into our client.

After an alert comes up, we actually do the appropriate levels of validation, prioritization, remediation and response, and we have a pretty meaningful book of business today that has grown rapidly in a two-year period, roughly a two-year period.

And we are proposing that solution probably on almost every deal that we’re involved in today, deal meaning opportunity prospect, and enterprise deal, almost every enterprise deal, it’s in the proposal..

Your next question comes from the line of Matt Hedberg with RBC Capital Markets. Please go ahead..

This is actually Matt Swanson for Matt. So, it sounds like, it’s another strong quarter from international markets. Could you talk a little bit about your plans for investment heading into 2018? And then, going to a point Wayne touched on earlier with the margins improving the regions.

Could you give us a sense for just how different the margin profile is for the international markets right now than North America?.

So, this is Mike, Matt. Thanks for the question. A lot of the investment that we did in the international regions, we really began on that journey probably three years, four years ago, in preparation for the expanded growth that we were planning for in this period of time and into the future.

So, any incremental investments that I would expect us to make outside of North America from an operating perspective would for the most part not be significant or material or rather be ordinary from what we’re doing.

The increased investments would be continuing on the go-to-market front to meet the market demand in EMEA and APJ and the growth that we’re seeing in those markets. So, we -- they have been great highlights for us, in particular, as I mentioned, Q3 was best quarters we had in both of those two markets..

And then, Matt, this is Wayne. On your question regarding the margin profile, U.S. versus rest of world, as I touched on, maybe said a little differently earlier, the reality is as the revenue ramps in EMEA and APJ, the margin profile is getting to where we would were to be and expect were to be, but it is still where the margin profile in the U.S. is.

So, still room for margin improvement in those parts of the world..

And then from the prepared remarks, it sounds like large deals are maybe getting larger with the expanded product portfolio.

Could you talk a little bit about how deal cycles trend and this has any impact on that?.

So, this is Mike, Matt. I don’t know if I could tell you we have a trend in deal cycles moving one way or another. There has clearly been an opportunity with larger deals that are going on shorter sales cycles than we clearly saw a year ago for example.

But, then, again, we’ve got some larger deals that seem continue to move at a much slower pace than I would have anticipated. So I can’t tell you that there is an overall trend.

As I mentioned earlier when kind of Equifax and the Uber announcements have come out -- and GDPR created flurry of interest in activity that I almost think that this has been going on so long from the Target to Home Depot and other ones that we are getting a little immune to it, the world seems to be.

So, I think it really depends on the specific organization and that organization’s either senior management team or board of directors and their interest. We’ve actually had some boards call us asking us to help ensure that the organizations are safe as they believe that they may be. So, long winded answer to your question.

I don’t think that there is really a trend one way or another, it’s really -- it feels kind of bifurcated..

Your next question comes from the line of Fatima Boolani with UBS. Please go ahead..

Good morning. Thank you for taking the questions. Mike, maybe a question for you to start out with. As I look at your customer count, it’s been fairly steady and stable at kind of the 4,400, 4,500 mark.

I am curious, if you can speak to maybe the one, two or top three things that today are the largest inhibitor to new logo acquisitions? And then, I have follow-up for Wayne..

So, thank you for the question. I think the first thing is probably worth mentioning is that we don’t look to manage from a logo acquisition perspective. We are more focused on annual contract value or annual recurring revenue and the growth there.

And I was very pleased with the increase from an enterprise perspective and the growth of 27% in the overall amount of value that we signed in larger contracts. And as we mentioned, we’ve got a bigger focus in -- if I broke it down by our North American sales organizations, we had a great quarter in EMEA, a great quarter in APJ.

And our North American basis, our enterprise organization has shown a tremendous productivity or good -- good productivity improvement in Q3 and we are looking for that to continue.

Our state and local education organization from a sales perspective is not where I would like it to be this year, and they are focusing hard to show continued improvement. And our small and medium-sized business group is doing really well.

And they’ve picked up their productivity both in Q3, and I have some cautious optimism on the leadership team there and the management team in the small and medium-sized business organization for us which indirectly would end up increasing the -- where the real growth from client perspective is going to come with the SMB organization in particular..

Fair enough. And just a follow-up to some of your earlier comments around the sales organization changes. You touched on three key pillars there, so the talent, coverage and quality of sales.

Maybe if you can speak to your comfort level with the current sales capacity? Maybe several quarters ago you kind of threw target of about maybe 200 quota grades [ph] or something in that neighborhood.

But, if you can sort of speak to your comfort level with the sales capacity and the tenure that you have on board and it would be helpful if you could give us a sense of what type of attrition you’ve seen in the last 12 months or so, and then, sort of what you’re projecting as you close out the year? Thank you so much..

Hopefully, I’ll -- you had a couple of questions in there. So, I will give you the grace that if I don’t answer all, you can come back and hit me with any of them. But, I’m going to work my way backwards. From a turnover in the sales organization perspective, we’ve seen a pretty consistent level in Q2 and Q3.

It was up a little bit in Q1, as we went through the sales leadership changes at that point in time, but we’ve not seen a large change in -- I don’t think we’re expecting turnover to be much different on a go forward basis.

We have the senior -- from a talent perspective, the senior leadership team is in place around the globe and that was one of the things that we worked on earlier this year.

And I don’t expect -- that team has rallied well, done a tremendous of leading the organization from a sales perspective and we feel really good about the leadership team at that level.

They’re highly respected, as I mentioned in my prepared remarks and experienced individuals who have relationships with their -- the teams that they’ve hired with them and the clients in the regions where they are. From a quota carrying perspective actually we’re looking to exit, I think this year around 195; we’re seeing today at around 171.

And we will probably look to continue to make progress on the 171, up to closer to the 195, maybe 180 or 185. But to be honest, our bigger focus is on the productivity of the sellers that we have. We’ve done an 8% increase -- we have sellers with over two years experience who’s up 14% over last year.

So, we’re continuing to get more tenured sellers, we’re continuing to focus on quality of sales and increasing the productivity. Quite frankly, I think a great example that can show how this would yield would be what we’re doing in EMEA with some of these changes that we’ve put in place in North American enterprise earlier this year.

The foundation was laid in EMEA couple of years ago by Jeff Longoria, and Ian Bancroft who’s executing on that strategy in EMEA is doing a really good job for us..

Our next question comes from the line of Gur Talpaz with Stifel. Please go ahead..

Okay, great. Thanks for taking my questions. So, Mike I was hoping to touch on two things here.

First, have you seen any sort of broader shift in the competitive landscape as other guys, like in MDR start to emerge a little bit? And then, two kind of following that theme a little bit, what have you seen in terms of customers and their migration to the public cloud and how they’re looking to secure that migration? Has that had any sort of impact on your business and caused any sorts of shifts in relative spend? Thank you..

Sure, thanks for the question. On your first question from a competitive landscape perspective in the MDR space, I would say that most of the competition that would be in the MDR space is more going to be from an SMB perspective.

And I would venture to say that MDR work that we’re now doing across our organization, we have a couple of hundred people dedicated to doing that work for our client base, in particular in the enterprise space. And going down into some of the SMB has not been material in the deals that we’ve been involved in.

So, I think we’ve actually probably got a bigger presence in that space than most of the competitive landscape that we see. From a cloud migration perspective, I think it’s created an opportunity for us, as I mentioned with our Cloud Guardian portfolio.

We’ve not seen any, to my knowledge, or we’ve not seen any reduction from a client retention or revenue retention perspective of clients moving to the public cloud..

That’s helpful and maybe one last question for me.

As you kind of push into these new areas of security orchestration, broader endpoint et cetera, as you kind of look to become more of a vendor you self of software, how do you think about the balance here of partnering with a lot of your key partnerships on the endpoint side, perhaps on the orchestration side versus competition with those same players? Thank you..

Yes. So, great question. And I think, if you focused our core around detection response, prevention, I’d say, then prevention and predict, ours is -- the core focus of what we’re doing is around detection and response. And the things that we’re doing around orchestration and remediation are not products that we’re looking to sell.

I mean quite frankly, the clients that we’re looking -- or the clients that we’re working with and the proposed opportunities we’re having, they’re looking for automation to be brought to bear to help them get the things that they want to have done.

Buying an orchestration product, if you will, we’d like to work with all of those orchestration products and vendor agnostic matter. We’re actually rolling out the things we’re doing from an orchestration perspective with Ansible and some things we’re doing with Red Hat, but with the work with the other orchestration products in the market.

So, we’re not looking to change our -- necessarily change our go-to-market where it would be not vendor neutral, but to provide our solutions in a technology-enabled fashion, which should also help increase our gross margin over time..

Our next question comes from the line of Rob Owens with KeyBanc Capital Markets. Please go ahead..

So, Mike, to build on that point.

Is that related to [ph] some of your solution churn at this point where some of your customers are moving towards orchestration and automation capabilities, and so they’re looking to you to perform other services? I’m still little confused why some of your customers made churn from one solution to another?.

So, let me give you -- it’s not the orchestration aspect of it that would drive it. Let me give you a great example. Somebody looks to close the data center. They have 15 data centers, they close one down and go down to 14 or 13, then that part of the work that we’re doing with them would be a reduction, right, it’d be a churn.

And the intent would be as we reach solution with them to look to redeploy that and something that could add more value in the remediation and orchestration aspect of things, help them appropriately figure out how to respond..

Got it.

So, it’s maybe more of a natural headwind, just with network consolidation that’s happening?.

Yes..

Okay. And then, secondarily, why didn’t you flow through the $2 million beat in the quarter? If I work relative to the midpoint of range, it could by $2 million, but just kind of tightening the range for the year. Given, I think you said SRC was its typical 20ish percent of the mix, I would assume that most upside came from subscription revenue.

So is there anything about that fourth quarter outside of conservatism on your part?.

Hi, Rob. This is Wayne. So, we had a -- good morning. So, the revenue growth in Q3, solid revenue growth on subscription side, but SRC -- our consulting revenue growth, as I talked about, was a little bit of -- it was very strong. And as we look into Q4, SRC, the consulting is a little bit less predictable than the subscription side.

So, we came up with the range of 117 to 118, which we feel very comfortable with..

So, operator, I think we have no more questions.

Is that correct?.

That is correct..

So, let me just close out the call. Thank you again everyone for joining us and for all your questions. We appreciate your support and we look forward to our fourth quarter call in late March. If we did not get to additional questions during this session, please don’t hesitate to reach out to us for follow-up.

And with that, best wishes to everyone for a safe and happy holiday..

Thank you..

Thank you..

Ladies and gentlemen, that concludes today’s call. You may all disconnect at this time..