Good morning and welcome to the SecureWorks First Quarter Fiscal 2021 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 conclusion of the call, a recording of the call will be made available on the same site. Now, I will turn the call over to Paul Parrish, Chief Financial Officer. You may begin..

Thanks, everyone, for joining us. With me today is our CEO, Mike Cote. During this call, we will reference non-GAAP financial measures, including non-GAAP revenue, gross margin, operating expenses, operating income, net income, EPS, EBITDA, adjusted EBITDA and adjusted free cash flow.

A reconciliation of these measures to their most directly comparable GAAP measures can be found in our web deck and press release. Please also note that all growth percentages refer to year-over-year change unless otherwise specified.

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 this morning's press release and our SEC reports. Now, I'll turn it over to Mike..

We will continue to advance our delivery of new software based solutions to customers. To further our focus on our customers we recently promoted Wendy Thomas to President of Customer Success, underscoring our commitment to delivering a differentiated customer experience.

And our goal is to get solutions in front of more prospects and customers through our go-to-market evolution by expanding our channel partnerships, as we announced last month. Our new software solutions are a compelling opportunity for channel partners to grow their business and partnership with the best cybersecurity team in the industry.

Q1 was a busy quarter for product innovation and expansion. We continue to evolve our cloud native Red Cloak platform and TDR application with a range of new integrations, analytics, and user experience improvements, focused on strengthening the ability for organizations to detect and respond to threats.

Red Cloak TDR also earned high marks in the MITRE ATT&CK Evaluation. And I was pleased that TDR performed well across the visibility and detection threat landscape, particularly our ability to manage early threat detections. And we achieved these results just six months after the product launch.

Additionally, we recently expanded our MDR service wrapper with support for VMware Carbon Black Cloud endpoint standard, as part of our continued partnership with leading security point product vendors, and to help customers get more value out of their tools.

As part of our broader activities in adjusting to COVID, we've quickly pivoted to identify new ways to partner with our customers by offering remote vulnerability assessments, flexible incident management retainers and security assessments. There is no company better positioned to keep customers faith through the evolving digital landscape.

Let me give you a few customer examples. First, a $4 billion revenue, 13,000 employee life sciences customer that partners with physicians to innovate products for structural heart disease and critical care, so patients can live longer, healthier and more productive lives.

Our roadmap enabled them to integrate, simplify and improve the effectiveness and efficiency of their security. The customer is seeing differentiated value from our Managed Red Cloak Threat Detection and Response software, covering a full environment in a complete outcome-based solution.

That's the power of scalable software with world class security expertise at the core. Second, a longtime European technology customer with $5 billion of revenue and 17,000 employees needed their security operations to scale with their growing business.

They selected our Red Cloak MDR solution that secures their technology landscape across endpoint, network and cloud, providing even greater value with our end-to-end capabilities. This is a great example of a longtime customer adopting our new software as they transition to the cloud.

And finally, another customer example, a regional commercial bank with $15 billion of assets under management. This is a model example of our consulting services to help create opportunities for our software subscription solutions.

During our engagements to test their security posture, we established a trusted relationship that was ultimately leveraged due to the differentiated value in our software driven Red Cloak MDR solution. These are just a few examples of we’re providing value and helping our customers grow their businesses securely.

We are leading the future of security, giving customers the speed and scale of machine learning, coupled with crowd-powered data and analytics, backed by a world class cyber security team.

This power and momentum from our singular focus on security to bringing software-driven solutions to market through our industry-leading threat intelligence, through our channel program, all to protect our customers and make the world safer. That's why we're here. It's what we do, and no one does it better.

Now, I'd like to turn it over to Paul to take you through the full financial results..

Thanks, Mike. We are pleased with our Q1 financial results in many respects. Some highlights include, strong growth in our subscription business, led by our software solutions; improved operating leverage and positive adjusted EBITDA for the 8th consecutive quarter.

Maneuvering within our dynamic global environment, we maintained our strong financial position and made progress with our new software solutions and launched our new channel program, as you just heard from Mike. In the first quarter of FY21, revenue of $141.2 million exceeded the top end of our guidance range and represent 6.3% increase over Q1 FY20.

Revenue from our managed security solutions, including increased revenue from our TDR, MDR offerings grew 7.3% year-over-year and comprised 75.3% of total revenue. Consulting revenue increased 3.2% year-over-year, led by double-digit sequential and year-over-year performance in our incident response and technical testing offerings.

Finally, revenue outside the U.S. topped the $40 million mark for the first time, representing 29% of total revenue in the first quarter, up from 24% of total revenue last year on consistently strong growth in the UK, Middle East and Japan. We exited the quarter with annual reoccurring revenues of $438 million.

Gross margin totaled $82.1 million in the first quarter of FY21 or 58.1% of revenue, a 260 basis point increase from the prior year, representing our 7th consecutive quarter of year-over-year non-GAAP gross margin improvement. First quarter operating expenses totaled $80 million compared with $76.3 million last year.

Research and development expenses stayed steady as a percent of revenue totaling 16.1% of revenue in the quarter compared to 16.2% in Q1 FY20. Sales and marketing expenses were 26% of revenue in the first quarter compared to 28.2% for the prior year Q1.

In Q1 FY21, we incurred lower travel-related costs associated with increased remote activities as a result of COVID. General and administrative expenses totaled 14.5% of revenue in the first quarter compared with 13.1% for the same quarter last year.

The increased costs were primarily attributable to professional fees and consulting costs incurred in Q1 FY21. Adjusted EBITDA in Q1 was $5.6 million compared with $0.8 million last year. Cash flow used in operating activities was $20.3 million in the first quarter compared with a $3 million use of cash in Q1 FY20.

Relative to other quarters, our first quarter cash flow from operations is impacted by the payment of annual bonus compensation. Unique to Q1 FY21, DSOs slightly increased to 75 days from 72 days in Q4. The current quarter DSO increase was primarily related to the payment delay request from our customers whose operations were impacted by COVID.

At the end of Q1 FY21, 6% of our accounts receivable were under such a payment modification request. We finished the quarter with cash of $156 million, which increased from $111 million at the end of the first fiscal quarter last year. CapEx was $1 million in the first quarter, and our $30 million credit facility remains untapped. Now for guidance.

In the second quarter of FY21, we expect both GAAP and non-GAAP revenue to be in the range of $135 million to $137 million. And we expect non-GAAP net income per share performance to be between $0.01 to $0.03. We remain focused on continuing to execute our strategic plan and may give quantitative full year guidance in future periods.

Our immediate focus is on our customers and our employees as we respond to their needs in this situation. I know you share our concern in this matter. As we move into Q&A, I want to reiterate Mike’s thanks to our SecureWorks teammates for their dedication to our customers.

And on behalf of the entire SecureWorks team, we appreciate your continued interest and support. Wendy Thomas will join Mike and I during the Q&A session. Operator, please open the lines for the questions..

I will now open the call for questions. [Operator Instructions]. Our first question comes from the line of Sterling Auty from JP Morgan. Your line is now open..

I'm wondering if the strengths internationally and the strength in incident response were the same.

In other words, was the strength internationally driven by incident response or other parts of the products and services portfolio?.

Good morning, Sterling. It's Mike Cote. Appreciate the question. They were not connected. It was nothing unusual. We continued to see strong performance out of our European operations and out of Japan, and they are just not specifically IR related..

And then the one follow up is, how do you -- what are the marketing plans and sales motions to help convert the strength that you saw in incident response into further managed service and product sales moving forward?.

Hi, this is Wendy Thomas. So, it's a great question and definitely something that we look to leverage. There's really two things that are important to us around incident response. Really many of our strategic kind of testing services. So one is of course, a source of lead gen.

And when you're in the trenches with those customers, being able to then help them build out an ongoing security program to secure them is definitely what we do. And the other thing about those for us is that they help us make our underlying platform more intelliget.

So we immediately protect all of our customers with the learnings that we get from those incident response engagements..

Our next question comes from the line of Saket Kalia from Barclays Capital. Your line is now open..

Hey, good morning, Mike. Mike, maybe just to start with you. Can you just talk a little bit more about TDR and just the general increasing software offerings here? It makes a ton of sense for customers that might want a DIY solution. I'm curious, who you feel TDR is potentially replacing at a customer when you're in a competitive situation.

Any thoughts on that sort of competitive backdrop with TDR realizing that it's still early?.

Yes. So great question. I appreciate it. I'm going to take the first part of it and then actually I'll bounce it over to Wendy and let her add a few things.

I think starting with the fact that from a pipeline perspective, as we shifted to the new cloud-based software, and I will put TDR in the bucket and then our new Managed Detection and Response offering is really up either managing or co-managing that with our customers, so they can be in a position where they can effectively take it all over themselves.

And I think it's important to remember when you say DIY, this is really a crowd-sourced community effort, whereas you're working on the platform or the TDR application on the overall platform that we've talked about now for a little while, you'll have the ability to work collectively, or you currently have the ability to work collectively and cooperatively across the environment.

But our pipeline today as we've shifted to the new cloud-based offering and TDR/MDR is growing almost 400%. And it currently represents about 25% of the overall pipe. And that's in the last six months, that growth. And as the end of -- from the end of Q1 till today, it's up another 13%.

So we're seeing -- in the overall economic environment, we're seeing good demand for it. I'm going to let Wendy sort of bounce in the second part of the question, kind of the overall, the competitive landscape and sort of how we see this evolving over time..

Yes, sure. Thank you. Look, we see convergence in many of the kind of individual security product markets or industry quadrants that are in place today, even our own in terms of MSS.

As things converge into whatever you want to call it, XDR or security analytics program, and what we see as our unique advantage to take advantage of that convergence is that, one, we -- data is not enough. And so having data doesn't mean you actually know how to secure an organization. So co-leading that is insufficient.

What we do is really take advantage of the fact that we have worked with leading security point product tools in that telemetry for many years now. We understand it. We've tagged it. And we can cross correlate across that data in order to provide really a holistic visibility and security for customers.

And so our customers consistently tell us that the value they see is in our security analytics and remediation expertise that both our technology and our teams bring to bear across all of their environments.

And so that and the fact that security is really what we do, right? So we're not using security to sell infrastructure or something else that might leave gaps that customers can't close on their own. And that's really where we bring the holistic solution to bear across things that were previously standalone products. .

Got it. That makes a lot of sense. And may be for my follow-up for you, Paul.

Can you just talk a little bit about sort of broad brush economics with MDR versus your traditional MSS offering? I'm not sure if that's sort of a contrast that you guys think about internally, but I think about sort of MDR as kind of a step up above sort of your traditional MSS prevention and detection.

So the question is, are your MSS customers, your traditional MSS customers may be willing to pay more for that MDR sort of service wrapper? Or is that something that maybe you see your MDR customers perhaps retain at higher rates? How do you think about the economics I guess for MDR specifically? Does it make sense?.

It does. And that’s what we focus on a lot. It’s very good question for us too. We see MDR as higher margins for us. It's a quicker install. With MSS it’s usually a little more lengthy process. MDR is very fast and it's actually getting faster and faster as the product continues to mature.

We have an average higher revenue per unit and our sales cycles continue to fluctuate a little bit around that but it's very much a faster sales cycle around selling MDR than it is the traditional MSS. .

Got it. That’s very helpful. Thanks guys..

Thank you. The only thing I’d add to the end of that, Paul, is that it also fits well into the channel strategy and the things that Maureen is driving for us. Yes..

Thank you. Our next question comes from the line of Brian Essex from Goldman Sachs. Your line is now open..

Mike, I just want to ask you, I think last quarter when we spoke it sounded like some professional services engagements were getting pushed down. It seems like that maybe where some of the better performance or better than expected performance came from this quarter.

Can you talk a little bit about what you're seeing on the professional services side and how sustainable some of that performance might be relative to what I think was expected to be down this quarter actually came in kind of low single-digit growth?.

So Brian, appreciate the question.

I think we sort of said in the prepared remarks, and I was really pleased and quite frankly proud of our team and the way we fluctuated over a week, I shouldn’t say fluctuated, the way we moved over a weekend to a fully remote workforce continuing to deliver on the products and solutions including our consulting solutions around the globe.

And it really underscores kind of the ability of not only our team's resilience in this environment but how quickly our customers were able to adapt with consulting solutions and services, which we were more concerned about than we were in the subscription, because those have been delivered remotely in the new software applications, but our consulting solutions, where we're able to quite frankly deliver remotely without missing a beat..

And then on the -- maybe to follow-up, maybe a little bit of color on the margin. I think that gross margin is a bit better than we had expected, particularly given the mix that we see in the revenue.

Maybe a little color on where the strength there came from and was that a function of renewals and pricing power in the quarter due to the kind of macro environment or was there something else kind of moving the margin there?.

Yes, we think it's from the efficiencies just gained from managing a remote environment, able to do more work remotely.

You cut out the travel, you cut out some of the lost time and delivering those services to our customers, basically the same labor force that we had delivered, the higher labor or higher work, thus, the efficiencies from that fill up our bottom-line..

Thank you. Our next question comes from the line of Fatima Boolani from UBS. Your line is now open..

Paul, I'll start with you. You quantified the exposure or impact rather to your accounts receivable as a result of customers requesting payment term flexibility into our concessions.

I'm wondering if we take a step back, if you can talk to us a little bit about your exposure at the revenue and maybe bookings level to some of the more challenged industries.

And to what extent -- or to what extent can you describe churn and/or renewal behavior in characteristics within these verticals over the last three to six months? And I have a follow up for Wendy if I may..

So we were focused on that through the -- our process of understanding the impact on our business from what's going on from COVID. And if you recall, we have no customer segment that exceeds 10% of our revenue. So as you look across the different sectors that are impacted by COVID, your thoughts go first to the travel and entertainment space.

And so we took a hard look at that and we have customers in that space. And they are some of the customers that are asking for some of the understanding around their receivables. And we don't have a large number in any one industry. But we took that in consideration as we set our reserves.

And that's why I referenced the 6% of our receivables, having that type of request around it. So we feel comfortable that we've appropriately looked at this, and the risk there around the ability of our customers to pay are acceptable to us and we think we have appropriately reserved..

And Wendy for you.

Under your purview around customer success, I wanted to get a better sense of what initiatives or efforts you have in place to drive overall debt retention rates higher as we think about increasing a number of software offerings that are flowing into the mix, maybe balancing that with services level churn on the very lower end MSS side, and then certainly with some of the more sophisticated and complex IR engagements that that you're involved with.

Would love to kind of understand the most sensitive levers within those to really get dollar net retention back up to over 100%? And that's it from me. Thank you..

So, probably you’ve heard us talk about evolving our approach to security as the industry has evolved.

In our product portfolio, which I have led for the last few years, has really been focused on evolving to put tools in the hands of our customers in the form of software, and really evolving our service offerings to align with different levels of security expertise at the organizations we serve, right? So some have their own teams and they want access to our deep expertise and some really need us to handle things on their behalf.

What we haven't spoken to you about is this customer experience as a differentiator. And for us, the focus areas on that, we've done a good bit of work around ramping up our listening posts across the customer journey and really accelerating our real time feedback and engagement loops.

And so we see opportunities there to really start to create a more connected customer experience, especially as customers evolve their solution sets with us.

So what we're really focused on is, especially as we move towards more of the software product side, things around ensuring high levels of adoption and checking in with customers often, creating opportunities for them to give us a real time feedback on products and features and usage and their experience.

And so the initiatives around not just improving our level of real time customer sentiment and engagement, but also around focus on adoption and product support. You'll hear more about that as we kind of build out the program here. But we think this is a great opportunity for us as we evolve as a company..

Thank you. Our next question comes from the line of Hamza Fodderwala from Morgan Stanley. Your line is now open..

Hi. Good morning. Thank you for taking my question. I was wondering, if I could start off with a bit of a broader question first.

Just broadly, how are you seeing budget priorities within security start to be perhaps reprioritized in this environment? And how do you see that -- which parts of the portfolio within SecureWorks do you see that benefiting and which parts of the portfolio do you think are being deemphasized perhaps?.

So this is Mike. First of all, thanks for the question. And it’s a good question and an interesting one. And I can't say that we've seen wholesale shifts in budgets from a security perspective, at least in the customer base and prospect base we deal with.

Clearly work from home was where everybody ran quickly to ensure that they had the infrastructure set up for those that didn't.

But I think most of the large organizations had some part of their employee base working from home and security clearly followed quickly behind and ensuring as we’ve kind of laid out the strategy with what we're doing on the Red Cloak platform or TDR to ensure we cover network endpoints, the cloud and business systems, we have continued to see an interest across the spectrum.

We also offered some unique consulting opportunities to help make sure people as they moved and pivoted to the work from home, had an opportunity to test and understand and ensure that they're -- that they have the proper controls in place and that those controls are working as expected. So, I mean, I guess that's what I’d say, I don't know. .

That's helpful. And just for a follow-up question. I know that you're not giving quantitative guidance for the full year.

But any color you can give us on -- based on your pipeline today, what you're seeing sort of into the back half of the year? And what would you have to see in your pipeline or from your customers to give that full year guidance again going forward?.

Yes, so great question. And I think what I would tell you is, the bigger issue is not necessarily the view from our customers. but I think the overhang from the economic environment on a global basis, and as people talk about -- we've heard for last 90 days, the V, the W, the Swish, the U, the bathtub.

I think the uncertainty and the macro environment from an uncertainty perspective is sort of the bigger question that we're trying to get our arms around. We are going -- I gave some preliminary data on our pipeline since the beginning of Q2 and I think we're feeling pretty good about how things are shaping up.

But there's still a lot of work to do and a lot of uncertainty around when people will actually make the buying decisions that would give us comfort going in. And we did give guidance on Q2, so kind of comfort going into Q3, Q4. .

Thank you. Our next question comes from the line of Gur Talpaz from Stifel. Your line is now open..

Hi, this is actually Chris Speros on for Gur. Thanks for taking my question and congrats on the quarter.

For Mike, can you talk about the demand that you're seeing for the Dell SafeGuard offering and how the SafeGuard pipeline is shaping up for the rest of the year?.

Sure. I'm going to let Wendy take that actually because she manages that. .

Yes, so that relationship is strong and really that was born as sort of an initial partnership with the Dell Technologies family for a unified and secure set of workspace solutions. So we're pretty proud of that partnership, now with Carbon Black, who is a longtime partner of us and obviously as part of VMware now.

And so while it's early days since the launch in kind of November, December timeframe, with Carbon Black, we have seen good growth there, good traction quickly, and more importantly, see a lot of opportunities to expand our footprint with those organizations who come in through that program, but then really need extended security across their entire platform..

And one more for Mike.

Can you talk about the SecureWorks’ new global partner program and the initial feedback of that you've received on the initiative from the B channel?.

Sure. Thanks, Chris. So we launched it two weeks ago, actually, and it was two weeks ago today we had over 200 attendees on the launch, the virtual launch. We've had a lot of interest, actually signed up 25 new partners already. So Maureen and her team are very busy. There's conversations ongoing with over another 100 partners.

And we've been excited to see the media interest around the globe and the early interest and opportunity from a momentum perspective. So, in a short period of time, I think Maureen and her team have done a really good job getting us out of the gate..

Thank you. At this time, I'm showing no further questions. I would like to turn the call back over to Paul Parrish for closing remarks..

That wraps up today's call. A replay of this webcast will be available on our Investor Relations page at SecureWorks.com along with our Q1 FY21 web deck with additional financial titles. Thanks again for joining us today..

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