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00:03 Good morning, and welcome to SecureWorks Third Quarter Fiscal twenty twenty two Financial Results Conference Call. Following prepared remarks, we will conduct a question and answer session. [Operator Instructions] 00:20 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. 00:34 Now, I will turn the call over to Andrew Storm, Vice President of Investor Relations. You may begin..

00:50 Thanks, everyone, for joining us. I'm Andrew Storm, VP of Investor Relations at SecureWorks. And with me are Wendy Thomas, our CEO; and Paul Parrish, our CFO. 01:00 During this call, we will reference non-GAAP financial measures.

You will find the reconciliations between GAAP and non-GAAP measures in the press release and presentation posted on the website earlier today. Please also note that all growth percentages refer to year-over-year change unless otherwise specified.

01:15 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. We assume no obligation to update our forward-looking statements. 01:35 Now, I'll turn it over to Wendy..

01:38 Thank you, Andrew, and welcome, everyone. Our focus at SecureWorks is to ensure our customers achieve their best security outcomes. And we help to secure their mission, their progress by enabling them to outpace and outmaneuver the adversary.

Buying individual security products that react independently won’t make an organization safe because they fail to provide timely visibility into their entire technology infrastructure.

02:06 For effective security, organizations require a holistic, integrated detection and response platform that measurably reduces their business risk from cyber exposure, optimizes their investment in security solutions and adjusts the shortage of expert security talent. Our Taegis Solutions were purpose built to solve these challenges.

02:29 First, Taegis brings a comprehensive big data answer to security challenges, applying our analytics and wide breadth and depth of detections across the endpoint, network, cloud, email and beyond, driving superior threat detection and enabling automated response.

With over ninety eight percent coverage against most categories of the minor attack framework, Taegis excels at detecting and halting sophisticated attacks early in the kill chain.

03:00 Second, Taegis was architected from day one to be extensible, unifying an organization's existing security infrastructure, empowering customers to maximize return on investment quickly. Industry analysts evaluate Taegis, regularly call out our breadth of integrations as a key differentiator in shortening customer time to value.

03:23 And third, with our twenty years of experience running scaled, effective security operations built into the design of Taegis, our platform enables significant improvements in our customers operating efficiency.

A recent Forrester study, concluded Taegis can reduce risk by eighty five percent with average savings of one million dollars over three years. A solid return given our average Taegis spend per customer of one hundred and forty nine thousand. 03:52 The market opportunity for us and our partners is large and growing.

With an estimated addressable market, approaching one hundred billion by twenty twenty five, growing in the double digits annually.

04:04 Reflecting the significant opportunity, we're proud to announce that in the third quarter, Taegis ARR nearly tripled from last year, reaching one hundred and twenty three million and Taegis ARR customers increased one hundred and seventy percent year over year to eight hundred.

04:21 Our growth has been driven by the strength of our solutions and our work to constantly innovate and improve our portfolio continues. In the third quarter, we announced the addition of a machine learning based endpoint prevention solution to Taegis.

The incorporation of superior prevention helps further reduce customer security risk and allows customers to both consolidate and reduce overall security spend. 04:48 We recently launched a global technology alliance partner program with several additional partners, including AWS, Zscaler, Corelight and others.

Because Taegis was architected from the outset to be extensible, we're able to provide customer value quickly as we expand our technology alliance partner relationships.

05:09 We also continue to improve our security orchestration and automation capabilities with best practice playbooks, additional connectors, and a growing set of automated response capabilities. These enhancements along with custom reporting, and extended log retention options, fuel our ability to display SIMs across security used cases.

05:31 In fact, SIM displacement is a big opportunity for us. The SIM market for security is several billion dollars a year. Despite the high cost implement and maintain and low security efficacy, our Taegis XDR used cases go beyond what SIMs promised, but never delivered on, especially on the response side.

05:51 Increasingly, we're seeing companies put out RFPs to upgrade their SIMs, but switch to buying Taegis instead. As an example, we recently signed a UK Logistics company to a multi-year deal.

This customer had an existing SIM that they had implemented, but there were significant gaps and visibility and coverage and maintain the system was requiring too much from their four member team. 06:15 In short, they were falling behind.

So, they put out an RFP to either supplement the support for their SIM or transition to another solution and eleven companies competed for the contract. The company chose SecureWorks Taegis for the following reasons. First, the security coverage went from sixty percent to one hundred percent reducing their financial risk of a breach.

06:39 Second, our detectors and integrated store capabilities, which are continuously updated and tuned by our data science and security experts reduced the workload on their team and significantly lower the operating costs they initially budgeted for. Third, the simplicity of our pricing model resonated.

They were wary of data overage charges and preferred our simple predictable pricing model. 07:03 And finally, our standard offering met their requirement for a minimum year of log retention.

Big picture, switching to Taegis XDR met all their needs, cut their operating costs in half, significantly reduced their risk, and the deployment was far easier than the SIM had been. 07:21 I'm hearing this story more and more from sales. Our biggest hurdle and our biggest opportunity is market awareness that these returns in fact can be achieved.

It's early, but the math around total cost of ownership for customers is compelling, and the security outcomes are clearly better. 07:40 To wrap up on product, I want to congratulate the team and call out some recent recognition. Taegis XDR won the twenty twenty one CISO Choice Awards for best security analytics.

IDC, named us as a leader in their twenty twenty one worldwide internet readiness report, covering both proactive and emergency internet response, powered by the Taegis platform.

And our vulnerability management product, Taegis VDR was reviewed by SC Media with the conclusion stating a novel and unique approach to removing much of the manual [mindless work] [ph] associated with vulnerability management.

08:18 The bold approach pays off and leaves us wondering why doesn't everyone do it this way? The vulnerability management market is more mature than XDR, but we see a shift underway from compliance driven to risk and security driven solutions, making the market right for disruption, with our solution well placed for this shift.

This recognition was earned on the strength of our technology and the favorable references of our customers. 08:46 In fact, the key to our success is the continuous and rapid innovation on Taegis fueled by the voice of our customers. And our customers regularly express their appreciation for how quickly we address their feedback.

Our customer centric approach is paying off. 09:01 Turning to go to market. There is a large number of security service providers that could improve their security efficacy and operational efficiency with Taegis. As an example this quarter, we displaced our major competitor at an existing MSSP in the Asia-Pac region.

09:19 The [indiscernible] moment came during a demo when they realized our solution is so intuitive, it could make their junior analysts far more effective. Taegis has everything needed delivered to their fingertips, all the counter threat info, research, telemetry, all-in-one.

They had also worried the competitors solution was missing threats, but with our coverage fully transparent and in the public via our software adversary tool, they were confident Taegis provide superior coverage. 09:49 There are also thousands of technology services providers globally that want to extend their services into security.

To succeed in this market, they need an expert security partner to help them ramp quickly and effectively. As the long term leader in managed security services, we take everything we've learned and accomplished in our twenty plus year history and provided to our partners, enabling them to deliver the same capabilities via our Taegis platform.

10:19 While we launched our MSSP program in February, we're excited by the results today, with thirty MSSP signed and nineteen fully certified with more in the pipeline. We'll continue to provide you updates on this front.

10:34 Finally, we announced to our customers and partners, the end of sale and end of life dates for the majority of our other managed security services. We will stop selling these services at the end of this fiscal year, and will not renew contracts with end dates that extend beyond the close of our next fiscal year.

This announcement made early in the fourth quarter, has already driven an uptick in customer engagement to initiate the transition process on to Taegis. 11:03 While the majority of our other MSS services are a natural transition, really an upgrade to Taegis.

There are a handful of non-strategic services, which we are transitioning to our MSSP partners or that our customers are taking in house. 11:18 To give you a sense of what I mean, let me share a customer story with you.

We proactively reached out to an international media customer, and asked if we could set up a demo of Taegis to show them how much incremental value it offers.

11:32 Our team walked them through the capabilities and pricing and after just a few conversations, they were sold on the depth and breadth of our detection capabilities, as well as expanded coverage of their entire network end point and cloud telemetry.

And they were confident with the incident response support that reflects the [indiscernible] and managed XDR. 11:52 The end result was re-solutioning to Taegis for twenty percent higher ARR with higher margins. Part of the deal, however, was that they insourced the firewall management we have been providing.

Because of this, the twenty percent lift in ARR was net of the loss of the firewall management revenue. Normalizing for that, we have been receiving fifty percent more ARR.

12:17 Paul will give you more details of the financial profile of our transition, but this is a good example of the transition we're driving, increasing the security value delivered to our customers, while executing a fundamental shift to a higher value business model.

12:32 To bring this home, SecureWorks today is a very different company than it was just a few years ago, when we first set our vision to turn the tide in the security fight. Our teams have delivered on this vision and are focused on supporting this transformation on behalf of our customers and partners.

And I would be remiss if I did not thank them for all that we've accomplished so far, and we'll continue to accomplish moving forward. 12:56 With that, I'll turn the call over to Paul Parrish..

13:00 Thanks, Wendy. To start, Taegis ARR continues to grow with over one hundred and twenty three million dollars of ARR at the end of the quarter, up twenty two percent over Q2. Taegis subscription revenue is up one hundred and fifty nine percent year over year, while other MSS revenue declined twenty percent.

Overall, subscription revenues were down four point nine percent year over year as we continue our transformation journey. 13:26 Average revenue per Taegis customer was approximately one hundred and forty nine thousand dollars continuing to generate a premium to our ninety eight thousand dollars or non- Taegis customers.

13:37 Professional services revenues of thirty point seven million dollars were down eight percent with total revenue declining five point six percent, primarily related to reduction in non-strategic business.

13:49 We've been actively shedding calls through the exit of low margin services, scaling support for our security platform and driving automation throughout the business to improve margins.

14:01 The result is gross margins expanded three hundred basis points year over year to sixty four percent with non-GAAP subscription gross profit margins up three hundred and seventy basis points, resulting in subscription gross profit up four hundred thousand dollars year over year despite the revenue decline.

14:19 Sales and marketing was relatively flat sequentially at twenty five percent of revenue due to lower direct selling cost, largely offset by increased investments in channel and marketing.

14:31 R and D rose year over year to twenty three percent of revenue as we continue investing to drive innovation on Taegis and maintain our lead in threat intelligence and research. 14:42 G and A was down year over year and flat as a percent of revenue.

Adjusted EBITDA was four point seven million dollars, down from eleven million dollars last year as we invest in Taegis. 14:55 Cash flow provided by operations was eleven point five million dollars with CapEx of one point six million dollars for the quarter.

Our balance sheet remains strong with two zero five million dollars of cash, no debt, and an untapped credit facility.

15:12 Looking forward to our guidance for FY twenty twenty two, we expect full year total revenue to be five thirty five million dollars to five thirty seven million dollars, [to] [ph] implying fourth quarter revenue of one hundred and twenty eight million dollars to one hundred and thirty million dollars.

15:29 We expect Taegis revenue to be between ninety million dollars to ninety two million dollars. Taegis revenue is being impacted by the timing of resolution customers as we do not fully recognize Taegis revenue until our prior services were completely shut down.

We're not losing the customer revenue, it’s just being recognized as revenue and other MSS. 15:51 We're raising full year adjusted EBITDA guidance, to nine million dollars to eleven million dollars. Looking to FY twenty twenty three, we will provide guidance on our fourth quarter call, but we want to give some color on what to expect.

16:06 We're transforming SecureWorks as a company, changes in our strategic services are seeing significant growth, offset by the intentional decline in revenue as we move away from non-strategic businesses.

16:20 Over the last twelve months, subscription revenue declined by twelve point six million dollars yet non-GAAP subscription gross profits were up five million dollars for a three twenty basis points improvement in subscription gross margins.

The improvement in subscription gross margins provides the evidence that our business shift is structurally improving for the better. 16:43 Looking to FY twenty twenty three, we expect these trends to continue as we push to finalize our transition.

Non-strategic services will continue to be a headwind, resulting in total ARR likely continuing to decline with a bottom no sooner than the back half of next year. 17:01 On the expense side, gross margins should continue expanding as our mix improves.

Further with growing industry recognition, and a long list to customer referrals, we're going to increase investments in our brand awareness to drive growth.

17:17 While sales and marketing has been flat through the end of Q3, we expect investments in Taegis to continue increasing, leading overall sales and marketing investments higher through next year. R and D will also increase through next year as we continue to invest in our products, and the outcomes they drive for our customers.

17:36 In summary, we had a solid quarter with evidence of our successful model transition continuing. And we look forward to our future. Wendy will now join us again as we begin our Q and A.

Operator, can you please introduce the first question?.

17:53 [Operator Instructions] We'll take our first question from Hamza Fodderwala with Morgan Stanley. Your line is open..

18:16 Hi guys. Thank you for the time. This is [indiscernible] on for Hamza. Maybe to start off my first question for Wendy.

Can you please provide some more context on your partnership strategy for Taegis and any contributions you expect from the partnership pipeline?.

18:36 Sure. Good morning and thanks for the question.

So, we in our history have always had deep partnerships with products in the industry simply because we want to be able to work holistically across our security – our customer security environment, right, and not force them into the risk of ripping and replacing, but to provide the kind of holistic visibility, detection, and response capabilities that let them stay completely secure.

19:04 So, as those customers continue to evolve their environment to serve their business needs, we want to make sure that we're in a position to continue to secure them without a blip at all. And so, we'll continue to work with the leading products in the marketplace in order to ensure that for our customers..

19:25 Awesome. And then a follow-up for Paul perhaps.

On Taegis, can you please provide a breakout of net new logos versus conversion of the existing base?.

19:38 So, we've talked in the past about, kind of a balanced and so that balance is continuing between new logos and re-solutioning out of our base and so that continued in Q3..

19:53 Great. Thank you so much..

19:57 Thank you. Our next question comes from Sterling Auty with JPMorgan. Your line is open..

20:04 Yeah, thanks. Hi, guys.

I wonder if you could give us a little color on what the competitive landscape for Taegis look like in the quarter on some of those new logos? So, when you did sign that you went through an RFP process or were in kind of a short-list comparison, what is the other solutions that you're seeing most often?.

20:26 Sure. Good morning. The solution we see – when there's actually an RFP, it is quite often to replace a legacy SIM. I think that's just kind of a life cycle and customers are seeing the cost of maintaining that or looking for a new solution. So, those are really where we have the opportunity to come in and show them.

20:26 There's really a better solution around detection and automated response with XDR that will save them the cost of setting up, supporting and maintaining those with their own team as opposed to having us do all of the detection bill, the advanced analytics, enriching data with context, mapping all of that to the minor attack framework and then enabling them with faster time to response.

21:20 So, the economics of that is pretty compelling in those situations, but when we see an actual RFP, that's what we've seen the most for..

21:31 Got you.

And can you help us understand how are you managing headcount through the transition? Meaning, are you able to re-appropriate people as certain parts of the business are facing down? Can you appropriate them into product related roles or is there actual turnover that you have to manage through?.

21:54 Sure, it's a great question. And we have absolutely made an intentional effort around leveraging the expertise of our team to continue to support our customers before they transition and then transition our teammates to support Taegis as our customers move as well.

Now, in total, you'll see our headcount is declining and that's just the nature of the shift towards partners who provide services, as well as the ability to provide scaled services on top of Taegis and that you'll see continue..

22:33 Thank you..

22:37 Thank you. Our next question comes from Saket Kalia with Barclays Capital. Your line is open..

22:45 Hey, great. Hey, good morning guys. Thanks for taking my questions here..

22:49 Good morning, Saket..

22:51 Hey, good morning. Paul, maybe we'll start with you.

Can you just recap some of the mechanics there with SaaS revenue? It feels like there's so much momentum there, but narrowing to the lower end of the range, it sounded like there was a mechanical issue, can you just flush that out a little bit just to better understand it?.

23:10 Yes. I'm glad you're seeing the momentum because we're excited about the momentum with Taegis. And so, as we're continuing this journey of the transformation, we can have quarters where we’ll be a bit stronger and the Taegis growth is strong and it's just reflective of our continued momentum in our transformation.

And overall, you'll see some decline as I've mentioned in my comments as we look out into the future, but that as we restructure and the proof points in that is the gross margin improvement. So, we see this all consistent with our plan..

23:43 Got it. Well, so that's very helpful Paul. Maybe on the SaaS revenue though specifically. I think that was going, I think the prior guide was ninety million dollars to one hundred million dollars that's getting narrowed to ninety to ninety two million.

You’d brought up something around timing with customer migrating, can you just dig into to sort of how that works?.

24:05 Yeah. So, as the customer agrees to resolution, there’s some things internally that they work through and the timing of that may have some impact on how quickly they move over. And so, we'll have some ebbs and flows of that, but the overall revenue remains with our company as they convert over to our Taegis..

24:27 Okay, got it. All right, Got it. That's helpful.

Wendy for you, maybe for a follow-up, maybe just of the last question on SIM, maybe the question is, what do you find are the pain points that Taegis solves versus a traditional SIM? I mean, you gave an example, it sounds like cost is one of them, was that from a tech perspective or a security perspective, can you dig into sort of why Taegis wins versus a traditional SIM?.

24:54 Sure, it really has to do with at the outset from the plug and play ability to integrate with their data sources. Our ability to leverage our cloud based architecture to do the analytics on that that their team does not have to build and maintain.

Now, we absolutely provide the ability for customers to customize alerts or suppression rules to that kind of thing.

Specific to their environment or to help them with that, but to do that on number half of the NIM having to staff and maintain a team to maintain the things that a security expert like us can do on their behalf, really saves them time and effort let’s heir team focus on things specific to their organization and really the efficacy and the time to that efficacy is much faster as we deploy across the entire customer base..

25:50 Got it. And very helpful. Thank you..

25:52 The ability to [indiscernible]. Sure. Absolutely..

26:00 Thank you. Our next question comes from Brian Essex with Goldman Sachs. Your line is open..

26:08 Great. Good morning and thank you for taking the question.

Wendy, I just wanted to ask, if you could provide a little more detail about the machine learning endpoint prevention product that you're introducing? Was that organically developed, is there a partner and what are the dynamics of that solution? Where does it tend to look like relative to some of the emerging other options out there?.

26:32 Sure. Absolutely. So, that is a combination of partnership and integration with our technology, and we've frankly been hearing from customers that they’ve been unhappy with their existing prevention solution, and they wanted to be able to just have that as a one stop shop as they work with us.

The difference that we bring with the machine learning approach there is that we can automatically disrupt endpoint threats. 27:01 So, and the additional value is for us and combining it is to enhance the investigations in the Taegis XDR piece with that prevention context as well.

And if you think about the ideal application of machine learning here, there is a tremendous amount of labeled data, so taking this approach versus a rule based approach to prevention, which is much easier to evade, we find is much more effective for customers..

27:29 Okay.

But at this point, you're not indicating who the partner would be, so we can get an idea of the platform and the technology?.

27:36 No, we're not..

27:38 Okay. Fair enough.

And then maybe just a follow-up, with the customers that have not agreed to re-solution, what is the nature of those customers, why, I guess what’s the primary reason why they're not re-solutioning yet and how do you intend to manage that installed base with kind of [end of life movement] [ph]?.

28:03 Sure. So, if you step back and look at that total subscription ARR, the largest impact to that in terms of a headwind is really is primarily the non-strategic revenue that we don't want to continue in.

And so that is the majority of the impact as opposed to customers who are in our target for re-solutioning if you will, those customers largely are transitioning to Taegis, but when you look at the mix of the subscription, customer count coming down, what you see is that the average revenue on those customers who are not moving are very small kind of sub twenty thousand per.

So, the shift to a holistic security solution on Taegis with the full coverage just may not be the kind of compliance checkbox play that they're looking for..

29:03 Got it. Got it. Very helpful. Thank you. I'll jump back to the queue..

29:11 Thank you. [Operator Instructions] And our next question comes from Mike Cikos with Needham. Your line is open..

29:25 Hey guys, thanks for taking the questions here.

First one on the non-strategic revenue, I know we're all on our side trying to juggle our models and figure out this Taegis transition, but at the same time, you guys are working away from this strategic revenue with most of fiscal twenty two now behind us, can you give us a better sense of what that headwind has been? And I guess ballpark is most of that behind us at this point or are we expecting a bigger headwind as we look out to fiscal twenty three with some of the preliminary commentary you guys provided?.

30:04 Sure. So, as we do disclose the, kind of total subscription ARR and then the Taegis portion of that ARR, what you can see is we're moving towards a shift where the inflection point comes of Taegis becoming the majority of that mix. We see that happening next year.

And as we move through that majority mix shift to Taegis, the headwind on that will be coming behind us, but we definitely do see that continuing next year as we continue to execute the transition, but expect the bulk of that with a couple of exceptions in certain markets to be in the second half of next year.

30:48 I mean and I'll just reinforce what Paul talked about, is that, as we deliberately move on from some of these businesses to see the revenue decline, but the gross profit dollars actually increase, we are creating value here by shifting the mix of the business to the right things going forward, but realize the total revenue headwind can be hard to click underneath..

31:12 Understood on the improving gross margin dynamics and profitability with the subscription and Taegis, but no quantifiable measurements as far as that non-strategic headwind that we're facing?.

31:27 We are not quantifying that for reasons that we're going to fight for every dollar of that to keep competitors coming after that over the course of next year..

31:39 Okay.

And another question if I could, just coming back to the, I guess commentary on the Taegis revenue, those customers who are re-solutioning and it sounds like this ties to the customer timelines, right? And they're coming off services before they go on at Taegis XDR and I guess, can you help us better understand what are some of the reasons or challenges that a customer has or why wouldn't they be making a quicker transition?.

32:22 So, we had a little problem with phone here, apologize. So, our customers agreed to re-solution and so we begin the time line with them, which is a quick process for many. And for some, there's some slowness there, the revenue stays, the revenue of our company as resolution.

So, the estimates that we gave early on had additional revenue that is still remaining in CTP that will then come over the Taegis as they fully resolution..

32:53 So just to give a little color as they potentially have one last data source that they want to customize and to the platform, if there's anything remaining on the previous platform, it remains in that other MSS category and so they are completely off of the CTP platform. We're not splitting..

33:21 Understood. Got it. Thank you..

33:27 Thank you. And our last question comes from Saket Kalia with Barclays. Your line is open..

33:36 Hey guys sorry, me again. Just wanted to hop in and just ask a follow-up to you, Paul. I think the end of life, right or sort of the comments that you made just around CTP and how that will support there will discontinue sort of in a phased fashion.

Can you just recap that for us a little bit and maybe I know you can't talk about the numbers necessarily, but how does the shape of that look like over the next two or three years? I mean, is there a point that MSS or the non-Taegis non-SRC revenue approaches really a point of immateriality? Sorry, there was a lot there.

Does that make sense?.

34:22 Well, if you go back to our long term model, we covered during Investor Day, our overall – our subscription revenues will increase and it's going over that horizon you just laid out. So, the professional services will continue to grow, but they will be a smaller portion of the overall pie as we continue to grow a description..

34:43 Right..

34:43 Well we do see just becoming in the majority next year in the total subscription ARR. And so that's when to your point, towards the end of next year, the materiality of the other MSS, if you will starts to be less of an impact for headwind..

35:04 Understood. Understood. Got it. That's very helpful. Thanks, guys..

35:10 Thank you. And there are no other questions in the queue. I'd like to turn the call back two Paul Parrish for closing remarks..

35:18 Okay. That wraps up the Q and A and today's call. A replay of this webcast will be available on our Investor Relations page at secureworks.com along with our Q3 web deck with additional financial titles. Thanks again for joining us today. Have a good day..

35:40 This concludes today's conference call. Thank you for participating. You may now disconnect..