SecureWorks Corp. (NASDAQ:SCWX) Q4 2023 Earnings Call Transcript

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SecureWorks Corp. (NASDAQ:SCWX) Q4 2023 Earnings Call Transcript March 23, 2023

Operator: Good morning everyone. My name is Bruno and I will be your conference operator today. At this time, I would like to welcome everyone to the SecureWorks Fourth Quarter and Full-Year Fiscal 2023 Financial Results. All lines have been placed on mute to prevent any background noise. A supplemental slide presentation to accompany the prepared remarks can be found on the company's website. After the speakers remarks, there will be a question-and-answer session. Thank you. At this time, I would like to turn the call over to Kevin Toomey, SecureWorks Vice President of Investor Relations. Mr. Toomey, you may begin your conference.

Kevin Toomey: Thanks, everyone, for joining us. With me this morning are Wendy Thomas, our CEO, and Paul Parrish, our CFO. During this call, unless otherwise indicated, we will reference non-GAAP financial measures. You will find the reconciliations between these GAAP and non-GAAP measures in the press release and presentation posted on our website earlier today. Please also note that all growth percentages refer to year-over-year changes 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 our press release, web deck and SEC filings. We assume no obligation to update our forward-looking statements. Now, I'll turn it over to SecureWorks CEO, Wendy Thomas.

Wendy Thomas: Thank you, Kevin. And welcome everyone. SecureWorks continues to deliver strong growth from our Taegis XDR solutions. Taegis revenue grew 120% year-over-year during fiscal 2023 with full-year revenue reaching 188 million. 2,000 Taegis customers are now seeing the benefits of our XDR-based approach to manage detection and response, up 400 from third quarter. Taegis annual recurring revenue grew 58% year-over-year to 261 million. As an important indication of the acceleration of our business transformation, Taegis ARR now represents over 80% of our total ARR up from 42% of the total at the end of the previous year. And we expect the mix of other MSS ARR to be minimal by year-end, approximately 5% of the total, primarily in Japan.

Reflecting in our business transition, when we began building Taegis, the XDR market didn't exist. We were building a technology platform to enable solutions that solved pressing customer needs, better security for their spends, with fewer vendors to manage, and a step function reduction in the SecOps burden on their teams from and a lack of automated containment. As the possibilities of XDR become clear to the market, our to be the XDR platform that is fundamentally open, one that evolves seamlessly with customers technology changes, and one that provides superior detection and unmatched response to prevent damaging security breaches, all-in an industry leading return on investment, and Taegis' unique approach to drive superior security outcomes is resonating with the market.

Since launching Taegis in 2020, we've delivered a 3-year compound annual growth rate of 156% in Taegis ARR. Let me dive in a bit more on what makes Taegis distinct in addressing customer security challenges across four categories. The first pillar that differentiates Taegis from other solutions is its superior . Detection is more than finding everything that poses a threat. It's about finding and prioritizing the most potentially impactful threat. We refer to this as finding the signal despite the alert noise. Over the last year, Taegis filtered 99% of the high and critical alerts generated from as false positives. And while Taegis is a powerful filter of noisy point solutions with a full coverage approach to XDR, Taegis regularly find malicious activity that other point products missed.

Taegis' telemetry normalization techniques and proprietary algorithms detect threat actor behavior based on our proprietary knowledge of their tactics and techniques. In fact, this past quarter, we shared details of our approach through the CTU threat crash. Our proprietary data warehouse with detection algorithms powered by more than 400 billion unique threat and knowledge nodes continuously updated by our in-house team of threat researchers. Much of the industry threat intelligence is published in a way that is difficult for most organizations to apply to their protection with machine readable threat intelligence updating our Taegis detectors every hour. Taegis power superior detection with unmatched speed. To share a real world example of how this resonates, a global manufacturing customer with a small in-house security team recently licensed Taegis.

With their previous security services provider, they had no visibility into the effectiveness, and they knew that their vulnerability management had not been keeping pace. They were concerned about the risk of a breach. After deploying Taegis, the platform quickly detected suspicious remote access activity to a specific device. This immediate detection coupled with proactive monthly threat hunt included in the Taegis subscription, quickly demonstrated the value of our integrated approach, the detection of malicious activity that other solutions missed, and customer confidence in their ongoing security with Taegis. Second, we continue to hear from customers that Taegis provides an unmatched level of response. The majority of security response actions across cloud, identity, network, and endpoint infrastructure occur automatically through the native SOAR capabilities in the Taegis platform.

These capabilities are augmented and curated by our team of SecOps experts on behalf of partners and customers and are informed by the thousands of incident investigations and responses performed via the Taegis platform each year. As an example, customers benefit from automated workflows that can simultaneously disable user logins in AWS, while isolating relevant endpoint hosts when a critical risk is detected. SecureWorks has been using machine learning to maximize the performance of our detectors for several years. We've found that over time, the quantity and quality of data drives machine learning model performance. The good news is, we have more than we need with 650 billion real world events per day and thousands of incident responses each year.

The proven combination of Taegis' holistic detection and automated response capabilities led to a deal recently won with an international healthcare company that was frustrated with their existing SIM solution. With the burden of maintaining integration for security monitoring, and a lack of automated investigation, their small team was stretched beyond capacity. Taegis enabled them to focus on real cyber threats, without adding to their security team while addressing their log management needs for less total spend. The added capability of platform to help them proactively and continuously understand and optimize their security posture in comparison to industry peers was a key selling point to their executive team. Three, Taegis is open without compromise.

We designed Taegis to address the reality and complexity of customer technology environments. Many customers come to us with end-point technologies from multiple vendors, deployed simultaneously across their organizations. Additionally, we see teams who manage across hybrid and multi-cloud environments. Unlike other XDR or EDR platforms, we designed Taegis to excel in detections across these mixed environments, with the proven ability to automate sophisticated response actions, all from a single pane of glass. This means better, faster protection, with scaled use of security resources, continue to make investments to protect even more customer tax services. For example, we recently announced enhanced integrations with Google Cloud Platform and Google Workspace.

Extended support for Google environments enhances alert visibility and traceability, delivering a simplified workflow for SOC analysts. I'll share a story from a recently signed deal with a financial services firm who had found gaps in their endpoint centric solution during a security assessment. And also had a small in-house IT team that was overburdened with alerts. Taegis not only provided better protection for their entire technology estate, including endpoint, network, and cloud, but also answered their need for retention and centralization of log data. With the ease of deployment and the valuable MDR partner that SecureWorks brought to the table, they were quickly able to optimize their spend, provide relief to their team, while delivering better security outcomes to their business.

Finally, customers choose Taegis for the measurable and superior return on investment. To help customers demonstrate the value of security investments to their leadership team, SecureWorks launched a new security posture dashboard in Taegis. The dashboard is dynamic, enabling customers to regularly monitor, maintain, and improve their readiness in the face of ongoing security alerts and do so in real-time comparison to others in their industry. Let me share a customer story. We recently signed with a global provider of insurance and reinsurance solutions. This customer needed to defend itself and its clients' data by proactively anticipating cybersecurity threats protecting their brand from reputation damaging breaches. But they were also excited about the opportunity to drive new revenue opportunities by developing safe and secure cloud applications offered as a service to their existing customers.

They shared with us that Taegis enabled them direct savings of at least $750,000 per year and potential cost avoidance of up to $100 million from a breach and that their productivity was enhanced by approximately $375,000 a year, due to an increase in their team's productivity. And as a provider of cybersecurity insurance, the customer is looking ahead to the benefit of increasing revenue and reduce cyber breaches from Taegis based offerings license to their customers. As we look at the security challenges that organizations face, we see that technology alone cannot solve all of the challenges. Many organizations struggle with a shortage of security talent, and the diversity of skills needed to effectively manage security programs. Our product, Taegis XDR was created to address these challenges.

Taegis has embedded orchestration and a collaborative interface and workflow designed to enable transparency and collaboration across customer teams, our partners, and our security experts. This allows everyone to work together in real-time and see the same information making the security program more effective no matter how it is delivered. Our unique open approach allows us to bring customers XDR based MDR across multiple go-to-market paths. First, we partner with solution providers to sell Taegis with SecureWorks provided MDR. Second, managed services providers sell and deliver Taegis powered MDR to their end customers under their brands. We now have multiple MSSP partners who are building their business on Taegis because we have demonstrated a compelling return on investment.

This is a growing opportunity for our business and a focus of our long-term strategy. Third, enterprise customers who have their own thought capabilities or who intend to grow their teams over time to a full-time SOC, use Taegis to filter the signal from the noise, automate investigations and response capabilities, hunt and manage . These customers know that Taegis lets them automate the mundane and focus on adding value security experts. In summary, our strategy is for our XDR platform to power industry leading MDR capabilities, allowing us to grow our customer base, and be the platform of choice as the XDR market matures. Let me change gears. And talk about our path to profitability as we near the end of our business model shift. For the past few years, we have effectively been managing two distinct businesses, making investments in a growing higher margin SaaS subscription business, while winding down our other MSS and outsourcing services lines of business.

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With the acceleration last year in our transformation, we have also been actively managing down our cost structure as we sunset those lines of business. With the end of life in other MSS services outside of Japan effective February 3 of this year, we announced a workforce reduction of approximately 9%, a key step in aligning our expense base to our go forward business. With the continued growth and scale that our Taegis platform brings and our ability to reduce the remaining duplicative cost structures over the course of this fiscal year, we expect to exit fourth quarter of fiscal 2024 near breakeven EBITDA setting us up for growing profitability in our go forward business in fiscal 2025. I want to thank our customers and partners for joining forces with us.

And I thank our teammates for their hard work and commitment to the SecureWorks mission of securing human progress. In addition, I'd like to thank Paul, our CFO, who last month, announced his intent to retire from SecureWorks. Paul joined SecureWorks shortly after we launched Taegis, bringing highly relevant experience in the SaaS space, leading similar business transformations. He's led our finance and accounting team with absolute integrity in our financial reporting and business operations with a lasting impact on our transformation and team, that we can all be proud of. We have an active search underway and expect to announce an appointment prior to Paul's retirement to ensure a smooth transition. Paul has been a valued partner and I'm grateful for his leadership.

And with that, I'll turn the call over to Paul Parrish, our CFO, to discuss our fourth quarter results and outlook for the first quarter and fiscal year 2024.

Paul Parrish: Thanks, Wendy. After nearly 41 years in industry, I made the decision to retire and I'm looking forward to the next chapter in my life. It's been an honor to have served as CFO of SecureWorks during such a pivotal time in the security industry, and I thank all of my teammates and peers at SecureWorks for this opportunity. Taegis showed continued strong growth in the quarter. Taegis subscription revenue was $60.2 million for the fourth quarter, up 106% year-over-year. For the full fiscal year 2023, Taegis revenue was $188 million growing 120% year-over-year. ARR increased $97 million year-over-year to end Q4 at $261 million, representing year-over-year growth of 58%. Taegis ARR was driven partly by stronger resourcing, upsell, and cross-sell.

We added 800 customers since Q4 of last year to end the year at 2,000 total Taegis customers. An average revenue per Taegis customer was approximately $132,000 a meaningful premium to the overall industry average. It is important to note also that ARPC is similar for new Taegis customer additions and re-solution customers. An important milestone we set out this year to achieve ARR from the Taegis platform contributing more than 75% of total subscription ARR. We're happy to report that we ended the fourth quarter at 82% of ARR from our Taegis platform, up from 42% at the beginning of FY 2023. Approximately 5% will remain by the end of FY 2024, enabling us to address our duplicative cost structure over the course of the year. Total revenue was $115 million in Q4, which was above the high-end of our guidance of $110 million to $112 million, driven by outperformance in both subscription and professional services revenues.

In Q4, our total gross profits decreased, due to the revenue declines associated with the end of life for our non-strategic services. We were able to keep gross margins relatively flat by continuing to scale Taegis as the other MSS business descales into . Subscription gross margins including both Taegis and other MSS were 69.4% better than Q3 subscription gross margins of 68.3% with the mix shift to Taegis. Q4 professional services adjusted gross margins of 42.8% were down slightly from Q4 in the prior year. As we continue to focus our professional service offerings on Taegis adjacent services, our professional services revenue now represents only 21% of our total revenue in-line with our revenue mix objectives. Sales and marketing expense in Q4 was similar to the prior year quarter.

The increase to 35% of revenue from 29.9% in Q4 of FY 2022 is due to the change in total revenue associated with the end of life for our non-strategic services. Our investments in sales and marketing have increased our recognition as a leading XDR platform and MDR provider and supported our transition to a partner first model. R&D expense was 29.8% of revenue, up from 22.6% in the fourth quarter of last year. Our changes in investments reflect the launch of integrations, capabilities, and features, align directly to feedback from our partners and customers. Total G&A expense as compared to the prior year Q4 reflects the impact of the benefit realized in Q4 FY 2022 from the timing of expense accruals during FY 2022. G&A was 17% of revenue, up from 12.3% in Q4 last year, which also reflects the decline in revenue affecting the percentage.

Adjusted EBITDA loss was $19.7 million, compared to a $2.1 million gain in prior year Q4. The overall change was driven by a combination of lower gross profits of $8 million and the remainder is related to operating expense items I've just discussed. In Q4 of FY 2023, adjusted EBITDA excludes $15.5 million of one-time re-organization costs, consisting primarily of severance and other termination benefits and real estate reduction related expenses. Cash flow provided by operations in Q4 FY 2023 was $6 million, compared with $19 million, provided by operations in prior Q4, which primarily reflects the impact of lower adjusted EBITDA. CapEx was $1 million for the quarter, relatively flat with the prior year. We finished the quarter with a strong balance sheet, a $143.5 million of cash, no debt, and an untapped credit facility.

Turning to our guidance for FY 2024. We expect Taegis ARR to end FY 2024 at $300 million or higher. We expect other MSS ARR to represent approximately 5% of total ARR at the end of FY 2024. We expect full-year total revenue to be $380 million to $400 million with the first quarter revenue of $96 million to $98 million. Keep in mind, we had a 53-week year in FY 2023 compared to 52-weeks in FY 2024. We expect full-year Taegis revenue to be $270 million to $280 million. Taegis subscription gross margins are expected to increase in FY 2024 and beyond. The benefit of that within total gross margin will be offset by the duplicative, fixed, and transition cost as we for our other MSS services. Full-year adjusted EBITDA range is expected to be between negative $29 million to $39 million.

This guidance reflects the following expectations. Sales and marketing as percent of revenue is expected to decline modestly in FY 2024. Our investment in R&D will remain flat as a percentage of the lower revenue base as we continue to lower our engineering support costs for our other MSS business. G&A spend will decline and expect it to remain flat as percentage of revenue year-over-year. Operating expenses in FY 2024 should decrease on an absolute basis as we manage the cost and proportionate to the revenue opportunity. We estimate there is approximately $25 million of duplicative, fixed, and transition related costs that we are incurring with $15 million in cost of revenues and $10 million in OpEx. As we turn down our other MSS services, we will manage the related cost out positively impacting FY 2024 and FY 2025.

As we accelerate the sunset of other MSS and benefit from scale in our Taegis, centric, and go forward business, we expect to be near breakeven EBITDA in the fourth quarter of FY 2024. As we exit this year, our business will have the transition behind us with a path to EBITDA profitability in the following fiscal year. Finally, EPS loss is expected to be in the $0.26 to $0.35 range. In summary, FY 2023 was a year of significant milestones in the company expansion of its Taegis XDR platform and FY 2024 is the year that we will begin to reflect shift in our business mix and growth potential from our go forward business. Wendy will now join us again as we begin Q&A. Operator, can you please introduce the first question?

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