SecureWorks Corp

NASDAQ:SCWX

Earnings Call Analysis

Earnings Call Transcript 2025-Q2

[Operator]

Good morning. My name is Calian, and I will be the conference operator for today. At this time, I'd like to welcome everyone to the SecureWorks Second Quarter Fiscal 2025 Financial Results Conference Call. [Operator Instructions]

At this time, I would like to turn the call over to Kevin Toomey, SecureWorks Vice President of Investor Relations. Mr. Toomey, please begin.

[Kevin Toomey, executive]

Thank you, operator. Good morning, and welcome to SecureWorks Second Quarter Fiscal 2025 Earnings Call. Joining me today are Wendy Thomas, our Chief Executive Officer; and Alpana Wegner, our Chief Financial Officer.

During this call, unless otherwise indicated, we will reference non-GAAP financial measures. You will find the reconciliations between these GAAP and non-GAAP measures in the press release and presentation posted on our website earlier today.

Finally, I'd like to remind you that all statements made during this call that relate to future results and events are forward-looking statements based on current expectations. Actual results and events could differ materially from those projected due to a number of risks and uncertainties, which are discussed in our press release, web deck and SEC filings which you can also find on the Investor Relations website at investors.secureworks.com.

We assume no obligation to update our forward-looking statements.

With that, I'll turn the call over to SecureWorks CEO, Wendy Thomas.

[Wendy Thomas, executive]

Thank you, Kevin, and welcome, everyone. Our business continued its strong momentum in the second quarter. Taegis revenue grew 7% year-over-year to $71 million, and we delivered on our Q2 total revenue commitment. Annual recurring revenue, or ARR, now stands at $290 million, driven by the strength in new customer acquisition and expansion. And our Taegis average revenue per customer, or ARPC, expanded to $150,000 per customer.

Our non-GAAP Taegis gross margin of 74% remained strong, growing 360 basis points year-over-year. And we delivered positive adjusted EBITDA once again this quarter. We are demonstrating that the security outcomes delivered by our Taegis platform, the success of our partner ecosystem and our advanced automation and AI capabilities are propelling the growth of our business profitably, and they give us ample runway to further benefit from the scale that our business model offers.

Taegis is increasingly receiving accolades from industry experts. SecureWorks was recently recognized as the Gold Winner in the Golden Bridge Awards in the category of AI and Cybersecurity Innovation, the only company out of more than 1,000 nominated to win this award, a testament to our commitment to excellence and innovation, helping organizations reduce cyber risk and prevent cyber-attacks by harnessing the power of AI and managed detection and response.

In the second quarter, we progressed our growth strategy in several key areas. Specifically, we launched Taegis IDR, our new identity threat detection and response solution, solving a threat vector that has plagued companies for years and furthering the protection of our customers. We gained traction across our global partner ecosystem, adding new key partners, increasing momentum and sales productivity and partner win rates. And we continue to increase the extensibility of our platform to enable customization of playbooks, integrations and advanced detectors to drive scale in the platform and increasing margins for partners and for us.

I'll turn to product innovation in the second quarter, starting with a significant product advancement in identity security. First, for background, as traditional cyber defenses have hardened, attackers are taking advantage of vulnerable user identity with nearly 80% of breaches involving some form of identity compromised in the mix. And given that identity misconfigurations impact 95% of organizations, the risk here remains high. To put that risk into context, the average cost of the data breach reported last year was $4.5 million. In speaking with CISOs, this is often the #1 fear that keeps them up at night, one that isn't covered by traditional controls such as endpoint. This is why we built and launched Taegis IDR, our identity threat detection and response solution to help security leaders detect, prioritize and respond to identity-based threats across their organization's environment and on the dark web.

Conventional identity and access management controls like multifactor authentication, are helpful but insufficient. Taegis IDR provides comprehensive attack surface coverage of credential access techniques, providing visibility into identities, monitoring for gaps in the environment, flagging risky user behaviors, alerting when credentials have been exposed on the dark web and detecting and accelerating response to identity-based threats in lockstep with Taegis XDR. Like all threats speed is of the essence, and these capabilities and a time to detect that's counted in seconds are superior to what we see in the market today. And these will make a meaningful difference in protecting our customers' environments, from one of the most prevalent and lucrative attack vectors deployed by threat actors.

I'm pleased with the feedback from our early adopters on Taegis IDR and the results they are experiencing. Customers appreciate Taegis IDR's ability to rapidly detect gaps and other misconfigurations in their environment, particularly in areas of misconfiguration and vulnerable exposures across the Azure and Microsoft ecosystems. Taegis IDR ensures customers can close those gaps while preventing threat actors from accessing and then moving laterally within their network.

This quarter, we also launched a more personalized MDR offering with guidance on proactive security posture management and defense called Taegis ManagedXDR Plus, many organizations struggle to find tailored cybersecurity solutions that fit their unique needs at an affordable price. They often have to settle for one-size-fits-all approaches that don't offer the proactive defenses they need for resilience. The Taegis Plus offering addresses this gap by providing a more targeted threat hunting experience, personalized security health guidance and customized reporting to support compliance with a growing set of regulatory requirements.

With this offering, we are making good on our commitment to help our customers mature their security posture over time with a clear return on their investment. This too grows our share of wallet further propelling our industry-leading ARPC. Shortly after we launched our Plus offering last quarter, we won a multiyear contract with a leading real estate development company in the Middle East. This company had a local MSSP relationship that was not providing the capabilities that they needed to address.

Gaps and threat detection were falling on their lean team which they had little to no time to proactively manage the security posture of their organization in the face of rising cyber-attacks on their business. This customer chose ManagedXDR Plus for the personalized proactive approach to getting ahead of the risk, improving their security posture, addressing the regulatory compliance requirements while scaling their security team all at a meaningful return on investment.

Our Taegis platform is also supporting our go-to-market momentum. But the industry is experiencing an inflection point in the approach to security resilience. We see this in the displacement, not only of legacy security technologies, but also in the consolidation of spend on and the number of technology partners. They are our Taegis XDR platform we're expanding to address a growing set of security use cases, such as identity and exposure management. Our open and integrated approach derisks the consolidation of technologies, with full visibility into the efficacy of Taegis endpoint controls, ensuring Taegis is well positioned as organizations reevaluate their security investments and resilient strategies.

Our support of choice means that customers can work within their own time constraints around their technology evolution with optionality to evolve their security controls to save vendor spend and management costs at a compelling per-endpoint pricing model that has no surprise variable data charges.

Last quarter, we won a consolidation opportunity with a leading multinational electronics company, where the team had invested in multiple security products in recent years, but were not seeing the results they had hoped for. Their team was even more overwhelmed with alerts from a variety of costly and unconnected security controls, while facing rising cyber risks to their business. This customer was seeking valid detections and the automation required to scale their existing SecOps team.

By consolidating on Taegis they immediately benefited from fewer higher fidelity detections, with full threat context and automated response capabilities. The ability to seamlessly manage security operations 24/7 with a predictable and compelling total cost of ownership led them to make SecureWorks the global security partner.

We also saw great momentum across our global partner ecosystem this quarter with the addition of new key partners and acceleration in our deals won together. This quarter, we expanded the number of partners we have with global reach, while offering all of our partners, strong operating margins, customized sales and technical enablement and marketing collaboration.

The broader channel increasingly appreciates the competitive advantages that Taegis and the SecureWorks suite of solutions offer, demonstrably reducing risk and supporting resilience, increasing the market's recognition that XDR represents the next era in Security. Supported by the growing success in our partner first go-to-market, we saw increasing momentum in sales productivity, with our Better Together go-to-market motion in 2Q, and our partner win rate improved to the highest level since we launched our Partner First go-to-market motion.

In Q2, approximately 80% of global Taegis new logo sales closed were partner deals, reflecting the security value Taegis based solutions bring to their customers. In the second quarter, we also continued to add to the more than 50 managed security services partners in our program. I'll highlight one MSSP partnership signed this quarter with a premier provider of IT and technology solutions. This partner is delivering managed detection and response services powered by the Taegis XDR platform to protect its elite clients across the financial services, life sciences, and professional services sectors.

This partner made a 7-figure ARR commitment upfront, beginning with the transition of customers from its legacy SIEM technology onto the Taegis platform to drive higher retention and margin expansion for their business. Partnerships like this provide further validation of Taegis's ability to drive scale for large managed security services providers, empowering them to provide organizations of all sizes with access to enterprise-level security within an attractive business model.

In conclusion, Taegis is defining the future of threat detection and response, driving superior sustainable growth and value creation. Our agile expansion of features and capabilities to protect against threat actor access vectors, delivering organizations improved security risk postures and the best security outcomes and our open without compromise approach. These, combined with our growing successful partnership ecosystem, put us at an advantage. In an environment where vendor consolidation and scaling spend on both security technology and talent are top priorities, demand for our Taegis security offerings remain strong.

Taegis is the platform of choice for organizations to bolster their security posture at a proven return on investment driving our growth now and into the future.

I want to thank you for investing in our mission to secure human progress, and thank you to our customers and partners for joining forces with us.

With that, I'd like to hand the call over to Alpana to cover our financial results and guidance.

[Alpana Wegner, executive]

Thanks, Wendy. Good morning, everyone. I will review our Q2 results before I provide expectations for Q3 and fiscal year '25. We once again hit our financial commitments in Q2. We delivered total revenue exceeding $82 million, which is at the high end of our expectations, primarily on the strength of subscription deals closing earlier in the quarter.

Year-over-year, total revenue growth was impacted by a $13 million decline in revenue from the wind down of our nonstrategic legacy business. Taegis subscription revenue was $71 million, up 7% year-over-year. Total ARR increased 5% year-over-year to $290 million, in line with our expectations.

Our ARPC was $150,000, up 14% year-over-year and remains a premium to the industry average, underscoring the value that Taegis provides our customers. The growth in our ARPC was driven by strength in new logo and existing customer expansion. We ended the quarter with 1,900 Taegis customers. We saw new customers added in the quarter at a higher ARPC than the customers that churned.

As our Taegis pricing is largely on a per-endpoint basis, growth in endpoint is another indicator of platform expansion. Our endpoint count grew more than 9% year-over-year in the second quarter.

Our Q2 operating results are strong, reflecting our continued focus on operational efficiency, productivity improvements and cost discipline. Q2 non-GAAP Taegis subscription gross margin of 74.3% an improvement of 360 basis points versus second quarter a year ago, driven by automation, continued cloud architecture scaling and by leveraging our AI and machine learning capabilities across the business.

Total non-GAAP gross margin expanded by 680 basis points to approximately 69% in the quarter. Total non-GAAP gross margin expanded by 680 basis points to approximately 69% in the quarter. Total gross margins reflect the end of life of our other MSS business in Q1, resulting in revenue being nearly 0 in Q2.

Adjusted EBITDA was $1 million, in line with our guidance of $1 million to $3 million, and an improvement from a loss of $10 million in Q2 of the prior year. EBITDA was impacted with more than $1.3 million of redundant or transitional costs, associated with the end of life of our other MSS business.

GAAP net loss was $15 million for the second quarter or $0.17 per share compared with GAAP net loss of $32 million or $0.38 per share in the same period last year. Non-GAAP net income was breakeven or $0.00 per share compared with non-GAAP net loss of $9 million or $0.10 per share in the same period last year.

Turning to the balance sheet and capital allocation. We ended Q2 with a strong balance sheet with $48 million in cash, no debt, and an undrawn $50 million credit facility. Our cash flow from operations was $4 million in the quarter compared with $27 million used in the prior year period. The decreased use of our operating cash is driven by our focus on cost discipline, reduction in duplicative costs and increase in operational efficiencies.

As a reminder, our cash flow can fluctuate from quarter-to-quarter, with the first half seasonally being a use of cash, primarily due to the timing of annual incentive payouts and the second half typically generating cash from operations.

Now turning to third quarter and full year fiscal '25 guidance. For Q3 fiscal year '25, we expect total revenue of $80 million to $82 million, adjusted EBITDA to be between breakeven and $2 million and we expect a range of non-GAAP net loss per share of $0.01 to non-GAAP net income per share of $0.01. For the full year fiscal '25, we now expect total ARR to be $300 million or greater. Total revenue of $328 million to $335 million, total non-GAAP gross margins to be 68%, inclusive of Taegis gross margins to be 74%. Adjusted EBITDA to be between $6 million and $12 million; non-GAAP net income per share to be between $0.03 and $0.09 and cash flow from operations to be between cash use of $2 million and cash generated of $8 million, and we expect CapEx to be in line with fiscal year '24.

In closing, our Q2 results give us confidence in our ability to meet our 2025 outlook. We are executing on our growth strategy, and we'll continue to deliver additional value to our customers and partners by opportunistically investing in sales and marketing to accelerate our partner momentum and product development on new and innovative capabilities, both across add-on and native security products. We remain committed to EBITDA profitability as we continue to drive scale in our business.

Thank you for joining us on the call today. Wendy will now rejoin us as we begin Q&A. Operator, can you please introduce the first question.

[Operator]

[Operator Instructions]

Our first question comes from Hamza Fodderwala of Morgan Stanley.

[Hamza Fodderwala, analyst]

Maybe Wendy, I'll start with you. Obviously, a lot of macro uncertainty out there, but a very intense threat environment at the same time. I'm wondering, going into your new fiscal year, how are you feeling about the overall macro and spending environment? And then maybe Alpana for you, how are you feeling about your position from an investment in a sales capacity standpoint to really drive that top line growth sustainably going forward?

[Wendy Thomas, executive]

Thanks, Hamza, for the questions. When we look at the marketplace right now, we see continued good demand for cybersecurity in general and then specifically for Taegis the acceleration in our opportunity around kind of legacy technology displacement, vendor consolidation, particularly SIEM replacement. When we look at the sort of macro factors for us, our sales cycles were stable, if not slightly better, kind of within the range of recent times. So we haven't seen a big shift there.

And frankly, just given where we are in terms of about a little over 18 months into our Partner First strategy, we saw really good performance in terms of those relationships this quarter, highest win rates, 80% of new sales, increasing mix of deals coming from those partners.

So from our position in terms of market tailwinds as well as our execution around our Partner First strategy, we continue to see good demand going into the second half of our fiscal year.

[Alpana Wegner, executive]

Yes. This is Alpana, to address the second question that you had, just from the investment and sales capacity standpoint, I'd say a couple of things there. One is, we have done some, as you know, from last year, done some restructuring within our go-to-market organization, and we do feel like we've got the right seller profile today as well as the right capacity to be able to deliver on the top line. Our partner ecosystem, and as Wendy just said, the positive momentum that we're seeing there is a more efficient go-to-market. And we do see that, that is generating the capability for us to deliver greater sales productivity.

That being said, I do expect that, and you saw a little bit of that in Q2 that we'll continue to invest in the go-to-market as well as products. Those are 2 fundamental areas to ensure that we can hit what we want to do from a top line perspective. And from an overall perspective, I'd say sales and marketing where it came in on Q2 as a percentage of revenue is where we expect it to trend for the rest of the year.

[Operator]

Our next question comes from Mike Cikos of Needham.

[Michael Cikos, analyst]

I just wanted to cycle back to the prepared remarks, I think there was a comment that some deals had closed earlier in the quarter, which benefited subscription revenues, it doesn't sound like it from a macro standpoint, but just wanted to see like the positive from that would be, "hey, linearity in the quarter improved to a certain degree, if someone was to read that negatively, they would say, hey, maybe there was something macro related that may have weighed on demand in the back half of the quarter."

Can you just clarify that dynamic to make sure that we're all being thoughtful here on that?

[Alpana Wegner, executive]

Yes. No, it was a positive dynamic from our perspective, which is just typically we see more deals come in at the end of the quarter than at the beginning of the quarter. This is just unusual, in that we had some larger deals come through at the earlier part of the quarter. So definitely a positive from our perspective and did not necessarily pull away from what we saw towards the end of the quarter.

[Michael Cikos, analyst]

And anything to read as far as potential sustainability for that improved linearity? Or was this quarter maybe viewed as maybe too early to call a trend just yet.

[Alpana Wegner, executive]

Yes. I don't see it as a trend at this point. I would say that it was just a bit of an anomaly for that -- for Q2. Look, as most CFOs I would love to see it happen every quarter on a repetitive basis, but it's a little early to call that as a trend.

[Michael Cikos, analyst]

Terrific. And then just a quick follow-up, if I could. I know that we were saying how EBITDA this quarter was impacted by those redundant costs. I believe it was $1.3 million is what you guys had cited. Just as a reminder for the audience, can you help us think about what are the remaining transitional costs from that end of life of other MSS that still need to flush out? And how should we think about that over the rest of the year?

[Alpana Wegner, executive]

Yes. I'm happy to say that we've got those costs behind us at this point. As you look at the second half of the year, you will see that we've got no remaining costs from a legacy business, the other MSS, and as you saw in Q2, the revenue had already come down to a very de minimis amount. And so that goes to 0 as well as the cost. We're at a point where we've transitioned and completed the wind down completely at the end of Q2, which as you know, is a pretty significant milestone for us and really enables the team to be focused on purely the go-forward, which is very exciting for us.

[Wendy Thomas, executive]

Yes. And you didn't ask, but I mean, pretty tremendous execution by the team to complete that transition. This is what opens it up for us as a business to grow in total revenue and sustained profitability with a business that now has turned towards building go-to-market momentum and investing in that as well as new product innovation as we've been able to leverage the platform we've built to take on more security use cases with a lot of investment that's already been made. So great incremental growth opportunities for us.

[Michael Cikos, analyst]

Totally understand and excited to see that next chapter for SecureWorks. Thank you.

[Operator]

Our next question comes from Saket Kalia of Barclays.

[Unknown Analyst]

You have Karli on for Saket today. I think really, I want to focus on some of the trends that we're seeing in the industry, so first, given the consolidation that we've seen in the SIEM market recently, how are you and the team thinking about the velocity of some displacements in the industry right now, is this disruption creating opportunity for your broader Taegis platform? And I'd also love to just touch a little bit on the term that you've been talking about consolidation of spend in the industry, especially on the number of technology partners from customers. How is secure kind of positioned in that trend especially now with some of your newer products to really benefit from that trend of consolidation.

[Wendy Thomas, executive]

Thanks, Karli, it's Wendy. Glad to take that. So I'll speak to the SIEM particularly first, which is that, that has been an opportunity where we've increasingly seen customers more than ready to move away from noisy, hard and expensive to maintain SIEMs to an XDR approach to detection and response. So that trend is only accelerating. Players forging together to try to fight that trend or get scale to invest.

We started building this platform nearly 7 years ago now. That is a very difficult thing to replicate in terms of the capabilities that we bring to bare detection and automated response, so that is a trend that for us, we will continue to see more and more deals, I believe, moving to Taegis as a result.

When I think about the consolidation trend, the way we designed the platform was also keeping in mind that essentially niche security products would become features of the platform over time. And they would be able -- we'll be able to address with this holistic approach to shielding a customer's entire technology estate with an XDR platform, and our IDR launch is a great example of that exposure management, our EDR launch and sort of 2.0 launch of that last quarter, they're all examples of the ability for an integrated platform to provide complete protection, but at a really compelling return on investment for customers.

So in both the consolidation conversation with native controls as well as the core detection response capabilities to replace SIEMs, we like where we're positioned in the market in terms of those tailwinds.

[Operator]

[Operator Instructions]

Next question comes from Madeline Brooks of Bank of America.

[Madeline Brooks, analyst]

Wendy, this question is for you. There's a lot of positive signals from the quarter like endpoint growth, which is up more than 9%, ARPC up 14%, but then we're seeing ARR, which, correct me if I'm wrong, is majority Taegis is up only 5% and further degradation from last quarter. So I guess, can you just help us understand the dynamics of bridging the gap between these really good positive points like the endpoint growth and ARPC growth, but kind of why we're not seeing that reflect in revenue right now? Maybe talk through some net retention or return dynamics that could be impacting that.

[Wendy Thomas, executive]

Sure. Thanks for the question. We absolutely see some sort of leading and lagging indicators in terms of different growth vectors. And that's why we look across all of them. Endpoint growth is clearly important given the growth in our managed services partner business model, which, if you recall, is when we really count those as one end customer but continue to grow revenue, which drives our ARPC and our endpoint count according to those relationships. And that's why we continue to kind of break those apart to just give you visibility into the different routes to market that we have.

When I think about our ARR growth, we're very confident around the turn we're seeing in getting traction in our partner first model, both in terms of the partners we continue to sign with global reach, really high-quality scaled global reach type of partners, and our investments have increasingly turned towards the enablement and support of those customers. And as we exit 2Q and see the kind of growing pipeline as we head into the second half, it definitely underpins our confidence in our ability to see ARR endpoint and expansion in our ARPC continues.

[Madeline Brooks, analyst]

And maybe just one follow-up question there, too, is, has the dynamics changed as you've gotten to the end of sunsetting your legacy business? Because I think if I recall correctly, there were a lot of customers who were able to transition over to the Taegis platform. It was giving a nice boost to growth. So is that maybe weighing a little bit on growth rates as well just being naturally at the end of that transition period?

[Alpana Wegner, executive]

Yes. Madeline, this is Alpana. I'll maybe share a little bit there on what we're seeing from a churn perspective and where our focus is just from overall retention. To your point, the -- I would say the preponderance of any sort of carryover from that transition and the legacy customer base is, for the most part, behind us at this point. We do see just as any normal business where we do see some levels of attrition across the customer base. From an ARPC standpoint, we did see some variability in what we add from a new customer base being at a higher ARPC and the ones that are churning being at a lower ARPC.

There could be some connectivity there that you could make, which is, the lower ARPC from a fit perspective isn't really the sort of market segment that is looking for our type of MDR services is and those oftentimes can be a nice opportunity for us to share and to transfer those over to our MSSP partners because they are better suited for what they're offering.

So there might be a little bit of overhang there, but we would say the preponderance is sort of behind us. And really for us, the focus from a retention standpoint is around what we see is where we get good retention across our customer base is when we've got good, strong, deep relationships.

We've got the additional ROI and value that we can add to them through our product portfolio, which is very much centered on, as Wendy shared in her prepared remarks, the product portfolio expansion that we are investing in and focused on. And then I would say at the core is just the constant continuous improvement that we see across our platform and our delivery from a SecOps perspective in detection and response.

And that's really underpinned by the automation that you see that we're investing in and seeing some of the benefits of that, not only from what we can do with our customer base in terms of retentiveness, but also get a little bit of that benefit, obviously, from a gross margin perspective as well.

[Madeline Brooks, analyst]

Yes. Got it. That makes sense. And maybe just one more ending comment for me here is competitors in your space disclose the number of modules and other products that their customers are adopting across the base, right, some disclose 3-plus modules, other disclosing 8-plus modules, any qualitative discussions around kind of more product adoption would be helpful. And maybe going forward, it would be helpful to see some disclosures, the platform story takes place around number of products that your customers are adopting.

[Alpana Wegner, executive]

Yes. Thank you for that. And certainly, as we think more about the number of products that we're launching, we're in the early stages of that this year. It's definitely on our radar to be able to share that information because I think it will be to you quite meaningful for analysts and investors.

[Madeline Brooks, analyst]

Absolutely.

[Operator]

Thank you. There are currently no further questions at this time. Mr. Toomey, I'd like to turn the call back over to you.

[Kevin Toomey, executive]

Great. Thank you. That wraps the Q&A and today's call. A replay of this webcast will be available on our Investor Relations page at secureworks.com, along with our supplemental web deck and additional financial tables. Thanks for joining us today.

[Operator]

This concludes today's conference call. You may now disconnect your lines.