SecureWorks Q2 2025 Earnings Call Transcript

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September 5, 2024

There are 9 speakers on the call.

Operator

Good morning. My name is Carly, and I'll 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

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

Operator

Toomey, please begin.

Speaker 1

Thank you, operator. Good morning, and welcome to SecureWorks' Q2 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.

Speaker 1

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.

Speaker 2

Thank you, Kevin, and welcome, everyone. Our business continued its strong momentum in the 2nd quarter. CAGUS revenue grew 7% year over year to $71,000,000 and we delivered on our Q2 total revenue commitment. Annual recurring revenue or ARR now stands at $290,000,000 driven by the strength in new customer acquisitions and expansion. And our CAGI's average revenue per customer, or ARPC, expanded to $150,000 per customer.

Speaker 2

Our non GAAP Tejas gross margin of 74% remains strong, growing 3 60 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 Tejas 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. Antagius 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 in managed detection and response.

Speaker 2

In the Q2, we progressed our growth strategy in several key areas. Specifically, we launched Cajus 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 in 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 Q2, starting with a significant product advancement in identity security.

Speaker 2

1st, 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 compromise 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 a data breach reported last year was $4,500,000 In speaking with CISOs, this is often the number one 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 Cajus 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 multi factor authentication, are helpful but insufficient.

Speaker 2

Tejas IDR provides comprehensive attack surface coverage of credential access techniques, providing visibility into identity, 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 TASIS 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 TEGIS IDR and the results they are experiencing. Customers appreciate TEGIS 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.

Speaker 2

Cajus 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 Tejas Managed XDR Plus. Many organizations struggle to find tailored cybersecurity solutions that fit their unique needs at an affordable price. They often have to settle for 1 size fits all approaches that don't offer the proactive defenses they need for resilience. The TEGIS 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.

Speaker 2

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 multi year 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 in threat detection were falling on their lean team, which meant 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.

Speaker 2

This customer chose Managed XDR Plus with a personalized proactive approach to getting ahead of the risk, improving their security posture, addressing their regulatory compliance requirements, while scaling their security team, all at a meaningful return on investment. Our TAEUS platform is also supporting our go to market momentum, that 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. Via our TEGIS XDR platform, we are expanding to address a growing set of security use cases, such as identity and exposure management. Our open and integrated approach de risks the consolidation of technologies, with full visibility into the efficacy of CAGES endpoint controls, ensuring CAGES is well positioned as organizations reevaluate their security investments and resilience strategies.

Speaker 2

Our supportive 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 Ontagius, they immediately benefited from fewer higher fidelity detections with full threat context and automated response capabilities.

Speaker 2

The ability to seamlessly manage security operations 20 fourseven 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 Tagus 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.

Speaker 2

In Q2, approximately 80% of global Tejas new logo sales closed were partner deals, reflecting the security value Tejas based solutions bring to their customers. In Q2, we also continued to add to the more than 50 managed security services partners in our program. I'll highlight 1 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 Tejas 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 TAGES platform to drive higher retention and margin expansion for their business.

Speaker 2

Partnerships like this provide further validation of Tejas' 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, Tejas 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 clusters 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 CAGES security offerings remains strong. CAGES 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.

Speaker 2

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.

Speaker 3

Thanks, Wendy. Good morning, everyone. I will review our Q2 results before I provide expectations for Q3 and fiscal year 2025. We once again hit our financial commitments in Q2. We delivered total revenue exceeding $82,000,000 which was at the high end of our expectations, primarily on the strength of subscription deals closing earlier in the quarter.

Speaker 3

Year over year, total revenue growth was impacted by a 13,000,000 dollars decline in revenue from the wind down of our non strategic legacy business. Page's subscription revenue was $71,000,000 up 7% year over year. Total ARR increased 5% year over year to $290,000,000 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 Tejas provides our customers. The growth in our ARPC was driven by strength in new logo and existing customer expansion.

Speaker 3

We ended the quarter with 1900 Tejas customers. We saw new customers added in the quarter at a higher ARPC than the customers that churned. As our Tejas pricing is largely on a per endpoint basis, growth in endpoints is another indicator of platform expansion. Our endpoint count grew more than 9% year over year in the Q2. Our Q2 operating results were strong, reflecting our continued focus on operational efficiency, productivity improvements and cost discipline.

Speaker 3

Q2 non GAAP Tejas subscription gross margin of 74.3 percent, an improvement of 360 basis points versus Q2 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 6 80 basis points to approximately 69% in the quarter. Total non GAAP gross margin expanded by 6 80 basis points to approximately 69% in the quarter. Total gross margins reflect the MS life of our other MSS business in Q1, resulting in revenue being nearly 0 in Q2. Adjusted EBITDA was $1,000,000 in line with our guidance of $1,000,000 to $3,000,000 and an improvement from a loss of $10,000,000 in Q2 of the prior year.

Speaker 3

EBITDA was impacted with more than $1,300,000 of redundant or transitional costs associated with the end

Speaker 4

of life of our other MSS business.

Speaker 3

GAAP net loss was $15,000,000 for the Q2 or $0.17 per share compared with GAAP net loss of $32,000,000 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 $9,000,000 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 $48,000,000 in cash, no debt and an undrawn $50,000,000 credit facility. Our cash flow from operations was $4,000,000 in the quarter compared with $27,000,000 used in the prior year period.

Speaker 3

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 Q3 and full year fiscal 2025 guidance. For Q3 fiscal year 2025, we expect total revenue of $80,000,000 to $82,000,000 adjusted EBITDA to be between breakeven and $2,000,000 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 2025, we now expect total ARR to be $300,000,000 or greater, total revenue of $328,000,000 to 3 35,000,000 dollars total non GAAP gross margins to be 68%, inclusive of Tejas gross margins to be 74%. Adjusted EBITDA to be between $6,000,000 12,000,000 dollars non GAAP net income per share to be between $0.03 $0.09 cash flow from operations to be between cash used of $2,000,000 and cash generated of 8,000,000 dollars And we expect CapEx to be in line with fiscal year 2024.

Speaker 3

In closing, our Q2 results give us confidence in our ability to meet our 2025 outlook. We are executing on our growth strategy and will continue to deliver additional value to our customers and partners by opportunistically investing in sales and marketing to accelerate our partner momentum and in 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 and A.

Speaker 3

Operator, can you please introduce the first question?

Operator

Thank you. Our first question comes from Hamzah Fodderwala of Morgan Stanley. Hamzah, your line is now open.

Speaker 5

Hi, good morning. Thank you for taking my question. 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?

Speaker 5

And then, maybe I'll partner for you, how are you feeling about, your position from an investment and a sales capacity standpoint to really drive that top line growth sustainably going forward? Thank you.

Speaker 2

Good morning. Thanks Hamzah for the questions. When we look at the marketplace right now, we see continued good demand for cybersecurity in general. And then specifically for CAGES, the acceleration in our opportunity around legacy technology displacement, vendor consolidation, particularly SIM replacements. When we look at the macro factors for us, our sales cycles stable, if not slightly better, kind of within the range of recent times.

Speaker 2

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.

Speaker 4

Yes. And then to good morning, this is Alpana. To address the second question that you had, just from an investment in the 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.

Speaker 4

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 product. 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 track to trend, excuse me, for the rest of the year.

Speaker 1

Thank you.

Operator

Thank you very much. Our next question comes from Mike Kykos of Needham. Mike, your line is now open.

Speaker 6

Hey, guys. Thanks for taking the questions here. 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.

Speaker 6

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?

Speaker 4

Yes. No, it is 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 and 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.

Speaker 6

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?

Speaker 4

Yes. I don't see it as a trend at this point. I would say that it was just a bit of anomaly for that for Q2. Look, as most CFOs would, 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.

Speaker 6

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 $1,300,000 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?

Speaker 6

And how should we think about that over the rest of the year?

Speaker 4

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. So that goes to 0 as well as the cost.

Speaker 4

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.

Speaker 2

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 sustain profitability with the 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.

Speaker 6

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

Speaker 2

Thank you.

Operator

Thank you. Our next question comes from Saket Kalia of Barclays. Saket, your line is now open.

Speaker 7

Hi, thank you. You have Carly on for Saket today. Thank you so much for taking my questions. I think really I want to focus on some of the trends that we're seeing in the industry right now. So first, given the consolidation that we've seen in the SIM market recently, how are you and the team thinking about the velocity of SIM displacements in the industry right now?

Speaker 7

And is this disruption creating opportunity for your broader TEGIS platform? And I'd also love to just touch a little bit on that trend that you've been talking about consolidation spend in the industry, especially on the number of technology partners from customers. How is SecureWorks kind of positioned in that trend, especially now with some Thanks, Carly. It's Wendy. Glad to take that.

Speaker 7

So I'll speak to the SIMM

Speaker 2

Thanks, Carly. 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 SIMs to an XDR approach to detection and response. So that trend is only accelerating.

Speaker 2

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 bear to detection and automated response. So that is a trend that for us we will continue to see more and more deals that I believe moving to Tejas 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.

Speaker 2

And they would be able we would be able to address with this holistic approach to shielding a customer's entire technology estate with the NxDR 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 and response capabilities to replace SIEMs, we like where we're positioned in the market in terms of those tailwinds.

Speaker 7

Got it. Thank you so much.

Operator

Thank you. Our next question comes from Madelyn Brooks of Bank of America. Madelyn, your line is now open.

Speaker 8

Great. Can you guys hear me?

Speaker 2

Yes. Good morning.

Speaker 8

Okay. Good morning. Wendy, this question is for you. There's a lot of positive signals from the quarter like endpoint growth, which is up, I think you said more than 9%, ARPC up 14%. But then we're seeing ARR, which correct me if I'm wrong, is majority TEGIS is up only 5% and then further degradation from last quarter.

Speaker 8

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. Thank you.

Speaker 2

Sure. Good morning and thanks for the question. We absolutely see some sort of leading and lagging indicators in terms of different growth factors, 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 is 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.

Speaker 2

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 continue.

Speaker 8

Rita, maybe just one follow-up question there too is, have the dynamics in churn 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 Tagus platform that 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?

Speaker 4

Yes. Maybe, Madeline, this is Elpana. I'll maybe share a little bit there on what we're seeing from a churn perspective and where our focus is just from an overall retention. To your point, I would say the preponderance of any sort of carryover from the 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.

Speaker 4

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. 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.

Speaker 4

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 both 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. Yes.

Speaker 8

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? So some disclosed 3 plus modules, other disclosing 8 plus modules. Any qualitative discussions around kind of more product adoption would be helpful and maybe going forward would be helpful to see some disclosure as the platform story takes place around the number of products that your customers are adopting?

Speaker 8

That's it for me. Thanks.

Speaker 4

Yes. Thank you for that. And certainly as we think more about our 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 your point meaningful for analysts and investors. 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.

Speaker 1

Great. Thank you. That wraps the Q and A in 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.

Speaker 7

Thank you.

Operator

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

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