Q3 2022 SecureWorks Corp Earnings Call
Good morning, and welcome to the secure box third quarter fiscal 2022 financial results Conference call. Following prepared remarks, we will conduct a question and answer session. If you have a question simply press Star then one on your telephone keypad at any time during the presentation at this.
All participants are in a listen only mode.
We're webcasting this call live on the secure works Investor Relations website. After the completion of the call a recording of the call will be made available on the same site.
Now I will turn the call over to Andrew Storm, Vice President of Investor Relations you may begin.
Thanks, everyone for joining us.
Andrew Storm VP of Investor Relations at secure work and with me are Wendy Thomas our CEO and Paul Parrish, our CFO. 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 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.
I'll turn it over to Wendy.
Thank you Andrew and welcome everyone. Our focus that took care works 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 wont make an organization safe.
Because they failed to provide timely visibility into their entire technology infrastructure.
For effective security organizations require a holistic integrated detection and response platform.
That measurably reduces their business risk from cyber exposure.
Optimizes their investment and security solutions and addresses the shortage of experts security talent.
Our <unk> solutions were purpose built to solve these challenges.
First Tejas brings a comprehensive big data answer to security challenges.
Applying our analytics and wide breadth and depth of Detections.
Ross the endpoint network cloud email and beyond driving superior threat detection and enabling automated response.
With over 98% coverage against most categories at the mine or attack framework, Kansas excels at detecting and halting sophisticated attacks early in the kill chain.
Second pages 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 evaluating cages regularly call out our breath of integration is a key differentiator and shortening customer time to value.
And third with our 20 years of experience running scaled effective security operations built into the design of Tejas our platform enables significant improvements in our customers operating efficiency.
A recent Forrester study concluded tejas can reduce risk by 85% with average savings of $1 million over three years.
Solid return given our average spend per customer of 149000.
The market opportunity for us and our partners is large and growing with an estimated addressable market approaching 100 billion by 2025 growing in the double digits annually.
Reflecting the significant opportunity we're proud to announce that in the third quarter pages are our nearly tripled from last year, reaching $123 million.
And tejas customers increased 170% year over year to 800.
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 Tejas.
The incorporation of superior prevention helps further reduce customer security risk and allows customers to both consolidate and reduce overall security spend.
We recently launched a global Technology Alliance partner program with several initial partners, including AWS, Zee scalar correlate and others.
Because tejas was architected from the outside to be extensible, where.
Able to provide customer value quickly as we expand our technology alliance partner relationships.
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 use cases.
In fact, some displacement as a big opportunity for us.
Tim market for security is several billion dollars a year, despite the high cost to implement and maintain and low security efficacy or Tejas xdr use cases go beyond what <unk> promised but never delivered on especially on the response side.
Increasingly we're seeing companies put out rfps to upgrade their sims, but switched to buying pages instead.
As an example, we recently signed a you can't logistics company to a multi year deal.
This customer had an existing sim that they'd implemented but they were significant gaps in visibility and coverage and maintaining the system was requiring too much from there for member team.
They were falling behind.
So they put out an RFP to either supplement to support for their son or transition to another solution and 11 companies computer for the contract.
The company chose secure works pages for the following reasons.
First the security coverage went from 60% to 100%, reducing their financial risk of a breach.
Second our detectors and integrated soar capabilities, which are continuously updated and tuned by our data science and security experts reduce the workload on their team and significantly lower the operating costs. They initially budgeted for.
Third the simplicity of our pricing model resonated.
They weren't weary of data overage charges and preferred are simple predictable pricing model.
And finally, our standard offering met that requirement for a minimum year of log retention.
Big picture switching to Tejas XT are met all their needs cut their operating costs and have significantly reduced their risk and the deployment was far easier than the Sim had been.
I'm hearing the 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.
To wrap up on product I want to congratulate the team and call out some recent recognition.
Tejas Xdr, one the 2021 C. So choice award for Best Security analytics, IDC named US as a leader in our 2021 worldwide Internet readiness report covering both proactive and emergency incident response powered by the tedious platform and our vulnerability management product Tejas V D. R.
It was reviewed by S. C media with a conclusion, stating a novel and unique approach to removing much of the manual mindless work associated with vulnerability management.
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 are our customers.
In fact, a key to our success is the continuous and rapid innovation on pages fueled by the voice of our customers and our customers regularly expressed their appreciation for how quickly we address their feedback are.
Our customer centric approach is paying off.
Turning to go to market.
There is a large number of security service providers that could improve their security efficacy and operational efficiency with tejas.
As an example, this quarter we displaced a major competitor at an existing MSP in the Asia Pac region.
The Aha moment came during a demo when they realized our solution. So intuitive it could make their junior analysts far more effective.
<unk> has everything needed delivered to their fingertips, all the counter threat info researched telemetry all in one.
They had also worried the competitor solution was missing threat, but with our coverage fully transparent and in the public via our software adversary tool. They were confident pages provides superior coverage.
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.
The long term leader in managed security services, we take everything we've learned and accomplished and our 20 plus year history and provided to our partners, enabling them to deliver the same capabilities via our <unk> platform.
While we launched our MSP program in February we're excited by the results to date.
With 30, MSS piece signed and 19 fully certified with more in the pipeline.
We will continue to provide you updates on this front.
Finally, we announced to our customers and partners at the end of sale and end of life dates for the majority of our other managed security services.
We'll stop selling these services at the end of this fiscal year.
And we will not renew contracts with N 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 onto tejas well the majority of our other MSS services are a natural transition really an upgrade to pages. There are a handful of non strategic services, which we are transitioning to our MSP partners.
Or that our customers are taking in house.
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 cages to show them, how much incremental value. It offers.
Our team walk 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 endpoint and cloud telemetry.
And they were confident with the incident response support that reflects the real are unmanaged xdr.
The end result was re solutions to pages for 20% higher a R R with higher margins.
Part of the deal however was that they in sourced the firewall management, we have been providing.
Because of this the 20% lift in IRR was net of the loss of the firewall management revenue.
Normalizing for that we have been receiving 50% more <unk>.
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.
To bring this home sick care works 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 our focus 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.
With that I'll turn the call over to Paul Parrish.
Thanks, Good morning, two smart changes or continues to grow with over $123 million of iron ore at the end of the quarter up 22% over Q2 subscription revenue.
59% year over year, while other MSS revenue declined 12%.
Overall subscription revenues were down four 9% year over year as we continue our transformation journey.
Average revenue per customer was approximately $149000 continuing to generate a premium to our 98.
Our non <unk> customers.
Professional services revenues of $30 $7 million were down 8% with total revenue declined five 6% primarily related to reductions in non strategic business.
Been actively shedding calls through the exit of low margin services scaling support for our city based platform and driving automation throughout the business to improve margins.
The result is gross margins expanded 300 basis points year over year to 64% with non-GAAP subscription gross profit margins up 370 basis points, resulting in subscription gross profit of $400000 year over year. Despite the revenue decline.
Sales and marketing was relatively flat sequentially at 25% of revenue due to lower direct selling costs, largely offset by increased investments in channel and marketing.
R&D rose year over year to 23% of revenue as we continue investing to drive innovation on pages and maintain our lead in threat intelligence and research.
<unk> was down year over year.
Flat as a percent of revenue.
Adjusted EBITDA was $4 7 million down from $11 million last year as we invest in stages.
Cash flow provided by operations was $11 5 million.
With Capex of $1 6 million for the quarter.
Our balance sheet remains strong with $205 million of cash no debt and an untapped credit facility.
Looking forward to our guidance for FY 'twenty, two we expect full year total revenue to be $535 million to $537 million.
This implies fourth quarter revenue of $128 million to a $130 million.
We expect changes revenue to be between $90 million to $92 million.
Hey, just revenue is being impacted by the timing of re solution customers as we do not fully recognize revenue until our car services were completely shut down we're.
We're not losing the customer revenue is just being recognized as revenue and other MSS.
We are raising full year, adjusted EBITDA guidance to 9% to $11 million.
Looking to FY 'twenty, three we will provide guidance on our fourth quarter call.
We want to give some color on what to expect.
We are transforming <unk>, so 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.
Over the last 12 months subscription revenue declined by $12 $6 million non-GAAP subscription gross profits were up $5 million for a 320 basis points improvement in subscription gross margins.
The improvement in subscription gross margins provides the evidence that our business shift structurally improving for the better.
Looking to FY 'twenty three we expect these trends to continue as we push to finalize our transition.
Non strategic services will continue to be ahead of them.
<unk> in total IRR likely continuing to decline with a bottom no sooner than the back half of next year.
On the expense side gross margins should continue to expanding as our mix improves.
Further with growing industry recognition and a long list of customer referrals were going to increase investments in our brand awareness to drive growth.
While sales and marketing has been flat through the end of Q3, we expect investments in pages to continue increasing leading overall sales and marketing investments higher through next year.
R&D will also increase through next year as we continue to invest in our products and the outcomes they drive for our customers.
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&A operator can you. Please introduce the first question.
I will now open the call for questions. If you have a question press Star then one on your telephone keypad at a courtesy to others. Please ask no more than one quite well no more than two questions.
We'll take our first question from.
<unk> father Waller with Morgan Stanley Your line is open.
Hi, guys. Thank you for the time.
For Hamzah.
Maybe to start off my first question for Wendy can you. Please provide some more context on your partnership strategy for cages and any contribution you expect from the partnership pipeline.
Sure Good morning, and thanks for the question. So we in our history have always had.
Deep partnerships with 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.
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.
A blip at all and so we will continue to work with the leading products in the marketplace in order to to ensure that for our customers.
Awesome.
A follow up for Paul perhaps alright on pages can you. Please provide a breakout of net new logos versus conversion of the existing base.
So we've talked in the past about some kind of a balanced and so that balance is continuing between new logos and resolution of our base and so that continued in Q3.
Alright, thank you so much.
Thank you.
Our next question comes from Sterling Auty with Jpmorgan. Your line is open.
Yeah. Thanks, Hi, guys I Wonder if you could give us a little color on what the competitive landscape for Tejas looked like in the quarter on some of those new logos. So when you did fine that you went through an RFP process or were in kind of a shortlist comparison what is the other solutions that you are seeing most often.
Sure good morning.
The solution, we see when there is actually an RFP. It is quite often to replace a legacy Sim.
I think that's just kind of a lifecycle and customers are seeing the <unk>.
Cost of maintaining that are looking for a new solution and so those are really where we're where we have the opportunity to come in and show them, There's really a better solution around detection and an automated response with xdr that both saves them the cost of.
Setting up supporting and maintaining those with their own team as opposed to having us do all of that.
Detection build the advanced analytics enriching data with context mapping all of that to the minor tax framework, and then enabling them with faster time to response so the the.
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.
Got you and can you help us understand how are you managing head count through the transition, meaning are you able to reappropriate people as certain parts of the business are facing down can you reappropriate them into product related roles or is there.
Actual turnover that you have to manage through.
Sure. It's a great question and we are absolutely made an intentional effort around <unk>.
Leveraging the expertise of our team to continue to support our customers before they transition and then transition our teammates to support pages as our customers move as well now in total you'll see our head count 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 Tejas.
That.
Florida, you'll see you'll see continue.
Thank you.
Thank you. Our next question comes from the.
Heat calia with Barclays Capital Your line is open.
Okay, Great Hey, good morning, guys. Thanks for taking my questions here.
Hey, good morning, Paul maybe I will start with you.
Can 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 can you just flush that out a little bit a little bit just to just to better understand that.
Yes, I'm glad you are seeing the momentum because we're excited about the momentum with pages.
And so as we're continuing this journey of the transformation.
Yes, we can.
Quarters, where it will be a little bit stronger and the.
This growth is strong and it's just reflective of our continued momentum in our transformation.
Overall youll see some decline as I've mentioned in my comments as we look out into the future, but that's as we restructure and the proof points and that is the gross margin improvement. So we see this all consistent with our plan.
Got it.
That's very helpful. Maybe on the SaaS revenue, though specifically I think that was going I think the prior guide was $90 million to $100 million, that's getting nearer to $90 million to $92 million you brought up something around timing with.
With customers migrating can you just dig into into sort of how that works.
Yeah, so as a customer.
Agrees to re solution.
Some things internally that I walked through and the timing of that.
They have some some impact on how quickly they move over and so we will have some ebbs and flows of that but the overall revenue remains with our company.
Convert over to Texas.
Got it alright got it that's helpful. Wendy for you maybe for the follow up maybe just maybe just off the off the last question on Sim. Maybe the question is what do you find all the pain points that tejas solves versus a traditional Sim I mean, you gave an example, it sounds like cost is one of them one of them from a tech perspective, our security.
Perspective can you just dig into sort of why he just wins versus the traditional Sim.
Sure. It really has to do with it at the outset from the plug and play ability to integrate with their data sources, our ability to leverage our cloud based architecture to to do the analytics on that their team does not have to build and maintain now we absolutely provide.
The ability for customers to customize alerts or suppression rules of that kind of thing.
Specific to their environment or to help them with that but to do that on their behalf rather than them having to.
Staff and maintain a team to maintain the things that we've got a security expert like us can do on their behalf really save them.
Time and effort, let's their team focus on things specific to their organization and and.
Really the efficacy and the time to that efficacy is much faster as we deploy across the entire customer base.
Got it very helpful. Thank you.
Sure absolutely.
Thank you. Our next question comes from Brian Essex with Goldman Sachs. Your line is open.
Great. Good morning, and thank you for taking the question when do you I just wanted to ask.
If you could provide a little bit more detail about the machine learning endpoint prevention.
That you are introducing was that organically developed as their partner and what's what are the dynamics of that solution. What does it tend to look like relative to.
Some of the emerging.
Other options out there.
Sure absolutely. So that is a combination of partnership and integration with our technology and we've frankly been.
Hearing from customers that they have been unhappy with our existing prevention solution 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 learning approach. There is that we can automatically disrupt endpoint threat, so and the additional value is core for us and combining it is to enhance the investigations and the <unk> X drp's without prevention context, as well, but if you think about the the ideal.
Occasion of machine learning here, there is a tremendous amount of labeled data. So taking this approach versus a rules based approach to prevention.
Which is much easier to evade we find that it's much more effective for customers.
Okay, but just at this point, you're not indicating with a partner with dealers. So we can get an idea of the platform and the technology.
No we're not.
Okay.
Fair enough and then and then maybe maybe just to follow up with with the.
Tumors that have not agreed to resolution.
What is what is the nature of those customers why I guess, what's the primary reason why they're not risk solutions, how do you intend to manage that installed base.
It's kind of end of life moment.
Sure.
If you if you step back and look at that total subscription are are 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 targets.
Before rich loosening, if you will those customers largely are transitioning to pages.
When you look at the mix of the subscription customer count coming down what you see is that the b.
The average revenue on those customers, who are not moving are very small kind of sub sub 20, <unk>. So the shift to a holistic security solution on.
Pages with the with the full coverage just may not be the kind of comply.
Compliance check box play that they're looking for.
Got it got it very helpful. Thank you I'll jump back in the queue.
Okay.
Thank you and once again, if you would like to ask a question press. The Star then one key on your Touchtone telephone.
And our next question comes from Mike <unk> with Needham Your line is open.
Hey, guys. Thanks for taking my 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.
Tejas transition, but at the same time you guys are walking away from this.
Nonstrategic 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.
Are we expecting a bigger headwind as we look out to fiscal 'twenty three with some of the preliminary commentary you guys provided.
Sure. So as we as we do disclose the kind of total subscription <unk> and then the pages portion of that <unk>. What you can see is we're moving towards a shift where the inflection point comes of pages, becoming the majority of that mix, we see that happening next year.
As we move through that <unk>.
A majority of mix shift to changes the headwind on that will be will.
We will be coming behind us, but we definitely do see that continuing next year as we continue to execute the transition but expect the.
The bulk of that with a couple of exceptions in certain markets to be.
To be in the second half of next year and.
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 hereby 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.
Understood on the on the improving gross margin dynamics and profitability with the subscription Tejas.
But no no quantifiable.
Measurements as far as that non strategic headwinds that we're facing.
We are not quantifying that for reasons that we're going to fight for every dollar of that to keep competitors from coming after that over the course of next year.
Okay and then another question if I could just coming back to the.
Commentary on the pages revenue.
Those customers, who are re solution again it sounds like this.
It ties to.
With customer timelines right and they are coming off services before they go on to page <unk>.
I guess could 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.
Okay.
Alright so.
With hunger Karl Johnsen.
Our customers agree.
<unk> re solution.
And so we begin the timeline with them, which is a quick process for many.
<unk>.
For some there is some slowness there, but revenue stays the revenue of our company as they re solution. So the estimates that we gave early on pad.
Additional revenue that is still remaining in CTV that well loved and come over to take just as they fully resource. So just to give a little color as they.
As they potentially have.
One last data source, that's what they want to customize them to the platform if there's anything remaining.
From on the previous platform. It remains in that other MSS category until they are completely.
Off of the.
CGP platform.
We don't think we're not split understood.
Got it thank you.
Thank you and our last question comes from.
Second calia with Barclays. Your line is open.
Hey, guys. Sorry me again, just wanted to 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 <unk> 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.
Is there a point that MSS or the non pages non pages non fee.
Src revenue.
Approaches approach is really a point of materiality.
There was a lot there does that makes sense.
Well if you go back to our long term model, we cover during Investor day.
Our overall.
<unk> scripts and revenues will increase significantly 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 subscription.
Right well, we do see that.
Becoming the majority of next year.
And the total.
Subscription <unk> and so that's one to your point towards the end of next year. The the materiality of the other MSS if you will.
It starts to be less of an impactful headwind.
Understood understood got it that's very helpful. Thanks, guys.
Thank you and there are no other questions in the queue I would like to turn the call back to Paul Parrish for closing remarks.
Okay that wraps up the Q&A on today's call a replay of this webcast will be available on our Investor Relations page at secure works Dot com, along with our Q3 web deck with additional financial tables.
Thanks again for joining us today have a good day.
This concludes today's conference call. Thank you for participating you may now disconnect.
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