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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
 
(Mark One)
 
 
 
 
 
þ
 
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended November 2, 2018
or
¨
 
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from            to           
 
Commission File Number: 001-37748
http://api.tenkwizard.com/cgi/image?quest=1&rid=23&ipage=12584360&doc=11
 
SecureWorks Corp.
(Exact name of registrant as specified in its charter)
 
 
Delaware
 
27-0463349
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)
 
 
 
One Concourse Parkway NE Suite 500
 
 
Atlanta, Georgia
 
30328
(Address of principal executive offices)
 
(Zip Code)

(404) 327-6339
(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ  No o
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes þ   No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of "large accelerated filer," "accelerated filer," "smaller reporting company," and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer ¨
 
Accelerated filer þ
Non-accelerated filer ¨ 
 
Smaller reporting company ¨
 
 
Emerging growth company þ 
     If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. þ
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No þ
As of December 3, 2018, there were 81,702,294 shares of the registrant's common stock outstanding, consisting of 11,702,294 outstanding shares of Class A common stock and 70,000,000 outstanding shares of Class B common stock.





TABLE OF CONTENTS
 
 
 
 
 
ITEM
 
 
 
PAGE
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 








Except where the content otherwise requires or where otherwise indicated, all references in this report to "Secureworks," "we," "us," "our" and "our Company" to refer to SecureWorks Corp. and our subsidiaries on a consolidated basis.

Part I. Financial Information
Item 1. Financial Statements
SECUREWORKS CORP.
CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL POSITION (Unaudited)
(in thousands)
 
November 2,
2018
 
February 2, 2018*
 
 
 
 
ASSETS
Current assets:
 
 
 

Cash and cash equivalents
$
115,779

 
$
101,539

Accounts receivable, net of allowances of $6,487 and $8,246, respectively
134,355

 
157,764

Inventories, net
632

 
1,030

Other current assets
41,084

 
40,551

Total current assets
291,850

 
300,884

Property and equipment, net
31,112

 
33,457

Goodwill
416,487

 
416,487

Purchased intangible assets, net
213,382

 
234,184

Other non-current assets
79,182

 
72,069

Total assets
$
1,032,013

 
$
1,057,081

 
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
 
 
 
Accounts payable
$
23,387

 
$
23,266

Accrued and other
71,224

 
81,625

Short-term deferred revenue
148,937

 
137,697

Total current liabilities
243,548

 
242,588

Long-term deferred revenue
15,295

 
14,948

Other non-current liabilities
61,233

 
68,455

Total liabilities
320,076

 
325,991

Commitments and contingencies (Note 6)


 


Stockholders' equity:
 
 
 
Preferred stock - $0.01 par value: 200,000 shares authorized; 0 shares issued

 

Common stock - Class A of $.01 par value: 2,500,000 shares authorized; 11,729 and 11,085 issued and outstanding as of November 2, 2018 and February 2, 2018, respectively.
117

 
111

Common stock - Class B of $.01 par value: 500,000 shares authorized; 70,000 shares issued and outstanding as of November 2, 2018 and February 2, 2018
700

 
700

Additional paid in capital
879,726

 
867,411

Accumulated deficit
(164,485
)
 
(137,162
)
Accumulated other comprehensive (loss) income
(3,054
)
 
30

Treasury stock, at cost - 71 and 0 shares, respectively
(1,067
)
 

Total stockholders' equity
711,937

 
731,090

Total liabilities and stockholders' equity
$
1,032,013

 
$
1,057,081

* Certain prior period amounts have been adjusted as a result of the adoption of the accounting standard for revenue recognition set forth in ASC 606.
 The accompanying notes are an integral part of these condensed consolidated financial statements.

3



SECUREWORKS CORP.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)
(in thousands, except per share data)
 
Three Months Ended
 
Nine Months Ended
 
November 2, 2018
 
November 3, 2017*
 
November 2, 2018
 
November 3, 2017*
 
 

 
 

 
 
 
 
Net revenue
$
133,060

 
$
117,101

 
$
387,999

 
$
347,019

Cost of revenue
62,133

 
55,311

 
185,211

 
164,831

Gross margin
70,927

 
61,790

 
202,788

 
182,188

Research and development
21,114

 
19,501

 
65,921

 
58,673

Sales and marketing
34,773

 
34,084

 
105,964

 
105,695

General and administrative
21,619

 
22,896

 
69,235

 
67,438

Total operating expenses
77,506

 
76,481

 
241,120

 
231,806

Operating loss
(6,579
)
 
(14,691
)
 
(38,332
)
 
(49,618
)
Interest and other, net
1,074

 
116

 
2,582

 
(953
)
Loss before income taxes
(5,505
)
 
(14,575
)
 
(35,750
)
 
(50,571
)
Income tax benefit
(1,770
)
 
(5,189
)
 
(8,427
)
 
(17,637
)
Net loss
$
(3,735
)
 
$
(9,386
)
 
$
(27,323
)
 
$
(32,934
)
 
 
 
 
 
 
 
 
Loss per common share (basic and diluted)
$
(0.05
)
 
$
(0.12
)
 
$
(0.34
)
 
$
(0.41
)
Weighted-average common shares outstanding (basic and diluted)
80,892

 
80,355

 
80,751

 
80,254

 
 
 
 
 
 
 
 
* Certain prior period amounts have been adjusted as a result of the adoption of the accounting standard for revenue recognition set forth in ASC 606.
 The accompanying notes are an integral part of these condensed consolidated financial statements.



4



SECUREWORKS CORP.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS (Unaudited)
(in thousands)
 
Three Months Ended
 
Nine Months Ended
 
November 2, 2018
 
November 3, 2017*
 
November 2, 2018
 
November 3, 2017*
Net loss
$
(3,735
)
 
$
(9,386
)
 
$
(27,323
)
 
$
(32,934
)
Foreign currency translation adjustments, net of tax
(349
)
 
(251
)
 
(3,084
)
 
1,268

Comprehensive loss
$
(4,084
)
 
$
(9,637
)
 
$
(30,407
)
 
$
(31,666
)
* Certain prior period amounts have been adjusted as a result of the adoption of the accounting standard for revenue recognition set forth in ASC 606.
The accompanying notes are an integral part of these condensed consolidated financial statements.

5



SECUREWORKS CORP.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
(in thousands)
 
Nine Months Ended
 
November 2, 2018
 
November 3, 2017*
Cash flows from operating activities:
 
 
 
Net loss
$
(27,323
)
 
$
(32,934
)
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
 
 
 
Depreciation and amortization
30,872

 
31,320

Stock-based compensation expense
14,475

 
10,092

Effects of exchange rate changes on monetary assets and liabilities denominated in foreign currencies
(1,924
)
 
1,368

Income tax benefit
(8,427
)
 
(17,637
)
Provision for doubtful accounts
2,371

 
3,525

Changes in assets and liabilities:
 
 
 
Accounts receivable
20,756

 
(27,557
)
Net transactions with parent
2,272

 
9,415

Inventories
398

 
984

Other assets
(4,472
)
 
18,546

Accounts payable
573

 
(1,997
)
Deferred revenue
11,252

 
5,480

Accrued and other liabilities
(14,784
)
 
(3,810
)
Net cash provided by (used in) operating activities
26,039

 
(3,205
)
Cash flows from investing activities:
 

 
 

Capital expenditures
(6,974
)
 
(11,676
)
Net cash provided by (used in) investing activities
(6,974
)
 
(11,676
)
Cash flows from financing activities:
 

 
 

Principal payments on financing arrangement with Dell Financial Services
(1,104
)
 
(800
)
Taxes paid on vested restricted shares
(2,153
)
 
(1,224
)
Purchases of stock for treasury
(1,068
)
 

Payments on financed capital expenditures
(500
)
 

Net cash provided by (used in) financing activities
(4,825
)
 
(2,024
)
 
 
 
 
Net increase (decrease) in cash and cash equivalents
14,240

 
(16,905
)
Cash and cash equivalents at beginning of the period
101,539

 
116,595

Cash and cash equivalents at end of the period
$
115,779

 
$
99,690

* Certain prior period amounts have been adjusted as a result of the adoption of the accounting standard for revenue recognition set forth in ASC 606.
The accompanying notes are an integral part of these condensed consolidated financial statements.

6



SECUREWORKS CORP.
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (Unaudited)
(in thousands, except per share data)
 
 
Common Stock - Class A
 
Common Stock - Class B
 
 
 
 
 
 
 
 
 
 
 
 
Outstanding Shares
 
Amount
 
Outstanding Shares
 
Amount
 
Additional Paid in Capital
 
Accumulated Deficit
 
Accumulated Other Comprehensive (Loss) Income
 
Treasury
Stock
 
Total Stockholders' Equity
Balances, February 2, 2018*
 
11,085

 
$
111

 
70,000

 
$
700

 
$
867,411

 
$
(137,162
)
 
$
30

 
$

 
$
731,090

Net loss
 

 

 

 

 

 
(27,323
)
 

 

 
(27,323
)
Other comprehensive loss
 

 

 

 

 

 

 
(3,084
)
 

 
(3,084
)
Vesting of restricted stock units
 
551

 
5

 

 

 
(5
)
 

 

 

 

Grant of restricted stock awards
 
386

 
4

 

 

 
(4
)
 

 

 

 

Common stock withheld as payment for withholding taxes upon the vesting of restricted shares
 
(222
)
 
(2
)
 

 

 
(2,151
)
 

 

 

 
(2,153
)
Stock-based compensation
 

 

 

 

 
14,475

 

 

 

 
14,475

Shares repurchased
 
(71
)
 
(1
)
 

 

 

 

 

 
(1,067
)
 
(1,068
)
Balances, November 2, 2018
 
11,729

 
$
117

 
70,000

 
$
700

 
$
879,726

 
$
(164,485
)
 
$
(3,054
)
 
$
(1,067
)
 
$
711,937

* Certain prior period amounts have been adjusted as a result of the adoption of the accounting standard for revenue recognition set forth in ASC 606.
The accompanying notes are an integral part of these condensed consolidated financial statements.


7


SECUREWORKS CORP.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)


NOTE 1 — DESCRIPTION OF THE BUSINESS AND BASIS OF PRESENTATION
Description of the Business
SecureWorks Corp. (individually and collectively with its consolidated subsidiaries, "Secureworks" or the "Company") is a leading global provider of intelligence-driven information security solutions singularly focused on protecting the Company's clients from cyber attacks. The Company's solutions enable organizations of varying size and complexity to fortify their cyber defenses to prevent security breaches, detect malicious activity in near real time, prioritize and respond rapidly to security incidents and predict emerging threats.
On February 8, 2011, the Company was acquired by Dell Inc. (individually and collectively with its consolidated subsidiaries, "Dell" or "Parent"). On October 29, 2013, Dell was acquired by Dell Technologies Inc., formerly known as Denali Holding Inc. ("Dell Technologies"), a parent holding corporation. For the purposes of the accompanying financial statements, the Company elected to utilize pushdown accounting for the acquisition of Dell by Dell Technologies. On April 27, 2016, the Company completed its initial public offering ("IPO"). Upon the closing of the IPO, Dell Technologies owned, indirectly through Dell Inc. and Dell Inc.'s subsidiaries, no shares of the Company's outstanding Class A common stock and all outstanding shares of the Company's outstanding Class B common stock, which as of November 2, 2018 represented approximately 85.6% of the Company's total outstanding shares of common stock and approximately 98.4% of the combined voting power of both classes of the Company's outstanding common stock.
The Company has one primary business activity, which is to provide clients with intelligence-driven information security solutions. The Company's chief operating decision maker, who is the President and Chief Executive Officer, makes operating decisions, assesses performance, and allocates resources on a consolidated basis. Accordingly, Secureworks operates its business as a single reportable segment.
Basis of Presentation and Consolidation
The Company's condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP"). The preparation of financial statements in accordance with GAAP requires management to make estimates and assumptions that affect the amounts reported in the Company's financial statements. The condensed consolidated financial statements include assets, liabilities, revenue and expenses of all majority-owned subsidiaries. Intercompany transactions and balances are eliminated in consolidation.
For the periods presented, Dell has provided various corporate services to the Company in the ordinary course of business, including finance, tax, human resources, legal, insurance, IT, procurement and facilities-related services. The costs of these services are charged in accordance with a shared services agreement that went into effect on August 1, 2015. For more information regarding the charges for these services and related party transactions, see "Note 10—Related Party Transactions."
During the periods presented in the financial statements, Secureworks did not file separate federal tax returns, as the Company is generally included in the tax grouping of other Dell entities within the respective entity's tax jurisdiction. The income tax benefit has been calculated using the separate return method, modified to apply the benefits for loss approach. Under the benefits for loss approach, net operating losses or other tax attributes are characterized as realized or as realizable by Secureworks when those attributes are utilized or expected to be utilized by other members of the Dell consolidated group. See "Note 9—Income and Other Taxes" for more information.
The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with GAAP for interim financial information and the requirements of the Securities and Exchange Commission ("SEC"). Accordingly, they do not include all of the information and disclosures required by GAAP for complete financial statement presentation. The year-end condensed consolidated balance sheet data was derived from audited financial statements, but does not include all disclosures required by GAAP. In the opinion of management, all adjustments consisting of normal recurring accruals and disclosures considered necessary for a fair statement have been included. All inter-company accounts and transactions have been eliminated in consolidation. The accompanying condensed consolidated financial statements and related financial information should be read in conjunction with the audited financial statements and the related notes thereto for the year ended February 2, 2018 included in Part II, Item 8 of the Company's Annual Report on Form 10-K filed with the SEC on March 28, 2018 (the "Annual Report").

8


SECUREWORKS CORP.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

Fiscal Year
The Company’s fiscal year is the 52- or 53-week period ending on the Friday closest to January 31. The Company refers to the fiscal year ending February 1, 2019 and the fiscal year ended February 2, 2018 as fiscal 2019 and fiscal 2018, respectively. Both fiscal 2019 and fiscal 2018 have 52 weeks, and each quarter has 13 weeks.
Use of Estimates
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting periods. Estimates are revised as additional information becomes available. In the Condensed Consolidated Statements of Operations, estimates are used when accounting for revenue arrangements, determining the cost of revenue, allocating costs and estimating the impact of contingencies. In the Condensed Consolidated Statements of Financial Position, estimates are used in determining the valuation and recoverability of assets, such as accounts receivables, inventories, fixed assets, goodwill and other identifiable intangible assets, and estimates are used in determining the reported amounts of liabilities, such as taxes payable and the impact of contingencies, all of which also impact the Condensed Consolidated Statements of Operations. Actual results could differ from these estimates.
Revision of Previously Issued Financial Statements
During the fiscal year ended February 2, 2018, the Company revised its balance sheet as of and for the period ended February 3, 2017 as a result of the correction of an error related to prepaid expenses for which the Company had been invoiced, but for which cash had not been remitted. This error resulted in an overstatement of other current assets and accounts payable balances in the Consolidated Statements of Financial Position and had a corresponding impact to the changes in the balances in the Consolidated Statements of Cash Flows, with no impact on the cash used in operating activities, for the period ended February 3, 2017. The error had no impact on the Consolidated Statements of Operations. Management has concluded that the impact of the misstatement was not material to the previously issued financial statements. Additional information concerning the effect of this revision on the previously issued consolidated financial statements is provided in Note 1 to Consolidated Financial Statements included in Part II, Item 8 of the Annual Report.
Recently Adopted Accounting Pronouncements
Compensation - Stock Compensation—In May 2017, the Financial Accounting Standards Board (the "FASB") issued Accounting Standards Update ("ASU") No. 2017-09, "Compensation – Stock Compensation (Topic 718): Scope of Modification Accounting." The amendments in this update provide guidance about which changes to the terms or conditions of a share-based payment award require an entity to apply modification accounting under Topic 718. The Company adopted this guidance during the three months ended May 4, 2018 with no material impact on its condensed consolidated financial statements.
Statement of Cash Flows—In August 2016, the FASB issued ASU No. 2016-15, "Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments - A consensus of the FASB Emerging Issues Task Force." The update was issued with the objective of reducing the existing diversity in practice in how certain cash receipts and cash payments are presented and classified in the statement of cash flows under Topic 230 and other topics. The adoption of this standard had no impact on the Condensed Consolidated Statements of Cash Flows.
Revenue from Contracts with Customers—The Company adopted ASU 2014-09, "Revenue From Contracts With Customers" ("ASC 606") effective February 3, 2018 using the full retrospective method. The cumulative effect of the adoption was recognized as a decrease to accumulated deficit of $51.8 million on February 2, 2018 and impacted certain other prior period amounts. Certain amounts and disclosures set forth in this Quarterly Report on Form 10-Q have been updated to comply with the new ASC 606 standard.
Summary of Significant Accounting Policies
Except for the accounting policies for revenue, deferred revenue, deferred commissions and deferred installation costs updated as a result of adopting ASC 606 (including Subtopic 340-40), there have been no significant changes to the Company's significant accounting policies as of and for the three and nine months ended November 2, 2018, as compared to the significant accounting policies described in the Annual Report.
Revenue Recognition—Secureworks derives revenue primarily from two sources: (1) subscription revenue related to managed security and threat intelligence solutions; and (2) professional services, including security and risk consulting and incident response solutions.

9


SECUREWORKS CORP.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

Subscription-based arrangements typically include security solutions, the associated hardware appliance, up-front installation fees and maintenance agreements, which are all typically recognized over the life of the related agreement. The Company has determined that hardware appliances and the related maintenance agreement included in the subscription-based solutions arrangements are incapable of being distinct within the context of the contract as they are required to access the Company's Counter Threat Platform. Moreover, any related installation fees are non-refundable and also incapable of being distinct within the context of the contract. Therefore, the Company has deemed these arrangements as a single performance obligation within the context of a typical subscription-based arrangement. The revenue and any related costs for these deliverables are recognized ratably over the contract term, beginning on the date on which service is made available to clients. Amounts that have been invoiced, but for which the above revenue recognition criteria have not been met, are included in deferred revenue.
Professional services consist primarily of fixed-fee and retainer-based contracts. Revenue from these engagements is recognized using an input method over the contract term.
The Company reports revenue net of any revenue-based taxes assessed by governmental authorities that are imposed on, and concurrently with, specific revenue-producing transactions.
The Company recognizes revenue when all of the following criteria are met:
Identification of the contract, or contracts, with a customer—A contract with a customer exists when (i) the Company enters into an enforceable contract with a customer, (ii) the contract has commercial substance and the parties are committed to perform, and (iii) payment terms can be identified and collection of substantially all consideration to which the Company will be entitled in exchange for goods or services that will be transferred is deemed probable based on the customer's intent and ability to pay. Contracts entered into for professional services and subscription-based solutions near or at the same time are generally not combined as a single contract for accounting purposes, since neither the pricing nor the services are interrelated.
Identification of the performance obligations in the contract—Performance obligations promised in a contract are identified based on the goods or services that will be transferred to the customer that are both (i) capable of being distinct, whereby the customer can benefit from the goods or service either on its own or together with other resources that are readily available from third parties or from the Company, and (ii) distinct in the context of the contract, whereby the transfer of the goods or services is separately identifiable from other promises in the contract. When promised goods or services are incapable of being distinct, the Company accounts for them as a combined performance obligation. With regard to a typical contract for subscription-based solutions, the performance obligation represents a series of distinct services that will be accounted for as a single performance obligation. In a typical professional services contract, the Company has a separate performance obligation associated with each service. The Company is generally acting as a principal in each subscription-based and professional services arrangement and, thus, recognizes revenue on a gross basis.
Determination of the transaction price—The total transaction price is primarily fixed in nature as the consideration is tied to the specific services purchased by the customer, which constitutes a series for delivery of the solutions over the duration of the contract. For professional services contracts, variable consideration exists in the form of rescheduling penalties and expense reimbursements; no estimation is required at contract inception, since variable consideration is allocated to the applicable period.
Allocation of the transaction price to the performance obligations in the contract—The Company allocates the transaction price to each performance obligation based on the performance obligation's standalone selling price. Standalone selling price is determined by considering all information available to the Company, such as historical selling prices of the performance obligation, geographic location, overall strategic pricing objective, market conditions and internally approved pricing guidelines related to the performance obligations.
Recognition of revenue when, or as, the Company satisfies performance obligation—The Company recognizes revenue over time using a time-elapsed output method to measure progress (i.e., ratable recognition) for the subscription-based performance obligation over the contract term. For any upgraded installation services, which the Company has determined represent a performance obligation separate from its subscription-based arrangements, revenue is recognized over time using hours elapsed over the service term as an appropriate method to measure progress. For the performance obligation pertaining to professional services arrangements, the Company recognizes revenue over time using an input method based on time (hours or days) incurred to measure progress over the contract term.

10


SECUREWORKS CORP.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

As indicated above, the Company has one primary business activity, which is to provide clients with intelligence-driven information security solutions. The Company's chief operating decision maker, who is the President and Chief Executive Officer, makes operating decisions, assesses performance, and allocates resources on a consolidated basis. There are no segment managers who are held accountable for operations and operating results below the consolidated unit level. Accordingly, the Company is considered to be in a single reportable segment and operating unit structure.
The following table presents revenue by service type (in thousands):
 
 
Three Months Ended
 
Nine Months Ended
 
 
November 2, 2018
 
November 3, 2017
 
November 2, 2018
 
November 3, 2017
Managed Security Services revenue
 
$
100,521

 
$
91,937

 
$
297,656

 
$
272,357

Security and Risk Consulting revenue
 
32,539

 
25,164

 
90,343

 
74,662

Total revenue
 
$
133,060

 
$
117,101

 
$
387,999

 
$
347,019


Deferred Revenue (Contract Liabilities)—Deferred revenue represents amounts contractually billed to customers or payments received from customers for which revenue has not yet been recognized. Deferred revenue that is expected to be recognized within one year is recorded as short-term deferred revenue and the remaining portion is recorded as long-term deferred revenue.
The Company has determined that its contracts generally do not include a significant financing component. The primary purpose of the Company's invoicing terms is to provide customers with simplified and predictable ways of purchasing its solutions, not to receive financing from customers or to provide customers with financing. Examples of such terms include invoicing at the beginning of a subscription term with revenue recognized ratably over the contract period.
Deferred Commissions and Deferred Fulfillment Costs—The Company accounts for both costs to obtain a contract for a customer, which are defined as costs that the Company would not have incurred if the contract had not been obtained, and contract costs by capitalizing and systematically amortizing the assets on a basis that is consistent with the transfer to the customer of the goods or services to which the assets relate. These costs generate or enhance resources used in satisfying performance obligations that directly relate to contracts. Applying the practical expedient guidance, the Company recognizes the incremental costs of obtaining contracts as an expense when incurred if the amortization period of the incremental costs of obtaining contracts that the Company otherwise would have recognized is one year or less.
The Company's customer acquisition costs are primarily attributable to sales commissions and related fringe benefits earned by the Company's sales force and such costs are considered incremental costs to obtain a contract. Sales commissions for initial contracts are deferred and amortized taking into consideration the pattern of transfer to which assets relate and may include expected renewal periods where renewal commissions are not commensurate with the initial commission period. The Company recognizes the deferred commissions on a straight-line basis over the life of the customer relationship (estimated to be seven years) in sales and marketing expenses. These assets are classified as non-current, and included in other non-current assets in the Condensed Consolidated Statements of Financial Position. As of November 2, 2018 and February 2, 2018, the amount of deferred commissions included in other non-current assets was $60.5 million and $57.2 million, respectively.
Additionally, the Company incurs certain costs to install and activate hardware and software used in its managed security services, primarily related to a portion of the compensation for the personnel who perform the installation activities. The Company makes judgments regarding the fulfillment costs to be capitalized. Specifically, the Company capitalizes direct labor and associated fringe benefits using standards developed from actual costs and applicable operational data. The Company updates the information quarterly for items such as the estimated amount of time required to perform such activity. The Company capitalizes and amortizes these fulfillment costs on a straight-line basis over the economic life of the services, or approximately four years, in cost of revenue. As of November 2, 2018 and February 2, 2018, the amount of deferred fulfillment costs included in other non-current assets was $10.8 million and $10.2 million, respectively.


11


SECUREWORKS CORP.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

ASC 606 Adoption and Revision Impact to Previously Reported Results
The Company adjusted its condensed consolidated financial statements from amounts previously reported due to the retrospective adoption of ASC 606 and the revision discussed above.
Select unaudited condensed consolidated statements of financial position line items which reflect the adoption of ASC 606 are as follows (in thousands):
 
 
February 2, 2018
 
Adjustments for Adoption of
 
February 2, 2018
 
 
(as reported)
 
ASC 606
 
(as adjusted)
Current assets:
 
 
 
 
 
 
Other current assets
 
$
42,163

 
$
(1,612
)
 
$
40,551

Total current assets
 
302,496

 
(1,612
)
 
300,884

Other non-current assets
 
4,677

 
67,392

 
72,069

Total assets
 
$
991,301

 
$
65,780

 
$
1,057,081

 
 
 
 
 
 
 
Current liabilities:
 
 
 
 
 
 
Deferred revenue
 
$
139,632

 
$
(1,935
)
 
$
137,697

Total current liabilities
 
244,523

 
(1,935
)
 
242,588

Other non-current liabilities
 
52,681

 
15,774

 
68,455

Total liabilities
 
312,152

 
13,839

 
325,991

Stockholders' equity:
 
 
 
 
 
 
Accumulated deficit
 
(188,936
)
 
51,774

 
(137,162
)
Accumulated other comprehensive (loss) income
 
(137
)
 
167

 
30

Total stockholders' equity
 
$
679,149

 
$
51,941

 
$
731,090


Select unaudited condensed consolidated statements of operations line items which reflect the retrospective adoption of ASC 606 are as follows (in thousands):
 
 
Three Months Ended November 3, 2017
 
Adjustments for Adoption of
 
Three Months Ended November 3, 2017
 
 
(as reported)
 
ASC 606
 
(as adjusted)
Net revenue
 
$
117,534

 
$
(433
)
 
$
117,101

Cost of revenue
 
55,726

 
(415
)
 
55,311

Gross margin
 
61,808

 
(18
)
 
61,790

Total operating expenses
 
79,693

 
(3,212
)
 
76,481

Operating loss
 
(17,885
)
 
3,194

 
(14,691
)
Interest and other, net
 
121

 
(5
)
 
116

Income tax benefit
 
(6,163
)
 
974

 
(5,189
)
Net loss
 
$
(11,601
)
 
$
2,215

 
$
(9,386
)
 
 
 
 
 
 
 
Net loss per common share (basic and diluted)
 
$
(0.14
)
 
$
0.02

 
$
(0.12
)

12


SECUREWORKS CORP.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 
 
Nine Months Ended November 3, 2017
 
Adjustments for Adoption of
 
Nine Months Ended November 3, 2017
 
 
(as reported)
 
ASC 606
 
(as adjusted)
Net revenue
 
$
347,250

 
$
(231
)
 
$
347,019

Cost of revenue
 
165,993

 
(1,162
)
 
164,831

Gross margin
 
181,257

 
931

 
182,188

Total operating expenses
 
238,196

 
(6,390
)
 
231,806

Operating loss
 
(56,939
)
 
7,321

 
(49,618
)
Interest and other, net
 
(953
)
 

 
(953
)
Income tax benefit
 
(19,937
)
 
2,300

 
(17,637
)
Net loss
 
$
(37,955
)
 
$
5,021

 
$
(32,934
)
 
 
 
 
 
 
 
Net loss per common share (basic and diluted)
 
$
(0.47
)
 
$
0.06

 
$
(0.41
)
Select unaudited condensed consolidated statement of cash flows line items which reflect the retrospective adoption of ASC 606 and the impact of the revision discussed above are as follows (in thousands):
 
 
Nine Months Ended November 3, 2017
 
Adjustments for Adoption
 
Adjustments for
 
Nine Months Ended November 3, 2017
 
 
(as reported)
 
of ASC 606
 
Revision
 
(as adjusted)
Cash flows from operating activities:
 
 
 
 
 
 
 
 
Net loss
 
$
(37,955
)
 
$
5,021

 
$

 
$
(32,934
)
Adjustments to reconcile net loss to net cash used in operating activities:
 
 
 
 
 
 
 
 
Effects of exchange rate changes on monetary assets and liabilities denominated in foreign currencies
 
1,368

 

 

 
1,368

Income tax benefit
 
(19,058
)
 
1,421

 

 
(17,637
)
Changes in assets and liabilities:
 
 
 
 
 
 
 
 
Other assets
 
24,291

 
(7,553
)
 
1,808

 
18,546

Accounts payable
 
(189
)
 

 
(1,808
)
 
(1,997
)
Deferred revenue
 
5,249

 
231

 

 
5,480

Accrued and other liabilities
 
(4,690
)
 
880

 

 
(3,810
)
Net cash provided by (used in) operating activities
 
$
(3,205
)
 
$

 
$

 
$
(3,205
)

Recently Issued Accounting Pronouncements
Intangibles - Goodwill and Other - Internal-Use Software—In August 2018, the FASB issued ASU 2018-15, "Intangibles-Goodwill and Other-Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract." ASU 2018-15 aligns the requirements for capitalizing implementation costs in such cloud computing arrangements with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software. The updated guidance is effective for the Company for annual and interim periods beginning in the Company's 2021 fiscal year, with early adoption permitted. Entities may choose to adopt the new guidance prospectively or retrospectively. The Company is currently evaluating the impact of this guidance on its consolidated financial statements.

13


SECUREWORKS CORP.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

Intangibles - Goodwill and Other—In January 2017, the FASB issued ASU No. 2017-04, "Intangibles-Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment." ASU 2017-04 eliminates Step 2 of the goodwill impairment test, which required the Company to determine the implied fair value of goodwill by allocating the reporting unit's fair value to each of its assets and liabilities as if the reporting unit was acquired in a business acquisition. Instead, the updated guidance requires an entity to perform its annual or interim goodwill impairment test by comparing the fair value of the reporting unit to its carrying value, and recognizing a non-cash impairment charge for the amount by which the carrying value exceeds the reporting unit's fair value, with the loss not exceeding the total amount of goodwill allocated to that reporting unit. The updated guidance is effective for the Company for annual and interim periods beginning in the Company's 2021 fiscal year, with early adoption permitted, and will be applied on a prospective basis. The Company does not expect that the adoption of this standard will have a material impact on its consolidated financial statements.
Financial InstrumentsCredit Losses—In June 2016, the FASB issued ASU No. 2016-13, "Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments." The amendments in this update replace the incurred loss impairment methodology in current GAAP with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates. The update is effective for the Company for fiscal years beginning with the Company's 2021 fiscal year, including interim periods within those fiscal years. The Company is currently evaluating the impact of this guidance on its consolidated financial statements.
Leases—In February 2016, the FASB issued ASU No. 2016-02, "Leases (Topic 842)," which requires lessees to recognize most lease liabilities on their balance sheets but recognize the expenses on their income statements in a manner similar to current practice. The update states that a lessee would recognize a lease liability for the obligation to make lease payments and a right-to-use asset for the right to use the underlying asset for the lease term. Companies are required to use a modified retrospective approach for leases that exist or are entered into after the beginning of the earliest comparative period in the financial statements. The update is effective for the Company for annual and interim periods beginning with the Company's 2020 fiscal year, and early adoption is permitted. The Company continues to evaluate the impact of this guidance on its consolidated financial statements and related disclosures, but expects that most of its operating lease commitments will be subject to the new standard and recognized as operating lease liabilities and right-to-use assets upon adoption.
NOTE 2 — LOSS PER SHARE
Loss per share is calculated by dividing net loss for the periods presented by the respective weighted-average number of common shares outstanding, and excludes any dilutive effects of share-based awards as they would be anti-dilutive. Diluted loss per common share is computed by giving effect to all potentially dilutive common shares, including common stock issuable upon the exercise of stock options and unvested restricted common stock and restricted stock units. The Company applies the two-class method to calculate earnings per share. Because the Class A common stock and the Class B common stock share the same rights in dividends and earnings, earnings per share (basic and diluted) are the same for both classes. Since losses were incurred in all periods presented, all potential common shares were determined to be anti-dilutive.
The following table sets forth the computation of net loss per common share (in thousands, except per share amounts):
 
Three Months Ended
 
Nine Months Ended
 
November 2, 2018
 
November 3, 2017*
 
November 2, 2018
 
November 3, 2017*
Numerator:
 
 
 
 
 
 
 
Net loss
$
(3,735
)
 
$
(9,386
)
 
$
(27,323
)
 
$
(32,934
)
Denominator:
 

 
 

 
 
 
 
Weighted-average number of shares outstanding:
 
 
 

 
 
 
 
Basic and Diluted
80,892

 
80,355

 
80,751

 
80,254

 
 
 
 
 
 
 
 
Loss per common share:
 

 
 

 
 
 
 
Basic and Diluted
$
(0.05
)
 
$
(0.12
)
 
$
(0.34
)
 
$
(0.41
)
 
 
 
 
 
 
 
 
Weighted-average anti-dilutive stock options, non-vested restricted stock and restricted stock units
5,287

 
4,664

 
5,355

 
4,822


* Certain prior period amounts have been adjusted as a result of the adoption of the accounting standard for revenue recognition set forth in ASC 606.

14


SECUREWORKS CORP.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

NOTE 3 — CONTRACT BALANCES AND CONTRACT COSTS

Promises to provide services related to the Company's subscription-based solutions are accounted for as a single performance obligation over an average period of two years. Performance obligations related to the Company's professional service contracts are separate obligations associated with each service. Although the Company has many multi-year customer relationships for its professional service solutions, the contractual period is typically structured as a separate performance obligation and recognized over a duration of less than one year. The Company invoices its clients based on a variety of billing schedules. During the nine months ended November 2, 2018, on average, approximately half of the Company's recurring revenue was billed in advance. In addition, many of the Company's strategic risk consulting engagements are billed in advance of service commencement. Deferred revenue represents the aggregate amount of billing in advance of service delivery.
Changes to the Company's deferred revenue during the nine months ended November 2, 2018 are as follows (in thousands):
 
 
As of February 2, 2018*
 
Upfront payments received and billings during the nine months ended November 2, 2018
 
Revenue recognized during the nine months ended November 2, 2018
 
As of November 2, 2018
Deferred revenue
 
$
152,645

 
$
171,946

 
$
(160,359
)
 
$
164,232

* Certain prior period amounts have been adjusted as a result of the adoption of the accounting standard for revenue recognition set forth in ASC 606.
Remaining Performance Obligation
The remaining performance obligation represents the transaction price allocated to contracted revenue that has not yet been recognized, which includes deferred revenue and non-cancellable contracts that will be invoiced and recognized as revenue in future periods. The remaining performance obligation consists of two elements: (i) the value of remaining services to be provided through the contract term for client's whose services have been activated ("active"); and (ii) the value of services contracted with clients that have not yet been installed ("backlog"). Backlog is not recorded in revenue, deferred revenue or elsewhere in the condensed consolidated financial statements until the Company establishes a contractual right to invoice at which point it is recorded as revenue or deferred revenue as appropriate. The Company applies the practical expedient in ASC paragraph 606-10-50-14(a) and does not disclose information about remaining performance obligations that are part of a contract that has an original expected duration of one year or less. Additionally, the Company has elected to use the practical expedient to not disclose backlog related to the comparative period under ASC 606-10-65.
The Company expects that the amount of backlog relative to the total value of its contracts will change from year to year due to several factors, including the amount invoiced at the beginning of the contract term, the timing and duration of the Company's customer agreements, varying invoicing cycles of agreements and changes in customer financial circumstances. Accordingly, any fluctuations in backlog are not always a reliable indicator of future revenues.
As of November 2, 2018, the Company expects to recognize remaining performance obligations as follows (in thousands):
 
 
Total
 
Expected to be recognized in the next 12 months
 
Expected to be recognized in 12-24 months
 
Expected to be recognized in 24-36 months
 
Expected to be recognized thereafter
Performance obligation - active
 
$
228,589

 
$
127,245

 
$
70,859

 
$
26,714

 
$
3,771

Performance obligation - backlog
 
$
53,037

 
$
18,883

 
$
18,883

 
$
14,553

 
$
718

Total
 
$
281,626

 
$
146,128

 
$
89,742

 
$
41,267

 
$
4,489



15


SECUREWORKS CORP.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

Deferred Commissions and Fulfillment Costs
The Company capitalizes a significant portion of its commission expense and related fringe benefits earned by its sales personnel. Additionally, the Company capitalizes certain costs to install and activate hardware and software used in its managed security services, primarily related to a portion of the compensation for the personnel who perform the installation activities. These deferred costs are amortized on a systematic basis that is consistent with the transfer to the customer of the goods or services to which the assets relate.
Changes in the balance of total deferred commission and total deferred fulfillment costs during the nine months ended November 2, 2018 are as follows (in thousands):
 
 
As of February 2, 2018
 
Amount capitalized
 
Amount recognized
 
As of November 2, 2018
Deferred commissions
 
$
57,229

 
$
13,938

 
$
(10,643
)
 
$
60,524

Deferred fulfillment costs
 
10,163

 
4,426

 
(3,779
)
 
10,810


The Company did not record any impairment losses on the deferred commissions or deferred fulfillment costs during the three and nine months ended November 2, 2018.
NOTE 4 — GOODWILL AND INTANGIBLE ASSETS
Goodwill relates to the acquisition of Dell by Dell Technologies and represents the excess of the purchase price attributable to Secureworks over the fair value of the assets acquired and liabilities assumed. There were no additions, adjustments or impairments to goodwill during the periods presented. Accordingly, goodwill totaled $416.5 million as of November 2, 2018 and February 2, 2018.

Goodwill and indefinite-lived intangible assets are tested for impairment on an annual basis during the third fiscal quarter, or earlier if an indicator of impairment occurs. The Company completed the most recent annual impairment test by performing a quantitative assessment of goodwill at the reporting unit level. In performing this quantitative assessment, the Company, using a combination of discounted cash flows and market approach (comparable market prices) to determine fair value of the reporting unit, compared the fair value to its carrying value. The assumptions used in the valuation are consistent with those which the Company believes hypothetical market participants would use. After performing the assessment, the Company determined that it was not more likely than not that the fair value of the Secureworks reporting unit was less than its carrying amount, which would not indicate a potential impairment as of November 2, 2018. Additionally, through a quantitative assessment using a discounted cash flow model, the Company determined that the fair value of the other indefinite-lived intangible asset exceeded its carrying value as of November 2, 2018.
Intangible Assets
The Company's intangible assets as of November 2, 2018 and February 2, 2018 were as follows:
 
 
November 2, 2018
 
February 2, 2018
 
 
Gross
 
Accumulated
Amortization
 
Net
 
Gross
 
Accumulated
Amortization
 
Net
 
 
(in thousands)
Customer relationships
 
$
189,518

 
$
(73,628
)
 
$
115,890

 
$
189,518

 
$
(63,058
)
 
$
126,460

Technology
 
135,584

 
(68,210
)
 
67,374

 
135,584

 
(57,978
)
 
77,606

Finite-lived intangible assets
 
325,102

 
(141,838
)
 
183,264

 
325,102

 
(121,036
)
 
204,066

Trade name
 
30,118

 

 
30,118

 
30,118

 

 
30,118

Total intangible assets
 
$
355,220

 
$
(141,838
)
 
$
213,382

 
$
355,220

 
$
(121,036
)
 
$
234,184



Amortization expense related to finite-lived intangible assets was approximately $6.9 million and $20.8 million for each of the three and nine months ended November 2, 2018 and November 3, 2017, respectively. Amortization expense is included within cost of revenue and general and administrative in the Condensed Consolidated Statements of Operations. There were no impairment charges related to intangible assets during the three and nine months ended November 2, 2018 and November 3, 2017.

16


SECUREWORKS CORP.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

NOTE 5 — DEBT
Revolving Credit Facility
On November 2, 2015, SecureWorks, Inc., a wholly-owned subsidiary of SecureWorks Corp., entered into a revolving credit agreement with a wholly-owned subsidiary of Dell Inc. under which the Company obtained a $30 million senior unsecured revolving credit facility. This facility was initially available for a one-year term beginning on April 21, 2016 and was extended on the same terms for an additional one-year term ending on April 21, 2018. During the three months ended May 4, 2018, the facility was amended and restated to extend the maturity date to March 27, 2019 and to reduce the annual rate at which interest accrues to the applicable London Interbank Offered Rate plus 1.15%.
Under the facility, up to $30 million principal amount of borrowings may be outstanding at any time. Amounts under the facility may be borrowed, repaid, and reborrowed from time to time during the term of the facility. The proceeds from loans made under the facility may be used for general corporate purposes. The credit agreement contains customary representations, warranties, covenants and events of default. The unused portion of the facility is subject to a commitment fee of 0.35%, which is due upon expiration of the facility.
The maximum amount of borrowings may be increased by up to an additional $30 million by mutual agreement of the lender and borrower. The borrower will be required to repay, in full, all of the loans outstanding, including all accrued interest, and the facility will terminate upon a change of control of SecureWorks Corp. or following a transaction in which SecureWorks, Inc. ceases to be a direct or indirect wholly-owned subsidiary of SecureWorks Corp. The facility is not guaranteed by SecureWorks Corp. or its subsidiaries. There was no outstanding balance under the credit facility as of November 2, 2018 or February 2, 2018.
NOTE 6 — COMMITMENTS AND CONTINGENCIES
Legal ContingenciesFrom time to time, the Company is involved in claims and legal proceedings that arise in the ordinary course of business. The Company accrues a liability when it believes that it is both probable that a liability has been incurred and that it can reasonably estimate the amount of the loss. The Company reviews the status of such matters at least quarterly and adjusts its liabilities as necessary to reflect ongoing negotiations, settlements, rulings, advice of legal counsel and other relevant information. Whether the outcome of any claim, suit, assessment, investigation or legal proceeding, individually or collectively, could have a material adverse effect on the Company's business, financial condition, results of operations or cash flows will depend on a number of factors, including the nature, timing and amount of any associated expenses, amounts paid in settlement, damages or other remedies or consequences. To the extent new information is obtained and the Company's views on the probable outcomes of claims, suits, assessments, investigations or legal proceedings change, changes in accrued liabilities would be recorded in the period in which such a determination is made. As of November 2, 2018, the Company does not believe that there were any such matters that, individually or in the aggregate, would have a material adverse effect on its business, financial condition, results of operations or cash flows.
Client-based Taxation ContingenciesVarious government entities ("taxing authorities") require the Company to bill its clients for the taxes they owe based on the services they purchase from the Company. The application of the rules of each taxing authority concerning which services are subject to each tax and how those services should be taxed involves the application of judgment. Taxing authorities periodically perform audits to verify compliance and include all periods that remain open under applicable statutes, which generally range from three to four years. These audits could result in significant assessments of past taxes, fines and interest if the Company were found to be non-compliant. During the course of an audit, a taxing authority may question the Company's application of its rules in a manner that, if the Company were not successful in substantiating its position, could result in a significant financial impact to the Company. In the course of preparing its financial statements and disclosures, the Company considers whether information exists that would warrant disclosure or an accrual with respect to such a contingency.
Indemnifications—In the ordinary course of business, the Company enters into contractual arrangements under which it agrees to indemnify its clients from certain losses incurred by the client as to third-party claims relating to the services performed on behalf of the Company or for certain losses incurred by the client as to third-party claims arising from certain events as defined within the particular contract. Such indemnification obligations may not be subject to maximum loss clauses. Historically, payments related to these indemnifications have been immaterial.
Concentrations—The Company sells solutions to clients of all sizes primarily through its direct sales organization, supplemented by sales through channel partners. The Company had no client that represented 10% or more of its net revenue for the three and nine months ended November 2, 2018 or November 3, 2017.

17


SECUREWORKS CORP.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

NOTE 7 — STOCKHOLDERS' EQUITY

On September 26, 2018, the Company's board of directors authorized a stock repurchase program, under which the Company is authorized to repurchase up to $15 million of the Company's Class A common stock through September 30, 2019. Repurchases may be made from time to time through open market purchases, in privately negotiated transactions, or in other types of transactions. The timing and amount of any repurchases under the program will be determined by management based upon market conditions and other factors. During the three and nine months ended November 2, 2018, the Company repurchased 70,783 shares of Class A common stock at an average price of $15.09, for an aggregate cost of $1.1 million. As of November 2, 2018, $13.9 million remained available for further purchases under the stock repurchase program.
NOTE 8 — STOCK-BASED COMPENSATION AND OTHER LONG-TERM PERFORMANCE INCENTIVES
The Company's board of directors adopted the SecureWorks Corp. 2016 Long-Term Incentive Plan (the "2016 Plan") effective April 18, 2016. The 2016 Plan provides for the grant of options, stock appreciation rights, restricted stock, restricted stock units, deferred stock units, unrestricted stock, dividend equivalent rights, other equity-based awards, and cash bonus awards. Awards may be granted under the 2016 Plan to individuals who are employees, officers, or non-employee directors of the Company or any of its affiliates, consultants and advisors who perform services for the Company or any of its affiliates, and any other individual whose participation in the 2016 Plan is determined to be in the best interests of the Company by the compensation committee of the board of directors. During the nine months ended November 2, 2018, the 2016 Plan was amended to increase the total shares of Class A common stock available for issuance by an additional 4,000,000 shares, which are now available for grants under the 2016 Plan.
In March 2017, the Company began granting long-term performance cash awards to certain employees under the 2016 Plan. The employees who receive these performance cash awards do not receive equity awards as part of the long-term incentive program. The long-term performance cash awards are subject to various performance conditions and vest in equal annual installments over a three-year period. The Company made no grants of such cash awards for the three months ended November 2, 2018 and granted $15.7 million of such cash awards for the nine months ended November 2, 2018. The Company made no grants of such cash awards during the three months ended November 3, 2017 and granted $11.6 million of such cash awards for the nine months ended November 3, 2017. The Company recognized compensation expense of $1.6 million and $5.1 million for the three and nine months ended November 2, 2018, respectively, and compensation expense of $0.5 million and $1.6 million for the three and nine months ended November 3, 2017, respectively, related to the long-term performance cash awards under the plan.
Under the 2016 Plan, the Company granted 131,600 and 1,850,008 restricted stock units for the three and nine months ended November 2, 2018 respectively, and 4,740 and 758,478 restricted stock units for the three and nine months ended November 3, 2017, respectively. The Company granted no restricted stock awards during the three months ended November 2, 2018 and November 3, 2017, and 405,000 and 283,988 restricted stock awards during the nine months ended November 2, 2018 and November 3, 2017, respectively. The annual restricted stock unit and restricted stock awards granted during fiscal 2019 and fiscal 2018 vest over a three-year period and approximately 50% of such awards are subject to performance conditions.    
NOTE 9 — INCOME AND OTHER TAXES
The Company's effective income tax rate for the three and nine months ended November 2, 2018 and November 3, 2017 was as follows:    
 
Three Months Ended
 
Nine Months Ended
 
November 2, 2018
 
November 3, 2017*
 
November 2, 2018
 
November 3, 2017*
 
 
 
 
 
 
 
 
Loss before income taxes
$
(5,505
)
 
$
(14,575
)
 
$
(35,750
)
 
$
(50,571
)
Income tax benefit
$
(1,770
)
 
$
(5,189
)
 
$
(8,427
)
 
$
(17,637
)
Effective tax rate
32.2
%
 
35.6
%
 
23.6
%
 
34.9
%

* Certain prior period amounts have been adjusted as a result of the adoption of the accounting standard for revenue recognition set forth in ASC 606.

18


SECUREWORKS CORP.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

During the periods presented in the accompanying condensed consolidated financial statements, the Company did not file separate federal tax returns as the Company generally was included in the tax grouping of other Dell entities within the respective entity's tax jurisdiction. The income tax benefit has been calculated using the separate return method, modified to apply the benefits-for-loss approach. Under the benefits-for-loss approach, net operating losses or other tax attributes are characterized as realized by the Company when those attributes are utilized by other members of the Dell consolidated group.
The change in the Company's effective income tax rate for the three and nine months ended November 2, 2018 compared to the effective income tax rate for the three and nine months ended November 3, 2017 was primarily driven by lower U.S. corporate income tax rate from 35% to 21% and the impact of the minimum tax on foreign earnings from the enactment of the U.S. Tax Cuts and Jobs Act ("U.S. Tax Reform Act" or the "Act"). The Company’s effective tax rate for the nine months ended November 2, 2018 also includes the discrete impact of approximately $0.3 million relating to the impact of the vesting of certain equity awards for which the fair value on the vesting date was lower than the fair value on the date the equity awards were originally granted. This change in fair value, which is measured by the price of the Class A common stock as reported on the NASDAQ Global Select Market, resulted in a lower actual tax deduction than was deducted for financial reporting purposes.
The U.S. Tax Reform Act was enacted in December 2017. GAAP requires the effect of changes in tax laws to be recognized in the period that includes enactment date. Among other things, the U.S. Tax Reform Act decreases the U.S. corporate income tax, establishes a modified territorial system by requiring a mandatory deemed repatriation tax on undistributed earnings of foreign subsidiaries (the "Transition Tax") and requires a minimum tax on certain future earnings generated by foreign subsidiaries. Due to the complexities involved in accounting for the enactment of the Act, SEC Staff Accounting Bulletin No. 118 ("SAB 118") allows companies to record provisional amounts in earnings for the first year following the Act's enactment, with those provisional amounts required to be finalized by the end of that year.
In accordance with GAAP and SAB 118, the Company recognized a provisional tax benefit in the fourth quarter of fiscal 2018 of $27.0 million primarily attributable to the remeasurement of deferred tax assets and liabilities at the lower statutory rate. This tax benefit was net of an expense estimate of approximately $0.6 million for the impact of the Transition Tax. The provisional estimates were made based on the Company's initial analysis using available information and estimates. During the nine months ended November 2, 2018, the Company recorded an adjustment to the provisional benefit recognized in fiscal 2018 of approximately $0.4 million due to a change in the remeasurement of a deferred tax liability. No other adjustments have been made to the provisional amounts recorded in the fourth quarter of fiscal 2018. The Company will complete its determination of the accounting implications of the U.S. Tax Reform Act in the fourth quarter of fiscal 2019. As indicated above, the Company is included in the tax groupings of other Dell entities and recognizes a tax benefit when its tax attributes are utilized by other members of the Dell consolidated group. Adjustments to these provisional estimates could have an impact on the Company's future financial results. Additionally, further regulatory or GAAP accounting guidance regarding the U.S. Tax Reform Act also could impact the Company's future financial results.
As of November 2, 2018 and February 2, 2018, the Company had $4.0 million of deferred tax assets related to net operating loss carryforwards for state tax returns that are not included with those of other Dell entities. These net operating loss carryforwards began expiring in the fiscal year ended February 2, 2018. Due to the uncertainty surrounding the realization of these net operating loss carryforwards, the Company has provided valuation allowances for the full amount as of November 2, 2018 and February 2, 2018. Because the Company is included in the tax filings of other Dell entities, management has determined that it will be able to realize the remainder of its deferred tax assets. If the Company's tax provision had been prepared using the separate return method, the unaudited pro forma pre-tax loss, tax benefit and net loss for the nine months ended November 2, 2018 would have been $35.8 million, $4.3 million and $31.5 million, respectively, as a result of the recognition of a valuation allowance that would have been recorded on certain deferred tax assets as well as certain attributes from the U.S. Tax Reform Act that would be lost if not utilized by the Dell consolidated group.
Net deferred tax balances are included in other non-current assets and other non-current liabilities in the Condensed Consolidated Statements of Financial Position.
As of November 2, 2018 and February 2, 2018, the Company had $23.4 million and $21.4 million, respectively, of a net operating loss tax receivable from Dell. The Company had $0.4 million and $0.8 million of unrecognized tax benefits as of November 2, 2018 and February 2, 2018, respectively.

19


SECUREWORKS CORP.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

NOTE 10 — RELATED PARTY TRANSACTIONS
Allocated Expenses
For the periods presented, Dell has provided various corporate services to Secureworks in the ordinary course of business. The costs of services provided to Secureworks by Dell are governed by a shared services agreement between Secureworks and Dell Inc. or its wholly-owned subsidiaries. The total amounts of the charges under the shared services agreement with Dell were $0.9 million and $2.9 million for the three and nine months ended November 2, 2018, respectively, and $1.1 million and $3.7 million for the three and nine months ended November 3, 2017, respectively. Management believes that the basis on which the expenses have been allocated is a reasonable reflection of the utilization of services provided to or the benefit received by the Company during the periods presented.
Related Party Arrangements
For the periods presented, related party transactions and activities involving Dell Inc. and its wholly-owned subsidiaries were not always consummated on terms equivalent to those that would prevail in an arm's-length transaction where conditions of competitive, free-market dealing may exist.
The Company purchases computer equipment for internal use from Dell that is capitalized within property and equipment in the Condensed Consolidated Statements of Financial Position. These purchases were made at pricing that is intended to approximate arm's-length pricing. Purchases of computer equipment from Dell and EMC Corporation, a wholly-owned subsidiary of Dell ("EMC"), totaled $0.8 million and $2.2 million for the three and nine months ended November 2, 2018, respectively, and $36 thousand and $1.5 million for the three and nine months ended November 3, 2017, respectively.
EMC, a company that provides enterprise software and storage, maintains a majority ownership interest in a subsidiary, VMware, Inc. ("VMware"), that provides cloud and virtualization software and services. The Company's purchases of annual maintenance services, software licenses and hardware systems for internal use from Dell, EMC and VMware totaled $0.6 million and $1.1 million for the three and nine months ended November 2, 2018, respectively, and $0.3 million and $1.0 million for the three and nine months ended November 3, 2017, respectively. Approximately $3.0 million of the purchases from VMware prior to the three months ended November 2, 2018 were financed through Dell Financial Services, of which approximately $1.1 million of such purchases were included in intercompany liabilities as of November 2, 2018.
The Company recognized revenue related to solutions provided to other subsidiaries of Dell, consisting of RSA Security LLC and Pivotal Software, Inc. The revenue recognized by the Company for security solutions provided to these entities totaled $0.1 million and $0.3 million for the three and nine months ended November 2, 2018, respectively, and $0.1 million and $0.2 million for the three and nine months ended November 3, 2017, respectively. Purchases by the Company from these subsidiaries totaled $0.2 million and $0.7 million for the three and nine months ended November 2, 2018, respectively. The Company had purchases from these subsidiaries of $4 thousand and $38 thousand for the three and nine months ended November 3, 2017.
The Company recognized revenue related to solutions provided to significant beneficial owners of Secureworks, which include Michael S. Dell, Chairman and Chief Executive Officer of Dell Technologies and Dell Inc. and Silver Lake Partners III, L.P. The revenues recognized by the Company from solutions provided to Mr. Dell, including MSD Capital, L.P. (a firm founded for the purposes of managing investments of Mr. Dell and his family), DFI Resources LLC and the Michael and Susan Dell Foundation, as well as Silver Lake Partners III, L.P., totaled $0.2 million and $0.3 million for the three and nine months ended November 2, 2018, respectively, and $0.1 million and $0.3 million for the three and nine months ended November 3, 2017, respectively.
The Company provides solutions to certain clients whose contractual relationship has historically been with Dell rather than Secureworks, although the Company has the primary responsibility to provide the services. Effective August 1, 2015, upon the creation of new subsidiaries to segregate some of the Company's operations from Dell's operations, many of such client contracts were transferred from Dell to the Company, forming a direct contractual relationship between the Company and the end client. For clients whose contracts have not yet been transferred and for contracts subsequently originated through Dell under a reseller agreement, the Company recognized revenues of approximately $14.5 million and $43.6 million for the three and nine months ended November 2, 2018, respectively, and approximately $11.2 million and $31.6 million for the three and nine months ended November 3, 2017, respectively.
As the Company's client and on behalf of certain of its own clients, Dell also purchases solutions from the Company at pricing that is intended to approximate arm's-length pricing. Such revenues totaled approximately $3.8 million and $13.9 million for the three and nine months ended November 2, 2018, respectively, and $5.7 million and $18.3 million for the three and nine months ended November 3, 2017, respectively.

20


SECUREWORKS CORP.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

As a result of the foregoing related party arrangements, the Company has recorded the following related party balances in the Condensed Consolidated Statements of Financial Position as of November 2, 2018 and February 2, 2018. During the third quarter of fiscal 2017, the Company began settling in cash its related party balances with Dell on a quarterly basis.
 
 
November 2, 2018
 
February 2, 2018
 
 
(in thousands)
Intercompany receivable
 
$

 
$

Intercompany payable
 
(20,837
)
 
(19,580
)
Net intercompany payable (in accrued and other)
 
$
(20,837
)
 
$
(19,580
)
 
 
 
 
 
Accounts receivable from clients under reseller agreements with Dell (included in accounts receivable, net)
 
$
23,623

 
$
25,229

 
 
 
 
 
Net operating loss tax sharing receivable under agreement with Dell (included in "Other current assets" and "Other non-current assets" at November 2, 2018 and in "Other current assets" at February 2, 2018)
 
$
23,362

 
$
21,380


NOTE 11 — FAIR VALUE MEASUREMENTS
The Company measures fair value within the guidance of the three-level valuation hierarchy. This hierarchy is based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date. The categorization of a measurement within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement. The three levels are defined as follows:
Level 1 - Quoted market prices in active markets for identical assets or liabilities
Level 2 - Other observable market-based inputs or unobservable inputs that are corroborated by market data
Level 3 - Significant unobservable inputs
Assets and Liabilities Measured at Fair Value on a Recurring Basis
The assets and liabilities of the Company that are measured at fair value on a recurring basis using the respective input levels as of November 2, 2018 and February 2, 2018 were as follows:
 
 
 
November 2,
2018
 
February 2, 2018
 
 
 
Level 1
 
Level 1
 
 
 
(in thousands)
Cash equivalents - Money Market Funds
 
$
65,250

 
$
58,967


Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis
The carrying amounts of the Company's accounts receivable, accounts payable and accrued expenses approximate their respective fair value due to their short-term nature.

21



Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
This management's discussion and analysis is based upon the financial statements of Secureworks which have been prepared in accordance with accounting principles generally accepted in the United States, or GAAP, and should be read in conjunction with our audited financial statements and related notes for the year ended February 2, 2018 included in Part II, Item 8 of our Annual Report on Form 10-K as filed with the SEC on March 28, 2018, which we refer to as the Annual Report. In addition to historical financial information, the following discussion contains forward-looking statements that reflect our plans, estimates and beliefs. Our actual results could differ materially from those discussed or implied in our forward-looking statements. Factors that could cause or contribute to these differences include those discussed in "Risk Factors" in Part I, Item 1A of our Annual Report.
Our fiscal year is the 52- or 53-week period ending on the Friday closest to January 31. We refer to the fiscal year ending February 1, 2019 and the fiscal year ended February 2, 2018 as fiscal 2019 and fiscal 2018, respectively. Fiscal 2019 and fiscal 2018 each have 52 weeks, and each quarter has 13 weeks. All percentage amounts and ratios presented in this management's discussion and analysis were calculated using the underlying data in thousands. Unless otherwise indicated, all changes identified for the current-period results represent comparisons to results for the prior corresponding fiscal periods.
Except where the context otherwise requires or where otherwise indicated, (1) all references to "Secureworks," "we," "us," "our," and "our Company" in this management's discussion and analysis refer to SecureWorks Corp. and our subsidiaries on a consolidated basis, (2) all references to "Dell" refer to Dell Inc. and its subsidiaries on a consolidated basis and (3) all references to "Dell Technologies" refer to Dell Technologies Inc., the ultimate parent company of Dell Inc.
Overview
We are a leading global cybersecurity company that protects organizations in the digitally connected world. We combine visibility from thousands of clients, machine learning and automation from our industry-leading SecureWorks Counter Threat PlatformTM, and actionable insights from our team of elite researchers and analysts to create a powerful network effect that provides increasingly strong protection for our clients. By aggregating and analyzing data from various sources around the world, we prevent security breaches, detect malicious activity in real time, respond rapidly and predict emerging threats.
Our mission is to unlock the value of our clients' security investments by simplifying their complex security operations and amplifying their defenses. Through our vendor-neutral approach, we create integrated and comprehensive solutions by proactively managing the collection of "point" products deployed by our clients to address specific security issues and provide supplemental solutions where gaps exist in our clients' defenses. We customize the right level of security for each client's unique situation, which evolves as the client's organization grows and changes.
We have pioneered an integrated approach that delivers a broad portfolio of information security solutions to organizations of varying size and complexity. Our flexible and scalable solutions support the evolving needs of the largest, most sophisticated enterprises staffed with in-house security experts, as well as small and medium-sized businesses and government agencies with limited in-house capabilities and resources.
Our solutions enable organizations to:
prevent security breaches by fortifying their cyber defenses,
detect malicious activity,
respond rapidly to security breaches, and
predict emerging threats.
The solutions leverage our proprietary technologies, processes and extensive expertise in the information security industry, which we have developed over more than 18 years. Key elements of our strategy include:
maintain and extend our technology leadership,
expand and diversify our client base,
deepen our existing client relationships, and
attract and retain top talent.
Our intelligence-driven information security solutions offer an innovative approach to prevent, detect, respond to and predict cybersecurity breaches. Through our managed security offerings, which are sold on a subscription basis, we provide global visibility and insight into malicious activity, enabling our clients to detect and effectively remediate threats quickly. Threat intelligence, which is typically deployed as part of our managed security offerings, delivers early warnings of vulnerabilities

22



and threats along with actionable information to help prevent any adverse impact. In addition to these solutions, we also offer a variety of professional services, which include security and risk consulting and incident response. Through security and risk consulting, we advise clients on a broad range of security and risk-related matters. Incident response minimizes the impact and duration of security breaches through proactive client preparation, rapid containment and thorough event analysis followed by effective remediation. We continuously evaluate potential investments and acquisitions of businesses, services and technologies that could complement our existing offerings. We have a single organization responsible for the delivery of our security solutions, which enables us to respond quickly to our clients' evolving needs and help them secure themselves against cyber attacks.
The fees we charge for our solutions vary based on a number of factors, including the solutions selected, the number of client devices covered by the selected solutions, and the level of management we provide for the solutions. Approximately 77% of our revenue is derived from subscription-based solutions, attributable to managed security contracts, while approximately 23% is derived from professional services engagements. As we respond to the evolving needs of our clients, the relative mix of subscription-based solutions and professional services we provide our clients may fluctuate.
Key Operating Metrics
In recent years, we have experienced broad growth across our portfolio of intelligence-driven information security solutions being provided to all sizes of clients. We have achieved much of this growth by providing solutions to large enterprise clients, which generate substantially more average revenue than our small and medium-sized business, or SMB, clients and by continually expanding the volume and breadth of the security solutions that we provide to all clients. This has resulted in steady growth in our average revenue per client. This growth has required continuous investment in our business, resulting in net losses. We believe these investments are critical to our success, although they may continue to impact our profitability.
We believe the operating metrics described below provide further insight into the long-term value of our subscription agreements and our ability to maintain and grow our client relationships. Relevant key operating metrics are presented below as of the dates indicated and for the quarterly periods then ended: