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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
 
(Mark One)
 
 
 
 
 
 
 
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended August 2, 2019
 
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=13097690&doc=13
 
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)
 

(Registrant’s telephone number, including area code): (404) 327-6339
Not Applicable
(Former name, former address and former fiscal year, if changed since last report)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Trading Symbol(s)
Name of each exchange on which registered
Class A Common Stock, 
SCWX
The NASDAQ Stock Market LLC
par value $0.01 per share
(NASDAQ Global Select Market)
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   No 
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    No 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a 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
Non-accelerated filer  
 
Smaller reporting company 
 
 
 
Emerging growth company
     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.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes  No 
As of September 3, 2019, there were 81,202,365 shares of the registrant's common stock outstanding, consisting of 11,202,365 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)
 
August 2,
2019
 
February 1,
2019
 
 
 
 
ASSETS
Current assets:
 
 
 

Cash and cash equivalents
$
117,716

 
$
129,592

Accounts receivable, net of allowances of $6,118 and $6,160, respectively
120,104

 
141,344

Inventories, net
1,090

 
468

Other current assets
24,591

 
27,604

Total current assets
263,501

 
299,008

Property and equipment, net
33,210

 
35,978

Operating lease right-of-use assets, net
25,034

 

Goodwill
416,487

 
416,487

Purchased intangible assets, net
192,580

 
206,448

Other non-current assets
90,463

 
78,238

Total assets
$
1,021,275

 
$
1,036,159

 
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
 
 
 
Accounts payable
$
19,224

 
$
16,177

Accrued and other
61,757

 
86,495

Short-term deferred revenue
165,206

 
157,865

Total current liabilities
246,187

 
260,537

Long-term deferred revenue
15,997

 
16,064

Operating lease liabilities, non-current
27,800

 

Other non-current liabilities
62,980

 
66,851

Total liabilities
352,964

 
343,452

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 $0.01 par value: 2,500,000 shares authorized; 11,203 and 11,016 issued and outstanding, respectively.
112

 
110

Common stock - Class B of $0.01 par value: 500,000 shares authorized; 70,000 shares issued and outstanding
700

 
700

Additional paid in capital
887,014

 
884,567

Accumulated deficit
(194,793
)
 
(176,263
)
Accumulated other comprehensive (loss) income
(4,826
)
 
(2,884
)
Treasury stock, at cost - 1,257 and 819 shares, respectively
(19,896
)
 
(13,523
)
Total stockholders' equity
668,311

 
692,707

Total liabilities and stockholders' equity
$
1,021,275

 
$
1,036,159


 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
 
Six Months Ended
 
August 2, 2019
 
August 3, 2018
 
August 2, 2019
 
August 3, 2018
 
 

 
 

 
 
 
 
Net revenue
$
136,605

 
$
128,778

 
$
269,447

 
$
254,939

Cost of revenue
63,595

 
62,548

 
126,436

 
123,078

Gross margin
73,010

 
66,230

 
143,011

 
131,861

Research and development
24,863

 
22,453

 
47,505

 
44,807

Sales and marketing
38,047

 
35,521

 
76,240

 
71,191

General and administrative
25,146

 
22,419

 
48,784

 
47,616

Total operating expenses
88,056

 
80,393

 
172,529

 
163,614

Operating loss
(15,046
)
 
(14,163
)
 
(29,518
)
 
(31,753
)
Interest and other, net
1,950

 
1,003

 
2,218

 
1,508

Loss before income taxes
(13,096
)
 
(13,160
)
 
(27,300
)
 
(30,245
)
Income tax benefit
(2,836
)
 
(3,391
)
 
(8,770
)
 
(6,657
)
Net loss
$
(10,260
)
 
$
(9,769
)
 
$
(18,530
)
 
$
(23,588
)
 
 
 
 
 
 
 
 
Loss per common share (basic and diluted)
$
(0.13
)
 
$
(0.12
)
 
$
(0.23
)
 
$
(0.29
)
Weighted-average common shares outstanding (basic and diluted)
80,674

 
80,839

 
80,571

 
80,680

 
 
 
 
 
 
 
 

 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
 
Six Months Ended
 
August 2, 2019
 
August 3, 2018
 
August 2, 2019
 
August 3, 2018
Net loss
$
(10,260
)
 
$
(9,769
)
 
$
(18,530
)
 
$
(23,588
)
Foreign currency translation adjustments, net of zero tax
(1,709
)
 
(1,165
)
 
(1,942
)
 
(2,735
)
Comprehensive loss
$
(11,969
)
 
$
(10,934
)
 
$
(20,472
)
 
$
(26,323
)


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)
 
Six Months Ended
 
August 2, 2019
 
August 3, 2018
Cash flows from operating activities:
 
 
 
Net loss
$
(18,530
)
 
$
(23,588
)
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
 
 
 
Depreciation and amortization
21,148

 
20,512

Stock-based compensation expense
10,525

 
9,642

Effects of exchange rate changes on monetary assets and liabilities denominated in foreign currencies
(1,650
)
 
(1,275
)
Income tax benefit
(8,770
)
 
(6,657
)
Other non cash impacts
1,830

 

Provision for doubtful accounts
1,026

 
1,571

Changes in assets and liabilities:
 
 
 
Accounts receivable
20,147

 
22,542

Net transactions with parent
(12,902
)
 
(1,334
)
Inventories
(622
)
 
407

Other assets
5,514

 
(5,162
)
Accounts payable
7,423

 
(1,392
)
Deferred revenue
7,175

 
12,240

Accrued and other liabilities
(19,082
)
 
(16,620
)
Net cash provided by operating activities
13,232

 
10,886

Cash flows from investing activities:
 

 
 

Capital expenditures
(10,659
)
 
(5,366
)
Net cash used in investing activities
(10,659
)
 
(5,366
)
Cash flows from financing activities:
 

 
 

Principal payments on financing arrangement with Dell Financial Services

 
(1,104
)
Taxes paid on vested restricted shares
(8,072
)
 
(2,139
)
Purchases of stock for treasury
(6,377
)
 

Payments on financed capital expenditures

 
(500
)
Net cash used in financing activities
(14,449
)
 
(3,743
)
 
 
 
 
Net (decrease)/increase in cash and cash equivalents
(11,876
)
 
1,777

Cash and cash equivalents at beginning of the period
129,592

 
101,539

Cash and cash equivalents at end of the period
$
117,716

 
$
103,316


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)




Three Months Ended August 2, 2019
 
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, May 3, 2019
 
11,521

 
$
116

 
70,000

 
$
700

 
$
882,012

 
$
(184,533
)
 
$
(3,117
)
 
$
(14,433
)
 
$
680,745

Net loss
 

 

 

 

 

 
(10,260
)
 

 

 
(10,260
)
Other comprehensive loss
 

 

 

 

 

 

 
(1,709
)
 

 
(1,709
)
Vesting of restricted stock units
 
90

 

 

 

 

 

 

 

 

Grant of restricted stock awards
 

 

 

 

 

 

 

 

 

Common stock withheld as payment for withholding taxes upon the vesting of restricted shares
 
(8
)
 

 

 

 
(607
)
 

 

 

 
(607
)
Stock-based compensation
 

 

 

 

 
5,609

 

 

 

 
5,609

Shares repurchased
 
(400
)
 
(4
)
 

 

 

 

 

 
(5,463
)
 
(5,467
)
Balances, August 2, 2019
 
11,203

 
$
112

 
70,000

 
$
700

 
$
887,014

 
$
(194,793
)
 
$
(4,826
)
 
$
(19,896
)
 
$
668,311




Six Months Ended August 2, 2019
 
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 1, 2019
 
11,016

 
$
110

 
70,000

 
$
700

 
$
884,567

 
$
(176,263
)
 
$
(2,884
)
 
$
(13,523
)
 
$
692,707

Net loss
 

 

 

 

 

 
(18,530
)
 

 

 
(18,530
)
Other comprehensive loss
 

 

 

 

 

 

 
(1,942
)
 

 
(1,942
)
Vesting of restricted stock units
 
907

 
9

 

 

 
(9
)
 

 

 

 

Grant of restricted stock awards
 
122

 
1

 

 

 
(1
)
 

 

 

 

Common stock withheld as payment for withholding taxes upon the vesting of restricted shares
 
(404
)
 
(4
)
 

 

 
(8,068
)
 

 

 

 
(8,072
)
Stock-based compensation
 

 

 

 

 
10,525

 

 

 

 
10,525

Shares repurchased
 
(438
)
 
(4
)
 

 

 

 

 

 
(6,373
)
 
(6,377
)
Balances, August 2, 2019
 
11,203

 
$
112

 
70,000

 
$
700

 
$
887,014

 
$
(194,793
)
 
$
(4,826
)
 
$
(19,896
)
 
$
668,311




7



Three Months Ended August 3, 2018
 
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, May 4, 2018
 
11,704

 
$
117

 
70,000

 
$
700

 
$
870,122

 
$
(150,981
)
 
$
(1,540
)
 
$

 
$
718,418

Net loss
 

 

 

 

 

 
(9,769
)
 

 

 
(9,769
)
Other comprehensive loss
 

 

 

 

 

 

 
(1,165
)
 

 
(1,165
)
Vesting of restricted stock units
 
97

 
1

 

 

 
(1
)
 

 

 

 

Grant of restricted stock awards
 

 

 

 

 

 

 

 

 

Common stock withheld as payment for withholding taxes upon the vesting of restricted shares
 
(4
)
 

 

 

 
(126
)
 

 

 

 
(126
)
Stock-based compensation
 

 

 

 

 
4,912

 

 

 

 
4,912

Balances, August 3, 2018
 
11,797

 
$
118

 
70,000

 
$
700

 
$
874,907

 
$
(160,750
)
 
$
(2,705
)
 
$

 
$
712,270




Six Months Ended August 3, 2018
 
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
 

 

 

 

 

 
(23,588
)
 

 

 
(23,588
)
Other comprehensive loss
 

 

 

 

 

 

 
(2,735
)
 

 
(2,735
)
Vesting of restricted stock units
 
545

 
5

 

 

 
(5
)
 

 

 

 

Grant of restricted stock awards
 
386

 
4

 

 

 
(4
)
 

 

 

 

Common stock withheld as payment for withholding taxes upon the vesting of restricted shares
 
(219
)
 
(2
)
 

 

 
(2,137
)
 

 

 

 
(2,139
)
Stock-based compensation
 

 

 

 

 
9,642

 

 

 

 
9,642

Balances, August 3, 2018
 
11,797

 
$
118

 
70,000

 
$
700

 
$
874,907

 
$
(160,750
)
 
$
(2,705
)
 
$

 
$
712,270

* 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.


8

SECUREWORKS CORP.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)


NOTE 1DESCRIPTION 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 technology-driven information security solutions singularly focused on protecting the Company's customers from cyber attacks.
On April 27, 2016, the Company completed its initial public offering ("IPO"). Upon the closing of the IPO, Dell Technologies Inc. ("Dell Technologies"), a parent holding corporation, owned, indirectly through Dell Inc. (individually and collectively with its consolidated subsidiaries, "Dell") 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 August 2, 2019 represented approximately 86.2% 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 customers with software-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, 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 11—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 10—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 1, 2019 included in Part II, Item 8 of the Company's Annual Report on Form 10-K filed with the SEC on March 28, 2019 (the "Annual Report").
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 January 31, 2020 and the fiscal year ended February 1, 2019 as fiscal 2020 and fiscal 2019, respectively. Both fiscal 2020 and fiscal 2019 have 52 weeks, and each quarter has 13 weeks.

9

SECUREWORKS CORP.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

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.
Recently Adopted Accounting Pronouncements
Leases—The Company adopted Accounting Standards Update ("ASU") No. 2016-02, "Leases (Topic 842)," effective February 2, 2019. Accounting Standards Codification ("ASC") 842 "Leases" requires lessees to recognize operating lease right-of-use ("ROU") assets, representing their right to use the underlying asset for the lease term, and lease liabilities on the balance sheet for all leases with lease terms greater than 12 months. The guidance also requires qualitative and quantitative disclosures designed to assess the amount, timing and uncertainty of cash flows arising from leases. The Company adopted ASU 2016-02 using the modified retrospective method and utilized the optional transition method under which the Company will continue to apply the legacy guidance in ASC 840, including its disclosure requirements, in the comparative period presented. In addition, Secureworks elected the package of practical expedients permitted under the transition guidance which permits the following: a) carry forward the historical lease classification, b) not separate lease components from non-lease components within the Company's facility lease contracts, c) not present comparative periods but rather record a cumulative catch-up during fiscal 2020, and d) allow the Company to elect, by asset class, not to record on the balance sheet a lease whose term is twelve months or less including reasonably certain renewal options. As a result of the adoption for the fiscal year beginning February 2, 2019, the Company recorded initial operating lease ROU assets and operating lease liabilities, all related to real estate, of $28.0 million and $31.8 million, respectively.
Summary of Significant Accounting Policies
Except for the accounting policies for leases, updated as a result of adopting ASC 842, there have been no significant changes to the Company’s significant accounting policies as of and for the three months ended August 2, 2019, as compared to the significant accounting policies described in the Annual Report.
Leases—The Company determines if any arrangement is, or contains, a lease at inception based on whether or not the Company has the right to control the asset during the contract period and other facts and circumstances. Secureworks is the lessee in a lease contract when the Company obtains the right to control the asset. Operating leases are included in the line items operating lease right-of-use assets, net; accrued and other; and operating lease liabilities, non-current in the condensed consolidated statements of financial position. Leases with a lease term of 12 months or less at inception are not recorded in the condensed consolidated statements of financial position and are expensed on a straight-line basis over the lease term in the condensed consolidated statements of operations. The Company determines the lease term by assuming the exercise of renewal options that are reasonably certain. As most of the Company's leases do not provide an implicit interest rate, Secureworks uses the Company's incremental borrowing rate based on the information available at commencement date in determining the present value of future payments. When the Company's contracts contain lease and nonlease components, the Company accounts for both components as a single lease component. Refer to "Note 7 —Leases" for further discussion.
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.
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,

10

SECUREWORKS CORP.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

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 Instruments - Credit 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.
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 share-based awards that may 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 loss per common share (in thousands, except per share amounts):
 
Three Months Ended
 
Six Months Ended
 
August 2, 2019
 
August 3, 2018
 
August 2, 2019
 
August 3, 2018
Numerator:
 
 
 
 
 
 
 
Net loss
$
(10,260
)
 
$
(9,769
)
 
$
(18,530
)
 
$
(23,588
)
Denominator:
 

 
 

 
 
 
 
Weighted-average number of shares outstanding:
 
 
 

 
 
 
 
Basic and Diluted
80,674

 
80,839

 
80,571

 
80,680

 
 
 
 
 
 
 
 
Loss per common share:
 

 
 

 
 
 
 
Basic and Diluted
$
(0.13
)
 
$
(0.12
)
 
$
(0.23
)
 
$
(0.29
)
 
 
 
 
 
 
 
 
Weighted-average anti-dilutive stock options, non-vested restricted stock and restricted stock units
5,246

 
5,285

 
5,351

 
5,390


NOTE 3 — CONTRACT BALANCES AND CONTRACT COSTS

Promises to provide services related to the Company's managed security 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 security and risk consulting professional service contracts are separate obligations associated with each service. Although the Company has many multi-year customer relationships for its various professional services, the arrangement is typically structured as separate performance obligations over the contract period and recognized over a duration of less than one year.

11

SECUREWORKS CORP.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

The following table presents revenue by service type (in thousands):
 
 
Three Months Ended
 
Six Months Ended
 
 
August 2, 2019
 
August 3, 2018
 
August 2, 2019
 
August 3, 2018
Managed Security Solutions revenue
 
$
102,768

 
$
98,435

 
$
201,866

 
$
197,135

Security and Risk Consulting revenue
 
33,837

 
30,343

 
67,581

 
57,804

Total revenue
 
$
136,605

 
$
128,778

 
$
269,447

 
$
254,939



Deferred revenue represents the aggregate amount of billing in advance of service delivery. Therefore, the Company invoices its customers based on a variety of billing schedules. The deferred revenue balance does not represent the total contract value of annual or multi-year, non-cancelable subscription agreements. During the six months ended August 2, 2019, on average, 57% of the Company's recurring revenue was billed in advance and approximately 43% was billed on either a monthly or a quarterly basis. In addition, many of the Company's professional services engagements are billed in advance of service commencement. The deferred revenue balance is influenced by several factors, including seasonality, the compounding effects of renewals, invoice duration and invoice timing.

Changes to the Company's deferred revenue during the six months ended August 2, 2019 and August 3, 2018 are as follows (in thousands):
 
 
As of February 1, 2019
 
Upfront payments received and billings during the six months ended August 2, 2019
 
Revenue recognized during the six months ended August 2, 2019
 
As of August 2, 2019
Deferred revenue
 
$
173,929

 
$
158,769

 
$
(151,495
)
 
$
181,203


 
 
As of February 2, 2018*
 
Upfront payments received and billings during the six months ended August 3, 2018
 
Revenue recognized during the six months ended August 3, 2018
 
As of August 3, 2018
Deferred revenue
 
$
152,645

 
$
133,910

 
$
(121,292
)
 
$
165,263

* 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 customers whose services have been activated ("active"); and (ii) the value of services contracted with customers 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.
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, fluctuations in backlog are not always a reliable indicator of future revenues.

12

SECUREWORKS CORP.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

As of August 2, 2019, 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
 
$
262,927

 
$
150,745

 
$
82,391

 
$
27,984

 
$
1,807

Performance obligation - backlog
 
34,971

 
12,489

 
12,371

 
9,770

 
341

Total
 
$
297,898

 
$
163,234

 
$
94,762

 
$
37,754

 
$
2,148


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 six months ended August 2, 2019 and August 3, 2018 are as follows (in thousands):
 
 
As of February 1, 2019
 
Amount capitalized
 
Amount recognized
 
As of August 2, 2019
Deferred commissions
 
$
62,895

 
$
7,556

 
$
(7,612
)
 
$
62,839

Deferred fulfillment costs
 
10,973

 
3,017

 
(2,712
)
 
11,278


 
 
As of February 2, 2018*
 
Amount capitalized
 
Amount recognized
 
As of August 3, 2018
Deferred commissions
 
$
57,229

 
$
9,479

 
$
(7,089
)
 
$
59,619

Deferred fulfillment costs
 
10,163

 
3,281

 
(2,460
)
 
10,984

* 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 Company did not record any impairment losses on the deferred commissions or deferred fulfillment costs during the three and six months ended August 2, 2019 and August 3, 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 August 2, 2019 and February 1, 2019.

Goodwill and indefinite-lived intangible assets are tested for impairment on an annual basis during the third fiscal quarter of each fiscal year, or earlier if an indicator of impairment occurs. The Company completed the most recent annual impairment test in the third quarter of fiscal 2019 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. On a quarterly basis, between each annual impairment test, the Company assesses various quantitative and qualitative factors that may be indicative of an impairment. Based on the Company's most recent evaluation, there were no indications of a potential impairment as of August 2, 2019.

13

SECUREWORKS CORP.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

Intangible Assets
The Company's intangible assets as of August 2, 2019 and February 1, 2019 were as follows:
 
 
August 2, 2019
 
February 1, 2019
 
 
Gross
 
Accumulated
Amortization
 
Net
 
Gross
 
Accumulated
Amortization
 
Net
 
 
(in thousands)
Customer relationships
 
$
189,518

 
$
(84,199
)
 
$
105,319

 
$
189,518

 
$
(77,152
)
 
$
112,366

Technology
 
135,584

 
(78,441
)
 
57,143

 
135,584

 
(71,620
)
 
63,964

Finite-lived intangible assets
 
325,102

 
(162,640
)
 
162,462

 
325,102

 
(148,772
)
 
176,330

Trade name
 
30,118

 

 
30,118

 
30,118

 

 
30,118

Total intangible assets
 
$
355,220

 
$
(162,640
)
 
$
192,580

 
$
355,220

 
$
(148,772
)
 
$
206,448



Amortization expense related to finite-lived intangible assets was approximately $6.9 million and $13.9 million for each of the three and six months ended August 2, 2019 and August 3, 2018, 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 six months ended August 2, 2019 or August 3, 2018.

NOTE 5DEBT
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 successive one-year terms ending on March 27, 2019. During the three months ended May 3, 2019, the facility was amended and restated to extend the maturity date to March 26, 2020 and to increase the annual rate at which interest accrues to the applicable London Interbank Offered Rate plus 1.50%. All other terms remained substantially the same.
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 August 2, 2019 or February 1, 2019.
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 August 2, 2019, 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.

14

SECUREWORKS CORP.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

Customer-based Taxation ContingenciesVarious government entities ("taxing authorities") require the Company to bill its customers 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 customers from certain losses incurred by the customer as to third-party claims relating to the services performed on behalf of the Company or for certain losses incurred by the customer 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 customers of all sizes primarily through its direct sales organization, supplemented by sales through channel partners. The Company had no customer that represented 10% or more of its net revenue for the three and six months ended August 2, 2019 or August 3, 2018.

NOTE 7 LEASES

The Company recorded operating lease cost for facilities of approximately $2.5 million and $3.9 million for the three and six months ended August 2, 2019, respectively, which included expenses of $1.2 million incurred in connection with the consolidation of certain facilities. The Company incurred additional variable lease costs of $0.3 million and $0.6 million for the three and six months ended August 2, 2019, respectively, which primarily consisted of utilities and common area charges.
The Company recorded operating lease cost of approximately $0.3 million and $0.7 million for the three and six months ended August 2, 2019, respectively, for equipment leases. Lease expense for equipment was included in cost of revenues. The Company also incurred costs for short-term equipment leases $0.3 million and $0.7 million for the three and six months ended August 2, 2019, respectively.
Cash paid for amounts included in the measurement of operating lease liabilities was $1.7 million and $3.4 million during the three and six months ended August 2, 2019.
Weighted-average information associated with the measurement of the Company’s remaining operating lease obligations is as follows:
 
 
August 2, 2019
Weighted-average remaining lease term
 
6.0 years

Weighted-average discount rate
 
5.34
%

The following table summarizes the maturity of the Company's operating lease liabilities as of August 2, 2019 (in thousands):
Fiscal Years Ending
 
 
2020
 
$
3,164

2021
 
4,861

2022
 
6,590

2023
 
5,813

2024
 
5,317

Thereafter
 
12,191

Total operating lease payments
 
$
37,936

Less imputed interest
 
(6,817
)
Total operating lease liabilities
 
$
31,119



15

SECUREWORKS CORP.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

The Company's leases have remaining lease terms of 1 year to 8 years, inclusive of renewal or termination options that the Company is reasonably certain to exercise.
Disclosure related to periods prior to adoption of the new lease standard
As of February 1, 2019, the Company had the following future minimum lease payments under non-cancelable leases prior to the adoption of the new lease standard:
Fiscal Years Ending
 
February 1, 2019

2020
 
$
5,237

2021
 
4,446

2022
 
6,190

2023
 
5,440

2024
 
4,936

Thereafter
 
11,825

Total operating lease payments
 
$
38,074



NOTE 8STOCKHOLDERS' 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. On March 26, 2019, the board of directors expanded the repurchase program to authorize the repurchase up to an additional $15 million of the Company's Class A common stock through May 1, 2020. 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 six months ended August 2, 2019, the Company repurchased 438,380 shares of Class A common stock at an average price of $14.55, for an aggregate cost of $6.4 million. As of August 2, 2019, $10.1 million remained available for further purchases under the stock repurchase program.
NOTE 9STOCK-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 Fiscal 2019, 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.
Under the 2016 Plan, the Company granted 114,728 and 1,273,004 restricted stock units during the three and six months ended August 2, 2019, respectively, and 115,455 and 1,718,408 restricted stock units during the three and six months ended August 3, 2018, respectively. The Company granted no restricted stock awards for the three months ended August 2, 2019 and August 3, 2018, and 175,000 and 405,000 restricted stock awards during the six months ended August 2, 2019 and August 3, 2018, respectively. The annual restricted stock unit and restricted stock awards granted during fiscal 2020 and fiscal 2019 vest over a three-year period and approximately 50% of such awards are subject to performance conditions.
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. During the three and six months ended August 2, 2019, the Company granted long-term performance cash awards of $0.1 million and $6.7 million, respectively. The Company made no grants for the three months ended August 3, 2018 and granted $15.7 million for the six months ended August 3, 2018. The Company recognized $1.8 million and $3.5 million of related compensation expense for the three and six months ended August 2, 2019, respectively, and related compensation expense of $2.0 million and $3.5 million for the three and six months ended August 3, 2018, respectively.

16

SECUREWORKS CORP.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

NOTE 10INCOME AND OTHER TAXES
The Company's effective income tax rate for the three and six months ended August 2, 2019 and August 3, 2018 was as follows (in thousands, except percentages):    
 
Three Months Ended
 
Six Months Ended
 
August 2, 2019
 
August 3, 2018
 
August 2, 2019
 
August 3, 2018
 
 
 
 
 
 
 
 
Loss before income taxes
$
(13,096
)
 
$
(13,160
)
 
$
(27,300
)
 
$
(30,245
)
Income tax benefit
$
(2,836
)
 
$
(3,391
)
 
$
(8,770
)
 
$
(6,657