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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 May 1, 2020
 
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
https://cdn.kscope.io/b37aeb51a80b82b9e8e575db1935ca83-swlogotranspcolor1posa20.jpg
 
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 June 3, 2020, there were 82,139,999 shares of the registrant's common stock outstanding, consisting of 12,139,999 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, except for per share data)
 
May 1,
2020
 
January 31,
2020
 
 
 
 
ASSETS
Current assets:
 
 
 

Cash and cash equivalents
$
155,990

 
$
181,838

Accounts receivable, net of allowances of $5,247 and $5,120, respectively
116,791

 
111,798

Inventories, net
812

 
746

Other current assets
27,404

 
27,449

Total current assets
300,997

 
321,831

Property and equipment, net
24,541

 
27,606

Operating lease right-of-use assets, net
22,207

 
23,463

Goodwill
416,487

 
416,487

Intangible assets, net
173,069

 
180,052

Other non-current assets
76,628

 
78,592

Total assets
$
1,013,929

 
$
1,048,031

 
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
 
 
 
Accounts payable
$
26,629

 
$
18,690

Accrued and other current liabilities
64,321

 
98,855

Short-term deferred revenue
175,671

 
175,847

Total current liabilities
266,621

 
293,392

Long-term deferred revenue
14,260

 
12,690

Operating lease liabilities, non-current
23,246

 
24,669

Other non-current liabilities
50,284

 
50,400

Total liabilities
354,411

 
381,151

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; 12,120 and 11,206 issued and outstanding, respectively.
121

 
112

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
898,370

 
896,983

Accumulated deficit
(215,465
)
 
(207,929
)
Accumulated other comprehensive (loss) income
(4,312
)
 
(3,090
)
Treasury stock, at cost - 1,257 shares
(19,896
)
 
(19,896
)
Total stockholders' equity
659,518

 
666,880

Total liabilities and stockholders' equity
$
1,013,929

 
$
1,048,031


 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
 
May 1, 2020
 
May 3, 2019
 
 

 
 

Net revenue
$
141,181

 
$
132,842

Cost of revenue
62,909

 
62,841

Gross margin
78,272

 
70,001

Research and development
24,073

 
22,642

Sales and marketing
37,452

 
38,193

General and administrative
27,516

 
23,638

Total operating expenses
89,041

 
84,473

Operating loss
(10,769
)
 
(14,472
)
Interest and other, net
993

 
268

Loss before income taxes
(9,776
)
 
(14,204
)
Income tax benefit
(2,240
)
 
(5,934
)
Net loss
$
(7,536
)
 
$
(8,270
)
 
 
 
 
Loss per common share (basic and diluted)
$
(0.09
)
 
$
(0.10
)
Weighted-average common shares outstanding (basic and diluted)
80,938

 
80,467

 
 
 
 

 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
 
May 1, 2020
 
May 3, 2019
Net loss
$
(7,536
)
 
$
(8,270
)
Foreign currency translation adjustments, net of tax
(1,222
)
 
(233
)
Comprehensive loss
$
(8,758
)
 
$
(8,503
)


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)
 
Three Months Ended
 
May 1, 2020
 
May 3, 2019
Cash flows from operating activities:
 
 
 
Net loss
$
(7,536
)
 
$
(8,270
)
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
 
 
 
Depreciation and amortization
10,486

 
10,365

Stock-based compensation expense
5,887

 
4,916

Effects of exchange rate changes on monetary assets and liabilities denominated in foreign currencies
(856
)
 
70

Income tax benefit
(2,240
)
 
(5,934
)
Provision for doubtful accounts
909

 
779

Changes in assets and liabilities:
 
 
 
Accounts receivable
(5,987
)
 
5,221

Net transactions with parent
2,494

 
5,850

Inventories
(66
)
 
(164
)
Other assets
5,267

 
2,747

Accounts payable
8,495

 
8,965

Deferred revenue
1,291

 
3,264

Accrued and other liabilities
(38,481
)
 
(30,834
)
Net cash used by operating activities
(20,337
)
 
(3,025
)
Cash flows from investing activities:
 

 
 

Capital expenditures
(1,020
)
 
(7,016
)
Net cash used in investing activities
(1,020
)
 
(7,016
)
Cash flows from financing activities:
 

 
 

Taxes paid on vested restricted shares
(4,491
)
 
(7,465
)
Purchases of stock for treasury

 
(910
)
Net cash used in financing activities
(4,491
)
 
(8,375
)
 
 
 
 
Net decrease in cash and cash equivalents
(25,848
)
 
(18,416
)
Cash and cash equivalents at beginning of the period
181,838

 
129,592

Cash and cash equivalents at end of the period
$
155,990

 
$
111,176


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 May 1, 2020
 
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, January 31, 2020
 
11,206

 
$
112

 
70,000

 
$
700

 
$
896,983

 
$
(207,929
)
 
$
(3,090
)
 
$
(19,896
)
 
$
666,880

Net loss
 

 

 

 

 

 
(7,536
)
 

 

 
(7,536
)
Other comprehensive loss
 

 

 

 

 

 

 
(1,222
)
 

 
(1,222
)
Vesting of restricted stock units
 
842

 
8

 

 

 
(8
)
 

 

 

 

Grant of restricted stock awards
 
455

 
5

 

 

 
(5
)
 

 

 

 

Common stock withheld as payment for withholding taxes upon the vesting of restricted shares
 
(383
)
 
(4
)
 

 

 
(4,487
)
 

 

 

 
(4,491
)
Stock-based compensation
 

 

 

 

 
5,887

 

 

 

 
5,887

Shares repurchased
 

 

 

 

 

 

 

 

 

Balances, May 1, 2020
 
12,120

 
$
121

 
70,000

 
$
700

 
$
898,370

 
$
(215,465
)
 
$
(4,312
)
 
$
(19,896
)
 
$
659,518



Three Months Ended May 3, 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
 

 

 

 

 

 
(8,270
)
 

 

 
(8,270
)
Other comprehensive loss
 

 

 

 

 

 

 
(233
)
 

 
(233
)
Vesting of restricted stock units
 
817

 
8

 

 

 
(8
)
 

 

 

 

Grant of restricted stock awards
 
122

 
2

 

 

 
(2
)
 

 

 

 

Common stock withheld as payment for withholding taxes upon the vesting of restricted shares
 
(396
)
 
(4
)
 

 

 
(7,461
)
 

 

 

 
(7,465
)
Stock-based compensation
 

 

 

 

 
4,916

 

 

 

 
4,916

Shares repurchased
 
(38
)
 

 

 

 

 

 

 
(910
)
 
(910
)
Balances, May 3, 2019
 
11,521

 
$
116

 
70,000

 
$
700

 
$
882,012

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


The accompanying notes are an integral part of these condensed consolidated financial statements.


7

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"), owned, indirectly through Dell Inc. ("Dell") and Dell'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 May 1, 2020 represented approximately 85.2% of the Company's total outstanding shares of common stock and approximately 98.3% 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 information security solutions. The Company's chief operating decision maker, who is the 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 assumptions and estimations that affect the amounts reported in the Company's financial statements and notes. The inputs into certain of the Company's assumptions and estimations considered the economic implications of the coronavirus disease 2019 ("COVID-19") pandemic on the Company's critical and significant accounting estimates. The condensed consolidated financial statements include assets, liabilities, revenue and expenses of all majority-owned subsidiaries.
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 cost of these services is 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 intercompany 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 January 31, 2020 included in Part II, Item 8 of the Company's Annual Report on Form 10-K filed with the SEC on March 27, 2020 (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 29, 2021 and the fiscal year ended January 31, 2020 as fiscal 2021 and fiscal 2020, respectively. Both fiscal 2021 and fiscal 2020 have 52 weeks, and each quarter has 13 weeks.

8

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 cost 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 due to risks and uncertainties, including uncertainty in the current economic environment due to the COVID-19 pandemic. The Company considered the potential impact of the COVID-19 pandemic on its estimates and assumptions and determined there was not a material impact to the Company's condensed consolidated financial statements as of and for the three months ended May 1, 2020. As the COVID-19 pandemic continues to develop, many of the Company's estimates could require increased judgment and be subject to a higher degree of variability and volatility. As events continue to evolve, the Company's estimates may change materially in future periods.
Recently Adopted Accounting Pronouncements
Intangibles - Goodwill and Other - Internal-Use Software—The Company adopted Accounting Standard Update ("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," effective February 1, 2020. 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 adoption of the standard had no material impact on the condensed consolidated financial statements.
Intangibles - Goodwill and Other—The Company adopted ASU No. 2017-04, "Intangibles-Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment," effective February 1, 2020. 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. 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 adoption of the standard had no impact on the condensed consolidated financial statements.
Financial Instruments - Credit Losses—The Company adopted ASU No. 2016-13, "Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments," effective February 1, 2020. 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 adoption of the standard had no material impact on the condensed consolidated financial statements.
Under the new standard, the Company assesses its allowance for credit losses on trade receivables by taking into consideration forecasts of future economic conditions, information about past events, such as its historical trend of write-offs, and customer-specific circumstances, such as bankruptcies and disputes. The allowance for credit losses on trade receivables is recorded in operating expenses in the Company's condensed consolidated statement of operations.
Summary of Significant Accounting Policies
There have been no significant changes to the Company’s significant accounting policies as of and for the three months ended May 1, 2020, as compared to the significant accounting policies described in the Annual Report.
Recently Issued Accounting Pronouncements
Income Taxes. In December 2019, the Financial Accounting Standards Board (the "FASB") issued ASU No. 2019-12, “Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes.” ASU No. 2019-12 simplifies the accounting for income taxes by eliminating certain exceptions to the guidance in Topic 740 related to the approach for intraperiod tax allocation, the methodology for calculating income taxes in an interim period and the recognition of deferred tax liabilities for outside basis differences. The new guidance also simplifies aspects of the accounting for franchise taxes and enacted changes in tax laws or rates and clarifies the accounting for transactions that result in a step-up in the tax basis of goodwill and allocation of consolidated income taxes to separate financial statements of entities not subject to income tax. ASU No. 2019-12 is effective

9

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

for fiscal years beginning after December 15, 2020, with early adoption permitted. Upon adoption, the Company must apply certain aspects of this standard retrospectively for all periods presented while other aspects are applied on a modified retrospective basis through a cumulative-effect adjustment to retained earnings as of the beginning of the fiscal year of adoption. The Company is currently evaluating the impact of this new standard 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 net 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
 
May 1, 2020
 
May 3, 2019
Numerator:
 
 
 
Net loss
$
(7,536
)
 
$
(8,270
)
Denominator:
 

 
 

Weighted-average number of shares outstanding:
 
 
 

Basic and Diluted
80,938

 
80,467

 
 
 
 
Loss per common share:
 

 
 

Basic and Diluted
$
(0.09
)
 
$
(0.10
)
 
 
 
 
Weighted-average anti-dilutive stock options, non-vested restricted stock and restricted stock units
5,294

 
5,456


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 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 service solutions, each arrangement is typically structured as a separate performance obligation over the contract period and recognized over a duration of less than one year.
The following table presents revenue by service type (in thousands):
 
 
Three Months Ended
 
 
May 1, 2020
 
May 3, 2019
Managed Security Solutions revenue
 
$
106,357

 
$
99,098

Security and Risk Consulting revenue
 
34,824

 
33,744

Total revenue
 
$
141,181

 
$
132,842



The deferred revenue balance does not represent the total contract value of annual or multi-year, non-cancelable subscription agreements. Rather, it represents the aggregate amount of billing in advance of service delivery. The Company invoices its customers based on a variety of billing schedules. During the three months ended May 1, 2020, on average, 58% of the Company's recurring revenue was billed in advance and approximately 42% 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

10

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

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 three months ended May 1, 2020 and May 3, 2019 are as follows (in thousands):
 
 
As of January 31, 2020
 
Upfront payments received and billings during the three months ended May 1, 2020
 
Revenue recognized during the three months ended May 1, 2020
 
As of May 1, 2020
Deferred revenue
 
$
188,537

 
$
95,768

 
$
(94,375
)
 
$
189,930


 
 
As of February 1, 2019
 
Upfront payments received and billings during the three months ended May 3, 2019
 
Revenue recognized during the three months ended May 3, 2019
 
As of May 3, 2019
Deferred revenue
 
$
173,929

 
$
87,863

 
$
(84,498
)
 
$
177,294


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 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 revenue.    
As of May 1, 2020, 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
 
$
267,464

 
$
154,540

 
$
80,848

 
$
24,140

 
$
7,936

Performance obligation - backlog
 
27,258

 
9,846

 
9,499

 
6,835

 
1,079

Total
 
$
294,722

 
$
164,386

 
$
90,347

 
$
30,975

 
$
9,014


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 solutions, 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 three months ended May 1, 2020 and May 3, 2019 are as follows (in thousands):

11

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

 
 
As of January 31, 2020
 
Amount capitalized
 
Amount recognized
 
As of May 1, 2020
Deferred commissions
 
$
62,785

 
$
1,436

 
$
(5,489
)
 
$
58,732

Deferred fulfillment costs
 
11,366

 
1,460

 
(1,395
)
 
11,431


 
 
As of February 1, 2019
 
Amount capitalized
 
Amount recognized
 
As of May 3, 2019
Deferred commissions
 
$
62,895

 
$
3,884

 
$
(3,914
)
 
$
62,865

Deferred fulfillment costs
 
10,973

 
1,570

 
(1,362
)
 
11,181

As referenced in the Annual Report, deferred commissions are recognized on a straight-line basis over the life of the customer relationship, which historically had been estimated to be seven years. During the third quarter of fiscal 2020, the Company determined a change in the estimated life of the customer relationship to be six years. The net impact of this change was an increase in operating loss for the three months ended May 1, 2020 of $1.1 million on a pre-tax basis, or $0.01 on a per share basis. The Company did not record any impairment losses on the deferred commissions or deferred fulfillment costs during the three months ended May 1, 2020 or May 3, 2019.
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 May 1, 2020 and January 31, 2020.

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 2020 by performing a qualitative assessment of goodwill at the reporting unit level, as well as the Company's indefinite-lived intangible asset. In performing this qualitative assessment, the Company evaluated events and circumstances since the date of the last quantitative impairment test, including the results of that test, macroeconomic conditions, industry and market conditions, key financial metrics and the overall financial performance of the Company. After assessing the totality of the events and circumstances, 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 and, therefore, that the first step of the quantitative goodwill impairment test was unnecessary. Additionally, based on the qualitative assessment performed in the third quarter of fiscal 2020, the Company determined that it was not more likely than not that the fair value of the other indefinite-lived intangible asset was less than its carrying amount and, therefore, that the first step of the quantitative goodwill impairment test was unnecessary. Further, no triggering events have subsequently transpired that would indicate a potential impairment subsequent to the test date through May 1, 2020.
Intangible Assets
The Company's intangible assets as of May 1, 2020 and January 31, 2020 were as follows:
 
 
May 1, 2020
 
January 31, 2020
 
 
Gross
 
Accumulated
Amortization
 
Net
 
Gross
 
Accumulated
Amortization
 
Net
 
 
(in thousands)
Customer relationships
 
$
189,518

 
$
(94,770
)
 
$
94,748

 
$
189,518

 
$
(91,246
)
 
$
98,272

Technology
 
137,371

 
(89,168
)
 
48,203

 
137,371

 
(85,709
)
 
51,662

Finite-lived intangible assets
 
326,889

 
(183,938
)
 
142,951

 
326,889

 
(176,955
)
 
149,934

Trade name
 
30,118

 

 
30,118

 
30,118

 

 
30,118

Total intangible assets
 
$
357,007

 
$
(183,938
)
 
$
173,069

 
$
357,007

 
$
(176,955
)
 
$
180,052



Amortization expense related to finite-lived intangible assets was approximately $7.0 million and $6.9 million for each of the three months ended May 1, 2020 and May 3, 2019, respectively. Amortization expense is included within cost of revenue and

12

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

general and administrative expense in the Condensed Consolidated Statements of Operations. There were no impairment charges related to intangible assets during the three months ended May 1, 2020 or May 3, 2019.

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 subsequently extended on the same terms for additional one-year terms. During the three months ended May 1, 2020, the facility was amended and restated to extend the maturity date from March 26, 2020 to March 26, 2021 and to decrease the annual rate at which interest accrues to the applicable London Interbank Offered Rate plus 1.30%. 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. There was no outstanding balance under the credit facility as of May 1, 2020 or January 31, 2020.
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.
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 May 1, 2020, 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.
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.

13

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

Concentrations—The Company sells solutions to customers of all sizes primarily through its direct sales organization, supplemented by sales through channel partners. During the three months ended May 1, 2020 and May 3, 2019, the Company had no customer that represented 10% or more of its net revenue.

14

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

NOTE 7 LEASES

The Company recorded operating lease cost for facilities of approximately $1.5 million and $1.4 million for the three months ended May 1, 2020 and May 3, 2019, respectively. Operating lease cost include expenses in connection with variable lease costs of $0.2 million and $0.3 million for the three months ended May 1, 2020 and May 3, 2019, respectively, which primarily consisted of utilities and common area charges.
For the three months ended May 1, 2020 and May 3, 2019, the Company recorded operating lease cost for equipment leases of approximately $0.7 million and $0.3 million, respectively. For the three months ended May 1, 2020 and May 3, 2019, equipment lease cost included $0.6 and $0.4 million, respectively, for short-term leases. Lease expense for equipment was included in cost of revenues.
Cash paid for amounts included in the measurement of operating lease liabilities was $0.9 million and $1.3 million during the three months ended May 1, 2020 and May 3, 2019, respectively.
Weighted-average information associated with the measurement of the Company’s remaining operating lease obligations is as follows:
 
 
May 1, 2020
Weighted-average remaining lease term
 
5.6 years

Weighted-average discount rate
 
5.34
%

The following table summarizes the maturity of the Company's operating lease liabilities as of May 1, 2020 (in thousands):
Fiscal Years Ending
 
May 1, 2020
2021
 
$
4,119

2022
 
6,474

2023
 
5,764

2024
 
5,325

2025
 
4,556

Thereafter
 
7,650

Total operating lease payments
 
$
33,888

Less imputed interest
 
(4,983
)
Total operating lease liabilities
 
$
28,905


The Company's leases have remaining lease terms of 1 month to 7 years, inclusive of renewal or termination options that the Company is reasonably certain to exercise.

NOTE 8STOCKHOLDERS' EQUITY

On September 26, 2018, the Company's board of directors authorized a stock repurchase program, under which the Company was 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, on which date the program terminated. Repurchases under the program could 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 were determined by management based upon market conditions and other factors. During the three months ended May 1, 2020, no shares of Class A common stock were repurchased.

NOTE 9STOCK-BASED COMPENSATION AND OTHER LONG-TERM PERFORMANCE INCENTIVES
The SecureWorks Corp. 2016 Long-Term Incentive Plan (the "2016 Plan") was adopted 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

15


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

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.
Under the 2016 Plan, during the three months ended May 1, 2020 and May 3, 2019, the Company granted 2,428,357 and 1,158,276 restricted stock units, respectively, and 454,546 and 175,000 restricted stock awards, respectively. The annual restricted stock unit and restricted stock awards granted during both such periods vest over a three-year period. Approximately 17% and 50% of such awards granted during the three months ended May 1, 2020 and May 3, 2019, respectively, are subject to performance conditions. Approximately one-half of the performance awards granted during the three months ended May 1, 2020 have been valued and are considered outstanding for accounting purposes.
The Company grants long-term cash awards to certain employees under the 2016 Plan. The employees who receive these cash awards do not receive equity awards as part of the long-term incentive program. The majority of the cash awards issued prior to fiscal 2021 are subject to various performance conditions and vest in equal annual installments over a three-year period. The cash awards issued during the three months ended May 1, 2020 are not subject to any performance conditions and vest in equal installments over a three-year period. The Company granted cash awards of $8.1 million and $6.9 million during the three months ended May 1, 2020 and May 3, 2019, respectively. The Company recognized $1.6 million and $1.8 million of related compensation expense for the three months ended May 1, 2020 and May 3, 2019, respectively.

NOTE 10INCOME AND OTHER TAXES
The Company's effective income tax rate for the three months ended May 1, 2020 and May 3, 2019 was as follows (in thousands, except percentages):    
 
Three Months Ended
 
May 1, 2020
 
May 3, 2019
 
 
 
 
Loss before income taxes
$
(9,776
)
 
$
(14,204
)
Income tax benefit
$
(2,240
)
 
$
(5,934
)
Effective tax rate
22.9
%
 
41.8
%

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 Company's effective tax benefit rate was 22.9% for the three months ended May 1, 2020 and 41.8% for the three months ended May 3, 2019. The change in the Company's effective income tax rate between the periods was primarily attributable to the impact of certain discrete adjustments related to stock-based compensation expense for the three months ended May 1, 2020 and May 3, 2019 of approximately $0.3 million and $2.2 million, respectively. The change related specifically 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 for the three months ended May 1, 2020 and higher than the fair value for the three months ended May 3, 2019 on the date the equity awards were originally granted. The 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 for the three months ended May 1, 2020 and a higher actual tax deduction for the three months ended May 3, 2019 than the amounts deducted for financial reporting purposes.
As of May 1, 2020 and January 31, 2020, the Company had $4.6 million and $4.6 million, respectively, 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 1, 2019. 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 May 1, 2020 and January 31, 2020. 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 three months ended May 1, 2020 would have been $9.8 million, $1.4 million and $8.4 million, respectively, as a result of the recognition of a valuation allowance that would have been recorded on a significant amount of deferred tax assets as well as certain attributes from the Tax Cuts and Jobs Act of 2017 that would be lost if not utilized by the Dell consolidated group.

16

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

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 May 1, 2020 and January 31, 2020, the Company had $11.0 million and $10.0 million, respectively, of a net operating loss tax receivable from Dell. The Company had $6.7 million and $6.6 million of unrecognized tax benefits as of May 1, 2020 and January 31, 2020, respectively.

NOTE 11 — 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. The total amounts of the charges under the shared services agreement with Dell were $1.0 million and $1.6 million for the three months ended May 1, 2020 and May 3, 2019, 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 $0.3 million and $1.4 million for the three months ended May 1, 2020 and May 3, 2019, 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 $0.4 million and $0.8 million for the three months ended May 1, 2020 and May 3, 2019, respectively. In October 2019, VMware acquired Carbon Black Inc., a security business with which the Company had an existing commercial relationship. For the three months ended May 1, 2020, purchases by the Company of solutions from Carbon Black totaled $1.6 million.
The Company recognized revenue related to solutions provided to other subsidiaries of Dell, consisting of RSA Security LLC, Pivotal Software, Inc. and Boomi, Inc. The Company recognized no revenue for the three months ended May 1, 2020 and $26 thousand for the three months ended May 3, 2019. Purchases by the Company from these subsidiaries totaled $60 thousand and $56 thousand for the three months ended May 1, 2020 and May 3, 2019, respectively.
The Company also 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, MSD Capital, L.P. (a firm founded for the purposes of managing investments of Mr. Dell and his family), DFI Resources LLC, an entity affiliated with Mr. Dell, and the Michael and Susan Dell Foundation, as well as Silver Lake Partners III, L.P., totaled $0.1 million for the three months ended May 1, 2020 and May 3, 2019, respectively.
The Company provides solutions to certain customers 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, in connection with the IPO, many of such customer contracts were transferred from Dell to the Company, forming a direct contractual relationship between the Company and the end customer. For customers whose contracts have not yet been transferred and for contracts subsequently originated through Dell under a reseller agreement, the Company recognized revenues of approximately $14.6 million and $14.8 million for the three months ended May 1, 2020 and May 3, 2019, respectively. In addition, as of May 1, 2020, the Company had approximately $1.7 million of contingent obligations to Dell related to outstanding performance bonds for certain customer contracts, which Dell issued on behalf of the Company.

17

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

As the Company's customer and on behalf of certain of its own customers, Dell also purchases solutions from the Company at pricing that is intended to approximate arm's-length pricing. Such revenues totaled approximately $6.0 million and $3.3 million for the three months ended May 1, 2020 and May 3, 2019, respectively.
The Company settles in cash its related party balances with Dell on a quarterly basis. 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 May 1, 2020 and January 31, 2020 (in thousands).
 
 
May 1,
2020
 
January 31, 2020
Net intercompany payable (included in "Accrued and other current liabilities")
 
$
5,763

 
$
3,209

 
 
 
 
 
Accounts receivable from customers under reseller agreements with Dell (included in "Accounts receivable, net")
 
$
11,396

 
$
13,674

 
 
 
 
 
Net operating loss tax sharing receivable under agreement with Dell (included in "Other current assets" and "Other non-current assets" at May 1, 2020 and in "Other current assets" at January 31, 2020)
 
$
11,021

 
$
10,040


NOTE 12 — 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 May 1, 2020 and January 31, 2020 were as follows (in thousands):
 
 
 
May 1,
2020
 
January 31, 2020
 
 
 
Level 1
 
Level 1
Cash equivalents - Money Market Funds
 
$
75,810

 
$
100,476


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.

18



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 January 31, 2020 included in Part II, Item 8 of our Annual Report on Form 10-K as filed with the SEC on March 27, 2020, 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, beliefs, expected future responses to and effects of the COVID-19 pandemic and other characterizations of future events or circumstances. 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 January 29, 2021 and the fiscal year ended January 31, 2020 as fiscal 2021 and fiscal 2020, respectively. Fiscal 2021 and fiscal 2020 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 provider of technology-driven information security solutions singularly focused on protecting our customers from cyber attacks. We combine deep expertise from service to thousands of customers, machine learning and automation from our proprietary technology, and actionable insights from our team of elite researchers and analysts to create a powerful network effect that provides increasingly strong protection for our customers. 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 vision is to be the essential cyber security company for a digitally connected world. Through our vendor-neutral approach, we create integrated and comprehensive solutions by proactively managing the collection of "point" products deployed by our customers to address specific security issues and provide supplemental solutions where gaps exist in our customers' defenses. We seek to provide the right level of security for each customer's unique situation, which evolves as the customer'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.
Our solutions leverage the proprietary technologies, processes and extensive expertise and knowledge of the tactics, techniques and procedures of the adversary that we have developed over more than 21 years. Key elements of our strategy include:
maintain and extend our technology leadership,
expand and diversify our customer base,
deepen our existing customer relationships, and
attract and retain top talent.

19



Our technology-driven information security solutions offer an innovative approach to prevent, detect, respond to and predict cybersecurity breaches. Through our managed security solutions, which are largely sold on a subscription basis, we provide global visibility and insight into malicious activity, enabling our customers to detect and effectively remediate threats quickly.
In fiscal 2020, we launched our first software-as-a-service application, Red Cloak Threat Detection and Response (TDR) and related Managed Detection and Response (MDR) powered by Red Cloak. This application provides customers visibility across their entire environment, applies advanced analytics developed using machine and deep learning on diverse data from a wide range of sources, and leverages workflows designed using our 21 years of security operations expertise and integrated orchestration and automation capabilities that increase the speed of response actions. Threat intelligence, which is typically deployed as part of our managed security solutions, delivers early warnings of vulnerabilities and threats along with actionable information to help prevent any adverse impact.
In addition to these solutions, we also offer a variety of services, which include security and risk consulting and incident response to accelerate adoption of our capabilities. Through security and risk consulting, we advise customers on a broad range of security and risk-related matters. Incident response minimizes the impact and duration of security breaches through proactive customer preparation, rapid containment and thorough event analysis followed by effective remediation. We have a single organization responsible for the delivery of our security solutions, which enables us to respond quickly to our customers' evolving needs and help them secure themselves against cyber attacks.
From April 2009 to May 1, 2020, the number of events processed by our technology platform increased from five billion to as many as 340 billion events per day. This significant growth has required continual investment in our business. We believe these investments are critical to our success, although they may continue to impact our near-term profitability.
The fees we charge for our solutions vary based on a number of factors, including the solutions selected, the number of customer devices covered by the selected solutions, and the level of management we provide for the solutions. In the first     quarter of fiscal 2021, approximately 75% of our revenue was derived from subscription-based solutions, attributable to managed security contracts, while approximately 25% was derived from professional services engagements. As we respond to the evolving needs of our customers, the relative mix of subscription-based solutions and professional services we provide our customers may fluctuate.
COVID-19
In December 2019, a novel strain of the coronavirus, COVID-19, was reported in mainland China. The World Health Organization declared the outbreak to constitute a "pandemic” on March 11, 2020. This led to a significant disruption of normal business operations globally, as businesses, including Secureworks, have implemented modifications to protect employees by restricting travel and directing employees to work-from-home, in some instances as required by federal, state and local authorities. While we instituted a global work-from-home policy beginning in March 2020, we did not incur significant disruptions in our business operations or a material impact on our results of operations, financial condition, liquidity or capital resources as of and during the three months ended May 1, 2020. Beginning in April 2020, we started to experience a limited reduction in customer demand for our solutions that we believe is attributable to COVID-19, and in future periods the pandemic might further curtail customer spending, lead to delayed or deferred purchasing decisions, and lengthen sales cycles. As of the end of the period, we also had experienced an increase in accounts receivables which we believe was attributable to slower customer payment cycles as a result of COVID-19. We expect that we may experience further delays in receiving payments due to the pandemic and reduced liquidity and capital resources may cause certain of our customers or partners to have difficulty fulfilling their payment obligations to us. These effects, individually or in the aggregate, could have a material negative impact on our future results of operations and overall financial performance.
In light of these considerations, we continue to actively monitor the impacts and potential impacts of the COVID-19 pandemic in all aspects of our business. The extent of the impact of COVID-19 on our future operational and financial performance will depend on various developments, including the duration and spread of the virus, impact on our employees, customers and vendors, impact on our customers liquidity, volume of sales, and length of our sales cycles, all of which remain uncertain and cannot be predicted, but which could have a material negative effect on our business, results of operations or financial condition. At this point, the extent to which COVID-19 may impact our financial condition or results of operations is uncertain. Due to our subscription-based business model, the effect of COVID-19 may not be fully reflected in our results of operations until future periods, if at all.
Key Operating Metrics
In recent years, we have experienced broad growth across our portfolio of technology-driven information security solutions provided to customers of all sizes. We have achieved much of this growth by providing solutions to large enterprise customers, which generate substantially more average revenue than our small and medium-sized business, or SMB, customers and by continually expanding the volume and breadth of the security solutions that we provide to all customers. Execution of this

20



strategy has resulted in steady growth in our average revenue per customer. 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 customer relationships. Relevant key operating metrics are presented below as of the dates indicated and for the quarterly periods then ended:
 
May 1, 2020
 
May 3, 2019
Subscription customer base
4,000

 
4,100

Total customer base
5,300

 
4,600

Monthly recurring revenue (in millions)
$
36.5

 
$
36.1

Annual recurring revenue (in millions)
$
437.7

 
$
433.0

Average subscription revenue per customer (in thousands)
$
109.4

 
$
104.9

Revenue retention rate
98
%
 
99
%
Subscription Customer Base. We define our subscription customer base as the number of customers who subscribe to our managed security solutions as of a particular date. We believe that growing our existing customer base and our ability to grow our average subscription revenue per customer represent significant future revenue opportunities for us.

Total Customer Base. We define our total customer base as the number of customers that, as of a particular date, subscribe to our managed security solutions as well as customers that buy professional and other services from us, as of a particular date.

Annual and Monthly Recurring Revenue. We define recurring revenue as the value of our subscription contracts as of a particular date. Because we use recurring revenue as a leading indicator of future annual revenue, we include operational backlog. We define operational backlog as the recurring revenue associated with pending contracts, which are contracts that have been sold but for which the service period has not yet commenced. Our increase in recurring revenue has been driven primarily by our continuing ability to expand our offerings and sell additional solutions to existing customers, as well as by larger subscription contracts to our enterprise customers.

Average Subscription Revenue Per Customer. The increase in our average subscription revenue per customer is primarily related to the persistence of cyber threats and the results of our sales and marketing efforts to increase the awareness of our solutions. Additionally, our customer composition of both enterprise and SMB companies provides us with an opportunity to expand our professional services revenue. For each of the three months ended May 1, 2020 and May 3, 2019, approximately 61% of our professional services customers subscribed to our managed security solutions.

Revenue Retention Rate. Our revenue retention rate is an important measure of our success in retaining and growing revenue from our subscription-based customers. To calculate our revenue retention rate for any period, we compare the monthly recurring revenue excluding operational backlog of our subscription-based customer base at the beginning of the fiscal year, which we call our base recurring revenue, to the monthly recurring revenue excluding operational backlog from that same cohort of customers at the end of the period, which we call our retained recurring revenue. By dividing the retained recurring revenue by the base recurring revenue, we measure our success in retaining and growing installed revenue from the specific cohort of customers we served at the beginning of the period. Our calculation includes the positive revenue impacts of selling and installing additional solutions to this cohort of customers and the negative revenue impacts of customer or service attrition during the period. The calculation, however, does not include the positive impact on revenue from sales of solutions to any customers acquired during the period. Our revenue retention rates may decline or increase from period to period as a result of several factors, including the timing of solution installations and customer renewal rates.

21



Non-GAAP Financial Measures
We use supplemental measures of our performance, which are derived from our financial information, but which are not presented in our financial statements prepared in accordance with GAAP. Non-GAAP financial measures presented in this management's discussion and analysis include non-GAAP revenue, non-GAAP gross margin, non-GAAP research and development expenses, non-GAAP sales and marketing expenses, non-GAAP general and administrative expenses, non-GAAP operating income (loss), non-GAAP net income (loss), non-GAAP earnings (loss) per share and adjusted EBITDA. We use non-GAAP financial measures to supplement financial information presented on a GAAP basis. We believe these non-GAAP financial measures provide useful information to help evaluate our operating results by facilitating an enhanced understanding of our operating performance and enabling more meaningful period-to-period comparisons.
There are limitations to the use of the non-GAAP financial measures presented in this management's discussion and analysis. Our non-GAAP financial measures may not be comparable to similarly titled measures of other companies. Other companies, including companies in our industry, may calculate non-GAAP financial measures differently than we do, limiting the usefulness of those measures for comparative purposes.
The non-GAAP financial measures we present, as defined by us, exclude the items described in the reconciliation below. As the excluded items can have a material impact on earnings, our management compensates for this limitation by relying primarily on GAAP results and using non-GAAP financial measures supplementally. The non-GAAP financial measures are not meant to be considered as indicators of performance in isolation from or as a substitute for revenue, gross margin, research and development expenses, sales and marketing expenses, general and administrative expenses, operating income (loss) or net income (loss) prepared in accordance with GAAP, and should be read only in conjunction with financial information presented on a GAAP basis.
Reconciliation of Non-GAAP Financial Measures
The table below presents a reconciliation of each non-GAAP financial measure to its most directly comparable GAAP financial measure. We encourage you to review the reconciliations in conjunction with the presentation of the non-GAAP financial measures for each of the periods presented. In future fiscal periods, we may exclude such items and may incur income and expenses similar to these excluded items. Accordingly, the exclusion of these items and other similar items in our non-GAAP presentation should not be interpreted as implying that these items are non-recurring, infrequent or unusual.
The following is a summary of the items excluded from the most comparable GAAP financial measures to calculate our non-GAAP financial measures:
Amortization of Intangible Assets. Amortization of intangible assets consists of amortization of customer relationships and acquired technology. In connection with the acquisition of Dell by Dell Technologies in fiscal 2014, all of our tangible and intangible assets and liabilities were accounted for and recognized at fair value on the transaction date. Accordingly, amortization of intangible assets consists of amortization associated with intangible assets recognized in connection with this transaction.
Stock-based Compensation Expense. Non-cash stock-based compensation relates to both the Dell Technologies and Secureworks equity plans. We exclude such expenses when assessing the effectiveness of our operating performance since stock-based compensation does not necessarily correlate with the underlying operating performance of the business.
Aggregate Adjustment for Income Taxes. The aggregate adjustment for income taxes is the estimated combined income tax effect for the adjustments mentioned above. The tax effects are determined based on the tax jurisdictions where the above items were incurred.

22



 
Three Months Ended
 
May 1, 2020
 
May 3, 2019
 
(in thousands)
GAAP and non-GAAP revenue
$
141,181

 
$
132,842

 
 
 
 
GAAP gross margin
$
78,272

 
$
70,001

Amortization of intangibles
3,460

 
3,410

Stock-based compensation expense
355

 
260

Non-GAAP gross margin
$
82,087

 
$
73,671

 
 
 
 
GAAP research and development expenses
$
24,073

 
$
22,642

Stock-based compensation expense
(1,291
)
 
(1,176
)
Non-GAAP research and development expenses
$
22,782

 
$
21,466

 
 
 
 
GAAP sales and marketing expenses
$
37,452

 
$
38,193

Stock-based compensation expense
(741
)
 
(781
)
Non-GAAP sales and marketing expenses
$
36,711

 
$
37,412

 
 
 
 
GAAP general and administrative expenses
$
27,516

 
$
23,638

Amortization of intangibles
(3,524
)
 
(3,524
)
Stock-based compensation expense
(3,500
)
 
(2,699
)
Non-GAAP general and administrative expenses
$
20,492

 
$
17,415

 
 
 
 
GAAP operating loss
$
(10,769
)
 
$
(14,472
)
Amortization of intangibles
6,984

 
6,934

Stock-based compensation expense
5,887

 
4,916

Non-GAAP operating income (loss)
$
2,102

 
$
(2,622
)
 
 
 
 
GAAP net loss
$
(7,536
)
 
$
(8,270
)
Amortization of intangibles
6,984

 
6,934

Stock-based compensation expense
5,887

 
4,916

Aggregate adjustment for income taxes
(2,803
)
 
(5,467
)
Non-GAAP net income (loss)
$
2,532

 
$
(1,887
)
 
 
 
 
GAAP loss per share
$
(0.09
)
 
$
(0.10
)
Amortization of intangibles
0.09

 
0.09

Stock-based compensation expense
0.07

 
0.06

Aggregate adjustment for income taxes
(0.03
)
 
(0.07
)
Non-GAAP earnings (loss) per share *
$
0.03

 
$
(0.02
)
* Sum of reconciling items may differ from total due to rounding of individual components
 
 
 
 
GAAP net loss
$
(7,536
)
 
$
(8,270
)
Interest and other, net
(993
)
 
(268
)
Income tax benefit
(2,240
)
 
(5,934
)
Depreciation and amortization
10,486

 
10,365

Stock-based compensation expense
5,887

 
4,916

Adjusted EBITDA
$
5,604

 
$
809



23



Our Relationship with Dell and Dell Technologies
On April 27, 2016, we completed our IPO. Upon the closing of our IPO, Dell Technologies owned, indirectly through Dell Inc. and Dell Inc.'s subsidiaries, no shares of our outstanding Class A common stock and all shares of our outstanding Class B common stock, which as of May 1, 2020 represented approximately 85.2% of our total outstanding shares of common stock and approximately 98.3% of the combined voting power of both classes of our outstanding common stock.
As a majority-owned subsidiary of Dell, we receive from Dell various corporate services in the ordinary course of business, including finance, tax, human resources, legal, insurance, IT, procurement and facilities related services. The costs of these services have been charged in accordance with a shared services agreement that went into effect on August 1, 2015, the effective date of our carve-out from Dell. For more information regarding the allocated costs and related party transactions, see "Notes to Condensed Consolidated Financial Statements—Note 11—Related Party Transactions" in our condensed consolidated financial statements included in this report.
During the periods presented in the condensed consolidated financial statements included in this report, Secureworks did not file separate federal tax returns, as Secureworks was 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. For more information, see "Notes to Condensed Consolidated Financial Statements —Note 10—Income and Other Taxes" in our condensed consolidated financial statements included in this report.
Additionally, we participate in various commercial arrangements with Dell under which, for example, we provide information security solutions to third-party customers with which Dell has contracted to provide our solutions, procure hardware, software and services from Dell, and sell our solutions through Dell in the United States and some international jurisdictions. In connection with our IPO, effective August 1, 2015 we entered into agreements with Dell that govern these commercial arrangements. These agreements generally were initially effective for up to one to three years and include extension and cancellation options. To the extent that we choose to or are required to transition away from the corporate services currently provided by Dell, we may incur additional non-recurring transition costs to establish our own stand-alone corporate functions. For more information regarding the allocated costs and related party transactions, see "Notes to Condensed Consolidated Financial Statements—Note 11—Related Party Transactions" in our condensed consolidated financial statements included in this report.
Components of Results of Operations
Revenue
We sell managed security solutions and threat intelligence solutions on a subscription basis and various professional services, including security and risk consulting and incident response solutions. Our managed security subscription contracts typically range from one to three years and, as of May 1, 2020, averaged two years in duration. 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 customers. Professional services customers typically purchase solutions pursuant to customized contracts that are shorter in duration. In general, these contracts have terms of less than one year. Professional services consist primarily of fixed-fee and retainer-based contracts. Revenue from these engagements is recognized under the proportional performance method of accounting. Revenue from time-and materials-based contracts is recognized as costs are incurred at amounts represented by the agreed-upon billing rates.
The fees we charge for our solutions vary based on a number of factors, including the solutions selected, the number of customer devices covered by the selected solutions, and the level of management we provide for the solutions. In the first quarter of fiscal 2021, approximately 75% of our revenue was derived from subscription-based arrangements, attributable to managed security solutions, while approximately 25% was derived from professional services engagements. As we respond to the evolving needs of our customers, the relative mix of subscription-based solutions and professional services we provide our customers may fluctuate. International revenue, which we define as revenue contracted through non-U.S. entities, represented approximately 29% of our total net revenue in the first quarter of fiscal 2021 and 25% of our total net revenue in the first quarter of fiscal 2020. Although our international customers are located primarily in the United Kingdom, Japan, and Canada, we provided managed security solutions to customers across 53 countries as of May 1, 2020.
Over all of the periods presented in this report, our pricing strategy for our various offerings was relatively consistent, and accordingly did not significantly affect our revenue growth. However, we may adjust our pricing to remain competitive and support our strategic initiatives.


24



Gross Margin
We operate in a challenging business environment, where the complexity and number of cyber attacks are constantly increasing. Accordingly, initiatives to drive the efficiency of our Counter Threat Platform and the continued training and development of our employees are critical to our long-term success. Gross margin has been and will continue to be affected by these factors as well as others, including the mix of solutions sold, the mix between large and small customers, timing of revenue recognition and the extent to which we expand our counter threat operations centers.
Cost of revenue consists primarily of personnel expenses, including salaries, benefits and performance-based compensation for employees who maintain our Counter Threat Platform and provide solutions to our customers, as well as perform other critical functions. Also included in cost of revenue are amortization of equipment and costs associated with hardware utilized as part of providing subscription services, amortization of technology licensing fees, amortization of intangible assets, fees paid to contractors who supplement or support our solutions, maintenance fees and overhead allocations. As our business grows, the cost of revenue associated with our solutions may fluctuate.
We operate in a high-growth industry and have experienced significant revenue growth since our inception. Accordingly, we expect our gross margin to increase in absolute dollars. We continue to invest in initiatives to drive the efficiency of our business to increase gross margin as a percentage of total revenue. However, as we balance revenue growth and efficiency initiatives, gross margin as a percentage of total revenue may fluctuate from period to period.
Operating Costs and Expenses
Our operating costs and expenses consist of research and development expenses, sales and marketing expenses and general and administrative expenses.
Research and Development, or R&D, Expenses. Research and development expenses include compensation and related expenses for the continued development of our solutions offerings, including a portion of expenses related to our threat research team, which focuses on the identification of system vulnerabilities, data forensics and malware analysis. R&D expenses also encompass expenses related to the development of prototypes of new solutions offerings and allocated overhead. Our customer solutions have generally been developed internally. We operate in a competitive and highly technical industry. Therefore, to maintain and extend our technology leadership, we intend to continue to invest in our R&D efforts by hiring more personnel to enhance our existing security solutions and to add complementary solutions.
Sales and Marketing, or S&M, Expenses. Sales and marketing expenses include salaries, sales commissions and performance-based compensation, benefits and related expenses for our S&M personnel, travel and entertainment, marketing and advertising programs (including lead generation), customer advocacy events, and other brand-building expenses, as well as allocated overhead. As we continue to grow our business, both domestically and internationally, we will invest in our sales capability, which will increase our sales and marketing expenses in absolute dollars.
General and Administrative, or G&A, Expenses. General and administrative expenses include primarily the costs of human resources and recruiting, finance and accounting, legal support, information management and information security systems, facilities management, corporate development and other administrative functions, and are partially offset by allocations of information technology and facilities costs to other functions.
Interest and Other, Net
Interest and other, net consists primarily of the effect of exchange rates on our foreign currency-denominated asset and liability balances and interest income earned on our cash and cash equivalents. All foreign currency transaction adjustments are recorded as foreign currency gains (losses) in the Condensed Consolidated Statements of Operations. To date, we have had minimal interest income.
Income Tax Benefit
Our effective tax benefit rate was 22.9% and 41.8% for the three months ended May 1, 2020 and May 3, 2019, respectively. The change in the Company's effective income tax rate between the periods was primarily attributable to the impact of the discrete adjustments related to stock-based compensation expense.


25



Results of Operations

The following tables summarize our key performance indicators for the three months ended May 1, 2020 and May 3, 2019.
 
 
Three Months Ended
 
 
May 1, 2020
 
 
 
May 3, 2019
 
 
$
 
% of
Revenue
 
%
Change
 
$
 
% of
Revenue
 
 
(in thousands, except percentages)
Net revenue
 
$
141,181

 
100.0
 %
 
6.3
 %
 
$
132,842

 
100.0
 %
Cost of revenue
 
$
62,909

 
44.6
 %
 
0.1
 %
 
$
62,841

 
47.3
 %
Total gross margin
 
$
78,272

 
55.4
 %
 
11.8
 %
 
$
70,001

 
52.7
 %
Operating expenses
 
$
89,041

 
63.1
 %
 
5.4
 %
 
$
84,473

 
63.6
 %
Operating loss
 
$
(10,769
)
 
(7.6
)%
 
(25.6
)%
 
$
(14,472
)
 
(10.9
)%
Net loss
 
$
(7,536
)
 
(5.3
)%
 
(8.9
)%
 
$
(8,270
)
 
(6.2
)%
 
 
 
 
 
 
 
 
 
 
 
Other Financial Information (1)
 
 
 
 
 
 
 
 
 
 
Non-GAAP net revenue
 
$
141,181

 
100.0
 %
 
6.3
 %
 
$
132,842

 
100.0
 %
Non-GAAP cost of revenue
 
$
59,094

 
41.9
 %
 
(0.1
)%
 
$
59,171

 
44.5
 %
Non-GAAP gross margin
 
$
82,087

 
58.1
 %
 
11.4
 %
 
$
73,671

 
55.5
 %
Non-GAAP operating expenses
 
$
79,985

 
56.7
 %
 
4.8
 %
 
$
76,293

 
57.4
 %
Non-GAAP operating income (loss)
 
$
2,102

 
1.5
 %
 
(180.2
)%
 
$
(2,622
)
 
(2.0
)%
Non-GAAP net income (loss)
 
$
2,532

 
1.8
 %
 
(234.2
)%
 
$
(1,887
)
 
(1.4
)%
Adjusted EBITDA
 
$
5,604

 
4.0
 %
 
592.7
 %
 
$
809

 
0.6
 %
_____________________
(1) 
See "Non-GAAP Financial Measures" and "Reconciliation of Non-GAAP Financial Measures" for more information about these non-GAAP financial measures, including our reasons for including the measures, material limitations with respect to the usefulness of the measures, and a reconciliation of each non-GAAP financial measure to the most directly comparable GAAP financial measure. Non-GAAP financial measures as a percentage of revenue are calculated based on non-GAAP revenue.

Three months ended May 1, 2020 compared to the three months ended May 3, 2019
Revenue
Net revenue, which we refer to as revenue, increased $8.3 million, or 6.3%, for the three months ended May 1, 2020. The revenue increase resulted primarily from revenue generated by our subscription-based solutions, which represented approximately 75% of total revenue for the three months ended May 1, 2020. Our existing customers continued to increase their contracted subscriptions for our solutions, with average revenue per customer increasing 4% year over year.
Revenue for certain services provided to or on behalf of Dell under our commercial agreements with Dell totaled approximately $6.0 million and $3.3 million for the three months ended May 1, 2020 and May 3, 2019, respectively. For more information regarding the commercial agreements, see "Notes to Condensed Consolidated Financial Statements—Note 11—Related Party Transactions" in our condensed consolidated financial statements included in this report.
We primarily generate revenue from sales in the United States. However, for the three months ended May 1, 2020, international revenue, which we define as revenue contracted through non-U.S. entities, increased to $40.5 million, or 24.7%. Currently, our international customers are primarily located in the United Kingdom, Japan, and Canada. We are focused on continuing to grow our international customer base in future periods.
Gross Margin
Our total gross margin increased $8.3 million, or 11.8%, for the three months ended May 1, 2020. As a percentage of revenue, our gross margin increased 270 basis points to 55.4% for the three months ended May 1, 2020. Gross margin on a GAAP basis includes amortization of intangible assets and stock-based compensation expense. On a non-GAAP basis, excluding these adjustments, gross margin increased $8.4 million, or 11.4%, for the three months ended May 1, 2020. As a percentage of revenue, our non-GAAP gross margin increased 260 basis points to 58.1% for three months ended May 1, 2020. The increase in gross margin as a percentage of revenue on both a GAAP and non-GAAP basis during the three months ended May 1, 2020 was primarily attributable to improvement in our subscription-based solutions margins as we continue to focus on delivering comprehensive higher-value security solutions and driving scale and operational efficiencies.

26



Operating Expenses

The following table presents information regarding our operating expenses during the three months ended May 1, 2020 and May 3, 2019.
 
Three Months Ended
 
May 1, 2020
 
 
 
May 3, 2019
 
Dollars
 
% of
Revenue
 
%
Change
 
Dollars
 
% of
Revenue
 
(in thousands, except percentages)
Operating expenses:
 

 
 

 
 

 
 

 
 

Research and development
$
24,073

 
17.1
%
 
6.3
 %
 
$
22,642

 
17.0
%
Sales and marketing
37,452

 
26.5
%
 
(1.9
)%
 
38,193