SolarWinds Corp

NYSE:SWI

Earnings Call Transcript 2024-Q1

[Operator]

Thank you for standing by. My name is Katelyn, and I will be your conference operator today. At this time, I would like to welcome everyone to the SolarWinds 2024 First Quarter Earnings Call. [Operator Instructions] I would now like to turn the call over to Tim Karaca, Group Vice President of Finance. Please go ahead.

[Tim Karaca, executive]

Thank you. Good morning to everyone, and welcome to the SolarWinds First Quarter 2024 Earnings Call. Sudhakar Ramakrishna, our President and CEO; and Bart Kalsu, our CFO, are with me today. Following our prepared remarks, we will have a question-and-answer session. This call is being simultaneously webcast on our Investor Relations website at investors.solarwinds.com.

You can also find our earnings press release and a summary slide deck, which is intended to supplement our prepared remarks during today's call. Please remember that certain statements made during this call are forward-looking statements, including those concerning our financial outlook, our market opportunities, our expectations regarding customer retention, our continued evolution to subscription-first mentality and the timing of the phases of such evolution, our expectations regarding our partner ecosystem, the SEC enforcement action, the impact of the global economic and geopolitical environment on our business, and our gross level of debt.

These statements are based on currently available information and assumptions, and we undertake no duty to update this information except as required by law. These statements are subject to a number of risks and uncertainties, including to numerous risks and uncertainties highlighted in today's earnings release and our filings with the SEC. Copies are available from the SEC on our Investor Relations website.

We will discuss various non-GAAP financial measures on today's call. Unless otherwise specified, when we refer to financial measures, we will be referring to non-GAAP financial measures. A reconciliation of the differences between GAAP and non-GAAP financial measures and the definition of other financial metrics discussed on today's call are available in our earnings press release and summary slide deck on the Investor Relations page of our website.

Finally, we note that the financial results discussed on today's call and in our earnings release are preliminary and pending final review by us and our external auditors and will only be final once we file our quarterly report on Form 10-Q.

With that, I will now turn the call over to Sudhakar.

[Sudhakar Ramakrishna, executive]

Thank you, Tim, and good morning, everyone. Thank you for joining us today. As always, I'd like to thank our employees, customers, partners and shareholders for their ongoing commitment to SolarWinds. I'm pleased to report that we delivered a strong start to the year, once again exceeding our guidance across our key metrics and demonstrating the compelling value of our platform solutions and the strength of our business model.

In particular, our ongoing evolution from a provider of monitoring tools to a comprehensive full stack provider of observability, database monitoring and service management solutions across hybrid and multi-cloud environments is increasingly having a positive impact on our ability both to support customers in their business transformations and to achieve our strategic and financial objectives. I am pleased with the strong execution of our teams, resulting in sustained ARR growth and the strongest quarterly adjusted EBITDA margin in over 3 years.

Now turning to business highlights from this quarter. In Q1 2024, we saw total revenue of $193 million, above the high end of the range we provided and representing year-over-year growth of 4%. Our total ARR grew 7% in Q1 of 2024. We continue to experience strong adoption of our Hybrid Cloud Observability solutions and expect to exceed $100 million in total ARR for these solutions in the second quarter. This significant milestone is a result of the ongoing conversion of our maintenance base with a healthy conversion factor as well as the acquisition of new customers.

We believe that tools consolidation, cloud modernization and simplicity are the key driving factors, and there continues to be a significant incremental opportunity ahead of us. With the ongoing success of our subscription-first strategy, in the first quarter, we delivered subscription revenue growth of 26% and subscription ARR growth of 36%. We delivered first quarter adjusted EBITDA of $92 million, above the high end of the range we provided and representing growth of 19% year-over-year and adjusted EBITDA margin of 48%, up 6 percentage points year-over-year. And as I mentioned earlier, this represents the highest quarterly level in over 3 years.

Our first quarter in-quarter maintenance renewal rate was 98%, and our trailing 12-month maintenance renewal rate is at 97%, an increase from 96% as of the end of the fourth quarter. And we delivered first quarter total ARR growth of 7% year-over-year, with continued execution of our subscription-first strategy that diluted in delivering the best time to value, time to detect, time to remediate issues for customers in their multi-cloud environments.

On April 2, we celebrated our 25th anniversary as a company, and I want to take a moment to reflect on what we have accomplished and what it means for our future. SolarWinds was founded in 1999 by a network engineer with a goal of building tools designed to simplify the lives of IT professionals. Through our team's focused execution over the years, we now have the privilege of serving over 300,000 customers around the world. Harkening back to our founding, our purpose is to enrich the lives of the people we serve, including our employees, customers, partners and shareholders.

This purpose continues to guide us as we help customers accelerate their business transformations via simple, powerful and secure solutions. We've evolved from being a provider of monitoring solutions to a provider of powerful full stack observability, database performance monitoring and service management solutions. We believe our comprehensive platform enables our customers to consolidate tools, reduce the complexities they face, lower costs and improve their productivity. We provide our customers with the flexibility to move at their own pace in their digital transformation journeys by offering a robust set of hybrid capabilities in addition to cloud-native ones.

As I look to our future, I'm confident in our team's ability to identify new opportunities to prioritize our investments, execute with discipline, continue serving the emerging needs of our customers and delivering strong financial results.

I will now share a few key product and solution updates we believe will better serve our customers and aid us in increasing our relevance to them. We expanded our observability offerings already-rich support of devices, containers, SD-WAN and cloud types with enhanced support for Azure, Palo Alto, ServiceNow, Aruba and others. These enhancements further improve customer capabilities to consolidate their tools achieve hybrid visibility and create node and lifetime value expansion opportunities for us.

We continue to enhance our common AI services framework across our observability and service management solutions. These services are designed to reduce alert fatigue and help our customers manage the complexity of their environments. We believe we have the broadest platform support in database monitoring. We added significant performance enhancements for full script SQL and remain very committed to open-source database technologies.

Finally, consistent with our Secure by Design initiatives and commitment, we are proud to have announced last month that we are the first software provider to publish a self-attestation in alignment with the new Cybersecurity and Infrastructure Security Agency Secure Software Development framework. We believe that these initiatives further the public-private partnerships that we have been fostering.

On the go-to-market front, we have made significant progress aligning our motions with our subscription-first strategy, including investing in our partner program to increase our reach efficiently and cost effectively. Our recent Transform Partner Summit further amplify the opportunity we can create by working with and through our partners. Our partners, including distributors, resellers, global system integrators and cloud service providers continue to contribute to our success. These and other go-to-market efforts continue to build on our world-class inside sales motions complemented by our simple, powerful and secure solutions.

As I turn the call over to Bart, I will reiterate my optimism that we will continue to accelerate the gains that are a direct result of our transformation efforts across all aspects of the business over the past 3 years. Specifically, we believe the ongoing uptake of our observability solutions, along with our database and service management solutions, will continue to support and sustain ARR growth while we invest judiciously in the future, resulting in continued adjusted EBITDA growth and margin expansion.

I will now ask Bart to expand on our financial performance and provide our second quarter and full year 2024 outlook. Bart?

[J. Kalsu, executive]

Thanks, Sudhakar. And thanks to everyone who has joined us on the call. We had a strong first quarter as we continue to drive strong ARR growth and increase the mix of our predictable recurring revenue while demonstrating sustained double-digit adjusted EBITDA growth. We're off to a good start to the year, and we believe we are on a positive trajectory in 2024.

Turning to the numbers. We finished the first quarter with total revenue of $193.3 million, a 4% increase compared to the prior year and above the high end of $192 million of the outlook for total revenue that we provided last quarter. We ended the first quarter with total ARR of $695 million, up 7% year-over-year. Our subscription ARR at the end of the first quarter was $251 million, an increase of 36% year-over-year. This growth continues to be driven by the execution of our subscription-first strategy.

As mentioned the last quarter, we now provide the number of customers who have annual recurring revenue of greater than $100,000 as we believe that total ARR from customers provides insight into the quality and repeatability of our business. We had 1,021 customers with over $100,000 of total ARR, representing 16% growth over the prior year.

Digging into the revenue details, our first quarter subscription revenue was $69 million, up 26% year-over-year. The increase in subscription revenue reflects the success of our subscription-first strategy, which includes converting a portion of our maintenance base to our subscription products. Maintenance revenue was $112 million in the first quarter, roughly flat compared to the prior year despite the conversion of a portion of these customers to our subscription products. Our maintenance renewal rate is at 97% on a trailing 12-month basis and was 98% for the first quarter. To remind you, as we convert maintenance customers to subscriptions, we exclude those customers from our renewal rate calculation.

As a result of the subscription revenue growth and strong maintenance renewal rates, we now have 93% of our total revenue as recurring revenue. For the first quarter, license revenue was $13 million, down 25% from $17 million in the prior year. As a reminder, our subscription-first focus has affected and will continue to affect our license sales performance. Our focus on operating discipline delivered another quarter of strong non-GAAP profitability. First quarter adjusted EBITDA was $92.1 million, growing 19% year-over-year, representing an adjusted EBITDA margin of 48% and coming in $7.6 million above the high end of the $84.5 million outlook we gave for the quarter.

In April, we paid a special dividend of $1 per share or $168 million in aggregate. We're proud of our work to deliver value back to our shareholders. We will continue to evaluate our capital allocation plans, balancing financial flexibility with debt repayment opportunities while evaluating opportunities to return capital to our shareholders and making selective strategic investments. Turning to our balance sheet. Our net leverage ratio at March 31, was approximately 2.7x our trailing 12-month adjusted EBITDA. This compares to 2.9x at the end of last quarter. And finally, adjusted for the dividend payment in April, our pro forma leverage ratio is at 3.2x adjusted EBITDA.

In January of 2024, we refinanced our term loan, decreasing the interest rate by 50 basis points from SOFR plus 3.75% to SOFR plus 3.25%, taking advantage of the interest rate environment at the time. We will continue to look for opportunities to reduce our variable interest rate as we go forward. We continue to generate strong cash flow, with $36.3 million in cash flow from operations in the first quarter. Our cash and cash equivalents and short-term investment balance was $312.8 million at quarter end. Our non-GAAP diluted earnings per share was $0.29 per share, well over the guidance range of $0.20 to $0.22 per share. Most of this beat is driven by our improved profitability as well as a onetime income tax benefit.

I will now walk you through our outlook before turning it over to Sudhakar for his final thoughts. I will start with our second quarter guidance and then discuss our updated outlook for the full year. For the second quarter, we expect total revenue to be in the range of $186 million to $191 million, representing 2% growth at the midpoint. Adjusted EBITDA for the second quarter is expected to be approximately $85 million to $88 million, representing 9% growth at the midpoint.

Non-GAAP fully diluted earnings per share are projected to be $0.21 to $0.23 per share assuming an estimated 171.6 million fully diluted shares outstanding. Finally, our outlook for the second quarter assumes a non-GAAP tax rate of 26%, and we expect to pay approximately $33 million in cash taxes during the second quarter of which $21 million is related to the toll tax.

For the full year, we expect total revenue to be in the range of $771 million to $786 million, representing 3% year-over-year growth at the midpoint, leaving it unchanged from our prior guide. We are raising our adjusted EBITDA for the full year, which is now expected to be approximately $360 million to $370 million, representing 11% year-over-year growth at the midpoint. Non-GAAP fully diluted earnings per share are projected to be $1 to $1.04 per share, assuming an estimated 173.4 million fully diluted shares outstanding. Our full year and second quarter guidance assumes a euro to dollar exchange rate of $1.05 to EUR 1.

With that, I'll return the call to Sudhakar for his closing remarks.

[Sudhakar Ramakrishna, executive]

Thank you, Bart. We continue to be very proud of the continuation of top line growth and adjusted EBITDA growth, both of which are a direct result of our transformation efforts and are indicative of the increasing relevance of our broad area of solution offerings, combined with our ability to innovate and to execute.

As you've heard from Bart, with continued execution discipline, we raised our full year adjusted EBITDA outlook. Customer environments continue to become more complex as they address the challenges and opportunities of their respective businesses. Equally, their budgets remain constrained, especially in this macro environment.

Customers are looking to consolidate tools and to improve security, all while seeking solutions that are cloud-ready, cost-effective and can enhance their productivity. With customers in various stages of their cloud evolution, hybrid visibility is an unsolved challenge. We believe we are ideally suited to address these customer requirements.

Finally, we believe that our focus on the SolarWinds platform gives us significant operating efficiency and enhances our ability to cost effectively innovate and help customers manage their hybrid and multi-cloud environments. The strong adoption of our Hybrid Cloud Observability solutions that we launched just 2 years ago is a testament to our strategy and execution abilities.

Our self-hosted and SaaS solutions represent a continuum for our customers, allowing them to extend their data centers to public cloud at the pace their business needs dictate. We believe these distinct capabilities combined with our execution discipline sets us up for continued profitable growth.

Although many unknowns around the macroeconomic environment persist, we remain focused on the things that we can control and I'm confident as ever in the direction of our business. I could not be prouder of our team's commitment to customer success. Again, I thank our employees, partners, customers and shareholders for their commitment to SolarWinds.

Bart and I are now happy to address your questions.

[Operator]

[Operator Instructions] And your first question comes from the line of Matt Hedberg of RBC Capital Markets.

[Matthew Hedberg, analyst]

Maybe the first question for Sudhakar. You guys reported a good quarter relative to certainly your guide and expectations, and I know you just kind of said the macro environment remains a bit uneven. I guess I'm wondering just from a high level, kind of given your results versus your guide, can you talk a little bit more about how the selling environment feels versus [indiscernible]? Is it kind of similar, and really, the upside to estimates is really just due to kind of the execution of the company?

[Sudhakar Ramakrishna, executive]

Good morning, Matt. First of all, thanks for continuing to support us and for your question. In terms of the selling environment, we don't really see much of a difference, let's say, in Q1 relative to Q4, or broadly speaking, the last few quarters. The value proposition that we have continues to resonate very well with our customers and especially in this environment.

So as we have guided for the future, we're taking into account numerous factors and largely the macroeconomic factors and are continuing to focus on what we can control at one level and execute as hard as we possibly can. But there's no [indiscernible] buying behaviors or selling patterns.

[Matthew Hedberg, analyst]

Just good execution. Okay. That's helpful. And then the success -- you guys have had a lot of success within observability, and it's really good to hear the $100 million target here. I'm kind of curious, as GenAI continues to resonate within your customers, are you seeing any sort of increased interest in your observability solutions vis-a-vis GenAI adoption within your customer base? Or is it too difficult to tell if that's maybe sort of [ to positively ] influence your observability solutions?

[Sudhakar Ramakrishna, executive]

Matt, it's still too early to say that there is a strong pattern, but we are enjoying, call it, early success and traction because we started investing in AI for the better part of 3 years now, or we have been investing, I should say. Most of the work or most of the benefits that customers derive have to do more with, call it predictive analytics or alert fatigue reductions, or alert stacking, I should say. And then more critically on the service management platform, in terms of improving the efficiency of digital assistance and response times.

So these are all consistent with our broader value proposition of time to value improvements, time to detect issue improvements and remediation improvements. As it relates to GenAI in terms of asking, call it, English language questions on an observability platform on optimization, performance, et cetera, we have the ability and the capabilities to implement those things as the SolarWinds platform progresses, but that's not like an immediate capability or need that the industry is looking for.

[Operator]

Your next question comes from the line of Sanjit Singh from Morgan Stanley.

[Sanjit Singh, analyst]

I want to talk a little bit about the subscription ARR, which is [indiscernible] quarter at 36%. I was wondering to what extent [indiscernible] contribute to that growth? Is there any way sort of decompose the growth between sort of expansion from the existing customer base versus migrations?

[J. Kalsu, executive]

Thanks for the question. Our subscription ARR growth is really -- it's primarily driven from the efforts that we have around our subscription-first strategy like we talked about. And a big effort on that is converting our existing customers over to the Hybrid Cloud Observability product. And we continue to do that.

That continues to lead the growth in the subscription ARR, and we're still doing that at a healthy uplift. We're still converting customers at over 1.6x what their current relationship is. So when we convert $1 of maintenance, we're converting that over to close to $1.60 of subscription revenue. So that's really what's driving the growth in subscription ARR.

[Sanjit Singh, analyst]

Understood. That's helpful. And then just more broadly, when I look at the growth of the company on a total revenue basis, I think you're guiding [ next to ] 2% full year to 3% versus kind of your total ARR growth, which has been sort of more like high single digits. Is there a scenario where the company sunsets new perpetual licenses and ultimately transitions customers fully to a subscription or a hybrid or a cloud [indiscernible] over time?

[Sudhakar Ramakrishna, executive]

I'll give a quick answer and then elaborate, Sanjit. Over time, the answer will be yes, largely driven by kind of the focus that we have, both on the product side, how we have packaged things and how we are positioning this value to our customers. At the same time, we believe that we -- this should not be a forced transition and should be based on a value proposition that we deliver to customers.

You've heard me talk about subscription transition for us is as much a value model transition as it is a business model transition, so we shouldn't be forcing it on the customers, but eventually, do I see it, given the trends in our subscription growth? I do. And the functions that are driving it is increased consolidation around our SolarWinds' platform, increased ability to both up and cross-sell to both existing customers as well as the expansion point that you just made. So we are tending in that direction anyway at this point.

[Sanjit Singh, analyst]

Early congrats on the $100 million on the observability milestone. That's great to see.

[Sudhakar Ramakrishna, executive]

Thank you, Sanjit. That was a significant achievement for our team. It's only been 2 years since we introduced those solutions, and to achieve that run rate is really a testament to the value proposition and the focus of our teams.

[Operator]

Your next question comes from the line of Pinjalim Bora of JPMorgan.

[Pinjalim Bora, analyst]

Congrats on the quarter. I want to stay in that line of what Sanjit was asking around the migration. It seems when I look at the sequential -- on the maintenance ARR, it seems like it's a much bigger decline this Q1 sequentially. I'm wondering if you have put in place anything that is different going to this year on the go-to-market side that drive more focus on that maintenance migration.

[Sudhakar Ramakrishna, executive]

On the maintenance migration to subscription, specifically to our observability solutions, our strategy has always been start in North America and evolve that motion to EMEA and to APJ. What we have experienced, and you've heard me talk about the flywheel motion.

What we are experiencing now in Q1 is an increased traction in EMEA that we had set up in 2023, and so the combined effect of that is what's driving more of our observability solution sales. And a meaningful part of that is through maintenance base conversions. So if you see a decline in maintenance base, that's not a bad thing given the healthy conversion factor that we are experiencing in the observability gains.

[Pinjalim Bora, analyst]

Yes. That's clear. But I'm also trying to understand your subscription ARR is obviously fantastic, but your total ARR is -- sequential additions is basically flat. But you're saying you're getting about 1.6x kind of a conversion rate.

So if I assume entire $6 million, $7 million decline in maintenance is going to your subscription ARR, that would mean -- including the maintenance -- the uplift that you have, that would mean that the new logo, apart from migration, is down a bit. Is that fair? Or am I just not thinking it right?

[J. Kalsu, executive]

I think if you're thinking about new logo adds to the license and maintenance space, yes, that would be down, but that's because of our focus on efforts on getting new customers to adopt one of our subscription products. And so that's the focus as it relates now, Pinjalim, to what we're doing on the license and maintenance side, so...

[Sudhakar Ramakrishna, executive]

We can follow up with -- during our one-on-one as well, Pinjalim.

[Operator]

Your next question comes from the line of Miller Jump of Truist Securities.

[William Miller Jump, analyst]

Congrats on the solid results. I think maybe just one more question on kind of the demand backdrop. Hyperscalers are reporting an acceleration in cloud revenue right now. So I guess just -- should we think about hyperscaler growth as a potential leading indicator for your cloud growth? Like if they call for a reacceleration with the increased contributions from GenAI and other projects, like is that a tailwind for you all? Or is that a lower correlation given the subscription transition?

[Sudhakar Ramakrishna, executive]

Right now, most of their reporting is on the infrastructure build-out side of the house and then the consumption of that infrastructure. Will that be a tailwind for us? I would say short answer is yes, but is that a significant part of our business at this point in time? And do we have to depend on that tailwind to succeed? I'd say no.

[William Miller Jump, analyst]

Okay. That's helpful. And then maybe just quick question on the guide. Strong revenue performance in the quarter, but reiterating the guide for the year, does that indicate that some of the outperformance was from deals getting pulled and -- from other quarters? Or is there something to maybe a more cautious outlook for the remainder of the year?

[Sudhakar Ramakrishna, executive]

Not really. We've had a very balanced quarter in Q1. And the guide on the top line, specifically, as you know, we increased the EBITDA guide for the entire year due to continued execution by our teams. The revenue guidance at this point is more a factor of looking at all outside factors, including macro and being conservative about how to model it. So as the year progresses, we'll continue to provide you better guidance on that, too.

[Operator]

[Operator Instructions] There are no further questions at this time. I will now turn the conference back over to Sudhakar Ramakrishna. Please go ahead.

[Sudhakar Ramakrishna, executive]

Thank you again for attending our call, and thank you for your continued support of SolarWinds. Talk to you soon.

[Operator]

Ladies and gentlemen, that concludes today's call. Thank you all for joining. You may now disconnect.