SolarWinds Corp

NYSE:SWI

Earnings Call Analysis

Earnings Call Transcript 2024-Q2

[Operator]

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

[Tim Karaca, executive]

Thank you. Good morning, everyone, and welcome to the SolarWinds Second Quarter 2024 Earnings Call. With me today are Sudhakar Ramakrishna, our President and CEO; and Bart Kalsu, our CFO. 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 the 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 [ 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 the 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 our other financial metrics discussed on today's call are available in our earnings press release and summary slide deck on our 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 another strong quarter, once again exceeding our guidance across our key metrics and building on the momentum we have experienced in the last several quarters. I believe our team's continued focus on customer success and execution has positioned us well for a strong second half of 2024. We believe our performance in a challenging software spending environment demonstrates the compelling value we deliver to customers and the resiliency of our business model. Now turning to business highlights from this quarter. First, our subscription-first strategy continued to bear fruit, and we are experiencing strong subscription revenue and ARR growth. Second, our customer retention metrics remained robust, highlighting the compelling value proposition of our platform. Third, we saw increasing adoption of and traction for our observability solution. And fourth, we continued with our ongoing product innovation, driven by our focus to improve productivity, reduce complexity and improve cost effectiveness for our customers. I will now touch on some of these before turning the call over to Bart for more color on the quarter and our financial outlook for the remainder of the year. In Q2 2024, we delivered total revenue of $193 million, above the high end of the guidance range we provided and representing year-over-year growth of 4%. We continue to see success with our subscription-first strategy and delivered year-over-year subscription revenue growth of 31% and subscription ARR growth of 36% in the second quarter. Our second quarter in [ quarter ] maintenance and renewal rate was 97%, and our trailing 12-month maintenance renewal rate was 97%, consistent with last quarter and up from 94% in the same quarter of the prior year. We delivered second quarter total ARR growth of 7% year-over-year, passing the $700 million mark in total ARR. We exceeded $100 million in total ARR for our hybrid cloud observability solutions, a significant milestone that is the result of the ongoing conversion of our maintenance base as well as the acquisition of new customers. As I shared last quarter, we believe that tools consolidation, cloud modernization and simplicity are the key driving factors and represents significant incremental future opportunity for us. We recorded double-digit adjusted EBITDA growth of 17% year-over-year and another quarter of achieving the Rule of 50. And finally, in July, we refinanced and extended our debt with another 50 basis point of rate reduction, which Bart will highlight further. Turning to our product portfolio. We continue to believe that our multifaceted solutions deliver the best time to value, time to detect and time to remediate issues across on-premises, cloud and hybrid environments. We believe that our observability, database performance and service management offerings are the most comprehensive in the industry and help customers reduce costs, while enabling them to accelerate their business transformation. I will now provide some product and solution updates that are aimed at the diverse and changing needs of our customers. We continue to enhance device and node support in our HCO solutions, giving us the opportunity to expand our footprint in customers' environments and to help them consolidate their tools further. We enhanced our support for Azure and AWS cloud and strive to continue to eliminate visibility gaps for our customers while improving their productivity and reducing their costs. Hybrid observability is a cornerstone of our observability solution. We enhanced the database performance analyzers, helping enterprises maximize performance and migration of their PostgreSQL databases across on-premises and cloud environments. We continue to further simplify the packaging of our database solutions to give customers the opportunity to experience the full breadth of our solutions. We believe we can expand our business further with these modifications. And we launched our free ITSM maturity model, a purpose-built and free tool for enterprises to evaluate and assess their existing ITSM practices. This tool also provides a road map for improving operational excellence and service delivery while reducing costs. I have previously described how our AIOps is leveraged to reduce alert fatigue and determine root cause analysis to further reduce mean time to detect and remediate issues, and how we are developing tools that in the future will allow us to implement predictive analytics into our observability solution. I'll now touch on AI extensions in our service desk solution that we announced in May as well as highlight our AI by Design principles that'll form a framework guiding our efforts across our portfolio. The ITSM extensions are designed to transform IT operations by improving workflows, accelerating remediation processes from days or hours to minutes using LLM and our own proprietary algorithms. Our SolarWinds AI is designed to allow a service desk assistant to instantly summarize ticket histories, suggest agent responses, and create real-time recommended steps for resolving issues. With the ever evolving nature of artificial intelligence, we knew it was essential that this and all future AI tools we build are carefully architected with security in mind. That is why we introduced our new AI by Design principles and extension of the Secure by Design principles that have guided our approach to security since 2021. These principles, which are privacy and security, accountability and fairness, transparency and trust, simplicity and accessibility, are an evolving framework to help customers establish a lasting relationship with AI built on security and productivity. Like Secure by Design, we believe our AI by Design principles should guide our industry as we enter and navigate the future of artificial intelligence. As we pass the halfway point of the year, we are on track to deliver on our 2024 priorities we provided earlier this year. First, extending our SolarWinds platform and delivering effective solutions built to help customers achieve hybrid visibility and to manage their hybrid and multi-cloud environments. Second, investing selectively while continuing to exercise expense discipline and expanding profitability. Third, focusing on subscription and ARR growth, customer success and retention, growing profitability and cash flow, and creating more value for our shareholders. I'm pleased with our execution against these priorities. Our strong foundation is the result of transformational efforts made across all aspects of our business, and I believe that we [ have ] set up for continued success in the second half of the year. Before I turn the call over to Bart, I want to acknowledge that this is Bart's last SolarWinds earnings call. As we announced in June, Bart will be moving on to pursue the next chapter in his career later this month. Bart has been my partner from the day I joined in this transformation journey. On behalf of all SolarWinds, Bart, I express my heartfelt gratitude to you for your many contributions and wish you great health and much success in your future endeavors. I want to welcome Lewis Black, who is joining us this month as our Chief Financial Officer. With over 25 years of experience in finance and operating roles, Lewis's experience in transforming technology companies will be crucial for our next phase of growth. Lewis is with me in the room today and looking forward to engaging closely with all of you going forward. With that, I will now turn it over to Bart to expand on our financial performance and provide our third quarter and full year 2024 outlook. Bart?

[J. Kalsu, executive]

Thanks, Sudhakar. It has been a privilege to be a part of SolarWinds over the past 17 years, and we are in great hands with Lewis taking over as the CFO. We had another strong quarter, and the second quarter was a continuation of the momentum from the first. We remain confident in our business and financial goals for the remainder of 2024. Despite what continues to be a challenging IT spending environment, we continue to see strong growth in the mix of predictable recurring revenue and have delivered sustained ARR growth. Turning to the numbers. We finished the second quarter with total revenue of $193.3 million, a 4% increase compared to the prior year and above the high end of the outlook for total revenue of $191 million that we provided last quarter. We ended the second quarter with total ARR of $705 million, up 7% year-over-year. Our subscription ARR at the end of the second quarter was $270 million, an increase of 36% year-over-year. This growth continues to be driven by our execution of our subscription-first strategy. We had 1,042 customers with over $100,000 of total ARR, representing 16% growth over the prior year. Digging into the revenue details, our second quarter subscription revenue was $70 million, up 31% year-over-year. The increase in subscription revenue continues to reflect the success of our subscription-first strategy, which includes converting a portion of our maintenance base to our subscription products. Maintenance revenue was $110 million in the second quarter, down 5% compared to the prior year. Such decline was expected as we continue to convert existing customers to our hybrid cloud observability product. Our maintenance renewal rate is at 97% on a trailing 12-month basis and was 97% for the second quarter. To remind you, as we convert maintenance customers to subscriptions, we exclude those customers from this 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 second quarter, license revenue was $13 million, down 17% from $16 million in the second quarter of 2023. As a reminder, our subscription-first focus has affected and will continue to affect our license sales performance. Our focus on operating discipline continues to drive strong results, and we delivered another quarter of strong non-GAAP profitability. Second quarter adjusted EBITDA was $92.5 million, growing 17% year-over-year, representing an adjusted EBITDA margin of 48% and coming in $4.5 million above the high end of the $88 million outlook we gave for the second quarter. Turning to our balance sheet. Our net leverage ratio at June 30 was approximately 3x our trailing 12-month adjusted EBITDA. This compares to 2.7x at the end of the first quarter. The increase is due to the special dividend of $168 million that was declared in the first quarter and paid in April. In July of 2024, we again refinanced our term loan, decreasing the interest rate by 50 basis points from SOFR plus 3.25% to SOFR plus 2.75%. In addition, we extended the maturity to February 2030, which we believe showcases the stability and recurring nature of our business. We will continue to attempt to take advantage of the interest rate environment and look for opportunities to further reduce our variable interest rate as we move forward. We continue to generate strong cash flow with $73.4 million in cash flow from operations in the 6 months ended June 30. Our cash and cash equivalents and short-term investment balance at quarter end was $169.6 million. Our non-GAAP diluted earnings per share were $0.26 above the guidance range of $0.21 to $0.23 per share. Most of this beat is driven by our improved profitability. I'll now walk you through our outlook before turning it over to Sudhakar for final thoughts. I will start with our third quarter guidance and then discuss our updated outlook for the full year. For the third quarter, we expect total revenue to be in the range of $191 million to $196 million, representing 2% growth at the midpoint. Adjusted EBITDA for the third quarter is expected to be approximately $90 million to $93 million, representing 8% growth at the midpoint. Non-GAAP fully diluted earnings per share are projected to be $0.24 to $0.26 per share, assuming an estimated 173.6 million fully diluted shares outstanding. And finally, our outlook for the third quarter assumes a non-GAAP tax rate of 26%, and we expect to pay approximately $8 million in cash taxes during the quarter. For the full year, we are raising the revenue guidance and expect total revenue to be in the range of $778 million to $788 million, representing 3% year-over-year growth at the midpoint. We are also raising our adjusted EBITDA for the year, which is now expected to be approximately $368 million to $375 million, representing 13% year-over-year growth at the midpoint. Non-GAAP fully diluted earnings per share are projected to be $1.04 to $1.08 per share, assuming an estimated 173.8 million fully diluted shares outstanding. Our full year and third quarter guidance assumes a euro to dollar exchange rate of $1.06 to $1.00. With that, I'll return the call to Sudhakar for his closing remarks.

[Sudhakar Ramakrishna, executive]

Thank you, Bart. I'm very excited about our progress in the second quarter evidenced by another strong performance on both revenue and adjusted EBITDA. We pride ourselves on delivering against our objectives and our team's execution focus continued to yield results. Secure by Design is the first major initiative I started a few days after I joined the company in January 2021. Our focus on continuous improvement, transparency and public-private partnerships has been unwavering. Against this backdrop, it is very gratifying for us that Judge Engelmayer largely agreed with our motion to dismiss the SEC's claims in his order on Thursday, July 18th. As we said in our public statement on the order, we look forward to the next stage where we will have the opportunity to present our evidence and to demonstrate why the remaining claim is factually inaccurate. In the meantime, we continue to focus on our mission to help customers accelerate their business transformation in multi-cloud environments and remain grateful for the support we have received from so many. Customers are constantly adapting to the rapid growth and innovation in our work, and we believe that our purpose of enriching their lives makes us uniquely qualified to serve them. In a world where budgets are constrained and complexity continues to grow, our solutions empower customers in all stages of their cloud transformation to achieve hybrid visibility and to cost effectively manage their assets. I'm as confident as ever in our ability to adapt to evolving customer needs and to continue to deliver compelling value. Our continued focus on customer success has not only helped us beat our stated financial goals, but also increase our revenue and adjusted EBITDA outlook for the year. I'm extremely proud of our team's efforts to deliver customer success, and again, 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] Your first question comes from the line of Pinjalim Bora with JPMorgan.

[Pinjalim Bora, analyst]

Congrats on a good quarter. I want to ask you about the macroenvironment overall during the quarter? It seems like there's a lot of conflicting kind of signals that we are getting. But what did you see during the quarter? How was the linearity in the quarter? And maybe talk about the pipeline going into Q3 and the second half?

[Sudhakar Ramakrishna, executive]

Pinjalim, thanks for the question. From our vantage point, there has not been any meaningful difference in macro from, let's say, Q1 to Q2 or in the first half of this year, as in either significant positive progress or any material deterioration. The value prop that our solutions continue to drive for our customers, that being improved consolidation, delivering hybrid visibility and helping them transition to cloud or SaaS at the pace at which they dictate, giving them future-proof road maps with extensions via AI by Design that I described, they're all resonating. And as you know, we have a very large and very diversified customer base as well, and that's come in very, very handy for us. In terms of pipeline, I would say this. We continue to focus on our pipeline generation activities. We are extending our partnerships. I'm sure you are familiar with our Transform Partner program. And we've been enlisting additional partners that help us extend our customer reach while continuing to be focused on our expense discipline methodologies.

[Pinjalim Bora, analyst]

One question on AI by Design philosophy that you have. Are we going to see most of these AI capabilities, including the one in the service desk in cloud? And do we expect that to be a motivation to kind of accelerate migration towards cloud for some of the customers? And maybe the second part to that is, how are you monetizing the service desk AI product?

[Sudhakar Ramakrishna, executive]

Absolutely. First thing, Pinjalim, I'll highlight is AI is not restricted only to our service desk product. We had introduced AIOps concepts into our observability platform in the context of alert stacking, productivity improvement, time to remediate efficiencies and so on. And so that set of principles will permeate through the portfolio. Now with regards to the service management product, the AI capabilities will be in one of our premier tier products, which has a higher ASP. And we are already seeing some initial traction around that. As to motivation for customers to move to the cloud, the way I look at it is customers -- our customers already have a choice today of deploying in the cloud. But even the customers that deployed in a self-hosted configuration can leverage our AI capabilities by essentially connecting to the cloud. So in other words, the entire deployment need not be in the cloud, but just the AI extensions can be. And so that's the flexibility that we offer our customers.

[Operator]

Your next question comes from the line of Schulz Patrick.

[Patrick Schulz, analyst]

Maybe for Sudhakar. Just growth from the large customers over $100,000 ARR has been very consistent in the past several quarters. How big of a driver is the hybrid cloud observability solution for this cohort? And what does adoption look like there?

[Sudhakar Ramakrishna, executive]

I didn't catch the last part of your question.

[Patrick Schulz, analyst]

With the larger customer cohort, just how big of a driver is the hybrid cloud observability solution? And what does the adoption look like?

[Sudhakar Ramakrishna, executive]

First, it is a significant driver for not just that cohort, but across the board. For the primary reasons that I have been highlighting, which is, we give the most elegant tools consolidation story for our customers. We give the most elegant hybrid visibility story for our customers where they can start in a self-hosted fashion and extend into the cloud. And of course, the simplicity of packaging and pricing is extremely appealing to our customers across the board. It does apply more broadly to the larger enterprise customers or larger customers in general because they tend to have more tools, they tend to be a bit more fragmented. And therefore, in this environment, it's a lot more compelling if we can consolidate their tools.

[Patrick Schulz, analyst]

And then, Bart, maybe one for you. I guess, first, congrats on a successful tenure with SolarWinds and best of luck with your next venture. We’re going to miss working with you. But looking at the guidance for the Q3 particularly, I mean, guidance is just 2% for next quarter after the first half of the year grew 4%. And you mentioned that there's been very little change in the macro backdrop. So can you just help bridge that delta there?

[J. Kalsu, executive]

Yes. What I'd say is it's very consistent with the way we've guided for the first half of the year. We tried to keep guidance somewhat in line with what our performance is. We try to be prudent when we provide guidance, and we want to give numbers that we feel confident that we can hit.

[Operator]

That concludes our Q&A session. I will now turn the conference back over to Mr. Sudhakar for closing remarks.

[Tim Karaca, executive]

Yes. There are a couple actually wireless callers. We couldn't get the name. And so hands up -- Can we check? I see a number with [ 404276 ], has the next question.

[William Miller Jump, analyst]

This is Miller Jump with Truist Securities. [indiscernible] my congrats to Bart for the work you've done with SolarWinds and on the next step in your career. It's a question for either of you. EBITDA margins have been remarkably strong. You obviously recently restructured the debt. So I'm just curious, do you all see any opportunities from here to increase investments to maybe drive growth in either the go-to-market or product side of the business right now?

[Sudhakar Ramakrishna, executive]

Yes, we continue to evaluate our investment opportunities and our focus is on balancing growth and profitability. As I've described in the past several times, in fact, our goal is to consistently deliver mid-40s EBITDA margins, and we are, as you highlighted, meaningfully above that. So as we look at the second half and also into 2025, we continually focus on how do we accelerate our road map, how do we get better efficiencies while scaling our go-to-market as well. So short answer to your question is yes. But this will be weighted against growth prospects, macro conditions, efficiencies and sustainability.

[William Miller Jump, analyst]

And maybe just one more. The subscription ARR sustaining its momentum against sequentially tougher comps now. Just curious if there's anything from the go-to-market side that you're seeing or that you've changed there that you think is driving this uptick and momentum we're seeing this year?

[Sudhakar Ramakrishna, executive]

It's a continued focus on the execution of our strategy that we outlined in 2021, which is a subscription-first motion. But as I've always described it, it's not just a business model transition. It's a value model transition for us. So our products are delivering better value, our observability solutions, database solutions, service management solutions continue to be extended to provide better value to customers. And it happens that when they procure it, they procure it in a subscription arrangement, and that's what's driving the growth.

[Operator]

Next question comes from the line of [phone] with Morgan Stanley.

[Oscar Saavedra, analyst]

This is Oscar Saavedra from Morgan Stanley on for Sanjit Singh. So my question is around, maybe some color on guidance, right? We've seen others in software actually cutting guidance. So maybe what sort of gives you that confidence to actually raise it? And maybe to what extent is that a result of maybe seeing stronger than -- or like maybe an improvement in the pace of maintenance to subscription migration?

[J. Kalsu, executive]

Yes, good question. We've outperformed for the first half of the year as far as the guidance that we gave. And there's really nothing in what we're seeing in the macroenvironment as well as our own internal demand that makes us see things any differently. So it gives us the confidence to go ahead and raise for the back half of the year. The good thing for us is a big piece of our bookings comes from existing customers. And like Sudhakar talked about, our customers see the value in our products. And they see the value and the transformation to both our hybrid cloud observability as well as our SaaS products.

[Oscar Saavedra, analyst]

I guess the second part of it was, to what extent maybe are you seeing an increase in the pace of those migrations? Or is it still going at the same pace that it historically has?

[Sudhakar Ramakrishna, executive]

For the most part, we have been achieving our plans and expanding our market opportunities. So in terms of accelerating the approach that we have taken has enabled our partners worldwide now. So the way to think about our conversion is we started first in North America, then we expanded into EMEA and now on to APJ. So it's more breadth of conversion across all our regions, and we've seen consistent results across geographies. And as more partners and more of our sales teams make that the primary motion, we expect to see this momentum.

[Operator]

So for the next question, I believe we have Mr. Sanjit Singh with Morgan Stanley.

[Sanjit Singh, analyst]

This is Sanjit. Sorry, I was toggling between multiple calls this morning. To follow up on Oscar's question, Bart, when I look at the subscription ARR performance and the total ARR performance, the growth rates are sustained. I think it was like 36% subscription ARR, total ARR growing 7%, 2 quarters in a row. So it seems like sustained growth there. When I look at the subscription revenue, it seems like it's sort of flatlining in sort of the $69 million to $70 million range. It has been really picking up in terms of like dollars quarter-over-quarter in the multiple quarters prior to that. Can you help me understand like why subscription revenue is sort of flattish in the context of what are clearly great subscription ARR and total ARR growth?

[J. Kalsu, executive]

Yes. Good question, Sanjit. The reality is our subscription revenue, it comes from a number of different bookings types. So our HCO product is an on-premise subscription. So it has a little bit different [ rev rec ] than your SaaS products. And so we talk a lot about us putting our maintenance customers over to subscription. So there's some variability in the [ rev rec ] related to that particular product. And so what you're seeing there is Q1, for example, we have our biggest HCO customer, subscription customer, and it results in a big -- a little bit of a pop in Q1. So we have to overcome that in the second quarter. What we expect to see is some increase in subscription revenue in the back half of the year, and then we'll just continue to build on that momentum. That's why we -- yes, good question, Sanjit, too as far as -- that's why we talk a lot more about subscription ARR because we think that's the better indicator of the health of the business.

[Operator]

That concludes our Q&A session. I will now turn the conference back over to Mr. Sudhakar for closing remarks.

[Sudhakar Ramakrishna, executive]

Thank you again for joining us today, and thank you again for your support to SolarWinds, and appreciate all our customers, partners and shareholders.

[Operator]

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