SolarWinds Q2 2024 Earnings Call Transcript

Quartr
Provided by Quartr
August 1, 2024

There are 9 speakers on the call.

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. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer session.

Operator

I would now like to turn the call over to Tim Karajah, Group Vice President, Finance. Please go ahead.

Speaker 1

Thank you. Good morning, everyone, and welcome to the SolarWinds Q2 2024 Earnings Call. With me today are Sudhakar Ramakrishna, our President and CEO and Bart Kaltu, 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.

Speaker 1

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 a 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.

Speaker 1

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

Speaker 2

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. 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.

Speaker 2

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 twenty twenty four. 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. 1st, our subscription first strategy continued to bear fruit and we are experiencing strong subscription revenue and ARR growth.

Speaker 2

2nd, our customer retention metrics remained robust, highlighting the compelling value proposition of our platform. 3rd, we saw increasing adoption of and traction for our observability solution. And 4th, 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 $193,000,000 above the high end of the guidance range we provided and representing year over year growth of 4%.

Speaker 2

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 2nd quarter. Our 2nd quarter in quarter maintenance and annual 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 2nd quarter total ARR growth of 7% year over year, passing the $700,000,000 mark in total ARR. We exceeded $100,000,000 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 represent significant incremental future opportunity for us.

Speaker 2

We recorded double digit adjusted EBITDA growth of 17 percent 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.

Speaker 2

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 clouds 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 analyzer, 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 solution.

Speaker 2

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 roadmap 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 solutions. 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 will form a framework guiding our efforts across our portfolio.

Speaker 2

The ITSM extensions are designed to transform IT operations by improving workflows, accelerating remediation processes from days or hours to minutes, using LLMs 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, an 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.

Speaker 2

As we pass the halfway point of the year, we are on track to deliver on our 2024 priorities we provided earlier this year. 1st, extending our SolarWinds platform and delivering effective solutions built to help customers achieve hybrid visibility and to manage their hybrid and multi cloud environments. 2nd, investing selectively while continuing to exercise expense discipline and expanding profitability 3rd, 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 a result of transformational efforts made across all aspects of our business, and I believe that we are set up for continued success in the second half of the year.

Speaker 2

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 transformational journey. On behalf of all Solarium's 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.

Speaker 2

With over 25 years of experience in finance and operating roles, Lewis' 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 Q3 and full year 2024 outlook. Bart?

Speaker 3

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 2nd 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.

Speaker 3

Turning to the numbers. We finished the 2nd quarter with total revenue of $193,300,000 a 4% increase compared to the prior year and above the high end of the outlook for total revenue of $191,000,000 that we provided last quarter. We ended the 2nd quarter with total ARR of $705,000,000 up 7% year over year. Our subscription ARR at the end of the second quarter was $270,000,000 an increase of 36% year over year. This growth continues to be driven by our execution of our subscription first strategy.

Speaker 3

We had 10 42 customers with over $100,000 of total ARR, representing 16% growth over the prior year. Digging into the revenue details, our 2nd quarter subscription revenue was $70,000,000 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 $110,000,000 in the 2nd 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.

Speaker 3

Our maintenance renewal rate is at 97% on a trailing 12 month basis and was 97% for the 2nd 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 Q2, license revenue was $13,000,000 down 17% from $16,000,000 in the Q2 of 2023. As a reminder, our subscription first focus has affected and will continue to affect our license sales performance.

Speaker 3

Our focus on operating discipline continues to drive strong results, and we delivered another quarter of strong non GAAP profitability. 2nd quarter adjusted EBITDA was $92,500,000 growing 17% year over year, representing an adjusted EBITDA margin of 48 percent and coming in $4,500,000 above the high end of the $88,000,000 outlook we gave for the 2nd quarter. Turning to our balance sheet. Our net leverage ratio at June 30 was approximately 3 times our trailing 12 month adjusted EBITDA. This compares to 2.7x at the end of the Q1.

Speaker 3

The increase is due to the special dividend of $168,000,000 that was declared in the Q1 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 $73,400,000 in cash flow from operations in the 6 months ended June 30.

Speaker 3

Our cash and cash equivalents and short term investment balance at quarter end was $169,600,000 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 Q3 guidance and then discuss our updated outlook for the full year. For the Q3, we expect total revenue to be in the range of $191,000,000 to $196,000,000 representing 2% growth at the midpoint.

Speaker 3

Adjusted EBITDA for the 3rd quarter is expected to be approximately $90,000,000 to $93,000,000 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 173,600,000 fully diluted shares outstanding. And finally, our outlook for the Q3 assumes a non GAAP tax rate of 26%, and we expect to pay approximately $8,000,000 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 $778,000,000 to $788,000,000 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 $368,000,000 to $375,000,000 representing 13% year over year growth at the midpoint.

Speaker 3

Non GAAP fully diluted earnings per share are projected to be $1.04 to $1.08 per share, assuming an estimated 173,800,000 fully diluted shares outstanding. Our full year and Q3 guidance assumes a euro to dollar exchange rate of 106:one. With that, I'll return the call to Sudhakar for his closing remarks.

Speaker 2

Thank you, excited about our progress in the Q2, evidenced by another strong performance on both revenue and adjusted EBITDA. We pride ourselves on delivering against our objectives and our team's execution focused continued to yield results. Secure by Design is the 1st 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 18.

Speaker 2

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 transformations 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 world, 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 transformations 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.

Speaker 2

Our continued focus on customer success has not only helped us beat our stated financial goals, but also increased 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. Pat and I are now happy to address your questions.

Operator

Thank you. We will now begin the question and answer session. And your first question comes from the line of Pinjali Bora with JPMorgan. Please go ahead.

Speaker 4

Great. Hey, guys. Thank you for I want to ask you about the macro environment overall. During the quarter, it seems like there's a lot of conflicting kind of signals that we're getting. But what did you see during the quarter?

Speaker 4

How was the linearity in the quarter? And maybe talk about the pipeline going into Q3 and the second half?

Speaker 2

Angelim, thanks for the question. Hope you're doing well. From our vantage point, there is 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 tools consolidation, delivering hybrid visibility and helping them transition to cloud or SaaS at the pace at which they dictate. Giving them future proof roadmaps with extensions via AI by design that I described.

Speaker 2

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 the same. We continue to focus on our pipeline generation activities. We are extending our partnerships.

Speaker 2

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.

Speaker 4

Yes, understood. One question on the 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 a second part to that is how are you monetizing the Service Desk AI product?

Speaker 2

Absolutely. First thing, Pinduel, 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.

Speaker 2

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 deploy it in a self hosted configuration can leverage our AI capabilities by essentially connecting to the cloud. So in other words, their 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.

Speaker 4

Understood. Thank you so much.

Operator

Your next question comes from the line of Schultz Patrick. Please go ahead.

Speaker 5

Hey guys, thanks for taking my question. Maybe first Sadhakar, just growth in 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 here?

Speaker 2

I think that's the last part of your question.

Speaker 5

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

Speaker 2

Got it. 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.

Speaker 2

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 that too.

Speaker 5

Okay, very helpful. 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 Q3, particularly, I mean, guidance is just 2% for next quarter after the first half of the year grew 4%.

Speaker 5

And you'd mentioned that there's been very little change in the macro backdrop. So can you just help bridge that delta there?

Speaker 3

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

Speaker 1

Couple actually wireless callers. We couldn't get the name. So hands up, can we check I see a number with 404276 as the next question.

Speaker 6

Can you guys hear me?

Speaker 1

Yes. Who is this? Sorry, we couldn't see the name. Hey,

Speaker 6

yes. Thank you. Yes. This is Miller Jump with Truist Securities. Please go ahead.

Speaker 6

Thank you for taking my question. Thank you. So, yes, thank you for taking my question and I'll echo my congrats to Bart for work you've done with SolarWinds and on the next step in your career. Just a question for either of you. EBITDA margins have been remarkably strong.

Speaker 6

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?

Speaker 2

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 roadmap, 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.

Speaker 6

Got it. That makes sense. And maybe just one more. The subscription ARR is 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 in momentum we're seeing this year?

Speaker 2

It's 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.

Speaker 5

Appreciate the thoughts. Thanks.

Operator

Next question comes from the line of 626-510-3317 with Morgan Stanley. Please go ahead.

Speaker 7

Hi. This is Oscar Saavedra from Morgan Stanley on for Sanjit Singh. Thank you for taking my question. So my question is around maybe some color on guidance, right? We've seen others in software actually cutting guidance.

Speaker 7

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? Thank you.

Speaker 3

Yes, good question. We've outperformed for the the 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 in the transformation to both our hybrid cloud observability as well as our SaaS products.

Speaker 1

Oscar, would you have any questions?

Speaker 7

Yes, yes. 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?

Speaker 2

For the most part, we have been achieving our plans and expanding our market opportunity. So in terms of accelerating, the approach that we have taken is enabled our partners worldwide now. So the way to think about our conversions 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.

Speaker 7

Got it. Thank you very

Speaker 3

much. Thanks, Oscar.

Operator

All right. So for the next question, I believe we have Mr. Sanjit Singh with Morgan Stanley. Please go ahead.

Speaker 8

Yes. Hi. This is Sanjit. I'm 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.

Speaker 8

I think it was like 36% subscription ARR, total ARR growing 7% 2 quarters in a row. So it seems like sustained growth there. I look at the subscription revenue, it seems like it's sort of flatlining in sort of the $69,000,000 to $70,000,000 range. It's been really picking up in terms of like dollars quarter over quarter in the multiple quarters prior to that. You help me understand like why subscription revenue sort of flattish in the context of what are clearly great subscription ARR and total ARR growth and total ARR growth?

Speaker 3

Yes. Good question, Sanjit. The reality is our subscription revenue 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.

Speaker 3

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 our biggest HCO customer, subscription customer, and it results in a little bit of a pop in Q1. So, we have to overcome that in the Q2. 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.

Speaker 8

Understood. Thanks very much.

Speaker 3

Yeah, good question, Sanjay, 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.

Speaker 8

Understood. Thank you.

Operator

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

Speaker 2

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.

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Key Takeaways

  • Strong Q2 financial results: Total revenue was $193.3 M (+4% Y/Y) with subscription revenue up 31%, total ARR grew 7% to $705 M, and adjusted EBITDA rose 17% to $92.5 M.
  • Subscription-first momentum: Conversion of maintenance customers drove 36% subscription ARR growth and lifted recurring revenue to 93% of total, including over $100 M ARR in hybrid cloud observability.
  • Product and AI innovation: Enhanced hybrid observability and database performance tools, launched a free ITSM maturity model, and introduced AI-driven Service Desk extensions under new “AI by Design” security and trust principles.
  • Raised outlook: Q3 revenue guidance of $191 M–$196 M (+2% Y/Y) and full-year revenue guidance of $778 M–$788 M (+3% Y/Y) were both raised, with full-year adjusted EBITDA now expected at $368 M–$375 M (+13%).
  • Leadership and legal update: CFO Bart Kaltu will be succeeded by Lewis Black, and a court order largely dismissed the SEC’s enforcement claims, leaving one allegation pending.
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