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Edited Transcript of SWI.N earnings conference call or presentation 1-Aug-19 9:00pm GMT

Q2 2019 SolarWinds Corp Earnings Call

Oct 14, 2019 (Thomson StreetEvents) -- Edited Transcript of Solarwinds Corp earnings conference call or presentation Thursday, August 1, 2019 at 9:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* David Hafner

SolarWinds Corporation - VP of IR

* J. Barton Kalsu

SolarWinds Corporation - Executive VP, CFO, CAO & Treasurer

* Kevin B. Thompson

SolarWinds Corporation - President, CEO & Director

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Conference Call Participants

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* Brad Alan Zelnick

Crédit Suisse AG, Research Division - MD

* Heather Anne Bellini

Goldman Sachs Group Inc., Research Division - MD & Analyst

* John Stephen DiFucci

Jefferies LLC, Research Division - Equity Analyst

* Matthew John Swanson

RBC Capital Markets, LLC, Research Division - Senior Associate

* Matthew Ryan Wells

Citigroup Inc, Research Division - Associate

* Mohit Gogia

Barclays Bank PLC, Research Division - Research Analyst

* Nicholas Ivan Negulic

SunTrust Robinson Humphrey, Inc., Research Division - Associate

* Sanjit Kumar Singh

Morgan Stanley, Research Division - VP

* Stewart Kirk Materne

Evercore ISI Institutional Equities, Research Division - Senior MD

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Presentation

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Operator [1]

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Good afternoon. My name is Emily, and I will be your conference operator today. At this time, I would like to welcome everyone to the SolarWinds Second Quarter 2019 Earnings Call. (Operator Instructions) Thank you.

 

David Hafner, Vice President of Investor Relations, please go ahead.

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David Hafner, SolarWinds Corporation - VP of IR [2]

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Thank you, Emily. Good afternoon, everyone, and welcome to SolarWinds' Second Quarter 2019 Earnings Call. With me today are Kevin Thompson, our President and CEO; and Bart Kalsu, our Executive Vice President and CFO. Following prepared remarks from Kevin and Bart, we'll have a brief question-and-answer session. Please note that this call is being simultaneously webcast on our Investor Relations website at investors.solarwinds.com.

 

Please remember that certain statements made during this call, including those concerning our financial outlook, our expectations regarding growth and profitability, our expectations regarding the impact and integration of the Samanage acquisition, our market opportunities and market share, our expectations regarding customer retention and the adoption of our new product offerings by our customer base, areas of focus for our business and our M&A strategy are forward-looking statements. These statements are subject to a number of risks, uncertainties and assumptions described in our SEC filings, including the risk factors discussed in our Form 10-K that was filed on February 25, 2019, and the Form 10-Q that we plan to file by August 14, 2019. Should any of these risks or uncertainties materialize or should any of our assumptions prove to be incorrect, actual company results could differ materially and adversely from those anticipated in these forward-looking statements. These statements are also based on currently available information, and we undertake no duty to update this information except as required by law. The cautionary statements regarding these forward-looking statements are further described in today's press release.

 

Unless otherwise noted, all 2019 results that will be discussed on today's call will include adjustments for the adoption of ASC 606, and all 2018 financial measures discussed today will be presented on an ASC 605 basis. All year-over-year comparisons will be impacted by these adjustments in 2019 unless otherwise noted. The tables accompanying today's press release include a presentation of our 2019 results on an ASC 606 basis and an ASC 605 basis. We will also provide our results and our outlook for revenue growth rates on a constant currency basis to provide a framework for assessing our performance and how we expect our business to perform, excluding the effect of foreign currency fluctuations. Our use and calculation of these non-GAAP financial measures are further explained in today's press release, and a full reconciliation between each non-GAAP measure and its corresponding GAAP measure is provided in the tables accompanying the press release, including adjustments for the impact of ASC 606. However, each non-GAAP item in our forward-looking financial outlook that we will provide today has not been reconciled to the comparable GAAP outlook item because providing projections of changes in individual balance sheet and income statement amounts is not possible without unreasonable effort, and release of such reconciliations would imply an inappropriate degree of precision. Unless otherwise indicated, references to profitability and comparable measures refer to such measures on a non-GAAP basis.

 

With that, I'll now turn the call over to Kevin.

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Kevin B. Thompson, SolarWinds Corporation - President, CEO & Director [3]

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Thanks, Dave. And thanks, everyone, for joining us for today's call. I'm very pleased with our second quarter 2019 results as they included accelerated top and bottom line growth, which resulted in total non-GAAP revenue and adjusted EBITDA that were both well above our outlook for the quarter. Second quarter non-GAAP revenue totaled $231 million, reflecting year-over-year growth on a constant currency basis of 15%. Adjusted EBITDA also exceeded the high end of our outlook range for the second quarter coming in at $111 million, reflecting year-over-year growth of 18% and an adjusted EBITDA margin of 48.1% as the majority of our revenue outperformance in the quarter flowed straight to the bottom line despite the dilutive impact of the Samanage acquisition, which closed during the second quarter.

 

As we discussed on our first quarter earnings call in April, the addition of Samanage extends our hybrid IT management capabilities to the IT service management market, allowing us to enhance our ability to serve the needs of the technology pro from the point of the identification of an issue through to the resolution of the issue. We plan to attack the ITSM market with the same disruptive SolarWinds approach you have seen us employ in the network and systems management market, which include easy-to-deploy try-and-use products and a disruptive approach to pricing. The Samanage team has had a great attitude throughout the entire acquisition process, and their excitement about becoming part of the SolarWinds family and commitment to making this acquisition successful has made the initial integration process go very well. We're excited about the new avenue of subscription revenue growth this brings for us in the ITSM market.

 

We have moved through the first 6 months of 2019 with solid momentum to reflect the work we have done over the last 3 years to position ourselves as the hybrid IT management provider of choice for organizations who need a comprehensive set of products to manage their infrastructure and applications without regard to where those IT assets sit, on-premise or in the cloud, and without regard to where those IT assets need to be managed from. As we look across our business, we feel good about the opportunity we see for sustainable, highly profitable, long-term growth in each of our product lines driven by the power of our go-to-market model, which has historically resulted in low customer acquisition costs.

 

In fact, even if subscription revenues have increased dramatically as a percentage of total revenue over the last 3 years, we have seen these costs as a percentage of revenue from new bookings remain remarkably consistent. In addition, a unique component of our operating approach is our global product development model, which has allowed us to deliver high-quality products with frequent product releases at a low cost as a percentage of revenue.

 

During the second quarter, we increased the pace of our revenue growth consistent with the outlook we provided at the beginning of the year. We have been able to drive acceleration in both our license and maintenance revenue and subscription revenue stream, which resulted from solid sales and marketing execution across our product line and an approach to product strategy that has resonated with our customers.

 

Our subscription businesses performed well during the second quarter, delivering approximately $81 million in non-GAAP revenue and growth of 26% on a constant currency basis with non-GAAP subscription revenue increasing to 35% of total non-GAAP revenue for the quarter. Even when excluding the contribution from the Samanage acquisition, growth in non-GAAP subscription revenue accelerated significantly compared to the first quarter led by a strong cohort growth from our [ASC] business.

 

Subsequent to the closing of the acquisition, Samanage also performed well in the quarter. This performance resulted from the combination of strong traction that the Samanage Service Platform has been seeing in the market prior to the acquisition combined with the power of the SolarWinds brand and our initial work to accelerate demand generation and brand awareness for SSD, which we relaunched as SolarWinds Service Desk in late June.

 

We remain confident in the outlook we provided on our first quarter earnings call for the revenue and adjusted EBITDA contribution from Samanage for 2019 as well as the long-term growth and profitability outlook, which we also provided.

 

We also had a strong quarter performance from our on-premise business as our portfolio of network and systems management products saw a combined constant currency license and maintenance revenue growth of 10% for the second quarter, including the highest rate of constant currency maintenance revenue growth we've delivered in the past 5 quarters at 12%. We believe the acceleration in license and maintenance revenue growth that we drove in the second quarter reflects the focus we have on ensuring that we are providing technology pros with the solutions they need to solve the IT management problems that they are facing today and that we remain committed to providing those solutions to the way they want them delivered at price points that are compelling. We also believe that we have assembled the most comprehensive product portfolio in IT management to meet the needs of the individual technology pro. In addition, we have continued to invest in our product, which solve problems in environments controlled directly by IT, including on-premise behind corporate firewalls and in private and hosted data centers. It is this approach which has allowed us to grow in a pace faster than the overall growth of this part of the IT management market.

 

The market position we have created combined with our unique and powerful go-to-market model has enabled us to consistently add a large volume of new customers that averaged nearly 7,000 new customers per quarter over the last 4 quarters. We have added this large volume of new customers while at the same time retaining existing customers at an industry-leading rate and expanding our financial relationship with our customers over time. In fact, during the second quarter of 2019, we grew the number of customers with $100,000 or more of trailing 12-month spend with us to 780 from 761 at the end of the first quarter. We believe this reflects the strength of our product, which simply work, and the viral nature of our land-and-expand model as almost all these large relationships started with a small initial purchase.

 

As we look ahead, based on our strong on-premise product portfolio, the work we have done to make this product portfolio relevant in hybrid IT infrastructure environments, the relationships we have with our customers and our disruptive go-to-market approach aided by software, we believe we can continue to take market share from legacy IT management business. As a result, we expect our license and maintenance revenue to grow faster than the growth rate of the on-premise IT management market.

 

With that, I will now turn the call over to Bart for a more detailed discussion of our Q2 results and a view of our outlook for the second half of 2019.

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J. Barton Kalsu, SolarWinds Corporation - Executive VP, CFO, CAO & Treasurer [4]

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Thanks, Kevin. And thanks again to everyone joining us on today's call. Before I begin my remarks, I want to provide a little context. First, our GAAP results for the second quarter are presented in detail in our second quarter press release. I also want to provide a quick reminder that we will discuss the second quarter financial information on this call on a non-GAAP basis and that we are presenting results as calculated under ASC 606, which aligns with the second quarter outlook we provided in April. The adjustments to revenue in the second quarter of 2019 required by ASC 606 netted to a $2,000 difference as compared to ASC 605, while expenses were $1.2 million lower under ASC 606 driven by the capitalization and associated amortization of sales commissions.

 

As Kevin indicated in his comments, the second quarter was another quarter of solid execution. We exceeded the high end of our outlook for the quarter for total license and maintenance revenue as well as subscription revenue. The high end of our previous outlook for total revenue was $229 million, and we finished the second quarter with total revenue of $230.6 million, which reflects year-over-year growth of 14%. However, we continue to battle foreign currency headwinds in the second quarter, and total revenue year-over-year growth on a constant currency basis was 15%. Non-GAAP recurring revenue was 83% of total non-GAAP revenue for the second quarter and continues to increase as a percentage of our total revenue, which is consistent with what we talked about last year during our initial public offering, and we expect that trend to continue when looking ahead.

 

Okay, I'll now walk you through the financial details of our second quarter results. I'll then provide you with our outlook for the third quarter and full year before turning it back over to Kevin for some final thoughts.

 

Second quarter revenue growth was led by non-GAAP subscription revenue of $80.6 million, which grew 23% year-over-year on a reported basis and 26% on a constant currency basis. This growth was led by our MSP product line, a solid contribution from our cloud-based application management products as well as the contribution from the Samanage acquisition that closed during the second quarter. We have continued to add products that expand our subscription revenue stream and expect subscription revenue to continue to lead our revenue growth for the second half of 2019.

 

Our success at landing and expanding and retaining customers translated into a solid increase in monthly recurring revenue in the second quarter of 2019 driven primarily by our MSP business. Our average subscription net retention rate remained consistent at 105% for the trailing 12 months. We believe that our continued focus on high-quality new customer growth in our MSP business combined with price increases from the first half of 2019, strong net retention rates and the growth from the ITSM product line will result in an acceleration of subscription revenue growth in the second half of 2019.

 

Total non-GAAP license and maintenance revenue was $150 million, which was an increase of 9% year-over-year on a reported basis and an increase of 10% on a constant currency basis. For the second quarter, non-GAAP maintenance revenue was $110.8 million, which was an increase of 11% year-over-year on a reported basis and an increase of 12% on a constant currency basis. Our strong maintenance revenue growth reflects the benefit of our unique maintenance model as it drives a higher proportion of recurring maintenance revenue for each dollar of license spend as compared to traditional license and maintenance models. Our maintenance growth also reflects the tailwind associated with 6 straight quarters of license revenue growth. However, we believe the primary driver of our maintenance growth is the loyalty of our customer base and their satisfaction with our products that is reflected by our high maintenance renewal rate, which was 96% on a trailing 12-month basis through the end of the second quarter.

 

We also had a very strong quarter of non-GAAP profitability in the second quarter of 2019. Second quarter adjusted EBITDA was $110.9 million, representing an adjusted EBITDA margin of over 48% and a strong quarter of growth as adjusted EBITDA increased by 18% year-over-year, well ahead of second quarter total revenue growth. We believe our ability to drive such high adjusted EBITDA in a quarter where we completed a dilutive acquisition is a great proof point of the leverage and efficiencies we have built into our operating model and the ability we have to drive sustainable, long-term earnings growth.

 

Non-GAAP expenses were approximately $124.2 million in the second quarter of 2019, which includes $18.9 million of non-GAAP cost of revenue and $105.3 million in non-GAAP operating expenses, which reflects an 11% increase year-over-year. Keep in mind that 2019 sales and marketing expenses reflects the adoption of ASC 606 and would have been $1.2 million higher on a 605 basis. All of our non-GAAP expenses grew at a rate slower than our reported revenue growth for the quarter. That includes our sales and marketing expenses, which were up 11% year-over-year. Sales and marketing spend as a percentage of total revenue was down year-over-year as a percentage of total revenue to 26.8% versus 27.5% in the second quarter of 2018 despite the dilutive impact of the Samanage acquisition.

 

We have maintained a very consistent level of sales and marketing spend as a percentage of revenue over the last 3 years. However, over the same time frame, we have built a very large subscription revenue stream, which has increased from 22% of total revenue to 35% of total revenue, and we have consistently added a very high volume of new customers each quarter across all our product lines. We believe our ability to hold sales and marketing spend at a consistent level relative to revenue while doing those 2 things illustrates the power of the SolarWinds approach and the efficiencies built into our go-to-market model, which allow us to drive very high volume of new customers in the door each quarter at a very low cost without regard to whether they are buying a license or a subscription.

 

We also have maintained non-GAAP gross margins of approximately 92% for more than 3 years as subscription revenue has increased meaningfully as a percentage of total revenue, which is a feat that very few companies have been able to accomplish. This further illustrates our point of view that having a large and growing subscription revenue stream does not mean you cannot also run a highly profitable business.

 

And finally, we ended the quarter with $155 million of cash. The decrease since the end of the first quarter is primarily due to the acquisition of Samanage in the second quarter, which we financed with cash off of our balance sheet. Cash collections were strong in the second quarter. And DSOs at June 30, 2019, were at 38 days, down from a slightly higher level at the end of March. At June 30, our net leverage was at 4.2x trailing 12-month adjusted EBITDA compared to 3.7x at March 31, which is lower by almost half a turn compared to the post-acquisition pro forma net leverage we discussed on our first quarter earnings call. Our outlook for net leverage is for the ratio to be approximately 3.5x by the end of 2019, assuming no additional acquisition activity.

 

I will now walk you through our updated outlook for the full year and our outlook for the third quarter of 2019 before turning it over to Kevin for some final thoughts. Please note that the revenue, adjusted EBITDA and EPS outlook we are providing today was based on ASC 606. We will continue to also provide our quarterly results under 605 in our earnings releases for the remainder of 2019 for comparison purposes to prior year. However, we have shifted to providing our outlook on an ASC 606 basis given our full adoption of 606 from a systems and processes perspective and the acquisition of Samanage as well as the immaterial difference in revenue between the 2 standards. That said, we will make sure to describe how our outlook has been impacted by the move to ASC 606 where applicable. So to quickly make a point, our total revenue outlook for the full year is effectively the same under 606 as it was under 605.

 

Okay. I'll first walk you through our updated outlook for the full year. Foreign currency exchange rates are a bit of a moving target these days. As a result, our updated outlook for the remainder of the year now assumes a euro to USD exchange rate of 1.11 versus our initial 2019 assumption of 1.14. We're also assuming a pound to dollar exchange rate of 1.22, which is consistent with current trading ranges versus our initial 2019 assumption of 1.3. The strengthening of the U.S. dollar against these 2 key currencies is the root of most of our foreign currency headwinds so far in 2019.

 

Our assumptions for other key foreign currency exchange rates are also lower against the U.S. dollar than they were in February of 2019 and lower than the assumptions we used for our revenue forecast from our first quarter earnings call in April due to currency exchange rates of those currencies. Foreign currency fluctuations have a larger relative impact on our subscription revenue than our license and maintenance revenue as our MSP business has a larger percentage of its revenue outside the U.S. compared our license and maintenance business.

 

Based on our strong results for the first half of 2019, we are updating and raising our 2019 revenue outlook for the full year despite the additional increase in foreign currency headwind since we last provided our full year outlook on our first quarter earnings call. The strengthening of the U.S. dollar during the second quarter and through July has an incremental $3.5 million negative impact on our outlook for the second half of the year, which raises the cumulative negative impact from foreign currency on our beginning of the full year revenue outlook to over $7 million. In the face of these foreign currency headwinds, we have raised the high end of our full year revenue outlook by $17 million since it was initially provided. This increase includes an improvement in our outlook for organic growth of our license and maintenance and subscription product lines as well as the impact of the acquisition of Samanage in the second quarter of 2019.

 

We now expect our full year 2019 non-GAAP total revenue to be in the range of $938 million to $950 million, representing growth of 12% to 14% over our total non-GAAP revenue in 2018. Note that consistent with the outlook we provided on our April earnings call, our revenue outlook is on a non-GAAP basis and excludes the purchase accounting-related reduction in Samanage's deferred revenue by -- required by GAAP. Adjusting our full year 2019 outlook using the same foreign currency rates that we experienced in 2018 results in 2019 constant currency growth of 13% to 15%.

 

Total license and maintenance revenue is expected to be in the range of $611 million to $619 million, representing growth of 7% to 9% on a reported basis, which equates to 8% to 10% on a constant currency basis. Non-GAAP subscription revenue is expected to be approximately $327 million to $331 million, representing growth of 23% to 24% on a reported basis and approximately 24% to 26% on a constant currency basis.

 

Turning into the second quarter, we are meaningfully ahead of the pace necessary to deliver the range of profitability that we laid out at the beginning of the year as adjusted for the Samanage acquisition. As a result, we plan to take the opportunities to spend some incremental dollars on new growth initiatives over the back half of the year with the intent to deliver a level of profitability at the high end of the outlook range we previously provided. With that being said, adjusted EBITDA is expected to be in the range of $450 million to $453 million, representing an estimated adjusted EBITDA margin of approximately 48%. Non-GAAP fully diluted earnings per share is expected to be in the range of $0.81 to $0.82 per share, assuming an estimated 311.7 million diluted shares outstanding for 2019. Our full year 2019 EPS outlook reflects an assumed 21% non-GAAP tax rate.

 

Now turning to our outlook for the third quarter of 2019. For the third quarter of 2019, we expect total non-GAAP revenue to be in the range of $241.5 million to $246 million, representing year-over-year growth of 13% to 15% on a reported basis and 14% to 16% growth on a constant currency basis. Total license and maintenance revenue for the third quarter is expected to be in the range of $157 million to $159.5 million, representing growth of 7% to 9% on a reported basis and 9% to 10% on a constant currency basis. Subscription revenue is expected to be in the range of $84.5 million to $86.5 million, representing growth of 25% to 27% on a reported basis and 25% to 28% on a constant currency basis.

 

Adjusted EBITDA is expected to be in the range of $112 million to $113.5 million for the third quarter, representing an adjusted EBITDA margin of approximately 46%. This lower-margin percentage in the third quarter compared to the second quarter is due to the dilutive impact of the Samanage acquisition, which is consistent with the dilutive impact we expected Samanage to have in the third quarter. Excluding the impact of Samanage, we expect our adjusted EBITDA margins to be higher than those in the second quarter. Non-GAAP fully diluted earnings per share is expected to be between $0.19 and $0.20 per share, assuming an estimated 311.5 million diluted shares outstanding for the full quarter. Our outlook for the third quarter assumes a non-GAAP tax rate of 22%, and we expect to pay approximately $8.5 million in cash taxes during the third quarter of 2019.

 

With that, I'll now turn the call back over to Kevin.

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Kevin B. Thompson, SolarWinds Corporation - President, CEO & Director [5]

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Thanks, Bart. As you can hear in our comments, we feel positive about the performance of the business over the first 2 quarters of 2019 and believe that we are positioned to deliver a year of accelerating subscription revenue growth and license and maintenance revenue growth. Our business has shown great operating leverage even as recurring revenue as a percentage of total revenue. And specifically, subscription revenue as a percentage of total revenue have increased meaningfully. These operating results fly in the face of the conventional wisdom that a recurring revenue business cannot be highly profitable.

 

As we have discussed previously, since the Take-Private transaction in 2016, we have been focused on increasing the percentage of our total revenues as recurring. As Bart stated in his comments, this focus has resulted in 83% of our total revenue being recurring in the first 6 months of 2019. And as we look into the future, it is our expectation that the recurring revenue will continue to grow at a faster pace than total revenue driven by our high-growth cloud-based subscription revenue products and the consistent growth of our maintenance revenue.

 

I am pleased that over the course of the last 2 quarters, we have been able to raise our revenue outlook for 2019 to $950 million at the high end of our range. Which reflects an increase of $17 million from the high end of the range of our initial outlook for 2019, which we provided on our third quarter 2018 earnings call. As Bart indicated in his comments, this increase is in spite over $7 million in unexpected foreign currency headwinds since we provided our original full year outlook for 2019. The increase in our outlook when adjusted for the negative impact of these foreign currency headwinds is over $24 million, which is comprised of a constant currency increase in our organic growth of approximately $12 million and an increase of approximately $12 million related to the Samanage acquisition. The increase in our organic growth outlook reflects the success that we have had in improving our license and maintenance revenue growth rates while accelerating our subscription revenue cohort growth rate as we've moved through the first half of 2019.

 

Consistent with our outlook, we have seen the momentum of our business accelerate sequentially in the second quarter, and we expect this momentum to continue as we move through the remainder of 2019. We expect this acceleration to be reflected in our revenue growth and cash flow over the second half of the year.

 

As we indicated on our first quarter earnings call, we have been focused on expanding the number of solutions we provide to our MSP customers to enable them to address the broad set of challenges they face as they manage the IT environment for the hundreds of thousands of small and midsize business customers, which they serve. During the second quarter, we launched several new products into our MSP customer base. This includes a new security offering, which allows our MSPs to move beyond just providing antivirus to their customers to providing protection against a broad range of attacks that all companies are facing in today's threat-laden IT infrastructure world. And we recently launched SolarWinds Passportal suite of products, which includes a set of passport management offerings and an IT documentation product for the MSP market. We have seen a high level of initial interest in each of these new products from our customers and expect to see strong penetration of our MSP customer base with these products over the remainder of 2019 and through 2020.

 

As we enter the second half of 2019, we are focused on several key growth initiatives. First, we are committed to driving a high level of interest in our new ITSM offering among the SolarWinds customer base. We did an initial launch of SolarWinds Service Desk, or SSD, into our customer base in early May and have already closed several transactions from that initial launch. During the second half of 2019, we plan to make driving adoption of SolarWinds SSD by our customers a high priority. We expect to learn a lot over the course of the next 2 quarters through this activity, which we believe will provide a road map for ITSM customer adoption as we move into 2020.

 

Second, as I've just stated, we added a number of new offerings to our MSP product portfolio during the second quarter. These new products are positioned to be adopted by our existing MSP customers with the goal of driving improved cross-sell, resulting in higher net retention rates. Driving this adoption will be a high priority for our MSP team over the second half of the year.

 

Third, we have aligned our public cloud management product portfolio around an application management story as that is the primary issue that this portfolio of cloud-based products addresses. This positioning has allowed us to begin to connect our on-premise-based products with our cloud-based products much more tightly. During the second quarter, we also began to work to launch our application management products into the international markets, which we have planned for the second half of 2019. And in addition, late in the second quarter, we stood up a small dedicated sales team focused on selling our application management products into our core IT customer base.

 

Now turning briefly to the environment for IT spending we are seeing in our business as we get a number of questions about this when we're meeting with investors. The demand environment for IT management during the first half of 2019 has been solid. We have seen incremental strength in North America, which includes U.S. Federal and in Asia Pacific. However, there has been some level of unevenness across the different regions in EMEA. Based on current indications we track, we believe that the IT spending environment in the back half of 2019 will be similar to what we saw in the first half of 2019 across most of the world. However, we do believe that the risk of additional uncertainty is increasing in EMEA particularly in the U.K. due to the status of the Brexit negotiation.

 

And while our confidence in our business has remained high, based on our results for the first half of 2019, the acceleration in growth we saw in the second quarter, the indications of acceleration we have seen in July, particular impact of new products we have recently released and our expansion into the ITSM market, we're also cognizant of these uncertainties in the global economic environment. We have considered potential impact of these uncertainties on our results for the second half of 2019 and believe that we are properly taking them into account in the outlook for the remainder of the year that Bart just provided.

 

The last topic I will briefly touch on is our M&A strategy as we look forward to the remainder of 2019 and into 2020. I want to make sure there's a clear understanding of our thoughts as it relates to potential future acquisition activity.

 

First, we believe that strategic M&A is a core competency, which we have developed over the last 13 years. We have shown the ability to acquire companies and products and quickly put them into our go-to-market engine, driving growth and a high level of profitability. As you've seen from our financial results, our operating model has also historically allowed us to generate cash quickly and deleverage rapidly. In fact, despite spending approximately $350 million on acquisition, during the first half of 2019, our net leverage ratio at June 30 is only slightly higher than where we began the year. As Bart indicated in his remarks, we expect it to drop over 0.5 turn during the back half of 2019, assuming no additional M&A activity. Over the long term, we plan to run our business at or below a 3x net leverage ratio, and we believe we can reach this goal while continuing to do strategic acquisitions.

 

Second, we view the strategic M&A as a vehicle that we can successfully use to quickly expand our position in markets where we have a presence today and as a way to move into new markets, creating an immediate, meaningful presence just like we did with the acquisition of Samanage, which moved us into the ITSM market. Given the cash flow characteristics of our model and our historical success in acquiring companies and products and putting them into our highly profitable go-to-market motion, we plan to continue to look for opportunity to add product to our portfolio through M&A, which will allow us to be disruptive in markets where these acquired products compete. And while most of the M&A transactions we have done historically have been small and our future transactions will also likely continue to be mainly on the smaller side because we were looking for modern technologies that have been architected to be easy to try to show value quickly and can be used by organizations of all sizes, we are not averse to taking advantage of opportunities to add meaningful growth engines to our business through larger M&A transactions should they become available. However, just to be clear, the point of my comment on this topic is not to prepare investors for an announcement of an M&A transaction in the next few days, but rather I simply wanted to provide context on how we're thinking about M&A so to the extent that we do additional acquisitions in the future, there's an understanding of our strategy.

 

Once again, thanks for joining us for our second quarter earnings call, and we will now open up the call for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from the line of Brad Zelnick from Credit Suisse.

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Brad Alan Zelnick, Crédit Suisse AG, Research Division - MD [2]

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Congrats on the continued momentum and really appreciate all the very thorough disclosure. My question, Kevin, is about security. With an acquisition in the password management space and also revamping log and event manager, can you remind us how you're thinking about security? And specifically, are you focused on expanding your security portfolio in the MSP space or you're thinking about it more broadly? Maybe it would help, where would you go, where wouldn't you go?

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Kevin B. Thompson, SolarWinds Corporation - President, CEO & Director [3]

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Yes. So Brad, a good question. I think if you look at what we've done so far, most of the activity we've had has been around infrastructure. And when you think about security -- we think about security as it relates to infrastructure not really about security that relates to kind of end point and necessarily access when you think about the core IT market, selling into that IT buyer who's managing their own environment. So as we think about that market, we really are thinking about here is a security that is really more infrastructure related. So whether that's vulnerability management, whether that is areas of access management -- I'm not talking about like a -- now I'm drawing a blank, but it will come to me in a minute -- I'm not talking about single sign-on and those kind of technologies, I'm talking really more about controlling who has access to what. We like those areas of technology because those are directly related to and associated with our current buyer.

 

On the MSP side of the business, a little bit different. The MSPs need to provide a very broad suite of security offerings to their end customers because the desire of small businesses is to get as much of the technology service they need. And when I say technology service, I mean product delivery as a service, not body-based services. They need as much of that technology service as they can from a single vendor and be able to look at all of that through a single UI to the extent that they can. So in the MSP business, we're likely to think about security in a slightly broader way. So we think about backup as part of security, this continuity, if you have an issue, and we provide a backup offering in that space. We added password management because small businesses don't need something like an -- it's simply too big. They just need to be able to control passwords and make sure that password control is strong. And that if they need to be able to reset a password, they can do it very, very quickly. And so it's a much lighter view of access in the MSP market. We'll continue to build out that portfolio of security offering based on what the MSPs and their end customers are telling us that they need.

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Brad Alan Zelnick, Crédit Suisse AG, Research Division - MD [4]

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That's very helpful context. And I just wanted to follow up by asking about the MSP price increases. How is that being observed by the market versus what you expected earlier in the year? And do you see additional opportunities to take price ahead?

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Kevin B. Thompson, SolarWinds Corporation - President, CEO & Director [5]

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So the price increases have been accepted pretty much the way we thought they would. There has been very little noise, no real impact on churn at all. And so that initial test, if you will, or pilot has gone well. We do believe there's opportunity to implement a price increase strategy. And as we move forward that has more consistency to it similar to what we do with our license and maintenance products on the maintenance side when we price -- increase price every year in the kind of 2.5% to 3.5% range depending upon the year, depending upon the product. So you should expect that we will have a methodology somewhat like that as we move into 2020. We haven't nailed it down completely but will provide more visibility into that as we get closer to the end of the year, but I do think there's an opportunity to be able to do that.

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Operator [6]

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Our next question comes from the line of John DiFucci from Jefferies.

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John Stephen DiFucci, Jefferies LLC, Research Division - Equity Analyst [7]

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Actually, Kevin, a follow-up to Brad's question he just asked. Just to be clear, in the guidance that Bart just gave for next quarter and for the year, is there any implied further price increase in that guidance?

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Kevin B. Thompson, SolarWinds Corporation - President, CEO & Director [8]

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No. There's no additional price increases in that guidance right now. We've done everything we're planning to do for this year in both the MSP business as well as in the license and maintenance business.

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John Stephen DiFucci, Jefferies LLC, Research Division - Equity Analyst [9]

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Okay. Great. And that's what I thought. I just wanted to clarify there. I guess one thing, Kevin, this is great because we've covered you, and Brad has, too, for a long time, and it's like the last time as well as this time. And one of the things about SolarWinds is it can be very exciting sometimes around earnings. And this is just a solid quarter across the board, which is nice to see. And I hate to say it's boring, it's not, because it's solid and they're great results, but it's not exciting in the other direction at all. It's good.

 

One of the things that you mentioned when you're talking about some of the -- what you're looking at in your guidance, some of the future -- I don't know, caution might be too strong a word -- but around EMEA. And I'm just curious, you also mentioned despite a bunch of things -- and you mentioned the acceleration in July. And I just wonder if you could expand a little bit more on that. So you got through your first month of the quarter -- by the way, there's other companies that reported tonight that did not have good quarters and had really bad ones in sort of infrastructure IT. And I'm just curious as to what you've seen so far in July.

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Kevin B. Thompson, SolarWinds Corporation - President, CEO & Director [10]

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Yes. So look, I think what we saw in the second quarter, we saw it continue into the month of July, which is activity levels have been solid really across the world. We've had -- I mentioned in my comments, we've had really incremental improvement in strength in North America. That includes both the commercial side of the North America business as well as the U.S. federal side of North America. We've also had very good results for a while now and that continued into the second quarter and into July at Asia Pacific. And EMEA results have been solid. They haven't been bad, that's just one part of the world where we're seeing a little bit more uneven, where certain countries in EMEA have been very strong, certain countries in EMEA had a little more volatility to the demand environment.

 

And so we really try to take that into account as we look at what we think could happen in the second half of the year. The great thing is 83% of our revenue is recurring today. Most of the revenue we're going to get out of the recurring side of the business is deals that we've already booked. We will get some revenue some -- from new customers and expansion of existing customers that we have between now and end of year, but that's a relatively small number compared to the total revenue number.

 

So we really haven't seen a change in demand environment in July compared to the second quarter. But we definitely saw in the second quarter a little bit of noise in EMEA. The U.K. is where we saw kind of the most hesitation, if you will, particularly around small businesses where I think they're just kind of waiting to see what happens from a Brexit perspective. And so we assume those trends continue as we look through the rest of the half and the rest of the year. So where there's unevenness, we've assumed there will continue to be unevenness. Where we have strength, we've continued that -- we've assumed that strength will kind of continue at the level that it's at, we've not assumed that it will get any stronger.

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Operator [11]

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Our next question comes from the line of Kirk Materne from Evercore ISI.

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Stewart Kirk Materne, Evercore ISI Institutional Equities, Research Division - Senior MD [12]

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Congrats on the quarter. I guess maybe I just want to start with the Samanage integration, how that's going. And then maybe just as part of that, maybe just sort of your broader thoughts, Kevin, on the cloud portfolio right now. You made some comments around the app management products at the end. And just kind of where you feel like you're sitting in that area right now and sort of the ability for those products to really accelerate as we end 2019.

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Kevin B. Thompson, SolarWinds Corporation - President, CEO & Director [13]

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Sure. Yes. So the integration of Samanage has gone really well. And I think I'd really credit most of that to the Samanage team. I think my team has worked hard, but the Samanage team has been really committed to making sure that the integration process has gone very, very well. And that's integration from both a people perspective but also their adoption of a lot of our operating methodology because we clearly are a business -- there's a defined set of methodologies in which we operate. It's what allows us to run at the level of profitability we run at and still deliver the level of growth you've seen from us over time. And they've actually been really enthusiastic about learning from us and about being able to leverage those capabilities which not every acquired company kind of looks at the opportunity that way. So it's going really well. We feel good about the product. We feel good about the market opportunity. We feel better today than we did when we closed the acquisition, which is also not always the case. So I'm really enthusiastic about it. Our customers have shown a lot of interest. I mentioned we've already closed a couple of transactions with SolarWinds customers in a very short window of time. We didn't launch that product into our customer base until June, and so we closed some sales very, very quickly. And in fact, with one customer, they were a long way down the road with a competitor. And as soon as they saw we had the product, they started to look at it and bought from us in a couple of weeks' period of time. So we feel really good with how that's going. And we got a lot of work to do. We have a lot to learn. Closing a couple of transactions is not closing hundreds and thousands of transactions at our customer base, which is ultimately the goal. So I feel really good about where we are right now.

 

As it relates to our application management product, which is our cloud-based offering, I feel like we are in a good spot from a technology positioning and strategy perspective, I think a much better spot than we were 6 months ago. And I'll give that credit to the fact that I stopped running it directly, and I put someone else in charge of it every day, and they're doing a better job than I was doing. So I feel like we've got the product positioned well, and we figured out the story we need to tell to our existing customers, to get them to really understand the incremental value that set of products can provide for them. So I feel like we're positioned well. It's still a small revenue number for us, but I think we've got it positioned the right way. And now the job over the next 6 months, 9 months, 12 months is to really start to drive a very high level of adoption by that set of cloud-based products by our existing customers. I want to make sure that we are really taking advantage of the Azure opportunity right now because we need to own that part of the cloud management market. No one else is really playing there, and that's where our legacy is. We grew up as a Windows company. We manage all environments today. But we know Microsoft's environment, we believe, better than everyone in all of IT management, and we have more customers who are managing those environments, we believe, than anyone else. And so I want to make sure we're really capitalizing on that opportunity. So that's where you're going to see us really spend our time over the next 6 to 12 months. We'll still continue to do what we've been doing in [any event], but I think there's a really close opportunity that's easy for us to win and where there's not a lot of competition right now where we got a lot of credibility as a provider. So I feel good about where we are. We just got to take what we've done and then turn that into kind of really explosive growth.

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Operator [14]

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

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Sanjit Kumar Singh, Morgan Stanley, Research Division - VP [15]

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Congrats on another strong quarter. I want to talk about the on-premise business and particularly the license business, which accelerated this quarter. I think coming off of 2018, which is a very strong year for on-premise IT, there was a view on the industry that we could see slower growth this year. And by me looking at the results in the first half, it seems like you accelerated. So Kevin, I was wondering if you could just sort of unpack sort of the factors that you see that's causing you to sustain this really impressive license and maintenance growth in the first half of this year.

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Kevin B. Thompson, SolarWinds Corporation - President, CEO & Director [16]

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Yes. So I think there's a couple of factors, Sanjit, that we have been talking about, and I think we've done a good job of executing all of it. First, I mentioned in my comments that there's a lot of technology still deployed -- still being deployed, new technology being deployed, in environments that IT pros control. So whether that's behind-the-firewall private data centers, hosted data centers, IT pros have to manage those technologies. And I think the only thing we've done that most of the other players in this space has not done that they have technology to manage those environments really well, we've continued to invest in our products. We've continued to make them better. We've continued to give them the ability to solve the problem more effectively than they solve them yesterday. And our customers in the market at large see that investment by us. And they see that we're committed to continue to provide them technologies to manage those environments because we don't believe those environments are going away anytime soon, if ever. And that's a big difference when you look at the market. Our products are simply better than anyone else's, and our level of investment is higher. And then we're doing great job, I think, on the marketing side of telling people the great things we're doing with those products. So we're taking share pretty quickly right now. And I think we'll continue to take share pretty quickly because there's no one that has the breadth of products we have, and no one is investing at the level that we've invested.

 

The other factor is, and I know we mentioned this kind of 2 calls ago I think, or maybe 3, I can't remember now because we've now done 4 of these, which is hard to believe since we went public, is that our products are also very relevant in the public cloud world. And we've got a number of customers who want to have the exact same level of visibility through the same product in -- with their infrastructure that sits in the public cloud as their infrastructure that sits on-premise. So a number of our customers have expanded their -- of our customers have expanded the use of our products to not only manage the environment they control directly but also to manage the assets they have sitting in the public cloud so they can see through one UI in a consolidated view of performance. And so as they do that, many of them are having to come back and buy more licenses from us because they don't have enough capacity to manage that now larger cumulative environment. And I think we'll continue to see that trend grow as we move forward. So it's not just our public cloud management, our application management products that are being used to manage public cloud, it's also that -- those on-premise products because they have the ability to do that also. Like those are the 2 things that we've done that allowed us to continue to grow at a pace that's kind of, what, 4 or 5x faster than the market. And we feel pretty good about our ability to continue to grow at a very nice high single-digit pace in that part of our business.

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Sanjit Kumar Singh, Morgan Stanley, Research Division - VP [17]

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That's really great to hear. And maybe if I ask basically the same question but for the MSP business, you mentioned in your script that you guys are seeing improved cohort growth. Is that driven from just greater usage of existing services within the MSP base, more customer base growth? Or are you starting to see the uptake of a lot of the new products and services that you guys have unleashed or put out to market the last couple of quarters?

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Kevin B. Thompson, SolarWinds Corporation - President, CEO & Director [18]

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Yes. So you're looking at a couple of factors that are driving that. So one, if you remember, I think we talked in January or February about the fact that we wanted to make sure with our MSP customer base that we are bringing MSPs into that customer base that were solid, stable businesses that we believe would grow over time. And then we have made some changes to our compensation program in Q4 2018 to make sure our reps were focused on bringing customers in and then making sure those customers grow in their first 6 to 9 months of their relationship with us because we've seen historically that if a customer grows in the first 6 to 9 months, that they will grow for a longer period of time at a faster pace, and they'll churn at a lower rate. And so that focus has really worked incredibly well. So that's been really the primary driver of that improvement in cohort growth. We have now added -- in the second quarter, we added a couple of products early this year, new products that sell into the MSP customer base, we are having success with those products. We're seeing a high level of interest in those products. And we've seen a meaningful level of adoption, but there's not a lot of revenue yet because it's an MRR model, and their usage of a new product from us is going to grow really every month they have that new product. So that's a secondary factor but one that we believe will have a bigger impact in the second half of the year than it did in the first half of the year. As long as we have a high degree of confidence, we're going to continue to see acceleration, in that sufficient revenue growth over the second half of the year because we are seeing that adoption starting to happen. And the customer adds, let's say, they added half our management and they do it for 20 employees, at one other company, if they really like it and it works really well, then they'll add part of their other company. Now they're up to 100 individuals they're buying password management for. Those are the kind of trends we typically see with a new product.

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Operator [19]

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Our next question comes from the line of Heather Bellini from Goldman Sachs.

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Heather Anne Bellini, Goldman Sachs Group Inc., Research Division - MD & Analyst [20]

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Great. Kevin, I just wanted to talk a little bit about the ITSM market. I'm just wondering -- I know you -- that it's relatively recently tucked into the business, but could you share with us on the competitive environment maybe what percentage of the market you think is greenfield versus competitive replacement? And when you are coexisting with other vendors, who's there most often, if you have a sense?

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Kevin B. Thompson, SolarWinds Corporation - President, CEO & Director [21]

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Sure. Yes. If you look at the market opportunity, Heather, what I would say is most companies have something that they're using to try to manage at a minimum kind of help desk activity. So you submit a ticket, somebody picks that ticket up, they do something with that ticket, they resolve the ticket and then they go on to the next issue that they need to address. So most companies have done some things. So whether that's a really basic piece of help desk software that they've got to deploy on-premise or whether that's a spreadsheet they're tracking those tickets on, I believe some -- believe it or not, some people still use spreadsheets, they're using something to try to manage that activity. But when you look at the small business up through kind of the high end of the mid-market, so companies that have kind of 2,000, 3000 employees, most of them are using something I'd define more as basic help desk than true service desk. So they don't really have true workflow management and process management that allows them to be effective and efficient across the management of not only an incident but also the management of all the assets that IT is responsible for. So I really define that as a primarily greenfield opportunity because we want to take those companies from only being able to afford and be able to handle the complexity of help desk, to be able to afford and deal with the complexity because we're going to take all the complexity away through service desk.

 

So in 85% of the companies that are out there today, I think it's really more of a greenfield opportunity than anything else. In the large enterprise, they're using something they would consider to be ITSM. But even there, there's some really good -- there are a few -- I'll say it differently -- a few good ITSM products out there, and there's a bunch of old stuff out there that really isn't very good anymore. So I think there is an opportunity for replacement. But our focus initially is going to be just like when we first got to SolarWinds, maybe fast forward a little bit because I think some products is better than our network management products when I got here in 2006. But assuming you fast forward in 2009, 2010 on the services network management and systems management market, we have a really great set of products that solves a very broad set of problems. And the biggest opportunity we saw that we can take advantage of the most quickly was in the mid-market and the SMB. So we're going to really aim at the mid-market or the SMB right now. We'll win some large companies while we're at it because our customers trust us, and if we offer it, a lot of them are going to look at it. So our primary focus will be mid-market and SMB where it's mainly greenfield right now.

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Operator [22]

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Our next question comes from the line of Matt Hedberg from RBC Capital Markets.

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Matthew John Swanson, RBC Capital Markets, LLC, Research Division - Senior Associate [23]

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This is Matt Swanson on for Matt. We talked the last quarter about investing in international markets. I think we called out Germany specifically. Could you just talk about, with some of the macro unevenness, if this changes any of your plans from an investment standpoint whether it's time to double down or pull back a little from the region?

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Kevin B. Thompson, SolarWinds Corporation - President, CEO & Director [24]

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It doesn't really change any of our plans. We've already begun the investment process in Germany. We have moved the senior leaders to Germany. We have got to have resources in that market to really take advantage of the opportunity we have. We do a decent amount in Germany already. As I said before, Germany should be our largest single market in Europe, and it's not. It's not even close to our single largest market in Europe. And so there's a big growth opportunity for us. So that investment is already well underway and moving down the path. And hopefully by the end of this year, we'll start to see some level of the impact from that investment.

 

We also talked about moving our application in cloud management products globally. That will happen in the third quarter. We'll add the sales reps outside the U.S. and start to do some marketing outside the U.S. because we do believe there's an opportunity there. And the last thing we kind of briefly mentioned and I said hey, we're going to start to invest in it, but don't ask me about it every quarter because it's going to be slow. In Japan, we have added a General Manager in Japan. We have increased investment just by a small amount in Japan. We're beginning to drive some activity. That will be the least impactful in the short term of our investments, but I believe it is a big opportunity in the long term, but it's going to be a much slower burn. So no, nothing we've seen is going to change the investment strategy or pace that we have planned for this year.

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Matthew John Swanson, RBC Capital Markets, LLC, Research Division - Senior Associate [25]

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That's helpful. And then if I could just circle back on the SIM product, could you just talk about from a capability standpoint what kind of all changed from the product that's replacing in the log of event management?

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Kevin B. Thompson, SolarWinds Corporation - President, CEO & Director [26]

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Yes. So really what we've done is we've taken a product that we have and we've really improved the security positioning of that product and kind of relaunched it with a lot of SIM messaging around it. Initially, we did a bunch of front-end work on it to improve the user experience. And so what the product historically was really good at was kind of the compliance use case of logs, it was being used by a lot of companies to deal with things like HIPAA compliance and that kind of stuff, regional banks, small insurance company on the compliance side of security, which is an area, too, that we really like because that doesn't really change that rapidly. So it allows you to build the technology at a relatively low cost and not have high cost of constantly running the product.

 

But what we've done is -- that product had a lot of security information and event capability, we just hadn't brought them to the surface through the UI. So the real work we had to do was do work around the UI to bring the events that we're seeing to the surface so that a customer can actually see them. And so we made that product so it's a much more kind of broad use case than it was before. So it's relatively easy to use, really easy to use compared to any other SIM product. I won't say it's the easiest to use product that we own, but it's very easy to use compared to any other SIM product and priced at a fraction of the competitors in the marketplace. So it is a really good, strong, basic log data to capture the security information event, tell you what happens, tell you what you need to do to address the issue and do that very quickly and do it in a really low cost. So it's a really great little product. And I think with the changes we've made in it, we expect that, that product will start to grow at a faster pace than it's been growing.

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Operator [27]

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Our next question comes from the line of Terry Tillman from SunTrust.

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Nicholas Ivan Negulic, SunTrust Robinson Humphrey, Inc., Research Division - Associate [28]

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This is actually Nick on for Terry. So I guess looking at the long-term model, how should we think about investing for growth versus showing further operating leverage? The company already has managed its profit level, so can you keep doing this steadily? And where are some more intriguing areas where operating leverage could potentially play out?

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J. Barton Kalsu, SolarWinds Corporation - Executive VP, CFO, CAO & Treasurer [29]

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So yes, this is Bart. So we talked about the fact that we're going to invest wisely, is what I would say. So we know that leverage is a touchy subject to some of our investors, so we're committed to getting our leverage closer to that 3x number. But we're going to do that over time, and we're not going to let M&A stand in the way of us doing deals -- I mean of us impacting our leverage. So we know that minus any other M&A activity, we'll be around 3.5x levered at the end of the year. But if there's the opportunity out there for us to do a deal, we're not going to do it just in spite of the fact that our leverage -- that we're committed to getting to a certain leverage number.

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Kevin B. Thompson, SolarWinds Corporation - President, CEO & Director [30]

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And from a profitability perspective, I think we have -- what we consistently said is we're going to let the margin rise. We're going to let it more rise at a very measured pace, that we're not going to let them get out in front of us. Because our model has the ability to throw off a tremendous level of profitability. It can be more profitable very, very quickly if we would like it to be. And so it's really that the approach we've taken is we're going to let margins rise, we're going to let them rise relatively slowly, we'll let them rise relatively slowly over a number of years because then there's a decent amount of expansion left in our margin profile. But we're not going to let it come up at a point a year, not that the model won't do that, it could; it's just we don't think that's the right decision for us to make. We will be let them come up slowly, we'll invest some of the margin that would have naturally come through to continue to drive growth, but you should expect margins to continue to come at a very measured pace over time.

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Operator [31]

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Our next question comes from the line of Matthew Wells from Citi.

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Matthew Ryan Wells, Citigroup Inc, Research Division - Associate [32]

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It's Matthew Wells from Citi. In the quarter, license and maintenance looked pretty strong. I'm just curious if you've observed any changes in the competitive landscape in the core network management business, but specifically how you're positioned as these on-prem customers move to the cloud.

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Kevin B. Thompson, SolarWinds Corporation - President, CEO & Director [33]

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Yes. So I think that when you look to network management business, we have not seen any real change to the competitive positioning. I think what we have seen, and this is something that we've been saying for a long time, is cloud does not remove the critical nature of the network. In fact, cloud makes the network more critical than it was before because you can't access those assets if you don't have connectivity to those assets. And in fact, connectivity is not really strong if you don't have fast connection. If that connection is not always available when you need it, then the ability to get to those assets that are deployed remotely from the user becomes a real issue. So network performance is a bigger issue today than it was 3 years ago. And we think network performance will continue to be a larger issue as we move into the future than it is even today. So I think the opportunity in network management is not one that will shrink with cloud. In fact, it's one that will continue to grow with applications deployed in the public cloud. And we think we're well positioned to be able to provide a set of capabilities to our customers, and the prospects for that matter, to be able to manage not only their environment inside the firewall, but to manage their connection between that environment and what is in the public cloud and then also to be able to manage any connection that need to be managed in order to show our performance is high in the public cloud.

 

So I'm not saying we have every piece of functionality we believe we ultimately need, we don't. There are still some things we need to add to our network management capability as the level of demand gets to a higher level. As you know, we aren't typically building in advance of demand, we're building behind demand. We want demand to exist, we want the problem to be understood and we want the user to be able to tell us, here's exactly what I need to solve the problem I have in order to take advantage of the opportunity in front of me. Now when I build something for them. They're going to use it immediately, and it's going to be successful. So there's still some things ultimately we believe we'll need to add to that network management portfolio as cloud continues to evolve and grow, but we think we're really well positioned for where the world is right now.

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Matthew Ryan Wells, Citigroup Inc, Research Division - Associate [34]

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That's helpful color. And I just had a follow-up. Kind of switching gears, last quarter, you spoke to 30-plus percent growth rates in that Samanage asset. After owning it for a quarter, do you have any incremental confidence here?

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Kevin B. Thompson, SolarWinds Corporation - President, CEO & Director [35]

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I would say I'm just as confident as we were in the last quarter when we gave that outlook. I think there's absolutely an opportunity just given the size of the market to be able to grow faster than that over time. But we still have dedicated -- we still have a lot to learn. How do we get this into our customer base? We know our customers are interested in the product. How do we get them to actually buy the product? We got some small success already, which is great, but I want to turn small success into large success. So I think we're going to learn a lot over the next 2 quarters that will give us better visibility into what it's going to take to make those growth rates even faster than what we laid out in the last call. But our confidence in the growth rates we laid out on the last call continue to be high.

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Operator [36]

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And our last question comes from Raimo Lenschow from Barclays.

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Mohit Gogia, Barclays Bank PLC, Research Division - Research Analyst [37]

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This is Mohit on for Raimo. So I will also add my congrats on the quarter as well, great numbers across the board. And I think I just want to ask a high-level question in terms of the product road map. Looking out, so you guys touched on sort of like security. You guys touched on application management, what's going on there, and obviously the leadership position in network management. So I'm wondering if you look from the lens of where you are now versus where you want to be, especially to AI, integrating AI ops across the portfolio, I'm just wondering if you can unpack as to where do you think you are in that journey and where you think sort of like you will want to be as AI ops get more steam among the customer base.

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Kevin B. Thompson, SolarWinds Corporation - President, CEO & Director [38]

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Yes. So where I'd say we are as it relates to AI ops, we're at a really basic level. We have some amount of AI capability across the portfolio. So we have that in our core network and systems management product. We have some in our ITSM product, and we've got some really basic capability in our MSP product line. So we have some really basic capabilities, but we are really early and very basic. And why? It really goes back to the comment I made just a couple of minutes ago, which is we are going to build technology behind the growth in demand for that technology. I will wait and make sure that we really understand and more importantly that the user really understand exactly what they want and exactly what they need, and they can tell us very clearly what that is because once they can tell very clearly what that is, then I can build them something that will meet their needs, to use the word perfectly, or as perfectly as a piece of software can be built, and I can price it at a level that's going to make it really, really compelling, or if I try to guess and I try to build in advance and I try to convince you what you need, that's a whole different value proposition.

 

So I think we're right where we need to be right now, which is we have a really basic capability, we have an understanding of the technology, but we are waiting for the market to mature. So we have a very clear view of exactly what it is that users are going to want because there's a lot of things you could do, but a lot of that you shouldn't do and a lot of that you won't need to do. And we want to wait until that is really fully fleshed out. And keep in mind, we're trying to serve the entire market, very, very small or very, very large. And AI is something that very large companies are playing with. They're not super comfortable with it, meaning these aren't the really large -- CIOs of really large companies, they're going to use a product that have some level of AI. But what I'll guarantee you is right now, they're not allowing that product on an automated basis based on that AI to make changes to their environment, they're allowing it to tell them what it should do. And 99% of them are stopping it and making sure they're okay with it before the change gets made because even they don't have the level of comfort yet that they just want to let all that happen in an automated basis because if it's not right, a lot of bad things can happen. So we're super, super early in that part of the market right now, but I think we're right where we want to be. And we will be there when we need to be there with the capability that every -- I'll use the word that every man needs, so the IT guy at every company needs. We won't be there in the short term with the things that only the Fortune 500 wants.

 

So with that, I think we're going to wrap the call up. Thanks, everyone, for listening to the call.

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Operator [39]

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And this concludes today's conference call. You may now disconnect.