Solarwinds, Inc. (SWI)

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SolarWinds Inc (SWI)

Q2 2013 Earnings Call

July 25, 2013 5:00 pm ET

Executives

David Hafner

Kevin B. Thompson - Chief Executive Officer, President and Director

Michael J. Berry - Chief Financial Officer and Executive Vice President

Jason Ream

Analysts

John S. DiFucci - JP Morgan Chase & Co, Research Division

Steven M. Ashley - Robert W. Baird & Co. Incorporated, Research Division

Aaron Schwartz - Jefferies LLC, Research Division

Keith Weiss - Morgan Stanley, Research Division

Scott Zeller - Needham & Company, LLC, Research Division

Mark Grant - Goldman Sachs Group Inc., Research Division

Daniel H. Ives - FBR Capital Markets & Co., Research Division

Kirk Materne

Tim Klasell - Northland Capital Markets, Research Division

Presentation

Operator

Good afternoon. Welcome to the SolarWinds Second Quarter 2013 Earnings Call. As a reminder, today's presentation is being recorded. [Operator Instructions] At this time, I would like to turn the call over to Mr. Dave Hafner, Director of Investor Relations. Please go ahead, sir.

David Hafner

Thank you, Doris. Good afternoon, everyone, and welcome to SolarWinds' second quarter 2013 earnings call. With me today are Kevin Thompson, our President and CEO; and Mike Berry, our Executive Vice President and CFO. Following prepared remarks from Kevin and Mike, we'll have a brief question-and-answer session. Please note that this call is being simultaneously webcast on our Investor Relations website at ir.solarwinds.com. The press release with our results for the second quarter was issued earlier today and is also posted on our Investor Relations website. Please remember that certain statements made during this call, including those concerning our financial outlook for the third quarter and full year 2013, the impact of strategic and operational items addressed in the second quarter on our future results, our estimates regarding our market opportunities and our ability to take advantage of such market opportunities, the areas of focus and investment in our business, the expansion of our sales organization, our growth strategy and expectations and our demand generation and marketing efforts are forward-looking statements. These statements are subject to a number of risks, uncertainties and assumptions described in our SEC filings, including our Form 10-Q for the second quarter of 2013, which we anticipate filing with the SEC on or before August 9, 2013, and the risk factors described in our annual report on Form 10-K for the fiscal year ended December 31, 2012.

Should any of the 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. Cautionary statements regarding these forward-looking statements are further described in today's press release. In addition, some of the numbers during this call will be presented on a non-GAAP basis.

Our use in calculation of these non-GAAP financial measures are explained in today's press release in a full reconciliation between each non-GAAP measure and its corresponding GAAP measure as provided in the tables accompanying the press release. 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 we cannot reasonably or reliably estimate future adjustments such as stock-based compensation, which is dependent on our stock price at the time. I'll now turn the call over to Kevin.

Kevin B. Thompson

Thanks, Dave. Good afternoon, everyone, and thanks for joining us on our second quarter 2013 earnings call. While we successfully addressed a number of strategic and operational items during the second quarter that we believe have positively impacted our current results or positively impact our future results, had a lot of highlights and performance during the quarter and ended the quarter with accelerating momentum in our North American commercial, Asia Pacific and Latin American businesses, our license sales results for the full quarter did not meet our expectations.

The pattern of the second quarter was different than the first quarter as we had strong results in April into the first few weeks of May, and had a solid month of June with accelerating momentum across much of our business. However, we had a weak finish for the month of May and we were unable to make up for it.

Despite the shortfall in license sales, we delivered a solid quarter of overall growth with total revenue increasing by 21% and non-GAAP operating margins and earnings per share coming in well ahead of our outlook. As we indicated on our first quarter earnings call on April 30, we had a strong start to license sales in the second quarter. License bookings in the first month of the quarter increased by 26% over April 2012, which was a growth rate meaningfully higher than the full quarter new license growth outlook we provided at 15% to 17%.

Our strong start to the second quarter coupled with the early return from certain of the changes we made to our business in early April, just to simply address some of the issues we experienced in the first quarter, gave us confidence in our second quarter outlook. However, a very weak finish to the second quarter in EMEA created a deficit that we were unable to overcome despite strong sequential and year-over-year growth from our U.S. federal business, strong year-over-year growth in commercial core product transaction volume, solid contribution from our North American Network Management and System Management businesses, who each also had a strong finish to the quarter in our record month of sales in June by the N-able team.

Despite the relatively slow start in 2013 compared to our outlook, our confidence in our core business is high. We believe that we have a very large and growing market opportunity for our Network Management business, our Systems Management business and our new MSP business. We believe that market opportunity in all of these areas remains largely untapped.

And that while the IT purchasing environment has been difficult and inconsistent, during the first 6 months of 2013, we need to return to executing at the high level at which we were executing in 2011 and 2012 to take advantage of these large and growing market opportunities.

Given our confidence in the size and immediacy of our estimated current market opportunity, we plan to invest aggressively in growing our business for the second half of 2013.

This will include additional investments in our product development organization. But first, accelerate development of key new features and modules for our Network Management product line; second, in our core performance and reporting engine, which will allow tighter integration of our products; and third, to move more quickly on developing new products and integrating certain key features of existing SolarWinds products that enables cloud delivery platform.

We're also planning to make meaningful investments in our demand generation program, an awareness campaign to enable us to more effectively reach IT pros all over the world at the very moment in time they're out searching on the web for solutions to problems that they must solve.

In addition, as we discussed on our first quarter earnings call, we have been and plan to continue to add resources to our global sales organization to increase our sales capacity to provide us with the ability to respond to the level of demand we intend to capture.

With great strength of our operating model, we were able to make all of these additional investments while still expecting to deliver non-GAAP operating margins that we believe will meet or exceed our prior outlook for the third and fourth quarters of 2013.

Mike will cover the details of our second half of 2013 outlook in his comments.

Total revenues for the second quarter of 2013 reached $77.5 million, which represents 21% growth over the second quarter of 2012. License revenue for the second quarter increased 6% year-over-year, totaling $31.1 million. Maintenance revenue continued its long series of rapid growth quarters, reaching a record high of $45.4 million, reflecting 31% growth over the second quarter of 2012.

In the second quarter, we continue to do a good job of retaining our customers, and in fact, our retention rate ticked up slightly in the quarter. We believe that we have one of the strongest recurring revenue streams in all of software, as the combination of our list price base maintenance pricing model and our historically strong customer retention rate have allowed us to deliver quarterly growth and greater than 30% in maintenance revenue for each quarter in the last 5 years.

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