SolarWinds Q4 2023 Earnings Call Transcript

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February 8, 2024

There are 8 speakers on the call.

Operator

Good morning. My name is Jeannie, and I will be your operator today. All lines have been placed on mute to prevent any background noise. Thank you. I would now like to turn the call over to Tim Khuraja, Group Vice President of Finance.

Operator

Mr. Khuraja, you may begin your conference.

Speaker 1

Thank you. Good morning, everyone, and welcome to the SolarWinds' 4th quarter 2023 earnings call. With me today are Sudhakar Ramakrishna, our President and CEO and Bart Kalsu, our CFO. Following our prepared remarks, we will have a question and answer session. This call is being simultaneously webcast on our Investor Relations website at investors.

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 timing of the phases of such evolution, our expectations regarding our partner ecosystem, the SEC enforcement action, the impact of the global economic and geopolitical environment on our business and our gross level of debt. These statements are based on currently available information and assumptions, and we undertake no duty to update this information except as required by law. These statements are subject to a number of risks and uncertainties, including the numerous risks and uncertainties highlighted in today's earnings release in 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 definition of other financial metrics discussed on today's call are available in our earnings press release and summary slide deck on the Investor Relations page of our website. Finally, we note that the financial results discussed on today's call And our earnings release are preliminary and pending final review by us and our external auditors, and will only be final once we file our Annual Report on Form 10 ks.

Speaker 1

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

Speaker 2

Thank you, Tim, and good morning, everyone. I hope you're off to a great start in 2024. As always, I'd like to thank our employees, customers, partners and shareholders for their ongoing commitment to SolarWinds. I'm pleased to report that we delivered another strong quarter, once again exceeding our guidance across all key metrics, Finishing the year on a high note and adding to the momentum we built throughout 2023. We believe Our performance continues to demonstrate not only the resiliency of our business model, but also the compelling value we deliver to our customers.

Speaker 2

Now turning to business highlights from this quarter. 1st, strong subscription revenue and overall ARR growth demonstrating the continued success of our subscription first strategy. 2nd, continued growth and adoption of our observability solution. 3rd, strong customer retention, which was a critical priority of ours in 2023. 4th, significant enhancements we delivered on our SolarWinds platform as it continues to be the foundation that fuels innovation For our self hosted and SaaS solutions, so customers can consolidate tools and experience hybrid visibility, simplicity and cost effective productivity across multi cloud environments.

Speaker 2

Finally, continued adjusted EBITDA growth and another quarter of achieving the rule of 50. I will now discuss some of our 4th quarter financial highlights before turning the call over to Bart, who will provide more detail on the quarter, our financial performance in 2023 and our financial outlook for 2024. In Q4 2023, we saw total revenue of $198,000,000 about the high end of the range we provided and representing a year over year growth rate of 6%. With the ongoing success of our subscription first strategy, in the Q4, we delivered subscription revenue growth of 36% and subscription ARR growth of 34%. We delivered 4th quarter adjusted EBITDA of $87,000,000 above the high end of the range we provided and representing growth of 17% year over year.

Speaker 2

Our 4th quarter in quarter maintenance renewal rate was 95% and our trailing 12 month maintenance renewal rate at the year end was 96%, an increase from 95% as of the end of the third quarter and 93% as of the year end 2022. And we delivered 4th quarter total ARR growth of 8% year over year with continued execution of our subscription first and platform Shifting to our product portfolio, we believe that SolarWinds provides the most comprehensive AI powered full stack observability solutions in the industry across networks, infrastructure, applications and databases. Our multifaceted product portfolio offers observability, database performance and service management solutions across on premises, cloud and hybrid environment, enabling customers to accelerate their business transformation In an increasingly multi cloud world, we help reduce customers' complexity and cost By eliminating tool sprawl, help rapidly detect and remediate issues, increase time to value and improve productivity. We believe that SolarWinds hybrid cloud observability contributes to increased retention and conversion rates and that our customers are enjoying increased value as we continue to evolve and extend the capabilities of our solutions. Across observability, service management and database performance management, our teams are continuing to deliver Customer Critical Capabilities.

Speaker 2

We believe our broad spectrum of self hosted to SaaS solutions most effectively enables our customers to accelerate their business transformation with deployment flexibility. Some recent enhancements include: In November, we announced SolarWinds Database Observability, A new offering that delivers comprehensive visibility into databases to increase the performance, scalability and efficiency of digital services and applications. Combined with our application observability capabilities, We can reduce customers' time to detect problems in their multi cloud environments. At AWS re:Invent 2023, we unveiled the latest enhancements to our SaaS delivered observability solution, Helping customers accelerate their cloud journeys and including support for open telemetry and new Kubernetes application setting intelligence, as well as the addition of cloud enabled, open source and NoSQL database observability capabilities. We continue to enhance our self hosted observability solutions with new device support to provide increased coverage for our customers.

Speaker 2

We also continue to evolve our network infrastructure and cloud observability solutions and had several customers leverage the power of our solutions to gain hybrid visibility. I'm pleased to share that just this week, we announced a series of transformative AI powered enhancements across our SaaS based observability solutions, most notably to our proven network infrastructure and cloud offerings. Building upon our networking heritage, we now offer complete visibility across on premises and cloud networks, including on premises and cloud network devices, virtual machines, hypervisors, containers and infrastructure as a service resources. We invite you all to learn more about our latest innovations At our next SolarWinds Day on Wednesday, February 28, Layered through all facets of our offerings is Secure by Design, our standard for secure software development and infrastructure security. We developed the Secure by Design initiative to address the ever changing threat landscape and to illustrate how security is a part of our organization's fabric.

Speaker 2

We believe our initiative not only delivers enhanced security for our customers, but also advances cyber safety for SolarWinds and for our industry at large and establishes a new standard for secure software development. Turning now to our partner ecosystem, as you've heard me discuss in recent quarters, Our partners, including global system integrators and hyperscalers are increasingly important for our expanding go to market motion and can help us expand our reach to customers in a scalable, efficient and cost effective manner. The SolarWinds model of inside and velocity sales is a foundation upon which we are building these additional go to market motions. In August 2023, we announced enhancements to our channel partner program designed to accelerate growth and revenue with and for our partners, these updates provide greater flexibility for our partners to achieve their targets, new opportunities for channel offering improvements and specialized options for database and ITSM products. We will continue to host our Transform Partner Summit with several exciting events planned for 2024, including our EMEA Summit in Lisbon, our APJ Summit in Bali and our Americas Summit in Miami.

Speaker 2

I look forward to meeting our partners and sharing our 2024 plans. I believe that partners are a force multiplier And together, we can help our customers further accelerate their business transformation. 2023 was a strong year across multiple dimensions, and I'll provide a quick recap. 1st, We successfully drove subscription adoption across our businesses, which is seen in our strong subscription revenue and ARR growth results. We believe this is consistent with how our customers want to consume our products And that an increase in our subscription base provides an even more solid foundation for our revenue and margin expansion efforts.

Speaker 2

2nd, we demonstrated rigorous expense discipline in a challenging macro environment by investing selectively, while managing costs and improving our operating margins as reflected in our 17% adjusted EBITDA year over year growth in 2023. 3rd, we continue to prioritize customer success and retention and successfully improved our maintenance renewal rates to 96% on a trailing 12 month basis. And 4th, we delivered on our innovation agenda by extending and enhancing the AI powered capabilities of our solutions, while also expanding our ecosystem to bring even greater value to our customers. It is my belief that we built a strong foundation and successful strategy that's a direct result of our focus on our transformational efforts across all aspects of our business over the last 3 years. With that, I will turn it over to Bart to expand on our financial performance and provide a full year 2024 outlook.

Speaker 2

Bart?

Speaker 3

Thanks, Sudhakar, and thanks to everyone for joining us. 2023 was a successful year for us as we started to see returns on many of the investments that we have made over the past few years. We have grown in total revenue and significant acceleration in our subscription revenue and subscription ARR. Margins were another area of focus for us, And we improved our adjusted EBITDA by $48,000,000 or 17% year over year. And our adjusted EBITDA margin is back to the mid-40s.

Speaker 3

The Q4 was consistent with the first three as we beat guidance across all key metrics. We are proud of the financial results we delivered in 2023. We have increased the mix of predictable recurring revenue, delivered double digit adjusted EBITDA growth and made substantial progress in improving our leverage profile. Turning to the numbers. We finished the 4th quarter with total revenue $198,000,000 a 6% increase compared to the prior year and above the high end of $192,500,000 of outlook For total revenue that we provided last quarter, on a full year basis, total revenue finished at $759,000,000 above the high end of outlook of $753,000,000 and well above the high end of the range of $725,000,000 to 740,000,000 that we provided at the start of the year.

Speaker 3

We ended the 4th quarter with total ARR of $684,000,000 up 8% year over year. Our subscription ARR at the end of the 4th quarter was $233,000,000 an increase of 34% year over year. This growth continues to be driven by the execution of our subscription first strategy. We have historically provided the number of customers who have spent more than $100,000 with us over the past 12 months. That number was 945 as of December 31, which was a 6% increase over the prior year.

Speaker 3

Moving forward, instead of that metric and consistent with our subscription transition, We will now be providing the number of customers who have annual recurring revenue or ARR of greater than $100,000 We believe that total ARR from customers is a better indicator of the health of the business since annual recurring revenue provides insight to the quality and repeatability of the business. We had 979 customers with over 100,000 of total ARR, representing a 15% growth over the prior year. Digging into the revenue details, our 4th quarter subscription revenue was $68,000,000 up 36% year over year, with full year subscription revenue of $234,000,000 an increase of 40% year over year. The increase in subscription revenue reflects the success of our subscription first strategy. Maintenance revenue was $115,000,000 in the quarter roughly flat compared to the prior year.

Speaker 3

Full year maintenance revenue was $462,000,000 up 1% year over year. As we have previously discussed, the conversion of a portion of our maintenance customers to subscriptions has impacted maintenance revenue, And we expect that it will continue to do so as we continue our subscription first transition. Our maintenance renewal rate is 96% on a trailing 12 month basis and was 95% for the Q4. The improvement in our renewal rate in 2023 was a testament to the loyalty of our customer base and the value of our solutions. As we convert maintenance customers to subscription, we exclude those customers from this renewal rate calculation.

Speaker 3

As a result of the subscription revenue growth and strong maintenance renewal rates, we now have 92% of our total revenue as recurring revenue. For the Q4, license revenue was $15,000,000 down 31% from $22,000,000 in the Q4 of 2022. And full year license revenue was $62,000,000 down 33% year over year. As a reminder, our delivered another quarter of strong non GAAP profitability. 4th quarter adjusted EBITDA was $87,000,000 growing 17% year over year, representing an adjusted EBITDA margin of 44% and coming in $4,500,000 above the high end of the $80,500,000 to $82,500,000 outlook we gave for the quarter.

Speaker 3

Full year adjusted EBITDA was 300 $28,600,000 growing 17% from the prior year, representing an adjusted EBITDA margin of 43% and coming in $4,600,000 above the $322,000,000 to $324,000,000 guidance we gave last quarter. As we've discussed in prior quarters, we're focused on our capital allocation, disciplined expense management and driving operational efficiencies across our business, while focusing on growth and our broader subscription transition. Given the uncertain macro outlook for 2023, we took measures to optimize our expense structure as part of our ongoing focus on improving operating margins in the first half of the year. During 2023, these measures resulted in $20,000,000 of restructuring charges, primarily associated with $14,000,000 of lease impairments for certain office locations and costs related to headcount reductions. Looking ahead, we will continue to monitor the environment closely and we plan to hire selectively and manage our costs in a disciplined manner.

Speaker 3

Turning to our balance sheet, we significantly improved our leverage position in 2023. Our net leverage ratio at December 31 was 2.9 times our trailing 12 months adjusted EBITDA. This compares to 3.9 times at the end of last year. In addition, in January of 2024, we refinanced our term loan, decreasing the interest rate by 50 basis points from SOFR plus 3.75 to SOFR plus 3.25, taking advantage of the latest interest rate environment. We continue to generate strong cash flow With $183,000,000 in cash flow from operations in 2023, our cash and cash equivalents and short term investment balance $289,000,000 at year end, bringing our net debt to under $1,000,000,000 Our cash position and positive cash flow give us the ability to fund future growth as well as flexibility on capital allocation alternatives moving forward.

Speaker 3

I will now walk you through our outlook before turning it over to Sudhakar for final thoughts. I will start with our Q1 guidance and then discuss our outlook for the full year. For the Q1, we expect total revenue to be in the range of $187,000,000 to $192,000,000 representing 2% growth at the midpoint. Adjusted EBITDA for the Q1 is expected to be approximately $81,500,000 to $84,500,000 representing 7% growth at the midpoint. Non GAAP fully diluted earnings per share are projected to be $0.20 to $0.22 per share, assuming an estimated 171,300,000 fully diluted shares outstanding.

Speaker 3

And finally, our outlook for the Q1 assumes a non GAAP tax rate of 26%, and we expect to pay approximately $12,000,000 in cash taxes during the Q1. For the full year, we expect total revenue to be in the range of $771,000,000 to $786,000,000 representing 3% growth year over year at the midpoint. Adjusted EBITDA for the year is expected to be approximately $350,000,000 to $360,000,000 representing 8% year over year growth at the midpoint. Non GAAP fully diluted earnings per share are projected to be $0.95 to $1 per share, assuming an estimated 173 2,000,000 fully diluted shares outstanding. Our full year and first quarter guidance assumes a euro to dollar exchange rate of 1.08 the 1.

Speaker 3

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

Speaker 2

Thank you, Bart. As you can see, the outlook Bart shared represents a continuation of top line growth and adjusted EBITDA growth. This coming on the heels of our strong 2023 performance reflects our belief In the increasing relevance of our broad array of product offerings combined with our ability to execute and innovate, Customer environments continue to become more complex as they address the challenges and opportunities of their respective businesses. Equally, their budgets remain constrained, especially in this macro environment. Customers are looking to consolidate tools and to improve security while reducing alert fatigue, all while seeking solutions that are simpler to procure and use, Cloud ready to help them transform at the pace of their business, cost effective, while enhancing productivity.

Speaker 2

We believe we are ideally suited to deliver these solutions to our customers. We take our obligations to deliver customer success very seriously, while being excited and disciplined about the opportunity ahead. Looking to 2024, we will continue to extend our SolarWinds platform and deliver effective solutions build to help customers manage their hybrid and multi cloud environments invest selectively While continuing to exercise expense discipline and seek to expand profitability, focus on subscription and ARR growth, customer success and retention, growing profitability and cash flow and creating more value for our shareholders. Although many unknowns around the macro environment persist, we remain focused on the things we can control. I'm pleased with all the work our teams have done to help us cap 2023 with a strong Q4, And I'm as confident as ever in the direction of our business.

Speaker 2

I could not be prouder of our team's commitment to customers' success. Again, I thank our employees, partners, customers and shareholders for their commitment to SolarWinds. Bart and I are now happy to address your questions.

Operator

Your first question comes from the line of Rob Oliver with Baird. Your line is open.

Speaker 4

Hi, good morning guys. Thank you very much for taking my question. I had 2 and the first and this could be for Sagar or for you Bart. I just wanted to ask for a bit more color around the Q the 2024 top line guide. There's a fairly significant divergence between the Q4 exit rate growth of 5.9% and what you guys have guided for the full year.

Speaker 4

And Given some of the success you guys are seeing in the subscription and the platform sale, just want to better contextualize That guidance for 2024? And then I had a quick follow-up.

Speaker 2

Thanks, Rob. First of all, hope you're doing wonderful. Let me put some context around the 2024 guide and I'll ask Bart to add any comments he has at that point. First, as you noted and as you saw from our results, we have been executing well to our plan And our priorities as evidenced in the 2023 results. We are not anticipating significant changes to the macro environment in 2024, but at the same time we are confident in our solution set, the confidence that the customers have in us, and our ability to execute.

Speaker 2

So we balanced a bunch of things, including if there are any macro unforeseen conditions and appropriately created our guidance with the goal that we continue to perform and perform well relative to it going forward.

Speaker 3

Yes. And Rob, I would just reiterate, there's still a little bit of uncertainty out there in the environment and macro. And so When we set guidance, we're just taking that into consideration. We haven't seen any noticeable changes in buying patterns as we go into 2024. We're just trying to be prudent.

Speaker 4

Got it. Okay, great. Thanks, helpful. And then my follow-up was around the partner program, Sudhakar, Definitely one of the changes that you've made here in putting your fingerprints on the company and it really sounds like You guys are making progress. I know it's been a lot of effort to kind of build this partner network, build trust with the partners in a business that wasn't traditionally partner focused.

Speaker 4

Could you help us you mentioned a lot of the events you have this year. Can you just help us understand, either with numbers or with kind of parameters, what would to success like how should we think about the contributions to the business from partners later this year? What would you like to see? Thank you.

Speaker 2

Absolutely, Rob. While we have made great strides with our partner program, I will say that we are still in the early innings of our transformation towards Leveraging partners globally. And when I talk about partners, I speak about, call it traditional resellers and distributors, Global system integrators, cloud service providers and MSPs, as well as the hyperscalers. So we have motions in all of these dimensions, but at various levels of maturity. We take a fairly holistic approach to partners where we truly believe that they are extensions to us.

Speaker 2

We've already seen results from partners generating demand, identifying new opportunities and closing them. So I'm very optimistic that we can work very closely together and truly build a force multiplier while at the same time doing it cost effectively. That's a foundation of how we operate at SolarWinds and that will continue. So where you're going to see some of the effects of it As we move forward is, especially with the GSIs, we are getting, access to larger accounts and winning a lot of those large enterprise accounts as well. This is not to say that we have a broad sales force in the field, which is expensive and speculative.

Speaker 2

It is very targeted on a solution by solution basis working with the GSIs and that gives us significant leverage from a cost of sales standpoint. And then from there, it trickles on down to traditional resellers, MSPs that continue to drive MSPs and CSPs that continue to drive subscription solutions and so on. So that's where I see the leverage. We're not really breaking down any financials there, but hopefully you'll continue to see that in our overall financials backdrop.

Speaker 4

Great, helpful. Thank you very much.

Operator

Your next question comes from the line of Matt Hedberg with RBC Capital Markets. Your line is open.

Speaker 5

Great, guys. Thanks for taking my question. I guess a follow-up On kind of the guidance, but also the 4Q results. You had a really strong beat this quarter, really good performance. You're kind of saying the macro environment remains uncertain.

Speaker 5

But I guess at a high level, did things get better for you in 4Q versus 3Q or was maybe just a little bit more budget flush that you planned on because the growth was particularly strong this quarter?

Speaker 2

Matt, I would say it was simple simply a continued focus on our execution. So we did not see Any, I would say, anomalies, either to the positive or the negative as it relates to Q4. Q4, as you know, is a seasonally bigger quarter for, most enterprise software companies. We are no exception. So we did have the benefit of that effect, But outside of that, there was nothing, call it, unnatural.

Speaker 5

Got it. Okay. And then on the maintenance conversion, I think historically you've said that you're converting those customers on a higher at a higher dollar value. I'm wondering if you have any metrics you could share on some of the conversion efforts?

Speaker 2

So the conversion metrics have stayed robust all through 2023, But I also want to provide some context as to why that is the case. As I've said in previous calls, It is not simply a matter of converting a maintenance dollar to a subscription dollar. As much as when we are doing it, We are doing it from typically a single point product or a small number of point products to our observability suite. That gives customers greater access to our complete functionality, enables them to do tool consolidation. So some of it is plain conversion and in most deals there is significant expansion as well.

Speaker 2

So when we talk about conversion factors, it's a blended rate of those two things.

Speaker 5

Got it. Thanks, Sudhakar.

Speaker 2

Thank you.

Operator

Your next question comes from the line of pendulum bohra with JPMorgan. Your line is open.

Speaker 6

Hey guys, Jaden Patel on for Pendulum. One quick question on our end. What is assumed in the guide in relation to the legal proceedings? You're assuming any disruption there? And what are you assuming for maintenance conversion going into 2024?

Speaker 6

Thanks.

Speaker 2

Thanks, Binjalim. On the legal proceedings, I can say that thanks to the focus of our teams, we really have not had any distractions related to that from an operational standpoint. We have a very competent team that is managing that and All of us and including me are able to focus on our customers, on our employees and on growing our business. Our customers have significant trust in us. We don't take that lightly and we continue to earn their trust every single day.

Speaker 2

And I'm sure you've seen that in our customer retention rates, growth rates, even after some of the more recent announcements around the legal proceedings have come through. It is my belief that as we continue to work with the authorities, the facts will come out and we feel very confident in our facts.

Speaker 6

Got it. Thanks for taking the questions.

Operator

Your next question comes from the line of Erik Sipagar with JMP Securities. Your line is open.

Speaker 7

Yes. Thanks for taking the question. Say, one of your competitors out this morning has talked to they talked more about how There is a growing demand for tool consolidation or there is an acceleration in that demand. And when the customer is making a tool consolidation decision, it's extended the sales cycle because it's a more complex decision. There's more sign off and things of that nature.

Speaker 7

I'm curious if you have seen anything along those lines.

Speaker 2

Eric, first of all, it is true that customers are looking To consolidate tools, impact our hybrid cloud observability solutions, one of the express value propositions of that is to help customers simplify and consolidate. The one distinguishing factor, I would say, Relative to some of the other competitors is we're able to get that consolidation and the deployment In a extremely simple fashion, time to value is one of our key drivers and that has always been the case For SolarWinds. So that enables us to continue drive velocity. That's number 1. Number 2 is that we Even as we compete and win larger deals, which tend to have naturally longer sales cycles as well.

Speaker 2

So we are not concentrated like some of the customers in, like, let's say, only the enterprise segment and not have to deal with the consequences of elongated sales cycle. But do I see it in deal to deal? Yes. But is it impacting our business? No.

Speaker 7

Very good. Thank you.

Operator

There are no further questions at this time. I will now turn the call back over to Sudhakar Ramakrishna for closing remarks.

Speaker 2

Thank you again. Thanks all for your support of SolarWinds. We will continue to work towards our strategic priorities, execute and look forward to sharing our results on an ongoing basis.

Operator

This concludes today's call. You may now disconnect.

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