SOLARWINDS CORPORATION The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the condensed consolidated financial statements and related notes thereto included elsewhere in this Quarterly Report on Form 10-Q. In addition to historical condensed consolidated financial information, the following discussion contains forward-looking statements that reflect our plans, estimates and beliefs. Our actual results could differ materially and adversely from those anticipated in the forward-looking statements. Please see the section entitled "Safe Harbor Cautionary Statement" above and the risk factors discussed in our Quarterly Reports on Form 10-Q for the quarters endedMarch 31, 2020 andJune 30, 2020 and our Annual Report on Form 10-K for the year endedDecember 31, 2019 for a discussion of the uncertainties, risks and assumptions associated with these statements. The following discussion and analysis also includes a discussion of certain non-GAAP financial measures. For a description and reconciliation of the non-GAAP measures discussed in this section, see "Non-GAAP Financial Measures." OverviewSolarWinds is a leading provider of information technology, or IT, infrastructure management software. Our products give organizations worldwide, regardless of type, size or IT infrastructure complexity, the power to monitor and manage the performance of their IT environments, whether on-premise, in the cloud, or in hybrid models. We combine powerful, scalable, affordable, easy to use products with a high-velocity, low-touch sales model to grow our business while also generating significant cash flow. We offer over 50 infrastructure-location agnostic products to monitor and manage network, systems, desktop, application, storage, database, website infrastructures and IT service desks. We intend to continue to innovate and invest in areas of product development that bring new products to market and enhance the functionality, ease of use and integration of our current products. We believe this will strengthen the overall value proposition of our products in any IT environment. OnFebruary 5, 2016 , we were acquired by affiliates ofSilver Lake Group , L.L.C andThoma Bravo, LLC in a take private transaction, or the Take Private. We applied purchase accounting on the date of the Take Private. InOctober 2018 , we completed our initial public offering, or IPO, and once again become a publicly traded company. Impacts of COVID-19 The impact from the rapidly changing market and economic conditions due to the COVID-19 pandemic on our business is uncertain. We initially responded to the COVID-19 pandemic by executing our business continuity plan and transitioning nearly all of our workforce to a remote working environment to prioritize the safety of our personnel. Substantially all of our workforce is currently working remotely. Due to the nature of our business, at this time, we have seen a small impact on our financial results and do not expect to experience a significant impact on our financial results due to the COVID-19 pandemic, but we are unable to predict with a level of precision the longer term impact it may have on our business, results of operations and financial condition due to numerous uncertainties, including the duration of the pandemic, actions that may be taken by governmental authorities in response to the pandemic, its impact to the business of our customers and their end-customers and other factors identified in Part II, Item 1A "Risk Factors" in our Form 10-Q for the quarters endedMarch 31, 2020 andJune 30, 2020 and our Annual Report on Form 10-K for the fiscal year endedDecember 31, 2019 . We will continue to evaluate the nature and extent of the impact of the COVID-19 pandemic to our business, consolidated results of operations and financial condition. Potential Spin-Off of MSP Business OnAugust 6, 2020 , we announced that our board of directors has authorized management to explore a potential spin-off of our MSP business into a newly created and separately traded public company. If completed, the standalone entity would provide broad and scalable IT service management solutions designed to enable managed service providers, or MSPs, to deliver outsourced IT services for their small and medium size business end-customers and more efficiently manage their own businesses.SolarWinds would retain its Core IT Management business focused primarily on selling software and cloud-based services to corporate IT organizations. We believe that, if completed, the potential spin-off would enable shareholders to more clearly evaluate the performance and future potential of each entity on a standalone basis, while allowing each to pursue its own distinct business strategy and capital allocation policy. If we proceed with the spin-off, it would be structured as a tax-free, pro-rata distribution to allSolarWinds shareholders as of a record date to be determined by the board of directors ofSolarWinds . If completed, upon effectiveness of the transaction,SolarWinds shareholders would own shares of both companies. Completion of any spin-off would be subject to various conditions, including final approval of our board of directors, and there can be no assurance that the potential spin-off will be completed in the manner described above, or at all. We have incurred and expect to incur significant costs in connection with exploring the potential spin-off transaction of our MSP business into a newly created and separately traded public company. Spin-off exploration costs include legal, accounting 18 -------------------------------------------------------------------------------- and advisory fees, implementation and integration costs, duplicative costs for subscriptions and information technology systems, employee and contractor costs and other incremental separation costs related to the potential spin-off of the MSP business. The potential MSP spin-off transaction results in operating expenses that would not otherwise have been incurred by us in the normal course of our organic business operations. Spin-off exploration costs incurred were$2.6 million during the three months endedSeptember 30, 2020 . We expect to incur additional spin-off exploration costs in future periods. Third Quarter Financial Highlights Our approach, which we call the "SolarWinds Model," is based on our commitment to building a business that is focused on growth and profitability. Below are our key financial highlights for the three months endedSeptember 30, 2020 as compared to the three months endedSeptember 30, 2019 . Revenue Our total revenue was$261.0 million and$240.5 million for the three months endedSeptember 30, 2020 and 2019, respectively. Our non-GAAP total revenue, which excludes the impact of purchase accounting, was$261.3 million and$242.7 million for the three months endedSeptember 30, 2020 and 2019, respectively. Recurring revenue, which consists of subscription and maintenance revenue, represented approximately 85% of our total revenue for the three months endedSeptember 30, 2020 compared to 82% for the three months endedSeptember 30, 2019 . We have increased our recurring revenue as a result of the growth in our subscription sales and the continued growth of our maintenance revenue. Our Core IT Management products are targeted for ITOps, DevOps, and IT security Professionals and provide hybrid IT performance management with a deep visibility into applications, databases, IT infrastructures, and the full IT stack, while remaining infrastructure-location agnostic. Our Core IT Management products include the products categorized as ITOM in our Annual Report on Form 10-K for the period endedDecember 31, 2019 . Core IT Management product revenue was$184.8 million and$173.4 million for the three months endedSeptember 30, 2020 and 2019, respectively. Our MSP products deliver broad, scalable IT service management solutions to enable MSPs to deliver outsourced IT services for their small and medium size business end-customers and more efficiently manage their own businesses. MSP product revenue was$76.2 million and$67.1 million for the three months endedSeptember 30, 2020 and 2019, respectively. We use Subscription Annual Recurring Revenue, or Subscription ARR, and Total Annual Recurring Revenue, or Total ARR, to evaluate the results of our recurring revenue model. Subscription ARR represents the annualized recurring value of all active subscription contracts at the end of a reporting period. As ofSeptember 30, 2020 , Subscription ARR was$411.1 million , up from$343.1 million as ofSeptember 30, 2019 . Total ARR represents the sum of Subscription ARR and the annualized value of all maintenance contracts related to perpetual licenses active at the end of a reporting period. As ofSeptember 30, 2020 , Total ARR was$887.2 million , up from$796.4 million as ofSeptember 30, 2019 , reflecting an increase of 11.4%. As ofSeptember 30, 2020 , we had over 320,000 customers. We have a broad and diverse customer base that is not concentrated in any segment or vertical industry. We define customers as individuals or entities that have purchased one or more of our products under a unique customer identification number since our inception for our perpetual license products and individuals or entities that have an active subscription for at least one of our subscription products. Each unique customer identification number constitutes a separate customer regardless of the amount purchased. We may have multiple purchasers of our products within a single organization, each of which may be assigned a unique customer identification number and deemed a separate customer. The SolarWinds Model allows us to both sell to a broad group of potential customers and close large transactions with significant customers. While some customers may spend as little as$100 with us over a twelve-month period, we had 1,004 customers who had spent more than$100,000 with us for the trailing twelve-month period endedSeptember 30, 2020 as compared to 857 for the twelve-month period endedSeptember 30, 2019 . We expect that the continued growth in the use of public and private clouds, increased outsourcing of IT management services to MSPs and cross-selling of subscription products into our existing customer base could result in an increase in our subscription revenue. We believe this increase, coupled with continued growth in maintenance revenue, could cause our recurring revenue to increase as a percentage of total revenue over time. Our license revenue has declined as a percentage of total revenue primarily due to the higher growth of our recurring revenue and represented approximately 15.1% of our total revenue in the three months endedSeptember 30, 2020 . Profitability We have grown while maintaining high levels of operating efficiency. Our net income for the three months endedSeptember 30, 2020 was$12.5 million compared to$4.4 million for the three months endedSeptember 30, 2019 . Our Adjusted EBITDA was$132.7 million and$115.0 million for the three months endedSeptember 30, 2020 and 2019, respectively. 19 -------------------------------------------------------------------------------- Cash Flow We have built our business to generate strong cash flow over the long term. For the three months endedSeptember 30, 2020 and 2019, cash flows from operations were$100.9 million and$75.2 million , respectively. During those periods, our cash flows from operations were reduced by cash payments for interest on our long-term debt of$14.6 million and$25.7 million , respectively and cash payments for income taxes of$23.7 million and$9.2 million , respectively. Acquisition InOctober 2020 , we acquiredSQL Sentry Holdings, LLC , or SentryOne, a leading technology provider of database performance monitoring and DataOps solutions for approximately$142.5 million . We funded the transaction with cash on hand. The SentryOne offering complements the on-premises and cloud-native database management offeringsSolarWinds has today to serve the full needs of the mid-market and better serve larger organizations. The addition of the SentryOne products to theSolarWinds portfolio also amplifies the depth and breadth of supportSolarWinds can offer for Microsoft and Microsoft Azure environments. Components of Our Results of Operations Revenue Our revenue consists of recurring revenue and perpetual license revenue. •Recurring Revenue. The significant majority of our revenue is recurring and consists of subscription and maintenance revenue. ?Subscription Revenue. We primarily derive subscription revenue from fees received for subscriptions to our SaaS offerings, and to a lesser extent, our time-based license arrangements. Subscription revenue includes sales of our MSP products as well as our cloud infrastructure, application performance management and IT service management, or ITSM products. We generally recognize revenue ratably over the subscription term once the service is made available to the customer or when we have the right to invoice for services performed. We generally invoice subscription agreements monthly based on usage or in advance over the subscription period on either a monthly or annual basis. Our subscription revenue grows as customers add new subscription products, upgrade the capacity level of their existing subscription products or increase the usage of their subscription products. Our revenue from MSP products increases with the addition of end customers served by our MSP customers, the proliferation of devices managed by those MSPs and the expansion of products used by those MSPs to manage end customers' IT infrastructures. •Maintenance Revenue. We derive maintenance revenue from the sale of maintenance services associated with our perpetual license products. Perpetual license customers pay for maintenance services based on the products they have purchased. We recognize maintenance revenue ratably on a daily basis over the contract period. Our maintenance revenue grows when we renew existing maintenance contracts and add new perpetual license customers, and as existing customers add new products. In addition, we typically implement annual price increases for our maintenance services. Customers typically renew their maintenance contracts at our standard list maintenance renewal pricing for their applicable products. We generally invoice maintenance contracts annually in advance. •License Revenue. We derive license revenue from sales of perpetual licenses of our on-premise network, systems, storage and database management products to new and existing customers. We include one year of maintenance services as part of our customers' initial license purchase. License revenue is recognized at a point in time upon delivery of the electronic license key. We allocate revenue to the license component based upon our estimated standalone selling prices, which is derived by evaluating our historical pricing and discounting practices in observable bundled transactions. InApril 2020 , we launched subscription pricing options for certain of our network, systems and database management products that have historically been sold as perpetual licenses. The new on-premise subscription option gives customers additional flexibility when purchasing our products. The on-premise subscription offerings are time-based revenue arrangements recognized at a point in time upon delivery of the software and support is recognized ratably over the contract period. On-premise subscription offerings are recorded in subscription revenue in our consolidated statement of operations. We plan to continue to sell perpetual licenses for these products and not require customers to transition to a subscription pricing model. The subscription pricing option may impact the mix of license and recurring revenue, but this impact is difficult to predict at this time due to uncertainty regarding the level of customer adoption of the new subscription pricing options. We expect a gradual shift in the mix between license and recurring revenue in each quarter as new customers purchase these on-premise subscription offerings. 20 -------------------------------------------------------------------------------- Cost of Revenue •Cost of Recurring Revenue. Cost of recurring revenue consists of technical support personnel costs, royalty fees, public cloud infrastructure and hosting fees and an allocation of overhead costs for our subscription revenue and maintenance services. Allocated costs consist of certain facilities, depreciation, benefits and IT costs allocated based on headcount. •Amortization of Acquired Technologies. We amortize to cost of revenue the capitalized costs of technologies acquired in connection with the Take Private and our other acquisitions. Operating Expenses Operating expenses consists of sales and marketing, research and development and general and administrative expenses as well as amortization of acquired intangibles. Personnel costs are the most significant component of operating expenses and consist of salaries, benefits, bonuses, sales commissions, stock-based compensation and an allocation of overhead costs based on headcount. The total number of employees as ofSeptember 30, 2020 was 3,241, as compared to 3,121 as ofSeptember 30, 2019 . Our stock-based compensation expense has increased due to equity awards granted to our employees and directors. Due to modifications to certain stock awards during the second and third quarters of 2020 to eliminate performance vesting conditions applicable to such awards, our stock-based compensation expense increased during the period and we expect this to continue in future periods. Our travel costs have declined in 2020 due to COVID-19 and we expect this to continue for the duration of the pandemic. •Sales and Marketing. Sales and marketing expenses primarily consist of related personnel costs, including our sales, marketing and maintenance renewal and subscription retention teams. Sales and marketing expenses also includes the cost of digital marketing programs such as paid search, search engine optimization and management, website maintenance and design. We expect to continue to hire personnel globally to drive new sales and maintenance renewals. •Research and Development. Research and development expenses primarily consist of related personnel costs. We expect to continue to grow our research and development organization, particularly internationally. •General and Administrative. General and administrative expenses primarily consist of personnel costs for our executive, finance, legal, human resources and other administrative personnel, general restructuring costs and other acquisition and spin-off exploration costs, professional fees and other general corporate expenses. •Amortization of Acquired Intangibles. We amortize to operating expenses the capitalized costs of intangible assets acquired in connection with the Take Private and our other acquisitions. Other Income (Expense) Other income (expense) primarily consists of interest expense and gains (losses) resulting from changes in exchange rates on foreign currency denominated accounts. We expect interest expense to decrease as we repay indebtedness. Foreign Currency As a global company, we face exposure to adverse movements in foreign currency exchange rates. Fluctuations in foreign currencies impact the amount of total assets, liabilities, revenue, operating expenses and cash flows that we report for our foreign subsidiaries upon the translation of these amounts intoU.S. dollars. See "Item 3. Quantitative and Qualitative Disclosures About Market Risk" for additional information on how foreign currency impacts our financial results. Income Tax Expense Income tax expense consists of domestic and foreign corporate income taxes related to the sale of products. The tax rate on income earned by our North American entities is higher than the tax rate on income earned by our international entities. We expect the income earned by our international entities to grow over time as a percentage of total income, which may result in a decline in our effective income tax rate. However, our effective tax rate will be affected by many other factors including changes in tax laws, regulations or rates, new interpretations of existing laws or regulations, shifts in the allocation of income earned throughout the world and changes in overall levels of income before tax. 21 --------------------------------------------------------------------------------
Comparison of the Three Months Ended
Three Months Ended
2020 2019
Percentage of Percentage of
Amount Revenue Amount Revenue Change
(in thousands, except percentages)
Subscription $ 100,564 38.5 % $ 83,122 34.6 % $ 17,442
Maintenance 121,134 46.4 113,755 47.3 7,379
Total recurring revenue 221,698 84.9 196,877 81.9 24,821
License 39,284 15.1 43,613 18.1 (4,329)
Total revenue $ 260,982 100.0 % $ 240,490 100.0 % $ 20,492
Total revenue increased $20.5 million , or 8.5%, for the three months ended
September 30, 2020 compared to the three months ended September 30,
2019 . Revenue from North America was approximately 66% and 67% of total revenue
for the three months ended September 30, 2020 and 2019, respectively. Other than
the United States , no single country accounted for 10% or more of our total
revenue during these periods. We expect our international total revenue to
increase slightly as a percentage of total revenue as we expand our
international sales and marketing efforts across our product lines. Core IT
Management product revenue was $184.8 million for the three months ended
September 30, 2020 compared to $173.4 million for the three months ended
September 30, 2019 , representing an increase of 6.6%. MSP product revenue was
$76.2 million for the three months ended September 30, 2020 compared to $67.1
million for the three months ended September 30, 2019 , representing an increase
of 13.4%.
Recurring Revenue
Subscription Revenue. Subscription revenue increased $17.4 million , or 21.0%,
for the three months ended September 30, 2020 compared to the three months ended
September 30, 2019 , primarily due to sales of additional MSP products as well as
the contribution from our cloud-based database management offerings and the
effect of the strengthening of most foreign currencies relative to the U.S.
dollar. Our subscription revenue increased as a percentage of our total revenue
for the three months ended September 30, 2020 compared to the three months ended
September 30, 2019 .
Our net retention rate for our subscription products was approximately 105% for
each of the trailing twelve-month periods ended September 30, 2020 and 2019 and
was driven primarily by strong customer retention and expansion in our MSP
products. We define our net retention rate for subscription products as the
implied monthly subscription revenue at the end of a period for the base set of
customers from which we generated subscription revenue in the year prior to the
calculation, divided by the implied monthly subscription revenue one year prior
to the date of calculation for that same customer base.
Maintenance Revenue. Maintenance revenue increased $7.4 million , or 6.5%, for
the three months ended September 30, 2020 compared to the three months ended
September 30, 2019 primarily due to a growing maintenance renewal customer base
from sales of our perpetual license products, strong maintenance renewal rates
and annual maintenance price increases.
Our maintenance renewal rate for our perpetual license products was
approximately 92% and 95%, respectively, for the trailing twelve-month periods
ended September 30, 2020 and 2019. The decrease in the maintenance renewal rate
for the trailing twelve-month period ended September 30, 2020 was primarily due
to a planned downgrade on one large U.S. Federal maintenance renewal in the
first quarter of 2020. We define our maintenance renewal rate as the sales of
maintenance services for all existing maintenance contracts expiring in a
period, divided by the sum previous sales of maintenance services corresponding
to those services expiring in the current period. Sales of maintenance services
includes sales of maintenance renewals for a previously purchased product and
the amount allocated to maintenance revenue from a license purchase.
License Revenue
License revenue decreased $4.3 million , or 9.9% primarily due to decreased sales
of our licensed products resulting from the difficult economic environment
during the quarter as a result of the global recession caused by COVID-19 and an
increase in the subscription sales of our network, systems and database
management products that have historically been sold only as perpetual licenses.
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Cost of Revenue
Three Months Ended September 30,
2020 2019
Percentage of Percentage of
Amount Revenue Amount Revenue Change
(in thousands, except percentages)
Cost of recurring revenue $ 23,484 9.0 % $ 20,614 8.6 % $ 2,870
Amortization of acquired technologies 45,463 17.4 44,172 18.4 1,291
Total cost of revenue $ 68,947 26.4 % $ 64,786 26.9 % $ 4,161
Total cost of revenue increased in the three months ended September 30, 2020
compared to the three months ended September 30, 2019 primarily due to increases
in public cloud infrastructure and hosting fees related to our subscription
products of $1.7 million , depreciation and other amortization of $0.9 million
and personnel costs to support new customers and additional product offerings of
$0.5 million , which includes a $0.4 million increase in stock-based compensation
expense. Amortization of acquired technologies includes $41.4 million and $40.8
million of amortization related to the Take Private for the three months ended
September 30, 2020 and 2019, respectively.
Operating Expenses
Three Months Ended September 30,
2020 2019
Percentage of Percentage of
Amount Revenue Amount Revenue Change
(in thousands, except percentages)
Sales and marketing $ 73,460 28.1 % $ 68,290 28.4 % $ 5,170
Research and development 31,288 12.0 29,575 12.3 1,713
General and administrative 33,558 12.9 25,405 10.6 8,153
Amortization of acquired intangibles 18,624 7.1 18,015 7.5 609
Total operating expenses $ 156,930 60.1 % $ 141,285 58.7 % $ 15,645
Sales and Marketing. Sales and marketing expenses increased $5.2 million , or
7.6%, primarily due to increases in personnel costs of $6.6 million , which
includes an increase of $4.0 million in stock-based compensation expense,
partially offset by reductions in travel and acquisition related costs of $1.7
million .
Research and Development. Research and development expenses increased $1.7
million , or 5.8%, primarily due to an increase in personnel costs of $2.7
million , which includes an increase in stock-based compensation expense of $2.0
million , partially offset by reductions in travel and acquisition related costs
of $0.5 million . We increased our worldwide research and development employee
headcount to expedite delivery of product enhancements and new product offerings
to our customers and to a lesser extent, through acquisitions.
General and Administrative. General and administrative expenses increased $8.2
million , or 32.1%, primarily due to a $7.0 million increase in personnel costs,
which includes a $6.6 million increase in stock-based compensation expense, and
a $2.5 million increase in costs related to the exploration of a potential
spin-off of our MSP business. These increases were partially offset by decreases
in our provision for losses on accounts receivables of $0.9 million .
Amortization of Acquired Intangibles. Amortization of acquired intangibles
increased $0.6 million , or 3.4%, primarily due to amortization related to the
VividCortex acquisition in December 2019 . Amortization of intangible assets
includes $11.9 million and $11.8 million of amortization related to the Take
Private for the three months ended September 30, 2020 and 2019, respectively,
with the remaining balance related primarily to the LOGICnow acquisition in May
2016 .
Interest Expense, Net
Three Months Ended
2020 2019
Percentage of Percentage of
Amount Revenue Amount Revenue Change
(in thousands, except percentages)
Interest expense, net $ (16,792) (6.4) % $ (27,418) (11.4) % $ 10,626
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Interest expense, net decreased by $10.6 million , or 38.8%, in the three months
ended September 30, 2020 compared to the three months ended September 30, 2019 .
The decrease in interest expense is primarily due to decreases in interest rates
on our debt and the reduction in our outstanding debt balance related to
quarterly principal repayments. The weighted-average effective interest rate on
our debt for the three months ended September 30, 2020 was 2.95% compared to
5.00% for the three months ended September 30, 2019 . See Note 5. Debt in the
Notes to Condensed Consolidated Financial Statements included in Item 1 of Part
I of this Quarterly Report on Form 10-Q for additional information regarding our
debt.
Other Income (Expense), Net
Three Months Ended
2020 2019
Percentage of Percentage of
Amount Revenue Amount Revenue Change
(inthousands, except percentages)
Other income (expense), net$ (547) (0.2) %$ 287 0.1 %$ (834) Other income (expense), net decreased by$0.8 million in the three months endedSeptember 30, 2020 compared to the three months endedSeptember 30, 2019 primarily due to the impact of changes in foreign currency exchange rates related to various accounts for the period. Income Tax Expense Three Months Ended September 30, 2020 2019 Percentage of Percentage of Amount Revenue Amount Revenue Change (in thousands, except percentages) Income before income taxes$ 17,766 6.8 %$ 7,288 3.0 %$ 10,478 Income tax expense 5,264 2.0 2,895 1.2 2,369 Effective tax rate 29.6 % 39.7 % (10.1) % Our income tax expense for the three months endedSeptember 30, 2020 increased by$2.4 million as compared to the three months endedSeptember 30, 2019 . The effective tax rate decreased to 29.6% for the period primarily due to an increase in income before income taxes and the impact of having a full valuation allowance against the deferred tax assets related to the current period losses related to the entities acquired in theSamanage acquisition completed inApril 2019 . For additional discussion about our income taxes, see Note 7. Income Taxes in the Notes to Condensed Consolidated Financial Statements included in Item 1 of Part I of this Form 10-Q. Comparison of the Nine Months EndedSeptember 30, 2020 and 2019 Revenue
Nine Months Ended
2020 2019
Percentage of Percentage of
Amount Revenue Amount Revenue Change
(in thousands, except percentages)
Subscription $ 290,039 38.5 % $ 233,467 34.1 % $ 56,572
Maintenance 353,981 47.0 330,840 48.3 23,141
Total recurring revenue 644,020 85.4 564,307 82.4 79,713
License 109,927 14.6 120,723 17.6 (10,796)
Total revenue $ 753,947 100.0 % $ 685,030 100.0 % $ 68,917
Total revenue increased $68.9 million , or 10.1%, for the nine months ended
September 30, 2020 compared to the nine months ended September 30, 2019 . Revenue
from North America was approximately 66% of total revenue for both the nine
months ended September 30, 2020 and 2019. Other than the United States , no
single country accounted for 10% or more of our total revenue during these
periods. We expect our international total revenue to increase slightly as a
percentage of total revenue as we expand our international sales and marketing
efforts across our product lines. Core IT Management product revenue was $531.2
million for the nine months ended September 30, 2020 compared to $491.1 million
for the nine months ended
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September 30, 2019 , representing an increase of 8.2%. Our MSP product revenue
was $222.7 million for the nine months ended September 30, 2020 compared to
$194.0 million for the nine months ended September 30, 2019 , representing an
increase of 14.8%.
Recurring Revenue
Subscription Revenue. Subscription revenue increased $56.6 million , or 24.2%,
for the nine months ended September 30, 2020 compared to the nine months ended
September 30, 2019 , primarily due to sales of additional MSP products, with
additional contribution from our acquired SolarWinds Service Desk and Database
Performance Monitor products. Our subscription revenue increased as a percentage
of our total revenue for the nine months ended September 30, 2020 compared to
the nine months ended September 30, 2019 .
Our net retention rate for our subscription products was approximately 105% for
each of the trailing twelve-month periods ended September 30, 2020 and 2019 and
was driven primarily by strong customer retention and expansion in our MSP
products. We define our net retention rate for subscription products as the
implied monthly subscription revenue at the end of a period for the base set of
customers from which we generated subscription revenue in the year prior to the
calculation, divided by the implied monthly subscription revenue one year prior
to the date of calculation for that same customer base.
Maintenance Revenue. Maintenance revenue increased $23.1 million , or 7.0%, for
the nine months ended September 30, 2020 compared to the nine months ended
September 30, 2019 primarily due to a growing maintenance renewal customer base
from sales of our perpetual license products, strong maintenance renewal rates
and annual maintenance price increases.
Our maintenance renewal rate for our perpetual license products was
approximately 92% and 95%, respectively for the trailing twelve-month periods
ended September 30, 2020 and 2019. The decrease in the maintenance renewal rate
for the trailing twelve-month period ended September 30, 2020 was primarily due
to a planned downgrade on one large U.S. Federal maintenance renewal in the
first quarter of 2020. We define our maintenance renewal rate as the sales of
maintenance services for all existing maintenance contracts expiring in a
period, divided by the sum previous sales of maintenance services corresponding
to those services expiring in the current period. Sales of maintenance services
includes sales of maintenance renewals for a previously purchased product and
the amount allocated to maintenance revenue from a license purchase.
License Revenue
License revenue decreased $10.8 million , or 8.9% primarily due to decreased
sales of our licensed products resulting from the difficult economic environment
during the second and third quarters of 2020 as a result of the global recession
caused by COVID-19 and, to a lesser extent, the effect of the weakening of most
foreign currencies relative to the U.S. dollar.
Cost of Revenue
Nine
Months Ended
2020 2019
Percentage of Percentage of
Amount Revenue Amount Revenue Change
(in thousands, except percentages)
Cost of recurring revenue $ 67,807 9.0 % $ 58,159 8.5 % $ 9,648
Amortization of acquired technologies 134,789 17.9 131,961 19.3 2,828
Total cost of revenue $ 202,596 26.9 % $ 190,120 27.8 % $ 12,476
Total cost of revenue increased in the nine months ended September 30, 2020
compared to the nine months ended September 30, 2019 primarily due to increases
in public cloud infrastructure and hosting fees related to our subscription
products of $4.8 million , personnel costs to support new customers and
additional product offerings of $2.9 million , which includes a $0.6 million
increase in stock-based compensation expense, and depreciation and other
amortization of $2.4 million . The increase in amortization of acquired
technologies is primarily related to intangibles acquired through the
acquisitions of Samanage and VividCortex in 2019. Amortization of acquired
technologies includes $122.8 million and $122.7 million of amortization related
to the Take Private for the nine months ended September 30, 2020 and 2019,
respectively.
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Operating Expenses
Nine Months Ended September 30,
2020 2019
Percentage of Percentage of
Amount Revenue Amount Revenue Change
(in thousands, except percentages)
Sales and marketing $ 216,550 28.7 % $ 193,698 28.3 % $ 22,852
Research and development 93,878 12.5 82,468 12.0 11,410
General and administrative 87,780 11.6 72,382 10.6 15,398
Amortization of acquired intangibles 55,214 7.3 51,818 7.6 3,396
Total operating expenses $ 453,422 60.1 % $ 400,366 58.4 % $ 53,056
Sales and Marketing. Sales and marketing expenses increased $22.9 million , or
11.8%, primarily due to increases in personnel costs of $19.7 million , which
includes an increase of $6.8 million in stock-based compensation expense, and
marketing program costs of $5.5 million . These increases were partially offset
by reductions in travel and acquisition related costs of $3.6 million . We
increased our sales and marketing employee headcount and marketing program costs
to support the growth in the business and through the acquisitions of Samanage
and VividCortex in 2019.
Research and Development. Research and development expenses increased $11.4
million , or 13.8%, primarily due to an increase in personnel costs of $12.6
million , which includes an increase of $5.4 million in stock-based compensation
expense, partially offset by a reduction in travel and acquisition related costs
of $1.1 million . The increase in our research and development personnel costs is
primarily due to increased employee headcount to expedite delivery of product
enhancements and new product offerings to our customers and through the
acquisitions of Samanage and VividCortex .
General and Administrative. General and administrative expenses increased $15.4
million , or 21.3%, primarily due to a $14.2 million increase in personnel costs,
which includes an increase of $9.5 million in stock-based compensation expense,
a $2.5 million increase in costs related to the exploration of a potential
spin-off of our MSP business and a $1.1 million increase in our provision for
losses on accounts receivables. These increases were partially offset by
decreases in offering and travel costs of $1.8 million and restructuring costs
of $1.0 million . The increase in our provision for losses on accounts
receivables is primarily related to a settlement with a distributor, from
customers acquired in recent acquisitions and customers potentially impacted by
the current economic uncertainty resulting from the COVID-19 pandemic.
Amortization of Acquired Intangibles. Amortization of acquired intangibles
increased $3.4 million , or 6.6%, primarily due to amortization related to the
Samanage and VividCortex acquisitions completed in 2019. Amortization of
intangible assets includes $35.5 million and $35.6 million of amortization
related to the Take Private for the nine months ended September 30, 2020 and
2019, respectively, with the remaining balance related primarily to the LOGICnow
acquisition in May 2016 .
Interest Expense, Net
Nine Months Ended
2020 2019
Percentage of Percentage of
Amount Revenue Amount Revenue Change
(in thousands, except percentages)
Interest expense, net $ (59,200) (7.9) % $ (82,977) (12.1) % $ 23,777
Interest expense, net decreased by $23.8 million , or 28.7%, in the nine months
ended September 30, 2020 compared to the nine months ended September 30, 2019 .
The decrease in interest expense is primarily due to decreases in interest rates
on our debt and the reduction in our outstanding debt balance related to
quarterly principal repayments. The weighted-average effective interest rate on
our debt for the nine months ended September 30, 2020 was 3.53% compared to
5.15% for the nine months ended September 30, 2019 . See Note 5. Debt in the
Notes to Condensed Consolidated Financial Statements included in Item 1 of Part
I of this Quarterly Report on Form 10-Q for additional information regarding our
debt.
26
--------------------------------------------------------------------------------Other Income (Expense), Net
Nine Months Ended
2020 2019
Percentage of Percentage of
Amount Revenue Amount Revenue Change
(inthousands, except percentages)
Other income (expense), net$ (942) (0.1) %$ 506 0.1 %$ (1,448) Other income (expense), net decreased by$1.4 million in the nine months endedSeptember 30, 2020 compared to the nine months endedSeptember 30, 2019 primarily due to the impact of changes in foreign currency exchange rates related to various accounts for the period. Income Tax Expense Nine Months Ended September 30, 2020 2019 Percentage of Percentage of Amount Revenue Amount Revenue Change (in thousands, except percentages) Income before income taxes$ 37,787 5.0 %$ 12,073 1.8 %$ 25,714 Income tax expense 12,025 1.6 6,654 1.0 5,371 Effective tax rate 31.8 % 55.1 % (23.3) % Our income tax expense for the nine months endedSeptember 30, 2020 increased by$5.4 million as compared to the nine months endedSeptember 30, 2019 . The effective tax rate decreased to 31.8% for the period primarily due to an increase in income before income taxes and the impact of having a full valuation allowance against the deferred tax assets related to the current period losses related to the entities acquired in theSamanage acquisition completed inApril 2019 . For additional discussion about our income taxes, see Note 7. Income Taxes in the Notes to Condensed Consolidated Financial Statements included in Item 1 of Part I of this Quarterly Report on Form 10-Q. Non-GAAP Financial Measures In addition to financial measures prepared in accordance with GAAP, we use certain non-GAAP financial measures to clarify and enhance our understanding, and aid in the period-to-period comparison, of our performance. We believe that these non-GAAP financial measures provide supplemental information that is meaningful when assessing our operating performance because they exclude the impact of certain amounts that our management and board of directors do not consider part of core operating results when assessing our operational performance, allocating resources, preparing annual budgets and determining compensation. Accordingly, these non-GAAP financial measures may provide insight to investors into the motivation and decision-making of management in operating the business. Investors are encouraged to review the reconciliation of each of these non-GAAP financial measures to its most comparable GAAP financial measure included below. While we believe that these non-GAAP financial measures provide useful supplemental information, non-GAAP financial measures have limitations and should not be considered in isolation from, or as a substitute for, their most comparable GAAP measures. These non-GAAP financial measures are not prepared in accordance with GAAP, do not reflect a comprehensive system of accounting and may not be comparable to similarly titled measures of other companies due to potential differences in their financing and accounting methods, the book value of their assets, their capital structures, the method by which their assets were acquired and the manner in which they define non-GAAP measures. Items such as the amortization of intangible assets, stock-based compensation expense and related employer-paid payroll taxes, acquisition related adjustments, costs related to the exploration of a potential spin-off of our MSP business and restructuring costs, as well as the related tax impacts of these items can have a material impact on our GAAP financial results. 27 -------------------------------------------------------------------------------- Non-GAAP Revenue We define non-GAAP subscription revenue, non-GAAP maintenance revenue, non-GAAP license revenue and non-GAAP total revenue, as subscription revenue, maintenance revenue, license revenue and total revenue, respectively, excluding the impact of purchase accounting from our acquisitions. We monitor these measures to assess our performance because we believe our revenue growth rates would be overstated without these adjustments. We believe presenting non-GAAP subscription revenue, non-GAAP maintenance revenue, non-GAAP license revenue and non-GAAP total revenue aids in the comparability between periods and in assessing our overall operating performance. Nine Months Ended Three Months Ended September 30, September 30, 2020 2019 2020 2019 (in thousands) Revenue: GAAP subscription revenue$ 100,564 $ 83,122 $ 290,039 $ 233,467 Impact of purchase accounting 293 2,215 2,366 4,034 Non-GAAP subscription revenue 100,857 85,337 292,405 237,501 GAAP maintenance revenue 121,134 113,755 353,981 330,840 Impact of purchase accounting - - - - Non-GAAP maintenance revenue 121,134 113,755 353,981 330,840 GAAP total recurring revenue 221,698 196,877 644,020 564,307 Impact of purchase accounting 293 2,215 2,366 4,034 Non-GAAP total recurring revenue 221,991 199,092 646,386 568,341 GAAP license revenue 39,284 43,613 109,927 120,723 Impact of purchase accounting - - - - Non-GAAP license revenue 39,284 43,613 109,927 120,723 Total GAAP revenue$ 260,982 $ 240,490 $ 753,947 $ 685,030 Impact of purchase accounting$ 293 $ 2,215 $ 2,366 $ 4,034 Total non-GAAP revenue$ 261,275 $ 242,705 $ 756,313 $ 689,064 Non-GAAP Operating Income and Non-GAAP Operating Margin We provide non-GAAP operating income and related non-GAAP margin using non-GAAP revenue as discussed above and excluding such items as the write-down of deferred revenue related to purchase accounting, amortization of acquired intangible assets, stock-based compensation expense and related employer-paid payroll taxes, acquisition and other costs, spin-off exploration costs and restructuring costs. Management believes these measures are useful for the following reasons: •Amortization of Acquired Intangible Assets. We provide non-GAAP information that excludes expenses related to purchased intangible assets associated with our acquisitions. We believe that eliminating this expense from our non-GAAP measures is useful to investors, because the amortization of acquired intangible assets can be inconsistent in amount and frequency and is significantly impacted by the timing and magnitude of our acquisition transactions, which also vary in frequency from period to period. Accordingly, we analyze the performance of our operations in each period without regard to such expenses. •Stock-Based Compensation Expense and Related Employer-Paid Payroll Taxes. We provide non-GAAP information that excludes expenses related to stock-based compensation and related employer-paid payroll taxes. We believe that the exclusion of stock-based compensation expense provides for a better comparison of our operating results to prior periods and to our peer companies as the calculations of stock-based compensation vary from period to period and company to company due to different valuation methodologies, subjective assumptions and the variety of award types. Employer-paid payroll taxes on stock-based compensation is dependent on our stock price and the timing of the taxable events related to the equity awards, over which our management has little control, and does not correlate to the core operation of our business. Because of these unique characteristics of stock-based compensation and related employer-paid payroll taxes, management excludes these expenses when analyzing the organization's business performance. •Acquisition and Other Costs. We exclude certain expense items resulting from the Take Private and other acquisitions, such as legal, accounting and advisory fees, changes in fair value of contingent consideration, costs related to 28 -------------------------------------------------------------------------------- integrating the acquired businesses, deferred compensation, severance and retention expense. In addition, we exclude certain other costs including expense related to our offerings. We consider these adjustments, to some extent, to be unpredictable and dependent on a significant number of factors that are outside of our control. Furthermore, acquisitions result in operating expenses that would not otherwise have been incurred by us in the normal course of our organic business operations. We believe that providing these non-GAAP measures that exclude acquisition and other costs, allows users of our financial statements to better review and understand the historical and current results of our continuing operations, and also facilitates comparisons to our historical results and results of less acquisitive peer companies, both with and without such adjustments. •Spin-off Exploration Costs. We exclude certain expense items resulting from the exploration of a potential spin-off transaction of our MSP business into a newly created and separately traded public company. These costs include legal, accounting and advisory fees, implementation and integration costs, duplicative costs for subscriptions and information technology systems, employee and contractor costs and other incremental separation costs related to the potential spin-off of the MSP business. The potential MSP spin-off transaction results in operating expenses that would not otherwise have been incurred by us in the normal course of our organic business operations. We believe that providing non-GAAP measures that exclude these costs facilitates a more meaningful evaluation of our operating performance and comparisons to our past operating performance. •Restructuring Costs. We provide non-GAAP information that excludes restructuring costs such as severance and the estimated costs of exiting and terminating facility lease commitments, as they relate to our corporate restructuring and exit activities and costs related to the separation of employment with executives of the Company. These costs are inconsistent in amount and are significantly impacted by the timing and nature of these events. Therefore, although we may incur these types of expenses in the future, we believe that eliminating these costs for purposes of calculating the non-GAAP financial measures facilitates a more meaningful evaluation of our operating performance and comparisons to our past operating performance. Nine Months Ended Three Months Ended September 30, September 30, 2020 2019 2020 2019 (in thousands, except margin data) GAAP operating income$ 35,105 $ 34,419 $ 97,929 $ 94,544 Impact of purchase accounting 293 2,215 2,366 4,034 Stock-based compensation expense and related employer-paid payroll taxes 21,867 8,889 46,502 24,147 Amortization of acquired technologies 45,463 44,172 134,789 131,961 Amortization of acquired intangibles 18,624 18,015 55,214 51,818 Acquisition and other costs 1,176 1,700 3,997 7,457 Spin-off exploration costs 2,632 - 2,632 - Restructuring costs 2,155 1,586 2,368 3,982 Non-GAAP operating income$ 127,315 $ 110,996 $ 345,797 $ 317,943 GAAP operating margin 13.5 % 14.3 % 13.0 % 13.8 % Non-GAAP operating margin 48.7 % 45.7 % 45.7 % 46.1 % Adjusted EBITDA and Adjusted EBITDA Margin We regularly monitor adjusted EBITDA and adjusted EBITDA margin, as it is a measure we use to assess our operating performance. We define adjusted EBITDA as net income or loss, excluding the impact of purchase accounting on total revenue, amortization of acquired intangible assets and developed technology, depreciation expense, stock-based compensation expense and related employer-paid payroll taxes, restructuring costs, acquisition and other costs, spin-off exploration costs, interest expense, net, debt related costs including fees related to our credit agreements, debt extinguishment and refinancing costs, unrealized foreign currency (gains) losses, and income tax expense (benefit). We define adjusted EBITDA margin as adjusted EBITDA divided by non-GAAP revenue. Adjusted EBITDA has limitations as an analytical tool, and you should not consider it in isolation or as a substitute for analysis of our results as reported under GAAP. Some of these limitations are: although depreciation and amortization are non-cash charges, the assets being depreciated and amortized may have to be replaced in the future, and adjusted EBITDA does not reflect cash capital expenditure requirements for such replacements or for new capital expenditure requirements; adjusted EBITDA excludes the impact of the write-down of deferred revenue due to purchase accounting in connection with our acquisitions, and therefore includes revenue that will never be recognized under GAAP; 29 -------------------------------------------------------------------------------- adjusted EBITDA does not reflect changes in, or cash requirements for, our working capital needs; adjusted EBITDA does not reflect the significant interest expense, or the cash requirements necessary to service interest or principal payments, on our debt; adjusted EBITDA does not reflect tax payments that may represent a reduction in cash available to us; and other companies, including companies in our industry, may calculate adjusted EBITDA differently, which reduces its usefulness as a comparative measure. Because of these limitations, you should consider adjusted EBITDA alongside other financial performance measures, including net income (loss) and our other GAAP results. In evaluating adjusted EBITDA, you should be aware that in the future we may incur expenses that are the same as or similar to some of the adjustments in this presentation. Our presentation of adjusted EBITDA should not be construed as an inference that our future results will be unaffected by the types of items excluded from the calculation of adjusted EBITDA. Adjusted EBITDA is not a presentation made in accordance with GAAP and the use of the term varies from others in our industry. Nine Months Ended Three Months Ended September 30, September 30, 2020 2019 2020 2019 (in thousands, except margin data) Net income$ 12,502
69,510 66,647 205,525 196,687
Income tax expense 5,264 2,895 12,025 6,654
Interest expense, net 16,792 27,418 59,200 82,977
Impact of purchase accounting on total revenue 293 2,215 2,366 4,034
Unrealized foreign currency (gains) losses 370 (807) 2,009 (907)
Acquisition and other costs 1,176 1,700 3,997 7,457
Spin-off exploration costs 2,632 - 2,632 -
Debt related costs 90 94 274 290
Stock-based compensation expense and related
employer-paid payroll taxes 21,867 8,889 46,502 24,147
Restructuring costs 2,155 1,586 2,368 3,982
Adjusted EBITDA $ 132,651 $ 115,030 $ 362,660 $ 330,740
Adjusted EBITDA margin 50.8 % 47.4 % 48.0 % 48.0 %
Liquidity and Capital Resources
Cash and cash equivalents were $425.0 million as of September 30, 2020 . Our
international subsidiaries held approximately $207.5 million of cash and cash
equivalents, of which 58.7% were held in Euros. We intend either to invest our
foreign earnings permanently in foreign operations or to remit these earnings to
our U.S. entities in a tax-free manner with the exception for immaterial state
income taxes. The Tax Act imposed a mandatory transition tax on accumulated
foreign earnings and eliminates U.S. federal income taxes on foreign subsidiary
distribution.
Our primary source of cash for funding operations and growth has been through
cash provided by operating activities. Given the uncertainty in the rapidly
changing market and economic conditions related to the COVID-19 pandemic, we
continue to evaluate the nature and extent of the impact to our business and
financial position. However, despite this uncertainty, we believe that our
existing cash and cash equivalents, our cash flows from operating activities and
our borrowing capacity under our credit facilities will be sufficient to fund
our operations, fund required debt repayments and meet our commitments for
capital expenditures for at least the next 12 months.
Although we are not currently a party to any material definitive agreement
regarding potential investments in, or acquisitions of, complementary
businesses, applications or technologies, we may enter into these types of
arrangements, which could reduce our cash and cash equivalents, require us to
seek additional equity or debt financing or repatriate cash generated by our
international operations that could cause us to incur withholding taxes on any
distributions. Additional funds from financing arrangements may not be available
on terms favorable to us or at all.
Indebtedness
As of September 30, 2020 , our total indebtedness was $1.9 billion , with up
to $125.0 million of available borrowings under our revolving credit facility.
See Note 5. Debt in the Notes to Condensed Consolidated Financial Statements
included in Item 1 of Part I of this Quarterly Report on Form 10-Q for
additional information regarding our debt.
30--------------------------------------------------------------------------------
First Lien Credit Agreement The First Lien Credit Agreement, as amended, provides for a senior secured revolving credit facility in an aggregate principal amount of$125.0 million , or the Revolving Credit Facility, consisting of a$25.0 million U.S. dollar revolving credit facility, or theU.S. Dollar Revolver, and a$100.0 million multicurrency revolving credit facility, or the Multicurrency Revolver. The Revolving Credit Facility includes a$35.0 million sublimit for the issuance of letters of credit. The First Lien Credit Agreement also contains a term loan facility (which we refer to as the First Lien Term Loan, and together with the Revolving Credit Facility, as the First Lien Credit Facilities) in an original aggregate principal amount of$1,990.0 million . The First Lien Credit Agreement provides us the right to request additional commitments for new incremental term loans and revolving loans, in an aggregate principal amount not to exceed (a) the greater of (i)$400.0 million and (ii) 100% of our consolidated EBITDA, as defined in the FirstLien Credit Agreement (calculated on a pro forma basis), for the most recent four fiscal quarter period, or the First Lien Fixed Basket, plus (b) the amount of certain voluntary prepayments of the First Lien Credit Facilities, plus (c) an unlimited amount subject to pro forma compliance with a first lien net leverage ratio not to exceed 4.75 to 1.00. Under theU.S. Dollar Revolver,$7.5 million of commitments will mature onFebruary 5, 2021 , and$17.5 million along with all commitments under the Multicurrency Revolver will mature onFebruary 5, 2022 . The First Lien Term Loan will mature onFebruary 5, 2024 . The First Lien Term Loan requires equal quarterly repayments equal to 0.25% of the original principal amount. Summary of Cash Flows Summarized cash flow information is as follows:
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