Q3 2020 SolarWinds Corp Earnings Call
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At this time all participants are in listen only mode. After the speakers presentation, there will be a question and answer session.
I ask a question during the session you will need to press star one of your telephone please.
Please be advised that todays conference is being recorded if you require any further assistance. Please press star zero I would now like to hand, the converts over to your speaker today, Howard Machek Senior director of Investor Relations. Thank you. Please go ahead.
Thank you operator, good afternoon, everyone and welcome to celebrate this third quarter 2020 earnings call with me today are Kevin Thompson, our president and CEO, our Kalamazoo, VP and Chief Financial Officer, and John color, you can give me Pete and president of our MSP business.
My prepared remarks, we'll have a brief question and answer session. This call is being simultaneously webcast on our Investor Relations website at Investor stop someone wins dot com.
Investor Relations Web site you can also find our earnings press release, and a 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.
The impact of the global economic environment on our business.
Due to the potential spin off of our MSP business. These statements are based on currently available information and assumptions, we undertake no duty to update this information except as required by law.
These statements are also subject to a number of risks and uncertainties, including the numerous risks related to the potential spin off of our MSP business into a newly created in I've been separately traded public company.
All information considering these concerning these statements and the risks and uncertainties associated with them.
Is highlighted in today's earnings release and in our filings with the FCC copies are available from the FCC runner Investor Relations website. Furthermore, we will discuss various non-GAAP financial measures on today's call unless otherwise specified we refer to these financial measures will be referring to the non-GAAP financial measures reconciliation of the differences between GAAP and non-GAAP EPS.
National measures that gets discussed on today's call are available in our earnings press release in summary, slide deck on the Investor Relations page of our website and with that I'll now turn the call over to Kevin.
Howard I'm pleased to report that we were able to deliver strong performance in the third quarter.
The high end of our outlook for total revenue and EBITDA. In addition to delivering solid year over year top line growth of 8% the thing to what it continued to be volatile and uncertain economic environment.
Total non-GAAP revenue for the third quarter, which was driven by improved sales to new customers over the second quarter and solid customer retention rate was approximately $261 million. In addition, we delivered an exceptional quarter profitability generating you're probably talking about $133 million in adjusted EBITDA meaningfully.
The high end of our outlook and reflecting a 51% adjusted EBITDA margin, which is the highest level non-GAAP profitability. We have delivered in the last 11 quarters.
As we saw in the second quarter the volatility of the economic environment has resulted in a business rhythm there's less linear than our historical average. However, we did see signs of improvement in linearity and stabilization of performance.
Third quarter across selected geographies in areas of the market compared to the second quarter.
From a geographic region perspective, the third quarter, we told the most meaningful improvement in performance in EMEA, followed by North American.
We had several operational highlights in the third quarter that I want to briefly mention.
First as you can remember you should remember in late April we launched subscription pricing options for each of the key offerings in our Rhine family Network systems and database management products.
And we had a good initial quarters subscription sales of these products in the second quarter.
Momentum continued into the third quarter, we think sequential doubling the dollar amount of subscription so the problem.
We currently believe we will see another strong quarter of sequential growth in subscription sale are there Ryan product family in the fourth quarter.
Second we were able to drive solid <unk> growth in the third quarter with total air are reaching approximately $187 million as of September 32020, reflecting year over year growth of 11%.
Griffin AOR grew at a meaningfully faster rate in the 20%, reaching 400 and $411 million at the end of the quarter.
Third we continue to see solid growth in the number of our large customer relationship despite the difficult economic environment.
They'll trade of a number of customers who spend over $100000 with us on a trailing 12 month basis.
Everything on a year over year basis by 17% to 1004 customers.
And finally customer retention rates across our product portfolio remain strong maintenance renewal rates of 92% of the third quarter and subscription deprecates rates stable at 105%.
A lot of thought they won't cover before turning the call over to Bart is of a more strategic nature related to our database management product portfolio.
As I indicated on several occasions over the last year, we believe that database management and operations in the large market opportunity for solar when that's.
This opportunity is being driven by digital transformation and the move to hybrid cloud infrastructure and the recognition by database administrators as well and then watched froze the need for greater visibility, we're observing ability and the performance of the critical applications upon which the business for a while.
In order to get a complete view about application performance visibility in the database performance is required.
We moved into the database management market in 2013 have created a meaningful presence in this market for solar wind during the last several years seven years over.
Over the last year, we've been investing in broadening our capabilities to monitor and manage the performance and databases all time.
Including the historical Oracle Artful sequel, My if you will traditional databases as well the near near databases, such as Mongodb, Sandra Ryan and Microsoft Azure sequel to name a few.
This increased investment they make management starting with the acquisition of heavy cortex. In December 2019, a leading cloud based provider of database performance management technology, which brought us the ability to manage many of the cloud native databases, which we made it today as well the ability to provide these management services from the cloud.
And I'd say most of you saw on last Friday after market close we announced that we have continued to build on these capabilities through the planned acquisition of temporary one a leading technology provider of database performance monitoring and they operate in solutions for Microsoft sequel server market Baggers sequel, and the actual data platform for cash.
Purchase price of approximately $142 million.
It's Henry one offerings complement and broaden the on premise native cloud and hybrid database management offerings that we currently have but are a great fit with our product portfolio.
I want to take this opportunity to welcome everyone team to the Delaware family. We are excited about the expertise that you bring this fast growth parts of our business.
We believe after this acquisition closes which is expected to occur. This week, we will provide the broadest deepest level of database monitoring and management coverage and the on premise, how black tea and native cloud infrastructure and application management market.
With that I will turn the call over to Mark will provide some additional details on our third quarter performance as well as our outlook for the fourth quarter and full year.
Thanks, Kevin and thanks, again to everyone joining us on todays call. The third quarter was solid across our key performance metrics, given the volatility and the current economic environment and reflected a second sequential improvement from the second quarter.
The combination of our uniquely high level of profitability and focused on conversion of adjusted EBITDA to free cash flow continue to pay dividends in the third quarter as our total cash balance reached $425 million at September 30.
As compared to $173 million at December 31, reflecting an increase of over $250 million. Our net leverage has consistently declined over the first nine months of 2020 and is now at 3.1 times, our trailing 12 month adjusted EBITDA.
Moving onto our financial results, we had a very strong quarter of profitability as Kevin said in the third quarter.
Adjusted EBITDA was $132.7 million, reflecting year over year growth of 15% and was nearly $11 million better than the high end of our outlook for the third quarter.
The sequential increase of approximately three percentage points of adjusted EBITDA or adjusted EBITDA margin from the second quarter and six percentage points compared to the first quarter was driven by continued disciplined expense management across our global business.
Lower than planned variable sales and marketing expenses.
Lower head count numbers than planned as a result of a slowdown in hiring due to the pandemic.
And strong cash collection activity, which resulted in minimal bad debt expense.
We do not expect adjusted EBITDA margins to remain quite as high a level in the fourth quarter. As we are planning to Reaccelerate, our go to market spending and hiring across the business as economic activity improves.
We drove approximately $108 million in Unlevered free cash flow in the third quarter, which puts our unlevered free cash flow for the nine months ended September thirtyth.
At 312 million and reflects a year to date conversion rate of 86%.
Conversion rate declined sequentially compared to the second quarter, primarily as a result of us federal income tax payments totaling $24 million, which were made in the third quarter.
Earnings per share on a non-GAAP basis for the third quarter totaled 28 cents per share based on 316.7 million fully diluted shares outstanding.
Switching over to revenue for the quarter total non-GAAP revenue was $261.3 million, which was an increase of 8% compared to the prior year and above the outlook that we provided for the third quarter of $254 million to $259 million and total non-GAAP revenue.
Total non-GAAP license and maintenance revenue in the third quarter grew by 2% year over year, reaching $160.4 million on a reported basis.
This growth was led by non-GAAP maintenance revenue, which increased by approximately 7% reaching $121.1 million.
Non-GAAP license revenue in the third quarter totaled $39.3 million, reflecting a year over year decrease of approximately 10%.
Our license sales performance was a meaningful improvement from the second quarter. When you adjust for the subscription sales of our on premise based product.
License revenue would have been down only 5% on a year over year basis for the third quarter.
We expect the economic environment in the fourth quarter to be similar to that in the third quarter and as a result, we do continue to expect some year over year decline in license revenue in the fourth quarter.
In addition, Orion product portfolio subscription sales are expected to be a headwind to license revenue growth of approximately four percentage points in the fourth quarter.
During the third quarter, 85% of our total revenue was recurring and recognize as either maintenance or subscription revenue.
Total non-GAAP recurring revenue for the third quarter grew at 12%, reaching $222 million third quarter recurring revenue growth was led by non-GAAP subscription revenue of 101 $101 million, which grew 18% year over year and was approximately $100 million on a constant currency basis.
Reflecting year over year growth of 17%.
As we have communicated in the past well over 50% of our subscription revenue is attributable to our MSP business.
As we explore the potential spin off of this business, we want to give John how are you guys, who has led our MSP business over the last four and a half years and Hewlett assumed the CEO role of a standalone and see if the spin off is completed and opportunity to give more context around the 2020 operating trends of our MSP business I will now turn the call over.
Hey, John.
Thanks, Mark up.
Up in the next few minutes discussing our Q3 and year to date performance and key trends in the industry.
I believe most of the research analysts and investors on this call are familiar with our MSP business.
Those listeners who are less familiar.
Our MSP business refers to our technology platform and purely software based solution that we provide to msps.
Msps or managed service providers are critical type of IP service provider.
Assumed responsibility for managing and protecting customers I'd system and services.
And in many cases app as outsourced IP Department remained the businesses around the world.
These msps use our technology to manage the environments of over 500000 small and medium sized businesses in all parts of the world monitoring.
Managing and securing your customers' devices and applications as well as managing disparate and user environments through a centralized dashboard.
But by nature of our business, we operate behind the scenes of our MSP partners.
And as part of a larger solutions pattern, we've thrived under relative obscurity to those outside.
Outside of the industry market.
We currently expect our EMS business generate slightly over 300 million of non-GAAP revenue in 2020 of which half about about half of which is outside of the U.S. and.
And we've done this we believe our best in class gross margin and profit margin for cloud based business driven by our efficient operating model.
We've been growing at a CAGR of 16% on a constant currency basis in the first quarter of 2018 and year to date 2020, growing non-GAAP revenue, 15% on a constant currency basis and 12% in the third quarter.
While we saw a slight deceleration in our MSP business as a result of Koby 19.
Our most recent trends indicate to the MLP market is beginning to accelerate.
Notably where our growth in the third quarter was a couple of percentage points higher than our MSP business revenue growth.
In addition, despite.
Despite the difficult economic environment, our net retention rates have held up well remained at approximately 107% on a trailing 12 month basis.
On a reported and constant currency.
However, due to the deceleration we start our MSP business in the second quarter.
We expect net retention rate to drop slightly in the fourth quarter before beginning to improve in early 2021.
Now I'll turn it back to Martin to take you through our total company outlook for the fourth quarter and the full year.
Thanks, John before I get into the details of our outlet as Kevin talked about we recently signed a definitive agreement to acquire century one.
Century, one fits the profile of companies that are core IC management business will focus on acquiring in the future.
We expect our GAAP revenue to be in the mid $20 million range in 2020 with a growth rate in the low double digits, which was impacted by the headwinds from the economic slowdown caused by the pandemic.
However, we expect their total revenue growth to accelerate in 2021 compared to their 2020 forecasted results and over the long term. We believe this acquisition will not be dilutive to our consolidated adjusted EBITDA margin.
We expect essentially one to close this week and it contributed approximately $2 million of GAAP revenue in the fourth quarter, which reflects the impact on revenue of the adjustment to reduce the beginning deferred revenue balance required by purchase accounting and to be approximately breakeven on a GAAP basis for the fourth quarter.
Turning to turning to our outlook and a quick reminder, our outlook assumes a euro to us the exchange rate of 1.17, and a British pound to us the exchange rate of 1.30.
For the fourth quarter and 2020 on a non-GAAP basis, we are increasing our outlook due primarily to the century, one acquisition and now expect total fourth quarter revenue to be in the range of $261 million to $266 million, representing a year over year growth of approximately 5% to 7% on a reported basis.
This fourth quarter outlook assumes a maintenance renewal rate in the 92% to 93% range and a consolidated fourth quarter net retention rate of approximately 104% on a trailing 12 month basis.
We are also increasing our fourth quarter adjusted EBITDA outlook, and now expect the range of $123 million to $126 million for the fourth quarter or an adjusted EBITDA margin of 47.4 at the midpoint, which result in earnings per share of approximately 25 cents per share for the fourth quarter, assuming a weighted.
Average number of shares outstanding of approximately 317.5 million shares.
Earnings per share guidance assumes a non-GAAP effective tax rate for the fourth quarter of 2020 of approximately 20% to 22%.
Based on our results for the third quarter and our outlook for the fourth quarter, we are raising our outlook for the total non-GAAP revenue and adjusted EBITDA for the full year 2020 as follows.
For the full year December 31, 2020 on a non-GAAP basis, we are increasing our outlook for total net total revenue as a result of the revenue beat in the third quarter and the century, one acquisition and now expect total revenue to be in the range of.
Billion, Okay, 17 to a billion, though 22, representing year over year growth of 8% to 9% on a reported and constant currency basis.
The full year revenue outlook that maintenance renewal rate and a 92% to 93% range any subscription net retention in the range of 103% to 104%.
We are also raising our adjusted EBITDA for the full year to a range of 486 to 489 million, which resulted in earnings per share of 98 cents per share for the full year, assuming 315.5 million shares outstanding on a weighted average basis.
Our earnings per share guidance assumes a non-GAAP effective tax rate for the full year of 2020 will be approximately 22%.
With that ill now turn the call back over to Kevin Thanks, Mark.
You can see from our third quarter results and our fourth quarter and full year outlook.
Our confidence in our ability to deliver continued growth. Despite the difficult economic environment has increased as we've moved through the last two quarters.
The first nine months of 2020, we have been focused on taking market share in our key markets.
Based on International data Corporation worldwide semi annual software tracker for the first half of 2020, we successfully increased our industry leading position in the network management market level, two full percentage points to 22.9% market share.
We believe we can further increase our market share over the next several quarters and not only the number management market and in all the key markets, where we compete today by leveraging our strong product portfolio and disrupt the go to market approach as CIO in MSP business owners look to reduce expenses, while increasing the level of performance and availability of infrastructure and application.
For which they are responsible.
We also believe based on the trends in our business several of which are generally discuss in their remarks.
Small and medium sized business market, which has been remarkably resilient. So far in this economic downturn is beginning to show signs of acceleration.
We expect to continue through the fourth quarter and into 2021.
Addition, and our core IP management business, we are seeing stable and improving spending trends from our enterprise customers as evidenced by the continued double digit growth in the number of our large customer relationship.
Now I want to provide an update on the strategic process, which our board previously authorized and we disclosed our second quarter call to explore a potential spin off of our MSP business into a newly created and separately traded public company.
Based on the additional work we have done over the last 90 days, we continue to believe in the rationale for the separation from strategic operational business growth and value creation perspective, as a separation of the MSP business from solar wind will create two independent companies that are both market leaders each.
Each focused on their different businesses customers and strategic initiatives.
Addition, each business would have the freedom to develop investment planned unique to the dynamic the maturity of the markets, which they serve.
Under the direction and oversight of our board of directors over the last three months, we've been reviewing the businesses.
Related considerations in depth in developing detailed plans to separate the two businesses in a separately traded public company.
Based on the work done today. It is our intent to proceed forward with the separation process, although the structure and timing of the transaction still must be finalized.
We expect that the spin off the MSP business may receive final approval by our board of directors what occurred during the first half of 2021.
However, there are still a number of legal organizational and operational items that must be accomplished over the coming months to finalize a definitive proposal for final separation for approval by our board of directors.
Well I thought ever which I'll provide an update on the status of the CEO search for silhouette.
First as a reminder, John Kelly you can do is on this call will be the CEO MSP business should the spinoff transaction to be completed.
Therefore, we are currently searching for a CEO to lead the core I'd management business.
We have engaged an outside executive search firm to lead the search and they have presented a number of qualified interested candidates to the search committee of our board of directors.
Committee has interviewed several candidates and believe that the pool of interested candidates the high quality.
Based on the quality of the candidates that have been interviewed thus far we hope to be able to complete the search process in a relatively short period of time.
Given that this may well be the last earning call, which I will lead to the CEO follow it for.
For me on the call we've known each other for my entire 14, and a half year tenure and solo and cumbersome. We even go all the way back to my days at Red hat for those in this group has been an amazing how fast two decades goodbye.
I appreciate the level of your engagement and interest in the solo in story over the last decade and I do believe we have created a very unique software company in solar with.
I Hope you will continue to be engaged to someone story in the years to come.
Certainly we'll run into each other again in the future is that it's still a small technology world.
Approximately 3300 deliveries around the world I will Miss the way you are constantly constantly challenged me I'll Miss your energy your enthusiasm and your ability to constantly pick yourself up.
Back in the game when things do not go exactly the way we wanted them to be.
Thank you for believing we built a great company on the foundation of Great products digital marketing and selling from the inside model when very few others believed it was possible cable.
Okay, believing there's still a lot of special things left to accomplish and solar when we are still the best story and software with that Barton I will open up the call for questions.
As a reminder to ask a question you will need to press star one on your telephone to withdraw your question press the pound key.
And your first question comes from a line of Brad Zelnick from Credit Suisse. Your line is open.
Fantastic. Thank you so much and Kevin.
Your party words to that that you just left us with I mean, it sounds like the odds of you being on the next call are pretty slim in which case.
If we don't connect publicly in this kind of forum I must say congrats on a phenomenal run.
You've really been a standout leader.
Only for solar winds, but but amongst all the companies we cover so thanks, Brian I true I truly wish you the best maybe just to the business if I could ask you Bart.
Great to see the the license trajectory improve temper.
10% down this quarter better than what than where you were last quarter and I totally understand there is some impact from the shift to on Prem subscription.
You've called out can you just remind us what portion of the on Prem offering is available as a subscription.
Is that going to change over time and grow to encompass all the offerings and even beyond Q4, I heard your comments, but as we think about just on trend what that license growth rate should be and what the trade off is how should we how should we even wrap our minds around that.
So yes, as you said right. We had a we had a really solid quarter from a license revenue perspective, and a noticeable improvement from what we saw in the second quarter. This.
Subscription pricing that we rolled out in April covers all of our key products. So if I'm looking at it as a percentage of revenue I haven't calculated it but it would be a very significant majority probably over 80, 85% of our total license quote license revenue products are now offered under a subscription basis. So.
That's the shift that we're looking at like like we've said before it's a transition for us we're not looking to move our existing customers also maintenance they still have a lower price on their maintenance than they would under subscription it's really centered around giving new new buyers the alternative to buy under a subscription agreement and is it really.
Just to kind of trend as we look at the fourth quarter, what we're assuming right now Brad is that the trend in that part of the business in the fourth quarter, a pretty consistent with what we saw.
In the third quarter, which is we had strength in certain markets EMEA was very good in the third quarter North America, including the.
Impact of selling in the state local and federal government was solid in the third quarter.
Some of the other markets were not quite as stable yet.
I mean, we will see that same variability in the fourth quarter and that the kind of the economic environment the level of spending or 90 perspective, particularly in on premise environments, where were really strong will be consistent in the fourth quarter with the third quarter. So we're not expecting any meaningful improvement in the fourth quarter I do think moving into 2021.
We will start to see improvement we may see some of the fourth quarter, but as you know.
The head of the noise level in the market right now is kind of pointing back to a higher level of shutdowns may start to occur at a higher level in the fourth quarter than what we saw in the third and then we try to take all that into our view of the fourth quarter.
Thank you that's very helpful and if I could maybe ask one of John.
As it relates to the MSP business you now have another company within the market. That's now public with data and I'd just be curious what if any impressions you have.
From from their IPO process, and as well just thinking about if you can educate us a little bit more on the finer points.
How solar winds is positioned against them in the market that would be really helpful.
Yes sure.
Where we're actually glad to see data of how the successful IPO respect.
The Dow team in the business they have there David good business, especially where they're focused.
And they're primarily focused in the backup and disaster recovery space.
So they've done a good job I believe educating the broader market.
Doing good job kind of telling the story that our msps carry on every day.
But where we actually find ourselves selling a lot of friends with them. Our msps will usually have the dato offering and our offering at the in the same in the same kind of environments as they manage and backup.
Medium enterprises across the globe.
The thing to remember Brad I think we talked about this is that we are really strong when it comes to remote mode.
Monitoring management automation and helping our MSP managed their customer environments, and we believe we've got the strongest broadened platform and product portfolio. There we have great security technology, right remote monitoring and management technology. Obviously, that's the business. We're really good at monitoring and managing performance of environment data really started the backup company.
Who bought a professional services automation company and so thats, where they are shrinking as were strong in different parts of the MSP market. So not that we don't compete but we are not direct head to head with them.
On a daily basis, because our strengths are little bit different we do have backup we have a really good cloud to cloud backup solution, which is growing very nicely for us.
But theyre more hardware based they are more environments that are not as cloudy as environment. We're in so well we compete in the market. We are really different in two businesses today.
Got it. Thank you so much guys.
Thanks, Brad.
Your next question comes online of sentencing from Morgan Stanley. Your line is open.
Hi, Thank you for taking the questions and it will be pretty strange appealing it's Kevin on the next call.
Kevin and solar wind you know like the business.
Is that either like peanut butter jelly, but I think probably the biggest accomplishment Kevin is clean.
Creating a sustainable business and that's exactly what you want you still.
Business that generate the cash and grew double digit.
In terms of they are in the middle of a really challenging economic environment.
So just to pick up on that last point, you sort of mentioned a new scripts have been about.
Signs of acceleration was wondering if you could give us a little more detail on that in sort of break it out by the MSP business Yep tea business, where are you seeing some of those sides. The as it relates to customer expansion and maybe whether its churn or or new customer acquisitions can you just give us some more color that'd be helpful. Yes.
So a couple of data points I mentioned that because I've talked fast sometimes they get lost one of the things we saw in the third quarter was an improvement in sales into new customers. So that's one of the trends. We're seeing we're seeing more businesses and then I have not been previously been customers of ours, which I know, it's hard to believe everyone not to customer during the number of customers we have a week.
Nice increase in the number of new customers compared to the second quarter were not at all time highs or anything like that but we saw an improvement in the third quarter over the second quarter. We also saw good spending levels by our larger enterprise customers. We closed a number of transactions of size in the quarter those transactions, we closed a little bit they closed in the second.
Timeframe, which for me is a sign that take all your growth at least know what their budgets are now, which I don't think they really did in the second quarter, so while but it may be down in some cases, they at least know what they are they know how to access them and then we know what they are able to spend them on because we're seeing the activity have a more purpose to it and with the idea of having a no.
Well they can spend the time frame they can spend it in.
The other thing we are seeing as we're seeing an increase in just the level of activity, meaning that with the right products online close.
People downloading ring whitepaper, calling in and talking to us so that activity levels starting to pick up again, so our reps are able to have more conversations than a day week month quarter.
Which is another sign that it leaves things are starting to return to normal a little bit technology pros have the time today now to look for solutions to make or live better to make their businesses run more effectively.
The MSP side, particularly in our larger MSP, we're starting to see device growth again, we're starting to see them look at expanding the number of services. They are offering to their end users. So they are looking at a adult provide advanced protection. So this customer today, let's talk to them about it unless provided to them tomorrow some of our newer offering or.
Starting to accelerate in India with our small business very small MLP and there were a lot of very very small in the phase of the market and that's probably another plate, we differentiate from data going back to the earlier question. We serve inventories of all sizes relative to guide to the delegated Roger one guy in dog and drive for that matter.
You will see that have your 100 technician in those really small MLP, where we saw devices really drop a good bit in the second quarter early third quarter. We've seen stabilization, we've seen that device count gets table that we haven't seen it start to grow really quickly yet, but we have seen stability. So those are the sign that we like and cross.
The business both in our small business customers as well as our large enterprise customers that tell us that while the economics. The economy is not in a great place I think we all agree that there's still some instability still some uncertainty I think there's more concern.
Consistent activity and consistency in spending that we're seeing before.
That's great detail, Kevin and then maybe one for John just thinking more broadly as we think about the potential strategic spin off later in 2021 it looks like.
If you get the gross profit business, John it's sort of been sort of 12%. The most recent quarter, but kind of mid teens, and then and expansion rate and that extension rate of in that sort of 105% to 108% range in.
In terms of if you wanted to grow the business faster what would be the growth vectors that you'd be targeting and like and what would be the sort of the key key levers you can pull to actually grow is it just a function of more investment was worth about where you need to take the product portfolio.
Area, you just sort of frame out the growth opportunity once it becomes super helpful. Sure we talked a lot about.
Some of the the reasons for the spin and for the MSP business is related to increased investment in a couple of areas around R&D and around our customer success initiatives. So Kevin mentioned that some of our newer products are catching some great momentum with our cross selling with MSP, both small and large so when you see it.
Increased investment and.
But more frequent addition to offerings to our MSP that they can go and make sure that they are securing and managing these small medium enterprises. So that's a big that's a big trend and then the second one is a long customer success, what we're finding is.
Introducing more humans in the loop Kevin talked about.
Steve being from one from one guy with the dog in the basement $2 billion enterprise, well well they have different needs and they need different touch points and type of customer success, and we'll be investing in that area to make sure that we're providing a little bit more about the spoke level of of service to these different types of the resources that we have in our business.
Understood. Thank you guys.
Thanks.
Your next question comes from a line of Rob Oliver from Baird. Your line is open.
Great. Thank you guys very much for taking my question just wanted to Echo the comments, Kevin Best wishes to you and your retirement somehow I doubt, it's going to end up being not [laughter].
Still trying to chase you had the peloton and I imagine that that thats going to widen when you have more free time.
Rob I raised my level three on the endurance ride on why [laughter], Yes, you are tough to.
The catch up with so thanks very much just a couple of quick questions from me.
Well one.
On the on the subscription side of things just curious you know it sounds like you guys are off to a good start with you know the Orion core products being sold.
Into new customers as an offering.
Is that where we are seeing.
The subscription momentum right now I, just would love to get an update since we Didnt you guys had a lot to talk about on this call. We didnt hear much about say I T assembler observe ability and you know just just curious, particularly given the tough rack macro where some of your price points might really play into the hands of people, particularly I'm thinking about some manage and others.
And then I had a quick follow up as well.
Yes. So are you looking at cloud product portfolio, we have an according to management part of the business that manages you applications manages.
As log management does that get them in the cloud we're seeing consistent performance. There we haven't seen an acceleration as a result of commit.
But we haven't really seen much slowdown in revenue growth either in that part of our business as a result of the pandemic I do believe we got good technology, we've got and selling price point we.
We indicated back a couple of quarters ago, we have reduced.
The amount of marketing spending and overall go to market spending on that set of products not because we don't believe that ultimately is going to be a large opportunity just because we believe we are still early and we don't want to get is spending more with the other players in that market that around spending.
2030 to one right now just not the way we go into market. So performing fine performing consistent way nothing acceleration didn't really expect it to we didn't build that into our outlook. So performing consistent with how we would expect them to perform I think the growth in subscription revenue has been driven by a lot of different pack environments, even though.
For sure two yeah, we're starting to sell a decent dollar amount still small as a percentage of total sales of our Ryan family of products, but a decent dollar amount in growing in dollars. We doubled sequentially Q2, Q3, we think we'll see another meaningful level of growth sequentially from Q3 and Q4 in sales in subscription.
Offerings to those that probably maybe a thing to remember is we do recognize some amount of that revenue when we sell to those on premise.
Got it in the form of subscription we recognize some of that upfront immediately add in subscription revenue.
It's not a very big dollar amount, yet, but that is helping start to accelerate that subscription revenue growth and should be an accelerator of subscription revenue growth.
Our core I'd business for quite a long time to come.
Great. Thanks, and my my follow up was on just not century. One you just wanted to dig in a little bit more on the thought process there was that.
You can see the ability to kind of get product that the infrastructure as a service players.
What was that and what is it in the product portfolio folio. There that you guys were were most attracted to thanks.
Thanks, very much guys now the interesting thing about century was they complement our product offerings that are really interesting way, there's very very little overlap they really fit nicely into the overall portfolio they've got a number of tools that they sell to David developer and they really are focused on the Microsoft environment. So Marshall sequel server.
Like with Azure sequel, Marseille data platform. They are really important that Microsoft world and they focus on building great.
Great relationship with that Microsoft database admin and they have both tools like we really don't have they've got monitoring capability that we did not have they got deeper monitoring capabilities in the ones, we have and the team there has a tremendous level of expertise in database management in general and then in specific in that Microsoft environment.
So bringing their team together with our team, we think create a pretty powerful combination and by adding their product portfolio to ours in that field and a lot of the gas we had in providing solutions to database developers and database administrators.
Really without regard to where they are deploying their technology, whether it's deployed in the cloud or whether it's deployed on premise. So it really does give us very very broad said they make management capability. We don't think anyone else in the market is really even close in terms of the breadth of coverage. We have you named the database you named the deployment model we now.
Provide not just some level of monitoring and management, but a deep level of monitoring and management and we can do that on premise. We can do that now in a hybrid world. We do that from the cloud and we can make money in the cloud. So it really gives us a very comprehensive suite kind of like what we develop in the never made a bit more Greg we meet everyone's network gear, we manage.
All the aspects of that gear, we have really no meaningful gas in our ability to manage network environment. The organizations of all sizes and all deployment models, we're now going to be in a similar position in terms of database management.
Great. Thanks again guys.
Excuse me for for those into the queue and operator can we please limit everyone to just one question going forward to help ensure that everyone gets any question. Thank you.
And your next question comes the line of Matt Hedberg from RBC capital markets. Your line is open.
Great. Thanks for taking my question guys, guys, and obviously Echo Everybodys comments, Kevin it's been a great run and I'm sure. We'll see you again, maybe in the near future.
John I'm curious you have so you had some some positive comments on on a reacceleration in the MSP business I'm curious about the growth dynamic when you think about adding additional msps versus selling more products through.
To Trs into their SMB customers, what's the right algorithm to think think about those two variables.
Yes, so I mean.
Our models pretty dynamic in that we grow obviously, when we add msps and we spend a good amount of effort there, but a lot of our effort both internally and that's why we're flexing up on our customer success is really help these MSP win and grow their business.
The the power metrics get obviously much larger out the further out you go right, so where we're managing millions of devices and we're managing hundreds of thousands by over 500000 small medium businesses. So the more that we can do to have those msps successfully manage and secure those small medium businesses. That's that's that's really.
With a highly leveraged model really starts to play so as we introduce more offerings for those SMB Sunil msps to offer to the SMB and provide a service around that that for us is a pretty profitable kind of return on our on.
On our investment no matter if you remember we talked about at the beginning of 2019, one of the changes John and team May as we moved away from just focusing on the number of inventories were adding and we started focusing on the healthy Msps. We wanted to add to our family of inventories and then focus on growing them. So that's when I say that it doesn't mean really.
Taking large admin fees, we're not we're chasing healthy small it must be healthy men. So there is a healthy lower unit base and then we're making sure that they grow over the term of the relationship with us and we as you remember we talked about the fact that we would change our sales rep compensation plan. So they live with the admin fees. They bring in for the first six months of their relations.
With us and we build into their quotas and expected growth in that relationship. So you can't just laying them and run away and land. The next one anymore, you've got to make sure you're making them successful. So I think that really goes to Johns comment on were making sure that even if we land grow we will add a bunch of new MSP, we want but that by itself is not the right equation. The algorithm is.
Wait a minute pizza can grow it doesn't matter how big they are when we land on display in MSP that can grow and then we've got to make sure we help them grow.
Super helpful. Thanks, a lot guys.
Thank you.
Your next question comes from the line of Kingsley Crane from Berenberg capital markets. Your line is open.
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Good afternoon, Thanks for taking my questions and likewise want to congratulate both Kevin and John.
I just have one quick one follow up on the Sentry one acquisition so.
Given the breadth of the capabilities you're acquiring here.
Including features in categories like data ops in cloud migration, how how might fit into the existing skews between EPA DPM.
Or perhaps are entirely to skew.
Yes look I think you should expect one there will be a lot of entirely due to their they have a great product set their products have been well package, they thought and very thoughtful about how they combine a set of beecher and put that into skew provided those set of capabilities to their customers because they have a really great knowledge of their customers and what their customers need and what their customers want.
Because they've been really focused on David them in particularly those in the Microsoft World for a number of years now. So we think the way they package their products and for most cases fits really nicely into our model now without a doubt we will find new ways to package the capabilities, we have with the capabilities they have because they do.
Provide features that we don't have that close gaps in some of our products and give our customers the ability to solve the problem, we're not giving them the ability to solve very effectively as as you see a combination of you're bringing their skews the market pretty much in the way they have them and then figured out ways to combine the product into a bigger.
Bigger offering if you will that solves a broader set of problems and figure out how to price them, but initially we're going to let them keep running.
Great job of building a great business and then we will gradually figure out how we bring value to their team might give them and giving them access to our customer base by giving them access to our development team by finding ways to combine the technology.
Wonderful thank you.
Your next question comes from the line of Terry Tillman from Truest Securities. Your line is open.
Yeah, Kevin Congrats from me as well and we will Miss you and I'm sure going to Miss our amazing questions.
Hardly.
I was it could listen there all the way back to the Red hat Dave.
Good listener. So that's one question on the federal government with September year end, what kind of observation can you make about the federal government in the quarter and just kind of the signals you're getting out of the public sector in general Thank you.
So public sector has been interesting over the last six months I think the federal government. So that part of the public sector has been strong.
Inconsistent been predictable at least as predictable as that part of the market ever did you guys know.
Buying process is a little bit obscure it requires a little bit of witchcraft to really understand it.
We've got a good team there is very experienced both as a long time as they do a good job of managing that profit so buying activity. There's been good we've got a very very strong customer base. There. We have had for a long time, we are embedded in a number of projects, where our customers continue to buy on at least an annual basis. Some cases more often so that's one of the market has been has been good.
State and local has been a little bit variable on the education side.
Not great. It's been you a little bit slow.
When you are kind of up and down school systems have been struggling with a lot of things as you guys know with most of them because they're a student being online and now hybrid it now.
Back in the classroom and they send them back home, but has there been a little bit hard to access but the team has been performing I think as well as can be expected in that environment stay a little bit better. So they state federal and where you see more frame kind of local education, you're seeing a little more weakness.
Thank you.
Your next question.
Question comes the line of Erik Suppiger from JMP Securities. Your line is open.
Yeah. Thanks for taking the question and again congrats on moving on.
Question on the Ryan.
As with your existing customers as the they they purchased new or add on business are they.
Doing that with subscription subscription business and if that's the case then does that ultimately lead to a deceleration in your maintenance business.
So the answer is it will result in a deceleration in our maintenance business. If you own a license from US you've always got all the same thing here, we get versus Virgin relationship, which is every release, we ever do left to write a dot that as long as you are active on maintenance. So we don't expect to see customers transition from.
Maintenance to subscription based on the pricing model, we have in the market today, because it's still less expensive for them to say on that made this relationship and there is nothing new they get by moving to subscription at least today.
The change in the future, but today you should not expect that now do we see some of our customers who bought licenses in the past buying subscriptions when they come back to buy new products. They don't know so lets say they own MPM, but they don't they don't own net flow or they don't own you know Sam and they come back by Nestle and sand in some circumstances.
We are seeing them make that purchase of an additional product in the form of a subscription but the majority of the time of the license that they are buying licenses most of the sales a subscription to permit a new customers. So far not all and I do think we'll see more and more of our existing customers by subscription to add to the licenses they already own just because those budgets are available to them.
And what we've always tried to do is make sure that we are as frictionless as possible and we make it easy for our customers to buy so they want to buy a subscription take that subscription product and integrated with their license product you can absolutely do that.
Very good thank you thank.
Thank you.
Your next question comes from the line of Sterling Auty from JP Morgan Your line is open.
Thirdly, what looks like somebody should open.
I do.
I'm argument.
Got it.
Yeah, it's like just on for Sterling Auty, So its look like.
Somebody decent some group and the score is docked the keys and what do you expect to happen from here given the macro backdrop.
Can you repeat the question I didn't hear the first part of your break it up just a little.
They still looks like it but somebody additions improved in the quarter is that the keys.
And what do you expect to happen from here given the macro backdrop.
Yes, so I think the the growth in the quarter and when they agree mentioned is way down we saw acceleration in the number of new customers, we were adding sequentially that doesn't drive a tremendous and dollar amount of revenue growth right away because both new customers start relatively small that's true and even see business that's true.
In the core IP management business is fair with our cloud management product. Most customers are relatively small we saw good customer retention in other words, our renewal rates for I'd say thrown our net retention rates stay stable that helped drive growth as I look forward.
The fourth quarter, you I do expect will continue its momentum in new customer additions I think that customer retention will continue to be strong and I think we will.
Good to see a little more rapid pace in which our customers are growing their relationships with us.
John mentioned on the MSP side or larger MSP are beginning to see device road when things are paying us more money on the large enterprise siding parking management, we're seeing good momentum in terms of customer is expanding in a meaningful way their relationships with us. So it's really a combination of all of that helps drive our overall revenue growth were not.
Really fully leveraged to one or the other them customer transactions tend to be larger and so we're going to see more growth in dollars from customer and even if we don't see more growth percentage.
And then a quick follow up if I can.
So in light Bill looking to split the company has there been any push back from new and existing customers.
No we haven't heard anything from our customers about the potential split of the business I think it really comes down to the fact that we.
We've been running the business into units for a while now the MSP market is a very very specific market requires a very specific engagement model. So we do digital marketing selling any inside we leverage a lot of our best practices. The way, we engage with an MSP partner is very different than the way, we engage with a corporate IP buyer or a dev ops buyer.
So reality is those two different cost parts of our customer base.
Don't care about each other very much and they are not using not really cross using products out of the two different product portfolio. So we haven't heard any noise at all from our customers about this potential split.
Thank you operator.
Your next question comes from the line of Mohit God you up from Barclays. Your line is open.
Hey, guys. Thanks for taking my question and Kevin I'll offer you My best wishes as you look ahead.
Professional Cordero Cytosorbents, let me. Thank you so staying on the topic Kevin So.
Well during the year I think we disclosed around.
Some sounds like initiatives around maybe you're going to look to sell the cost of the cross 90 pounds to the MSP business, but even outside of that way. So I'm, assuming as he looked under discussions of separating the two businesses.
They are maybe sourcing synergies.
Maybe on the product R&D side, maybe on the go to market side.
Hi, how are you sort of like thinking about those synergies of they are in the mid as two separate just making sure that we submitted geez that happen as it goes into submission. Thanks for taking the question, yes without a doubt we have share technology between the product portfolios overtime.
And one of the things, we're making sure we do as part of the process of looking at how we would separate the two businesses is making sure that both businesses get all the IP. If you will that they need to accomplish the things they need to call. The in the future. So we believe that there are certain IP that existed before and you manage the business that the MSP business needs to be.
Successful, we'll make sure that we cross license that so they continue to have access to it and they are selling it already if they're not selling it already but the biggest strategic Anil will cross license until they can hand going the other direction also so not worried about technology that synergy because one we've done a lot of the work that we needed to do to share technology between.
The product portfolios or the product platform and we've got a good view, we believe well need to be done in the future. So we'd be able to handle that in a way that we create that separation the way we create.
Licensing between the two businesses and also the way we build a transition services agreement between the two businesses to make sure that we made to maintain the momentum in both so not really worried about that I think we've got a good handle on it we've got a good plan. We've got good visibility of what we want to do on the go to market side of the house. The reality is that what we've really worked hard at over the last.
Four years it to create.
Our best practices that we're leveraging across our global business.
And so the key is to make sure those best practices have ended up in each of the business units. We believe that they have and so we have a separate go to market team previously separate go to market team for the core I'd management business, we share a lot of the same processes and practices and methodologies, but those will continue to be used by both businesses when we split into two.
A separate company so.
There's there's not a lot of the capability and from a go to market perspective, when we split because we have shared those capabilities to all the team have expertise have those processes. They have those methodologies.
So there should be no slowdown as a result of the split.
Thank you operator, I think we have time for one more question.
And your last question comes from the line of Brian Taylor from Jefferies. Your line is open.
Hi, This is love Soto on for Brent Thill, Oh rats, Kevin on the grade compressor run.
Miss you all the best for the future I wanted to ask.
I wanted to ask one quick one on the margins, obviously impressive margins this quarter, but.
But some you mentioned some commentary that the go to market to signing to increase investments in terms of headcount next quarter sort of what what is this investment sort of focused on and.
You know as we look out 2021, what do you expect in terms of margins. Thank you yes.
Yes, the comment on it.
Headcount was not limited to go to work and we have been very very careful about adding resources over the last six months one because we are all working from home and when we add people, we want to make sure they're productive so we slowed down the rate in which we've been hiring to make sure that today.
That's it for me other world that we can do a good job on boarding and training and getting people productive right away. So it's not just go to market, where we will hire a little bit more in the fourth quarter than we did in the second and third quarter go to market as one of the areas, but also R&D also newcomers.
Our backend systems team MSP business, we talk about as good as you know as part of the separation process is looking to invest more heavily in product more heavily and customer success. We're doing some of that hiring now so it's really across a number of areas, where we expect to hire more and I'll use the word expect because with hiring you never know exactly how it's going to go.
There are couple of holidays in the fourth quarter. So does make it a little more difficult to hire but our expectation is we'll add more people to the team in the.
Fourth quarter than we had third quarter, obviously, we have the impact of the city what acquisition that we expect right at breakeven on a GAAP basis in the fourth quarter, but that breakeven will bring our overall EBITDA margins down a little bit breakeven doesn't equal 51%. So that had a little bit of impact is on the go to market that is really making smart marketing.
Smith and spending money, where we're seeing return we pulled back at our variable spending in marketing in the second or third quarter because of a view that we can spend a lot of money and maybe get clicks within the people, we click and not have the ability to buy and we still pay the money when you get the click whether they have the ability to buy or not as I indicated in my comments, we think that I keep wrote them off road image.
We have a better view today than they did three four months ago of the money they've got available said, they've got a better view of the stability and performance of their own business. So they've got more intent to buy now when they engage so we're willing to ramp our spending back up a little bit.
We're still going to be very very profitable in the fourth quarter.
Still really.
Even more profit than probably what we set out at the beginning of the year for the fourth quarter. We did have two extraordinary level of profitability, we delivered in the third quarter.
And I think with that operator, we're going to wrap the call up we appreciate the questions and the attention I think.
For being on the call.
Ladies and gentlemen, this concludes today's conference call. Thank you for participating you may now disconnect.
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