Welcome to at least my last session of TMT day three at the Morgan Stanley conference. I'm Sanjit Singh. I run the infrastructure software coverage on the software team at Morgan Stanley. Super pleased to have the management team from SolarWinds here. The CEO, Sudhakar Ramakrishna, and CFO, Bart Kalsu. Thank you for coming and joining us once again at the TMT conference. Yeah. Thanks for hosting us. Thank you. All right. Let's get through the disclosures, and we'll start the conversation. For important disclosures, please see the Morgan Stanley research disclosure website at www.morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley sales representative. To start the conversation, Sudhakar, maybe just draw, you know, or create, you know, create the narrative arc for us in terms of 2021, we were dealing with, you know, the fallout from SUNBURST. Last year was about I think like a theme around product. From your perspective, why don't you tell us, like, where you think the business is executing well, and where you'd like to see things improve and maybe your sort of, you know, mission statement for 2023 for the team. First of all, thanks for having us here, and thank you again for your time here. Like Sanjit said, 2021 was really a year of maintaining and stabilizing customer retention. That was our focus in 2021 after what happened with SUNBURST. We were very successful in doing that. We had incremental improvements in customer retention all through 2021. At the same time, we started planting seeds for our transformation, largely from a portfolio standpoint as well as go-to-market. On the portfolio, I would say that the efforts in 2021 and the early parts of 2022 resulted in some significant portfolio enhancements and announcements. The very first one is what we refer to internally as Hybrid Cloud Observability. That we released in April of 2022, and a subsequent release was done in July. Following on, call it the other side of the coin for Hybrid Cloud Observability, was our native SaaS observability solution that we released in October of 2022. It was a rapid progression of two significant and major releases in the same year. We also added significant enhancements to our service management or ITSM solution and our database solution. Where we stand today is we participate in three large segments of, call it, the broader market, which includes observability, database management and optimization, and service management, mostly focused on the mid-market, but we have our select group of large enterprise customers as well. On the go-to-market side, I'm sure all of you are familiar with the famed SolarWinds model. What we ended up doing starting in 2021 was selectively adding people in the field and also striking some significant global system integrator partnerships. What that has done is it has allowed to participate in larger deals even as we kept nourishing our velocity motion. Bart reports every quarter how we are doing on the 100K customer deals over the last 12 months. Right. That has been steadily increasing. Of course, 2022 had its own challenges with the macro conditions effects and so on. Despite those headwinds, we still delivered growth. We still delivered significant profitability in 2022. In 2023, it is going to be a case of continued margin expansion as well as balancing that with growth. One key factor I'll highlight is underlying our growth is acceleration of our subscription transition. Mm-hmm. We did really well in 2022, and you can expect us to continue doing similar things in 2023 and for a multi-year journey that we are on. That's where we are today. That's a great overview. Let's talk. I want to spend a lot of the conversation on the growth side and on product because you guys already have the profitability and the margins relative to most of your software peers. You know, understanding, like, the growth equation is particularly important. Let's go through some of the macro topics as well. You know, when investors look at SolarWinds, they think about, you know, a 300,000 customer base. A lot of those are mid-market SMB customers. How have those cohorts, those SMB and mid-market cohorts behaved thus far? How, like, how are you thinking how that plays off, plays out in 2023? I think there's two ways to look at that, Sanjit. Is the first thing is to look at what Sudhakar referenced earlier, and that is on our renewal and retention rates. Renewal and retention rates for us in 2022, you know, our customers got back to their historical norms. We renewed 90%, 91%, 92% of our maintenance base in 2022. More importantly, we're starting to migrate some of that customer, that maintenance customer base over to our subscription products that Sudhakar referenced earlier. When you start to look at our income statement, you're gonna see a trend. You're gonna see license revenue is under pressure, but just offsetting that, you're gonna see growth in subscription revenue. We started to talk about that in 2022. It's that subscription-first mentality- Mm-hmm. That Sudhakar referenced. You saw a substantial increase in subscription ARR for us in 2022. Mm-hmm. That'll continue to be the case. It comes from two places. It comes from selling subscriptions to new customers and then migrating our maintenance base over to the subscription products as well. All the trends for us from a renewal and retention standpoint got back to historical norms in 2022, and we think we'll start to see even some improvement on that in 2023. When we convert a maintenance customer, so far, a dollar of maintenance is converting to close to $2 of subscription revenue. We don't expect that to always be the case. We think we can convert a dollar of maintenance to $1.3 or $1.5 of subscription revenue. We think that that's what the norm will be, when we get a little bit of a bigger population. There's opportunity there for us is what we see. What's? And- Sorry. Sanjit, I also wanna talk about the customer profile because you started with. Yeah. ... mid-market and the SMB piece. There's a lot of commentary around the SMB and mid-market feeling the pressures of the macro a lot more than like let's say the large enterprise and so on. I wanna provide a point of clarification there. When we think about mid-market customers, we are talking in our context of highly sophisticated mid-market customers. A law firm, a financial institution, a healthcare facility, which are not like thousands of people, but they are super well capitalized, have great financials, and look at technology as a differentiator for them to conduct their business. So those tend to be like super robust. And the data point I can offer you is that even through this economic cycle and into Q1, our overall pipeline has actually been growing. That's not to say large enterprise customers are not doing well, but if anything, if you look at deal cycles, in the large enterprise space, there's more scrutiny and more layers of-. Mm-hmm. product management, whereas in the mid-market, you don't really have that phenomenon. Mm-hmm. I like our chances because of the diversification that we have from a customer base standpoint. You know, I've been with the company for 15 years, Sanjit. We've gone through cycles before, right? That's right. I was actually at SolarWinds when we had the last recession, which was 2008. Mm-hmm. We were one of the first companies to go public in 2009. I think one of the things that demonstrates the resiliency of our business model is our average transaction size. Our average transaction size is still less than $10,000, even today. We've talked about introducing an enterprise motion, we've talked about other routes to market, at the end of the day, it's still a land and expand story for us when we talk about bringing on a new customer. Mm-hmm. Our average transaction size is still less than $10,000. I tell people, you know, the great thing about that is when you go through tough times like right now. Mm-hmm Purchasing decisions are getting more scrutiny, right? I can tell you as a CFO, you know, when I'm looking at purchase decisions that maybe are gonna go to a little higher level of scrutiny, it's not the $10,000 transactions that I'm looking at. Right. It's the $100,000 transactions, $200,000. You know, we continue to have that SolarWinds, that flywheel, high volume, high velocity motion. Mm-hmm. We've just supplemented it now with some other routes to market that Sudhakar referenced earlier. Bart, could I follow up on the comment on the uplift that you're seeing from maintenance. Mm-hmm. Yeah to subscription? Because even if it's not two, it's 1.35- Yeah. to 1.5, that's still really good. Significant. Really good. What's sort of the, what is sort of the If you sort of unpack the drivers of that uplift? When most vendors go through that transition... Mm-hmm. ... it is largely a business model transition. I'm changing a dollar of maintenance to a dollar of subscription, it's like for like. In our case, we consciously chose not to do that. Instead, what we do is we ask the customer to trade off a dollar of maintenance, but we give them something more in value. Like, I may trade off a dollar of network monitoring maintenance- Mm-hmm. ... you get Hybrid Cloud Observability in return. It's really a value proposition and a value equation model for the customer. That is the reason why even though it's been about, what, now three full quarters, we are seeing 2X for that. They buy based on the value that we deliver, and they pay up for it. Yeah. What that does, is, which is not yet fully implied in our revenues and such because it's got a compounding effect, is that entire $2 comes up for renewal next year. You get a lift in revenues as a result of doing that. Yeah. That's a phenomenon I think that we will start showing even more progress this year, and that has a multi-year compounding effect. It makes a lot of sense. It's very, very interesting. To wrap up sort of like kind of the macro business model discussion, Bart, if you could just sort of walk through what's contemplated in the 2023 outlook relative to some of the macro risks out there and the budget uncertainty with respect to pipeline closure rates. Yeah. ... deal cycles, that type of thing. Yeah. You know, obviously, you know, just like most other companies, we were impacted in 2022, you know, by what was going on in the macro, Sanjit. The good thing is that, you know, we've seen some improvement in our international business. You know, the FX rates, you know, were extremely volatile in 2022. We've seen some improvement in that. The euro, for example, was below one for part of 2022. We've modeled in, I think our euro to U.S. dollar rate that we put in our model was somewhere around 1.05. That's an improvement. As far as the macro buying patterns, you know, what we saw in the back half of the year, we don't expect that to change dramatically in 2023. We've tried to be conservative when we set our guidance. We're expecting to see some improvement, but we think that's because of some of the things that we've talked about on the product side. Mm-hmm. It's not like we're expecting a dramatic increase, in the macro or in buying patterns in 2023 over what we saw in 2022, especially the back half of 2022. We get a full year effect of Hybrid Cloud Observability. We only got like barely six months. Mm-hmm. ... from launch. We get a full year effect of the SaaS observability solutions and the ongoing motions that we have developed with our global systems. Yeah, I think that's the good thing about for us, Sanjit, is that we have an install base. Mm-hmm, mm-hmm. ... the number of customers. In times like this, we can focus on that install base and focus on migrating those customers from maintenance to subscription. Mm-hmm. We don't have to go out and find new customers in this kind of environment. When the macro turns for us. Mm-hmm. ... we're in our favor, guess what? We'll be another 12 months into our journey on the subscription side. Yeah. It's really interesting because I think, you know, obviously, we'd all like to see a better economy and a better spending environment. In some ways, this, you know, sort of in the back of my head, this could be like SolarWinds' moment, right? Yeah. You guys have been profitable for years, free cash flow positive for years, and now we're in a environment where customers, buyers are looking to do more with less. Yep. You guys are typically a lower cost solution relative to your, to your peers. In terms of framing out the opportunity of observability, both on the hybrid cloud side and the cloud native side, what has been, you know, maybe sort of summarize what you've seen thus far in the next six months and what does sort of the pipeline look like for hybrid and cloud native observability for 2023? I'll address it in a couple of ways for you, Sanjit. First, your observation of it could be SolarWinds moment is absolutely true. A lot of our hybrid cloud observability wins have been what we dub internally as tools consolidation. Customers are going through tools consolidation. They want a solution that can support their entire breadth of needs and simplify their environment, reduce their cost, increase their productivity. That is the proposition there. That part of the business has been accelerating, I would say, as we have launched that in July of last year. I expect that to happen all through this year. The pipeline for that is fairly robust and continues to grow on a, honestly, a weekly basis. Like I said, the SaaS piece of it is complementary to it. We have got some initially good traction. As you know, industry-wide, there's a questioning, so to speak, of how much should I spend on cloud? Mm-hmm. What are the economics of it? I expect some slowdown as a result of that. Mm-hmm. It does not affect us for two reasons. One is it's not a huge and material part of our business. Mm-hmm. Two is for us, hybrid cloud and native is a continuum. Mm-hmm. A customer can buy one and evolve to the other as their business needs dictate. Mm-hmm. We're not dependent on their cloud spend for our business. Those two phenomenon will, I think, help us and be a tailwind for us. As you think about, kind of mentioned the theme of tool consolidation, better consolidation, all of the monitoring observability companies that I cover, they all sort of speak to the same sort of opportunity. The question is: what's going to give SolarWinds a license to win and be a net consolidator of spend? Like if you sort of speak to that on like? Absolutely. why SolarWinds wins? Absolutely. I think there is legitimate reason why many vendors kind of have that proposition. When they're thinking about tools, they might think horizontally as opposed to just vertically, and I'll quickly explain what that means. It's not uncommon for a customer to have many application monitoring tools. It's not uncommon for a customer to have many logs management tools. Mm-hmm. When those vendors are talking about tools consolidation, they're consolidating app monitoring tools as one, log monitoring tools as one. The way we look at it is a customer's environment is a combination of their networks, their systems, their databases, applications, and their cloud deployments. That's what we are trying to consolidate for them, 'cause that's a, I would say, a more sustainable, more cost-effective way for them to do over time. We have all the assets to be able to do that, as opposed to coming at it simply from an application monitoring standpoint or simply from a log monitoring standpoint. As a follow-up to that question, like when I look at the way observability is talked about, like everyone just sort of bypasses the networking layer. Yes. Right? Like no one talks about it, right? Yes. Metrics, traces, and logs. You guys have been the leading network monitoring player for, you know, over, well over a decade now. Is the network, can that be a point of differentiation and a strategic advantage? What are you doing to evolve network monitoring for a more hybrid cloud on native cloud world? You made that comment even one of our earnings calls. That's right. Yeah. ... if you remember. I have a distinct memory of that. The way I look at it is if you think about observability, a lot of vendors come from, obviously, from their heritage or legacy. Typically, the way they have come in with is application-oriented or log-oriented. Mm-hmm. We look at observability across the entire stack, starting from the network all the way to the user. In that context, we are having to evolve network monitoring as well. What was traditional network monitoring, meaning managing switches and routers and networks, which still is relevant, by the way, but not a huge growing market, we have now evolved to more SDN as well as cloud network monitoring. Mm-hmm. Ultimately, there is a network, whether you're in the cloud or on premises, and that needs to be monitored and managed and optimized. That's how we are evolving that piece of the business. Makes total sense. We've talked about observability. There's opportunities outside of observability that you guys can pursue, and it's probably even related. Let's talk a little bit about the opportunity in ITSM. Yeah. In service management, you know, obviously a big category. ServiceNow has proved that that's a big category. You have other players like Atlassian, coming in as well as several others. It's kind of a similar question to observability. I mean, you guys have gone through this category via an acquisition, you know, a couple of years ago. What is the opportunity for SolarWinds in ITSM, and who do you think, like, what's the opportunity, or who do you think you can displace? There's a couple of opportunities there for us. One in the context of observability, which I'll go into, and two on a standalone basis. Our ITSM solution is a 100% SaaS-delivered solution. We have now been accelerating the innovation around that. In fact, you mentioned Atlassian. The people that run that business for us are from, originally from Atlassian as well. Mm-hmm. Last year, that was one of our faster-growing solutions. We have chosen to stay strictly within the mid-market. The proposition is, unlike other ITSM solutions, our time to value in a customer's environment is greatly compressed, so keeping in line with SolarWinds fundamentals. The other reason why we are focusing on that is in the context of observability, a customer is able to, let's say, highlight or pinpoint what the issue is in their environment, but they're not really able to solve it. Some other team solves it. Right. What we are doing on the SolarWinds platform, Sanjit, is combining observability and service management such that visualization or observability and remediation kind of go together. Mm. We are automating that cycle. Mm for customers. That's a very compelling proposition for resource-strapped mid-market customers, which nobody else is able to do. moving from a system of alerting- Exactly. to a system of action. Exactly. That seems like a pretty exciting opportunity. In the service management strategy, do you guys also espouse the view that it's not just something that can be, you know, pointed at IT, but, you know, you could make a finance team a service desk. Absolutely. a marketing team a service desk? Absolutely. What's sort of the vision there outside of IT? Absolutely. We call beyond IT. Mm-hmm. Up until 2022, we were largely focused on IT. We have now expanded beyond IT into the ESM, and you'll see expansions of our service management portfolio with integrations in those realms, HR, finance and others. Mm. Makes- Enterprise Service Management is what we call it, instead of IT Service Management. How, like, is this a sales motion that's relatively nascent? Is that something that will evolve over time? How much muscle do you have in that space? We have, I mean, we had specialists last year. Mm. This year, our entire generalist sales force is being trained on that. Mm-hmm. The point I'll make, given our focus on mid-market, is we're not having to chase after multiple buying centers. Mm-hmm. In the mid-market customer, the uniqueness of it is, it is a single buyer, like a CIO or a VP of IT, as an example, who's making the entire purchase decision. Mm. That is our sweet spot. Right. unlike you mentioned, ServiceNow and such. Mm. We are not going after every single large enterprise departmental buyer. That is not an environment we are comfortable in. The way we are addressing that segment is strictly through our GSI partnerships, who participate in larger, more integrated deals, and we draft off of that. Right. Makes total sense. My favorite end market in software is the database or data management market. Huge market, you know, hundreds of billions, you know, in five years, still growing double digits. A pretty large category. It kind of makes sense that database performance monitoring would be a thing as well. Yeah. Sort of frame out the opportunity for us there, both in terms of like, kind of legacy databases as well as, kind of the modern, you know, New SQL, NoSQL databases. What's your sort of coverage of those types of databases? then how big of a business can database performance monitoring be for SolarWinds? Database performance monitoring or database optimization, broadly speaking, for us is already a double-digit million market, business, I would say. We don't split those things out. Mm-hmm. I expect that to have continuing growth for several years. If I were to project into the future, it's not like a forecast as much as. Mm. I believe there's a half a billion dollar market opportunity for us just as a standalone business. Mm-hmm. However, like you mentioned earlier about the observability piece, we increasingly have integrated that in the context of app monitoring and network monitoring and such. There's an integrated motion and a standalone motion. That's how we look at the three pillars that we have. In terms of coverage, the reason why customers buy our database optimization product is the breadth of database coverage that we have. We have both organic innovation more recently, but through some of the acquisitions that we made over the years, breadth of platform support is one of the key drivers that we have. I think I remember some of those acquisitions around, like, the Microsoft. Microsoft SQL Sentry. Mm-hmm. previous to that, with various Informix, Postgres. Mm-hmm. ... and now more increasingly NoSQL as well. Interesting. Let's stop and see if there's any questions from the audience. If you raise your hands, we'll get a question to you from the management team. If not, we can continue. All right. Let's talk about go-to-market. I think in Q4, one of the themes of the call was working more closely with the GSIs and the channel more specifically. What's gonna change in 2023 in terms of partner strategy versus what we've seen in the past couple of years? I'll start with a significant announcement that we made with HCL most recently. What HCL has done is taken our Hybrid Cloud Observability and essentially OEM'd it. HCL calls it iObserve. Mm-hmm. It's branded HCL iObserve, but it's SolarWinds Hybrid Cloud Observability. What they're doing with it is their entire sales team is being trained on it and compensated on it. In essence, if you think about a force multiplier, we don't have to be restricted to simply our sales teams. We now have an extension to HCL. That's number one. Number two is HCL has significant strength in the service provider or telco market, we historically have really never concentrated on that segment. They're taking that into that market from a observability standpoint, that gives us market expansion opportunity. That's an example of the types of relationships that we are building with the global system integrators, there are other system integrators that are working with us on similar vein, but different solutions. One of the system integrators to be announced shortly is more focused on database infrastructure management because that's their sweet spot. That's two aspects of it. The next layer of partnering strategy is with MSP customers and cloud service providers. Again, with the SaaS release and such, we now have strategic partnerships with AWS and Azure, and there's a lot of co-sell motions that are in place. The last but not least is our traditional partners who now have the same level of enablement that we have implemented internally to us. They're a true extension of who we are as a go-to-market team. Another part of the go-to-market strategy that you guys talked about in the Q4 earnings call was, you know, building more Product-Led Growth muscle. Yeah. When I first heard it, I was like, "I thought you guys invented that," right? Like, that's like high velocity sales was something that, like, I think, SolarWinds sort of brought to market. Like, can you sort of just define and differentiate to us, like, how is, you know, the product-led growth motion different than classic- Yeah. ... SolarWinds and where you're gonna focus resources going forward? The product-led growth point that we highlighted in the Q4 earnings call was more related to the SaaS evolution and driving more PLG from that. Mm-hmm. The historic portion of SolarWinds is known as Download, Try, Quote in the old days. Mm-hmm. increasingly it'll start becoming Try and Buy. Mm-hmm ... is the way we are driving it. I would say that's a more of a mid to late 2023 thing that we are building. Got it. like, what's the motivation there? Is that about? Does that fit into, like, a margin expansion strategy, like lower cost of sale or? Absolutely. Also growth. Frictionless growth is the way I would describe. Mm-hmm. Yeah. What we want to increasingly do is stay focused on solving fairly complex problems simply for customers, where the proposition is, I want us to have the best time to value for our customer because I think customers end up buying a lot of software and it takes forever to realize value. We want us to be the best time to value. Following that based on the solutions we deliver, best time to detect issues and best time to remediate their issues. That's our value proposition to customers. Given the amount of cash flow the business generates, wanted to ask you, Bart, a little bit about capital return and capital strategy between buybacks, debt pay down. How should we think about that? Sure. ... that capital strategy. Yeah. ... in 2023 and beyond? Yeah. In 2022 we refinanced our debt in the back half of the year. We paid down about $650 million of our debt to get our gross debt down to a little bit more manageable level. Interest rates obviously have come up quite a bit over the last nine months. Paying down debt was a good use of our cash. We think we'll get to the end of 2023, if we haven't done anything on the M&A front, which I don't really see a whole lot going on, we are likely to pay down debt again, just with interest rates as high as they are. If we generate another $100 million-$125 million worth of cash this year, you add that to what we currently have and, you know, would not surprise me if we made another debt payment. By the end of the year. Otherwise, you know, stock buybacks, dividends, things like that, I would say those are probably, especially on the dividend side, I think that's more like two or three years down the road. For now. Mm-hmm we wanna get our debt down to a more manageable level, and we wanna make sure that we're, you know, still investing in the business. That's our most likely uses of cash for now. In terms of, like, net share dilution, is there a particular level of dilution that you're targeting? You know, most of our share dilution to date, to be honest with you, just comes from, you know, from us. Yeah. ... from a stock-based comp standpoint. Mm-hmm. You know, we do a very good job of not, you know, managing that fairly tightly, to be honest with you. You know, it's not like we have a number that we're targeting. Our stock-based comp as a percentage of revenue is a fairly low number compared to a lot of our peers. That's true. We think we do a good job, from a shareholder standpoint there. Maybe the, like, last one to wrap up the conversation is around margins and EBITDA margins. Yeah. I think, the outlook or for 2023, the guidance sort of implies getting to 40%. Historically, the business has gotten mid to high 40s%. Yeah. What would be the timeline to get back to those levels of margins? Like, what needs to happen in the business for you guys to return there? You know, we're doing everything we can on the cost control side. Mm-hmm. When we gave guidance, back in February for 2023, we committed to growing EBITDA from a dollar standpoint, so we didn't just give a margin guidance Mm-hmm number, we actually gave a dollar number from an EBITDA standpoint. No matter where we land on the revenue spectrum, whether it's at the low end of guidance or whether it's a high end of guidance, we're committed to delivering EBITDA growth in 2023. As far as the goal of getting back to the mid-forties, you know, that's it's gonna take time. We think we'll be in the low forties at the end of this year with an exit rate, you know, closer to 42 or 43. It's just a matter of, you know, revenue acceleration kinda helping us, helping us get to that mid-forty range as well, so. I can tell you from a cost standpoint, you know, Sudhakar and I were investing in the business for the last two years, whether it was the breach, go-to-market, or product, all three of those things, you know, were things that we needed to invest in over the last two years. Now it's time for us to start to get some return on those investments. Yeah. Wait for the growth to flow through. Yep. Yep. That's great. Well, thank you so much for the conversation. Thank you. I really appreciate your thoughts. Thank you. Thanks, Sanjit. Thanks, Bart.