SolarWinds - Q3 2020
October 27, 2020
Transcript
Speaker 0
Ladies and gentlemen, thank you for standing by, and welcome to the SolarWinds Third Quarter 2020 Earnings Conference Call. At this time, all participants are in a listen only mode. After the speakers' presentation, there will be a question and answer Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Howard Ma, Senior Director of Investor Relations. Thank you.
Please go ahead.
Speaker 1
Thank you, operator. Good afternoon, everyone, and welcome to SolarWinds' 3rd quarter 2020 earnings call. With me today are Kevin Thompson, our President and CEO Mark Kalsu, EVP and Chief Financial Officer and John Taliuca, EVP and President of RMSP Business. Following prepared remarks, we'll have a brief question and answer session. This call is being simultaneously webcast on our Investor Relations website at investors.
Solarwinds.com. On our Investor Relations website, 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 and the update to the potential spin off of our MSG business. These statements are based on currently available information and assumptions, and we undertake no duty to update this information except as required by law. These statements are 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 and separately created public company.
Additional information concerning these statements and the risks and uncertainties associated with them is highlighted in today's earnings release and in our filings with the SEC. Copies are available from the SEC or on our Investor Relations website. Furthermore, we will discuss various non GAAP measures on today's call. Unless otherwise specified, when we refer to these financial measures, we will be referring to non GAAP financial measures. A reconciliation of differences between GAAP and non GAAP financial measures discussed on today's call are available in our earnings press release and summary slide deck on the Investor Relations page of our website.
And with that, I'll now turn the call over to Kevin. Thanks, Howard. I'm pleased to report that we were able to deliver strong performance in the 3rd quarter, exceeding the high end of our outlook for total revenue and EBITDA in addition to delivering solid year over year top line growth of 8% in the face of what has continued to be a volatile and uncertain economic environment. Total non GAAP revenue for the Q3, which was driven by improved sales to new customers over the 2nd quarter and solid customer retention rates, was approximately $261,000,000 In addition, we delivered an exceptional quarter of profitability, generating approximately $133,000,000 in adjusted EBITDA, meaningfully exceeding the high end of our outlook and reflecting a 51% adjusted EBITDA margin, which is the highest level of non GAAP profitability we have delivered in the last 11 quarters. As we saw in the 2nd quarter, the volatility of the economic environment has resulted in a business rhythm that is less linear than our historical average.
However, we did see signs of improvement in linearity and in stabilization of performance in the Q3 across selected geographies and areas of the market as compared to the Q2. From a geographic region perspective, in the 3rd quarter, we saw the most meaningful improvement in performance in Avian followed by North America. We had several operational highlights in the Q3 that I want to briefly mention. First, as you should remember, in late April, we launched subscription pricing options for each of the key offerings in our Orion family of network systems and database management products. And we had a good initial quarter of subscription sales of these products in the 2nd quarter.
The momentum continued into the 3rd quarter with a sequential doubling of the dollar amount of subscriptions sold of these products. We currently believe we will see another strong quarter of sequential growth in subscription sales of the Orion product family in the 4th quarter. 2nd, we were able to drive solid ARR growth in the 3rd quarter, with total ARR reaching approximately $887,000,000 as of September 30, 2020, reflecting year over year growth of 11%. Subscription ARR grew at a meaningfully faster rate of 20%, reaching $411,000,000 at the end of the quarter. 3rd, we continue to see solid growth in the number of our large customer relationships despite the difficult economic environment.
This is illustrated by the number spent over $100,000 with us on a trailing 12 month basis, increasing on a year over year basis by 17% to 1,004 customers. And finally, customer retention rates across our product portfolio have remained strong, with maintenance renewal rates of 92% in the 3rd quarter and subscription net retention rates stable at 105%. The last item I will cover before turning the call over to Bart is of a more strategic nature related to our database management product portfolio. As I have indicated on several occasions over the last year, we believe that database management and operations is a large market opportunity for SolarWinds. This opportunity is being driven by digital transformation and the move to hybrid cloud infrastructure and the recognition by database administrators as well as DevOps pros of the need for greater visibility or observability in into the performance of the critical applications upon which the business relies.
In order to get a complete view of application performance, visibility into database performance is required. We moved into the database management market in 2013 and have created a meaningful presence in this market for SolarWinds during the last 7 years. Over the last year, we've been investing in broadening our capabilities to monitor and manage the performance of databases of all sites, including the historical Oracle, Microsoft SQL and MySQL traditional databases as well as the newer databases such as MongoDB, Cassandra, Redis and Microsoft Azure SQL to name a few. This increased investment in database management started with the acquisition of Vivint 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 manage today, as well as the ability to provide these management services from the cloud. As I assume most of you saw, on last Friday after market closed, we announced that we have continued to build on these capabilities through the planned acquisition of CenturyOne, a leading technology provider of database performance monitoring and data operation solutions for Microsoft SQL Server, Microsoft Azure SQL and the Microsoft Data Platform for a cash purchase price of approximately $142,000,000 The CenturyOne offering complement and broaden the on premise, native cloud and hybrid database management offerings that we currently have and are a great fit with our product portfolio.
I want to take this opportunity welcome the CenturyOne team to the SolarWinds family. We are excited about the expertise that you bring to this fast growth part of our business. We believe this acquisition closes, which is expected to occur this week, we will provide the broadest and deepest level of database monitoring and management coverage in the on premise, covered IT and native cloud infrastructure and application management markets. With that, I will turn the call over to Bart, who will provide some additional details on our Q3 performance as well as our outlook for the Q4 and full year.
Speaker 2
Thanks, Kevin, and thanks again to everyone joining us on today's call. The Q3 was solid across our key performance metrics given the volatility of the current economic environment and reflected a sequential improvement from the to pay dividends in the 3rd quarter as our total cash balance reached $425,000,000 at September 30, as compared to $173,000,000 at December 31, reflecting an increase of over $250,000,000 Our net leverage has consistently declined over the 1st 9 months of 2020 and is now at 3.1 times our trailing 12 months adjusted EBITDA. Moving on to our financial results. We had a very strong quarter of profitability, as Kevin said, in the Q3. Adjusted EBITDA was $132,700,000 reflecting year over year growth of 15% and was nearly $11,000,000 better than the high end of our outlook for the 3rd quarter.
The sequential increase of approximately 3 percentage points of adjusted EBITDA of adjusted EBITDA margin from the 2nd quarter and 6 percentage points compared to the 1st quarter was driven by continued disciplined expense management across our global business, lower than planned variable sales and marketing expenses, lower headcount 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 at quite as high of a level in the 4th quarter as we are planning to reaccelerate our go to market spending and hiring across the business as economic activity improves. We drove approximately $108,000,000 in unlevered free cash flow in the 3rd quarter, which puts our unlevered free flow for the 9 months ended September 30 at $312,000,000 and reflects a year to date conversion rate of 86%. Our conversion rate declined sequentially compared to the 2nd quarter, primarily as a result of U. S.
Federal income tax payment totaling $24,000,000 which were made in the 3rd quarter. Earnings per share on a non GAAP basis for the Q3 totaled $0.28 per share based on 316,700,000 fully diluted shares outstanding.
Speaker 1
Switching over to revenue
Speaker 2
for the quarter. Total non GAAP revenue was 261 $300,000 which was an increase of 8% compared to the prior year and above the outlook that we provided for the Q3 of $254,000,000 to $259,000,000 of total non GAAP revenue. Total non GAAP license and maintenance revenues in the Q3 grew by 2% year over year, reaching $160,400,000 on a reported basis. This growth was led by non GAAP maintenance revenue, which increased by approximately 7% reaching $121,100,000 Non GAAP license revenue in the 3rd quarter totaled $39,300,000 reflecting a year over year decrease of approximately 10%. Our license sales performance was a meaningful improvement from the Q2.
When you adjust for the subscription sales of our on premise based products, license revenue would have been down only 5% on a year over year basis for the Q3. We expect the economic environment in the 4th quarter to be similar to that in the 3rd quarter, and as a result, we do continue to expect some year over year decline in license revenue in the 4th quarter. In addition, Orion product portfolio subscription sales are expected to be a headwind for license revenue growth of approximately 4 percentage points in the 4th quarter. During the 3rd quarter, 85% of our total revenue was recurring and recognized as either maintenance or subscription revenue. Total non GAAP recurring revenue for the 3rd quarter grew at 12% reaching $222,000,000 3rd quarter recurring revenue growth was led by non GAAP subscription revenue of $101,000,000 which grew 18% year over year and was approximately $100,000,000 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 Halieka, who has led our MSP business over the last four and a half years and who would assume the CEO role of the standalone entity if the spin off is completed, an opportunity to give more context around the 2020 operating trend of our MSP business. I will now turn the call over to John. Thanks, Mark. I'll spend the next few minutes discussing our Q3 year to date performance and key trends in the industry.
Believe most of the research analysts and investors on this call are familiar with our MSP business. For those listeners who are less familiar, our MSP business refers to our technology platform and purely software based solutions that we provide to MSPs. MSPs or managed service providers are a critical type of IT service provider that assume responsibility for managing and protecting the customer's IT system and services. And in many cases, App has outsourced IT departments for millions of businesses around the world. These MSPs use our technology to manage the IT environment of over 500,000 small and medium sized businesses in all parts of the world, monitoring, managing and securing their customers' devices and applications as well as managing disparate end 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 the larger SolarWinds parent, we've thrived under relative obscurity to those outside of the MSB market. We currently expect our MSB business to generate slightly over $300,000,000 of non GAAP revenue in 2020, of which about half of which is outside of the U. S. And we've done this with what we believe are best in class gross margin and profit margin for a cloud based business, driven by our efficient operating model.
We've been growing at CAGR of 15% on a constant currency basis since the Q1 of 2018. And year to date 2020, we've grown non GAAP revenue 15% on a constant currency basis and 12% in the 3rd quarter. While we saw slight acceleration in our MSP business as a result of COVID-nineteen, our most recent trends indicate that the MSP market is beginning to reaccelerate. Notably, ARR growth in the Q3 was a couple of percentage points higher than our MSP business revenue growth. In addition, despite the difficult economic environment, our net retention rates have held up well and remained at approximately 107 percent on a trailing 12 month basis, both on a reported and constant currency.
However, due to the deceleration we saw in our MSP business in Q2, we expect net retention rates to drop slightly in the Q4 before beginning to improve in early 2021. Now, I'll turn it back to Bart to take you through our total company outlook for the Q4 and the full year. Thank you, John. Before I get into the details of our outlook, as Kevin talked about, we recently signed a definitive agreement to acquire CenturyOne. CenturyOne fits the profile of companies that our core IT management business will focus on acquiring in the future.
We expect our GAAP revenue to be in the mid-twenty million dollars range in 2020 with a growth rate in the low double digit, which was impacted by the headwinds from the economic slowdown caused by the pandemic. However, we expect our 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 margins. We expect CenturyOne to close this week and to contribute approximately $2,000,000 of GAAP revenue in the 4th quarter, which reflects the impact on revenue of the adjustments to reduce the beginning deferred revenue balance required by purchase accounting and to be approximately breakeven on a GAAP basis for the Q4. Turning to our outlook and a quick reminder, our outlook assumes a euro to USD exchange rate of 1.17 and a British pound to USD exchange rate of 1.30. For the Q4 of 2020, on a non GAAP basis, we are increasing our outlook due primarily to the CenturyOne acquisition and now expect total 4th quarter revenue to be in the range of $261,000,000 to $266,000,000 representing a year over year growth of approximately 5% to 7 percent on a reported basis.
This 4th quarter outlook assumes a maintenance renewal rate in the 92% to 93% range and a consolidated 4th quarter net retention rate of approximately 104% on a trailing 12 month basis. We are also increasing our 4th quarter adjusted EBITDA outlook and now expect a range of $123,000,000 to $126,000,000 for the 4th quarter or an adjusted EBITDA margin of 47.4% at the midpoint, which results in earnings per share of approximately $0.25 per share for the 4th quarter, assuming a weighted average number of shares outstanding of approximately 317,500,000 shares. Our earnings per share guidance assumes a non GAAP effective tax rate for the Q4 of 2020 of approximately 22%. Based on our results for the Q3 and our outlook for the Q4, 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 revenue as a result of the revenue fees in the 3rd quarter and the CenturyOne acquisition and now expect total revenue to be in the range of $1,017,000,000 to $1,022,000,000 representing year over year growth of 8% to 9 percent on a reported and constant currency basis.
The full year revenue outlook assumes a maintenance renewal rate in the 92% to 93 percent range and a subscription net retention in the range of 103% to 104%. We are also raising our adjusted EBITDA outlook for the full year to a range of $486,000,000 to $489,000,000 which results in earnings per share of $0.98 per share for the full year assuming 315,500,000 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%. And with that, I'll now turn the call back over to
Speaker 1
Thanks, Mark. As you can see from our Q3 results and our Q4 and full year outlook, our confidence in our ability to deliver continued growth despite the difficult economic environment has increased as we have moved through the last two quarters. For the 1st 9 months of 20 we've been focused on taking market share in our key markets. Based on International Data Corporation's worldwide semi annual software tracker, for the first half of twenty twenty, we successfully increased our industry leading position in the network management market by almost 2 full percentage points to 22.9% market share. Believe we can further increase our market share over the next several quarters in not only the network management market, but in all of the key markets where we compete today by leveraging our strong product portfolio and disruptive go to market approach as CIOs and MSP business owners look to reduce IT spend, while increasing the level of performance and availability of the infrastructure applications for which they are responsible.
We also believe based on the trends in our business, several of which Bart and John discussed in their remarks, that the small and medium sized business market, which has been remarkably resilient so far in this economic downturn, is beginning to show signs of acceleration, which we expect to continue through the Q4 and into 2021. In addition, in our core IT 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 relationships. Now I want to provide an update on the strategic process, which our Board previously authorized and we disclosed on our Q2 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 the separation of the MSP business from SolarWinds will create 2 independent companies that are both market leaders, each focused on their different businesses, customers and strategic initiatives. In addition, each business would have the freedom to develop investment plans unique to the dynamics and maturity of the markets which they serve.
Under the direction and oversight of our Board of Directors, over the last 3 months, we've been reviewing the businesses and related considerations in-depth and developing detailed plans to separate the 2 businesses into separately traded public companies. Based on the work done to date, 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 of the MSC business and then receive final approval by our Board of Directors would occur during the first half of twenty twenty one. However, there are still a number of legal, organizational and operational items that must be accomplished over the coming months to finalize the definitive proposal for final separation for approval by our Board of Directors. The last item for which I'll provide an update is the status of the CEO search for SolarWinds.
First, as a reminder, John Paliuca, who is on this call, will be the CEO of the MSP business should the spin off transaction be completed. Therefore, we are currently searching for a CEO to lead the core IT management business. We've engaged an outside executive search firm to lead this search and they have presented a number of qualified and interested candidates to the search committee of our Board of Directors. The search committee has interviewed several candidates and believes that pool of interested candidates is of 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 earnings call which I will lead as the CEO of SolarWinds. For me on the call, we have known each other for my entire 14.5 year tenure at SolarWinds. And for some, we even go all the way back to my days at Red Hat. For those in this group, isn't it amazing how fast 2 decades go by? I appreciate the level of your engagement and interest in the SolarWinds story over the last decade, and I do believe that we have created a very unique software company in SolarWinds.
I hope that you will continue to be engaged in the SolarWinds story in the years to come. And I'm certain we will run into each other again in the future as it is still a small technology world. We have approximately 3,300 Solaris around the world. I will miss the way you have constantly challenged me. I will miss your energy, your enthusiasm and your ability to constantly pick yourself up and get back in the game when things did not go exactly the way we wanted them to.
Thank you for believing we could build a great company on the foundation of great products, digital marketing and a selling from the inside model when very few others believed it was possible. Keep believing as there
Speaker 0
And your first question comes from the line of Brad Zelnick from Credit Suisse. Your line is open.
Speaker 2
Fantastic. Thank you
Speaker 3
so much. And Kevin, your parting words 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, at least 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, not only for SolarWinds, but amongst all the companies we cover. So I truly wish you the best. Maybe just to the business, if I can ask you, Bart, great to see the license trajectory improve 10% down this quarter better than where you were last quarter.
And I totally understand there's some impact from the shift to on prem subscription that you've called out. Can you just, a, remind us what portion of the on prem offering is available as a subscription? About just on trend, what that license growth rate should be and what the trade off is, how should we even wrap our minds around that?
Speaker 2
Yes, as you said, Brad, we had a really solid quarter from a license revenue perspective and a noticeable improvement from what we saw in the second quarter. The 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 are now offered under a subscription basis. So that's the shift that we're looking at. Like we've said before, it's a transition for us.
We're not looking to move our existing customers off of maintenance. They still have a lower price on their maintenance than they would under a subscription. It's really centered around giving new buyers the alternative to buy under a subscription agreement.
Speaker 1
And as it relates to kind of trends as we look at the Q4, what we're assuming right now, Brad, is that the trends in that part of the business in the 4th quarter are pretty consistent with what we saw in the Q3, which is we had strength in certain markets. The EMEA was very good in the Q3. North America, including the impact of selling into state, local and federal government was solid in the 3rd quarter. Some of the other markets were not quite as stable yet. We're assuming we'll see that same variability in the Q4 and that the kind of the economic environment, the level of spending from an IT perspective, particularly in on premise environments where we're really strong, we'll be consistent in the Q4 with the Q3.
So we're not expecting any meaningful improvement in the Q4. I do think moving into 2021, we will start to see improvement. We may see some in the Q4, but as you know, the noise level in the market right now is kind of fluctuating back to a higher level of shutdowns in May, start to occur at a higher level in the Q4 than what we saw in the 3rd. And so we try to make all that into our view of the Q4.
Speaker 3
That's very helpful. And if I can 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 Datto. And I'd just be curious, what if any impressions do you have from their IPO process? And as well, just thinking about if you can educate us a little bit more on the finer points as to how SolarWinds is positioned against them in the market, that would be really helpful.
Speaker 2
Yes, sure. Look, we're actually glad to see Datto have a successful IPO with respect to the Datto team and the business that they have there. They have a 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 a good job kind of telling the story that our MSPs carry on every day.
But where we actually find ourselves selling a lot of times with them, our MSPs will usually have the Datto offering and our offering in the same kind of environment as they manage and back up small medium enterprises across the globe.
Speaker 1
Yes. I think the thing to remember, Brad, I think we talked about this is that we are really strong when it comes to remote monitoring management automation and helping our MSPs manage their customer environments. And we believe we've got the strongest growing platform and product portfolio there. We have great security technology. We have great remote monitoring and management technology.
Obviously, as a business, we're really good at monitoring and managing performance of environment. Data really started as a backup company who bought a PA Professional Services Automation Company. So that's where their strength is. We're strong in different parts of the MSP market. So it's not that we don't compete, but we are not direct head to head with them on a daily basis because our strengths are a little bit different.
We do have backup and we have a really good cloud to cloud backup solution, which is growing very nicely for us. But they're more hardware based, they are more environments that are not as cloudy as environments we're in. So while we compete in the market, we are relatively different in 2 businesses today. Got it.
Speaker 0
Your next question comes from the line of Sanjit Singh from Morgan Stanley.
Speaker 4
Hi, thank you for taking the questions. And it will be a pretty strange feeling if Kevin is on the next call. I can imagine Kevin and SolarWinds, like that is those sweet teas that are going to like peanut butter and jelly. But I think probably the biggest accomplishment, Kevin, is creating a sustainable business. And that's exactly what you built, a business that generates tons of cash and grew double digit in terms of ARR in the middle of a really challenging economic environment.
And so just to pick up on that last point, you sort of mentioned in your script, Kevin, about science of acceleration. I was wondering if you could give us a little more detail on that. Can you sort of break it out by the MSP business. Where are you seeing some of those sides as it relates to customer expansion and maybe whether it's churn or new customer acquisitions? If you can just give us some more color there that would be helpful.
Speaker 1
Yes. So a couple of things like I mentioned that because I talked fast and I don't think you lost. One of the things we saw in the Q3 was an improvement in sales and new customers. So that's one of the trends that we're seeing. We're seeing more businesses that have not been previously been customers of ours, which I know it's hard to believe that everyone's not a customer, given the number of customers we have.
So we saw a nice increase in the number of new customers compared to the 2nd quarter. We're not at all time highs or anything like that. We saw an improvement in the Q3 of Q2. We also saw good spending levels by our larger enterprise customers. We closed a number of transactions assigned in the quarter.
Those transactions, not only did we close those, but we closed in the expected timeframe, which for me is a sign that technology pros at least know what their budgets are now, which I don't think they really did in the Q2. So while budgets 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're able to spend them on because we're seeing the activity have a more purpose to it and with the IT pros having a knowledge of what they can spend and the top rate they can spend it in. The other thing we are seeing is we're seeing an increase in just the level of activity, meaning demos of our product, online quotes, people downloading and reading white papers, calling in and talking to us. So that which is another sign that at least things are starting to return which is another sign that at least things are starting to return to normal a little bit. Technology pros have the time of the day now to look for solutions to make their lives better, to make their businesses run more effectively.
Building 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're offering to their end users. So they're looking at, hey, I don't provide a pinpoint section to this customer today, let's talk to them about it and let's provide it to them tomorrow. Some of our newer offerings are starting to accelerate again. And even with our small business, very small MSDs and there are a lot of very, very small MSDs in the market, That's probably another place we differentiate from data going back to the earlier question.
We serve in the feeds of all sizes from 2 guys in a dog in the garage or 1 guy in a dog in the garage, for that matter, to USBs that have 100 technicians in those really small MSPs where we saw the devices really drop a good bit in the Q2 and early Q3, we've seen stabilization. We've seen that device count get stable. Now we haven't seen it start to grow really quickly yet, but we have seen stability. So those are the signs that we look at across the business, both in our small business customers as well as our large enterprise customers that tell us that while the economy is not in a great place, I think we all agree to that. There's still some instability, still some uncertainty.
I think there's more consistent activity and consistency in spending than what we were seeing before.
Speaker 4
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 look at the growth profile of the business, Sean, it's sort of
Speaker 5
been sort of 12% in the
Speaker 4
most recent quarter, but kind of mid teens and then an expansion rate a net expansion rate of in the sort of 105% to 108% range. In terms of if you wanted to grow the business faster, sectors that you'd be targeting? And what would be the sort of the key leverage in Compulse actually grows? Is it just a function of more investment equals more growth or do you need to take the product portfolio into new areas? Can you just sort of frame out the growth opportunity for us?
I think that would be super helpful.
Speaker 2
Sure. We talked a lot about some of the reasons for the spin. And for the MSP business, it's really the increased investment in a couple of areas around R and 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 MSPs, both small and large. So what you'd see is an increased investment and more frequent addition of offerings to our MSPs that they can go and make sure that they're securing and managing these small, medium enterprises.
So that's a big trend. And then the second one is along customer success. What we're finding is introducing more humans in the loop. Kevin talked about the MSPs being from 1 guy with his dog in the basement to $1,000,000,000 enterprise, well, they have different needs and they need different touch points and types of customer success. So we'll be investing in that area to make sure that we're providing a little bit more of a bespoke level of service to these different types of personas that we have in our business.
Speaker 4
Understood. Thank you, guys.
Speaker 2
Thanks, Tim. Thanks, Tim.
Speaker 0
Your next question comes from the line of Rob Oliver from Baird. Your line is open.
Speaker 6
Great. Thank you guys very much for taking my question. And just wanted to echo the comments, Kevin. Best wishes to you and your retirement. Somehow, I doubt it's going
Speaker 1
to end up being that.
Speaker 6
Still trying to chase you on the Peloton, and I imagine that that cap is going to widen when you have more free time. Yes, you're tough to catch up with. So thanks very much. Just a couple
Speaker 2
of quick questions from
Speaker 6
me. 1, on the subscription side of things, just curious, it sounds like
Speaker 4
you guys are off to
Speaker 6
a good start with the Orion core products being sold into new customers as an offering. Is that where we are seeing the subscription momentum right now? I guess would love to get an update since we didn't you guys had a lot to talk about on this call. We didn't hear much about, say, ITSM or observability. And just curious, particularly given the tough macro where some of your price points might really play into the hands of people, particularly I'm thinking about Samanage and others and got a quick follow-up as well.
Speaker 1
Yes. So if you look at that cloud product portfolio we have in the core IT management part of the business that manages applications, manages the log management, the ITSM and the cloud. We're seeing consistent performance there. We haven't seen an acceleration as a result of Komet, 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've got good technology, we've got selling price points.
As 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 there's going to be a large opportunity just because we believe we're still early and we don't want to get into spending more with the other players in that market that are out spending us 2030 to 1 right now, just not the way we go in intermarket. So performing fine, performing consistently, not seeing an acceleration, didn't really expect it to. We didn't build that in our outlook. So performing consistent with how we would expect them to perform. I think the growth in subscription revenue is being driven by a lot of different factors.
One, it's because of for sure. 2, yes, we're starting to sell a decent dollar amount, still small as a percentage of total sales of our Orion family of products, but a decent dollar amount is growing in dollars. We've doubled sequentially Q3 to Q3. We think we'll see another meaningful level of growth sequentially from Q3 to Q4 in sales and subscription offerings to that product group. And maybe I think to remember is we do recognize some amount of that revenue when we sell one of those on prem products in the form of subscription.
We recognize some of that upfront immediately as in subscription revenue. We'll be in 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 for our core IT business for quite a long time to come.
Speaker 6
Great. Thanks. And my follow-up was on just on CenturyOne. You just wanted to dig in
Speaker 1
a little bit more on
Speaker 6
the thought process there. Was it the ability to kind of get product, get the infrastructure as
Speaker 1
a service players?
Speaker 6
What was it and what is it in the product portfolio that you guys were most attracted to? Thanks very much, guys.
Speaker 1
Yes, the interesting thing about CenturyLink is that they complement our product offerings in a 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 database developers and they really are focused on the Microsoft environment. So Microsoft SQL Server, Microsoft Azure SQL, Microsoft Data Platform, they were really born in that Microsoft world and they focused on building great relationships with that Microsoft database admin.
And they have those tools which we really don't have. They've got monitoring capabilities that we did not have. They've got deeper monitoring capabilities than 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 creates a pretty powerful combination. By adding their product portfolio to ours, it now fills in a lot of the gaps we had in providing solutions to database developers and database administrators really without regard to where they're deploying their technology, whether it's deployed in the cloud or whether it's deployed on premise.
So it really does give us a very, very broad set of database management capabilities. We don't think anyone else in the market is really even close in terms of the breadth of coverage we have. You name the database, you name the deployment model, we now provide not just some level of monitoring 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 can do that from the cloud and we can manage things in the cloud. So it really gives us a very comprehensive suite, kind of like what we developed in the network management market, right?
We manage everyone's network gear. We manage all the aspects of that gear. We have really no meaningful gaps in our ability to manage network environments and organizations of all sizes in all deployment models. We are now going to be in a similar position in terms of database management. Great.
Thanks again, guys. Thank you. Excuse me. For those in the queue and operator, can we please eliminate everyone with just one question going forward to help ensure that everyone gets any question? Thank you.
Speaker 0
And your next question comes from the line of Matt Hedberg from RBC Capital Markets. Your line is open.
Speaker 2
Great. Thanks for taking my question, guys. And I'll obviously echo everybody's 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 had some positive comments on a reacceleration of the MSP business.
I'm curious about the growth dynamic when you think about adding additional MSPs versus selling more products through to their SMB customers. What's the right algorithm to think about those two variables? Yes. So, I mean, our model is pretty dynamic in that we grow obviously when we add MSPs and we spent 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 to really help these MSPs win and grow their business. The power metrics get obviously much larger as the further out we go, right?
So we're managing millions of devices and we're managing 100 of 1000 over 500,000 small, medium businesses. So the more that we can do to have those MSPs successfully manage and secure those small, medium businesses, that's really where the highly leveraged model really starts to play. So as we introduce more offerings for those SMBs excuse me, for those MSPs to offer to the SMB and provide a service around, that for us is a pretty profitable kind of return on our investment.
Speaker 1
Yes. Matt, if you remember, we talked about at the beginning of 2019, one of the changes that John and his team made is we moved away from just focusing on the number of MSPs we're adding and we started focusing on the healthy MSPs we wanted to add to our family of MSPs and then focus on growing them. So that's when I say that, it doesn't mean we're really chasing large MSPs or not. We're chasing healthy small MSPs, healthy mid sized MSPs, healthy large MSPs and then we're making sure that they grow over the term of the relationship with us. And when you remember, we talked about the fact that we have changed our sales rep compensation plan, So they live with the MSPs they bring in for the 1st 6 months of their relationship with us and we build into their quotas an expected growth in that relationship.
So you can't just land 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 Joe's comment. Making sure that MSPs we land grow, we won't have much of new MSPs, we won't put that by itself is not the right equation. The algorithm is land MSPs that can grow.
It doesn't matter how big they are when we land them, just land MSPs that can grow and then we got to make sure we help them grow. Super helpful.
Speaker 3
Thanks a lot, guys.
Speaker 1
Thank you.
Speaker 0
Your next question comes from the line of Kingsley Crane from Berenberg Capital Markets. Your line is open.
Speaker 2
Good afternoon. Thanks for taking my questions. And likewise, I want to congratulate both Kevin and John. I just have one quick one follow-up on the CenturyOne acquisition. So given the breadth of the capabilities you're acquiring here, including features and categories like data ops and cloud migration, How might these fit into the existing SKUs between DPA and DPM or perhaps their entirely new SKU?
Speaker 1
Yes. So look, I think you should expect, 1, there will be a lot of entirely new SKU. They have a great product set. Their products have been well packaged. They've thought and very thoughtful about how they combine a set of features, put that in a SKU and provide 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 database app and 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 some problems we're not giving them the ability to solve very effectively today. You see combination enough, you're bringing their SKUs to market pretty much the way they have them and then us figuring out ways to combine the products into a 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 because they've done a great job of building a great business and then we'll gradually figure out how we bring value to their team by giving them access to our customer base, by giving them access to our development team, by finding ways to combine the technology.
Speaker 2
Wonderful. Thank you.
Speaker 0
Your next question comes from the line of Terry Tillman from Truist Securities. Your line is open.
Speaker 3
Kevin, congrats from me as well. And we will miss you, and I'm sure you're
Speaker 5
going to miss our amazing questions.
Speaker 1
I was a good listener all the way
Speaker 3
back to the Red Hat Day. I was a good listener. So I'll just ask 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.
Speaker 1
So public sector has been interesting over the last 6 months. I think the federal government, so that's part of the public sector, has been strong, been consistent and predictable, at least as predictable as that part of the market ever gets. As you guys know, federal buying process is a little bit obscure. It requires a little bit of witchcraft to really understand it. But we've got a good team there that is very experienced with us a long time.
They're doing a good job of managing that process. So buying activity there has 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 part of the market has been good. State local has been a little bit variable on the education side, not great. It's been been a little bit slow, been kind of up and down. School systems have been struggling with a lot of things. As you guys know, with most of their students being online and now hybrid and now some back in the classroom and they send them back home, the budgets there have been a little bit hard to access, but the team has been performing, I think, as well as can be expected in that environment.
State, a little bit better. So as a state federal is where you see more strength, In a local education, you're seeing a little more weakness. Thank you. Yes.
Speaker 0
Your next question comes from the line of Erik Suppiger from JMP Securities.
Speaker 2
Taking the question and again congrats on moving on. Question on Ryan, as with your existing customers as they purchase new or add on business, are they doing that with subscription business? And if that's the case, then does that ultimately lead to a deceleration in your maintenance business?
Speaker 1
So the answer is it won't result in a deceleration in our maintenance business. If you own a license from us, we've always gotten all the same things you would get for a subscription relationship, which is every release we ever do left and right dot, you just add as well as your 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, it's still less expensive for them to stay on that maintenance relationship and there's nothing new they get by moving to subscription at least today. That could 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 own?
So let's say they own NPM, but they don't own NetFlow or they don't SAM. They come back to buy NetFlow with SAM. 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, if they own license and they're buying licenses, most of the sales and subscriptions have come into new customers so far, not all. And I do think we'll see more and more of our existing customers buy subscriptions 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 frictional as possible and we make it easy for our customers to buy. So if they want to buy subscription and take that subscription product and integrate it with their licensed product, you can absolutely do that.
Speaker 2
Very good. Thank you. Thank you.
Speaker 0
Your next question comes from the line of Sterling Auty from JPMorgan. Your line is open.
Speaker 5
Yes, it's Alexis on for Sterling Auty. So it looks like your customer additions improved in this quarter. Is that the case? And what do you expect to happen from here given the macro backdrop?
Speaker 1
Can you repeat the question? I didn't hear the first part. You're breaking up just a little.
Speaker 5
Okay. So looks like your customer additions improved in the quarter. Is that the case? And what do you expect to happen from here given the macro backdrop?
Speaker 1
Yes. So I think the growth of the quarter, one thing we mentioned is we saw acceleration in the number of new customers we were adding sequentially. That doesn't drive a tremendous dollar amount of revenue growth right away because most of the new customers start relatively small. That's true in the MSC business, that's true in the core IT management business, it's true with our cloud management product, both customers are relatively small. We saw good customer retention in the quarter.
Our renewal rates stayed strong, our net retention rates stayed stable. That helped drive growth. As I look forward at the Q4, I do expect we'll continue to see some momentum in new customer additions. I think that customer retention will continue to be strong. I think we will begin to see a little more rapid pace at which our customers are growing their relationships with us.
As John mentioned on the MSP side, our larger MSPs are beginning to see device growth, which means they're paying us more late. On the large enterprise side and core IT management, we're seeing good momentum in terms of customers expanding in a meaningful way, their relationships are with us. So it's really the combination of all of that to help drive our overall revenue growth. We're not really fully leveraged to 1 or the other zone. Customer transactions tend to be larger.
And so we're going to see more growth in dollars from customers even if we don't see more growth in percentage.
Speaker 5
And a quick follow-up if I can. So in light of looking to split the company, has there been any pushback from new or existing customers?
Speaker 1
No, we haven't heard anything from our customers about the sequential split of the business. I think it really comes down to the fact that we've been running the business in 2 units for a while now. The MSP market is a very, very specific market and requires a very specific engagement model. So while we do digital marketing, selling from the 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 IT buyer or a DevOps buyer.
So reality is those 2 different parts of our customer base, they don't care about each other very much. And they're not using they're not really cross using products out of the 2 different product portfolios. So we haven't heard any noise at all from our customers about this potential split. Thank you. Operator, next
Speaker 4
question comes from
Speaker 0
Your next question comes from the line of Mohit Gajah from Barclays.
Speaker 5
Kevin, I'll offer you my best wishes as well as you look ahead to a professional career outside of Silver Wind 20. So staying on that topic, Kevin. So earlier in the year, I think we discussed around some sort of initiatives around maybe you're going to look to sell cross sell cross IT products into the MSP base. But even outside of that, right, so I'm assuming as we go through the discussions of separating the 2 businesses, there are maybe certain synergies maybe on the product R and D side, maybe on the go to market side. How do you sort of like think about those synergies if they are and maybe as 2 separate just making sure that no dis synergies that happen as a result of the separation?
Thanks for taking my question.
Speaker 1
Yes, without a doubt, we have shared technology between the product portfolios over time. And one the things we're making sure we do as part of the process of looking at how we would separate these 2 businesses is making sure that both businesses get all of the IT, if you will, that they need to accomplish the things they need to accomplish in the future. So if we believe that for certain IT businesses, not the core IT management 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 if they're selling it already. If they're not selling it already, but they believe it's strategic to them, we'll cross license it so they can in going in other direction also.
So I'm not worried about technology dissynergy because one, we've done a lot of the work that we needed to do to share technology between the product portfolios and the product platforms. And we've got a good view, we believe, of what will need to be done in the future. So we'll be able to handle that in the way that we create the separation, the way we create licensing between the two businesses and also the way we build the transition services agreement between the two businesses to make sure that we 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 a good visibility on 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 4 years is to create a set of best practices that we're leveraging across our global business. And so the key is to make sure those best practices MSP, a separate go to market team for the core IT 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 2 separate companies.
So there's not a loss of a capability from a go to market perspective when we split because we have shared those capabilities to all the teams, have the expertise, they have those processes, they have those methodologies. So there should be no slowdown as a result of the split. Thank you, Mohit. Operator, I think we have time for one more
Speaker 0
And your last question comes from the line of Brent Thill from Jefferies.
Speaker 5
This is Russ Souda on for Brent Phil. Congrats, Kevin, on a great impressive run and wish you all the best for the future. I wanted to ask one quick one on the margin, obviously, impressive margins this quarter. But some you mentioned some commentary that the go to market you're planning to increase investments in terms of headcount next quarter. So what is this investment sort
Speaker 3
of focused on? And
Speaker 5
as we look out to 2021, what do you expect in terms of margin? Thank you.
Speaker 1
Yes. The comment on headcount was not limited to go to market. We have been very, very careful about adding resources over the last 6 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 rating which we've been hiring to make sure that in a distant from each other world that we can do a good job of onboarding and training and get people productive right away.
So it's not just going to market we will hire a little bit more in the Q4 than we did in the second and third quarter. Go to market is one of the areas, but also R and D, also our back end system teams. MSP business, we talked about, it's been a part of the separation process of looking to invest more heavily in product, more heavily in 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 use the word expect because with hiring you never know exactly how it's going to go. And there are a couple of holidays in the Q4, which sometimes makes it a little more difficult to hire, but our expectation is we'll add more people to the team in the Q4 than we had the Q3. Obviously, we have the impact of the Century 1 acquisition that we expect to run at breakeven on a GAAP basis in the 4th quarter, but that breakeven will bring our overall EBITDA margins down a little because breakeven doesn't equal 51%. So that will have a little bit of an impact. And on the go to market side, it's really making smart marketing investments and spending money where we're seeing return.
We pulled back in our variable spending and marketing in the second quarter and Q3 because of a view that we could spend a lot of money and maybe get clicks, but then the people would 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 IT Pros, DevOps Pros, MSPs have a better view today than they did 3, 4 months ago. Of the money they've got available to spend. 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 4th quarter, still really even more profitable than probably what we set out at the beginning of the year for the Q4. We just had an extraordinary level of profitability we delivered in the Q3. And I think with that, operator, we're going to wrap the call up.
We appreciate the questions and the attention. And thanks for being on the call.
Speaker 0
Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.