SolarWinds - Q3 2022

Transcript

Speaker 0

Good morning. My name is Adra, and I will be your conference operator today. At this time, I would like to welcome everyone to SolarWinds Q3 2022 Earnings Call. Today's conference is being recorded. All lines have been placed on mute to prevent any background noise.

After the speakers' remarks, there will be a question and answer session. At this time, I would like to turn the conference over to Tim Khuraja. Please go ahead.

Speaker 1

The Thank you. Good morning, everyone, and welcome to the SolarWinds' 3rd quarter 2022 earnings call. With me today is Sudhakar Ramakrishna, our President and CEO and Bart Kalsu, our CFO. Following prepared remarks, we will have a question and answer session. This call is being simultaneously webcast on our Investor Relations website Investor Relations website, you can also find our earnings press release and the summary slide deck, which is intended to supplement our prepared remarks during today's call.

Conference call. Please remember that certain statements made during this call are forward looking statements, including those concerning our financial outlook, our market opportunities, our expectations regarding customer retention and our evolution to subscription first mentality, the impact of the global economic and geopolitical environment on our business, the timing of the phases of our subscription evolution, our gross level of debt SEC and the impact of cyber incident and cybersecurity generally on our business. These statements are based on currently available information and assumptions, conference call today, and we undertake no duty to update this information except as required by law. These statements are subject to a number of risks SEC and uncertainties, including the numerous risks and uncertainties highlighted in today's earnings release and our filings with the SEC. The Copies are available from the SEC on our Investor Relations website.

We completed the subpoena of Enable on July 19, 2021, and accordingly have included the results of the Enable business as discontinued operations for historical periods. Therefore, the financial results presented on this call reflect SolarWinds as a stand alone business and do not include any contribution company's EnerSys business. Furthermore, we will discuss various non GAAP financial measures on today's call. The Unless otherwise specified, when we refer to financial measures, we will be referring to the non GAAP financial measures. A reconciliation of the 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.

As a reminder, Beginning with the Q1 of 2022, we no longer adjust our revenue for the impact of purchase accounting. For the Q3 of 2022, non GAAP total revenue is equivalent to our GAAP total revenue. Finally, we note that the financial results discussed on today's call and in our earnings release are preliminary and standing final review by our internal auditors, and we will not be final until we file the quarterly report on Form 10Q. Conference call. With that,

Speaker 2

I will now turn the call over to Sudhakar. Thank you, Tim. Good morning, everyone, and thank you for joining us today. As always, I'd like to start by thanking our employees, customers, partners and shareholders for their ongoing commitment to SolarWinds. I'm extremely proud of all our team accomplished during the quarter Considering a challenging macro environment.

Let me start with a few comments on our Q3 2022 results. We have several highlights, including continued subscription revenue growth in line with our subscription first strategy, continued execution on customer retention, healthy EBITDA margin reflecting our commitment to expense and operating discipline, expansion of our route to market with the announcement of our Transform Partner Program. Strong adoption of hybrid cloud observability, representing the superior value that we believe we deliver to customers. Continued federal business execution demonstrating our strength in and commitment to the public sector strategic and major product announcements, including key milestones in our observability evolution. I will touch on some of these before turning it over to Bart for more color on the quarter as well as our financial outlook for the balance of the year.

In Q3 2022, we delivered revenues of $179,000,000 Since we provided guidance, revenue assuming foreign currency exchange rate used in our previously issued outlook Within our guidance range and on a constant currency basis, we delivered a 1% year over year growth. I'm excited to report that in Q3, our in quarter maintenance renewal rate was 91% And our trailing 12 month renewal rates are now at 91%. Both these metrics were impacted negatively by currency headwinds, But even with that, I'm happy to report the strong execution. I attribute these results to the commitment of our team, the relevancy of our solutions, the resiliency of our business model and the trust our customers plays in us. The We continue to make demonstrable progress with our subscription first strategy and delivered 3rd quarter subscription revenue growth of 51% year over year.

While shifting to a subscription first strategy has resulted in some total revenue headwinds, We continue to believe it is the right strategy for our business as we focus on growing annual recurring revenues to over $1,000,000,000 Laser Foundation for even more predictable revenue and the opportunity to expand our lifetime value with customers. We ended the Q3 of 2022 with 882 customers over the comparable period in the previous year. More and more, we are helping customers reduce tools strong, achieve comprehensive visibility across multi cloud environments, eliminate alert fatigue and accelerate their digital transformation, Leading to larger deal sizes. Adjusted EBITDA was $70,300,000 Now I'd like to take a step back and reflect on the strategy we laid out at our Analyst and Investors Day 1 year ago We committed to our customers and to the industry that we will retain the best of what made SolarWinds what it is today, evolve with our customers' needs and grow together in our mission to help customers accelerate their business transformation to the simple, powerful and secure solution designed for hybrid and multi cloud environment. I believe our portfolio and execution enable us to deliver the best time to value, best time to detect issues and the best time to remediate issues in our customers' multi cloud environments.

We aim to be the best at improving our customers' security, productivity and total cost. Our portfolio is broad and we believe our addressable market is large. We are making strong progress in our database performance monitoring service management part of the business. But today, I'll focus on our evolution to observability and it's significant to our future growth. The A key element of our strategy is transitioning from monitoring to observability solutions to address the productivity, cost and complexity challenges our customers increasingly face.

We made tremendous progress during Q3 and many of you joined us for our first ever SolarWinds Day event 2 weeks ago, Where we made exciting announcements. First, we unveiled SolarWinds observability based on our SolarWinds platform, This will be the basis for all future solutions. This full stack software as a service solution We also announced an updated version of our SolarWinds Hybrid Cloud Observability Solution less than 6 months asset initial introduction. Isaac Cloud observability now features enhanced anomaly detection capabilities powered by artificial intelligence and machine learning, call. While continuing to enable SolarWinds customers to migrate from on premises to SaaS at their own pace applications and databases.

However, hybrid and multi cloud IP environments are becoming increasingly complex solution and more challenging for customers to manage. Observability solutions are designed to solve this problem to the Expedite Anomaly Detection and Resolution. SolarWinds was born built on a foundation and commitment to providing customers with simple, secure and value based solutions to help them digitally transform their company. These latest announcements reinforce our foundational principles. Another element Transform Partner Program last month.

Transform represents our enhanced focus on Xiaomi's growth and development Global System Integrators, Managed Service Providers and Cloud Partners across the globe. We are excited to strengthen our relationship with our partners leadership hires to support our channel growth, including Chad Reese, who joined SolarWinds during the quarter as our President of Americas Sales Global Challenge. Chad brings 25 years of technology industry experience, serving in leadership positions at IBM Amongst others, one thing that has stood out to me during my tenure at Sullivan is the resiliency of our business model and the stickiness of our solutions, particularly during challenging periods. We believe our highly cost effective solutions, diversified customer base, compelling value proposition and high velocity transaction model Enable us to operate successfully through challenging macro environments. This is reflected in our consistently strong customer retention the Like many of our software peers, we did experience some delays in deal closures during the quarter, particularly in Europe.

We'll continue to monitor the environment closely, but we remain confident in our long term opportunity and are sharply focused strategic priorities. We are and always have been focused on our capital allocation and expense management. We continue to seek to balance growth and margin expansion. Our management team has led companies through previous downturns And we intend to diligently manage costs across our businesses. These attributes remain a foundation of who we are and over the years We have worked hard to build an even sturdier business model on this foundation.

With that, I will turn it over to Bart to expand on our financial performance and to provide an updated full year outlook. Bart?

Speaker 3

The Thanks, Sudhakar, and thanks again to everyone joining us on today's call. I'd like to start by reminding everyone of our 2022 strategic focus around growing with a subscription first mentality. With this, it is important to emphasize that our subscription transition will be multifaceted. The first phase of the transition entails selling subscriptions of both our existing on premises products and our hybrid cloud observability product. The The second phase of the transition begins with the recent launch of our SaaS observability solution.

It is our belief that these two models of subscription growth will persist in our business and our overall focus is to grow subscription ARR, while exercising operating discipline. The Our Q3 results reflect our ongoing progress with this transition and represents another quarter of execution of our strategy. Turning to the numbers. We finished the Q3 with total revenue of $179,400,000 Which is a slight decline compared to the prior year and below the total revenue range of outlook we provided of $180,000,000 to $185,000,000 Total revenue assuming the foreign currency exchange rates used in our previously issued outlook would have been $180,300,000 and within our guided range. Like other companies with foreign currency exposure, we felt the impact of the decrease in the value of the euro compared to the U.

S. Dollar. On a constant currency basis, our total revenue would have been approximately $184,000,000 which is a slight increase over the prior year. The We ended the 3rd quarter with total ARR of $623,000,000 roughly flat compared to the prior year. And on a constant currency basis, our total ARR would have represented an increase of approximately 2% over the prior year.

The Our subscription ARR as of September 30 was $159,000,000 which is an increase of 23% year over year. This growth is mainly due to the execution of our subscription first strategy as well as the conversion of a portion of our maintenance base to the hybrid cloud observability solution. Digging into the revenue details, our 3rd quarter subscription revenue was $42,000,000 up 31% year over year. Our subscription revenue growth reflects the ongoing success of our subscription first efforts. The transition to a subscription first strategy creates headwinds the current quarter total revenue.

However, we believe that an increasing percentage of new deals made on a subscription basis will result in a higher recurring revenue in the long term. Maintenance revenue was $114,000,000 in the 3rd quarter, which is a decrease of 4% from the prior year. As we have discussed recently, our maintenance revenue has been impacted by the conversion of a portion of our maintenance customers to subscriptions As well as the lower euro to U. S. Dollar conversion rate in 2022 compared to the prior year.

Our maintenance renewal rate is at 91% on a trailing 12 month basis, the as well as our in quarter rate for the Q3. These rates are consistent with our historical performance and both are impacted by currency headwinds. We believe this is a testament to the loyalty of our customer base and our focused customer retention and expansion efforts over the past 12 to 18 months. Note that as we convert maintenance customers to subscription arrangements, we will exclude those customers from the renewal rate calculation. The For the Q3, license revenue was $23,000,000 which represents a decline of approximately 22% as compared to the Q3 of 2021.

Keep in mind that our new perpetual license sales performance will continue to be impacted by our subscription first focus. As noted previously, our increased sales of subscriptions the the decline in license revenue in the quarter. Earlier in the year, we talked about how our federal customers are slowing to reach spending decisions. And we are pleased that we saw improved sales performance from our federal and public sector customers in the Q3 compared to a year ago. The We finished the Q3 of 2022 with 882 customers who have spent more than $100,000 with us in the last 12 months, which is a 12% improvement over the previous year.

This marks the 3rd consecutive quarter with double digit growth in this metric. We continue to supplement our traditional high velocity low touch sales approach with the targeted efforts to build more strategic relationships conference call with our enterprise customers, which we detailed at our Analyst and Investor Day 1 year ago. I'm also pleased to report that we delivered another quarter of strong non GAAP profitability. 3rd quarter adjusted EBITDA was $70,300,000 representing an adjusted EBITDA margin of 39%, Which is in line with our outlook for the quarter, even as we continue to invest selectively in our business. Excluded from adjusted EBITDA in the 3rd quarter, our one time cost conference call of approximately $10,800,000 of litigation and governmental investigation costs and other professional fees related to the Sunburst cyber incident.

We expect one time cyber incident related costs to fluctuate in future quarters and these one time cyber costs are difficult to predict. Turning to our balance sheet. Net leverage at September 30th was approximately 3.9 times our trailing 12 months adjusted EBITDA. Our cash, cash equivalents and short term investment balance was at $493,000,000 at the end of the 3rd quarter, Bringing our net debt to approximately $1,100,000,000 In September, we made a voluntary debt prepayment in the amount of $300,000,000 Our debt matures in February of 2024 and we expect to make an additional payment to further reduce our level of gross debt in parallel as we work on a potential refinancing. I will now walk you through our outlook before turning it over to Sudhakar for some final thoughts.

I will start with our Q4 guidance and then discuss what that means for the full year. We arrived at our guidance taking into account the macro environment, FX headwinds and the impact of our subscription first business model transition. For the Q4, we expect total revenue to be in the range of 178 $283,000,000 representing a slight 3% year over year decline at the midpoint. On a constant currency basis, revenue at the low and high end of the range would be approximately $5,000,000 higher and it would represent a range of 2% decline to 1% growth year over year. The Adjusted EBITDA margin for the 4th quarter is expected to be approximately 38% to 39%.

Non GAAP fully diluted earnings per share is projected to be $0.23 to $0.25 per share, assuming an estimated 162,200,000 fully diluted shares outstanding. And finally, our outlook for the Q4 assumes a non GAAP tax rate of 25% and we expect to pay approximately $9,800,000 in cash taxes during the Q4. While our business model has proven to be resilient during challenging economic conditions and we remain confident in our business transition, We are lowering our full year guidance. This is primarily driven by our cautious approach that macro and economic conditions could deteriorate further and FX headwinds may continue. We are appropriately accounting for the fact that we remain early in our subscription transition.

For the full year, we now expect total revenue to be in the range of 7 end of $715,000,000 which is a slight 1% year over year decline and compares to prior guidance of $715,000,000 to 725,000,000 the On a constant currency basis, our total revenue guidance would be $725,000,000 to $730,000,000 or growth of 1% to 2% year over year. The Adjusted EBITDA margins for the year are expected to be approximately 39%, which is consistent with the guidance we provided last quarter. While we continue to manage our expenses, we remain focused on our product roadmap, robust core execution and subscription first strategy. The non GAAP fully diluted earnings per share is projected to be $0.87 to $0.89 per share, assuming an estimated 100 and 51,700,000 fully diluted shares outstanding. Our full year and 4th quarter guidance assumes a euro to dollar exchange rate of 0.97.

Finally, when you review our GAAP financials, you will notice an additional impairment of our goodwill, which resulted in a $279,000,000 non cash charge in the 3rd quarter. We determined this impairment was appropriate in light of the current macroeconomic environment and the continued deterioration in the equity markets. We are happy to announce that last week, we agreed to settle our securities class action lawsuit pending in the Western District of Texas the sworn amount that will be covered by insurance. While we still have ongoing government investigations related to cyber matters And we'll continue our approach of transparency and collaboration. Having resolved this litigation will enable the company to focus on

Speaker 2

our strategy. The You can

Speaker 3

find a more detailed update on our litigation and government investigations in our 8 ks filed today. With that, I'll turn the call back over to Sudhakar for his closing remarks.

Speaker 2

Thank you, Bart. The midpoint of the outlook Bart provided still represents year over year growth on a constant currency basis, which reflects our continued belief in the relevance of our solutions, the execution abilities of our teams and most critically the trust our customers and partners place in us. I'm very pleased with the momentum building for our new innovation and I'm confident as ever in the long term trajectory of our business. As we look to Q4 and to next year, I would like to share 3 near term priorities for us. 1st, we have a robust renewal business with over 90% renewal rate.

We remain very focused on customer retention and expansion efforts as we have been for the past 18 months. We continue to aggressively seek to drive subscription adoption across our business. While this has resulted and will likely continue to result in some variability in our reported revenue, the accelerated shift to subscription. It's consistent with how our customers want to consume our products and a key to our long term strategy And third, we will continue to exercise expense discipline in an increasingly challenging macro environment. As we look to 2023, we expect to continue to look for opportunities to invest selectively, to manage expenses tightly and to improve our operating margins.

We have an experienced management team and we have led companies to the CIRR through many economic cycles. I conclude again by thanking our employees, partners, customers and shareholders for their commitment to SolarWinds. Bart and I will now be happy to address your questions.

Speaker 0

The We'll take our first question from Terry Tillman at Truist Securities.

Speaker 4

Great. Good morning, team. This is Conor Pascarella on Terry, thanks for taking my questions. First one,

Speaker 2

I'd love to just dig

Speaker 4

a little bit deeper into federal this quarter. It seems like it was a pretty nice quarter in Q3, the busy season. Just curious on any important trends you saw amongst offerings or product adoptions during the quarter for these customers and maybe how the shift to SaaS or federal stacked up against enterprises. Any color there would be helpful.

Speaker 2

Thanks for your question. On the federal side, as Bart mentioned and I highlighted, we had the good growth in Q3. This is a result of not just like 1 quarter of activity. As you know, we have continued our engagement with our federal customers the For a long time and in particular for the last 2 years, and look at the quarter results as a further, call it, reflection of the confidence that the federal customers have in us and broadly speaking public sector, because we did well across the entire public sector, Fed and SLED last quarter. A combination of factors, I would say.

One is, I keep highlighting the stickiness of our solutions and the relevance and the value that we deliver to customers. 2 is the execution of our overall public sector teams this conference call in terms of engaging with customers, reaching out, supporting them through call it challenging times

Speaker 4

the Perfect. That's helpful. Thanks for the color. Maybe just as a follow-up, as you think about international markets like Europe, it seems that there's still a continuation of the longer sales cycles over there. How should we think about the pipeline in Europe and maybe the return of those deals as we move into next year?

Thank you, guys. Absolutely.

Speaker 2

Yes. The Europe with regards to the foreign exchange issues, you obviously know them all. So I'm not the except to highlight that it did have an impact on our reported revenues. With regard to the to demand as it relates to pipeline generation. The demand has been strong across all regions, Europe included.

The That being said, due to let's call it local condition, be it in Southern Europe or in Central Europe, some deals Get Push, which is going to happen in every business almost in every quarter and particularly accentuated, let's say, in these environments. The But at the same time, the trajectory of demand is on the up and we are managing our risk Across the business in terms of deal closure rates, the beauty of our company, I would say, is we have a very large part of our business that's A transaction high velocity business and we are increasingly supplementing it with partner activity and call it the high touch part of the business.

Speaker 4

The Great. Appreciate it. Thank you.

Speaker 0

We'll move next to Matthew Hedberg at RBC Capital Markets.

Speaker 5

The Hey, everyone. This is Simran on for Matt Hedberg. Thanks for taking our question. My first question is that with the continued the discussion of the question and answer session. Can you give us any update on SME spending and if there continues to be heightened scrutiny on deals over there?

Speaker 2

I'd say a lot more of the scrutiny happens to be in, call it, the upper mid market and enterprise. The SME segment, typically in these environments and especially with the cost effectiveness of our solutions the continues to be more robust, quite simply because of the base of customers that we have. The And so customer concentration is really, really low. And unlike, let's say, a pure play enterprise vendor. We are very broadly diversified across a large base of customers.

So I wouldn't say that there's anything particularly soft about the SME itself.

Speaker 5

The Okay, got it. And then also you recently announced the launch of SolarWinds Observability. The How has that initial response been and what would you say are the key benefits to that platform?

Speaker 2

Absolutely. It's been the a little over 2 weeks, I would say, since we launched this. The initial response from call it a pretrial standpoint with Customers has been very positive and likewise with analysts as well. The We recognize that this is going to be a journey of evolution from monitoring to observability. So don't look at it as we Stop what we are doing and then shift everything over to this.

As much as it's a continuum for customers as they deploy multi cloud environment as they think about evolving from premises to the cloud. And so the advantages that we provide, I'll state them Quite simply, one is that we are the only vendor that provides them a full continuum from premises to multi cloud environment, the number 1. Number 2 is that we provide the same levels of simplicity and cost effectiveness, ease of use that we have always been known for and we are able to deliver the best full stack capabilities. By that what I mean is the combination of network system application and database observability, including security observability on the same platform. The So continued focus on cost effectiveness, continued focus on ease of use, ease of deployment the and continued ability to give them full visibility to their entire environment.

Speaker 4

The

Speaker 5

Got it. Thank you.

Speaker 0

We'll take our next question from Patrick Schultz at Baird.

Speaker 6

The Hey, guys. Congrats on a great quarter and thanks for taking my question. I guess, first, it sounds like your partner strategy is just continuing to evolve. So I'm just wondering if you could talk a little bit the about how you see the partner ecosystem progressing in light of the current macro conditions? And with the recent product announcements you had at Solar Wednesday, How important is that partner ecosystem as you look to bring your solutions to market?

Absolutely.

Speaker 2

Again, thanks for your comments and questions. First, let me start with call it the high end or a higher end of the customer segment that we've been reaching out. That velocity of the transactional side of the business has always relied on partners. And so So think of this as amplification of it with both traditional value added resellers as well as MSPs. Now coming to the new products that you mentioned, the focus has been to work with large global system integrators.

The The relevance of us to them is only increasing. We have had very strong and close solutions that are now building with the Global System Integrators, where they're able to put their entire sales teams to work and integrate our solutions into their offerings and help us participate in larger digital transformation initiatives. The The reason for highlighting that from our perspective is we are the technology supplier in this overall equation. The That's a market that we traditionally have not accessed quite simply because it also tends to be longer sales cycles and more expensive. But having GSIs on our side is going to help us reach better through the Transform program the and also do it in a cost effective manner.

So I'm very excited about our opportunities in the broader enterprise space as we digitally transform customers with these solutions. To date, we did not have those solutions, but now we do and we also now have the relationship.

Speaker 6

The Great. That's very helpful color. And then just a quick one on renewals. Just given the ongoing macro uncertainty, How should we be thinking about the renewal level? Is the low 90% range sustainable even if we do enter into more challenged macro period?

The And are you seeing renewal rates diverge based on either the customer cohort sizes or geographies?

Speaker 2

No. As Bart mentioned, Despite currency headwinds, we have been able to maintain or get to our 91% trailing 12 months renewal rate. My belief the In talking to customers and looking at various partners is that that will continue to sustain.

Speaker 6

The Great. Thank you guys so much for my questions.

Speaker 0

We'll go next Eric Suppiger at JMP Securities.

Speaker 7

Yes. Thanks for taking the questions. First off, Bart, the You noted margin expansion in fiscal 'twenty three. Curious if you can give us any context in terms of the What you would aspire for there? Then secondly, can you talk a little bit about what is this going on with from an interest expense perspective as rates move up, how should we be modeling interest expense?

The And then lastly, so Doctor, when you're talking about your partners, your Global System Integrators working with SolarWinds. When are they using SolarWinds as part of their portfolio versus other observability

Speaker 4

the Technologies.

Speaker 2

Maybe I can address that first, Eric, and then Pat can chime in on the margin expansion. But I'll also highlight that We'll give a full view of 2023 when we report our Q4 results as well, including margin goals that we have established. And As I wrote, as I mentioned in my prepared comments, expense discipline and margin expansion is a key near term hierarchy for us As we enter 2023. Now coming to your question, Eric, I would say it is it varies. The We are engaged with a few very large and significant global system integrators at this point.

At least in one or a couple of cases, their strategy and approach given the comprehensiveness of our overall portfolio, especially now with both hybrid cloud observability and SaaS is that we will increasingly become their sole Observatory vendor. That is at least the stated strategy. I can't go into a lot of details yet just because those have not yet been fully announced, But that is the path we are taking. So just like we are consolidating tools and reducing tools for all with our customers, the the platform that has the broadest applicability to customers as they basically have talked. So that's kind of one approach.

The The other approach in some of the system integrators is much more pointed, meaning that they will either database monitoring solution as the first solution into the customer or for that matter our service management solution. So providing both an integrated platform as well as some of the more discrete solutions helps them pick and choose in that context. But increasingly, we are seeing their interest in the whole portfolio, given the advancements we've made in the last 18 months or so.

Speaker 7

The Great. Thank you. And Bart? And Eric, as

Speaker 3

far as our interest expense goes, we're in the process of the trying to work on refinancing our debt. So it's a little difficult for me to tell you exactly what to say from a modeling perspective. Obviously, the recent spike in interest the has caused our cash tax our cash interest to go up. I think it was around 14,000,000 the interest that we paid in the Q1. That number is up to about $24,000,000 in the 3rd quarter.

And obviously, that was impacted by the paying down some of our debt in the Q3. So when you're modeling it out, you should assume that somewhere in that it will be the A little bit it will be in that $24,000,000 range, maybe slightly less because we made a payment in the middle of the quarter.

Speaker 7

The Very good. All right. Thank you.

Speaker 0

Our next question comes from Bob Koinck at Morgan Stanley.

Speaker 2

Hi. This is Bob filling in for Sanjit. Just a question on your observability product that you rolled out on AWS and Azure. The Maybe can you talk about pricing in these products and in terms of how they the stack up against competitors in terms of pricing. Definitely.

So our goal is to continue to be a cost effective solution, I would say, across the industry. So in that sense, we compare very favorably with our competition. The It will be very difficult to provide like exact apples to apples because we tend to package and sell more full stack capabilities and that has again has the same connotation that I was highlighting on the hybrid cloud observability of tools consolidation the And simplification of deployment environments. So but on the other hand, I will reinforce that our pricing strategy continues to be Not so much a prize leader, in other words, I've mentioned this at our Analyst Day, we are not a cheap and cheerful company, so to speak, as much as

Speaker 0

school going next to Kirk Materne at Evercore ISI.

Speaker 8

Yes, thanks. Sudhakar, can you just on the observability side, Can you just talk about sort of the thought process about where the customers come from? Meaning, are these customers that are early on in the journey to the cloud? Are these potential customers that have started down the path with another vendor. I'm just trying to get a sense on how much of this opportunity for you all is going to be greenfield versus maybe replace

Speaker 3

the And how that might go over the long term? Thanks.

Speaker 2

Absolutely. So I'll give you kind of the Sure on how to think about this as we get into 2023. As it relates to Heidrick cloud observability, I would segment the adoption of the solution in 2 ways. 1 is our existing customers who are on a maintenance arrangement, Evolving and expanding with hybrid cloud availability for two reasons. One is the total and comprehensive functionality that we deliver to them, As well as the on ramp that we provide them to the cloud.

So in other words, they can move to the cloud at the pace at which they are ready to the So that's one set of customers. The second set of customers, which represent greenfield opportunities for us, our customers displacing, I would say, legacy monitoring solutions in favor of hybrid cloud observability, again for the reasons I mentioned, consolidation of tool sprawl, elimination of alert fatigue and so on. Now coming to the SaaS observability, which will again be a continuum of the hybrid cloud observability. I expect more of the customers in the initial phases to the call it our traditional application monitoring customers and largely speaking in the mid market, the Enterprise segment. But that's early days still given that we just announced it 2 weeks ago.

Speaker 8

The Okay. That's very helpful. And then Bart, you mentioned that the federal business did better this quarter. I guess, is there anything specific going on there just In terms of normal buying patterns returning and how should we think about that vertical as an opportunity?

Speaker 3

The Yes. Just the federal space is always the 3rd quarter is always our most active quarter, when it comes to our federal business, just because that's the end of their fiscal year. The That's always been the case. We also earlier in the year, we talked about we actually made a small acquisition of a company called Monolytic, Which is a service provider to some federal customers of ours. So we've made a lot of the investments and time with that customer base over the last year and a half or so for obvious reasons.

And so we continue to see opportunities. This call. We see that market expanding for us now that we're past the cyber incident.

Speaker 2

Great. Thank you all.

Speaker 0

The And that does conclude our question and answer session. At this time, I'll turn the conference back over to management for any closing remarks.

Speaker 3

I think that concludes our call. Thanks everybody. Thank you all.

Speaker 4

The conference call.

Speaker 0

Thank you. And that does conclude today's conference call. Thank you for your participation. You may now disconnect.