SolarWinds Corporation
Q1 2013 Earnings Call Transcript

Published: 1 May 2013

[Operator:]

Good afternoon. Welcome to SolarWinds' First Quarter 2013 Earnings Call. [Operator Instructions] At this time, I would like to turn the call over to Mr. Dave Hafner, Director of IR. Please go ahead, sir.

[David Hafner:]

Thank you, Kevin, good afternoon, everyone, and welcome to SolarWinds' First Quarter 2013 Earnings Call. With me today are Kevin Thompson, our President and CEO; and Mike Berry, our Executive Vice President and CFO. Following prepared remarks from Kevin and Mike, we'll have a brief question-and-answer session. Please note that this call is being simultaneously webcast in our Investor Relations website at ir.solarwinds.com. The press release with our results for the first quarter was issued earlier today and is also posted on our Investor Relations website. Please remember that certain statements made during this call, including those concerning our business and financial outlook, growth strategy and expectations, areas for focus and investment in our business, sales and marketing efforts, product development and acquisition efforts, estimates regarding our market opportunity, other opportunities for the company and our products and our ability to capitalize on these opportunities are forward-looking statements. These statements are subject to a number of risks, uncertainties and assumptions described in our SEC filings, including our Form 10-Q for the first quarter of 2013, which we anticipate filing with the SEC on or before May 10, 2013, and the risk factors described in our annual report on form 10-K for the fiscal year ended December 31, 2012. Should any of the risks or uncertainties materialize, or should any of our assumptions prove to be incorrect, actual company results could differ materially and adversely from those anticipated in these forward-looking statements. These statements are also based on currently available information, and we undertake no duty to update this information except as required by law. Cautionary statements regarding these forward-looking statements are further described in today's press release. In addition, some of the numbers during this call will be presented on a non-GAAP basis. Our use and calculation of these non-GAAP financial measures are explained in today's press release and a full reconciliation between each non-GAAP measure and its corresponding GAAP measure is provided in the tables accompanying the press release. Each non-GAAP item in our forward-looking financial outlook that we will provide today has not been reconciled to the comparable GAAP outlook item because we cannot reasonably or reliably estimate future adjustments such as stock-based compensation expense, which is dependent on our stock price at that time. I'll now turn the call over to Kevin.

[Kevin B. Thompson:]

Thanks, Dave. Good afternoon, everyone, and thanks for joining us on our first quarter 2013 earnings call. We've had a series of quarters, which span a period over 2.5 years, in which we have been able to report and we've exceeded both our own expectation and the expectations of the investing community for the growth of our business. It has been our goal that this trend would remain unbroken. Unfortunately, despite a solid front half of the first quarter and all of our considerable effort, we were unable to finish the first quarter with the strength that we were forecasting. As a result, did not deliver the license revenue growth result we were expecting. Total revenue for the first quarter of 2013 reached $72.9 million, which represents 22% growth over the first quarter of 2012, missing our outlook by $2.4 million at the midpoint. And while many software companies will be satisfied with revenue growth of 22%, we are not. We believe that we have a large and relatively untapped market opportunity and that we are capable of consistently delivering meaningfully higher growth rates than our first quarter 2013 growth rate of 22%. License revenue for the first quarter increased 12% year-over-year, totaling $30.7 million, missing our outlook by $2.7 million at the midpoint. Maintenance revenue continued it's long series of rapid growth quarters. Once again, exceeding our forecast, reaching a record high of $42.2 million, reflecting 31% growth over the first quarter of 2012. In the first quarter, we continue to do a good job of retaining our customers. Our historically strong customer retention rates has allowed us to deliver quarterly growth of greater than 30% and maintenance revenue for each quarter in the last 5 years. We have indicated on a number of occasions in the past that customer retention and maintenance revenue are important to our business model as we build the model focus on the long-term value of the customer rather than short-term revenue. The experience our customers have in all of their dealings with us, is one of the key areas of focus for us. So with that context, I know that the first question in most of your minds is, what happened in the second half of the first quarter? It was not consistent with your expectation as it relates to the new license sales. I would expect that the second question is, how does your new license sales performance in the first quarter impact your view of the remainder of 2013? In our remarks, Mike and I, will do our best to answer both of these questions, we will also discuss why we are confident in our ability to deliver accelerated revenue growth rate over the remainder of 2013. We experienced several significant contrast in performance in the first quarter of 2013. We had strong growth in demand for our core licensed product of the first quarter, specifically SolarWinds' Network Performance Monitor, SolarWinds' IP Address Manager and SolarWinds' Server & Application Performance Monitor. However, this increase in demand did not translate to a consistent increase in new license sales across all of our products. Second, we had a record percentage increase in commercial core product transaction volume in the first quarter. However, our average transaction size fell by a meaningful percentage, which offset much of the positive impact from the significant increase in core product transaction volume. And third, we had a strong start to the first quarter. At the halfway point of the quarter, we believe we were well-positioned to meet or exceed our outlook and it felt like momentum was building. However, in the last 6 weeks of the first quarter, our transaction velocity and growth slowed significantly. I will now provide some additional detail in each of these points, as well as how we have responded to them. The interest level in our products as measured by downloads of our core license products for evaluation was at the highest level we have seen in well over 2 years, across both our network management and systems manager product portfolios. The increased interest level in our core products was also consistent across most of our major geographic regions, which included North America, EMEA and Latin America. In addition, at the product level, we saw some of the highest overall growth in demand in our core network management products

[Michael J. Berry:]

Great. Thank you, Kevin, a very good afternoon to everyone on the call. As usual, on today's call, I will summarize the financial highlights and key metrics from the first quarter as well as our outlook for the second quarter and full year 2013. Before going through those numbers, I want to highlight that we had a strong profitability performance in the first quarter of 2013, as our non-GAAP operating margin and earnings per share both exceeded our outlook. Our non-GAAP operating margin of 55.9% was the highest amount in the last 3 years and the $0.41 of non-GAAP earnings per share is a record high for SolarWinds. I will talk more about the leverage we believe is inherent in our financial model and the benefit it brings to our company in a few minutes. Okay, with that said, let's move on to the financial results for the quarter. For the first quarter 2013, license revenue was $30.7 million for a year-over-year growth rate of 12%. Maintenance revenue was $42.2 million for a year-over-year growth rate of 31%. Total revenue was $72.9 million, for a 22% year-over-year growth rate. Non-GAAP operating income finished at $40.7 million for a non-GAAP operating margin of 55.9%. Non-GAAP EPS was $0.41 in the quarter versus $0.30 in the first quarter of 2012. Our non-GAAP operating margins and earnings per share exceeded the high-end of our outlook for the first quarter 2013 by 4.4 percentage points and $0.04, respectively. These strong profitability results were mainly the result of maintenance revenue that exceeded the high-end of our outlook and lower than planned expenses across the whole company. The majority of the variance in operating expenses related to lower accruals for our performance-based incentive plans. We had a strong quarter of cash collections that helped drive higher than expected cash flow results. Cash flow from operations in the first quarter 2013, was $30.9 million versus $28.2 million in the first quarter 2012. Free cash flow in the first quarter 2013 finished at $34.8 million versus $30.7 million in the first quarter 2012. While the first quarter 2013 free cash flow was approximately $13 million below the record level of the fourth quarter 2012, we had expected this result mainly due to the timing of certain large customer payments, as well as higher cash payments in the first quarter 2013 related to accrued annual company-wide bonus payments that related to fiscal year 2012 results. Okay, let's take a step back and look at our profitability and cash flow results. We talked a lot about the ability of our financial model to bring incremental profitability when we are able to exceed our revenue outlook. During the very few quarters, since we went public in 2009, where our revenue results have not met our expectations, we have still been able to achieve our non-GAAP operating margin and earnings per share outlook. The leverage that we have in the business model and flexibility to increase or decrease this spigot on spending is one of the positive attributes of our model. One important aspect to our flexibility is our performance-based compensation plans. We have structured these plans to align our interests with the interest of shareholders such that if we exceed our revenue targets within our margin expectations, then all of our employees share in that upside. If we did not meet or exceed those revenue targets, our performance-based compensation plans payout at a much lower-level. Additionally, there are variable spending areas that we monitor throughout a quarter that we can tweak based on the current revenue trends. This is not that to say that we are guaranteeing that we will always hit our profitability targets, but we can say we have been able to meet or exceed our non-GAAP operating and earnings per share target each quarter since we have been a public company, which started with the second quarter of 2009. Moving on to the balance sheet. Our total cash balance finished at $274 million, which includes our short and long-term investments of approximately $53 million. The increase in cash and cash equivalents during the first quarter 2013 of approximately $42 million consisted of cash generated from cash flow from operations of $30.9 million, cash provided from financing of $4.1 million and cash provided from investing activities of $8.4 million. Approximately 21% of the total cash and investments balance is held in our international subsidiaries as of March 31, 2013. Accounts receivable finished at $34.3 million as of March 31, 2013, resulting in a DSO of 42.4 days. Our total deferred revenue was $109.3 million as of March 31, 2013, which resulted in a year-over-year growth rate of 32% and a sequential increase of $6.5 million from December 31, 2012. Let's move on to our key business metrics. Our core transaction volume grew in the first quarter 2013 by 53%, comprised of commercial growth of 56% and a slight drop in the U.S. federal core transaction volume of 3%. The total trailing 12-month average transaction size, excluding Kiwi and DameWare, finished at approximately $8,000, which is lower by about 8% from the same measure from the fourth quarter 2012 of approximately $8,600. In addition, the average commercial transaction size, again excluding Kiwi and DameWare, for only the first quarter 2013, finished at approximately $6,400 versus the comparable average transaction size in the first quarter 2012 of approximately $8,200, a decline of 22%. As Kevin indicated on his remarks, I want to provide a little more detail on why the average transaction size changed in the first quarter. We have discussed in previous calls that our key business metrics will continue to be influenced by the specific product mix that we have in a given quarter or over several quarters. This was really illustrated in the first quarter as a result of the strong transaction volumes for Web Help Desk and Serve-U Managed File Transfer, which typically have an average sales price size of approximately $2,000, as well as a strong performance of standalone SolarWinds' IP Address Manager, which also has an average sales price slightly below our core SolarWinds' Network Performance Monitor and Systems Application Monitor products. To help illustrate this point, if we exclude the standalone Web Help Desk and Serve-U transactions, the trailing 12-month average transaction size would have actually increased by 4% versus the comparable measure from the first quarter 2012. As we have said for the last several quarters, we expect our growth to be driven by an increase in core transaction volume versus larger transactions size and the result in the first quarter is largely an outcome of our expansion strategy to add new products to our IT management product portfolio. Commercial markets and new license sales grew 13% year-over-year in the first quarter, driven primarily by 14% growth in our 2 largest geographies, North America and EMEA. This growth rate was slightly offset by 11% new license sales growth in Lat-Am and, basically, flat year-over-year performance in Asia-Pacific. The performance of all of our geographic regions largely reflected a very similar trend of significant increases in core product transaction volumes, to a great extent, offset by a meaningful reduction in average transaction size, which Kevin discussed earlier. For the first quarter, from a total revenue perspective, core network management grew by 16%; core systems management grew by over 50%; and our network and the system tools products, combined, grew by 6%. In addition, our international revenue as a percentage of total revenue was approximately 27% versus 25% in the first quarter 2012. Lastly, our worldwide maintenance renewals team had a very strong quarter with record renewal bookings that grew year-over-year by 43%. Okay, let's move on to the outlook for the second quarter and the full year 2013. Before I go through the specific numbers for the outlook, I'd like to hit on a -- I would like to hit on a few important drivers. As Kevin mentioned in his prepared comments, while the new license sales results in the first quarter 2013 were below our expectations, we continue to feel good about the direction of our business and currently expect our new license sales growth to rebound from the growth rate seen in the first quarter. In line with that view few, we currently expect April's year-over-year growth in new license sales to accelerate quite, quite nicely over the growth experienced in March. Additionally, as Kevin indicated, we have increased the pace of our sales hiring coming out of the first quarter as we feel that we need more sales capacity to respond to incoming demand and transaction volume. This increase in sales hires includes additional capacity in all the regions we operate in, but primarily focused on our North American and EMEA installed base, systems management and network management teams. Before I summarize the new outlook, I'd like to discuss our revised non-GAAP operating margin outlook. Coming off the first quarter results as well as the outlook for the remainder of 2013, we continue to assess where we are investing our money to fund the areas that we feel have the highest potential to drive our growth. In addition to the incremental sales investment I just discussed, we continue to relocate marketing investment to drive our demand generation and awareness activities to the programs that we expect to have the highest ROI. And, as is typical, we are constantly evaluating other expenses to help ensure a prudent use of capital based on our most up-to-date expectations. As a result of the first quarter results and our new outlook, we have raised our full year non-GAAP operating income outlook to between 52% and 53% for the full year. As it relates to FX rates, our outlook assumes a euro to U.S. dollar exchange rate of $1.30 for the second quarter of 2013. With that being said, for the second quarter 2013, we currently expect the following

[Kevin B. Thompson:]

Thanks, Mike. I thought it would now be appropriate to provide a little context around the financial outlook for the second quarter and full year 2013 that Mike just provided. I will now give you a view into what we're seeing as it relates to velocity of our business at this stage of the second quarter. First, we continue to have good conversations with IT pros around our products they're intending to buy. We still are not hearing any meaningful volume that IT budgets are being constricted or reduced and IT pros seem to believe that they have a set budget for the second quarter and full year, which they have the ability to access and spend, which as Mike indicated in his comments, has resulted in accelerating growth in April as compared to March. Second, we are already begin to see the positive impact of the additional sales capacity that we've brought on early in the second quarter on our ability to handle a greater volume of core product demand and transaction volume. Third, we have had a strong start to U.S. Federal new license sales in the second quarter. As of the end of April, which is today, we have already equaled our total U.S. federal new license sales for the entire first quarter. In addition, based on the interactions we have had so far in the quarter, it appears that U.S. Federal budgets have been allocated and spending patterns have become more consistent and a little more predictable than they were in the first quarter. However, despite these factors, we have taken a cautious view of U.S. Federal spending for the remainder of the second quarter in our Q2 outlook. Fourth, we're experiencing a very solid start to our commercial market sales in North America and EMEA with both regions collecting both higher growth in same period in the same quarter and the growth rates included in the Q2 outlook from these regions, which Mike provided. And last, we're also seeing a higher number in dollar amount of transactions in the $20,000 to $75,000 range early in the second quarter than we saw in the corresponding period in Q1, which would indicate to us that budgets are moving a little more freely than they were in the first quarter. Based on the factors above, coupled with the changes we have made in the metrics that we are using to determine our outlook, which I mentioned earlier in my remarks, we feel positive about our ability to deliver results that meet our second quarter outlook. As it relates to the full year of 2013, we continue to believe we will deliver and are committed to delivering a solid growth year. Our product road maps across all of our core products are strong and we intend to bring many new features to market over the course of 2013 that will allow us to step in front of an increasing number of purchasing cycles, in which IT pros are out actively searching the web for solutions to current problems. In addition, we believe that we have made the changes necessary in our demand generation strategy and sales staffing model to allow to be able to respond to a much higher level of core product transaction volume and average transaction size that is likely to be lower than our 2012 average. However, we do expect our average transaction size in the second quarter to increase from the $6,400 average commercial transactions size that we experienced in the first quarter. We also have made meaningful enhancements to our approach to selling into our installed base early in the second quarter, which we believe will begin to pay dividends through even faster adoption of additional products by our customers over the remainder of 2013. We also believe that we have taken a cautious view to both our commercial and U.S. Federal new license sales performance for the last 9 months of 2013 and I can assure you that we will be giving it everything we have to deliver results that meet or exceed the full year outlook that we have provided. Over the remainder of 2013, we plan to continue to aggressively explore opportunities to expand the number of problems that we can solve for IT Pros, responsible management and performance of IT infrastructure. We expect to do this through a combination of acquiring new technologies, as well as funding new R&D teams to develop new products. We are also committed to investing and expanding the capability of our current products and continuing to improve our customers' experience with these products. This should allow our current products to solve a wider range of problems for both customers and prospects. This is an integral part of our strategy for continuing to have customer retention rates that are among the best in software. Our confidence on our market opportunity in network management and system application management remains unchanged. And we continue to be committed to delivering long-term new business growth rates in excess of 20%. We believe that many opportunities remain to add new functionality in methods of delivering technology to customers in our core markets of network management and systems management, which will allow us to deliver this growth. Our focus over the remainder of 2013 will be to capitalize on some of these opportunities. With that, we will open up the call for questions.

[Operator:]

[Operator Instructions] And we'll take our first question from John DiFucci with JPMorgan.

[John S. DiFucci:]

Kevin, we all know the macro environment is difficult out there, it's been a tough quarter for software across the board. You mentioned sort of the resulting lower ASP, do you see this improving based on sort of the macro environment improving? Or is there anything you can do to improve through your approach or even the structure or packaging of the existing or even new products? Or do you just ramp up sales here, sales capacity, and sort of wait out the macro environment?

[Kevin B. Thompson:]

Yes, I think that's a good question. So what I would say is, it's been, yes, it was an interesting quarter in the sense that midway through the quarter, we were right where we wanted to be, we thought our momentum was actually increasing and not decreasing. And then we definitely saw a change in the momentum of our business and the speed in which transactions were closing. So I don't know if that's a -- if that's a broad-based macro issue that's going to extend longer or something that is very unique to the first quarter. But what I would say is that there are a number of things that we are going to respond to that, so part of it is our transaction volumes are actually really strong, stronger than we anticipated, some of the highest transaction volumes, well, in fact, the highest transaction volume growth that we've ever had. And so we were closing a lot of transactions, it's just we weren't closing with the same transaction value. And those slightly larger transactions, which will be small for most companies, but for us, kind of fit in the slightly larger category in that $20,000 to $30,000 to $40,000 range. Those are the ones that really felt like they slowed down in late February and really through the month of March. So we've done a couple of things

[John S. DiFucci:]

Okay. That's helpful. And if I could just a follow up. You mentioned several times and then Mike mentioned that you added a number of sales people in the quarter. Can you at least give us the percentage of increasing in sales capacity, if not the number?

[Kevin B. Thompson:]

Yes, so we don't -- giving you a number probably won't be very helpful, because we haven't historically given out the total numbers of sales reps that we've had. But our plan is to add kind of 10% plus to our sales team, because we're at about 10% to 12% higher number of transactions per rep, core product transaction per rep, than where we want to be, and where we believe we ought to be, if were going to do a good job of attaching multiple product invoices, if we're doing a good job of driving the ASP at the level we'd like to drive it. So somewhere in that 10% to maybe 15% range as we move through the quarter. But a great thing about our model is we expect the rep to sell something in the first week. And we expect the rep to be almost pretty fully productive within 30 days. So we will get some benefit from the reps we are adding in the second quarter already, as well as any reps that we add throughout the second quarter and beyond. And one comment is we have included -- all those costs are included the outlook that Mike provided. So we're going to be able to do that inside of an increasing non-GAAP operating margin.

[Operator:]

We'll go next to Steve Ashley with Robert W. Baird.

[Steven M. Ashley:]

So my first question is, were there deals and business that you didn't get to during the period or was that not part of the challenge with the staffing?

[Kevin B. Thompson:]

Yes. I wouldn't so much as the deals we didn't get to, Steve, it's more that we didn't get the quality of touches on even the deals we close that we normally would, which what that means is, is when we get to the point that we've got a transaction volume that kind of outstrips our capacity, it means that reps don't have the ability to touch deals a number of times we asked them to touch the deal. They don't have the ability to have as fulsome discussion around other technology that, that customer might need based on the things that we hear as we're talking about the product that we're selling them. So it's not that we didn't close a lot of transactions, we did, up 56% on the commercial side, year-over-year, up 52% across the commercial and Federal year-over-year. So we closed a lot more transactions than we ever have in a single quarter. We just didn't have as many products for invoice and we didn't have it with the average transaction size, because I don't believe we had enough reps to really do that. Here's the great thing, the opportunity is not lost, right? We sell them a product, and what we know with is our customers, for the most parts, love our technologies. And once they buy 1 product, within 6 months, they're generally going to come back and buy the second product. We're also having great success with our installed base team of accelerating that time period. So we haven't lost an opportunity to sell them more technology. It's still there. We're just going to have to do it in Q2 and beyond. We just didn't get enough of that done in the first quarter.

[Steven M. Ashley:]

And then in terms of the 2, maybe what I'm going to call flagship products, network performance manager and the SAM product. It sounds like the customers were not coming in and buying those initially as was maybe what I thought was the normal course, and then you try to attach to those larger ticket items. It sounds like you've had more customers coming in for other products. And so, number one, was the license revenue from those 2 core products down year-over-year and was that kind of the case?

[Kevin B. Thompson:]

So let's talk about -- yes, we'll talk about them separately. So SolarWinds application performance monitor, which is our server & application monitoring product, had a really, really strong quarter. As I indicated, total revenue, or Mike indicated, total revenue of about 50% for our systems & application management product portfolio, in the first quarter. So a very strong quarter there. So we had a very strong SolarWinds Application and Performance Monitor in the quarter. We have not had quite as strong as SolarWinds network performance monitor quarter and that is where we saw people coming in and buying products like SolarWinds IP Address Manager, which is a network management product, doesn't sell for much, but solves kind of a core -- your network management problem that the SolarWinds network performance monitor doesn't. So it doesn't solve it. So you have to buy IP Address Manager to solve that very specific problem around DNS and DHCP and IP address management. So we found more customers coming in and buying just that versus them coming in and buying SolarWinds' Network Performance Monitor and SolarWinds' IP Address Manager. If you remember, we made SolarWinds' IP Address Manager fully standalone, probably 9 to 12 months ago and have really improved that product. So we do believe that, over time, we'll get those people who bought just SolarWinds' IP Address Manager to come back and by SolarWinds' Network Performance Monitor, but it's a great example of where we did not do as good a job as we believe we should do and can do at cross selling. And a larger number of those people who came in and bought SolarWinds' IP Address Manager should've also walked out the door with the SolarWinds' Network Performance Monitor in their bag. And we didn't make that happen at the level we should have and wanted to do in the first quarter, just means that the rest of this year and early next year, we've got to do a good job of going back into those customers who just bought 1 network management product and getting them to buy SolarWinds' Network Performance Monitor and then SolarWinds' NetFlow Traffic Analyzer and so on and so on.

[Operator:]

We'll go next to Aaron Schwartz with Jefferies.

[Aaron Schwartz:]

I know you guys said you sort of missed the midpoint here in Q1, I think it was about $2.4 million that looks like the guidance is lower by about $4 million. So obviously, there's an offset of sales capacity coming online here. But you also made a comment, I think, that April saw some better trends relative to the end of March. So I guess the question I would have is that already some of the sales hires seeing some productivity or a sort of 'organic' productivity kicking back up in the month of April?

[Kevin B. Thompson:]

Good question. So I guess the answer is both. I think we're already seeing some of the reps that we hired very early in the second quarter begin to have a positive impact on our business. As I indicated earlier, we expect the new sales rep to sell something in the first week. We expect them to be as good as the reps who have been here for a while or almost as good anyway within 30 days, because we hire folks who are able to improve that quickly and because our model is one that's pretty well defined and we're going to make sure that we give them a good number of opportunities to work on. And then in addition, as I indicated, we are already seeing more of the deals in that $20,000 to $75,000 range closed in April than what we saw in the corresponding period in the first quarter and that's mainly -- our historical team has been here a while that's working those transactions. So it's a combination of both and as also indicated, we've got a very good start to U.S. Federal in the second quarter. Our U.S. Federal sales as of the end of April are already as much as our full first quarter. So we're already working on growth at this point quarter-over-quarter sequentially in U.S. Federal, so that business has been much stronger early in the quarter than it was in Q1.

[Aaron Schwartz:]

Okay, that's helpful. And second question for me, if I could. Maybe just taking a step away from sort of the quarter-to-quarter dynamics, but you've talked a lot over the last year about the cross sales teams and the impact that's had on the model. How do you think that impacts ASPs longer-term? Or some of the cross sales teams just selling an individual point product and should we -- how should we think about maybe the modeling for that longer-term?

[Kevin B. Thompson:]

So our installed base teams are doing well and they've got a lot of traction, as I indicated, up 98% year-over-year in new license sales. So a real bright spots in the first quarter in terms of performance and we've also made some meaningful enhancements in the technology we give them, to be able to be even more successful. So we're pretty excited about what we can do the installed base side. In terms of what their average transaction size, I think it'll be a bit lower than what our -- kind of $8,000, $8,400 average has been historically. But for the most part, it should be somewhere in that -- close in that range. So a little bit lower but not a lot lower, because think about it, if someone bought SolarWinds' Network Performance Monitor and they bought the highest-end version of what we sell, it's going to cost him around $20,000. We go in and try to sell them SolarWinds SolarWinds' NetFlow Traffic Analyzer with our installed base team, which is the first product we're going to sell them because it's a product that attaches the most often, the SolarWinds' Network Performance Monitor. The average price for the, for the same size is going to be around $15,000. So there is a relative size, most of the time, and what we've got our installed base team focused on -- if you remember our Analyst Day, we had that chart that kind of went from the center out and we've got to a really focus on those things that are closest to the center. So selling core products to existing core product customers in most of our core products, not all, but most of our core product and definitely the ones we're focusing on now have ASPs that are somewhere in that 5K to 9K range. So that's the range that they are in.

[Operator:]

Our next question comes from Greg Dunham with Goldman Sachs.

[Gregory Dunham:]

One, I wanted to hit on the kind of the business at that $20,000 to $75,000 level. And just trying to get a sense of how big of a piece is that of your license revenues? And any sense of -- did the number of leads for that level of business change at all or has that grown in concert with growth of other leads?

[Kevin B. Thompson:]

Sure. So if you look at the -- if you remember at Analyst Day, Mike put a chart up, and that chart was kind of a -- what you call that?

[Michael J. Berry:]

Normal distribution?

[Kevin B. Thompson:]

Yes. Normal distribution of -- see, I forgot for a minute, normal distribution of deal sizes. And so if you look at it, the greatest volume in transaction that we do is in that kind of sub 10K range. And it also is a very large percentage of the total dollar value that we booked, a lot smaller number of transactions that we do are in that of $20,000 to $75,000 range and most of those are right there in the $20,000 to $30,000 range with a let fewer them in the kind of $30,000 to $75,000. But when you kind of look at the distribution of ranges between $20,000 and %75,0000. So it's a decent amount of our total dollar volume, but it's not the majority of our total dollar volume, majority driven by that kind of sub 10K range and definitely by the sub 20K if you take it up to 20. So it has a meaningful impact on ASP though, because it's not that many transactions. But your 150K transaction it takes 6 to 7 of our normal ASP transactions to get to that level. So it has a meaningful impact on ASP. What I would say is we're to close the same number of transaction in that $20,000 to $75,0000 range that we closed in the fourth quarter, then we would have been above the midpoint of our range. So that's kind of the level of impact it had in the first quarter.

[Gregory Dunham:]

Right. And then, did -- was the conversion rates just dropped due to macro pressures or...

[Kevin B. Thompson:]

Yes. So as I said in my remarks, we had about the same kind of number of transactions in that size, size range in the total dollar value of transactions in that size range, in our pipeline, in the first quarter that we had in the fourth quarter and we had in the first quarter last year. So it's not a number of that kind of swings at the plate, if you will. What we had is simply the ones we had didn't close at the rate we expected them to close. So it's a conversion rate issue. I think, some of that's on us. We should have done a better job of qualifying those transactions and making sure that they closed. So we have put a lot of effort into that in the month of April and we're already seeing the benefit of that. So a lot of that is on us. I think some of that is that we just saw the IT pros we're working with struggle a little bit to get POs issued, because they were telling us they were going to buy, they're telling us they're going to buy by a certain date and they just had trouble getting the orders to us within the timeframe that they had committed to. So there's some factors going on that definitely made it a little more difficult for them to get purchase orders out of their purchasing department and into our hands. And so there's something going on there. But I think, to a large part, we just should've responded more quickly than we did. And we feel like we've made a lot of these adjustments in April.

[Operator:]

We'll go next to Keith Wise with Morgan Stanley.

[Keith Weiss:]

Just wanted to dig into the solution or the idea of having to add more sales reps. And just getting more clarity on -- it seems to me or the question I have is, whether this is a capacity issue or sales process issue, because the deals are coming in and you have the leads but you're just not getting the attach of additional product on the lead to get the ASP there, why is that a sales capacity issue versus a sales process issue?

[Kevin B. Thompson:]

What I would say is it's both, right? It's a process issue that's caused by a capacity issue. So you've heard us say, we expect the rep to close at least a deal a day and I strongly -- I challenge you to go find another enterprise software company that has their reps close, on average, a deal a day. And to close a day just takes a certain amount of time no matter how small the deal is. Because in the most cases, customers are giving us POs and we have to get the PO out of customer's hands. We have to get that PO processed. So it just takes a certain amount of time and a certain number of phone calls that you have to make as a sales rep to close a deal a day. You're not making 1 call a day to close a deal a day. You're making lots of phone calls a day to close a deal a day. And if you're closing more than 1 transaction a day, that means you have less time in a day to go through all the steps of our sales process. You have less time in a day to make sure that you're really listening to what the customer is say when they're talking about the problem they're trying to solve, to see if they give you a clue as to some other problem they have, they would tell you they need another one of our products. If you don't have time to have quality conversations and enough quality conversations, then you're not going to attach that the second product or you're not going to attach that third product. So I think it is a good question. It is a process problem caused by the sheer volume of transactions that we were trying to close. So we just weren't doing a good a job at the process in Q1. By adding capacity, we believe, it gives the reps the time to follow the process. It gives the reps the time to listen for those cues and to demo that second product or demo that third product on the call and get the customer interested in it and get that deal closed. It also gives us the ability just to close a sheer -- even higher volume of $2,000, $3,000, $4,000 transactions in Q2 and beyond than we were able to close in the first quarter. We have certain product line but we literally couldn't have closed more business with a number of reps that we had. But those reps were already doing more transactions than we thought they could do, especially around some of the lower-priced products in our systems & application management product, we couldn't have closed more business than we close with the number of reps that we had.

[Keith Weiss:]

Got it. So it seems like there's 2 parts -- 2 potential solutions

[Kevin B. Thompson:]

So what I would say is that we definitely saw a very high level of inbound demand, as I mentioned in my remarks, if you measure it based on downloads of the core licensed products that we sell. We had very strong sequential demand, very strong year-over-year demand in North America, EMEA and Latin America and a little lower demand in growth in Asia-Pacific. So very strong quarter on the demand side. But what I would say is, the way we responded to that is not to necessarily slow down the expansion of number of problems we solve, but what we've done is try to focus harder on the quality of the demand that we're handing to the sales reps. Meaning, just because you download now doesn't mean I'm directly going to feed that to a sales reps. With some products, what we've seen is downloads from certain sources are not as high quality or not going to convert at the level we like them to convert. We can only put a certain volume at a defined quality level into the system. And so what we're doing is nurturing even some of our downloads further, before we handle -- hand those of download to a rep. And that's definitely one of the changes we made walking into Q2. And that's how we're going to deal with that issue. I don't think we need to slow down the expansion of a number of problems we solve. We just need to be smarter about when we give a download or when we give an opportunity that comes from a source other than a download to a rep to begin to work, so we don't waste the reps time. And I'm just tell you, we're not going to get that completely right overnight. We've been working at that for a long time, but now that we've seen another spike in demand, we're going to have to do even a better job of that in the future than we've already been doing and that will help us get that conversion rate back up. We definitely saw those conversion rates from inbound lead to opportunity to deal close drop below the level we'd like them to be at in the first quarter. Good thing is that's happened to us before. We know how to address it. And we're addressing it now and we'll get those conversion rates backup.

[Operator:]

We'll take our next question from Rob Owens with Pacific Crest Securities.

[Rob D. Owens:]

I just had a question to try and understand, I guess, the linearity when it comes to these midsize transactions, $25,000 to $75,000. Are they typically, third month type of transactions because they represent larger transactions for your customers?

[Kevin B. Thompson:]

They shouldn't be. And as I indicated, this quarter we've seen a much better start in the month of April, closing a larger volume of those transactions in April than we did in the same period last year and in the same period last quarter, for that matter. So they shouldn't be. They should close with a rhythm and a linearity that is consistent with the rest of our business. We don't expect to be perfectly linear. We, in fact, are too linear in the first quarter. If we'd been a little less linear then we would have -- we would had a little better outcome on the license sales side. But we do expect to be more linear than most of our peers. And so we expect the linearity to be relatively consistent across really any transaction that's above that kind of a 3K range. We think the linearity ought to be relatively the same, that 0 to 3K is going to be the most linear of all the transactions we do for obvious reasons. They're very small, they don't require hardly any approval at all. And so they go through very, very quickly. But really when it get above 3 to 5K, where it has to go through an approval process, the linearity ought to be consistent.

[Rob D. Owens:]

Okay. And then from a capacity standpoint, I understand the increased sales capacity. So your sales guys can touch a deal more. But why doesn't dollar quota influence that sales behavior more so. I guess I'm a little confused on that point, if it was function of salespeople's inability to touch deals in the sales process that you would like or the quality of deals that are coming to those sales folks?

[Kevin B. Thompson:]

Well, [audio gap] it's the deal process that we drive. I mean, keep in mind, we get a download, we don't know if that download is turning into a $30,000 opportunity or $3,000 opportunity because most of our products have prices in that range, right? You can buy SolarWinds Network Performance Monitor for less than $5 but you could also spend a lot more than that on SolarWinds' Network Performance Monitor and maybe start to attach products, that deal gets much larger. So we really mandate to our reps, they touch every deal and work [audio gap] exact same way and if you look over the last 2.5 years, that's worked really very well for us and that has resulted in a lot of consistency, both in total quarterly performance and then within the quarters. And so that's something we drive from a management point of view. We don't let our reps just sit on larger transactions. We're driving every rep to get to that 70 to 75 transactions closed bar every single quarter. So it's really the way our processes is designed. It drives reps to work in a certain way, at a certain speed against the opportunities that are coming into their cube. I'm not saying that every single rep we had, had more deals to work than they needed. I was saying across all the reps that we had, on the average, we did -- is we didn't get the level of attach rates. We didn't get the level of products for invoice, we saw that 8% decline in the number of products per invoice. We haven't had a decline in the number of products per invoice in the last 2.5 years. That's the first time we've seen that and we could tell based on what the attach rates were and what products didn't do as well as others, that there is a -- that we just weren't executing the process the same way we traditionally have and the way that we want to. And also if you look at the sheer dollar unit number, we've been doing this a while now, when you look at almost 85 transactions per rep, that's over a transaction a day, that's just more than we feel like we can average on the core product side across all of our reps and do as good a job as we ought to be doing. Now, I can tell, Steve, the great thing is none of the opportunities are lost. We're going to go get those customers to buy more product from us. We just didn't get them buy as much products in first quarter as we would've liked. So it's not any one, one factor, as I indicated, that drove the change in ASP. It's really a combination of factors. We didn't attach as many products per invoice. We saw fewer transactions in the $20,000 to $75,000 range that actually closed, even though we have a similar number in the pipeline and we saw larger volume of standalone product sales -- of products like SolarWinds' IP Address Manager, where in the past, a larger number of those transactions would have the SolarWinds' NPM attached.

[Operator:]

We'll take our next question from Elizabeth Colley with Needham & Company.

[Elizabeth Colley:]

Can you give us an update on the localization efforts for your products in Germany and Japan?

[Kevin B. Thompson:]

Yes. So we're continuing to make progress. We are -- we've got -- we've done a good bit of work on the product side. Focused more on Germany than on Japan. We've got really 2 products that we need localized in Japan, localized for now, which is SolarWinds' Network Performance Monitor and the SolarWinds' NetFlow Traffic Analyzer. Those are our core flagship network and management products. Those are really the 2 core products that we've built this business on. If you look back at 2006, 2007, 2008 they really drove our growth in North America. And so we're leading with those in Japan, and we don't really believe we need a lot more products other than that in Japan right now, because it is an awareness game right now, not a number of products that are localized. In Germany, we've got more products localized, we've got DameWare localized, we've got a SolarWinds Web Help Desk localized, we've got SolarWinds' NPM localized, we've got SolarWinds' NetFlow Traffic Analyzer localized. We are working on localizing SolarWinds' Server & Application Performance Monitor. So there we've got a lot more awareness and so do to get more products localized and we are making solid progress against that. We'll have a couple of more products localized kind of every year as we move forward. We don't have this belief that we have to get them all localized tomorrow. The goal is to get the products to drive the most demand and drive the highest attach localized, because once we get to those deployed, we believe we can attach other products even in English language to them.

[Operator:]

Our next question comes from Kirk [indiscernible] with Evercore Partners.

[Unknown Analyst:]

I guess, Kevin, the $20,000 to $75,000 deal volume, I guess how many of those were, I guess, downsized in the process or pushed out? I guess, how much just ended up being maybe the deal is closed a little later, people couldn't get the PO out versus just not having the right amount of those deals in the funnel?

[Kevin B. Thompson:]

Yes. There wasn't an issue of not having enough of those deals in the funnel, as I indicated. We had about the same number that we've had previously. The number that we expected we're kind of have. We didn't close as of them as we thought we would. We really don't see deals get downsized very often and then close at that level. Generally, they wait and then the PO will come. And so, really, it's more that they stay in the pipeline, they didn't close the deal in March. Some of those, obviously, have already closed in the month of April. And more will close as we move through the quarter. And we'll generate a bunch of downloads between now and the end of the quarter that will end up in deals closing of that size range. Because even in that size range for us, the average deal cycle is really no different than $10,000 to $15,000 transaction. We don't typically see a longer deal cycle, historically. Definitely saw a little longer one in Q1 but that hasn't been true in terms of historical pattern. So I think it's just simply a matter of making sure we've got -- we do a good job on deals of all sizes. Because what our sales managers will say to you all the time is my ASP will take care of itself and it generally has, if I just keep closing transactions. So I may be a little lower in the first month, I may be a littler higher in the second, I may be right on in the third month. But historically, what our sales managers will tell you is if I just keep closing deals, the ASP will take care of itself and that's really what it has done in almost every quarter leading up to this point. This quarter, we saw a little different behavior, but I said, I think we've made some adjustment to deal with that to make sure that we have more management helping the reps work on all their deals, not just larger ones. We're not a large deal focused organization, we're never going to be a large deal focused organization. That just happened to have a big impact on our ASP. And if ASP would have been higher than our normal range, or even, it can be quite a lower than our normal range, and we've been right where we thought we'd be for the quarter, and that's why I think it was a trend that we did to highlight, because it did have an impact on ASP.

[Unknown Analyst:]

And then just one really quick follow-up. You guys mentioned that the product per invoice is obviously down this quarter, because there wasn't enough time to sort of work those deals the way they would normally be worked. I guess from a process standpoint, if you had a client on the line already, why wouldn't you work that no matter even if it took you a little longer, meaning, you're already having discussion with them. It seemed to be easier to up sell an additional deal than start an entirely new deal cycle with a new client. So I guess I'm just asking how big is -- you guys have had more products out in the market now. Are you confident that it's just not a reversion in terms of the price per invoice or products per invoice went up and now we're sort of normalizing back down, if you could give any more color around that, that would be helpful.

[Kevin B. Thompson:]

Sure. So I think products per invoice has got nothing to do with the number of products we have in the marketplace. In fact, the number of products we have in the marketplace should allow us to drive higher volume of product per invoice. Now with that being said, because a lot of our newer products had a lower ASP than our historical products, they indicated -- we will likely see lower average transaction sizes in 2013 based on what we're seeing now than what we saw in 2012. So the key is going to make sure we are able to respond to that. Why don't we just spend more time on the phone? Well, keep in mind, our reps have lots of phone calls they need to make in a day. They have lots of transactions they need to work in a day. They got to work way more than 1 transaction to get a transaction to close, 1 transaction to close everyday. So they're working 20, 30, 40 transactions every single day in order to get 1 to close, that drives a certain pace, a certain amount of time that they have available to spend on a call because that's the way we train them, that's they way we ask them to behave and that's they way we want them to behave. And so it just naturally means when you have a lot more work to do, we have a lot more downloads in your funnel the are varying quality that you have to get to everyday -- because we tell them touch them all, everyday, touch them all. Touch them within 2 hours when they get downloaded. That drives their behavior and drives the pace of work that they have to move at. And we just got things at the level across the entire business that if they did what we've asked them to do, it just didn't leave them enough hours in a day to have as quality a conversation as we want them to have. So it's really an outcome of the process we develop and the process that we drive. In this particular quarter, that process maybe it hurt us a little bit, maybe it didn't. I mean definitely on the recognized license revenue, we would have liked to have done better. We wanted to do better, we intended to do better and we're not happy with that outcome. However, on the just sheer volume of new customers I added, on the sheer volume of transactions that my team closed, they did a great job on that front. They closed a bunch transactions, the highest growth we've had. So part of the process worked really, really well, part of the process didn't work really very well, but that really falls on us as a management team that we didn't see that earlier and respond to that more quickly.

[David Hafner:]

Kevin, we have time for 2 more questions.

[Operator:]

We'll take our next question from Gregg Moskowitz with Cowen.

[Gregg Moskowitz:]

Just a clarification, I apologize if I missed it. I heard the core transaction growth a few times on the call, I didn't actually catch the commercial sales and Federal sales on a year-over-year basis and also, Mike, if you happen to have any sort of color on license sales growth by major geo, that will be helpful.

[Michael J. Berry:]

Okay, Gregg, so let me go back to that. So a couple of pieces, commercial and new license sales grew 13% quarter-over-quarter, driven primarily by 14% growth in North America and EMEA, Lat-Am was up 11% and Asia-Pacific was basically flat. From -- and if I know your last question, from a total revenue perspective, what we've disclosed is core network management grew by 16%, Systems Management grew by over 50% and the network and system tools combined grew by 6%. We don't have anything by geo nor do we disclose any revenue by geo by product.

[Gregg Moskowitz:]

Okay, that's helpful, Mike. And then just one other questions, most of my other ones had been asked. But at the Analyst Day back in November, I believe you were targeting 20% to 23% license revenue growth for 2013 and within your new revenue guidance, what does that reflect roughly in terms of licensed revenue expectations?

[Michael J. Berry:]

So for the full year, Gregg, that's going to reflect upper teens to still 20% of the high-end.

[Kevin B. Thompson:]

Yes, really what we've done is just say, hey, we didn't get to the Q1 number and we have not baked in at this point that we're going to recover that shortfall in the last 9 months of the year. We hope to, we plan to and do everything we can to do that. But we haven't baked that in any right now. So that's basically what we changed.

[Operator:]

And our final question comes from Tim Klasell with Northland Securities.

[Tim Klasell:]

My question has to do around the margins, obviously, your guidance calls for improving margins, so that's great. But how do you reconcile that with maybe having to have salespeople spend more time, maybe do a little bit more touch with some of these midsized transactions? To me that would sound or would say maybe a little bit of a margin headwind, so...

[Kevin B. Thompson:]

Yes, what I'd say, Tim, is that we're not saying they need to touch on them longer than historically have, but if you touch them a little more thoroughly than they were able to in the first quarter. So it's really just being able to put the quality of touch that we've had in the 10 quarters leading of to Q1 on those transactions to make sure that they're going to closed. And we've built into our outlook for the rest of this year that Mike provided our view of sales productivity, cost per dollar of revenue sold. And so even if we have a little decline in sales productivity, which we basically have factored in just because of sheer volume and transaction, they're going to close at a slightly lower ASP, may say they can't quite get the same dollar amount than they were getting to before, that's all baked in to the outlook we provided and we're able to see the margins expand a little bit even with that.

[Tim Klasell:]

Okay, Good. And then one final question, I know you guys always sort of adjust how you monitor the pipeline and give guidance and that those dials are constantly adjusting. Was there anything at the beginning of this year that you changed that you maybe in 20/20 hindsight wish you hadn't?

[Kevin B. Thompson:]

No, we didn't change anything, but with 20/20 hindsight, I would have. So maybe that was the problem, is that there was some changes that we should've seen and I don't think we really could have is January, right? But as I indicated, at the midpoint in Q1, we were doing well. Momentum was increasing. Growth was picking up at the midpoint of the first quarter and it really wasn't until we hit the last week of February that all of a sudden things started to slow down a little bit. So I don't know that there's anything we could have seen at the beginning of the year. Definitely, I think we could have responded maybe a little faster than we responded in March, but it's not like we didn't respond at all. We felt things started to shift just little bit on us on the last week of February, definitely sensed that, that was continuing in the first of March. We put a huge focus on a lot of things in March to try to get things moving. We just didn't have enough time left in the quarter to do that, as I've indicated, we've seen some of that benefit already in April with a strong April with growth much better in March and better than what we've got right embedded in our outlook. We're just -- we're going to be a little bit cautious until we see how the rest of the quarter plays out. We feel good about where we are now. We still have some things we're working on and we're going to make sure that we are pretty vigilant in adjusting any additional changes in behavior we see in the environment we're selling into. But we feel like we've made a number of adjustments. We feel like we've put headlights on the right things, and we're monitoring things more closer than we ever have to make sure that we continue the momentum that we built in April.

[David Hafner:]

Okay, everyone, that includes our first quarter earnings call. Thanks to everyone who tuned in today.

[Operator:]

Ladies and gentlemen, this does conclude today's conference. We thank you for your participation.