David Hafner Kevin B. Thompson - Chief Executive Officer, President and Director Jason Ream - Chief Financial Officer and Executive Vice President of Finance

John S. DiFucci - JP Morgan Chase & Co, Research Division Aaron Schwartz - Jefferies LLC, Research Division Steven M.

Ashley - Robert W. Baird & Co.

Incorporated, Research Division Keith Weiss - Morgan Stanley, Research Division Ben McFadden Stewart Materne - Evercore Partners Inc., Research Division Tim Klasell - Northland Capital Markets, Research Division Robert Scott Zeller - Needham & Company, LLC, Research Division

Thank you, Aaron. Good afternoon, everyone.

Welcome to SolarWinds Third Quarter 2013 Earnings Call. With me today are Kevin Thompson, our President and CEO; and Jason Ream, our Executive Vice President and CFO.

Following prepared remarks from Kevin and Jason, we'll have a brief question-and-answer session. Please note that this call is being simultaneously webcast on our Investor Relations webcast at ir.solarwinds.com.

The press release with our results for the third quarter was issued earlier today and was also posted on our Investor Relations website. Please remember that certain statements made during this call, including those concerning our financial outlook for the fourth quarter and full year 2013, our investment strategy and areas of strategic focus; our growth opportunities and expectations; and the integration of recent acquisitions 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 third quarter of 2013, which we anticipate filing with the SEC on or before November 12, 2013, and the risk factors described in our annual report on Form 10-K of our 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 that are on this call will be presented in 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 table accompanying the press release.

Each non-GAAP item in our forward-looking financial outlook that we will provide today has not been reconciled to comparable GAAP item because we cannot reasonably or reliably estimate future adjustments of stock-based compensation expense, which is dependent on our stock price at the time. I'll now turn the call over to Kevin.

Thanks, Dave. Good afternoon, everyone, and thanks for joining us on our third quarter 2013 earnings call.

To start, we hope to see many of you next week at our Analyst Day in Boston on November the 7th. We will save our thoughts on future products, marketing growth strategies for that event and focus our comments on this call on our third quarter results.

We are pleased to report that we saw improved performance in our Commercial Market business in the third quarter. Our Commercial Market license sales growth rate accelerated across many key areas.

Our strong third quarter Commercial Markets sales results allowed us to overcome U.S. Federal license sales, which were approximately $2 million below our expectations for the quarter and still deliver total revenue which exceeded the high end of our outlook.

As I mentioned, primarily driven by the changes we have made in our business over the last several quarters, our commercial market performance are strong across many key areas. First, in the third quarter, we drove the highest level of year-over-year growth in commercial market license sales of our flagship Network Management products -- SolarWinds Network Performance Monitor, SolarWinds NetFlow Traffic Analyzer and SolarWinds Network Configuration Monitor that we have seen in the last 6 quarters.

Second, we saw an acceleration in commercial market license sales growth of our key systems management products with SolarWinds Server & Application Monitor license sales accelerating from its second quarter 2013 growth levels and SolarWinds Virtualization Manager experiencing its strongest quarter of year-over-year license sales growth in the last 4 quarters. Third, after a difficult second quarter in EMEA and Asia-Pacific, we saw accelerating growth in these geographies in the third quarter.

New license sales in EMEA increased by over 12% sequentially. Our improved EMEA performance was driven primarily by strength in network management license sales in the U.K.

and Russia, partially offset by weakness in Germany. We also saw a significant improvement in performance in Asia Pacific as new license sales in the region grew by 9% year-over-year in the third quarter compared to a slight year-over-year decline in the second quarter.

Our growth in Asia Pacific was driven by strength in China and Hong Kong. Fourth, our commercial market core product transaction volumes continued a string of strong growth quarters, increasing by 18% as compared to the third quarter of 2012.

In addition, we experienced a sequential increase in commercial core product average transaction size, reaching approximately $7,700 for the third quarter 2013. And finally, our MSP business, which is almost exclusively focused on the commercial market, delivered a record number of new subscription customers in the quarter and reached an all-time high in subscription bookings, delivering 87% year-over-year growth.

We remain excited about the growth opportunities for our MSP business and in the fourth quarter, we expect to begin to leverage more aggressively many of the assets we have at our disposal across our global business to accelerate the growth of this business even further. Turning to our U.S.

Federal business, our U.S. Federal license sales result in the third quarter of 2013 were disappointing.

They reflect what we believe was a uniquely challenging environment. We navigated this environment well in the first 2 quarters of 2013, delivering solid year-over-year growth.

However, late in the third quarter, the issues surrounding the sequester or lack of an approved increase to the debt ceiling and the uncertainties around the looming U.S. government shutdown seemed to catch up with us.

We believe we had taken a conservative view of our U.S. Federal pipeline given the chaos surrounding these issues.

However, as we near the end of the third quarter and the reality of the pending shutdown grew closer, we had a number of what we consider run rate deals, in the $100,000 to $300,000 size range, get delayed. However, the silver lining is that we believe that most of the deals that slipped out of the third quarter are still active opportunities that we have the potential to close over the coming quarters.

The sum of all of these resulted in a solid quarter of overall growth in the third quarter, against a very strong year-over-year growth compare with total revenue increasing by 23%, exceeding the high end of our outlook and reaching a record high of $87.9 million. We also, once again, showed that we are among the most efficient operators in all the technology as our solid growth rate was accompanied by non-GAAP operating margins and earnings-per-share that came in well ahead of our outlook for the third quarter.

This is despite the dilutive impact of the N-able acquisition on the quarter and significant investments we made in our core business. We believe we remain unique in our ability compared to our high-growth peers in software of simultaneously delivering this combination of revenue growth and strong operating profitability.

We have stated on a number of occasions that we created our pricing and product packaging model to maximize the long-term value of the customer and not to optimize the first year license value. This approach, coupled with our historically high customer retention rate, has allowed us to consistently grow our recurring revenue at a higher rate than our total revenue growth rate.

Over the last 12 months, since we've added subscription revenue to the mix, the composition of our total revenue has changed in a meaningful way to the point that 61% of our total revenue is now recurring. Our recurring revenue, which includes maintenance revenue and subscription revenue, grew by 42% as compared to the third quarter of 2012, increasing to a record $53.5 million.

Our recurring revenue exceeded the high end of our outlook by over $2 million for the third quarter due primarily to stronger-than-expected new subscription sales of our MSP team and better-than-anticipated customer retention rates. We plan to provide additional color on the character mix of our total revenue and how we expect it to trend in the future at our Analyst Day next week.

While we feel positive about many of the performance trends that we saw in the third quarter, we're still addressing a number of opportunities to meaningfully improve our performance. Our focus, as we look forward, is on investing in initiatives which we believe will accelerate top-line growth rate in the fourth quarter of 2013, in calendar 2014 and beyond.

The increased level of investment across our business that we discussed on our second quarter earnings call is well underway. Over the last 90 days, we have significantly increased the capacity of our product development organization.

These additional product development resources are focused on accelerating development of new products, key new features and modules for our Network and Systems Management core products and on enhancing our core performance and reporting engine to allow for tighter integration of our developed and acquired products. We plan to provide additional detail on these product investments at our Analyst Day next week also.

Consistent with the intent that we discussed on our second quarter earnings call, we made a meaningful investment on our sales organizations during the third quarter, increasing our global sales rep headcount by over 14% since our last earnings call. We're now positioned to more successfully respond to increasing levels of inbound demand.

In addition, we increased the depth and maturity of our global sales leadership team since the second quarter, including adding a new VP and 2 new Directors of Sales to our EMEA sales leadership team and also added several new Directors of Sales to our North American leadership team. We have also already made and expect to make additional meaningful investments in our demand-generation programs and awareness campaign to enable us to more effectively reach IT pros all over the world at the very moment in time they are out searching on the web for solutions to problems that they must solve.

On that note, I'm excited to announce that John Rizzo has agreed to join our leadership team as EVP, Chief Marketing and Chief Customer Officer effective November 4. John was most recently the Chief Marketing Officer at Jive Software, where he's part of the leadership team that took Jive public in 2012.

John, in addition to being technically skilled, brings a deep knowledge of both enterprise and consumer software marketing models to SolarWinds along with consumer branding skills, which is an ideal and unusual combination for our go-to-market model. He is a proven leader and has served not only as a top marketing executive in a number of high-growth companies, but has also filled the CEO role for several technology companies over the course of his career, as well as early leadership stints at brand leaders like Intel and Apple.

John will focus on a number of initiatives that include branding, awareness building, demand generation and demand conversion. He will also spearhead new focused initiatives around SolarWinds' customers as Chief Customer Officer.

Under John's leadership, you'll see us make a much more significant effort to create a connection in the minds of IT pros in the market between SolarWinds and the idea of easy-to-use, affordable IT management software that solves most of the problems they face each day. We want to be the go-to-brand for IT management software, for IT pros and companies of all sizes, not just when they search the web for solution to their problems but during conversations with colleagues, when they think about their plans for the upcoming year and, of course, when they try and buy new software.

We're glad to have John onboard for the next phase of our growth. You will get an opportunity to meet him and listen to his thoughts on how we'll take SolarWinds' marketing to the next level at our Analyst Day next week.

Due to the great strength of our operating model, we were able to make all of these additional investments, which I've discussed, while delivering non-GAAP operating margins in the third quarter that exceeded our outlook. Our operating model has strong leverage that we have shown the ability to effectively manage time and time again.

Jason will cover the details of our fourth quarter 2013 outlook and the impact on our investment plans on his outlook and his comments. Before I turn the call over to Jason, I want to provide a quick update in our acquisition of Confio, which we announced on October 7.

As a reminder, Confio has been one of the fastest-growing providers of database performance management software for the last several years. As we indicated on our call, when we announced the acquisition on October 7, we believe that the strength of Confio's products and the distinct similarities between our respective sales and marketing models will allow Confio's product and team to easily plug in our marketing and sales engine.

Importantly, those similarities include a strong inbound demand-based marketing engine and effective and efficient sales model based on selling from the inside and products that solve problems faced by organizations of all sizes, are powerful and scalable yet affordable and easy to try, buy and use. As we stated in our announcement call, we believe database performance management is the last major component we needed to round out our Systems Management product portfolio.

With the addition of Confio's Ignite database performance management solution, we are now able to solve virtually all of the major problems based on a daily basis by system administrators and other IT pros responsible for delivering high-performing business infrastructure and application to their respective businesses. I will now turn the call over to Jason for a more detailed review of our third quarter financial performance and a view of our outlook for the fourth quarter of 2013.

Thank you, Kevin, and good afternoon to everyone on the call. During my discussion today, I'm going to walk through some of the components of revenue to help you get an understanding of what contributed to our third quarter results; talk about our spending, both in how it impacted our third quarter operating margins, as well as the investments we are currently making in the business; walk-through certain key balance sheet accounts; and provide our outlook for the fourth quarter of 2013.

Before I dive into all of that, however, I'd like to hit just a few financial highlights in the quarter. First, total revenue for the third quarter was $87.9 million, more than $600,000 above the high end of our guidance and representing 23% growth versus the third quarter of 2012.

This revenue result was driven by license revenue that was within our guidance range and from the out=performance of our strong maintenance revenue model and our new subscription revenue stream. Maintenance and subscription are the backbone of our recurring revenue model and now represent 61% of our total revenue base.

Our recurring revenue stream is more predictable, more profitable and more reflective of the relationship we have built with our customers and will be an even greater strategic focus for us going forward. Second, new commercial license sales for SolarWinds' traditional IT management products grew 5% versus the third quarter of 2012, consistent with the high end of our outlook range.

At the overall commercial level, we are pleased that new license sales in the commercial market, the largest part of our market opportunity, are growing. But 5% is not a growth rate with which we are satisfied.

There were some brighter notes within that number, however, that Kevin mentioned earlier and that I will describe in a minute. Third, as we told you last quarter that we would, we significantly increased our investment in both the acquired N-able business, as well as the traditional SolarWinds business during the third quarter.

During the quarter, our total non-GAAP operating expenses increased by over $7.7 million versus Q2, yet we still delivered non-GAAP operating margins of approximately 50% and non-GAAP earnings-per-share of $0.31, both meaningfully above our outlook. Turning to revenue, we finished the quarter with $34.4 million of license revenue, within our guidance range of $34.2 million to $35.7 million.

There were several positive factors that contributed to that result and several challenges that we faced and I'll take you through both. On the positive side, as I mentioned before, new license sales of our IT management products to commercial customers grew 5% year-over-year.

Fueling that growth were several positive factors, in particular that new license sales of our core Orion-based network management products to commercial customers grew by 9% versus last year and acceleration versus the growth rates in Q1 and Q2 of this year. Our Systems Management product group also accelerate its commercial license sales growth rate versus those from last quarter.

N-able continues to drive outstanding results and deliver bookings in the third quarter, above what was included in our outlook and above our expectations. The transition to subscription only for new business appears to be delivering positive results as N-able's strong momentum among MSPs resulted in 29% year-over-year growth in new business transaction volumes this quarter.

All revenue from N-able was recognized ratably, including subscription and maintenance revenue, which each fall into their respective line items on the income statement. License sales, which are primarily to pre-acquisition customers upgrading their existing perpetual license, are also recognized ratably on the license revenue line.

Despite the ratable recognition model, based on out-performance at the end of Q2 and during this quarter, N-able delivered over $3.2 million subscription revenue, well ahead of our outlook. In terms of factors that negatively impacted our revenue results, several of our core products, specifically SolarWinds Storage Manager and SolarWinds Log & Event Manager, delivered new license sales below what we had expected and below what was needed to support our overall growth objectives.

The reasons for these results vary. In the case of Storage Manager, we still see significant demand for information about the availability and performance of storage resources but know that we need to make that offering more tightly integrated with the rest of our products in terms of technology and user experience.

In the case of Log & Event Manager, after a strong year of growth in 2012 and solid performance from the first 2 quarters of 2013, Log & Event Manager did not perform well in Q3. In this case, we simply have not executed as well as we can in reaching potential customers and explaining to them how we can solve their problems.

Log & Event Manager is a great product in a very large market, so we definitely have high expectations for what the product can do over time. New license sales for each of the products that I just talked about experienced year-over-year declines in the third quarter, which were not consistent with our targets, significantly offsetting growth in other core product areas.

Obviously, as Kevin mentioned in his remarks, our federal business did not perform consistent with our relatively modest expectations and had a negative impact on our overall results of this quarter, which were otherwise positive. In our guidance for Q3, we said that we expected our federal new license sales to be essentially flat relative to the third quarter of 2012 and had that turned out to be the case, we would have delivered license revenue above our outlook range for Q3.

We had guided for federal new license sales to be approximately 20% of the total for Q3 and in fact, federal new license sales were only 17% of the total, down more than $2 million versus Q3 of last year. Turning to maintenance revenue.

We had another very strong quarter. And in fact, celebrated a bit of a milestone recognizing over $50 million in quarterly maintenance revenue for the first time, which represents growth of 33% versus the third quarter of 2012.

Our maintenance revenue growth continue to be bolstered by strong customer retention rates that were slightly better than our historically strong levels. Now I'd like to provide a few key metrics that we have given to you in the past, including core product transaction volumes and average transaction size.

Core product transaction volumes across both commercial and U.S. Federal, and this excludes N-able, grew by 16% from the third quarter of 2012 and were up versus last quarter as well.

Our average transaction size for core products over the trailing 12 months ending September 30 dropped slightly to approximately $7,500 this quarter. This is a decline from Q3 of last year, but the decline is due to the addition, over the last 12 months, of several products that are lower in price but still important to the overall solution that we provide to our IT Pro customers.

However, I do want to point out that the overall average transaction size in Q3 itself was $8,000, an increase from $7,400 in Q2. Now let's turn to operating expenses.

Total non-GAAP operating expenses in the quarter was $39.7 million. This represents growth of almost $8 million versus Q2 and over $10 million versus the third quarter of 2012.

Of the $7.7 million sequential increase versus Q2, $4.2 million came from having a full quarter of N-able's operating expenses included in our results and $3.5 million of the increase came from investments we made in ramping activities to drive additional growth for core SolarWinds products. As Kevin mentioned, we have been focused for some time now on hiring throughout our sales organization in order to provide us with additional capacity and leadership and our hiring efforts began to deliver results during the third quarter.

We also significantly ramped up our marketing expense from Q2 to Q3, making more investments in top-of-the-funnel awareness and in promoting the SolarWinds brand, which we believe will have a positive impact on future growth. More broadly within marketing, we are focused on a number of initiatives that include not only branding, but awareness building, demand generation and demand conversion as well.

Similarly, we grew our investment in R&D where we are not only building new products but also adding features to existing products and ensuring that each release for each product moves the bar forward in a meaningful way. As we look at product development, we are focused on several initiatives.

First, we want to continue to deliver on the promise of delivering new technology for customers on SolarWinds maintenance for each of our products. Second, we are investing in products -- in new products that fit tightly within our current product portfolio and are building new, remarkable features for existing products that we believe will appeal to new and existing customers alike.

And third, we are working to more tightly integrate the core products in our portfolio in order to deliver a suite of products with a seamless user experience. We want to create technology linkages that make the combined experience richer than the sum of the individual products, but still make the individual products compelling enough that an IT Pro with just that need is excited about the product, buys it and becomes an advocate for SolarWinds.

We'll talk more about our products fit strategy at our upcoming Analyst Day, but I wanted to give you a flavor of where our operating expense investment is being directed. Net-net, our increased spending resulted in a non-GAAP operating margins for the quarter -- for the third quarter of approximately 50%, which was higher than our outlook and, to be frank, higher than where we want our operating margins to be at this point.

While we are pleased with our plans for increased investment and the efforts underway to realize those goals, we are not satisfied with the rate at which we grew our investment in the third quarter given the very large growth opportunity we see in front of us. The fact that total revenue was above the top end of our guidance certainly drove some of our margin upside, but a significant amount of our margin out-performance came from spending that was below planned.

I can tell you, however, that the management team has organized itself around driving their teams to seize the market opportunity that we see and spend did build throughout the quarter and reached a meaningfully higher run rate by September than we had in July or August. Going forward, we intend to invest more aggressively in certain key areas, specifically marketing and product development.

These investments are included in our outlook for the fourth quarter and represent an increase relative to the operating expense -- expectations we provided at the end of the second quarter before the impact of the Confio acquisition. Turning to the balance sheet.

Our accounts receivable were $45.5 million at the end of September, an increase of $9.8 million from the end of June. The majority of the increase in AR came from 1 significant renewal on a federal government maintenance contract that has been consistently renewed for many years now.

Our cash collections in Q3 were strong, totaling $90 million relative to $80 million in Q2. Our cash and investments balance was approximately $223 million at September 30, split between approximately 58% in the U.S.

and 42% held internationally. Lastly, although we acquired Confio and put in place a revolving credit facility during early October, not impacting our September 30 cash balances, I want to give you a view of what our cash balance would've been at September 30 pro forma for those events.

Our actual cash and investments balance of $223 million, less $103 million paid in the acquisition, plus $40 million in debt drawn on the facility would have resulted in the cash and investments balance of approximately $160 million, split between 41% in the U.S. and 59% held internationally.

Now I'd like to walk you through our outlook for the fourth quarter of 2013 and the assumptions that underlie the guidance. First, we assume that our core SolarWinds commercial business continues the strong momentum, particularly in demand generation, that we saw begin to build during the third quarter.

Our guidance assumes meaningful sequential growth from Q3 to Q4 and commercial new license sales, consistent with our typical Q3 to Q4 experience, but year-over-year growth, in line with our total license growth in Q3 as we will remain conservative in our outlook until we see several quarters of improving performance. Second, we assume that new license sales within our federal business, U.S.

Federal business, decline by over 60% from Q3 to Q4, which is consistent with the rate of decline we have experienced in prior years. We believe that this is a relatively conservative view of this part of our business given the recent budget deal agreed to by Congress.

Third, with respect to expenses, we assume that operating expenses from the SolarWinds and MSP businesses, excluding the recently acquired Confio, increased by $5 million to $6 million from Q3 to Q4 due to increased investment in the MSP business and due to the increased investment in the core SolarWinds business, which we walked through on this call. Fourth, as we said on our call a few weeks ago, we expect the acquisition of Confio to add approximately $2 million to $3 million in total revenue and $4.25 million to $5 million in total expense to our Q4 results.

Lastly, we assume an average euro-dollar exchange rate for Q4 of $1.33. With that said, our current expectations for the fourth quarter of 2013 are for license revenue in the range of $35.5 million to $36.5 million, or a growth rate of 7% to 10% versus Q4 of 2012; maintenance revenue in the range of $51.2 million to $51.9 million, or a year-over-year growth rate of 27% to 28%; and subscription revenue in the range of $3.6 million to $3.8 million.

This implies a total recurring revenue growth rate of 35% to 38% and recurring revenue comprising 60% to 61% of total revenue. We expect total revenue to be in the range of $90.3 million to $92.2 million, or a year-over-year growth rate of 23% to 25%; non-GAAP operating margins in the range of 40% to 41%; net interest expense, including the interest on our recently drawn credit facility, of $250,000; non-GAAP tax rate of 28.5%; and weighted average shares outstanding for the quarter of 77.1 million shares and non-GAAP earnings per share of $0.33 to $0.34.

I won't walk you through our full-year guidance at this point since it's just math based on the first 9 months actuals and the fourth quarter outlook, although we have provided in our press release. So at this point, I will turn the call back to Kevin.

Thanks, Jason. As you've heard in our remarks, we believe we have made solid progress in improving the predictability and the level of performance across a number of areas of our marketing and sales engine in the third quarter.

We are particularly encouraged by the acceleration of our commercial business growth rates on a geographic basis and also pleased that our third quarter results reflected the strongest quarter of year-over-year growth we have seen since the third quarter of 2012 in sales of our -- many of our most important Network Management and Systems Management products. In addition, based on many of the indicators we track, we believe we're entering the fourth quarter with the highest level of overall business momentum that we have entered in the quarter with this year.

So while we are still focused on making sure that our business is firing on all cylinders, our increased momentum, coupled with increasing percentage of our total revenue which is recurring, gives us confidence -- are confident in our ability to deliver sequential acceleration in year-over-year growth rates in the fourth quarter. We remain convinced that the size and immediacy of our market opportunity and are confident in the growth strategy we have been executing against in the last 3 years.

As you look at the assets we've assembled over the last 4 months, including the recent acquisition of Confio, we have made significant progress towards our goal of creating an IT management platform that will allow us to solve performance management problems for all things IT, and to solve these problems the way IT Pros want them solved, regardless of whether that is 1 problem at the time, as a solution to a set of problems or whether the IT assets that need to be managed are on-premise, in the cloud or deployed in a hybrid model. Based on the confidence we have in our business and in the large and immediate growth opportunity in front of us, we are investing aggressively to attack this opportunity.

These investments are focused on providing us with the ability to increase the pace in which we bring new products to market, increasing the speed at which we are improving and adding exciting new features to our existing products and also accelerating the work we've been doing to move many of our core products we've acquired and internally developed on the Orion's performance management reporting and alerting engine. In addition, we are enhancing our marketing team and infrastructure to allow us to more effectively and predictably market our broad and growing portfolio of products on a global basis and to connect with our users in the IT Pro community even more effectively than we have in the past.

We will discuss our investment strategy in more detail when we see many of you next week. Turning to a quick preview of our Analyst Day, which will be held on November 7th in Boston.

We believe we have created a session those who choose to join us will find valuable. We're planning to share our thoughts in the direction of IT management over the next several years and how we believe SolarWinds need to be positioned to be a leading player for many years to come.

We'll also provide a view to the path we are following in our drive to reach $1 billion of revenue and beyond. I hope to see many of you there.

With that, we'll open up the call for questions.

It's good to see you guys putting up these results here. Kevin and Jason, I guess just 1 question on something you said about commercial license sales.

So you said, I think, that growth of core was greater than in the last 6 quarters and commercial license growth was about 5%. And that's up a little bit from last quarter, but it's meaningfully below what it was in the prior 4 quarters.

So this all sort of implies that the rest of commercial license beyond core was much weaker than it had been, at least prior to last quarter...

Let me give you a little more detail on that, John. So what we said was the growth of specific products.

So SolarWinds Network Performance Monitor, which is still a product that's -- it's the largest product we have in our portfolio, SolarWinds NetFlow Traffic Analyzer, SolarWinds Network Configuration Monitor, really the 3 flagship products. And our Network Management product portfolio grew faster than they have at any time in the last 6 quarters.

And then, SolarWinds Application Performance Monitor -- Server & Application Monitor, we change names, I get them confused, grew -- that grew accelerated growth from Q2. And SolarWinds Virtualization Manager which is.

other -- the real other key product in our systems management product portfolio grew faster than any time that it has in the last 4 quarters. So that wasn't a comment on our total core product portfolio.

That was really pointing out that where we focused, if you remember back to last quarter's call, we said we were going to focus on network management. We're going to focus on SolarWinds Network Performance Monitor because it is the product that drives the sales and attach of other products and the result of that focus has resulted in accelerating growth for those key products.

We have a number of other products that performed well on the commercial side in the quarter, but a couple didn't performed well. Jason mentioned SolarWinds Log & Event Manager which is a really good product.

We just didn't do a good job of creating demand. In late second quarter or early third quarter for that product as a result, we're down year-over-year when we'd had a really nice growth run for that product.

We also saw SolarWinds Storage Manager declined a little bit and that was a combination of doing a better job of creating demand and making sure we integrate that product more and more tightly, which is one of the areas we're investing in right now with our core performance engine because it will give an experience that is very much the same as the users get when they are using our other products and that just doesn't exist right now, which makes the product a little bit more difficult for us to sell. So it's one of those things that we needed address for a while.

We now are making that a priority. So in the areas where we put tremendous focus walking into this quarter, the products that need to grow and where growth needed to accelerate, more in Q4 and more next year, we saw positive progress.

Had a couple of products we weren't focusing on quite as hard in Q3 that fell off on us a little bit. We are going to get that corrected, hopefully in Q4.

We've given ourselves really the time to get that corrected next year, but our focus is to get it corrected now and hopefully, be able to put up stronger growth rates than what we are expecting right now. So does that help a little bit?

Yes, that helps a lot, Kevin. And if I may, just a follow-up on the U.S.

federal business. And I guess 2 questions.

I guess, why do you think these deals would have slipped at the end of September if the shutdown was not until October 1, after the quarter had ended? And then, now that the government's back in business, do you believe that you've accounted for the fact that we're still in sequestration, and that's still in effect.

And is that in guidance? Because when I look at -- you gave sequential guidance, at least in my math, it shows like slightly up by low-to-mid single-digits year-over-year.

I just want to -- I guess, maybe if some of those deals have closed, it gives you confidence or so far in the quarter? If you can address those 2 things on the federal government?

Sure. So as I said in my comments, the deals that slipped were all relatively very small deals for the federal government, actually relatively small deals for our federal business, kind of $100,000 to $300,000 range.

And there are a number of those that didn't close. We said we're about $2 million short on the bookings line for federal in the quarter.

So we had 10 to 12 relatively small deals slipped that were funded, that we were told we were going to get and the POs just didn't come. And really what we saw happen, and I don't if it's similar to what other folks saw happened, as we got close to the end of the quarter.

It was pretty clear at that point there was going to be a shut down. Procurement agents just stopped working to kind of hours they normally work in the month of September in order to push deals through and unfortunately, for us, our deals just weren't big enough to get to the top of the pile and get priority.

We weren't closing $10 million or $20 million deals with big agencies. It's a bunch of relatively small deals with a number of different agencies and they just -- we couldn't get the focus on them that we needed to get.

So that's why, I think, they didn't close at the end of September. They just weren't big enough to get priority and we just had a number of procurement agents we were working with that really kind of ceased to care.

They knew that they were going to be taken off on October 1, and they didn't know for how long. So those deals are in the pipeline, and we think there -- we're actively in conversation and so we had a hope that those will close.

Now we did not build into our outlook that those would all close in the fourth quarter. We've assumed it could take 2 or 3 quarters.

It could take all of this fiscal year for all of those transactions to close. So as we look at the fourth quarter, we really look at the pipeline we have.

We did negatively impact that pipeline, if you will, for the environment we find ourselves in. And what I'd say is that it's kind of flat to down.

So it's at the low end of our range, federals down by a decent amount year-over-year. At the high-end of our outlook, Federal flat to slightly down, year-over-year.

So we actually are not expecting it to be up. We think it will be flat to slightly down, and we have the room for it to be flat to a little more than slightly down.

I just wanted to sort of, I guess, reflect on this quarter relative to what happened this year on the expense side. I know coming out of Q1, one of the things you really highlighted was sales capacity and then really needing to backfill some of that.

And then in Q2, it seemed like you are behind in doing that but it was such a priority for you. So can you just walk through why it's still in this quarter it took so long it sounds like for you to really add the sales capacity?

It sounded like it was slow and you really only sort of got to stride in September. So I guess, why from April until September did it take so long for you to add sales capacity where you really highlighted that it's such a critical part to getting the model back on track?

Yes, so we talked about a little bit of that last quarter. So in Q2, we hired a bunch of reps, but we lost more reps in Q2 than we had planned.

Now most of those we asked them to leave. It wasn't they decided to leave.

We just did not do quite a good job of hiring so we were hiring quickly in the second quarter, as I believe we should be doing. And so we ended up asking too many reps to leave, so didn't end up with a net capacity we wanted to have, even though we hired enough reps in terms of gross numbers we added in Q2.

I think what we did coming into Q3 is make sure we're doing a much better job in both retaining the reps we've added, of making sure the reps we've added are successful and that -- we are given the ability to get to their number because that's important for all reps. And then we did a better job of hiring in Q3.

We added more reps in Q3 than we did in Q2. I think we did a better job of hiring so our retention rates were better in the third quarter than the second quarter.

So I think we've already addressed why we didn't get there in Q2 and Q3. I think we did what we said we're going to do which is we're going to get there, we're going to make sure we do good job of hiring, do a better job of retention and we did both of those in the third quarter.

Aaron, this is Jason. I made the comment in my prepared remarks that the spend built throughout the quarter, that is really more of a comment around marketing and R&D where we're making increased investments in the business to really chase the opportunity that we see.

And obviously, in the case of R&D, our spend is primarily hiring there and Rob is still looking for a specific technical talent depending on which products we're hiring for. So that does take some time to get that flywheel moving and the hiring ramp built up there.

In marketing, we really turned on the spigot, I think, later in the quarter until that, that can get moving more quickly. But that's when I made a comment about spend building throughout the quarter and being at a higher run rate in September.

It's more around the marketing and R&D side.

Okay. So the sales capacity was not as back-end loaded as some of the other...

The sales capacity really came in through the quarter, late Q2 through Q3 and by the end of the quarter, we said we wanted to be up 10% to 15% by the end of Q3 and we're up 14% net capacity add as of today since the last call, so over the last 90 days, which means we did exactly what we needed to do to position ourselves, to have the capacity we need to handle a higher level of demand and not to be worried so much about quality mix.

Okay. And then second question, if I could real quickly, just a mechanics question.

But on N-able, on the subscription deals, just for the deferred revenue model, are those built annually or quarterly or can you just give some guidance for what sort of you're seeing there in the billing terms?

Most of those right now, Aaron, are billed monthly. And that's one of the things that we will try to address as we move forward, is to get those billed for a little longer period of time, but the retention rates have been very good.

So even though they are billed monthly, we're not seeing any real challenges with churn at all. Retention rates have been as high or higher than what we had anticipated.

But right now, almost all billed monthly. That's why you don't see a big -- I mean, our deferred revenue actually hopped a lot.

We had a really good retention quarter, that's why you haven't seen a bigger impact on deferred from our MSP business or from N-able because they're billing monthly and then we recognize -- we bill it, then we recognize it, bill it, recognize it, bill it, recognize it.

I'm actually going to follow-up Aaron's question on N-able but I would ask about what really drove the strength there? You're talking about bookings being up 87%, being a little better than expected.

Have you driven headcount? Have you brought some of your product feature functions over to the product?

What has kind of changed on their end that's driving their better performance?

We have not really done anything on the technology side yet. They're selling the products they had when we made the acquisition.

We are looking at moving some of our features and functions over to their platform and that's obviously our strategy as we move forward and one of the reasons the combination has such power. But what I would say is that, that management team, which is all still in place, is really doing a phenomenal job.

They add -- we helped add a little bit of process, we've given them a little bit of access but not a lot yet to our marketing, but some. But they're just really executing well against a market opportunity that's going quickly where they had established themselves as the leader.

It was actually -- they had a partner conference last week in Scottsdale where they got about 25% of their -- a little more than 25% of their global partner base at the conference, biggest turnout they've ever had. And I spoke at that conference.

And their MSP partners are really excited. Very enthusiastic about what they're doing on the technology side, very excited about the fact that we've combined SolarWinds and N-able because they see the power that we can bring, both from a technology platform, as well as the ability to just create technology and build technology much more quickly than N-able could do in the past.

So I think we just helped create a little momentum that, that management team is doing an awesome job of executing against.

And then on Confio, and I apologize if you walked us through this already but in terms of the roadmap for that product, I'm assuming really no change in the fourth quarter, just let them as a standalone company go through that. But what do you start to change and what do you start to bring to their go-to-market as we go into next year?

Yes, so we'll talk more about product roadmaps obviously next week. But what I would say is that they've got a great product, Confio Ignite, which is their database performance management product, is very strong.

It solves the problem, it solves very well. It's very deep in terms of its ability to look inside the database and tell you what's going on from a performance point of view, and then really tell you what you need to address in order to fix that problem.

And they've done a good job of creating brands. So for the fourth quarter, I want them to let them run.

They've had a very good year up through September before we bought them, and I really want to allow that team to finish their year. And then as we move through this quarter, we're working on the roadmap and the integration plans with the technology and then in the full integration plan of how will integrate their organization into ours.

So we'll give you a little better of feel of roadmap next week. But no real big changes in their technology.

The product's easy to use, it's easy to try, we think the pricing model makes sense. And so it's really about just bringing our global processes, our global reach, our brand, our customer base so that we can attack it with our product also, which I think will hopefully accelerate their growth.

If I'm looking at the trends on kind of my metrics stat, it seems like you've seen 2 quarters in a row sequentially -- sequential improvements in ASP. But offsetting that has been 2 quarters in a row, pretty significant drops in the core transaction growth that's kind of offsetting that increase in the ASP.

So 2 questions. One, is that improving ASP, is that an indication that the core issues that we had in Q1 about sort of getting deals in the right size, that they're starting to get fixed?

And two, should we be concerned about the deceleration in growth in that core transactions?

Yes, so on the average transaction side, I think what you're seeing is, one, the focus on driving growth in Network Management really focus on SolarWinds Network Performance Monitor, SolarWinds NetFlow Traffic Analyzer and SolarWinds Network Configuration Monitor. Those 3 products have average transaction sizes that are higher than when we sell them, than our overall average transaction size, as the SolarWinds Virtualization Manager and SolarWinds Server & Application Monitor.

So those 5 products have an higher average transaction size than our average overall. So what you're seeing is the impact of that.

I think that's a very positive trend. It says the right products are growing at the right transaction sizes, it means the right size of the product mix because those products range in price for about $3,000 to about $20,000, and we have -- we're right in the middle of where we want to be with those products.

Where you're seeing the impact on core product transaction volume is, one, Log & Event Manager. We mentioned that we just didn't had a great quarter in Q3 with that product.

That's execution, not product. It's really a great technology.

We just didn't focus enough on it while we were focusing on other things and we got to make sure we address that. That product has an average transaction size of around $5,000.

And so we dropped a good bit of volume there that we need to pick up. And so I'm not concerned about the drop in core product transaction volume.

If our core product transaction volume growth can be in that 20% to 30% range, then I think we can drive much higher growth than we're driving right now. And when we got -- our Federal business is just flat to slightly growing.

And if we had Log & Event Manager back to where it needs to be and Storage Manager back to where it needs to be, then that 20% to 25% range can drive north of 30% overall top line growth for us relatively easily. So I don't think you should be expect, it's always going to be in that 40%, 45% range because some of that volume was a relatively low-priced product.

We've been trying to make sure we've got a better mix of slightly higher-priced products and lower-priced products so the volume may come down a little, but the average transaction size should continue to rise. So it's not exactly where I wanted to be yet in terms of core product transaction volume.

I'd like to see that more in the mid-20s. But if that would have been in the mid-20s, we've really been in a really good spot.

We had a solid quarter, but in a really good spot for the quarter.

Okay, got it. I mean, it might be helpful, because I feel like there have been different problems in Q1 versus what was in Q2 and what we talked about in Q3.

Was the core problem that we had in Q1, which I thought had to do with making sure each transaction built to its potential of making sure you're attaching enough products on to each transaction and that's why you need to hire the more salespeople and have more sales capacity and more sales management. Has that problem been resolved or was it just mix shift kind of covered over the symptoms of that problem?

So has that problem been addressed? Look, to a large extent, yes, we made a lot of progress today, and that's all.

And when you look at average transaction size going up, it's because if I sell more SolarWinds NPM then I'm going to sell more SolarWinds NTA, because SolarWinds NTA attaches at a pretty high rate to SolarWinds NPM. So when our product mix is where we wanted it to be, then generally, and I can't make that an always statement, but generally our attach rate and our average transaction size is going to be trending in the direction we want them to trend.

When we do too many sales of small standalone products, or not too many, too many as a percentage of total because you never have too many. Just too many as a percentage of total, then you're going to see average transaction size and attach rate come down.

We definitely saw average transaction size and attach rates be more in the range where we wanted them to be in the third quarter. We just had a couple of core products, Log & Event Manager and Storage, to be the 2 primary ones that didn't perform at the level I wanted them to perform, on the commercial side.

Now on the federal side, it was a different story and we've talked about that. So I think we've addressed and, well, are addressing that issue.

We're seeing positive improvement from that. A lot of that's happened because we actually added a number of sales reps in Q3.

Remember, in Q2 our net sales capacity didn't rise that much. But our net sales capacity rose by a meaningful amount by the end of the third quarter which means we're better positioned, we have more momentum which I indicated in my comment, walking into the fourth quarter.

So I think we are addressing them. We're seeing positive improvement from the changes we've already made, and we expect to see more positive improvement as we move forward.

This is actually Ben for Rob. I was wondering if you could talk about the -- you talked about the Fed falling off at the end of quarter but could you talk about linearity in the quarter from a commercial standpoint?

Then also, kind of what you saw with commercial at the beginning of this month, kind of where the government shutdown if there's any ramifications on the commercial side with that as well?

Yes, so I'll address Q3, but I won't really address how we're doing this month. Month's not over yet, and so it's really too early to talk about that.

But as it relates to Q3, and let's kind of break it apart. The federal side actually started well, had good kind of volume and momentum through the first 2 months of the quarter and while September picked up, it didn't pickup at the pace that it normally does.

When you look at a typical federal fiscal year end, the month of September is generally the bulk of the quarter because the federal government just can't get out of their own way to get most of the deals done before the last hour. And so we just didn't see a pickup as much in September as it normally did.

So the first 2 months felt relatively normal. We had a good first 6 months of the year.

Our federal business actually grew through June in 6 months year-to-date over the prior year but Q3, while it started well, it just didn't pickup the way it normally does in September, on just the sheer volume side of the business. We typically just see a tremendous volume of transaction in the month of September, and we just didn't see that.

So that's on the federal side. On the commercial side, the business really trended about the way we thought it would.

We had a stronger finish to the quarter than I think we've had in Q1 and Q2 for certain. Maybe a little bit slower start.

But overall, trended relatively consistently with what we expected but it's a little stronger in the second and third month than we thought it would be and slightly weaker, but not by a real significant amount in the first month of Q3.

Okay. And then regarding Europe, it looks like you rebounded.

I was wondering if you could just drill down a little bit more on kind of what you're seeing in that market? Is the improvement strictly based upon the growth in sales headcount and also maybe you can give us some kind of an update on what you're seeing in Germany, because I think you mentioned that as being a little bit weaker?

Yes. So I think the growth in Europe is primarily driven by us doing a better job of executing against the demand that we've been creating.

We indicated in Q2 that our level of execution in Europe was nowhere near where we wanted it to be, where we expected to be and that we were taking some actions to address that. That adding management, making sure that we are really following our processes as well as we possibly can, adding some reps for certain because our capacity was not where we wanted it to be as we exited the second quarter.

So I think a combination of those factors helped us perform better in the third quarter. So I feel good about where we exited the quarter.

We still have work to do in Europe, but I feel good as I look at Q4 about the momentum the team has built. I feel good about the infrastructure we've put in place and now -- and I feel good about the level of execution improvement.

Now we've just got to continue that improvement as we move through the fourth quarter. As it relates to Germany, it was really -- I don't think it's anything specific in terms of economic factors.

I don't think Germany screaming from an economic point of view right now. It's never been a big country for us.

It's one that we've said consistently, we want to be a much larger part of our European business and we were starting to make progress. I think we took a little bit of a step backwards in the third quarter in that move, but I don't think there's anything systemic to the market that I'm worried about.

We just got to do a better job of executing against it. To that point, we've added a couple of German-speaking reps that we feel pretty good about, and we'll make sure that we give them enough to work on and hopefully, we'll see that market grow for us in the fourth quarter.

Kevin, I guess, just a little bit of follow-up in Europe. I guess, do you worry at all that some of the bounce back this quarter was just sort of lost momentum in the second quarter catching up?

I guess, what gives you confidence either from a pipeline perspective that sort of improvement you saw this quarter can carry through into the fourth quarter? Is it just a level of turnover, I know you guys put some new sales management in that area.

Can you just give maybe a little more detail on that?

Sure. I mean, it's a combination of factors, Kirk.

So one, I think, we have done a good job of really making sure that we are following the processes that make the SolarWinds reps successful. So I think the team in Europe has kind of recommitted themselves, if you will, to make sure we're following their process very well and we're doing it effectively.

I think we've also done a good job of taking the sales team and we had in helping them to improve their performance by doing maybe a little better job at training, a little better job at coaching. I think we've also added a number of very qualified reps, so we're excited about for the team and so we're building more pipeline and we've got more guys focused on closing deals and they got a greater volume of deals that they're chasing.

And when you look at some of our metrics that we track in terms of conversion rates and average transaction sizes, all those trends are improved in the third quarter. So the bunch of different things we look at that gives us the confidence that we're going to have, continue to have strong performance and we're going to see another strong sequential growth quarter in Europe in Q4 like what we saw in Q3.

And sorry, if you guys mentioned this. I'm not sure if you guys have talked about it internally, but just to level set expectations.

Are you guys going to talk a little bit about '14 at the Analyst Day next week? I know that's sort of what you guys have done over the last few years.

I'm just kind of curious about thought process on that.

Yes, we'll talk about 2014, at least at a high level at Analyst Day next week.

First, a quick metrics question. Do you have any $500,000 plus deals this quarter?

I know normally you have a few into Q3. How does that perform this Q3?

Yes, Tim, this is Jason. We did have one $500,000-plus deal this quarter, obviously, with the federal government.

It was a renewal of a deal that we have had for many, many years. It also had a new license component that we're essentially adding on to the deployment of our technology that they already have.

So that new license component as well as significant maintenance renewal portion.

Okay. It was substantially less than $1 million.

So it wasn't -- we definitely didn't see as much big deal activity but we weren't counting on that. But we didn't see as much big deal activity in the third quarter as we've seen historically.

But the deals that slipped were all in that $100,000 to $300,000 range because we don't count on any of those really big deals, as we look at our federal quarters.

Okay, great, great. And then to sort of maybe a broader question on the market.

Do you feel as you're adding more products, your deals I'm sure, are getting a bit more complex here and there, even from the views -- eyes of your customers, do you think you're getting more seasonal? Because we're watching the ASPs pick up as we track through the quarter, performance seems to be picking up.

I know you guys are putting a lot of effort towards it, but do you think your buyers are getting more seasonal?

I don't think they are. I mean, yes, our performance is improving, but we're focused on making sure that it does.

So I think that's really why our performance is improving more than anything else. Our average transaction sizes are coming back up again after dropping in the first quarter but that's more of a conscious effort to drive demand mix in a way that we have in our transaction sizes, slightly larger.

So I don't think we're going to get more seasonal. At this point, still an $8,000 average transaction size.

We've been there before. We've been higher.

We've been almost $9,000 in average transaction size, if you go back 3 or 4 quarters. And so I don't think we're, at this point, we're at an average transaction size where seasonality should have a big impact on the business.

In terms of changing the trends we've seen in the past, right? I think Q3, federal fiscal year end, that's going to have an impact.

Q4, calendar year end, year end for a lot of companies, so that tends to have a bit of an impact. I think those trends have been in place for a while and that we tend to -- our growth rate tend to accelerate as we move through the year, but I don't think it changes from what you've really seen historically.

Okay, great. And then just one about distribution.

It seems like you push on certain products and you have great success and then products that you aren't pushing on seem to disappoint a bit. Do you think you have enough capacity, because maybe you want a few more guys pushing on more of the products.

What's your thinking about for Q4? What would you like that to be up compared to Q3 [ph]?

So look, I like to see every product grow all the time and the team knows that's my general theory in life, is everything should be growing. Nothing has -- there's no excuse good enough for why any product should not be growing because we have all the great technologies now.

That being said, to your point, I think we have not done a great job of making sure that as we put a lot of focus on a specific set of products, we don't lose complete focus on others. And that's where I'm excited about having John Rizzo joining the team.

John is a seasoned marketing leader. He's used to working in organizations that have lots of different products.

And I think he's going to bring kind of level of discipline that we need to have to make sure that we don't lose focus while we're -- if we're picking areas to double down on, that we don't completely lose focus on other areas. So that's just one of the things we got to get better at and pushing the whole product portfolio forward at the same time.

I think we've done a pretty good job of that over the last 3 years. Obviously, not quite as good as job over the last couple of quarters, but the products we are really focused on improving performance on in Q3 did.

And I think we created momentum that will hopefully cause that performance to continue to improve and now, we go back and pick up a couple where I think we took our eye off of the ball a little bit and move those forward. But I think John has enough budget to add that capacity.

It's part of the investments that we've talked about we're making, is to make sure we add the level of spending and that's a combination of program spending as well as people to make sure we can push all these products forward at a similar pace.

Okay. And capacity growth for Q4, organic, I guess?

Yes, I mean, in terms of people we add, it will be organic.

Okay, and how -- can you give me us a percentage, like, again, for Q3, you gave 14%?

On the sales side, no, we didn't -- we don't have a specific percentage I was going to share this quarter. I think we're in really good shape in terms of the sales capacity exit in Q3.

We will add more capacity in the fourth quarter in order to keep up with our growth to make sure we don't get behind again. And so Paul will talk a little bit about that -- actually, a fair bit about that at Analyst Day.

And I don't know, we haven't really decided whether we will give a specific percentage. But he'll talk about how we're thinking about capacity, how he's thinking about capacity in 2014 and beyond.

So I think he will maybe give you even more than what you want to hear as he answers that question next week.

I apologize if I've been bouncing around on calls here, if you have touched on this already. But can you give us some color about the rollout of the efforts to do the sales team that's also the installed base, Kevin, and how that looks geographically, domestic versus international, if you rolled that out further?

Yes. We have and that team is doing very well.

The installed base team was up 111% year-over-year in the third quarter. So that investment is already beginning to pay dividends at a pretty high level.

So you'll see us continue to invest in that effort, as long as we're seeing the kind of growth we've seen which was over 80% in the second quarter -- in the first quarter, almost 40% in the second quarter, 111% in the third quarter. So we're going to continue to invest in growing the team as long as we see growth rates anywhere in that zip code.

They don't have to be 111% in order for me to continue to invest in the team. And Paul will also talk about that more at Analyst Day in terms of kind of how we've done, what we've done, what we're going to do as we move forward, but that's been a very positive investment for us so far.

Okay, so just to -- I'm not sure if I missed it but you have continued rolling it out internationally?

Yes, we have. And as well as continuing to add in North America.

So it's not just adding installed base sales reps in Europe and in Asia which we've done, but we've also adding more installed base reps in North America and we'll add more internationally as long as the performance stays at the levels we've seen for the first 9 months of this year. It's been one of the very -- one of the real highlights of this year so far, is how consistently that team has been able to perform and to grow.

Thanks, Scott. Okay, that concludes today's call.

Thanks to everyone who dialed in, and we hope to see you all next week in Boston. So long for now.