UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington D.C. 20549

FORM 10-Q

(Mark One)



☑	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended ~~June~~September 30, 2019



☐	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to

Commission File Number: 001-38711

SolarWinds Corporation

(Exact name of registrant as specified in its charter)



Delaware		81-0753267
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

7171 Southwest Parkway

Building 400

Austin, Texas 78735

(512) 682.9300

(Address and telephone number of principal executive offices)

Securities registered pursuant to Section 12(b) of the Act:



Title of Each Class	Trading Symbol	Name of Each Exchange on Which Registered
Common Stock, $0.001 par value	SWI	New York Stock Exchange

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. þ Yes ¨ No

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). þ Yes ¨ No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company," and "emerging growth company" in Rule 12b-2 of the Exchange Act.



Large accelerated filer	☐	Accelerated filer	☐
Non-accelerated filer	☑	Smaller reporting company	☐
Emerging growth company	☑

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). ☐ Yes ☑ No

On ~~August 8,~~November 1, 2019, ~~310,144,732~~311,180,888 shares of common stock, par value $0.001 per share, were outstanding.

SOLARWINDS CORPORATION

Table of Contents



PART I - FINANCIAL INFORMATION
		Page
Item 1.	Financial Statements	4
	Condensed Consolidated Balance Sheets as of ~~June~~September 30, 2019 and December 31, 2018	4
	Condensed Consolidated Statements of Operations for the three and ~~six~~nine month periods ended ~~June~~September 30, 2019 and 2018	5
	Condensed Consolidated Statements of Comprehensive Income (Loss) for the three and ~~six~~nine month periods ended ~~June~~September 30, 2019 and 2018	6
	Condensed Consolidated Statements of Stockholders' Equity for the three and ~~six~~nine month periods ended ~~June~~September 30, 2019	7
	Condensed Consolidated Statements of Redeemable Convertible Class A Common Stock and Stockholders' Deficit for the three and ~~six~~nine month periods ended ~~June~~September 30, 2018	8
	Condensed Consolidated Statements of Cash Flows for the ~~six~~nine month periods ended ~~June~~September 30, 2019 and 2018	9
	Notes to the Condensed Consolidated Financial Statements	10
Item 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations	22
Item 3.	Quantitative and Qualitative Disclosures of Market Risk	37
Item 4.	Controls and Procedures	3938
PART II - OTHER INFORMATION
Item 1.	Legal Proceedings	40
Item 1A.	Risk Factors	40
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	40
Item 6.	Exhibits	40
	Signatures	41
	Certifications

Safe Harbor Cautionary Statement

This quarterly report on Form 10-Q contains forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and the Private Securities Litigation Reform Act of 1995. Such statements may be signified by terms such as “aim,” “anticipate,” “believe,” “continue,” “expect,” “feel,” “intend,” “estimate,” “seek,” “plan,” “may,” “can,” “could,” “should,” “will,” “would” or similar expressions and the negatives of those terms. In this report, forward-looking statements include statements regarding our financial projections, future financial performance and plans and objectives for future operations including, without limitation, the following:

expectations regarding our financial condition and results of operations, including revenue, revenue growth, cost of revenue, operating expenses, operating income, non-GAAP operating income, non-GAAP operating margin, adjusted EBITDA and adjusted EBITDA margin, cash flows and effective income tax rate;

expectations regarding investment in product development and our expectations about the results of those efforts;

expectations concerning acquisitions and opportunities resulting from our acquisitions;

expectations regarding hiring additional personnel globally in the areas of sales and marketing and research and development;

expectations regarding our international earnings and investment of those earnings in international operations;

expectations regarding timing and impact of our adoption of new accounting standards;

expectations regarding our capital expenditures; and

our beliefs regarding the sufficiency of our cash and cash equivalents, cash flows from operating activities and borrowing capacity.

Forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements to be materially and adversely different from any future results, performance or achievements expressed or implied by the forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, the following: (a) the inability to generate significant volumes of high quality sales leads from our digital marketing initiatives and convert such leads into new business at acceptable conversion rates; (b) the inability to sell products to new customers or to sell additional products or upgrades to our existing customers; (c) any decline in our renewal or net retention rates; (d) our inability to successfully identify, complete, and integrate acquisitions and manage our growth effectively; (e) risks associated with our international operations; (f) our status as a controlled company; (g) the possibility that general economic conditions or uncertainty cause information technology spending to be reduced or purchasing decisions to be delayed; (h) the timing and success of new product introductions and product upgrades by SolarWinds or its competitors; (i) the possibility that our operating income could fluctuate and may decline as percentage of revenue as we make further expenditures to expand our operations in order to support additional growth in our business; (j) potential foreign exchange gains and losses related to expenses and sales denominated in currencies other than the functional currency of an associated entity; and (k) such other risks and uncertainties described more fully in documents filed with or furnished to the Securities and Exchange Commission, including the risk factors discussed in our Form 10-K for the year ended December 31, 2018. Given these risks and uncertainties, you should not place undue reliance on these forward-looking statements. Also, forward-looking statements represent our management’s beliefs and assumptions only as of the date of this quarterly report on Form 10-Q. Except as required by law, we assume no obligation to update these forward-looking statements publicly, or to update the reasons actual results could differ materially and adversely from those anticipated in these forward-looking statements, even if new information becomes available in the future.

In this report “SolarWinds,” “Company,” “we,” “us” and “our” refer to SolarWinds Corporation and its consolidated subsidiaries. The term “Silver Lake Funds” refers to Silver Lake Partners IV, L.P., Silver Lake Technology Investors IV, L.P., and SLP Aurora Co-Invest, L.P., and the term “Silver Lake” refers to Silver Lake Group, L.L.C., the ultimate general partner of the Silver Lake Funds. The term “Thoma Bravo Funds” refers to Thoma Bravo Fund XI, L.P., Thoma Bravo Fund XI-A, L.P., Thoma Bravo Fund XII, L.P., Thoma Bravo Fund XII-A, L.P., Thoma Bravo Executive Fund XI, L.P., Thoma Bravo Executive Fund XII, L.P., Thoma Bravo Executive Fund XII-a, L.P., Thoma Bravo Special Opportunities Fund II, L.P. and Thoma Bravo Special Opportunities Fund II-A, L.P. and the term “Thoma Bravo” refers to Thoma Bravo, LLC, the ultimate general partner of the Thoma Bravo Funds. The term “Sponsors” refers collectively to Silver Lake and Thoma Bravo, together with the Silver Lake Funds and the Thoma Bravo Funds and, as applicable, their co-investors.

PART I: FINANCIAL INFORMATION

Item 1. Financial Statements

SolarWinds Corporation

Condensed Consolidated Balance Sheets

(In thousands, except share and per share information)

(Unaudited)


	June 30,			December 31,			September 30,			December 31,
	2019			2018			2019			2018
Assets
Current assets:
Cash and cash equivalents	$	155,290		$	382,620		$	221,060		$	382,620
Accounts receivable, net of allowances of $3,404 and $3,196 as of June 30, 2019 and December 31, 2018, respectively	96,293			100,528
Accounts receivable, net of allowances of $3,469 and $3,196 as of September 30, 2019 and December 31, 2018, respectively							102,233			100,528
Income tax receivable	732			893			708			893
Prepaid and other current assets	27,756			16,267			24,108			16,267
Total current assets	280,071			500,308			348,109			500,308
Property and equipment, net	37,921			35,864			35,694			35,864
Deferred taxes	6,854			6,873			6,690			6,873
Goodwill	3,990,044			3,683,961			3,929,602			3,683,961
Intangible assets, net	873,144			956,261			815,801			956,261
Other assets, net	19,328			11,382			20,180			11,382
Total assets	$	5,207,362		$	5,194,649		$	5,156,076		$	5,194,649
Liabilities and stockholders’ equity
Current liabilities:
Accounts payable	$	11,492		$	9,742		$	10,345		$	9,742
Accrued liabilities and other	49,022			52,055			47,933			52,055
Accrued interest payable	846			290			262			290
Income taxes payable	9,436			15,682			18,460			15,682
Current portion of deferred revenue	289,203			270,433			293,365			270,433
Current debt obligation	19,900			19,900			19,900			19,900
Total current liabilities	379,899			368,102			390,265			368,102
Long-term liabilities:
Deferred revenue, net of current portion	29,323			25,699			30,706			25,699
Non-current deferred taxes	128,815			147,144			114,919			147,144
Other long-term liabilities	136,996			133,532			130,565			133,532
Long-term debt, net of current portion	1,898,713			1,904,072			1,896,062			1,904,072
Total liabilities	2,573,746			2,578,549			2,562,517			2,578,549
Commitments and contingencies (Note 10)
Stockholders’ equity:
Common stock, $0.001 par value: 1,000,000,000 shares authorized and 306,747,844 and 304,942,415 shares issued and outstanding as of June 30, 2019 and December 31, 2018, respectively	307			305
Preferred stock, $0.001 par value: 50,000,000 shares authorized and no shares issued and outstanding as of June 30, 2019 and December 31, 2018, respectively	—			—
Common stock, $0.001 par value: 1,000,000,000 shares authorized and 307,029,150 and 304,942,415 shares issued and outstanding as of September 30, 2019 and December 31, 2018, respectively							307			305
Preferred stock, $0.001 par value: 50,000,000 shares authorized and no shares issued and outstanding as of September 30, 2019 and December 31, 2018, respectively							—			—
Additional paid-in capital	3,027,849			3,011,080			3,037,845			3,011,080
Accumulated other comprehensive income	10,495			17,043
Accumulated other comprehensive income (loss)							(43,951		)	17,043
Accumulated deficit	(405,035		)	(412,328		)	(400,642		)	(412,328		)
Total stockholders’ equity	2,633,616			2,616,100			2,593,559			2,616,100
Total liabilities and stockholders’ equity	$	5,207,362		$	5,194,649		$	5,156,076		$	5,194,649

The accompanying notes are an integral part of these financial statements.

SolarWinds Corporation

Condensed Consolidated Statements of Operations

(In thousands, except per share information)

(Unaudited)


	Three Months Ended June 30,						Six Months Ended June 30,						Three Months Ended September 30,						Nine Months Ended September 30,
	2019			2018			2019			2018			2019			2018			2019			2018
Revenue:
Subscription	$	78,780		$	65,238		$	150,345		$	128,291		$	83,122		$	67,713		$	233,467		$	196,004
Maintenance	110,793			98,767			217,085			195,767			113,755			101,817			330,840			297,584
Total recurring revenue	189,573			164,005			367,430			324,058			196,877			169,530			564,307			493,588
License	39,175			37,713			77,110			74,573			43,613			43,747			120,723			118,320
Total revenue	228,748			201,718			444,540			398,631			240,490			213,277			685,030			611,908
Cost of revenue:
Cost of recurring revenue	19,386			17,708			37,545			34,595			20,614			18,022			58,159			52,617
Amortization of acquired technologies	43,972			43,967			87,789			88,286			44,172			43,835			131,961			132,121
Total cost of revenue	63,358			61,675			125,334			122,881			64,786			61,857			190,120			184,738
Gross profit	165,390			140,043			319,206			275,750			175,704			151,420			494,910			427,170
Operating expenses:
Sales and marketing	64,813			56,414			125,408			109,096			68,290			56,926			193,698			166,022
Research and development	27,705			23,773			52,893			48,526			29,575			23,274			82,468			71,800
General and administrative	25,241			21,066			46,977			40,252			25,405			19,597			72,382			59,849
Amortization of acquired intangibles	17,301			16,653			33,803			33,781			18,015			16,507			51,818			50,288
Total operating expenses	135,060			117,906			259,081			231,655			141,285			116,304			400,366			347,959
Operating income	30,330			22,137			60,125			44,095			34,419			35,116			94,544			79,211
Other income (expense):
Interest expense, net	(28,177		)	(34,387		)	(55,559		)	(76,476		)	(27,418		)	(35,627		)	(82,977		)	(112,103		)
Other income (expense), net	(1,078		)	(26,327		)	219			(74,463		)	287			(13		)	506			(74,476		)
Total other income (expense)	(29,255		)	(60,714		)	(55,340		)	(150,939		)	(27,131		)	(35,640		)	(82,471		)	(186,579		)
Income (loss) before income taxes	1,075			(38,577		)	4,785			(106,844		)	7,288			(524		)	12,073			(107,368		)
Income tax expense (benefit)	3,194			(11,562		)	3,759			(19,919		)	2,895			(126		)	6,654			(20,045		)
Net income (loss)	$	(2,119	)	$	(27,015	)	$	1,026		$	(86,925	)	$	4,393		$	(398	)	$	5,419		$	(87,323	)
Net income (loss) available to common stockholders	$	(2,119	)	$	(99,193	)	$	1,014		$	(228,938	)	$	4,350		$	(75,006	)	$	5,359		$	(303,944	)
Net income (loss) available to common stockholders per share:
Basic earnings (loss) per share	$	(0.01	)	$	(0.97	)	$	—		$	(2.25	)	$	0.01		$	(0.73	)	$	0.02		$	(2.98	)
Diluted earnings (loss) per share	$	(0.01	)	$	(0.97	)	$	—		$	(2.25	)	$	0.01		$	(0.73	)	$	0.02		$	(2.98	)
Weighted-average shares used to compute net income (loss) available to commons stockholders per share:
Shares used in computation of basic earnings (loss) per share	306,587			102,018			306,122			101,832			306,890			102,078			306,381			101,915
Shares used in computation of diluted earnings (loss) per share	306,587			102,018			310,353			101,832			311,102			102,078			310,607			101,915

The accompanying notes are an integral part of these consolidated financial statements.

SolarWinds Corporation

Condensed Consolidated Statements of Comprehensive Income (Loss)

(In thousands)

(Unaudited)


	Three Months Ended June 30,						Six Months Ended June 30,						Three Months Ended September 30,						Nine Months Ended September 30,
	2019			2018			2019			2018			2019			2018			2019			2018
Net income (loss)	$	(2,119	)	$	(27,015	)	$	1,026		$	(86,925	)	$	4,393		$	(398	)	$	5,419		$	(87,323	)
Other comprehensive income (loss):
Foreign currency translation adjustment	21,160			(58,922		)	(6,548		)	(25,569		)	(54,446		)	(10,520		)	(60,994		)	(36,089		)
Other comprehensive income (loss)	21,160			(58,922		)	(6,548		)	(25,569		)	(54,446		)	(10,520		)	(60,994		)	(36,089		)
Comprehensive income (loss)	$	19,041		$	(85,937	)	$	(5,522	)	$	(112,494	)	$	(50,053	)	$	(10,918	)	$	(55,575	)	$	(123,412	)

The accompanying notes are an integral part of these consolidated financial statements.

SolarWinds Corporation

Condensed Consolidated Statements of Stockholders' Equity

(In thousands)

(unaudited)


	Three months ended June 30, 2019															Three months ended September 30, 2019
	Common Stock			Additional Paid-in Capital			Accumulated Other Comprehensive Income (Loss)			Accumulated Deficit			Total Stockholders’ Equity			Common Stock			Additional Paid-in Capital			Accumulated Other Comprehensive Income (Loss)			Accumulated Deficit			Total Stockholders’ Equity
	Shares	Amount		Additional Paid-in Capital			Accumulated Other Comprehensive Income (Loss)			Accumulated Deficit			Total Stockholders’ Equity			Shares	Amount		Additional Paid-in Capital			Accumulated Other Comprehensive Income (Loss)			Accumulated Deficit			Total Stockholders’ Equity
Balance at March 31, 2019	306,405	$	306	$	3,019,652		$	(10,665	)	$	(402,916	)	$	2,606,377
Balance at June 30, 2019																306,748	$	307	$	3,027,849		$	10,495		$	(405,035	)	$	2,633,616
Foreign currency translation adjustment	—	—		—			21,160			—			21,160			—	—		—			(54,446		)	—			(54,446		)
Net loss	—	—		—			—			(2,119		)	(2,119		)
Comprehensive income													19,041
Net income																—	—		—			—			4,393			4,393
Comprehensive loss																												(50,053		)
Exercise of stock options	239	—		221			—			—			221			133	—		165			—			—			165
Restricted stock units issued, net of shares withheld for taxes	18	—		(101		)	—			—			(101		)	31	—		(184		)	—			—			(184		)
Issuance of stock	86	1		38			—			—			39			42	—		25			—			—			25
Equity awards assumed in acquisition	—	—		595			—			—			595
Issuance of stock under employee stock purchase plan																75	—		1,080			—			—			1,080
Stock-based compensation	—	—		7,444			—			—			7,444			—	—		8,910			—			—			8,910
Balance at June 30, 2019	306,748	$	307	$	3,027,849		$	10,495		$	(405,035	)	$	2,633,616
Balance at September 30, 2019																307,029	$	307	$	3,037,845		$	(43,951	)	$	(400,642	)	$	2,593,559


	Six months ended June 30, 2019															Nine months ended September 30, 2019
	Common Stock			Additional Paid-in Capital			Accumulated Other Comprehensive Income (Loss)			Accumulated Deficit			Total Stockholders’ Equity			Common Stock			Additional Paid-in Capital			Accumulated Other Comprehensive Income (Loss)			Accumulated Deficit			Total Stockholders’ Equity
	Shares	Amount		Additional Paid-in Capital			Accumulated Other Comprehensive Income (Loss)			Accumulated Deficit			Total Stockholders’ Equity			Shares	Amount		Additional Paid-in Capital			Accumulated Other Comprehensive Income (Loss)			Accumulated Deficit			Total Stockholders’ Equity
Balance at December 31, 2018	304,942	$	305	$	3,011,080		$	17,043		$	(412,328	)	$	2,616,100		304,942	$	305	$	3,011,080		$	17,043		$	(412,328	)	$	2,616,100
Foreign currency translation adjustment	—	—		—			(6,548		)	—			(6,548		)	—	—		—			(60,994		)	—			(60,994		)
Net income	—	—		—			—			1,026			1,026			—	—		—			—			5,419			5,419
Comprehensive loss													(5,522		)													(55,575		)
Exercise of stock options	286	—		257			—			—			257			419	—		422			—			—			422
Restricted stock units issued, net of shares withheld for taxes	18	—		(101		)	—			—			(101		)	49	—		(285		)	—			—			(285		)
Issuance of stock	1,502	2		786			—			—			788			1,544	2		811			—			—			813
Issuance of stock under employee stock purchase plan																75	—		1,080									1,080
Equity awards assumed in acquisition	—	—		595			—			—			595			—	—		595			—			—			595
Stock-based compensation	—	—		15,232			—			—			15,232			—	—		24,142			—			—			24,142
Cumulative effect adjustment of adoption of revenue recognition accounting standard	—	—		—			—			6,267			6,267			—	—		—			—			6,267			6,267
Balance at June 30, 2019	306,748	$	307	$	3,027,849		$	10,495		$	(405,035	)	$	2,633,616
Balance at September 30, 2019																307,029	$	307	$	3,037,845		$	(43,951	)	$	(400,642	)	$	2,593,559

The accompanying notes are an integral part of these consolidated financial statements.

Condensed Consolidated Statements of Redeemable Convertible Class A Common Stock and

Stockholders' Deficit

(In thousands)

(unaudited)


	Three months ended June 30, 2018																		Three months ended September 30, 2018

	Redeemable Convertible Class A Common Stock			Common Stock			Additional Paid-in Capital			Accumulated Other Comprehensive Income (Loss)			Accumulated Deficit			Total Stockholders’ Deficit			Redeemable Convertible Class A Common Stock				Common Stock				Additional Paid-in Capital			Accumulated Other Comprehensive Income (Loss)			Accumulated Deficit			Total Stockholders’ Deficit
	Shares	Amount		Shares	Amount		Additional Paid-in Capital			Accumulated Other Comprehensive Income (Loss)			Accumulated Deficit			Total Stockholders’ Deficit			Shares	Amount			Shares		Amount		Additional Paid-in Capital			Accumulated Other Comprehensive Income (Loss)			Accumulated Deficit			Total Stockholders’ Deficit
Balance at March 31, 2018	2,661	$	3,216,722	101,986	$	102	$	—		$	108,647		$	(934,533	)	$	(825,784	)
Balance at June 30, 2018																			2,661	$	3,288,900		102,061		$	102	$	—		$	49,725		$	(1,033,568	)	$	(983,741	)
Foreign currency translation adjustment	—	—		—	—		—			(58,922		)				(58,922		)	—	—			—		—		—			(10,520		)				(10,520		)
Net loss	—	—		—	—		—			—			(27,015		)	(27,015		)	—	—			—		—		—			—			(398		)	(398		)
Comprehensive loss																(85,937		)																		(10,918		)
Exercise of stock options																			—	—			37		—		13			—			—			13
Issuance of stock	—	—		75	—		27			—			—			27			—	—			35		—		17			—			—			17
Repurchase of stock																			—	(17		)	(45	)	—		(448		)	—			—			(448		)
Accumulating dividends	—	72,178		—	—		(158		)	—			(72,020		)	(72,178		)	—	74,608			—		—		258			—			(74,866		)	(74,608		)
Stock-based compensation	—	—		—	—		131			—			—			131			—	—			—		—		160			—			—			160
Balance at June 30, 2018	2,661	$	3,288,900	102,061	$	102	$	—		$	49,725		$	(1,033,568	)	$	(983,741	)
Balance at September 30, 2018																			2,661	$	3,363,491		102,088		$	102	$	—		$	39,205		$	(1,108,832	)	$	(1,069,525	)


	Six months ended June 30, 2018																			Nine months ended September 30, 2018

	Redeemable Convertible Class A Common Stock			Common Stock				Additional Paid-in Capital			Accumulated Other Comprehensive Income (Loss)			Accumulated Deficit			Total Stockholders’ Deficit			Redeemable Convertible Class A Common Stock				Common Stock				Additional Paid-in Capital			Accumulated Other Comprehensive Income (Loss)			Accumulated Deficit			Total Stockholders’ Deficit
	Shares	Amount		Shares		Amount		Additional Paid-in Capital			Accumulated Other Comprehensive Income (Loss)			Accumulated Deficit			Total Stockholders’ Deficit			Shares	Amount			Shares		Amount		Additional Paid-in Capital			Accumulated Other Comprehensive Income (Loss)			Accumulated Deficit			Total Stockholders’ Deficit
Balance at December 31, 2017	2,661	$	3,146,887	100,734		$	101	$	—		$	75,294		$	(805,156	)	$	(729,761	)	2,661	$	3,146,887		100,734		$	101	$	—		$	75,294		$	(805,156	)	$	(729,761	)
Foreign currency translation adjustment	—	—		—		—		—			(25,569		)	—			(25,569		)	—	—			—		—		—			(36,089		)	—			(36,089		)
Net loss	—	—		—		—		—			—			(86,925		)	(86,925		)	—	—			—		—		—			—			(87,323		)	(87,323		)
Comprehensive loss																	(112,494		)																		(123,412		)
Exercise of stock options	—	—		2		—		—			—			—			—			—	—			39		—		13			—			—			13
Issuance of stock	—	—		1,337		1		378			—			—			379			—	—			1,372		1		395			—			—			396
Repurchase of stock	—	—		(12	)	—		(24		)	—			—			(24		)	—	(17		)	(57	)	—		(472		)	—			—			(472		)
Accumulating dividends	—	142,013		—		—		(526		)	—			(141,487		)	(142,013		)	—	216,621			—		—		(268		)	—			(216,353		)	(216,621		)
Stock-based compensation	—	—		—		—		172			—			—			172			—	—			—		—		332			—			—			332
Balance at June 30, 2018	2,661	$	3,288,900	102,061		$	102	$	—		$	49,725		$	(1,033,568	)	$	(983,741	)
Balance at September 30, 2018																				2,661	$	3,363,491		102,088		$	102	$	—		$	39,205		$	(1,108,832	)	$	(1,069,525	)

The accompanying notes are an integral part of these consolidated financial statements.

SolarWinds Corporation

Condensed Consolidated Statements of Cash Flows

(In thousands)

(Unaudited)


	Six Months Ended June 30,						Nine Months Ended September 30,
	2019			2018			2019			2018
Cash flows from operating activities
Net income (loss)	$	1,026		$	(86,925	)	$	5,419		$	(87,323	)
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Depreciation and amortization	130,040			129,614			196,687			193,903
Provision for doubtful accounts	951			1,165			1,494			1,991
Stock-based compensation expense	15,085			172			23,917			332
Amortization of debt issuance costs	4,591			6,708			6,915			9,272
Loss on extinguishment of debt	—			60,590			—			60,590
Deferred taxes	(20,352		)	(13,076		)	(29,692		)	(14,085		)
(Gain) loss on foreign currency exchange rates	(100		)	12,545			(907		)	12,747
Other non-cash expenses (benefits)	(414		)	1,332
Other non-cash expenses							58			1,451
Changes in operating assets and liabilities, net of assets acquired and liabilities assumed in business combinations:
Accounts receivable	7,289			158			(781		)	(13,963		)
Income taxes receivable	149			(409		)	129			(131		)
Prepaid and other assets	(6,172		)	(1,107		)	(6,243		)	(1,931		)
Accounts payable	1,442			920			357			(3,958		)
Accrued liabilities and other	(5,009		)	3,974			(5,327		)	9,745
Accrued interest payable	556			(10,906		)	(28		)	(10,516		)
Income taxes payable	(4,385		)	(15,764		)	(2,356		)	(16,112		)
Deferred revenue	16,735			16,004			26,299			22,291
Other long-term liabilities	220			2,130			905			1,779
Net cash provided by operating activities	141,652			107,125			216,846			166,082
Cash flows from investing activities
Purchases of property and equipment	(8,774		)	(9,256		)	(10,606		)	(12,794		)
Purchases of intangible assets	(2,480		)	(1,301		)	(3,601		)	(2,082		)
Acquisitions, net of cash acquired	(349,504		)	(12,990		)	(349,504		)	(60,578		)
Proceeds from sale of cost method investment and other	1,662			10,715			4,174			10,715
Net cash used in investing activities	(359,096		)	(12,832		)	(359,537		)	(64,739		)
Cash flows from financing activities
Proceeds from issuance of common stock and incentive restricted stock	—			1,723
Proceeds from issuance of common stock under employee stock purchase plan and incentive restricted stock							1,080			1,723
Repurchase of common stock and incentive restricted stock	(141		)	(52		)	(382		)	(568		)
Exercise of stock options	257			1			422			13
Premium paid on debt extinguishment	—			(22,725		)	—			(22,725		)
Proceeds from credit agreement	35,000			626,950			35,000			626,950
Repayments of borrowings from credit agreement	(44,950		)	(689,950		)	(49,925		)	(694,925		)
Payment of debt issuance costs	—			(5,561		)	—			(5,561		)
Payment for offering costs	—			(1,009		)	—			(2,194		)
Net cash used in financing activities	(9,834		)	(90,623		)	(13,805		)	(97,287		)
Effect of exchange rate changes on cash and cash equivalents	(52		)	(3,308		)	(5,064		)	(3,439		)
Net increase (decrease) in cash and cash equivalents	(227,330		)	362			(161,560		)	617
Cash and cash equivalents
Beginning of period	382,620			277,716			382,620			277,716
End of period	$	155,290		$	278,078		$	221,060		$	278,333

Supplemental disclosure of cash flow information
Cash paid for interest	$	51,749		$	81,161		$	77,478		$	114,148
Cash paid for income taxes	$	26,467		$	7,857		$	35,643		$	8,045

The accompanying notes are an integral part of these consolidated financial statements.

SolarWinds Corporation

Notes to Condensed Consolidated Financial Statements (Unaudited)

1. Organization and Nature of Operations

SolarWinds Corporation, a Delaware corporation, and its subsidiaries (“Company”, “we,” “us” and “our”) is a leading provider of information technology, or IT, infrastructure management software. Our products give organizations worldwide, regardless of type, size or IT infrastructure complexity, the power to monitor and manage the performance of their IT environments, whether on-premise, in the cloud, or in hybrid infrastructure models. Our approach, which we refer to as the SolarWinds Model, combines powerful, scalable, affordable, easy to use products with high-velocity, low-touch sales. We’ve built our business to enable the technology professionals who use our products to manage “all things IT.” Our range of customers has expanded over time from network and systems engineers to a broad set of technology professionals, such as database administrators, storage administrators, web operators, developers and DevOps professionals, as well as managed service providers, or MSPs. Our SolarWinds Model enables us to sell our products for use in organizations ranging in size from very small businesses to large enterprises.

2. Summary of Significant Accounting Policies

We prepared our interim condensed consolidated financial statements in conformity with United States of America generally accepted accounting principles, or GAAP, and the reporting regulations of the Securities and Exchange Commission, or the SEC. They do not include all of the information and footnotes required by GAAP for complete financial statements. The accompanying condensed consolidated financial statements include the accounts of SolarWinds Corporation and the accounts of its wholly owned subsidiaries. We have eliminated all intercompany balances and transactions.

The interim financial information is unaudited, but reflects all normal adjustments that are, in our opinion, necessary to provide a fair statement of results for the interim periods presented. This interim information should be read in conjunction with the audited consolidated financial statements in our Annual Report on Form 10-K for the year ended December 31, 2018.

With the exception of the changes in our revenue recognition and other related policies upon the adoption of new revenue accounting standard described below, there have been no material changes to our significant accounting policies described in our Annual Report on Form 10-K for the year ended December 31, 2018. See Recently Adopted Accounting Pronouncements below regarding the impact of the adoption of the new revenue accounting standard and Revenue Recognition for discussion of our updated revenue recognition policies.

Use of Estimates

The preparation of financial statements in conformity with GAAP requires our management to make estimates and assumptions that affect the reported amounts and the disclosure of assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting periods. The actual results that we experience may differ materially from our estimates. The accounting estimates that require our most significant, difficult and subjective judgments include:

the valuation of goodwill, intangibles, long-lived assets and contingent consideration;

revenue recognition;

stock-based compensation;

income taxes; and

loss contingencies.

Recently Adopted Accounting Pronouncements

On January 1, 2019 we adopted the Financial Accounting Standards Board, or FASB, Accounting Standards Codification (“ASC”) No. 2014-09 “Revenue from Contracts with Customers,” or ASC 606, which replaced all existing revenue guidance under ASC 605 “Revenue Recognition,” including prescriptive industry-specific guidance, or ASC 605. This standard’s core principle is that an entity will recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. We adopted ASC 606 using the modified-retrospective method. Results for reporting periods beginning after January 1, 2019 are presented in compliance with the new revenue recognition standard ASC 606. Historical financial results for reporting periods prior to 2019 are presented in conformity with amounts previously disclosed under the prior revenue recognition standard, ASC 605. These financial statements include additional information regarding the impacts from the adoption of the new revenue recognition standard on our financial results for the three and ~~six~~nine month periods ended ~~June~~September 30, 2019. This includes the presentation of financial results for the three and ~~six~~nine month periods ended ~~June~~September 30, 2019 under ASC 605 for comparison to the prior year period.

SolarWinds Corporation

Notes to Condensed Consolidated Financial Statements (Unaudited)

The most significantly impacted areas are the following:

•

License and Recurring Revenue. The adoption of the new standard resulted in changes to the classification and timing of our revenue recognition. Under the new guidance, the requirement to establish VSOE to recognize license revenue separately from the other elements is eliminated. This change impacted the allocation of the transaction price and timing of our revenue recognition between deliverables, or performance obligations, within an arrangement. In addition, we now recognize time-based license revenue upon the transfer of the license and the associated maintenance revenue over the contract period under the new standard instead of recognizing both the license and maintenance revenue ratably over the contract period. The overall adoption impact to total revenue is immaterial, though we have experienced some changes to the timing and classification between license and recurring revenue. Additionally, some historical deferred revenue, primarily from arrangements involving time-based licenses, will never be recognized as revenue and instead has been recorded as a cumulative effect adjustment within accumulated deficit.

•

Contract Acquisition Costs. We expensed all sales commissions as incurred under the previous guidance. The new guidance requires the deferral and amortization of certain direct and incremental costs incurred to obtain a contract. This guidance requires us to capitalize and amortize certain sales commission costs over the remaining contractual term or over an expected period of benefit, which we have determined to be approximately four to six years.


•	Other Items. The impact of the adoption of the new standard on income taxes resulted in an increase of deferred income tax liabilities. The adoption of this standard did not impact our total operating cash flows.

The cumulative effect of the changes made to our condensed consolidated balance sheet as of January 1, 2019 for the adoption of ASC 606 to all contracts with customers that were not completed as of December 31, 2018 was recorded as an adjustment to accumulated deficit as of the adoption date as follows:



	December 31, 2018						January 1, 2019
	As reported			Adjustments			As adjusted

	(in thousands)
Assets:
Prepaid and other current assets⁽¹⁾	$	16,267		$	1,300		$	17,567
Other assets, net⁽¹⁾	11,382			3,857			15,239
Total assets⁽¹⁾	5,194,649			5,157			5,199,806

Liabilities:
Current portion of deferred revenue⁽²⁾	270,433			(2,338		)	268,095
Deferred revenue, net of current portion⁽²⁾	25,699			(434		)	25,265
Non-current deferred taxes	147,144			1,662			148,806
Total liabilities	2,578,549			(1,110		)	2,577,439

Stockholders' equity (deficit):
Accumulated deficit	(412,328		)	6,267			(406,061		)

_______


(1)	Adjustment represents the impact of the adoption of ASC 606 on deferred contract acquisition costs related to the capitalization of certain sales commissions. See Deferred Commissions below for further discussion.


(2)	Adjustment represents the impact of the adoption of ASC 606 on our deferred revenue balances. See Deferred Revenue below for further discussion.

SolarWinds Corporation

Notes to Condensed Consolidated Financial Statements (Unaudited)

The impact of adoption of ASC 606 on our condensed consolidated statement of operations and condensed consolidated balance sheet was as follows:


	Three Months Ended June 30, 2019									Six Months Ended June 30, 2019								Three Months Ended September 30, 2019							Nine Months Ended September 30, 2019
	As reported ASC 606			ASC 606 impact			Without adoption of ASC 606 (ASC 605)			As reported ASC 606		ASC 606 impact			Without adoption of ASC 606 (ASC 605)			As reported ASC 606		ASC 606 impact			Without adoption of ASC 606 (ASC 605)		As reported ASC 606		ASC 606 impact			Without adoption of ASC 606 (ASC 605)

	(in thousands)																	(in thousands)
Revenue:
Subscription	$	78,780		$	230		$	79,010		$	150,345	$	354		$	150,699		$	83,122	$	12		$	83,134	$	233,467	$	366		$	233,833
Maintenance	110,793			244			111,037			217,085		479			217,564			113,755		298			114,053		330,840		777			331,617
Total recurring revenue	189,573			474			190,047			367,430		833			368,263			196,877		310			197,187		564,307		1,143			565,450
License	39,175			(472		)	38,703			77,110		(664		)	76,446			43,613		(1,161		)	42,452		120,723		(1,825		)	118,898
Total revenue	$	228,748		$	2		$	228,750		$	444,540	$	169		$	444,709		$	240,490	$	(851	)	$	239,639	$	685,030	$	(682	)	$	684,348
Gross profit	165,390			2			165,392			319,206		169			319,375			175,704		(851		)	174,853		494,910		(682		)	494,228
Total operating expenses	135,060			1,191			136,251			259,081		2,591			261,672			141,285		1,361			142,646		400,366		3,952			404,318
Operating income (loss)	30,330			(1,189		)	29,141			60,125		(2,422		)	57,703			34,419		(2,212		)	32,207		94,544		(4,634		)	89,910
Net income (loss)	$	(2,119	)	$	(1,189	)	$	(3,308	)	$	1,026	$	(2,422	)	$	(1,396	)	$	4,393	$	(2,212	)	$	2,181	$	5,419	$	(4,634	)	$	785


	June 30, 2019									September 30, 2019
	As reported ASC 606			ASC 606 impact			Without adoption of ASC 606 (ASC 605)			As reported ASC 606			ASC 606 impact			Without adoption of ASC 606 (ASC 605)

	(in thousands)									(in thousands)
Assets:
Prepaid and other current assets	$	27,756		$	(2,076	)	$	25,680		$	24,108		$	(2,199	)	$	21,909
Other assets, net	19,328			(5,859		)	13,469			20,180			(6,971		)	13,209
Total assets	5,207,362			(7,935		)	5,199,427			5,156,076			(9,170		)	5,146,906

Liabilities:
Current portion of deferred revenue	289,203			2,177			291,380			293,365			2,885			296,250
Deferred revenue, net of current portion	29,323			445			29,768			30,706			599			31,305
Non-current deferred taxes	128,815			(1,662		)	127,153			114,919			(1,662		)	113,257
Total liabilities	2,573,746			960			2,574,706			2,562,517			1,822			2,564,339

Stockholders' equity (deficit):
Accumulated deficit	(405,035		)	(8,895		)	(413,930		)	(400,642		)	(10,992		)	(411,634		)

Recent Accounting Pronouncements Not Yet Adopted

Under the Jumpstart our Business Startups Act, or the JOBS Act, emerging growth companies can delay adopting new or revised accounting standards until such time as those standards apply to non-public companies. As a result of the market value of our common stock held by non-affiliates on June 30, 2019, we will no longer qualify as an emerging growth company as of December 31, 2019 and can no longer take advantage of the extended transition period for adopting new or revised accounting standards. Accordingly, we have revised our planned adoption dates below from the non-public company effective dates to the public company effective dates.

In February 2016, FASB issued an accounting standard to provide updated guidance requiring the recognition of all lease assets and liabilities on the balance sheet. The accounting standard required the use of a modified retrospective transition method.

SolarWinds Corporation

Notes to Condensed Consolidated Financial Statements (Unaudited)

In July 2018, FASB issued additional guidance that provides entities with an optional transition method in which an entity can apply the new standard at the adoption date and recognize a cumulative-effect adjustment to the opening balance retained earnings in the period of adoption. The updated accounting guidance is effective for public companies for interim and fiscal periods beginning after December 15, 2018. Early adoption is permitted and the standard provides for certain practical expedients. As we will lose our emerging growth company status as of December 31, 2019, we will retroactively adopt the updated guidance as of January 1, 2019 in our Annual Report on Form 10-K for the fiscal year ended December 31, 2019. The adoption of the new standard will result in leases currently designated as operating leases being reported on our consolidated balance sheet at their net present value, which will increase total assets and total liabilities. Our total undiscounted lease payments under non-cancellable operating leases was approximately $124.0 million as of December 31, 2018. The standard is not expected to have a material impact to our consolidated statement of operations or consolidated statement of cash flows. ~~We will update our disclosures as we progress towards the required adoption date.~~

In January 2017, FASB issued an accounting standard to simplify the accounting for goodwill impairment. The new guidance removes step two of the two-step quantitative goodwill impairment test, which requires a hypothetical purchase price allocation. The updated guidance is effective for public companies for fiscal years beginning after December 15, 2019 and may be adopted early for any interim or annual goodwill impairment tests performed after January 1, 2017. We expect to adopt the updated guidance in fiscal year 2020. We do not believe that this standard will have a material impact on our consolidated financial statements.

Fair Value Measurements

We apply the authoritative guidance on fair value measurements for financial assets and liabilities that are measured at fair value on a recurring basis and non-financial assets and liabilities, such as goodwill, intangible assets and property, plant and equipment that are measured at fair value on a non-recurring basis.

The guidance establishes a three-tiered fair value hierarchy that prioritizes inputs to valuation techniques used in fair value calculations. The three levels of inputs are defined as follows:

Level 1: Unadjusted quoted prices for identical assets or liabilities in active markets accessible by us.

Level 2: Inputs that are observable in the marketplace other than those inputs classified as Level 1.

Level 3: Inputs that are unobservable in the marketplace and significant to the valuation.

See Note 5. Fair Value Measurements for a summary of our financial instruments accounted for at fair value on a recurring basis. The carrying amounts reported in our consolidated balance sheets for cash, accounts receivable, accounts payable and other accrued expenses approximate fair value due to relatively short periods to maturity.

Accumulated Other Comprehensive Income (Loss)

Changes in accumulated other comprehensive income (loss) by component are summarized below:


	Foreign Currency Translation Adjustments			Accumulated Other Comprehensive Income (Loss)			Foreign Currency Translation Adjustments			Accumulated Other Comprehensive Income (Loss)

	(in thousands)						(in thousands)
Balance at December 31, 2018	$	17,043		$	17,043		$	17,043		$	17,043
Other comprehensive gain (loss) before reclassification	(6,548		)	(6,548		)	(60,994		)	(60,994		)
Amount reclassified from accumulated other comprehensive income (loss)	—			—			—			—
Net current period other comprehensive income (loss)	(6,548		)	(6,548		)	(60,994		)	(60,994		)
Balance at June 30, 2019	$	10,495		$	10,495
Balance at September 30, 2019							$	(43,951	)	$	(43,951	)

Revenue Recognition

We generate recurring revenue from fees received for subscriptions and from the sale of maintenance services associated with our perpetual license products and license revenue from the sale of our perpetual license products. We recognize revenue related to contracts from customers when we transfer promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. This is determined by following a five-step process which includes (1) identifying the contract with a customer, (2) identifying the performance obligations in the contract, (3) determining the transaction price, (4) allocating the transaction price, and (5) recognizing revenue when or as we satisfy a performance obligation, as described below.

SolarWinds Corporation

Notes to Condensed Consolidated Financial Statements (Unaudited)

•

Identify the contract with a customer. We generally use a purchase order, an authorized credit card, an electronic or manually signed license agreement, or the receipt of a cash payment as evidence of a contract with a customer provided that collection is considered probable. We sell our products through our direct sales force and through our distributors and resellers. Our distributors and resellers do not carry inventory of our software and we generally require them to specify the end user of the software at the time of the order. If the distributor or reseller does not provide end-user information, then we will generally not fulfill the order. Our distributors and resellers have no rights of return or exchange for software that they purchase from us and payment for these purchases is due to us without regard to whether the distributors or resellers collect payment from their customers. Sales through resellers and distributors are typically evidenced by a reseller or distributor agreement, together with purchase orders or authorized credit cards on a transaction-by-transaction basis.

•

Identify the performance obligations in the contract. Performance obligations promised in a contract are identified based on the goods or services that will be transferred to the customer that are separately identifiable from other promises in the contract, or distinct. If not considered distinct, the promised goods or services are combined with other goods or services and accounted for as a combined performance obligation. Determining the distinct performance obligations in a contract requires judgment. Our performance obligations primarily include perpetual and time-based licenses, maintenance support including unspecified upgrades or enhancements to new versions of their software products and subscriptions to our software-as-a-service, or SaaS, offerings. See additional discussion of our performance obligations below.

•

Determine the transaction price. We determine the transaction price based on the contractual consideration and the amount of consideration we expect to receive in exchange for transferring the promised goods or services to the customer. We account for sales incentives to customers, resellers or distributors as a reduction of revenue at the time we recognize the revenue from the related product sale. We report revenue net of any sales tax collected. Our return policy generally does not allow our customers to return software products.

•

Allocate the transaction price. We allocate the transaction price of the contract to each distinct performance obligation based on a relative standalone selling price basis. Determining standalone selling prices for our performance obligations requires judgment and are based on multiple factors including, but not limited to historical selling prices and discounting practices for products and services, internal pricing policies and pricing practices in different regions and through different sales channels. For our subscription products and maintenance services, our standalone selling prices are generally observable using standalone sales or renewals. For our perpetual and time-based license products, we estimate our standalone selling prices utilizing the residual approach by considering our pricing and discounting practices. We review the standalone selling price for our performance obligations periodically and update, if needed, to ensure that the methodology utilized reflects our current pricing practices.

•

Recognize revenue when or as we satisfy a performance obligation. Revenue is recognized when or as performance obligations are satisfied either over time or at a point in time by transferring a promised good or service. We consider this transfer to have occurred when risk of loss transfers to the customer, reseller or distributor or the customer has access to their subscription which is generally upon electronic transfer of the license key or password that provides immediate availability of the product to the purchaser. See further discussion below regarding the timing of revenue recognition for each of our performance obligations.

The following summarizes our performance obligations from which we generate revenue:



Performance obligation		When performance obligation is typically satisfied
Subscription revenue
SaaS offerings		Over the subscription term, once the service is made available to the customer (over time)
Time-based licenses		Upon the delivery of the license key or password that provides immediate availability of the product (point in time)
Time-based technical support and unspecified software upgrades		Ratably over the contract period (over time)
Maintenance revenue
Technical support and unspecified software upgrades		Ratably over the contract period (over time)
License revenue
Perpetual licenses		Upon the delivery of the license key or password that provides immediate availability of the product (point in time)

SolarWinds Corporation

Notes to Condensed Consolidated Financial Statements (Unaudited)

Recurring Revenue. Recurring revenue consists of subscription and maintenance revenue.

•

Subscription Revenue. We primarily derive subscription revenue from fees received for subscriptions to our SaaS offerings and our time-based license arrangements. We generally invoice subscription agreements monthly based on usage or in advance over the subscription period on either a monthly or annual basis. Subscription revenue for our SaaS offerings is generally recognized ratably over the subscription term once the service is made available to the customer or when we have the right to invoice for services performed. Revenue for the license performance obligation of our time-based license arrangements is recognized at a point in time upon delivery of the license key and the revenue for the technical support performance obligation of our time-based license arrangements is recognized ratably over the contract period. The amount of revenue related to the license performance obligations of our time-based license arrangements included in subscription revenue is less than 10% of our total consolidated revenue. Our subscription revenue includes our cloud application management, MSP and IT service management, or ITSM, products.

•

Maintenance Revenue. We derive maintenance revenue from the sale of maintenance services associated with our perpetual license products. We typically include one year of maintenance service as part of the initial purchase price of each perpetual software offering and then sell renewals of this maintenance agreement. Customers with maintenance agreements are entitled to receive technical support and unspecified upgrades or enhancements to new versions of their software products on a when-and-if-available basis for the specified contract period. We believe that our technical support and unspecified upgrades or enhancements performance obligations each have the same pattern of transfer to the customer and are therefore accounted for as a single distinct performance obligation. We recognize maintenance revenue ratably on a daily basis over the contract period.

License Revenue. We derive license revenue from the sale of our perpetual licenses. Revenue for the license performance obligation of our perpetual license arrangements is recognized at a point in time upon delivery of the electronic license key. Perpetual license arrangements are invoiced upon delivery.

Deferred Revenue

Deferred revenue primarily consists of transaction prices allocated to remaining performance obligations from maintenance services associated with our perpetual license products which are delivered over time. We generally bill maintenance agreements annually in advance for services to be performed over a 12-month period. Customers have the option to purchase maintenance renewals for periods other than 12 months. We initially record the amounts allocated to maintenance performance obligations as deferred revenue and recognize these amounts ratably on a daily basis over the term of the maintenance agreement. We record deferred revenue that will be recognized during the succeeding 12-month period as current deferred revenue and the remaining portion is recorded as long-term deferred revenue.

Details of our total deferred revenue balance was as follows:


	Total Deferred Revenue			Total Deferred Revenue

	(in thousands)			(in thousands)
Balance at December 31, 2018	$	296,132		$	296,132
Adoption of ASC 606	(2,772		)	(2,772		)
Deferred revenue recognized	(213,418		)	(327,701		)
Additional amounts deferred	229,837			349,665
Deferred revenue acquired in business combinations	8,747			8,747
Balance at June 30, 2019	$	318,526
Balance at September 30, 2019				$	324,071

We expect to recognize revenue related to these remaining performance obligations as follows:

Revenue Recognition Expected by Period
Total
Less than 1
year
1-3 years
More than
3 years

(in thousands)
Expected recognition of deferred revenue $ 318,526
$ 289,203
$ 28,526
$ 797



	Revenue Recognition Expected by Period
	Total		Less than 1 year		1-3 years		More than 3 years

	(in thousands)
Expected recognition of deferred revenue	$	324,071	$	293,365	$	29,639	$	1,067

SolarWinds Corporation

Notes to Condensed Consolidated Financial Statements (Unaudited)

Deferred Commissions

Deferred commissions, which consist of direct and incremental sales commissions and related fringe benefits, are capitalized using the portfolio approach if we expect to benefit from those costs for more than one year. Deferred commissions are allocated to each performance obligation within the contract and amortized on a straight-line basis over the expected benefit period of the related performance obligations. We expense commissions as incurred when the expected amortization period is one year or less. Deferred commissions allocated to new maintenance arrangements and certain SaaS offerings are amortized over an average expected benefit period of approximately four to six years which was determined based on the expected life of our technology. Deferred commissions allocated to perpetual licenses, maintenance renewal arrangements and MSP offerings are expensed as incurred. Deferred commissions are classified as current or non-current assets based on the timing the expense will be recognized. The current and non-current portions of our deferred commissions are included in prepaid and other current assets and other assets, net respectively, in our condensed consolidated balance sheets. The amortization of our deferred commissions is included in sales and marketing expense in our condensed consolidated statement of operations.

Details of our deferred commissions balance was as follows:


	Deferred Commissions			Deferred Commissions

	(in thousands)			(in thousands)
Balance at December 31, 2018	$	—		$	—
Adoption of ASC 606	5,157			5,157
Commissions capitalized	3,823			5,706
Amortization recognized	(1,045		)	(1,693		)
Balance at June 30, 2019	$	7,935
Balance at September 30, 2019				$	9,170

Classified as:
Current	$	2,076		$	2,199
Non-current	5,859			6,971
Total deferred commissions	$	7,935		$	9,170

Cost of Revenue

Amortization of Acquired Technologies. Amortization of acquired technologies included in cost of revenue relate to our licensed products and subscription products as follows:


	Three Months Ended June 30,				Six Months Ended June 30,				Three Months Ended September 30,				Nine Months Ended September 30,
	2019		2018		2019		2018		2019		2018		2019		2018

	(in thousands)								(in thousands)
Amortization of acquired license technologies	$	35,741	$	36,305	$	71,578	$	72,913	$	35,646	$	36,061	$	107,224	$	108,974
Amortization of acquired subscription technologies	8,231		7,662		16,211		15,373		8,526		7,774		24,737		23,147
Total amortization of acquired technologies	$	43,972	$	43,967	$	87,789	$	88,286	$	44,172	$	43,835	$	131,961	$	132,121

3. Acquisition

On April 30, 2019, we acquired SAManage Ltd., or Samanage, an IT service desk solution company, for approximately $342.1 million, including $341.5 million paid in cash and $0.6 million in fair value of replacement equity awards attributable to pre-acquisition service. By acquiring Samanage, we entered the ITSM market and based on the acquired technology introduced the SaaS-based service desk solution, SolarWinds Service Desk, into our product portfolio. We funded the transaction with cash on hand and $35.0 million of borrowings under our Revolving Credit Facility. We incurred ~~$1.9~~$2.0 million in acquisition related costs, which are included in general and administrative expense for the ~~six~~nine months ended ~~June~~September 30, 2019. Goodwill for this acquisition is not deductible for tax purposes.

The initial determination of the fair value of the assets acquired and liabilities assumed is based on a preliminary valuation and the estimates and assumptions for these items are subject to change as we obtain additional information during the measurement period. Subsequent changes to the purchase price or other fair value adjustments determined during the measurement period will

SolarWinds Corporation

Notes to Condensed Consolidated Financial Statements (Unaudited)

be recorded as an adjustment to goodwill. Measurement period adjustments for the three months ended September 30, 2019 resulted in a decrease in goodwill of $13.7 million primarily related to adjustments to the fair value of the Samanage identifiable intangible assets acquired. We may have additional measurement period adjustments as we finalize the fair value of certain assets acquired and liabilities ~~assumed, including the identifiable intangible assets.~~assumed.

The following table summarizes the consideration paid and the amounts recognized for the assets acquired and liabilities assumed:


	Total Fair Value			Total Fair Value
	(in thousands)			(in thousands)
Current assets, including cash acquired of $6.2 million	$	18,927		$	18,957
Property and equipment and other assets	550			428
Identifiable intangible assets	35,900			49,700
Goodwill	299,920			286,208
Current liabilities	(2,234		)	(2,230		)
Other long-term liabilities	(2,288		)	(2,288		)
Deferred revenue	(8,713		)	(8,713		)
Total consideration	$	342,062		$	342,062

The following table summarizes the fair value of the acquired identifiable intangible assets and weighted-average useful life:


	Fair Value		Weighted-average useful life	Fair Value		Weighted-average useful life
	(in thousands)		(in years)	(in thousands)		(in years)
Developed product technologies	$	17,500	5	$	26,900	5
Customer relationships	18,400		4	22,800		4
Total identifiable intangible assets	$	35,900		$	49,700

We estimate the amounts of revenue and net loss related to the Samanage acquisition included in our condensed consolidated financial statements from the effective date of the acquisition are insignificant for the ~~six~~nine months ended ~~June~~September 30, 2019. Pro forma information for the acquisition has not been provided because the impact of the historical financials on our revenue, net income (loss) and net income (loss) per share is not material. We recognize revenue on the acquired products in accordance with our revenue recognition policy as described above in Note 2. Summary of Significant Accounting Policies.

4. Goodwill

The following table reflects the changes in goodwill for the ~~six~~nine months ended ~~June~~September 30, 2019:


	(in thousands)			(in thousands)
Balance at December 31, 2018	$	3,683,961		$	3,683,961
Acquisitions	311,101			297,466
Foreign currency translation and other adjustments	(5,018		)	(51,825		)
Balance at June 30, 2019	$	3,990,044
Balance at September 30, 2019				$	3,929,602

The goodwill from acquisitions resulted primarily from our expectations that we will now be able to offer our customers additional products in new markets. Additionally, we expect the acquisitions will attract new customers for our entire line of products.

SolarWinds Corporation

Notes to Condensed Consolidated Financial Statements (Unaudited)

5. Fair Value Measurements

As of ~~June~~September 30, 2019, we had no0 financial assets that were measured at fair value on a recurring basis. The following table summarizes the fair value of our financial assets that were measured on a recurring basis as of December 31, 2018. There have been no transfers between fair value measurement levels during the ~~six~~nine months ended ~~June~~September 30, 2019.



	Fair Value Measurements at December 31, 2018 Using
	Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Total

	(in thousands)
Money market funds	$	117,100	$	—	$	—	$	117,100

As of ~~June~~September 30, 2019 and December 31, 2018, the carrying value of our long-term debt approximates its estimated fair value as the interest rate on the debt agreements is adjusted for changes in the market rates. See Note 6. Debt for additional information regarding our debt.

6. Debt

The following table summarizes information relating to our debt:


	June 30,					December 31,					September 30,					December 31,
	2019					2018					2019					2018
	Amount			Effective Rate		Amount			Effective Rate		Amount			Effective Rate		Amount			Effective Rate

	(in thousands, except interest rates)										(in thousands, except interest rates)
Revolving credit facility	$	—		—	%	$	—		—	%	$	—		—	%	$	—		—	%
First Lien Term Loan (as amended) due Feb 2024	1,960,150			5.15	%	1,970,100			5.27	%	1,955,175			4.79	%	1,970,100			5.27	%
Total principal amount	1,960,150					1,970,100					1,955,175					1,970,100
Unamortized discount and debt issuance costs	(41,537		)			(46,128		)			(39,213		)			(46,128		)
Total debt	1,918,613					1,923,972					1,915,962					1,923,972
Less: Current portion of long-term debt	(19,900		)			(19,900		)			(19,900		)			(19,900		)
Total long-term debt	$	1,898,713				$	1,904,072				$	1,896,062				$	1,904,072

Senior Secured First Lien Credit Facilities

The First Lien Credit Agreement provides for senior secured first lien credit facilities, consisting of the following as of ~~June~~September 30, 2019:

a $1.99 billion First Lien Term Loan with a final maturity date of February 5, 2024; and

a $125.0 million revolving credit facility (with a letter of credit sub-facility in the amount of $35.0 million), or the Revolving Credit Facility, consisting of (i) a $100.0 million multicurrency tranche and (ii) a $25.0 million tranche available only in U.S. dollars, of which $7.5 million has a final maturity date of February 5, 2021 and $17.5 million has a final maturity date of February 5, 2022.

Prior to the completion of our initial public offering, or IPO, in October 2018, borrowings under our Revolving Credit Facility bore interest at a floating rate which was, at our option, either (1) a Eurodollar rate for a specified interest period plus an applicable margin of 3.00% or (2) a base rate plus an applicable margin of 2.00%. Upon completion of our IPO, the applicable margins for Eurodollar rate and base rate borrowings were reduced to 2.50%, and 1.50%, respectively. The Eurodollar rate applicable to the Revolving Credit Facility is subject to a “floor” of 0.0%.

Prior to the completion of our IPO, borrowings under our First Lien Term Loan bore interest at a floating rate which was, at our option, either (1) a Eurodollar rate for a specified interest period plus an applicable margin of 3.00% or (2) a base rate plus an applicable margin of 2.00%. Upon completion of our IPO, the applicable margins for Eurodollar and base rate borrowings were

SolarWinds Corporation

Notes to Condensed Consolidated Financial Statements (Unaudited)

each reduced to 2.75% and 1.75%, respectively. The Eurodollar rate applicable to the First Lien Term Loan is subject to a “floor” of 0.0%.

The Eurodollar rate is equal to an adjusted London Interbank Offered Rate, or LIBOR, for a one-, two-, three- or six-month interest period with a LIBOR floor of 0%. The base rate for any day is a fluctuating rate per annum equal to the highest of (a) the rate of interest in effect for such day as publicly announced by Credit Suisse as its “prime rate” and (b) the federal funds effective rate in effect on such day plus 0.50% and (c) the one-month adjusted LIBOR plus 1.0% per annum.

The First Lien Term Loan requires equal quarterly repayments equal to 0.25% of the original principal amount.

In addition to paying interest on loans outstanding under the Revolving Credit Facility and the First Lien Term Loan, we are required to pay a commitment fee of 0.50% per annum of unused commitments under the Revolving Credit Facility. The commitment fee is subject to a reduction to 0.375% per annum based on our first lien net leverage ratio.

The First Lien Credit Agreement contains a number of covenants that, among other things, restrict, subject to certain exceptions, our ability to: incur additional indebtedness; incur liens; engage in mergers, consolidations, liquidations or dissolutions; pay dividends and distributions on, or redeem, repurchase or retire our capital stock; and make certain investments, acquisitions, loans, or advances. In addition, the terms of the First Lien Credit Agreement include a financial covenant which requires that, at the end of each fiscal quarter, if the aggregate amount of borrowings under the Revolving Credit Facility exceeds 35% of the aggregate commitments under the Revolving Credit Facility, our first lien net leverage ratio cannot exceed 7.40 to 1.00. The First Lien Credit Agreement also contains certain customary representations and warranties, affirmative covenants and events of default. As of ~~June~~September 30, 2019, we were in compliance with all covenants of the First Lien Credit Agreement.

In April 2019, we borrowed $35.0 million under our Revolving Credit Facility to partially fund the acquisition of Samanage. The outstanding borrowings were repaid in full during the three months ended June 30, 2019.

7. Redeemable Convertible Class A Common Stock

Prior to the conversion of Class A Common Stock into common stock at our IPO in October 2018, our Class A Common Stock accrued dividends at a rate of 9% per annum and had a liquidation preference equal to $1,000 per share plus any accrued and unpaid dividends.

Immediately prior to the completion of our IPO, we converted each outstanding share of our Class A Common Stock into 140,053,370 shares of common stock, which was equal to the result of the liquidation value of such share of Class A Common Stock, divided by $19.00 per share. The liquidation value for each share of Class A Common Stock was equal to $1,000. At the time of the conversion of the Class A Common Stock, we converted $717.4 million of accrued and unpaid dividends on the Class A Common Stock into 37,758,109 shares of common stock equal to the result of the accrued and unpaid dividends on each share of Class A Common Stock, divided by $19.00 per share.

SolarWinds Corporation

Notes to Condensed Consolidated Financial Statements (Unaudited)

8. Earnings (Loss) Per Share

A reconciliation of the number of shares in the calculation of basic and diluted earnings (loss) per share follows:


	Three Months Ended June 30,						Six Months Ended June 30,						Three Months Ended September 30,						Nine Months Ended September 30,
	2019			2018			2019			2018			2019			2018			2019			2018

	(in thousands)												(in thousands)
Basic earnings (loss) per share
Numerator:
Net income (loss)	$	(2,119	)	$	(27,015	)	$	1,026		$	(86,925	)	$	4,393		$	(398	)	$	5,419		$	(87,323	)
Accretion of dividends on Class A common stock	—			(72,178		)	—			(142,013		)	—			(74,608		)	—			(216,621		)
Earnings allocated to unvested restricted stock	—			—			(12		)	—			(43		)	—			(60		)	—
Net income (loss) available to common stockholders	$	(2,119	)	$	(99,193	)	$	1,014		$	(228,938	)	$	4,350		$	(75,006	)	$	5,359		$	(303,944	)
Denominator:
Weighted-average common shares outstanding used in computing basic earnings (loss) per share	306,587			102,018			306,122			101,832			306,890			102,078			306,381			101,915

Diluted earnings (loss) per share
Numerator:
Net income (loss) available to common stockholders	$	(2,119	)	$	(99,193	)	$	1,014		$	(228,938	)	$	4,350		$	(75,006	)	$	5,359		$	(303,944	)
Denominator:
Weighted-average shares used in computing basic earnings (loss) per share	306,587			102,018			306,122			101,832			306,890			102,078			306,381			101,915
Add incentive stock awards	—			—			4,231			—
Add dilutive impact of employee equity plans													4,212			—			4,226			—
Weighted-average shares used in computing diluted earnings (loss) per share	306,587			102,018			310,353			101,832			311,102			102,078			310,607			101,915

The following weighted average outstanding shares of common stock equivalents were excluded from the computation of the diluted earnings (loss) per share attributable to common stockholders for the periods presented because their effect would have been anti-dilutive or for which the performance condition had not been met at the end of the period:


	Three Months Ended June 30,		Six Months Ended June 30,		Three Months Ended September 30,		Nine Months Ended September 30,
	2019	2018	2019	2018	2019	2018	2019	2018

	(in thousands)				(in thousands)
Stock options to purchase common stock	2,420	2,647	341	2,343	286	2,782	322	2,525
Performance-based stock options to purchase common stock	299	424	128	295	125	316	127	267
Non-vested restricted stock incentive awards	2,269	3,392	2,587	3,192	2,147	3,512	2,439	3,435
Performance-based non-vested restricted stock incentive awards	916	1,755	1,098	1,784	899	1,537	1,031	1,566
Restricted stock units	6,719	—	4,672	—	5,498	—	4,948	—
Performance stock units	885	—	921	—	918	—	920	—
Employee stock purchase plan	61	—	30	—	127	—	63	—
Total anti-dilutive shares	13,569	8,218	9,777	7,614	10,000	8,147	9,850	7,793

Prior to the conversion at the IPO, Class A Common Stock was not included in the basic or diluted earnings (loss) per share calculations as it was contingently convertible upon a future event. See Note 7. Redeemable Convertible Class A Common Stock for additional details of the conversion of the Class A Common Stock. The calculation of diluted earnings per share requires us to make certain assumptions related to the use of proceeds that would be received upon the assumed exercise of stock options and purchases under our employee stock purchase plan.

SolarWinds Corporation

Notes to Condensed Consolidated Financial Statements (Unaudited)

9. Income Taxes

For the three months ended ~~June~~September 30, 2019 and 2018, we recorded income tax expense of ~~$3.2~~$2.9 million and income tax benefit of ~~$11.6~~$0.1 million, respectively, resulting in an effective tax rate of ~~297.1%~~39.7% and ~~30.0%~~24.0%, respectively. For the ~~six~~nine months ended ~~June~~September 30, 2019 and 2018, we recorded income tax expense of ~~$3.8~~$6.7 million and income tax benefit of ~~$19.9~~$20.0 million, respectively, resulting in an effective tax rate of ~~78.6%~~55.1% and ~~18.6%~~18.7%, respectively. The increase in the effective tax rate for the three and ~~six~~nine months ended ~~June~~September 30, 2019 compared to the same period in 2018 was primarily due to the impact of having a full valuation allowance against the deferred tax assets related to the current period losses from the recent Samanage acquisition.

Our policy is to include interest and penalties related to unrecognized tax benefits as a component of income tax expense. At ~~June~~September 30, 2019, we had accrued interest and penalties related to unrecognized tax benefits of approximately ~~$4.6~~$5.0 million.

We file U.S., state and foreign income tax returns in jurisdictions with varying statutes of limitations. The 2011 through ~~2017~~2018 tax years generally remain open and subject to examination by federal tax authorities. The 2011 through 2018 tax years generally remain open and subject to examination by the state tax authorities and foreign tax authorities. We are currently under examination by the IRS for the tax years 2011 through the period ending February 2016. We are under audit by the Indian Tax Authority for the 2014 and 2017 tax years. We are currently under audit by the California Franchise Tax Board for the 2012 through 2014 tax years. We were notified in January 2019 that the Massachusetts Department of Revenue would audit the 2015 through February 2016 tax years. We are not currently under audit in any other taxing jurisdictions.

On July 27, 2015 in Altera Corp. v. Commissioner, the U.S. Tax Court issued an opinion related to the treatment of stock-based compensation in an intercompany cost sharing arrangement. In February 2016, the U.S. Internal Revenue Service appealed the decision to the U.S. Court of Appeals for the Ninth Circuit. On June 7, 2019, the Ninth Circuit reversed the 2015 decision of the U.S. Tax Court. On July 22, 2019, Altera Corp. filed a petition for a rehearing before the full Ninth Circuit. As of ~~June~~September 30, 2019, we have not recorded any benefit or expense. We will continue to monitor ongoing developments and potential impacts to our consolidated financial statements.

10. Commitments and Contingencies

Legal Proceedings

From time to time, we have been and may be involved in various legal proceedings arising in our ordinary course of business. In the opinion of management, resolution of any pending claims (either individually or in the aggregate) is not expected to have a material adverse impact on our consolidated financial statements, cash flows or financial position and it is not possible to provide an estimated amount of any such loss. However, the outcome of disputes is inherently uncertain. Therefore, although management considers the likelihood of such an outcome to be remote, an unfavorable resolution of one or more matters could materially affect our future results of operations or cash flows, or both, in a particular period.

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the condensed consolidated financial statements and related notes thereto included elsewhere in this quarterly report on Form 10-Q. In addition to historical condensed consolidated financial information, the following discussion contains forward-looking statements that reflect our plans, estimates and beliefs. Our actual results could differ materially and adversely from those anticipated in the forward-looking statements. Please see the section entitled “Safe Harbor Cautionary Statement” above and the risk factors discussed in our Annual Report on Form 10-K for the year ended December 31, 2018 for a discussion of the uncertainties, risks and assumptions associated with these statements. The following discussion and analysis also includes a discussion of certain non-GAAP financial measures. For a description and reconciliation of the non-GAAP measures discussed in this section, see “Non-GAAP Financial Measures.”

Overview

SolarWinds is a leading provider of information technology, or IT, infrastructure management software. Our products give organizations worldwide, regardless of type, size or IT infrastructure complexity, the power to monitor and manage the performance of their IT environments, whether on-premise, in the cloud, or in hybrid models. We combine powerful, scalable, affordable, easy to use products with a high-velocity, low-touch sales model to grow our business while also generating significant cash flow.

We offer over 50 products to monitor and manage network, systems, desktop, application, storage, database and website infrastructures, whether on-premise, in the public or private cloud or in a hybrid IT infrastructure. We intend to continue to innovate and invest in areas of product development that bring new products to market and enhance the functionality, ease of use and integration of our current products. We believe this will strengthen the overall value proposition of our products in any IT environment.

On February 5, 2016, we were acquired by affiliates of Silver Lake and Thoma Bravo in a take private transaction, or the Take Private. We applied purchase accounting on the date of the Take Private. In October 2018, we completed our initial public offering, or IPO, in which we sold and issued 25,000,000 shares of our common stock at an issue price of $15.00 per share. We raised a total of $375.0 million in gross proceeds from the offering, or approximately $353.0 million in net proceeds. A portion of the net proceeds from the offering were used to repay the $315.0 million in borrowings outstanding under our second lien term loan.

~~Second~~Third Quarter Financial Highlights

Our approach, which we call the “SolarWinds Model,” is based on our commitment to building a business that is focused on growth and profitability. Below are our key financial highlights for the three months ended ~~June~~September 30, 2019 as compared to the three months ended ~~June~~September 30, 2018.

Revenue

Our total revenue was ~~$228.7~~$240.5 million and ~~$201.7~~$213.3 million for the three months ended ~~June~~September 30, 2019 and 2018, respectively. Our non-GAAP total revenue, which excludes the impact of purchase accounting, was ~~$230.6~~$242.7 million and ~~$202.8~~$214.0 million for the three months ended ~~June~~September 30, 2019 and 2018, respectively. Recurring revenue, which consists of subscription and maintenance revenue, represented approximately ~~83%~~82% of our total revenue for the three months ended ~~June~~September 30, 2019 compared to ~~81%~~80% for the three months ended ~~June~~September 30, 2018. We have increased our recurring revenue as a result of the growth in our subscription sales and the continued growth of our maintenance revenue.

Profitability

We have grown while maintaining high levels of operating efficiency. Our net ~~loss~~income for the three months ended ~~June~~September 30, 2019 was ~~$2.1~~$4.4 million compared to a net loss of ~~$27.0~~$0.4 million for the three months ended ~~June~~September 30, 2018. Our Adjusted EBITDA was ~~$110.9~~$115.0 million and ~~$94.1~~$106.5 million for the three months ended ~~June~~September 30, 2019 and 2018, respectively.

Cash Flow

We are building our business to generate strong cash flow over the long term. For the three months ended ~~June~~September 30, 2019 and 2018, cash flows from operations were ~~$78.3~~$75.2 million and ~~$71.8~~$59.0 million, respectively. During those periods, our cash flows from operations were reduced by cash payments for interest on our long-term debt of ~~$26.3~~$25.7 million and ~~$32.4~~$33.0 million, respectively and cash payments for income taxes of $9.2 million and $0.2 million, respectively.

Acquisition

On April 30, 2019, we acquired SAManage Ltd., or Samanage, an IT service desk solution company, for approximately $342.1 million. By acquiring Samanage, we entered the IT service management, or ITSM, market and based on the acquired technology introduced the SaaS-based service desk solution, SolarWinds Service Desk, into our product portfolio. See Note 3. Acquisition in the Notes to Condensed Consolidated Financial Statements included in Item 1 of Part I of this Form 10-Q for additional discussion of the acquisition.

Follow-On Offering by Selling Stockholders

In May 2019, we completed a follow-on offering for 15,000,000 shares of our common stock sold by certain selling stockholders at an offering price of $18.00 per share. The selling stockholders received all of the proceeds from the offering. We continue to be a controlled company within the meaning of the NYSE corporate governance standards.

Components of Our Results of Operations

Revenue

Our revenue consists of recurring revenue and perpetual license revenue.


•	Recurring Revenue. The significant majority of our revenue is recurring and consists of subscription and maintenance revenue.

▪

Subscription Revenue. We primarily derive subscription revenue from fees received for subscriptions to our SaaS offerings, and to a lesser extent, our time-based license arrangements. ~~Subscriptions~~Subscription revenue includes sales of our cloud application management, MSP and ITSM products. We generally recognize revenue ratably over the subscription term once the service is made available to the customer or when we have the right to invoice for services performed. We generally invoice subscription agreements monthly based on usage or in advance over the subscription period on either a monthly or annual basis. Our subscription revenue grows as customers add new subscription products, upgrade the capacity level of their existing subscription products or increase the usage of their subscription products. Our revenue from MSP products increases with the addition of end customers served by our MSP customers, the proliferation of devices managed by those MSPs and the expansion of products used by those MSPs to manage end customers’ IT infrastructures.

•

Maintenance Revenue. We derive maintenance revenue from the sale of maintenance services associated with our perpetual license products. Perpetual license customers pay for maintenance services based on the products they have purchased. We recognize maintenance revenue ratably on a daily basis over the contract period. Our maintenance revenue grows when we renew existing maintenance contracts and add new perpetual license customers, and as existing customers add new products. Customers typically renew their maintenance contracts at our standard list maintenance renewal pricing for their applicable products. We generally invoice maintenance contracts annually in advance.

•

License Revenue. We derive license revenue from sales of perpetual licenses of our products to new and existing customers. We include one year of maintenance services as part of our customers’ initial license purchase. License revenue is recognized at a point in time upon delivery of the electronic license key. We calculate the amount of revenue allocated to the license by estimating our standalone selling prices utilizing the residual approach by considering our pricing and discounting practices.

Cost of Revenue


•	Cost of Recurring Revenue. Cost of recurring revenue consists of technical support personnel costs, royalty fees, public cloud infrastructure and hosting fees and an allocation of overhead costs for our subscription revenue and maintenance services. Allocated costs consist of certain facilities, depreciation, benefits and IT costs allocated based on headcount.


•	Amortization of Acquired Technologies. We amortize to cost of revenue the capitalized costs of technologies acquired in connection with the Take Private and our other acquisitions.

Operating Expenses

Operating expenses consists of sales and marketing, research and development and general and administrative expenses as well as amortization of acquired intangibles. Personnel costs are the most significant component of operating expenses and consist of salaries, benefits, bonuses, sales commissions, stock-based compensation, contractor fees and an allocation of overhead costs based on headcount. The total number of employees as of ~~June~~September 30, 2019 was ~~3,025,~~3,121, as compared to ~~2,540~~2,666 as of ~~June~~September 30, 2018. In connection with our IPO in October 2018, we granted equity awards to our employees and directors consisting of ~~restricted stock~~

restricted stock units and performance stock units resulting in an increase in stock-based compensation expense in the periods subsequent to the IPO.

•

Sales and Marketing. Sales and marketing expenses primarily consist of related personnel costs, including our sales, marketing and maintenance renewal and subscription retention teams. Sales and marketing expenses also includes the cost of digital marketing programs such as paid search, search engine optimization and management, website maintenance and design. We expect to continue to hire personnel globally to drive new sales and maintenance renewals.


•	Research and Development. Research and development expenses primarily consist of related personnel costs. We expect to continue to grow our research and development organization, particularly internationally.

•

General and Administrative. General and administrative expenses primarily consist of personnel costs for our executive, finance, legal, human resources and other administrative personnel, general restructuring charges and other acquisition-related costs, professional fees and other general corporate expenses. In the periods after the Take Private and prior to our IPO, these expenses also included management fees payable to our Sponsors, which were eliminated upon the completion of our initial public offering.


•	Amortization of Acquired Intangibles. We amortize to operating expenses the capitalized costs of intangible assets acquired in connection with the Take Private and our other acquisitions.

Other Income (Expense)

Other income (expense) primarily consists of interest expense, gains (losses) resulting from changes in exchange rates on foreign currency denominated intercompany loans and accounts, and losses on extinguishment of debt. We expect interest expense to decrease as we repay indebtedness.

We established a foreign currency denominated intercompany loan as part of the Take Private to provide a conduit to utilize foreign earnings effectively. The gains (losses) associated with the changes in exchange rates on amounts borrowed are unrealized non-cash events. Substantially all of these unrealized amounts are related to this one foreign currency denominated loan. As of July 1, 2018, this foreign currency denominated intercompany loan was designated as long-term due to a change in our investment strategy and the new Tax Act. Therefore, beginning on July 1, 2018, the foreign currency transaction gains and losses resulting from remeasurement are recognized as a component of accumulated other comprehensive income (loss). As of September 30, 2019, we determined that the intercompany loan will not be repaid and it was reclassified as a capital contribution.

Foreign Currency

As a global company, we face exposure to adverse movements in foreign currency exchange rates. Fluctuations in foreign currencies impact the amount of total assets, liabilities, revenue, operating expenses and cash flows that we report for our foreign subsidiaries upon the translation of these amounts into U.S. dollars. See “Item 3: Quantitative and Qualitative Disclosures About Market Risk” for additional information on how foreign currency impacts our financial results.

Income Tax Expense

Income tax expense consists of domestic and foreign corporate income taxes related to the sale of products. The tax rate on income earned by our North American entities is higher than the tax rate on income earned by our international entities other than Canada and Sweden. We expect the income earned by our international entities to grow over time as a percentage of total income, which may result in a decline in our effective income tax rate. However, our effective tax rate will be affected by many other factors including changes in tax laws, regulations or rates, new interpretations of existing laws or regulations, shifts in the allocation of income earned throughout the world and changes in overall levels of income before tax.

Comparison of the Three Months Ended ~~June~~September 30, 2019 and 2018

Revenue


	Three Months Ended June 30,										Three Months Ended September 30,
	2019				2018						2019				2018
	Amount		Percentage of Revenue		Amount		Percentage of Revenue		Change		Amount		Percentage of Revenue		Amount		Percentage of Revenue		Change

			(in thousands, except percentages)										(in thousands, except percentages)
Subscription	$	78,780	34.4	%	$	65,238	32.3	%	$	13,542	$	83,122	34.6	%	$	67,713	31.7	%	$	15,409
Maintenance	110,793		48.4		98,767		49.0		12,026		113,755		47.3		101,817		47.7		11,938
Total recurring revenue	189,573		82.9		164,005		81.3		25,568		196,877		81.9		169,530		79.5		27,347
License	39,175		17.1		37,713		18.7		1,462		43,613		18.1		43,747		20.5		(134		)
Total revenue	$	228,748	100.0	%	$	201,718	100.0	%	$	27,030	$	240,490	100.0	%	$	213,277	100.0	%	$	27,213

In the first quarter of 2019, we adopted FASB Accounting Standards Codification (“ASC”) No. 2014-09 “Revenue from Contracts with Customers,” or ASC 606, which replaced all existing revenue guidance under ASC 605 “Revenue Recognition,” including prescriptive industry-specific guidance, or ASC 605. We adopted ASC 606 using the modified-retrospective method therefore, results for the ~~second~~third quarter of 2019 are presented in compliance with ASC 606 and historical financial results for reporting periods prior to 2019 are presented in conformity with amounts previously disclosed under ASC 605. The impact of the adoption of ASC 606 on our total revenue for the three months ended ~~June~~September 30, 2019 was insignificant. See Note 2. Summary of Significant Accounting Policies in the Notes to Condensed Consolidated Financial Statements in Item 1 of Part I of this Quarterly Report on Form 10-Q, for a full description of implementation impact of ASC 606 including the presentation of financial results for the three month period ended ~~June~~September 30, 2019 under ASC 605 for comparison to the prior year period.

Total revenue increased ~~$27.0~~$27.2 million, or ~~13.4%~~12.8%, for the three months ended ~~June~~September 30, 2019 compared to the three months ended ~~June~~September 30, 2018. Revenue from North America was approximately ~~65%~~67% and 64% of total revenue for ~~both~~ the three months ended ~~June~~September 30, 2019 and ~~2018.~~2018, respectively. Other than the United States, no single country accounted for 10% or more of our total revenue during these periods.

Recurring Revenue

Subscription Revenue. Subscription revenue increased ~~$13.5~~$15.4 million, or ~~20.8%~~22.8%, for the three months ended ~~June~~September 30, 2019 compared to the three months ended ~~June~~September 30, 2018, primarily due to sales of additional MSP ~~and cloud management products.~~products, with additional contribution from our acquired SolarWinds Service Desk product. These increases were partially offset by the effect of the weakening of most foreign currencies relative to the U.S. dollar. Our subscription revenue increased as a percentage of our total revenue for the three months ended ~~June~~September 30, 2019 compared to the three months ended ~~June~~September 30, 2018. ~~Subscription revenue for the three months ended June 30, 2019 would have been approximately $0.2 million higher under ASC 605. See~~ ~~Note~~ ~~2. Summary of Significant Accounting Policies~~ ~~in the~~ ~~Notes to Condensed Consolidated Financial Statements~~ ~~in Item 1 of Part I of this Quarterly Report on Form 10-Q, for a full discussion of the impact of ASC 606 on our revenue for the three months ended June 30, 2019.~~

Our net retention rate for our subscription products was approximately 105% for the trailing twelve-month period ended ~~June~~September 30, 2019 and was driven primarily by strong customer retention in our MSP products. We define our net retention rate for subscription products as the implied monthly subscription revenue at the end of a period for the base set of customers from which we generated subscription revenue in the year prior to the calculation, divided by the implied monthly subscription revenue one year prior to the date of calculation for that same customer base.

Maintenance Revenue. Maintenance revenue increased ~~$12.0~~$11.9 million, or ~~12.2%~~11.7%, for the three months ended ~~June~~September 30, 2019 compared to the three months ended ~~June~~September 30, 2018. ~~Of this change, $11.2 million~~The increase was primarily attributable to a growing maintenance renewal customer base from sales of our perpetual license products and strong maintenance renewal rates, partially offset by the effect of the weakening of most foreign currencies relative to the U.S. dollar. The remaining $0.8 million increase was attributable to the purchase accounting adjustment to deferred revenue in the three months ended June 30, 2018 which reduced revenue for the period. Maintenance revenue for the three months ended June 30, 2019 would have been approximately $0.2 million higher under ASC 605. See ~~Note~~ ~~2. Summary of Significant Accounting Policies~~ ~~in the~~ ~~Notes to Condensed Consolidated Financial Statements~~ ~~in Item 1 of Part I of this Quarterly Report on Form 10-Q, for a full discussion of the impact of ASC 606 on our revenue for the three months ended June 30, 2019.~~

Our maintenance renewal rate was approximately ~~96%~~95% for the trailing twelve-month period ended ~~June~~September 30, 2019. We define our maintenance renewal rate as the sales of maintenance services for all existing maintenance contracts expiring in a period, divided by the sum previous sales of maintenance services corresponding to those services expiring in the current period. Sales of maintenance services includes sales of maintenance renewals for a previously purchased product and the amount allocated to maintenance revenue from a license purchase.

License Revenue

License revenue ~~increased $1.5~~decreased $0.1 million, or ~~3.9%,~~0.3% primarily due to ~~increased sales of our licensed products in each of our North American and international locations, partially offset by the effect of~~ the weakening of most foreign currencies relative to the U.S. ~~dollar. License revenue for~~dollar and slightly lower North American license sales compared to the three months ended ~~June~~September 30, ~~2019 would have been approximately $0.5 million lower under ASC 605. See~~ ~~Note~~ ~~2. Summary of Significant Accounting Policies~~ ~~in the~~ ~~Notes to Condensed Consolidated Financial Statements~~ ~~in Item 1 of Part I of this Quarterly Report on Form 10-Q, for a full discussion of the impact of ASC 606 on our revenue for the three months ended June 30, 2019.~~2018.

Cost of Revenue


	Three Months Ended June 30,										Three Months Ended September 30,
	2019				2018						2019				2018
	Amount		Percentage of Revenue		Amount		Percentage of Revenue		Change		Amount		Percentage of Revenue		Amount		Percentage of Revenue		Change

			(in thousands, except percentages)										(in thousands, except percentages)
Cost of recurring revenue	$	19,386	8.5	%	$	17,708	8.8	%	$	1,678	$	20,614	8.6	%	$	18,022	8.5	%	$	2,592
Amortization of acquired technologies	43,972		19.2		43,967		21.8		5		44,172		18.4		43,835		20.6		337
Total cost of revenue	$	63,358	27.7	%	$	61,675	30.6	%	$	1,683	$	64,786	26.9	%	$	61,857	29.0	%	$	2,929

Total cost of revenue increased in the three months ended ~~June~~September 30, 2019 compared to the three months ended ~~June~~September 30, 2018 primarily due to increases in personnel costs to support new customers and additional product offerings of $1.4 million, which includes a $0.4 million increase in stock-based compensation expense, public cloud infrastructure and hosting fees of $0.6 million and depreciation and other amortization of ~~$0.4~~$0.5 million. Amortization of acquired technologies includes ~~$41.0~~$40.8 million and ~~$41.5~~$41.3 million of amortization related to the Take Private for the three months ended ~~June~~September 30, 2019 and 2018, ~~respectively, with the remaining balance related primarily to the LOGICnow acquisition in May 2016.~~respectively.

Operating Expenses


	Three Months Ended June 30,										Three Months Ended September 30,
	2019				2018						2019				2018
	Amount		Percentage of Revenue		Amount		Percentage of Revenue		Change		Amount		Percentage of Revenue		Amount		Percentage of Revenue		Change

			(in thousands, except percentages)										(in thousands, except percentages)
Sales and marketing	$	64,813	28.3	%	$	56,414	28.0	%	$	8,399	$	68,290	28.4	%	$	56,926	26.7	%	$	11,364
Research and development	27,705		12.1		23,773		11.8		3,932		29,575		12.3		23,274		10.9		6,301
General and administrative	25,241		11.0		21,066		10.4		4,175		25,405		10.6		19,597		9.2		5,808
Amortization of acquired intangibles	17,301		7.6		16,653		8.3		648		18,015		7.5		16,507		7.7		1,508
Total operating expenses	$	135,060	59.0	%	$	117,906	58.5	%	$	17,154	$	141,285	58.7	%	$	116,304	54.5	%	$	24,981

Sales and Marketing. Sales and marketing expenses increased ~~$8.4~~$11.4 million, or ~~14.9%~~20.0%, primarily due to increases in personnel costs of ~~$6.6~~$6.1 million, which includes an increase of ~~$2.3~~$2.6 million in stock-based compensation expense, and marketing program costs of ~~$1.2~~$4.1 million. We increased our sales and marketing employee headcount through the acquisition of Samanage and to support the sales of additional products and growth in the ~~business and through the acquisition of Samanage.~~business. Sales and marketing expense for the three months ended ~~June~~September 30, 2019 would have been approximately ~~$1.2~~$1.4 million higher under ASC 605 due to the impact of the capitalization and amortization of commission expense under ASC 606. See Note 2. Summary of Significant Accounting Policies in the Notes to Condensed Consolidated Financial Statements in Item 1 of Part I of this Quarterly Report on Form 10-Q for further discussion of the impact of the adoption of ASC 606.

Research and Development. Research and development expenses increased ~~$3.9~~$6.3 million, or ~~16.5%~~27.1%, primarily due to an increase in personnel costs of ~~$4.0~~$5.9 million, which includes an increase in stock-based compensation expense of ~~$2.0~~$2.6 million. We increased our ~~worldwide~~ research and development employee headcount through the acquisition of Samanage and to expedite delivery of product enhancements and new product offerings to our ~~customers and through the acquisition of Samanage.~~customers.

General and Administrative. General and administrative expenses increased ~~$4.2~~$5.8 million, or ~~19.8%~~29.6%, primarily due to a ~~$2.6~~$5.3 million increase in personnel costs, which includes a $3.1 million increase in stock-based compensation, a ~~$2.3 million increase in acquisition and restructuring costs and a $1.4~~$1.9 million increase in professional fees and other public company costs and a $1.3 million increase in acquisition and restructuring costs. These increases were partially offset by a reduction of $2.5 million related to management fees payable to our Sponsors that were eliminated upon the completion of our initial public offering in October 2018.

Amortization of Acquired Intangibles. Amortization of acquired intangibles increased ~~$0.6~~$1.5 million, or ~~3.9%~~9.1%, for the three months ended ~~June~~September 30, 2019 compared to the three months ended ~~June~~September 30, 2018 primarily due to an increase in amortization related to the Samanage acquisition. See Note 3. Acquisition in the Notes to Condensed Consolidated Financial Statements in Item 1 of Part I of this Quarterly Report on Form 10-Q for further discussion of the Samanage acquisition including the intangible assets acquired. Amortization of intangible assets includes ~~$11.9~~$11.8 million and ~~$12.0~~$11.9 million of amortization related to the Take Private for the three months ended ~~June~~September 30, 2019 and 2018, respectively, with the remaining balance related primarily to the LOGICnow acquisition in May 2016.

Interest Expense, Net

Three Months Ended June 30,
2019 2018
Amount Percentage of Revenue Amount Percentage of Revenue Change

(in thousands, except percentages)
Interest expense, net $ (28,177 ) (12.3 )% $ (34,387 ) (17.0 )% $ 6,210



	Three Months Ended September 30,
	2019					2018
	Amount			Percentage of Revenue		Amount			Percentage of Revenue		Change

				(in thousands, except percentages)
Interest expense, net	$	(27,418	)	(11.4	)%	$	(35,627	)	(16.7	)%	$	8,209

Interest expense, net decreased by ~~$6.2~~$8.2 million, or ~~18.1%~~23.0%, in the three months ended ~~June~~September 30, 2019 compared to the three months ended ~~June~~September 30, 2018. The decrease in interest expense is primarily due to the repayment of $315.0 million in outstanding borrowings under our second lien term loan in October 2018 and the reduction in the interest rate spread under our credit facilities resulting from our IPO in October 2018. See Note 6. Debt in the Notes to Condensed Consolidated Financial Statements included in Item 1 of Part I of this Form 10-Q for additional information regarding our debt.

Other Income (Expense), Net


	Three Months Ended June 30,													Three Months Ended September 30,
	2019					2018								2019					2018
	Amount			Percentage of Revenue		Amount			Percentage of Revenue		Change			Amount			Percentage of Revenue		Amount			Percentage of Revenue		Change

				(in thousands, except percentages)													(in thousands, except percentages)
Unrealized net transaction gains (losses) related to remeasurement of intercompany loans	$	(23	)	—	%	$	(26,614	)	(13.2	)%	$	26,591		$	334		0.1	%	$	51		—	%	$	283
Other income (expense)	(1,055		)	(0.5	)	287			0.1		(1,342		)	(47		)	—		(64		)	—		17
Total other income (expense), net	$	(1,078	)	(0.5	)%	$	(26,327	)	(13.1	)%	$	25,249		$	287		0.1	%	$	(13	)	—	%	$	300

Other income (expense), net increased by ~~$25.2~~$0.3 million in the three months ended ~~June~~September 30, 2019 compared to the three months ended ~~June~~September 30, 2018 primarily due to the impact of changes in foreign currency exchange rates related to various intercompany loans and accounts for the period. As of July 1, 2018, we changed our assertion regarding the planned settlement of a certain intercompany loan. We evaluated our investment strategy in light of our global treasury plans and the new Tax Act and have determined there is no need to settle the principal related to the loan. Therefore, beginning on July 1, 2018, the foreign currency transaction gains and losses resulting from the remeasurement of this long-term intercompany loan denominated in a currency other than the subsidiary's functional currency are recognized as a component of accumulated other comprehensive income (loss) and not included in other income (expense), net.

Income Tax Expense (Benefit)


	Three Months Ended June 30,													Three Months Ended September 30,
	2019					2018								2019					2018
	Amount			Percentage of Revenue		Amount			Percentage of Revenue		Change			Amount			Percentage of Revenue		Amount			Percentage of Revenue		Change

				(in thousands, except percentages)													(in thousands, except percentages)
Income tax expense (benefit)	$	3,194		1.4	%	$	(11,562	)	(5.7	)%	$	14,756		$	2,895		1.2	%	$	(126	)	(0.1	)%	$	3,021
Effective tax rate	297.1		%			30.0		%			267.1		%	39.7		%			24.0		%			15.7		%

Our income tax expense for the three months ended ~~June~~September 30, 2019 increased by ~~$14.8~~$3.0 million as compared to the three months ended ~~June~~September 30, 2018 primarily as a result of an increase in the income before income taxes for the period. The effective tax rate increased by ~~267.1%~~15.7% for the period primarily due to the impact of having a full valuation allowance against the deferred tax assets related to the current period losses from the recent Samanage acquisition. For additional discussion about our income taxes, see Note 9. Income Taxes in the Notes to Condensed Consolidated Financial Statements included in Item 1 of Part I of this Form 10-Q.

Comparison of the ~~Six~~Nine Months Ended ~~June~~September 30, 2019 and 2018

Revenue


	Six Months Ended June 30,										Nine Months Ended September 30,
	2019				2018						2019				2018
	Amount		Percentage of Revenue		Amount		Percentage of Revenue		Change		Amount		Percentage of Revenue		Amount		Percentage of Revenue		Change

			(in thousands, except percentages)										(in thousands, except percentages)
Subscription	$	150,345	33.8	%	$	128,291	32.2	%	$	22,054	$	233,467	34.1	%	$	196,004	32.0	%	$	37,463
Maintenance	217,085		48.8		195,767		49.1		21,318		330,840		48.3		297,584		48.6		33,256
Total recurring revenue	367,430		82.7		324,058		81.3		43,372		564,307		82.4		493,588		80.7		70,719
License	77,110		17.3		74,573		18.7		2,537		120,723		17.6		118,320		19.3		2,403
Total revenue	$	444,540	100.0	%	$	398,631	100.0	%	$	45,909	$	685,030	100.0	%	$	611,908	100.0	%	$	73,122

In the first quarter of 2019, we adopted FASB Accounting Standards Codification (“ASC”) No. 2014-09 “Revenue from Contracts with Customers,” or ASC 606, which replaced all existing revenue guidance under ASC 605 “Revenue Recognition,” including prescriptive industry-specific guidance, or ASC 605. We adopted ASC 606 using the modified-retrospective method therefore, results for the first ~~half~~three quarters of 2019 are presented in compliance with ASC 606 and historical financial results for reporting periods prior to 2019 are presented in conformity with amounts previously disclosed under ASC 605. ~~Total~~The impact of the adoption of ASC 606 on our total revenue for the ~~six~~nine months ended ~~June~~September 30, 2019 ~~would have been approximately $0.2 million higher under ASC 605.~~was insignificant. See Note 2. Summary of Significant Accounting Policies in the Notes to Condensed Consolidated Financial Statements in Item 1 of Part I of this Quarterly Report on Form 10-Q, for a full description of implementation impact of ASC 606 including the presentation of financial results for the ~~six~~nine months ended ~~June~~September 30, 2019 under ASC 605 for comparison to the prior year period.

Total revenue increased ~~$45.9~~$73.1 million, or ~~11.5%~~11.9%, for the ~~six~~nine months ended ~~June~~September 30, 2019 compared to the ~~six~~nine months ended ~~June~~September 30, 2018. Revenue from North America was approximately 66% and 65% of total revenue for the ~~six~~nine months ended ~~June~~September 30, 2019 and ~~2018.~~2018, respectively. Other than the United States, no single country accounted for 10% or more of our total revenue during these periods.

Recurring Revenue

Subscription Revenue. Subscription revenue increased ~~$22.1~~$37.5 million, or ~~17.2%~~19.1%, for the ~~six~~nine months ended ~~June~~September 30, 2019 compared to the ~~six~~nine months ended ~~June~~September 30, 2018, primarily due to sales of additional MSP ~~and cloud management products.~~products, with additional contribution from our acquired SolarWinds Service Desk product. These increases were partially offset by the effect of the weakening of most foreign currencies relative to the U.S. dollar. Our subscription revenue increased as a percentage of our total revenue for the ~~six~~nine months ended ~~June~~September 30, 2019 compared to the ~~six~~nine months ended ~~June~~September 30, 2018. ~~Subscription revenue for the six months ended June 30, 2019 would have been approximately $0.4 million higher under ASC 605. See~~ ~~Note~~ ~~2. Summary of Significant Accounting Policies~~ ~~in the~~ ~~Notes to Condensed Consolidated Financial Statements~~ ~~in Item 1 of Part I of this Quarterly Report on Form 10-Q, for a full discussion of the impact of ASC 606 on our revenue for the six months ended June 30, 2019.~~

Maintenance Revenue. Maintenance revenue increased ~~$21.3~~$33.3 million, or ~~10.9%~~11.2%, for the ~~six~~nine months ended ~~June~~September 30, 2019 compared to the ~~six~~nine months ended ~~June~~September 30, 2018. ~~Of this change, $19.7 million~~The increase was primarily attributable to a growing maintenance renewal customer base from sales of our perpetual license products and strong maintenance renewal rates, partially offset by the effect of the weakening of most foreign currencies relative to the U.S. dollar. The remaining $1.6 million increase was attributable to the purchase accounting adjustment to deferred revenue in the six months ended June 30, 2018 which reduced revenue for the period. Maintenance revenue for the six months ended June 30, 2019 would have been approximately $0.5 million higher under ASC 605. See ~~Note~~ ~~2. Summary of Significant Accounting Policies~~ ~~in the~~ ~~Notes to Condensed Consolidated Financial Statements~~ ~~in Item 1 of Part I of this Quarterly Report on Form 10-Q, for a full discussion of the impact of ASC 606 on our revenue for the six months ended June 30, 2019.~~

License Revenue

License revenue increased ~~$2.5~~$2.4 million, or ~~3.4%~~2.0%, due to increased sales of our licensed products in each of our North American and international locations, partially offset by the effect of the weakening of most foreign currencies relative to the U.S. dollar. ~~License revenue for the six months ended June 30, 2019 would have been approximately $0.7 million lower under ASC 605. See~~ ~~Note~~ ~~2. Summary of Significant Accounting Policies~~ ~~in the~~ ~~Notes to Condensed Consolidated Financial Statements~~ ~~in Item 1 of Part I of this Quarterly Report on Form 10-Q, for a full discussion of the impact of ASC 606 on our revenue for the six months ended June 30, 2019.~~

Cost of Revenue


	Six Months Ended June 30,											Nine Months Ended September 30,
	2019				2018							2019				2018
	Amount		Percentage of Revenue		Amount		Percentage of Revenue		Change			Amount		Percentage of Revenue		Amount		Percentage of Revenue		Change

			(in thousands, except percentages)											(in thousands, except percentages)
Cost of recurring revenue	$	37,545	8.4	%	$	34,595	8.7	%	$	2,950		$	58,159	8.5	%	$	52,617	8.6	%	$	5,542
Amortization of acquired technologies	87,789		19.7		88,286		22.1		(497		)	131,961		19.3		132,121		21.6		(160		)
Total cost of revenue	$	125,334	28.2	%	$	122,881	30.8	%	$	2,453		$	190,120	27.8	%	$	184,738	30.2	%	$	5,382

Total cost of revenue increased in the ~~six~~nine months ended ~~June~~September 30, 2019 compared to the ~~six~~nine months ended ~~June~~September 30, 2018 primarily due to increases in personnel costs to support new customers and additional product offerings of ~~$2.1~~$3.5 million, which includes a ~~$0.8~~$1.2 million increase in stock-based compensation expense, and depreciation and other amortization of ~~$0.8~~$1.4 million. These increases were offset by a decrease in amortization of acquired technologies of ~~$0.5~~$0.2 million. Amortization of acquired technologies includes ~~$82.0~~$122.8 million and ~~$83.3~~$124.6 million of amortization related to the Take Private for the ~~six~~nine months ended ~~June~~September 30, 2019 and ~~June 30,~~ 2018, ~~respectively, with the remaining balance related primarily to the LOGICnow acquisition in May 2016.~~

respectively.

Operating Expenses


	Six Months Ended June 30,										Nine Months Ended September 30,
	2019				2018						2019				2018
	Amount		Percentage of Revenue		Amount		Percentage of Revenue		Change		Amount		Percentage of Revenue		Amount		Percentage of Revenue		Change

			(in thousands, except percentages)										(in thousands, except percentages)
Sales and marketing	$	125,408	28.2	%	$	109,096	27.4	%	$	16,312	$	193,698	28.3	%	$	166,022	27.1	%	$	27,676
Research and development	52,893		11.9		48,526		12.2		4,367		82,468		12.0		71,800		11.7		10,668
General and administrative	46,977		10.6		40,252		10.1		6,725		72,382		10.6		59,849		9.8		12,533
Amortization of acquired intangibles	33,803		7.6		33,781		8.5		22		51,818		7.6		50,288		8.2		1,530
Total operating expenses	$	259,081	58.3	%	$	231,655	58.1	%	$	27,426	$	400,366	58.4	%	$	347,959	56.9	%	$	52,407

Sales and Marketing. Sales and marketing expenses increased ~~$16.3~~$27.7 million, or ~~15.0%~~16.7%, primarily due to increases in personnel costs of ~~$11.2~~$17.3 million, which includes an increase of ~~$5.1~~$7.7 million in stock-based compensation expense, and marketing program costs of ~~$3.6~~$7.7 million. We increased our sales and marketing employee headcount to support the sales of additional products and growth in the business and through the acquisition of Samanage. Sales and marketing expense for the ~~six~~nine months ended ~~June~~September 30, 2019 would have been approximately ~~$2.6~~$4.0 million higher under ASC 605 due to the impact of the capitalization and amortization of commission expense under ASC 606. See Note 2. Summary of Significant Accounting Policies in the Notes to Condensed Consolidated Financial Statements in Item 1 of Part I of this Quarterly Report on Form 10-Q for further discussion of the impact of the adoption of ASC 606.

Research and Development. Research and development expenses increased ~~$4.4~~$10.7 million, or ~~9.0%~~14.9%, primarily due to an increase in personnel costs of ~~$5.2~~$11.1 million, which includes an increase of $6.3 million in stock-based compensation expense, partially offset by a reduction in acquisition and Take Private related costs of ~~$0.9~~$1.2 million. ~~The increase in personnel costs is primarily related to a $3.6 million increase in stock-based compensation expense.~~ We increased our worldwide research and development employee headcount to expedite delivery of product enhancements and new product offerings to our customers and through the acquisition of Samanage.

General and Administrative. General and administrative expenses increased ~~$6.7~~$12.5 million, or ~~16.7%~~20.9%, primarily due to a ~~$5.5~~$10.6 million increase in personnel costs, which includes an increase of $8.6 million in stock-based compensation expense, a ~~$2.7~~$4.8 million increase in professional fees and other public company costs and a ~~$2.7~~$4.0 million increase in acquisition and restructuring

costs. These increases were partially offset by a reduction of ~~$5.0~~$7.6 million related to management fees payable to our Sponsors that were eliminated upon the completion of our initial public offering in October 2018.

Amortization of Acquired Intangibles. Amortization of acquired intangibles increased ~~by an insignificant amount~~$1.5 million, or 3.0%, for the ~~six~~nine months ended ~~June~~September 30, 2019 compared to the ~~six~~nine months ended ~~June~~September 30, ~~2018.~~2018 primarily due to amortization related to the Samanage acquisition. Amortization of intangible assets includes ~~$23.8~~$35.6 million and ~~$24.4~~$36.3 million of amortization related to the Take Private for the ~~six~~nine months ended ~~June~~September 30, 2019 and ~~June~~September 30, 2018, respectively, with the remaining balance related primarily to the LOGICnow acquisition in May 2016.

Interest Expense, Net

Six Months Ended June 30,
2019 2018
Amount Percentage of Revenue Amount Percentage of Revenue Change

(in thousands, except percentages)
Interest expense, net $ (55,559 ) (12.5 )% $ (76,476 ) (19.2 )% $ 20,917



	Nine Months Ended September 30,
	2019					2018
	Amount			Percentage of Revenue		Amount			Percentage of Revenue		Change

				(in thousands, except percentages)
Interest expense, net	$	(82,977	)	(12.1	)%	$	(112,103	)	(18.3	)%	$	29,126

Interest expense, net decreased by ~~$20.9~~$29.1 million, or ~~27.4%~~26.0%, in the ~~six~~nine months ended ~~June~~September 30, 2019 compared to the ~~six~~nine months ended ~~June~~September 30, 2018. The decrease in interest expense is primarily due to the repayment of $315.0 million in outstanding borrowings under our second lien term loan in October 2018 and the reductions in the interest rate spread under our credit facilities resulting from the refinancing transaction we completed in March 2018 and our IPO in October 2018. See Note 6. Debt in the Notes to Condensed Consolidated Financial Statements included in Item 1 of Part I of this Form 10-Q for additional information regarding our debt.

Other Income (Expense), Net


	Six Months Ended June 30,												Nine Months Ended September 30,
	2019					2018							2019				2018
	Amount			Percentage of Revenue		Amount			Percentage of Revenue		Change		Amount		Percentage of Revenue		Amount			Percentage of Revenue		Change

				(in thousands, except percentages)											(in thousands, except percentages)
Unrealized net transaction gains (losses) related to remeasurement of intercompany loans	$	(33	)	—	%	$	(12,711	)	(3.2	)%	$	12,678	$	301	—	%	$	(12,660	)	(2.1	)%	$	12,961
Loss on extinguishment of debt	—			—		(60,590		)	(15.2	)	60,590		—		—		(60,590		)	(9.9	)	60,590
Other income (expense)	252			0.1		(1,162		)	(0.3	)	1,414		205		—		(1,226		)	(0.2	)	1,431
Total other income (expense), net	$	219		—	%	$	(74,463	)	(18.7	)%	$	74,682	$	506	0.1	%	$	(74,476	)	(12.2	)%	$	74,982

Other income (expense), net increased by ~~$74.7~~$75.0 million in the ~~six~~nine months ended ~~June~~September 30, 2019 compared to the ~~six~~nine months ended ~~June~~September 30, 2018 primarily due to a loss of $60.6 million on extinguishment of debt related to the refinancing of our credit facilities in March 2018 and the impact of changes in foreign currency exchange rates related to various intercompany loans for the period. As of July 1, 2018, we changed our assertion regarding the planned settlement of a certain intercompany loan. We evaluated our investment strategy in light of our global treasury plans and the new Tax Act and have determined there is no need to settle the principal related to the loan. Therefore, beginning on July 1, 2018, the foreign currency transaction gains and losses resulting from the remeasurement of this long-term intercompany loan denominated in a currency other than the subsidiary's functional currency are recognized as a component of accumulated other comprehensive income (loss) and not included in other income (expense), net.

Income Tax Expense (Benefit)


	Six Months Ended June 30,													Nine Months Ended September 30,
	2019					2018								2019					2018
	Amount			Percentage of Revenue		Amount			Percentage of Revenue		Change			Amount			Percentage of Revenue		Amount			Percentage of Revenue		Change

				(in thousands, except percentages)													(in thousands, except percentages)
Income tax expense (benefit)	$	3,759		0.8	%	$	(19,919	)	(5.0	)%	$	23,678		$	6,654		1.0	%	$	(20,045	)	(3.3	)%	$	26,699
Effective tax rate	78.6		%			18.6		%			60.0		%	55.1		%			18.7		%			36.4		%

Our income tax expense for the ~~six~~nine months ended ~~June~~September 30, 2019 increased by ~~$23.7~~$26.7 million as compared to the ~~six~~nine months ended ~~June~~September 30, 2018 primarily as a result of an increase in the income before income taxes for the period. The

effective tax rate increased by ~~60.0%~~36.4% for the period primarily due to the impact of having a full valuation allowance against the deferred tax assets related to the current period losses from the recent Samanage acquisition. For additional discussion about our income taxes, see Note 9. Income Taxes in the Notes to Condensed Consolidated Financial Statements included in Item 1 of Part I of this Form 10-Q.

Non-GAAP Financial Measures

In addition to financial measures prepared in accordance with GAAP, we use certain non-GAAP financial measures to clarify and enhance our understanding, and aid in the period-to-period comparison, of our performance. We believe that these non-GAAP financial measures provide supplemental information that is meaningful when assessing our operating performance because they exclude the impact of certain amounts that our management and board of directors do not consider part of core operating results when assessing our operational performance, allocating resources, preparing annual budgets and determining compensation. Accordingly, these non-GAAP financial measures may provide insight to investors into the motivation and decision-making of management in operating the business. Set forth in the ~~first table~~tables below are the corresponding GAAP financial measures for each non-GAAP financial measure. Investors are encouraged to review the reconciliation of each of these non-GAAP financial measures to its most comparable GAAP financial measure included below.

While we believe that these non-GAAP financial measures provide useful supplemental information, non-GAAP financial measures have limitations and should not be considered in isolation from, or as a substitute for, their most comparable GAAP measures. These non-GAAP financial measures are not prepared in accordance with GAAP, do not reflect a comprehensive system of accounting and may not be comparable to similarly titled measures of other companies due to potential differences in their financing and accounting methods, the book value of their assets, their capital structures, the method by which their assets were

acquired and the manner in which they define non-GAAP measures. Items such as the amortization of intangible assets, stock-based compensation expense and related employer-paid payroll taxes, acquisition related adjustments and restructuring charges, as well as the related tax impacts of these items can have a material impact on our GAAP financial results.

Non-GAAP Revenue

We define non-GAAP subscription revenue, non-GAAP maintenance revenue, non-GAAP license revenue and non-GAAP total revenue, as subscription revenue, maintenance revenue, license revenue and total revenue, respectively, excluding the impact of purchase accounting. We monitor these measures to assess our performance because we believe our revenue growth rates would be overstated without these adjustments. We believe presenting non-GAAP subscription revenue, non-GAAP maintenance revenue, non-GAAP license revenue and non-GAAP total revenue aids in the comparability between periods and in assessing our overall operating performance.


	Three Months Ended June 30,				Six Months Ended June 30,				Three Months Ended September 30,				Nine Months Ended September 30,
	2019		2018		2019		2018		2019		2018		2019		2018

	(in thousands)								(in thousands)
Revenue:
GAAP subscription revenue	$	78,780	$	65,238	$	150,345	$	128,291	$	83,122	$	67,713	$	233,467	$	196,004
Impact of purchase accounting	1,819		328		1,819		962		2,215		154		4,034		1,116
Non-GAAP subscription revenue	80,599		65,566		152,164		129,253		85,337		67,867		237,501		197,120
GAAP maintenance revenue	110,793		98,767		217,085		195,767		113,755		101,817		330,840		297,584
Impact of purchase accounting	—		786		—		1,599		—		574		—		2,173
Non-GAAP maintenance revenue	110,793		99,553		217,085		197,366		113,755		102,391		330,840		299,757
GAAP total recurring revenue	189,573		164,005		367,430		324,058		196,877		169,530		564,307		493,588
Impact of purchase accounting	1,819		1,114		1,819		2,561		2,215		728		4,034		3,289
Non-GAAP total recurring revenue	191,392		165,119		369,249		326,619		199,092		170,258		568,341		496,877
GAAP license revenue	39,175		37,713		77,110		74,573		43,613		43,747		120,723		118,320
Impact of purchase accounting	—		—		—		—		—		—		—		—
Non-GAAP license revenue	39,175		37,713		77,110		74,573		43,613		43,747		120,723		118,320
Total GAAP revenue	$	228,748	$	201,718	$	444,540	$	398,631	$	240,490	$	213,277	$	685,030	$	611,908
Impact of purchase accounting	$	1,819	$	1,114	$	1,819	$	2,561	$	2,215	$	728	$	4,034	$	3,289
Total non-GAAP revenue	$	230,567	$	202,832	$	446,359	$	401,192	$	242,705	$	214,005	$	689,064	$	615,197

Non-GAAP Operating Income and Non-GAAP Operating Margin

We provide non-GAAP operating income and related non-GAAP margin using non-GAAP revenue as discussed above and excluding such items as the write-down of deferred revenue related to purchase accounting, amortization of acquired intangible assets, stock-based compensation expense and related employer-paid payroll taxes, acquisition and Sponsor related costs and restructuring charges and other. Management believes these measures are useful for the following reasons:

•

Amortization of Acquired Intangible Assets. We provide non-GAAP information that excludes expenses related to purchased intangible assets associated with our acquisitions. We believe that eliminating this expense from our non-GAAP measures is useful to investors, because the amortization of acquired intangible assets can be inconsistent in amount and frequency and is significantly impacted by the timing and magnitude of our acquisition transactions, which also vary in frequency from period to period. Accordingly, we analyze the performance of our operations in each period without regard to such expenses.

•

Stock-Based Compensation Expense and Related Employer-paid Payroll Taxes. We provide non-GAAP information that excludes expenses related to stock-based compensation and related employer-paid payroll taxes. We believe that the exclusion of stock-based compensation expense provides for a better comparison of our operating results to prior periods and to our peer companies as the calculations of stock-based compensation vary from period to period and company to company due to different valuation methodologies, subjective assumptions and the variety of award types. Employer-paid payroll taxes on stock-based compensation is dependent on our stock price and the timing of the taxable events related to the equity awards, over which our management has little control, and does not correlate to the core operation of our business. Because of these unique characteristics of stock-based compensation, management excludes these expenses when analyzing the organization’s business performance.

•

Acquisition and Sponsor Related Costs. We exclude certain expense items resulting from the Take Private and other acquisitions, such as legal, accounting and advisory fees, changes in fair value of contingent consideration, costs related to integrating the acquired businesses, deferred compensation, severance and retention expense. We consider these adjustments, to some extent, to be unpredictable and dependent on a significant number of factors that are outside of our control. Furthermore, acquisitions result in operating expenses that would not otherwise have been incurred by us in the normal course of our organic business operations. We believe that providing these non-GAAP measures that exclude acquisition and Sponsor related costs, allows users of our financial statements to better review and understand the historical and current results of our continuing operations, and also facilitates comparisons to our historical results and results of less acquisitive peer companies, both with and without such adjustments.

•

Restructuring Charges and Other. We provide non-GAAP information that excludes restructuring charges such as severance and the estimated costs of exiting and terminating facility lease commitments, as they relate to our corporate restructuring and exit activities and charges related to the separation of employment with executives of the Company. These charges are inconsistent in amount and are significantly impacted by the timing and nature of these events. Therefore, although we may incur these types of expenses in the future, we believe that eliminating these charges for purposes of calculating the non-GAAP financial measures facilitates a more meaningful evaluation of our operating performance and comparisons to our past operating performance.


	Three Months Ended June 30,						Six Months Ended June 30,						Three Months Ended September 30,						Nine Months Ended September 30,
	2019			2018			2019			2018			2019			2018			2019			2018

	(in thousands, except margin data)												(in thousands, except margin data)
GAAP operating income	$	30,330		$	22,137		$	60,125		$	44,095		$	34,419		$	35,116		$	94,544		$	79,211
Impact of purchase accounting	1,819			1,114			1,819			2,561			2,215			728			4,034			3,289
Stock-based compensation expense and related employer-paid payroll taxes	7,540			131			15,258			172			8,889			160			24,147			332
Amortization of acquired technologies	43,972			43,967			87,789			88,286			44,172			43,835			131,961			132,121
Amortization of acquired intangibles	17,301			16,653			33,803			33,781			18,015			16,507			51,818			50,288
Acquisition and Sponsor related costs	3,499			5,559			5,757			10,747			1,700			5,614			7,457			16,361
Restructuring costs and other	1,872			819			2,396			1,213			1,586			281			3,982			1,494
Non-GAAP operating income	$	106,333		$	90,380		$	206,947		$	180,855		$	110,996		$	102,241		$	317,943		$	283,096
GAAP operating margin	13.3		%	11.0		%	13.5		%	11.1		%	14.3		%	16.5		%	13.8		%	12.9		%
Non-GAAP operating margin	46.1		%	44.6		%	46.4		%	45.1		%	45.7		%	47.8		%	46.1		%	46.0		%

Adjusted EBITDA and Adjusted EBITDA Margin

We regularly monitor adjusted EBITDA, as it is a measure we use to assess our operating performance. We define adjusted EBITDA as net income or loss, excluding the impact of purchase accounting on total revenue, amortization of acquired intangible assets and developed technology, depreciation expense, stock-based compensation expense and related employer-paid payroll taxes, restructuring and other charges, acquisition and Sponsor related costs, interest expense, net, debt extinguishment and refinancing costs, unrealized foreign currency (gains) losses, and income tax expense (benefit). We define adjusted EBITDA margin as adjusted EBITDA divided by non-GAAP revenue. Adjusted EBITDA has limitations as an analytical tool, and you should not consider it in isolation or as a substitute for analysis of our results as reported under GAAP. Some of these limitations are: although depreciation and amortization are non-cash charges, the assets being depreciated and amortized may have to be replaced in the future, and adjusted EBITDA does not reflect cash capital expenditure requirements for such replacements or for new capital expenditure requirements; adjusted EBITDA excludes the impact of the write-down of deferred revenue due to purchase accounting in connection with our acquisition, and therefore includes revenue that will never be recognized under GAAP; adjusted EBITDA does not reflect changes in, or cash requirements for, our working capital needs; adjusted EBITDA does not reflect the significant interest expense, or the cash requirements necessary to service interest or principal payments, on our debt; adjusted EBITDA does not reflect tax payments that may represent a reduction in cash available to us; and other companies, including companies in our industry, may calculate adjusted EBITDA differently, which reduces its usefulness as a comparative measure.

Because of these limitations, you should consider adjusted EBITDA alongside other financial performance measures, including net income (loss) and our other GAAP results. In evaluating adjusted EBITDA, you should be aware that in the future we may incur expenses that are the same as or similar to some of the adjustments in this presentation. Our presentation of adjusted EBITDA should not be construed as an inference that our future results will be unaffected by the types of items excluded from the calculation of adjusted EBITDA. Adjusted EBITDA is not a presentation made in accordance with GAAP and the use of the term varies from others in our industry.


	Three Months Ended June 30,						Six Months Ended June 30,						Three Months Ended September 30,						Nine Months Ended September 30,
	2019			2018			2019			2018			2019			2018			2019			2018

	(in thousands, except margin data)												(in thousands, except margin data)
Net income (loss)	$	(2,119	)	$	(27,015	)	$	1,026		$	(86,925	)	$	4,393		$	(398	)	$	5,419		$	(87,323	)
Amortization and depreciation	65,577			64,399			130,040			129,614			66,647			64,289			196,687			193,903
Income tax expense (benefit)	3,194			(11,562		)	3,759			(19,919		)	2,895			(126		)	6,654			(20,045		)
Interest expense, net	28,177			34,387			55,559			76,476			27,418			35,627			82,977			112,103
Impact of purchase accounting on total revenue	1,819			1,114			1,819			2,561			2,215			728			4,034			3,289
Unrealized foreign currency (gains) losses⁽¹⁾	1,208			26,088			(100		)	13,502			(807		)	202			(907		)	13,704
Acquisition and Sponsor related costs	3,499			5,559			5,757			10,747			1,700			5,614			7,457			16,361
Debt related costs⁽²⁾	95			144			196			61,733			94			105			290			61,838
Stock-based compensation expense and related employer-paid payroll taxes	7,540			131			15,258			172			8,889			160			24,147			332
Restructuring costs and other	1,872			819			2,396			1,213			1,586			281			3,982			1,494
Adjusted EBITDA	$	110,862		$	94,064		$	215,710		$	189,174		$	115,030		$	106,482		$	330,740		$	295,656
Adjusted EBITDA margin	48.1		%	46.4		%	48.3		%	47.2		%	47.4		%	49.8		%	48.0		%	48.1		%

________________


(1)	Unrealized foreign currency gains primarily relate to the remeasurement of our intercompany loans and to a lesser extent, unrealized foreign currency gains on selected assets and liabilities.


(2)	Debt related costs include fees related to our credit agreements, debt refinancing costs and the related write-off of debt issuance costs. See Note 6. Debt in the Notes to Condensed Consolidated Financial Statements in Item 1 of Part I of this Quarterly Report on Form 10-Q for additional information regarding our debt.

Liquidity and Capital Resources

Cash and cash equivalents were ~~$155.3~~$221.1 million as of ~~June~~September 30, 2019. Our international subsidiaries held approximately ~~$130.9~~$153.3 million of cash and cash equivalents, of which ~~84.3%~~77.5% were held in Euros. The Tax Act imposes a mandatory transition tax on accumulated foreign earnings and eliminates U.S. federal income taxes on foreign subsidiary distribution. Effective January 1, 2018, we began recognizing the tax impact of including certain foreign earnings in U.S. taxable income as a period cost. We intend either to invest our foreign earnings permanently in foreign operations or to remit these earnings to our U.S. entities in a tax-free manner. For this reason, we have not recognized deferred income taxes for local country income and withholding taxes that could be incurred on distributions of certain foreign earnings or for outside basis differences in our subsidiaries.

Our primary source of cash for funding operations and growth has been through cash provided by operating activities. We believe that our existing cash and cash equivalents, our cash flows from operating activities and our borrowing capacity under our

credit facilities will be sufficient to fund our operations, fund required debt repayments and meet our commitments for capital expenditures for at least the next 12 months.

Although we are not currently a party to any material definitive agreement regarding potential investments in, or acquisitions of, complementary businesses, applications or technologies, we may enter into these types of arrangements, which could reduce our cash and cash equivalents, require us to seek additional equity or debt financing or repatriate cash generated by our international operations that could cause us to incur withholding taxes on any distributions. Additional funds from financing arrangements may not be available on terms favorable to us or at all.

Indebtedness

As of ~~June~~September 30, 2019, our total indebtedness was $2.0 billion, with up to $125.0 million of available borrowings under our revolving credit facility. See Note 6. Debt in the Notes to Condensed Consolidated Financial Statements included in Item 1 of Part I of this Form 10-Q for additional information regarding our debt.

First Lien Credit Agreement

On March 15, 2018, or the Refinancing Date, we entered into Amendment No. 4 to First Lien Credit Agreement, originally dated as of February 5, 2016.

The First Lien Credit Agreement, as amended, provides for a senior secured revolving credit facility in an aggregate principal amount of $125.0 million, or the Revolving Credit Facility, consisting of a $25.0 million U.S. dollar revolving credit facility, or the U.S. Dollar Revolver, and a $100.0 million multicurrency revolving credit facility, or the Multicurrency Revolver. The Revolving Credit Facility includes a $35.0 million sublimit for the issuance of letters of credit. The First Lien Credit Agreement also contains a term loan facility (which we refer to as the First Lien Term Loan, and together with the Revolving Credit Facility, as the First Lien Credit Facilities) in an original aggregate principal amount of $1,990.0 million.

The First Lien Credit Agreement provides us the right to request additional commitments for new incremental term loans and revolving loans, in an aggregate principal amount not to exceed (a) the greater of (i) $400.0 million and (ii) 100% of our consolidated EBITDA, as defined in the First Lien Credit Agreement (calculated on a pro forma basis), for the most recent four fiscal quarter period, or the First Lien Fixed Basket, plus (b) the amount of certain voluntary prepayments of the First Lien Credit Facilities, plus (c) an unlimited amount subject to pro forma compliance with a first lien net leverage ratio not to exceed 4.75 to 1.00.

Under the U.S. Dollar Revolver, $7.5 million of commitments will mature on February 5, 2021, and $17.5 million along with all commitments under the Multicurrency Revolver will mature on February 5, 2022. The First Lien Term Loan will mature on February 5, 2024.

The First Lien Term Loan requires equal quarterly repayments equal to 0.25% of the original principal amount.

Second Lien Credit Facility

On the Refinancing Date, we entered into the Second Lien Credit Agreement with Wilmington Trust, National Association, or Wilmington Trust, as administrative agent and collateral agent, and the other parties thereto. The Second Lien Credit Agreement provided for a term loan facility, or the Second Lien Credit Facility, in an original aggregate principal amount of $315.0 million.

In October 2018, we completed our IPO and used a portion of our net proceeds from the offering to repay the borrowings under our Second Lien Credit Facility.

Summary of Cash Flows

Summarized cash flow information is as follows:


	Six Months Ended June 30,						Nine Months Ended September 30,
	2019			2018			2019			2018

	(in thousands)						(in thousands)
Net cash provided by operating activities	$	141,652		$	107,125		$	216,846		$	166,082
Net cash used in investing activities	(359,096		)	(12,832		)	(359,537		)	(64,739		)
Net cash used in financing activities	(9,834		)	(90,623		)	(13,805		)	(97,287		)
Effect of exchange rate changes on cash and cash equivalents	(52		)	(3,308		)	(5,064		)	(3,439		)
Net increase (decrease) in cash and cash equivalents	(227,330		)	362			(161,560		)	617

Operating Activities

Our primary source of cash from operating activities is cash collections from our customers. We expect cash inflows from operating activities to be affected by the timing of our sales. Our primary uses of cash from operating activities are for personnel-related expenditures, and other general operating expenses, as well as payments related to taxes, interest and facilities.

For the ~~six~~nine months ended ~~June~~September 30, 2019 as compared to the ~~six~~nine months ended ~~June~~September 30, 2018, the increase in cash provided by operating activities was primarily due to the increase in net income for the period, net of the effect of non-cash ~~items for the period.~~items. Changes in our operating assets and liabilities were primarily due to the timing of sales and cash payments and receipts. Cash flow from operations for the ~~six~~nine months ended ~~June~~September 30, 2019 was reduced by ~~$26.5~~$35.6 million of cash paid for taxes which includes an $8.8 million cash payment related to the transition tax as a result of the Tax Act. Cash flow from operations for the ~~six~~nine months ended

~~June~~ September 30, 2018 included losses on extinguishment of debt of $60.6 million and a reduction in accrued interest payable of ~~$10.9~~$10.5 million related to our March 2018 debt refinancing.

Investing Activities

Investing cash flows consist primarily of cash used for acquisitions, capital expenditures and intangible assets. Our capital expenditures primarily relate to purchases of leasehold improvements, computers, servers and equipment to support our domestic and international office locations. Purchases of intangible assets consist primarily of capitalized research and development costs.

Net cash used in investing activities increased in the ~~six~~nine months ended ~~June~~September 30, 2019 as compared to the ~~six~~nine months ended ~~June~~September 30, 2018 due to an increase in cash used for acquisitions and a decrease in cash proceeds related to the sale of a cost-method investment and other. The $349.5 million of cash used for acquisitions primarily relates to the acquisition of Samanage in April 2019. See Note 3. Acquisition in the Notes to Condensed Consolidated Financial Statements in Item 1 of Part I of this Quarterly Report on Form 10-Q for further discussion of the Samanage acquisition.

Financing Activities

Financing cash flows consist primarily of issuance and repayments associated with our long-term debt, fees related to refinancing our long-term debt, offering costs and proceeds from the issuance of shares of common stock through equity incentive plans.

Net cash used in financing activities decreased in the ~~six~~nine months ended ~~June~~September 30, 2019 as compared to the ~~six~~nine months ended ~~June~~September 30, 2018 primarily due to deemed gross repayments and borrowings made in connection with the refinancing of our debt agreements in March 2018. Net cash used in financing activities for ~~six~~nine months ended ~~June~~September 30, 2019 includes the proceeds and repayment of the $35.0 million in borrowings under our Revolving Credit Facility and ~~$10.0~~$14.9 million in quarterly principal payments due under our First Lien Credit Agreement. Net cash used in financing activities for ~~six~~nine months ended ~~June~~September 30, 2018 includes debt issuance costs and a redemption premium paid in connection with the redemption and exchange of our second lien floating rate notes in March 2018.

Contractual Obligations and Commitments

As of ~~June~~September 30, 2019, there have been no material changes in our contractual obligations and commitments as of December 31, 2018 that were disclosed in our Annual Report on Form 10-K.

Critical Accounting Policies and Estimates

Our condensed consolidated financial statements are prepared in conformity with GAAP and require our management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, costs and expenses and related disclosures. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. Actual results may differ from these estimates, and such estimates may change if the underlying conditions or assumptions change. To the extent that there are differences between our estimates and actual results, our future financial statement presentation, financial condition, results of operations and cash flows will be affected, perhaps materially.

In many cases, the accounting treatment of a particular transaction is specifically dictated by GAAP and does not require management’s judgment in its application, while in other cases, management’s judgment is required in selecting among available alternative accounting standards that allow different accounting treatment for similar transactions. We believe that these accounting policies requiring significant management judgment and estimates are critical to understanding our historical and future performance, as these policies relate to the more significant areas of our financial results. These critical accounting policies are:

the valuation of goodwill, intangibles, long-lived assets and contingent consideration;

revenue recognition;

stock-based compensation;

income taxes; and

loss contingencies.

A full description of our critical accounting policies that involve significant management judgment appears in our Annual Report on Form 10-K for the year ended December 31, 2018. With the exception of the change in our revenue recognition and other related policies upon the adoption of the new revenue standard described below, there have been no material changes to our critical accounting policies and estimates since that time.

Revenue Recognition

We generate revenue from fees received for subscriptions, the sale of maintenance services associated with our perpetual license products and the sale of perpetual license products. We recognize revenue related to contracts from customers when we

transfer promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. This is determined by following a five-step process which includes (1) identifying the contract with a customer, (2) identifying the performance obligations in the contract, (3) determining the transaction price, (4) allocating the transaction price and (5) recognizing revenue when or as we satisfy a performance obligation.

We identify performance obligations in a contract based on the goods and services that will be transferred to the customer that are identifiable from other promises in the contract, or distinct. If not considered distinct, the promised goods or services are combined with other goods or services and accounted for as a combined performance obligation. Determining the distinct performance obligations in a contract requires judgment. Our performance obligations primarily include perpetual and time-based licenses, maintenance support including unspecified upgrades or enhancements to new versions of their software products and subscriptions to our hosted SaaS offerings.

We allocate the transaction price of the contract to each distinct performance obligation based on a relative standalone selling price basis. Determining standalone selling prices for our performance obligations requires judgment and are based on multiple factors including, but not limited to historical selling prices and discounting practices for products and services, internal pricing policies and pricing practices in different regions and through different sales channels. For our subscription products and maintenance services, our standalone selling prices are generally observable using standalone sales or renewals. For our perpetual and time-based license products, we estimate our standalone selling prices utilizing the residual approach by considering our pricing and discounting practices. We review the standalone selling price for our performance obligations periodically and update, if needed, to ensure that the methodology utilized reflects our current pricing practices.

Customers with maintenance agreements are entitled to receive technical support and unspecified upgrades or enhancements to new versions of their software products on a when-and-if-available basis for the specified contract period. We believe that our technical support and unspecified upgrades or enhancements performance obligations each have the same pattern of transfer to the customer and are therefore accounted for as a single distinct performance obligation.

We sell our software products through our direct sales force and through our distributors and other resellers. Our distributors and resellers do not carry inventory of our software and we generally require them to specify the end user of the software at the time of the order.

We account for sales incentives to customers, resellers or distributors as a reduction of revenue at the time we recognize the revenue from the related product sale. We generally deliver licenses and subscriptions directly to the end user whether the customer buys direct or through a reseller or distributor. We report revenue net of any sales tax collected.

Recent Accounting Pronouncements

See Note 2. Summary of Significant Accounting Policies in the Notes to Condensed Consolidated Financial Statements in Item 1 of Part I of this Quarterly Report on Form 10-Q, for a full description of recent accounting pronouncements, which is incorporated herein by reference.

Off-Balance Sheet Arrangements

During the ~~six~~nine months ended ~~June~~September 30, 2019, we did not have any relationships with unconsolidated organizations or financial partnerships, such as structured finance or special purpose entities that would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Interest Rate Risk

We had cash and cash equivalents of ~~$155.3~~$221.1 million and $382.6 million at ~~June~~September 30, 2019 and December 31, 2018, respectively. Our cash and cash equivalents consist primarily of bank demand deposits at ~~June~~September 30, 2019 and bank demand deposits and money market funds at December 31, 2018. We hold cash, cash equivalents and short-term investments for working capital purposes. Our investments are made for capital preservation purposes, and we do not enter into investments for trading or speculative purposes.

We do not have material exposure to market risk with respect to our cash and cash equivalents, as these consist primarily of highly liquid investments purchased with original maturities of three months or less at ~~June~~September 30, 2019.

We had total indebtedness with an outstanding principal balance of $2.0 billion at ~~June~~September 30, 2019 and December 31, 2018. Borrowings outstanding under our various credit agreements bear interest at variable rates equal to applicable margins plus specified base rates or LIBOR-based rates with a 1% floor. As of ~~June~~September 30, 2019 and December 31, 2018, the annual weighted-average rate on borrowings was ~~5.15%~~4.79% and 5.27%, respectively. If there was a hypothetical 100 basis point increase in interest rates, the annual impact to interest expense would be approximately $19.7 million. This hypothetical change in interest expense has been calculated

based on the borrowings outstanding at December 31, 2018 and a 100 basis point per annum change in interest rate applied over a one-year period.

We do not have material exposure to fair value market risk with respect to our total long-term outstanding indebtedness which consists of $2.0 billion U.S. dollar term loans as of ~~June~~September 30, 2019, not subject to market pricing.

See Note 6. Debt in the Notes to Condensed Consolidated Financial Statements in Item 1 of Part I of this Quarterly Report on Form 10-Q for additional information regarding our debt.

Foreign Currency Exchange Risk

As a global company, we face exposure to adverse movements in foreign currency exchange rates. We primarily conduct business in the following locations: the United States, Europe, Canada, South America and Australia. This exposure is the result of selling in multiple currencies, growth in our international investments, additional headcount in foreign countries and operating in countries where the functional currency is the local currency. Specifically, our results of operations and cash flows are subject to fluctuations in the following currencies: the Euro, British Pound Sterling and Australian Dollar against the United States Dollar, or USD. These exposures may change over time as business practices evolve and economic conditions change. Changes in foreign currency exchange rates could have an adverse impact on our financial results and cash flows.

Our condensed consolidated statements of operations are translated into USD at the average exchange rates in each applicable period. Our international revenue, operating expenses and significant balance sheet accounts denominated in currencies other than the USD primarily flow through our United Kingdom and European subsidiaries, which have British Pound Sterling and Euro functional currencies, respectively. This results in a two-step currency exchange process wherein the currencies other than the British Pound Sterling and Euro are first converted into those functional currencies and then translated into USD for our consolidated financial statements. As an example, revenue for sales in Australia is translated from the Australian Dollar to the Euro and then into the USD.

Our statement of operations and balance sheet accounts are also impacted by the re-measurement of non-functional currency transactions such as intercompany loans, cash accounts held by our overseas subsidiaries, accounts receivable denominated in foreign currencies, deferred revenue and accounts payable denominated in foreign currencies. Our foreign currency denominated intercompany loan was established as part of the Take Private to provide a conduit to utilize foreign earnings effectively. The gains (losses) associated with the changes in exchange rates on amounts borrowed are unrealized non-cash events. As of July 1, 2018, the foreign currency denominated intercompany loan is designated as long-term due to a change in our investment strategy and

the new Tax Act. Therefore, beginning on July 1, 2018, the foreign currency transaction gains and losses resulting from remeasurement are recognized as a component of accumulated other comprehensive income (loss). As of September 30, 2019, we determined that the intercompany loan will not be repaid and it was reclassified as a capital contribution.

Foreign Currency Transaction Risk

Our foreign currency exposures typically arise from selling annual and multi-year maintenance contracts and subscriptions in multiple currencies, accounts receivable, intercompany transfer pricing arrangements and other intercompany transactions. Our foreign currency management objective is to minimize the effect of fluctuations in foreign exchange rates on selected assets or liabilities without exposing us to additional risk associated with transactions that could be regarded as speculative.

We utilize purchased foreign currency forward contracts to minimize our foreign exchange exposure on certain foreign balance sheet positions denominated in currencies other than the Euro. We do not enter into any derivative financial instruments for trading or speculative purposes. Our objective in managing our exposure to foreign currency exchange rate fluctuations is to reduce the impact of adverse fluctuations in such exchange rates on our earnings and cash flow. The notional amounts and currencies underlying our foreign currency forward contracts will fluctuate period to period as they are principally dependent on the balances of the balance sheet positions that are denominated in currencies other than the Euro held by our global entities. There can be no assurance that our foreign currency hedging activities will substantially offset the impact of fluctuation in currency exchange rates on our results of operations and functional positions. As of ~~June~~September 30, 2019 and December 31, 2018, we did not have any forward contracts outstanding and while we do not have a formal policy to settle all derivatives prior to the end of each quarter, our current practice is to do so. The effect of derivative instruments on our condensed consolidated statements of operations was insignificant for the three and nine months ended ~~June~~September 30, 2019 and 2018.

We are exposed to credit-related losses in the event of non-performance by counterparties to derivative financial instruments, but we do not expect any counterparties to fail to meet their obligations given their high credit ratings. In addition, we diversify this risk across several counterparties and actively monitor their ratings.

Foreign Currency Translation Risk

Fluctuations in foreign currencies impact the amount of total assets, liabilities, revenue, operating expenses and cash flows that we report for our foreign subsidiaries upon the translation of these amounts into U.S. dollars. If there is a change in foreign currency exchange rates, the amounts of assets, liabilities, revenue, operating expenses and cash flows that we report in U.S. dollars

for foreign subsidiaries that transact in international currencies may be higher or lower to what we would have reported using a constant currency rate. To the extent the U.S. dollar strengthens against foreign currencies, the translation of these foreign currency denominated transactions results in reduced assets, liabilities, revenue, operating expenses and cash flows for our international operations. Similarly, our assets, liabilities, revenue, operating expenses and cash flows will increase for our international operations if the U.S. dollar weakens against foreign currencies. The conversion of the foreign subsidiaries’ financial statements into U.S. dollars will also lead to remeasurement gains and losses recorded in income, or translation gains or losses that are recorded as a component of accumulated other comprehensive income (loss).

Item 4: Controls and Procedures

Evaluation of Disclosure Controls and Procedures

Our management, with the participation of our Chief Executive Officer and our Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures as of ~~June~~September 30, 2019. The term “disclosure controls and procedures,” as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), means controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms.

Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company’s management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure. Management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Based on the evaluation of our disclosure controls and procedures as of ~~June~~September 30, 2019, our Chief Executive Officer and Chief Financial Officer concluded that, as of such date, our disclosure controls and procedures were effective at a reasonable assurance level.

Changes in Internal Control over Financial Reporting

There were no changes in our internal control over financial reporting that occurred during the quarter ended ~~June~~September 30, 2019 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II: OTHER INFORMATION

Item 1. Legal Proceedings

From time to time, we have been and may be involved in various legal proceedings and claims arising in our ordinary course of business. At this time, neither we nor any of our subsidiaries is a party to, and none of our respective property is the subject of, any material legal proceeding. However, the outcome of legal proceedings and claims brought against us are subject to significant uncertainty. Therefore, if one or more of these legal matters were resolved against us in the same reporting period for amounts in excess of management’s expectations, our consolidated financial statements for a particular period could be materially adversely affected.

Item 1A. Risk Factors

For a discussion of our potential risks and uncertainties, see the information under the heading “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2018. There have been no material changes from the risk factors disclosed therein.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

Issuer Purchases of Equity Securities

Period
Number of
Shares
Purchased
(1)

Average
Price Paid
Per Share

Total
Number
of Shares
Purchased
as Part of a
Publicly
Announced
Plan or Program

Approximate Dollar
Value of
Shares That
May Yet Be
Purchased
Under the
Plan or Program
(in thousands)
April 1-30, 2019 3,000
$ 0.27
—
$ —
May 1-31, 2019 —
—
—
—
June 1-30, 2019 114,500
0.27
—
—
Total 117,500
—



Period	Number of Shares Purchased (1)	Average Price Paid Per Share		Total Number of Shares Purchased as Part of a Publicly Announced Plan or Program	Approximate Dollar Value of Shares That May Yet Be Purchased Under the Plan or Program (in thousands)
July 1-31, 2019	—	$	—	—	$	—
August 1-31, 2019	—	—		—	—
September 1-30, 2019	212,400	0.27		—	—
Total	212,400			—

________________

(1)

All repurchases relate to employee held restricted stock that is subject to vesting. Unvested shares are subject to a right of repurchase by us in the event the employee stockholder ceases to be employed or engaged (as applicable) by us prior to vesting. All shares in the above table were shares repurchased as a result of us exercising this right and not pursuant to a publicly announced plan or program.

Item 6. Exhibits

EXHIBIT INDEX



Exhibit Number		Exhibit Title
3.1		Third Amended and Restated Certificate of Incorporation as currently in effect
3.2		Amended and Restated Bylaws as currently in effect
31.1		Certification of Chief Executive Officer pursuant to Exchange Act Rules 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2		Certification of Chief Financial Officer pursuant to Exchange Act Rules 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1		Certifications of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
101		Interactive Data Files (formatted as Inline XBRL)
104		Cover Page Interactive Data File (formatted as Inline XBRL and contained in Exhibit 101)

SOLARWINDS CORPORATION

SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.



		SOLARWINDS CORPORATION

Dated:	~~August 12,~~November 7, 2019	By:	/s/ J. Barton Kalsu

			J. Barton Kalsu
			Chief Financial Officer
			(Principal Financial and Accounting Officer)