Solarwinds Corporation (SWI) Q2 2021 Earnings Call Transcript

Solarwinds Corporation (SWI)
Q2 2021 Earnings Call
Aug 03, 2021, 8:30 a.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Ladies and gentlemen, thank you for standing by and welcome to the SolarWinds second-quarter 2021 earnings call. [Operator instructions] It is now my pleasure to hand the conference over to Ashley Hook.

Ashley Hook -- Investor Relations

Thank you, Nicole. Good morning, everyone, and welcome to the SolarWinds second-quarter 2021 earnings call. With me today are Sudhakar Ramakrishna, our president and CEO; and Bart Kalsu, our EVP and chief financial officer. Following prepared remarks, we'll have a brief question-and-answer session.

This call is being simultaneously webcast on our investor relations website at investors.solarwinds.com. On our investor relations website, you can also find our earnings press release and a summary slide deck, which is intended to supplement our prepared remarks during today's call. Please remember that certain statements made during this call are forward-looking statements. Including those concerning our financial outlook, the impact of the cyber incident on our business, our market opportunities, the impact of the global economic environment on our business, and the related -- the recently completed spin-off of the N-able business.

These statements are based on currently available information and assumptions, so we undertake no duty to update this information except as required by law. These statements are also subject to a number of risks and uncertainties, including the numerous risks related to the cyber incident and the recently completed spin-off of the N-able business. Additional information concerning these statements and the risks and uncertainties associated with them is highlighted in today's earnings release in our -- and in our filings with the SEC. Copies are available from the SEC or on our Investor Relations website.

In addition, we know that our financial results for the second quarter include the impact of the N-able business for the entirety of the quarter took the spin-off is not completed until July 19, 2021. In today's remarks when we reference our ongoing SolarWinds business, this referred to our core IT management business, excluding N-able. Furthermore, we will discuss various non-GAAP financial measures on today's call. Unless otherwise specified, when we refer to financial measures, we will be referring to the non-GAAP financial measure.

A reconciliation of the differences between GAAP and non-GAAP financial measures discussed on today's call are available in our earnings press release and the summary slide deck on our investor relations website. Going forward, we will begin to present certain financial measures on a GAAP basis only. With that, I'll now turn the call over to Sudhakar.

Sudhakar Ramakrishna -- President and Chief Executive Officer

Thank you, Ashley. Good morning, everyone, and thank you for joining us today. I hope you're doing well and staying safe. I want to start by first thanking our employees, customers, partners, and our shareholders for their ongoing commitment to SolarWinds.

Our employees, we call ourselves Solarians, continue to demonstrate excellent commitment to our customers. As I outlined in the Q4 2020 earnings call, customer retention is our No.1 priority in 2021, and we make great progress toward this goal in Q2. I attribute the progress to the dedication of our employees, the relevance of our solutions to address customer needs, and the commitment of our partners and customers to SolarWinds. We substantially completed our investigation into the cyber incident and published our findings in May and continue to apply the learnings via our Secure by Design initiatives.

I have also had the opportunity to share our findings in public forums such as the RSA, CYBERSEC Global and U.K. Cybersecurity Conferences as well as with industry peers and government authorities around the world. It is an unfortunate fact that no company regardless of its size, competency, and resources seemed immune to cyber attacks as evidenced by the recent high-profile breaches. In this environment, our pledge of transparency and industry collaboration remains strong and had been well received by customers, partners, and the private industry as we accelerate our journey to deliver simple, powerful, and secure solution.

As a reminder, our Secure by Design initiative focuses on three core areas. First is to enhance the security of our internal environment and infrastructure. Two is to enhance the safe -- security of our software businesses and environment. And third is innovating to enhance software supply chain build processes.

We devised a unique software build process that performs across three discrete environments with different characteristics and permissions. This build process results in a changing threat surface and a contrasting threat window, thereby making it more difficult for threat actors to break-in and, therefore, enhancing the integrity of our software supply chain. This approach has resonated well with our customers, many of whom are also developers of software. And we are winning significant deals with customers as a direct result of these aspect of our Secure by Design initiative.

Also, as part of our ongoing effort to make customer environments more safe and secure, we plan to publish white papers and other materials to help the industry at large. I will now touch on a few financial and operational highlights in Q2 for our consolidated business. For the second quarter, we delivered revenue well above the high end of the range of our outlook with total consolidated non-GAAP revenue, ending the quarter at $262 million, representing year-over-year growth of 6%. Our consolidated results include N-able for the second quarter, which we've successfully spun out last month.

Second-quarter consolidated adjusted EBITDA was $111.1 million, representing an adjusted EBITDA margin of 42%, exceeding the high end of our outlook for the second quarter. Our Q2 ongoing SolarWinds maintenance renewal rate of 86% is above the low to mid-80s renewal rate we noted we expected in 2021. We continue to focus on customer retention as a key priority and hope to grow back to our historical and best-in-class renewal rate of over 90%. We secured the largest on-premises sale subscription bill in the company's history from a large healthcare provider in the United States.

This further validates our transition to a business with a higher subscription mix and the confidence that customers place in our portfolio roadmap. Our consolidated subscription revenues growing 17% year over year with our ongoing SolarWinds subscription revenue growing 16% year over year. And this area of our business will continue to be a -- key focus of mine on an ongoing basis. We are winning large public sector deals throughout the world.

In many of these customer engagements, our Secure by Design initiative features prominently. We are seeing that the comprehensiveness of our initiative, as described earlier in my comments and its applicability to a broad range of customer environments, is a key differentiator. During the second quarter of 2021, we launched SolarWinds Database Insights for SQL server, expanding our comprehensive database performance management portfolio. Uniting the features and functionality of the award-winning SolarWinds Database Performance Analyzer and the SolarWinds SQL Sentry Database Insights for SQL server provides the in-depth performance and environmental data teas need to optimize the performance of Microsoft's SQL server and other leading database platforms running on-premises, in the cloud or in hybrid environment.

Our products and services received more than 35 industry and customer awards in the first half of 2021. Notably, TrustRadius named nine SolarWinds IT operation management products as 2021 Top Rated award winners across 13 categories, and the company's commitment to customer support and success was honored through five Stevie Awards. We continue to attract excellent talent across all functions of five organizations. People see the opportunity we have with our mission and strategy to address what we believe will be a $100 billion market opportunity.

Last but not the least, we've reached another significant milestone by completing the spin-off of our managed service business now known as N-able on July 19, 2021. By operating at two independent publicly traded companies, we believe that SolarWinds and N-able will be better positioned to align with each other's market needs and customer requirements, enhancing the successful operations of both companies in the future. With that, I will turn it over to Bart to provide more details on our financial performance and outlook.

Bart Kalsu -- Executive Vice President and Chief Financial Officer

Thanks, Sudhakar, and thanks again to everyone for joining us on today's call. I will discuss our second-quarter results on a consolidated basis consistent with what we have discussed in the past. I will also provide supplemental information related to the ongoing SolarWinds business. As most of you know, our spin-off of the N-able business occurred last month on July 19th.

Therefore, N-able's results are included in our second-quarter financial results and our second-quarter guidance assumed N-able's results for the full quarter. We are in the process of preparing carve-out financial statements. In the future periods, our public filings will present N-able as discontinued operation. Our second-quarter financial results reflect solid execution while demonstrating the resiliency of our model.

That execution led to another quarter of better-than-expected results and finished well above the high end of the range of our outlook for the second quarter with total non-GAAP revenue ending the quarter at $262 million, representing year-over-year-growth of 6%. Total N-able revenue for the second quarter was $85 million, representing year-over-year growth of 16%. The N-able management team will talk about their results in a separate earnings call on August 12. Excluding N-able, total ongoing SolarWinds revenue was $177 million, above the high end of our second-quarter revenue outlook of $170.5 million to $174 million.

Total license and maintenance revenue was $149.5 million in the second quarter, which is flat with prior year. Maintenance revenues was $123 million in the second quarter, up 5% versus the prior year. We typically disclose the maintenance renewal rate for our potential license products on a trailing 12-month basis, which was 90% through the end of the second quarter. This includes more than two quarters of renewal since the cyber [Inaudible].

Also consistent with the first quarter, we want to provide the in-quarter renewal rates rate for the [Inaudible]. Our second-quarter in-quarter renewal rate is currently at approximately 86%, which again is above our expectations at the start of the year. Our primary focus for the first half of the year was to ensure that our customers recognize our efforts related to our Secure by Design commitment and trust us to help them transform faster in increasingly hybrid IT world. And we believe our renewal rates so far in 2021 demonstrate that trust.

For the second quarter, license revenue was $26.7 million, which represents a decline of approximately 21% as compared to the second quarter of 2020. On-premises subscription sales resulted in an approximately 9-percentage-point headwind to our license revenue for the quarter. The remainder the decline in license revenue reflects the combination of the impact of the security incident, including our decision to pause demand generation and customer acquisition activities from December through the first quarter as well as the continuing impact of the COVID-19 pandemic. That said, we improved our new license sales performance sequentially and the year-over-year decline in the second quarter is an improvement from the year-over-year decline in the first.

We saw acceleration in new license sales in our commercial business in the second quarter. We are working to continue that trend as we move through the rest of the year. Total ARR reached approximately $992 million as of June 30th, reflecting year-over-year growth of 14%. Our ongoing SolarWinds ARR represented $640 million out of that total at the end of the second quarter.

Ongoing SolarWinds ARR grew 12% year over year due to the incremental revenue from SentryOne, the SentryOne acquisition in the fourth quarter of last year, and our continued focus on retaining our maintenance base. Moving to our subscription revenue, second-quarter consolidated non-GAAP subscription revenue was $112.5 million, up 17% year over year, of which $82.8 million was from the N-able business. Our ongoing SolarWinds subscription revenue with $30 million in the second quarter, which reflects 60% year-over-year growth. This is an area of [Inaudible].

We finished the second quarter of 2021 with 1,107 customers that spent more than $100,000 with us in the last 12 months, which is a 16% improvement over the previous year. We are continuing our efforts to build larger relationships with our enterprise customers in our ongoing SolarWinds business. We also had a solid second quarter of non-GAAP profitability. Second-quarter consolidated adjusted EBITDA was $111 million, representing an adjusted EBITDA margin of 42%, exceeding the high end of the outlet for the second quarter.

And unlevered free cash flow improved in the second quarter for total of [Inaudible]. Excluded from EBITDA and unlevered free cash flow are one-time costs of approximately $24 million, including $13 million of spin-off-related costs and $11 million of cyber-related remediation, containment, investigation, and professional fees. [Inaudible] I do want to clarify that these cyber-related costs not included in adjusted EBITDA are one-time [Inaudible]. They are separate and distinct from the Secure by Design initiative, which are aimed at [Inaudible].

Costs related to our Secure by Design initiatives are and will remain part of our recurring cost structure on a go-forward basis. We expect a one-time cyber-related cost of plus [Inaudible] counting further in the first half of the year. These one-time cyber costs are, however, difficult to predict. They not only include the significant cost of the forensic investigation efforts, which we substantially completed in May, but also costs associated with our ongoing litigation, government investigations, any potential judgments or fines, and related professional fees.

We expect our insurance coverage to offset a portion of these expenses and will be presented net of any insurance proceeds received. Our one-time spin-related costs will continue through the third quarter as we finish the legal and accounting compliance work associated with the spin as well as the ongoing work associated with separating our internal systems in connection [Inaudible]. As of June 30th with 3.2 times, our trailing 12 months adjusted EBITDA, SolarWinds will retain the full amount of the $1.9 billion in term debt. On July 30th, we completed a two for one reverse stock split and declared a dividend of $1.50 per share on a post-split basis, which we will be -- which will be paid on August 24th, primarily from the approximately $236 million of cash that was distributed by N-able in connection with the spin-off.

In addition, N-able will repay $325 million of intercompany debt. SolarWinds will retain that cash on our balance sheet for the foreseeable future. And as a result of this repayment, we expect our cash balance to be approximately $680 million at the end of the third quarter, bringing our net debt to approximately $1.2 billion on a [Inaudible]. I will now walk you through our ongoing SolarWinds outlets before turning it back over to the Sudhakar for some final thoughts.

Consistent with our guidance for the past year, we will only provide third quarter of typically one outlet for total revenue, adjusted EBITDA and earnings per share. We are also only providing guidance as it relates to our ongoing SolarWinds business, which is what remains after the spin-off of N-able. For the third quarter of 2021, we expect ongoing SolarWinds total non-GAAP revenue to be in the range of $176 million to $180 million, representing a year-over-year decline of 3% to 5%. Adjusted EBITDA for the ongoing SolarWinds business for the third quarter is expected to be approximately $70.5 million to $72 million, which implies an approximately 40% adjusted EBITDA margin.

As a reminder, our EBITDA margin forecast includes the incremental spending associated with our Secure by Design initiatives, our ongoing investments in our international sales teams, and database management products, and the continued evolution of our subscription model. Non-GAAP fully diluted earnings per share is projected to be approximately $0.27 per share assuming an estimated $160.2 million fully diluted shares outstanding, which reflect the reverse stock split completed on July 30th. Finally, our outlook for the third quarter assumes a non-GAAP tax rate of 22%, and we expect to pay approximately $7.5 million in cash taxes during the third quarter of 2021. The third quarter outlook incorporates a few factors.

First, as we discussed during our third quarter 2020 earnings call, our federal business had one of the stronger quarters in our history creating cost compare. For that reason, while we continue to grow sequentially in new license sales to our federal customers in 2021, we are not expecting results like the prior year. The second is that maintenance revenue reflects the impact of lower new license sales since the start of the pandemic in early 2020, as well as our expectation that the renewal rates in 2021 will be in the mid-80s. And finally, our third quarter outlook reflects the continued transition of a portion of our new sales to on-premises subscriptions.

While we are not providing a full-year outlook, I will say that we expect new license and subscription sales in our commercial business to continue to improve in the third quarter and as we move into the fourth quarter, which is usually our strongest quarter of the year for new bookings. Based on what we've seen so far in the first half, we expect that the maintenance renewal rates will be in the mid-80s for the rest of 2021, and we are targeting to return to historical performance in 2022. We intend to continue to expand the subscription offerings of our on-premises products in 2021 and 2022, and make new subscription sales a much higher priority with our sales. As we think about our EBITDA margins for the rest of the year and into 2022, the costs associated with our Secure by Design initiative, investment in transitioning our product portfolio to a greater subscription mix, and our continued investment in our sales and marketing initiatives are factored into the margins in the short term.

We continue to remain committed to accelerating margins again in 2022 and beyond. With that, I will turn the call back over to Sudhakar for his closing remarks.

Sudhakar Ramakrishna -- President and Chief Executive Officer

Thank you, Bart. Our team's competence, commitment, and attitude continue to be evident as we deliver a strong Q2 performance and results exceeding our outlook in both revenue and EBITDA. We are executing our mission to help customers accelerate their business transformation by a simple, powerful, and secure solution for hybrid IT environment. We believe, our consolidated platform breadth and depth of capability and our commitment to customer success will enhance our ability to be relevant to customers and enhance the lifetime value potential of our customer base.

For the remainder of 2021, our focus will continue to be on executing on the initiatives that I outlined during our Q4 2020 earnings call, focusing on customer retention and demonstrating ongoing progress in subscription, license, and maintenance growth across all geographies and sectors. Additionally, we continue to call on our long-term strategic portfolio and model. We look forward to hosting you all for an analyst day in Q4 of this year. Please stay tuned for additional details.

I'll conclude again by thanking our employees, partners, and customers for their commitment to SolarWinds. We hope to continue to demonstrate progress across all dimensions of strategy and operations as we execute our second-half plan and into 2022. Bart and I now will be happy to address your questions.

Questions & Answers:

Operator

[Operator instructions] The first question will come from the line of Matt Hedberg with RBC Capital Markets

Dan Bergstrom -- RBC Capital Markets -- Analyst

Hey, it's Dan Spitzberg for Matt Hedberg. Thanks for taking our questions. Could you talk a little bit about customer retention? Obviously, a key focus here. The renewal rate continues to track ahead of that kind of a low to mid-80% figure you provided in February.

What's behind that? And then, what are you focused on doing orr is it more just more time needed to move back to that historical 90% range?

Sudhakar Ramakrishna -- President and Chief Executive Officer

Matt, this is Sudhakar to take that question. The first thing I will highlight is the commitment of our employees to customer success. We have been engaged with customers constantly and we continue to be engaged with customers both instantly. The second is the relevance of our solutions to customers.

As they engage with us, understand what happened, as well as understand the initiatives that we have taken that I call Secure by Design, they seem to appreciate not only the value that our product bring to them, but also the commitment that we have to the safety and security of customer environment at large. So those are two contributing factors I will say, the commitment of our employees and the relevance of our solution. In terms of what it would take to get back to historical levels? This is basically going to be a journey, Matt, which is in the first half of this year quite literally and also into Q3, customer engagement and customer retention has been our priority. And as customers come back up on line, they will be sometimes delayed in terms of their evaluation processes, delayed in their renewal practices and so on.

And so we factored all of those when we came out of [Inaudible] low to mid-80s renewal rate, which has as you noted, are obviously trending better than what we projected. And so our belief is that we'll continue on that path going forward into 2022 and beyond.

Dan Bergstrom -- RBC Capital Markets -- Analyst

Great, thanks. Very helpful. And then, could you talk to linearity trends in the quarter? Anything different from what you'd expect as far as building on the first quarter? And then July is completed at this point. Anything to note as far as third-quarter trends? Thank you.

Sudhakar Ramakrishna -- President and Chief Executive Officer

So what I'd highlight is reinforce Bart's comments that quarter-after-quarter, month-after-month, we are seeing progress across various parts of our business as well as various geographies. I'll also highlight that in Q1, for the most part, we did not pursue demand generation activities because our first priority and the main priority was to help customers stabilize their environments. It was only later into Q1 that we reinitiated, so to speak, our demand generation activities, and those are gaining more momentum as it goes through the through the year. And so that continues to have a meaningful impact into Q3 and Q4.

Ashley Hook -- Investor Relations

We'll take the next question.

Operator

The next question comes from the line of Sterling Auty with JPMorgan.

Sterling Auty -- JPMorgan Chase & Co. -- Analyst

Yeah, thanks. Hi, guys. I apologize if I ask you to repeat some things. We're juggling multiple calls but when you talk about renewal rates, you kind of talked about continuing in the mid-80s.

But what I'm curious about is maybe some of the commentary that you heard back from customers. It doesn't sound like there was a material uptick in the quarter, but how would you characterize what you did see relative to what you expected coming into the quarter?

Bart Kalsu -- Executive Vice President and Chief Financial Officer

Yes, Sterling. I mean as we said, our Q2 in quarter renewal rate is currently at 86%. This is this is consistent with what we did in Q1, maybe slightly lower but not necessarily what we did -- what we, if not out of line with what we expected. When we send out renewal quotes, we send out 90 days ahead of time.

So Q1 was in flight from a renewal standpoint at the time of the cyber incident. So that's one of the reasons why we expected Q1 to be better maybe than the rest of the year is because we knew that a certain part of our base had already renewed. So as we move into the rest of the year is why we continue to say that the renewal rates would be in the mid-80s, low to mid-80s as we move through 2021 even though the first quarter was a little higher. We were very pleased with the fact that we are now at 86% on in-quarter renewals for the second quarter.

We also know that the rest of the year is going to be -- will be -- still be a challenge for us but it is our number one focus and it's our number one priority is maintaining our customer base.

Sudhakar Ramakrishna -- President and Chief Executive Officer

And, Sterling, just to add to Bart's comments, he noted in his prepared remarks that our trailing 12-month renewal rates are at 90%. So one thing I'd highlight in this environment and the reason why we give a full-year outlook in terms of our approach to renewal rate is that every quarter, different set of customers come up for renewal. And as we've engaged with them to help their environments become more and more stable, there's inevitably in some cases where customers will take a little bit extra time to renew compared to, call it, historical trends. And so we're trying to pack up all of those and that's the reason why we sometimes go back and update the renewal rates, be it for Q1, [Inaudible] this quarter as well, largely to the upside.

Sterling Auty -- JPMorgan Chase & Co. -- Analyst

Understood. And then, on the margin front, you kind of gave the three areas of investment that you're making but I want to make sure I understand. What ones of those, do you expect to be kind of temporary investments and maybe give us an order of magnitude where we should see increasing leverage off of whatever spend we're going to see next quarter? And what ones are going to be kind of continuing to invest, maybe that's similar to growth so we don't get as much leverage?

Bart Kalsu -- Executive Vice President and Chief Financial Officer

Yeah. So, Sterling, when we talked about the Secure by Design initiatives on the previous earnings call, we talked about those the cost associated with those being in the $20 million to $24 million range. We think it's going to come in maybe at the lower end of that number but those costs -- that incremental cost is going to be in our ongoing cost structure. Those are things like increasing some of our headcount in our R&D organization, around our supply chain process, some [Inaudible] testing and some of the other things that we're going to do from a systems standpoint to enhance our IT structure.

Things like that are going to be just part of our ongoing structure but -- and hopefully, the cost -- those costs are not going to ramp as our business goes up. And so those are just going to be costs that will be built in. The cost associated with some of the things that we also talked about and that is enhancing our international sales teams, some of where we've seen some positive results in 2021 that's been outside the U.S., and we're going to continue to invest in our international go-to market motion. We also believe that the database market is a market of opportunity for us, not just this year, but as we go into 2022.

And so we're going to continue to invest in that market as well. And we hope that those investments will scale as revenue grows over time.

Sterling Auty -- JPMorgan Chase & Co. -- Analyst

Understood. Thank you.

Operator

The next question comes from the line of Kingsley Crane with Berenberg.

Kingsley Crane -- Berenberg Capital Markets -- Analyst

Hi. Thanks for taking my question. So on July 9th, you released a vulnerability for Serv-U or hot fix for that vulnerability. So could you please tell us about how many customers were impacted by this and how the customer conversations are going since that point?

Bart Kalsu -- Executive Vice President and Chief Financial Officer

I'll take that. Yes, we did issue a patch for the vulnerability. The way I would categorize that is that it has obviously nothing to do with the SUNBURST release that we reported back in December. This is a typical -- unfortunately, a typical zero day vulnerability that afflicts us and other software vendors.

And this would be an example that I would cite of server security research community and the vendor community, that includes us, working closely together to understand possible vulnerabilities and getting ahead of the curve by patching and releasing that to customers. So the way I would describe the customer support aspect and feedback is like with any issue, that it's a quality issue, a security issue. We proactively reached out to customers, helped them with any download needs that they had, any upgrade needs that they had. But in terms of customer support volume, I would not say that it was anything unusual for us to handle.

Kingsley Crane -- Berenberg Capital Markets -- Analyst

OK. Perfect. That's very helpful. That's it for me.

Operator

The next question will come from the line of Sanjit Singh with Morgan Stanley.

Sanjit Singh -- Morgan Stanley -- Analyst

Good morning. Thank you for taking the question and congrats on the N-able spin. I had some questions on guidance. So if you look at this quarter's results, total revenue was up 2%.

Next quarter, we're looking for a decline of, I think, 3% to 5%. Sort of can you help me try to bridge that, given the consistency on the maintenance renewal side that you're expecting? And then also from a maintenance ARR side on the core IT business, that was up quite healthy, I think 11% in Q2. So, any sort of context you can provide on why the business would go x growth in Q3?

Sudhakar Ramakrishna -- President and Chief Executive Officer

Definitely. Sanjit, I'll provide some color and Bart will jump in as needed as well. The first component I will highlight is that there is a ongoing focus within our business to evolve to do subscription, and so we are going to have some headwinds associated with subscription. So that's one factor that I highlight.

Two as we accounted in model for our Q3 bookings, we have to keep in mind the federal sector where we continue to make progress even on a sequential basis. But last year's fed reported Q3 2020 was one of the largest in our company's history, and so we had a very tough compare year over year associated with that. And then the third factor that we accounted for although our renewal and maintenance brief continued to improve is factoring in the fact that in 2020 due to the pandemic, new product license sales were tepid. And so we are modeling our renewal rates and renewal dollars associated with that particular fact.

So the combination of these three things is what causes us to predict the way we are. And we'll -- obviously, as Bart highlighted, continue to focus on our commercial business, continue to demonstrate progress month after month, quarter after quarter.

Bart Kalsu -- Executive Vice President and Chief Financial Officer

And, Sanjit, I just want to reiterate. Maintenance revenue for us is more of a trailing indicator of our business. So we're somewhat -- you're going to see some slowdown in our maintenance revenue, primarily because of the bookings and what's happened to our license bookings over the last four to six quarters. You'll start to see that in our maintenance revenue.

So you will see a reacceleration in our maintenance revenue until we start to factor in more of these quarters where we're growing license revenue year over year.

Sanjit Singh -- Morgan Stanley -- Analyst

Understood. And, Sudhakar, you make a good point on the subscription transition. If you can talk about sort of the unit economics of the subscription transition. It sounds like we're about $120 million roughish in subscription ARR, growing at a pretty healthy clip even if you account for the acquisition.

In terms of sort of the year one impacts for a customer, what does that a revenue headwind look like? And what do you, what is the sort of revenue breakeven time frame? Is that sort of two-year or three-year? Can you just sort of review the basics of the subscription transition for us? That's will be helpful.

Sudhakar Ramakrishna -- President and Chief Executive Officer

So, Sanjit, first of all, we are making significant progress in the subscription part of our business, as we noted. In terms of unit economics and comment term, [Inaudible] he's looking at economics is typical of the software industry. So think of it as a two- to three-year type of a return model.

Sanjit Singh -- Morgan Stanley -- Analyst

Understood.

Bart Kalsu -- Executive Vice President and Chief Financial Officer

Sanjit, if you remember when we priced our subscription offering, our on-premises subscription offerings, we looked at the three-year value of a license and maintenance model. We divided that by 2.75 and that's how we derive what our subscription pricing was going to be. Yes, that's the model that we're following. And then so the subscription booking is going to be, obviously,less than what a new license or maintenance booking would be a negative one.

There is a little bit of an upfront component to the subscription revenue and we'll talk about some of these things in more detail at our analyst data that Sudhakar talked about earlier. We'll also be able to talk a little bit more about how that -- what we think that impact will be in 2022.

Sanjit Singh -- Morgan Stanley -- Analyst

Understood. Thank you so much.

Bart Kalsu -- Executive Vice President and Chief Financial Officer

Thanks.

Operator

 The next question will come from the line of Kirk Materne with Evercore ISI.

Kirk Materne -- Evercore ISI -- Analyst

Yes, thanks very much. Sudhakar, can you talk a little bit about, how conversations are going in terms of customers now maybe thinking about the on-prem versus cloud? On your management is just kind of curious if you've seen any real change in that trend. Obviously, new licenses were up sequentially. So that's good to them until it's changing too fast.

But  just kind of curious about, how those conversations are trending these days. Thanks.

Sudhakar Ramakrishna -- President and Chief Executive Officer

Definitely. So customers want a choice in this particular category. So the way I would describe this is that hybrid is probably the way to think about the world as they move forward. It's not a matter of premises only or cloud only.

And so what customers are really looking for is a platform that can support the evolution of premises to the cloud. As you will see in our upcoming product packaging pricing models, we are going to give greater comfort to customers as they traverse this journey, on-premises to cloud into a hybrid world. And to more and more part of our conversations that are around that aspect. Without going into too much detail, there's also nuances between even in the cloud context, whether things are cloud native versus cloud managed, and we are working on positions out in both of those.

In fact, what I would say is that that combination of Secure by Design initiatives as well as the articulation of our portfolio roadmap to customers is giving them confidence that we can be a vendor that will not only supposed their needs in the current context but also involve more and multilayered cloud containers and hybrid application ecosystem.

Kirk Materne -- Evercore ISI -- Analyst

Very helpful, and then maybe just one for Bart. Bart, when we think about the third quarter you mentioned of you guys have a tough federal comp coming up. I'm just wondering how you think about sort of the federal impact maybe on maintenance rates or if you feel better or worse about that particular segment of your population or can you just talk about too specifically? But after we get to the third quarter, should we feel like you guys gotten over that -- should you have, I guess, a better view of ongoing maintenance rates once you get through this sort of big seasonal quarter for you all?

Bart Kalsu -- Executive Vice President and Chief Financial Officer

Yeah. I mean the fed businesses is a big piece of our business curve but it's not it's not what I would consider significant it's not massive. It will have an impact on its end in the third quarter. It's one of the reasons why even though our renewal rates have more been in high 80s, we still want to say be somewhat conservative guy renewal rates to be in the mid-80s for the rest of 2021 is because that number is a blend of both our commercial and our federal business.

And so we know there is going to be some impact in the third quarter as it relates to our fed customers. So that's the -- that's why we've guided, like I said to the mid-80's, we're going to push harder and we know we hope to do better than that. I think we've ended Q1 at like 89% on the renewal rate from a renewal rate standpoint and we think the 86% for the second quarter has some room to improve as well. So we're going to always push for more but that's -- because of the fed business in the third quarter, that's why we are guiding to that mid-80s for the rest of the year.

We do think that this is a one year phenomenon for us. We do expect to get back to what our historical levels have been when we get into 2022 and we think the move to subscription for us will be positive as well because it'll give us the ability to land and expand customers in a much easier fashion.

Kirk Materne -- Evercore ISI -- Analyst

Thank you.

Operator

The next question will come from the line of Rob Oliver with Baird.

Rob Oliver -- Baird -- Analyst

Great, thank you. Good morning, guys. Sudhakar, I was wondering if you could just share a little bit about your philosophy around the product evolution of the platform. You had mentioned that you did plan it to call the portfolio a little bit.

I know you guys have also been opportunistic and the database seems to be an area where you could continue to do so. But just wondering if you could talk a little bit about your philosophy on how you think about calling that portfolio.

Sudhakar Ramakrishna -- President and Chief Executive Officer

Sure. I would probably not use the word call in this context as much as how do we consolidate our capabilities such that our value propositions to customers become more crystal clear and compelling. So in that range in the near term and I think it's -- let's call it, a couple of quarters, our focus will be on better integrations and better packaging and pricing of our portfolio. So on one hand, that will improve our ASPs possibly but on the other hand, it will deliver a more compelling value to customers, so that's our first step.

But continuing on that trend, we are working fast and furious, I would say, on a hybrid platform that will be a singular platform upon which all of our capabilities will be delivered. So in this regard, we can support a land, expand, penetrate motion much more successfully with customers as opposed to having them deliver multiple-point products. So there's efficiencies for the customers at one level, but there's also internal R&D efficiencies because we're only working on one platform, one set of user experiences, consistent with our commitment to deliver not only powerful and simple solutions, but also secured solutions.

Rob Oliver -- Baird -- Analyst

Got it. That's helpful. Thanks. And then just to follow up on that one, just on the SentryOne business in particular, I just was wondering if you could talk about the database opportunity and database trends.

And then, that I think at one point -- I don't know if this was just public speculation about whether that would stay with you guys or go with N-able. Is N-able going to remain a large customer for SentryOne? If you could just maybe help us understand that I'm sure maybe we'll get more color at the analyst day but any thoughts would be appreciated. Thank you.

Sudhakar Ramakrishna -- President and Chief Executive Officer

Sure. Our first of all, SentryOne is very much part of ongoing SolarWinds, step 1. Step 2 is that while SentryOne is very significant to us from a SQL database environment standpoint, SolarWinds also has incredibly powerful database solutions prior to SentryOne as well. And so one of the key strategic things that we have done is integrating our database portfolio such that we have the broadest portfolio to support the most number of platforms out there, be it SQL server, Oracle, [Inaudible] and others, but also be able to deliver them in such a fashion that customers can deploy them either on-premises or in the cloud.

So that particular set of integrations is already complete. And the most recent thing that I announced in my prepared remarks was the extension of those capabilities called Database Insights, which is an extended motion that our sales teams are engaged with customers, as we speak.

Rob Oliver -- Baird -- Analyst

Great. Thanks again, guys.

Operator

The next question will come from the line of Terry Tillman with Truist.

Terry Tillman -- Truist Securities -- Analyst

Good morning. Thanks for taking my questions. I guess, Sudhakar, the first question is just related to this largest subscription deal today, I guess, you had commented on with a healthcare provider. Could you shed a little bit more light in terms of what product or products they bought? And how is the pipeline for large subscription deals? And then, I have a follow up.

Sudhakar Ramakrishna -- President and Chief Executive Officer

On the first part of your question. That was a great example of a customer who is able to leverage a broad swathe of our portfolio. So it wasn't like one particular product, let's call it  network performance monitoring as an example, but it was actually a combination of our product elements to support their broader needs. So this also relates back to the point that I was making about in the next couple of quarters, you will see us packaging our solutions and pricing them in ways that will be more compelling from a customer standpoint.

And so what you will see is that more of our packaging will be thematic to customers where they're not only consuming a point product, but are able to solve multiple solutions. And the solutions could be application monitoring integrated with database monitoring, as an example, or a combination of network management and database management in the same environment. So increasingly, you'll see that. And then that will not necessarily culminate, but it will actually evolve into that hybrid IT platform that I mentioned.

With regards to your question on the pipeline, the way I'll address it is that subscription, selling, and proposition is a heightened area of focus for our sales teams, including the incentive structures to support and promote that.

Terry Tillman -- Truist Securities -- Analyst

OK. And, Bart, maybe just a follow up. Thanks for the commentary on the $30 million ongoing subscription business. I think it was up 16% year over year.

As we look into 3Q and for 4Q, I mean anything at all you could share on how this ramps from $30 million? Thank you.

Bart Kalsu -- Executive Vice President and Chief Financial Officer

Yeah. I mean the -- it is being impacted by the SentryOne acquisition that we closed last year in the fourth quarter. So the $30 million is going to have some increase in Q3 just because of the SentryOne deal that closed in November of last year. So you will see a little bit of a slowdown as far as the growth goes because of the acquisition last year.

And really the growth will be driven by what -- how effective our sales force is in transitioning some of these opportunities into subscription deals. We're not going to be -- it's going to be a customer-led decision. We are going to try to get our sales force incented to push the subscription deals but the hardship is -- has yet to occur.

Ashley Hook -- Investor Relations

We'll take the next question.

Operator

Next, we have a follow up from Sterling Auty with JPMorgan.

Sterling Auty -- JPMorgan Chase & Co. -- Analyst

Yeah. Thanks for coming back in. I'm getting a number of questions from investors around the fed business. I know you haven't broken down specifics but I'm going to push a little bit.

So when you back out the MSP business, how would you characterize the size of the fed business that's left? That's number one. Number two, can you quantify how big is the surge that you that you saw last year? And three, I think people expect a pretty healthy spending environment out of the government this year as well. Why do you think that perhaps wouldn't repeat itself?

Bart Kalsu -- Executive Vice President and Chief Financial Officer

So our fed business, Sterling, we've talked about it in the past in the third quarter. I would say, its approximately 10% of our total revenue base when we're looking at what data is our -- available to renew. Our fed business is somewhere in that 10% range. As you know, our federal customers are not one individual customer.

It's a bunch of individual users within the federal government. We talked about our one big customer in the first quarter. That is our single largest customer by far. The rest of our business is made up of smaller individual agencies within the federal government, like I said.

So if you're thinking about it from a total revenue standpoint, it's approximately 10% when you when you add up all those different customers. As far as the third quarter goes, I mean for us, the biggest impact to our business from the cyber incident was the noise within the federal government. So therefore, conversations with the federal government and any of the agencies within the federal government has been a little slower for us and have been where we've gotten the most, I would say, if you want to say pushback, it's been within the federal government.

Sterling Auty -- JPMorgan Chase & Co. -- Analyst

Understood. Thank you.

Ashley Hook -- Investor Relations

We'll take one more question.

Operator

 Our question is from the line of Erik Suppiger with JMP Securities.

Erik Suppiger -- JMP Securities -- Analyst

Yeah. Thanks for taking the questions. I'm just trying to understand, where you are in terms of your focus on lead generation versus customer retention? I understand you restarted your lead generation efforts at the end of Q1. Are you doing all of your traditional campaigns for driving leads generating incremental business, or where are you in terms of the ramp? And then, can you talk a little bit about what the profile of the customer is most at risk for churn? You just noted that federal is probably the highest churn of any sector.

But what types of customers do you see that are most reluctant to renew?

Sudhakar Ramakrishna -- President and Chief Executive Officer

So let me address that. First, I want to provide a point of clarification on the fed churn comment that you made. We, I don't think we are highlighting that they have the highest propensity for churn. As much as they tend to be the most conservative customers as it relates to paying things back online.

So helping them, working with them, and analyzing their environment is the priority of ours. So just a point of clarification. To your point on demand generation, for the most part, in quarter one, we did not have normal demand-generation activities. That was only later into Q1 that we started ramping those back up, and I would characterize them as being steady state today.

With regards to what customers are having the highest propensity to churn, the way I'd describe it is that every one of our customers is super important to us, large or small, regardless of sector. But in terms of are we seeing a specific pattern of churn in a specific customer segment? The short answer is no. Quite simply because we do not have a lot of churn based on what we are seeing with customers and even where we do, there isn't enough of a sample set to give you a trend of where we are seeing it.

Erik Suppiger -- JMP Securities -- Analyst

OK. Very helpful. Thank you.

Ashley Hook -- Investor Relations

I think that's it for us. We're going to end the call.

Duration: 54 minutes

Call participants:

Ashley Hook -- Investor Relations

Sudhakar Ramakrishna -- President and Chief Executive Officer

Bart Kalsu -- Executive Vice President and Chief Financial Officer

Dan Bergstrom -- RBC Capital Markets -- Analyst

Sterling Auty -- JPMorgan Chase & Co. -- Analyst

Kingsley Crane -- Berenberg Capital Markets -- Analyst

Sanjit Singh -- Morgan Stanley -- Analyst

Kirk Materne -- Evercore ISI -- Analyst

Rob Oliver -- Baird -- Analyst

Terry Tillman -- Truist Securities -- Analyst

Erik Suppiger -- JMP Securities -- Analyst

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