SolarWinds Inc (SWI) Management Discusses Q2 2013 Results - Earnings Call Transcript

Jul.26.13 | About: SolarWinds, Inc. (SWI)

SolarWinds Inc (NYSE:SWI)

Q2 2013 Earnings Call

July 25, 2013 5:00 pm ET

Executives

David Hafner

Kevin B. Thompson - Chief Executive Officer, President and Director

Michael J. Berry - Chief Financial Officer and Executive Vice President

Jason Ream

Analysts

John S. DiFucci - JP Morgan Chase & Co, Research Division

Steven M. Ashley - Robert W. Baird & Co. Incorporated, Research Division

Aaron Schwartz - Jefferies LLC, Research Division

Keith Weiss - Morgan Stanley, Research Division

Scott Zeller - Needham & Company, LLC, Research Division

Mark Grant - Goldman Sachs Group Inc., Research Division

Daniel H. Ives - FBR Capital Markets & Co., Research Division

Kirk Materne

Tim Klasell - Northland Capital Markets, Research Division

Operator

Good afternoon. Welcome to the SolarWinds Second Quarter 2013 Earnings Call. As a reminder, today's presentation is being recorded. [Operator Instructions] At this time, I would like to turn the call over to Mr. Dave Hafner, Director of Investor Relations. Please go ahead, sir.

David Hafner

Thank you, Doris. Good afternoon, everyone, and welcome to SolarWinds' second quarter 2013 earnings call. With me today are Kevin Thompson, our President and CEO; and Mike Berry, our Executive Vice President and CFO. Following prepared remarks from Kevin and Mike, we'll have a brief question-and-answer session. Please note that this call is being simultaneously webcast on our Investor Relations website at ir.solarwinds.com. The press release with our results for the second quarter was issued earlier today and is also posted on our Investor Relations website. Please remember that certain statements made during this call, including those concerning our financial outlook for the third quarter and full year 2013, the impact of strategic and operational items addressed in the second quarter on our future results, our estimates regarding our market opportunities and our ability to take advantage of such market opportunities, the areas of focus and investment in our business, the expansion of our sales organization, our growth strategy and expectations and our demand generation and marketing efforts are forward-looking statements. These statements are subject to a number of risks, uncertainties and assumptions described in our SEC filings, including our Form 10-Q for the second quarter of 2013, which we anticipate filing with the SEC on or before August 9, 2013, and the risk factors described in our annual report on Form 10-K for the fiscal year ended December 31, 2012.

Should any of the risks or uncertainties materialize or should any of our assumptions prove to be incorrect, actual company results could differ materially and adversely from those anticipated in these forward-looking statements. These statements are also based on currently available information, and we undertake no duty to update this information except as required by law. Cautionary statements regarding these forward-looking statements are further described in today's press release. In addition, some of the numbers during this call will be presented on a non-GAAP basis.

Our use in calculation of these non-GAAP financial measures are explained in today's press release in a full reconciliation between each non-GAAP measure and its corresponding GAAP measure as provided in the tables accompanying the press release. Each non-GAAP item in our forward-looking financial outlook that we will provide today has not been reconciled to the comparable GAAP outlook item because we cannot reasonably or reliably estimate future adjustments such as stock-based compensation, which is dependent on our stock price at the time. I'll now turn the call over to Kevin.

Kevin B. Thompson

Thanks, Dave. Good afternoon, everyone, and thanks for joining us on our second quarter 2013 earnings call. While we successfully addressed a number of strategic and operational items during the second quarter that we believe have positively impacted our current results or positively impact our future results, had a lot of highlights and performance during the quarter and ended the quarter with accelerating momentum in our North American commercial, Asia Pacific and Latin American businesses, our license sales results for the full quarter did not meet our expectations.

The pattern of the second quarter was different than the first quarter as we had strong results in April into the first few weeks of May, and had a solid month of June with accelerating momentum across much of our business. However, we had a weak finish for the month of May and we were unable to make up for it.

Despite the shortfall in license sales, we delivered a solid quarter of overall growth with total revenue increasing by 21% and non-GAAP operating margins and earnings per share coming in well ahead of our outlook. As we indicated on our first quarter earnings call on April 30, we had a strong start to license sales in the second quarter. License bookings in the first month of the quarter increased by 26% over April 2012, which was a growth rate meaningfully higher than the full quarter new license growth outlook we provided at 15% to 17%.

Our strong start to the second quarter coupled with the early return from certain of the changes we made to our business in early April, just to simply address some of the issues we experienced in the first quarter, gave us confidence in our second quarter outlook. However, a very weak finish to the second quarter in EMEA created a deficit that we were unable to overcome despite strong sequential and year-over-year growth from our U.S. federal business, strong year-over-year growth in commercial core product transaction volume, solid contribution from our North American Network Management and System Management businesses, who each also had a strong finish to the quarter in our record month of sales in June by the N-able team.

Despite the relatively slow start in 2013 compared to our outlook, our confidence in our core business is high. We believe that we have a very large and growing market opportunity for our Network Management business, our Systems Management business and our new MSP business. We believe that market opportunity in all of these areas remains largely untapped.

And that while the IT purchasing environment has been difficult and inconsistent, during the first 6 months of 2013, we need to return to executing at the high level at which we were executing in 2011 and 2012 to take advantage of these large and growing market opportunities.

Given our confidence in the size and immediacy of our estimated current market opportunity, we plan to invest aggressively in growing our business for the second half of 2013.

This will include additional investments in our product development organization. But first, accelerate development of key new features and modules for our Network Management product line; second, in our core performance and reporting engine, which will allow tighter integration of our products; and third, to move more quickly on developing new products and integrating certain key features of existing SolarWinds products that enables cloud delivery platform.

We're also planning to make meaningful investments in our demand generation program, an awareness campaign to enable us to more effectively reach IT pros all over the world at the very moment in time they're out searching on the web for solutions to problems that they must solve.

In addition, as we discussed on our first quarter earnings call, we have been and plan to continue to add resources to our global sales organization to increase our sales capacity to provide us with the ability to respond to the level of demand we intend to capture.

With great strength of our operating model, we were able to make all of these additional investments while still expecting to deliver non-GAAP operating margins that we believe will meet or exceed our prior outlook for the third and fourth quarters of 2013.

Mike will cover the details of our second half of 2013 outlook in his comments.

Total revenues for the second quarter of 2013 reached $77.5 million, which represents 21% growth over the second quarter of 2012. License revenue for the second quarter increased 6% year-over-year, totaling $31.1 million. Maintenance revenue continued its long series of rapid growth quarters, reaching a record high of $45.4 million, reflecting 31% growth over the second quarter of 2012.

In the second quarter, we continue to do a good job of retaining our customers, and in fact, our retention rate ticked up slightly in the quarter. We believe that we have one of the strongest recurring revenue streams in all of software, as the combination of our list price base maintenance pricing model and our historically strong customer retention rate have allowed us to deliver quarterly growth and greater than 30% in maintenance revenue for each quarter in the last 5 years.

On a very positive note, our business model once again showed its unique leverage. Despite the dilutive impact of the N-able acquisition, which closed in late May, and lower than expected license sales growth, we delivered non-GAAP operating margins of 54.4% for the second quarter and non-GAAP earnings per share of $0.40, both of which significantly exceeded our outlook.

We believe that the leverage in our model is still somewhat misunderstood and definitely underappreciated. We have historically shown the ability to meet or exceed our targets for non-GAAP operating margin in earnings per share without regard to the level of our total revenue, which we believe is unique in all of enterprise software.

Mike will provide some additional insight in the components of the leverage in our model with his remarks.

We'll start with a review of some of the highlights in performance in the second quarter. I will then cover certain areas where our performance in the second quarter did not quite meet our expectations and our plans to address each of these areas to get our growth rate back to the level that we believe we should be achieving.

We had a number of highlights in performance in the second quarter of 2013. U.S. federal sales performance was strong in the second quarter, delivering growth of 35% over the second quarter of 2012 and 92%, sequentially. We had a solid quarter of license sales in our Latin American business, increasing by 43% as compared to the second quarter of 2012 and 17%, sequentially.

Our North American installed base sales team had a very strong quarter, posting year-over-year growth in new license sales of 36% against a difficult prior-year comparison as the second quarter of 2012 had the strongest installed base sales quarter in all of 2012. As a result of the success we are continuing to see with our installed base sales initiative, we are planning to significantly increase our investment in this initiative in the second half of 2013 by meaningfully increasing the size of our dedicated installed base sales team and marketing team.

And our MSP business had a record month of new business subscription bookings in June 2013, growing by 48% as compared to June 2012. We're excited about the level of demand and the strength of both the technology and the team we have added to the N-able acquisition. We believe that this is a very exciting addition to our business that will be able to deliver strong growth rates well into the future.

New license sales in our Asia-Pacific business grew by 12% sequentially, primarily driven by an increase in close rate of deals, in the size range of $10,000 to $50,000. The total dollar value of commercial license transaction closed during the second quarter that are greater than $20,000 increased by 5% sequentially, primarily as a result of our efforts to improve our close rates of deals in the size range of $20,000 to $50,000.

Our average commercial transaction size increased to $6,900 for the second quarter as compared to $6,400 in the first quarter of 2013, which was slightly higher than we expected. However, as a result of our change in product mix, which we discussed in our first quarter call, the average commercial transaction size declined by 15% as compared to the second quarter of 2012.

Sales performance and server and application monitor increased by 26% against a very strong year-over-year growth comparison. As we have discussed on a number of occasions, one of the unique aspects of our business model is a transaction velocity that our business requires which translates into a significant number of closed transactions each quarter.

One of the important highlights in the second quarter is that we were once again able to drive a significant increase in commercial, core product transaction volume, reaching 30% growth as compared to the second quarter of 2012. The growth in commercial core product transaction volume was comprised of 44% growth in international and 23% growth in North America. We count on increasing core product transaction volume needs to be a driver of our growth.

In the second quarter of 2013, the average number of core product transactions closed per sales rep declined sequentially by approximately 14%. However, the number of core products per transaction, which we believe would increase literally with a decrease in the number of core product transactions per rep, increased by only 2%, which is less than we anticipated. We are focused on increasing the number of core products per transaction in the third and fourth quarters. We expect to accomplish this goal while working to get our sales capacity to its playing level and by increasing our marketing effort and showing the connection between our products in the set of problem combinations that our products can solve.

While we made good progress against our sales hiring plan during the second quarter, we were not able to increase our net sales capacity during the quarter to its playing level, primarily as a result of higher-than-expected involuntary sales turnover in our international businesses. We've increased our sales hiring plans in EMEA and Asia-Pacific, and to a lesser extent, in North America for the remainder of 2013 to enable us to meet our planned sales capacity.

Turning to the discussion of those areas where our performance in the second quarter do not meet our expectations.

We still are not seeing an acceptable level of global growth in our Network Management license sales. The weakness we saw in EMEA in the second quarter had a sizable negative impact on our total Network Management sales in the quarter. However, we also performed at a lower level than we expected in our North American commercial business, which was partially offset by a strong quarter of network management license sales in our U.S. federal business.

To be direct, we're simply not getting the job done in stepping in front of the existing level of demand to the market for solution to network performance issue. We believe the opportunity is very large and our last estimate to global market opportunity for network management is a little over $30 billion. We've not even scratched the surface of this opportunity.

In addition, even though our installed base sales have been growing rapidly over the last year, we have barely begun to make a dent in the over $6 billion estimated network management market cross-sell and upsell opportunity alone, which we have inside our own installed base. We believe that we can accelerate the rate in which customers are purchasing additional network management products from us. So regardless of the economic conditions around the world, I believe that we should be growing our network management license sales at a much faster rate than we have in the first 6 months of 2013.

To that end, we're planning to increase our focus on capturing a greater share of the existing demand by IT pros for solutions to network performance issues. We intend to do this by increasing our efforts related to search, which includes organic, direct and paid, as well as consistently executing campaigns aimed at increasing the level of awareness of the SolarWinds brand and all of the IT performance problems that our products can solve for IT pros. Accelerating the growth in our network management license sales will be our most important similarity of focus in investment through the remainder of 2013.

After a decent start to the second quarter in the month of April, the momentum in our EMEA business fell off sharply. We ended the second quarter approximately $2 million short of our license sales outlook for EMEA business as bookings in the region declined by 19% sequentially. The shortfall in EMEA new license sales comprised the majority of the difference between the outlook for total license revenue we provided on April 30 and our reported results.

While we believe that some of the issues we encountered in EMEA during the last 2 months of the quarter were external to our business to reflect some of the macroeconomic turmoil in the region, we have taken or are in the midst of taking a number of corrective actions designed to improve our performance in the EMEA business. These actions include doing a better job in the hiring and training process in EMEA, which we believe will reduce our involuntary turnover rate for our sales rep; adjusting the organization structure of the EMEA sales team to lower the sales manager to sales rep ratio, which provides greater oversight of pipeline management with a goal of driving conversion rate into a more acceptable range; the creation of a dedicated installed base sales team in EMEA; and the addition of 2 new director of sales positions to the EMEA sales management team to increase the depth and maturity of EMEA sales management organization.

As we acquired DameWare in December 2011, our team has done a very good job of significantly increasing the sales of the DameWare products from their historical level. The DameWare product line has been a solid contributor to our systems management business, adding both a large number of new system administrators as customers and delivering good license sales growth each quarter in 2012. We had built into our outlook for the second quarter of 2013 a global decline of approximately 30% in the license sales of our DameWare product in a year-over-year basis.

We projected this decline because the second quarter of 2012 was a difficult comparison as it included a significant amount of license upgrade sales to DameWare customers that originally purchased DameWare licenses prior to our acquisition of DameWare in December 2011. However, the actual decline in DameWare license sales in the second quarter of 2013 was over 40% as our upgrade license sales fell by more than anticipated.

We have adjusted our outlook for the second half of 2013 to reflect a similar level of year-over-year decline in DameWare upgrade license sales in the third and fourth quarters to what we experienced in the second quarter. That being said, we have made several promotional and pricing changes to the DameWare product, which we believe will improve the performance of these products in the second half of 2013. However, until we see evidence of a positive impact from these changes, we're going to include them in our outlook. As we discussed in our first quarter earnings call, we had a very high level of overall demand for our core products in the first quarter. As we entered the second quarter, we adjusted our demand generation plan to focus on increasing the quality and conversion rate of the demand we generated within the second quarter for our core products.

We were successful at increasing the quality of demand that we generated in the second quarter. However, the quality level we were targeting, the level of overall demand measured by download for our core product, declined by more than what we anticipated. This decline contributed to our license sales portfolio for the quarter. In our demand generation plans for the third and fourth quarters of 2013, we have revised our mix as it relates to quantity versus quality of demand with a goal of hearing a higher level of overall demand while maintaining acceptable conversion rate. We expect that this change will increase the amount of total pipeline created and closed beginning late in the third quarter and carrying forward through the fourth quarter. However, we have not included any business from these changes in our current outlook, which Michael discussed in his remarks. And finally, while our APAC business had good sequential growth, our total license sales for the quarter were still below our expectations. As we move into the second half of 2013, we are working on improving the consistency of performance of this team throughout every week of each quarter. With that goal, we have asked one of our most experienced North American sales VP who has a long track record of success with us in growing various part of our business, to assume a leadership role of the APAC business in the next several quarters.

I'll now turn the call over to Mike for a more detailed review of our second quarter financial performance and our view of our outlook for the second half of 2013. After Mike's remarks, I will provide some additional thoughts on the market opportunity that we're addressing and how we believe the strategy for our business that we have been implementing over the last 2 years has positioned us to be successful in driving long-term growth.

Michael J. Berry

Great. Thank you, Kevin. A very good afternoon to everyone on the call. As usual, on today's call, I will give you an overview of the financial results and key metrics from the second quarter, as well as our outlook for the third quarter and full year of 2013.

As I give an overview of these results, I will also give more details on the financial impact from the N-able acquisition. Before going through those numbers, I would like to review some of the financial highlights for the second quarter 2013.

We continue to generate strong maintenance revenue growth in the second quarter of 2013. Excluding the contribution from N-able, maintenance revenue leads to record $44.7 million, reflecting year-over-year growth of $10.1 million or 29%. We also had strong profitability performance in the second quarter of 2013 as our non-GAAP operating margin and EPS both exceeded our outlook.

Our non-GAAP operating margin of 54.4% was well above our outlook and if you exclude the dilutive impact from N-able in the quarter, the non-GAAP operating income margin from the core SolarWinds business was in excess of 56%, which was slightly higher than the strong level recorded in the first quarter 2013.

As Kevin mentioned, N-able had a strong quarter. Including the contribution from the N-able maintenance renewals, total revenue from N-able was approximately $1.7 million in the second quarter. This exceeded our second quarter outlook of $700,000 to $800,000 in revenue for N-able. The major factors for N-able exceeding our outlook included a strong month for new bookings and continued strong renewal rates for both subscription and maintenance agreements.

In addition, the higher-than-expected revenue from N-able contributed meaningfully to our stronger-than-expected non-GAAP operating income amount in the second quarter as the incremental impact from N-able was a non-GAAP operating income loss of approximately $900,000 versus our outlook, which assumed a loss of approximately $2.2 million. Cash collections were strong again in the second quarter 2013 as our DSOs came in at 42 days. Excluding the impact of N-able, DSOs would've been below 40 days for the first time in company history.

Lastly, despite the dilutive impact of the N-able acquisition, the strong cash collections helped drive solid cash flow from operations of $40.7 million, representing 23% year-over-year growth. Okay, with that said, let's move on to the financial results for quarter.

For the second quarter 2013, license revenue was $31.1 million for a year-over-year growth rate of 6%. Maintenance revenue was $45.4 million for year-over-year growth rate of 31%. The $45.4 million includes approximately $700,000 of maintenance revenue from N-able. Subscription revenue, which came entirely from N-able, was $1 million. Total revenue was $77.5 million, for a 21% year-over-year growth rate.

In addition, we closed one transaction in April in U.S. federal that was greater than $500,000 in license revenue. Non-GAAP operating income finished at $42.1 million for a non-GAAP operating margin of 54.4%. Non-GAAP EPS was $0.40 in the quarter versus $0.33 in the second quarter 2012. Our non-GAAP operating margins and earnings per share exceeded the high-end of our outlook for the second quarter 2013 by over 5 percentage points and $0.04, respectively. These strong profitability results were mainly the result of stronger than forecasted revenue from N-able, higher maintenance revenue and lower-than-planned expenses across the whole company.

As I mentioned, we had another strong quarter of cash collections that helped to offset the approximately $1 million negative impact of N-able and drive solid cash flow results. Cash flow from operations in the second quarter 2013 was $40.7 million versus $33.2 million in the second quarter 2012. Free cash flow in the second quarter of 2013 finished at $41.3 million versus $34.3 million in the second quarter 2012.

Importantly, the leverage we have built into our financial model was once again illustrated during the second quarter. While we were disappointed to fall short of our licensed revenue goal for the quarter, we were still able to achieve and actually exceed our outlook for non-GAAP operating margin and EPS. We believe the leverage inherent in our model helps to tightly align our interests with those of our shareholders as our compensation plans across all areas of the company, but particularly at the leadership level, are weighted heavily toward our performance.

In addition, due to the velocity at which our business operates, a meaningful amount of our operating expenses are variable in nature in those dollars generally flow with the pace of the business. And though we cannot guarantee we will always be able to meet or exceed our profitability targets, we continue to feel confident in our ability to manage those targets effectively based on our performance-based compensation structure, along with the visibility and control we have to dial variable expenses up or down in a given period. Moving on to the balance sheet. Our total cash balance on June 30 finished at $196.3 million, which includes our short and long-term investments of approximately $47 million.

Cash and cash equivalents was $78 million less than the amount as of March 31. This was mainly due to the cash used for the acquisition of N-able of approximately $120 million, offset slightly by cash generated from cash flow from operations of $40.7 million. Approximately 39% of the total cash investments balance is held in our international subsidiaries as of June 30. Total accounts receivable finished at $35.8 million as of June 30, 2013, resulting in a DSO of 42 days. As I mentioned, if we exclude the impact of N-able revenues and accounts receivable, our DSOs finished at just over 39 days.

Our total deferred revenue was $114.5 million as of June 30, 2013, which includes approximately $2.8 million attributable to N-able, most of which was booked in purchase accounting. Let's move on to our key business metrics. Our core transaction volume grew in the second quarter of 2013 by 28%, comprised of commercial growth of 30% and basically flat growth for the U.S. federal core transaction volume. The total trailing 12-month average transaction size, excluding Kiwi and DameWare, finished at approximately $7,700, which is lower by about 12% from the same measure from the second quarter of 2012 of approximately $8,800.

If we look at the average commercial transaction size for only the quarterly amount, again, excluding Kiwi and DameWare, the average transaction size increased slightly. For just the second quarter 2013, the average commercial transaction size finished at approximately $6,900 versus a comparable average transaction size of approximately $6,400 in the first quarter 2013 or below an increase of 8% on a sequential basis. For the second quarter of 2013, commercial market license sales grew 4% and the U.S. federal business grew 35%, both on a year-over-year basis. And North American commercial region grew by 5% and our Latin American business had a strong quarter growing year-over-year by 43%. As Kevin mentioned, our EMEA business did not have a good quarter as new license sales in EMEA declined year-over-year by 6%. APAC license sales increased sequentially by 12% and grew year-over-year by 7%.

All of our geographic regions had increases in core product transaction volumes in the quarter of greater than 20%, which were largely offset by a reduction in average transaction size across all regions as compared to the second quarter of 2012. For the second quarter, on a positive note, from a total revenue perspective, core network management, excluding log and event manager, grew by 17%, which was slightly better than the 16% total revenue growth experienced in the first quarter 2013.

In addition, our core systems management products grew by approximately 38% as our flagship system and application management product continue 30% plus growth rate. However, we also experienced year-over-year declines in total revenue for our Storage Manager and DameWare products. This decline in Storage Manager was largely tied to the weakness in our EMEA results welding were space the Kevin discussed earlier.

Okay. Let's move on to the outlook for the third quarter and the full year 2013. Before I go through the specific numbers for the outlook, I'd like to hit on a couple of important drivers. First, as it relates to N-able, we are increasing our outlook for the second half of 2013 for both revenue and profit. As Kevin discussed in his remarks, N-able had a record month of new bookings in June, as well as continued strong renewal rates for both maintenance and subscription. We are now -- we now currently expect N-able's total revenue for June 2013 through December 2013 to be between $11.5 million and $12.5 million versus our prior outlook of $8 million to $9 million. This higher revenue outlook will also help reduce the expected dilutive impact of N-able for the full year 2013 to a non-GAAP operating income loss of approximately $7 million versus the previous outlook of approximately $12 million. One thing to note with N-able is that since the majority of their renewals are on a month-to-month basis, N-able's bookings will not meaningfully impact our deferred revenue growth going forward. Second, in our current outlook, we have reduced the expected license revenue growth and associated new maintenance revenue from license sales for the remainder of the year as we implement the actions that Kevin discussed in his opening remarks that are aimed at driving higher license revenue growth in the future quarters. In the process, we have taken what we believe is a conservative approach to our outlook to give us the time and room to see that these changes create the positive impact of our growth rate that we expect. Third, as the third quarter is typically a strong quarter for U.S. federal new license sales, I want to make sure and hit on our key assumptions.

For the third quarter 2013 outlook, we are currently expecting our U.S. federal team to have another solid third quarter of new license sales. However, keep in mind that on the year-over-year basis, these amounts are being compared to a very strong third quarter 2012. So for the third quarter 2013, we currently expect U.S. federal to grow by over 100% on a sequential basis versus the second quarter 2013 and to be essentially flat on a year-over-year basis versus the third quarter 2012 amounts. Our U.S. federal pipeline would indicate that we have the potential to have a stronger quarter than these amounts. However, we are taking a conservative view of U.S. federal close rates given that we are still in a sequester period. This would equate the U.S. federal being about 20% of the new license sales in the third quarter 2013, which is similar to the third quarter 2012. Additionally, our forecasting methodology for the U.S. federal business is consistent with prior period and specifically, it's consistent with the third quarter 2012.

At this point, I'd like to spend some more time on the non-GAAP operating margin outlook for the second half 2013. As I discussed earlier, we achieved a non-GAAP operating margin of approximately 54% in the second quarter 2013, which was a full 5 percentage points higher than our outlook as adjusted for the N-able acquisition. The outlook for the second half of 2013 includes non-GAAP operating margins of between 44% and 45%, which, while a good bit below the second quarter 2013 actual operating margin is actually in line with to 100 basis points greater than the prior outlook we provided on the conference call in May 2013 announcing the N-able acquisition. And importantly, we are maintaining that margin level despite our decreased revenue outlook and increased investment plan for the second half of the year.

Let's go through the main components of the incremental expenses that are built into our outlook for the second half of 2013. First, as you are aware, we have significantly exceeded our margin outlook for the first half of the year, which largely reflects lower-than-planned expenses, specifically in sales and marketing. So while the second half does indicate a significant acceleration in spending focused on driving higher license revenue in 2013 and providing positive momentum entering 2014, it is important to note that our expenses for the first half of the year were lower than planned and will not imply a steeper ramp in the second half spending, had we met our outlook for license revenue in the first half of the year.

Next, an obvious driver of our higher projected expenses is that the third quarter includes all 3 months of N-able expense versus just 1 month in the second quarter. This is expected to add approximately $5 million to $6 million in incremental expenses to the third quarter 2013. As Kevin mentioned, we continue to hire additional sales people and embedded in the operating expense outlook is an expected increase of 10% to 15% in the number of sales reps by the end of the third quarter. We also plan to more aggressively invest in marketing in the second half of the year in order to fund additional demand generation and branding activity in an effort to accelerate growth along with making key planned additions to the marketing management team. While we expect R&D to stay in the range of 10% to 11% of total revenue, we expect to continue to invest in new resources across the globe to support our product initiatives.

In summary, we have reduced our full year revenue outlook by approximately 4 percentage points or approximately $12 million to $15 million. Even with this change in our revenue outlook, we have maintained our outlook for non-GAAP operating margin that is in line with to slightly better than our prior outlook. As it relates to FX rates, our outlook assumed the euro to U.S. dollar exchange rate of $1.30 for the third quarter of 2013.

Okay. With all that being said, for the third quarter of 2013, we currently expect the following: License revenue in the range of $34.2 million to $35.7 million or year-over-year growth rate of 1% to 5%. This outlook assumes year-over-year new license sales growth of 3% to 6% for commercial business and approximately flat year-over-year growth in new license sales within our U.S. federal business. Maintenance revenue in the range of $48.3 million to $49 million, or a year-over-year growth rate of between 28% and 30%. Subscription revenue in the range of $2.2 million to $2.5 million. Total revenue of $84.7 million to $87.2 million, or a growth rate of 18% to 22%. Non-GAAP operating income margin in the range of 44% to 45%. And non-GAAP earnings per share between $0.35 and $0.36, assuming fully diluted shares outstanding of 77.1 million and a non-GAAP effective tax rate of 28%.

For the full year 2013, we currently expect the following: Total revenue in the range of $322.7 million to $327.7 million, or a year-over-year growth rate of 20% to 22%. Non-GAAP operating margins of approximately 49%. Non-GAAP earnings per share between $1.51 and $1.54, assuming full year diluted shares outstanding of 77 million and a full year tax rate of approximately 26.5%. As it relates to our full year outlook for non-GAAP EPS, I would also note that the $1.51 to $1.54 is actually $0.03 to $0.05 higher than our original non-GAAP EPS outlook for 2013 adjusted for its dilutive impact of N-able that we discussed in May.

In addition, with regard to our non-GAAP operating margin, we expect to provide you with more insight into its trajectory heading into 2014 at our Analyst Day in November. However, at this point, including the impact of N-able, we can say that we currently expect to generate non-GAAP operating margins of approximately 50% by the second half of fiscal 2014.

Lastly, from a total revenue perspective, for the full year 2013, we expect our core network management revenue to grow in the mid-teens percentage range, our core Systems Management revenue to grow in the upper 30% range and the revenue from network and System Management tools to grow in the low-single-digit percentage range.

This concludes my prepared remarks. I'll now turn the call back over to Kevin.

Kevin B. Thompson

Thanks, Mike. In our remarks, we have tried to provide an in-depth view in the areas of our business where our momentum has continued or is accelerating, as well as into those areas that are not performing up to the level of our expectations and our plans to address these areas. We take very seriously the outlook that we provide and we go into each quarter with a plan and a path that we believe will allow us to meet or exceed our outlook. We have a very competitive team that loves to win and hates to lose. We take every loss no matter how small or large extremely personally.

We believe that the outlook we provided for the second half of the year is achievable and provides us with both the room and time for the change we have made to our business to take hold and begin to deliver positive results. With that being said, we are confident in the growth strategy that we have laid out and been executing for the last 2-plus years.

We believe we have created a business and technology platform that provides us with a path for long-term, meaningful and highly profitable growth. We believe in the size and immediacy of our current market opportunity and also feel that we are positioned well to further expand that market opportunity. We plan to accelerate growth investments in our business over the next several quarters as we have, believe it or not, been much more profitable on a non-GAAP basis than we want to be, as the leverage in our model has continued to build.

We believe that the great majority of our growth opportunities in the key IT management market that we serve is still in front of us. And we are planning to do all we can to capture these opportunities. When you look at the assets we have assembled over the last 24 months, we believe that we have made significant progress toward our goal of creating an IT management platform that will allow us to solve performance management problems for all things IT. And to solve these problems the way the IT pros want to have them solved, whether that is on premise from the cloud or a combination of these 2 approaches. We have expanded from network management to add the ability to manage servers, systems and applications while at the same time adding the beginning of security management through our product portfolio through the addition of Log & Event Management. With the recent acquisition of N-able, we have added a cloud-based technology platform that we believe provides us with the ability to serve a segment of the small-business market that we did not previously serve effectively. N-able also provides us with what we believe is the right set of products and platforms to reach the growing number of small businesses that rely heavily on SaaS-based technology to run their business. These small businesses have little to no internal IT resources. They're relying on MSPs to provide the IT management services that they need to manage the performance and security of their network, desktops and other proprietary systems. We also believe that the N-central platform provides us with a strong cloud delivery platform which we can use to provide additional cloud-based management services to IT pros in the future, as the demand for these technologies and a cloud-based delivery model become more mainstream of organizations of all sizes.

On the SolarWinds technology front, we have been and continue to be in the process of creating a set of core products and use the same performance alerting and reporting engine. This provides us with the ability to continue to solve the individual problems that IT pros are out on the West searching for solutions to, as well as providing those same IT pros with the ability to even more easily add SolarWinds solution to additional problems that they encounter which are fully integrated with the SolarWinds products that they already own. We believe this will allow us to more quickly and successfully attack our estimated over $11 billion in growing opportunity for cross-sell and up-sell inside our installed base. Our confidence in our growth strategy and in our business is high. We are committed to delivering new business growth rate that will be among the highest in enterprise software and levels of profitability that few companies are able to reach. We continue to target a new business long-term growth rate, we believe 20%. We believe that this growth rate is achievable with solid execution. With that, we'll open up the call for questions.

Question-and-Answer Session

Operator

[Operator Instructions] And we'll go first to John DiFucci with JPMorgan.

John S. DiFucci - JP Morgan Chase & Co, Research Division

Kevin and Mike, you've now done 2 quarters of more modest growth than you've been putting up in the past, and also more modest than you anticipated. I guess, how much of this issue is internal sales execution? How much is macro? And importantly, and this is a question I -- this is the big question I get all the time. How much of it is due to market forces? Are you starting to come up against an issue of saturation in your core network management market? I mean, I think that's the $2.8 million question and that $2.8 million is what you missed in terms of license by this quarter.

Kevin B. Thompson

Yes, let's start with the last question and then maybe move backwards. If I forget any parts of the question, then you can remind me. As it relates to the market, we don't believe that the market is saturated. We don't believe that our growth opportunities is behind us. In fact, we think most of our growth opportunities in all of our businesses, plus particularly network management, is still in front of us. So I think most of the issues that we've seen over the last couple of quarters is a combination of execution against the level of demand that exists in the marketplace. We try to dial our demand engine up and down based on a quality, quantity mix that we measure pretty tightly. And we just haven't gotten that completely right in the first 6 months 2013. We definitely had a change in buying behavior and that's more of a macro issue. But that's what caused us the need to adjust that quantity-quality mix and make sure that we have the right level of demand at the right level of quality to get to our outlook. So we really believe that it is -- while the market has not been easy, it's our job to really dial that demand engine in, so that we can deliver the level of growth we ought to be delivering. We clearly have given ourselves a room in the back half and we've given an outlook that is below where we would like to see our business to go. We'd like to grow much faster than that and our investments and our efforts will be to try to do that. I think we try to put a -- an outlook in place that we feel good about achieving even if, if we're not able to fully 0 in, in the next 6 months on some of the metrics that we're working on. Some of it is execution. We had a really poor finish to the quarter in Europe and it caught us by surprise. We had had a really strong European business in 2012. They had an okay first quarter, but it really got soft as we moved into the -- into May and just didn't get much better in June and in the rest of our businesses, we had a soft last couple of weeks of May but then a strong finish in June and a finish we thought would be strong enough still to get us to our outlook. It just ended up a little bit short. We just ran out of time because of the kind of the hole we dug for ourselves in the last 2 weeks of May. So we don't think it's a market issue. The market is there. The market is big. We've expanded our market opportunity. Just in our installed base alone, we got a $6 billion opportunity for just network management. That excludes all of the other products that we have. That is sitting there waiting for us to do a good job of taking it. We're doing a good job there. We can do a better job. So don't think it's market. It's mainly forces that while may -- they may not be completely under our control. Our ability to react to them is under our control. We're not doing as well as we ought to do right now. That's something we're absolutely going to fix.

John S. DiFucci - JP Morgan Chase & Co, Research Division

Okay. I actually -- I think you hit all of those points. But If I could follow up, actually for Mike, you said you've given yourself some room on the guidance, for the annual guidance here. And frankly, Mike, I know you as a relatively conservative person. I guess, so assuming that next quarter, U.S. federal is going to be flat year-over-year in a time, as you said, you're faced with sequestration. I guess -- I don't know, how much visibility do you really have into U.S. federal? Yes, there's automated cuts across U.S. federal and they are important to you and it just seems -- it seems that without knowing how much incremental -- how much better visibility you might have into that? It just seems to me that, that's actually poses a risk for next quarter, that it's going to be flat year-over-year?

Michael J. Berry

Yes, so John, it's Mike. When we said our outlook, we feel we have pretty good visibility into the pipeline. As I mentioned in my prepared remarks, we feel like what's in the pipeline should actually allow us to do a little bit better. We have invested significantly in the federal business, allowed all different areas around sales, marketing, we've done a much better job of penetrating in some of the civilian agency and other groups. So it is a big number that's why we called that out. We would rather not forecast it flat. We do think the business should grow, but given the size of the number we are trying to be conservative around closed rate of what's in the pipeline because of sequestration.

John S. DiFucci - JP Morgan Chase & Co, Research Division

Okay. And you said that -- I assume that's based on your experience in this quarter or the entire quarter you're faced with sequestration also?

Kevin B. Thompson

Well, I mean, if you look at the second quarter, we are off 96%, sequentially, in federal in the second quarter. So sequestration really did not have a negative impact on federal in the second quarter, up 35% year-over-year and we're in a sequester quarter in the second quarter also. So sequester is there, and the second quarter is there, and the third quarter, but because the number grows between Q2 and Q3, we've taken a more conservative view of closed rate. But in the second quarter, your team did a good job of closing deal and had good visibility and operating in the same sequester environment. But we take a more conservative view of Q3 than our results for Q2 would indicate that we would have to but I think that it's the right way to look at it for the exact same reasons that you indicated.

John S. DiFucci - JP Morgan Chase & Co, Research Division

Okay, great. And I'm sorry, Kevin, you just -- did you just say that U.S. federal -- I know it's a smaller number but was up 35% year-over-year in the second quarter?

Kevin B. Thompson

Yes.

Operator

Our next question comes from Steve Ashley with Robert W. Baird.

Steven M. Ashley - Robert W. Baird & Co. Incorporated, Research Division

I would just like to talk about the North American business and just to make sure that I have this straight in my mind. First of all, is that during the first quarter, you never really saw a falloff in demand coming in, in terms of demo and website kind of visits? And if that -- and during the first quarter, it was a conversion problem but then during the month of May, you actually saw a demand falloff that stayed lighter into June but then picked up at the end. So my first question is, is that correct? And second of all, help us understand that lull in demand you saw, maybe in May, in June, and what was behind that?

Kevin B. Thompson

Yes, so maybe let me rephrase that just a little bit. So we went into the second quarter with the demand generation plan in terms of the number of downloads we thought we'd generate and the quality level we were aiming at. And so we, by design, reduce the number of downloads, not so much web visits, but the number of people actually download one of our products for evaluation. Because mainly what our reps do is they just call out or download the products we sell. So we, by design, went into second quarter with a plan to reduce the quantity of downloads we're going to put in front of our sales rep because of the conversion issues we saw in the first quarter. We said we're going to reduce the volume, improve the quality and improve the efficiency and effectiveness of the dollars we're spending and of the time the reps are spending on the phone. So that was by design. What happened is at the end of the quarter is with that quality level we were aiming at, we weren't able to generate the volume of download we really needed to generate. We have the quality too high, which did end up with a negative impact. So it's not that the demand fell off that exists in the market, what fell off is the amount of that demand we were capturing, turning into a download and handing to a sales rep to make a phone call on and that's where we just didn't dial it up exactly right based on the environment that we're in, based on what we believe and the metrics we were looking at. We thought at the quality level we were targeting. We now had higher volume than were actually generated, given a little bit of a turbulent environment, we needed to dial that quality mix back just a little bit, and let the volume kick up, which is what we've done going into July. So it's more by design but it had a little larger negative impact than the one that we had designed it to have. And that is, I think, to John's question, that's where the fact that the environment has been a little bit turbulent. That's where that makes it a little harder for us than maybe what we've seen historically. So we're turning the volume level back up, we're making sure we've got all the sales capacity in the seat, we did a good job of hiring in Q2. Our retention wasn't quite as good because we turned some reps over on our decision because I don't think we've done quite as good a job of hiring as we needed to do. I think we've fixed that problem going into this quarter. We are planning to be much more full in terms of capacity. So we can handle all the higher volume and demand even if the quality level drops a little, which it will, because by design, we've organized our demand generation plans that way this quarter. In terms of momentum, we had a good April, we talked about that. We had a good first couple of weeks of May. We had a really soft finish to May across the business, particularly in Europe. Europe stayed weak in June. But Asia-Pacific, Latin America and North America, all accelerated in June. We just didn't accelerate enough to make up for the soft finish to May and we didn't accelerate enough to make up for the fact that EMEA just didn't accelerate in the month of June. We've done a bunch of stuff to make sure we have a better -- we will do everything we can to have a better third quarter in Europe and I feel like we will. But we got to go and make that happen now.

Steven M. Ashley - Robert W. Baird & Co. Incorporated, Research Division

And can we get more color -- you talked about some unforced turnover of reps in Europe. Maybe some color on that? And if that was a contributing factor to the falloff in demand or not?

Kevin B. Thompson

Well, it's a -- it was in Europe and in Asia, so our international business. We had a capacity plan we entered into quarter with, we talked about it in the Q1 call. We didn't get to that net capacity. We hired enough gross reps to get there but because we had a little higher involuntary turnover than we had built in our plan, we ended up a little bit short on the net rep side. That doesn't affect demand that's coming in but it does affect 2 things: It affects the conversion rate of that demand, because it still causes the reps we have to have to make more phone calls and work more deals, and there's only so many deals we think that they can work. It, also, if you go back to one of the comments I made, it impacts the number of core products that end up on an invoice. Because if a rep doesn't have as much time to spend with each customer as we'd like, then they're going to sell 1 product or 1.5 product on average instead of 2.5 products on average to that customer because they simply don't have the time to spend that will allow them to do that. So really impact is in those 2 ways. Our reps don't create demand. Our reps respond to demand. But we got to make sure we got enough to respond to demand to drive the ASP average transaction size we want to drive.

Operator

And we'll go next to Aaron Schwartz with Jefferies.

Aaron Schwartz - Jefferies LLC, Research Division

I had a follow-up question on the sales capacity issue. I know you highlighted that as being a big focus coming out of Q1 and then to hear it being flat for the quarter here. It seems like a little different than what you planned on. First of all, on the Europe component there, what was the factor that drove that change for you? Was there something specific? It seems like maybe you made a big change there, which got in the way of you meeting your sales capacity goal. And then specifically within North America, can you comment on sales capacity, what that increased in the quarter? And then secondly, within the net man business, I know you made a change in early April to reverse, I guess, the split up between core and net man and the config component here to try to increase attach rate? Could you just comment on the traction of that and where that is going into the back half of the year?

Kevin B. Thompson

Okay. I will try to remember all of that. If I don't remember it all, then ask anything I don't remember. So as it relates to sales rep, we actually did end up with more reps at the end of Q2 than we had at the end of Q1, just we're in the kind of low to mid-single digits up and we wanted to be in that 10% to 15% up. So we did end up Q2 to Q1 but not as much as we intended to. In terms of did we make a big change, no, we didn't. I'll tell you a couple of things, one, we're hiring quickly. When you hire quickly, you got to make sure you're hiring well while you're hiring quickly. I don't know if we hired as well as we could have in our international business. So I think that's part of it is we need to make sure we were doing a really good job of hiring, but also really good job of training as we put steps in place to make sure we're hiring a little more effectively but also more importantly, probably, that we're doing a really good job of training those reps. We trained them very quickly but we have to make sure we do a good job of training them on our sales methodology so they can be successful. So that's the changes we made as we really walked into back half of Q2 and into Q3, realizing we had not done a good a job as we wanted to in adding capacity. I don't think we've done the right thing to be able to resolve that. I think we're in better shape now than we were as we exited Q2. We're definitely up in the number of net sales reps we have and our capacity is up. Today, although we're at the end of the quarter with, we still have some hiring to do. But I feel pretty good about where we are and where we should end the quarter. So I do think that we will get to that target in the third quarter and we weren't able to quite get to in the second quarter. As it relates to North America, we were closer to our net sales capacity in North America than we were in international, which is why I really called out international because we were quite all the way to where we needed to be, but we're a lot closer and it had a much smaller impact in North America than it did outside of North America. So we had kind of less ground to make up in terms of hiring. And that make sense. I've got a bigger organization in North America, I've got more manages, more directors, more VPs and so we've got the capacity, I think, to take a little more time in the North American side of the business than our European and Asia Pacific business do because they're just smaller organizations. They don't have some of the infrastructure yet that we've got in North America. But in a lot of areas, in North America, our installed base team grew significantly in the second quarter. We're going to grow significantly again in the third quarter in North America. We have already begun to build and have reps on the ground in Europe in that installed base sales team. Once we get that team fully productive, then we'll go to Asia and build an installed base team in Asia. So the sales hiring is moving forward. We're doing a better good job of it in third quarter than we did in the second quarter. The turnover rates are back in line with where we expect them to be, where they've been historically, so I feel like it's a bit off of a blip we had in the second quarter, as we accelerated hiring that we're not going to have moving forward. In what part of your question that I may not -- Oh, attach rate. So the -- we have not seen all the impact yet that we expect from bringing those teams back together. We made a few additional organizational changes walking into the third quarter in North America. They are also aimed at driving higher attached rate of our systems management product to our network management product. So what I would say is, we didn't make all the progress that we wanted to make. However, I feel good about where we are right now. I really feel better than I have in a very long time about the structure of our North American team and the way we've got our leadership team in place in North America. I also feel good about some of the changes we made in Europe. We spent a fair amount of time in Europe, between myself and Paul Strelzick, head of Worldwide Sales, over the last 4 to 6 weeks. And so I feel like we have got a really much stronger management structure in both in North America and Europe and we've got some more hiring to do on the management structure side in Europe that will really allow us to scale more effectively than we have over the first 6 months of the year. So I feel much better about that than I have in a very long time. We still have a little bit of work to do in Asia. But as I indicated, we've asked one of our experienced North America sales VPs to take responsibility for Asia-Pacific and help us build out that infrastructure and make sure that we've got, not just a couple of people that are good because we have that. But that we have an infrastructure under those folks that allows them to scale so not so much of the weight's pulled on a couple of individual, and that's just some of the growing pain that you go through when a business has been growing quickly and you believe that internal experience is really important to success. Sometimes you end up at a position where you don't quite have the depth that you'd like to have and you're in areas where there has been the case. I feel like we've addressed 85% of that already, with about 15% of that still to be addressed as we move through Q3 and into Q4.

And our next question from Morgan Stanley comes from Keith Weiss.

Keith Weiss - Morgan Stanley, Research Division

A lot of moving parts here and I'm feeling a little bit slow this afternoon. I was hoping maybe we could simplify for me. So coming out of Q1, there was a set of fixes that you guys had put in place, maybe you can walk me -- to what degree were those fixes the right fixes? Were they successful? And when you're talking about these new fixes for Q2, how many of them are new? Or is it just adjusting what you've done before?

Kevin B. Thompson

Yes, good question. So what I would say is that the decisions we made in the first quarter, I think were the right decisions. And the changes we made were the right changes. Some of those changes had your positive impact in the second quarter. Some of those changes are just beginning to have a positive impact now. I figure we did make a fair number of changes. I think we did a pretty good job of executing those changes. We could have done a little better job which means we would have, I think, a little quicker impact on the positive side that we've had. But I think all of the changes we made in the first quarter coming into Q2, were the right things to do, either have had or will have or are having now, a positive impact on our sales performance and our marketing performance. So I feel like we've made a lot of right decisions. Some of them we've had to tweak just a little bit because we didn't get them to a 100% right, but we got them to 80% right. As I look at what we've done in Q2, some of it is different. Some of it is taking what we've learned in Q1 into [indiscernible] a little more aggressive than we were as we moved into the second quarter [indiscernible] is shuffling, maybe, is a good word of the way the sales is impacting [indiscernible] saying that the opportunity to attach products when we've got a customer on the phone with multiple problems. So that we solve all of the problems we can on that call without slowing down the sales cycle, and that's the magic. So I think we've done some more changes when we walked into the third quarter that will cause that to be more effective. I also believe that we have put a sales structure in place at the top sales management level that is the most scalable structure we've ever had. And that's required some meaningful change. It required a little bit of pain but those changes are already having a positive impact on both performance and morale, and I'm pretty excited about them. So some of them are new, I good bit of what we did as we walked into the third quarter was new. Some of it was just tweaked of what we did in the second quarter, but I do feel good about where we are right now. I don't see there are any big changes left that I would expect to make over the next 2, 3 quarters. I know something could pop up that I don't expect to see right now, but I would be a little bit surprised. I feel like we have done the things to put an organization in place that's going to get us to $500 million and beyond in revenue from a sales structure point of view. We still have some work to do on the marketing side. Mike mentioned in his comments that we got some important marketing hires that I'd like to make in the third quarter that will give us some more depth and give us some more leadership. And then we can attack more problems simultaneously. I think I've let that team run a little too thin, and they've got kind of more to do than that management needs to do right now, that's why they need some help. And maybe need some more depth in your experience on that team. So that would be the area where I wouldn't tell you I'm exactly where I want to be at this point in the quarter. But I would expect that at least by early fourth quarter, I'll have the remaining piece of that puzzle in place, and we'll be in really good shape as we look at 2014.

Keith Weiss - Morgan Stanley, Research Division

Got it. So then just in terms of the license miss in Q2, so then -- it sounds like as a result of perhaps some of the changes in Q1 took longer to take effect than you anticipated but also maybe some new problems popped up within Q2. So a, is that the right way to characterize it? B, how do you get confident that the same sort of effect doesn't impact Q3, that you're confident you gave yourself like Mike was saying, enough leeway that these changes will sort of -- you get to the results that you need?

Kevin B. Thompson

Yes, so look, I think that the single biggest issue that we had in the second quarter was our performance in EMEA. It just -- the business really slowed down in the -- in late in the second quarter, in May, and then it just didn't pick back up in June. So that's really the single biggest issue we had in the quarter. I feel like we've done a couple of things: So, one, we made some really good changes to that sales organization. We've implemented some of the things that worked really well in North America like the install base sales team and a couple of other things that are not quite as significant as that. So I expect to get positive results in third quarter. We also took a lot out of the EMEA forecast. And in the third and fourth quarter, as part of the outlook that Mike provided, it's the single largest reduction we've made in the forecast on a percentage basis as we look to the -- at the last 6 months of the year. So I don't think that, that business presents a significant risk as we look at Q3 and Q4 because we made some changes that feel good or we're starting to see some positive results. We've also given ourselves a fair bit of room. As I look at the forecast from the back half of the year, to be honest, it's painful for me. It's not the growth levels that I expect us to be at. It's not the growth levels I wanted to be at. It's not growth levels that I feel good about. But they're growth levels that my guys feel positive about our ability to reach and then give us time and give us room, we believe, to do the things that we need to do to drive much higher growth as we exit the year and make sure that we have a tremendous amount of momentum is the goal and the plan as we enter 2014. So we don't feel great about the outlook but what I feel great about is the things we've done strategically. I think we have put the right places -- pieces in place. We've got a business model that has tremendous leverage that gives us a lot of money to invest. We've got a set of markets that we can attack with a great set of technologies that we've pulled together over the last couple of years that are really comprehensive in their ability solve problems for system administrators and for network managers and for IT pros that are generalists. We can solve most of the problems we have. We really do have the ability to solve most performance problems of IT. So the market is there, the products are there. I think we've got the right team in place with the few things we need to add that we can get back to that 20% plus growth that we're driving this business at. So we're not willing to commit to that for the last 6 months of the year because we've got some things we need to see them work and some things that we've done. We want to make sure they gives us the level of results that we expect. So that's where we're driving the business, that's where we believe the business ought to be. So that's the long answer to your question but that's where our heads are at.

Operator

And our next question comes from Scott Zeller with Needham & Company.

Scott Zeller - Needham & Company, LLC, Research Division

Wanted to get back to a discussion around the quality of leads. There's been excellent growth in the transaction count and I think, Kevin, you had talked earlier about the leads. Can you give us some more color around what your view is on the quality of those leads over the past few quarters? And is that something that is perhaps not where you want it to be? And how difficult is it to change those, the quality of leads, if you can go through that...

Kevin B. Thompson

Yes. Good questions. You're right. We've had really strong core product transaction volume growth in both the first quarter and the second quarter. So if you just looked at that, you'd say, "Hey, things are going well. You're driving a lot of growth in volume and transaction. Your growth in volume and transaction, after the decline in ASP, your average transaction size would be -- it looks like it ought to be enough to be driving a much stronger first 6 months than we've had." So I do feel good about that. I feel good about the overall volume of transactions of the core products that we're driving. What I don't feel good about is some of the products within that mix where we're not driving the volume of growth that we believe we can drive and that we believe we should drive. And a lot of that's around the core network management product where we have -- we just haven't dialed in to the exact right mix of quantity and quality. So in Q2, we drove a much higher quality of downloads. Our conversion rates were better. Of those downloads, there's an opportunity, and those opportunities into deals closed. We closed more business from downloads generated in the quarter than we closed the business in the quarter in Q2 than we did in Q1. So we did a lot of good things on the demand generation side in the second quarter. That's why -- look, I'm disappointed in the shortfall of license sales but not worried about where our business is headed because we did a lot of good things. We just didn't get it -- we just didn't get the recipe exactly correct. We will get that recipe right. And we hope we get it right in Q2. We give it our -- we're giving ourselves the room to continue to adjust it for a little bit longer. I think that's where the impact of an environment that has changed has had on kind of how we look at our business with the metrics that we track. How long does it take? I can change the quality/quantity dial very quickly. We can literally change it in a matter of days or a week and then start to see the impact of that change but it takes longer for the impact of that change in terms of just raw volume of demand that we create. What takes longer is to see what impact that had on conversion rate all the way to deals closed. Because our average sales cycle is still in that 30- to 45-day range to maybe 60 days. And you know what products we're talking about? So the demand dial, we can turn up and down very quickly. And how that translate into deals closed takes a little bit longer. When we've started to turn the demand dial back up in June, when we saw that we weren't getting enough volume in the first couple of months of the quarter. We started to turn the volume dial back up. We're now about 55 days, maybe 45 days into turning that volume dial back up. We're just now starting to get a feel for what that's going to mean on closed transactions. So we don't have all the data we need but we're not that far away from it.

Scott Zeller - Needham & Company, LLC, Research Division

Okay. And just a follow-up, Kevin. So I'm hearing year-over-year transaction count up nicely, conversion rates up Q-to-Q. Does that suggest then that the execution in sales and the bundling effort or attach rate is where the weakness is?

Kevin B. Thompson

Well, I would say in North America, we definitely didn't have the kind of attach rate we'd like to see. They can be better -- they weren't awful. They just weren't improving at the rate we want them to improve, and I mentioned that in my remarks, that we didn't get the increase in the number of products per transaction that we were expecting. We got a little bit of an increase, 2%, but it wasn't as high as we anticipated it would be. So we did have positive improvement in the quarter but not the level of positive improvement that we wanted to have. In Europe, we just didn't perform well in Europe, and there's not one thing I can point out, I could give you -- and I did give you did several, 4 or 5 things we didn't do as well as we thought we would. We've addressed all of those issues and we expect to do better in the third quarter. So that's the way I'd respond to that question.

Operator

Next question comes from Greg Dunham with Goldman Sachs.

Mark Grant - Goldman Sachs Group Inc., Research Division

This is Mark Grant, on for Greg. Just a couple of quick ones for me, and I apologize if you've touched on this already, but if you could give a little bit of color around how some of the higher-end Orion and larger ASP network management deals, how the linearity was over the course of the quarter? And then, how you're seeing that so far in July? And then shifting gears, afterward, if you could talk a little bit about the -- your taste for acquisitions going forward if you're going to maintain that same acquisition cadence? Or if you want to take a little time off and digest N-able before you go after something else?

Kevin B. Thompson

Yes. So, as I've mentioned -- we mentioned in our remarks it was a bit of a barbell as it relates to the quarter. We had a good April, a good start to May, then we had a pretty weak finish to May and our close rates were not really where we want them to be. Then we saw those close rates improve across the months of June. So it was kind of an odd quarter for us in that it was good on both ends and not good -- not as good as we'd like it to be in the kind of second half of the middle. So that's really where we saw the weakness, and that is the bit of the defecit that we've created for ourselves that we thought we would overcome in June, as we looked at June because we saw June was accelerating. We just couldn't accelerate enough to cover the defecit that we left ourselves as we exited May. Then next [ph] acquisition -- I think the good thing about N-able, and I mentioned this when we did the call in May, maybe to reiterate, we got a really solid management team, I mean, in the N-able acquisition. That team knows what they're doing. They've been successful for the last couple of years, they don't need our help to be successful. We are providing some expertise, we are providing some knowledge about some of the things we do we that we think will positively impact their business. We're partnering with them a lot on the technology front, as I indicated, to decide what technology of ours, what features of our products that we think can be successful in their platform. What features in their products do we think we can repackage and sell the way we sell technology. So we're partnering pretty tightly there, but that team really is able to run that business without a tremendous help from our organization. That team reports to their COO, who's been in place for a number years and he reports to me. With them, it's really not distracting the operational side of our business much, other than on the finance side, where Mike is having to do a fair bit of work to integrate the system so we get on one system over the next couple of quarters. That's the one area where, I think, it's caused a bit more effort. Across most of the rest of the business, they're really not involved with the N-able team. I'm really running that -- as an organization, they've got a strong management team and we decided before we bought them that, that's how we're going to run them. That gives us the flexibility, to answer your question nowm that if we find a good acquisition to do that can either improve our business management or network management portfolio or could improve the positioning that we've begun to create with N-able, in terms of cloud delivery. We're still going to look at those because N-able has not eating up a tremendous amount of resource internally, right now. I do think we've got the capacity if we find the right thing. We're looking for the right thing. I don't think our volume of deals will be as high. In 2013, there already hasn't been in the first 6 months as it was in 2012. So we'd have to get really busy to do as many deals in 2013 as we did in 2012. But I think maybe the maturity of the deals we do would be slightly greater than what you saw in 2012. I think we've done a lot of the really small technology tuck-ins but we don't need many people. We just need some technology. Doesn't mean we won't do some technology deals, we may, but that's maybe the long answer to your question, so if we buy something, don't be surprised. If we don't, don't be surprised either. We're going to be selective. Were going to do deals that we believe have -- that will have a positive long-term impact on the business, focus more on transactions where ASP, the product we buy, are in that $6,000 to $8,000 range versus the $3,000 range that most of the deals we did in 2012 were at because I think that's kind of where we ought to be as we look at 2013 and 2014.

Operator

From FBR Capital Markets, we'll go next to Daniel Ives.

Daniel H. Ives - FBR Capital Markets & Co., Research Division

Kevin, I mean, obviously, you guys have had massive success over the last few years. But then obviously, there was the dark period in '09, '10. What should give investors confidence that we're not going into a Groundhog Day situation in terms of what we saw a number of years ago with 3, 4 missed quarters in a row? I mean, do you feel that you got your arms around this? That this is kind of -- this is it and we kind of maybe stabilized from here?

Kevin B. Thompson

Yes, it's a good question. So first, I guess, what I'd say is, back in 2010, we had 2 rough quarters and then we came out of that then we've really been on a tear until we got into early this year. So the other thing I would say is look, we definitely didn't deliver the level of growth we wanted to deliver. We still grew north of 20%, we delivered 54% operating margin and I guess one of the things I'd challenge investors is go find me another story that's able to be a little short on the revenue number and beat their profit number, earnings per share number and their cash flow number the way we've been able to do historically. So I don't know that I'm here in the dark days I know there's a couple of quarters we didn't do as well as I'd like it do. I think we have built a business that has tremendous strength, tremendous leverage, that has a big growth opportunity in front of us. I think we've shown the ability as a management team before that when we run into a bump, we're going to get over that bump and when we get over that bump, we're going to start to grow again and deliver more of the kind of results that we expect from ourselves much less what investors would like to see. I do think we're in a dark period. I think we've had a bump. All companies go through a bump at some point and we've gotten to be a pretty large company, but I do think we understand what the issues are that we need to address. I think we've addressed a number of those issues. We are driving hard to have results that are much stronger as we move forward than what you saw in the first 6 months of the year. But even the first 6 months of the year, we grew over 20%. I know there's not that many companies growing that fast right now. So I get what we need to deliver on the outlook we provide. That's not lost on us. I want to grow a lot faster than we're growing. I'm not enjoying myself over the last 6 months. It's not where I want us to be. I've got a great team and a great platform and a great set of technologies and a really big market that we believe we barely scratched the surface of. So I'm confident that we're going to grow, we're going to grow faster, that we're going to deliver on the promise that this company has. So what I'd say to investors is one, we're a 20% grower even when you say we're in our dark days and a 54% operating margin company, that's not bad. We will do better than that and a bunch of people doubted us in 2010. They should have bought and held shares in 2010. You can doubt us again, I'm not going to tell you what to do as an investor but we are going to grow. And we're going to deliver profit and cash flow that most companies will never be able to deliver on a percentage basis. That's the power of our business model.

Daniel H. Ives - FBR Capital Markets & Co., Research Division

That was an insightful answer. In terms of international, I mean, obviously, Europe is where you saw some soft spots there. I mean, in terms of just replicating the model within the U.S. international. Obviously, that's a big ingredient in the potential growth. Does it feel like it's just the right people filling in the right spots there? I mean, did you still feel like penetration, the model, it was going to be as successful internationally as it's been in the U.S.?

Kevin B. Thompson

Yes, I mean, we are an international business. If you ignore the last 2 quarters, we've been growing faster than our North American business for quite some time. So we've had a lot of success internationally. We've had a lot of success in Asia, we have a lot of success in Europe. But I think we've proven the model works. And we've proven that our go-to-market is effective in those markets. It's a matter of doing a better job of converting the demand or receiving. Doing a better job of scaling our teams, making sure we get the level of depth and maturity leadership level that we need. And in certain countries, we haven't even scratched the surface of the market opportunity, much less, not hitting even close in any kind of point of saturation. In Germany, we're still very small. We're still not getting the level of growth in Germany I'd like to see us at. We're not at the growth size in Germany we have to be at, given the size of that market even though we've made progress over the last year. In the U.K, we did pretty well, but we can grow faster. So there's no market, I would say, we're doing as well as I'd like to see it, but we have grown very quickly internationally. I don't think there's a question, does the model work? We had to make sure that we scale. That's not a question if the model works.

Operator

We'll go next to Ginette Rowe with Evercore Partners.

Kirk Materne

It's Kirk. Just a quick question for you guys. Kevin, I guess, you talked about the quality and the quantity dial. I guess when you get into the international markets and you get into multi -- multiple geographies in Europe, I guess how much harder is it to sort of shift that around? And I guess, how does that play into your thought process on, I guess, Europe and, I guess, internationally more broadly as you guys think about the second half of the year?

Kevin B. Thompson

Yes, so if you look at just growth demand, the growth level of demand that we get in no way converts into for a moment, there's actually, we get more growth demand outside North America than we get inside North America. So it's not a question of can we drive volume. There are certain countries where I'd like us to be able to drive more volume than we're driving. It just looks in total at international but we do have the ability to turn that volume quality mix almost as quickly as we can turn it in North America on a just overall look at the total international business. There are countries where it takes a little bit longer because the growth volume of the demand is not quite as high. The awareness of our brand and all the things that our brand stands for is not as high as I mentioned in my remarks. One of the areas we're going to invest in as we look at the second half of the year is really invest in awareness in those countries in the international marketplace where we're not well enough known and where the breadth of the problems we could solve is definitely not well enough known because those are the areas where it's not quite as easy to just turn it up. Bit if you look at just total volume growth, it's really not that much more difficult.

Operator

Our final question comes from Tim Klasell with Northland Securities.

Tim Klasell - Northland Capital Markets, Research Division

So my question has to do with -- sounds like as you turn the dial on quantity versus volume, I was wondering how does the ASP reflect with that? As you turn up the dial on volume, are you seeing ASPs come down? Or are we seeing sort of just a fundamental shift in the purchasing habits of your potential customers?

Kevin B. Thompson

Yes. So, I mean, when you look at some of the metrics we disclosed, we saw a number of core product transactions go up every -- go up per transaction, go up ever so slightly during the quarter. We saw -- it went up about 2%, average transaction size went up by 8% sequentially. We saw a positive impact, the number of products per transaction and average transaction size is the results of 2 things: one is demand was a little bit higher. We added a few more sales reps on the floor net, which allowed us to do a better -- a little better job on driving average transaction size. I think the quality level can drop a little bit as long as we get all the capacity added that we intend to add, then we can still hold that average transaction size around the level that we had in the second quarter. We said in the first quarter, don't expect it to come up really quickly because we are driving a lot of volume growth, as evidenced by the 30% core product transaction volume growth that we've sold on the commercial side in the quarter, so that volume growth will limit a little bit in the mix of products is that then we will have a little bit of rate at which it will grow that average transaction size. I feel good about where we grew it to in the second quarter. I just wanted to do a few more transactions then we would have been in a good shape.

Tim Klasell - Northland Capital Markets, Research Division

Okay, good enough. And then going back to the question around saturation of the market. Maybe you said it earlier on, I've been juggling a few calls tonight. But what was the growth rate on the network side versus the APM side? I think you broke that out last quarter and I didn't quite pick up on it on any of the comments so far.

Michael J. Berry

Tim, it's Mike. So network management -- total revenue for network management excluding loss of that manager grew by 17% year-over-year versus 15% last quarter. And then our systems business grew by 38% year-over-year and the tools business was relatively flat.

Jason Ream

All right, everybody. Thanks for joining us. And that concludes our second quarter earnings call. Have a good day.

Operator

And ladies and gentlemen, that does conclude today's presentation. We thank you for your participation.

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