N-Able Inc

NYSE:NABL

Earnings Call Analysis

Strong Revenue Growth and Strategic Focus Drive Positive Outlook

In the second quarter of 2024, N-able reported revenue of $119.4 million, a 13% increase year-over-year, exceeding their guidance. Adjusted EBITDA was $46.8 million, with a robust margin of 39%. The company emphasized its strength in security solutions, with a notable contribution from its new Managed Detection and Response (MDR) service. N-able's shift to long-term contracts, now making up 40% of revenue, is set to enhance stability and growth. The financial forecast for 2024 has been raised, with expected revenue between $463 million and $465 million and adjusted EBITDA between $165.5 million and $167.5 million.

Strong Financial Results Reflect Growth and Resilience

In the second quarter, N-able reported robust financial results, exceeding expectations with total revenues of $119.4 million, marking a 13% year-over-year growth in both reported and constant currency terms. Adjusted EBITDA reached $46.8 million, resulting in an impressive adjusted EBITDA margin of 39%. This achievement constitutes the company’s seventh consecutive quarter operating above the Rule of 45, indicating consistency in maintaining high growth alongside profitability.

Acute Focus on Cybersecurity Fuels Demand

Cybersecurity has emerged as a top priority for small and medium-sized businesses (SMBs), with 60% of surveyed companies citing it as a major concern. N-able's comprehensive security solutions, including endpoint detection and response (EDR) and managed detection and response (MDR), are capitalizing on this demand. The company's EDR solution currently protects about 1.8 million endpoints. Furthermore, N-able's new MDR solution has gained traction, becoming one of the fastest-growing products.

Long-Term Contracts Drive Stability and Customer Growth

N-able has made significant strides in transitioning its customer base from month-to-month arrangements to long-term contracts. Starting the year with less than 10% of revenue from these contracts, the figure has climbed to approximately 40%. This strategic move is projected to enhance operational predictability for both N-able and its customers, aligning with the growing trend among Managed Service Providers (MSPs) favoring stable relationships over flexible consumption.

Financial Outlook and Guidance for Future Growth

Looking forward, N-able has provided guidance for the third quarter of 2024, predicting revenues between $114.5 million and $115 million, equating to a 6% to 7% growth year-over-year. For the full year 2024, the company expects revenues of $463 million to $465 million, reflecting around 10% year-over-year growth. Moreover, N-able has raised its full-year adjusted EBITDA outlook to between $165.5 million and $167.5 million, indicating a 16% increase at the midpoint. This positions the company for sustainable growth despite anticipated short-term challenges.

Adapting to Market Dynamics with Strategic Investments

N-able is aware of the macroeconomic uncertainties affecting MSPs and has acknowledged the importance of cost optimization among its customer base. Nevertheless, the company reported a 20% year-over-year increase in bookings, highlighting strong demand for its services. N-able's proactive approach includes investing in enhancing its IT management platform while offering innovative security and data protection solutions that promise to capture a larger market share.

Resilience and Long-Term Vision in a Changing Landscape

Looking ahead, N-able remains committed to increasing its footprint within the burgeoning cybersecurity and IT management market. The company aims to achieve mid-teens growth driven by successful tactical execution, emphasizing product innovation and deepening existing customer relationships through strategic upselling and cross-selling initiatives. This trajectory not only reflects N-able's confidence in its long-term potential but also positions it well to navigate the evolving landscape of managed IT services.

Earnings Call Transcript 2024-Q2

[Operator]

Welcome to the N-able Second Quarter 2024 Earnings Call. My name is Sam, and I will be coordinating your call today. I will now hand you over to your host, Griffin Gyr, to begin. Griffin, please go ahead.

[Griffin Gyr, executive]

Thanks, operator, and welcome, everyone, to N-able's Second Quarter 2024 Earnings Call. With me today are John Pagliuca, N-able's President and CEO; and Tim O'Brien, EVP and CFO. Following our prepared remarks, we will open the line for a question-and-answer session. This call is being simultaneously webcast on our Investor Relations website at investors.n-able.com. There, you can also find our earnings press release, which is intended to supplement our prepared remarks during today's call.



Certain statements made during this call are forward-looking statements, including those concerning our financial outlook, our market opportunities and the impact of the global economic environment on our business. These statements are based on currently available information and assumptions, and 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 those highlighted in today's earnings release and our filings with the SEC.



Additional information concerning these statements and the risks and uncertainties associated with them is highlighted in today's earnings release and in our filings with the SEC. Copies are available from the SEC or on our Investor Relations website. 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 non-GAAP financial measures. A reconciliation of certain GAAP to non-GAAP financial measures discussed on today's call is available on our earnings press release and our Investor Relations website.



Now I will turn the call over to John.

[John Pagliuca, executive]

Thank you, Griffin, and welcome to everyone joining us on the call. Today, I will discuss our second quarter results, our progress on top business objectives and share an update on the market environment and other strategic initiatives.



Let's start with our results, where we exceeded the high end of our top and bottom-line guidance. Revenue was $119.4 million, growing approximately 13% year-over-year on a reported and on a constant currency basis. And adjusted EBITDA was $46.8 million, representing an adjusted EBITDA margin of 39%. This marks our seventh consecutive quarter operating north of the Rule of 45 on a constant currency revenue growth and adjusted EBITDA basis.



Security was a standout theme in the quarter. Small and medium-sized businesses are feeling acute pressure to protect their operations. According to the U.S. Chamber of Commerce Small Business Index report, 60% of surveyed companies cite cybersecurity as a top concern. Our extensive security portfolio of advanced endpoint detection and response, managed detection and response, password management and e-mail protection offers the critical protection they deserve.



As one testament to our success in delivering enterprise-grade protection to the SMB, we now protect approximately 1.8 million endpoints with our EDR solution. Powerful capabilities and our frictionless buying experience are key to the success. Enabling 1-minute deployment, self-provisioning and easy configuration across the MSP's multi-tenant environment helped this robust security solution seamlessly protect SMBs while saving our MSP's time and money.



Our newly launched MDR solution is also resonating. While still in the early innings, MDR is tracking as one of our fastest-growing SKUs at this stage of its life cycle and with a considerable bright spot in the quarter. N-able MDR augment MSP operations, empowering them to provide human eyes on glass without burdening themselves with increased internal staff. This democratizes MSP's ability to add human interpretation to secure alerts and incidents, a true game changer.



We are confident that we are well positioned to continue penetrating this fast-growing multibillion-dollar MDR market. While stopping an attack is paramount, businesses must also ensure that they have software systems in place to recover data due to a successful cyber-attack, natural disaster, unexpected outage or any event that could cause data loss. Cove, our data protection solution does just that. With Cove, MSPs can quickly, comprehensively and affordably restore data and get back to business.



Our Microsoft 365 backup solution is now protecting 2.4 million users, and we continue to grow our share in this critical data protection market segment. Security is a priority across organizations. Our quarterly results reflect this paradigm with data protection and the security product group leading our growth. With rising threat levels and cyber regulatory requirements creating considerable pressure and risk, we are steadfast believers in the long-term demand for security software and are proud to bring MSPs and SMBs, the critical protection they deserve, efficiently integrated into our IT management platform.



Let's now look at the progress made on our top business objectives. Our product development engine continues to deliver new capabilities. In data protection, we dramatically improved our variable retention capabilities, allowing partners to meet changing legal and compliance requirements. We also further bolstered Cove's PSA integration capabilities. This PSA integration highlights product usage information, greatly enhancing the ease of billing. These strong value-added capabilities with clear use cases, build on our foundational product advantages of cloud-first multi-tenant architecture and favorable cost of ownership.



We continue to further cost position as a trusted protector of what our enterprise's most critical assets, data. We also made great progress with our RMM platforms. One exciting update is the strengthening of our identity centralization management capabilities. We now offer our partners an automated means of provisioning and deprovisioning users into N-able. This highly requested feature is a powerful time-saving enhancement.



MSPs face considerable complexity and often tedious repetitive process as they manage IT systems for multiple heterogeneous clients. Efficiency boosting improvements like identity centralization are critical for scaling their operations. These product efforts are resonating in the market. In Central, our leading RMM platform, led the way in our new customer acquisition motion, representing 4 of the top 5 new customer deals in the quarter.



And in central, customer list rose over 20% year-over-year. A growing number of MSP partner advocates and the strong presence of N-able MSPs on the top third-party MSP industry list gives us confidence that our improvements are meeting the mark. Our mission is to empower MSPs with software that makes IT simpler and safer and we are delivering.



On the go-to-market front, we made key advancements. From a geographic perspective, we invested in our direct sales motion in the German market at the beginning of the year. While we are still in the early part of the investment curve, lead generation has already nearly doubled. With the region representing significant GDP and MSP spending, we believe this investment will have a strong return over the coming months and years.



We are also seeing success with our business of security and co-master disaster recovery classes. These programs serve the dual purpose of educating customers on our product set and connecting them with MSPs, enabling them to learn from their peers.



Strategic repairing, a human in the loop approach with efficient digital initiatives is part of our customer engagement model that allows us to profitably access the fragmented SME market, and we believe that our go beyond technology model is resonating with our partners and prospects. We are also seeing traction with our direct and upmarket customer segments. In central IG sales continue to grow at a fast clip, and we saw continued success with larger enterprise-focused MSPs. This success reflects both market trends and our operational achievement.



From a market perspective, we have seen increasing IT complexity, prompting larger enterprises to outsource portions of their work to specialized mature MSPs. And on the operational front, our product innovation expands our appeal across the market. Our recognition on the MES mid-market 100 stands as a testament to our success in this sector.



Now turning to an update on our long-term contract initiative and the market environment. We entered 2024 with a strategic objective to transform our customer relationship. As the MSP market matures, so have our customer needs, scaling MSPs prefer operational predictability and stability over consumption level flexibility. To meet this growing demand and to drive a more predictable commercial relationship for N-able, we ramped up our effort to transition customers from consumption and/or month-to-month contracts to annual a multiyear agreements.



We began the year with less than 10% of revenue from annual multiyear deals. Now approximately 40% is from long-term contracts, and we expect most of our revenue will be long-term committed MRR by the end of the year. We believe this initiative cements our position as a strategic partner with our customers' operations and will drive stronger alignment and better long-term economics for both sides.



Providing our MSPs predictability drives multiple benefits for N-able. We believe entering into long-term contracts with our customers will help minimize future downward spending fluctuations and support strong gross retention. This initiative also frees up our partner success resources, allowing them to spend more time on symbiotic expansion-focused discussions, which can help drive high cross-sell and net retention. We are confident that long-term contracts are the right strategy for sustained success. That said, there have been near-term negative financial impact as customers optimize their estates before signing long-term deals.



Turning to the market. As MSPs continue to scale and strive for operational excellence, they remain cost diligent and face tight customer budgets. The endpoint security space is also maturing. Although these factors have weighed on our growth this year, our channel checks with MSPs remain positive, and MSPs continue to provide mission-critical IT and security services to hundreds of thousands of organizations globally. Customers continue to grow their business with N-able, with our bookings up 20% year-over-year. And while we navigate short term, our focus is on investing and executing with rigor to drive enterprise value over the long term.



Our game is fixed on 2 clear objectives. One top objective is modernizing our IT management platform. Modernization efforts have already delivered a new cloud management capabilities, core performance upgrades and a streamlined user experience. We believe that continuing to execute the strategic focus area will allow us to capture a broader and deeper slice of the expanding SMB IT estate and propel our growth.



Another objective is deepening our presence in security. Protection and resilience are paramount to customers and security and cloud backup spending generally projected to grow faster than broader IT budgets. We believe Cove, MDR and our powerful IT management platform, which is tailored to MSP's unique needs positions us to win in these attractive growth categories.



With that, I would like to turn the call over to Tim to discuss our financial results and outlook. And then I'll circle back for some closing remarks. Tim?

[Tim OBrien, executive]

Thank you, John, and thank you all for joining us today. Our second quarter results were strong, exceeding guidance on the top and bottom line. SMEs and MSPs continue to rely on our IT management, data protection and security solutions to produce critical business outcomes with data protection and security leading our growth in the quarter.



For our second quarter results, total revenue was $119.4 million, representing approximately 13% year-over-year growth on a reported and constant currency basis. Subscription revenue was $117.4 million, representing approximately 14% year-over-year growth on a reported and constant currency basis. Other revenue, which consists primarily of revenue from the sale of maintenance services associated with the historical sales of perpetual licenses and revenue from professional services was $2 million.



We ended the quarter with 2,194 partners contributing $50,000 or more of ARR, which is up approximately 1% year-over-year. Partners with over $50,000 of ARR now represent approximately 56% of our total ARR, up from approximately 55% a year ago. Dollar-based net revenue retention, which is calculated on a trailing 12-month basis was approximately 108% or 106% on a constant currency basis. As a reminder, our pricing and packaging changes, coupled with rationalization related to our long-term contract initiative began materially impacting net revenue retention starting in the second quarter.



Turning to profit and margins. Note that unless otherwise stated, all references to profit measures and expenses are calculated on a non-GAAP basis and exclude the items outlined in the GAAP to non-GAAP reconciliations provided in today's press release. Second quarter gross margin was 84.7% compared to 84.8% in the same period in 2023. Second quarter adjusted EBITDA was $46.8 million, up approximately 34% year-over-year, representing approximately 39% adjusted EBITDA margin



Unlevered free cash flow was $35.5 million in the second quarter. CapEx inclusive of $1.9 million of capitalized software development costs was $5.1 million or 4.3% of revenue. Non-GAAP earnings per share was $0.14 in the quarter based on 187 million weighted average diluted shares. We ended the quarter with approximately $158 million of cash and an outstanding loan principal balance of approximately $340 million, representing net leverage of approximately 1.1x. Approximately 46% of our revenue was outside of North America in the quarter.



Before turning to our financial outlook, I will give commentary on our second quarter results. Revenue was above the high end of our guidance range. Our performance was driven by steady demand, a positive FX impact of approximately $500,000 relative to expectations and a positive net impact from our long-term contract initiatives. The net effect of our long-term contract initiative in the quarter reflects a positive impact from accelerated revenue recognition in accordance with ASC 606 triggered by the signing of long-term contracts, partially offset by the spend rationalization from some customers that John mentioned.



About 15% of our ARR is on-premise in nature, and ASC 606 accounting standards call for a portion of on-premise revenue in long-term contracts to be recognized as a lump sum in the month the contract begins with the remainder recognized ratably over the contract term. This resulted in an increased amount of in-period revenue recognized from customers that transitioned from month-to-month arrangements to long-term contracts.



606 treatment drives lumpiness in revenue results, which flows through to our adjusted EBITDA and will impact revenue and adjusted EBITDA in future periods. We expect the net positive impact from the long-term contract initiative to be most pronounced in the second quarter and to result in a net positive impact to revenue for the year.



Turning to our financial outlook. Our guidance accounts for the following elements. First, we are assuming FX rates of 1.08 for the euro and 1.27 for the pound for the remainder of 2024, along with updates to other currencies to more closely reflect the current rate environment. These updated rates drive approximately $1.3 million of positive revenue impact for the remainder of 2024 relative to our FX assumptions during our May call.



Second, our guidance reflects continued success in converting customers to long-term contracts. We anticipate the net revenue impact associated with our long-term contract initiative will be less pronounced in the second half of the year. We anticipate net retention will face moderate near-term pressures to drive long-term benefits. Third, we anticipate operating in an uncertain macro environment. With that in mind, for the third quarter of 2024, we expect total revenue in the range of $114.5 million to $115 million, representing 6% to 7% year-over-year growth on a reported basis and approximately 7% growth on a constant currency basis.



We expect third quarter adjusted EBITDA in the range of $39.5 million to $40 million, representing an adjusted EBITDA margin of 35%. For the full year 2024, we now expect total revenue of $463 million to $465 million, representing approximately 10% year-over-year growth on a reported and constant currency basis. We are raising our adjusted EBITDA outlook and now expect full year adjusted EBITDA in the range of $165.5 million to $167.5 million up approximately 16% year-over-year at the midpoint and representing an approximately 36% adjusted EBITDA margin.



While 606 dynamics created shifts within the quarters, we are slightly raising the midpoint of our full year revenue outlook and profit outlook relative to our last guidance. We reiterate that we expect CapEx, which includes capitalized software development costs will be approximately 5% of total revenue for 2024. We also expect adjusted EBITDA conversion to unlevered free cash flow to be approximately 64% for the full year. We expect total weighted average diluted shares outstanding of approximately $187 million to $108 million for the third quarter and $187 million to $189 million for the full year.



Finally, we expect our non-GAAP tax rate to be approximately 28% in the third quarter and 25% for the full year. In closing, we were pleased with the second quarter and our ability to raise the midpoint of our full year revenue and adjusted EBITDA outlook. While we see some transitory pressures, MSP level retention and new customer acquisitions have remained steady, which we believe set a strong foundation for future growth.



We will aim to make selective growth investments to capture the growing market opportunity. And with our strong profit margins, cash generation and balance sheet, we also continue to explore avenues for inorganic growth.



Now I will turn it over to John for closing remarks.

[John Pagliuca, executive]

Thanks, Tim. We believe we've made tremendous progress across the business in the second quarter and have ambitious goals for the second half of the year and beyond. Our view of the long-term opportunity and our growth outlook remains steadfast. With platform modernization and security fueling our product vision, we believe successful tactical execution can meaningfully drive the N-able growth algorithm forward.



Primary drivers include our contract initiatives and market shift towards larger MSPs to sustain gross retention in the high 80s to low 90s. Successful cross-selling of our expanded product set to drive net retention in the 110% range and growing the market presence of Cove, both with MSPs and internal IT, coupled with our new MDR solution to fuel new customer acquisition and contribute an additional mid-single digits of growth.



In total, we aim to grow the business in the mid-teens. As the recent global outage demonstrated, IT is needed to keep the world running. We believe that our mission to empower MSPs with leading technology has never been more important, and we are excited to continue to drive successful IT outcomes for businesses across the globe.



And with that, we'll open up the line for questions. Operator?

[Operator]

Thank you very much. [Operator Instructions] We have our first question from Matthew Hedberg from RBC.

[Michael Richards, analyst]

It's Mike Richard on for Matt. Maybe you guys could talk more about the optimization you're seeing from customers? Like how is that come in relative to your expectations? Where are you seeing it from customers in terms of your product portfolio? And then could you quantify that positive impact that you've seen? And was this like already contemplated in guidance heading into the quarter?

[John Pagliuca, executive]

Mike, this is John. I'll start. I'll ask Tim to add a little bit more color on the second part of your question. Look, I think it's important to make sure the reason for the strategy and the picture folks are aligned and understand that. We look at it. We've mentioned to this group and also just into the broader audience that within our base, we have an opportunity of about $30-plus per device per month. to really go realize. And we've been realizing about $3 to $4 of that.



And part of the strategy is to lock in our customers, give them the predictability so then we can focus on the expand. The timing of this exercise really is more related to the expansion that we have in our offerings. Now that we've added MDR now that we've added additional bits in Cove with that cross-sell opportunity, that white space opportunity growing, we felt the right thing would be to lock in the customer. So I would call it 2/3 offense, where we're really trying to lean in, but also 1/3 defense. When we go into a customer arrangement that's month-to-month or consumption based, we see fluctuations on what those billings would be.



And then most notably, the MSP market itself, not us, but the MSP market itself, we do see consolidation. And we believe that when we're locking in our customers to 2 or 3 years and there may be consolidation, now we have N-able has a much better opportunity to remain the technology stack of choice, which is what the MSP usually wants. And so, for us, it's also just being able to lock in those customers, focusing in on the growth and therefore, we can get going on really that expand part of the equation because the opportunity the white space within our base is massive. So that's really the big bits.



Where we're seeing some of the rationalization. Look, I'd say it's a collection of things. I can give you more of an anecdote in that if a customer might be giving us $10,000 or $15,000 of monthly recurring revenue. That's completely consumption based, and we're asking them to commit to a 36-month period. You can imagine that the customer might look for some pricing concessions in exchange for that long-term commitment. So we are seeing it in situations like that where we're asking the customer to lock in long term. And we're frankly fine with giving them some pricing concessions in exchange for that commitment as a strategic partner. So we're seeing it in there.



And then just by nature, when you're asking somebody to commit, they're going to go through their estate and see if there might be some solutions or some devices that they might not necessarily have if there's some software type of thing that they might try to realize. There's no really heightened product area, I would say, that's seeing it. It's more about, "Hey, you're asking me to commit to 24, 36 months, 12 months. Let me look at my estate and make sure that I'm willing to commit" because at the end of the day, these SMEs -- excuse me, these MSPs or SMEs, and they want to make sure that they're driving their top and bottom line in a responsible manner. So we expected some of this.



Overall, the LTC program has been ahead of the expectation as far as customers wanting to commit, willing to commit. So that gives us a good vote of confidence that we're putting the right products in market. And as a result, I think what ends up happening is we're ahead of that program, and you're seeing a little bit more pull in that related to 606. So the pull-in on 606 is more of a kind of an indicator that the customers are willing to commit. And as a result, we have a more resilient revenue base than we had even 6 months ago.

[Michael Richards, analyst]

Great. And then a quick follow-up. How did linearity shape up in the quarter? Was there anything you guys saw from like a macro perspective that things worsened heading out of the quarter into July and maybe now with some of the market volatility and given some software peers have seen some heightened macro uncertainty. Just some more color on that as well.

[John Pagliuca, executive]

Sure. The best indicator as far as some of the market velocity is with our bookings. And we referenced in the prepared remarks, elements of our bookings being up 20%. Overall, both in new customer acquisition and new SKU sales, our bookings were also up north of 20%. So that's a good indicator. Again, as late as this quarter, we're continuing to see our products resonating in the market.



Anything to call out within the month? Not really. I'd say overall, what we're seeing our customers really just really making sure that they're double checking more the price. The demand is there, MSPs are in high demand, all the channel checks support that, that the MSPs are continuing to be in high demand because they're providing a mission-critical service to their SMEs.



And those SMEs are quite resilient, right? These SMEs, for the most part, they're in health care, they're in the financial institutes, some are even in state and local government. So they're in recession resilient and, I would say, overall resilient SME markets. But that being said, those SMEs are double checking to make sure that they're getting their best value. And we're seeing MSPs making sure that they're paying their right price for things like endpoint security, as an example.

[Operator]

Our next question comes from Jason Ader from William Blair.

[Jason Ader, analyst]

On the bookings, up 20%, I just wanted to understand, is that some of the annual shift that's going on there? Because if you're going to do a multiyear 36 month, that's going to really help the bookings number. Is that a factor in why that bookings was so strong?

[John Pagliuca, executive]

Jason. Great question. I'm glad you asked this so that we could clarify. So the way that we define our bookings are it's the annual contract value. So the value of the 12 months. So frankly, even if it was a multiyear deal, we wouldn't be counting that way. So this is purely the annual contract value from the first 12 months and of our new customer acquisition, some new landed customers to N-able and then new SKU. So if you are a central customer and you made the right decision to now go and consume Cove, that would be a new SKU. And so, it excludes anything or any type of multiyear type of contract, I'd say it's all 1 year, 12 months.

[Jason Ader, analyst]

All right. That's helpful clarification. And then I guess I'm just trying to reconcile the bookings data with the guidance for the second half, which is under 10% growth. So how do you help us reconcile that delta.

[Tim OBrien, executive]

Jason, it's Tim. A couple of things. One we've spoken to before, one is the grow over the pricing and packaging changes that we spoke to last quarter or the last couple of quarters. And last quarter, we referenced, that's about a 2.5 to 3-point headwind in quarter 2, 3, 4 this year, and that will carry into Q1 of next year as well. And some of the transitory headwinds really carry for 4 quarters. And so that's part of that equation. That's not part of our bookings.



What's also not part of our bookings is any of that rationalization that John spoke to as customers have been moving into these long-term contracts. So those 2 things combined are what I would say, dragging the year-over-year performance that's factored into our guidance in the second half of the year versus the bookings component. So we're really trying to highlight that the fundamentals of the business are very strong.



Our MSP dollar retention is in line with the last 3 quarters. Bookings are strong, up 20% year-over-year. We just have a couple of those transitory headwinds that will carry with us through the second half of this year and into the early part of 2025. But post that, we'll grow through those transitory headwinds and we'll have the thesis and the benefit of really focusing on cross-selling into these long-term committed customers through the second half of this year and into next year and beyond to drive what we believe is growth acceleration in 2025, but more acutely in the second half.

[Jason Ader, analyst]

All right. Then just a quick 2-part follow-up. First is are other vendors in the market also moving to annual from monthly? Or are you guys unique there? And then secondly, why wouldn't you see more in-period rev rec in the second half like you did in Q2 tied to that shift from monthly to annual.

[Tim OBrien, executive]

Sure. Maybe I'll take the first one and you can take the second one. So yes, we are seeing competitors, in fact, a little bit of this. I mentioned the 2/3 offense and the 1/3 defense. Our competitors, by and large, are locking in customers to multiyear deals, actually.



So in some ways, we're playing a little bit more catch-up. It's also a good indicator as the MSPs mature as they're getting larger, there's a willingness. And actually, I would say, even a propensity to lock in the contracts for longer term, much more akin to an enterprise type of procurement relationship. So we are seeing the other larger players in the space do the long-term bit. And I can pass it over to Tim on the second part.

[John Pagliuca, executive]

Yes. And Jason, on some of the dynamics of the rev rec, as some of the revenue is accelerated or it becomes more lumpy on upfront, versus over time, it does take away from revenue in future periods. So all the success we had in the first half of 2024 on getting customers committed into these long-term contracts has pulled revenue into the first and more acutely in the second quarter, and that takes some revenue out of Q3 and Q4 for the rest of the year. So like we...

[Jason Ader, analyst]

If you're converting more customers to annual, why wouldn't you see more of that 606 impact in the.

[Tim OBrien, executive]

We will. But Q1 and Q2 did not have the headwinds from us committing customers prior to those quarters. So we really started this initiative at the beginning of the year. So there were no real headwinds in Q1 when we started this. There were minimal headwinds in Q2 where we saw, I would say, a bigger portion of ARR committed in that period.



Q3 and Q4 now have a bigger tax on them because of the success in Q1 and Q2. Q1 and Q2 did not have the same tax that Q3 and Q4 have from the dynamics. We have baked in and we have assumed that we continue to commit customers into that fashion, but it's offsetting some of the revenue that was pulled forward into Q1 and Q2 from the success that we have there.

[Operator]

Thank you very much. Our next question comes from Brian Essex from JPMorgan.

[Unknown Analyst]

This is Charlotte on for Brian. Quick question on the net dollar retention rate. I know you mentioned some headwinds associated with the pricing and packaging. Can you give us an extent of like how much the headwind is expected to hit that in future periods? And at what point do we expect it to, I guess, maybe go back to the 110 level or above, like at what point should be normalized? What do you have factored into guidance?

[Tim OBrien, executive]

Yes, absolutely. Yes, I'll reiterate some of the color I gave previously on some of the transitory headwinds we have on the net revenue retention for the second half of the year and will be part of the beginning parts of 2025 as well.



About 2.5 to 3 points is related to some of the pricing and packaging changes that we mentioned last quarter, coupled with the impact from some of the rationalization we've seen from the long-term contract initiative that we've implemented. So in terms of timing and the impact, I expect that impact to carry through the second half of this year and into Q1 and Q2 of 2025, I would expect a more normalized dollar-based net revenue pension rate in the second half of 2025.

[Operator]

Thank you very much. Our next question comes from Mike Cikos from Needham.

[Michael Cikos, analyst]

Maybe just to continue on that point for a second. If we think about those headwinds, is there a way -- like should we expect the headwinds to be most acute in 3Q and then abate thereafter? Or should this be like a mounting pressure where it will actually be the biggest headwind by the time we get to Q2 of next year. Like how do you think about the slope of this as it plays out?

[Tim OBrien, executive]

I would expect it to be steady on how we do the math on our retention rate is a trailing 12-month average. I would expect additional pressure that we mentioned in the prepared remarks on the dollar-based net revenue retention rate. But from a velocity standpoint, I would expect it to be gradually steady to gradually improving as we kind of chart through the end of 2024 and in 2025.

[Michael Cikos, analyst]

Okay. And I guess the other question, I know last quarter, we were talking about this as well as far as the shift to annual commitments. I just wanted to see with the first 6 months under our belts now. But what is the feedback that you're receiving? Like do they understand the reason for this push?



And I would think so if John is saying that this seems like it's a little bit more of a catch-up versus other players and competitors out there, but also trying to be cognizant of some of the pain out there just given people are trying to preserve capital and what is this uncertain macro we find ourselves in.

[John Pagliuca, executive]

Mike, it's John. Look, the customers, it's actually resonating quite well. I think the customers appreciate the level of predictability. We're giving them -- by the way, we're also -- unlike our competitors, our competitors kind of forced a lot of this on their customer base. We elected not to force this and make it an option. And so, I should make that clear.



And so I think the customer base appreciated the optionality that this afforded them. And effectively, the option was, hey, look, if you're going to stay consumption-based or month-to-month, there will be a steady stream of price increases. If you're looking to commit and provide that stability to us, that will turn into better economics for you that will turn into better predictability to you.



And so I think overall, given them the optionality is really resonating with the customer base. And then we can put our work and our collective focus on helping them grow their business, expand their services. And that's been the other thing. A lot of these conversations on earth opportunity when we're having conversations about their 2- or 3-year tech stack, what they're trying to do, their goals over the long term.



It's unearthing additional code opportunities that's one thing, additional MDR opportunity. So we're locking in, they're looking at us as a strategic partner and how we can focus on driving their business forward. So overall, I believe the tone is resonating is differentiated from what some of the other folks in the market have done and I think it's been appreciated.

[Operator]

Thank you very much. [Operator Instructions] We have a follow-up question from Jason Ader from William Blair.

[Jason Ader, analyst]

I thought I would ask a sort of zoom out question for you, John, just on this MSP space. Do you have a sense of how much of the SMB IT market has shifted to kind of the MSP model and approach versus running their own IT internally? And do you think a weak macro backdrop actually slows down or speeds up the trend, which obviously has been towards MSPs and outsourced IT. But I think it would help investors to just frame where we are in the market in terms of SMB IT shift to the MSP model.

[John Pagliuca, executive]

Sure. So ultimately, small, medium business, midsized companies, large Fortune 500 companies, they're all left with the choice. And that choice is how do I best monitor, manage and protect my assets? And what we're finding, Jason, is that more and more of those enterprises are saying it's more cost-effective to let someone who's specializing on this to actually provide part of it.



What we're seeing is more and more mid-market and larger companies using MSPs to augment, so the TAM in which the MSPs are actually servicing are growing because Fortune 1000 companies, mid-market companies are now looking to MSP to do part of that. Why? Because it's getting harder, right? And everyone is struggling with a very low unemployment rate for IT professionals and security professionals. So they're looking to MSPs to help with part of their stack. That could be patching that could be with a security service like an MDR offering that can be with the backup disaster recovery offering.



So by and large, we're seeing the demand for these MSPs to go to a further market. I've been in this industry now for over 11 years. And when I started, MSPs were primarily servicing the VSME, companies that were 50 employees and under. MSPs are now servicing Fortune 1000 companies.



And what's also happening is that these MSPs are growing up. MSPs are now publicly traded. MSPs are now part of several billion-dollar enterprises as a result of their maturity of their scale, they're now able to service larger and larger enterprises. So these provide tailwinds overall to the industry, and that's what has us confident in the long-term tailwind of the MSP space.



The service that these folks provide are mission critical. And if you're a CIO or a CISO of a midsized company or a large company, now with the level of maturity and the tools that companies like N-able provide, they now can rely on MSPs as a nice augment, a cost-effective augment. To your other point, if you're a CISO or a CIO of a mid-market company and you're faced with budget pressures from your CFO or your CEO, this augment plays a good way to offload maybe some of the higher labor costs if you were to do it yourself.



And so, I believe, actually, it's a nice play for mid-market companies for larger companies to take a step back and say, "Hey, where can I outsource some of my cost, some of my labor and do so in a cost effective, number one, but number two, in a lot of ways, more secure manner." And so, our technology allows for this co-managed play where an internal IT department can have eyes on glass, the same eyes on glass that the MSP can have.



So it gives the internal IT department the transparency that they want, but it saves them some of the cost because it's relying on that MSP to provide some of that labor and the expertise, which is why I believe, overall, for a bunch of factors, it's very much a recession-resilient industry.

[Operator]

Thank you very much. [Operator Instructions] We have no further questions. I will now hand over back to John for closing remarks. John?

[John Pagliuca, executive]

Thank you, operator, and thank you all for joining us today. Looking forward to talking to you next quarter.

[Operator]

That concludes today's call. Thank you for joining. You may now disconnect your lines.