N-Able Inc

NYSE:NABL

Earnings Call Transcript 2021-Q3

[Operator]

Hello, everyone, and welcome to the N-able Third Quarter 2021 Earnings Call. My name is Charlie and I will be your coordinator for today's call. You will have the opportunity to ask a question at the end of the presentation. [Operator Instructions].

I will now hand you over to your host Howard Ma, Senior Director of Investor Relations, to begin. Howard, please go ahead.

[Howard Ma, Senior Director, IR]

Thank you, Charlie, and welcome, everyone, to N-able's third-quarter 2021 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, our continued expectations following the spinoff of our business from SolarWinds in July 2021, 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 related to the spinoff transaction completed in July.

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 IR 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 on our IR website.

And now I will turn the call over to John.

[John Pagliuca, President, CEO]

Thanks, Howard, and thank you all for joining us today. First off, I want to express my gratitude to the entire N-able team for staying focused on operational execution. We rallied around the phrase Forward Together, and leveraged that sentiment to our MSP partners and N-ableite employee base to deliver on a successful spinoff.

It's still hard to believe that the transaction was only a few months ago and, with that milestone in our rearview mirror, everyone really has a renewed energy. It has been rewarding to witness the ownership and drive to serve our MSP partners across the entire organization, and it shows in our performance in the third quarter and what we are already seeing in the fourth quarter.

Our third-quarter revenue of $88.4 million exceeded the high-end of our outlook, representing approximately 16% year-over-year growth, which included approximately 2 percentage points of FX benefit. Our net retention rate remains consistent at 110% on a trailing 12-month basis, reflecting healthy expansion across our partner base while leveraging customers. For those that represent $50,000 or more of ARR on our platform, now represent 46% of total ARR as of quarter end.

We believe N-able is well-positioned in a dynamic industry with increasing tailwinds. Businesses both big and small around the world don't have the means to deal with ever-growing IP complexity and cyber threats. The digital evolution is accelerating with small and medium enterprises looking to differentiate their business and enable distributed workforces across a variety of environments and devices. As a result, SMEs increasingly rely on MSPs for proactive and recurring IT services.

We believe MSPs are and will continue to be the essential workforce for SMEs to serve mission-critical IT needs. Meanwhile, MSPs, and more broadly IT service providers of all types, need platforms aligned with the needs of their end customers. We saw continued robust demand for security and data protection offerings in the quarter, which was then outpacing our overall revenue growth.

Cyber security is increasingly top of mind for service providers of all sizes as cyber criminals exploit vulnerabilities in the supply chain and ransomware and phishing attacks become more prevalent. Partners are more intensely scrutinizing both the built-in security mechanisms within vendor products and vendor security protocols. Security is a core aspect of N-able's culture and we are committed to the shared responsibility we all have as technology companies within the MSP ecosystem.

The increased investments we have made in effective security management and our people, processes and technology is a strength we bring to our conversations with partners. With that in mind, I wanted to share some wins in the quarter that illustrate the power of N-able's model and our ability to capitalize on key industry trends, including platform standardization, MSP consolidation and heightened focus on cybersecurity.

First, a US-based MSP with a dedicated security practice signed a multiproduct six-figure ARR deal, including our RMM, EDR, backup and risk intelligence, which displaced an incumbent competitor. Our breadth of offerings, partner success programs and security capabilities were the deciding factors in this win.

Second, a Netherlands based MSP that recently acquired four partners chose to standardize on our RMM platform, also a six-figure ARR deal due to our ease-of-use, extensibility and our strong automation capabilities.

Third, in a similar situation, an existing US-based partner was acquired as part of the rollup strategy. The acquirer was looking to standardize multiple RMM platforms onto one. And after a competitive process, ultimately chose N-able due to our scalability, automation capabilities and partner success programs, which resulted in a large five figure ARR deal.

These standardization plays reflect our leadership in RMM and indicate that our strategy, product mix and approach to partner success are resonating with market demands. We matter the most with the messiest for our MSPs and tens of thousands of partners around the world prove that.

We also had some notable expansion deals in the quarter. First, a US-based partner that was using a competitive RMM vendor for a separate companies' division standardized on our RMM while also adopting EDR, resulting in a six figure ARR deal through the preferred vendor due to our ability to drive efficiency via automation of key processes, resulting in reduction of labor costs for the MSP.

Second, we had a five figure ARR EDR cross sell win to a Canadian MSP that has been an RMM customer for over five years as they upgraded their endpoint security posture.

Third, we had a large five figure ARR data protection cross sell deal to a UK-based MSP. Here we displaced a competitor with our fully cloud-based image recovery approach to backup that is fast, comprehensive and highly cost-effective.

We are seeing success across several areas that reflect fundamental pillars of our go-to-market strategy. From a technology perspective, we win because of our platform's scalability, security and extensibility. Our partners need technology that is powerful and easy to use, which enables them to deliver high-value to their end customers while earning higher profits for themselves.

For instance, our EDR solution, powered by native integration with SentinelOne, is being leveraged by many MSPs to increase both revenue within their existing customer base and to win new customers. Our EDR allows partners to create advanced security packages containing behavior based threat detection and faster return to operation times with rollback capabilities. It makes it possible for partners to decrease risk to their customers while increasing their margins.

The expansion deals I highlighted are all-around team efforts and evidence that our partner success investments are paying off. Every day partner success managers work to help partners identify business challenges and leverage our proprietary resources such as the MSP Institute, Head Nerds and MarketBuilder solve those challenges.

They also help connect success engineers and sales engineers with partners to resolve technical issues while educating them on automation security features. Partner success is a critical component of our customer centric culture. Our focus on partner success allows us to listen and learn from our customers, which directly informs innovation, what new products to bring to market and how to best meet customer needs.

Moving along, I wanted to share some third-quarter product highlights. We were recognized in CRM's 2021 annual report card as the best-in-class MSP platform, ranking first in three of four major categories scored, including product innovation, partnership and managed and cloud services. Our Mail Assure email security solution received Virus Bulletin's verified spam plus rating with zero false positives.

Our Microsoft engine integration continues to provide value for customers looking to manage Microsoft devices. We now have over 400 MSPs using this capability. And as we look ahead to Q4 on the product front, our DNS filtering offering is in preview in a limited number of customer live environments and the early feedback has been positive. This not only marks an important addition to our security stack, but also illustrates our differentiated ecosystem approach.

By enabling our solution via a single pane of glass and natively integrating with leading third-party technology providers, our ecosystem framework powers a flexibility and extensibility that our partners desire. Additionally, our solutions fully support the recently released Microsoft Windows 11 operating system. This was a significant release and a major event for our partners to upgrade and migrate their customers.

N-able continues to work diligently to help ensure that partners and prospects experience this new transition to the upgrade. We will fully support Apple's new Mac OS Monterey by the end of this quarter.

Now I will touch on the progress we've made through branding, marketing and recruiting efforts before turning the call over to Tim. While we officially rebranded in March, it takes time for a new brand to fully resonate. About six months after the rebrand, the number of monthly search queries for N-able has multiplied nearly tenfold, surpassing what we were getting as SolarWinds MSP.

In addition, the number of monthly qualified opportunities generated from brand queries has increased significantly in comparison to the same period a year ago before our name change. We will continue to improve and refine the Why N-able story by demonstrating the differentiated value of our solutions relative to competitors. Our website is a key vehicle for the story and we are revolving our online presence and positioning to demonstrate our value proposition, prospects and existing partners.

Additionally, we plan to increase our marketing activities with more N-able hosted events, participation in trade shows, engaging videos and webinars. And last but not least, we remain focused on hiring and retaining top talent to support our growth initiatives. In the third quarter we launched what we call The Way We Work, which is a hybrid working model based on trust and flexibility that supports meaningful interactions for our colleagues.

We are committed to exploring innovative ways to support our growing base of more than 1,300 N-ableites around the world. Thank you. I will now turn the call over to Tim for a review of our Q3 financial results and outlook.

[Tim O'Brien, EVP, CFO]

Thank you, John, and thanks to all of you for joining us on the call today. I will start out with a note that our third-quarter financial results contain a 19 day sub period, during which we still operated as a part of SolarWinds prior to the completion of our spinoff. For those 19 days, our financials were calculated using carveout methodology. Starting in the fourth quarter, N-able financial results will be presented on a completely standalone basis.

As John mentioned, total revenue in the third quarter was $88.4 million, an increase of 16% year-over-year, and included approximately 2 points of FX benefit. Subscription revenue was $86.1 million, an increase of approximately 17% year-over-year. Other revenue was $2.3 million, down 11% year-over-year, and primarily represents maintenance revenue from a legacy license model that we discontinued in the first quarter of 2020.

Quarterly performance continued to be driven by our security and data protection solutions. Revenue from our N-able EDR and staff cloud-to-cloud backup solutions outpaced overall revenue growth. From a geographic perspective, revenue outside of North America represented 49% of the total. Dollar-based net revenue retention, which is calculated on a trailing 12-month basis, was 110%.

Our healthy expansion rates have been driven by our partner enabled growth model where we grow by acquiring new partners when existing partners acquire new end customers and when they manage more devices and deliver incremental services powered by the N-able platform. We ended the quarter with 1,662 partners that represent $50,000 or more of ARR with us, a 25% year-over-year increase. Partners with over $50,000 of ARR now represent 46% of our total ARR, up from 40% a year ago.

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.

Third-quarter gross margin was 87.7% compared to 87.4% in the third quarter of 2020. Adjusted EBITDA was $29.7 million, representing an adjusted EBITDA margin of 33.6%. Unlevered free cash flow was approximately $1.3 million in the quarter and contained two one-time items. The first was a $20 million outflow representing a net repayment to SolarWinds related to intercompany trade payables which occurred prior to the spinoff and our cash peg of $50 million at the time of spinoff.

The second was $3.4 million related to the transfer of assets in our Philippine's office from SolarWinds to us that is recognized in the CapEx line. This transfer was cash neutral. Excluding these two items unlevered free cash flow would have been $24.8 million in the quarter. CapEx was $7.3 million, or approximately 8% of revenue. CapEx contained $3.4 million of asset transfers related to our Philippine's office that I just mentioned. Excluding that, CapEx would have been approximately $4 million or 4.5% of revenue.

Non-GAAP earnings per share in the quarter was $0.10 based on 175.8 million weighted average diluted shares. We ended the third quarter with approximately $62 million of cash, up from approximately $50 million at the end of the second quarter. Our outstanding loan principal balance was $350 million representing net leverage of approximately 2.5 times.

Now I will provide our financial outlook for the fourth quarter and full year. For the fourth quarter we expect total revenue of $88.5 million to $89 million, representing approximately 11% year-over-year growth. Based on current rates, we expect FX to have a neutral impact on reported revenue in the fourth quarter.

Note that the fourth quarter has tougher year-ago comparison relative to the third quarter. In the fourth quarter of 2020, we started to see improvements in both new ARR and expansion rates following COVID impact on the second and third quarters of 2020. This was followed by a challenging start to 2021 due to slowdown in demand generation after the Sunburst cyber incident and rebranding efforts, which had flow-through impact on the first three quarters of the year.

We expect fourth-quarter adjusted EBITDA of $27.5 million to $28 million, representing approximately 31% margin at the midpoint. For the full year of 2021 we are raising total revenue expectations to $345.5 million to $346 million, representing 14% year-over-year growth. We expect approximately 3 percentage points of FX benefit for the full year 2021.

We are raising our adjusted EBITDA outlook for 2021 to a range of $113.1 million to $113.6 million or a 32.8% margin at the midpoint. We expect elevated CapEx in the fourth quarter in the range of $12 million to $14 million primarily due to timing of spinout-related office build outs. We expect CapEx to return to approximately 4% of revenue starting in 2022.

We expect total weighted average diluted shares outstanding of approximately 181 million in the fourth quarter and approximately 169 million for the full year. We expect our non-GAAP tax rate to be approximately 25% in both the fourth quarter and the full year.

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

[John Pagliuca, President, CEO]

Thanks, Tim. Q3 was our first almost full quarter as a standalone company. While we are focused on execution, it's important to remind ourselves of our recent achievements, including rebranding, successfully separating from SolarWinds, building out a new executive team and continuing to hire top talent on top of this foundation. And we did all this while weathering a pandemic.

We have entered a period of time where businesses of all sizes are ramping up, not just to differentiate for the post-pandemic new economy, but for a new type of worker who is used to a hybrid working model. In this environment MSPs are looking to us to help them ensure that their service offerings are robust, scalable and secure.

We are proud that we are an integral part of our MSPs' ability to land, expand and retain their customers. We grow as they grow. And above and beyond our software platform, it is the support and guidance we provide them with our award-winning training, education and marketing resources that is one of the keys to their success. As we focus on acceleration in 2022, it is the teamwork of our people and the support of our partners that sets us up for the bright future for the Company.

As we look ahead we will continue to invest in our go-to-market motions, partner success initiatives and innovation to ensure we deliver and remain top of mind for our partners going forward.

With that, operator, we are ready to take questions.

[Operator]

[Operator Instructions] Matt Hedberg, RBC Capital Markets.

[Matt Hedberg, RBC Capital Markets]

Great, guys, thanks for taking my questions. Good morning. John, so growth in large customers was really impressive this quarter. And you noted a lot of overall momentum in the business and you even just said you're focused on accelerating in 2022. Can you put a finer point, though, on specifically why you're having success in some of these larger customers? Is it sort of an evolution of the business, is it product? I assume it's a lot of things, but that really stood out to me with the growth there.

[John Pagliuca, President, CEO]

Hey, Matt, good morning and appreciate you hopping on and thanks for the question. It's a couple of things. First, on the macro level, we are seeing the market mature. Some in the industry refer to the MSP era we are in right now as kind of the golden era for the MSPs. And we are seeing MSPs starting to consolidate.

We are seeing some smart money come into the space where really MSPs are maturing and they are beginning, Matt, to get into larger opportunities, not just the SMEs but also the midmarket. And so, as they grow, frankly, our platform -- our RMM platform plays to that strength. We handle complex environments that MSPs are now bumping into, number one.

And number two, the breadth and depth of our security offerings just really lends itself to these bigger, more mature MSPs. As the market matures, as these MSPs continue to grow in both size and maturity our platform, and frankly our strategy, I think positions us ourselves to continue to win in that area.

So, it's a combination of what's going on in the macro and it plays really well into our strategy, this concept of being able to give MSPs the ability to manage more in complex environments and the breadth and depth of our security offerings. That's kind of the one-two punch that these MSPs are looking for. And then you couple that in with what I would call more bespoke partner success in helping them even with their biz dev and so on. I think it is the right combination for these larger MSPs.

[Matt Hedberg, RBC Capital Markets]

No, it certainly looks like it’s resonating. And then, Tim, one for you. Your comments on why Q4 growth is going to be a little bit different than Q3, currency and compare in particular. But I’m wondering, as we start to think about next year, 2022, can you help us with or remind us about the seasonality of your business? Obviously you’re a carveout now from SolarWinds. But just – I just want to make sure that we’re thinking about the seasonality next year appropriately in terms of your demand cycles.

[Tim O’Brien]

Yes, sure, Matt. Thanks for the question. In terms of seasonality, we don’t have much seasonality in the business. I would say it’s fairly linear; we don’t have any hockey stick periods or anything like that to model out in terms of how we look to 2022.

[Operator]

Mike Cikos, Needham & Company.

[Mike Cikos, Needham & Company]

Hey, guys, thanks for the taking the questions here. Another one, if I could, just on this growth outlook for 4Q and as we're thinking about calendar 2022. I guess one of the things I'm trying to put together if we're thinking about currency and maybe the more difficult comp in 4Q of calendar 2020. And then the pause button that you guys had hit earlier in the year as far as lead GEN activities.

Can you help us think about that? I understand we're looking at 4Q here, but early in calendar 2022 now are those -- is the pause on lead GEN activity expected to still have an impact there? Or should we be mostly through it as we exit Q4? Anything there would be incremental.

[Tim O'Brien, EVP, CFO]

Yes, to give some color. So yes, if we look back at a year ago, we saw the business accelerating coming out of COVID. And like we said in the prepared remarks, in Q1 we had a slowdown in demand gen due to the rebrand and the cyber incident. In our business sometimes it takes a quarter or two just for some of that impact to matriculate into the results. And I think we are seeing things come back from where they were in the first half of the year now, which we would expect to matriculate into the business as we grow over some of those challenges as we get into 2022.

[John Pagliuca, President, CEO]

Yes, and, Mike, just to add and point back to some of the things that -- this is John -- that I mentioned. We are seeing better performance with the website, we're seeing better performance with demand gen, we're seeing better performance with our search and the optimizing there. Part of that was the rebrand. And as we continue to build, we're starting to see some strong momentum as we are even going into Q4.

[Mike Cikos, Needham & Company]

That's great, thanks. And I guess for the follow-up, could you remind us -- I know there are three big things that we are looking at for you guys. It is international investments, it's partner success investments, and it's really the research innovation on the platform.

And I guess if we're touching on all three of those, the last one would really be the one I'm driving at, because I know you guys have spoken on security and data protection, this robust demand environment you are seeing now to back to back quarters.

How sustainable do you feel that is? Because it really feels like the market is coming to you in that sense. And that's one of the things I'm trying to get a better feel for when we are looking further down the road for you.

[John Pagliuca, President, CEO]

Sure, yes, you're right, and appreciate you framing growth initiatives and the way you did it was perfect. So, it is in the investing in international with sales and marketing, number one. And we are starting to see green shoots already. We've been investing really throughout 2021 and we're starting to see green shoots there.

The partner success initiatives and the prepared remarks, a lot of those are examples of our expand where -- were opportunities that came from our partner success, having the right business conversations with these MSPs, seeing what their problems are, really listening and then bringing them with a solution, which goes to your last question.

A lot of times a solution -- it's not necessarily a technological solution but it's also a business solution. So, when we look at MSPs and we help them with their growth strategy, we're finding MSPs looking at ways to grow wallet share at their small-medium enterprise and their midmarket enterprise. And small-medium enterprises really are mindful that they need this layered security approach.

So, we are giving MSPs the tools, the collateral, the framework to have that conversation with these companies, with these CEOs of these small-medium companies, with these business owners and giving them this layered security approach. That's why EDR and data protection is so successful. They are having the right conversations with these SMEs, the SME is saying, hey look, I need to add this to my security posture.

And what used to be more of an inconvenience if you had a cyber incident before is now an extinction event for these small-medium enterprises. They're aware, they're willing to invest. That's a tremendous opportunity for both N-able but also the MSPs to get closer to the customers to add a new book of business, to an additional security layer.

So, you asked about sustainability. I believe we are in the early innings here as far as where we are on data protection, on EDR, on endpoint protection. And then remember, unfortunately there's no one magic pill that makes us all secure. And as the bad guys continue to evolve their strategies, we need to continue to evolve and put the right security solutions in the hands of these MSPs and these SMEs to help keep them secure. And if there is an incident, to get back and going as fast as they can.

And that's why we are continuing to invest on our continuity story, that's why we are in this preview with our DNS filtering. We are going to continue to invest in different security and data protection offerings, because it is early innings and they need a complete layered approach to making sure that their businesses are not interrupted or, worse, extinct.

[Operator]

Edward Magi, Berenberg.

[Edward Magi, Berenberg]

Congrats on a strong quarter. You guys noted in a few of these key wins and contract expansions that your automation capabilities were one of the key reasons for the win. Can you dig a little deeper into the automation capabilities of your offerings just to get a little better understanding of what you mean when we use the term automation here? Thanks?

[John Pagliuca, President, CEO]

Yes, it's a great question. And it's a buzzword that I feel sometimes folks throw around a little bit too loosely. So, we have -- in both of our RM platforms, we have an RM platform that's a little bit more geared towards the low end of the market and one that is geared more towards the high-end of the market. In both platforms we have an automation platform that allows MSPs to leverage scripts.

So, a lot of times these are like power shelf scripts that -- and it comes in two forms -- it comes in two forms. We have a whole host of -- a library of scripts that an MSP can leverage and plug in and -- or we give them effectively, think of it like a workbench or a platform that they can actually craft their own scripts.

And what this allows them to do, whether it be the library that they pull off from our library, or whether it be a script that they write themselves, it allows them to eliminate or greatly reduce the mundane tasks that they're doing. So, if there are checks that they're doing, if there are updates that they need to do they can write a script. And what that does -- the number one cost for an MSP is the labor.

And so, if we can take an MSP and help them manage more with less -- and less people, less man-hours, less time staring at the screen, and have it run more through an automation or a script where they can set it and forget it and run that script, they are decreasing their dependency on human intervention, lowering their labor overhang, and ultimately driving them to be more profitable.

It also results in better utilization for the technician. They don't want to be stuck doing mundane tasks, so if we can get them, they write a script once, now they can carry it across their customer for the next month or the next quarter or whenever the circumstance presents themselves.

Or even better, prescribe that script or that automation lever across their entire estate. That is the power of our platform is now they can go deploy that script or that policy across their estate, driving down their labor, increasing their profitability. Does that help?

[Edward Magi, Berenberg]

Great, great color there. Thanks a lot for that. And perhaps another product vision focused question. You announced that Mail Assure security received a top result from an independent test. Can you expand upon the sophistication of email threats for SME and MSPs and the importance of mail assured security software in preventing these threats? Thanks.

[John Pagliuca, President, CEO]

Yes, great question. So, right now we are all seeing it. It doesn't matter if they are a small enterprise or midmarket or a large company. Phishing attacks and spam is one of the more prevalent ways the bad guys try to get in to these environments. And by adding an additional layer that's filtering out the spam, and we have an enormous database. We have millions of mailboxes.

And the way our solution works is it is machine learning where it is learning all the behaviors and it's aggregating, taking the collective intelligence across all these different mailboxes. Of course, what's getting marked as spam. So, if we have a small-medium enterprise that is marking something in Australia as spam, we are aggregating that relatively close to real time, putting that in so that if someone sees a similar type of behavior, a similar type of domain coming across now let's say in North America hours later, that's now being blocked.

So, with mail it's a scale game, right. And the reason why our algorithm or our filtering is where it is is because of the scale that we have. And it's this kind of collective intelligence that allows us to continue to be one of the more highly rated filtering solutions out there. So, the more you can filter the smarter the engine gets, the bigger your mailbox is, the bigger your ecosystem, the sharper the algorithm and the better the performance. And this is all really to help MSPs and their SMEs block out some of these phishing and spam attacks.

So, that's kind of the name of the game there and we're quite proud of what the team has accomplished with our Mail Assure offering. It is a key component on this layered security for MSPs.

[Edward Magi, Berenberg]

Fantastic. Thanks for the color there and congrats on achieving that. That is all from me. Appreciate it.

[Operator]

Jason Ader, William Blair.

[Jason Ader, William Blair]

Thank you, good morning. I guess my two questions -- first is just on the NRR trajectory, 110% seems pretty steady. What are the puts and takes there as you look out for the next couple of years? Do you feel like there's room to improve that NRR? And then I know it's a trailing 12 months. Can you give us any color on the trendline right now?

[Tim O'Brien, EVP, CFO]

Thanks, Jason. Hey, this is Tim. Happy to give some more color there. When I think about breaking down our dollar-based net retention, I really think about how we think about our growth algorithm. And there's really a few components to it. One is just gross retention on the existing base and then it's the partner led expansion that we really focus on between our partners' success motion and our sales motion.

So, I think we have opportunity for improvement on all three of those fronts. We've seen improvement on gross retention in this past quarter. We're starting to see some of the returns from that partner success investment that John spoke to. And then we are seeing part of the focus of our partners' success managers is to help our partners sell in markets and new SMEs. So, that's part of that expansion story on the partner enabled growth.

And then the other part of it is -- where we've added color on success that we've seen with our EDR and cloud-to-cloud backup solutions is cross-selling new offerings to the SMEs and working with and partnering with the MSPs to bring those new services to market, which generate new strong revenue streams for them going forward. Hopefully that helps.

[Jason Ader, William Blair]

Got it. So, it sounds like from a trajectory standpoint though it's moving in the right direction because of the gross retention improvement. Is that fair?

[Tim O'Brien, EVP, CFO]

Yes, I would say that's been the driver, but I think my point was that there's opportunity, I feel or we feel, on kind of all three of those fronts, on the SME expansion, the selling of additional services and approved gross retention.

[Jason Ader, William Blair]

Great. And then, John, for you, just wanted to get a little bit of the lay of the land on kind of MSP end market right now as we're hopefully seeing some improvements in the macro environment and vaccination rates, etc. As you think about the last 1.5 years, did it feel to you like there was some kind of Darwinian situation with MSPs where the strong have survived? And is that one of the reasons why you're seeing the strength with the larger MSPs, that basically some of the smaller MSPs are becoming less relevant?

[John Pagliuca, President, CEO]

No, I don't think the smaller MSPs are becoming less relevant. Let's back up to COVID because it's an excellent use case. During COVID, MSPs did the right thing. And what do I mean by that? They had to quickly focus on their existing book of business. So, part of the growth algorithm for the MSPs, just like any other company, is to land new customers. Well, during COVID, MSPs really were not out there landing new customers. They had to go help mobilize their customers' base.

Customers now had to deal with a hybrid workforce, had to deal with using personal computers and created a huge surface area problem from a security point of view. MSPs went from talking to their customers maybe once a month or once a quarter to every day. And so, the focus for the MSPs shifted from landing new customers to really helping stand up their existing book of business, and that's what I believe the best MSPs did.

So, what did that mean? We saw them growing their book of business by adding services and getting closer, their retention rates went up. But the new part of their equation, adding new SMEs, slowed a little bit. What we're seeing more from a consolidation point of view, from a macro point of view -- and I'll talk about the low end in a second because you'll see the relevance.

On the consolidation front we are seeing MSPs -- because of labor scarcity, and labor scarcity is not just hitting the MSP market, it's hitting the global market, and it's not just hitting the SME, it's hitting larger companies. We're seeing MSPs -- the doors or the opportunities for the MSPs are getting larger and larger.

MSPs are now walking into publicly traded companies, they're walking into larger shops to help augment where there's labor shortage for these internal IT departments. So, this concept of co-managed IT is becoming more and more of a trend. We are seeing MSPs being part of an internal IT department, taking on key aspects of an internal IP department. Why? Because there's a labor scarcity issue.

So, what is that doing? If the midsize and large MSPs are stepping up into larger opportunities, it is creating an opportunity for these lower MSPs to land what we would call more the traditional SMEs or the VSMEs in the market.

So, overall I'm quite bullish. I think the health of the MSP industry is strong. We're seeing it strong in the high-end, we're seeing a lot of consolidation, but I'm also seeing a good number of smaller shops thriving and doing well and leveraging our automation to become profitable because they are having a labor scarcity issue too, right? They're a three-person shop, how can they do more with less? They leverage our automation.

[Jason Ader, William Blair]

Great and one quick final one. Just on this labor shortage macro issue -- how does this not result in acceleration in your business in 2022? It just seems like it's probably not going to get a lot better anytime soon. The complexity of the security, it's just getting worse. How do you help us understand the impact of that labor shortage on your business? And in particular, how you are equipping these MSPs to help their customers?

[John Pagliuca, President, CEO]

You're right to consider it a tailwind. I consider it a tailwind and we look at that as an opportunity to help our MSPs in a couple of different areas. We talked about automation a good amount on this call. But also just the breadth and depth of our monitoring. We give MSPs the ability to monitor Apple devices, Windows devices. With the integration we've done with Microsoft we've allowed them, again, the concept of doing more with less, Jason, is one of our big themes.

And we believe we are the vendor or the partner that MSPs look at as giving them the ability to do more with less, that we'll win the long game. And that's what our strategy is and that's where our investment is. And that's why -- and by the way, it's equal parts technology and platform and also partner success because we need to give them a little bit more of the tools in leveraging our collective intelligence that we see across our 25,000 MSPs to help them sharpen up their business.

And the good news is we are seeing MSPs increase their EBITDA, we're seeing -- which is overall healthy for the ecosystem. We are seeing MSPs leveraging the automation, expanding their book of business with their end customers, going into larger accounts and in turn that's creating a more profitable customer base for us, which obviously, from an ecosystem point of view, is a good thing. So, I agree with you, I guess, is more the way I would leave it. I believe that it is a tailwind for both N-able and also the MSPs who are servicing these companies that are dealing with labor scarcity.

[Operator]

Keith Bachman, Bank of Montreal.

[Keith Bachman, Bank of Montreal]

I had a clarification and then a question. Clarification, could you talk about what FX rates have done on your dollar-based net retention both in the June quarter and for the current quarter and the implications for the December quarter? I think it was quite a bit of help in the June quarter, perhaps a bit less in September. I'm just trying to normalize the dollar-based net retention.

The larger question, big picture, is on the backup market. And I was hoping you could talk about your current expectations, how we should be thinking about the backup market, break it down into, A, the competition, what is the pure play vendors on your technology platform versus others that are out there? And then, B, how we should be thinking about perhaps some of the capabilities of Microsoft [indiscernible] or not and how you're positioned to work with Microsoft on some of their Azure workplace in particular? Thanks very much.

[John Pagliuca, President, CEO]

Sure. Thanks, Keith, and why don't we answer the second one first and then we'll go from there? So, backup -- so our backup and data protection offering is one of our larger and faster growing offerings in the portfolio. We both land new MSPs and internal IT departments with our backup offering, and we cross-sell our backup and data protection offering into the MSPs that are leveraging either of the RMM platforms, and frankly any other tool.

So, it's a tremendous offering that we have found great success in our cross-sell motion and continued success in our new customer acquisition. So why? Well, really it is the technology, right? It's completely cloud based compared to some of our competitors that are still dependent on a piece of hardware and appliance.

And the algorithm in which we've elected to do our backup in our restore just allows it to be faster, more efficient, more efficient to the MSP, more efficient to the SME, more efficient on the bandwidth, and we are a more cost-effective solution.

So, we believe we have an offering that not only competes but wins as it relates to a lot of the offerings that are out there that are kind of based on more of an older tech. And the fact that we're not image-based I think also gives us an advantage. So, it's a market that's critical for the MSPs. It is one of the pillars that every MSP is offering to their MSPs. It's a key part of the NIST framework, the ability to backup and restore. And now that's evolving, right?

Now as more and more workloads are pushing to the cloud, more and more folks are using Office 365. That need hasn't changed, it's just moved. So, we're seeing a tremendous uptick in our Office 365 data protection offering, which allows small-medium enterprises the ability to back up their Office 365, backup their SharePoint, backup going forward their Teams environments at a pretty low-cost point, as like effectively a belt and suspenders approach.

Not because -- really the ability to restore. And our ability to restore, I would say, puts us head and shoulders above what a lot of folks are doing. It's a tailwind to our business. I think it is a strong add for our MSPs. And I think the way our technology is built, the fact that it's inside of our platform, it's a more efficient play.

We allow MSPs to backup and protect workstations, servers, virtual machines, so instances that are in the cloud, Office 365 instances. So, in one platform we give them the whole spectrum, and I'm not sure anyone else has that breadth from a one platform view.

[Tim O'Brien, EVP, CFO]

Hey, Keith, just to add some color on the FX. If I look back over trailing 12 months, there's a little bit of a tailwind as it relates to net retention probably in the range of a point or 2. I can't predict the future, I don't know where FX rates will go over the next 12 months, but if I just look at where they are now compared to where they were over the course of most of or at least the first half of 2021, it would lead to a bit of a headwind as we go forward.

[Operator]

At this time, we have no further questions. I'll hand back over to management for any further remarks.

[Howard Ma, Senior Director, IR]

That’s all from our side. We appreciate everyone calling in and showing their interest in N-able. Thank you.

[Operator]

We thank you for joining today's call. The call has now concluded and you may now disconnect your lines.