N-Able Inc

NYSE:NABL

Earnings Call Transcript 2022-Q4

[Operator]

Hello, and welcome to the N-able Fourth Quarter and Full-Year 2022 Earnings Call. My name is Elliot, and I'll be coordinating your call today. [Operator Instructions]

I'd like to hand over to Griffin Gyr, Investor Relations lead. The floor is yours. Please go ahead.

[Griffin Gyr, Investor Relations]

Thanks, operator, and welcome, everyone, to N-able's fourth quarter and full-year 2022 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.nable.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 spin-off 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 spin-off transaction completed in July 2021.

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 also 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 the non-GAAP financial measures. A reconciliation of certain GAAP to non-GAAP financial measures discussed on today's call is available in our earnings press release on our Investor Relations website.

And now I will turn the call over to John.

[John Pagliuca, President and CEO]

Thank you, Griffin, and thank you all for joining us today. As we close out our first full-year as a stand-alone company and welcome in the new year, I want to reflect on our accomplishments and tremendous progress we've made. We started 2022 with our rally cry, earned more fans, which is a broad-reaching aspiration that goes from our employees, who are the foundation of our success to our MSP partners, who are the primary focus of our business to industry stakeholders and investors.

Through the solid execution of our strategy by our across the globe, we believe we are successfully delivering on this mission. We achieved strong financial results, executed important initiatives across all product categories, and enhanced our broader platform experience for our partners. And we did all of this while laying the groundwork for future success.

In the fourth quarter, we delivered strong profits, while simultaneously driving revenue growth, another clear proof point of the strength of our model and the robust demand for the mission-critical platforms and services we provide. In Q4, we exceeded the high-end of our top and bottom-line guidance ranges, delivering revenue of $95.8 million and adjusted EBITDA of $31.2 million, respectively. This equates to constant currency revenue growth of 13% and an adjusted EBITDA margin of 32.6%.

And for the full-year, we achieved constant currency revenue growth of approximately 13% and an adjusted EBITDA margin of 30.9%. We are pleased to deliver these results amidst an uncertain macroeconomic environment. Our MSP partners and their small and medium enterprise customers continue to deal with industry-specific headwinds of labor scarcity, increasing IT complexity in the move to the cloud, as well as the relentless growth of cybersecurity threats.

Here at N-able, we believe we operate a resilient business model to deliver both growth and profit and provide core must-have software and services through an efficient platform experience and a genuinely partner-first approach. Our software is high in the IT priority stack, and customers have generally sought monitoring, data protection and security solutions regardless of the economic environment. We exist to make our partners more efficient, more effective and more secure or as we have said before, turning industry headwinds into tailwinds for both our MSP partners and for us.

With regards to labor scarcity, the IT Trade Group CompTIA in December 2022 reported that the U.S. unemployment rate for technology occupations in all sectors stood at 1.8%, roughly half the national average. The difficulty SMEs have in hiring talent is compounded by the fact that IT is getting more complex and more mission-critical to business operations. SMEs face application and vendors sprawl, network challenges of hybrid work environments and moving workloads to the cloud.

And cybersecurity continues to drive spending as well. Analysis Mason predicts that SMB security spending via MSPs will grow from $25 billion in 2022 to $48 billion in 2027 at a CAGR of 14%. Together, these dynamics drive spending on managed services and software solutions. And as we are a premier software provider to MSPs, these trends directly fuel our business.

Gartner observes these same market trends. In their IT spending worldwide report from December 2022, Gartner predicts that in every industry, IT spending on services will grow more quickly than spending on internal IT capabilities. Our product strategy is focused on creating tools that enable MSPs to solve technology pain points for their SME customers simply and securely. And importantly, in 2022, we executed this mission.

Starting with monitoring and management, we listened to the needs of our market and adjusted our strategy to take advantage of the unique segmentation opportunity we found in tiering our offerings. We launched N-sight, which is our all-in-one offering aimed at early growth MSPs that include three major components of our platform. Our cloud-based RMM for monitoring and management, our N-able take control for remote support and MSP manager for professional services automation, plus our full suite of onboarding, support and community resources to help them build their businesses.

As a testament to the success of N-sight, on a currency-neutral basis contribution from new N-sight customers was up approximately 30% in 2022, compared to 2021. We also delivered additional Apple management capabilities to the N-sight platform to align with the growth of Apple devices.

To give you an example of the increased customer value of this offering, in the fourth quarter, a European MSP was looking for an RMM platform. Two critical customer criteria, which are to realize a short time to value, specifically that their technicians could be up and running quickly, and that the RMM tool could integrate cleanly with other software they use. After a competitive bake-off, the customer felt N-sight was the best fit for their needs and signed a $50,000 ARR deal. While N-sight focuses on the smaller end of the market, we have also reinvigorated our push on N-central, our RMM offering aimed at seasoned, larger MSP partners.

In 2022, we added features and functionality to N-central, including new Apple management capabilities. We have seen strong proof of the power of N-central's orchestrate at scale, allowing MSPs to take on large workloads to manage devices, users and assets with a minimal amount of labor. We believe we lead the MSP market in enabling MSPs to manage Windows, Linux and Apple devices from one consolidated dashboard. As a result of our continued investment in growing our market leadership with N-central, our gross retention is up almost 2% year-over-year.

Our Cove Data Protection offering launched in 2022 has also made considerable strides. Cove, which combined our already successful backup solutions with innovations such as our standby image feature, our true Delta technology and Mac document backup is no longer the best kept secret in data protection. As a cloud-first, enterprise-grade and truly SaaS offering, Cove is fast being recognized as a leader with MSPs and is starting to make inroads in the corporate IT space as well.

A deal we closed in the fourth quarter of 2022 demonstrates the efficacy of Cove. One partner, who is working with a mid-market enterprise that was about to begin migrating its Microsoft 365 from on-prem to the cloud. We worked closely with the MSP to demonstrate Cove's ease-of-use and cloud-first approach. As a result, they decided to move a large portion of their Microsoft 365 estate to Cove. This deal represented a nearly $100,000 ARR deal for N-able. Our data protection as a service approach seems to be resonating.

On a currency-neutral basis, the contribution from new customer cohorts was up approximately 40% in 2022, compared to 2021. And we now have over 12,000 total partners using Cove Data Protection. In addition, Cove was recently recognized with the SEC Backup and Archive Innovation of the Year Award.

Our security offerings also shined in 2022. As our suite of solutions has grown, we are now covering a broad spectrum of market needs, ranging from enterprise-grade EDR to traditional antivirus solutions, to password management and e-mail protection. Demand from SMEs grew as they sought security software during uncertain times in 2022, and many MSPs turn to us to meet that demand, so they could stack our enterprise-grade, fully integrated tools and grow their wallet share with their customers.

We launched DNS filtering earlier in ‘22 and just announced the general availability of our managed EDR offering, which we soft launched in Q4. Managed EDR supplements the N-able EDR solution with dedicated management security services. With continued labor shortages and typically high cost of building and maintaining a SOC, managed EDR allows MSPs to affordably reinforce and extend their IT security teams powered by SentinelOne's 24/7 security operations center. This means they can more quickly investigate and resolve threat events for their SME customers, attractive always-on model.

A great example of the appeal of our security solutions and the strength of our go-to-market motion was a deal we closed in the fourth quarter. A health care-focused MSP was having compatibility issues with their antivirus software and seeking to upgrade their security posture. Once we showed the MSP the benefits of EDR, integrated with N-central and the advantages of the enterprise-grade technology deployed simply, they signed a more than $100,000 ARR deal. This partner has been with us since 2017 and has consulted with us on how to price, package and market their business over the years.

As I've discussed before, we take the word partner seriously. It is a distinction that must be earned and something we feel is a differentiator. We understand deeply that when our partners grow, we grow, something I call the snowball effect. So we are continuing to invest in the areas to help our partners better understand the nuances of their business and how to leverage the opportunities this sector holds. We will keep that focus because we believe it is paramount to our mutual success.

Now as I have said before and will again, the focused execution of our strategy by N-able is across the organization is the root of our success. To recap 2022 highlights across the business. Our marketing teams packaged and launched our Cove Data Protection and N-sight platforms. Our fourth quarter total bookings were high for the year and exceeded our Q4 ‘21 figures. We earned our partner fandom every day, and it showed up as we increased our dollar-based gross revenue retention across the business by 130 basis points on a constant currency basis.

Our R&D and service teams brought six new products and billable services to market, including N-sight, Cove standby image, managed EDR, DNS filtering, cloud user hub and enhanced services. We opened our Warsaw Poland office with more than 70 employees currently based there, expanding our presence in Europe. And our business development efforts brought us key strategic capabilities, including the Spinpanel acquisition that we completed in July. We are laser-focused on delivering on our mission to empower the success of MSPs across the globe. Thank you to more than the 1,400 N-ablelites, who tirelessly personified are rally cry, earning more fans every day.

Turning to 2023. We are still committed to earn more fans. We believe we are well positioned to take it to another level. This year, we will focus on raising the bar and our quest to become the vendor of choice for MSPs across all sizes across the globe. We expect to continue to elevate our go-to-market efforts, earn new partners and grow our brand presence and awareness. We are also leveling up our commitment to improving our partner success resources and services in driving new product launches and enhancements throughout the year to help our partners win and grow their customer base.

The elevating force behind our strategy in 2023 continues to be the industry tailwinds that we believe are still firmly in our favor. Our focus will be on raising the bar in three key areas. The first is what we call manage everything. As our partners are looking to help their SMEs navigate the ever-changing technology landscape, we are focused on enhancing our solutions to give them the tools to become even more mission-critical.

In 2023, we will look to augment cloud monitoring and management capabilities, extending into Azure management and broadening our Microsoft 365 management. This will help MSPs bridge the divide between server-based and cloud assets. And just as customers need help with Azure and Microsoft 365, they need help managing their Microsoft licenses. Cloud user hub based on Spinpanel technology, which we acquired last year, does just that.

Increasing our capabilities for Apple device management is another important avenue of growth. With Mac market share gains far outpacing PCs, the ability to manage and monitor Apple environment is a strong value add to our MSP partners. We believe this added functionality will make us the single vendor for end-to-end Apple and Microsoft coverage for monitoring, data protection and endpoint security. And as we go through 2023, I look forward to updating you on our journey to manage everything.

As we all know, managing IT assets is critical but not enough. And that's why the second focus area for our MSPs is protect and secure. In 2023, we plan to further execute on the full potential of Cove Data Protection, expanding into broader Azure and Microsoft 365 use cases, along with continued investment in underlying product functionality. These investments will better position us to ride the wave of demand for enterprise-grade, cloud-first, integrated data protection solutions. Protection and security go hand-in-hand. And this drives the trend we see with Cove as an entry point for many prospective MSP partners. And a delighted Cove customer has often turned into N-able for other solutions as well.

Recently, we were talking with a top 10 partner about security in the MSP business, and we thought they summed it up perfectly when they said, we love what you have, but give us more. We intend just to do just that. We see a growing convergence in endpoint management and security and are working on adding new solutions to identify security risks in the environments we already manage. Look to hear more from us in 2023 on the security front.

And finally, the key area is what we refer to as operational efficiency, which is helping our partners through automation and standardization with N-able as their one-stop shop for fulfilling their business goals. Standardization for the MSP mean software cost consolidation, improved technician efficiency and significant time savings. As we work with our partners to automate their processes using our tools, they can accelerate their customers transition to the cloud, stack more solutions to increase the value they provide and scale their growth in efficiency seamlessly.

For us, this implies a significant cross-sell opportunity within our existing base, but also the potential for growing our market share. Once again, as our partners grow, we grow. Our market is resilient. Our positioning and strategy are on target, and our focus is clear. We look forward to delivering updates on our strategic initiatives within these focus areas throughout the year.

And I will now like to turn the call over to Tim to discuss our financial results and outlook.

[Tim O'Brien, EVP and CFO]

Thank you, John. and thanks to all of you for joining us on the call today. I want to start by recognizing the many accomplishments of our team in 2022, including enhancing our product capabilities, bringing new offerings to market and successfully operating in an evolving macroeconomic environment throughout the year. I look forward to building on this foundation in 2023.

Now I will review our fourth quarter and full-year 2022 results. Total revenue in the fourth quarter was $95.8 million, representing 7% year-over-year growth or 13% on a constant currency basis. Subscription revenue was $93.4 million, representing approximately 7% year-over-year growth or 13% on a constant currency basis. Other revenue, which primarily represents maintenance revenue from our discontinued perpetual license model was $2.4 million, up 5% year-over-year.

We ended the quarter with 1,898 partners that represent $50,000 or more of ARR, a 13% year-over-year increase. Partners with over $50,000 of ARR now represent 51% of our total ARR, up from 47% a year ago.

Dollar-based net revenue retention, which is calculated on a trailing 12-month basis was 103%. On a constant currency basis, dollar-based net retention held steady quarter-over-quarter at 108%.

For the full-year, we finished 2022 ahead of our outlook with total revenue of $371.8 million, representing approximately 7% year-over-year growth or 13% on a constant currency basis. Subscription revenue was $362.6 million, representing approximately 98% of total revenue and growing approximately 8% year-over-year or 13% on a constant currency basis.

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. Also note that historical financials for the period prior to the effective spin-off date of July 19, 2021, included operating expenses that were prepared using our carve-out allocation methodology while we were still a part of SolarWinds.

While the allocations and estimates in these carve-out financials are based on assumptions that we believe are reasonable, our stand-alone financials are not necessarily directly comparable to those prepared prior to the effective spin-off date.

Fourth quarter adjusted EBITDA was $31.3 million coming in well ahead of the high-end of our outlook, representing 32.6% adjusted EBITDA margin. Full-year 2022 adjusted EBITDA was $114.7 million, which represents an adjusted EBITDA margin of 30.9%.

Fourth quarter gross margin was 85%, compared to 86.6% in the fourth quarter of 2021. Full-year 2022 gross margin was 85.2%, compared to 86.8% in 2021. The key drivers of the decline are changes in foreign exchange rates, product mix and new product investments.

Unlevered free cash flow was $74.9 million in 2022 and $17.6 million in the fourth quarter. Unlevered free cash flow for the year represented 65% conversion from adjusted EBITDA.

CapEx was $21 million or 5.7% of revenue for the full-year and $7.8 million or 8.2% of revenue in the fourth quarter. CapEx in the fourth quarter included the impact from a strategic asset purchase.

Non-GAAP earnings per share was $0.10 in the fourth quarter based on 182 million weighted average diluted shares and $0.34 for the full-year based on 181 million weighted average diluted shares. We ended the year with $98.8 million of cash and had an outstanding loan principal balance of $345.6 million, representing net leverage of approximately 2.2 times based on trailing 12-month EBITDA.

Before turning to our 2023 outlook, I want to give some commentary on our fourth quarter and full-year results, as well as share some thoughts about the state of our business. The fourth quarter beat on revenue was driven by strong demand for solutions across all categories. Relative to our stated guidance rates, we also saw FX favorability in the quarter, which drove approximately half of the $2 million beat.

The strong adjusted EBITDA output in the quarter is a function of the flow-through of the revenue beat to the bottom line, some seasonal fluctuations in spending and a reduction in force that represented less than 5% of our workforce.

The decision to take this action was a difficult one to make, was done across the company and not focused on any particular function or location. As we came to year-end, we wanted to ensure our business and teams were best positioned for future growth and success in 2023 and beyond with the right levels of investment in resources.

Now I will provide our financial outlook for the first quarter and full-year 2023. For the first quarter of 2023, we expect total revenue in the range of $97.5 million to $98 million, representing approximately 7% to 8% year-over-year growth or approximately 11% to 12% on a constant currency basis. We expect first quarter adjusted EBITDA in the range of $29 million to $29.5 million, representing approximately 30% margin at midpoint.

For the full-year 2023, we expect total revenue of $408 million to $412 million, representing 10% to 11% year-over-year growth or 11% to 12% growth on a constant currency basis. We expect full-year adjusted EBITDA in the range of $122 million to $126 million or approximately 30% to 31% margin.

With the continued macro uncertainty and variability we saw in 2022, we are assuming FX rates for the remainder of 2023 of 1.04 for the euro and 1.17 for the pound. For full-year 2023, we expect CapEx to be approximately 6% of revenue and adjusted EBITDA conversion to unlevered free cash flow to be approximately 65%, both in line with 2022.

As a reminder, our debt is floating and currently fixed to LIBOR. We will transition to SOFR in 2023, and we anticipate approximately $30 million of interest expense for the full-year, which assumes an effective interest rate of approximately 8%.

We expect total weighted average diluted shares outstanding of approximately 183 million for the first quarter and approximately 184 million for the full-year. Finally, we expect our non-GAAP tax rate to be approximately 27% to 28% in both the first quarter and the full-year.

To recap, we saw strong market demand in Q4, and we are confident in our strategy and positioning as we enter 2023. We believe the outlook we provided for the first quarter and full-year account for the current macro environment. As a reminder, our model has many different growth vectors, including new customer acquisition, cross-sell of our existing product suite into our partner base, launching new product offerings and capacity growth. We will continue to monitor the performance of all aspects of the model.

Our 2023 operating plan calls for continued investment in our growth and it is important to reiterate that our business model allows us to be nimble and adapt to these plans if we see changes in the demand environment. We believe strongly in the long-term secular trend of SME IT spend and managed services growth, and we intend to continue to invest in important strategic areas outlined by John earlier in a profitable and sustainable manner.

Now I'll turn it over to John for closing remarks.

[John Pagliuca, President and CEO]

Thank you, Tim. As we dive into 2023, the leadership team and our fellow N-ablelites are energized by the potential we have to make a real impact for our partners and for their SME customers. We will raise the bar to deliver solutions and services that are purpose built for the MSP market.

And as previously mentioned, we are focused on enabling MSPs to manage everything, protect and secure, and elevate their operational efficiency. We believe we have positioned ourselves optimally to provide the solutions that MSPs need to alleviate the pain points for SMEs to grow as they grow and to continue to adapt ahead of the curve, riding these industry trends well into the future.

We believe that we have an all-weather business model to deliver both growth and profit, and we will continue to provide core, must-have software and services to MSPs through an efficient platform experience. Our focus is sharp, and we look forward to continuing to execute on our vision.

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

[Operator]

Thank you. [Operator Instructions] Our first question is taken from Mike Cikos from Needham & Company. Your line is open.

[Mike Cikos, Needham]

Hey, thanks for taking the questions, guys. And I guess first topic I wanted to delve into would really be the guidance that we have here for calendar ‘23 with the 11% to 12% constant currency revenue growth. Can you help us think through like what gives you the confidence to guide to that 11% to 12% FX-neutral revenue growth?

And then the second, like really what I'm trying to dig at is, as some of the puts and takes that the team weighed in deriving that growth forecast. Can you help us think through that?

[John Pagliuca, President and CEO]

Yes, sure. Hey Mike, how are you? This is John. So the -- Tim outlined the dynamics of our business model nicely in the prepared remarks, right? And it starts with that gross retention number and those 25,000 MSPs that continue to be part of that snowball as I like to say. So the start of the foundation there is on that gross retention. We continue to see the strength in our platform and the dependency, frankly, that our MSPs have on the mission-critical platform that they use service their customers. So the base there is that our gross retention is on the uptick and that the customer satisfaction continues to be high. And that gives us our base.

If you think about our revenue snowball, it's in the mid-90% of our business comes from our existing base, the retention of the customer base and then the expansion there. And we continue to see the second leg of our MSP partners buying more services from us. Our data protection, we noted the penetration that we're getting at the MSP level. There continues to be a lot of white space as they continue to adopt Cove across their base.

Our MSPs are continuing to add on our security services, and we've got really good traction. But again, there's continued significant white space in our endpoint security and our DNS filtering and our mail security. So we look at the traction and success of our cross-sell motion and the white space that's not just for us, but also our MSPs. And that's really the base of our revenue and the base of the forecast.

We have strong views into each of the cohorts and the consistency of the cohorts, and that's the foundation. And then, of course, Mike, like every business, we take a look at the velocity and the demand for new customer acquisition. And I think we did a good job being prudent along that line and not necessarily leaning forward as far as new customer acquisition. But again, that's not as significant part of our snowball revenue there.

So that's -- those are the different dimensions, and that's how we looked at the year. And that's how we always look at the year, Mike. And it starts with looking at the customers by geo, by segment as we talked about the smaller end, the larger end and building based on the cohort growth from there.

[Mike Cikos, Needham]

That's great. And if I could just build on that for a second. Like I know you were talking about the gross retention, and we got the fact that the net revenue retention, again, on an FX-neutral basis was consistent quarter-to-quarter at that 108%, right? So as we look at calendar ‘23, are you assuming improvements in either that net retention rate or that gross retention rate?

[Tim O'Brien, EVP and CFO]

No, Mike, I wouldn't say the guidance assumes that we hold both fairly steady in the 2023 outlook.

[Mike Cikos, Needham]

Got it. Got it. And then one more, if I could, before I turn it over to my colleagues. But I know that I think it was closing out the guidance comments, you guys have discussed this sub-5% workforce reduction that you had put in place. Can you help us think through what the expected cost benefit to N-able was as a result of that reduction?

And then the second question is, I know that previously, the company has spoken about hiring whether it's revenue-generating sales folks or anything of that sort. So is the company still hiring post risk? And like if you are, where are those more strategic areas where you continue to build -- I guess, build expertise and those different department functions?

[John Pagliuca, President and CEO]

Sure, sure. Again, this is John, Mike. Short answer is we continue to lean in and we're hiring. And we're hiring in those key areas that you touched on, quota-carrying sales folks, but also in R&D. And we're a technology company. And in the prepared remarks, we talked about staying at or ahead of the curve, providing MSPs the ability in this ever-changing technology landscape to have the tools that they can have to meet that changing environment, right? So we're leaning in on R&D. We have a -- we continue to hire there. That's probably our highest area of recruiting effort right now.

As it relates to the reduction in force, as Tim mentioned, we do take these things seriously. But a reminder, we just concluded our first year as a public company. We just concluded our first year as a company in 2022. And when you do that, you make some investments, you make some hires, you build for a certain bit.

And then when we came into our planning cycle in 2023, we looked at areas that we wanted to invest in more, we looked at some functions where we had some scale and some efficiency, and we made some difficult decisions. But overall, you'll see us from a net point of view, adding heads in 2023, and we expect to be at a higher head count rate at the end of this year than we did in 2022.

So net-net, we'll be hiring more, bringing more N-ablelites, pushing that technology agenda forward and hopefully at a faster clip than we even did in 2022, which was pretty impressive considering we brought on six new offerings in the last year.

[Mike Cikos, Needham]

Got it. Got it. And just to cycle back to the earlier comment on the [RIF] (ph). So did you guys quantify what the cost benefit of that RIF was? And then I guess, when was that implemented? Or is there still more to come as far as communicating that to the affected folks?

[Tim O'Brien, EVP and CFO]

Mike, yes, we didn't comment get the savings, but I would say, as John hit on it was mostly done to shift where some of our investments were as we went into 2023. That being said, we did execute it within Q4, and we did see some savings within the quarter that I would say, perpetuated some of the profit beat and the margin acceleration probably to the tune of about 50 basis points to 100 basis points in the quarter.

[Mike Cikos, Needham]

Got it. Thank you very much, guys. I’ll turn it over to my colleagues.

[John Pagliuca, President and CEO]

Thanks, Mike.

[Operator]

We now turn to Matt Hedberg from RBC Capital Markets. Your line is open.

[Matt Hedberg, RBC Capital Markets]

Great. Thanks, guys for the questions. John, in the past, we've talked about RMM. I think it's like $1 to $3, maybe a couple of bucks per device. I think what stood out to me is all of the innovation that you guys talked about, the six products, sort of, launched last year. Can you talk about what that potential is on a per device basis as you sort of expand this broader platform?

[John Pagliuca, President and CEO]

Sure. Yes. And the economics of the business, it really goes to the root of the business model, Matt. So I appreciate the question. And so -- you're right. So the remote monitoring piece, depending on the size and some of the scale of the MSP, it can range from $1 to $3 per month per device. When you stack all of our offerings up, that number gets closer to about a $15, $16 per device per month, SAM, so to speak, if you will, within our existing customer base, right?

And so that, by the way, is a pretty impressive number. If we were to cross-sell and get 100% adoption across every device, that's well over $1 billion of additional opportunity inside our existing base with our existing solutions today. And that's before, Matt, we added managed EDR and before we -- as we continue to add new offerings. So EDR is a good example, we'll increase our endpoint security. Historically, endpoint security on an antivirus bit was potentially as low as $1 per month per device with EDR, that's a couple of dollars as we continue to add more goodness in helping MSPs become more efficient and more secure with endpoint security, that revenue, that ASP per device stacks to as high as potentially $7 per device.

So there's a tremendous amount of white space there in endpoint security. MSPs do a great job packaging that up and selling that to the SME. We have compliance and cyber insurance companies mandating services like EDR for companies that want to get underwritten. And so we see that as a tremendous white space opportunity, both for N-able and for our MSP partners. And that's the name of the game here. We continue to add MSPs, they add small, medium enterprises. They keep adding to well over 0.5 million SMEs and the well over 7 million devices that we have. And then we add new services for them to cross-sell and to their customers and grow that cross-sell number for N-able. And so there's a good amount of, I'd call it, very much early innings as far as our ability to keep continuing to cross-sell into our base.

[Matt Hedberg, RBC Capital Markets]

Got it. Yes. No thanks a lot for that. Yes, it certainly seems like that per device opportunity continues to go up, which is great. And then Tim, maybe on the capital allocation side, you talked a little bit about the RIF. As you approach ‘23, how do you think about capital allocation between maybe -- continue to delever? Or are you at the level that you need to be, M&A, just sort of just general capital allocation philosophy entering there?

[Tim O'Brien, EVP and CFO]

Yes, Matt. How are you doing? The way we think about it is looking at the capital markets today, I would say we have favorability compared to the current rate environment. So based on that, based on kind of our leverage rate, we feel comfortable with where we're at as well as being able to look at anything strategic as we go through 2023 as well. So our plan as of now is we're kind of comfortable with where we're at, happy with where we're at, continue to evaluate it as markets change. But for 2023, based on kind of where we're at and where the markets are at, I would say, we plan to kind of stay the course.

[Matt Hedberg, RBC Capital Markets]

Got it. Thanks, guys. Congrats on the strong year-end.

[Tim O'Brien, EVP and CFO]

Thanks, Matt.

[Operator]

We now turn to Jason Ader from William Blair. Your line is open.

[Jason Ader, William Blair]

Yes, thanks. Hey, guys. I want to ask you first about the -- just the macro environment. How is this period different than what we saw kind of post -- kind of early days of COVID in terms of demand? And then maybe just some comments on U.S. versus Europe.

[John Pagliuca, President and CEO]

Sure. Jason, John here. So compared to COVID, there's some similarities, and I'll touch on those and tease out some of the differences. So in COVID, what we saw is that MSPs were logging into our platform at 2 times the rate they were before COVID. And that really spoke to how mission-critical our platform is to these MSPs and helping them because that created a spike in helping them effectively push their small, medium enterprises into that remote work environment, into that digital kind of evolution that we speak to.

And financially from the business, we saw an uptick in strong demand from data protection and security as MSPs prepared their customers for that new world. During COVID, we saw a slowdown in new customer acquisition. Our MSPs, whether they be N-able MSPs or MSPs broadly speaking focused on their customer base and not on new platform changes, right? They didn't have the time for that. Compared now to the environment that we're in, we continue to see really strong demand for our data protection and security services.

And as we mentioned in the prepared remarks, relatively speaking, security spend is a resilient part of the industry. So we continue to see a strong demand, both in data protection and security. But unlike COVID, where MSPs didn't have the time to look at new platforms, we're seeing MSPs look at new RMM platform. So we're -- compared to COVID, we're doing much better from an NCA point of view as it relates to both platforms.

And we mentioned in the prepared remarks N-sight. We repackaged N-sight in 2022 from a pricing and packaging, but more importantly, from a user experience point of view to help these MSPs become more efficient. And as a result, you saw that strong uptick in that cohort that I mentioned where we're landing much more customers in that lower end than we did last year.

So relative to COVID, I would say, NCA is stronger, and our cross-sell motion is as strong as it was in COVID. And the retention piece is stronger than what it was at COVID. And COVID, we saw maybe a little bit on the low end of the market some atrophy there where folks might have just been going out of business, and we're not really seeing that. As we mentioned in our prepared remarks, gross retention is stronger.

As it relates to geo, while we said demand was strong across all service areas, nothing really to call out from a geography point of view as well. We continue to perform well in our Asia Pac. And Asia Pac for us is primarily Australia and New Zealand, and in our European markets as well. So nothing really to call out as a differentiator. It's been pretty consistent both quarter-over-quarter and year-over-year. As it relates to Q4, it was strong and pointing up and to the right.

[Jason Ader, William Blair]

Great, great. And then just as an unrelated follow-up, how do we think about the threat from Microsoft Intune to your RMM business? And to just the RMM category as a whole, it just seems like Microsoft is well positioned there. They're getting a tremendous amount of adoption of Intune across the market. I don't know specifically if there's something about it that wouldn't be well suited for MSPs. But how do we think just over the next like three to five years about the potential threat from Intune?

[John Pagliuca, President and CEO]

Yes. We have a good working relationship with Microsoft, actually. And Intune is not in RMM and you can talk to any MSP, any technician actually, you can look at a redo-thread right now that's going on. And Intune is not an RMM and Microsoft knows that. We work closely with Microsoft, because we believe we provide an experience with the MSP. We always emphasize, [Matt] (ph), this concept of purpose built, right?

That means it's architected in a way that MSPs can look across, they can look at one particular user or one account, one small, medium business across their entire account or their entire estate. And the fact that we're architected in a way that gives them a consolidated view and look across their entire environment and provide them with alerts and automation to help them run their businesses efficiently is where we stand up.

So we actually integrate with Intune. We actually pulled the Intune experience, the Microsoft 365 experience. And later this year, the Azure experience into our platform. Microsoft has many clouds, as you know. And our job is to help integrate that for one experience so that the MSPs, if you think about it, we're this aggregator and whether they're using Microsoft operating systems, a Linux operating system or Apple devices, we need to provide that single pane of glass that one standard.

And more importantly, a bunch of automation so that they can roll out their rules and policies and alerting in one single manner. And so that's where we differentiate. So our product teams and our dev teams work along with the Microsoft teams to help them. And in addition, as it relates to data protection and security, Microsoft right in their terms and conditions, suggests that customers use a third-party cloud-based backup offering to back up their data as well for an extra layer of security. So we have a good working relationship with them. We look at the relationship in the way we can differentiate and help MSPs get more efficient is the reason why they continue to use us in concert with the Microsoft cloud offerings that they have.

[Jason Ader, William Blair]

Okay, thanks. And then one quick one for Tim before I wrap up here. Tim, can you break down the product mix for us? I know you've done that in the past between RMM and security and backup and PSA.

[Tim O'Brien, EVP and CFO]

We've never broken down the mix, at least -- what we've done is give color on just kind of the growth of those segments. And I would say the story is kind of unchanged there where both the data protection and security parts of the business are growing faster than overall revenue. And based on the demand we see, expect that trend to kind of continue into the beginning of the year here as well.

[Jason Ader, William Blair]

Great, thanks. Good luck.

John Pagliuca

Thanks, [Matt] (ph)

[Operator]

Our next question comes from Brian Essex from JPMorgan. Your line is open.

[Brian Essex, JPMorgan]

Hi, good morning and thank you for taking our question. I was wondering if I could maybe ask about your over $50,000 MSPs. So I guess on the larger side, how should we think about the margin contribution from those MSPs as you grow? It looks like you're adding them at a pretty good clip here, just maybe compared to the smaller ones that you service.

[Tim O'Brien, EVP and CFO]

Yes. So that stat is a combination of a couple of things. You're not wrong. We continue to add large MSPs, but the beauty in our model is we can also land in MSP giving us, let's say, $12,000 of ACV. And then as they're growing and adding more SMEs, they grow, but then as we were talking about with the previous question, then we're adding in the additional services. So a lot of times, when we're getting that increase in the numbers because an MSP is increasing their ACV to us via a successful cross-sell. So when they add data protection, when they add endpoint security, the LTV of the customer doubles and sometimes triples as they keep adding these important services to their business.

So it really speaks to two things. Our ability to win and we continue to do quite well at the high end of the market with our win rate there. But it really speaks to the success we have with our partnership in growing and as they add more services. And so it's a combination of those two things and why we refer to it as a snowball and we're growing as they're growing.

From a contribution margin, I'd say our cost to retain is much better than the industry because of the stickiness in our model because it's a partner-led growth. A lot of our growth comes not from us selling into the MSP, but from them adding services and selling into the SME. In some ways, think about it this way, our 25,000 MSPs and the 250,000 technicians that are working for those MSPs effectively become our sales force.

So as we give them goodness like managed EDR and our other -- our DNS filtering and help them package that, now they go off and sell to the SME these security services, add to their book of business with their existing customer base. And as a result, they trip over that $50,000 mark. So that's an important number for us as it shows the health of the partnership and that snowball effect growing. Hopefully, that helps.

[Brian Essex, JPMorgan]

Yes. No, super helpful makes a lot of sense. And I guess how do we think about the profitability given the, I guess, higher catch rates of those over $50,000 MSPs relative to what the rest of the customer base looks like?

[Tim O'Brien, EVP and CFO]

So I'm not sure there's -- so the shape of the higher ones, so they actually have a higher initial sale. The bigger MSPs have a higher sales. So I'd say the breakeven period to the larger MSPs is actually quicker than some of the smaller MSPs. Like N-sight customers that we talked about before, they come in usually with a lower ASP and their breakeven period has a little bit of a longer slope. But because of the power of the model, because of the way that the technology works, it really -- whether they're a small MSP or a large MSP, the unit economics are quite strong. And that's given off the strength of our low cost to retain, which I think is evident in the fact that we have the 30% EBITDA margins, right?

[John Pagliuca, President and CEO]

Yes. And Brian, just to add, if you think like an LTV to CAC ratio on that customer base, it's definitely more favorable than the lower end of the market. And also, if you look at retention rates, as you go up the stack in our customer base, gross retention rates are higher with our larger customers, they're higher within that customer segment of $50,000 ARR and greater as well. So that obviously is a tailwind to that LTV to CAC ratio as well. So probably just some additional information there to kind of think about the longer-term profitability of those customers.

[Brian Essex, JPMorgan]

Yes, that's helpful. I'm just trying to determine are you at some kind of an inflection point now that it makes those customers comprise more than 50% of our ARR. And then I guess with regard to the previous question on, I guess, level of confidence in the guidance for 2023. How much visibility do you get from your MSP customers in terms of what they're seeing for demand on their platform? And do they give you kind of inputs into what your planning process looks like for 2023? Just wondering at a level of communication there.

[John Pagliuca, President and CEO]

So we have 25,000 MSPs all across the globe. We have I'd say, a high frequency from a contact point of view across the base. We've invested in partner success over the last couple of years to increase a little bit more of that high-touch relationship and bringing in growth specialists to help the MSPs grow. So I'd say we have a good sense from the customer base with our partner success teams as far as what their growth areas are. And what I'll tell you is the MSPs, generally speaking, and of course, there is exceptions, are really focusing on growing their wallet share. That was true in 2022 as well.

But what we're seeing is for MSPs and if you think about it with labor scarcity, an MSP -- when an MSP adds customers, it typically means they'll need to add a technician, right? Not at a 1:1, but there's some linearity or correlation there. But when an MSP adds a service, especially if they're leveraging an N-able service, they're growing the wallet share of their customer base, growing their top line, growing their profit and not necessarily dependent on adding labor. That's why managed EDR as an example, is an important thing for them. They can grow their wallet share; it will help them with their efficiency.

So we -- I believe we'll continue to see strong demand from a security and data protection point of view. And that's a lot of the feedback that we get is that they're looking at focusing growing their wallet share as that. But when I spoke to the MSPs, I'd say, a couple of quarters ago at our Empower event, which is our first live event that we did in a couple of years, due to COVID, the demand is quite strong, and it aligned with what I was talking about, strong demand for data protection, strong demand for security and their strategy aligned with either growing their wallet share and/or adding more security services.

[Brian Essex, JPMorgan]

Got it. That's helpful. And then -- so I appreciate that. And maybe last one for me to kind of pivot off of that on the wallet share. What are you seeing out there in terms of MSP consolidation? And how does that compare with prior trends? And how might that impact your business going forward, either as your customers consolidate with other MSPs or potentially on the lower end, maybe they get acquired by other MSPs?

[John Pagliuca, President and CEO]

Great question. So I often say our TAM is not defined by the number of MSPs in the market. Our TAM is truly defined by that IT spend from the SME. And when two MSPs consolidate, really nothing happens to the TAM that's out there, right? And in fact, what usually happens is that MSPs the largely get and we're seeing MSPs now that are over $1 billion in revenue. Some are publicly traded. They're backed by private equity. They're backed by venture capital. They're getting, I'd say, much more mature in their business approach.

What's happening is the ceiling of which the customers that they're selling into has gone higher over the last couple of years. So we're seeing MSPs now selling into Fortune 1000 companies. And as a result, where when Tim and I got into the space 10-years ago, MSPs were primarily focused on small and medium enterprises that were 50 employees and down.

But now that the industry has matured, they have matured. The consolidation has forced a little bit more maturity. Our tech has allowed them to go up the stack. And now they're selling into mid-market. They're selling in with a co-managed bit to the Fortune 1000. So actually, it's somewhat counterintuitive, but as the consolidation happens, MSPs are going up the stack, raising that bar and potentially gaining them access to a bigger IT spend as they do that. Typically speaking, at N-able, the larger the MSP, the more our N-central product stands up and our win rate actually is better at the higher end because of the power that gives them the ability to orchestrate at scale.

And so -- and you asked for -- I answered your second question first. Your first question, do we continue to see consolidation. Yes. We continue to see that. Like your guess is as good as mine with rising interest rates, obviously, for MSPs and for everyone buying power somewhat gets degradated, right? And so I haven't seen a slowdown yet, but it's probably not crazy to assume that as -- with rising interest rates, it will put a little bit more pressure or scrutiny on acquisition. But MSPs continue to be acquisitive, and they do so because they're -- sometimes they're buying tech, sometimes they're buying a customer base or geography. And there's a bunch of goodness when these MSPs do that. It helps them drive scale and help them drive efficiency and ultimately drive their bottom line.

[Brian Essex, JPMorgan]

Great. Super helpful. Fantastic color. Thank you very much. I appreciate it.

[John Pagliuca, President and CEO]

Thanks, Brian.

[Operator]

This concludes our Q&A. I'll now hand back to John Pagliuca, CEO, for any closing remarks.

[John Pagliuca, President and CEO]

Thank you, operator, and thank you all for joining and listening in to the fourth quarter results. We look forward to providing an update in another quarter or so. Thank you, and have a great day.

[Operator]

This call has now concluded. We'd like to thank you for your participation. You may now disconnect your lines.