Earnings Call Transcript - NABL Q3 2023

Operator, Operator

Hello, and welcome to the N-able Third Quarter 2023 Earnings Call. My name is Alex, and I will be coordinating the call today. I will now hand over to your host, Griffin Gyr, Investor Relations Manager. Please go ahead.

Griffin Gyr, Investor Relations Manager

Thanks, operator and welcome everyone to N-able's third quarter 2023 earnings call. With me today are John Pagliuca, N-able's President and CEO; and Tim O'Brien, EVP and CFO. Following our prepared remarks, we will open the line for a question-and-answer session. This call is being simultaneously webcast on our Investor Relations website at investors.n-able.com. There, you can also find our earnings press release, which is intended to supplement our prepared remarks during today's call. Certain statements made during this call are forward-looking statements, including those concerning our financial outlook, our market opportunities, and the impact of the global economic environment on our business. These statements are based on currently available information and assumptions, and we undertake no duty to update this information except as required by law. These statements are also subject to a number of risks and uncertainties, including those highlighted in today's earnings release and our filings with the SEC. Additional information concerning these statements and the risks and uncertainties associated with them is highlighted in today's earnings release and in our filings with the SEC. Copies are available from the SEC or on our Investor Relations website. Furthermore, we will discuss various non-GAAP financial measures on today's call. Unless otherwise specified, when we refer to financial measures, we will be referring to non-GAAP financial measures. A reconciliation of certain GAAP to non-GAAP financial measures discussed on today's call is available in our earnings press release at our Investor Relations website. And now I will turn the call over to John.

John Pagliuca, President and CEO

Thank you, Griffin. Welcome everyone and thank you for joining us today. As the managed service provider sector evolves, the IT outsourcing market continues to thrive. This is driven by several key factors. IT is becoming more intricate and costly as companies seek to benefit from digital operations, modernize outdated systems, and comply with increasing regulatory demands. This combination of challenges diverts organizations from their primary operations, leading them to outsource and enhance their IT requirements through MSPs. N-able was established with this in mind. Our steadfast mission to empower MSPs with purpose-built technology positions us advantageously within the growing small and medium enterprise IT ecosystem, helping partners tackle these challenges directly. We believe our third quarter outcomes demonstrate the robustness of our market and reinforce our position as a leading software supplier to MSPs. Despite a fluctuating macro environment, we outperformed our revenue and profit expectations with earnings of $107.6 million, marking a 15% annual growth or 13% on a constant currency basis. Adjusted EBITDA reached $36.6 million, yielding an adjusted EBITDA margin of 34%, our highest margin to date as a public company. As Tim will elaborate further, we are maintaining our constant currency revenue forecast of 13% for the full year 2023 and raising the midpoint of our adjusted EBITDA guide from $136.3 million to $139.5 million. We have achieved this while laying the groundwork for future success. Our team has propelled critical strategic initiatives forward, and we are especially thrilled to announce our entry into a new product category with the launch of N-able Managed Detection and Response this month. Our relentless commitment to delivering value to the MSP community requires us to adapt to rapidly changing technological needs through focused product innovation. With around 25,000 MSPs, ranging from sole proprietors to global technology service providers, we believe we possess a distinctive vantage point into the dynamic market landscape. I would like to highlight three major trends influencing our product development, focus, and strategy. First, consolidation and modernization. Second, the movement up-market. And third, escalating security standards. Firstly, we see technology consolidation and modernization influencing customer preferences. In this unpredictable economic climate, MSPs are prioritizing operational efficiency and solutions with a proven return on investment. Our integrated platform and leading technology solutions align with MSP requirements, aiding in the reduction of tool clutter and facilitating their growth. We believe our comprehensive suite of top-tier RMM, data protection, and security solutions, paired with our multi-tenant platform and external integrations, place us in a strong position to meet MSPs' desires for tech stack consolidation and modernization. The second trend is MSPs moving up-market. Large enterprises are facing many of the same IT challenges as small and medium businesses and are increasingly relying on MSPs for assistance with their IT or security operations. We believe this trend expands the potential market for both MSPs and N-able. Our investments in products and market strategies are designed to support MSPs in capitalizing on this opportunity. The scalability, automation, and efficiency of our solutions resonate with MSPs focusing on larger markets, and we are continuously raising our standards to position N-able as a leader in this developing segment. A positive outcome of the MSP up-market trend is that the capabilities we develop to assist MSPs in entering larger markets also enhance our ability to directly engage mid-sized and large IT departments. While our primary focus remains on our MSP partners, we are also pursuing direct IT sales as opportunities arise and are observing favorable momentum in this area of our business. Now, regarding the third trend, increasing security standards. The significant impact of a successful cyberattack has consistently made security a top priority for businesses. Beyond purchasing security solutions to protect themselves, MSPs are also confronting rising global compliance standards that boost the demand for security. The message here is clear: security is transitioning from an optional concern to a mandatory necessity. With our extensive and recently enhanced suite of security offerings, which includes endpoint protection, mail protection, content filtering, and more, we provide a comprehensive security approach that meets regulatory mandates and protects the modern digital enterprise. Last quarter, we made significant strides in advancing our product offerings to take advantage of these trends, and I would like to share updates along with encouraging market feedback we've received. Starting with Cove, we have heavily invested in enhancing our technology to better enable Cove's scalability into larger domains and assist MSPs in moving up-market. A recent deal in the third quarter, which involved displacing a known competitor in the up-market space, reflects our success as it represents our largest initial Cove deal ever, exceeding $500,000 in annual recurring revenue. Additionally, we have a recent example from an MSP customer who replaced 11 legacy data protection solutions by choosing to consolidate with Cove. This MSP conducted a thorough evaluation of each product and specifically highlighted Cove's technical superiority, user-friendly interface, and compliance with data sovereignty requirements thanks to geographically diverse data centers. As sophisticated attacks now frequently target data copies away from core networks, the line between data protection and security is becoming increasingly blurred. Modern data protection solutions must not only restore data but also ensure its safety, and Cove was designed with this necessity in mind. Our cloud-focused approach prevents customer data copies from being exposed to local networks, reducing vulnerabilities and providing clients with peace of mind. The response to Cove's innovations has been highly positive. Our new customer cohort in 2023 is the best we've ever had, and our Cove Microsoft 365 backup solution is currently protecting over 1.8 million users, growing at approximately 48% year-over-year. Cove is also gaining industry accolades, recently being named a champion in Canalys' managed backup and recovery leadership matrix. Regarding our RMM solutions, we remain dedicated to addressing MSP concerns wherever they arise. We are simplifying the complexities of hybrid environments, users, and devices, moving beyond traditional RMM confines to deliver a modern, comprehensive IT management platform. Significant progress was made towards this vision in the third quarter. We introduced a refreshed user interface with a new asset inventory view, building on previous releases of analytics features and enhanced Apple management capabilities. These advancements provide technicians with greater insight into their IT landscapes and enable more effective IT stack management. This can lead to substantial business benefits. Our strong functionalities enhance MSPs' abilities to penetrate up-market and support large organizations with varying operating systems while capitalizing on the benefits of technology consolidation. Our strategy is resonating with clients, and we are observing consistent demand in this area. Moving to security, we continue to improve our security offerings and are particularly excited about entering the managed detection and response sector. MDR integrates cutting-edge technology with human expertise to deliver superior protection for organizations. This combination addresses a significant pain point for our customers; as threats become more frequent, organizations require assistance managing them. Issues like alert fatigue, adapting to the evolving threat landscape, and staffing shortages mean companies need support. A recent survey involving thousands of our MSPs revealed a strong demand for MDR services from N-able. Research firms also reinforce the market potential for MDR, with Canalys stating that the opportunity for cybersecurity services will surpass that of selling cybersecurity technologies this year. MDR encompasses more than just managed EDR, as it extends beyond endpoints to deliver comprehensive security visibility and response throughout the customer's entire IT ecosystem, including users, cloud applications, and networks. This is powerful. Integrating MDR enhances our offerings and positions us as a one-stop shop for security solutions and services. We benefit from a strategic partnership in this field, backed by key players in national cyber defense with modern, cloud-native architecture. We view this as a significant opportunity, and since introducing this technology, customer engagement has consistently exceeded our expectations. In addition to expanding our solutions, we are committed to enhancing the customer experience. To that end, we recently upgraded our integration framework to boost functionality across our security offerings. This enhancement also broadens our ecosystem, allowing for quicker time-to-market with vendors seeking to expand their reach through partnership with us. Across the security domain, from MDR to mail solutions, security remains paramount, and we are dedicated to advancing our customers' security endeavors. With these trends fueling demand, we are investing in and operating for the long term while focusing on delivering exceptional technology that positions N-able to lead in the MSP era. Our operational initiatives and strategic objectives all align with our sell-to and sell-through business model. We view our MSP customers as partners, leveraging our approximately 25,000 MSPs to reach and sell solutions to over 500,000 small and medium enterprises. This partnership creates a multi-faceted growth model that allows us to effectively tap into SME IT spending with robust profit margins. When we acquire an MSP, we experience growth. When an MSP acquires a customer, we grow. And as an MSP customer's workforce expands, we grow. Additionally, when we launch a new service, we unlock growth potential across our MSP and SME networks. These components of our model form the foundation of our growth strategy, which includes MSP retention, cross-selling new services to existing MSPs, MSP device growth, and attracting new MSPs. I want to share operational updates from the third quarter concerning each of these elements. Starting with the addition of new MSPs, our customer acquisition engine remains strong. Although we have just completed three quarters of the year, the dollar figures for our 2023 customer cohort are the highest recorded since going public. We are successfully reaching new customers who are choosing to partner with N-able. This achievement, despite an unpredictable macro environment, reflects the strength of our value proposition and signifies the dedication of our go-to-market teams. We believe that education fosters adoption, and our N-able team was highly active in the market, engaging with customers. In the third quarter alone, we hosted seven roadshows across North America, sponsored 11 global industry events, and conducted over 50 head nerd boot camps, reaching thousands of partners and prospects. Beyond acquiring new MSPs, our initiatives to educate partners on the value of our offerings have also fueled their growth. We noticed steady cross-selling activity in the quarter. Given our diverse solution portfolio encompassing RMM, data protection, and security, empowered MSPs find it easy to expand. Our average revenue per partner is rising as customers adopt more of our solutions. We see significant potential for deeper penetration within our existing base, with cross-selling opportunities worth billions. Although our cross-selling and new customer acquisition are healthy, the uncertain macro environment is affecting partner device growth and retention. We are observing tighter IT budgets and slower device growth as a consequence. We believe these tighter budgets have led partners to rationalize and optimize their existing expenditures. However, we found multiple bright spots in our efforts to retain and grow our customer base. Our partner success organization achieved its highest customer satisfaction score ever for technical support. There remains robust demand for our N-able head nerds, who act as partner champions and experts. In our commitment to continuously enhance the customer experience, we launched the N-ableMe partner success center, engaging nearly 13,000 partners through this platform. We focus on these elements of our operations because our growth is linked to our partners' growth. With MSPs serving as an extension of our sales force, we efficiently tap into SME IT expenditures, and our adjusted EBITDA margin for the third quarter was the highest since going public, underscoring the effectiveness of our strategy. Great technology and outstanding operational execution are vital to our business, but our people and culture are fundamental to our success. One area of emphasis is our ongoing dedication to diversity, equality, and inclusion. Recently, we hosted a global, cross-functional women’s leadership summit aimed at fostering cultural transformation and enhancing our women leaders' capabilities. We were also proud to receive three awards from Comparably, a prominent workplace and corporate reputation platform, this quarter. With that, I would like to pass the call to Tim for an overview of our financial results and outlook, after which I will return for some concluding thoughts.

Tim O'Brien, EVP and CFO

Thank you, John and thank you all for joining us today. Our third quarter results were strong, exceeding guidance on both the top and bottom lines. Steady demand for our platform, solutions, and strong cost management highlighted by our highest ever adjusted EBITDA margin as a public company helped drive our outperformance. Looking ahead, we believe our market remains durable, and while we are mindful of the macro environment, our business model, with multiple growth vectors and a clear strategic focus, remains well-positioned to capitalize on the growing demand for MSPs. For our third quarter results, total revenue was $107.6 million, representing approximately 15% year-over-year growth or approximately 13% on a constant currency basis. Subscription revenue was $105.2 million, representing approximately 15% year-over-year growth or approximately 13% on a constant currency basis. Other revenue, which consists primarily of revenue from the sale of maintenance services associated with the historical sales of perpetual licenses and revenue from professional services, was $2.4 million, up approximately 2% year-over-year. We ended the quarter with 2,134 partners that contribute $50,000 or more of ARR, which is up approximately 19% year-over-year. Partners with over $50,000 of ARR now represent approximately 55% of our total ARR, up from approximately 50% a year ago. Looking at net retention for the third quarter, dollar-based net revenue retention, which is calculated on a trailing 12-month basis, was approximately 108% or 110% 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. Third quarter gross margin was 84.6% compared to 84.8% in the same period in 2022. Third quarter adjusted EBITDA was $36.6 million, up approximately 27% year-over-year, representing approximately 34% adjusted EBITDA margin. Unleveraged free cash flow was $30.2 million in the third quarter, and CAPEX, inclusive of $2 million of capitalized software development costs, was $5.5 million, or 5.1% of revenue. Non-GAAP earnings per share was $0.09 in the quarter, based on 186 million weighted average diluted shares. We ended the quarter with approximately $127 million of cash and an outstanding loan principal balance of approximately $343 million, representing net leverage of approximately 1.6 times. Approximately 46% of our revenue was outside of North America in the quarter. Turning to our financial outlook, as John discussed, we see tailwinds in our market and believe in the long-term opportunity for N-able. As we look to the near term, we see macro uncertainty creating caution in SME IT budgets, with organizations seeking to optimize spend in a tighter budgetary environment which we have reflected in our guidance. And while our R&D engine continues to bring critical, robust solutions to MSPs, our growth expectations are reflective of the time to market for these new products which we continue to work to accelerate. With that in mind, for the fourth quarter of 2023, we expect total revenue in the range of $106.5 million to $107 million representing approximately 11% to 12% year-over-year growth, or approximately 10% to 11% on a constant currency basis. We expect fourth quarter adjusted EBITDA in the range of $35 million to $35.5 million, representing an adjusted EBITDA margin of approximately 33%. For the full year 2023, we now expect total revenue of $420 million to $420.5 million, maintaining the midpoint of our prior full-year guidance, representing approximately 13% year-over-year growth on both a reported and constant currency basis. We are raising our adjusted EBITDA outlook, and now expect full year adjusted EBITDA of $139.2 million to $139.7 million, up approximately 22% year-over-year at the midpoint, and representing an approximately 33% adjusted EBITDA margin. There have been changes to the foreign exchange environment since our last outlook and I want to take a moment to reconcile the impact of these changes on our guidance. In our previous call, we assumed FX rates for the Euro and Pound of 1.07 and 1.25, respectively. Using updated FX rates for the remainder of the year of 1.05 for the Euro and 1.22 for the Pound, and updating other currencies to reflect the current rate environment, translates to a negative impact on revenue of approximately $1.1 million for the fourth quarter. We believe our ability to maintain the midpoint of our full year 2023 revenue guidance and raise full year 2023 adjusted EBITDA guidance despite these FX headwinds, speaks to our operational strength. We reiterate that we expect CAPEX, which includes capitalized software development costs of approximately $8.5 million, will be approximately 6% of total revenue for 2023. We also expect adjusted EBITDA conversion to unlevered free cash flow to be approximately 65% for the full year. We expect total weighted average diluted shares outstanding of approximately 187 million for the fourth quarter and 186 million for the full year. Finally, we expect our non-GAAP tax rate to be approximately 23% in the fourth quarter and 25% for the full year. In closing, we are pleased with our strong third quarter. Looking forward, while we are mindful of the macro uncertainty, we believe we are uniquely positioned to benefit from the robust long-term addressable market opportunity. We have a proven track record of execution. Our customer base is diversified by region and industry, and the IT management, security and data protection solutions we provide are high IT priorities. The addition of our new MDR offering adds another gear to the business model. With our strong adjusted EBITDA margins, free cash flow, and balance sheet, we have considerable capital allocation flexibility to invest strategically to meet the needs of our market.

John Pagliuca, President and CEO

Now, I will turn it over to John for closing remarks. Thanks, Tim. We scaled our business to new heights in the third quarter and made progress on critical strategic initiatives. As we march forward on our quest to advance the age of the MSP, our vision is clear and we believe the opportunity is vast. The SME IT ecosystem we serve is large and growing, and our differentiated model, which efficiently cracks the code to the trillion dollar plus SME IT market by providing enterprise-grade technology to MSPs, delivers both growth and profit. With our clear strategy and appealing market opportunity providing direction and energy to over 1500 plus N-ableites, our sharp focus is on driving operational excellence and continuing to deliver great technology to MSPs. And with that, we will open up the line for questions.

Operator, Operator

Thank you. Our first question for today comes from Mike Cikos of Needham. Your line is now open. Please go ahead.

Mike Cikos, Analyst

Hey team, I appreciate you addressing the questions. It's impressive to see the revenue exceeding expectations and the maintenance of our revenue guidance, along with the increase in EBITDA for the full year despite some foreign exchange challenges mentioned by Tim earlier. There are two angles to consider, and both questions relate to the new customer growth we're discussing. John, I value your insights and the growth strategy you've outlined. The first question relates to the macroeconomic landscape. You mentioned that the calendar 2023 customer cohort represents a selective group in terms of revenue for new customers since going public. In light of the macro situation, how should we assess the cautious environment? Is it evident that the difficulties are increasing on a quarter-to-quarter basis compared to 90 days ago? That's my first question, and I have a follow-up regarding the macro situation.

John Pagliuca, President and CEO

Thanks, Mike and appreciate you following the stock. I'm looking forward to talking to you and your team a little more tomorrow. So on the quarter-on-quarter comment, look we purposely wanted to spell out the growth algorithm just to remind folks that we have this multifaceted approach. As you mentioned, the NCA part of the algorithm was quite strong, it was quite strong in Q3, even compared to Q2. There's really no major difference in the macro environment that we're necessarily seeing from Q2 to Q3, like quarter-over-quarter performance. I would say it's more, Mike, a little bit of a continuation of the same where we're seeing MSPs looking to hit their targets, both their top line and their bottom line targets and the way that they're achieving that is more through cross-sell of additional services, rather than adding SMEs. And so that's where we're seeing a little bit of that moderated device ads coming up. And so I'd say it's a continuation of really the moderated device ad and a little bit more of a focus on where they're spending their money as it relates to licenses, licensing costs across their broader portfolio.

Mike Cikos, Analyst

Got it and thank you for the color there. And then the second question, this one comes back to the new customers, but through the lens of almost competition here. And so I just wanted to see, is there any change on the competitive front, obviously, we are some quarters removed from the Data acquisition, is there any benefit coming to N-able through that? And then the secondary pieces, obviously, you guys are talking about the MDR offering and what that does for N-able, but I have to imagine in some sense that elevates you guys at a competitive level. So any feedback that you guys are receiving since the MDR, I know you had some bullish comments in the prepared remarks, but just wanted to see if I can get any incremental color on those two pieces? Thank you.

John Pagliuca, President and CEO

Yeah, on the NCA, I'd say we continue to see a strong uptick in our core data protection offering. So when we spun the business out a couple of years back, we looked at Cove and data protection as a category; there is tremendous opportunity; one, from the category and what we're seeing as the demand from the MSP base, but two, we have a differentiated offering from a technology and from a TCO, total cost of ownership. So we decided a couple of years back to invest in the new brand, bring back up to the front, as we called it internally, and really started pushing the COVID initiative and suite as more of an NCA, new customer offering as opposed to just a cross-sell offering. We are finally starting to see the fruit of all that hard work from our go-to-market teams and the brand and our product leadership continuing to differentiate that offering. So overall, across the geos I would say we're pretty consistent. But if I had to point to one headline or bright spot, it's really that Cove’s data protection offering having success in new customers. On the MDR front, yeah, we are bullish. This is an offering that we've been studying in the market that we've been studying for quite some time and wanted to make sure that we found an offering that could, by itself, differentiate N-able compared to all the competitive landscape. We think this will help, Mike, both on our cross-sell. As you know, we have a large security offering and so MSPs look to N-able, and they trust N-able with the security offerings. So we expect them to continue to trust N-able with the MDR offering. But also this will help us with NCA, new customer acquisition. Even some of our early conversations with some of the MSPs in the market, if they're not in the market for data protection offering or an RMM offering we're having now a conversation with them on MDR. And so we're quite excited as to what this offering brings both in terms of cross-sell, but also new customer acquisition. So look for further updates as we get into 2024 there.

Mike Cikos, Analyst

That's great to hear. Thank you.

Operator, Operator

Thank you. Our next question comes from Jason Ader of William Blair. Your line is now open. Please go ahead.

Jason Ader, Analyst

Yeah, thank you. Good morning, guys. I just wanted to ask about the RMM business drill down on that a little bit. Just for modeling purposes, can you just remind us what you've said publicly about how big RMM is as percentage of your revenue?

Tim O'Brien, EVP and CFO

Hey Jason, this is Tim. Thanks for the question. Drilling down on the RMM business, in terms of what we said, historically, in terms of size of the business, we don't just go to the size of the underlying kind of product lines within the business, but we have given color on just kind of stack ranking them and just how to think about the components of the overall business. So RMM is number one. Data protection is number two, and security is number three. The combination of data protection and security is bigger than RMM. So they're all sizable product lines within the business.

Jason Ader, Analyst

Got you, okay. And then on the RMM side, it sounds like it's sort of a continuation of some of the pressure on device growth. We've heard sort of in the market that there's also been a fair amount of pressure on pricing, sort of per device pricing. And I'm wondering just how have those dynamics shifted over time? I don't know if it's a competitive situation where some people in the market are kind of bombarding the price. But what I guess, what is the strategy to grow RMM in a weak macro environment, let's just assume that we're going to be in a sort of same tighter environment through 2024, how do you guys counteract maybe some of that pressure, on device growth or on pricing? I don't want to put words in your mouth but if you could comment on the pricing environment there and then also just what the strategy would be to grow RMM in a weaker macro environment, putting aside the strength that you're seeing in DP and security?

John Pagliuca, President and CEO

Thanks, Jason. Hey, this is John Pagliuca. One of the reasons why we don't really disclose revenue by type is we look at the broader opportunity from the LTV of the MSP. And so if you think about the opportunity on the MSP, I know you're familiar with our Investor Relations deck, we typically say, per device that's around mid $20 per device type of opportunity. By the way, now with MDR that opportunity is now in the low $30s. So that's why we're so excited about MDR. But when you think about the stack, RMM depending on what offering they have, that could be $1 to $3 of that $30 back up, and data protection is a material piece. Security is from an opportunity stack point of view, probably the largest one. What we tried to do was focus on the word adoption, as opposed to just revenue by RMM. For us, this is not too dissimilar to some of our competitors, where we're looking to land and get the trust of the MSP. Historically, the front door coming into N-able for MSPs has been RMM. That's when they would come in, and then we would go and add and cross-sell from there. But now with data protection, we're finding a different rhythm and a different pattern. We're actually landing with Cove and now we're cross-selling into RMM. We hope and expect to do that with MDR as well. That will give at least three, potentially four different lanes or avenues into N-able from the cross-sell motion. Then we can begin building that trust in that value with the MSPs to get that stack up to about that $30 per device or user per month type of opportunity. For us, the focus really is not necessarily on the RMM revenue; it's on the RMM adoption, more so it's on the N-able MSP partner relationship, so we can unlock that $30. If you take that $30 and you factor in roughly 8 million devices that we have and multiply that by 12, you get that $2 billion to $3 billion opportunity. And that's where the real game is going to be won. For us, it's all about landing the customer regardless of what path and then through trust and showing the value of the platform and how we can help them with their TCO, their total cost of ownership and help with their efficiency play add more and more services to the MSP. So that's really the strategy. A slight evolution there, three or four years ago it was, hey, come into N-able through RMM, one of our two RMMs. Today it's coming through one of those two leading RMMs or through data protection. Tomorrow it will be through MDR and other types of security offerings. That’s why we're excited about how we think about the overall $2.83 billion opportunity, that's just within our customer base today.

Jason Ader, Analyst

I understand, that makes sense. I want to clarify the evolution you mentioned. Is this evolution partly a result of the pricing changes over the last five years from $1 to $3, which has been declining, prompting you to broaden your offerings? Or is it more about the changing needs of the market?

John Pagliuca, President and CEO

I'd say this: the stack, the opportunity stack has gotten larger, right. When I think about the market, I often refer to it as the X and Y axis. On the X axis are all the services. If you're a business or any company, if you have one service that you're going to market with, well, then you are laser-focused on that particular price point. But as we add services and the TAM increases by the X axis, you have a little bit of more of a strategy as to what you're playing for. What we're really playing for are making sure that we're lending the MSP and helping them add more small medium enterprises. So, you're willing to take a different cost mix for the different offerings because you're not just focused on one offering. It's one of the benefits, I'd say, of becoming a bigger, more of a platform story, adding data protection, adding security. We now can focus on the bigger LTV. So, I don't think it's necessarily that the need for RMM has diminished. I just believe that that tech stack has gone up just by itself. I've been in this business for about 10 years. That tech stack might have started about $15 or so years ago. Now that we're adding things in endpoint security, we're adding things like managed detection and response, we're adding things like Office 365 backup, the value of the tech stack continues to increase, which somewhat changes the strategy and the tactics that you want to go and really acquire those customers because they're of more value to you to land them and grow them.

Jason Ader, Analyst

Makes sense, thanks. Thanks for that. Appreciate it.

Operator, Operator

Thank you. Our next question comes from Matt Hedberg of RBC Capital Markets. Your line is now open. Please go ahead.

Matt Hedberg, Analyst

Great, thank you for answering my questions. John, in your earlier comments, you mentioned that having a direct IT relationship with certain customers might be beneficial. I assume these are relatively large customers. Could you elaborate on that strategy and explain how you determine the balance between allowing an MSP to manage everything and establishing a more direct relationship?

John Pagliuca, President and CEO

Hey Matt, thanks. Great question. What I was referring to there is that internal IT department. If you think about our offerings now, whether it's our Cove data protection offering or the remote monitoring and management, those use cases are very similar and scratch a similar itch with the internal IT department, especially where there's more of a robotics framework, remote office, branch office folks are working from home, they're in a hybrid environment, different geos, different offices. The IT professional is under the same type of scrutiny and performance issues as an MSP. And what's that all about? Efficiency. An MSP or an internal IT department has that same need where they can leverage our tools, our platform via our automation and do more with less. So the use case and the personas are very similar. We've been finding that our offerings have had quite success for quite some time. We’re really just leaning in a little bit more with a more specialized sales and go-to-market team there because what we're finding is we were not necessarily marketing or selling to that mid-market enterprise, but they were buying from us. In 2023, we really began a little bit more of a focused effort to talk to that persona, understand what that persona needs, and setting up a sales and marketing motion that satisfies their needs. It's been a success overall, that part of the business has been one of our bright spots for sure. As far as your second question on the line, there's not really a line. If an internal IT department is choosing to manage their own digital assets themselves, then N-able will provide them that software. The benefit of our tools, and the same thing with our MDR offering, is we allow MSPs to co-manage with these customers. If you're a CIO of an internal IT department, you can choose to use our central RM platform or Cove data protection. Then you can bring in an MSP to augment. Both your internal team and your managed service provider, your IT consultant, can have eyes on glass and see the same environment. What's happening now, Matt, I mentioned with Jason's question that I always refer to our TAM as the X axis on the services and the Y axis as the size of the customers. Because of both our direct motion to internal IT departments, but also as a result of MSPs landing larger and larger customers, our TAM is increasing, that Y axis and the size of enterprise that enable servicing is getting bigger. This concept of a co-managed environment where a CIO is saying, hey, look, I have my own IT. My own IT staffing issues, let me pull in an MSP to augment some of these services that I need. I can do so and actually save some budget as well. We're finding that to be a healthy formula.

Matt Hedberg, Analyst

That's super helpful John, seems like a nice incremental catalyst as well next year, as you kind of continue that motion. And then maybe one for Tim, NRR I think it looks like it ticked up maybe 100 basis points on a constant currency perspective from Q2. Obviously, this is a trailing 12-month metric. But, with that slight improvement how do you see that perhaps trending into Q4? I mean, could it move up a little bit if there's a little bit of Q4 budget flush because obviously there's an impact on maybe 2024 as a result of that, but just kind of curious on your thoughts there?

Tim O'Brien, EVP and CFO

Yeah, on the trailing 12-month, it was slightly up I would say. On the quarter it was pretty consistent Q3 versus Q2. I wouldn't say historically we haven't seen like a budget flush end of the year from an MSP perspective to lend to any type of unnatural acceleration from an NRR perspective. I would say as we think about NRR and Q4, I would expect it to be fairly consistent. It's been a pretty steady metric; we did get a slight increase due to the timing of some of the price change in Q2, that will live with us kind of through the second quarter of next year. But we aren't modeling any significant change from an NRR perspective quarter-over-quarter.

Matt Hedberg, Analyst

Got it? Thanks a lot, guys.

Operator, Operator

Thank you. Our next question comes from Brian Essex of J.P. Morgan. Your line is now open. Please go ahead.

Brian Essex, Analyst

Hi, good afternoon. Thank you for taking the question. And great to see the incremental operating margin expansion. Maybe on that point, Tim, if you could help us understand some of the levers behind some of the cost controls that you had in the quarter, it looks like operating expenses actually declined sequentially, which initially looks like it might be seasonal but then when we dig into some of the drivers of that, some of them may be different. Maybe you can help us understand what levers did you pull in the quarter, how sustainable are they, and how you think about operating leverage as we kind of start to look into 2024?

Tim O'Brien, EVP and CFO

Yes, definitely. Reviewing the P&L, we have historically identified leverage opportunities in all three areas: G&A, sales and marketing, and R&D. In 2023, we strategically increased our investment in R&D to accelerate the introduction of new products to our partners, and I believe we will see a return on that investment. G&A expenses have remained relatively stable since the business was spun off, and we anticipate gaining leverage in that area now and in the future. Sales and marketing is another area where we consistently evaluate our return on investment. We analyze our spending in detail and optimize it based on performance standards. This ongoing review has been part of our approach since going public, and we plan to maintain it. Ranking leverage opportunities across the P&L, I would list G&A first, followed by sales and marketing, and then R&D, though there are opportunities in all three areas.

Brian Essex, Analyst

Got it, that’s super helpful. Maybe if I could circle back on MDR, to follow up. Any sense that you might have in terms of any pent up demand and how long you might have been, I guess, seeding your installed base for that and what you anticipate ultimate penetration rate might be?

John Pagliuca, President and CEO

Sure, we know from talking to our customers, and we hit this a little bit in the prepared remarks. We did a pretty sizable customer survey where we asked them what their bigger focus areas were for 2023 and 2024. Cybersecurity services were very much top of mind. From talking to our customers and even looking at the survey results, we believe that there's a good amount of opportunity. The good news here, Brian, is that they’re for both our small MSPs and our large MSPs. So on your adoption, I believe that it'll cover the broader install base. The double-click into that is, what type of uptick will the MSPs have as they roll this out to their small and medium enterprise. We believe, as there's more of a driver from a compliance point of view, and by the way, if we back up there are two things that are really driving this; one, when companies are looking to get cyber insurance, there's a much more focus overall on the stack and being able to not just protect but also detect and respond across the base. This is helping MSPs. The second thing, there's a big push from a compliance point of view. Security, really before was a decision of how willing am I to take a risk as a small medium enterprise or as an MSP. Now, with compliance, what used to be maybe a sliding scale from a risk aversion, or a range of gray is now more black and white and binary. If you want to be compliant, whether you're in healthcare industry, FinTech, or whether you're in a certain geography like in the UK with cyber essentials, if you want to play in that market, as a small medium enterprise, you need to be compliant. They're pretty specific as to what that need is and what those requirements are. This is driving a lot of the need for the cybersecurity services to pop up at the small medium enterprise. We're seeing it across the geographies and across the verticals that our MSPs participate in and across the different sizes. So we're quite bullish on the opportunity. It'll take some time as the MSPs roll this out and get comfortable with the motion themselves. But we're quite optimistic that it will have a broad appeal to our install base.

Brian Essex, Analyst

Great, great color. Thank you.

Operator, Operator

Thank you. At this time, we currently have no further questions. So I'll hand back to John Pagliuca for any further remarks.

John Pagliuca, President and CEO

Thank you all for participating in our quarterly call and for the questions and looking forward to talking to you all at the beginning of 2024. Take care.

Operator, Operator

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