Earnings Call Transcript - NABL Q1 2022

Operator, Operator

Hello and welcome to today’s N-able’s First Quarter 2022 Earnings Call. My name is Bailey and I will be your moderator for today’s call. All lines will be muted during the presentation portion of the call with an opportunity for questions and answers at the end. I would now like to pass the conference over to Jeffrey Magoma with N-able. Jeffrey, please go ahead.

Jeffrey Magoma, Unidentified Company Representative

Thank you, Bailey, and welcome everyone to N-able’s first quarter 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.n-able.com. There you can also find our earnings press release which is intended to supplement our prepared remarks during today’s call. Certain statements made during this call are forward-looking statements, including those concerning our financial outlook, our market opportunities, our continued expectations following the 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 last year. Additional information concerning the 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 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

Thanks, Jeff, and thank you all for joining us today. We are pleased with both our execution and financial performance in Q1. Our revenue growth was 12% on a constant currency basis that exceeded the high end of our outlook, leveraging the strength of our data protection as a service and security offerings. Operationally, we are on track with the initiatives we outlined last summer in preparation for our spin-off. Our investment in partners' success is resulting in better retention figures, more cross-sell opportunities, and a better customer experience. Our increased investments in product have allowed us to re-establish our cadence, bringing additional offerings to our MSPs and delivering a disruptive data protection offering that is winning in the marketplace. Our investments in additional sales motions and channel expansion are unlocking opportunities in new geographies and areas. As I mentioned on the last call, this year, we are rallying behind the phrase, earn more N-able fans. So far in 2022, it has really galvanized our strategy and accelerated our momentum. As you know, we call our MSP customers, our partners, because our relationship goes deeper than a mere transaction or sale. Our partners look to N-able to provide them with world-class technology that allows them to efficiently and securely scale their business and support the IT needs of their customers. Despite all the noise in the market, we remain focused on a different kind of disruption, placing powerful and disruptive technology and business tools in the hands of our partners, enabling them to achieve their growth goals and increase their value to their customer base. Because when they grow, we grow. We know that in order for us to earn more fans, we need to execute on our mission to empower MSP partners to solve their most pressing problems and keep them secure ahead of their competition. We have made a long-term commitment to our partners’ success and continuously improve on all fronts. We’ve talked about our industry tailwinds. The digital evolution continues to accelerate and pose both opportunities and challenges to SMEs. The levels of IT complexity, labor scarcity, and rising cyber threats are increasing, underscoring the importance of IT service providers. This aligns with our strategy and business model. First, IT complexity is rapidly increasing. What this means for MSPs is that their customers will continue to ask them to manage widespread digital assets with increasing IT demands. They will need to automate and secure new processes and workflows to ensure their SMEs remain productive. N-able’s commitment to allow MSPs to manage everything means that from a single platform, our partners can meet this move toward hybrid work and manage the additional complexity of diverse device types, cloud computing environments, and SaaS applications. Second, labor scarcity, specifically for tech talent, affects everyone from SMEs to larger enterprises who are relying on outsourcing to fill in talent, to SMPs themselves who need to do more with fewer resources. Our technology is built to allow technicians to automate and help MSPs as well as the businesses they support to scale effectively. Third, cybersecurity threats are on the rise, making the work our MSPs do not just important, but mission-critical to business continuity for hundreds of thousands of businesses around the world. Given the current geopolitical situation, both state and non-state actors pose a heightened threat to businesses in Europe and around the world. MSPs are looking to us to provide them with enterprise-grade security solutions with the simplicity that SMEs require. A lot of our activity on the product front directly addresses these industry tailwinds. I mentioned briefly on our last call that we launched N-able DNS filtering in February as a new security offering to our partners. This AI-driven content filtering and threat protection service allows MSPs to better monitor, manage, and proactively protect their customers' networks, regardless of location or connection. This is ideal for hybrid work environments. We have seen a strong uptake since the launch and expect continued acceleration into the second quarter. Our focus on data protection has always been a key growth driver for N-able. Just last week, we announced the launch of Cove Data Protection. We believe that Cove is disruptive to the market due to its fundamentally different architecture, allowing MSPs to modernize their approach to data protection, and enabling seamless backup, archiving, and recovery of data, eliminating up to 90% of labor time and moving approximately 60 times less data, thus simplifying operations for our partners. Leading into this launch, we celebrated milestones that underscore the power Cove Data Protection brings to the market. We received the Backup and Disaster Recovery award from Cloud Computing magazine, which recognizes excellence in the advancement of cloud computing technologies. Since launching our backup solution for Microsoft 365 domains in December 2019, we are now protecting over 33,000 M365 domains as of the end of April. We believe traditional local-first image backup does not suit modern IT environments and certainly misses the mark for MSPs. Our solution was built from the ground up to be cloud-first. Unlike others that claim to be cloud, but are merely legacy architectures with added secondary cloud features that add complexity, Cove provides appliance-free, direct-to-cloud capability with advanced disaster recovery benefits, designed for cost efficiency, scalability, and reliability that MSPs and their customers require. I'll illustrate this with a feature currently in customer preview, slated for general availability in early Q3, called Standby Image. This elegant toolset allows MSPs to have backups sent to the cloud while maintaining a standby image at their preferred location, enabling fast and flexible disaster recovery without the need to purchase proprietary appliances. Cove effectively addresses the primary needs for modern data management systems. Our partners report that with Cove, they can reduce backup time from 40 hours a month to just four hours, go from three full-time support technicians down to about half a technician, and see a decrease in support tickets from 95 tickets per day down to nine. This is a massive impact for service-oriented organizations and allows them to focus on more strategic, value-added work. A recent report from William Blair estimated the total addressable market for data management at $37 billion in 2024, highlighting the market potential. Though we are currently not well known in the backup and disaster recovery space, we have received consistently positive feedback from partners and prospects when they switch from competitive solutions to N-able. As we establish our brand in data protection, we anticipate significant growth. Additionally, our N-able Mail Assure email security solution has been awarded first place in the latest comparative review, achieving the highest score in both March 2022 testing and the previous September. We received the highest VBSpam plus rating with malware catch rates of 99.96% and zero false positives. We are also conducting an external preview of an additional feature called Mail Assure Private Portal, which secures emails beyond managed devices with audited access and encryption. This feature has received positive feedback from our MSP partners. Finally, we are soft launching our new professional services offering, designed to help MSPs better address labor scarcity issues. Known as N-able Enhanced Services, this offering aims to help partners unlock the potential of N-able products, optimize team efficiency, and accelerate time to value by delivering solutions to customers faster. This structured offering responds to partner feedback and culminates in significant investment in service delivery, focusing on what our partners value about us. We believe this will open doors to larger scale opportunities. Lastly, I want to share some notable wins. We won a large six-figure N-central deal with a multinational medical research company in Europe looking for a management solution for their global assets. They were impressed by N-central’s advanced security and full visibility into their dispersed specialized infrastructure. Additionally, we sold a near six-figure deal for our Cove Data Protection solution to a large MSP primarily serving Mac users. This win highlighted our superior value, technology, and service, significantly benefiting their profitability and scalability.

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 review our first quarter financial results, then discuss our outlook for the remainder of 2022. As John mentioned, we finished the first quarter ahead of our outlook, with total revenue of $90.9 million representing 9% year-over-year growth, or 12% on a constant currency basis. Note that if foreign exchange rates had held at the rates used when we provided our guidance, our revenue for the quarter would have been approximately $250,000 higher. Subscription revenue was $88.6 million representing approximately 10% year-over-year growth or 13% on a constant currency basis. Other revenue, primarily maintenance from our discontinued legacy license model, was $2.2 million, down 12% year-over-year consistent with prior quarters. We ended the quarter with 1,733 partners with greater than $50,000 of annual recurring revenue (ARR), a 15% year-over-year increase. Partners with over $50,000 of ARR now represent 48% of total ARR, up from 43% a year ago. We saw strength across our portfolio with our EDR and Microsoft 365 backup solutions continuing to outpace total company revenue growth. Dollar-based net revenue retention, calculated on a trailing 12-month basis, was 108%. The decrease relative to last quarter is solely due to changes in foreign exchange rates. 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. First quarter gross margin was 85.7% compared to 86.6% in the first quarter of 2021. First quarter adjusted EBITDA was $27 million, representing approximately 30% EBITDA margin. Unlevered free cash flow was $13.5 million in the first quarter. Q1 capital expenditures were $3.8 million, or 4.2% of revenue. Non-GAAP earnings per share were $0.9 in the quarter based on 180 million weighted average diluted shares. We ended the quarter with approximately $70.4 million of cash and an outstanding loan principal balance of $348.3 million, representing net leverage of approximately 2.5 times. Now, I will provide our financial outlook for the second quarter and full year. There have been material changes to the foreign exchange environment since our last outlook, and we are updating our guidance to reflect these changes. Setting aside fluctuations in foreign exchange rates, our full-year outlook remains consistent with our prior guidance. I want to start by reconciling our prior 2022 outlook based on current FX rates. Previously, we assumed FX rates for the euro and pound of 1.13 and 1.35 respectively. We also noted that every point on the euro represented approximately $900,000 of annual revenue, and every point on the pound represented around $300,000. Given the updated FX rates of 1.05 for the euro and 1.23 for the pound, our prior 2022 revenue guidance of $384 million to $388 million translates to $375 million to $379 million, a $9 million impact for Q2 through Q4. Regarding our prior 2022 adjusted EBITDA outlook of $118 million to $122 million, using these new FX rates, our adjusted EBITDA outlook translates to $112 million to $116 million, approximately a $6 million impact for Q2 through Q4. While the global macro environment remains fluid and FX rates may continue to fluctuate, based on current assumptions, we expect second quarter 2022 total revenue in the range of $91 million to $91.5 million, representing about 7% year-over-year growth, or 13% on a constant currency basis, up from 12% in Q1. For the full year 2022, we anticipate total revenue of $376 million to $379 million, reflecting approximately 9% year-over-year growth on a reported basis or 13% to 14% growth on a constant currency basis, in line with our previous constant currency guidance. We expect second quarter adjusted EBITDA in the range of $26 million to $26.5 million, representing roughly 29% margin at the midpoint. For the full year, we expect adjusted EBITDA in the range of $112.5 million to $115.5 million, equating to about 30% margin at the midpoint. We reiterate that capital expenditures will be approximately 4% to 5% of total revenue. We also expect adjusted EBITDA conversion to unlevered free cash flow to be around 70% for the full year. We expect total weighted average diluted shares outstanding to be approximately 181 million for the second quarter and 182 million for the full year. Finally, we anticipate our non-GAAP tax rate to be about 24% in the second quarter and 26% for the full year.

John Pagliuca, President and CEO

Thanks, Tim. As Tim pointed out, despite the fact that we had to update our outlook to account for adverse changes in foreign exchange rates, operationally we are very much on track for our plan this year. We are starting to see the revenue acceleration we are projecting in the second half of the year. As you can see, we are executing well in our key investment areas, backed by a strategy rooted in a deep understanding of our market, and a leadership team that is committed to our growth and our partners’ success. We see a great deal of opportunity in the current market environment, and it is creating a lot of energy and excitement up and down the company. Earlier, I mentioned that a major part of earning more fans is geared toward our partners and other external parties. But the real impetus and inspiration derive from my fellow N-able employees, who are key to our success. I’m proud to say our teams are being recognized for their exceptional work. We recently won two awards from Comparably for Best Global Culture and Best Company Outlook. We also just announced that we were honored with four American Business Awards, also known as the Stevies: a Gold award for IT Department of the Year for the spin-off, a Silver award for Human Resources Executive of the Year for our CHRO Kathleen Pai, a Silver award for Customer Service Department of the Year, recognizing our partner success management team, and a Bronze award for achievement in product innovation for Cove Data Protection. This external recognition underscores and validates our efforts to build a company that earns fans among our partners and their customers, our employees, and all of our stakeholders. 2021 was a foundational year with the rebrand, spin-off, and emphasis on hardening security into all layers of our operations, product development lifecycle, and culture. In 2022, we are in full value creation mode for our partners and N-able. The work we are doing now will determine our trajectory moving forward, and as you can see, we are off to a great start. Operator, we are now ready to open the line for questions.

Operator, Operator

Thank you. The first question today comes from Matt Hedberg of RBC Capital Markets. Matt, please go ahead, your line is now open.

Matt Hedberg, Analyst

Oh, sure. Thanks guys, good morning. John, thanks for the comments. I’m curious, you had good results here and you’re guiding to effectively no change and constant currency growth rates for the year. You’ve got a broad exposure to kind of global SME trends. Can you talk about sort of the resiliency of those end markets if the economic conditions globally were to change and deteriorate? So just maybe speak to the mission-critical nature of your solutions and how perhaps they might fare if there are a bit more challenged economic times ahead?

John Pagliuca, President and CEO

We’re not really seeing a degradation in demand for the MSPs' security offerings; our data protection offerings, and monitoring needs continue to be high. So, we’re not seeing degradation, neither from the SME nor from the MSP. I think it speaks to the importance of the MSP community. The other thing when we think about demand, is that MSPs present a labor arbitrage. As SMEs look for better ways to scale, our solutions help MSPs scale their business, drive efficiency, and increase profitability. This, in turn, helps SMEs mitigate some of their internal resource costs by leveraging the MSP.

Matt Hedberg, Analyst

Now, that makes a ton of sense, and you guys have a long history here serving these end markets. Maybe the second question, one of your peers that serves MSPs is in the process of being acquired. I guess I’m curious, what does that mean from your perspective? Do you think this speaks to the opportunity to further consolidate MSP spend from your perspective? What's your view on the magnitude of this market?

John Pagliuca, President and CEO

That’s why we continue to aspire to be a Rule of 50 company, demonstrating both growth and profit. We gain that profit by leveraging MSPs. The transaction reflects the power of this model. I view this as a golden era for MSPs, and I believe that transaction affirms the notion that we are in a growth market.

Mike Cikos, Analyst

Yes, good morning. Thanks for getting me on the call today guys. I did want to circle back to John’s opening remarks where you cited better retention figures. Can you provide more color on those retention trends? Additionally, I noticed that gross margin stepped down slightly quarter-to-quarter and year-over-year. Is this decline attributable to increased expenses related to cloud hosting offerings or the expansion of your customer success team, which likely benefits those retention figures?

Tim O’Brien, EVP and CFO

On the retention figures, looking at it on a constant currency basis reveals improved gross and net retention in Q1 compared to Q4. The investment in partner success is yielding returns on both growth and net retention; one, by retaining customers at a higher rate, and two, driving opportunities created from that motion and the closure rates that we are seeing.

Mike Cikos, Analyst

Thanks. And can you share any insights regarding your exposure in Europe and the situation in Belarus, particularly how much business is impacted?

John Pagliuca, President and CEO

The revenue from Ukraine, Russia, and Belarus was de minimis last quarter, so there's no significant impact on our business currently. We do have an R&D center in Belarus, but we have adequate resources in non-impacted regions to support our products if the situation changes.

Keith Bachman, Analyst

I wanted to understand your potential impact of economic conditions on your business, particularly in light of past experiences like COVID-19. How do you foresee your business faring in a recessionary environment compared to others?

John Pagliuca, President and CEO

During COVID, we did see an increase in demand for our security and data protection offerings. MSPs focused on their existing customers, ensuring productivity and security, which led to strong retention and cross-selling opportunities. The demand for our solutions remained steady, and the ability to scale through MSPs helped SMEs navigate those challenging times. I believe we would see a similar trend in other recessionary periods.

Keith Bachman, Analyst

Given the recent updates on currency impacts on your guidance, can you explain the $6 million EBITDA impact compared to the $9 million revenue impact? Why is there such a significant difference?

John Pagliuca, President and CEO

You had it right; it was a $9 million revenue impact and a $6 million EBITDA impact primarily due to unfavorable currency fluctuations, particularly with the euro. Most of our international costs are based in GBP due to our operations in Scotland, which is where some of this drop-through occurs.

Jason Ader, Analyst

I wanted to ask about Cove. Can you explain how Cove is more efficient than traditional backup software?

John Pagliuca, President and CEO

Our cloud-first architecture allows data to flow directly to the cloud without needing to first go through an appliance, leading to better economics for both customers and MSPs. It also means a more secure solution since the cloud is inherently less of a target for bad actors. This efficiency contributes to Cove being a disruptive force in the market.

Jason Ader, Analyst

Does the setup lead to faster recovery times?

John Pagliuca, President and CEO

Yes, both recovery time objectives (RTO) and recovery point objectives (RPO) are very efficient due to our approach. Additionally, our standby image feature allows MSPs flexibility in managing backups, further enhancing our recovery capabilities. Historically, our backup solution has operated as a cross-sell motion. However, Cove's new offerings have allowed us to land directly with MSPs. We are actively promoting our complete data protection suite and positioning it as a primary solution rather than a secondary offering. Thank you all for your ongoing interest in N-able. I am looking forward to talking to you in about 90 days.

Operator, Operator

That concludes the N-able first quarter 2022 earnings call. Thank you for your participation. You may now disconnect your lines.