N-able, Inc. (NABL) FY 2023 MD&A
This page reproduces the company's own Item 7 MD&A text from the linked SEC filing. It is filer text, not grepcent analysis, scoring, or investment advice.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our Consolidated Financial Statements and related notes thereto included elsewhere in this report. In addition to historical consolidated financial information, the following discussion contains forward-looking statements that reflect our plans, estimates and beliefs. Our actual results could differ materially and adversely from those anticipated in the forward-looking statements. Please see the sections entitled “Safe Harbor Cautionary Statement” and “Risk Factors” above for a discussion of the uncertainties, risks and assumptions associated with these statements. The following discussion and analysis also includes a discussion of certain non-GAAP financial measures. For a description and reconciliation of the non-GAAP measures discussed in this section, see “Non-GAAP Financial Measures” below.
Overview
N-able, Inc., a Delaware corporation, and its subsidiaries (“Company”, “we,” “us” and “our”) is a leading global provider of cloud-based software solutions for managed service providers (“MSPs”), enabling them to support digital transformation and growth for small and medium-sized enterprises (“SMEs”), which we define as those enterprises having less than 1,000 employees. With a flexible technology platform and powerful integrations, N-able makes it easy for MSPs to monitor, manage, and protect their end-customer systems, data, and networks. Our growing portfolio of security, automation, and backup and recovery solutions is built for IT services management professionals. N-able simplifies complex ecosystems and enables customers to solve their most pressing challenges. In addition, we provide extensive, proactive support—through enriching partner programs, hands-on training, and growth resources—to help MSPs deliver exceptional value and achieve success at scale. Through our multi-dimensional land and expand model and global presence, we are able to drive strong recurring revenue growth and profitability.
Separation from SolarWinds
On August 6, 2020, SolarWinds Corporation (“SolarWinds” or “Parent”) announced that its board of directors had authorized management to explore a potential spin-off of its MSP business into our company, a newly created and separately traded public company, and separate into two distinct, publicly traded companies (the “Separation”).
On July 19, 2021, SolarWinds completed the Separation through a pro-rata distribution (the “Distribution”) of all the outstanding shares of our common stock it held to the stockholders of record of SolarWinds as of the close of business on July 12, 2021 (the “Record Date”). Each SolarWinds stockholder of record received one share of our common stock, $0.001 par value, for every two shares of SolarWinds common stock, $0.001 par value, held by such stockholder as of the close of business on the Record Date. SolarWinds distributed 158,020,156 shares of our common stock in the Distribution, which was effective at 11:59 p.m., Eastern Time, on July 19, 2021. The Distribution reflected 316,040,312 shares of SolarWinds common stock outstanding on July 12, 2021 at a distribution ratio of one share of our common stock for every two shares of SolarWinds common stock. In addition, on July 19, 2021, and prior to completion of the Distribution, we issued 20,623,282 newly-issued shares of our common stock in connection with a private placement of N-able’s common stock (the “Private Placement”). As a result of the Distribution, we became an independent public company and our common stock is listed under the symbol “NABL” on the New York Stock Exchange.
Our financial statements for the periods through the Separation and Distribution date of July 19, 2021 are Consolidated Financial Statements prepared on a “carve-out” basis. Our financial statements for the period from July 20, 2021 forward are Consolidated Financial Statements based on our reported results as a standalone company. The financial information included herein should be read in conjunction with the audited Consolidated Financial Statements in our Annual Report on Form 10-K for the year ended December 31, 2022, referred to as our “2022 Annual Report.” See Note 2. Summary of Significant Accounting Policies and Note 13. Relationship with Parent and Related Entities in the Notes to Consolidated Financial Statements for further details.
SolarWinds Cyber Incident
As previously disclosed, SolarWinds was the victim of a cyberattack on its Orion Software Platform and internal systems, or the Cyber Incident. SolarWinds has confirmed to us that it has concluded its internal investigations related to the Cyber Incident. SolarWinds has not identified SUNBURST in any of its more than 70 non-Orion products and tools, including, as previously disclosed, any of our N-able solutions. SolarWinds, together with its partners, have undertaken extensive measures to investigate, contain, eradicate, and remediate the Cyber Incident. As SolarWinds previously disclosed in its investigatory updates, it has substantially completed this process and believes the threat actor is no longer active in its environments.
In response to the Cyber Incident and in connection with the Separation and Distribution, we continue to work to further enhance security, monitoring and authentication of our solutions. Specifically, we have implemented in-product security enhancements to the N-able portfolio of products, including, multi-factor authentication, unified single sign-on services, and
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secure secret vaults. We have also introduced new identity and access controls, scanning and remediation technologies and standards and monitoring tooling across our enterprise IT and production environments. We expect to incur additional expenses in future periods related to continued enhancements to our security measures across our solutions.
Of the expenses SolarWinds recorded related to the Cyber Incident through the Separation and Distribution date of July 19, 2021, none have been allocated to the N-able business and, as a result of the indemnification provisions under the Separation and Distribution Agreement entered into in connection with the Separation and Distribution (the “Separation and Distribution Agreement”), we have not recorded any contingent liabilities with respect to the Cyber Incident as of December 31, 2023 and 2022, respectively. In addition, as a result of the Cyber Incident, SolarWinds is subject to numerous lawsuits and governmental investigations or inquiries. To date, we have not been separately named in such lawsuits and investigations, but in the future we may become subject to lawsuits, investigations or inquiries related to the Cyber Incident. In such event, subject to the terms of the Separation and Distribution Agreement, SolarWinds would indemnify us for costs we may incur.
We believe the Cyber Incident has caused reputational harm to SolarWinds and also had an adverse impact on our reputation, new subscription sales and net retention rates. In 2021, we experienced an adverse impact to new subscription sales and expansion rates relative to historical levels. We believe this was due in part to our decision in response to the Cyber Incident to temporarily reduce investments in demand generation activities through January 2021, as well as a result of certain MSP partners delaying their purchasing decisions as they assessed the potential impact of the Cyber Incident. In October 2023, the SEC filed a complaint against SolarWinds and its chief information officer alleging violations of the Exchange Act and Securities Act relating to SolarWinds’ cybersecurity disclosures and public statements, as well as its internal controls and disclosure controls and procedures. This brought renewed attention to the Cyber Incident and questions from some of our MSP partners. However, we also have seen consistency among renewal rates with our larger MSP partners and have not observed material adverse trends with respect to the usage of our solutions. In addition, following our resumption of regular demand generation activities in February 2021, we were encouraged by engagements with both prospective and existing MSP partners. In general, our sales cycles and time from contract to revenue recognition are primarily short in nature and based on trends through the fiscal year ended December 31, 2023, we believe that the adverse impacts of the Cyber Incident on our financial results have diminished. Nevertheless, there is risk that the Cyber Incident may continue to have an adverse impact on our business in future periods, and to the extent such impact continues, including as a result of new discoveries or events, it could have an adverse effect on our business, results of operations, cash flows or financial position.
Results of Operations
Our financial statements for the periods through the Separation and Distribution date of July 19, 2021 are Consolidated Financial Statements prepared on a “carve-out” basis. Our financial statements for the period from July 20, 2021 forward are Consolidated Financial Statements based on our reported results as a standalone company. Through the Separation and Distribution date of July 19, 2021, we operated as a part of SolarWinds. Therefore, stand-alone financial statements were not historically prepared for us. The accompanying historical Consolidated Financial Statements have been prepared from SolarWinds’ historical accounting records and are presented on a stand-alone basis as if our business’ operations had been conducted independently from SolarWinds. The Consolidated Financial Statements present our historical results of operations in accordance with GAAP.
Prior to the Separation and Distribution, N-able comprised certain stand-alone legal entities for which discrete financial information was available. As SolarWinds recorded transactions at the legal entity level, for the legal entities which were shared between the N-able business and other SolarWinds operations for which discrete financial information was not available, allocation methodologies were applied to certain accounts to allocate amounts to us as discussed in Note 1. Organization and Nature of Operations in the Notes to Consolidated Financial Statements.
The Consolidated Statements of Operations include all revenue and costs directly attributable to N-able as well as an allocation of expenses related to facilities, functions and services provided by SolarWinds prior to the Separation and Distribution. These corporate expenses have been allocated to our business based on direct usage or benefit, where identifiable, with the remainder allocated based on headcount where appropriate. These allocations are primarily reflected within operating expenses in our Consolidated Statements of Operations. We believe the basis on which the expenses have been allocated to be a reasonable reflection of the utilization of services provided to, or the benefit received by, us during the periods presented. However, these allocations may not be indicative of the actual expenses we would have incurred as a stand-alone company during the periods prior to the Separation and Distribution or of the costs we will incur in the future. See Note 13. Relationship with Parent and Related Entities in the Notes to Consolidated Financial Statements for further details of the allocated costs.
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Fourth Quarter Financial Highlights
Revenue
We deliver a platform of integrated solutions that enables our MSP partners to manage and secure the IT environments and assets for their SME end customers, as well as more efficiently manage their own businesses. Our total revenue was $108.4 million and $95.8 million for the three months ended December 31, 2023 and 2022, respectively.
As of December 31, 2023, we had approximately 25,000 customers. Additionally, as of December 31, 2023, we had 2,196 MSP partners with annualized recurring revenue, or ARR, over $50,000 on our platform, up from 1,898 as of December 31, 2022, representing an increase of approximately 16%. Over the same period, MSP partners with over $50,000 of ARR on our platform grew from approximately 51% of our total ARR as of December 31, 2022 to approximately 56% of our total ARR as of December 31, 2023. We determine ARR as the annualized recurring revenue as of the last month of a given period. We calculate ARR by multiplying the recurring revenue and related usage revenue, excluding the impacts of credits and reserves, recognized during the final month of the reporting period from both long-term and month-to-month subscriptions by twelve. We use ARR, and in particular, ARR attributable to MSP partners with over $50,000 of ARR, to enhance the understanding of our business performance and the growth of our relationships with our MSP partners.
Profitability
We have grown while maintaining high levels of operating efficiency. Our net income for the three months ended December 31, 2023 and 2022 was $9.4 million and $7.0 million, respectively. The increase in net income for the three months ended December 31, 2023 was primarily due to an increase in revenue, a decrease in amortization of acquired intangibles, a decrease in general and administrative expense and an increase in other income, net, partially offset by an increase in income tax expense, an increase in research and development expense, an increase in cost of revenue, an increase in sales and marketing expense, and an increase in interest expense, net. Our Adjusted EBITDA, calculated as net income of $9.4 million and $7.0 million for the three months ended December 31, 2023 and 2022, respectively, excluding amortization of acquired intangible assets and developed technology of $1.6 million and $2.6 million, respectively, depreciation expense of $3.9 million and $3.5 million, respectively, income tax expense of $7.4 million and $3.4 million, respectively, interest expense, net of $7.7 million and $6.4 million, respectively, unrealized foreign currency gains of $(1.8) million and $(2.1) million, respectively, acquisition related costs of $(0.5) million and $(0.2) million, respectively, spin-off costs of $0.1 million and $0.3 million, respectively, stock-based compensation expense and related employer-paid payroll taxes of $10.9 million and $8.7 million, respectively, and restructuring costs and other of $0.5 million and $1.7 million, respectively, was $39.2 million and $31.2 million for the three months ended December 31, 2023 and 2022, respectively.
Cash Flow
We have built our business to generate strong cash flow over the long term. For the three months ended December 31, 2023 and 2022, cash flows from operations were $31.2 million and $18.4 million, respectively. Our cash flows from operations were reduced by cash payments for interest of $7.3 million and $5.3 million for the three months ended December 31, 2023 and 2022, respectively, and cash payments for income taxes of $3.9 million and $3.1 million for the three months ended December 31, 2023 and 2022, respectively.
Components of Our Results of Operations
Revenue
Our revenue consists of the following:
•Subscription Revenue. We primarily derive subscription revenue from the sale of subscriptions to the SaaS solutions that we host and manage on our platform. Our subscriptions provide access to the latest versions of our software platform, technical support and unspecified software upgrades and updates. Subscription revenue for our SaaS solutions is generally recognized ratably over the subscription term once the service is made available to the MSP partner or when we have the right to invoice for services performed. In addition, our subscription revenue includes sales of our self-managed solutions, which are hosted and managed by our MSP partners. Subscriptions of our self-managed solutions include term licenses, technical support and unspecified software upgrades. Revenue from the license performance obligation of our self-managed solutions is recognized at a point in time upon delivery of the access to the licenses and revenue from the performance obligation related to the technical support and unspecified software upgrades of our subscription-based license arrangements is recognized ratably over the agreement period. We generally invoice subscription agreements monthly based on usage or in advance over the subscription period on either a monthly or annual basis.
•Other Revenue. Other revenue consists primarily of revenue from the sale of our maintenance services associated with the historical sales of perpetual licenses and revenue from professional services. MSP partners with maintenance
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agreements are entitled to receive technical support and unspecified upgrades or enhancements to new versions of their solutions on a when-and-if-available basis for the specified agreement period.
Cost of Revenue
•Cost of Revenue. Cost of revenue consists of public cloud infrastructure and hosting fees, an allocation of overhead costs for our subscription revenue and maintenance services, royalty fees and technical support personnel costs. We allocate facilities, depreciation, IT and benefits costs based on headcount.
•Amortization of Acquired Technologies. We amortize to cost of revenue capitalized costs of technologies acquired in connection with the take private transaction of SolarWinds in early 2016 and subsequent business combinations, including the July 1, 2022 acquisition of Spinpanel B.V. (“Spinpanel”). Amortization related to the take private transaction of SolarWinds concluded during the three months ended March 31, 2023.
Operating Expenses
Operating expenses consist of sales and marketing, research and development and general and administrative expenses as well as amortization of acquired intangibles. Generally, personnel costs are the most significant component of operating expenses and include salaries, bonuses and stock-based compensation and related employer-paid payroll taxes, as well as an allocation of our facilities, depreciation, IT and benefits costs. For the periods through the Separation and Distribution date of July 19, 2021, SolarWinds provided facilities, information technology services and certain corporate and administrative services to us. Expenses relating to these services have been allocated to N‑able and are reflected in the Consolidated Financial Statements. We had total employees of 1,584 and 1,462 as of December 31, 2023 and 2022, respectively. Our stock-based compensation expense increased during the year ended December 31, 2023 as compared to the prior fiscal year primarily due to the impact of new equity awards that were granted to employees following the Separation and Distribution through December 31, 2023.
•Sales and Marketing. Sales and marketing expenses primarily consist of related personnel costs, including our sales, marketing, partner success and product management teams, as well as an allocation of our facilities, depreciation, IT and benefits costs. Sales and marketing expenses also include the cost of digital marketing programs such as paid search, search engine optimization and management and website maintenance and design, marketing development funds, as well as the cost of events for existing and prospective customers. We expect to continue to grow our sales and marketing organization over time to drive new MSP partner adds, retain and expand with existing MSP partners and pursue initiatives designed to help our MSP partners succeed and grow.
•Research and Development. Research and development expenses primarily consist of related personnel costs, including our engineering, development operations, user experience, and security operations teams, as well as an allocation of our facilities, depreciation, IT and benefits costs. We expect to continue to grow our research and development organization over time and also to incur additional expenses associated with bringing new product offerings to market and our enhancements of security, monitoring and authentication of our solutions.
•General and Administrative. General and administrative expenses primarily consist of personnel costs for executives, finance, legal, human resources, business applications and other administrative personnel, general restructuring charges and other acquisition-related costs, professional fees and other general corporate expenses, as well as an allocation of our facilities, depreciation, IT and benefits costs. We expect to continue to grow our general and administrative organization over time to support continued growth of our business.
•Amortization of Acquired Intangibles. We amortize to operating expenses capitalized costs of intangible assets primarily acquired in connection with the take private transaction of SolarWinds in early 2016 and subsequent business combinations, including the July 1, 2022 acquisition of Spinpanel. Amortization related to the take private transaction of SolarWinds concluded during the three months ended March 31, 2023.
Other Expense, Net
Other expense, net primarily consists of interest expense related to the Credit Agreement and losses resulting from changes in exchange rates on foreign currency denominated accounts, partially offset by gains resulting from changes in exchange rates on foreign currency denominated accounts and dividend income from our money market fund financial assets. See Item 7A. Quantitative and Qualitative Disclosures About Market Risk for additional information on how interest rates impact our financial results.
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Foreign Currency
As a global company, we face exposure to adverse movements in foreign currency exchange rates. Fluctuations in foreign currencies impact the amount of total assets, liabilities, revenue, operating expenses and cash flows that we report for our foreign subsidiaries upon the translation of these amounts into U.S. dollars. See Item 1A. Risk Factors and Item 7A. Quantitative and Qualitative Disclosures About Market Risk for additional information on how foreign currency impacts our financial results.
Income Tax Expense
Income tax expense consists of domestic and foreign corporate income taxes related to the sale of subscriptions. Our effective tax rate will be affected by many factors including changes in tax laws, regulations or rates, new interpretations of existing laws or regulations, valuation allowance, uncertain tax positions, stock-based compensation, permanent nondeductible book and tax differences, shifts in the allocation of income earned throughout the world and changes in overall levels of income before tax.
Comparison of the Years Ended December 31, 2023 and 2022
Revenue
| Year Ended December 31, | ||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2023 | 2022 | |||||||||||||||
| Amount | Percentage of Revenue | Amount | Percentage of Revenue | Change | ||||||||||||
| (in thousands, except percentages) | ||||||||||||||||
| Subscription revenue | $ | 412,072 | 97.7 | % | $ | 362,609 | 97.5 | % | $ | 49,463 | ||||||
| Other revenue | 9,808 | 2.3 | 9,160 | 2.5 | 648 | |||||||||||
| Total subscription and other revenue | $ | 421,880 | 100.0 | % | $ | 371,769 | 100.0 | % | $ | 50,111 |
Total revenue increased $50.1 million or 13.5%, for the year ended December 31, 2023 compared to the year ended December 31, 2022. We base revenue by geography on the billing address of each MSP partner. Based on MSP partner location, revenue from the United States was approximately 48.8% and 48.7% of total revenue for the years ended December 31, 2023 and 2022, respectively. Revenue from the United Kingdom was approximately 10.2% and 10.3% of total revenue for the years ended December 31, 2023 and 2022, respectively. Other than the United States and the United Kingdom, no single country accounted for 10% or more of our total revenue during these periods.
As a result of the impact of the COVID-19 pandemic, we experienced a deceleration in our year-over-year subscription revenue growth rate in the second quarter of 2020 as compared to our growth rates in prior periods. We attribute this deceleration primarily to increased churn and downgrades from existing MSP partners and slower MSP partner adds. Beginning in the third quarter of 2020, and continuing through the fourth quarter of 2023, we have seen the impact on revenue growth continue to dissipate. Please see Item 1A. Risk Factors in this Annual Report on Form 10-K for additional discussion regarding risks to our business that may result from the COVID-19 pandemic.
Subscription Revenue. Subscription revenue increased $49.5 million, or 13.6%, for the year ended December 31, 2023 compared to the year ended December 31, 2022. The increase in subscription revenue was primarily driven by growth in sales of our data protection, security, and remote monitoring and management solutions. Our subscription revenue increased slightly as a percentage of our total revenue for the year ended December 31, 2023 compared to the year ended December 31, 2022.
Our annual dollar-based net revenue retention rate for our subscription products was approximately 110% and 103% for the years ended December 31, 2023 and 2022, respectively, and was driven primarily by strong customer retention and expansion in our MSP products, in addition to favorable movements in foreign currency exchange rates. To calculate our annual dollar-based net revenue retention rate, we first identify the MSP partners with active paid subscriptions in the last month of the prior-year period, or the base partners. We then divide the subscription revenue in the last month of the current-year period attributable to the base partners by the revenue attributable to those base partners in the last month of the prior-year period. Our dollar-based net revenue retention rate for a particular period is then obtained by averaging the rates from that particular period with the results from each of the prior eleven months. Our calculation includes any expansion revenue and is net of any contraction or cancellation, but excludes credits and revenue attributable to any MSP partner who was not a partner with a paid subscription in the prior period.
Other Revenue. Other revenue increased $0.6 million, or 7.1%, for the year ended December 31, 2023 compared to the year ended December 31, 2022, primarily due to an increase in professional services revenue.
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Cost of Revenue
| Year Ended December 31, | ||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2023 | 2022 | |||||||||||||||
| Amount | Percentage of Revenue | Amount | Percentage of Revenue | Change | ||||||||||||
| (in thousands, except percentages) | ||||||||||||||||
| Cost of revenue | $ | 66,369 | 15.7 | % | $ | 56,133 | 15.1 | % | $ | 10,236 | ||||||
| Amortization of acquired technologies | 1,839 | 0.4 | 2,477 | 0.7 | (638) | |||||||||||
| Total cost of revenue | $ | 68,208 | 16.1 | % | $ | 58,610 | 15.8 | % | $ | 9,598 |
Total cost of revenue increased $9.6 million, or 16.4%, in the year ended December 31, 2023 compared to the year ended December 31, 2022 primarily due to an increase in public cloud infrastructure and hosting fees and royalties related to our subscription products of $6.5 million, an increase in personnel costs driven by headcount and salary increases of $0.9 million, which includes an increase in stock-based compensation expense of $0.2 million, and an increase in depreciation of servers and amortization of capitalized internal-use software costs of $3.1 million, partially offset by a decrease in amortization of intangible assets acquired in connection with the take private transaction of SolarWinds in early 2016 and subsequent business combinations of $0.7 million and a decrease in allocated facilities and IT costs of $0.3 million. Amortization related to the take private transaction of SolarWinds concluded during the three months ended March 31, 2023.
Operating Expenses
| Year Ended December 31, | ||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2023 | 2022 | |||||||||||||||
| Amount | Percentage of Revenue | Amount | Percentage of Revenue | Change | ||||||||||||
| (in thousands, except percentages) | ||||||||||||||||
| Sales and marketing | $ | 134,691 | 31.9 | % | $ | 125,301 | 33.7 | % | $ | 9,390 | ||||||
| Research and development | 78,180 | 18.5 | 63,484 | 17.1 | 14,696 | |||||||||||
| General and administrative | 69,885 | 16.6 | 71,125 | 19.1 | (1,240) | |||||||||||
| Amortization of acquired intangibles | 597 | 0.1 | 5,853 | 1.6 | (5,256) | |||||||||||
| Total operating expenses | $ | 283,353 | 67.1 | % | $ | 265,763 | 71.5 | % | $ | 17,590 |
Sales and Marketing. Sales and marketing expenses increased $9.4 million, or 7.5%, primarily due to an increase in personnel costs driven by headcount and salary increases of $8.0 million, which includes an increase in stock-based compensation expense of $2.0 million, an increase in marketing program costs of $1.4 million, and an increase in subscription costs of $0.8 million, partially offset by a decrease in contract services costs of $0.3 million, a decrease in restructuring costs of $0.2 million, and a decrease in allocated facilities and IT costs of $0.1 million. We expect to continue to grow our sales and marketing organization over time to drive new MSP partner adds, retain and expand with existing MSP partners and pursue initiatives designed to help our MSP partners succeed and grow.
Research and Development. Research and development expenses increased $14.7 million, or 23.1%, primarily due to an increase in personnel costs driven by headcount and salary increases of $14.6 million, which includes an increase in stock-based compensation expense of $1.8 million, an increase in contract services costs of $1.1 million, an increase in subscription costs of $0.8 million, and an increase in allocated facilities and IT costs of $0.4 million, partially offset by an increase in capitalized internal-use software costs of $2.3 million and a decrease in restructuring costs of $0.1 million. We expect to continue to grow our research and development organization over time and also to incur additional expenses associated with bringing new product offerings to market and our enhancements of security, monitoring and authentication of our solutions.
General and Administrative. General and administrative expenses decreased $1.2 million, or 1.7%, primarily due a decrease in contract services costs of $1.5 million, gains on contingent consideration related to the July 1, 2022 acquisition of Spinpanel of $1.4 million, a decrease in costs associated with our separation from SolarWinds of $1.0 million, a decrease in director and officer liability insurance costs of $0.9 million, and a decrease in rent expense of $0.5 million, partially offset by an increase in personnel costs driven by headcount and salary increases of $3.3 million, which includes an increase in stock-based compensation expense of $1.8 million, and an increase in bad debt expense of $0.8 million. See Note 3. Acquisitions, Note 7. Fair Value Measurements, and Note 15. Commitments and Contingencies in the Notes to Consolidated Financial Statements for additional information regarding the acquisition of Spinpanel.
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Amortization of Acquired Intangibles. Amortization of acquired intangibles decreased $5.3 million, or 89.8%, primarily due to the conclusion of amortization of intangible assets acquired in connection with the take private transaction of SolarWinds in early 2016 during the three months ended March 31, 2023.
Interest Expense, Net
| Year Ended December 31, | ||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2023 | 2022 | |||||||||||||||
| Amount | Percentage of Revenue | Amount | Percentage of Revenue | Change | ||||||||||||
| (in thousands, except percentages) | ||||||||||||||||
| Interest expense, net | $ | (30,252) | (7.2) | % | $ | (18,852) | (5.1) | % | $ | (11,400) |
Interest expense, net increased by $11.4 million, or 60.5%, in the year ended December 31, 2023 compared to the year ended December 31, 2022, primarily due to the impact of increased interest rates on borrowings under the Credit Agreement. Changes in interest rates have had and could continue to have an adverse impact on our financial results and cash flows since outstanding borrowings under the Credit Agreement bear interest at variable rates. See Note 13. Relationship with Parent and Related Entities and Note 9. Debt in the Notes to Consolidated Financial Statements for additional information regarding our related party debt and Credit Agreement, respectively.
Other Income, Net
| Year Ended December 31, | ||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2023 | 2022 | |||||||||||||||
| Amount | Percentage of Revenue | Amount | Percentage of Revenue | Change | ||||||||||||
| (in thousands, except percentages) | ||||||||||||||||
| Other income, net | $ | 4,259 | 1.0 | % | $ | 1,881 | 0.5 | % | $ | 2,378 |
Other expense, net increased by $2.4 million, or 126.4%, in the year ended December 31, 2023 compared to the year ended December 31, 2022, primarily due to an increase in dividend income from our money market fund financial assets of $3.1 million, partially offset by an increase in the impact of changes in foreign currency exchange rates of $0.7 million related to various accounts for the period.
Income Tax Expense
| Year Ended December 31, | ||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2023 | 2022 | |||||||||||||||
| Amount | Percentage of Revenue | Amount | Percentage of Revenue | Change | ||||||||||||
| (in thousands, except percentages) | ||||||||||||||||
| Income before income taxes | $ | 44,326 | 10.5 | % | $ | 30,425 | 8.2 | % | $ | 13,901 | ||||||
| Income tax expense | 20,914 | 5.0 | 13,718 | 3.7 | 7,196 | |||||||||||
| Effective tax rate | 47.2 | % | 45.1 | % | 2.1 | % |
Our income tax expense for the year ended December 31, 2023 increased by $7.2 million as compared to the year ended December 31, 2022. The effective tax rate increased to 47.2% for the year ended December 31, 2023 primarily due to changes in the UK statutory tax rate, changes in income before income taxes by jurisdiction, the valuation allowance recognized on the deferred tax assets in the U.S. and non-deductible stock-based compensation. For additional discussion about our income taxes, see Note 14. Income Taxes in the Notes to Consolidated Financial Statements.
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Comparison of the Years Ended December 31, 2022 and 2021
Revenue
| Year Ended December 31, | ||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2022 | 2021 | |||||||||||||||
| Amount | Percentage of Revenue | Amount | Percentage of Revenue | Change | ||||||||||||
| (in thousands, except percentages) | ||||||||||||||||
| Subscription Revenue | $ | 362,609 | 97.5 | % | $ | 336,845 | 97.2 | % | $ | 25,764 | ||||||
| Other revenue | 9,160 | 2.5 | 9,611 | 2.8 | (451) | |||||||||||
| Total subscription and other revenue | $ | 371,769 | 100.0 | % | $ | 346,456 | 100.0 | % | $ | 25,313 |
Total revenue increased $25.3 million, or 7.3%, for the year ended December 31, 2022 compared to the year ended December 31, 2021, driven by our data protection and security solutions. We base revenue by geography on the billing address of each MSP partner. Based on MSP partner location, revenue from the United States was approximately 48.7% and 46.4% of total revenue for the years ended December 31, 2022 and 2021, respectively. Revenue from the United Kingdom was approximately 10.3% and 11.1% of total revenue for the years ended December 31, 2022 and 2021, respectively. Other than the United States and the United Kingdom, no single country accounted for 10% or more of our total revenue during these periods.
Recurring Revenue
Subscription Revenue. Subscription revenue increased $25.8 million, or 7.6%, for the year ended December 31, 2022 compared to the year ended December 31, 2021. Our increase in subscription revenue was driven by the addition of new MSP partners and an increase in revenue from existing MSP partners as they added new SME customers and adopted new solutions. Our subscription revenue increased slightly as a percentage of our total revenue for the year ended December 31, 2022 compared to the year ended December 31, 2021.
Our annual dollar-based net revenue retention rate for our subscription products was approximately 103% and 110% for the years ended December 31, 2022 and 2021, respectively, and was driven primarily by strong customer retention and expansion in our MSP products. The decline in our annual dollar-based net revenue retention rate for the year ended December 31, 2022 compared to the year ended December 31, 2021 was due to adverse movements in foreign currency exchange rates.
Other Revenue. Other revenue decreased $0.5 million, or 4.7%, for the year ended December 31, 2022 compared to the year ended December 31, 2021 due to decreases in sales of our perpetual licenses and the related maintenance agreements. As of the three months ended March 31, 2020, we have discontinued perpetual license upgrades.
Cost of Revenue
| Year Ended December 31, | ||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2022 | 2021 | |||||||||||||||
| Amount | Percentage of Revenue | Amount | Percentage of Revenue | Change | ||||||||||||
| (in thousands, except percentages) | ||||||||||||||||
| Cost of revenue | $ | 56,133 | 15.1 | % | $ | 46,677 | 13.5 | % | $ | 9,456 | ||||||
| Amortization of acquired technologies | 2,477 | 0.7 | 5,755 | 1.7 | (3,278) | |||||||||||
| Total cost of revenue | $ | 58,610 | 15.8 | % | $ | 52,432 | 15.1 | % | $ | 6,178 |
Total cost of revenue increased $6.2 million, or 11.8%, in the year ended December 31, 2022 compared to the year ended December 31, 2021 primarily due to an increase in royalties and public cloud infrastructure and hosting fees related to our subscription products of $4.6 million, an increase in personnel costs of $2.2 million driven by headcount and salary increases to support new MSP partners and additional solution offerings, which includes an increase of $0.2 million in stock-based compensation expense, an increase in allocated costs of $1.9 million, and an increase in depreciation and other amortization of $1.2 million, partially offset by a decrease of $3.3 million in amortization of intangible assets acquired in connection with the take private transaction of SolarWinds in early 2016.
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Operating Expenses
| Year Ended December 31, | ||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2022 | 2021 | |||||||||||||||
| Amount | Percentage of Revenue | Amount | Percentage of Revenue | Change | ||||||||||||
| (in thousands, except percentages) | ||||||||||||||||
| Sales and marketing | $ | 125,301 | 33.7 | % | $ | 112,678 | 32.5 | % | $ | 12,623 | ||||||
| Research and development | 63,484 | 17.1 | 53,959 | 15.6 | 9,525 | |||||||||||
| General and administrative | 71,125 | 19.1 | 80,575 | 23.3 | (9,450) | |||||||||||
| Amortization of acquired intangibles | 5,853 | 1.6 | 13,482 | 3.9 | (7,629) | |||||||||||
| Total operating expenses | $ | 265,763 | 71.5 | % | $ | 260,694 | 75.3 | % | $ | 5,069 |
Sales and Marketing. Sales and marketing expenses increased $12.6 million, or 11.2%, primarily due to an increase in personnel costs of $10.5 million driven by headcount and salary increases, which includes an increase in stock-based compensation expense of $3.3 million, an increase in advertising expense of $1.0 million, an increase in subscription costs of $0.6 million, and an increase in contract services costs of $0.4 million. We increased our sales and marketing employee headcount to support the sales of additional solutions and drive growth in the business.
Research and Development. Research and development expenses increased $9.5 million, or 17.7%, primarily due to an increase in personnel costs of $6.0 million driven by headcount and salary increases, which includes an increase in stock-based compensation expense of $1.7 million, an increase in contract services costs of $2.6 million, an increase of $1.4 million in subscription costs, and an increase of $0.7 million in allocated facilities and IT costs to support our domestic and international operations, partially offset by an increase in capitalized internal-use software costs of $1.1 million. We increased our worldwide research and development employee headcount to expedite delivery of enhancements and new solutions to our MSP partners.
General and Administrative. General and administrative expenses decreased $9.5 million, or 11.7%, due to a decrease of $17.0 million in costs associated with our separation from SolarWinds, partially offset by a $2.9 million increase in personnel costs driven by headcount and salary increases, which includes an increase of $2.5 million in stock-based compensation expense, an increase of $1.3 million in depreciation of leasehold improvements, computers, furniture and equipment to support our domestic and international office locations, an increase in director and officer liability insurance costs of $1.1 million as a result of becoming a standalone company upon the Separation and Distribution, an increase in restructuring-related costs of $1.0 million, an increase in contract services costs of $0.9 million, and an increase in acquisition-related costs of $0.2 million and net gains on contingent consideration of $0.1 million related to the July 1, 2022 acquisition of Spinpanel. We increased our worldwide general and administrative employee headcount in connection with the Separation and Distribution.
Amortization of Acquired Intangibles. Amortization of acquired intangibles decreased $7.6 million, or 56.6%, primarily due to a decrease in amortization of intangible assets acquired in connection with the take private transaction of SolarWinds in early 2016 and the impact of changes in foreign currency exchange rates.
Interest Expense, Net
| Year Ended December 31, | ||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2022 | 2021 | |||||||||||||||
| Amount | Percentage of Revenue | Amount | Percentage of Revenue | Change | ||||||||||||
| (in thousands, except percentages) | ||||||||||||||||
| Interest expense, net | $ | (18,852) | (5.1) | % | $ | (20,472) | (5.9) | % | $ | 1,620 |
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Interest expense, net decreased by $1.6 million, or 7.9%, for the year ended December 31, 2022 compared to the year ended December 31, 2021, primarily due to repayment of borrowings under our long-term related party debt and the impact of lower interest rates under the Credit Agreement compared to our long-term related party debt. See Note 13. Relationship with Parent and Related Entities and Note 9. Debt in the Notes to Consolidated Financial Statements for further details regarding our related party debt.
Other Income (Expense), Net
| Year Ended December 31, | ||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2022 | 2021 | |||||||||||||||
| Amount | Percentage of Revenue | Amount | Percentage of Revenue | Change | ||||||||||||
| (in thousands, except percentages) | ||||||||||||||||
| Other Income (expense), net | $ | 1,881 | 0.5 | % | $ | (1,266) | (0.4) | % | $ | 3,147 |
Other (expense), net increased by $3.1 million, or 248.6%, for the year ended December 31, 2022 compared to the year ended December 31, 2021, primarily due to the impact of changes in foreign currency exchange rates related to various accounts for the period and dividend income from our money market fund financial assets.
Income Tax Expense
| Year Ended December 31, | ||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2022 | 2021 | |||||||||||||||
| Amount | Percentage of Revenue | Amount | Percentage of Revenue | Change | ||||||||||||
| (in thousands, except percentages) | ||||||||||||||||
| Income before income taxes | $ | 30,425 | 8.2 | % | $ | 11,592 | 3.3 | % | $ | 18,833 | ||||||
| Income tax expense | 13,718 | 3.7 | 11,479 | 3.3 | 2,239 | |||||||||||
| Effective tax rate | 45.1 | % | 99.0 | % | (53.9) | % |
Our income tax expense for the year ended December 31, 2022 decreased by $2.2 million as compared to the year ended December 31, 2021. The effective tax rate decreased to 45.1% for the year ended December 31, 2022 primarily due to changes in income before income taxes by jurisdiction, offset by the valuation allowance recognized on the deferred tax assets in the U.S. and non-deductible stock-based compensation and costs associated with the Separation and Distribution. For additional discussion about our income taxes, see Note 14. Income Taxes in the Notes to Consolidated Financial Statements.
Non-GAAP Financial Measures
In addition to financial measures prepared in accordance with GAAP, we use certain non-GAAP financial measures to clarify and enhance our understanding, and aid in the period-to-period comparison, of our performance. We believe that these non-GAAP financial measures provide supplemental information that is meaningful when assessing our operating performance because they exclude the impact of certain amounts that our management and Board of Directors do not consider part of core operating results when assessing our operational performance, allocating resources, preparing annual budgets and determining compensation. Accordingly, these non-GAAP financial measures may provide insight to investors into the motivation and decision-making of management in operating the business. Investors are encouraged to review the reconciliation of each of these non-GAAP financial measures to its most comparable GAAP financial measure included below.
While we believe that these non-GAAP financial measures provide useful supplemental information, non-GAAP financial measures have limitations and should not be considered in isolation from, or as a substitute for, their most comparable GAAP measures. These non-GAAP financial measures are not prepared in accordance with GAAP, do not reflect a comprehensive system of accounting and may not be comparable to similarly titled measures of other companies due to potential differences in their financing and accounting methods, the book value of their assets, their capital structures, the method by which their assets were acquired and the manner in which they define non-GAAP measures. Items such as the amortization of intangible assets, stock-based compensation expense and related employer-paid payroll taxes, acquisition related adjustments, spin-off costs related to associated with the Separation and Distribution, as well as the related tax impacts of these items can have a material impact on our GAAP financial results.
Non-GAAP Operating Income and Non-GAAP Operating Margin
We provide non-GAAP operating income and related non-GAAP operating margins excluding such items as stock-based compensation expense and related employer-paid payroll taxes, amortization of acquired intangible assets, acquisition related
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costs, spin-off costs and restructuring costs and other. We define non-GAAP operating margin as non-GAAP operating income divided by total revenue. Management believes these measures are useful for the following reasons:
•Stock-Based Compensation Expense and Related Employer-Paid Payroll Taxes. We provide non-GAAP information that excludes expenses related to stock-based compensation and related employer-paid payroll taxes associated with our employees’ participation in N-able's stock-based incentive compensation plans. We believe that the exclusion of stock-based compensation expense provides for a better comparison of our operating results to prior periods and to our peer companies as the calculations of stock-based compensation vary from period to period and company to company due to different valuation methodologies, subjective assumptions and the variety of award types. Employer-paid payroll taxes on stock-based compensation is dependent on our stock price and the timing of the taxable events related to the equity awards, over which our management has little control, and does not necessarily correlate to the core operation of our business. Because of these unique characteristics of stock-based compensation and related employer-paid payroll taxes, management excludes these expenses when analyzing the organization’s business performance.
•Amortization of Acquired Technologies and Intangible Assets. We provide non-GAAP information that excludes expenses related to purchased technologies and intangible assets associated with our acquisitions. We believe that eliminating this expense from our non-GAAP measures is useful to investors because the amortization of acquired technologies and intangible assets can be inconsistent in amount and frequency and is significantly impacted by the timing and magnitude of our acquisition transactions, which also vary in frequency from period to period. Accordingly, we analyze the performance of our operations in each period without regard to such expenses.
•Acquisition Related Costs. We exclude certain expense items resulting from acquisitions, such as legal, accounting and advisory fees, changes in fair value of contingent consideration, costs related to integrating the acquired businesses, deferred compensation, severance and retention expense. We consider these adjustments, to some extent, to be unpredictable and dependent on a significant number of factors that are outside of our control. Furthermore, acquisitions result in operating expenses that would not otherwise have been incurred by us in the normal course of our organic business operations. We believe that providing non-GAAP measures that exclude acquisition related costs allows investors to better review and understand the historical and current results of our continuing operations and also facilitates comparisons to our historical results and results of less acquisitive peer companies, both with and without such adjustments.
•Spin-off Costs. We exclude certain expense items resulting from the spin-off into a newly created and separately traded public company. These costs include legal, accounting and advisory fees, system implementation costs and other incremental costs incurred by us related to the Separation and Distribution. The spin-off transaction results in operating expenses that would not otherwise have been incurred by us in the normal course of our organic business operations. We believe that providing non-GAAP measures that exclude these costs facilitates a more meaningful evaluation of our operating performance and comparisons to our past operating performance.
•Restructuring Costs and Other. We provide non-GAAP information that excludes restructuring costs such as severance, certain employee relocation costs, and the estimated costs of exiting and terminating facility lease commitments, as they relate to our corporate restructuring and exit activities. These costs are inconsistent in amount and are significantly impacted by the timing and nature of these events. Therefore, although we may incur these types of expenses in the future, we believe that eliminating these costs for purposes of calculating the non-GAAP financial measures facilitates a more meaningful evaluation of our operating performance and comparisons to our past operating performance.
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| Year Ended December 31, | ||||||||||
|---|---|---|---|---|---|---|---|---|---|---|
| 2023 | 2022 | 2021 | ||||||||
| (in thousands, except margin data) | ||||||||||
| GAAP operating income | $ | 70,319 | $ | 47,396 | $ | 33,330 | ||||
| Stock-based compensation expense and related employer-paid payroll taxes | 45,093 | 37,658 | 30,092 | |||||||
| Amortization of acquired technologies | 1,839 | 2,477 | 5,755 | |||||||
| Amortization of acquired intangibles | 597 | 5,854 | 13,482 | |||||||
| Acquisition related costs | (1,096) | 289 | (87) | |||||||
| Spin-off costs | 735 | 1,616 | 15,653 | |||||||
| Restructuring costs and other | 2,113 | 2,662 | 422 | |||||||
| Non-GAAP operating income | $ | 119,600 | $ | 97,952 | $ | 98,647 | ||||
| GAAP operating margin | 16.7 | % | 12.7 | % | 9.6 | % | ||||
| Non-GAAP operating margin | 28.3 | % | 26.3 | % | 28.5 | % |
Adjusted EBITDA and Adjusted EBITDA Margin
We regularly monitor adjusted EBITDA and adjusted EBITDA margin, as they are measures we use to assess our operating performance. We define adjusted EBITDA as net income or loss, excluding amortization of acquired intangible assets and developed technology, depreciation expense, income tax expense (benefit), interest expense, net, unrealized foreign currency losses (gains), acquisition related costs, spin-off costs, stock-based compensation expense and related employer-paid payroll taxes and restructuring and other costs. We define adjusted EBITDA margin as adjusted EBITDA divided by total revenue. Adjusted EBITDA has limitations as an analytical tool, and you should not consider it in isolation or as a substitute for analysis of our results as reported under GAAP. Some of these limitations include:
•although depreciation and amortization are non-cash charges, the assets being depreciated and amortized may have to be replaced in the future, and adjusted EBITDA does not reflect cash capital expenditure requirements for such replacements or for new capital expenditure requirements;
•adjusted EBITDA does not reflect changes in, or cash requirements for, our working capital needs;
•adjusted EBITDA does not reflect the significant interest expense, or the cash requirements necessary to service interest or principal payments, on our related party debt;
•adjusted EBITDA does not reflect tax payments that may represent a reduction in cash available to us; and
•other companies, including companies in our industry, may calculate adjusted EBITDA differently, which reduces its usefulness as a comparative measure.
Because of these limitations, you should consider adjusted EBITDA alongside other financial performance measures, including operating income and net income and our other GAAP results. In evaluating adjusted EBITDA, you should be aware that in the future we may incur expenses that are the same as or similar to some of the adjustments in this presentation. Our presentation of adjusted EBITDA should not be construed as an inference that our future results will be unaffected by the types of items excluded from the calculation of adjusted EBITDA. Adjusted EBITDA is not a presentation made in accordance with GAAP and the use of the term varies from others in our industry.
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| Year Ended December 31, | ||||||||||
|---|---|---|---|---|---|---|---|---|---|---|
| 2023 | 2022 | 2021 | ||||||||
| (in thousands, except margin data) | ||||||||||
| Net income | $ | 23,412 | $ | 16,707 | $ | 113 | ||||
| Amortization | 6,396 | 11,191 | 20,384 | |||||||
| Depreciation | 15,227 | 13,249 | 13,385 | |||||||
| Income tax expense | 20,914 | 13,718 | 11,479 | |||||||
| Interest expense, net | 30,252 | 18,852 | 20,472 | |||||||
| Unrealized foreign currency losses (gains) | 358 | (1,246) | 1,433 | |||||||
| Acquisition related costs | (1,096) | 289 | (87) | |||||||
| Spin-off costs | 735 | 1,616 | 15,653 | |||||||
| Stock-based compensation expense and related employer-paid payroll taxes | 45,093 | 37,658 | 30,092 | |||||||
| Restructuring costs and other | 2,113 | 2,662 | 422 | |||||||
| Adjusted EBITDA | $ | 143,404 | $ | 114,696 | $ | 113,346 | ||||
| Adjusted EBITDA margin | 34.0 | % | 30.9 | % | 32.7 | % |
Liquidity and Capital Resources
Cash and cash equivalents were $153.0 million as of December 31, 2023. As our sales and operating cash flows are primarily generated by international entities in the United Kingdom and Canada, our international subsidiaries held approximately $146.1 million of cash and cash equivalents, of which 76.2%, 15.3% and 2.8% were held in United States Dollars, Euros, and British Pound Sterling, respectively. We intend either to invest our foreign earnings permanently into foreign operations or to remit these earnings to our United States entities in a tax-efficient manner. The U.S. Tax Cuts and Jobs Act of 2017 imposed a mandatory transition tax on accumulated foreign earnings and eliminates United States federal income taxes on foreign subsidiary distributions.
Our primary source of cash for funding operations and growth has been through cash provided by operating activities. Given the uncertainty in the rapidly changing market and economic conditions, we continue to evaluate the nature and extent of the impact to our business and financial position. However, despite this uncertainty, we believe that our existing cash and cash equivalents and our cash flows from operating activities will be sufficient to fund our operations and meet our commitments for capital expenditures for at least the next twelve months.
In connection with the Separation and Distribution, on July 19, 2021, certain subsidiaries of the Company entered into a credit agreement (the “Credit Agreement”) with JPMorgan Chase, Bank, N.A. as administrative agent and collateral agent and the lenders from time to time party thereto. The Credit Agreement provides for $410.0 million of first lien secured credit facilities (the “Credit Facilities”), consisting of a $60.0 million revolving credit facility (the “Revolving Facility”), and a $350.0 million term loan facility (the “Term Loan”). On July 19, 2021, prior to the completion of the Distribution, the Company distributed approximately $16.5 million, representing the proceeds from the Term Loan, net of the repayment of related party debt due to SolarWinds Holdings, Inc., payment of intercompany trade payables, and fees and other transaction-related expenses, to SolarWinds. The Revolving Facility is primarily available for general corporate purposes. We had total borrowings of $335.0 million and $337.0 million as of December 31, 2023 and 2022, respectively, net of debt issuance costs of $7.1 million and $8.6 million, respectively. In addition to our total borrowings, we are also committed to cash interest payments of approximately $129.7 million over the term of the Credit Agreement, based upon an interest rate as of December 31, 2023 of 8.40%. See Note 9. Debt in the Notes to Consolidated Financial Statements for further details regarding the Credit Agreement.
In addition to committed payments related to the Credit Agreement, we are also committed to purchase obligations of $71.0 million through the fiscal year ended December 31, 2027 and remaining operating lease liabilities of $39.5 million through the fiscal year ended December 31, 2032. Purchase obligations represent outstanding purchase orders for items including public cloud infrastructure and hosting fees, royalty fees, marketing activities, software license and support fees, and accounting and legal fees. On October 4, 2023, we entered into a non-cancellable royalty agreement for third-party cloud-based platform and hosting services, with an effective date of September 1, 2023. Our total commitment under this agreement is $39.0 million, with royalty fees of $35.8 million payable over the next 2.7 years as of December 31, 2023. See Note 6. Leases in the Notes to Consolidated Financial Statements for further details regarding our operating leases.
In addition, as contemplated by the Separation and Distribution agreement, cash in excess of $50.0 million was distributed by the Company to SolarWinds during the three months ended September 30, 2021.
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Although we are not currently a party to any material definitive agreement regarding potential investments in, or acquisitions of, complementary businesses, applications or technologies, we may enter into these types of arrangements, which could reduce our cash and cash equivalents, require us to seek additional equity or debt financing or repatriate cash generated by our international operations. Additional funds from financing arrangements may not be available on terms favorable to us or at all.
During the year ended December 31, 2023, we did not have any relationships with unconsolidated organizations or financial partnerships, such as structured finance or special purpose entities that would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes.
Due to and from Affiliates
There were no amounts due to or from SolarWinds as of December 31, 2023 and 2022, respectively, due to the termination of the Transition Services Agreement during the year ended December 31, 2022. See Note 13. Relationship with Parent and Related Entities in the Notes to Consolidated Financial Statements for further details regarding amounts due to or from affiliates.
Summary of Cash Flows
Summarized cash flow information is as follows:
| Year Ended December 31, | ||||||
|---|---|---|---|---|---|---|
| 2023 | 2022 | |||||
| (in thousands) | ||||||
| Net cash provided by operating activities | $ | 90,089 | $ | 71,413 | ||
| Net cash used in investing activities | (22,336) | (30,209) | ||||
| Net cash used in financing activities | (15,173) | (10,402) | ||||
| Effect of exchange rate changes on cash and cash equivalents | 1,621 | 1,309 | ||||
| Net increase (decrease) in cash and cash equivalents | $ | 54,201 | $ | 32,111 |
Operating Activities
Our primary source of cash from operating activities is cash collections from our MSP partners and our distributors. We expect cash inflows from operating activities to be affected by the timing of our sales and the consumption of our solutions by our MSP partners. Our primary uses of cash from operating activities are for personnel-related expenditures, and other general operating expenses, as well as payments related to taxes, interest and facilities.
For the year ended December 31, 2023 as compared to the year ended December 31, 2022, the increase in cash provided by operating activities was primarily due to an increase in accrued liabilities and other, an increase in income taxes payable, an increase in accounts payable, the elimination of due to and from affiliates, and a decrease in income taxes receivable, partially offset by an increase in prepaid expenses and other assets, an increase in accounts receivable, an increase in other long-term assets, an increase in deferred revenue, and a decrease in other long-term liabilities. The net cash inflow of $2.1 million and net cash outflow of $3.8 million resulting from the changes in our operating assets and liabilities for the years ended December 31, 2023 and 2022, respectively, excluding the changes noted above, was primarily due to the timing of sales, cash payments and receipts.
Investing Activities
Investing cash flows consist of cash used for acquisitions, net of cash acquired, capital expenditures and intangible assets. Our capital expenditures principally relate to purchases of servers for cloud infrastructure primarily to support our data protection solutions, as well as leasehold improvements, computers and equipment to support our domestic and international office locations. Purchases of intangible assets consist of capitalized research and development costs.
Net cash used in investing activities decreased for the year ended December 31, 2023 as compared to the year ended December 31, 2022, primarily due to a decrease in acquisitions, net of cash acquired, partially offset by increases in capital expenditures and capitalized research and development costs.
Financing Activities
Financing cash flows consist of payments of tax withholding obligations related to restricted stock, the exercise of stock options, proceeds from the issuance of common stock under the Employee Stock Purchase Plan, deferred acquisition payments, and repayments of borrowings from the Credit Agreement
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Net cash used in financing activities increased for the year ended December 31, 2023 as compared to the year ended December 31, 2022, primarily due to an increase in payments of tax withholding obligations related to restricted stock, an increase in deferred acquisition payments, and a decrease in proceeds from exercises of stock options, partially offset by proceeds from the issuance of common stock under the Employee Stock Purchase Plan.
Critical Accounting Policies and Estimates
Our Consolidated Financial Statements are prepared in conformity with GAAP and require our management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, costs and expenses and related disclosures. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. Actual results may differ from these estimates, and such estimates may change if the underlying conditions or assumptions change. To the extent that there are differences between our estimates and actual results, our future financial statement presentation, financial condition, results of operations and cash flows will be affected, perhaps materially.
In many cases, the accounting treatment of a particular transaction is specifically dictated by GAAP and does not require management’s judgment in its application, while in other cases, management’s judgment is required in selecting among available alternative accounting standards that allow different accounting treatment for similar transactions. We believe that these accounting policies requiring significant management judgment and estimates are critical to understanding our historical and future performance, as these policies relate to the more significant areas of our financial results. These critical accounting policies are:
•the valuation of goodwill, intangibles, long-lived assets and contingent consideration;
•revenue recognition;
•income taxes; and
•management’s assessment of allocations of expenses prior to the Separation and Distribution.
Acquisitions
We allocate the purchase prices of our acquired businesses to the assets acquired and the liabilities assumed based on their estimated fair values, with the excess recorded as goodwill. If applicable, we estimate the fair value of contingent consideration payments in determining the purchase price. The fair value of identifiable intangible assets is based on significant judgments made by management. We typically engage third-party valuation appraisal firms to assist us in determining the fair values and useful lives of the assets acquired. The valuation estimates and assumptions are based on historical experience and information obtained from management, and also include, but are not limited to, future expected cash flows earned from the intangible asset and discount rates applied in determining the present value of those cash flows. Unanticipated events and circumstances may occur that could affect the accuracy or validity of such assumptions, estimates or actual results.
Goodwill
Our goodwill was derived from the take private transaction of SolarWinds in February 2016 and subsequent business combinations, where the purchase price exceeded the fair value of the net identifiable assets acquired. The N-able legal entities were managed as a single reporting unit of the Parent prior to the Separation and Distribution and N-able continues to be managed as a single reporting unit following the Separation and Distribution. Goodwill is tested for impairment at least annually during the fourth quarter or sooner when circumstances indicate an impairment may exist. An impairment of goodwill is recognized when the carrying amount of a reporting unit exceeds its fair value. For purposes of the annual impairment test, we assess qualitative factors to determine if it is more likely than not that goodwill might be impaired and whether it is necessary to perform the quantitative impairment test which considers the fair value of the reporting unit compared with the carrying value on the date of the test. Qualitative factors include industry and market considerations, overall financial performance, changes in management or key personnel, changes in strategy, changes in customers and other relevant events and circumstances affecting the reporting unit.
On October 1, 2023, we performed the annual qualitative assessment for our reporting unit. For the annual impairment analysis, we assessed several events and circumstances that could affect the significant inputs used to determine the fair value of our reporting unit, including the significance of the amount of excess fair value over carrying value, consistency of operating margins and cash flows, budgeted-to-actual performance from prior year, overall change in economic climate, changes in the industry and competitive environment, key management turnover, and earnings quality and sustainability. As of October 1, 2023, there were no unanticipated changes or negative indicators in the above qualitative factors that would impact the fair value of our reporting unit as of the annual impairment analysis date. As such, we determined there were no indicators of impairment and that it was more likely than not that the fair value of our reporting unit was greater than its carrying value and therefore performing the next step of the impairment test was unnecessary.
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Fair value determination of our reporting unit requires considerable judgment and is sensitive to changes in underlying assumptions and factors. As a result, there can be no assurance that the estimates and assumptions made for purposes of the qualitative goodwill impairment test will prove to be an accurate prediction of future results. If an event occurs that would cause us to revise our estimates and assumptions used in analyzing the value of our goodwill, the revision could result in a non-cash impairment charge that could have a material impact on our financial results.
Identifiable Intangible Assets
We evaluate long-lived assets, including finite-lived intangible assets and other assets, for impairment whenever events or changes in circumstances indicate that the carrying amount of the asset group may not be recoverable. Events or changes in circumstances that could result in an impairment review include, but are not limited to, significant underperformance relative to historical or projected future operating results, significant changes in the manner of use of the acquired assets or the strategy for our overall business, and significant negative industry or economic trends. If an event occurs that would cause us to revise our estimates and assumptions used in analyzing the value of our property and equipment or our finite-lived intangibles and other assets, that revision could result in a non-cash impairment charge that could have a material impact on our financial results.
Revenue Recognition
We primarily generate revenue from the sale of subscriptions to our SaaS solutions and subscription-based term licenses and, to a lesser extent, from the sale of maintenance services associated with our perpetual licenses. We recognize revenue when we transfer promised goods or services in amounts that reflect the consideration to which the entity expects to be entitled in exchange for those goods or services. This is determined by following a five-step process which includes (1) identifying the agreement with a customer, (2) identifying the performance obligations in the agreement, (3) determining the transaction price, (4) allocating the transaction price, and (5) recognizing revenue when or as we satisfy a performance obligation, as described below.
We identify performance obligations in an agreement based on the goods and services that will be transferred to the MSP partner that are separately identifiable from other promises in the agreement, or distinct. If not considered distinct, the promised goods or services are combined with other goods or services and accounted for as a combined performance obligation. Determining the distinct performance obligations in an agreement requires judgment. Our performance obligations primarily relate to our SaaS solutions, subscription-based term licenses and maintenance support including unspecified upgrades or enhancements to new versions of our solutions.
We allocate the transaction price of the agreement to each distinct performance obligation based on a relative stand-alone selling price basis. Determining stand-alone selling prices for our performance obligations requires judgment and are based on multiple factors primarily including historical selling prices and discounting practices for our solutions and services. We review the stand-alone selling price for our performance obligations periodically and update, if needed, to ensure that the methodology utilized reflects our current pricing practices.
Income Taxes
We use the liability method of accounting for income taxes as set forth in the authoritative guidance for accounting for income taxes. For the period ended July 19, 2021, income taxes as presented in the financial statements of N-able attribute current and deferred income taxes of SolarWinds to stand-alone financial statements of N-able in a manner that is systematic, rational and consistent with the asset and liability method prescribed by Financial Accounting Standards Board (“FASB”) ASC Topic 740: Income Taxes (“ASC 740”). Accordingly, the income tax provision of N-able for the period was prepared following the separate return method. Under this method, we recognize deferred tax liabilities and assets for the expected future tax consequences of temporary differences between the respective carrying amounts and tax basis of our assets and liabilities. For the period beginning July 20, 2021, the income tax provision was computed on a post-Separation and Distribution basis following the authoritative guidance reflected in ASC 740.
In calculating our effective tax rate, we make judgments regarding certain tax positions, including the timing and amount of deductions and allocations of income among various tax jurisdictions.
The guidance on accounting for uncertainty in income taxes requires us to identify, evaluate and measure all uncertain tax positions taken or to be taken on tax returns and to record liabilities for the amount of these positions that may not be sustained, or may only partially be sustained, upon examination by the relevant taxing authorities. Although we believe that our estimates and judgments are reasonable, actual results may differ from these estimates. Some or all of these judgments are subject to review by the taxing authorities. To the extent that the actual results of these matters is different than the amounts recorded, such differences will affect our effective tax rate. We recognize interest expense and penalties on uncertain tax positions as a component of our income tax expense. ASC 740 defines the threshold for recognizing the benefits of tax return positions in the financial statements as “more-likely-than-not” to be sustained by the tax authority based solely on its technical merits as of the reporting date. If a tax position is not considered more-likely-than-not to be sustained solely on its technical merits, no benefits
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of the position are to be recognized in the financial statements. If a tax position meets the more-likely-than-not threshold, it should be measured based on the largest benefit that is more than 50 percent likely to be realized.
We establish valuation allowances when necessary to reduce deferred tax assets to the amounts expected to be realized. On a quarterly basis, we evaluate the need for, and the adequacy of, valuation allowances based on the expected realization of our deferred tax assets. The factors used to assess the likelihood of realization include our latest forecast of future taxable income, available tax planning strategies that could be implemented, reversal of taxable temporary differences and carryback potential to realize the net deferred tax assets. As of December 31, 2023, we recorded a valuation allowance of $4.9 million in the U.S. As of December 31, 2022, we recorded a valuation allowance of $2.0 million in the U.S. and $1.6 million outside the U.S., respectively. If, based upon the weight of all available evidence, it is more likely than not (a likelihood of greater than 50%) that some portion or all of the deferred tax assets will not be realized, a valuation allowance must be recorded to reduce the deferred tax assets.
Management’s Assessment of Allocations
For the periods through the Separation and Distribution date of July 19, 2021, N-able operated as a part of SolarWinds. Consequently, stand-alone financial statements were not historically prepared for N-able. The Consolidated Financial Statements have been prepared using the legal entity approach from SolarWinds’ historical Consolidated Financial Statements and accounting records of N-able prior to the Separation and Distribution and are presented on a stand-alone basis as if N-able’s operations had been conducted independently from SolarWinds.
For the periods through the Separation and Distribution date of July 19, 2021, SolarWinds provided facilities, information technology services and certain corporate and administrative services to N-able. Expenses relating to these services have been allocated to N-able and are reflected in the Consolidated Financial Statements. Where direct assignment is not possible or practical, these costs were allocated based on headcount. Management believes the assumptions underlying the Consolidated Financial Statements, including the assumptions regarding allocated expenses, reasonably reflect the utilization of services provided to, or the benefit received by, us during the periods presented. However, the expenses reflected in the Consolidated Financial Statements may not be indicative of the actual expenses that would have been incurred during the periods presented if N‑able historically operated as a separate, stand-alone entity. Actual costs that would have been incurred if we had been a stand-alone company would depend on multiple factors, including organizational structure and strategic decisions in various areas, such as information technology and infrastructure. In addition, the expenses reflected in the Consolidated Financial Statements may not be indicative of related expenses that will be incurred in the future by N-able.
Recent Accounting Pronouncements
See Note 2. Summary of Significant Accounting Policies in the Notes to Consolidated Financial Statements in Item 8 of Part II of this Annual Report on Form 10-K, for a full description of recent accounting pronouncements, which is incorporated herein by reference.