Tenable Holdings, Inc. (NASDAQ:TENB) Q3 2023 Earnings Call Transcript
Tenable Holdings, Inc. (NASDAQ:TENB) Q3 2023 Earnings Call Transcript November 1, 2023
Tenable Holdings, Inc. misses on earnings expectations. Reported EPS is $-0.13423 EPS, expectations were $0.19.
Operator: Greetings, and welcome to Tenable's Q3 2023 Earnings Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder this conference is being recorded. It is now my pleasure to introduce your host, Erin Karney, Vice President, Investor Relations. Thank you, Ms. Karney, you may begin.
Erin Karney: Thank you, operator, and thank you all for joining us on today's conference call to discuss Tenable's third quarter 2023 financial results. With me on the call today are Amit Yoran, our Chief Executive Officer; and Steve Vintz, our Chief Financial Officer. Prior to this call, we issued a press release announcing our financial results for the quarter. You can find the press release on the IR website at tenable.com. Before we begin, let me remind you that we will make forward-looking statements during the course of this call, including statements relating to our guidance and expectations for the fourth quarter and full-year 2023 and expectations for the first quarter of 2024, growth and drivers in our business, changes in the threat landscape in the security industry and our competitive position in the market; growth in our customer demand for and adoption of our solutions, including Tenable One, planned innovation and new products and services, the potential benefits and financial impact of our recent acquisition of Ermetic and our expectations regarding long-term profitability and free cash flow.
These forward-looking statements involve risks and uncertainties, some of which are beyond our control. which could cause actual results to differ materially from those anticipated by these statements. You should not rely upon forward-looking statements as a prediction of future events. Forward-looking statements represent our management's beliefs and assumptions only as of today and should not be considered representative of our views as of any subsequent date. We disclaim any obligation to update any forward-looking statements or outlook. For a further discussion of the material risks and important factors that could affect our actual results, please refer to those contained in our most recent annual report on Form 10-K our quarterly report on Form 10-Q for the quarter ended June 30, 2023, and subsequent reports that we file with the SEC, which are available on the SEC website at sec.gov.
In addition, during today's call, we will discuss non-GAAP financial measures. These non-GAAP financial measures are in addition to and not a substitute for or superior to measures of financial performance prepared in accordance with GAAP. There are a number of limitations related to the use of these non-GAAP financial measures versus their closest GAAP equivalents. Our earnings release that we issued today includes GAAP to non-GAAP reconciliations for these measures and is also available on the Investor Relations section of our website. I'll now turn the call over to Amit.
Amit Yoran: Thank you, Erin. I will provide some context on our financial performance in the quarter, discuss the accelerating momentum we are seeing with our platform and touch on our growth strategy with cloud. We delivered a solid Q3 with strong contributions from Tenable One, OT and the public sector. In addition, we continue to deliver significant margin leverage by delivering a $10 million beat to operating income. While the underlying performance of the business was good this quarter, the mix of our business was different than we typically see and led to an unusual divergence between sales and CCB. At a high level, due to the outsized strength in public sector, we saw a much larger mix shift to perpetual licenses and services with minimal contribution to CCB.
Our flexible deployment model gives our customers the ability to optimize their architecture in the cloud, on-premise or hydra, which directly benefits our customers through unified visibility and simplified management. We believe we are the only vendor to deliver exposure management for both on-premises and hybrid deployments, which enables us to address our customer deployments bias. During the quarter, we added a record number of seven-figure customers, a testament to the growing importance of our solutions and our strength in public sector and large enterprise. Our products are helping customers secure even more areas of their tax surface, expanding their use cases and consolidating around Tenable. In particular, our outperformance in federal reflects a strong mix of business and our expansion into larger, more strategic deals.
We're also seeing great traction in signing large OT deals signaling our growing leadership in this space. This boils down to our installed customer base trusting us to expand beyond VM to help them manage risk using our portfolio of products. We believe our leadership in helping organizations understand risk positions us for considerable opportunity going forward that we think we are still in the early innings of. While we're pleased with our performance in the quarter and saw strength in large deals, we're seeing some softness in the mid-market, which we expect to persist in Q4 and into next year. As the use of technology continues to expand, customers are looking for clarity around their attack surface including accurately identifying all the assets in their environment and prioritizing which areas of the attack surface are most at risk.
Tenable One connects the dots from externally facing points of attack across the entire surface of systems, identities, permissions, vulnerabilities and configurations and delivers differentiated analytics, including building asset inventories and identifying and prioritizing a top path which magnify risk. As an innovator, we continue to build out capabilities within Tenable One. We are now using generative AI to deliver faster, more intuitive insights so customers can be more efficient and focus more resources on preventing successful attacks. Additionally, we expect that new features, including AI-fueled identity assessment will only serve to accelerate our time to value for customers. Looking at the buying patterns of customers, we continue to see a broad distribution of asset types, particularly from our specialty products.
We also saw strong adoption from Tenable One from our security center customers this quarter. Security center customers represent a very sizable base. They're increasingly operating in hybrid environments. Our ability to deliver the insights and analytics from Tenable One without requiring them to go through structural changes resonate deeply with these customers. Within our specialty products, we're seeing increased emphasis on active directory security and cloud security as customers continue to struggle with how to adequately manage risks in those areas of their tax service. Tenable cloud security now with Ermetic is a complete code to cloud, highly competitive CNAPP offering. Customers everywhere understand that securing the cloud is critical and incredibly complex.
Security teams have to be cloud experts to find and prioritize the most urgent risk and how to address them. In many cases, customers do not even know what assets they have, let alone what access has been granted to those assets. The situation is complicated further as cloud adoption accelerates and naturally multiplies user identities, machine identities and the complex web of entitlements, which grow exponentially. Tenable and Ermetic are helping organizations address some of the most difficult challenges in cloud security today. Our cloud security solutions are simplifying security management to meet the increasing and relentless demand for cloud infrastructure growth. Additionally, they enable security professionals to understand the complex relationships and risk across assets, identities and their entitlement and reduce the risk caused by explosion in the volume and permission of users and machine identities in the cloud.
The unique combination of Tenable and Ermetic gives customers a tightly integrated cloud-native application protection platform and capabilities for cloud environments. An elegant user experience minimizes complexity and can speed adoption. Even the more mature organizations have not yet integrated commonly deployed security tools like infrastructure is code, cloud security posture management, cloud workload protection and cloud infrastructure entitlement management across multiple cloud environments. Tenable and Aromatic can bring together greater context to our customers' overall security program by integrating these point products into a single unified CNO offering. We're delivering unparalleled insights into identities and access, which go hand-in-hand with configurations and vulnerabilities in being absolutely critical to securing cloud workloads.
And with the integration of insights from Tenable One customers can also consolidate, simplify and reduce costs. Our sellers are having incredible engagement with our customers. Pipeline is strong out of the gate and excitement is running high. We continue to execute well with our product vision and balanced growth strategy. Over the next few quarters, we'll continue to execute on our product road map and integrate hermetic, which we expect to enable us to demonstrate more leverage in our business. Cyber security has never been more important nor more fundamental to our economies and business than it is today, requiring corporate leaders to elevate cybersecurity within their organizations. As just one example, the SEC's recent cyber risk management and infinite disclosure rules require disclosures on board oversight and management's role in assessing and managing material risks from cybersecurity threats.
Companies will continue to feel pressure from management teams, Boards and increasingly, regulators, shareholders and customers, and we will continue to turn to Tenable to understand where they're exposed and how to reduce risk. I'll now turn the call over to Steve for further commentary on our financial results and outlook.
Steve Vintz: Thank you. As Amit discussed earlier, we are pleased with the underlying performance of the business this quarter which is not reflected in our calculated current billings. I will provide more commentary momentarily, but first, please note that all financial results we discuss today are non-GAAP financial measures with the exception of revenue. As Erin mentioned at the start of this call, GAAP to non-GAAP reconciliations may be found in our earnings release issued earlier today. Now on to the results for the quarter. Calculated current billings, defined as revenue recognized in the quarter, plus the change in current deferred revenue grew 8% year-over-year to $224.7 million. As I have mentioned on prior calls, CCB is typically a close but not perfect proxy for sales in the quarter and is influenced by a number of factors such as mix of business, deal timing, including early renewals.
Since our IPO, CCB growth has generally tracked in line with the underlying sales growth of the business. However, this is the first quarter in which there was such a large disparity. Current IPO growth in the quarter was 15% and is a closer approximation of the underlying performance of the business this quarter. During the quarter, we saw significant outperformance in the public sector. specifically in U.S. Federal, which benefited from a robust spending environment related to the September 30 fiscal year-end. We closed a few strategic agency-wide seven-figure deals on both the defense and the civilian side, some of which are listed on public procurement sites. Consequently, the outperformance in U.S. Federal resulted in a higher mix of public sector sales and overall, a much higher mix of professional services and perpetual licenses that either did not contribute or minimally contributed to CCB in the quarter.
The total impact here was approximately $12 million of lower CCB in the quarter. To provide a little more color, these services were sold primarily with our VM and OT offerings that are tied to large government programs and included initial software purchases as part of deployment planning exercises that we expect will result in additional product purchases over the next several quarters. We believe these large strategic wins not only demonstrate our leadership position in the federal market but also give us a very significant opportunity to sell additional software in future periods. Also, please note that perpetual license software sales are recognized over five years, not upfront. So $0.04 of the annual contract is excluded from CCB. Another major highlight was Tenable One, which represented 20% of new sales in the quarter and grew over 100% year-over-year.
Despite these strengths, we did start to see some headwinds in the mid-market where spending was constrained, particularly with new logos. It's important to note that while the top of the funnel remains strong, there appears to be a more cautious outlook from buyers in this market related to the broader macro, which impacted our conversion rates in the quarter. In terms of key metrics, we added 386 new enterprise platform customers in the quarter. Also, as discussed earlier, large deals were strong as we added 58 net new 6-figure customers in the quarter. And we also closed a record number of seven-figure deals in the quarter, which reflects strength in the large enterprise market as well as the public sector. Our dollar-based net expansion rate was 111% in the quarter, compared to 111% last quarter.
As a reminder, the expansion rate is calculated on an LTM basis. Revenue was $201.5 million, which represents 15% year-over-year growth. Revenue in the quarter exceeded the midpoint of our guided range by $3.5 million. Our percentage of recurring revenue remains high at 95% this quarter, which is consistent with prior periods. I'll now turn to expenses. I'll start with gross margin, which was 80% this quarter compared to 81% last quarter. As I mentioned on the last call, we expect margins to be modestly lower in the second half of the year as we absorb the initial public cloud costs related to the upcoming relief of cyber Asset Management and AI-powered analytics. Sales and marketing expense was $79 million, which was down from $81.4 million last quarter.
Sales and marketing expense as a percentage of revenue was 39%, compared to 42% last quarter. Sales and marketing expense decreased sequentially, primarily due to lower personnel costs and event marketing spend related to the timing of industry conferences, partially offset by higher commission expense. R&D expense was $27.8 million, which was down from $28.1 million last quarter. R&D expense as a percentage of revenue was 14% this quarter, flat in comparison to last quarter. R&D expense decreased sequentially primarily due to lower personnel costs, partially offset by increased public cloud costs. G&A expense was $18.5 million, which is up from $17.8 million last quarter. G&A expense as a percentage of revenue was 9% this quarter and flat relative to last quarter.
Income from operations was $36.6 million which was significantly better than expected and exceeded the midpoint of our guided range by approximately $10 million. Operating margin for the quarter was 18% and which was 470 basis points better than the midpoint of our guidance. The sizable upside in earnings this quarter reflects the strength of our business model and our ability to cost effectively acquire customers and expand those relationships over time. It's also worth noting that our operating margin improved over the same period last year by approximately 490 basis points. Additionally, you will note $6.5 million of other expense net this quarter. Included in this amount is a $5 million impairment charge related to a strategic investment in a privately held company.
All of this resulted in EPS of $0.23, which was approximately $0.045 better than the midpoint of our guided range. Now let's turn to the balance sheet. We finished the quarter with $693 million in cash and short-term investments. Accounts receivable was $179.4 million and total deferred revenue was $681.5 million, including $518.4 million of current deferred revenue, which gives us a lot of visibility into expected revenue over the next 12 months. We generated approximately $48 million of unlevered free cash flow during the quarter. Year-to-date, unlevered free cash flow was $132 million, which pushed us well within reach to achieve our annual unlevered free cash flow target for the full year, which we are raising today after adjusting for the Ermetic acquisition.
With 95% recurring revenue, high gross margins and renewal rates, we feel confident that we can continue to expand our operating and free cash flow margins over the ensuing years. With the results of the quarter behind us, I'd like to discuss our outlook for the fourth quarter and full year 2023, which reflects the estimated impact of the Ermetic acquisition that closed on October 2. For the fourth quarter, we currently expect revenue to be in the range of $204 million to $208 million, non-GAAP income from operations to be in the range of $23 million to $24 million. Non-GAAP net income to be in the range of $16 million to $17 million, assuming interest expense of $8.3 million, interest income of $4.9 million and a provision for income taxes of $3 million.
Non-GAAP diluted earnings per share to be in the range of $0.13 to $0.14, assuming 123.5 million fully diluted weighted average shares outstanding. And for the full year, we currently expect calculated current billings to be in the range of $862 million to $870 million, revenue to be in the range of $789.4 million to $793.4 million. Non-GAAP from operations to be in the range of $107.9 million to $108.9 million, non-GAAP net income to be in the range of $83 million to $84 million assuming interest expense of $31.5 million, interest income of $24.2 million and a provision for income taxes of $9.1 million. Non-GAAP diluted earnings per share to be in the range of $0.68 to $0.69 per share, assuming 121 million fully diluted weighted average shares outstanding and unlevered free cash flow to be in the range of $168 million to $173 million.
I'd like to provide some commentary regarding our outlook today. The trends we observed in the mid-market in Q3 are expected to persist. So we think it's appropriate, revise our CCB range for the year to reflect a more cautious outlook in Q4 as well as the flow-through of our CCB results in the third quarter. Revenue, which is recurring in nature, reflects a $3.5 million beat in Q3 and a $1 million rate. Also as a reminder, Ermetic is not expected to contribute materially to the top line in the fourth quarter. In terms of profitability, we are increasing our outlook for income from operations for the full year by $10 million which reflects a $15 million beaten raise for Tenable and less $5 million related to the impact of the Ermetic acquisition.
Net income for the full year reflects a $10 million beat in rate for Tenable, less $8 million related to the impact of Ermetic, which includes $3 million of foregone interest income. We're also revising our outlook for unlevered free cash flow to reflect a $3 million rate Tenable due to the operational efficiencies we continue to realize in our business, less $15 million of costs due to the impact of the acquisition. In terms of 2024, we will provide guidance for Q1 and the full-year on our earnings call in February, but we believe mid-teen CCB growth, which reflects the contribution from Ermetic and the current selling environment in the mid-market is a fair expectation of growth for the upcoming year. Q4 is an important input, the setting expectations for the upcoming year.
So we want to have that data point in hand before we discuss the business in more specific terms. All of that said, we will continue to effectively balance growth with profitability and expect unlevered free cash flow to grow approximately 25% next year, which reflects the anticipated impact of Ermetic. We expect Ermetic to be breakeven and unlevered free cash flow in the fourth quarter of 2024 and be accretive to EPS for the full-year in 2025. At this point, I'd like to turn the call back over to Amit for some closing comments.
Amit Yoran: Thanks, Steve. In summary, Q3 is a clear indication of our ability to drive continued leverage in the business. We are at an exciting time in our business and have a ton of opportunity ahead of us. We look forward to updating you on our next call and seeing you at the Needham, D.A. Davidson, Wells Fargo, Stephens and Barclays conferences in the coming weeks. Additionally, we expect to have our Investor Day in the first half of 2024. We'd now like to open the call up for questions.
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