Tenable Holdings Inc

NASDAQ:TENB

Earnings Call Analysis

Solid Q3 Performance with Strong Guidance Ahead

In the third quarter, revenue reached $201.5 million, showing a year-over-year growth of 15% and surpassing the guided range by $3.5 million. The company's recurring revenue stands at 95%, with a gross margin of 80%. Operating income hit $36.6 million, well above the forecast by $10 million, translating into an earnings per share (EPS) of $0.23. Looking ahead, Q4 revenue is estimated between $204-208 million, with full-year revenue projected at $789.4-793.4 million. The acquisition of Ermetic is factored into the future, with expectations of a 25% increase in unlevered free cash flow next year.

Quarterly Performance with a Strong Public Sector Influence

The company experienced significant outperformance in the U.S. Federal public sector due to robust government spending, closing several strategic, high-value deals. These large contracts primarily involved professional services and perpetual license sales that slightly impacted the Calculated Current Billings (CCB) with an approximately $12 million reduction. Perpetual licenses are recognized over five years, influencing how CCB is reported. Tenable One emerged as a growth driver, representing 20% of new sales and doubling year-over-year. However, a cautionary environment has emerged in the mid-market with spending constraints, particularly among new logos. The company added 386 new enterprise platform customers, and large deals remained strong, which is encouraging for future large enterprise and public sector engagements.

Financial Highlights and Revenue Beat

Revenue grew by 15% year-over-year to $201.5 million, surpassing guidance by $3.5 million. The company boasts a high percentage of recurring revenue at 95%. Gross margin slightly decreased to 80% due to initial public cloud costs, yet operational efficiency led to an $36.6 million income from operations, which was $10 million above guidance, reflecting an operating margin improvement of about 490 basis points from last year. Notably, a $5 million impairment charge related to a strategic investment was also recorded. Earnings per share (EPS) at $0.23 exceeded expectations, and the quarter concluded with strong financial positioning, including $693 million in cash and investments, and substantial unlevered free cash flow generation, which positions the company to hit its increased annual target.

Outlook for the Fourth Quarter and Forward-Looking Expectations

For Q4, the company forecasts revenue between $204 million to $208 million, with non-GAAP operating income expected to be between $23 million to $24 million, and non-GAAP net income ranging from $16 million to $17 million. Revenue guidance reflects a cautious stance due to mid-market challenges, though not expecting a significant contribution from the Ermetic acquisition in the top line for Q4. Full-year targets are updated to reflect recent performance and acquisitions, with plans to discuss 2024 guidance in the upcoming February earnings call. The company anticipates mid-teen CCB growth and a 25% increase in unlevered free cash flow for the next year, reflecting Ermetic's impact. It's projected that Ermetic will become accretive to EPS in 2025.

Positioned for Continued Growth and Profitability

In closing, Q3's results underscore the company's ongoing proficiency in leveraging its business model for growth while ensuring profitability. The firm stands at a pivotal moment with considerable opportunities for expansion and enhancement of its financial health. The management team is optimistic about the company's trajectory and its potential to yield significant value for shareholders in the foreseeable future.

Earnings Call Transcript 2023-Q3

[Operator]

Greetings, and welcome to Tenable's Q3 2023 Earnings Conference Call. [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, executive]

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 Stephens, 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 Aromatic 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, executive]

Thank you, Erin. [indiscernible] 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 7-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 [indiscernible] is a complete code to cloud, highly competitive [ Snap ] 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 [indiscernible] 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 [indiscernible] 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.

[Stephen Vintz, executive]

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 RPO 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 7-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 5 years, not upfront. So [indiscernible] of the annual contract is excluded from CCP.

Another major highlight was Tenable One, which represented 20% of 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 7-figure deals in the quarter, which reflects strength in the large enterprise market as well as the public sector.

Our [indiscernible] 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, executive]

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 [indiscernible], 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.

[Operator]

[Operator Instructions] The first question comes from the line of Brian Essex with JPMorgan. Please go ahead.

[Brian Essex, analyst]

Steve, really appreciate the color around the moving pieces with CCB. Amit, just a question for you, and I'll maybe keep it to one. With regard to code to cloud security, we're seeing a lot of different companies target this space, whether it's larger platform vendors or best-of-breed vendors operating in certain niches of that market. Who do you typically see competitively? How are you winning in that market? And what is your outlook for market share in -- as we kind of like think about your ability to penetrate that space in the years ahead?

[Amit Yoran, executive]

Yes. So I guess I'll start off by saying Tenable has been an active participant in the cloud security market for some time. Obviously, we move forward with an acquisition of Accurics some time ago. We continue to build organic capability [ agentless ] assessment and do some integration along those lines. With the most recent acquisition at the beginning of Q4 of Ermetic, we believe we have a highly competitive, fully integrated SNOP offering that can look at infrastructure's code, see what that build-out looks like assess systems and how they're operating in real time in cloud environments. And so we have that very elegant code to cloud visibility and also the ability to go inverse. So from a piece of operating code in from operating live systems in cloud environments, we can trace back toward the code which produce those systems and how they're executing. So we feel like we've got a highly differentiated, highly competitive capabilities in the integration of Tenable's existing functionality and cloud capabilities with what Ermetic brings to the table.

To that end, we think we're going to be head ahead competitive with all of the major and market-leading CNAP vendors out there and feel like we have a number of key differentiators and capabilities, including the cloud infrastructure entitlement management functionality that is market leading, which Ermetic brings to the table and our visibility and our ability to give customers visibility across hybrid environments. So not just what's happening in their cloud or what systems they have, they are connecting to their cloud and the much more accurate picture of overall exposure.

[Brian Essex, analyst]

That's great. Maybe a quick follow-up. Are you currently seeing those vendors competitively now? Or is it mostly greenfield treated?

[Amit Yoran, executive]

No, we're seeing those vendors competitively now. Again, we've differentiated ourselves in a number of fronts historically, including how tightly we can integrate the on-prem and cloud vulnerabilities including the agentless assessment and infrastructure's code, I think with the addition of Ermetic and unified elegant CNAP offering, we feel like we can continue to leverage those traditional differentiators, but -- and also go direct head-to-head competition with all of the market-leading CNAP vendors and win more than our fair share.

[Operator]

Next question comes from the line of Rob Owens with Piper Sandler.

[Robbie Owens, analyst]

I'm going to follow in line with Brian and ask one question that's really going to turn into two. Steve, first of all, just around the CCB discussion, and I appreciate the disclosure there. Is the commentary around the fact that when it's a perpetual deal, it's ACV is actually less? And so that negatively impacts CCB? Because obviously, billings as revenue plus change in deferred, so you're getting the revenue more upfront? Or is it the services that are associated with the contract that then wouldn't be necessarily in deferred revenue, given how those work? I was a little confused.

[Stephen Vintz, executive]

Yes. Rob, so we mentioned the outperformance in public sector, which weighed on CCB. And specifically, we saw -- if you look at our performance in public sector, specifically U.S. Federal, it was twice as high this quarter in terms of mix of business as any quarter we've experienced previously since going public. So a much higher mix of business Fed procurement bias is more weighted towards perpetual licenses, and these deals are large and complex and strategic in nature and came with a higher level of services. So it was the combination of both perpetual licenses and professional services that's not fully reflected in CCB.

With regard to perpetual licenses, these perpetual licenses are, in effect, amortized over 5 years. That's how we recognize revenue. So consequently, only 1/5 of the annual contract value related to these deals are reflected in calculated current billings. Professional services will be delivered over the course of the next several quarters. And unlike our enterprise customers, these services cannot be built upfront and consequently, they're not included.

[Robbie Owens, analyst]

Great. And then, Amit, for you. Obviously, very unfortunate with the geopolitical situation in the Middle East right now. And I know Ermetic is over there. I'm just curious given when it was acquired and what's transpired since any changes to time line, thoughts of integration into the cloud security suite as well?

[Amit Yoran, executive]

Yes. I'll start off just by saying our team there is incredibly resilient and incredibly proud of the work that they're doing and their ability to keep focus. That said, we do anticipate some modest delays in integration activities. But for the most part and at a strategic level, they continue to move forward and feel like those changes will be modest.

[Operator]

Next question comes from the line of Joel Fishbein with Truist Securities.

[Joel Fishbein, analyst]

I have one for you similar to Brian. But on the OT space. That space seems to be crowded, but it seems like you are doing well there. And I'd love to just understand the competitive dynamics of the space and then why Tenable is winning there? A lot of the companies we cover are talking about OT, but it seems like you've got some real traction there. We have to just get a little bit more color.

[Amit Yoran, executive]

Yes. We're incredibly bullish about our OT business. And that comes on the heels of a couple of quarters in succession here where we're talking about it on the earnings call, saying we're pulling down larger 6-figure and 7-figure deals. We're winning larger opportunities in both public sector, significant opportunities in public sector with OT and continued traction in critical infrastructure. We think these are markets that will continue to grow in importance from a cybersecurity perspective. There's a couple of key differentiators for us.

One is we've got a very large and robust and diverse customer base on a global basis. They're used to coming to us to help them evaluate cyber risk. And we think that visibility, which we can provide on a unified basis across both OT and IT is a strategic differentiator for us relative to what most OT vendors provide, which is just a very myopic focus on control systems. If you walk through a factory floor, if you look at a pipeline, if you look at manufacturing operations, data center automation. What you'll see is that all of these systems, all of these activities have a combination of OT and IT in their environment, and it's impossible to help someone assess and understand the risk to that operation looking only at control systems. So we think we've got a highly competitive product. We think it's strategically differentiated in our ability to combine IT and OT in the evaluation of risk. And we've got a significant customer base and distribution for that technology into a -- what is a rapidly growing market.

[Operator]

Next question comes from the line of Hamza Fodderwala with Morgan Stanley.

[Hamza Fodderwala, analyst]

Steve, maybe a question for you and Amit as well. Just if I look at your outlook here, so you did about 8.5% on current billings growth this quarter. The guidance for Q4 implies somewhere between 10% to 11% and then you're guiding for mid-teens next year, I guess, if you back out the acquisition sort of low teens. I'm just curious because it does seem like the environment got a little bit worse for you on the mid-market side. What gives you confidence that you can accelerate next year?

[Stephen Vintz, executive]

Hamza, this is Steve. Yes, our guidance for the fourth quarter does assume at the midpoint 11% and at the high end, 12%, the range is 9% to 12% here. As we look out over the next year, I think the selling conditions that we're seeing today, specifically in the mid-market, we expect to persist. And what we said direction for next year is mid-teens growth. That's inclusive of the contribution from Ermetic. And so largely, if we look at next year, we're assuming no change in the selling conditions, same selling environment. And we also have some slightly easier compares. So that skews growth a little bit. So I think we're taking a cautious approach to our outlook next year. But again, Q4 is a big quarter for us. And it's important to have that data point in hand. So in February, we'll provide guidance and talk about the business in more specific terms, but we want to make sure that we have a cautious outlook. And there's a lot of great things about our business, and the performance in the quarter was really strong, as we're commenting. It's not reflected in TCB, but saw major outperformance in U.S. Federal. But we think it's appropriate just given some of the selling conditions in the mid-market to take a cautious approach here.

[Amit Yoran, executive]

Yes. I guess the only thing I would add to that is, look, we saw exceptional strength in the quarter on a number of fronts in terms of Tenable One's growth both as a percentage of product and growth overall, the large enterprise traction, the 7-figure deals, half million dollar deals, all record numbers for us, the strength in federal. And I think candidly, just the competitiveness of the product, if you look products. If you look at our portfolio across the board, whether it's in identity, in OT, our capabilities in cloud security and our ability to differentiate both in core VM as well as in this unified platform sale, our confidence in the sales team's confidence in what they're seeing as has never been stronger. So that gives us confidence going into 2024. And like Steve said, we'll see how Q4 plays out and look forward to updating folks on the plan as we get into the Q1 call.

[Operator]

Next question comes from the line of Andrew Nowinski with Wells Fargo.

[Andrew Nowinski, analyst]

Great. Thank you. I was wondering on the mid-market softness, was there anything specific to any maybe sort of verticals within that mid-market or any regions that were particularly soft? Or was that just broad-based? And maybe like what percentage of your installed base or revenue is derived from that mid-market segment?

[Stephen Vintz, executive]

It's more broad-based in nature and approximately about 25% of our total sales, as we've discussed before, is attributed to the mid-market and it appears that smaller-sized customers, specifically in the mid-market, are certainly feeling more of the impact of the macro, which tends to be fluid from quarter-to-quarter.

[Andrew Nowinski, analyst]

Okay. And then I had a question on the larger customers, the 100,000 -- the customers that spend over $100,000 looks like you added 386 -- excuse me, 58% this quarter which was down on a year-over-year basis. So I'm wondering, given that you have Tenable One, which I believe is a much higher price point than a larger -- presumably larger deal sizes, was there any softness there that may have caused your new logo adds of the large customers to decline on a year-over-year basis?

[Amit Yoran, executive]

Yes. I guess I would just start off by saying, listen, any time you're in a tougher macro environment and I think what you're hearing consistently from us and other software companies is that new logo ads is typically weaker in tougher markets. That said, we're still adding more than 300-plus logos onto our enterprise platforms, still a solid number of 6-figure adds. And on top of that record number of $7 million and $0.5 million plus deals. So we have strength in the more mature customer base, the larger enterprises that really value and understand security a little bit better. And solid performance even in the tougher mid-market.

[Operator]

Next question comes from the line of Brad Reback with Stifel.

[Brad Reback, analyst]

Amit, high-level question, given the breadth and depth of the product portfolio at this point and the vagaries of the mid-market which kind of is always that way up and down. What's the thought of pivoting the sales force to more of an upmarket focus?

[Amit Yoran, executive]

Well, it's certainly something that we look at and try and provide careful balance around. And as you recall, we've got a real hybrid sales approach, where we've got inside sellers, which we think are cost effectively going after our mid-market customers. We're 100% dedicated to channel. We transact all of our business through channel partners, which also help us achieve scale and cost effectiveness into that mid-market. And then direct touch enterprise sales team working hand in glove with partners to get to those larger opportunities and larger enterprise customers. So we look at -- and also operate on the e-commerce side for the higher-volume transactions. So we try and find the appropriate balance to have cost-effective leverage and opportunity because ours is a solution which is probably applicable. So we'll continue to look at that going into next year, make sure that we're optimizing our go-to-market spend for the greatest return.

[Brad Reback, analyst]

Got it. And then given the valuation of the stock and the significant amount of free cash flow that you all are generating at this point, what's the Board's thought on share repurchase activity?

[Stephen Vintz, executive]

Well, I think there's a clear use of -- the good news is we're generating increasing levels of cash flow, and we have confidence that we'll continue to drive higher levels of cash flow. I think the operating margins have expanded significantly over the years as have the free cash flow margins.

And in terms of use of cash, I would say the security market is very fragmented. Amit can comment further, but clearly, we're using cash to acquire strategic and accretive assets. We're going deeper and wider in cloud security, which is a major market opportunity for us. And then we'll continue to evaluate other uses of cash to provide better returns for shareholders.

[Operator]

Next question comes from the line of Roger Boyd with UBS.

[Roger Boyd, analyst]

As the CNAP platform gets larger, I wonder if you could provide any update on maybe where you are in terms of adoption of cloud security within the installed base? And then Amit, more of a high-level question, but it feels like the industry has been talking about CNAP consolidation for some time. And you talked to customers, and it still sounds like buyer behavior is skewing towards picking and choosing different point products and CSPM, et cetera. So I guess love to get your perspective on how you think that the time line for like cloud security consolidation plays out?

[Amit Yoran, executive]

Yes. First of all, I'll start by saying we're seeing tremendous demand on the cloud security side. At this point, I'd say prior to acquisition, Tenable is already delivering cloud security capability to over 1,000 customers. And so we're seeing demand. We're seeing momentum and we continue to invest organically and inorganically in building out those capabilities.

Certainly, market-leading on the infrastructure's code side. I think Ermetic is the absolute market leader when it comes to cloud infrastructure and entitlement management. And so to your point earlier, even where other solutions have been deployed, Ermetic has shown the ability to sell alongside those products with their team functionality. That said, I do believe that we're going to see a lot of consolidation, both in security and specifically within cloud security because these capabilities really need to be tightly integrated to maximize value for customers because what you have in the cloud, how it's configured, how it's vulnerable, who has access to those assets, what are the permissions and entitlements to those assets, what would it look like if any of those identities or assets were compromised. I think all of those data points are tightly intertwined both from a security and compliance perspective, and I think that there's a very natural progression from point products in cloud unified CNAP platforms. And I think that's what you're hearing from most of the market-leading cloud security vendors and certainly what Ermetic is bringing to the table for Tenable.

[Roger Boyd, analyst]

Appreciate the color. Thank you.

[Operator]

Next question comes from the line of Gray Powell with BTIG.

[Gray Powell, analyst]

Great. So yes, maybe just kind of drill in on the Q4 outlook. I'd be curious, are you guys expecting a budget flush this year? And then just on a comparison basis, like how does the environment feel today versus this time last year? Is it better, same or worse in terms of just the visibility that you feel like you have?

[Stephen Vintz, executive]

Yes, in terms of budget flush, there certainly -- if you look heading into Q4, we'd expect Q4 to be sequentially higher in terms of CCB on an absolute dollar basis relative to what we're providing today. So the fourth quarter tends to be seasonally strong for us. It can represent over 30% of our total sales. We do see budget flush. We would expect that in the fourth quarter. We do -- we are expecting some of the selling conditions that we experienced in the mid-market to persist. But overall, we feel good about the guidance that we're giving today. And I think in terms of the comparison to last year, I think it's fair to say that this is a new budget cycle, a new fiscal year and new logos are tougher to transact in this environment. But we're also very pleased to see us demonstrate real momentum, not only with Tenable One, where it's growing over 100%, and we're seeing higher selling prices there. but also really strength in large deals. As Amit commented earlier, we had a record number of 7-figure deals, also $0.5 million deals and up. So the value that we deliver to our customers continues to grow in terms of importance and it's resulting in larger deals.

[Amit Yoran, executive]

Yes, I guess the only other thing I would add to that is less on the macro and more on the competitiveness of product sets, whether it's on the OT side, our ability to win -- compete and win and deliver on cloud security on identity and the unification of these capabilities, Tenable One, the sales and go-to-market teams have never had greater confidence in the products that we're bringing to the market and our ability to value differentiate from competition. So there's a lot of cost for optimism.

[Operator]

Next question comes from the line of Brian Colley with Stephens Inc.

[Brian Colley, analyst]

So I wanted to drill down on the commentary around the mid-market. Could you just elaborate on whether you saw -- was it less new logos in the mid-market? Or was it more related to expansion business? And then -- is part of this due to increased competition in the mid-market?

[Amit Yoran, executive]

Yes. Great question. I would say it is absolutely on the new logo side. We continue to see strength in renewal rates. I think Steve called out a net dollar renewal rates remain consistent and healthy, both in enterprise and mid-market

On the competitive dynamics, competitive landscape, we just continue to see strength and improvement. I think this quarter was the first significant step above previous quarters in terms of competitive win rates and close rates. So we feel really good about where we're at competitively, from a product perspective as well as our ability to execute just as we said, more difficult to stand back new logos in the mid-market in this economy.

[Brian Colley, analyst]

Got it. Okay. That's helpful. And then one for you, Steve. Apologies if I missed it, but did you disclose the statistic on what Tenable One represented as a percentage of new business and total sales?

[Stephen Vintz, executive]

I did, 20% approximately of total new enterprise sales.

[Operator]

Next question comes from the line of Garrett [indiscernible], Jonathan Ho with William Blair.

[Unknown Analyst]

This is Garrett [indiscernible] on for Jonathan Ho. So you noted success with selling Tenable One as a strength in the quarter. So how has pricing been for those specific deals? Have you been able to realize as much pricing as you anticipated? Or has there been a lot of discounting involved? I would just like to get some color there.

[Stephen Vintz, executive]

No change in pricing dynamics. We continue to see strong traction with Tenable One. Selling prices there are 70% higher selling the platform in comparison to selling stand-alone VM. We have an asset-based pricing model with Tenable One. And because Tenable One not only includes VM, but also newer asset types. We are covering more assets within our customers' environment. So that's what's driving the selling price is higher, only ability to capture more of those systems and more of those assets, but also delivering more value, greater insight. So the price per asset consequently is higher, but no changes in pricing.

[Operator]

Next question comes from the line of Matthew [indiscernible] with Needham.

[Unknown Analyst]

This is Matt [indiscernible] on from Mike Cikos over at Needham. I wanted to ask about how pipeline looked in Q3 both in comparison to the first 2 quarters, which I believe are both record quarters and also in terms of linearity throughout the quarter?

[Stephen Vintz, executive]

Yes. First I would say top of the funnel remains strong for us. And as we've stated on prior calls, we continue to generate healthy levels of demand and the size and the shape of those pipelines are very strong. I think where we're seeing and what we specifically discussed in the call as relates to the mid-market is the conversion rate is the bottom of the funnel. And the biggest factor here is no decision. We're not seen any changes in pricing or competitive dynamics. We're confident we'll continue to be able to close deals at a very high rate. In this market though, the macro impacts some customers more so than others. And it's fluid from 1 quarter to the next.

So the good news is that demand, we believe, remains healthy. We have adequate pipeline coverage as we look into the fourth quarter, now that we're 1 month in, we take it all into consideration in terms of flow. We're off to a strong start here in the fourth quarter. But the quarter is back-end loaded, just like other software companies, it's not unusual for us to close 50%, 60% or more of our total new enterprise sales in the last month, and a lot of that can come in the last couple of weeks of the quarter. But overall feeling good as we head into Q4.

[Unknown Analyst]

Awesome. And then despite macro pressures you mentioned, net expansion rate was steady in the quarter after decreasing for 2 in a row. Is it fair to think that this has stabilized at this level? Or how should we think about that going forward?

[Stephen Vintz, executive]

Yes. Well, the net dollar expansion rate was 111%. So consistent with what we saw in the prior quarter. Keep in mind, the NDRR is an LTM number. It reflects the culmination of sales and upgrades over the prior quarters. And I think it's fair to say that the market was a little stronger last year than it is this year. So we're certainly encouraged to see it continue to be at 111%. There could be further moderation in the rate. It could also increase. We don't optimize the business for any one metric. I think that's important to note. And pipeline opportunities in any given quarter can fluctuate between new logos and upsell opportunities. So certainly, there can be some variability here but we wanted to provide transparency and we report it quarterly. And I think that's important. So the good news is gross -- the [indiscernible] themselves are very strong. And when customers renew, they expand more, and we expect continued expansion as we move along here, not only for Q4 but also for the full year.

[Operator]

Mr. [indiscernible]

[Unknown Analyst]

Yes, great, Thank you so much.

[Operator]

This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.