Qualys - Q2 2024

Transcript

Operator (participant)

Good day, and thank you for standing by. Welcome to the 2024 second quarter Qualys investor call. At this time, all participants are in listen-only mode. After the speaker's presentation, there will be a question-and-answer session. To ask a question during this session, you'll need to press star one one on your telephone. You'll then hear an automated message advising your hand is raised. To withdraw your question, please press star one one again. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your first speaker today, Blair King, Investor Relations. Please go ahead.

Blair King (Head of Investor Relations)

Thank you, Marvin. Good afternoon, and welcome to Qualys' second quarter 2024 earnings call. Joining me today to discuss our results are Sumedh Thakar, our President and CEO, and Joo Mi Kim, our CFO. Before we get started, I'd like to remind you that our remarks today will include forward-looking statements that generally relate to future events or our future financial or operating performance. Actual results may differ materially from these statements. Factors that could cause results to differ materially are set forth in today's press release and our filings with the SEC, including our latest Form 10-Q and 10-K. Any forward-looking statements that we make on this call are based on assumptions as of today, and we undertake no obligation to update these statements as a result of new information or future events.

During this call, we will present both GAAP and non-GAAP financial measures. Reconciliation of GAAP to non-GAAP measures is included in today's earnings press release. As a reminder, the press release, prepared remarks, and investor presentation, all available on the investor relations website. With that, I'd like to turn it over to Sumedh.

Sumedh Thakar (President and CEO)

Thank you, Blair, and welcome to our second quarter earnings call. In Q2, we witnessed organizations increasingly optimize spend within an already tight IT spending environment. Given this dynamic, organizations are standardizing on trusted platforms to consolidate security stacks, leverage automation, and achieve expedient remediation of risk. Qualys has a unique, organically built platform to address this need. Nevertheless, crisp execution is required to fully capitalize on this opportunity. While we have made meaningful progress on several fronts, including growing our sales and marketing team, building momentum with partners, and growing our new business, we have work to do in addressing our upsell execution in the current environment, which resulted in lower than expected bookings growth this quarter. With the upcoming departure of our Chief Product Officer later this month, I plan to directly oversee the product and marketing teams to position us for forward success.

I am confident in our ability to re-accelerate growth in the long term, with sharpened execution on product-led growth and improved alignment between our product messaging and marketing activities, to drive operational efficiencies in our go-to-market motion. At this time, I'd like to thank Pinkesh Shah, our Chief Product Officer, for his contribution during his tenure at Qualys. Although Q2 was a challenging upsell quarter for us, which continued with continued increase in deal scrutiny, we are fortunate that many of our customers have already begun a long-term transformation journey with us. Through the conversations I've had with many CISOs over the past several quarters, their message is clear: They are looking to pivot to a natively integrated risk management solution.

In the face of sluggish macro, escalating threat environment, and cybersecurity skill gap, organizations need to reduce complexity and cost while presenting measurable risk reduction initiatives to boards and C-level executives. Against this backdrop, Q2 was another quarter of rapid innovation for Qualys, reflecting on our ongoing commitment to technology leadership and customer success. Qualys's mission has been to bring innovative new security solutions to market, fueled by customer insights. As a result, we have established a strong track record of converting operational challenges into structural competitive advantages while maximizing lifetime value, ensuring frictionless outcome at scale, and driving immediate ROI on security spend. For example, Qualys pioneered a patching category for security teams. Building on this success, we commenced development of our TruRisk Eliminate capability several quarters ago.

I am now pleased to announce that some of these increasingly popular solution amongst our beta customers will soon enable organizations to respond to zero-day threats and mitigate top exploitable vulnerabilities, even when a patch is non-existent or cannot be deployed. This new subset of our broader TruRisk Eliminate roadmap, which we call TruRisk Mitigate and TruRisk Isolate, empower security teams to apply fixable, automated, and intelligent risk-based response solutions to address cybersecurity risk based on an organization's own unique operational characteristics, remediation timelines, and business objectives. With these new capabilities soon going GA, strong customer support, and over 45 million patches deployed year to date on Qualys agents, we are increasingly confident that we are once again transforming our customers' security operations while further magnifying our competitive differentiation in the market.

Continuing our innovation to help our customers address risks coming from the use of latest technologies like AI, LLM, we are pleased to announce our newest capability, which we call Qualys TotalAI. As organizations rapidly deploy AI LLM technologies, the security teams are looking for help to quickly find and comprehensively assess vulnerabilities in these models. With seamless AI security posture management integration, these new adaptive capabilities discover AI LLM usage within customers' environment, scan for vulnerabilities, and prevent data leakage for comprehensive risk assessment, prioritization, and remediation across the entire attack surface with a single click of a button. In addition, we are pleased to announce an extension to our TotalCloud CNAPP platform, which now discovers and assesses the risk of all known and unknown in-use Kubernetes container images.

Leveraging our own AI and ML technology, we are establishing a baseline for normal behavior for each host container, serverless function, and other objects. Now, through real-time observation of file system processes and network activity, our newest runtime security tools provide organizations with a predictive and threat-based protection to actively detect anomalous activities, prevent zero-day attacks, automate response, and help ensure PCI 4.0 compliance in both containerized and legacy environments. These new container runtime insights, combined with TruRisk factors within a unified, actionable dashboard, allow for immediate threat qualification, prioritization, and remediation from code to cluster. We believe this new capability uniquely sets us apart to enable secure and compliant cloud consumption at scale. Turning to our federal agenda, we recently achieved FedRAMP Moderate certification for our TotalCloud CNAPP and EDR solutions, marking another key milestone for the company.

We continue to expect our pending FedRAMP High certification for several key applications later this year, making Qualys the only modern alternative to legacy on-prem scanners for federal, state, and local government agencies at the high impact level. Our investments to establish a public sector presence are starting to yield results, supporting our confidence to address this new vertical and drive incremental growth in the business over time. Finally, with respect to our upcoming Enterprise Risk Management solution, we remain on track for GA later this year. This extension to our platform is currently in private beta with select few design partners.

The ability to bring first and third-party data into our platform to holistically detect, quantify, prioritize, and remediate vulnerabilities with automated workflows on a unified dashboard across on-prem cloud and multi-cloud environments is evolving into the go-to risk management solution for enterprises, especially in the context of a tight spending environment. The early customer feedback we are receiving is very positive, and it's great to see CSOs from around the world actively attend and engage in the many, many risk quantification workshops we have been conducting over the past several months. These innovative new approaches to cybersecurity risk management, along with several others we have showcased at Black Hat this week, allow our customers to reduce complexity and cost, and of equal importance, create multi-dimensional paths for durable long-term growth in our business. Moving to our business update.

We believe that with continued deal scrutiny comes larger opportunity for Qualys over the long term, as our natively integrated risk management platform helps customers consolidate technologies and achieve better outcomes within fewer resources and immediate ROI. With many of our customers already embracing Qualys to help rearchitect and consolidate their stack, Qualys VMDR solution has translated into an enviable customer base, deep penetration, and significant industry recognition. As recently announced, Qualys' VMDR with TruRisk was voted the best vulnerability management solution at the 2024 SC Awards Europe for the second consecutive year. We believe Qualys' placement as the number one VM solution further validates our investments in the platform and continue to represent the gold standard for securing customer environments today and in the future.

Given Qualys' blueprint for delivering greater value to our customers, our VMDR solution with TruRisk is not only fueling new logo lands, but also helping increase platform adoption, especially in the areas of cybersecurity asset management with EASM and patch management and cloud security. Let me share a couple of recent wins with new customers, which illustrates why companies turn to Qualys to help consolidate their security tools and improve their security posture. In Q2, a large federal government agency became a customer of Qualys. This new customer was previously using multiple legacy and next-gen solutions to manage a variety of risk management use cases across their security, IT, and DevOps teams. In addition to the complexity of using multi-point products, this government agency was frustrated with increasing costs associated with on-prem deployments.

Looking to migrate into a natively integrated, cloud-based FedRAMP High impact level ready solution that met the security, the CISA BOD guidelines, they replaced two of their existing vendors in a high six-figure bookings phase one deployment, using multiple Qualys modules right out of the gate. These initial deployments include cybersecurity asset management with EASM and VMDR with TruRisk and patch management. Through this highly strategic and competitive win, this customer is now able to leverage unified dashboards that provide them with greater insights and automation that than many of the competitive products they evaluated, while taking full advantage of the speed and scale of an integrated platform.

This win is a further testament to the investments we're making to expand our federal business, and we are also very pleased with the turnout and encouraging feedback from many large government agencies at our first public sector cybersecurity risk conference that we held in May. In a second new high six-figure customer win, a hypergrowth cloud-native SaaS business standardizing Qualys's Enterprise TruRisk Platform. This company's security team struggled with managing multiple consoles, lack of integration, complex workflows, misdetections, and extended remediation times, which restricted their ability to protect themselves. This customer is now consolidating on the Qualys Enterprise TruRisk Management platform, replacing several competing vendors through a natively integrated multi-product solution, including cybersecurity asset management, EASM, VMDR with TruRisk, patch management, and our TotalCloud CNAPP solution.

Now, with a comprehensive multi-sensor solution, single user interface, and single platform, they have complete visibility and automated remediation across their endpoints and multi-cloud environments. With seamlessly integrated solutions delivered natively on our platform to solve modern security challenges, more and more Qualys customers are beginning to understand how cybersecurity transformation drives better security outcomes, saves time, and costs less. As a result, customers spending $500,000 or more with us in Q2 grew 18% from a year ago to 199. Beyond these wins, we are also increasingly gaining leverage from our partner ecosystem. Our pipeline of business opportunities with partners continues to grow, and our partner-led win rates increased again in Q2.

As our market perception and brand awareness continue to strengthen, we anticipate partner integration with our platform will continue to increase, further strengthening our strategic position, expanding our ecosystem, and broadening our reach. In summary, our rapid innovation engine underscores our growing thought leadership and the value proposition we deliver to customers seeking to transform, consolidate, and fortify their security posture. Given the large market opportunity in front of us and multiple growth drivers in our business, we anticipate that we can grow at scale long term, generate cash, and invest in key initiatives that will further extend the gap between Qualys and the competition. With that, I'll turn the call over to Joo Mi to discuss in more detail our second quarter results and outlook for the third quarter and full year 2024.

Joo Mi Kim (CFO)

Thanks, Sumedh, and good afternoon. Before I start, I'd like to note that except for revenues, all financial figures are non-GAAP, and growth rates are based on comparisons to the prior year period, unless stated otherwise. Turning to second quarter results, revenues grew 8% to $148.7 million, with channel continuing to increase its contribution, making up 46% of total revenues, compared to 43% a year ago. As a result of our continued commitment to leverage our partner ecosystem to drive growth, we were able to grow revenues from channel partners by 17%, outpacing direct, which grew 2%. By geo, 14% growth outside the U.S. was ahead of our domestic business, which grew 5%. US and international revenue mix was 58% and 42%, respectively.

As for calculated current billing, we would like to note that our Q2 calculated current billing were negatively impacted by the sunset of our embedded solution for Microsoft Defender as of May first. Earlier this year, we announced that we will be retiring our integration on Microsoft Defender and transitioning to BYOL model. Since this went into effect in Q2, we have been fielding inbounds from former Qualys and Microsoft Defender users and working closely with them to ensure that they understand the value of our cloud security solution, TotalCloud CNAPP. Normalized for this change, our calculated current billings growth would have been 1%. In Q2, with the continued challenging spend environment resulting in lower performance and upsell, our net dollar expansion rate declined to 102% from 104% last quarter.

Conversely, we continue to see strong returns on our new business initiatives and achieved double-digit new bookings growth for the fourth consecutive quarter. With this momentum and new customer bookings growth, we believe we're building a stronger foundation to drive expansion and share gains over time. In terms of product contribution to bookings, Patch Management and Cybersecurity Asset Management combined made up 13% of LTM bookings and 22% of LTM new bookings in Q2. Cloud security solutions, TotalCloud CNAPP, made up 4% of LTM bookings. Turning to profitability, reflecting our scalable and sustainable business model, adjusted EBITDA in Q2 was $69.9 million, representing a 47% margin, compared to a 48% margin a year ago.

Operating expenses in Q2 increased by 10% to $59 million, primarily driven by a 22% increase in sales and marketing investments aimed at capturing the market opportunities in front of us. As we continue to increase our investment intensity and focus on sales and marketing enablement, customer success, and productivity, we believe we will be able to drive wallet share and long-term returns. EPS for the second quarter of 2024 was 1.52, and our free cash flow was $48.8 million, representing a 33% margin, compared to 37% in the prior year. In Q2, we continued to invest the cash we generated from operations back into Qualys, including $1 million on capital expenditures and $35 million to repurchase 233,000 of our outstanding shares.

As of the end of the quarter, we had $230.7 million remaining in our share repurchase program. With that, let us turn to guidance, starting with revenues. For the full year 2024, we are now expecting our revenues to be in the range of $597.5 million-$601.5 million, which represents a growth rate of 8%. This compares to revenue guidance of $601.5 million-$608.5 million last quarter. For the third quarter of 2024, we expect revenues to be in the range of $149.8 million-$151.8 million, representing a growth rate of 5%-7%. This guidance assumes continued deal scrutiny and no improvement to our net dollar expansion rate through the back half of this year.

Shifting to profitability guidance, for the full year 2024, we expect EBITDA margin of 43%-44% and free cash flow margin in the mid- to high 30s. We expect full year EPS to be in the range of 5.46-5.62, up from the prior range of 5.06-5.30. For the third quarter of 2024, we expect EPS to be in the range of 1.28-1.36. Our planned capital expenditures in 2024 are expected to be in the range of $12 million-$16 million, and for the third quarter of 2024, in the range of $4 million-$7 million.

Consistent with prior guidance, for the remainder of 2024, we intend to align our product and marketing investments to focus on specific initiatives aimed at driving more pipeline, supporting sales, including enhancing our partner program and expanding our federal vertical. As a percentage of revenues, we expect to prioritize an increase in investment in sales and marketing, as well as related support functions, systems, and people, with more modest increases in engineering and G&A. With that, Sumedh and I would be happy to answer any of your questions.

Operator (participant)

Thank you. At this time, we will conduct a question and answer session. As a reminder, to ask a question, you'll need to press star one one on your telephone and wait for your name to be announced. To withdraw your question, please press star one one again. Please stand by while we compile the Q&A roster. Our first question comes from the line of Joel Fishbein of Truist Securities. Your line is now open.

Joel Fishbein (Managing Director Senior Software Equity)

Hey, thank you very much for taking the question, and, and congrats. Joo Mi, really great growth internationally, and I guess Sumedh as well. Can you talk about, you know, what drove the international growth? And then maybe, Joo Mi, if you could talk about more specifics about some of the investments that you're making in sales and marketing going forward, that would be very helpful. Thank you so much.

Joo Mi Kim (CFO)

Yeah, happy to. The international growth, we're seeing a stronger demand in that region relative to the U.S. With that said, the U.S. growth rate is impacted by the Microsoft Defender. And so that's been a headwind on the U.S. business as well as the direct business that we just share the growth rate for. In terms of the sales and marketing investment, that we feel like it has been doing really well, and the higher return on ROI is from the investment that we made on the partner side. As you can tell, our initiatives when it comes to enhancing our partner relationships and really working with them to revamp how we go to market and further incentivize our partners to understand why it makes sense for them to propose and put Qualys as a vendor of choice, has been resonating.

And so for us, it's number one, partner, and then number two, of course, primarily our investment is related to the headcount. So as we're targeting continuing to grow the sales and marketing headcount by double digits in 2024, and we are on track to meet that goal, we're positive with the momentum that we're seeing in the business today.

Sumedh Thakar (President and CEO)

Yeah, and Joel, I'll add to that is, you know, while we had a tough upsell quarter for Q2, I think our investments that we've been making in the last few quarters have really, you know, given us a lot of positive things that we're excited about. As example, with our new business growing double digits because of the way that we're, we're enabling our new business sales team, because of the way, as Joo Mi said, we're investing with our partners, and the partners' pipeline is increasing. Their win rates with our partners are increasing as well. I'm pretty excited about our investment that we started last year in the federal space, which again had getting a six-figure new net new business deal in the federal space for us is exciting.

It also highlights the opportunity that we have on the federal side, and including within our existing customer base as well, our investments in terms of taking our learnings from what we have been able to be successful with our new business, being able to train our post-sales teams as well, to be more of hunters, to enable them in a much better way, et cetera, has led to, you know, customers who are spending $500,000 or more with us, also growing 18% from last year in the same quarter. So those are, you know, a lot of the positive things that our investments are leading to positive trends.

I think clearly we see an opportunity in this macro environment that we have and the scrutiny that we face from our customers with VM to really be able to get our sales team to our product and marketing teams to align better and our sales team to execute better on the upsell opportunities that that will come with the new way the customers are looking at their security spend and focusing on risk management, and really, you know, being able to spend their money from cybersecurity where the risk is. That's the big question a lot of people are not quite able to answer: is where is your risk exactly? That's what our EASM platform is going to help.

Joel Fishbein (Managing Director Senior Software Equity)

Thank you so much. Appreciate it.

Operator (participant)

Thank you. One moment for our next question. Our next question comes from the line of Shrenik Kothari of Baird. Your line is now open.

Shrenik Kothari (Senior Research Anlayst)

Hey, yeah, thanks for taking my question. So, Joo Mi, you mentioned, of course, the channel revenue now making up 46%, which is kind of really ticking up nicely. So can you just help provide some more details on kind of overall, I would say, a breakdown of the contribution for different types of partners, if possible? Of course, you highlighted how you guys were trying to partner with some of the cloud providers and marketplaces like AWS, Azure, Oracle. Just curious if you can provide us some more color in terms of those drivers, and then I'll follow up.

Sumedh Thakar (President and CEO)

... Yeah, we-- Shrenik, we don't break it down that way, but, yeah, I can tell you that right now, you know, our, our channel partners or resellers are definitely working very closely with us and really bringing us a lot of the opportunities, because they see the comprehensive set of capabilities that we can very rapidly bring to their customers who are currently in the market, have a project, and have a budget to execute on that. So they are sort of the first, folks who are working closely with us. In the last quarter, we released our MSSP portal, so we're seeing traction with, managed service providers who are continuing to add patch management as a service, because just having VM scanning as a service is not a big differentiator.

So more and more of them are leveraging Qualys for now providing patch management as a service. Now we're starting to see that same thing from partners on, being able to provide services around cloud security deployments as well. We have a really nice, strong partnership with OCI on the GTM side, but as well as working with AWS on the ADP credits with joint customers are some of the areas that we're really seeing good momentum. We don't break it down exactly like that, but that should give you a high level, you know, sort of view of where we are seeing success with partners.

Shrenik Kothari (Senior Research Anlayst)

Got it. That, that's very helpful, Sumedh. And Joo Mi, one quick follow-up. Of course, Sumedh, you highlighted the development of this enterprise risk platform kind of helping, and how you're monetizing that offering. Just curiously, given on the other side, there is aggressive overall pricing in the core VM that we are hearing from other players, kind of perhaps undercutting pricing there. Just curious, like, how were you able to show the upside on the gross margins as well, and in this current environment? And can you provide us some quantitative insights into that and its expected impact on net dollar retention rates as well? Appreciate it.

Joo Mi Kim (CFO)

Yeah, in terms of the gross margin, we were very pleased to post an 84% gross margin, up from 82% last year, and then even 83% last quarter. That's primarily due to our optimization when it comes to our data centers, in addition to the fully depreciated assets that we're seeing right now. As you know, we have both the, you know, hardware as well as on the cloud assets, and we're just leveraging and optimizing to make sure that we're getting the margins that we think make sense for our business today.

Sumedh Thakar (President and CEO)

And then on the VM question that you asked, look, I think we've talked about this for the last many quarters, that VM is evolving, and customers are really looking to focus on remediation as well. And so even when they are looking at scan-only solutions that only give them more things and CVEs to fix, when they are looking to optimize their budget for an outcome, they are looking at how to balance the scanning with patch management. And that's why our TruRisk Eliminate capability that we came out with, giving customers more solutions they can buy from us in terms of being able to mitigate the risk, is the most important. Because the...

You know, if today's cyber budgets are, have been tight, and the questions that cybersecurity professionals are getting asked is, "Well, what's the outcome? What, how much risk are you reducing?" And if you're not able to articulate the risk and how much risk you're actually reducing, that's really when they face challenges with, you know, should we get an increase in this budget if we're not focusing on remediation? And so just in the first half of this year, getting 45 million patches deployed by Qualys agents really highlights that VM today is about vulnerability assessment, but also combining with patch management and ability to mitigate the risk. And we see that in the numbers today with our patch management, cybersecurity asset management, for net new bookings customers when they're coming to us.

Why we are seeing good success with that new business is we offer a unique differentiator in the market when people are looking to change their scanning solution, because we're offering them patch management combined with the scanning solution. That's really where the vulnerability management has been evolving, and this is nothing new. That's why we invested a few quarters ago to really focus on the remediation aspect of vulnerability management, because, you know, there is no, there is no M in the VM if you don't actually fix things.

Shrenik Kothari (Senior Research Anlayst)

Got it. Super helpful. Thanks, Sumedh and Joo Mi.

Operator (participant)

Thank you. One more question. Our next question comes from the line of Matt Hedberg of RBC. Your line is now open.

Matt Hedberg (Research Analyst)

Great, thanks for taking my questions, guys. It sounds like NRR dipped down to 102, I think from 104, last quarter. I'm curious, does that... Do you feel like that's starting to bottom now? You know, do you think, you know, perhaps in the second half, whether it's pipeline or other drivers, you know, we could see a rebound there?

Sumedh Thakar (President and CEO)

I think as we work with our customers, we're definitely facing a, you know, scrutiny on their when they have to do additional spend with Qualys. So that's where we are working. I mean, this is leading to a lot of great engagements, and that's where we are leading to the more conversations, how they optimize their spend, how they can balance their spend in the scanning side with the spend on the patch management and asset management side. And that's where you see, you know, in some cases, they optimize right now for getting some additional solutions from Qualys, where they can grow in the future.

I think we will have to continue to see in next quarter how these conversations that we are having this quarter translate into additional upsells for the customers, because, as you know, in this current environment, it's a little bit harder to with the scrutiny that they face to know what is the timing of when they will adopt these additional solutions, especially with cloud security, et cetera. So we're pretty excited about the opportunity that we see. I think we're gonna have to watch the next couple of quarters on how this rate evolves.

But over long term, definitely feel like we have all the goods that customers are, existing customers are looking to invest additionally, and which is, in my mind, is patch management, cloud security, overall sort of risk management, and more importantly, now questions coming up about AI, AI security. And so our new solution that we announced that we're gonna get out in September, which is really helping customers identify all of their AI LLMs, and looking at the risk of those, are going to be very positive. Those conversations, how they lead into additional upsells, and the timing of that is something that we're watching very closely.

Matt Hedberg (Research Analyst)

That's great. That's super helpful. And then, in terms of the Microsoft Defender headwinds, can you remind us again when those will abate officially and, you know, not become a drag on billings?

Joo Mi Kim (CFO)

Yeah, the sunset was effective May first, so it hit us for the first time in Q2. So the biggest impact that we, we expect to see is in Q2.

Matt Hedberg (Research Analyst)

In other words, then. So, what you're saying, Jimmy, is that it's not gonna be as big of a headwind in Q3 and Q4, or just maybe, yeah, maybe just think about that headwind as we—in a couple quarters.

Joo Mi Kim (CFO)

That's right, that's right. It's not gonna be material enough for us to normalize it in Q3 and Q4. Q2 is really the biggest quarter based on the billing schedule, and that's why when you take a look at our calculated current billings, the 2% decline normalized for this, if it hadn't happened, then it would've been approximately 1%.

Matt Hedberg (Research Analyst)

Got it. Super helpful. Thanks, guys.

Operator (participant)

Thank you. One moment for next question. Our next question comes from the line of Kingsley Crane of Canaccord Genuity. Your line is now open.

Kingsley Crane (Managing Director)

Hi, thank you. So you've done a remarkable job building out the platform the past couple years. I just wanna ask broadly, how would you describe VM demand at the moment? How cyclical is this? How secular is this? And then why do you view VM foundational, and then how can you leverage that to expand spend with the existing customers? Thanks.

Sumedh Thakar (President and CEO)

Yeah, great question. See, VM continues to be very foundational for any risk management exercise that any organization have. You know, if you look at every single cybersecurity standard out there requires regular scanning and patching for VM. I think as we have talked about, and I have talked about this in a few earnings calls in the past as well, is that VM is evolving. And so the... While the overall focus on customers remains on VM, the focus within VM, it's, it's really customers are focusing on how do we get an outcome of actually being able to reduce the risk by fixing the things that were being discovered by VM.

And so, what we see with our customer base is that they are, with the tight budgets that they have and the scrutiny that they're putting on the conversations, actually looking to balance between how much they focus on scanning and what's the point of scanning everything if they're not able to actually remediate stuff. And so how do they balance their investment in the VM sector between scanning and patch management and also asset management, as well as how do you expand the scanning into the cloud environment? And so those are the conversations that we hear a lot more. I think the VM as a key part of risk management for the organization continues to be a key priority for all the customers that we talk to.

So, I think we, as they are working with tight budgets right now and looking to balance that, I think we see this as a good opportunity for us, because it is giving us opportunity to get our additional products, like Patch Management, Cybersecurity Asset Management, seeded in with these customers as they're buying smaller amounts. But in the future, this could lead them to cover more of the estate that they currently have with us with scanning.

Kingsley Crane (Managing Director)

Great. That's, that's well said. And then one more. So I wanna just talk about dynamics when selling cloud security, whether that's TotalCloud CNAPP or something individual like CSPM. Post CrowdStrike outage, vendor concentration has been widely discussed, rightly or wrongly. You know, so big picture, how do you think the outage will play out, specifically in cloud security, given how nascent the space is, and, you know, how much of an opportunity you see?

Sumedh Thakar (President and CEO)

Look, I think the questions customers are asking are obviously valid in terms of how do you balance the risk of the security solution being deployed itself versus the risk it is mitigating, right? And I think the advantage I see for Qualys is that we are not concentrated on the agent as being the foundational way to deliver service, security service to the customer, like some of the other providers, when, you know, the agent is the main and the only way that they can deliver services. We have a pretty comprehensive capability of delivering security services that match the customer's operational appetite of deploying different ways to assess risk, and so we have agentless scanning, we have snapshot scanning, we have agent-based scanning, we have offsite scanning. So there's many different ways.

And so what we see with customers, we obviously got a lot of questions asked around, you know, what are, what are the best ways that Qualys is, of course, ensuring that we are testing, we are very confident about the way we roll out our updates for different technologies. But also the fact that they can actually, with their licensing balance, their risk of where they want to deploy agentless scanning versus where they want to deploy agent-based scanning. And we give those options to them, which they are pretty happy about, that they don't have to really take that big risk of only having an agent, and that's the only way to deliver the service.

In cloud, I think the advantage is that you can do a good amount of assessment with CSPM just using APIs without deploying a particular way of scanning. This is why about a year ago, when we released our FlexScan, which is a part of our TotalCloud CNAPP solution, the license actually includes the ability for the customers to do four types of different scans on the same asset, and they can pick and choose. So if they want, they can do an API assessment with absolutely nothing installed. On the workload, they can use an agent to be installed automatically. They can use an automatic network scanner in that environment, or they can use a snapshot scan of a workload image that is not actually live.

So I do see that in cloud security, while the questions will come up, it's not so much about, in my mind, the vendor concentration. It's really about the sensor concentration in my mind, which is: Is your vendor providing you multiple different ways to assess your environment in leveraging basically the different types of risk profile that you might have on different assets?

Kingsley Crane (Managing Director)

Right. Agreed with that. Thanks again, and congrats.

Sumedh Thakar (President and CEO)

Of course.

Operator (participant)

Thank you. One moment for our next question. Our next question comes from the line of Yun Kim of Loop Capital. Your line is now open.

Yun Kim (Managing Director)

Okay, great. Sunset on the Microsoft Defender headwind, I am assuming you planned for that. Clearly, there was some execution issue that you did not anticipate. If you can elaborate on that a bit, and then also, what are the products that were directly affected by the lower attach rate related to Microsoft Defender?

Sumedh Thakar (President and CEO)

Microsoft was leveraging, you know, our very basic sort of, scan-only legacy capability, right? Which was not VMDR. So, those customers. And we did not have access to those customers, to be able to work with them, to upsell them to all the other things that our, like, current customers upsell to, whether it's cybersecurity risk management, whether it's, patch management, whether it is, TotalCloud, assessment, or now with the new, AI scanning that we are releasing. So for us, it, you know, it was customers in that environment were only using scan-only solution from us. And as we all see right now, what's happening in the market is really customers are looking for a more holistic, comprehensive outcome of their VM solution, which includes actual fixing and reduction of risk and not just more scanning.

And so, that's really where we see the opportunity, is customers don't just want more CVE reporting. They want a way to say, "These are the things you should fix that will reduce the risk," and then a solution that can fix that. And so that's where we see the opportunity. If these customers come to us, we can focus on helping them see the bigger picture of how they can reduce the risk from their vulnerabilities, rather than just, you know, keep looking at them and not doing anything about them.

Yun Kim (Managing Director)

Okay, great. Thanks for that answer. Joo Mi, anything that we should be aware of in regard to pricing, especially with second half renewal season coming up?

Joo Mi Kim (CFO)

No change from our perspective, from a competitive standpoint, and no change from our own pricing.

Yun Kim (Managing Director)

Okay, great. Thank you so much.

Operator (participant)

Thank you. One moment for next question. Our next question comes from the line of Jonathan Ho of William Blair. Your line is now open.

Jonathan Ho (Research Analyst)

Hi, good afternoon. I just wanted to, you know, maybe dig in a little bit more in terms of understanding the need to balance profitability with, you know, some of the investments that you've been making on the channel side. You know, can you give us a sense of, you know, have the, you know, initial investments, you know, sort of paid off the way that you've expected? I know it takes a little bit of time to translate into, you know, billings and, you know, ultimately to revenue, but, you... Or has it been disappointing? Has it been, you know, sort of... Yeah, just wanna get a sense of how you're thinking about that.

Sumedh Thakar (President and CEO)

Great question, Jonathan. Look, when we, we embarked on this journey, you know, a couple of years ago, really, we, we've been focusing on a few different things, and, some of them, sometimes work, some of them don't. But overall, like I said, we are pleased with the investment really bringing us, that improvement in, 4 straight quarters of double-digit growth for new business, which we have not had, as much in the past. And then just looking at, opportunities coming from partners, looking at partner opportunities, having better, close rates, looking at continuing our $500,000-plus customers actually increase in this tough environment by 18%.

So I do think that different things that we have done in terms of training our new business sales reps, in terms of investment channel, have brought us those sort of opportunities. And now in the further quarters, we need to focus on working through those opportunities, closing through those opportunities, continuing to invest additionally with our channel partners. But like we said, you know, we are, you know, in a fairly unique position this year to continue to actually invest in our sales and marketing GTM because we see the opportunity when most other companies are really cutting down on their sales marketing investment.

I think that's really what we look for in the further quarters, is improvements in our upsell rates, in similar to what we are seeing with our new business and, you know, really continuing our investment on the federal side. Like I said, just getting a good six-figure deal in the federal net new business deal on the federal side is also very promising for us because of the investments we're making with the team that we have built, the marketing investment we made this year to actually host a conference just specifically for federal, which is our first one, and also the investment we have made in being FedRAMP Moderate.

But more importantly, we're just, you know, really, really anticipating and waiting for the FedRAMP high certification, which we are looking forward to getting end of this year. And I think that investment over the next couple of years should give us really significant advantage, because there's no other FedRAMP high platform that has so many different capabilities and modules that go in together with that.

And so I think there are certain, you know, these are some of the things that have worked and continuing to work, and we are looking now to take the learnings from the new business improvements and apply those to our existing business so that our, you know, post-sales farmers learn how to do a little bit of hunting and be able to find some of these deals in a tough macro environment, and be able to bring additional opportunities while working closely with the partner side on the upsell, just as the way we are working on the partner with the partners on the new business as well.

Jonathan Ho (Research Analyst)

Excellent. And just a quick follow-up: So as you take on additional Chief Product Officer, you know, responsibilities, can you help us understand, you know, where you see the biggest opportunities? Is this narrowing of the product focus? Is this, you know, approaching new areas? I'm just trying to understand, you know, how you think about sort of, you know, taking on these additional, you know, responsibilities and, and, what you see as that opportunity. Thank you.

Sumedh Thakar (President and CEO)

Yeah. Look, I - you guys, you know, you know my history. It's a little bit hard to get the chief product officer out of me. It's always there somewhere. But, if you... Look, we - for us, we have always been innovation driven, really listening closely to our customers and bringing solutions to market, like we do with patch management, was all about operational efficiency, which is what you know, the security teams are looking at. And so as I look forward to the next couple of years, if you look at the current environment, the challenges cybersecurity professionals are facing when you look at the almost flat budget increase in cyber overall is because of not being able to articulate the question, well, how much risk is cyber bringing to our business?

Because without that, you cannot really -- if you don't know how much risk you have, you cannot articulate that risk in dollar value, you cannot decide on exactly how much should you spend, which is the appropriate amount to take down that risk. That's really what I'm excited about with our ETM platform that we're coming out with and our, some of our beta partners that are out there. It's not -- there are multiple different security controls you can implement to reduce risk, but let's first focus on being able to identify, being able to articulate the risk in dollar terms to the business. And from there, you can decide which are the most effective security controls that you can put in place to bring down that risk. And it may not be the exact same control in every environment.

You know, in some cases, maybe a Zero Trust is a better security investment, given how much risk you have, versus in other cases, maybe a better patch management solution is enough to reduce the risk. And so as I look at from a product perspective, you know, first, I'm glad that Dino and has built a good team, and they're taking more and more focus on the GTM side.

So it gives me additional opportunity to focus and work with the product and marketing teams to not only look at the future products that we are coming up with, especially on risk management, risk articulation, but also in the short term, the opportunity, given what we are seeing with our TotalCloud solution, the conversations that we are having with customers, being able to align my product management and product marketing teams together so we can execute better on marketing our TotalCloud solutions and being able to create additional opportunities. So some of those things are really what I'm looking forward to as I, you know, look into this Chief Product Officer role.

Jonathan Ho (Research Analyst)

Great. Thank you.

Operator (participant)

Thank you. One moment for our next question. Our next question comes from the line of Rudy Kessinger of D.A. Davidson. Your line is now open.

Rudy Kessinger (Managing Director)

Hey, guys. Thanks for taking my question. I guess just on this tough upsell environment, you know, your net expansion rate is down to 102%, but it's almost down to basically no upsell. I guess, are you seeing contractions with, you know, any sizable portion of your customer base? Not customers who churn, but customers who are staying with you, are they reducing their footprint? Or I guess, just where could that bottom... Obviously, we would think it would bottom at 100%, but it could potentially even go lower than that?

Sumedh Thakar (President and CEO)

Great question, Rudy. So as we mentioned, overall, our gross retention has stayed the same, around 90%. And so I think for us, it's really about customers, as I mentioned earlier, are looking to balance the set of solutions that they have from Qualys, looking at how can they have a better impact by adopting additional solutions from Qualys, like Patch Management, Cybersecurity Asset Management. And sometimes based on, you know, they may decide that at this particular environment, I would rather take those licenses and focus more on Patch Management than my server environment, and because currently the budgets are tight. So what we are seeing is right now, you know, our overall gross retention continues to be about the same.

It's more about customers looking at optimizing and balancing their spend between the different capabilities, and as part of that, adopting additional capabilities, which may not in the immediate term mean an immediate upsell from a total amount perspective in that particular opportunity, but it also creates this opportunity in the future that we can increase the accounts there. And so again, I think this is sort of the we had a tough quarter on this. Overall industry, you know, expansion rates are coming down, but we'll we, we're gonna take the conversations that we are having because of this right now and see how they're gonna those conversations are leading to opportunities to close in the next couple of quarters.

So again, we are, of course, we look forward to improving our net expansion rate over the next few quarters. When that, the timing of that exactly is something we are also keeping a close eye on.

Operator (participant)

Thank you. One moment for our next question.... Our next question comes from the line of Rob Owens of Piper Sandler. Your line is now open.

Aidan Burrell (Investment Banking Analyst)

Hi, this is Aidan on for Rob Owens. Thank you for taking my question. Can you provide more color on the economic backdrop in the quarter related to deal scrutiny? And also, what did you see related to demand from enterprise and SMB customers in 2Q? Thank you.

Sumedh Thakar (President and CEO)

I think the macro generally continued to be the same as we have expected, where, you know, it's budgets are generally flat. We are seeing, you know, customers trying to think about, in some cases, cybersecurity versus AI, which is why we're excited about our AI security product. Overall, I think the macro has stayed the same. We faced, you know, additional scrutiny, I would say, this quarter, from customers just looking to say, "Well, should we continue to, you know, adopt different solutions while keeping the overall spend the same? Or should we just keep as is and not expand too much?" So I would say that for us, it's really about...

And I don't think we saw any major difference between the enterprise versus the SMB segment from the last, you know, from what we've been seeing in the last few quarters. And so I think the environment continues to be tough, and we continue to face, or at least this quarter, we faced additional scrutiny on the, the budgets.

Operator (participant)

Thank you. One moment for our next question. Our next question comes from the line of Joshua Tilton of Wolfe Research. Your line is now open.

Patrick O'Neill (Equity Research Analyst)

Hey, this is Patrick on for Josh. Thanks for taking my question. Wanted to dive a little deeper on the customers impacted by the sunsetting of the Microsoft partnership. You mentioned that you were having conversations with those customers throughout the quarter. So can you just talk about your updated expectations for those customers moving over to Qualys to use your solutions directly? And then also, what does the size of that opportunity look like?

Sumedh Thakar (President and CEO)

I think, like, as Joo Mi said, right, the sunset actually happened just recently in May, when the actual sunset happened. I think for us, it's we did not have access to those customers, so we can't, you know, we couldn't quite reach out to them, as we had mentioned earlier. I think it is about, as customers are sort of transitioning to a different solution or have the option, they're looking at, and sometimes they come and talk to us. So we've had a few customers come and talk to us.

We may not always know that they are coming from that Microsoft thing, because a lot of times they might have additional footprint already with Qualys, and they may just expand and buy additional licenses for their Azure environment instead of what they were doing with Qualys, with the Azure integration. I don't think at this point we're thinking of that opportunity as anything that, from what we see, as a material thing in Q3, Q4. I think we'll continue to see how the conversations evolve and see how many of those actually continue to come to us, but we're not assuming any additional benefit in the guidance that we've given from coming from that opportunity.

Patrick O'Neill (Equity Research Analyst)

Okay, thanks. Then just a quick follow-up. Is there any color you can give us on how you expect billings growth trend for maybe 3Q or the full year? Thanks.

Joo Mi Kim (CFO)

Yeah, we have... We don't guide to current billings, but we did indicate that the annual current billings growth will trend more or less along the lines of, the same as revenue growth rate, so I would assume the same. For the second half, the revenue growth guidance will be more or less in line with the current billing.

Patrick O'Neill (Equity Research Analyst)

Helpful. I appreciate it.

Operator (participant)

Thank you. One moment for our next question. Our next question comes from the line of Brian Essex of J.P. Morgan. Your line is now open.

Brian Essex (Executive Director)

Great. Thank you for taking the question. I was wondering if you could maybe dig in a little bit on, you know, customer spending more than $500 and overall customer count, in aggregate. How should we think about that faster-growing large customer cohort versus the smaller customers, and puts and takes there that maybe give us an indication of where you're focusing your efforts from a sales and marketing perspective?

Joo Mi Kim (CFO)

From the sales and marketing perspective, we're, we are focused more on the enterprise. It's just because that's where we've seen more success. And as you can tell by our larger customers who continue to increase their spend with us, and we've seen success there, we are continuing to see some headwind on the smaller end, the smaller customers or the SME and SMB space.

Brian Essex (Executive Director)

And those 500-plus customers, is that revenue from those customers that are growing 18%, or is it the customer count that's growing 18%?

Joo Mi Kim (CFO)

The customer count and the dollar amount is, are growing both at 18%, actually.

Brian Essex (Executive Director)

Got it.

Joo Mi Kim (CFO)

The 18% that we referenced is the customer count, but the dollar amount is about the same.

Brian Essex (Executive Director)

Got it. That's helpful. Thank you.

Operator (participant)

Thank you. One moment for our next question. Our next question comes from the line of Hamza Fodderwala of Morgan Stanley. Your line is now open.

Hamza Fodderwala (Senior VP, Investor Relations and Strategic Finance)

Hi, thank you for fitting me in back here. Clarify on the billing department, apologies if this was earlier, but,

Sumedh Thakar (President and CEO)

Sorry, Hamza, we're having a hard time hearing you.

Hamza Fodderwala (Senior VP, Investor Relations and Strategic Finance)

Hi, can you hear me better?

Sumedh Thakar (President and CEO)

Breaking up, your audio. Maybe just try again.

Hamza Fodderwala (Senior VP, Investor Relations and Strategic Finance)

Probably, but just a question on the current billings for Joo Mi. I think so down 2% this quarter. I believe you mentioned the Microsoft headwind. Without that, it would've been about up 1%. Anything else that I'm, that... If you could give the Microsoft customer, you have Microsoft as a partner as well as a customer, any changes in conversation?

Sumedh Thakar (President and CEO)

We couldn't quite hear the last part. Can you repeat the last part about the customer-

Hamza Fodderwala (Senior VP, Investor Relations and Strategic Finance)

Relationships

Sumedh Thakar (President and CEO)

-Microsoft.

Hamza Fodderwala (Senior VP, Investor Relations and Strategic Finance)

If Microsoft remains a customer, any changes in conversation there?

Joo Mi Kim (CFO)

No, no change.

Hamza Fodderwala (Senior VP, Investor Relations and Strategic Finance)

No change.

Joo Mi Kim (CFO)

It's as expected.

Hamza Fodderwala (Senior VP, Investor Relations and Strategic Finance)

Okay.

Joo Mi Kim (CFO)

With respect to the impact on our top line from both Microsoft Azure and Microsoft customer for this year.

Hamza Fodderwala (Senior VP, Investor Relations and Strategic Finance)

Okay, thank you.

Operator (participant)

Thank you. I'm showing no further questions at this time. Thank you for your participation in today's conference. This does conclude the program. You may now disconnect.

Joo Mi Kim (CFO)

Goodbye.