Varonis Systems, Inc.
Q3 2019 Earnings Call Transcript

Published: 28 Oct 2019

[Operator:]

Greetings. Welcome to the Varonis Systems Inc. Third Quarter 2019 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. Please note this conference is being recorded. I would now like to turn the conference over to your host James Arestia, Director of Investor Relations. Thank you. You may begin.

[James Arestia:]

Thank you operator. Good afternoon. Thank you for joining us today to review Varonis' third quarter 2019 financial results. With me on the call today are Yaki Faitelson, Chief Executive Officer; and Guy Melamed, Chief Financial Officer and Chief Operating Officer. After preliminary remarks, we will open up the call to a question-and-answer session.

[Yaki Faitelson:]

Thanks Jamie and good afternoon everyone. Our third quarter results demonstrated the power of the Varonis Data Security Platform. Total revenues were $65.6 million and 74% of our license revenues were from subscriptions compared to guidance of 55%. We are proud that even with substantially higher subscription mix; we exceeded the high end of our revenues guidance. At the beginning of 2019, only three quarters ago, we announced our transition from a perpetual to prescription-based model. We said moving as quickly as possible is our top priority and we now expect that the transition will be substantially complete in the next few quarters. Let's discuss why our subscription offering resonating so well with our customers. The growth of data and increased awareness around data security, together with an evolving regulatory environment align perfectly with our use cases. As a result, we are achieving a high level of customer engagement and unleashing the potential of our platform. Here are some examples; a large bank turned to Varonis to gain visibility into their data. Reduced open access to sensitive data and monitor their on-premise and cloud environments for threats. They purchased subscription for seven of our licenses and we finally gained control of their data stores. They will identify limit access to sensitive at-risk data, repairment and file system permission in matter of weeks, and monitor for threats across the hybrid environment, all in a single pane of glass. This is just one example of the customer making the larger initial investment with Varonis using the flexibility of our subscription model. Another example was a Federal agency that has been relying on Varonis for years to secure its sensitive information. They initially started with DatAdvantage, the foundation of our Data Security Platform. Over the years, they added Data Classification Engine and DatAlert Suite. In Q3, the agency again expanded their investment in Varonis, while subscription offering they added DatAdvantage for Directory Services, Automation Engine, and Data Transport Engine. Now, the agency will receive alerts to unusual activity around Active Directory; reduce risk by finding and fixing excessive permissions faster than ever, and helping ensure sensitive files remain where they should be. This is also a good example how existing customers benefit from our subscription model. Examples like that confirm the value of our platform technology and its alignment with the need to reduce risk, detect and response to threats, and improve regulatory compliance, whether through broader initial deployment or the expansion of existing deployment.

[Guy Melamed:]

Thanks, Yaki. Good afternoon everyone. The highlights this quarter are

[Operator:]

Thank you. Our first question comes from the lone Matt Hedberg with RBC. Please proceed with your question.

[Matt Hedberg:]

Hi, guys. Thanks for taking my question. Congrats on the strong results. Yaki, I wanted to talk about growth. ARR grew 52% and I believe you said on a normalized basis revenue grew 30%. I guess, I'm wondering from a high level, can you remind us of how fast do you think your underlying markets are growing? I guess I'm trying to get a sense for maybe how fast we should think about growth post transition?

[Yaki Faitelson:]

Hi, Matt. The overall market is – always was everybody, but the key is that the subscription really unleash the potential of the platform. The three use cases that we are catering for the data protection, detection of cybersecurity, internal threats and regulation are top priority for our customers. And what is happening is they can buy more right off the bat and they – we can really expand with them. And what we see that it's just becoming a top priority for almost every organization out there. The sales cycle is becoming much more predictable and more strategic and simpler, because it's most of it's under the CSO. The cloud is a big driver. As I said regulation is a big driver and everything that is happening in the cyberspace once you bypass the perimeter of security really unmatched with our ability to detect this cybersecurity threats, and just working extremely well. So, we really believe that just the friction and our ability to capture market share, the efficiency of the sales process are working very well and we believe that with this transition to subscription, we can grow fast and we can do it for many years and being very efficient in doing so.

[Matt Hedberg:]

That's great. And maybe one for Guy, in your prepared remarks you noted that post transition you plan to show margin improvement you may committed to profitability. Obviously, the margins today are being impacted negatively by the model transition. But can you help us think about sort of – obviously, you guys are going to continue to invest for growth, but what's the right way to think about margin expansion post the transition?

[Guy Melamed:]

So, you're right Matt. The transition continues to have a short-term impact on our financial results. But we have been and really remain committed to profitability. And to give some color for 2020, we'll obviously provide guidance in our Q4 results. But just to give some color on how we think about next year. Next year really is a year of two halves you have kind of the first part, the first six months of the year where the subscription mix was – will be significantly higher than kind of the first half of 2019. And then the second part of the year, when the subscription mix is expected to be kind of within the similar ranges. And when you look at kind of how we think about expenses, we feel good about the business. So we want to continue to invest really while we're balancing growth and profitability, which really has been kind of our philosophy for many years. So I think in summary, we really have a track record of commitment to profitability and plan to continue on that path.

[Matt Hedberg:]

Great. Thanks a lot. Well, done guys.

[Operator:]

Our next question comes from the line of Brent Thill with Jefferies. Please proceed with your question.

[Brent Thill:]

Thank you. You mentioned product attach is higher in subscription than you saw in perpetual. I'm curious, if you could just comment on where you're seeing strongest product attach in perhaps the strongest opportunities going forward?

[Yaki Faitelson:]

Hi. It's just – it's all over. We see a lot with the data protection with the automation engine. The cloud is huge for us. So, just the hybrid world works very well for us. The cloud is a big driver. Everything that's related with 365 and as you work extremely well, classification because of regulation and you tie everything to the cybersecurity, they're alerting the forensics that we are doing, we'll see it from all over. So a lot of this success is coming from customer demand. The customer need and the understanding that they need more and more of the licenses in the platform and the automation around it. Once you're bringing it to the customer with relatively little effort they get a lot of value. And once they're adding more platforms, they're having much better data protection, they are more in compliance and the alerting and the detection that we are providing of just increasing in accuracy in orders of magnitude. So we're really hitting on all cylinders in terms of the platform and unleashing the potential of the platform and it's time perfectly to customer demand, which obviously it will coming from the customer.

[Guy Melamed:]

Just to get some data points. What we used to see under the perpetual model is that customers would buy on their first initial purchase between two to three licenses. And what we see under the subscription model is that new customers are buying between four to five licenses. So it ties to what Yaki is saying that they're consuming more of the product and buying this as a platform itself.

[Yaki Faitelson:]

The platform still works very well in the initial deal and working very well in the expansion.

[Brent Thill:]

And just a quick follow-up. Just from a global perspective, is the sales force now all on board and up to speed on the shift to subscription. It would seem with the numbers they are but any pockets left to get the sales force on board with this go-to-market model?

[Yaki Faitelson:]

Yes they are. And the subscription is just the top priority. Obviously, in EMEA, we did some changes to make sure that everybody on board but we are in the right direction and we're really becoming a subscription business. As far as we know, this is one of the fastest transitions in history of enterprise software to subscription. And everybody on board and it's also working very well with the customers. Most of the customers, the vast majority, this is what they want. And they'll get much more value from us selling them in a subscription model.

[Brent Thill:]

Okay. Thank you.

[Yaki Faitelson:]

Thanks.

[Operator:]

Our next question comes from the line of Saket Kalia with Barclays Capital. Please go with your question.

[Saket Kalia:]

Hi, guys. Thanks for taking my questions here.

[Yaki Faitelson:]

Hi, Saket.

[Saket Kalia:]

Hey, Yaki, hey, Guy, maybe just to start with you. It's obviously early to get a good sample size here. But I think you should have started to see at least some of your early subscription pilot customers come up for renewal. So I was wondering if you can just talk about what you're seeing from that first cohort of subscription customers that signed a year ago and maybe even Q4 of last year and their willingness to renew under the new pricing model?

[Guy Melamed:]

Hi, Saket. Yes, you're right. Q3 last year is really when we started kind of the pilot and that ran for Q3 and Q4. We're very happy with the renewal rate for our Q3 pilot.

[Saket Kalia:]

Got it, got it. Yaki maybe just my follow-up for you. Lots of traction on subscription, as I think we all see. For the customers that are still on maintenance. Can you just talk about how you envision that base sort of evolving over time? I think we've seen companies transition this -- transition their maintenance base to subscription using various methods. Curious how you think about that base long term?

[Yaki Faitelson:]

Yes, you know there is so much just to sell and the value is coming from the platform and this is what the customers want. So our focus to be -- to move faster subscription, it's not to go and convert the maintenance but as it is recurring revenues what we are doing is selling them new licenses. This is how it works. We are not going to the base and converting just maintenance, we are going and selling additional licenses and make sure that we are platform plan -- played to the base and as we said before, the platform is working very well with new customers with expansion.

[Saket Kalia:]

Got it. Very helpful. Thanks guys.

[Yaki Faitelson:]

Thank you.

[Guy Melamed:]

Thanks, Saket.

[Operator:]

Our next question comes from the line of Shaul Eyal with Oppenheimer. Please proceed with your question.

[Shaul Eyal:]

Thank you. Good afternoon, guys. Congrats on the consistent execution and without a doubt, the improved outlook. One for Yaki, one for Guy. So, Europe bounced back it would appear. And I know you addressed it absolutely coherently over the course of the past few quarters. What's driving that improvement vis-à-vis from macro concerns about a moderating European economic environment?

[Yaki Faitelson:]

Hi, Shaul. We don't see -- we see the same sales cycle, we see overall Europe good demand, everything for us in Europe and for the company. To move so fast is not easy. This is hard work to take a company and in three quarters to move in this kind of rates. And also for the fourth quarter, the whole focus is to move it to subscription. And with Europe we needed to do some changes, make sure that everybody on board. And it's -- overall it's moving in the right direction. But we just -- we see very good market there. Historically, we did very well. And also in the fourth quarter, the top priority is just to move to subscription and the increase the ARR.

[Shaul Eyal:]

Understood. And Yaki, while we have you maybe on that topic and trying maybe to expand it a little bit. So clearly, the strategy has been unfolding better than expected; customers are coming for more modules that the platform gets expanding. And without a doubt the name becomes much more recognizable out there in the market. So do you think that down the road in the quest to the $1 billion target, do you think we might start to see seven-digit transactions potentially becoming more of a routine rather than exception down the road?

[Yaki Faitelson:]

I don't know. I just know that at this point what I know it's becoming a top priority for organizations. So, everything that is happening in the marketplace works very well for us. The explosion of data and with a lot of automation that we introduced the ability for customers to solve very fast with very little human intervention, the biggest risk in data protection. What we have done with just cybersecurity, once you bypass the perimeter, the way that we are doing this user behavior analytics, it's working extremely well. And regulation, so I just think that it's going to be a top priority for customers out there from every size and to focus more on the enterprise, who give larger initial deals and very good expansion. So I don't know in terms of one deal or the other, but I just think that the initial deal and the overall customer lifetime value make a lot of sense. We'll be able to focus a lot on our customers make sure that they are extracting a lot of value from the platform, and we're starting to see that the up-sells are really related to usage. So if they're using the products more with relatively little effort, because we have this automation in each one of the use cases. So just -- I would just believe that everything will become much more efficient and over time our ability to get more from our customers will just increase.

[Shaul Eyal:]

Thank you so much.

[Yaki Faitelson:]

Thanks Shaul.

[Operator:]

Our next question comes from the line of Chad Bennett with Craig-Hallum. Please proceed with your question.

[Chad Bennett:]

Thanks for taking my question. Phenomenal job on the quarter guys.

[Yaki Faitelson:]

Thank you.

[Chad Bennett:]

So maybe a question for Guy first. I know you don't want to give specifics necessarily on next year. But considering where we're at in the transition and now we're going to annualize on those numbers, specifically in the March quarter, how should we think about seasonality there just because we haven't really seen it yet? Seasonality of the March quarter in terms of subscription revenue and license revenue compared to when you were a peer license company?

[Guy Melamed:]

So, without boring you to death with accounting treatment, the 606 really requires that subscription deals for on-prem are recognized similar to perpetual. So we expect the same kind of seasonality where Q1 is kind of our lowest -- smallest quarter in terms of -- in dollar terms and then Q4 being kind of the largest. But again, kind of going back to the way we look at 2020, it really will be kind of a year of two halves where the Q1 -- when we -- Q1 2019 is really when we started the transition. And the subscription mix is lower. And Q1 2020 subscription mix should be significantly higher. So it won't really be apples-to-apples in terms of Q1 and also Q2 of 2020. And but as we get to the second part of the year, the second half it will be much more of an apples-to-apples comparison on a top line basis.

[Chad Bennett:]

And maybe this is just a more blunt way of asking it, do you expect to return to revenue growth in the March quarter overall year-over-year?

[Guy Melamed:]

So, we'll provide our guidance in Q4 of this year, and we'll give much more color on the 2020 line item and how we see that. But conceptually, we'll just have to break it into those two years the first and second half. And from an expense perspective, because the business is doing well we want to continue to invest.

[Chad Bennett:]

Okay. And maybe a couple of segment questions, I think you touched on EMEA and we have the overall revenue. Can you just give us a sense for how EMEA performed in terms of subscription revenue sequentially?

[Guy Melamed:]

We were happy with the adoption of the subscription mix in EMEA. I think the team there is on board understand the value that it provides customers and we expect that to continue in Q4.

[Chad Bennett:]

Okay. One last one for me just fed. You highlighted the substantial deal in the quarter. Is there any way to indicate how fed performed for you guys in terms of bookings or revenue this quarter compared to any quarter historically then I'll jump off. Thanks.

[Yaki Faitelson:]

We saw a nice contribution from fed, we're very proud of the team. And we are very happy with the subscription adoption as well.

[Chad Bennett:]

Okay. Thanks guys.

[Guy Melamed:]

Thanks, Chad.

[Operator:]

Our next question comes from the line of Gur Talpaz with Stifel. Please proceed with your question.

[Gur Talpaz:]

Great. Thanks for taking my question, and congrats on the quarter. Based on what you're seeing, do you see a point where you'd be comfortable ripping the band-aid off so to speak and only selling subscriptions? I know you gave initial color for 2020, but given just the rapid growth you've seen here in subscription, is there a point where you, kind of, say you know what we're good to hear, we were comfortable we're only going to sell subscription going forward?

[Yaki Faitelson:]

Hi, Gur. We are all about the customers. You see the results, we can't be more committed to subscription and it's working extremely well. And -- but we're three quarters into it. And at the right time we will consider it, but we're definitely in the right direction with subscription and very committed to sell subscription and as much as we can subscription.

[Gur Talpaz:]

That's helpful. And then if you look at initial sales with subscription, are you seeing customers buying more DatAdvantage for different storage areas? I mean, are you seeing them deploy DatAdvantage across broader parts of the network than they would have done with perpetual not just additional solution module adoption, but really just the core DatAdvantage solution? Or you think that's being deployed across a broader part of the network? Thank you.

[Yaki Faitelson:]

Yes, definitely. Without a doubt. We see they're deploying more DatAdvantage. We see a lot of strong adoption of the DatAdvantage to all the 365 environment. But it's just working with all the licenses. They can really consume the platform, and have all the automation, get much more value and then buy more.

[Gur Talpaz:]

That's helpful. And maybe if I can throw one more in there for Guy. Guy you talked about four to five licenses at initial deal versus two to three for perpetual. How should we think about potential customer LTV here and differences between the two given that you've got a few quarters now under your belt of subscription selling? Thank you very much.

[Guy Melamed:]

So I think what we see is definitely the -- how this transition and how the sale of subscription has unleashed the potential of the platform. Customers are consuming this and purchasing licenses much more as a platform play and that's really beneficial because the more licenses they have, the more value they can generate from our products. So we believe and we see the additional purchases of license is a very positive thing for customers where they can continue to buy more licenses after that

[Operator:]

Our next question comes from the line of Melissa Franchi with Morgan Stanley. Please proceed with your question.

[Melissa Franchi:]

Okay. Thanks for taking my question and congrats on the quarter. Yaki, looking beyond the change to subscription. Have your customers ask for more cloud-based offerings from you all versus your on-premise offerings? And is that something that you have given a consideration to?

[Yaki Faitelson:]

Our customers if they want to install the platform they can install it. In Azure they can install it in AWS. So if they have cloud infrastructure, they don't have an issue to install it. But primarily what they're asking for us to support more of this data repository in the cloud and this is what we are doing and it's driving a lot of growth for us.

[Melissa Franchi:]

Okay, got it. So I just want to follow-up on the earlier question on renewal rates. And I know that it is early, but Guy is your assumption that the renewal on the subscription will be similar to maintenance?

[Guy Melamed:]

Yes.

[Melissa Franchi:]

Yes, okay. Thank you very much.

[Yaki Faitelson:]

Thanks Melissa.

[Guy Melamed:]

Thank you.

[Operator:]

Our next question comes from the line of Daniel Ives with Wedbush. Please proceed with your question.

[Daniel Ives:]

Yeah, thanks. Can you talk about regulatory especially GDPR some of the signs? And even what's happening here in the U.S. from a state perspective, how that's driving sales cycles and maybe activity? Thanks.

[Yaki Faitelson:]

Regulation primarily what it's doing it's just helping the organizations out there to understand how to treat data and cybersecurity and elevating the awareness to the senior executives on the Board on the risk and the need to protect the data and infrastructure just as a trust foundation to function. So it's definitely -- it's helping us. But this is something that works over a long time. It's just an educational process that organizations are having a lot of regulation in the -- generating a lot of need, but this is something that's just building up over time.

[Daniel Ives:]

Great. And then when have you scheduled a date for the seminar on how to do a subscription transition yet? When you're pricing going to do that seminar?

[Guy Melamed:]

We'll, send the link.

[Daniel Ives:]

Okay. Yeah, just let me know when the link's out. Thanks.

[Guy Melamed:]

Thanks, Dan.

[Operator:]

Our next question comes from the line of Erik Suppiger with JMP. Please proceed with your question.

[Erik Suppiger:]

Yeah, thanks for taking the question, and congrats. First off, can you talk a little bit about deal size? I understand the number of subscriptions or services that customers -- new customers are buying moves up from two to three to four to five. But in light of the move to subscription, it's hard for us to gauge what the overall deal size is for a new customer. Can you talk a little bit about how the dynamics around that have changed with the move to subscription?

[Guy Melamed:]

Hi. So we provide our ASP on an annual basis. Providing it on a quarterly basis can be slightly confusing, because historically Q4 has been our largest quarter for the year. So in the next earning call when we report Q4 numbers, we'll provide more color on the ASP.

[Erik Suppiger:]

Okay. And then lastly on the number of new customers, when do you think that's going to reverse and start growing again? I understand you're shifting to larger customers, but when do you think you see new adds will start to accelerate?

[Guy Melamed:]

The way we look at the new customer adds is that it's really working in line with our strategy. When you look at the delta between the Q3 adds year-over-year, it's all related kind of to the less than 500-employee companies, so like the lowest user group. And it really fits well with our strategy. So, we're not just focused about bringing new customers, but also kind of the quality of those customers and the larger customers where we can later on sell more license. So it's really working very well for us. And we will continue in that strategy.

[Erik Suppiger:]

Thank you

[Guy Melamed:]

Thanks, Erik.

[Operator:]

Our next question comes from the line of Jonathan Ruykhaver with Baird. Please proceed with your question.

[Jonathan Ruykhaver:]

Yes. Good afternoon. I'm kind of curious, when you look at the data security issues around GDPR Active Directory and Office 365 in particular. Can you just talk about how those use right for provide Varonis in terms of demand trends? And then, which one do you see driving a greater platform opportunity for the company?

[Yaki Faitelson:]

Hi. It's all of them. Just you have this unstructured data that it's very hard to align the right people to access the right data. And once you're going to the cloud with all of the added collaboration features, it's becoming much bigger. And in one single pane of glass to control everything and every regulation talking about data protection, data classification and the ability to stop and alert on any cyber attacks. So, it's all -- they're all data security platform that we added a lot of telemetry and it's become -- a lot of it related to Edge devices and infrastructure. It's -- everything works very well in terms of your classified data and remediate the risk making sure the data is in the right places and alert on any abnormal behavior. This is exactly the platform play. And the fact that you have a lot of data in the cloud and on-prem and its users in every organization are accessing it wherever it lives and you have this information and data spot works very well for us. It's just makes the playing so much bigger.

[Jonathan Ruykhaver:]

Would it be safe to assume that Office 365 is the larger of those three use cases?

[Yaki Faitelson:]

It's a big use case.

[Jonathan Ruykhaver:]

Right. Okay. And then, my final question, when you look at cloud data stores versus on-premise. Do you see any notable emphasis by customers on one or the other when you look at the business mix today? Or are those security concerns influence your opportunity equal across on-premise and cloud today?

[Yaki Faitelson:]

It's equal in on-premise and cloud, but in the cloud if you're doing a mistake and you open it for the whole world is -- it's more than just your employees. And some of these technologies have a lot of productivity tools for the end user, but that it's much easier for him to do a mistake and open these data stores to much more -- to many more people than they intended. So, its equal opportunity, but sometimes in the cloud the problem can be bigger.

[Jonathan Ruykhaver:]

Are you seeing faster growth with your products that address cloud security data stores today?

[Yaki Faitelson:]

The cloud is big for us, but it's the same. When a customer wants to solve the problem, usually they want to solve it on-prem. Most of the data is still on-prem. I will say well over 90% of the data is still on-prem, but it's starting to gain volume of data in the cloud and there is more data -- they have more data in the cloud. They definitely see more acute need to use Varonis always was data growth really fuel Varonis growth.

[Jonathan Ruykhaver:]

Right. Okay. That’s helpful. Thank you.

[Guy Melamed:]

Thanks, Jonathan.

[Operator:]

Our final question comes from the line of Rishi Jaluria with D.A. Davidson. Please proceed with your question.

[Rishi Jaluria:]

Hi guys. Thanks for taking my question. Maybe just one or two for Guy. First, just thinking about the normalized growth calculation that you provided which is really helpful. It looks like you're using a different calculation this time than you did on the slide deck last quarter when I pulled that up where you're actually kind of taking the delta between subscription this quarter, subscription of the year-ago quarter and then adding back in the subscription from a year-ago quarter and you're doing that again for Q3 of last year. Can you maybe help us understand the difference in your calculations now versus what we got 90 days ago? And is that the new calculation that you should be using going forward? And I think retrospectively as well? And then kind of a follow-up, just on the ARR side naturally got a huge uplift sequentially in ARR from your subscription mix. Just how should we be thinking about that ARR line going forward? Thanks.

[Guy Melamed:]

Sure. So there's a couple of questions there I'll try and break them one by one. First of all, in terms of the change in kind of the way we're calculating it. This is -- really the first quarter we're taking into consideration the pilot amounts and we don't want to double count. So we're being very responsible on every metric we're providing. And that's why the conversion factor is only being applied to the incremental subscription. Kind of the second part that you asked about how we would apply it going forward. So we adopted the conversion factor in our Q1 earning call, really in response to kind of the multiple requests from analysts and investors that provide the means of analyzing the business during the transition. And as you know, the conversion factor has been commonly used by other companies during their transition. But we understand that the SEC is not going to permit the use of that conversion methodology anymore. So as a result, this is really the last quarter that we will provide normalized results. But we have always believed that ARR is the most important KPI when assessing the health of a subscription business. And as such, the ARR will be the focus metric moving forward. So, given the transition has progressed much quicker than we originally anticipated, with the expected subscription mix of 75% in Q4 and with our guidance for subscription mix in 2020 of plus or minus 80%, we really are a subscription company and we'll be focused on ARR as our leading KPI going forward.

[Rishi Jaluria:]

Okay. That’s helpful. Thank you.

[Guy Melamed:]

Thanks Rishi.

[Operator:]

Since there are no further questions left in the queue, I would like to pass the floor back over to management for any closing remarks.

[Yaki Faitelson:]

Thank you. Before we end the call, we would like to thank all of our employees for their hard work and contribution to our success this quarter. We also like to thank all of our customers and partners for their continued support. Thank you all for joining us today and we're looking forward to talk to you soon.

[Operator:]

This concludes today's teleconference. You may now disconnect your lines at this time. Thank you for your participation and have a wonderful day.