Varonis Systems Inc

NASDAQ:VRNS

Earnings Call Transcript 2017-Q4

[Operator]

Greetings and welcome to the Varonis' Fourth Quarter 2017 and Full Year Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded.

I would now like to turn the conference over to your host Yun Kim, Investor Relations.

[Yun Kim, IR]

Thank you, operator. Good afternoon and thank you for joining us today to review Varonis' fourth quarter and full year 2017 financial results. With me on the call today are Yaki Faitelson, Chief Executive Officer; and Guy Melamed, Chief Financial Officer. After preliminary remarks, we will open up the call to a question-and-answer session.

During this call, we may make statements related to our business that would be considered forward-looking statements under federal securities laws, including projections of future operating results for our fourth quarter and fiscal year ending December 31, 2018. Actual results may differ materially from those set forth in such statements.

Important factors such as risks associated with the anticipation growth in our addressable market; competitive factors, including increased sales cycle time; changes in the competitive environment, pricing changes and increased competition; the risk that we may not be able to attract or retain employees, including sales personnel and engineers; general economic and industry conditions, including expenditure trends for data security solutions; risk associated with the closing of large transactions, including our ability to close large transactions consistently on a quarterly basis; our ability to build and expand our direct sales efforts and reseller distribution channels; new product introductions and our ability to develop and deliver innovative products; risks associated with international operations; and our ability to provide high quality services and support offerings could cause actual results to differ materially from those contained in forward-looking statements.

These factors are addressed in the earnings press release that we issued today under the section captioned forward-looking statements, and these and other important risk factors are described more fully in our reports filed with the Securities and Exchange Commission. We encourage all investors to read our SEC filings. These statements reflect our views only as of today and should not be relied upon as representing our views as of any subsequent date. Varonis expressly disclaims any application or undertaking to release publicly any updates or revisions to any forward-looking statements made herein.

Additionally, non-GAAP financial measures will be discussed on this conference call. A reconciliation for the most directly comparable GAAP financial measures is also available in our fourth quarter and full year 2017 earnings press release, which can be found at www.varonis.com in the Investor Relations section. Also, please note that a webcast of today's call will be available on our website in the Investor Relations section.

With that, I'd like to turn the call over to our Chief Executive Officer, Yaki Faitelson. Yaki?

[Yaki Faitelson, CEO]

Thank you and good afternoon, everyone. Q4 was a very strong finish to 2017 with license revenues increasing 34% for the quarter and 33% for the full year. These demonstrate that our highly differentiated data security solutions are helping to solve critical needs of organizations globally. Total revenues for the fourth quarter were $73.2 million, an increase of 35%, and total revenues for the full year were $217.4 million, 32% growth year-over-year. For the full year 2017 most U.S. and European revenues grew greater than 30%.

In the last three years, we have doubled the revenues and done so while improving the profitability profile and delivering meaningful levels of cash flow from operation. We're building an organization that is durable and well positioned to extend our link globally. There are several key trends that are driving our business, which we think are sustainable and provide a foundation for future growth.

One, data growth continues to be explosive across all data stores, both on premises and in the cloud, which has remained prominent in the new and data centric security solutions are becoming a priority, especially in an increasingly complex hybrid environment to have reached a much greater level of awareness around the problem and our differentiated platform, especially with senior level executive who own and control budgets. They realized that securing data is not just an IT problem, but a business problem.

To keep the business safe, they have to keep their data safe with new regulation roaming, data protection and data center security are even more clinical than ever. Our investments in innovation and our focus on companies we started to more employees are paying off. As new customers make larger initial commitments and new product license is growing to grow in our installed base, we believe that we have barely scratched the surface across our core customer base and we continue to add meaningful number of new customer each quarter, we're just beginning the journey.

Let spend the moment on these important items for our business and why we believe we are positioned to execute against the considerable opportunity ahead of us in 2019 and beyond. The data centric approach to security is becoming a standard, almost every breach involve data assets in the form of files, emails and video that are stored in going on premises and cloud file system. These are high value, high volume data stores without us are away out of control. The market is increasingly recognizing our data security platform, as the leader in protecting these data, our highly differentiated solution, locking sensitive data determine who can and should access it and can detect abnormal user behavior that threaten the sensitive data.

We also automate the labor intensive processes required to lockdown and sustain current access. Customers also know that we are living in a hybrid world, while most of our customers critical data resides on premises today, there is a move to the cloud without the well defined parameter, any point data security solution requires support for relevant on premises and cloud data environment. We believe our solution supports a comprehensive list of relevant data environment in the market today. Adoption of Office 365 solutions are accelerating, we plan to continue to support mobile environment in the future most on premises and the cloud.

For example, during the first quarter a provider of natural gas based in UK undertook a major security initiative to reduce risk related to overall expose sensitive data and gains this ability into who has access to what and monitor their activities for potential breach. The single most important requirement for this initiative with a technology platform that could provide this ability close both on premises and cloud data environment with single pane of glass. After the Varonis risk assessments then companies believes that Varonis was the only vendor that has demonstrated its capabilities on their hybrid production environment.

The Company decided to implement our data security platform including DatAdvantage and Data Classification Engine for multiple only on premises and cloud environment, DatAlert and Data Transfer Engine. As I said before, data security has become a business in a board level problem. If you don’t know where the data resides with access to it and how it looks down, you are vulnerable to breaches on regulatory time. The result is that we have seen most simplicity and reduced friction in the sales motion in much more sophistication in the product usage. We are speaking directly to CIOs and CISOs at some of the largest companies around the globe. We appreciate the value of our solution and their relevance in addressing their most pressing data security issues.

Looming the regulation also increased the awareness for solutions. In Q4, we began to see the benefit from GDPR as we said consistently. While GDPR helps with awareness and present opportunity that we believe we are well position to capture, we never lean on GDPR alone, we always focused on the broader value that comes with adapting our comprehensive data security platform. Our platform and methodology help organization from the mentally changed the way they manage and secure the sensitive data when filed beyond checking boxes for compliance, more than five of our licenses directly associated with some portion of GDPR relation. Our GDPR pattern helped us begin the sales forces and make our risk assessment more relevant with GDPR that is important to remember.

The GDPR pattern required both DatAdvantage and the Data Classification Engine. In addition, we saw an increased interest in our other product offerings such as DatAlert, Data Transport Engine and DataPrivilege. We also helped companies with GDPR -- which also help companies with GDPR compliance and more importantly dramatically improved the overall security efficiency. With the GDPR deadline approaching a major global insurance provider who has been Varonis customers turn to our source system, we are able to help them locate, manage and protect sensitive personal identifiable information through GDPR pattern. We are also able to use the opportunity to further reduce the Company exposure to a potential data breach and insider threat by deploying additional DatAdvantage licenses for cloud data environment using DatAlert to monitor the hybrid environment.

Being an existing customer, we understood the risk of open global access in both in access control. In fact, they have been working with a third-party firm to help them to address this problem manually over the past several years, which took on average an hour consultant time speak just one folder with the automation engine. The Company is now able to immediate 1,000s of unique folders in one hour. We continue to expect the GDPR production will have a long tail and will be one of the many global drivers of our business in 2018. This customer example in our expanding use cases illustrates how innovation is lifeblood of Varonis. In 2017, we introduced the automation engine GDPR pattern.

In Varonis Edge along with innovation across the product family, the market continued to handle for automation in gross saving security solutions as organizations target to keep pace in data growth, complexity and relentless new attacks. We believe that the automation engine is a quantum leap in data protection. It automates labor intensive processes require to make sure only the right people have access to the most sensitive data, remember our risk assessment show that's on average at least 20% of an organization data is open to every employee that approximately 50% of the companies have at least 1,000 entity files open to everyone in the Company through automation engine fixes these issue automatically in small fraction of the time otherness state. Significantly reducing the likelihood of the bridge and dramatically reducing the scope of potential damage, the automation engine adaption has been very, very strong and a key differentiator for us.

Varonis Edge, the third product announcement we made in 2017 spot sign of malware advanced persistent threats and other attack, imprudent next to that through alert customers get about their data from DatAlert. With the complete picture of an attack, our first getting how they move around was sensitive data, they touch and try to touch, we elevate our vacuum and security analytics, data classification and through our remediation capabilities in coping for instructor protection. Innovation strengthened our lead in the market and enhances the overall value we provide to your customers. In 2018, we expect to increase our investment in R&D to deliver new product, feature and functionality building on past success. New product introduction and our focus on customer with thousands or more employees sure our land and expand strategy, which is paying off.

This mid and large size enterprises know that they have the problem and we see less friction in the sales motion when we reach leaders in this companies who controls the budget. We have consistently increased the percentage of customers who own two or more products and our other sales prices up to $83,000. We see greater initial commitment allowed to offset with numerous product families and licenses to sale we believe that the unstop opportunity within our customer base is substantial, and we continue to add meaningful number of new customers each quarter, on both fronts, our land and expand strategy. We'll still be scratching the surface and our opportunity and driving last and value across the customer base, new customer, a UK-based financial services firm who is suspicious of insiders snooping around files and emails and also detecting an also wide access from outside.

We wanted to secure the email communication and monitor and track suspicious activity across all of the on-premises and cloud data environment. Our solution provided them with the ability to protect and secure their highly valuable data and also to detect the real-time abnormal activities coming from stealth and type of user account that outsider used to gain access, which they were not able to do before. They purchased DatAdvantage, DatAlert with and Data Classification Engine to increase the overall security measure in addition they are the trained automation engine to further reduce the risk profile against insider threat and GDPR pattern to help them with their reporting requirement.

As an example of an up-sell, a large pharmaceutical company first turned to Varonis DatAdvantage last year for user permissions management, one of the facilities was experiencing extremely high turnover rates and they were suspicious that employees were walking out the door with valuable intellectual property. In Q4, the Company decided to take further steps to protect its intellectual property from being stolen and edit DatAlert to detect any abnormal user activities that could signal any employee stealing intellectual property and the data classification engine to continuously locate and secure all their highly valuable intellectually property on the network. These are all great example for our strategies with risk assessment to identify our customers standpoint and demonstrate our value proposition earlier in the sale process, and we believe that the highly differentiated and comprehensive data security solutions are unmatched.

We built strong relationship with our customers with their value will deliver and expand our penetration through innovation. Our strategy supports our investment in R&D and sales and marketing to support regulation of GDPR and strengthening market internationally and ensure we have enough trained sales people to capture our meaningful opportunity and drive doable, scalable growth over the long-term. I'm confident more than ever that we have the strategy, the market and the team to build a billion dollar business.

Before I turn the call over to Guy, I would like to congratulate him on also being named Chief Operating Officer, the role is already being performing for much of the last year, and we would also like to congratulate David Bass on his promotion to Executive Vice President of Engineering and Chief Technology Officer effective of March 1, 2018. David has been with Varonis since the beginning and has been instrumental in our product vision, leading our product development organization for long time. I would also like to take a moment to express my gratitude to Ohad, who has been true friend and partner to me and who was instrumental in building the Company from the ground up and turning it to the highly successful global company it is today. Ohad is stepping away from the role of CTO and I look forward to his ongoing contribution to Varonis and as he remained a member of the Board of Directors.

With that, let me turn the call over to Guy. Guy.

[Guy Melamed, CFO]

Thank you, Yaki, and good afternoon everyone. I'll begin by reviewing our fourth quarter and full year results in accordance with ASC 605 then I'll move on to discussing our outlook for Q1 and full year 2018 according to the new 606 standard. I would like to note that this change in standard has no material impact on our financial.

For Q4, total revenues were strong at $73.2 million, an increase of 35% year-over-year and above our guidance range. Q4 license revenues were $46.6 million. This represents a 34% increase from Q4 '16. Maintenance and services revenues were $26.6 million, increasing 35% compared to the same period last year. These results were supported by a consistently high maintenance renewal rate, which again came in at over 90%.

Looking at the business geographically, we saw strong growth. U.S. revenues increased 28% to $42.8 million or 58% of total revenue. EMEA revenues increased 52% to 26.5 million, representing 36% of total revenue. Rest of the world revenues were $3.9 million or 5% of our total revenue. For the fourth quarter, existing customer license and first year maintenance revenue contribution was 44% up from 43% in Q4, 2016.

During the quarter, we added 331 new customers and for the full year similar to last year added nearly 1,000 new customers, fueling our land and expand strategy. We continue to have success adding new customer who make larger initial commitments and meaningfully expand with us overtime. This supports our strategy to target companies with 1,000 or more employees while at the same time we’re increasing revenues from our ever growing customer base.

As of December 31, 2017, 32% of our customers had purchased two or more product families, up from 48% as of the same date last year. We believe that this positive trend validates our platform approach to data security and supports our investments in R&D to expand and extend the solution we offer our customer. It also further reinforces the significant opportunity we still have to sell into our existing customer base.

One upcoming change in regard to our product families, when we first introduced DatAlert, we thought of it as an add-on to DatAdvantage since then the detection has become a core use case in its our business driver while at the same time DatAlert become far more sophisticated. With our introduction of Varonis Edge which compliments DatAlert, we've decided to make them their own product families beginning in 2018 when we report Q1, 2018, we will provide the associated attached rate and prior year compare.

ASP, our ASP was $83,000 was a full year 2017 compared with $65,000 in prior year, reflecting the strong business trends and increases in customer life science value we're driving. Before moving on to the profit and loss items, I would like to point out that I will be discussing non-GAAP results going forward unless otherwise stated. For Q4 '17, that reflects a total of $5.4 million in stock-based compensation expense and $284,000 of payroll tax expense related to stock-based compensation.

We report non-GAAP results in addition to and not as a substitute to financial measures calculated in accordance with GAAP. Please note that a detailed GAAP to non-GAAP reconciliation can be found in the tables of our press release, which is available on our website. Gross profit for the fourth quarter was $67.6 million, representing a gross margin of 92.4%, consistent with gross margin in Q4 ’16.

Turning to operating expenses, during the fourth quarter in line with our strategy, we continue expanded our sales and marketing teams in Europe and the U.S. to drive growth. In R&D, we remain focused on increasing our strategic investments to deliver additional products and features, expand our use case and enhance our value to customers. The result is that we’ve been able to drive growth in scale in our business. During the fourth quarter, our operating margin improved to 16% from 14.9% in Q4 '16.

As you know, foreign exchange gains and losses can fluctuate. During the quarter, we had financial income of $321,000, compared to financial expenses of $739,000 in Q4 ’16 primarily due to foreign exchange gains this quarter. Our guidance does not consider any potential impact to financial and other income and expense associated with foreign exchange gains and losses as we do not estimate movement in foreign currency rates.

Net income was $11.2 million for the fourth quarter of 2017 or $0.36 per diluted share an improvement compared to net income of $7 million or $0.24 per diluted share for the fourth quarter of 2016. This is based on 31.1 million diluted shares outstanding for Q4 '17 and 29.3 million diluted shares outstanding for Q4 '16. During the quarter, we added 52 net additional employees ending the quarter with 1,251 employees, a 14% increase from 1,098 at the end of 2016.

I will now quickly recap full year 2017 results, total revenues were $217.4 million increasing 32%, license revenues increased 33% for the full year and maintenance and services revenues increased 31%. Non-GAAP operating income was 7.4 million a significant improvement compared to 2.5 million loss in 2016 with operating margin improving to 3.4% from negative 1.5% in 2016.

Non-GAAP net income per diluted share was $0.24 in 2017 compared with a loss of $0.17 per basic and diluted share for 2016. Looking at the balance sheet we ended the year with approximately $136.6 million in cash, cash equivalents and short term investments. For the year, we generated positive operating cash flow of $16.4 million compared to $7.3 million in 2016.

Now turning to guidance, I would like to note again that this guidance is based on ASC 606 which has no material impact on our financial. Beginning with our Q1 2018 results, we plan to report on a fill retrospective method. In addition, we've provided a 605 to 606 reconciliation for Q1 and full year 2017 in our press release.

As a reminder, a meaningful portion of our expenses are in Israel mainly related to R&D. Historically, we've handled foreign exchange fluctuation by entering into hedging contract when we finalize our yearly budget. In 2017 the U.S. dollar devalued significantly against the Israeli Shekel, consistent with the previous years we entered into hedging transaction for the full 2018 year.

Based on these rates, we expect the headwind to our Q1 2018 and fiscal year 2018 operating margin of approximately 300 basis points. For the first quarter of 2018 we expect total revenues of $49.2 million to $50 million representing year-over-year growth of 24% to 26%. We expect our non-GAAP operating loss to range between 8.6 million and 8.2 million and non-GAAP loss per basic and diluted share of $0.32 to $0.31. This assumes the tax provision of $400,000 to $600,000 and 28.3 million basic and diluted shares outstanding.

For the full year 2018, we expect total revenues in the range of 260 million to 264.5 million representing year-over-year growth of approximately 21% to 23%. We expect our non-GAAP operating income to be in the range of 1.5 million to 4 million and non-GAAP net loss per basic and diluted share of $0.04 to non-GAAP net income per diluted share of $0.2. This assumes the tax provision of $2.7 million and $3.2. It is also based on $28.6 million basic and diluted shares outstanding and $32.2 million diluted shares outstanding respectively.

For 2018, we expect to continue to see improvement in our cash flow from operations compared to 2017. I would like to note that we will be making leasehold improvements in several of our offices globally in order to have the infrastructure we need to support our next leg of growth. Our expectation is that CapEx will be approximately 12 million to 17 million for 2018 depending on the exact timing of those projects.

On the R&D front, we expect to increase expenditures as a percentage of total revenue during 2018 while showing overall leverage, excluding the impact of currency fluctuation. We believe these investments will strengthen our capabilities to achieve our goal of building a $1 billion business that grows revenues meaningfully while expanding profit.

With that, we would be happy to take questions. Operator?

[Operator]

[Operator Instructions] Our first is from Matt Hedberg of RBC Capital Markets. Please proceed with your question.

[Matt Hedberg, RBC Capital Markets]

Outside of the headline numbers, the European growth I think it was 52% released it out to me. Yaki in your prepared remarks you mentioned GDPR, I'm wondering, is there anything else that drove those results? Was there any pent up demand or budget flush in Q4? And then I have got one follow-up.

[Yaki Faitelson, CEO]

No, nothing you know just for us was, business is usual exactly how it's staying and the market is evolving. So what we saw overall that the problem that we saw in data protection, cyber security, information management just becoming much more mainstream and a top priority for C-level. And what happened with GDPR is that, GDPR is really generating a very thoughtful process regarding cyber security, data protection and infrastructure protection. And they bring very high -- a level decision-maker that the think body of the assets, why they need to do and in this process they only swing. We don’t sell for GDPR we just sell our overall value and it's just a perfect fit for the start process that GDPR provoke. So, we always did well Europe, this is a business that you need to measure on you’re a multi coral of view, but without a doubt in the overall surge motion, GDPR makes it more predictable. It's like that we can make marketing campaign for growth.

[Matt Hedberg, RBC Capital Markets]

And then in terms of the disclosure for looking forward to the DatAlert disclosure on Q1, so I guess I'll ask about the automation engine. Again, I think you mentioned it on the call, but can you give us an idea of who is adopting I assume it's mostly existing customers? Is there any sort of anecdotal evidence on the attached rates and the up sell opportunities for the automation engine?

[Yaki Faitelson, CEO]

Firstly, it's still early but the early indicators are outstanding and it's to our new customers and up-sale, it's for everybody -- stand-up remediation is at the core of information securities today, make sure of that the right people will be able to access their idea is 60% of the battle. And what is going on I think this year environments organizations understand that this is something that they need to do, but you need tremendous automation and R&D and the automation engine works extremely well. So in terms of -- it was far beyond our expectations. Again, it's still early innings, but we believe that we can sell it to a lot of our customers and also to take this feature set and make it applicable to so many things. It's just showing a lot of those forms.

[Operator]

Our next question is from the line of Gur Talpaz with Stifel.

[Gur Talpaz, Stifel Nicolaus]

Yaki, you talked about reduced sales friction in the go-to-market motion. I was hoping you could talk a bit more about that in terms of what you’re seeing in terms of customer and channel awareness for the company and for your products, and perhaps what's driving that reduced friction?

[Yaki Faitelson, CEO]

What is driving it is, it's just the traditional security solutions are still relevant, but they have very limited value in protecting data and the core infrastructure, mainly in this very complex hybrid mode and a very data centric approach to security that is practical, it just its walking very well. So what you see is that cyber security is becoming just a board level discussion, you need to protect your organization, you need to protect your customer, or you will not be in business, you need the overall trust foundation. And then you need to get -- you need to know where to invest, you can spend a lot of money and get nothing, and you also need a solution that the organization can digest.

And what is happening, there are three things that happened; one, we've seen many more project; we've seen many more sea level discussion, usually the CSO is the catalyst, we sell to the CSO and he brings all the stakeholders from the business and IT. And another thing that we see Gur is simple and much more sales motion and significantly more sophistication in the use of the product. And our ability to get into the organization operation like DLS, automation engine, critical classification, from there to do remediation and ownership and really take our customer to a very predictable expected journey of value. So definitely not this clearly but surely the market is shifting. And also we are hitting scale and it makes sense for the partners to push it and we have more and more brand recognition and almost no competition. So all of these factors the scale working very well for us.

[Gur Talpaz, Stifel Nicolaus]

And Yaki, you always say look at the story on a multi-quarter view. If you do that, you've accelerated license quite nicely here into the lowest 30s. Maybe talk about what's helping to drive that multi-quarter acceleration. Is it pushing into customers that have 1,000 employees or more? Is it general increase in ASP multi-solution adoption all the above? Any color there would be very helpful. Thank you.

[Yaki Faitelson, CEO]

So it's all of the above. But if I have to break it down, and because of the market becoming more mature, a targeted approach to the market coverage works very well. So we didn't do any tremendous shift, with just thousands and above, it’s a huge market. I think the Federal, just in North America and Europe, is close to 30,000 potential customers, it’s big. The other thing is as the market is more maturing customer wants more licenses to get the -- customers the same size and do bigger initial purchase and much stronger total customer lifetime value that works very well for us, so just coverage of market. And then when we have these thousand plus customers, we maintain very good relationship with them and then they still are just becoming more predictable. But I think what you said is 100% right, you need to look at it in a multi-quarter view and you need to look at how we articulate what is going on and how the market is developing. And I think it’s just -- it’s a very unique situation.

[Operator]

Our next question comes from Rakesh Kabir, Barclays. Please proceed with your question.

[Rakesh Kabir, Barclays]

First maybe for you Yaki, just to go back to the automation engine, understanding that it’s early. Can you just talk a little bit about how automations -- again in early days, how you can see this product impact the average selling price in some of your existing deals?

[Yaki Faitelson, CEO]

With your permission, I just don't want to talk about the ASPs. The simplistic way to look at it is somebody buys DatAdvantage for Windows -- it’s just natural that you let the automation engine and it can increase drastically the average sales price. But if I want to step -- just to take a step back and look at the problem, when you are going through any risk assessment 20%, 30% sometimes 50% of the data is open to everybody in the organization. In terms of saying that more than thousand sizes is critical-critical information is open to everybody in the organization. Without breaking any business process, it takes so much time to fix it. You need to understand what's going on, even with the core DatAdvantage. This is a tremendous quantum leap. You’re talking about second to none productivity gains in a very quantifiable way to reduce risk.

And if you're looking at any malware -- and almost -- and inside of the first thing that they're doing is that browsing the file shelves to see what is open and to take critical information, and this eliminates this key problem. So this is just a very, very interesting product that in a very quantifiable frictionless way still one of the biggest security problems and have massive cost savings, because if you need to do it without it, it just very hard undertaking and it’s many times just impossible to do it in any realistic timeframe.

[Rakesh Kabir, Barclays]

Maybe for my follow up, maybe for you Guy, I think you said that R&D is going to go up as a percentage of revenue, understandably because of FX. But could you just talk a little about how you think about the sales and marketing line in 2018. Presumably you're not going to be seeing as much FX headwind there. So just anything you could talk about headcount plans or other drivers on how sales and marketing grows in 2018?

[Guy Melamed, CFO]

So we're very focused on our goal to becoming a billion dollar company. So when I think what we've done in the past, we've focused on our investments, we put them in the right place and we've definitely seen good ROI in terms of R&D. And if you just look in the last year alone, we came up with three products; the automation engine, GDPR and Varonis Edge. So in that regard, we're definitely focused on putting the right investments in R&D for the long-term. When you look at the sales and marketing, we’ve seen good leverage in that department and we definitely plan in 2018, if you exclude the FX headwinds, we definitely plan to improve margins compared to 2017. So we're very focused on the bottom line. And our philosophy hasn’t changed, but we want to continue to invest now for the long term.

[Operator]

Our next question is from Greg McDowell, JMP Securities. Please proceed with your question.

[Greg McDowell, JMP Securities]

My first question, I want to ask about sales productivity and how you're thinking about making investments in 2018 in the sales force, especially as it relates to geographies and may be build sales versus inside sales. Just maybe how you’re thinking about sales headcount, sales productivity and trends you’re seeing. I'll stop there thanks.

[Yaki Faitelson, CEO]

The total available market just in units, economics and customer is thousand plus is huge. And as we add more products that we can sell, so our sales people know to be productive, they need account coverage and anytime we bring a new customer, we can sell them too much and we need to maintain these relationships, make sure that they are successful. So it’s a balanced -- it's little different to think about it is the balance between us covering the market. We also need to make sure that we manage the right attention and effort economy and the probability model for us to be successful and productive, the company coverage and per rep. So in a very -- in the right way we are going to increase capacity. Obviously, most of the focus is thousand plus. So where we’re going to increase capacity with this enterprise reps and most of our investments are in North America and Europe at this point, slowly but surely we will go to APAC. But this is really where we are investing, because we are still very small relatively to the overall opportunity.

And lastly as the market is -- this is a lead platform is the market is evolving, some in used cases are just stemming from the platform with so much visibility of how to innovate. So we starting with this small bets, we see how they are working and then we are going deep and wide with things like the automation engine and DLS and others. And making sure that once a customer is on board, we can sell them so much for a very long time. So this is really the way to look at it and everything and all the investments need to materialize and make sure that gradually improving the economics of the business.

[Greg McDowell, JMP Securities]

And one quick follow up, just the commentary on the disclosure and making them their own product family. Is that strictly a financial related disclosure or if you’re a Varonis customer, are you going to be buying and consuming or is there any like price list change to -- or bundling change that customers will feel? And if yes, how should we think about the impact of this change?

[Yaki Faitelson, CEO]

Obviously, there's price list change, because we have now Edge on the price list, and last year was a big innovation year for us, with Edge, with the GDPR patterns, with the overall automation engine. But really the innovation is three big things one is everything that's related to security analytics, very, very well. We are extremely effective with everything that's related to unstructured data and file systems and active directory. We expand now with Edge to proxies and to DNS and VPN. And with that and everything that's related to insider and malware detection after the malware pass the parameter security, in my humble opinion we’re the most important security analytics company in the world.

The second one is remediation, making sure the right people can really access the right data. This is another big thing that we are innovating across our platform and to serve this information management to make sure that we know what information is critical it is in the right place and in the right hand. And this is really schematically how to think about the three big areas of focus, and everything that's related to security analytics, just the DatAlert became this big part of our business, really fast and our customers realize tremendous value. And we believe that the fourth multiplier with Edge is -- can be extremely strong. So it just makes sense to put them both in one family.

[Guy Melamed, CFO]

And Greg just to add on that, starting Q1 2018 when we put the Edge and DatAlert together, we’ll provide number of companies that have two or more product families and also number of companies who have three or more product families. Just to provide from a disclosure perspective to give you more transparency and visibility to attach rates of DatAlert and Edge.

[Operator]

Our next question is from Shaul Eyal, Oppenheimer. Please proceed with your question.

[Shaul Eyal, Oppenheimer]

So, great thoughts, ongoing thought with the automation products, good feedback from customers. Even though it's early days, assuming you're not operating in sort of a void, who are you seeing on a competitive landscape when approaching customers with the automation product?

[Yaki Faitelson, CEO]

With automation, because it's such a natural item to DatAdvantage, at this point we just don't -- we barely see any competition. To DatAdvantage, there is so little competition and this is just an organic extension if you will to our commit engine, our ability to do remediation. So this is the place that -- this is still a highway for us, we are almost alone.

[Shaul Eyal, Oppenheimer]

And maybe second with automation. So is the discussion or the upsell opportunity with that pool, does that take you in a different direction within the organization. Is it someone new within the IT department you need to push your product towards, or pretty much the same people you've been interacting with so far when pushing it into your existing and new customer base?

[Yaki Faitelson, CEO]

Same people, it's similar to the overall sales motion. The only difference is that the ending is to pay more money. It's just very small, here you have just tremendous automation without any friction to solve one of your biggest problems that is very visual and it just has additional cost. This is how it works.

[Guy Melamed, CFO]

And Shaul, just to give -- in addition to that, if you want to buy the automation engine the prerequisite is DatAdvantage. So we have to buy that and automation engine is 50% of the DatAdvantage less price. So really at the end of the day, it really helps us with customer lifetime value. We can extract more dollars from customers, new and existing overtime.

[Operator]

Our next question comes from Melissa Franchi, Morgan Stanley. Please proceed with your questions.

[Melissa Franchi, Morgan Stanley]

Yaki, I just have a question about the business model, so primarily its license and maintenance today. I'm just wondering if customers are asking you to maybe increasingly sale subscription based offerings. And I'm just wondering what the thought process on maybe going to more ratable sources of revenue overtime if that’s something that’s on the roadmap?

[Yaki Faitelson, CEO]

At this point they are not asking us to do it. We are not thinking to change them. Although, maybe in the future we will release some products that we will sale on a subscription base, but at this point the model stay the same.

[Melissa Franchi, Morgan Stanley]

And then just a quick one for Guy. Can you just remind us the percent of exposure to FX both on revenue and on OpEx, specifically for OpEx exposure to the shekel?

[Guy Melamed, CFO]

So as I said in my prepared remarks, we have a portion of our expenses in Israel and it’s mainly related to R&D. So you can see when we get close to closing our budget, we just lock in and close hedging transactions to the year and that’s mostly the exposure. There are some exposures in some of the other departments, like support in Israel and back office as part of the G&A, but the majority is related to R&D.

[Melissa Franchi, Morgan Stanley]

And on the top line, the FX exposure?

[Guy Melamed, CFO]

On the top line, we have exposure to pound and euros. We are naturally hedged in those currencies because we pay our employees in that local currency. So it's not the same exposure as the shekel where we don’t have any revenue coming from new Israeli shekel.

[Melissa Franchi, Morgan Stanley]

Is there an FX tailwind to revenue in the guidance?

[Guy Melamed, CFO]

Yes, for the year, there’s approximately 2% tailwind related to FX in those currencies.

[Operator]

Our next question comes from Alex Henderson, Needham and Company. Please proceed with your question.

[Alex Henderson, Needham and Company]

I was hoping you could be a little bit more granular on the R&D, so just want to make I understood mechanics of it. So is it 19.4% revenues in R&D? And it sounds like you’re suggesting we simply add 300 basis points to that number and then on top of that, add some non currency related spending growth. I was wondering if you were to adjust out the currency impact of what kind of growth in R&D you’re anticipating on a constant currency basis.

[Guy Melamed, CFO]

So I wouldn’t take the 300 basis points and put them all in R&D, I would just say that the majority of the FX is related to R&D, because we have great engineers team in Israel. But it is in fact as well by the support team in Israel and the back office. So I would say the majority relates to R&D. But what we have decided is not to have the FX impact our decision to invest. And I think what we’ve done nicely in 2017 is prove everyone that we can show operating margin improvement.

And if you look at the last three years alone, you will see that we improved the operating margin by close to 1600 basis points. So we know how to do that. And part of our decision now to invest in R&D and put aside the FX impact is our desire to become a billion dollar business in sales. And this is what we need to do in order to get there. And that’s why we’re putting slightly more investments in the R&D department. Does that answer your question?

[Alex Henderson, Needham and Company]

No, not actually at all. I totally understand why you are doing it, it makes perfectly good sense, it's a good business strategy and I have no issues with that. I'm just trying to get some sense of what the rate of change would be if I adjust out the currency impact. Are you increasing it modestly less than the rate of growth in your revenue guidance, excluding the impact of currency or is there some other rate of change that we should be thinking about excluding currency?

[Guy Melamed, CFO]

So excluding currency, you would still see the R&D pushing out of revenue increase slightly. But what we still want to do is we would still try and show operating margin improvement compared to 2017, excluding the FX. So if you’re looking specifically on the R&D front, the FX would impact about 220 roughly around that number basis points just from FX.

[Alex Henderson, Needham and Company]

So 5% to 10% growth in R&D excluding currency?

[Guy Melamed, CFO]

Roughly so, yes.

[Alex Henderson, Needham and Company]

And going back to the customer count, I missed the customer count. Could you give us that again?

[Guy Melamed, CFO]

331.

[Alex Henderson, Needham and Company]

And finally, you did talk about the split out DatAlert and Varonis is hedging all that. Could you talk a little bit about the scaling of that package when you separate it out, how big a package is it on a dollar per user or dollar per seat or whatever you want to measure it on relative to the other factors that you have? Is it similar size?

[Guy Melamed, CFO]

So the split that we’re doing is just from a financial reporting perspective. We are providing the information to investors and basically breaking out Varonis edge and DatAlert and they are going to be the own products families. The only reason we wanted to provide the heads up now is to be transparent when the metrics change. But there is no change in the way we've priced and there is no bundling or any combination of licenses, we’re just providing that for transparency purposes.

[Alex Henderson, Needham and Company]

So it's not changing structure or the go-to-market exposure?

[Guy Melamed, CFO]

No, this is just from a reporting perspective. This is to provide I know one of the questions that we get a lot is what are the attach rates of DatAlert. Now that DatAlert fits with Varonis Edge and we’re introducing that in 2018, it makes a lot of sense to put them together as one product family. And we’re just -- from a reporting perspective, we’ll provide the number of customers that have two or more product families and number of customers that have three or more product families starting Q1 2018.

[Operator]

Our next question comes from Mark Schappel, The Benchmark Company. Please proceed with your question.

[Mark Schappel, The Benchmark Company]

Yaki, starting with you with respect to your move up market into larger organization. So I was wondering if you could just address what you're doing differently as a company on the marketing front to make sure you're reaching the right people.

[Yaki Faitelson, CEO]

We are doing -- obviously we have many programs but just the same things we just -- we're doing more targeted marketing for thousand plus in the 10-15 verticals that are working very well. We are doing a lot of field marketing very effective one with our standard partners to new postfix and to the base, we just starting all of our marketing campaigns but that’s working very well. These are -- a lot of these organizations are just hungry for a solution like ours, so it’s working well. And in many markets, we're generating very good awareness and there is a very good brand recognition and understanding before we are there of the problems that we are solving.

[Mark Schappel, The Benchmark Company]

And as a follow up, with respect with operating margins longer term. What are the thoughts on a normalized operating margin expansion rate over the next couple of years? Is this something we could expect somewhere in the range of say 100 to 200 basis points?

[Yaki Faitelson, CEO]

So I think what we're doing right now is exactly what we said we would do. I think we're executing according to our plan. We've been able to show significant operating margin improvement when we wanted to. And what we plan to do is excluding FX headwinds. We expect to show margin improvements in 2018, and that's consistent with our philosophy. But we just feel that now is the right time to invest in R&D and improve and increase the use cases for our customers.

[Operator]

Our next question comes from Michael Kim, Imperial Capital. Please proceed with your question.

[Michael Kim, Imperial Capital]

Can you talk a little bit about the activity in the government vertical if you continue to see inflection or positive momentum as we're heading in '18? And what resources or investments you're putting into that vertical and partner leverage? Thanks.

[Yaki Faitelson, CEO]

Yes, across the all governments, we're doing very well in government. Last year we invested in the federal market and we got strong results and we believe that we're well positioned to be the same this year. The year just started, so it’s how to comment on it. But it seems that overall it’s a very good vertical for us, a vertical that understand the problem that has a lot of data, a lot of clinical data that they need to protect and we can do well there.

[Michael Kim, Imperial Capital]

And are the products they're purchasing different from what you're seeing on the enterprise side.

[Yaki Faitelson, CEO]

No, it’s the same, exactly the same.

[Michael Kim, Imperial Capital]

And then just as a follow up on the migration of cloud, or migration of IT more close to the cloud. Is that becoming an increasing driver to license growth and give you an opportunity to expand your coverage of data?

[Yaki Faitelson, CEO]

Yes, without a doubt. So we really experienced just very, very good traction with our support of Office 365 and Azure and it’s just a matter of big platform. And when we are going to a customer, they world is hybrid. So they have just data all over the place and we're licensed by user and platforms that we are supporting. And this is just same files, same file shares and almost same active directory. So it’s very easy for us to extend so it’s working very well with us and it’s working very well with new customers and without a doubt the cloud is increasing the total available market.

[Operator]

Ladies and gentlemen, we have reached the end of question and answer session. I’d like to turn the call back to Yaki Faitelson for closing comments.

[Yaki Faitelson, CEO]

Before we end the call, I would like to thank all of our employees for their contribution to our success in the past quarter and through the full 2017 year, and all of our customers and partners for their continued support. Thank you all for joining us and we’re looking forward to speaking to you soon.

[Operator]

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