Varonis Systems Inc
NASDAQ:VRNS

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Varonis Systems Inc
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Earnings Call Transcript

Earnings Call Transcript
2019-Q4

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Operator

Greetings, and welcome to Varonis Systems, Inc’s. Fourth 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. [Operator Instructions] 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.

J
James Arestia
Director of Investor Relations

Thank you, operator. Good afternoon. Thank you for joining us today to review Varonis' fourth quarter and full-year 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.

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 first quarter and fiscal year ending December 31, 2020.

Actual results may differ materially from those set forth in such statements. Important factors, such as risks associated with anticipated growth in our addressable market, competitive factors, including; increased sales cycle time; changes in the competitive environment; pricing changes; transition and sales from perpetual licenses to a subscription-based model; 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 and cybersecurity solutions; risks 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 resell our 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 service 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 people 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 2019 earnings press release, which can be found at www.varonis.com in the Investor Relations section. Also, please note that an updated investor presentation as well as a webcast of today's call, are 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?

Y
Yakov Faitelson

Thanks, Jamie, and good afternoon, everyone. I am thrilled to speak with you today as we review our 2019 performance and discuss our expectations for 2020. 2019 was truly a monumental year for Varonis for many reasons, none bigger than the pace of our transition to a subscription model.

Going into the transition, we believe that customers who purchase five or more licenses will more likely to buy even more licenses because of the value they receive. What we didn't know was how eager existing customers would be to purchase additional licenses to subscription. We also didn't know how well our salesforce would take to the new model.

A year later, it is an understatement to say that the transition has proceeded much faster than we expected. I will leave it to you to decide if this was the fastest transition in history, but in any case, I am extremely proud of the team's strong execution and what they have accomplished this year.

We just had our 2020 sales kickoff, I'm always excited to spend time with our colleagues from around the world, see their enthusiasm and hear about the differentiated value we deliver to customers. The stories this year made it crystal clear that the power of our platform has never been stronger and the need for our platform has never been greater.

Over the last year, we have truly transformed building the foundation for a durable and scalable subscription business. This achievement speaks to how eager customers are to adopt our platforms to subscription and the urgency to reduce risk detect and respond to threats and address privacy and regulatory compliance in both on-prem and cloud stores.

Let's go over our results. For the first quarter, total revenues were $72.6 million, with 82% of license revenues from subscriptions, exceeding our guidance of 75%. For the full-year, total revenues were $254.2 million, with 65% of license revenues from subscriptions. We are very pleased to have achieved this 65% full-year subscription mix compared to our expectations of 10% at the beginning of the year.

As we look at across regions, North America had a very strong year, as the teams immediately embraced our subscription transition and quick time to value it creates for customers. After a slow start in EMEA in 2019, the team has completely embraced the new subscription model and we feel good about the 2020 pipeline in that region.

Before Guy discuss the financial results in great detail, I want to talk today about three strategic topics. First, the secular trends that continue to benefit Varonis; second, the opportunity we see to continue to provide substantial value to our customers; and finally, our evolution into subscription business, and how this will accelerate our flywheel and propel the business forward.

First, let's discuss the secular trends, where everything starts and end with data. With massive data growth both on-prem and in the cloud, data protection is not a project with the finish line, but an ongoing challenge for CISOs that require data-centric solutions, the number one problem in data protection is overexposed sensitive data.

We have spoken many times how many exposed folders and files we find during the risk assessment. In 2019, we looked at over 1,000 organizations and found that they created on average over 1.2 million exposed folders in a single quarter. These folders are opened to every employee. Why? Data growth, data migration, human errors, and merger and acquisitions.

Organization now can either use automation to remediate these exposures or they can accept potential existential risk. At the same time, this threat landscape is becoming increasingly sophisticated, powerful cyber weapons created by experts and even government agencies are now in the hands of common cyber thiefs. We see them every day, as we help organization detect and investigate malware and investor system threats.

Before we get there, we see that organization into detect very little or they are drowning in alerts. All of this is happening while companies face an evolving regulatory environment around data and privacy. This is the day-to-day reality for our customers, who are limited by scarcity of security talent.

As a result, company increasingly turn to Varonis for the automation our platform delivers, they get actionable insight into their hybrid data, meaningful efficient detection and rapid ongoing remediation.

Our objective is to be the primary vendor for enterprise to protect their data while we started in 2005 with one license. The Varonis Data Security Platform has evolved over the last 15 years to 26 licenses across six product families and today addresses three premium use cases; data protection, privacy and compliance, and threat detection and response.

The 2018 release of Version 7 was the quantum leap forward for Varonis and for our customers, with enhancements like new dashboard for Office 365, Active Directory and GDPR, sort of for dramatically faster investigations and automated data subject access request.

Our customers can clearly visualize the risk perform accurate data classification at scale, detect and respond to threats and remediate data exposures almost effectively and efficiently than ever before. And we installed Version 7 during the risk assessment and show them where those sensitive data stored, scale or exposed on-prem on cloud data stores. When we show them how they can rapidly detect and investigate attacks on insiders, malware and APTs and when we show them our plan for getting things under control without much manual effort, our operational journey, it is very powerful selling tool.

This is why the evolution of Varonis to a subscription company makes sense and why in just four quarters over 80% of our license revenues are coming from subscriptions. Subscriptions allow customers to invest in more of our platform upfront while leaving room for meaningful expansion over time.

Customers who make larger initial purchases to greater automated value, and we expect they will buy more products from us in the years to come. In selling the platform, our relationship have become much more strategic and we are spending much more time with our customers as we uncover more pinpoints and involve additional stakeholders within the customer. We can address more use cases and help them reach the value target.

For example, during the risk assessment for the U.S. financial institution, Varonis Edge flag suspicious network activity from an account belonging to a formal employee. The CIO and VP of IT were convinced. They were blind when it came to those sensitive data and needed Varonis to secure it and monitor for suspicious activity.

In Q4, this Company became a new customer purchasing subscription for six products, including DatAlert Edge and Automation Engine. Now, they are able to monitor threats from the perimeter and resolve the global data exposures, reducing the risk in days, not months or years.

Another example of the recent strategic win for the U.S. County that decided to take proactive steps to avoid becoming the next ransomware victim. The risk assessment revealed nearly 25,000 folders and over 11,000 sensitive files open to every employee in the organization. All of these files would be at risk if even a single endpoint was infected with ransomware.

In Q4, this county purchased subscriptions for five Varonis products. Now, they will be alerted to suspicious events that could be early indications for an attack and automatically lock down compromise hose before it is too late. These are just two of many great examples of customers who can now invest in the Varonis platform and more quickly deliver value because of our transition to a subscription model.

When we made the decision to transition, we knew that the rapid evolution of our business model requires discipline and focus, and that we needed to manage change across the large organization. We had to put new compensation plan and convert a pipeline of hundreds of millions of dollars as quickly as possible. I want to thank our team for the remarkable joint effort in 2019 in transitioning the Varonis model at such a rapid pace.

So what does all this means? Simply put, we are focused on selling our platform and delivering value to customers. Our model transition make it easier to do so, as customers are adopting a greater part of the platform more quickly to impose the initial land and the following expansion deals.

The secular trends in tailwinds and our focus on innovation has resulted in an integrated and automated platform to help our customers with highly complex security challenges. We are extremely pleased with 2019 and we know that execution in 2020 and beyond will accelerate our flywheel and propel us toward our $1 billion target.

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

G
Guy Melamed

Thanks, Yaki. Good afternoon, everyone. Fourth quarter results capped an outstanding year of subscription transition with 82% of license revenues coming from subscription, compared to our guidance of 75% and 62% year-over-year growth in ARR to $210.5 million.

Throughout the year, you've heard me discuss the fourth quarter where we have the highest number of renewals as the final test in our subscription transition. Would existing customers adopt subscription on a large scale? The great news is that we passed with flying colors, with the highest contribution from existing customers this year at 57%.

Not only did our existing customers renew the maintenance of their perpetual licenses, they added to their Varonis deployment with additional licenses under the subscription model, far exceeding our expectations heading into the quarter. While this dynamic generated a modest revenue headwind this quarter compared to the Q3 contribution from existing customers of 50%, it underscores that we are a subscription company and the opportunity that we see ahead.

Now, let's turn to results. Total revenues for Q4 were $72.6 million, in the upper end of our guidance range despite the higher than guided subscription mix. Fourth quarter license revenues were $38.4 million, which included $31.6 million of subscription revenues.

New subscription customers continued to buy on average between four and five licenses in the initial deal compared to purchasing between two and three licenses under the perpetual model. Lastly, maintenance and services revenues were $34.2 million. Maintenance renewal rates on perpetual licenses once again exceeded 90% in the fourth quarter.

As mentioned, ARR was $210.5 million as of the end of Q4 and grew 62% compared to last year. This significant increase correlates with a much greater contribution we are seeing from subscription revenues, a more predictable and recurring revenue stream and reflects the underlying health of our business.

Looking at the business geographically, North America revenues were $49.4 million or 68% of total revenues. In EMEA, revenues were $19.5 million, representing 27% of total revenues. Rest of World revenues were $3.7 million or 5% of total revenues. We added 229 new customers during the fourth quarter and we ended 2019 with approximately 7,100 customers.

Much like the previous few quarters, the difference in year-over-year Q4 new customer adds was again associated with the smallest user group, companies with fewer than 500 employees. As of December 31, 76% of our customers had purchased two or more product families, up from 73% at the same time last year. 45% of our customers purchased three or more product families, compared with 40% in Q4 of 2018.

Turning back to the income statement, I'd like to point out that we will be discussing non-GAAP results going forward. Gross profit for the four quarter was $63.5 million, representing a gross margin of 87.5% compared to 91.7% in the fourth quarter of 2018. This reflects the higher mix of subscription revenues and our continued investment in our customer success teams to support the transition.

Operating expenses in the fourth quarter totaled $65.9 million. As a result, our operating loss was $2.4 million or an operating margin of negative 3.3% for the fourth quarter, compared to operating income of $15.5 million or an operating margin of 17.7% in the same period last year.

While the transition continues to have a short-term impact on our financial results, we are committed to profitability and expect to show progressively improving operating leverage as we move through 2020 even with our continued investments to grow the business and capitalize on the market opportunity.

During the quarter, we had financial income of approximately $339,000 primarily due to interest income. Our guidance does not consider any potential impact to the financial and other income and expense associated with interest income or any impact related to foreign exchange gains or losses as we don't estimate movements in foreign currency rates.

Our net loss was $2.8 million for the fourth quarter of 2019 or a loss of $0.09 per basic and diluted share compared to net income of $17.3 million or income of $0.53 per diluted share for the fourth quarter of 2018. This is based on 30.5 million basic and diluted shares outstanding for Q4 2019 and 32.5 million diluted shares outstanding for Q4 2018.

Turning to the balance sheet, we ended the year with $125 million in cash and cash equivalents, marketable securities and short-term deposits. For the year, we used $10.7 million of cash from operations compared to generating $23.5 million of cash from operations in 2018.

As a reminder, we are collecting on annual contract value amounts in this transition and therefore, we continue to see a short-term impact on cash flows. We ended the year with 1,574 employees, an 8% increase from the end of 2018.

Moving to guidance. As mentioned in the previous earnings call, I want to reiterate that 2020 is a year of two halves. In the first half of the year, the subscription mix will be significantly higher than it was in the first half of 2019 when we were at the beginning of the transition.

As a result, we will continue to face material revenue headwinds in the first and second quarter. At the same time, our expenses are relatively fixed. As a result, there will be short-term pressure on our operating margins in the first half of the year, which we expect to alleviate in the second part of the year. Taken together, we expect that revenue growth and margin expansion will sequentially improve each quarter as we progress throughout the year.

For the first quarter of 2020, we expect total revenues of $59 million to $60 million, representing growth of 5% to 6%. We expect our non-GAAP operating loss to range between negative $17.3 million to negative $16.5 million and non-GAAP net loss per basic and diluted share in the range of $0.57 to $0.55. This assumes a tax provision of $400,000 to $600,000 and 30.9 million basic and diluted shares outstanding.

For the full-year, we expect total revenues in the range of $286 million to $292 million, representing growth of 13% to 15%. We expect our full-year non-GAAP operating loss to be in the range of negative $27 million to negative $24.8 million and non-GAAP net loss per basic and diluted share in the range of $0.93 to $0.89. This assumes a tax provision of $2.2 million to $3.2 million and 31.4 million basic and diluted shares outstanding.

There are some additional points to consider as you think about 2020. First, we handle foreign exchange rates by entering into hedging contracts. In 2020, those contracts result in an approximate 100 basis points headwind to operating margins compared to 2019, which is reflected in our guidance.

Second, on a quarterly basis, we will be providing total customer accounts only starting with the first quarter of 2020. Third, we expect that CapEx in 2020 will be in the range of $10 million to $14 million. And finally, we expect that the subscription mix in 2020 and going forward will be in the 90% plus range.

In summary, this was an outstanding year for Varonis as our rapid transition to subscription has transformed the company and strengthened our fundamentals. We feel good about the business and we will continue to invest while balancing growth and profitability, which has been our philosophy for many years. I want to thank the team for their contributions in 2019 and we are excited to continue our momentum in 2020.

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

Operator

Thank you. At this time, we will be conducting a question-and-answer session. [Operator Instructions] Our first question comes from the line of Brent Thill with Jefferies. Please proceed with your question.

U
Unidentified Analyst

Hey guys, thanks. This is Howard on for Brent. I have a question for, Guy. I was hoping that you could help me reconcile to potentially conflicting data points, so that 57% of license in first-year maintenance that attributable to existing customers. So that was a significant uptick as you pointed out. But at the same time, the number of new customer adds, the 229 this quarter, that's been declining about 20% over the last four quarters or so. So within the framework of land and expand, it might seem that more of the new business growth is coming from the expand portion. So is that a fair statement? And is that consistent with your internal plans?

G
Guy Melamed

Let me try and break that into the two components of it. When we look at the new additions, the new customer adds, in the last couple of years, we've been focused not only on the number of new customers we bring in, but on the quality of those customers, and we've been focused on the customers with the lower user count, the ones that are over 1,000 employees, and that's been working very well for us.

So when you think about the delta between the new customer adds that we've had in the last couple of quarters compared to the previous year, the delta really relates to the lowest user group, the companies with less than 500 employees and that's been very consistent with our strategy and that's been working very well.

In terms of the existing customer – the license coming from existing customers, yes, as you point out, that was very healthy this quarter. We always said that Q4 was a test for us. We wanted to make sure that customers not only renew their maintenance of perpetual license, but add additional licenses with the subscription model and that worked very well for us in Q4. We passed that test with flying colors.

So the 57% of license from existing customers did generate minor revenue headwind compared to the guidance, but really shows how strong the business is, and the reason we raised our 2020 subscription mix to be 90% plus.

U
Unidentified Analyst

Thanks, Guy, and that's really helpful on the color on moving up market. And if I just may have a follow-up for, Yaki, a related question on – just on the renewal rates. So given – now that you've fully lapped transition to the subscription model, any insights that you have to changes to renewal rates for the legacy on-prem base that is now subscription, that'd be helpful? Thank you.

Y
Yakov Faitelson

At this point, we haven't seen any change. So for us, it's the same trend.

G
Guy Melamed

Let me add some color there. When we look at the renewal rate for perpetual license, maintenance coming from perpetual license, that's been over 90% and we're very happy with that. We don't see any change there. In terms of the renewal coming from the subscription, from renewals there, we've seen in the past renewals is an opportunity to upsell to existing customers. We've actually seen that in the second part of 2018 is when we had the pilot and we saw that, that came as an opportunity for us to actually upsell to customers in the second part of 2019 as well. It's still a small sample, but we're very happy with that.

U
Unidentified Analyst

Okay. Thank you, guys.

Y
Yakov Faitelson

Thank you.

G
Guy Melamed

Thanks, Howard.

Operator

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

M
Melissa Franchi
Morgan Stanley & Co. LLC

Great. Thanks for taking my question. Maybe I'll start with Europe, and just trying to understand what's going on there. It looks like the declines accelerated this quarter, but it's hard to understand if it's the subscription transition or if it's something fundamentally. Yaki, can you just maybe talk about what you're seeing in Europe and how the salesforce has been adopting subscriptions in that region?

Y
Yakov Faitelson

Yes. As you know, we started the year with some friction in Europe and we need to make some leadership changes. And really took us close to five months to make sure that we have all our ducks in a row. And the top priority for the year was to move to be a subscription company.

So we did really in one year, what takes to most company that managed to do the transition four to five years. And the Q4 mix in EMEA was better than the 82% mix for the company. So we believe that we are in a good place. We feel good about the pipeline and the team is well positioned to do well in 2020.

M
Melissa Franchi
Morgan Stanley & Co. LLC

Okay. That's very helpful. And a follow-up for Guy. I know you're not guiding to ARR growth next year, but I'm wondering if you could just help us put maybe some parameters around what we should expect next year, particularly as we're getting into more difficult comps in the second half of the year. How to think about that relative to revenue growth? Thanks.

G
Guy Melamed

Absolutely. So we talked about 2020 being the year of two halves. When you think about the first part of the year, we still have some revenue headwind because the subscription mix in the first part of 2020 will be higher than the subscription mix we had in the first part of 2019. So the revenue headwind will actually have kind of the reverse relationship in terms of ARR. We should see ARR grow at a higher number there.

And then in the second part of the year, where it's much more apples-to-apples on a revenue basis, the ARR should be closer to the revenue growth and that's kind of the way to think about it throughout 2020.

M
Melissa Franchi
Morgan Stanley & Co. LLC

Got it. Thank you very much.

G
Guy Melamed

Thank you.

Y
Yakov Faitelson

Thanks.

Operator

Our next question comes from the line of Matt Hedberg with RBC Capital Markets. Please proceed with your question.

M
Matthew Hedberg
RBC Capital Markets, LLC

Hey, guys. Thanks for taking my questions. Obviously the ARR growth was impressive well above where I think a lot of us were thinking this quarter. And I guess to follow-up on Melissa's question, thinking even a little bit longer term, so not just 2020, but longer term, now that we're through the, effectively the end of the transition and that mix is now 90% plus. Is there a way that we should think about a framework for sort of like sustainable ARR growth? Or maybe said differently, just underlying market growth? I think it's kind of helpful when we think about even longer term than just 2020.

Y
Yakov Faitelson

Yes. Hi, Matt. I think that the overall, the underlying market growth, what we're seeing empirically is that anybody with unstructured data and critical infrastructure needs Varonis. What is really changed significantly is our ability to go up market in a very predictable way and also that customers are buying much more. The overall customer lifetime value, when we engage with the customer in the right way, really increasing leaps and bounds.

Just to understand, we are doing extremely well with everything that's related to the Cloud 365, we have six licenses there. We have Azure AD, and OneDrive Online and SharePoint Online and Exchange and the two DCs. So when we engage with customers, we can take so much more and add so much more value.

For us when the transition will kick in, so when the flywheel will kick in, the higher mix subscription will start to kick in, in the later quarters of this year. We believe that we can do a – we can start to show overall very healthy growth. And we can – when we believe that we can maintain 20%-plus growth for a long time.

M
Matthew Hedberg
RBC Capital Markets, LLC

Super, helpful. And then I know Yaki, you've talked about one of the byproducts of this transition has been reduced friction in sales processes. And considering how quickly you've moved through this transition, when you think about 2020, are there additional steps that you're taking from a go-to-market perspective to maybe even further reinforce the value proposition that you guys delivered there?

Y
Yakov Faitelson

No, we changed. We changed so many things. We have this – the way that we go-to-market, we have what we call the Value QBR, the way that we are mapping how we are taking the customers to value and we also see that all the products really working. We really sell everything in the platform.

And the big change, Matt, was that customers are willing to spend a lot of time with us. We see more C-level people. Our dashboard is being used by, and the reports by business people. And what we want to make sure is that we will master this skill, that form being very opportunistic and starting small and growing, we need to start being and go bigger.

We see that many customers are starting with six licenses and we just see a path with many, many, many customers and prospects to go to 12 and 15 and more licenses. There is just a clear path. And in one-year, I can tell you that it's a completely different business, completely different sales motion and completely different way that the customers are getting the value.

We are just becoming so much more strategic with our customer base, and really was – how the platform is fitting to the overall market condition and our ability to spend more time with customers and then they are bringing the right people and we are able to show them in a very quantifiable way, how we are providing business value immediately and ongoing.

M
Matthew Hedberg
RBC Capital Markets, LLC

Super, helpful. Thanks.

G
Guy Melamed

Thanks, Matt.

Operator

Our next question comes from the line of Alex Henderson with Needham. Please proceed with your question.

A
Alex Henderson
Needham & Company, LLC

Great. Thank you very much. Great job, guys. Really impressive. I was hoping you could talk a lot about deal process time and deal sizes and what the pipeline looks like? Clearly, selling a subscription is a little bit harder exercise than selling perpetual. You had a very tight pattern around perpetual. Has that lengthened the process time to get deals done? And obviously you're selling a lot more subscriptions. I would assume that's also in turn increasing deal sizes. Can you give us any sense of those two dynamics and what the pipeline of leads looks like? Thanks.

Y
Yakov Faitelson

Yes, thank you. So in terms of the sales cycles, they relatively stay the same. But in terms of our time to spend with customers, we spend more time with them, and they are willing to spend much more time with us, and we are able right off the bat just to sell them more licenses. And so this is really what we see the ability to sell more of the platform upfront and overall ongoing.

And one of the things that we see now that most of our pipeline is subscription pipeline. Last year, we almost forcefully, really transitioning from perpetual to subscription, and Q4 was a huge test, Alex.

Getting into Q4, that it's CapEx heavy, and to do this 82%, we saw part of the team. It was just an unbelievable achievement. And now that everybody knows, the customer knows, and all of our salespeople that this is done, we are a subscription business and all the pipeline and most of the quotes is a subscription pipeline, it's we are in a very good position just to sell the platform and in significantly frictionless way to get the subscription deal.

G
Guy Melamed

And Alex, just to add on that, when we sold perpetual licenses, we usually had in the initial sale between two to three licenses. We saw under the subscription model that new customers by between four to five licenses. We saw that in the first three quarters of 2019, and that was consistent in the fourth quarter. So we're very happy. And the increase in number of licenses hasn't changed our sales cycle.

A
Alex Henderson
Needham & Company, LLC

Okay. One last question if I could, just a follow on there. To the extent that you're selling now a lot more license, getting a lot more automation upfront. I assume that the installation happens faster as well as a result of that and time to value happens faster. So is there also now that you've got a year's experience under your belt, some evidence to suggest that the time to the next upsell is also faster? Thank you.

Y
Yakov Faitelson

Thanks, Alex. In terms of actual installation, it's the same, but when they are buying more licenses, they get extremely fast automated value. And this works very well. And we still have, just initial indicators, so we can say that these are stationary trends, once we understand it more, we are going to communicate to you what exactly we see. But we just want to make sure that these trends are really solid before we are telling you that this is something that it's worth to pay attention to.

A
Alex Henderson
Needham & Company, LLC

Great. Thanks for the color.

Y
Yakov Faitelson

Thank you.

Operator

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

S
Saket Kalia
Barclays Bank PLC

Hey, Yaki. Hey, Guy. How are you guys doing?

G
Guy Melamed

Good, thank you.

S
Saket Kalia
Barclays Bank PLC

Yes, absolutely. Hey, Guy. Maybe first for you. Maybe thinking about the subscription transition from a slightly different angle from expense perspective actually, I believe there were strong sales incentives this year to really encourage that behavior around leading with subscription, clearly, was very successful program. I guess now that we're at the tail end of that transition, how does sales comp change, high levels of course but qualitatively to really maybe start to drive more leverage in the business?

G
Guy Melamed

Let me try and break that question on the commission side, but also take the opportunity to talk a little bit about the expense as a whole for Q1 and 2020. And I'll start with the comp. When we looked at the comp, we had to make sure that the sales reps are incentivized to do the right thing. I think the comp plan was done very well in a sense that it rewarded the reps for doing things that were beneficial for the Company, and we're keeping most of that going forward.

There is not any major changes going into 2020. The only small component is that we're dealing with OPS renewals, with subscription renewals, which were compensating the reps, but obviously at a lower percentage than bringing new business in. That kind of relates to the comp.

In general, in terms of the expense side, because this is a year of two halves and we talked about that in the prepared remarks and in one of the previous questions and the expenses are relatively fixed and that really results in some short-term pressure on operating margins in the first half of the year, but that should be alleviated in the second part of the year, and we expect to show sequential margin improvement going through 2020.

S
Saket Kalia
Barclays Bank PLC

Got it. That's really helpful, Guy. Yaki, may be for my follow-up for you. I think we mentioned earlier that, in the maintenance business, the renewal rates there, I think, continue to be pretty strong at 90% plus. I guess, the higher level question is, how do you sort of envision maintenance customers over time? I mean, is there an opportunity to maybe more proactively convert them to subscription, or is that just maybe more of a natural evolution for them to opt in for subscription? Does that make sense?

Y
Yakov Faitelson

It makes sense, but for us, we are selling subscription and the maintenance subscription, it's a subscription business, and what we want to do and is just to make sure that everything else they are buying is going to be just subscription and what is very important for us is that the subscription model let us really unlock the potential of the platform.

So what is important for us is to go to these customers that have two, three, four licenses and make sure that within two, three years, they will have 15 licenses. And we believe that with many of them, we have clear path of how to do it. So we have this tremendous base.

With so much potential, we now have a clear path in terms of budgets and their ability to buy it. It's just to say, let's do everything, let's make sure that on your protected on-prem and in the cloud and have all the automation and really addressing the three use cases, everything that related to data protection and privacy and compliance and threat detection and response.

And we just believe that we have a clear path and this is how we also to think about the transition in one year, we transitioned, then we also really hitting a very nice scale. And this is because the base is buying. And as Guy said, Q4 was the – we can make test because it's customers that are – but were usually buying perpetual and have these perpetual renewals. They are coming and just buying more and more with subscriptions.

So after the fourth quarter, I can tell you that we really have clear visibility and a lot of evidence from the base that we can take this enormous asset that we have with the 7,000 customers and really make sure that they will use the platform and increase drastically to overall customer lifetime value.

S
Saket Kalia
Barclays Bank PLC

Very helpful. Thanks guys.

Y
Yakov Faitelson

Thank you.

Operator

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

C
Christopher Speros
Stifel, Nicolaus & Company, Inc.

Hi. This is actually Chris Speros on for Gur. And Yaki, to just piggyback on what you just were describing. The subscription model continues to yield four to five licenses upfront versus two to three for the perpetual model. With more than a full-year of subscription selling and a better understanding of the subscription renewal process, how should we think about the degree to which the subscription model can enhance potential customer LTV in the long-term?

Y
Yakov Faitelson

It's drastically. We just see now that all the products are working and customers are really trying to buy everything that we have for the three use cases. And it just makes sense for us to spend a lot of time with them and when they are buying more initially, it's much easier to upsell and just every sales campaign becoming so much more predictable.

C
Christopher Speros
Stifel, Nicolaus & Company, Inc.

That makes a ton of sense there. And one more in regard to the competitive environment. Historically, Varonis wouldn't count a competitor, while performing a risk assessment and one out of every 30 or so assessments. Does this remains the case or has your persisting outsized growth resulted in a more crowded market?

Y
Yakov Faitelson

No, we don't see more competition. In terms of the competition landscape, it's the same.

G
Guy Melamed

Thanks Chris.

Operator

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

C
Chad Bennett
Craig-Hallum Capital Group LLC

Great. Thanks for taking my questions. Nice job on a strong year end. By my math, the EMEA business from an execution standpoint did really well in the fourth quarter, so congrats on that. So I guess Guy, if we look at the guide for fiscal year 2020 in the implied growth rate on the subscription side, it's 90% plus of growth, and I think a lot of people are trying to ask us in different ways, but if we kind of look at whether it's net new growth in that 90% number or cross-sell, upsell in that number, kind of how would you think about what's going to drive subscription growth this year? And maybe you have targets on where you end in terms of two plus products and three plus products and so forth that you'd care to share. Thanks.

G
Guy Melamed

Thanks for the question. I think the subscription transition really unleashed the platforms potential. So we saw both new customers buying more licenses as I discussed in the previous question, but we also saw our existing customers embracing this transition and buying licenses under the new model.

So when we think about what's going to drive 2020 and the reason we kind of upped up that subscription mix to be 90% plus goes back to how well we felt Q4 was. Q4 as we talked in the prepared remarks was really a test to make sure that customers are buying and the existing customers not only renew the maintenance of perpetual, but they buy additional licenses under this new model.

So when we think about 2020, we think that both new customers will continue to buy subscription. We think that we have a tremendous opportunity within our existing customer base for them to buy additional licenses under the subscription model. And also, like I said before, the renewal of subscription is an opportunity to upsell to those customers. So all of those components together give us kind of the confidence to the 90% plus number we guided for.

C
Chad Bennett
Craig-Hallum Capital Group LLC

And the renewal on the subscription customers that you're lapsing or annualizing. I mean, do we think that uplift is kind of a 20% CAGR annually. I'm thinking in terms of like a net expansion number. Maybe, it's too early to talk about that, but how should we think about that if you care to frame it in anyway? Thanks.

G
Guy Melamed

So the right way to look at it is that looking at the NRR, but the NRR kind of the earliest to have meaningful data is at the end of this year. So we don't want to jump the gun and jump to conclusions. We feel that the numbers are healthy, but the right way to look at it is at the earliest at the end of this year.

C
Chad Bennett
Craig-Hallum Capital Group LLC

Okay. Thanks guys. Nice job.

G
Guy Melamed

Thank you.

Y
Yakov Faitelson

Thanks, Chad.

Operator

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

H
Hannah Rudoff
D. A. Davidson & Co.

Hi guys. This is Hannah on for Rishi. Thank you for taking my questions today. I know you guys have mentioned spending more time with customers now under this new model. I was wondering if you could talk about if the role of resellers has changed all under the subscription model. So any color you could provide would be great.

Y
Yakov Faitelson

Hi. The role of resellers didn't change, but we feel that we became significantly more important to the partner community just because the annuities. They have this very nice deals that customers can renew every year. So it makes sense for them to support their customers and support the effort they can get from Varonis every year, much more. So overall, it didn't change, but definitely becoming much more important to the main partners.

H
Hannah Rudoff
D. A. Davidson & Co.

Okay. Great. And then, I know it might be a little early for this question, but is there anything you can mention about the growth trajectory of what a customer looks like beyond the adoption of initial purchase? And if you've noticed any trends more broadly among new customers?

Y
Yakov Faitelson

We can't mention it now like just a trend and what we can expect from every customer, but just we can tell you that all the products are selling, the cloud is doing extremely well everything that related to 365, and we can see that customers can exponentially grow the amount of licenses that they have.

H
Hannah Rudoff
D. A. Davidson & Co.

Okay, thank you.

G
Guy Melamed

Thanks, Hannah.

Operator

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

D
Daniel Ives
Wedbush Securities Inc.

Yes, thanks. So when you guys getting this – when you get into a deal and you actually get an assessment, I mean what percent those deals from a high level you think you're winning?

G
Guy Melamed

So we don't actually breakdown the numbers, but let me give you some color. When we are able to get into the room, the right people high enough within the organization and we can get the CISO in and we show the risk assessment, that's kind of the jaw dropping moment when a lot of the companies realize how vulnerable they are and how much sensitive data, sometime it's just sitting there. So, it really is a question of who we get in the room and when we have the right people in the room, the rates are really good.

D
Daniel Ives
Wedbush Securities Inc.

Great. Okay. Look, I asked the last quarter also again, Guy, when is the subscription ARR in the quickest time that most people have ever seen seminar, could you just let us know? Thanks.

G
Guy Melamed

I told you we signed you up as the first participant.

D
Daniel Ives
Wedbush Securities Inc.

Okay, just let us know in 2Q. Thanks.

G
Guy Melamed

Thanks, Dan.

Y
Yakov Faitelson

Thanks, Daniel.

Operator

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

S
Shaul Eyal
Oppenheimer & Co. Inc.

Thank you. Hi, good afternoon, guys. Trying to build on some prior questions from an ARR perspective and I know it might have been a little late to the call. Is there any magic number from a subscription respective or subscription customer needed to sustain the strong ARR growth we have seen?

I know, Yaki, you mentioned before six subscriptions because look at the shift to subscription has really accelerated modules adoption, but you guys have an additional, I think like 18 to 20 additional modules to upsell. So how should we be thinking about it within this framework?

Y
Yakov Faitelson

Hi, Shaul. We have close to 25 licenses, and we really believe that many of our customers can use a lot of them. So, I think that, with time, we'll see how it depends on working, but just initially, we saw that so many of them are getting more than 10 licenses. So we still can't have just a plug number in terms of licenses and ARR, but we understand very well how the value works and how the overall customer lifetime value works. So the main thing that we can tell you that the model is really unlock the ability of our customer base to consume the innovation and get much more value.

S
Shaul Eyal
Oppenheimer & Co. Inc.

Understood. And as we think about the ongoing investments into 2020, I think also, Guy, in the context of two halves of the year, where is it exactly that you guys are putting money to work, and I think also from a geographic perspective, how should we be thinking about it?

G
Guy Melamed

So the way we're thinking about the investments is really kind of across the Board. In terms of the sales department, we want to invest and hire sales people because it takes us up to 12 months to get a rep in the mature territories to be fully productive and we want to put that investment to work.

Knowing that we have some short-term pressure because of the headwind of revenue, but it's still makes a lot of sense to make those investments right now on the sales front. We've also had tremendous ROI on investments we had on the R&D department and we want to continue to invest there.

And on top of that, we're investing in customer success and professional services to support the subscription transition. So our philosophy hasn't changed. We want to continue to invest in a responsible way because we're focused not just on the growth side of things, but we're focused on profitability.

And we've always had that in mind, and we're continuing, we are very committed to profitability. We just understand that there is some short-term kind of wins because short headwinds because of the revenue side, but we're trying to invest wisely on all fronts. In terms of the geographies, I'd say in terms of the investments mostly in North America because of the potential that we have there and kind of the second in line is EMEA.

S
Shaul Eyal
Oppenheimer & Co. Inc.

Understood. Well done, guys.

G
Guy Melamed

Thank you.

Operator

Ladies and gentlemen, we have reached the end of our question-and-answer session. And I would like to turn the call back over to Mr. James Arestia for any closing remarks.

J
James Arestia
Director of Investor Relations

So, thanks everyone for joining the call today. Just wanted to let everyone know that we will be at the JMP Technology Conference in San Francisco on February 24. That presentation will be webcast with the link on our Investor Relations website. And we look forward to speaking with everyone throughout the quarter. Please don't hesitate to reach out to me with any questions. Thanks, again.

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.