Varonis Systems Inc

NASDAQ:VRNS

Earnings Call Transcript 2022-Q4

[Operator]

Welcome to the Varonis Systems, Inc. Fourth Quarter 2022 Earnings Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded.

And it is now my pleasure to introduce to you, Tim Perz with Investor Relations. Thank you, Tim. You may begin.

[Tim Perz, IR]

Thank you, operator. Good afternoon. Thank you for joining us today to review Varonis' fourth quarter and full year 2022 financial results. With me on the call today are Yaki Faitelson, Chief Executive Officer; and Guy Melamed, Chief Financial Officer and Chief Operating Officer of Varonis. After preliminary remarks, we will open 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 our future operating results for our first quarter and full year ending December 31, 2023. Due to a number of factors, actual results may differ materially from those set forth in such statements. These factors are set forth in the earnings press release that we issued today under the section captions, 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 of any -- 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 2022 earnings press release and investor presentation, which can be found at www.varonis.com in the Investor Relations section. Lastly, please note that a webcast of today's call is 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, President, Co Founder and Chairman]

Thanks, Tim, and good afternoon, everyone. Thank you for joining us to discuss our fourth quarter and full year 2022 performance. I would also like to provide an update on our new SaaS offering and updated outlook.

We are at a very exciting time in our story as we introduce Varonis SaaS to the world nearly 100 days ago. Varonis SaaS is a big milestone for us is the first version of Data Advantage, the birth of our company. At the same time, there is a lot of uncertainty in the world, whether it is inflation, raising interest rates, growing layoff announcements or just general economic slowing.

In the midst of all of this uncertainty, one thing is certain, whatever will happen in the world, people with eat, sleep and create data and that data needs to be protected.

Turning to our fourth quarter results. It is still very early, but the initial reception to our new SaaS platform was encouraging and that business performs better than we expected, though of a very small sample size. At the same time, the slowing macro environment continued to impact our customers. Our fourth quarter ARR came in above the high end of our guidance range we provided you last quarter. Although our reported growth remains below the goals we had at the start of the year.

Guy will review the quarterly results and our outlook in more detail, but the initial performance of Varonis SaaS gives us additional confidence in our ability to weather this current economic environment and emerge from this transition with healthy growth and profitability on our path to achieving $1 billion in ARR.

Now I would like to take a step back and take a moment to remind you of the importance of what we do. Data is the most valuable assets for any company, second only to its people. If you have data, someone wants it. Everything depends on it, but data is completely out of control.

Companies who don't know what data they have or where it is, employees have too much access to weigh too much data on too many systems. This is a problem for every organization today, regardless of size, industry or geographic location.

When we started, we needed to evangelize the problem. Today, everyone knows that data security is important, but without Varonis, the struggle to locate their sensitive data, see who has access to it and safely lock down without disrupting their business.

Securing data continue to get harder as massive on-prem and cloud repository growth. In the past few years of hybrid work, cloud and remote device usage exploded and together expanded their attack purpose by order of magnitude, whether it is APT, cyber criminals or home insider. There will always be a vulnerable system somewhere in this massive attack surface, and all it takes is one compromised user of machine to inflict significant amount damage, while the main attacker views will change, their end target, data, is always the same. You can replace an endpoint, you can rebuild an infrastructure, but once attacker gets to the data, it is all over. You can't enrich data. This is why data protection is the most important security problem to solve.

With SaaS, we reduced the customer effort needed to solve this problem with significant automation that is built into the software. Although there are many benefits has to get from our SaaS platform, I would like to outline the top three. First and most important, customers are much better protected with much less effort. Varonis has much more automation to find and lock down exposures that come from over sharing, unneeded access and misconfiguration. We have more visibility into usage and behavior on all data stores that matter the most, which enhances our ability to detect and respond to attack.

With our enhanced visibility, we now offer proactive incident response for SaaS customers, providing another layer of protection, again, reducing customer effort, continual automatic updates enable customers to stay in front of new and evolving threats and regulation and all of this is delivered faster.

Second, SaaS is easier to deploy and has significantly lower infrastructure costs and should result in quicker time to value. And third, SaaS is easier to maintain and upgrade, which saves our customers time and headcount, two of the scarce resources for any season. I would like to spend another moment diving deeper into our proactive incident response, which is a key differentiator for Varonis SaaS offering.

As part of the growing SaaS subscriptions, customers get air cover from our world-class incident response team who proactively watch suspicious activity, investigate alerts and notify customers of potential incidents. This will reduce the pressure on customer security team and improve their ability to stop threats and the ability to provide this across our entire SaaS customer base make the service orders of magnitude more power.

On top of these critical benefits, we are making it easier to consume Varonis as we are doubling down on the bundling strategy we introduced at the beginning of last year. We have seen great reception from customers who received Varonis platform protection upfront and former sales force who benefit from a simpler pricing discussions, both in the initial deal and the revenues.

The new strategy is a win-win for our customers and our company. Our customers receive more value from our platform in the initial deal. For our sales force, it is an easier story to tell our customers know that Varonis protect their largest and most important data store and application. They know the business outcomes that Varonis help them achieve, this is what matters to our customers and why we are doubling down on our platform selling approach. Our updated packaging ensure that customers receive an autonomous data security platform that will help them achieve their business outcomes on day one.

Now that I have provided you with an update of how we are making it easier for customers to see value on the Varonis platform, let me review some of the benefits that we should realize through our SaaS offering. First, we expect SaaS will result in a shorter sales cycle, risk assessments, the core of our go-to-market motion are expected to be quicker and easier to deploy because customer infrastructure requirements are greatly reduced. Along this, our updated product packaging should help simplify the pricing discussion, which we also think will result in shorter sales cycles.

Second, our new customer launch be largely driven by platform selling approach and a 25% to 30% pricing uplift, which is justified by the product's lower total cost of ownership as compared to our on-premise subscription offering. We expect that quicker time to value and improved customer satisfaction will lead to greater customer lifetime value and even better renewal rates in these larger initiatives. And SaaS help us to innovate faster and support our customers more easily, which we expect to benefit our margin profile as we scale.

It is still very early in the transition, but we are beginning to see initial proof of this benefit.

Before I turn the call to Guy, I want to briefly discuss the capital of key customer wins from Q4 with illustration. A global packaging company over 4,000 employees became a Varonis customer this quarter. This organization wanted to improve its ability to detect and respond to threats on sensitive data and intellectual property and comply with GDPR and CCPA privacy requirements. This deal was originally an OPS deal that was switched to a SaaS deal during the fourth quarter because of infrastructure and resource cost savings we could realize.

The purchase packages to protect Windows, Microsoft 365 and Active Directory and we're already in discussions to supplement the fretting capabilities with edge and to protect the exchange online and Box environment.

At the same time, our existing customer base continue to serve as a key growth driver. A couple of weeks ago, a health care organization, originally a customer will purchase a double-digit number of perpetual and OPS licenses upgraded to our SaaS platforms and will protect its hybrid window environment is the power of Varonis SaaS.

This renewal was a win-win for the customer and Varonis. The customer with benefits from greater automation and will reduce its total cost of ownership due to lower infrastructure costs. We will recognize an uplift in ARR as a result of the conversion.

We are excited by the initial reception of the Varonis SaaS and look forward to sharing how we see this driving our doable growth in the coming years at our Investor Day on March 14.

Finally, I would like to thank our team for their tireless efforts this past year, and we are excited to make this transition a success in 2023. With that, let me turn the call over to Guy. Guy?

[Guy Melamed, CFO and COO]

Thanks, Yaki. Good afternoon, everyone. In addition to providing more color on our fourth quarter performance and updating our 2023 full year outlook, I plan to focus my time today on the initial progress of our SaaS transition, and update to our views of how the macro environment is affecting our customers.

Let's start with the early signs we're seeing from our new SaaS rollout. As Yaki mentioned, while it's still very early in the transition, the behavior we're seeing from our customers and our sales force during the fourth quarter gives us increased confidence in our anticipated trajectory of this transition as compared to when we first made the announcement nearly 100 days ago.

Regarding the macro environment, we did see a deterioration, but it was slightly more benign than what we assumed in our guidance. Despite the softening of the macro environment, our fourth quarter results came in above the top end of the guidance on both ARR and the bottom line. We ended the year with ARR of $465.1 million, up 20% year-over-year or 24% adjusting for FX and Russia.

In the fourth quarter, we were approximately free cash flow breakeven, which was up from negative $6 million last year, reflecting the inherent operating leverage in the business model and the measures we took to manage our expenses.

In the fourth quarter, SaaS as a whole performed better than we expected and represented approximately 10% of new business and upsell ARR. For the year, we sold approximately $3.5 million of DA Cloud, which was slightly below our expectations, but we believe the number was impacted by the announcement of our new SaaS product as reps gravitated towards selling Varonis SaaS once we introduce the product. It's still very early stages, but we are very pleased with the behavior seen in the fourth quarter which leaves us cautiously optimistic about our 2023 outlook.

Now I'd like to elaborate on what we saw in the fourth quarter from a macro perspective. As we assumed in our Q4 guidance, economic cost, continued to negatively impact our European business and worsening of the macro environment began to impact our North America business as well. Across the board, we saw additional deal scrutiny and longer sales cycles. Some of the deals that slipped in Q4 have since closed, but we expect deal cycles to continue to lengthen as a result of the ongoing additional budgetary scrutiny. Despite this, our pipeline continues to build as the deals that have slipped were not lost to competition and remain in the pipeline.

In spite of the uncertainty in the economy and widely publicized focus on optimizing cloud spend, we continue to see healthy new customer interest and engagement from our existing customers. As of December 31, 2022, 78% of our customers with 500 or more employees purchased four or more licenses, up from 73% a year ago and 63% two years ago. 50% of those customers purchased six or more licenses, up from 41% last year and 30% two years ago.

Due to the SaaS packaging changes that Yaki discussed earlier, this will be the last quarter that we provide these metrics. We plan to introduce new KPIs to help you better understand the trends in our business at our Investor Day next month.

Lastly, our dollar-based net retention rate for subscription customers was 115% ABM this 2022 or 117% adjusting for FX and Russia.

Turning now to our fourth quarter results in more detail. Before I get into the numbers, I'd like to take a moment to remind you of the importance of ARR. You've heard me talk about ARR as the leading metric for the past six quarters. We talked about this because we saw this with the direction that the company was moving. And going forward, this metric will only become even more important.

During the transition period, the shift of our business from term licenses where approximately 80% of the deal value is recognized upfront to a SaaS model with fully ratable revenue will make our income statement metric less indicative of the health of the business than they have been in the past. Throughout this transition period, ARR and free cash flow will be our and your north stars because they are not impacted by the speed of the transition. To help you better understand the differences in accounting treatment for SaaS versus on-prem subscription deals, we've included a slide in our investor presentation.

Now on to the numbers. Q4 total revenues were $142.6 million, up 13% year-over-year or 17% adjusting for FX and Russia. During the quarter, as compared to the same quarter last year, we had approximately a 2% headwind to our year-over-year revenue growth rate as a result of having increased SaaS sales in our booking mix, which are recognized fully ratable versus the upfront recognition of our on-prem subscription products. Subscription revenues were $116.7 million, and maintenance and services revenues were $25.9 million, as our renewal rates, again, were over 90%.

When looking at our reported maintenance and services growth rate on a year-over-year basis, I'd like to call out three headwinds, which impact the comparability: a, FX was a 200 basis point headwind; b, the exit of our Russia business was another 200 basis points in headwind; and c, the conversion of perpetual maintenance to on-prem subscription was 100 basis points, for a total of approximately 500 basis points.

In North America, revenues grew 17% to $104.3 million or 73% of total revenue, reflecting a slowdown in the economy in the region and a headwind from the SaaS mix, too. In EMEA, revenues grew 1% to $34.4 million or 24% of total revenue. Adjusting for FX and Russia, growth was 16%. The rest of world revenues grew 19% to $3.9 million or 3% of total revenue.

Moving down the income statement. I'll be discussing non-GAAP results going forward. Gross profit for the fourth quarter was $128.3 million, representing a gross margin of 89.9% compared to 89.6% in the fourth quarter of 2021. Operating expenses in the fourth quarter totaled $102.3 million. As a result, fourth quarter operating income was $26 million or an operating margin of 18.2%, this compares to operating income of $22.4 million or an operating margin of 17.7% in the same period last year.

After accounting for the 50 basis points headwind in related to our shekel hedging program, the expansion was 100 basis points. During the quarter, as compared to the same quarter last year, we had approximately a 1.5% headwind to our operating margin as a result of having increased SaaS sales in our booking mix, which are recognized fully ratable versus the upfront recognition of our on-prem subscription products.

During the quarter, we had financial income of approximately $5.2 million, driven by interest income on our cash and short term investments. Net income for the fourth quarter of 2022 was $26.1 million or income of $0.21 per diluted share compared to net income of $18.5 million or income of $0.16 per diluted share for the fourth quarter of 2021. This is based on 126 million and 118.6 million diluted shares outstanding for Q4 2022 and Q4 2021, respectively.

As of December 31, 2022, we had $732.5 million in cash, cash equivalents, marketable securities and short-term deposits. For the 12 months ended December 31, 2022, we generated $11.9 million of cash from operations compared to $7.2 million generated in the same period last year. CapEx for 2022 was $11.4 million compared to $10.5 million last year.

Free cash flow improved from negative $3.3 million in 2021 to $0.5 million in 2022, despite an approximate $4 million headwind from the Tax Cuts and Jobs Act capitalization of R&D provisions.

During the fourth quarter, we repurchased 2.9 million shares at an average purchase price of $19.37, and we have $43.6 million remaining on our share repurchase authorization. We ended the year with approximately 2,150 employees, a decrease from the third quarter, which reflects the 5% headcount reduction measures taken, which were completed in the fourth quarter.

I will now briefly recap our full year 2022 results. Total revenues grew 21% to $473.6 million or 25% adjusting for FX and Russia. Our full year operating margin was 6.2% compared to 6.5% for 2021. After adjusting for the 200 basis points headwind on from our Shekel hedging program, the expansion was 170 basis points.

Turning to our guidance in more detail. From a macro perspective, we are factoring in a continued worsening of the economic conditions across the board, which assumes four quarters of softness in both EMEA and North America -- versus 2 to 2.5 and one quarter, respectively, in 2022. This also continues to factor in additional budgetary scrutiny, longer sales cycles and an increase in unemployment expectations among a worsening of other economic conditions.

From a SaaS transition standpoint, we are factoring in a six-month ramp-up period, which began in early January when the new sales comp plan was introduced. Our guidance also assumes increased sales force turnover in the first half of the year, lower sales productivity as our sales force gains comfort in selling the new product as well as longer sales cycles as on-prem subscription deals in the pipeline may convert to SaaS. These assumptions will primarily impact the first and second quarters and are based on learnings from our last transition. While all of these factors create a level of uncertainty, this is already contemplated in our guidance.

Before I get into the numbers, our first quarter and full year guidance now assumes a 15% SaaS mix of new business and upsell ARR, up from 5% previously. This reflects the encouraging initial reception from our customers and our sales force to our new SaaS product in the fourth quarter.

We have a two-phase approach to the transition. In Phase 1, which we just initiated, we are focused on selling SaaS to new customers, and this metric will help you gauge the success of this initiative. Phase 2, which is converting our base of existing customers to SaaS will come later on. But if an existing customer wants the benefit of our SaaS earlier, we will, of course, work with them as we always do.

To be clear, the SaaS mix calculation is SaaS new business and upsell ARR divided by total new business and upsell ARR. For example, if we had a renewal of $100,000 that converts to SaaS at $150,000, then we would only include the incremental $50,000 of upsell in the numerator and the nominator of the SaaS mix calculation.

Now turning to our guidance. For the first quarter of 2023, we expect total revenues of $106 million to $108 million, representing growth of 10% to 12%, non-GAAP operating loss of negative $7 million to negative $6 million and non-GAAP net loss per basic and diluted share in the range of negative $0.05 to negative $0.04. This assumes 108.5 million basic and diluted shares outstanding.

For the full year of 2023, we expect ARR of $513 million to $523 million, representing year-over-year growth of 10% to 12%. Free cash flow of $20 million to $25 million, which includes the $6 million to $8 million headwind related to the TCJA capitalization of R&D provisions. Total revenues of $519 million to $529 million, representing growth of 10% to 12%.

Non-GAAP operating income of $36 million to $41 million and non-GAAP net income per diluted share in the range of $0.33 to $0.35. This assumes 127.3 million diluted shares outstanding and CapEx is expected to be $8 million to $10 million.

In summary, we remain laser-focused on execution on our SaaS transition and thoughtfully managing our business for long-term growth under any economic condition which, in turn, will unlock significant value for all Varonis stakeholders.

Thanks for joining us today. I look forward to seeing you all in person at our Investor Day on March 14 in New York.

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

[Operator]

Thank you. We will now be conducting a question-and-answer session. [Operator Instructions] And our first question comes from the line of Matt Hedberg with RBC Capital Markets. Please proceed with your question.

[Unidentified Analyst]

Yeah. Thank you. This is Matt Johnson [ph] on for Matt. And congratulations, guys, on the quarter in this macro, especially on that fast transition. I guess, Guy, you made a comment about your guidance that you're using some of the insights you learned from your subscription transition. And I think just given the rapid pace and success of that subscription transition, it might be helpful for us to hear a little more about what you're seeing that's the same and maybe what's different in these early stages in the SaaS transition based on your conversations with customers and with your sales force?

[Guy Melamed, CFO and COO]

That's a great question. I think when we look at the introduction of the SaaS offering that we really only introduced 100 days ago, the feedback that we're receiving from both our customers and our sales team is very positive. With that said, it's very, very early in the transition. So there's a lot of lessons that we've taken from the previous transition.

And that's why when we build the guidance, we factored in some deterioration in the macroeconomic environment, and we factored a lot of kind of longer sales cycles and more deal scrutiny. But from the SaaS perspective, we factored in a six-month ramp-up period. And that really just started in January when we introduced the new comp plan.

But on top of that, we also kind of assumed increased sales force turnover in the first half of the year, lower sales productivity as our sales force gains comfort in selling the new product. And on top of that, we also assume that our sales teams are going to try and convert some of the deals that are in the pipe as on-prem subscription and try and convert them to SaaS. All of these assumptions are baked into our guidance, and the expectation is that they will impact us mostly in the first six months of the year. But I can tell you that overall, the feedback that we've received has been extremely positive.

[Operator]

Thank you. And the next question comes from the line of Hamza Fodderwala with Morgan Stanley. Please proceed with your question.

[Hamza Fodderwala, Morgan Stanley]

Hi, guys. Good evening. Thanks for taking my question. Just a couple of quick clarifying questions. It seems like EMEA, the growth rate there on a constant currency basis was pretty consistent with what you saw in Q3. Is it fair to say that region came in a little bit better than you expected?

And then Guy, you talked about doubling down on the bundle strategy. Can you talk a little bit about how you're thinking about discounting into '23 to drive that SaaS adoption? Are we thinking about those maybe going up a bit to get that SaaS adoption upfront -- or are they more or less staying the same versus a year ago? Thank you.

[Yaki Faitelson, CEO, President, Co Founder and Chairman]

Overall, the adoption in Europe was what we expected. And regarding the bundles, it's just all about the value. With the bundles customers get just a lot of automation, which just works extremely well with our SaaS strategy. The SaaS is still in the early innings. And we need to see how it will evolve. But so far, the initial reaction is very, very encouraging. .

[Guy Melamed, CFO and COO]

Matt, and just to touch on the actual percentages, EMEA revenue was at 1% in Q4. And yes, as you mentioned, when we factor in the FX, the effect of the FX and the exit of the Russia business, when you kind of look at it on a constant currency basis, excluding Russia, we were at 16%. With that said, we definitely saw kind of the macroeconomic environment in Europe with longer sales cycles and more deal scrutiny, and we definitely saw that in Q4 as well as in Q3.

And when we look at the 2023 guidance, we baked in kind of continued deterioration from this point kind of for the rest of the year. And the fact that we're ramping up kind of the SaaS transition and taking that into consideration as well.

[Operator]

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

[Saket Kalia, Barclays]

Okay. Great. Hey, guys. Thanks for taking my question here. Yaki, maybe I'll direct it to you. So a lot of fun stuff here with SaaS just in the early days, but I was wondering if you could just share some of the early customer feedback that you've gotten? You went through some of them, but I'm curious -- our customer is buying this because it's easier to support, right, because Varonis is hosting it, or is it because Varonis Cloud maybe covers more applications or something else? And again, understanding that it's still very early. What do you think the main selling points have been early on from a customer perspective?

[Yaki Faitelson, CEO, President, Co Founder and Chairman]

The main selling part without a doubt are the outcomes. It's a complete game changer regarding the outcomes. We have -- when we built it, we had a rule and we said 10% of the effort, 10 time more value. And we managed to fulfill the vision end-to-end. When you are coming, it's very easy to install. But then the ability to classify data automatically and understand what data is critical and overexposed. And now with 365 the Varonis robot is doing the right sizing of the permissions completely automatically that we see all the abnormal behavior in our cloud. And proactively, we are doing it for the customers.

Customers, Saket, can realize massive value we're doing nothing. It's completely, completely automatic. Having said that, also the overall time to value, you are coming no hardware requirements. So yes, there is a lot of data on-prem and it's going to just -- you need a collector. So this setup is a fraction of the time and everything that's related to our ability to also to find attacks that are closer to the data set early in the Quarter chain works extremely well. So just we're able to fulfill that vision. We are very, very excited from everything we've seen on the outcomes, the automation, the stability, our ability to serve problems definitely so far many very encouraging signs.

[Operator]

Thank you. [Operator Instructions] Our next question comes from the line of Fatima Boolani with Citi. Please proceed with your question.

[Fatima Boolani, Citi]

Hi, good evening. Thank you for taking my questions. Guy, this one is for you. You talked about introducing a new compensation program and sales incentives to drive selling behavior around the SaaS platform. I'm curious, does that mean that you've completely deemphasized and more or less created these incentives around selling term business? I mean are you sunsetting that entire program entirely to shift 100% to SaaS selling. Any clarification there would be great. I'd appreciate it. Thank you.

[Guy Melamed, CFO and COO]

Fatima, it's a great question. When we build kind of the comp plan we try and align it to what the company is trying to do from a strategic perspective. So we worked a lot on trying to align them. And when you think about where the company is going, it kind of goes back to the color that we gave about Phase 1 and Phase 2, having kind of Phase 1 targeting new customers and trying to sell them SaaS.

So building the comp plan is really kind of a -- it's a combination of an art and a science. We try to align having our reps focused on selling SaaS to new customers. And if they do that, there's a lot of character. Obviously, we want to see how this progresses and we'll give more color as we go along. But the whole concept of the comp plan is to align where we want the company to go and that's focusing on that Phase 1 selling SaaS to new customers.

[Operator]

And the next question comes from the line of Joel Fishbein with Truist Securities. Please proceed with your question.

[Joel Fishbein, Truist Securities]

Thank you. And thank you for taking my question. I guess this is for both of you guys. Yaki, you talked about that the SaaS is really selling bundles to the platform. And I'm just curious if you can share -- I know it's early, but share how it's like-for-like, what you're selling on-prem with the SaaS solution that would justify a 25% to 75% uplift in price? I think that's on a lot of people's minds with regard to how that transition actually works.

[Yaki Faitelson, CEO, President, Co Founder and Chairman]

I think that's even unrelated to the bundle, it's very easy for us to justify because this is the total cost of ownership on prem. And we built a very sophisticated and coherent calculator, and we can show it to the customer. So far, the understanding very well.

In terms of buying the bundle, it's easy for the customer because at the end of the day, they want automation. If you take a step back, in security, there is an end means to an end. The end is always data. The issue is that data protection is very hard. And once you provide a lot of automation, you're really taking the bottleneck out of the process. And the only way to get automation is really to buy all the bundles.

And with the bundles, the licenses, it's 1 plus 1 equals 5 many times. So in most cases, it works very well. Total cost of ownership a lot of -- and just a lot of automation. This provides very good ROI. Everybody understand that they need to protect data. So, so far, we see that the offering is very compelling.

[Guy Melamed, CFO and COO]

And just to touch on the bundling, like Yaki said, we're basically doubling down on the success that we saw with the on-prem subscription bundling. So customers, they'll see more value in the initial deal, and they'll buy more over time, which really increases the initial deal size, but also the retention metrics and the customer lifetime value. But it also helps our sales force because really, it's a simpler discussion both on the initial deal and on the renewals as well.

So we're not trying to sell 40 different products. We're trying to sell the outcomes. We're trying to sell the Varonis platform and that really both helps our customers and helps our sales force.

[Yaki Faitelson, CEO, President, Co Founder and Chairman]

The discussion is about just about the value and then you can represent it with one SKU and not to start and say, this is a license and that is a license people trying to solve problems, and this is what we are going to do.

[Operator]

And the next question comes from the line of Brian Essex with JPMorgan. Please proceed with your question.

[Brian Essex, JPMorgan]

Hey great. Thank you. Good evening. Thank you for taking the question. Maybe my one question for Yaki, if you will. -- it sounds like guidance is kind of on the conservative side if you're modeling it kind of incremental deterioration and conversations with CIOs that we're having indicate kind of more back half-weighted seasonality is they're taking a cautious approach to spending this year.

Could you help us understand what your conversations with customers are like with regard to spending intentions for the year? It sounds like your backlog is building quite nicely. And how to think about how they might be prioritizing data security within this, I guess, stratification of security spending that they have, what does that fall on the priority scale? And are you just assuming deferrals into the back half of the year and then deterioration on top of that? Or what might your outlook be for like better-than-expected spending environment in the second half as it relates to customer conversations that you're having?

[Yaki Faitelson, CEO, President, Co Founder and Chairman]

Most of the customer security efforts -- the objective is to protect the digital assets. And now we have this technological platform with the SaaS to be completely automatically. So you're trying to solve something that is hard. Many times, they will postpone it. And what we see now is the SaaS, but still early stages. But we see that it's much easier for us to get budgets, to show value and customers don't need to put a lot of effort.

So we believe that with time when the sales force will know how to sell it in the right way, the customer will understand it, we really reduced so much friction in every -- in every step in the sales motion and in the value journey of our customers. So this is very exciting.

The other thing that we sold historically is that many times, at hard times organizational setting and really analyzing and scrutinizing where they need to put the dollars, and we always benefit from it because you want to protect data. And in this environment, after COVID, it's very hard for almost -- very easy for almost every organization, very easy to understand where the critical data and what we need to do with it. So where you have cynical data with a lot of collaboration, all the right directory services. So today, we can say, yes, on almost all the automation and the support almost all the critical data repositories on-prem and in the cloud.

So I think that over time, we believe that there are -- there is a high probability that more and more budget will come towards us because this is the problem that customers are trying to solve. And if you can do it automatically, it just should be a top priority for most of them. I see many customers, and I can tell you that data protection, protecting their digital assets is a top priority for almost every organization out there. I also believe that with time, you will see that it's a strong secular plan and many other security line items are more cyclical than that.

So data is going and going in many repositories and this is what bad actors want. If it's APTs, insider Ransomware attack, this is the objective to gave data. And once customers will get the data, it's all over. You can't enrich data. So we are just in the right place and we have the right technology to do it almost effortlessly for the customers.

[Operator]

Thank you. And our next question comes from the line of Roger Boyd with UBS Securities. Please proceed with your question.

[Roger Boyd, UBS]

Great. Thank you for taking my question. And congrats on the quarter. Guy, you talked about sales force attention maybe drifting to the Varonis SaaS offering over Data Advantage Cloud in the quarter. Just curious, like what sort of synergies are there for Advantage Cloud to be sold now that Varonis SaaS has been launched? Is there a broader bundling opportunity there? And maybe as you think about the 15% SaaS mix for calendar '23, how should we think about DA Cloud versus for SaaS contributing there? Thanks.

[Guy Melamed, CFO and COO]

Well, I'll try and address the sub questions within the question. First of all, we increased the SaaS mix from 5% 100 days ago to 15%. Going forward, we're going to talk about SaaS sales as a whole. We definitely see reps and our account managers trying to sell to customers, both Varonis SaaS and the DA Cloud. I've talked a lot about the fact that the DA Cloud takes time from an adoption perspective. And we've seen that in the past with other licenses where until it takes some time, and we saw that with the Office 365 where it took some time and then it started becoming a major contributor.

We feel very positive about the DA cloud being a tailwind for us in the years ahead. I think when you look at kind of the synergies there, the fact that we protect data wherever it resides, is a great advantage, and we can enter into new customers that had applications that we couldn't support before and now we can support them. And that combined with the Varonis SaaS, that gives a significant value to our customers that Yaki talked about before.

[Yaki Faitelson, CEO, President, Co Founder and Chairman]

And also, if you look at what we are supporting, it's very easy to understand what is the adoption of the SaaS applications, and the cloud data repository, you see that it's something that almost every organization has. So what is happening today is that Varonis is really protecting data. And we want to protect critical data wherever you have it with all the access all the data flows that users are doing in applications, APIs and to do it automatically. So we believe that the whole platform it's something that almost in every organization.

[Operator]

Thank you. [Operator Instructions] Our next question comes from the line of Shaul Eyal with Cowen & Company. Please proceed with your question.

[Shaul Eyal, Cowen]

Thank you, hi. Good afternoon, guys. Congrats on the SaaS, on the rapid progress. Are you seeing similar SaaS buying behavior between U.S. and EMEA? Or is SaaS, for some reason, more pronounced in the U.S.?

[Yaki Faitelson, CEO, President, Co Founder and Chairman]

Hi, Shaul. So in I4, we did it only, in terms of the Varonis SaaS, we've done it only in the U.S. We open it now for EMEA and the pipeline is encouraging. And so we will give you more details as this progressing. But in general, we just see that it's just a non in terms of the objections, I don't have time, I don't have hardware or don't have people. We really eliminated all the major objections. So if you have clinical data and you want to protect it, the way to do it is to use our platform.

[Operator]

And our next question comes from the line of Joseph Gallo with Jefferies. Please proceed with your question.

[Joseph Gallo, Jefferies]

Hey, guys. Appreciate the question. I just wanted to follow up on DA Cloud since I think that's such an important growth vector for you guys. Guy, you mentioned that it takes time. You specifically mentioned the office product. What is it that takes time? Is it a product feature issue? Is it an awareness issue? Is it a sales comfortability issue? Just kind of curious if you could provide a little more detail on that.

[Yaki Faitelson, CEO, President, Co Founder and Chairman]

I see. I see. In terms of the DA cloud, we just wanted to make sure that the product is very mature, and we have all the feature set. And if you can see all the releases we have done in the fourth quarter, they are tremendous. In each one of the reuse cases, threat detection and response, data protection. We have a lot of configuration management there and also -- and also classification.

Once you have everything, it's also -- it takes some time that the sales force knows how to sell it, and we have done it. What Guy mentioned is that in the fourth quarter, when you have Varonis SaaS, when you always -- when you release something like that and you're introducing SaaS there is some kind of friction. This is why we told you that every time you're doing something major like that, it takes us just two quarters to get our ducks in a row, if you will. But DA Cloud is -- we believe that it's a tremendous growth engine for us. It's -- you have a lot of data in this repository very complex permission structure, a lot of configuration also, a lot of the API connectivity.

These are tremendous platforms that introduce a lot of -- introduced a lot of risks and our very unique intellectual property works very well there. And we believe that DA Cloud is a massive opportunity for the company moving forward. And we have done all the right things in terms of development, enablement to make sure that we can realize great gains from this platform in the future.

[Operator]

And our next question comes from the line of Rob Owens with Piper Sandler. Please proceed with your question. Please proceed with your question.

[Rob Owens, Piper Sandler]

Thanks for taking my questions. Just curious on the road map for the SaaS solution. And are you currently at feature parity with on-prem and what's to come down the pike in the near term? Thanks.

[Yaki Faitelson, CEO, President, Co Founder and Chairman]

Thanks for the question. So we are not in complete feature parity, but they are starting the SaaS, some stuff that are much more advanced than on-prem, somethings in the on-prem -- we need to be in parity. We are moving very, very fast with the cloud. It's a fit to 70%-80% of the Varonis on-prem customer, and it's a fit for every new customer we get to parity. We also have many new advancements in this platform, so we really prioritize.

The other thing, the beauty of the cloud is we can see the usage. You can see how the stuff that we are doing affecting our customers, and we can prioritize if we can prioritize effectively.

[Operator]

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

[Chad Bennett, Craig Hallum]

Great. Thanks for taking my question. So maybe for Guy. Just -- it seems like you're obviously seeing pretty significant early traction in the SaaS platform. And so you upped kind of your sales mix or ARR mix from 5 to 15. And assuming that, that price lift sticks of 25 to 30, I think you effectively reiterated ARR for this year relative to what you talked about before. Wouldn't that be up an uplift or a tailwind to overall ARR if, in fact, you're seeing a higher mix of SaaS ARR that's higher priced?

[Guy Melamed, CFO and COO]

Chad. Yeah, like you're saying, we definitely saw a lot of great traction with the SaaS introduction, which gave us the confidence to increase the SaaS mix from 5% to 15%. With that said, we're very early in this transition. And that's why when you look at kind of the ARR number, when you look at the overall number, it didn't move much. We did increase it slightly, but it didn't move much. This is because we're at the beginning of the year. We wanted to start -- we talked about kind of the six-month ramp-up time that we factored in. But we feel very good about the SaaS offering. And over the last 100 days, we gained a lot of great feedback for both our customers and our sales force.

[Operator]

And our next question comes from the line of Andrew Nowinski with Wells Fargo. Please proceed with your question.

[Andrew Nowinski, Wells Fargo]

Thank you. I just had a question on the SaaS mix also. So I think you generated -- or excuse me, 10% of the new business from SaaS in Q4. And then you said 15% in Q1 and 15% for the year. So I'm wondering why wouldn't the mix continue to increase throughout the year as more sales reps get ramped up and et cetera. So just wondering why it's staying flat at 15% after Q1.

[Guy Melamed, CFO and COO]

100 days ago, it was a 5% mix and we get again, like I said before, we gained a lot of confidence. But again, we're very early in this process, and we do expect some friction that will happen in the first six months of the transition, which is already baked in the guidance. We will obviously update everyone as we progress through this transition, and we'll give more color as we see kind of the pipeline build.

But because we're so early in this transition, we moved it up from 5% to 15%, and we want to start with this. And then we'll update and give -- we'll be as transparent as possible throughout the transition and give metrics that can allow everyone to see the progress and the progression within the transition.

[Operator]

And our next question comes from the line of Shrenik Kothari with Robert W. Baird. Please proceed with your question.

[Shrenik Kothari, Robert W. Baird]

Hey, good evening. Great to hear about the SaaS progress. And thanks for taking my question. One for Yaki and a quick follow-up for Guy. So Yaki, you mentioned about the slowing macro continue to impact customers continued worsening of conditions across the board, both EMEA and crawling into North America. Just comparing with your commentary last quarter, you cited of course, EMEA revenues, but there was also some weakness in the U.S. Federal trends? Can you comment on the on the U.S. federal trends, is it trending above your expectations now or in line? I mean just a quick comment.

And then very quickly on the operating margins. You mentioned about 1.5% headwind -- just wanted to know the breakdown between hosting and support costs versus the sales incentive structure related headwinds? Thank you.

[Yaki Faitelson, CEO, President, Co Founder and Chairman]

We are building a very healthy pipeline in the federal market. This sector in general has a lot of critical data that they need to protect and many did actives that want the data. If you want to protect this massive data stores in new solutions like ours, and we believe that we can do very well in the federal market.

And when you have an economic slowdown, it's usually impacting IT spend. But again, if you have critical data, someone wants it, it's just essential for every business. So we believe that we tease can weather any economic slowdown very effectively.

[Guy Melamed, CFO and COO]

In terms of the margins, one of the things that we've talked a lot about -- and you've probably heard me talk about ARR being the leading indicator for the last six quarters. We wanted to make sure that everyone understands that when we're shifting our business from term license where we recognize approximately 80% of the deal's value upfront to a SaaS model with kind of a fully ratable revenue. It will make our income statement metric less indicative of the health of the business than it's been in the past. So the headwind that we're talking about is obviously impacted the most by the way revenue is recognized between the two models.

And that's why we said that throughout the transition, ARR and free cash flow will be our north stars because they're not impacted by the speed of the transition. So obviously, as we announced at our Investor Day, happening on March 14, we'll give more color, we'll give more color not just on the headwinds, but we'll give color on KPIs and we'll try and be as transparent as possible to allow analysts and investors to work with us during this transition.

[Operator]

Thank you. [Operator Instructions] Our next question comes from the line of Joshua Tilton with Wolfe Research. Please proceed with your question.

[Joshua Tilton, Wolfe Research]

Hey, guys. Can you hear me?

[Guy Melamed, CFO and COO]

Yeah.

[Joshua Tilton, Wolfe Research]

Great. Just one quick one for me. I think we all walked away from the last earnings call with a message that the 4Q guidance and the initial 2023 guidance was derisked that you guys kind of only be 5%. I know there's no real change to the growth outlook for 2023. I guess is the message still the same? Should we walk away into feeling that you guys have tended to derisk the growth outlook for 2023?

[Guy Melamed, CFO and COO]

That's hard -- the line is very hard to hear, but I think I understood the question of whether we feel more confident about our guidance and have we still factored in macroeconomic uncertainties. And if that's the question.

The answer is basically yes to both. We feel more confident about where we are today versus where we were 100 days ago. The reception of the SaaS offering has been extremely positive. I thought we talked about that both from our customers and our sales force.

With that said, when we look at the guidance for 2023, we did bake in additional worsening of the economic conditions across the board. We assumed softness in EMEA and North America. We assumed budgetary scrutiny, longer sales cycles, basically worsening of the economic conditions. So we feel better about the business. But as we guide today for 2023, we wanted to account for both macroeconomic deterioration and some of the friction that might occur with the introduction of the SaaS offering, and that would ramp up time of basically six months.

[Operator]

And our next question comes from the line of Erik Suppiger with JMP Securities. Please proceed with your question.

[Erik Suppiger, JMP Securities]

Yeah, thanks for taking the question. Can you just talk a little bit about the linearity that you saw through the quarter? It sounds like things may be eroded. So did the end of the quarter slow? And then you also talked about some turnover in the sales organization. Can you comment on what kind of turnover are you expecting in the sales organization?

[Guy Melamed, CFO and COO]

So the quarter actually behaved very similar in terms of seasonality. We didn't see any abnormal behavior when we look at kind of the seasonality, where similar to other software enterprise businesses, we do have a large component of the business come in the last couple of weeks of every quarter. So we didn't see any major trends there.

In terms of the turnover, I can tell you that the reception of the SaaS offering, as we've mentioned several times on this call has been extremely positive. But some of the lessons that we've taken from kind of the move from perpetual to on-prem is some increased turnover, which we baked into our guidance and factor that in. So that's kind of the way we thought about it. But as of now, everything is kind of going in line with our expectations.

[Operator]

And our final question comes from the line of Shebly Seyrafi with FBN Securities. Please proceed with your question.

[Shebly Seyrafi, FBN Securities]

Yes. Thank you very much. So I want to delve into the 13-point deceleration in North America growth, from 30% to 17%. How much of that was the SaaS headwind? Can you talk about like the different trends you saw between the large customers and smaller customers? And finally, did you see in January or February, early February, this month, a noticeable pickup in North American business versus the end of last year?

[Guy Melamed, CFO and COO]

Now when we gave guidance last quarter, we said that we expected to see some spillover from the macroeconomic conditions in EMEA to North America with some increased deal scrutiny and longer sales cycles in the region. And that was in line with our expectations. So the results kind of that we saw in Q4 were kind of in line with how we saw it when we guided last quarter.

There was about 300 basis points of headwind from the SaaS mix shift that impacted our North America reported revenue in Q4. And in terms of January and February, February has only just started. But I could tell you, we gave guidance. We feel good with the guidance that we have provided, and we'll update as we kind of progress and we'll give some color on the SaaS transition during our Investor Day on March 14.

[Operator]

At this time, there are no further questions. Now I'd like to turn the floor back over to Tim Perz for any closing comments.

[Tim Perz, IR]

Thanks for joining us today. We look forward to seeing you all at our Investor Day on March 14 in New York.

[Operator]

This concludes today's teleconference. You may now disconnect your end at this time. Thank you for your participation. And have a great day.