Varonis Systems Q2 2024 Earnings Call Transcript

Quartr
Provided by Quartr
July 29, 2024

There are 14 speakers on the call.

Operator

Greetings, and welcome to the Verona System, Inc. 2nd Quarter 2024 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. As a reminder, this conference is being recorded.

Operator

It is now my pleasure to introduce your host, Tim Peart, Investor Relations. Thank you, sir. You may begin.

Speaker 1

Thank you, operator. Good afternoon. Thank you for joining today to review Varonis' 2nd quarter financial results. With me on the call today are Yaki Faitelson, Chief Executive Officer and Guy Malamed, Chief Financial Officer and Chief Operating Officer of Varonis. After preliminary remarks, we will open the call to a question and answer session.

Speaker 1

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 Q3 and full year ending December 31, 2024.

Speaker 2

Due to

Speaker 1

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

Speaker 1

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 Q2 2024 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, Daki Fidelson. Daki?

Speaker 3

Thanks, Tim, and good afternoon, everyone. Thank you for joining us today to discuss our 2nd quarter results, our SaaS transition progress and the tailwinds impacting our business. First, I would like to remind you why Varonis exists and how we help our customers. Today, the purpose of almost any cyber attack is to steal data, but the purpose of the security solutions most organization deploy to protect their endpoints and their perimeter. These technologies are very important, but they aren't enough to protect data.

Speaker 3

To protect data, you must have a data first solution and a data first approach. Vonage's data first approach helps companies locate the sensitive data, visualize who has access to it, automatically lock it down and then detect and respond to threaten it. To give a simple example, credit card companies keep making it harder for bad actors watch the watch the credit card transactions and compare them to what they know normal usage looks like to detect and stop fraudulent transaction. Varonis uses the same approach for protecting data, make it harder for the wrong people to access it and monitor the data transactions to spot and stop anything abnormal like ransomware insider threat or AI abuse With our SaaS platform and recently released MDDR offering, we have a sophisticated and automated solution that enable customers to protect their data with very little time and effort. This allows companies to collaborate safely while also managing risks.

Speaker 3

Innovation has always been at the core of Varonis. And in late June, we achieved the FedRAMP in process designation, which represents an important step towards enabling us to provide the benefit of our SaaS platform to our federal government customers. I would like to take a moment to thank everyone involved in the process. Now I would like to turn to our Q2 results, which reflect the growing momentum of our SaaS platform in the recently introduced MDDR offering. These offerings are driving strong new customer addition and healthy conversion activity from existing customers.

Speaker 3

ARR grew 18% to $584,200,000 and year to date we generated $67,300,000 of free cash flow versus $40,000,000 generated last year. That ARR now represents approximately 36% of total ARR. Guy will review our Q2 results and our updated guidance in more detail shortly. This was another quarter of strong execution by our team that has risen to the challenge of a stable but a challenging environment still with elevated levels of bill scrutiny. The transition to SaaS delivery model is progressing quickly because of the many benefits that our customers realize.

Speaker 3

Customers can achieve automated outcomes, which means they can ensure the data is protected with very little effort. SaaS is quicker to deploy and operationalize because of significantly lower infrastructure in personal investments and SaaS is easier to maintain and upgrade. Additionally, there are 3 key benefits that we realize. They are shorter sales cycle, larger initial length and margin benefits over time. I would now like to turn to a couple of tailwinds that we believe will drive momentum in our business.

Speaker 3

The first is our managed data detection and response offering, which we call MDDR. This is the 1st managed service for monitoring and protecting critical data and is only available to our SaaS customers because of the visibility and automation that is built into our SaaS platform. MDDR was only introduced in Q1 and is already becoming a key driver of new business wins and existing customers' conversion to SaaS. And we believe that we are just scratching the surface with this opportunity. We continue to see that CSAW don't take the resources to monitor and investigate alerts fast enough.

Speaker 3

With MBDR, we ended this for them. If we see a threat, we can stop it and simply notify the customer after the threat has been neutralized. We pioneered the use of machine learning to perform user behavior analysis and build highly accurate threat models. Our team leverages the significant automation plus our unique telemetry to efficiently detect if data is under attack and to take threats missed by others. Bottom line, the early proof points that we are seeing leaves us excited about what the future holds for MDDR.

Speaker 3

The second tailwind, we see generative AI. This technology is top of mind for many organizations and is a key theme in nearly all conversation with prospects and customers. The productivity benefit that Gen AI brings are widely understood, but Gen AI also worsens the data access risks companies already face. Take for example, a bank that was piloting a GenAI tool with users on their trading floor. They wanted to make trade more productive and earn the bank more money.

Speaker 3

The traders started to use it for research. They started searching for answers on questions like what stocks do our employees invest in. The problem is the tool started showing names, social security numbers, 401 position and account numbers. The security team immediately turn it off because they were going to face major funds and sanctions. And it wasn't because those traders were acting maliciously, they were just trying to use the tool and ended up finding extremely sensitive data that was mistakenly open to everybody in the company.

Speaker 3

We believe the gnaI adoption within enterprises will serve as a catalyst that exposes their underlying data security risks. And this is the very problem that Varonis was built to solve. As a result, we expect that as companies adopt GenAI, they will be forced to make addressing those risks a top priority. Without Varonis, rightsizing access controls is extremely challenging. We mitigate these risks by automatically ensuring only the right people can access the data necessary for their job function.

Speaker 3

Companies are thoughtfully considering these risks before expanding from pilots into broad rollouts. The feedback we are hearing from customers continue to strengthen the conviction we have in our ability to benefit from enormous secular tailwinds and we are seeing a healthy win and we are seeing a healthy pipeline build with respect to this opportunity. With that, I would like to briefly discuss a couple key customer wins from Q2. A large Midwest hospital system became a Veronis customer this quarter. This organization was concerned about where is sensitive data was located, who had access to it and how they would respond to a ransomware attack.

Speaker 3

During the risk assessment, we detected attacks already in progress, including an attack on their CEO account coming from outside the organization. The company was able to prevent it and ensure that account was secured. The second attack that occurred was the business email compromise that began when an employee clicked on a fishing link that came from a malicious email and the account started accessing files from an unusual geolocation. Luckily, our team was able to confirm they would detect and stop this compromise before any sensitive data was accessed, because we have a conclusive record of the data transaction and prevent any damage from being done, they purchased Varonis SaaS for their hybrid environment with NDDR protection and we're able to avoid material breach that could require them to publicly file any data breach disclosures. We continue to see healthy demand from existing customers converting from our self hosted platforms to Varonis SaaS.

Speaker 3

One example of this is a multinational commercial real estate firm that has been a Veronix customer since 2014. They wanted to decrease their infrastructure spend and reduce the time spent maintaining and upgrading their software. Moving to Veronika SaaS allow them to immediately cut their server footprint and reduce their ongoing maintenance requirements. In addition to these operational savings, they will automatically remediate overexposure in Microsoft 365. They also purchased the Veronix SaaS hybrid package through the Azure Marketplace, which simplified the procurement process.

Speaker 3

In summary, the adoption of our SaaS platforms and MDDR offering are driving positive business momentum, and we are just scratching the surface of our long term opportunity. We are excited to enter the second half of twenty twenty four from a strong position to capitalize on the tailwind of MDDR, GenAI in increasing data centric compliance regulation. With that, let me turn over to Guy. Thanks,

Speaker 4

Yaki. Good afternoon, everyone. Thank you for joining us today. Our Q2 performance gives us increased confidence in our full year trajectory driven by our SaaS platform and MDDR offering. At the end of Q2, SaaS ARR increased to approximately $210,000,000 or 36% of our total company ARR, driven by strong contribution from new logos and existing customer conversions.

Speaker 4

This momentum, coupled with the tailwinds Yaki mentioned, allows us to raise our full year ARR and free cash flow guidance and also to increase our SaaS ARR expectations. The key drivers of our business this quarter were SaaS and MDDR. With each passing quarter, our story becomes more strategic and simpler for customers. SaaS eliminates the 2 biggest prospects of not wanting hardware or having the headcount to manage the platform. SaaS obviously requires less hardware and meaningfully simplifies maintenance and upgrade And MDDR removes the need for people to review alerts since we do it all for them.

Speaker 4

We're seeing that the value proposition of story is shortening deal cycles when compared to on prem subscription deals. Generative AI remains a theme in nearly every customer conversation we are having and reinforces our view that this will become a secular tailwind. Our pipeline continues to be healthy as a result. And as we discussed in the past, we are still not seeing material contribution to our reported metrics derived from it. Consistent with our prior comments, we have not included the impact of material Gen AI adoption in our guidance.

Speaker 4

As we enter the second half of the year, we look forward to converting more of the installed base of on prem subscription customers to our SaaS platform. Pricing continues to be in line with our price list increase of 25% to 30% and in some cases we see deal sizes increase in excess of that as customers consume more of the platform upon conversion to our SaaS platform. We expect that the ramp up of this phase will not be linear and momentum should grow in each quarter with further acceleration in dollar terms in 20 252026. In the 2nd quarter, ARR grew 18% year over year to $584,200,000 and year to date we generated $67,300,000 of free cash flow, which was up from $40,000,000 generated over the same period last year. These metrics demonstrate our commitment to balancing top line growth with improving cash flow generation during the transition.

Speaker 4

Turning now to our Q2 results in more detail. As a reminder, the leading indicators of our transitions are ARR, free cash flow and ARR contribution margin. As we have said many times, the faster we progress through the transition, the more headwinds we will experience to our traditional income statement metrics, but we view this in a positive light. As compared to 3 months ago, we feel increasingly confident in the trajectory of the business following our Q2 results. While the macro environment remains challenging, it is also stable and SaaS and NDDR are resonating well in this market to drive positive business momentum.

Speaker 4

Q2 total revenues were $130,300,000 up 13% year over year. During the quarter as compared to the same quarter last year, we had approximately a 6% headwind to our year over year revenue growth rate as a result of having increased SaaS sales in our booking mix, which are recognized rapidly versus the upfront recognition of our on prem subscription products. In the 2nd quarter, SaaS revenues were $44,800,000 Term license subscription revenues were $62,700,000 and maintenance and services revenues were $22,800,000 as our renewal rate were again over 90%. Moving down the income statement, I'll be discussing non GAAP results going forward. Gross profit for the Q2 was $109,600,000 representing a gross margin of 84.1 percent compared to 87.1% in the Q2 of 2023.

Speaker 4

Gross margin continued to be strong and the year over year change is due to the revenue headwind associated with a higher mix of SaaS sales, increased headcount to support the transition and increased hosting costs. Operating expenses in the 2nd quarter totaled $107,500,000 As a result, 2nd quarter operating income was $2,100,000 or an operating margin of 1.6 percent. This compares to operating income of $900,000 or an operating margin of 0.8% in the same period last year. During the Q2 as compared to the same quarter last year, we had approximately a 5% headwind to our operating margin as a result of having increased SaaS sales in our booking mix, which are recognized ratably versus the upfront recognition of our on prem subscription products. 2nd quarter ARR contribution margin was 14.9%, up from 8.2% last year.

Speaker 4

The significant leverage improvement even during the early stages of the transition reflects our ability to drive strong incremental margins while growing ARR and transitioning to SaaS. During the quarter, we had a financial income of approximately $8,100,000 driven primarily by interest income on our cash deposit and investments in marketable securities. Net income for the Q2 of 2024 was 6,800,000 dollars or $0.05 per diluted share compared to net income of $1,100,000 or net income of $0.01 per diluted share for the Q2 of 2023. This is based on $128,000,000 $127,300,000 diluted shares outstanding for Q222 2024 and Q222, respectively. As of June 30, 2024, we had $790,300,000 in cash, cash equivalent, short term deposits and marketable securities.

Speaker 4

For the 6 months ended June 30, 2024, we generated $68,400,000 of cash from operations compared to $42,600,000 generated in the same period last year and CapEx was $1,100,000 compared to $2,600,000 last year. Turning now to our updated 2024 guidance in more detail. It is important to note that our guidance now assumes 48% of total company ARR will come from our SaaS platform by year end. As it relates to our quarterly revenue guidance, there are more conversions embedded in our Q4 guidance versus our Q3 guidance because we have more renewals in Q4 from a seasonal perspective. And the Q3 is Federal's largest quarter and we still expect to sell on prem subscription in that vertical.

Speaker 4

For the Q3 of 2024, we expect total revenues of $140,000,000 to $143,000,000 representing growth of 14% to 17%, non GAAP operating income of $7,000,000 to $8,000,000 and non GAAP net income per diluted share in the range of $0.07 to 0 point 0 $8 This assumes 128,200,000 diluted shares outstanding. For the full year 2024, we now expect ARR of $629,000,000 to $635,000,000 representing growth of 16% to 17 percent. Free cash flow of $80,000,000 to $85,000,000 total revenues of $544,000,000 to $552,000,000 representing growth of 9% to 11%, non GAAP operating income of $18,000,000 to $21,000,000 non GAAP net income per diluted share in the range of $0.22 to $0.24 This assumes 128,100,000 diluted shares outstanding. In summary, our 2nd quarter performance coupled with the many tailwinds in our business gives us confidence to raise our full year ARR and free cash flow guidance and also to increase our SaaS ARR expectations. We look forward to driving continued momentum as we move through the 2nd phase of our SaaS transition and unlocking meaningful value for our customers, our company and our shareholders.

Speaker 4

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

Operator

Thank you. We will now be conducting a question and answer session. Our first question comes from Saket Kalia with Barclays. Please proceed with your question.

Speaker 5

Okay, great. Hey guys, thanks for taking my question here and nicely done this quarter.

Speaker 6

Thank you.

Speaker 3

Thank

Speaker 6

you. So I'll keep it

Speaker 5

to 1 here. Yaki, can you maybe just talk about the success that you're having in converting your on prem customers to SaaS? And Guy, maybe as part of that discussion, I mean, you talked about, I think, sort of an in line uplift that as you talked about in the past. But it sounds like maybe it's doing a little bit better. Maybe you could just talk us through just anecdotally how the economics are looking on some of those conversions?

Speaker 5

Thanks.

Speaker 3

Hi, Saket. The task conversions are working very well because of the offering. We're talking about completely automated outcomes. If you have us, most probably, you will not have a data breach and a data loss, and we are taking a lot of the operations on us. This is on top of just the regular SaaS benefits.

Speaker 3

So it's literally 10% of the effort for the customers and 10 times more value. This works extremely well and it's very easy for us to demonstrate the immediate value and the ongoing value. The customers are benefiting tremendously while moving to SaaS. So this is a very easy proposition for them to move to our SaaS platform.

Speaker 6

And from a pricing perspective, there's a 25%, 30% price list uplift on a like for like basis. So when you assume kind of the same features and functionality. But when we look at the data, the discount rates have helped firms. So we really are recognizing pricing in line with that uplift. And what's very interesting to see is that when we kind of built the packaging for SaaS, our desire really was to have customers consuming more of a platform.

Speaker 6

And what we're seeing is that they're actually doing that. We're seeing deal sizes increase in excess of that uplift. So that's working really well for us. When you look at the conversions in Q2, that really helped us get to approximately 36 percent of total ARR coming from SaaS or really $210,000,000 And what we actually saw is an increase in the conversion. A lot of them came from perpetual maintenance customers, which was really a positive sign for us.

Speaker 6

So when we look at kind of the pace of the transition, focus is on SaaS ARR is kind of the leading metric to measure the progress and we're really happy with the progress we've done so well.

Operator

Our next question comes from Hamzah Sakhawal. Please proceed with your question.

Speaker 7

Great. Thank you for taking my question and congrats on the continued SaaS momentum. Yaki, why don't I ask this question to you on what you talked about with generative AI, not expecting contribution this year, which I think is prudent. I just wanted to get a sense of your timing as to when think these Gen AI deployments will be more mainstream at the enterprises that you serve? And when do you think Varonis could start to benefit from some of these deployments, right?

Speaker 7

You're already talking about seeing more interest in pipeline. So I was wondering if you could maybe flesh out the timing of this opportunity for us?

Speaker 3

Thanks for the question. Before the timing of the opportunity, I will tell you what I see from customers that POC, this tool, this copilot and airlines, but immediately it's exposing the problem of excessive permissions and in effect. So you use it and just it's like a patent from hell that goes and mine all the available data. And by that, you go to the platform make hours. You get to a lot of data that you don't need to get.

Speaker 3

And once you get it, you just keep digging and people are starting to do a lot of things that can harm organization badly. And this is even before it's in the wrong end, God forbid, you have like an attack over something like that. I think that eventually it's inevitable that it will be in the hands of every business user. I don't know how to predict, but I believe it eventually will be something like World War XF, it will be in the end of every end user. And if you will not solve the data protection problem and even the same behavior, so going to have just to have a lot of risk.

Speaker 3

And we definitely start to see that in a major way organizations are starting to use it. But we're also starting to see just a material slowly, material impact on the pipeline. I think that people have to understand that this is inevitable to use this tool because of the productivity Again, then you can't do it. But if you will do it as is without fixing permissions, understanding of normal behavior, the ability to classify your data is a very good proposition for the organization. So we believe that over time, we will benefit from it, and we believe that slowly but surely, this is something that will be in the hands in one way or the other.

Speaker 3

We believe it will be in the hands of every knowledge we'll get.

Speaker 6

And Hamzah, just to add from a numbers perspective and add to what Yaki just said, when you kind of look at the results of the quarter, they were really strong and that's without Copilot being a material contributor yet. So when we look at kind of the guidance and the assumptions there, we don't bake in any optimistic assumptions in our guidance before we see enough data to support the trends. So we haven't yet baked in any contribution related to CoPilot. We're seeing that healthy pipeline that Yaki talked about and similar to what we have done in the past, we'll be happy to update you on any changes when the time is right. So bottom line, it's not part of the current guidance, but we think it should serve as a tailwind to the business.

Operator

Our next question comes from Brian Essex with JPMorgan. Please proceed with your question.

Speaker 8

Hi, good afternoon and thank you for taking the question and congrats from me as well. Nice to see the acceleration or slight acceleration ARR along with better profitability and cash flow, particularly so early on in your transition process. And I guess that leads me into the question, maybe for Guy, sustainability of profitability and cash flows here on out, how should we think about it both in terms of the sustainability and level of potential margin expansion that we might expect?

Speaker 6

When you look at kind of our philosophy in terms of the investments and growing top line growth, we've always been very focused on increasing the top line, but making sure that some of it coming to the bottom line and making sure that we're generating more meaningful cash generation. I think we've done that very well. As you mentioned, it's not easy to do that at the beginning of a transition. I think we managed that very well. But when you kind of look at the quarter, there were a couple of things that really contributed kind of the strength of the quarter and I think can help us drive top line growth and free cash flow going forward.

Speaker 6

We're definitely seeing shorter sales cycles on SaaS and also seeing healthy and much better new logo activity. That's being driven by SaaS value proposition and the fact that we're eliminating the 2 biggest pushbacks to the customers. 1, not wanting them to buy hardware and the second one is that they don't have enough people to support the solution. So kind of when you look at the momentum in the quarter, really the factors that drove that outperformance in the quarter were those 2. And overall, we're really happy with the progress and want to make sure that we grow top line and generate more meaningful free cash flow in the years ahead.

Operator

Our next question comes from Joel Fishbein with Truist Securities. Please proceed with your question.

Speaker 9

Thanks for taking the question and congrats on the great execution. Yaki for you, you mentioned the hospital system that deployed Varonis during the quarter. And I would love to understand the competitive landscape around that deal or competitive dynamics. And also, Guy, if you could share maybe the size of the deal, any parameters around that would be really helpful as well. Thank you.

Speaker 3

Yes. Thanks. So overall, we don't see more competition in the pipeline. For different use cases, we see different companies. But essentially, regarding this deal and others, what I think that is very important to understand, I hundreds of big breaches in the last few years.

Speaker 3

And they all usually have modern security stuff, world class EDR and modern firewall and SIEM. But once you have an identity, there is no perimeter anymore. And you need a data first solution in order to solve this problem. You can invest a lot without getting the benefit. With our SaaS solution, it's really in order to protect

Speaker 6

your data, the first thing you need to do and

Speaker 3

the last thing that is going to save you and you get a world class security people looking at it, 1 to 4 by 7 to make sure we don't have a data breach over data loss. This is just a common thing to us all the deals and with more automation and more coverage, we have more use cases and more ways to get into enterprises. So just the whole sales motion with the value proposition is working very well.

Speaker 6

And in terms of the deal itself, what was very interesting about the deal is that they bought the full package including the MBDR. So they wanted to make sure that we help them in protecting against any breaches that take place. And obviously, what we can do with them, we can do with many other customers. So this was several $100,000 in deal size. They bought the full package.

Speaker 6

They had about just over 6,000 users. So a very healthy deal in what they consume from a platform perspective and the ASC that we were able to get there.

Operator

Our next question comes from Matt Hedberg with RBC. Please proceed with your question.

Speaker 8

Great. Thanks for taking my question, guys. Congrats as well. There were some questions earlier on about Gen AI and CoPilot, but I wanted to focus on Office 365. I think you had an Analyst Day, I believe it was in March of 2023, you talked about maybe 1% penetrated in the Office 365 base.

Speaker 8

I think you said the time of that equated to maybe $125,000,000 of cloud or SaaS ARR. I'm curious, could you give us an update about how that's progressing? It just seems like that's such a huge opportunity. Just sort of wonder if there's an update on how you think about penetration within that opportunity?

Speaker 6

So you're absolutely right. We laid out kind of the penetration. It was about 1%. And when you look at kind of the Office 365 in terms of how that's contributing to total ARR, we've seen a steady increase as a percentage of total ARR that's coming from the Office 365. But what's actually very interesting to see is that customers are now consuming more of a platform together with the MVDR, which is making this extremely more appealing for them and helps in kind of the whole conversation with the customer.

Speaker 6

So I wouldn't say that we're even close to scratching the surface. It's obviously improved slightly, but in terms of the opportunity, we're so far from having been getting to a point where it gets to the mid single digit percentages. So we're far away from that. And that just shows kind of the essence of how we can take advantage of the opportunity going forward.

Operator

Our question comes from Fatima Boolani with Citi. Please proceed with your question.

Speaker 10

Hi, good afternoon. Thank you for taking my questions. Guy, I wanted to ask you about MDDR and if you can help put some numerical contours around some of the comments you made around the solution driving new customer velocity, better transaction velocity, influencing deal sizes. Just wondering if you can add a little bit more quantitative color around that. And the reason I ask is this time last year, you were in very early innings of your SaaS transition and you didn't really have a formalized monetization model for MBDR whereas this year you do.

Speaker 10

So I'm wondering if you can compare and contract how much MBDR has positively influenced the SaaS momentum and the broader metrics? Thank you.

Speaker 3

Absolutely. I think that's

Speaker 6

a great question. Just to remind everyone, we actually introduced MBDR at the beginning of this year. So it's not even been full 2 quarters, but the way we're seeing both the sales force and our customers adopt it has been phenomenal. They've really embraced the simplicity of us doing things for them. So that's been very well received.

Speaker 6

In terms of exactly quantifying how much it's increasing in terms of ASP, we're seeing the ASP go up. But if you remember, we talked a lot about the fact that the way we price MBDR is that either you buy additional licenses and then you get the MBDR at a reduced price or if you want to buy kind of MDDR as a standalone with kind of, I'd say, the package plus, then you would pay a higher price. And what we've actually seen from a behavioral perspective is that the customers actually are going towards the buying the extended package, which is helping us in terms of the ASP. I don't want to quantify it because it's so early, less than 2 quarters in, But I can tell you that in terms of adoption, it's been one of the fastest adopted, I call it platform because we're selling the platform with MBDR. So it's been one of the fastest business adopting platform.

Speaker 6

And not only that, we truly believe that this offering should be part of every customer. It's obviously going to take time, but that's kind of the journey that we believe every customer should go through.

Speaker 3

We are also surprised with how effectively it is. This offering of saving customers like main customers on a weekly basis from a catastrophe, from attacks that people bypass the perimeter, they have an identity and they can do massive amount of damage in the way that user behavior analytics is working. We love the telemetry that we are taking from Active Directory, Azure will be stuff like Okta, DNS and proxy, make sure that most of the time they even don't get to the data. If they get to the data, we see immediately the abnormal behavior, stop them and doing very effective forensics also on the data layer, and they know exactly what happened. So it's just it's just amazing to see how effective it is and how much value it brings to customers.

Operator

Our next question comes from Shaul Eyal with TD Cowen. Please proceed with your question.

Speaker 11

Thank you. Good afternoon. Congrats on the outperformance and improved guidance. Yaki or Guy, it's been about 10 days since the global CrowdStrike ID outage. Just curious, Yaqui, maybe for your views and have you seen any increased interest, heightened interest over the course of this past very, very short period?

Speaker 6

Not really.

Speaker 3

It's a software outage can have sometimes go wrong with this. What happened here, CrowdStrike is a great company. They're taking care of it. But in general, what we see are completely unrelated to CrowdStrike is that organizations understand that they need a data security platform. I think that in general, we understand that perimeter security is very important, but it's not enough.

Speaker 3

And you can be 99 point 9% okay, but then bad actors don't manage to buy the fit in any way. And if you don't get something like that, it will end up with the horrible breach. So this is what we see in the market. That just organizations understand that they need to be the first solution, and this is the way to protect the valuable information.

Operator

Our next question comes from Andrew Nowinski with Wells Fargo. Please proceed with your question.

Speaker 2

Okay. Thank you. So you talked about now expecting more conversions in Q4, which obviously creates a revenue headwind. But I'm wondering what prompted this change in assumptions this quarter and what you saw in the results in Q2 that may have prompted that because the guidance for the year suggests a fairly steep deceleration in Q4 revenue growth. Just wondering what maybe what changed or what prompted the change?

Speaker 2

Thanks.

Speaker 6

Andrew, I don't think there's any change in the way we're looking kind of at the Q2 and definitely not putting anything in different light in Q4. I think there is a couple of things to note about the conversion. First of all, Q4 is the largest quarter. So we're taking advantage of any renewal as an attempt and desire to convert them into SaaS. And I

Speaker 3

think if you look at

Speaker 6

Q2, there was a large revenue beat and that revenue beat had a couple of mechanics behind this that had to do with it. First of all, I think it's important to note that ARR

Speaker 3

is kind of the leading indicator

Speaker 6

and was really strong this quarter with good momentum in the business. I think that's very clear. During the transition, I think revenue is not really the indicator that would indicate on the health of our company, and I think we've been very clear on that as well. And when we look at what we said in the past, the more conversions we see from on prem subscription to SaaS, the greater the headwind for our traditional income statement metrics. And this quarter, we actually had really strong conversion and there were 2 positive factors that took place that didn't cause revenue headwinds.

Speaker 6

The first one was that we saw perpetual maintenance customers choose to convert to our SaaS platform. Since perpetual maintenance revenue is recognized rapidly, just like SaaS did, there is a tailwind when those customers convert to SaaS because of the uplift. So as you remember, when we laid out the transition plan during the Investor Day last year, we didn't initially plan for those customers to convert to our SaaS offering. So the fact that we're seeing this happen in a natural way is a huge positive for the business. And kind of the second factor that impacted Q2 is that we saw an increase in customers choosing to convert ahead of the actual renewal date, which doesn't serve as a headwind to revenue this quarter, will have an impact on our revenue in future quarters.

Speaker 6

So really to summarize, when you look at kind of the momentum of the business, it's really strong. And although revenue should not be the measure for the health of the business, the reason it was stronger this quarter is because of the perpetual maintenance customer conversion and the early on prem customer conversions that will impact revenue in Q3 and Q4.

Operator

Our next question comes from Roger Boyd with UBS. Please proceed with your question.

Speaker 12

Hey, everyone. Thanks for taking the questions. And again, congrats on the good results. You launched a number of database SKUs at the beginning of the year, including for Snowflake. Can you just talk about the momentum you're seeing with those products and particularly with the Snowflake SKU?

Speaker 12

Have the data security concerns stemming out of the incident there benefited the uptake or pipeline of that product? Thanks.

Speaker 3

I think that you see you're starting to see a lot of concerns from every data repository that the big complicated in the mission model and the use is a lot of collaboration and Snowflake is one of them. We definitely starting to see a lot of momentum for this product and we also see that the very big intellectual property that we have, the big technology that we have is very much needed there. The other thing that we see that exactly what I said about the perimeter is if you want to protect data, you need to protect data. You need the data first solution. Because if you don't have it, as I said, once you have an identity, that's it.

Speaker 3

You are in the data. And I just think that once you have the right product, organizations are starting to take their security very seriously.

Operator

Our next question comes from Joe Gallo with Jefferies. Please proceed with your question.

Speaker 5

Hey guys, thanks for the question. Just wanted to double click on the new logo business. How was it this quarter? Any quantitative metrics, whether it's total customers or growth that you can share? And should we expect that side of the business to accelerate now that you have Copilot and MDDR in addition to the sales comp changes?

Speaker 5

Thanks.

Speaker 6

So the majority of the new ACV in Q2 was driven by new logos. We're definitely seeing shorter sales cycles on the SaaS deals And SaaS is really opening up new markets for us because it eliminates, as I said before, the 2 biggest pushback we used to get. One is that they don't have the people or don't want the hardware. So when you look at kind of the opportunity of growing the new business and we talked a lot about kind of SaaS and MBDR combined simplifying the conversation, making it easier for our sales team to talk to customers and kind of talk about the value proposition in a simplistic way. I obviously hope and I think we have good indicators that the new customer would continue going forward.

Speaker 6

But I can tell you that when you look at the results in Q2, the Q2 new business was very strong.

Operator

Our next question comes from Jason Ader with William Blair. Please proceed with your question.

Speaker 9

Yes, good afternoon guys. I wanted to ask about gross margin. I guess a little surprised at how strong it was in the quarter just given the growing mix of SaaS. Can you just talk about what your expectations are for the second half of the year and into next year for gross margin? And are there any kind of specific idiosyncrasies around the gross margin beyond just the rising SaaS mix, which obviously has a negative impact?

Speaker 6

Yes. You're 100% right. We were very happy with the gross margins. They were really strong. I think that when you look at the ARR contribution margin and do it based on cost, you'll see that we were really at the same percentage that we had last year, which is 12%.

Speaker 6

So we were extremely happy with that. If you look ahead, the one thing that we want to make sure is convert our customers to SaaS. So the quicker we convert them, the more headwind we'll get from a revenue perspective. And on top of that, we have to make some investments in support to transition really to support the transition. So you should see gross margins somewhat having kind of declining slightly, but I can say to you that when we look at gross margins in the bigger picture, we're really happy with where we are, especially with the initial investments that we need to make to support this transition.

Speaker 6

And we expect to see the leverage even further coming in the years ahead.

Speaker 9

So Guy, just to be clear, the gross margin for Q3 and Q4, you expect to be below where Q2 was?

Speaker 6

So we don't really guide on the gross margins on a quarterly basis. I'll talk conceptually about the fact that overall when you look at kind of gross margins this quarter versus last year on the ARR contribution margin, you didn't see much of a change. You might see a bit of a change because of the investments that we're making. But overall, in the big picture, the gross margins are really healthy, and we're really happy with what we're seeing from kind of the margins on the SaaS product. And on top of that, there's leverage that you see in the different departments.

Speaker 6

You get the leverage in the sales and marketing. There's leverage down the road on the R and D when you stop supporting 2 types of codes. So the fact that we're making those investments in kind of the support team and the customer success team to support the transition doesn't really impact the overall bottom line and we're very committed on showing operating margin improvement. And when you look at the ARR contribution margin, we saw a really nice increase versus last year.

Operator

Next question comes from Rob Owens with Piper Semler. Please proceed with your question.

Speaker 8

Great. Thank you for taking my question. I was hoping maybe you could elaborate a little bit around compressing sales cycles on the SaaS front. And if you could quantify that versus maybe where your traditional sales cycles are? And I guess secondarily, what you're seeing from a renewal standpoint?

Speaker 8

Thank you.

Speaker 6

So I can definitely dig into this. I think what we're seeing in the sales cycles already that they're shorter on the SaaS versus the on prem subscription. I think it comes to the fact that the value proposition of our platform together with the simplicity of the story is causing that shortening deal cycles when you compare them to the on time subscription deals. We said from day 1 that we expect sales cycles to be shorter on SaaS versus the on prem subscription because of the simplicity. How much it came down should be really a focus point, whether it's 25%, 33% or even 50% shorter.

Speaker 6

The point is really that we're seeing a significant enough reduction for us to talk about it and call it out today. So really, it gives us a lot of momentum, and I think it's a critical benefit that we talked a lot about on the fact that we transitioned to SaaS and the benefits that that generates. In terms of the renewal rate, we're seeing very healthy renewal rates. We're very happy with them. And we've also said that we expect over time to have renewal rates increase with the SaaS offering.

Operator

Our next question comes from Joshua Tilton with Wolfe Research. Please proceed with your question.

Speaker 2

Hey guys, thanks for taking my question. First of all, congrats on a great quarter. I guess what I'm trying to understand is just I think if I look back, this is probably one of your best beats on ARR, total ARR in quite some time. And I'm just trying to understand what exactly changed this quarter that drove that rate of change to the positive and how durable is that going forward? I know you mentioned that Gen AI is not contributing to the model yet, but did you just do way more conversions this quarter?

Speaker 2

Did MDDR just start showing up in the numbers? Or is it just a function of maybe maintenance to SaaS uplift is just much higher than what you've seen on your prior conversion rate? So just help us understand exactly what drove this rate of change and durable you think this outperformance you delivered today is going forward?

Speaker 6

First of all, thank you. We're really happy with kind of the results of the quarter. And as you mentioned, the strong quarter is really without the co pilot being a material contributor yet. I think when you look at kind of the underlying factors that help drive this quarter, one of them was the shorter sales cycle on SaaS and the other one was much better new logo activity. Those were kind of 2 of the elements that drove that.

Speaker 6

I think it kind of ties to the fact that MDDR together with our SaaS offering is making things much easier for our customers to consume. So when you look at kind of the overall health of the business, we're really happy with where we are. Obviously, we're very focused on continuing on that execution, but I wouldn't say that the conversion is what drove the business. What drove the business in Q2 was the new logo activity and the shorter sales cycles that we signed

Operator

that. Our next question comes from Rudy Kupender with D. A. Davidson. Please proceed with your question.

Speaker 6

Hey guys, thanks for taking my questions and congrats

Speaker 12

on the numbers. Looks like

Speaker 8

a great quarter. I guess I'm curious on CoPilot you've talked about it becoming a healthier material contributor to pipeline. If we combine that with what you've said about some of these faster sales cycles on SaaS and obviously those deals being SaaS deals, I guess that would imply we should start to see some material benefit to your new business from CoPilot probably several quarters out from now. Is that the right way we should be thinking about it? Or with some of these deals around CoPilot, are you seeing them progress slower or faster than your typical deal just given how the pace of how those companies are rolling out CoPilot?

Speaker 8

Thank you.

Speaker 6

So one thing we try to do is only comment on kind of data that gives us enough confidence to call it out. And you've heard us talk about the expectation that sales cycles on SaaS would be much shorter from day 1 of announcing the transition.

Speaker 3

But this is kind of

Speaker 6

the Q1 that we feel confident in calling it out because 18 months have gone by since we announced the transition and we have that data to support it. I don't know how CoPilot kind of changes the data. I can promise you that from a transparency perspective, we've been we've tried to be very clear in providing color when we see data that materializes. But I think if you look at kind of co pilot starting to contribute, we really don't know if it can contribute later this year or in 2025. What I promise you is that once we see data that supports that, we'll call it out and provide you that color.

Speaker 3

The way to think about it, we believe, is to understand that if these Copilot tools are going to be in the hands of knowledge users, the security the need for security will be almost inevitable. And without a doubt, at this point, we believe that we have the best product in the market. So if this tool will be in the hands of users and we believe that there is real AI evolution. Based on LLM, you will need solution like Vowance in order to protect it.

Operator

Our next question comes from shanik Khosari with Robert W. Baird. Please proceed with your question.

Speaker 13

Yes. Thanks for taking my question and great job this quarter. Yaki, so you highlighted of course the short field side within the pricing uplift continues to be strong. In some cases you see deal sizes increase in excess of what customers as a result of customers consuming more of the platform upon conversion and highlight the real estate farm was immediately able to reduce the footprint and the maintenance by moving to SaaS. Just that's all great.

Speaker 13

Just curious if you still have a long tail of the on prem base, which might be a bit more price sensitive and bit more averse to transition that we kind of have been hearing. So, and you have sales incentives you touched upon, but just can you elaborate a bit on how to plan on working with these customers to demonstrate the value proposition and justify this price uplift of the SaaS platform for this existing cohort of on prem? And I have a quick follow-up for Guy.

Speaker 3

Yes. I think that with the vast majority of our customers, it's just very compelling to move to SaaS because of the automated outcomes. So we just you want to make sure that you can avoid a breach without almost any effort and it works very well. But these transitions are hard work. You need great attention to details, a lot of execution.

Speaker 3

You need to go to the customers that use one product and you need to make sure that they understand that this is something completely different and demonstrate. But we know how to do it. We know how to do transitions. But can tell you that every day is just a lot of work and you need to do it diligently and effectively, but this is exactly what we are doing and you can see the results.

Speaker 13

Yes.

Operator

It appears we have no further questions at this time. We would now like to turn the floor back over to Tim Kurz for closing comments.

Speaker 1

Thanks for the interest in Varonis. We look forward to speaking with you all at conferences this quarter.

Operator

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

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Key Takeaways

  • Q2 financials: ARR grew 18% to $584.2 M and YTD free cash flow rose to $67.3 M from $40.0 M, with SaaS ARR reaching 36% of the total, driving raised full-year guidance of $629 M–$635 M in ARR and $80 M–$85 M in free cash flow.
  • SaaS transition momentum: Customers enjoy automated outcomes, shorter sales cycles, larger initial deal sizes and long-term margin benefits, while on-prem and perpetual maintenance clients are converting to SaaS at a 25%–30% list-price uplift and often higher effective ASPs.
  • MDDR traction: The new Managed Data Detection & Response service, available only on SaaS, is quickly driving new logo wins and existing customer migrations by proactively stopping threats with minimal customer effort.
  • Generative AI tailwind: As enterprises adopt GenAI, hidden data-access risks are being exposed, reinforcing the need for a data-first security approach; Varonis reports growing pipeline interest tied to AI use cases, though it isn’t yet in FY24 guidance.
  • FedRAMP in-process: In June Varonis achieved FedRAMP in-process designation, marking a key step toward offering its SaaS platform to U.S. federal government customers once full authorization is obtained.
AI Generated. May Contain Errors.
Earnings Conference Call
Varonis Systems Q2 2024
00:00 / 00:00