Greetings. Welcome to the Varonis Systems, Inc. Second Quarter 2019 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] Please note that this conference is being recorded.

I will now turn the conference over to your host James Arestia, Director of Investor Relations. Mr. Arestia, you may begin..

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

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 third quarter and fiscal year ending December 31, 2019. Actual results may differ materially from those set forth in such statements.

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

These factors are addressed in the earnings press release that we issued today under the section captioned Forward-Looking Statements, and these and other important risk factors are described more fully in our reports filed with the Securities and Exchange Commission. We encourage all investors to read our SEC filings.

These statements reflect our views only as of today and should not be relied upon as representing our views as of any subsequent date. Varonis expressly disclaims any application or undertaking to release publicly any updates or revisions to any forward-looking statements made herein.

Additionally, non-GAAP financial measures will be discussed on this conference call. A reconciliation for the most directly comparable GAAP financial measures is also available in our second quarter 2019 earnings press release which can be found at www.varonis.com, in the Investor Relations section.

Also, please note that a webcast of today's call will be available on our website in the Investor Relations section. With that, I'd like to turn the call over to our Chief Executive Officer, Yaki Faitelson.

Yaki?.

Thanks, Jamie, and good afternoon, everyone. I am excited to update you today on the success we are having with our transition to a subscription company. It is proceeding better and faster than we could have ever imagined. For Q2, I am pleased to report that 56% of our license revenues were from subscription.

This obviously far exceeded our guidance of 25%, so we are again raising our expectations for the full year mix, from 25% to 45%. When we raised the 2019 mix to 25% a quarter ago, we said that this put us a year ahead of schedule.

Today, we raise the guidance to 45%, we continue to shorten the traditional timeline to complete such a transition, and we are building a much stronger business with greater visibility and predictability. We are also very pleased that EMEA had a solid quarter as a result of the changes we made in Q1.

In fact, the subscription percentage for both North America and EMEA were in line with the reported mix. Most importantly, the business overall is very healthy, as we estimated that normalized license and subscription revenue growth in Q2 was above 25%.

In short, we are growing the way we knew we could; subscription is unleashing the full potential of our platform. I’ll talk more about business growth shortly, but let’s quickly touch on our results. Second quarter total revenues were $59.6 million. Q2 subscription revenues were $14.8 million, while perpetual license revenues were $11.5 million.

In just our second quarter of the transition, we generated more subscription revenues than perpetual license revenues, confirming the customer demand to consume the platform under our new model. Maintenance on our perpetual license and services revenues were $33.3 million.

Consistent with Q1, the larger mix of subscription revenues clearly impacted our reported license revenues this quarter. We estimate that had the subscription mix been in line with the 25% guidance we provided, our Q2 reported revenues would have been approximately $68 million, well above the high end of our guidance.

Let’s talk more about the transition, the key drivers of growth that we are seeing, and some examples of customers who are benefiting from the subscription model and our platform. Data continues to explode across all data stores, both on-prem and in the cloud, creating an increasingly complex hybrid environment.

With the number of high-profile breaches we have seen, data-centric solutions are a priority for CISOs. In the face of current and pending regulations, compliance has never been more important. We are starting to see fines for GDPR infractions that have real consequences for companies’ financial results and reputations.

Security and compliance concerns open up many opportunities for thoughtful discussions with customers in which we can demonstrate the full value of our platform.

For example, a large investment company in Europe who has relied on Varonis since 2013 added GDPR Patterns as well as DatAnswers for Windows and SharePoint, to pinpoint customer information for data subject access requests under GDPR. With our subscription offering, the customer was able to better maintain compliance with current regulations.

They also purchased Edge to better safeguard against breaches, and went from four licenses to eight. Another customer, a major non-profit organization, sought to reduce risk, work toward compliance with HIPAA, GDPR and the California Consumer Privacy Act, and boost their threat detection and response capabilities.

Without visibility into where sensitive data resided in their environment and who had access, they were blind. Data Classification Engine with GDPR and CCPA support will identify regulated and sensitive data throughout their environment.

They will also use DatAlert to detect breaches, and, of course, DatAdvantage and Automation Engine to reduce risk, as our subscription model allowed them to buy five licenses in this initial deal. This final example is a large regional healthcare provider that had spent three years trying to clean up global access groups and lock down sensitive data.

A trusted partner recommended Varonis. A Data Risk Assessment found over 750,000 folders and 2,000 sensitive files open to every user in the entire organization, a potential nightmare under HIPAA. With our Automation Engine, we showed how Varonis could clean up global access within weeks.

With Edge, we opened their eyes to the dangers of DNS tunneling, a very stealthy way that attackers exfiltrate sensitive data. Our subscription model allowed them to purchase six licenses and almost instantly realize benefits in data protection, compliance and threat detection, three premium business concerns.

Through the subscription model, customers who buy more initially can realize the value of the platform much quicker, and with the large number of licenses we have, we can continue to upsell over time. In other words, subscription is leading to both broader initial deployments and expansion of existing deployments.

We added 162 customers this quarter and have added approximately 300 in the first half of this year. Almost all of the delta in the new customer adds versus last year is in the 0-500 customer group.

This is in line with our strategy to focus our time and attention on customers who can make larger initial commitments and expand with us over time, and we saw that happen this quarter. Additionally, it is important to remember that half of our revenues come from our existing customers, with whom we remain underpenetrated.

We are spending more time with these customers and becoming much more strategic and efficient in our coverage. This focus on the right customers will translate to greater efficiencies in our model, as we expect to see significant leverage from the sales force over time, as we complete our subscription transition.

These larger customers have moved up the adoption curve and have a greater awareness of the full value we can provide them around data protection, compliance and security analytics. We have a proven technology and approach, and we are confident that the secular trends and industry changes that we see should serve as a tailwind for years to come.

As we have said, moving to subscription is our top priority, which requires discipline, focus and execution. The results this quarter demonstrate that we are well underway, and we want to be a case study in how companies can successfully move to subscription as rapidly as possible.

Our customers and channel partners are happy, and I would like to thank our salesforce and sales leadership, who are embracing this transition and doing better than ever.

At the same time, we believe the addressable market is ours, the asset is scarce, and the transition will allow us to more quickly and efficiently reach our $1 billion sales target, as we are truly unlocking the potential of our platform.

We are building a stronger company with greater long-term value for stockholders, and we look forward to a strong second half of 2019. With that, let me turn the call over to Guy.

Guy?.

Thanks, Yaki. Good afternoon, everyone. This quarter’s highlights include subscription revenues representing 56% of total license revenues compared to 4% a year ago, and subscription and maintenance from perpetual license revenues representing 78% of total revenues, compared to 45% a year ago.

We continue to maintain a three year breakeven period even with the significantly higher dollar amount of subscription, and a continuation of the increased license adoption trends. The bottom line is this. The transition is unleashing the potential of our platform while delivering greater long-term value for our stockholders.

For Q2, total revenues were $59.6 million, a decrease of 4% year-over-year. Second quarter license revenues were $26.4 million, which included nearly $15 million of subscription revenues. In only the second full quarter of this transition, our subscription revenues exceeded perpetual license revenues.

Guidance was 25%, and with the continued outperformance, we again validate why the move to subscription makes so much sense for our customers and for Varonis. To remind you, our subscription price list is set between 40% to 45% of the perpetual price list, including first year maintenance.

This equals a three-year break even period, which we saw in our Q1 and Q2 results. Using that three-year breakeven period, which yields a 2.2 factor license and subscription revenues growth was 26% on a normalized basis.

Subscription adoption for both existing and new customers remains strong with new customers continuing to buy on average between four and five licenses in the initial deal, as opposed to two and three licenses under the old perpetual model. And like Q1, we saw existing customers more than happy to purchase upsells via subscription.

Maintenance and services revenues were $33.3 million, increasing 16% compared to the same period last year. I would like to make a few comments about the maintenance and services line. First, to remind everyone, maintenance related to subscription is included in the subscription line in our financial statement.

Second, as our subscription mix increases, we expect less maintenance revenues associated with perpetual license revenue. Maintenance renewal rates on perpetual licenses once again exceeded 90%, and we expect them to stay at these high level.

Lastly, included in the maintenance is a small professional services component that historically has been low single-digit as a percentage of total revenue. We expect this professional services component to become even smaller going forward, as we offer licenses that provide greater automation and as our channel partners take on more services work.

Annualized recurring revenues, or ARR, a key performance indicator for subscription companies, is defined as the annualized value of active term-based subscription license plus maintenance contracts related to perpetual licenses in effect at the end of the reported period.

As of June 30, 2019, ARR was $155.2 million, compared to $111.9 million at the same time last year, representing growth of 39%. This increase reflects the strength of the business as we transition to a subscription based license model.

Turning back to our results, looking at the business geographically, North America revenues increased 4% to $40 million or 67% of total revenue. In EMEA, revenues decreased 18.3% to $17.6 million, representing 29% of total revenue. But the subscription mix for that region was in line with our reported mix.

Our sales teams in EMEA and across the world have now fully embraced the business model transition, and the impact is noticeable. Rest of World revenues were $2.1 million, or 4% of total revenues. For the second quarter, existing customer license and first year maintenance revenues contribution was 51%, up from 42% in Q2 2018.

During the quarter, we added 162 new customers, and we ended Q2 with approximately 6,800 customers. As of June 30th, 2019, 74% of our customers had purchased two or more product families, up from 71% at the same time last year. 42% of our customers purchased three or more product families compared with 38% in Q2 of 2018.

Moving to the income statement, I’d like to point out that I’ll be discussing non-GAAP results going forward, unless otherwise stated, which for Q2 exclude $14.8 million in stock-based compensation expense and $261,000 of related payroll tax expense.

Also excluded are foreign exchange losses of $426,000 related to FX differences from the revaluation of assets and liabilities denominated in non-U.S. dollars. Gross profit for the second quarter was $52 million representing a gross margin of 87.3%, compared to 90.5% in the second quarter of 2018.

Operating expenses in the second quarter totaled $61 million. As a result, our operating loss was $8.9 million, or an operating margin of negative 15% for the second quarter, compared to an operating loss of $1 million or an operating margin of negative 1.6% in the same period last year.

The move to subscription impacts our short term operating results, but we have been and remain committed to profitability and believe we will come out of the other side of this transition with a healthy margin profile.

During the quarter, we had financial income of $491,000, compared to financial income of $321,000 in the second quarter of 2018, both primarily due to interest income.

Our guidance does not consider any potential impact to the financial and other income and expense associated with foreign exchange gains or losses as we don’t estimate movements in foreign currency rates.

Our net loss was $9 million for the second quarter of 2019 or a loss of $0.30 per basic and diluted share, compared to a net loss of $1.3 million or $0.04 per basic and diluted share for the second quarter of 2018. This is based on $30.3 million and $28.9 million basic and diluted shares outstanding for Q2 2019 and Q2 2018 respectively.

Turning to the balance sheet, we ended the quarter with $146.3 million in cash, cash equivalents, marketable securities and short term-deposits. For the first six months of 2019, we generated operating cash flow of $3.0 million, compared to operating cash flow of $20.4 million in the first six months of 2018.

In this transition, we are collecting on ACV amounts and therefore see a short-term impact on cash flows. We ended the quarter with 1,448 employees, a 6% increase from the second quarter of 2018.

Before I turn to guidance, I would note that we have added a few new slides to our investor presentation found in the IR section of our website to provide additional visibility into the real strength of our business.

Slides 7 and 8 show the mix that subscriptions and maintenance from perpetual license revenues represent out of total revenues for Q2 and the first half of 2019. The substantial growth in this mix this year demonstrates how rapidly we are building a stronger and more sustainable business.

The normalized license and subscription revenues I mentioned before is illustrated in Slide 10, showing growth of approximately 26% for Q2. Slide 11 illustrates that at 25% subscription revenues mix we originally expected, Q2 revenues would have been comfortably above the high end of our guidance. Moving to guidance.

Given the impressive results we are seeing with subscription adoption, we are again, significantly increasing our expectation for subscription mix as a percentage of license revenues. For the third quarter, we expect the mix to be approximately 55% or $15.5 million in subscription revenues.

For the full year, we now expect the subscription mix as a percentage of license revenues to be approximately 45% or $56 million. This is a substantial increase from our previous guidance of 25%. For the third quarter of 2019, we expect total revenues of $61 million to $62.5 million.

We expect our non-GAAP operating loss to range between negative $10.5 million to negative $9.5 million and non-GAAP loss per basic and diluted share in the range of $0.36 to $0.34. This assumes a tax provision of $500,000 to $700,000 and 30.4 million basic and diluted shares outstanding. I would like to provide more detail on our updated guidance.

We are effectively raising our guidance on a normalized basis for the third quarter versus what was implied in our prior full-year guidance. Our Q3 guidance assumes a 2.2 conversion factor and a three-year breakeven, and for Q4, we expect the conversion factors to range between 2.2 and 2.5.

Consistent with this, we still estimate that for every incremental $1 million of subscription revenues we generate versus our guidance, we will see a $1.2 million to $1.5 million headwind to reported revenues, which we expect to equally impact operating margins.

As a result, for the full-year 2019, we now expect total revenues in the range of $255.5 million to $259.5 million. We now expect our full-year non-GAAP operating loss to be in the range of negative $27 million to negative $25 million and non-GAAP net loss per basic and diluted share in the range of $0.93 to $0.90.

This assumes a tax provision of $2.2 million to $3.2 million and 30.2 million basic and diluted shares outstanding. We have summarized our guidance for the remainder of 2019 on Slide 16 of our investor presentation. In summary, Q2 results greatly exceeded our expectations, and we are fully committed to continuing the subscription transition.

We feel confident about the strength of our business and are excited by the implied raise of the Q3 guidance. With that, we’d be happy to take questions.

Operator?.

[Operator Instructions] Our first question comes from the line of John DiFucci from Jefferies. Please proceed with your question..

Thank you. I have a question for Guy and then a follow-up for Yaki. So Guy, thank you for all this information. You’ve given us a lot of information. It's really helpful. But the one thing in this all, it all makes sense, but one thing that doesn't make sense to me is deferred revenue this quarter.

Like I would've thought it with a greater mix of subscription and subscription on an annual basis being a higher price than maintenance, deferred revenue would have been better than what we were looking for instead of a little bit less than what we're looking for.

So can you sort of talk to that?.

Absolutely. So our deferred revenue is impacted by our subscription move and don't, forget that the second and third year auto renewal component in our deals are not part of our deferred revenue. So, we only recognize the first-year maintenance portion that hasn't been recognized, not the licensed portion.

So, when you look at our long-term deferred revenue that actually went down in Q2, 2019 compared to Q2 2018, which is kind of in-line with this story and when you look at long-term deferred revenue, it's single digits. And that's kind of the way it's been for a while. So, it's very consistent and is impacted by the transition..

Okay. So actually you just said something that helped here. So there's an – even with subscription because of ASC 606 accounting, you're recognizing an upfront portion of license from those deals. So that's actually not in deferred. It's just the maintenance from the subscription, that's a differed, so that, thank you, that's helpful.

That's very helpful. And Yaki.

So Yaki, people have been talking a lot and Guy, you can chime in on this too, a lot about GDPR over the last, I don't know, year and a half and you've often said, hey listen, it comes up a lot and whether it's driving revenue, it certainly drives discussion and we've just been sort of waiting for the bite of GDPR, meaning the fines being like some major fines.

And this month we just had, and I know it's this month, so it's really early, but we just had two major fines. One to BA British Airways and one to Marriott.

And I'm just curious and I know it is really soon, but have you noticed anything, has anything come back from your sales force that hey listen, we're getting more inquiries on the backend of these major fines being levied.

Anything like that happening that you can detect at this point?.

Hi John. It's still early, but I can tell you in general that we see that the sales motion and the perceived value becoming significantly, significantly more strategic.

Like everything we are doing becoming just more predictable and these are three used cases in the data protection and compliance and threat detection is just working extremely well, more budgeted project and customers with the subscription understand how they can consume the old platform. And it's worked very well.

And now the GDPR, you have GDPR, now you have the California Consumer Privacy Act and everything that's going around us and you have so many breaches that this advanced APTs that organizations are losing terabytes of terabytes of unstructured data.

Everything is working, working for us as a tailwind and the subscription and the adoption curve really, really integrated extremely well in the right timing and its working very well for us. We can spend time with customers, they understand, we see more C-level people, more people on the business side, seeing the dashboard, getting the reports.

So it's really working very well..

Okay, thanks. Thanks guys. So we'll just keep – this has been certainly an interesting ride, it’s certainly will remain that way. So thanks for everything..

Thank you..

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

Hey guys, thanks. Well done on the quarter. Yaki, obviously the subscription revenue was a lot better than we were expecting. And you're getting a lot of traction there. As this mix to subscription continues to increase, Guy also mentioned 90% plus renewal rates on maintenance contracts.

I'm wondering, are we going to get to a point here where buying a license and maintenance contract isn't an option and maybe you look to convert sort of legacy licensed contracts just pure subscription?.

Yes. Matt, it's still early. Definitely the subscription transition is going so much better than we anticipated. It’s just going very well. And we are intensely focused on the execution. But we need – we have almost 7,000 customers that most of them bought perpetual. We need to be careful with the customer relationships.

So in every deal now, we're trying to make sure that it will be subscription, from all the indicators that we have this is the fastest transition to subscription that we are aware of. But I can’t come with a bold statement now and tell you that will not sell anymore perpetual.

But we are definitely underway to be a very strong subscription business and it's definitely shortening the time and increasing the predictability and the probability for us to get to $1 billion in sales and [marketing] [ph]..

That's great. And then you sort of – that dovetails into my follow-up, which was we’ve seen the success in bigger customers you've alluded to it on the call so deemphasizing zero to 500, which makes a lot of sense.

I guess, could you talk about maybe the success, are you seeing – these larger customers, are you seeing the new subscription, are there – are these shorter contracts cycles and then maybe talk about the level of investment here.

Are there additional investments needed to sort of even further penetrate the high end of the market?.

So sales cycles – sales cycles relatively stayed the same, they just can buy more upfront in over time. So this works very well for us and it’s still – we barely contested.

We don't have a lot of competition but just so many budget buckets that finding APTs, everything that related for compliance, data protection there’s just so much budgets for us and a lot of it is under the CISO but just the Compliance Officer, the DPO, so it makes a lot of sense for us to spend time with the customer.

And they have the clear path how they can get to 10 licenses and more, the budget makes sense. The economics makes sense, definitely the move to subscription with all the automation that customer wants from us, makes every single move predictable for us and for the customer..

Got it. Well done..

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

Hi guys. Thanks for taking my questions here. Maybe just for you, Yaki first. Clearly, a lot of success in selling subscription and that reflects the execution.

I guess, I'm curious what the customer feedback has been on subscription, meaning are customers finding that additional benefit in subscription for the higher value of course, compared to what you are offering them on perpetual. I realize that it's more products than an initial sale.

But talk about the other beneficial points that a customer is getting beyond sort of the pricing in the upfront versus subscription?.

The pricing is definitely – the more licenses as the byproduct of the overall value. At the end, out of everything is a lot of automation.

Automation in high fidelity alerts, automation in remediation, automation in classification on one end and on the other end is visibility, to understand what is going on with this massive amount of data and the overall data support and what's going on when we can – when customers can buy a security package with many more platforms, the value is exponentially bigger and they can have more reports and they don't have too many holes.

They also can get immediate time to value and ongoing value. And when they are going to the cloud, when they have different infrastructure, it's clear for them how they are going to expand.

So now they – everybody understand the problems and the form compliance and insiders threat and advanced precision threat and everything that's just going on around us. We just benefiting from very strong awareness, once we are demonstrating the product, they really want to consume the platform.

And when we sell them enough licenses right off the bat, they have this automation in security, remediation and visibility. And this is really what we see and this is respect to a lot of disciplined execution. This is what is diving this very fast transition to subscription..

Got it. Got it. For my follow-up, maybe for you, Guy. Can you just talk a little bit about the mix of license from existing customers? It's generally being in – been in that same range we've seen of about 50-50.

But I guess just as subscription becomes even, an even bigger part of the business, can you just talk about how that higher subscription mix could potentially impact that metric as we think about it going forward, if at all?.

Absolutely. So as you remember, we’ve priced the subscription price list as 40%, 45% of the perpetual price list including our first-year maintenance.

And when you look at the behavior of new customers, we definitely see that new customers are buying between four to five licenses in that first initial purchase compared to what we saw under the perpetual model, where they bought between two to three licenses.

So that what we see from our ability of a break-even here is that 45% which is that three-year break-even period, we see that break-even period be lower than three years. But we're very, very happy with the adoption of our existing customers.

They're embracing this transition and we saw that during the pilot, we saw that in Q1 and this is consistent in Q2. Existing customers are buying licenses under the subscription model and that break-even is slightly higher than three years, but that gets us to a very healthy mix of three-year break-even.

So we're very happy with the fact that both new customers and existing customers are adopting them..

Very helpful. Thanks guys..

Thank you..

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

Thanks. I actually wanted to ask a question in the back of your slide deck, where you talked about the implied fourth quarter and in that context you imply a much lower rate of conversion in that period.

I was just wondering if you could go or I was just hoping you could go through the reasons why that's a lower transition to subscription in that quarter versus the other quarters, assuming its year-end budget flush, but that would be helpful. Thanks..

Absolutely. So as you remember, we gave some commentary last quarter when we gave guidance on the subscription mix. We expected Q3 last quarter to be 27% and then expected Q4 to be in the low 20s.

So we're actually approximately doubling the subscription mix for the second part of the year, and that's a great indication that we feel very good about this transition, that's the reason we're approximately doubling that percentage. But similar to the commentary that we gave last quarter, Q4 is more of a CapEx weighted quarter.

So we just don't know and we just want to be a bit cautious. And that's by the way, part of the reason that on the conversion factor, we're expecting Q3 to be at that 2.2 factor, which is that three-year break-even and for Q4, we're taking the range of 2.2 to 2.5. But we just don't know.

We feel very good about this transition and very happy to increase our subscription mix for the second part of the year. .

Yes, it makes good sense. One more question if I could.

So this sales channel approach, so as a Varonis sales guy does the transaction, say, with a three-year subscription, and the customer agrees to say, just hypothetically pay, $300,000 on a deal over three years, how does that roll through the compensation to the salespeople? How does that change with respect to what you would have seen otherwise?.

So, I don't want to bore everyone to death with 606, but to keep it very simple, you match the commission expense with the revenue recognition.

So if you – if I take your example of $100,000 annual ACV for three years, we will recognize the license portion, when we shipped the license in year one, which would be about $83,000, and then about $17,000 is the maintenance portion, which would be recognized over that first-year period.

And then year three, we would have that $83,000 again, in the quarter we ship the invoice and the maintenance again, and we have the commission in the same ratio. So kind of matching principle between the revenue and the commission, and that's the way 606 requires you to do this. .

So, that's how 606 requires it, but is that how the salesperson is compensated in year one?.

No. So – we have – I don't want to get into too much detail, but the sales rep have a portion that is paid in year one and a portion that is paid in year two after we collect the second-year payment. .

I see. Okay. Thank you very much..

Thank you. .

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

Thank you. Good afternoon, gentlemen. Congrats on the results. Yaki, when we think about Varonis down the road as do $1 billion revenue company, you talk about over the course of the past few quarters and we understand this is without a doubt a longer term vision without committing to a specific timeframe.

But what level of profitability should we be anticipating; single-digit, double-digit, operating margins? I would imagine that with a quick ramp up we're seeing in the shift to subscription, we should be in probably the double-digit zip code.

Am I looking at it correctly?.

I would let Guy answer what zip code we are going to be. But from my end, I just see that – just think about – overall about the business, very fast to subscription a platform play, we have a lot of licenses to sell with a lot of value and a lot of just the data spoil over on-prem and in the cloud that works very well.

Look, a lot of our revenues come from the customer base. On the perpetual business we have more than 90% renewal rate. We just think that we can be a very, very strong and very unique subscription business. And possibility is very, very important for us.

And we also believe that over time, just with the subscription, everything becoming so much more efficient that we can realize much better efficiencies. And all of these days, the balancing act between being profitable and growing, we wanted to make sure, we're constantly inching forward. So the philosophy didn't change there.

Everything we are doing now, will give us a much better possibility as fast as we can build this fly wheel, it's going to kick in. So this is really the overall philosophy and we are very focused on executing on it..

And Shaul, just to add on that. We said all along that as we exit this transition, we feel very comfortable going back to the revenue growth levels that we've seen in the past, which is 20-plus-percent.

I think that this quarter, when you look at a normalized basis and we specifically provided those to really compare apples-to-apples, we wanted to make sure that investors understand kind of how strong the businesses. And having a Q2 normalized growth of license and subscription of approximately 26%, is very good. We're very happy with that.

And don't forget, we're only in kind of the – we're starting our third quarter of this transition. I know it feels like we've been in subscription mode for years, but this is only our third quarter..

Got it. Okay, that's fair. That's fair. And sticking with the shift to subscription.

Any major bundles that you're seeing as becoming more preferred by converting customers?.

So we actually don't go to our existing customers and try and convert their perpetual license. What we have seen is that existing customers are willing to buy additional licenses under the subscription mode. But we're not going to existing customers in China convert them to what they already own from perpetual to subscription..

And in terms of the license is mixed with everything. It can be the data analytics with the Edge and 365, it can be where the content classification with Automation Engine, everything is so much connected and it just depends on what use case is more pressing for the customer and you need more automation..

Understood. Thank you. Good job. Congrats..

Our next question comes from the line of Keith Weiss from Morgan Stanley. Please proceed with your question..

Thank you guys for taking the question. It’s Keith Weiss filling in for Melissa Franchi. I wanted dig in one on sort of the execution side of the equation and one on the subscription.

On the execution, I was hoping, you can give us an update in terms of kind of how the changes that you guys put into place and the first half of the year in Europe are taking hold how you guys feel about kind of the execution and your kind of sales capacity and how that's been doing in Europe on the execution side.

And on the subscription transition side of the equation, it’s been a really fast ramp, and I agree this is fast as I've ever seen anything ramp in terms of subscriptions. But given the fact that you're not pushing existing customers to go over towards subscriptions and the Q4 commentary on that, there's likely to be CapEx intensive.

How should we think about kind of the longer term dynamic? Where do you think perpetual versus subscription kind of starts to level out or would it be a normalized rate given what you see in your customer base today?.

So I'll start and then I'll let Yaki chip in. When we look at EMEA, looking at the Q2 performance, the subscription mix was very much in line with our reported mixed. And we're very happy with that mix. We're happy that our salesforce has adopted this and we're happy that allowing customers to really utilize and unleash the potential of this platform.

This subscription transition is truly about the customers allowing them to utilize and purchase more licenses up front. And I'm very happy. We're very happy that the European team has kind of done very well in this adoption in the second part of the year. In terms of where does this go ahead.

Yes, we have existing customers but as we saw during the pilot and Q1 and Q2, those existing customers are buying or enjoying this subscription offering. So we were aiming to be a subscription company. That's what we're targeting. That's what we're trying to be. And we see that working very well..

As Guy said, the option in the subscription is working extremely well. The customers are very excited from the platform play, which is the budgets and their overall budgets are working. But we just need the empirical evidence of Q4. This is early in the transition, it's working extremely well.

But we just, as we are moving forward in this transition and have more visibility. We are telling you exactly what we say. We will do the same with the fourth quarter. We are very a prudent management and then we just need to be careful..

Excellent. Very nice quarter guys..

Thank you. Thank you..

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

Hi, this is actually Chris Spiros on for Gur. Yaki, you noted that CISOs are increasingly prioritizing data centric security projects.

Have this trend have increased the awareness altered the competitive landscape 20 degree? Or does the frequency in which you did you encounter a competitor and a transaction does that still remain quite low?.

Yes. It's slow. It's even less than we saw than we saw in the past. But we definitely see a lot of awareness for data centric security approach and its working very well for us..

And another one for Yaki, growth adoption of both DatAlert and the Data Classification Engine continues to be impressive.

You've noted that new subscription customers are now adopting four to five licenses on average, outside of DatAlert and the Data Classification Engine, to which solutions have most benefited from this trend?.

Yes. I think that overall all of them. The cloud 365 is doing very well for us. Everything that related to active directory and as UID, with all the compliance we see a nice deals with DatAnswers. Edge is doing very well. Just we are really benefiting from all the platform..

Great. Thanks, Yaki..

Thank you..

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

Yes, thanks.

So look, I think many of us, we’re seeing trends overall transitions then I can never remember one this quick from a subscription perspective, maybe can you give me –maybe the one or two key things that have driven the success code over the last six months? I'll start there?.

Great. First and foremost is the innovation in the market condition. We just innovated a lot in the customers understanding and all the investment in automation, the way that they can get tremendous value facts. It works very well for us. And our Version 7.0 was just monumental engineering achievement in the right time. This is first and foremost.

So the adoption curves for all the licenses the understanding that these are premium use cases – business use cases, so this works extremely well. And the second thing is the execution. We did – we will very focused to make sure that everything is working and that the company is working very well, the way that we're quoting works very well.

How to move the sales motion to sales motion that is very strategic and also in the places that we have these things, the people were not 100% on both, we made sure that they will not be.

So we just say – they said first and foremost is just the fitness of the platform to the market condition and after that is just intense execution and great attention to detail..

Great. And what do you think has been the biggest hurdle to overcome and then maybe something the next few quarters.

If you think about sales cycles or partners, what would you think the biggest hurdle that you're seeing in terms of the move to subscription?.

They are no hurdles. The only success is just to do a lot of small – many, many small things right every single day and this is something that they think we see.

You know the partners are happy because the annual – just revenues for them mixed a lot of sense and they talked some makes a lot of sense for our sales force and primarily for customers, which is the most important thing. We just need to keep doing what we're doing.

And you know, we got in Q4, we just don't know how much it will be CapEx heavy, but I will tell you that the top priority for all the leadership team here and also every employee in the company is to move to subscription as fast as possible..

Great job. Thanks..

Thank you..

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

Hi guys. Thanks very much for taking my question. And great to see some continued progress on the subscription transition. I wanted to start with you, Guy, on the guidance for the full year, if we go through it kind of implied Q4 guidance. It's not just interesting that maintenance and services line will decline year-over-year in Q4.

What I understand there's no maintenance related to subscription deals is on the subscription line. and then you talk a little bit about there’s a headwind from services itself declining as you offer more to partners and you have more automation out of the box.

But since you’re not converting the existing perpetual maintenance to subscription just yet, can you really, can you just help us understand why so that maintenance component related to perpetual decline on a year-over-year basis?.

Absolutely, so the maintenance and services line, as you said is comprised of two components. And when you look at the maintenance portion, it’s obviously derived by the perpetual sales that are sold there and it’s very important to remind everyone that the maintenance portion of subscription is part of the subscription line item in the P&L.

So, in the services and maintenance line item, the only thing you have is what’s related to professional services and what’s related to maintenance from perpetual license. So, that’s one reason.

When we’re selling and moving as quickly as we are, obviously, the maintenance portion of the perpetual license will be impacted on our renewal rates have been consistently over 90%. So, we’re very happy with that. On the professional services side, yes, it’s used to be historically in the low-to-mid single digits out of total revenue.

And we’ve actually seen that percentage slightly go down and that’s for two main reasons; one is that our license offering are becoming much more on the automated side, so that requires less professional services days from our customers, and the second reason is that our VARs are doing some of those professional services days on their own POs.

So that’s the reason we’re seeing that, it’s part of our strategy. We’re happy with that trend and it’s kind of normal with this fast transition..

Okay. Got it. Thanks. That’s helpful. And then just, I don’t want to get to whatever state that you’re at, but – and just kind of thinking about the CCPA opportunity, I mean, clearly, GDPR has been at least from an awareness perspective, I think important for you.

And I’m sure over time, it’ll be a major contributor to actual business, but how should we be thinking about CCPA as an opportunity, given that it’s going to take awhile to actually kick in, but is this something that could be equivalent to the GDPR tap opportunity or is there another ways to be think about that?.

No, in a very just tangible way, we are never trying to predict it, but we can tell you that in the digital world and digital economy and the overall cyber universe without very strong privacy laws that you can impose, you will have a massive consequences and diminished productivity. And this is what we see.

You think about it open every few one newspaper every day and you see privacy and data security and what will happen with the election and how we can get values from data this is a big thing. I think that we have in the midst of it in order to make sure that productivity and security can really coexist you need the technologies like Varonis.

And this is something that I think with the explosion of information; this is something that you’re going to see. So, I can tell you what it will do into the – in the next two, three quarters.

But I tell you, I can tell you that this is top of mind for every board and every organization, and it also makes sense for us to go up market and it became a massive business driver or because if you can protect the data, you just – you can protect the enterprise. And this is what we believe that more awareness like that will happen more signs than.

As mentioned before, we come to regular companies from all of our supplies like Marriott, like British Airways and this is something that works very, very well for them..

Great. That’s helpful. Thanks, Yaki. Thanks, Guy..

Thank you..

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

Great. Thanks for taking my question. So, not to kind of throw water on the pace of the model conversion, but I mean a significant part of this is the accounting change, right under 606, we’re second year into that.

And effectively, you’re recognizing term license or subscription revenue when it’s booked in a quarter like a perpetual license, right? And so that’s good, right? Because it accelerates the conversion process a lot relative to companies that had to do it under 605.

But as we look out a year when we’re kind of on – I don’t even know if we’ll be on normalized subscription run rates back then.

but is it fair to say when we look out a year or two that quarter-to-quarter volatility in the subscription line will still be there, because of revenue rec?.

So, there’s – let me answer in several ways. First of all, 606 requires you to recognize the license portion when you ship the license and the maintenance is recognized over that one-year period. When we have a three-year deal with year two and year three, kind of that auto renewal component, we only recognize the first portion of year one.

We don’t recognize year two and year three. And when you talk about the subscription shifts being impacted by 606, I think that’s slightly misleading the way you present it, because when you look at other companies that have transitioned and they have provided their percentage of subscription mix, they did it out of booking.

When you look at the 606 way, you’re basically kind of comparing the same way. So, the essence of our transition is basically representing and mimicking the way you would recognize it on a booking perspective. And we don’t provide the booking color, but it’s very similar, because we’re only recognizing that one-year portion.

So from a recurring revenue component, you will see the shift from quarter-to-quarter, because of the maintenance that is recognized ratably, but you have significantly more predictability and visibility, because of that year two and year three that come to us..

Right? Correct. I appreciate the color. And then if we think about the subscription performance year-to-date, how much of it was from pipeline conversion exiting last year? That was possibly perpetual license based that converted to subscription versus just net new pipeline that you guys booked and recognized..

So, our sales cycle is between three to nine months and on the larger deals, it’s up to 12 months. So, when you think about the pipeline and the way it’s evolved, most of the deals, during the year, have either been socialized with the customer under the perpetual pricing or perpetual quotes have been provided to customers.

So, our sales force is actually having to go back and change those quotes, offer it to customers. And as you can see, customers are embracing the change, because it allows them to buy more licenses. And I’m going back to kind of the prepared remarks.

The fact that customers are – new customers are buying between four to five licenses as opposed to two to three allows them to recognize significant more value than what they would recognize under the perpetual.

So, that’s been working very well, but it is important to remember that throughout the 2019 year, we are still going through pipeline that has either been introduced or discussed, or even presented to customers with perpetual price..

Got it. And then maybe one last one, great to see the improvement, I mean market improvement at EMEA sequentially. I think you guys are alluding to this, but I just want to make sure, do we feel like EMEA has fully adopted the model change and we should knock on would be kind of up into the right from here so to speak. Thanks..

Yes..

Okay. Thanks..

Thank you..

Thank you..

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

Yes. congrats on the strong underlying performance.

I only have one question; we continue to hear really positive feedback from the channel regarding these significant increase to the amount of data for the rate at which Varonis can respond to events occurring within that data with Version 7.0, and I kind of asked a similar question last quarter, but can you provide enough data on where you see the adoption within the installed base for 7.0? And then also, it might be hard to answer this just because of the changes that are occurring around this subscription pricing, but just the impact that might be having on broader license adoption and ASPs..

The customer base is upgrading fairly fast to version 7.0. It’s working – as you said, it’s working very well like all the used cases are just reflected very well in this version and much easier for them to buy overwhelmed more licenses..

And maybe, Yaki, if you could just speak to some of the improvements you made around automation and incident response. That’s the other feature we hear from the channel that seems to be quite attractive to the end users..

Yes.

I think, in terms of the user behavior analytics, what we’ve done on the organizational level, once you really bypass the perimeter security, we edit just a lot of the machine learning and models based on the various reliable streams that we have, starting with understanding critical content, how everybody in the organization is using data, classifying users to service account.

And then really mixing everything with a lot of analyses from active directory, VPN and the VPN and DNS and proxy, and it’s working extremely well.

So, our ability to give extremely good alerts that are human-readable and after that, make sure everybody that did some very basic knowledge in security will be able to a catch the most sophisticated attacks and also do very advanced forensics. And this is something that works extremely well.

The customer was starting to realize that on the organizational level what we call that is completely new innovation and user behavior analytics can really work and it’s just very exciting for us.

And I think that also slowly, but surely investors starting to understand it, because this is a place that put a lot of effort and it’s working extremely well. Like the subscription, we had very good surprises. So, it just works extremely well, I think that what – what the team did here on a security analytics, it’s just amazing..

That’s helpful. Thank you very much..

Thank you..

Thank you..

We have reached the end of the question-and-answer session and I’ll now turn the call over to management for closing remarks..

Before we end the call, I would like to think all of our employees for the hard work and contribution to our success this past quarter. We also would like to thank all of our customers and partners for the continuous approach. Thank you all for joining us today and we’re looking forward to speaking with you against them..

This concludes today’s conference and you may disconnect your lines at this time. Thank you for your participation..