Greetings, and welcome to the Varonis Systems First Quarter 2023 Earnings Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Tim Perz, Director of Investor Relations. Thank you, sir. You may begin.

Thank you, operator. Good afternoon. Thank you for joining us today to review Varonis' first quarter 2023 financial results. With me on the call today are Yaki Faitelson, Chief Executive Officer; and Guy Melamed, Chief Financial Officer and Chief Operating Officer of Varonis. After preliminary remarks, we will open the call to a question-and-answer session. During this call, we may make statements related to our business that would be considered forward-looking statements under federal securities laws, including projections of future operating results for our second quarter and full year ending December 31, 2023. Due to a number of factors, actual results may differ materially from those set forth in such statements. These factors are set forth in the earnings press release that we issued today under the section 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 first quarter 2023 earnings press release and investor presentation, which can be found at www.varonis.com in the Investor Relations section. Lastly, please note that a webcast of today's call is available on our website in the Investor Relations section. With that, I'd like to turn the call over to our Chief Executive Officer, Yaki Faitelson. Yaki?

Thanks, Tim, and good afternoon, everyone. Thank you for joining us to discuss our first quarter 2023 performance. I'm happy to share the progress on our SaaS transition, excited by the initial SaaS adoption we saw and feel optimistic about our ongoing SaaS journey. So let's start with our first quarter results. The reception of the Varonis SaaS continues to exceed our expectations, and this quarter provided us with additional proof points that our strategy to transition to SaaS is working. Our first quarter SaaS mix came in at 37%, well ahead of our guidance for 15% and ARR grew 18% year-over-year to $478.1 million. We reported revenues of $107.3 million and free cash flow of $35.7 million. At the same time, the economic slowdown continues to impact our customers. And as a result, our near-term growth remains below where we believe it can be over the long term. We are still seeing additional scrutiny on deals in Europe and North America, but Varonis SaaS has come out at just the right time in an environment where all spending is being highly scrutinized. Varonis SaaS offer customers a faster time to value, with drastically reduced overall total cost of ownership because of the lower infrastructure and headcount related expenses required to operate. We are pleased with the team's performance despite the difficult in macro backdrop. And though we are only a quarter into the year, we are raising our SaaS mix and ARR guidance. Guy will review our Q1 results and our updated outlook in more detail. Before I talk more about the progress of our SaaS rollout and what we are hearing from customers, I want to remind you why Varonis exists and the problem we solve. Data is the most important asset that a company has next to…

Thanks, Yaki. Good afternoon, everyone. In addition to providing more color on our first quarter performance and our updated 2023 full year outlook, I plan to focus my time today on our SaaS transition and how the economy continues to affect our customers and in turn, our business. We are pleased with how the team performed during Q1 and are encouraged about what this means for the rest of the year. Although it is early, and we have a lot of work to do, the reception of SaaS from our customers and our sales force, together with our confidence in the pipeline and the ARR uplift we are seeing, allows us to raise both our SaaS mix and our full year ARR guidance. As I discussed in length at the Investor Day in March, ARR, free cash flow and ARR contribution margin are the leading indicators for our business during this transition. The shift from on-prem subscription licenses where approximately 80% of the deal value is recognized upfront to a SaaS model with fully ratable revenue will cause initial headwinds on reported revenue as the SaaS mix increases. However, these headwinds are simply a function of accounting treatment and are not indicative of the trajectory of our transition or of our overall business. In fact, the greater these accounting-related headwinds are, the faster it means we are progressing throughout our transition, which we obviously view as positive. Given the momentum we saw in the first quarter and our pipeline and expectations going forward, we are raising our ARR and SaaS mix outlook, which also means we are adjusting lower our revenue outlook. Our better-than-expected start is being driven by Varonis SaaS, which is resonating with our customers and our sales force. Our first quarter SaaS mix represents 37% of new…

At this time, we will be conducting a question-and-answer session. [Operator Instructions] Our first question comes from Matt Hedberg with RBC Capital Markets. Please proceed with your question.

Great, guys. Thanks for taking my question. And congrats on the execution. The environment certainly does not seem to be easy out there. Yaki, obviously, a lot of the focus on the call was on SaaS adoption. And I really enjoyed the example you give was a large insurance customer. I think you said they saw a 30% uplift to ARR when they converted to SaaS. I'm curious, is that sort of a standard uplift that you're seeing across the base when it converts? Or maybe said differently, if a customer just goes straight to SaaS initially, is kind of 30% more ARR, ACV spending typically what you're seeing versus an on-prem contract?

Hi, Matt. We just in the early stages, Matt, as we discussed before, 25% to 30%, it's very easy -- relatively easy to justify in terms of the total cost of ownership. It's a wash [ph], but when we convert to SaaS, we also believe that a lot of the customers will buy significantly more bundles. You know what is very exciting for us is that the automated outcome and coverage is really working. And so far, the conversion to SaaS is really surprising us from every aspect and primarily the overall value proposition. So in terms of the total cost of ownership, when it's apple-to-apples, we think that it's -- this should be the overall increase, but we also believe that customers will consume significantly more licenses.

Our next question comes from Hamza Fodderwala with Morgan Stanley. Please proceed with your question.

Hey, guys. Thank you for taking my question. Hamza here. So I just want to clarify, Yaki, the point you made earlier. Is it fair to say that the environment got worse in Q1 versus Q4? Or was it relatively consistent?

Yeah. Overall, I will say that it was relatively the same. It's a hard macro environment, but I will tell you what we do see and historically, this is something that worked for us. At the end of the day, attacks can come from anywhere and any device, but they're always going in one direction and this is the data. When you have this hard environment, what happen is that people are really analyzing what is going to give them the biggest ROI. And when you need to protect data and if you're protecting data, if the data is protected with us and you failed with everything else, you did your job right. But if you -- if the data is not protected, and you have 99% perimeter security and you have one insider that we saw is the Pentagon incident, one compromised user or a machine in the blast radius, so much of the data is exposed, then you have what we call lasting damage. So what we see is that its customers are very attentive. And with the SaaS, we're just reducing a lot of friction. And what we have discussed in the Analyst Day is 10% of the effort, orders of magnitude of the value is really working and with DA Cloud and everything that we are doing, we see more coverage and really with the incident response. It's pretty amazing. They need to do very little in order to get a lot of value. So hard macro, but I think that at the end of the day, data security is a secular trend. And if we keep doing what we are doing in terms of coverage and automation, I think that we can -- relative basis can do very, very well.

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

Okay, great. Hey, good afternoon, guys. It's Saket from Barclays. Thanks for taking my question here. Yaki, maybe for you. Clearly, the SaaS transition is going faster than you expected. Maybe I could just shift to a product question. What's been the early feedback from customers in terms of feature parity between the SaaS products and the on-prem? And to the extent that there's still a gap, right, and you'll tell us whether there's a gap, how do you sort of think about that sort of narrowing over time? Does that make sense?

Yeah. So thanks for the question. So for new customers, it's a completely -- it's just a no-brainer because we have so much more advanced capability in remediation, mainly in 365 in the proactive incident response and just all the benefits that are coming with SaaS. So this is -- it's a non-issue. With customers that have some of the features that we still don't have in the SaaS platform, we are moving very fast to narrow the gap. And we believe in several quarters, we are going to narrow everything and also, we'll be able to do frictionless migration. Now we have 80% of what we have on the on-prem platform, but we are moving very, very fast. As I said before, it's -- so far, it's just in every aspect of the SaaS transition, we have just very good indicators.

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

Thank you for taking my questions. And good execution against your plan. Guy, for you. Can you just go through what the percent of business that were going to renew? I think you said something about a decent renewal in Q2, but I'd like to understand the cadence of that throughout the year. And then your assumptions around conversion rates, would be helpful. Thank you.

So first of all, if you're talking about the renewal rate, our renewal rate is consistently over 90%, and that's continuing. But in terms of the conversion, I think that's a very good question. And when we look at Q1, the conversions in Q1 weren't significant. It was a couple of hundred thousand dollars. But as we look ahead, in Q2, we've seen increased renewal conversions in the pipeline. Now more reps are talking about SaaS when they talk to our existing customers when the renewals are coming up. Now to be clear, we're not providing any additional incentives for us to do this. They're really doing it on their own, but it's happening because customers see the benefits of SaaS. It's a much better product, and reps are getting more commission on the uplift. And because of this larger pipeline, we have baked in just over $1 million into our Q2 guidance, which again isn't a significant number, but we do want to highlight this for the modeling sake because if that renewal conversions do end up being more significant, it will be an even larger headwind to revenue and operating margin. But that is a positive development for us, especially on ARR.

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

Hi, good afternoon. Thank you for taking the question. Guy, you talked in your script about elevated sales turnover, which was pretty much in alignment with your expectations and what you articulated to us when you were talking us through some of the risks around the transition. I'm curious how you're thinking about sales capacity for the remainder of the year and how we should see you maybe rehire or backfill? Or should some of the dynamics with ASP uplift and some of these conversations you're having around higher ACD conversations with existing customers, is that supposedly going to make up for some of the turnover? So just any commentary on sales capacity given the elevated turnover. Thank you.

So as you mentioned, and as I talked in the prepared remarks, we did see some turnover, but it was very much as expected, and we're very much pleased with the engagement of the vast majority of our sales force and their ability to transition to selling SaaS, and that's tracking better than our initial guidance. We're getting great feedback from our reps and our customers on the product and the benefits. We're hiring in strategic positions and locations. We want to continue to invest. We'll do it in a prudent way, as we have done in the past. But overall, we're very pleased with the reception of SaaS and the way the sales force has received that.

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

Hey, thanks for taking the question. And congrats on the execution. Just to be clear, I think you talked about the prior revenue guide of 10% and 12% growth, assuming that the environment would deteriorate further from what you saw in 3Q and 4Q. I guess, I'm wondering, did you add any additional macro considerations to the model or absent the outperformance you had in SaaS mix, would you likely have been reiterating the full year revenue guidance? Thanks.

That's a great question. Our reduction of revenue, revenue coming down by $9 million is entirely related to the increase of the SaaS mix from 15% to 35%. There's obviously revenue headwind coming from the accounting treatment, and that's why we reduced that revenue number and increased our ARR number, which moved up by $6 million for the year. We definitely baked in macroeconomic uncertainty. We did that at the beginning of the year. We didn't change anything related to that and the entire reduction of revenue is related to the SaaS uplift.

Very clear. Thank you.

Our next question is with Brian Essex with JPMorgan. Please proceed with your question.

Hi, great. Thanks, good afternoon. And thanks for taking my question. Maybe I guess for either one of you, if you could give us a little bit of color. I think you mentioned during the prepared remarks that you had some customers that decided to convert to SaaS and then some stuck with on-prem. Could you give us a little more color around like what the gating factors were there of customers that were in the pipeline? And what kind of got them over the hurdle to convert? And then conversely, maybe which ones decided to say on-prem and why?

Yeah. We are not pushing conversion. It's just they understood that some of the features that we have with 365 and Proactive IR and they just almost forced us to do the conversion. It just made much more sense for them -- much more sense for them to do it. Over time, we don't see the vast, vast majority of customers who want to move to SaaS, it's a no-brainer for them. It's just a question of timing and feature currently [ph].

And Brian, just to add. There is basically two types. There's new customers that received quotes that had on-prem subscription pricing on them. We did see many of those deals convert to SaaS within the quarter, and we expect that to continue. But as Yaki mentioned, the conversion of existing customers with their renewals from on-prem subscription to SaaS wasn't a material number in Quarter1, but the color that I gave on the increased pipeline that we see in Quarter2 is kind of the reason we called and gave some commentary on that.

Our next question comes from Rob Owens with Piper Sandler. Please proceed with your question.

Good afternoon. And thanks for taking my question. Curious how the shift to SaaS is impacting the top of the pipeline or top of the funnel. Anything that you can give us from a quantification standpoint. Thanks.

Overall, what I can say more than anything else that is resonating much better with the customer. So if you will go to every organization in the world and say do you want that only the right people can access the right data. You know what is critical and reliably can alert and stop any abnormal behavior, everybody will say yes. The question is how can you do it with -- in a frictionless manner and to make sure that you would lead completely automatically. And this is something that we are doing with SaaS. So it's -- the overall reception in terms of the way that they receive value, in the way that they can deploy it and just get value from the platform is much, much better.

It's basically eliminating two of the biggest hurdles and objections that we got from customers when we sold on-prem subscription which is, one, we don't want to deal with the hardware and that gets eliminated when we have the SaaS offering. And the second objection is we don't have enough people. And those two benefits are pretty significant, which basically generates a total cost of ownership that is lower for the customer with much more of the automation that Yaki talked about.

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

Hey, guys. Thanks for taking the question. I just have a quick one on the numbers. I just want to make sure I have a handle on everything here. But I think the previous commentary you ended 2022 with $3.5 million in ARR from DA Cloud. You also had a 10% SaaS mix. And I'm just trying to understand, is that 10% SaaS mix, which is new and upsell business, is that part of the $3.5 million that you finished the year with in DA Cloud? Or is that on top of the $3.5 million in ARR from DA Cloud? Thank you.

35% SaaS mix is related to Q1 2023. And I think there's been some confusion in the way that metric is defined. So let me spend a second by just clarifying it. The SaaS mix is the percentage of new growth ACV. So it's out of a much larger denominator than if you do that based on a calculation from net new ARR. But in relation to your question, it relates to Q1 new ACV sales, not related to last year.

Our next question comes from Chad Bennett with Craig Hallum Capital Group. Please proceed with your question.

Great. Thanks for taking my question. So, yeah, kudos on the accelerated shift to the SaaS business, and you're seeing kind of deals in flight shift, which I think is good. But just, Guy, considering the ARR, pretty dramatic ARR shift on a percentage basis from '15 to mid-30s in your expectations for this year from an ARR perspective to SaaS. And it sounds like the price improvement related to the SaaS deals or ACV related to those has held, right, based on your commentary. And you're not really baking in more macro negativity. I just would have thought the magnitude of going from 15% to 35% of bookings coming from SaaS would have more than a $6 million benefit in the guide. Am I not -- is there -- are there puts and takes I'm not thinking about there? Or is there more to it?

Well, I can walk you through how we're thinking about this. First of all, this is the first quarter into the year. And as I mentioned before, it's the smallest one of the year, and there's a lot of macro uncertainty still out there, which we continue to bake into our guidance. And we take the commitment to the Street very seriously. So we definitely feel extremely encouraged about the SaaS transition with the feedback that we've been getting. And the pricing we've realized, as you've asked, so far gives us the confidence in that 25% to 30% uplift. So I think this is early in the year, but we feel very confident in where we stand today after 1 quarter of the year.

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

Okay, thank you. So you mentioned an existing Fortune 500 insurance company that renewed, and you upsold DA Cloud to that customer, which I think contributed in part to that 30% increase in ARR you saw. So how much of that 30% increase was attributable to DA Cloud? And then what kind of attach rate of DA Cloud are you seeing when a customer buys the SaaS platform?

So one of the things that we talked about in the Investor Day is that we're going to talk about the Varonis SaaS as one mix because we want to avoid the confusion and the puts and takes. So the 37% SaaS mix in Q1 and the guidance that we gave for 35% for the year kind of combines everything under SaaS. I can tell you that we're pleased with the adoption of both -- of the products, the Varonis SaaS and the DA Cloud. I think that the customers definitely see the benefits, and we're very excited to raising the number from 15% SaaS mix to 35% after one quarter.

But in terms of DA Cloud and the attach rates, when you look at our customers and everything we have in the platforms in terms of DA Cloud, each and every one of our customers have several DA Cloud platform, SaaS platforms, that we support. And we just believe that just on paper, we can sell to all of them, and we think that everything related to the protection of this SaaS platform is -- the market is becoming more ready. And everything that we had on the on-prem and with 365, we bring to these platforms, and we just believe that the overall platform and the value proposition has massive otentiall.

Our next question comes from Shrenik Kothari with Robert W. Baird. Please proceed with your question.

Hey, thanks for taking my question. So you mentioned from SaaS transition standpoint, you're still factoring the ramp-up period in the first half of the year, which kind of assumes increased turnover productivity and longer cycles. So given that you mentioned the faster transition and especially increased renewal conversions without any additional incentives and the larger pipeline visibility that you also spoke, can you provide some more granularity around the implications on the turnover, the ramp productivity, et cetera, that would be greatly appreciated.

So when we gave guidance at the beginning of the year, we basically talked about the first six months, the first two quarters where we expect to see the majority of the friction. And that friction is coming from two places. One is the expectation for higher sales turnover, which I can tell you, we were pleased with kind of the adoption of our sales force. They very much understand the benefits for both the customers and the company. And it's -- obviously, when you see the numbers, the 37% SaaS mix was well ahead of our guidance. But the second thing we talked about was the fact that deals that were in flight that were introduced to customers with on-prem subscription pricing as part of the negotiation and the conversation, we expect our sales force to go back to those customers and try and move them to SaaS, which will add some friction in the conversation. And we expect to kind of go through that. And for the vast majority of those deals in the first part of the year and on the larger deals, we should clean through that pipeline in the second part of the year. But the majority of that friction happens in the first six months, and we called that out, talked a lot about that in the last call in the Investor Day that we had. And that still holds, that's still part of the expectation. But I think we can clear through those conversations with customers for the most part in Quarter2.

Our next question is with Shebly Seyrafi FBN Securities. Please proceed with your question.

Yeah, thanks very much. So you noted that you're seeing additional scrutiny on deals in Europe and North America. But your European business or EMEA business declined by 5% -- actually grew by 2% in constant currency. That was versus like 24% constant currency growth the year before. So a 22-point decel year-to-year. North America would decel only 13 points. So it looks like EMEA is slowing down more than North America on a constant currency basis. Can you elaborate on why that's the case and what actions you're taking to improve results in EMEA?

So first of all, when you look at the numbers, I think there's a bit of a confusion there. We saw FX headwinds related to EMEA that was about 7% on the EMEA revenue number. We also had the Russia business impact that -- still impacted us we still recognized in Q1 of last year, and that was another 2% headwind. But on top of that, you're also seeing the headwind related to the SaaS transition. So selling SaaS with the way the accounting treatment related to that will generate headwind. And the adoption of SaaS in Europe was very good. Not similar to our transition from perpetual to on-prem subscription, where we had conversations with our European teams at the time for all of you that were part of that transition, I'm sure you remember that. But in this transition, our European teams have adopted the SaaS transition very well, and that also has an impact on the comparison. So I don't think it's the right way to look at revenue numbers year-over-year, and that will probably be a bit of a confusion going forward, and that's why we talked about the ARR. I will say that we're definitely seeing longer sales cycles and deal scrutiny, and that's -- for the most part, we're seeing that in Europe. We're also seeing it in North America. But the numbers themselves should not be looked on a year-over-year basis because of the items I mentioned.

We have reached the end of our question-and-answer session. I would now like to turn the floor back over to Tim Perz for closing comments.

Thanks, everyone, for joining us. We appreciate your interest in Varonis.

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