Varonis Systems, Inc. (NASDAQ:VRNS) Q1 2023 Earnings Call Transcript

Varonis Systems, Inc. (NASDAQ:VRNS) Q1 2023 Earnings Call Transcript May 1, 2023

Operator: 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. 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.

Tim Perz: 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?

Yaki Faitelson : 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 its people. And because of its importance, data is a prime target for bad actors. At the same time, data is out of control. The growth of the cloud and remote device usage has only made securing data more challenging. Varonis helps companies locate sensitive data, visualize who has access to it and automatically lock it down. This allows companies to collaborate safely and get the most value from their data, while at the same time, managing risks. Recent events made it obvious how hard it can be to protect data from risk of insiders, but it’s less obvious that outside attackers become insighted when they compromise the system of a person. In either case, without our solution, employees and contractors can always ask for sensitive data than they should.

Now let’s turn to some of the feedback that we have recently begun hearing from customers who are using Varonis SaaS. As a reminder, last quarter and at our Investor Day in March, I spoke about three key benefits our customers get from our SaaS plan. First, customers are much better protected with much less effort with our automated remediation and proactive incident response.Second, SaaS is easier to deploy and has significantly lower infrastructure costs. And third, SaaS is easier to maintain an upgrade. At our Investor Day, I spoke about three benefits that we expect to realize: one, shorter sales cycle; two larger lend; and three, margin benefits over time. So it is still early. We as a company and our customers are already beginning to see evidence of these benefits.

One example is a specialty chemical manufacturer with 1,000 employees that suspected that they had issues with overexposed data. But prior to installing Varonis SaaS, found it difficult to visualize who had access to data and configuration risks, let alone remediate them. Within the first day of installation, Varonis enabled them to see expose sensitive information that was open to the entire company and even sensitive files that were open to anyone on the Internet. For this link security team, stopping its visibility alone wouldn’t have been enough. Manual remediation was a nonstarter as it does not scale and never ends. Before installing Varonis, this team has successfully tried to use multiple other point solutions that did not meet their needs due in part to the lack of automation, leveraging the power of automation with Varonis SaaS has allowed them to classify PII, alert around ransomware and most importantly, remediate overexposed links in Microsoft 365.In the end, they purchased Varonis SaaS packages to protect their on-prem Windows and Microsoft 365 deployments.

Another example is one of the country’s largest convenience store operators. This company was performing a gap analysis on its security architecture and realize that it’s fair to understand who can and does access data in Microsoft 365 and also had no way to locate sensitive data in their environment at scale. They could not see links shared with anyone on the Internet older than 30 days, and there was no way to remediate old links without breaking collaboration. Prior to bringing us in, they were trying to address these problems using Microsoft’s building functionality but is proved to be manually intense and ultimately unsuccessful. Once they installed Varonis, this organization gained real time visibility into these overexposed links. Not only this, but our proactive incident response team identified and stopped a live ransomware attack on their network.

A customer had a number of perimeter technologies that were bypassed but because we look at the data and we found files that we’re being encrypted on the networks and immediately locked the bad actor out, stopping the incident. What started as a data classification project quickly expanded into much more. This customer purchased Varonis for Windows and Microsoft 365, which allow them to realize the benefits of proactive incident response, with this infrastructure spend streamline the procurement process and simplify the ongoing maintenance of the Varonis deployment. In addition, this new customer wins, we also had several existing customers convert to Varonis SaaS this quarter. One of these conversions was a Fortune 500 insurance company and at first, became a customer in 2020.

We prepared for renewal discussions, our customer mentioned a multiyear plan to migrate its on-premises data center into the cloud and wanted to leverage the power of Varonis SaaS. Prior to the renewal, they had 13 on-prem subscription licenses after the renewal, they purchase Varonis SaaS package for Windows, Microsoft 365, Active Director and Exchange Online as well as DA Cloud for AWS and S3. As a result of this conversion and upsell, we recognize an increase in ARR of greater than 30%, which gives us additional confidence in our pricing model. We are in discussions to protect our Salesforce.com and JIRA environments as well as expanding into additional geographies they have in Europe and Asia. In my conversation with customers, it is clear that the simplicity and automated protection of Varonis SaaS is resonating, which leaves me feeling optimistic about our outlook in spite of the economic slowdown that is impacting our customers.

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

Guy Melamed: 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 business and net new upsell ARR, this is our guidance of 15% and the examples that Yaki just discussed are evidence of this reception. Early feedback and the average deal sizes we have seen so far gives us further confidence in the pricing uplift that we previously provided. To that end, during the quarter, some of our reps did decide to go back to deals where an on-prem subscription quote was already put in front of the customer and introduced the SaaS product into the conversation. While some of these did convert, for other deals, it created some near-term disruption and elongated those sales cycles.

We think this will work itself out in the second part of this year and is already factored into our guidance. We even saw some existing customers that during the renewal conversations, were happy to convert their entire platform to SaaS and buy additional SaaS licenses. Although the ARR impact of these renewal conversions wasn’t material this quarter, it was ahead of our projection. As it relates to our updated guidance, we’re not assuming significant conversions or a material change in the dollar value of these conversions versus Q1. But as a modeling note, if these conversions continue to trend ahead of our projections, this will further benefit our North Star metrics, which are ARR free cash flow and ARR contribution margin. At the same time, this would cause a headwind to reported revenue and operating margin, which you should view as a positive in terms of the progression of the transition.

As I look at our Q2 pipeline of renewal conversions, it has increased significantly versus Q1, which you should keep in mind as you think through your models. Turning to our sales force. As expected, we did see some turnover, but we are pleased with the engagement of the vast majority of our sales force and their ability to transition to selling SaaS is tracking better than our initial expectations. Further, some of this success is being driven by our learnings from our 2019 transition around setting up programs to reduce friction while providing the right incentives for both the rep and the company. As Yaki mentioned, we believe we have the right solution for the market since Varonis SaaS as allows customers to achieve a faster time to value with significantly lower infrastructure costs.

And while it’s still early in the year, we feel good about the benefits both our customers and we will achieve as a result of the SaaS transition. In the first quarter, ARR grew 18% year-over-year to $478.1 million and assuming the same SaaS mix as we guided for, we would have been well ahead of our revenue guidance. We generated $35.7 million of free cash flow, which was up from $21 million in the same period last year, reflecting our commitment to top line growth while improving cash flow generation. I’d like to elaborate on what I said earlier regarding the macro environment. During Q1, we saw the slowing economic climate continue to weigh on customers’ purchasing patterns. Across the board, we continue to see an elevated level of deal scrutiny and extended sales cycles involving multiple layers of approval, with Europe, in particular, seeing the largest impact.

We expect longer deal cycles to continue as a result of ongoing budgetary scrutiny, and our updated guidance already takes this and more into consideration. Turning now to our first quarter results in more detail. Before I get into the numbers, let me remind you of what we’ve said from the beginning. ARR, free cash flow and ARR contribution margin are the leading indicators for this transition. Remember the shift of our business from term licenses to a SaaS model will make our traditional income statement metrics less indicative of the true health of our business than they have been in the past. We have again included several slides in the investor presentation that illustrate the impact of the transition on various metrics. Now on to the numbers.

Q1 total revenues were $107.3 million, up 12% year-over-year. During the quarter, as compared to the same quarter last year, we had approximately a 7% headwind to our year-over-year revenue growth rate as a result of having increased SaaS sales in our bookings mix, which are recognized ratably versus the upfront recognition of our on-prem subscription products. Subscription revenues were $83 million in maintenance and services revenues were $24.4 million as our renewal rates, again, were over 90%. In North America, revenues grew 18% to $81.2 million or 76% of total revenues. In EMEA, revenues declined 5% to $22.9 million or 21% of total revenues. Currency was a 7% headwind in the region. Rest of the World revenues grew 9% to $3.2 million or 3% of total revenue.

Just to remind you, reported revenue growth rates throughout all regions were impacted by a higher SaaS mix. Moving down the income statement. I’ll be discussing non-GAAP results going forward. Gross profit for the first quarter was $92.9 million, representing a gross margin of 86.5% compared to 85.6% in the first quarter of 2022. Operating expenses in the first quarter totaled $97.1 million. As a result, first quarter operating loss was $4.3 million or an operating margin of negative 4%. This compares to operating loss of $7.9 million or an operating margin of negative 8.2% in the same period last year. During the quarter, as compared to the same quarter last year, we had approximately a 6% headwind to our operating margin as a result of having increased SaaS sales in our bookings mix which are recognized fully ratable versus the upfront recognition of our on-prem subscription products.

First quarter ARR contribution margin was 5.6%, up from 4.1% last year, reflecting our ability to drive strong incremental margins while growing ARR and transitioning to SAP. During the quarter, we had financial income of approximately $7.2 million, driven primarily by interest income on our cash deposits and short-term investments. Net loss for the first quarter of 2023 was $0.1 million or $0.00 per basic and diluted share compared to a net loss of $10.2 million or a loss of $0.09 per basic and diluted share for the first quarter of 2022. This is based on $108.4 million and $108.2 million basic and diluted shares outstanding for Q1 2023 and Q1 2022, respectively. As of March 31, 2023, we had $756.3 million in cash, cash equivalents, marketable securities and short-term deposits.

For the three months ended March 31, 2023, we generated $36.8 million of cash from operations compared to $24.5 million generated in the same period last year, and CapEx was $1.1 million compared to $3.5 million last year. During the first quarter, we repurchased 100,000 shares at an average purchase price of $25.19, and we have $41 million remaining on our share repurchase authorization. We ended the quarter with approximately 2,150 employees, roughly flat versus last quarter. Turning to our guidance in more detail. Our second quarter and full year guidance now assumes a 35% SaaS mix of new business and upsell ARR, up from 15% previously. A few additional modeling notes on this metric as we look to the back half of the year. First, Federal’s largest quarter is the third quarter, and because we are not yet Fed-run certified, we expect this to be a headwind to our SaaS mix in Q3.

Second, despite the momentum we saw this quarter, Q1 is still the smallest quarter of the year. And as such, we are taking a prudent approach in building our outlook as the dollar value of deals we expect to close in the second half is much larger than in the first, which is in line with historical trends. And third, we’re not assuming significant conversions of renewals from on-prem subscription to SaaS or a material change in the dollar value of these conversions versus Q1. We are raising our ARR guidance, which reflects the faster adoption from our customers to Varonis SaaS. This also results in greater ARR contribution margin, which reflects our ability to focus on operating leverage during the transition. The higher SaaS mix drives corresponding adjustments to revenue and operating income guidance because of the ratable accounting treatment of SaaS versus the upfront accounting treatment of on-prem subscription.

Ultimately, we view the update to our guidance as a clear sign that the transition is progressing in a positive direction and continue to view ARR, free cash flow and ARR contribution margin as our North Stars during this transition. Lastly, as a reminder, our guidance continues to factor in headwinds from macro perspective, which includes ongoing budgetary scrutiny, longer sales cycles and an increase in unemployment as well as worsening of other economic conditions. From a SaaS transition standpoint, we are still factoring in a ramp up period in the first half of the year, which assumes increased sales force turnover, lower sales productivity and longer sales cycles as an on-prem subscription deals in flight may convert to SaaS. Now turning to our guidance.

For the second quarter of 2023, we expect total revenues of $118 million to $120 million, representing growth of 6% to 8%. Non-GAAP operating income of $0.5 million to $1.5 million and non-GAAP net income per diluted share in the range of $0.01 to $0.02. This assumes 127.2 million diluted shares outstanding. For the full year 2023, we now expect ARR of $520 million to $528 million, representing growth of 12% to 14%. Free cash flow of $20 million to $25 million, which includes a $6 million to $8 million headwind related to the TCJA capitalization of R&D provision. Total revenues of $510 million to $520 million, representing growth of 8% to 10%. Non-GAAP operating income of $29 million to $34 million and non-GAAP net income per diluted share in the range of $0.30 to $0.34.

This assumes 126.8 million diluted shares outstanding. In summary, despite continued challenges in the macro environment, the year is off to a solid start with the adoption of Varonis SaaS, showing positive momentum reflected by our first quarter SaaS mix of 37%. These results in our pipeline give us the confidence to raise our full year ARR outlook while driving strong incremental contribution margins. With that, we would be happy to take questions. Operator?

Q&A Session

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

Matt Hedberg : 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?

Yaki Faitelson : 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 , 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.

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

Hamza Fodderwala : 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?

Yaki Faitelson : 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.

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

Saket Kalia : 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?

Yaki Faitelson : 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.

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

Joel Fishbein : 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.

Guy Melamed : 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.

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

Fatima Boolani : 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.

Guy Melamed : 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.

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

Roger Boyd : 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.

Guy Melamed : 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.

Roger Boyd : Very clear. Thank you.

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

Brian Essex : 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?

Yaki Faitelson : 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 .

Guy Melamed : 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.

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

Rob Owens : 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.

Yaki Faitelson : 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.

Guy Melamed : 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.

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

Josh Tilton : 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.

Guy Melamed : 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.

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

Chad Bennett : 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?

Guy Melamed : 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.

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

Andrew Nowinski : 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?

Guy Melamed : 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.

Yaki Faitelson : 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.

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

Shrenik Kothari : 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.

Guy Melamed : 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.

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

Shebly Seyrafi : 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?

Guy Melamed : 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.

Operator: 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.

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

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