Varonis Systems, Inc. (VRNS) Q4 2018 Earnings Report, Transcript and Summary

Greetings and welcome to the Varonis Fourth Quarter and Fiscal Year 2018 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] As a reminder, this conference is being recorded. I would now like to turn the conference over to your host Jamie Arestia, Investor Relations. Please go ahead.

Thank you, operator. Good afternoon. Thank you for joining us today to review Varonis' fourth quarter and full year 2018 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 first 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 the anticipated growth in our addressable market; competitive factors, including increased sales cycle time; changes in the competitive environment; pricing changes; transitioned in sales from perpetual licensing to a more 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 cybersecurity 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 fourth quarter 2018 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'm very excited to be here today, talking to you about the opportunity we see for Varonis in 2019 and beyond, which, as you saw in our earnings release, is highlighted by the active shift we are making in our business to our subscription licenses. At the recent annual kickoff, I spent time with our colleagues from around the world, sharing our 2019 goals and how we are striving to build a $1 billion business with durable growth and scale and the shift to subscription is a big part of this. Today, I would like to do the same with you. But let's start with our results. We had another strong year. 2018 total revenues of $270.3 million grew 25% over 2017. Full year license revenues of $147.6 million grew 23% year-over-year and full year maintenance and services revenues of $122.7 million grew 29%. From a geographic standpoint, North American revenues for the full year grew 20%, while EMEA revenues grew 76%. I'm proud of what Varonis has been able to accomplish. Our total revenues has more than doubled in the last three years as we continue to build a business that solves critical needs of organizations globally. We continue to make considerable progress on key initiatives across the business. We have had success increasing the number of our customers with more than 1,000 employees across our customer base. We continue to see more customers buying more of our product. Our 2018 average sales price was $91,000 and continue to show steady growth. It was $59,000 in 2015, $65,000 in 2016 and $83,000 in 2017. We're on the low this year about the operational journey and the key playbooks that are working for us globally. We continue to invest time and energy in the following these playbooks ensuring that risk assessments are entry point for our bill. We know this works and this is confirmed by the field on a daily basis. We have also learned that we provide more value from the start to customers when they buy several of our products. This is what you have heard us describe as a journey of value, generating more licenses, and covering more data stores, customers gain more clarity on the potential risk and event that are taking place in the organization. Lastly, our brand awareness is growing as our robust product offering is solving broad range of security needs for our customers. Varonis data security analytics and forensics exchange platform drives three successful use cases each of which we believe is large available budget dollars in whole good opportunity for us. The first is data protection. Senior executives involved around the world had the greater awareness that securing data is not just an IT problem, but a business problem and that protecting intellectual property and other sensitive data is more critical than ever. The second is threat detection and response, our alert in forensics keeps getting more enriched and conclusive and the more data stores we monitor, the more valuable solutions become. I will talk more about some of these enhancements in a few minutes. The last few cases complaint, and with HIPAA, PCI and GDPR in place and regulation coming in the United States at the California Consumer Privacy Act and others on the way, our offering gives customers the ability to scale and to meet this regulation in an increasingly automated way. I will talk more about this later. But this last point in automation is critical and this is a significant demand for our customers, who can utilize our products to reduce the risk of internal and external spread and become more compliant. As we enter 2019, we see much available market in wonderful platform adoption both through the adoption of new customers as well as the expansion in the existing customer base. This is supported by these three use cases I just mentioned as well as our focus on innovation. We also recognize that we need to make it easier for our customers to adopt more of the platform earlier in the journey with us and make it smoother for our sales teams and partners to sell the full platform, which will ultimately drive accelerated increases in total customer lifetime value. Based on this, I'm very excited to announce that we have started transitioning our licenses on perpetual to subscription models. So let's talk about our platform, why this makes sense right now. To-date we have nearly two dozen licenses to sell compared with to 10 licenses at the time of our 2014, IPO. And our ability to innovate is accelerating. With our portfolio of powerful solution when we now do a risk assessment, customers want and know that they need multiple licenses to manage and protect their clinical data. However, we have also seen that there are barriers to buying the many perpetual licenses they want, both in the selling motion and the deal price. The result is that customers start with two or three licenses and buy more over time. With the move to subscription, we are providing a pathway for customers to realize more of the value of the broader platform right off the bat. As we deliver more comprehensive data security to our customers, subscription licenses should provide Varonis with higher mix of recurring revenues offering greater long-term visibility and predictability for our business. Let me give you some background how we got here? This transition is something we have been contemplating for some time. We have studied the market, observed what other companies have done and have talked to customers and partners and we received very positive feedback. In the second part of 2015 we put a pilot program in place that exceeded our expectation. The program was in two established territories; one in the U.S. and one in Europe and covered the accounts of sizes, the smallest with 130 users and the largest with over 16,000. During this time we had multiple transactions where customers both seven, eight or nine licenses representing a significant increase in total contract value, but importantly with matchless friction than what we have seen in our perpetual licensing, the average number of licenses sold in the pilot was well above our perpetual average and one large enterprise bought 10 licenses. Average sales forces were quite strong and we also saw existing customers by subscription. Overall, we believe the pilot offset ample evidence of why subscription makes sense and gave us the confidence to aggressively all it out the cost of the company and with our partners. In order to gain traction we are appropriately incentivizing the sales force who recently laid out a plan for our self-ed that encourage them to sell multi-license, multi use in numerous subscription deals versus perpetual. This was extremely well received in the annual kickoff event. We have never seen the sales force so excited. The next thing we are doing is offering the variety of our products we have in the simplified way of packaging with bundle and each bundle appear is one line item on our price list. In the past we most commonly led the new sale with a bundle of 3 licenses. Now we have over 25 different bundles available which provide our customers more tailored options to choose from, building on the use cases we are addressing and allowing us to take our customers on the journey of value more rapidly. We also see that pieces have more and more office budget for subscription product. And as we have introduced new offering the number of budget line item we can pull from has gone. To-date there are seven or eight different buckets we can take from. And regardless of how many subscription licenses, the customer buys initially we still believe that absolute course opportunities are there as customers consume more per platform to achieve substantial level of risk reduction and operational efficiency. I want to close by talking about a few recent examples of our innovation and desire to offer greater value to our customers. One important theme across a number of our more recent products is automation. As organization grapple with the explosive goals and complexity of data, they are seeking cost and time-saving security solutions that provides value by reducing labor-intense processes, ensuring -- people have access sensitive data is critical and the Automation Engine does this in a fraction of the time others may take. Adoption of this product has been very strong and we expect this to continue as we become more of the platform. We also recently announced version seven of our platform which features new dashboards for cloud security, active directory security and compliance, new threat models, threat intelligence, and new playbooks that enable customers to easily follow best practices, responses to security incident. Version seven also provides increased speed and scalability we saw support for both as well as enhancements to support for Office 365 where adoption has been very, very strong. Version seven is a major, major step forward in our platform and we will continue to invest in R&D to buy depreciation and advance our data security platform. I still believe we have much more innovation ahead of us than behind us. All this innovation coupled with the shift to subscription make Varonis much more a platform play and our goal, quite simply, is to have all of our customers realizing the full value of our platform. Before I turn the call over to Guy, who will discuss our results and guidance in great detail, I just want to say how excited I am for the evolution of our business model. We think this will be a win for our customers, for Varonis, for our partners, and for our stockholders. With that, let me turn the call over to Guy. Guy?

Thanks Yaki. Good afternoon everyone. I'd like to begin today by expanding a bit more on the subscription shift we're initiating, after that I'll recap our fourth quarter and full year 2018 results, before I turn to our 2019 guidance, which as you can expect, has subscription assumptions that affect our model going forward. You've heard us talk for some time now about our goal to get to $1 billion in sales. As Yaki discussed, now is the right time strategically for us to take the next step toward that goal by making the transition to subscription. We believe our customers are ready, our sales teams are ready, our partners are ready, and it just makes sense from a financial and operational standpoint. Customers can now take better advantage of the power of the platform by buying more licenses off the back with our subscription bundle and at the same time have room for expansion in the years ahead. With subscription, we can drive greater business predictability and visibility with an increase in recurring revenue as well as the ability to sell more into our total addressable market and increase customer lifetime value. We don't expect the transition to be perfectly linear, but we have learned a great deal from the pilot we ran. We learned how excited our -- are about generating recurring revenue, we learned about engaging with customers and also how to incentivize our sales force. We expect to continue to learn more this year as we go through the journey with our customers. One additional metric we'll provide this year is the percentage of subscription revenue out of total license revenue. For 2019, we currently expect that percentage to be approximately 10% of total license revenue. Given that Q1 is typically our lowest revenues quarter, we believe that it will be important to look at the business throughout the first six months of the year to gain better insight into the trend. I'll discuss our guidance in more detail shortly, but an important point to note is that the more success we have in driving subscription adoption, the greater the effect on our near-term reported results, effectively masking the significant underlying long-term value being created. We'll of course update you along the way in our program. With that, let's discuss our Q4 and 2018 full year results. For Q4, total revenues were $87.5 million, an increase of 20% year-over-year. Q4 license revenues were $53.3 million, which represents a 16% increase from Q4 2017. Approximately 6% of our license revenues during the fourth quarter was subscription. As you know that percentage in the past has been low single digits and in Q4 last year that percentage was less than 2%. Maintenance and service revenues were $34.2 million increasing 27% compared to the same period last year. These results were supported by our strong maintenance renewal rate, which was over 90% and which speaks to the success of our land-and-expand strategy and the value of our platform delivery. Looking at the business geographically, North America revenues increased 18% to $52.4 million or 60% of total revenue. EMEA revenues increased 22% to $32.2 million, representing 37% of total revenue. Rest of World revenues were $2.9 million or 3% of total revenues. For the fourth quarter, existing customer license and first year maintenance revenue contribution was 54%, up from 44% in Q4 2017. During the quarter, we added 275 new customers and for the full year added approximately 875 new customers, ending 2018 with approximately 6,600 customers. As of December 31, 2018, 73% of our customers had purchased two or more product families, up from 69% at the same date last year. 40% of our customers purchased three or more product families, compared with 36% in Q4 of 2017. As Yaki mentioned our ASP was $91,000 for the full year 2018 compared with $83,000 in 2017. This reflects the strong business trend and increases in customer lifetime value we are driving. Before moving to the profit and loss items, I'd like to point out that I'll be discussing non-GAAP results going forward unless otherwise stated, which for the fourth quarter of 2018 exclude a total of $10.8 million in stock-based compensation expense and $244,000 of payroll tax expense related to stock-based compensation. We report non-GAAP results in addition to and not as a substitute for financial measures calculated in accordance with GAAP. A detailed GAAP to non-GAAP reconciliation can be found in the tables of our press release, which is available on our website. Gross profit for the fourth quarter was $80.2 million, representing a gross margin of 91.7% compared to 92.6% in the fourth quarter of 2017. Operating expenses in the fourth quarter totaled $64.7 million. As a result our operating income was $15.5 million, or an operating margin of 17.7% for the fourth quarter, compared to the operating income of $13.4 million or an operating margin of 18.4% in the same period last year. We continue to show leverage as planned, excluding the FX headwind this quarter. During the quarter, we had financial income of $704,000, primarily from interest income, compared to financial income of $321,000 in the fourth quarter of 2017, primarily due to the foreign exchange gain. As you know, foreign exchange gains and losses can fluctuate. Our guidance does not consider any potential impact to financial and other income and expense associated with foreign exchange gains and losses, as we don't estimate movements in foreign currency rates. Our net income was $17.5 million for the fourth quarter of 2018, or income of $0.54 per diluted share, compared to net income of $12.5 million or $0.40 per diluted share for the fourth quarter of 2017. This is based on 32.5 million and 31.1 million diluted shares outstanding for Q4 2018 and Q4 2017 respectively. I would note that our Q4 net income included a tax benefit of $1.3 million, the result of a settlement we recently concluded, whereby we released certain income tax accruals previously made under FIN 48. I'll now quickly recap full year 2018 results. Total revenues were $270 million, increasing 25% versus last year. License revenues increased 23% for the full year and maintenance and services revenues increased 29%. I want to remind everyone that embedded in our 2018 financial guidance was our desire to continue to grow revenues while improving our non-GAAP operating margin, excluding the 300 basis points headwind related to FX. We continue to execute against our plan, exceeding our expectations and improving our margin. Non-GAAP operating income was $9.8 million, compared to $7.6 million in 2017, an improvement of approximately 300 basis points for the year, excluding the FX impact. Non-GAAP net income per diluted share was $0.32 in 2018, compared with $0.23 for 2017. This is based on 32.3 million and 30.9 million diluted shares outstanding for the full year 2018 and full year 2017 respectively. Turning to the balance sheet. We ended the year with approximately $159 million in cash, cash equivalents, marketable securities and short-term deposits. For the year, we generated operating cash flow of $23.5 million compared to cash flow generated from operation of $16.4 million in 2017. We ended the year with 1,460 employees, a 17% increase from the end of 2017. I'll now turn to guidance, which primarily reflects the effect of our subscription transition, coupled with a very tough compare in the first half of the year in Europe. First, we're focused on signing multi-year subscription deals with annual auto renewals. Under ASC 606, we recognize each year of subscription revenue similar to the way we recognize perpetual license revenue. This means, license revenues are recognized upfront and the associated maintenance revenues are recognized over the one-year period. Second, while our pilot showed healthy ASPs, we do expect there would be some impact from this transition, which we believe will be far outweighed over time by the increase in lifetime value and added visibility as we increase the recurring revenue portion of the business. But for the first quarter of 2019, we expect total revenues of $58.5 million to $60 million representing year-over-year growth of approximately 9% to 12%. We expect our non-GAAP operating loss remains between $11 million and $10 million and non-GAAP loss per basic and diluted share in the range of $0.38 to $0.36. This assumes a tax provision of $400,000 to $600,000 and 29.8 million basic and diluted shares outstanding. For the full year 2019, we expect total revenues in the range of $297 million to $305 million representing year-over-year growth of approximately 10% to 13%. We expect our non-GAAP operating income to be in the range of $3.5 million to $8.5 million and non-GAAP net income per diluted share in the range of $0.04 to $0. 16. This assumes a tax provision of $2.2 million to $3.2 million and 33.4 million diluted shares outstanding. For the full year, total revenues are expected to increase approximately 11% at the midpoint of our guidance, and we expect the percentage of revenues that are recurring to increase year-over-year. Our guidance includes assumptions around the split of perpetual versus subscription deals, and some ASP difference. As I mentioned earlier, we are targeting that in full year 2019, subscription revenues will constitute approximately 10% of our license revenue. As it relates to expenses, we will continue to make investments in R&D across our platform to drive innovation. Most of our R& D expenses are in Israel, and we have historically handled foreign exchanges fluctuation by entering into hedging contracts. We've done so again for the full 2019 year. And given the movement in exchange rate expect approximately 100 basis point tailwind compared to 2018, all of which we expect to reinvest in R&D. For sales and marketing, we are incentivizing the sales force to sell subscription and expect to have additional commission expense to support this transition in 2019. Keep in mind that, if this transition takes place at a faster pace, there could be additional compensation expense. The new commission plan we have put in place is designed to scale on the auto renewal. The result is that we expect an operating margin for the full year of 2019 of approximately 2% at the midpoint. As you probably noticed, we have slightly widened the guidance ranges of both revenue and non-GAAP operating margin to reflect our best expectations on the base of subscription transition adoption, as a potential variability of note. I'd like to point out that, while our 2018 CapEx was $9.6 million and slightly below the range, we provided at this time last year this was largely due to timing related, two leasehold improvement projects in North Carolina and Israel. Our expectation is that CapEx will be approximately $23 million to $28 million for 2019, again depending on the exact timing of these projects. I'm excited as Varonis embarks on this subscription transition. This shift in the business model is a critical step on our path towards building $1 billion business and increasing stockholders value. We learned a great deal from the subscription pilot program, we ran in the second half of 2018 and are excited to roll it out globally. This model will generate the opportunity for our customers to realize more value both off the bat and over time. It will also build our recurring revenue stream for both us and our partners and allow us to build a stronger business base on continuous innovation with greater long-term visibility, predictability and improved customer lifetime value. With that we would be happy to take questions. Operator?

[Operator Instructions] Our first question comes from Matt Hedberg with RBC Capital Markets. Please proceed with your question.

Great. Thanks a lot guys for taking my questions. Guy I want to start with you. I'm wondering a couple of points. Could you help us with what the subscription mix was for 2018? I think you told us what it was for Q4. And second, is there any additional metrics you can provide to kind of help bridge the gap subscription revenue assumptions you laid out 2019 of 10% which implies then your revenue growth of 10% to 13% versus consensus closer to 18? I guess maybe conceptually, a way to think about that is what impact say, an additional 100 bps of subscription mix, what does that impact have in total growth? Is there like a rule of thumb to think about that?

Hi, Matt. How are you? So first of all in Q4 2018 we had about 6% of subscription out of total license compared to less than 2% in Q4 last year. Now when you look about -- when you look at the guidance that we provided, we really thought a lot about this transition and we had a very successful pilot in H2 of 2018 with really healthy ASPs. But when you compare apples-to-apples assuming you sell the same number of licenses, there is an ASP difference as you've seen that in many of the other transitions of other companies. Subscription really allows us to sell more licenses and unlock the potential of the platform. When you look at the guidance many deals are already in flight with six to nine months of sales cycle. Some of these deals are large. So when you look at the perpetual quotes that have been provided to these customers, we still want to make sure that we transition this to subscription as quickly and aggressively as we can without causing any friction with our customers. That's why we have to take a bit of a range of assumptions and we're really asking for six months kind of to roll this out globally and see how this turns out?

Okay. Maybe then as a follow-up, it sounds like you said this was well received at sales kickoff by both sales folks as well as partners. Do you expect to make any change to the sales force to support this? And I guess how do you think about it incenting the sales force to sell this? I just sort of curious on, how does the customer view this, is there incentives in place, I guess is the question?

Guy will talk about incentive -- in just a second. In terms of the overall sales motion you just -- we'll sell the overall platform. So what happens essentially we start to see inflection point of the overall adoption of the quarter. We had the 365 that was very strong. Everything we have done we started with security. It became top priority for a full compliance. All the managements we had done with Active Directory and now it is in version seven, customer wants all the platform. We increased prices 15 times in the last three years, 15 times. And what happens when we spend more time with the customers, more than thousand users, and you see how it's reflecting the ASPs and how the overall customer value is working and how the -- working in absolute to large customers, but we couldn't really unlock the potential of the platform. When we come to a customer and he wants everything, he's getting a sticker shock. So, we just started the only way that can really consume it is with a -- in a subscription -- in a subscription model. So, we really tested it and we just started. Once we switch to subscription, unless it's [indiscernible] and remember, the sales cycle are six to nine months, many of the large builds are around the year, so we have some time here just to readjust, but there is a high level of confidence that in terms of the platform play -- and in the platform play, there's a lot of things related to automation. So, the immediate time to value an ongoing value increasing exponentially without the customer doing a lot of effort and it's easier to do the upsell. And you need to understand when we are talking about DatAdvantage and with the DCE and all the security package and all these products for this 365 environment and Directory Services for Azure, these are 11, 12 licenses and we believe that most of our customers can get those. So, this is just the right time for us to do it and now Guy will explain to you how the incentive plan is working.

So, Matt, in terms of the incentive plan, we are incentivizing the sales force to sell subscription. So, obviously, when you do such a transition, you want to make sure that you're supporting that change. However, this comp plan is designed to scale in years two and years three. So, in the auto renewal, basically, there's an operating margin improvement from our end.

Got it. Thanks guys.

Thank you.

Thank you.

Our next question comes from the line of John DiFucci with Jefferies. Please proceed with your question.

Thank you. So, Yaki and Guy, you say to give you six months for the split, and by the way, things have happened in the past with Varonis and you have said, okay, this is what's happening whether it's Europe or whatever it is and this is what is going to happen going forward, and you've always come through on that. But your stock's down almost 20% right now on these numbers, so we need a little bit more I think. Like what's the equivalent list price for a perpetual license in maintenance versus subscription license in maintenance for the same capacity? Like can you give us that? And then -- that's one thing that would be really helpful. And then the other thing is in this particular quarter -- because we - this is kind of somewhat a surprise for us. It makes sense what you're doing by the way. It makes total sense, okay. And like I said you guys have -- in the past, you've delivered in what you said. But in this particular quarter, if that 6% of license was less than 2% like it was last year, what would the delta have been in license? Now, I realize this is mostly you're all on-premise, so -- on-premise subscription, so you're still recognizing license upfront, but it's probably less license and would be if it is perpetual. Those are my two questions and that would be really helpful if you can give us some read on that.

So, John, I'll try and tackle both questions, I'll start with the last one. In terms of the Q4 impact, when we rolled this pilot out in the second part of 2018, we saw healthy ASPs there. However, when you look at Q4 having 6% of the license this quarter versus the 2%, there's obviously an impact. Many of those deals that were introduced initially as perpetual and they transformed into subscription. And you've gone through many of these transitions with other companies in the past, so you can make those assumptions of what would be the impact from a licensed perspective. Now in terms of the pricelist between subscription and perpetual, one thing that we’re trying to do is provide more value to our customers, meaning that if we could have sold in the past two, three perpetual licenses off the bat, we want to make sure that we sell more of those licenses and give customers the ability to use more of the platform off the bat, so they can sell five, six. We talked about in the prepared remarks that in some of those customers purchased six, seven, eight and even more of those licenses in one deal. So the comparison of one license of perpetual versus one license of subscription is very similar to what you've seen with other companies, but we want to get to a point where we can sell more of those licenses off the bat.

Okay. Go ahead, Yaki, sorry.

No, I think that what you can expect -- the fact that we were able to execute very well is our ability to hold very stationary trends in the business. We understand the business very well. We understand how the pipeline is building up and now everything is just falling into place. We also have very, very high level of confidence that over the long-term will not have a big heap to ASPs and units of economics in terms of customer lifetime value will be much greater and the visibility to just -- to overall business would be much greater and the business will be significantly more predictable. But when we are talking about the six months every time you're doing it change, there is some friction. And the other thing as Guy explained earlier, lot of deals in fly when we leverage deal in fly and you're going to take it from perpetual to subscription, many times it's how to add more licenses. What we want is that we want to move as fast as we can. We just don't want to be in between for too long. So we are very, very -- want to be very, very responsible with the way that we guide and we just want to make sure that we will have all the stationary trends to have all the deals that are in flight to make sure that we compare enough of them, everything that is new we are trying to make all efforts to move to subscription, and we really understand how the business is working, and we'll have a lot of -- more confidence to guide. The other thing, obviously, as we will move faster to subscription with – we will be able to take the same build apple-to-apple and move faster to subscription, it can have some impact on the revenue growth. So we've been very measured but this is the right time from the platform. Everything starts from the value proposition. Everything starts from the customers, how we can deliver value for the customer and how we can really capitalize on the opportunity that we have on the cloud and compliance, the automation engine is huge for us. Automation engine is giving for each and every customer, but when you're selling perpetual and usually they by 2.5, three licenses; it's very hard to add a component that is critical that if you have Automation Engine in the classification, there is order of magnitude, more value to the customer and you easily go into the cloud and the customer understand the automation and buy more of cybersecurity. So this is what we are talking about in six months. So the six months is to get to the regulatory stationary trends to make sure that we have enough quotes out there to have a sales motion and the people are not afraid in the risk assessment to show the whole platform, because the customers can buy it and then there is a lot of -- just a lot of friction. We need to be able to sell the platform. And this is why we are doing it. And all the building blocks of getting here was spending more time with 1,000-plus customers, we're starting to have this budget, the deal became bigger and bigger. We had the Automation Engine. And usually we don't know, and then we start the adoption of all the products from every direction and just want to do it, and want to make sure we are transitioning. And then, it's the same for all this, with the same stationary trend, fundamental strengths, very strong value proposition that we can predict very well. And we really believe that then this business can grow 20-plus-percent in scale and the economics to work very well. So this is what we are doing here.

Okay. And I appreciate all that. And by the way, it does make sense, Yaki and Guy. The only thing is, the timing just sounds kind of a surprise to us, number one. But that's okay, because it sounds like things happened really quickly and you made the right decision for the long term of the company. But, Guy, you just said -- listen, you've been through these transitions. We have. But ASC 606 is brand-new and it causes so much havoc for on-premise subscriptions. So we really haven't seen it. And the ones that we have seen, there's a couple right now and there's a lot of volatility in those stocks. So let me ask one question here on that. Normally the rule of thumb that we look at is that if subscription, if it was recognized all ratably, like it used to be under ASC 605, would be about two-times maintenance, if maintenance was 20% to 25% of license. Now if that's the case, like in a three-year subscription, and then now we can take that and then we can go back and say, okay, even in an on-premise subscription maintenance is 20% to 25% of license, and then work into what the subscription license would be relative to a perpetual license. And if I were to make those assumptions, am I in the ballpark? Am I looking at this, at least, how it's priced today? Does that make sense?

Yes. So let me give you some color, John. First of all, with the ASC 606, we're aiming for multi-year subscription deals, but those are with auto renewals. So we will recognize the year one only, year two and year three will be part of the balance sheet. And then, when we get to year two – year two and year three will flow through the P&L with really no balance sheet effect. Your assumptions on the term license perpetual are correct. We are aiming though to try and sell more of our licenses to provide more value to customers. So the plan is to generate more licenses bought upfront by those customers and being able to do the upsell in the years ahead. The deals that are already have been introduced as perpetual, those are much harder to transform into subscription with additional licenses that will be purchased.

Okay. That’s all very helpful. Now I can go back and try to look at this quarter and also try to think about the future and we look forward to, I guess, over the next six months as you have more visibility to give us. So thank you.

Thank you, John.

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

Hey, Yaki, hey, Guy. How you guys doing?

Hey, how are you?

Good, good. Yaki, just maybe first for you sort of staying on the point about pricing particularly if taken from a slightly different angle, the goal here I think is customers taking on more product with subscription, right, because you have so much more to offer. Can you just give us some broad brushes not on the dollars but how the pricing will work? Meaning, will it be an all-you-can-eat price for all the products per user that Varonis offers? Or are we still going to be offering subscription pricing for some of the individual products that we have as well?

Yes. Thank you for the question. No, it will be some individual products we're going to have bundles. We expect that from two, three licenses customers right off the bat will buy four to six and then they will just buy more of this just logically we saw how the whole thing is working. So we just think that over time right-off the bat we can double the number of licenses and then we'll have just a lot of meat on the bone, if you will for up-sells. And we also we believe that the up-sells will come faster, because they can buy a lot of the feature that they provide tremendous automation, so we will get more value with less friction, less FTEs, less process. And we just believe that overall the whole business model will work well and we also believe that most of our customer base are very, very good candidates with 12, 13, even 15 licenses.

In fact, just to add on that. What we saw during the pilot in the second part of the year is that the number of licenses sold was significantly higher than what we usually sell in the initial deal as perpetual.

Got it. And Guy, maybe my follow-up for you, and I think you touched on this in your response to the prior questions. But, can you remind us how billing terms and duration will change if at all for subscription versus traditional license and maintenance? You mentioned some things about auto renewal, some things around off balance sheet impact. Can you just flesh that out a little bit just to make sure we know the right metrics to look on?

Absolutely. So in terms of metrics, we'll provide and we provided kind of the guidance for the year. The percentage of subscription out of total licensee, we will continue to update throughout the quarters on that metric. And obviously, once we see things rolling out globally and we get more from kind of rolling this out, we'll provide more visibility. We are aiming to sell multi-year subscription deals with an auto renewal component. So we will recognize year one, very similar to the way we recognize perpetual, so the license component will be recognized up front and the maintenance portion would be recognized over the term of the year. And then in year two, we will do the same and year three, we will do the same. So there won't be any balance sheet impact with those multi-year subscription deals.

I see. I see. So maybe just, I'm sorry to ask another question. But I think it's an important one. With the rev rec around the subscription it feels like we'll be somewhat similar to what that we have right now. But over time it feels like we'll also get annual visibility, right? As those one-year contracts come back for year two and year three, they will renew at the same time and that's what will give us the annual visibility if you will, as opposed to quarterly up into the right SaaS like revenue. Is that -- does that make sense in terms of how I am thinking about it?

Yes. Makes sense and that's correct.

Got it, awesome. Thanks very much guys.

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

Okay, thanks for taking my question. So, I want to get some more color around the transition particularly go-to-market. It sounds like roughly speaking you're going to offer the same products as both license and subscription, meaning that it's going to be customer choice. I guess the question number one is, how do you get comfortable with the 90/10 mix for 2019? And then my second question is, is this something you plan on doing in perpetuity meaning the hybrid model or you're going to rip the band aid off eventually and just go up shore subscription? Thank you.

Eventually, we want to move more towards subscription and the sales force are incentivized very, very strongly to sell subscription. This is the way to go. And we also – also the customers, we believe that over time most of the customer, this is how they will want to buy because this is how they value -- this is realizing value from the overall product. But the way the go-to-market is, what we still go winning from the beginning of the year is that the sales force was a bit gun shy to show the whole strength of the platform in the risk assessment because when customer said, okay give me six, seven licenses quote, you know it was a sticker shot, but this is everything that they need and didn’t work. So we started very gradually to move to subscription and then went to two established territories that have everything. They have a lot of upsell, new customers, new teams everything, plenty of teams and we just said, let's see how everything is working? And it works very well. So we have enough empirical evidence that this is the way we need to go. We have a lot of confidence that this will be -- this is the right way for us to spend time with our customers. This is the right way to unlock the potential of the platform and make sure that we can show the whole strength and sell everything. And the other thing that they said which is very important to understand with the automation engine, everything that we have done with cybersecurity, so everything that's related to automated remediation and automated alerting, coupled with a lot of accuracy and automation interest justification give them immediate time to value. And with our shift to 1000-plus customers, customers that are larger, a lot of upsell to our customer base, you see how the base is buying. We just understood that we need to move to a different -- to the subscription model to make sure that we cater the value to them in the way that they can consume the product and we improve drastically the unit of economics over time.

And it also sounds like, you've got some empirical evidence around the reduced fiction that you sort of keep alluding to. I know the data points there are limited, but given what you saw, can you give us some more color around that reduced friction as far as go-to-market relative to where you were historically as far as sales cycles et cetera?

Yes. It's -- so first, it's just sample but one we're starting to sell to --. We have just one buyer and this buyer primarily have OpEx budget. So, this is first -- as a start, this is how they're buying products and when you look at the overall security features, we want -- now it seems they want to DLS, directory services, Edge, 365 is a top priority, the Automation Engine. So, they need a lot of products to get to the remediation, compliance, and cybersecurity offering and we just saw that it's much easier for us to sell six, seven licenses. When you are going to sales, and you will shop and you need to give a quote of six, seven licenses, it's a complete sticker shop. But if they don't want many licenses, it made a lot of sense to increase the prices because it's the key milestone to get to the billion-dollar plan. And we just thought that in order to move forward, we need to get critical mass of product, critical mass of value, then they need less professional services and they can do much more by themselves. And once they won't -- once we sell the value and they want the six, seven licenses, subscription is almost the only way to go because if you're going with perpetual relatively to the customer size, it's just cost.

Thanks Yaki.

[Operator Instructions] Our next question comes from the line of Alex Henderson with Needham & Company. Please proceed with your question.

Hey guys. I think a lot of the questions have already addressed, what everybody is thinking which has left us all beating around the bush. The bottom-line question I think to put it straight bluntly is had you not changed to a subscription model, would you have been given guidance that's consistent with discrete estimates for CY 2019? Or would you have given guidance below that? It seems pretty clear to me looking at the printed numbers and the momentum and commentary that what you're giving in terms of guidance for CY 2019, in fact, would be consistent as they beat and raise for the 2019 outlook. Could you confirm that please?

Alex, hi how are you?

I was better if I was not a client.

So, obviously, the guidance is impacted by our move to subscription where we have many deals that have been already introduced as perpetual. And because they have been introduced as perpetual we just want to have a larger range of assumptions and some -- and that's why we're giving the guidance that we are providing, but we feel very good about this transition. We think it works very well for our customers, for our wards, and our sales force is very excited about it.

With all due respect everybody I think on the phone agrees that that's the case and the stock is down 20%, the problem is that we need to go clients and say is management team seeing an erosion of business or are they seeing strength in their business? And the question is being asked point blank had you not transition, would you have been given guidance that is consistent or better than what The Street had been forecasting in CY 2019 or not? It's a simple question. You know the numbers. I know you've done the calculation both ways. Is the business as strong as The Street had thought it was?

The business is very strong and we are doing the transition from a place of strength. We are doing the transition because the maturity of the platform, the feature of the platform and the feature to the market conditions, the way that customers are buying it, the way the customers are using it and this is why we are doing it. It is the only reason we are doing the change. We are doing the change just to make sure that customers can realize the value. We are doing the change to unlock the potential of the platform and nothing more.

Right. So it sounds like you would have been at/or above The Street based on that commentary.

We're not specifically commenting on The Street guidelines, so…

Is there a reason why you won't give us any sense of what you would have done? There's absolutely nothing in the requested data that is ever going to be proven out. All we need to know is have you changed the outlook of the company at all? It doesn't sound like it. So, there's no reason to make that comment.

You can see based on the Q4 numbers that the subscription portion was significantly larger than what it was last year. And obviously based on transitions we've gone through with other companies there's an impact. And when we look at the guidance for 2019, we're factoring a lot of range of assumptions including the fact that we're rolling this out globally, most of the quotes have already been introduced as perpetual and we're asking for six months in order to get better -- see how this rolls out globally.

Okay. Let me ask one last question and I’ll leave the floor, a simple one. You gave us the year-ago quarter for the fourth quarter and the fourth quarter, but you didn't give us 2018. What was the base of subscription that we should be using? It was 6% in the fourth quarter. What was it for the full year 2018?

Well, first of all we introduced the pilot through the second part of 2018. Subscription for us was low single-digit usually and historically. We saw, obviously, in Q3 a higher number because of that pilot, but it was -- when you look at the impact Q3 and Q4 we’re really the only quarters that were impacted by this transition because of the pilot.

So, 3% for the year?

Slightly around that number.

Perfect. I’ll leave the floor. Thank you.

Thank you.

Our next question comes from the line of Melissa Franchi with Morgan Stanley. Please proceed with your question.

Thank you for taking my question. Guy or Yaki, it’s just about the rollout, you said you rolled it out in the U.S. and EMEA. If I'm looking at U.S. revenue in Q4, you did see a deceleration, a fairly meaningful deceleration in Q4 relative to other geos? Is that simply just because you saw better-than-expected adoption of subscription? Or was there any fundamental factor that impacted growth in Q4?

Hi, Melissa. So in spite of perpetual license fluctuation, we have high level of confidence that North America will do very well in H1 and in the year. In 2019 business is good. It's a good pipeline and we see very good mix of deal, and we believe that it will do very well.

Okay. So just to confirm, it was just because of the subscription transition?

Just a fluctuation of the perpetual model from sometimes -- you have fluctuation in the quarter, but the business in North America is strong.

Okay. Got it. And then, we discussed a lot about the incentives that you're implementing in the sales force. You didn't really talk about changes that you're making in working with the channel as you're rolling out the subscription and the bundles. Can you talk about what the channel feedback has been and where you are in the process of getting them onboard to selling subscription?

The channel feedback was tremendous. It's one of the -- it's because, just think about it, for them even if you are doing a 200k deal and then you get less than the renewals, for them it makes much more sense, because the channel partners that we did pilot we saw that they can sell five, six licenses. So it was nice size deals for them and then they get it every year. So the channel are ecstatic about the change and we believe that we can get over time much more from the channel partners, because the overall economics of a subscription business makes much more sense for them, it's more predictable. And 15 points even 20 points of margin every year from a nice size deal and to build the professional services around it, this is exactly what they want.

Got it. Thank you very much.

Thank you.

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

Great. Thanks for taking my questions. So I think the transitions, kind of, been beat to death. But I'm just trying to reconcile the language that you guys have used historically when it came to your position in the security space and how unique your solution set was and the value you bring to customers, whether it's one license, two license, five, six, seven, eight. And if you look at your, kind of, dollar value per customer, it's not a big number quite frankly in the security realm. I'm just trying to reconcile why price was such a big issue or becoming a bigger issue. I understand you're selling more products upfront. But are you seeing any competitive pressure from a pricing or subscription competitive pressure out there that maybe you weren't seeing a year ago?

No. We see less competition than ever. And if you -- what you need to understand is that difference between two, three licenses and six in perpetual model, if you are coming -- just an example, I don't have the prices in front of me. So just to illustrate, but if you're coming to 1,000 user shop and you ask them to do 120k deal, or 240k deals, it's a big issue for them. And then what happens, they're not buying all the products that they need and they get partial value and they don't get the overall automation. So we didn't have -- we increased prices 15 times in the last three years. Price wasn't an issue there, because we innovated a lot and we saw just an increase in the adoption curve of the old platform and this is how customers want to consume it and we just wanted to make sure that we can cater to them that they can get to 11, 12, 15 licenses within two, three years. At least the mid-market customer. So this is what we saw. So there is a big difference if you need to sell a 500k deal or a 220k per year. And we just saw that many times – they can buy more product and they can realize much more value and then easier to upsell, because there's another thing what we see that when they hit certain product of ours that provides a lot of automation, it's much easier for us to sell additional products.

I guess maybe just real quick to sum it up. Do you think whether it's 10 perpetual license or 10 subscription license or whatever you think kind of a good penetration rate is within a customer has your dollar spend your TAM with the customer under a subscription model was just perpetual license went up or went down?

So Chad, first of all, I think it's important to note that, the ASP has been going up very nicely over the last couple of years. It went up from $59,000 to $65,000 to $83,000 to $91,000 in 2018. So the ASP increase has been very healthy. What we have seen is that customers want to buy more licenses off the bat. And during the pilot, we ran in the last six months of 2018, we saw that the subscription allows them to lock the value of the platform and they are buying more licenses through that model than what they would've done through the perpetual model.

Okay. Thanks.

Thank you, Chad.

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

Yeah. Thanks. So my question is from a timing perspective when you think back, I mean, is this something where you're not doing it maybe a year ago or year and half ago and say it's more from your perspective that you're in a position of strength to do it competitively? Maybe you could just about timing doing in this today versus what say a year ago?

Hi. It was the overall adoption of the platform. We saw that the cloud products with 365 works extremely well, Automation Engine was extremely well and everything we have done is Active Directory and everything that the DLS products the security analytics products is worked very well. And this was – it's always about the adoption curve. After we saw the adoption curve, we really start to look at our customers, we did the pilot. We've been very, very thoughtful about it. And then we understood overall customer lifetime value. We looked at the overall discount that we are doing, a budget factor for customers one of the budget buckets that we are getting – findings from, and we just compiled everything we've been not empirical evidence and also how we can have a much more effective sales motion, the overall risk allocation and effort economy of time within the customer base and how we are covering the market, the coverage model and it makes sense. It just makes sense to do it now. There is never a good time, but in terms of times, scale, converting, the customer we just felt that this is the right time and there's just a time that you need to transition. And we just be a clear part. We believe that, we have the products already to be well above $1 billion in sale, but we need to cater the products in the right way to the market and make sure that customers can buy and the realizing value. And this is all the basis of it. So we understand that, transitions are always – there is always some friction in transition, but we doing it with a lot of clarity and a lot of strength and believe that it can be very successful.

Got it. And do you geographically I mean, do you think let just say, U.S. version you know like ones going to be easier than the other or quicker in terms of the ramp on the subscription? What's kind of your sense just based on what you've seen on the pilot program?

From the two markets, two areas we did the pilots both looks the same. And we will be able to answer this question more clearly at the end of the quarter. But overall we believe that the transition was awkward.

And just to add one more thing. In terms of the pilot, we saw it work very well with new customers. We saw it very well working with existing customers through the upsell. And just to remind you that the better we do in this subscription transition, the larger the short-term impact we will see, but obviously with much stronger underlying fundamentals.

Thank you.

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

Hey guys. Thanks for taking my questions and squeezing me in. Two really brief ones. First is, is the subscription transition primarily a sales and go-to-market? Or is there going to be any changes in the kind of the R&D and product development side things like more iterative releases in the subscription plan? Then I've got a follow-up.

It's primarily a go-to-market.

Okay. Thanks. And then just in the outlook for 2019 why only 10% of license coming from subscription? I understand there's existing deals in motion that were offered as perpetual, but it sounds like new deals that haven't even kicked off yet, are still going to be available as both perpetual and term? If this is the right thing for the health of the business long-term, why not kind of cut off essentially perpetual licenses for at the very least new customers and then only offer term?

So first of all, like you said many of the deals are in flight and have already been introduced as perpetual. We want to move as aggressively as we can to subscription but we don't want to cause any friction with our existing customers. And when you look at the sales cycle, some of the sales cycle is six to nine months. On the larger deals, it's slightly longer than that. So all we're asking, as we're rolling this out globally is to give us six months. We'll learn more through the six months and we'll update you along the way.

We are also in the business of not disappointing people. With our five years as a public company, we're always doing exactly what we said and we're very responsible with the guidance and we're trying to predict only the things that we can and have clear visibility to how they're going to play out. It's just a very good -- we have a high level of confidence that it will work very well, but this is the right way to start.

All right. Thanks, Yak and Guy.

Thank you.

Ladies and gentlemen, we have reached the end of the question-and-answer session, and I would like to turn the call back to management for closing remarks.

Thank you. I would like to thank all of our employees for their hard-work and contribution for our success this past quarter. I'd also like to thank all the customers and partners for their continued support. Thank you all for joining us today and we are looking forward to speaking with you soon.

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