Varonis Systems, Inc. (VRNS) Q2 2022 Earnings Report, Transcript and Summary

Greetings. Welcome to Varonis Systems, Inc. Second Quarter 2022 Earnings Conference Call. [Operator Instructions] Please note, this conference is being recorded. I will now turn the conference over to James Arestia, Vice President of Investor Relations. Thank you. You may begin.

Thank you, operator. Good afternoon. Thank you for joining us today to review Varonis' second quarter 2022 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 third quarter and full year ending December 31, 2022. 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 on our second quarter 2022 earnings press release which can be found at www.varonis.com in the Investor Relations section. Lastly, please note that an updated investor presentation as well as a webcast of today’s call are 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. Thanks for joining us today. Our Q2 results once again demonstrated the strength of our platform and the durability of our business model, highlighted by 30% year-over-year growth in ARR. We are especially pleased with the performance in North America which contributed significantly to this quarter growth. And given the uncertainty of the times, companies around the world continue to recognize the growing urgency to secure sensitive data. The needs of our customers has always driven our innovation and fuel our growth. And as the world moves to more hybrid working environment, the Varonis data security platform has become even more critical in protecting sensitive data, wherever it is stored. Today, I would like to discuss the trends we are seeing and how we are positioned to capitalize on them, so let's jump in. Looking back, we founded Varonis because we understood the capacity to create and share data far exceeded the capacity to protect it. Since then, the relentless goal and complexity of data has dramatically increased the attack surface for all companies, making it even harder to protect. Today, it covers all geographies, sectors and sizes, acquiring the coverage in automated protection that our offering provides. The pace of our innovation has matched this rapid growth. And today, we provide our customers a comprehensive solution for protecting sensitive data. While on-prem data continue to grow, nearly every company is creating more and more important data in the cloud. Most organizations that we speak with are deeply concerned that the data isn't fully protected and secured within the new complex cloud environments, they utilize and dependent on. Their concerns are quickly validated and rightly escalated during our initial risk assessment. It goes like this. our sales reps start with a few simple questions, do you know where your sensitive data is stored? Do you know whether the only the right people have access to it? Would you know if your sensitive data was being stolen or encrypted? What we find is that most organizations cannot answer yes to any of these questions at any time. For any of their data, much less all of it and this problem has only become worse as companies add more data to the cloud. Why is that? First, cloud applications were built to create and share sensitive data more easily which inevitably pushed security down as a concern. This is true to Microsoft 365 in Azure, where we have seen tremendous customer engagement over the past few years as well as additional cloud applications like Google Drive, AWS and Salesforce, to name a few. Second, the many CSOs we speak with, the Skype cloud application is the black boxes. They typically report that because each application offer different security capabilities and permission models, some of which are extremely complex, each new application increases the risk surface in ways that are hard to see. Think about a data inside the CRM system, like Salesforce, not only does it contain sensitive information that must be protected in accordance with regulation of GDPR, CCPA and others but it also holds the key to the sales pipeline and customer record. This data is clearly mission critical to every organization. Losing it or having it stolen can damage your reputation, cost millions in fines and cause existential risk to your business. This would be catastrophic. The CSOs can tell us that without Varonis, mapping access, finding sensitive data and tracking suspicious activity, would be impossible. With DatAdvantage Cloud, organizations can visualize their biggest cloud risk proactively, reduce the blast areas and conduct faster cross-cloud investigations. DatAdvantage Cloud significantly expand our market opportunity and provides long-term potential. DatAdvantage Cloud is in early innings and we have always said that our new licenses take time to gain critical mass. Nevertheless, we are pleased with customer conversations and the pace of selling which improved sequentially in Q2 as we continue building pipeline for the second half of the year and beyond and we are still on pace for the $5 million ARR expectations we guided for at the beginning of the year. Before I turn the call to Guy, I would like to highlight a few customer wins from Q2. A technology company with more than 7,000 employees became a new Varonis customer in Q2. They needed to fix critical open access and data retention issues but estimated, thus doing so manually to take yearly. After a risk assessment demonstrated how Varonis would automatically shrink their glass radios rates, in a fraction of the time and at much lower cost, they purchased our Silver Bundle which contains seven licenses and the intent to expand deployment of our platform in line with the growing data in Microsoft 365 and Salesforce. Turning to our existing customers, you have heard me say that it Veronis more is more. When customers consume more licenses, they get higher level of automated value which in turn leads to additional purchases, all moving towards the double-digit license target we have for every Veronis customer. A great example of this is one of the largest telecommunications providers in North America was first became Varonis’ customers in 2015 when they were looking to protect their data on-prem. Over the years, we purchased additional subscriptions, including data classification to identify sensitive data and the automation engine to proactively reduce the blast radius. During the second quarter, this organization of over 100,000 employees purchased an unplanned enterprise license agreement which gives them access to 26 Veronis licenses, to better address ransomware threats and to protect data in Microsoft 365. And we are already discussing with them the next purchase our DatAdvantage Cloud SaaS offering that can help protect their data in AWS. To recap, the expansion of the attack surface, we believe, that the global customers’ needs for strategic data protection has never been more. Our unmatched capability to address this need coupled with our ongoing innovation, continue to drive value for all Varonis stakeholders. We remain focused on two things: executing against the enormous market opportunity before us and closing in on our $1 billion ARR target. With that, let me turn the call over to Guy. Guy?

Thanks, Yaki. Good afternoon, everyone. Thank you for joining us today. Highlighted by 30% year-over-year growth in total ARR and 31% revenue growth in North America, our second quarter results demonstrates strong top line performance and continued operating leverage. Total revenue growth for Q2 was 26%. And after adjusting for FX on Russia which I will discuss in a moment, total revenue growth was 30%. And on the expense side, accounting for the shekel-dollar headwind that we've discussed at length in the past, we are extremely pleased that operating margins improved by 330 basis points, in line with our strategy of balancing top line growth and margin expansion. Before we drill down into the full Q2 results, let me describe what we're seeing in EMEA, where reported growth was 11% for the quarter. Given that there are a number of external factors beyond anyone's control, these results do not reflect our true performance and the opportunity ahead of us. As we all know, during the first half of 2022, the U.S. dollar strengthened significantly against the euro and the pound, a trend which accelerated in the second quarter with a euro dropping to a 20-year low. And second, as we reported in the last call, exiting the Russia business negatively impacted ARR and revenue by $4 million to $5 million for the full 2022 year. After adjusting for these headwinds, Q2 revenue growth in EMEA was 25%. These dynamics continue to generate near-term uncertainty in the region. Regardless, we will continue to focus on the factors we can control which include our sales investments and strategic growth plan for EMEA which we believe position us well to capture the vast multiyear opportunity we see. Turning now to our second quarter results in more detail. Total revenues grew 26% to $111.4 million. This includes subscription revenues of $84.4 million which grew 44% year-over-year. Maintenance and services revenues were $27.1 million, with renewal rates again over 90%. Looking at the business geographically. North America had another strong quarter as revenues grew 31% to $80.8 million or 73% of total revenue. As I mentioned, EMEA revenues grew 11% to $27.2 million or 24% of total revenues. Lastly, Rest of World revenues grew 47% to $3.5 million or 3% of total revenue. As of June 30, 2022, 75% of our customers with 500 or more employees purchased four or more licenses, up from 68% a year ago and 58% two years ago. At the same time, 45% of those customers purchased six or more licenses, up from 35% a year ago and 24% two years ago. Our newer bundled offerings are being well received by both new and existing customers as we progress toward our goal of getting Varonis customers to double-digit license. These trends are also reflected in another strong quarter of ARR growth at 30% year-over-year. After adjusting for the FX and Russia headwinds that I described earlier, ARR growth was 32%. Turning back to the income statement. I'll be discussing non-GAAP results going forward. Gross profit for the second quarter was $97.1 million, representing a gross margin of 87.2% compared to 86.9% in the second quarter of 2021. Operating expenses in the second quarter totaled $95.5 million. As a result, second quarter operating income was $1.7 million or an operating margin of 1.5%, above the high end of our guidance. This compares to operating income of $1.1 million or an operating margin of 1.2% in the same period last year. After accounting for the 300 basis points of headwinds related to the shekel, dollar that I mentioned earlier, the expansion was 330 basis points. Margin expansion through measured responsible cost management has always been at the forefront of how we manage the business, as evidenced once again in Q2. During the quarter, we had financial expense of approximately $68,000, primarily due to interest expense on our convertible notes which was mostly offset by interest income. Net loss for the second quarter of 2022 was $0.1 million or a loss of $0.00 per basic and diluted share compared to net loss of $0.8 million or a loss of $0.01 per basic and diluted share for the second quarter of 2021. This is based on 109.7 million and 106.4 million basic and diluted shares outstanding for Q2 2022 and Q2 2021, respectively. As of June 30, 2022, we had approximately $789 million in cash, cash equivalents, short-term deposits and marketable securities. For the six months ended June 30, 2022, we generated $10.1 million of cash from operations compared to $11.1 million generated in the same period last year. In the first half of 2022, our cash flow was negatively impacted by FX headwinds of approximately $7 million. We ended the second quarter with 2,181 employees, an increase of 54 net new employees from the first quarter. We plan to continue investing responsibly to support the overall growth of the business. Moving to our guidance. We are once again reaffirming our full year guidance for both ARR and revenues while meaningfully raising our expectation for full year operating income despite the following headwinds: first, the significant strengthening of the U.S. dollar against the euro and the pound during the first half of 2022 which accelerated in the second quarter, as I already discussed. This is relevant given that we price both our new business and renewals in local currency. And as such, this trend impacts ARR and revenue. Second, the exit of our Russia business which as previously discussed, will impact our full year revenue and ARR guidance by approximately $4 million to $5 million. And third is our exposure to the new Israeli shekel which we have partially mitigated through our hedging program for 2022 and is already factored into our guidance. For both the third quarter of 2022 and full year 2022, this headwind is expected to be 200 basis points. With that impact, the midpoint of our operating income guidance now shows year-over-year expansion of approximately 140 basis points for Q3 and year-over-year expansion of approximately 260 basis points for the full year. For the third quarter of 2022, we expect: total revenues of $123 million to $125.5 million, representing growth of 23% to 25%; non-GAAP operating income of $8.5 million to $10 million; and non-GAAP net income per diluted share in the range of $0.05 to $0.06. This assumes 127.1 million diluted shares outstanding. For the full year 2022, we expect: ARR of $484 million to $489 million, representing year-over-year growth of 25% to 26%; total revenues of $485 million to $490 million, representing growth of 24% to 26%; non-GAAP operating income of $32.5 million to $36.5 million; and non-GAAP net income per diluted share in the range of $0.19 to $0.22. This assumes 126.9 million diluted shares outstanding. In summary, with another quarter of strong top line growth and margin expansion, we are confident in our ability to continue driving durable value creation for all Varonis stakeholders. Looking ahead, we are well positioned to deliver against the enormous market opportunity before us. Thanks for joining us today. And with that, we would be happy to take questions. Operator?

[Operator Instructions] Our first question is from Matt Hedberg with RBC Capital Markets.

One question. Okay. Guy, you maintained your full year revenue in ARR guide despite incremental FX headwinds which was really great to see. I guess can you help us with how you thought about or incorporated second half macro uncertainty in your guidance? In other words, does it assume conditions kind of stay the same? Does it maybe worse? Just sort of a little bit more thought on kind of the philosophy there.

Absolutely. So we take a very responsible approach when we look at guidance and factor in what we see in terms of the pipeline, what we saw in terms of the results in Q2. And Q2 was a good quarter for us. It was very strong in what we can control. And when we look at kind of our ability to execute well, we feel very good in our ability to do that in the second part of the year. Obviously, we talked a bit about the uncertainties in Europe and we assume that, that will continue in the second part of the year. But overall, baking everything together, we feel very good with our guidance.

Our next question is from Joseph Gallo with Jefferies.

Guy, I think you gave about 400 numbers and I greatly appreciate that but I humbly ask for a clarification or maybe just a few more. Regarding revenue and ARR headwinds, was that total year-over-year headwinds related to FX? And if so, what was the incremental headwind to ARR and revenue since the last time you gave guidance in 2Q? And then any sense of what the incremental revenue headwind was for the year for revenue?

So Joe, as you mentioned, there's a lot of numbers out there. So I want to be kind of very concise and make sure that everyone understands that we don't start confusing everyone and there's a lot of numbers out there. So when you look at the FX headwind and when you compare that to when we actually gave guidance and I'll take that compared to February of 2022, the actual headwind is over $10 million on the FX side. And then on top of that, you have the Russia impact that we talked about having between $4 million to $5 million. When you bake those two together, you have roughly $15 million of headwind compared to when we gave our initial guidance. Obviously, in Q2, the currency accelerated the decline. The U.S. dollar strengthened and there was obviously an impact there. But to try and keep kind of the numbers very set and straight not start confusing everyone with all the numbers out there, it's important to know that about $15 million of headwind on the top line are against -- when we gave our initial guidance and we're still reaffirming guidance because we feel very good about our ability to execute.

Our next question is from Fatima Boolani with Citigroup.

Guy, just to some of your commentary around the observations in the EMEA business, climate, I think you were very clear about things you can control versus things you can’t. Maybe you may be a little bit more explicit on, a, what you can control? And b, give us some examples of things you can’t control, whether that be signs of sales cycle elongation, signs of slower pipeline build, anything more tangible on the EMEA front and what you’re observing that is baked into your guidance now, that would be really helpful.

Absolutely. So I'll start by kind of giving some of the numbers. When you look at the reported number for EMEA, we grew 11% but that truly doesn't reflect the underlying business performance. And when we talk about what we can't control, obviously, there's the FX headwinds. And just to remind everyone, we price in local currency in Europe, both our new business and the renewals. So that’s why the FX was impacted. And on top of that, you have the Russia impact that we talked in length in the last quarter. So when you look at the adjusted number with what we can control, the growth in EMEA was actually 25%.

The other thing primarily -- hi, it's Yaki, is execution. We are just intensely focused about our customer success. And despite the economic challenges, almost a reorganization is basically the event data is super critical. And we believe that we are the most practical way to protect your organization information. After COVID, the one stationary trend is the data is concentrated in the center -- in the data center, at the SaaS applications and now with DA Cloud every covered. If you’re going to dissect any insider sale to APT [indiscernible]. Organization run with the IT security efforts to protect digital assets and this is what we are doing. We want to make sure that our customers are very successful results. And so far, this is something that we are able to do effectively.

Our next question is from Joel Fishbein with Truist Securities.

Guy, would like to just ask about your -- any changes to your hiring plans going forward. Versus your initial plan, obviously, you’ve cut back on some expenses, I’d love to dig down a little bit deeper into where you’re hiring or continuing to hire? And what the plans are throughout the rest of the year?

So we're definitely continuing our hiring and making sure that we can truly capitalize on the longer-term opportunity. I think when you look at our philosophy and it's not just in the last couple of quarters. But if you look back for many, many years, we've been very much focused on top line growth but at the same time, bringing some of it to the bottom line and showing operating margin leverage. And I’m very happy that we continue to do this even in this environment. But at the same time, we want to continue to hire and do that in a prudent and responsible way and that’s the way we’re thinking about it.

We are not really inside of the overall opportunity. So many data repositories that are coming in the cloud that present many opportunities for us. We can really do the three use case series which is detection and response, data protection, privacy and compliance very effective to all of them. There is a tremendous market that we need to cover but look at our history, we’re always doing it in a responsible way. And we are here for the long term and we understand how the business is acting at scale. We’re just doing the right investments to make sure that we balance very well growth plans or innovation and profitability.

Our next question is from Rob Owens with Piper Sandler.

I was wondering if you could, building on Fatima’s question, maybe address deal sizes. And on larger transactions, are you guys seeing incremental sign-offs like other vendors in the market? Or is it kind of business as usual, especially as you look at that North American market?

North America, it was business as usual. In Europe, we see more C-level scrutiny but thankfully they are signing on orders. The other thing that historically, at least worked very well for us is when customers are doing thoughtful process around purchasing security products, we usually benefit from it. And when you want to protect your digital information, we believe, as I said before, we are the most practical way to do it and now with DA Cloud, we have much more coverage, we provide much more automation. So when we are doing the sales campaign in the right way with the PSC cater to our customers that, as you can see, they value more and more, we are able to be deliver that.

Our next question is from Shaul Eyal with Cowen & Company.

I think definitely you guys deserve congrats on quarterly performance and guidance in light of everything going on. I think you might have put many concerns to rest with this set of results and guidance. So I just want to make sure that I get it correctly. If we adjust for constant currency, add back the Russian written-off contribution, so your revenue guidance for the second half would have actually gone higher. And maybe just a word about linearity trends during the second quarter, maybe just a final word on July trends thus far.

Absolutely. So when -- based on today's rates, the Q3 adjusted revenue growth is 29% at the midpoint. And the full year adjusted revenue and ARR growth is 30% at the midpoint. And like you mentioned, that includes the impact from Russia.

Got it. Maybe on linearity trends during second quarter, anything unusual? What about July thus far?

So July started strong and we feel very confident with the second part of the year.

Our next question is from Saket Kalia with Barclays.

Guy, maybe just to mix it up a little bit. I was wondering if you could just talk a little bit about the bundled pricing a little bit, right? That really started in earnest last quarter. Maybe the question is, what’s been the reception from the sales team? And just any early reads, just understanding it’s still early just in bundling but any early reads that you’ve seen from customers that adopt those bundles?

Absolutely. We were very pleased with kind of the bundles adoption in the second quarter. The sales force adopted it really well. We see good reception from our customers. Just to remind you, though, all the bundles that we sold this quarter were already deals in motion because our sales cycles are between 3 to 9 months and up to 12 months on the larger deal. So overall, we're very pleased with the adoption of the bundle this quarter.

Our next question is from Andrew Nowinski with Wells Fargo.

I just want to go back to ARR. I think you just said that the adjusted ARR growth for FY ‘22 is now 30% factoring in FX and Russia which is about five points lower than it was last year. So given all the new licenses you have now which I think you’re over 40% now. And the new bundles you launched last quarter and the traction with DA Cloud, I guess I wouldn’t have expected a five point deceleration from last year. So are there any other headwinds that we should keep in mind as we try to assess maybe how conservative that ARR guidance actually might be?

First of all, it's on a much larger number. I think when you look at the ARR growth factoring in the headwinds and looking at the Russia numbers 30% at the midpoint is a number that we feel very comfortable with and feel very good with. I think overall, the trends of the business and the adoption and licenses and our customers consuming more of the platform is something that we're very happy with. When you look at the number of licenses that are four or more licenses and six or more licenses, they indicate on how we're selling the platform. So overall, we're pleased with the results and with our ability to continue to grow in the years ahead.

Our next question is from Chad Bennett with Craig-Hallum Capital Group.

So just on Microsoft's call last week, they were talking about their Microsoft Office commercial products and their server-based products, in the quarter, there was a little bit of weakness, especially SMB-related and I guess it's all about how you define it. But I guess more importantly, going forward, they are a little more conservative on kind of the expectations around office, especially on-prem and their server-based on-prem products. Just kind of how do you guys think about that? I know it’s a little bit apples and oranges and you’re not as nearly as penetrated into that vast base as anybody would think but just any insight there on just -- I know you’re levered to the Microsoft applications pretty decently on the outlook there.

We are under penetrating the overall market and even within our customer base and the penetration is not a concern. And our main customers with Office 365 that need our detection capabilities, we are going to execute and try to help them. So overall, like market penetration and single-piece nature is not a concern.

Got it. Then maybe a follow-up just on -- Guy, on the operating leverage on a kind of constant currency or back out nature, I mean, looked good and it seems like the messaging is there's more to come or expect to see significant operating leverage going forward. Just -- I mean, just looking at -- and I appreciate the FX headwinds in Russia and whatnot. But there’s been a pretty significant deceleration on the subscription side of the business from a growth rate standpoint. And sales and marketing as a percentage of revenue has barely pledged, right? And so how should we think about -- and you don’t want to think short term, you want to think long term but how should we think about just generally operating leverage on an annual basis or just going forward?

Well, I think when you look at the operating margin, just being at midpoint at just over 7% with when you think about the U.S. dollar and [indiscernible] shekel a headwind that is kind of another 200 basis points of a headwind for us, we're showing operating margin leverage, I think there's a lot of ability for us to expand but do it -- doing it at the right pace. You don’t want to show operating margin that leaves the opportunity hanging and not investing in the right way. So if you look back in our balancing between top line growth and operating margin improvements. I think we’ve done a pretty good job and want to continue to do it in a responsible way with the right and necessary investments. And when you look at kind of the Q2 results, there is a lot of noise and headwinds but we’re pleased with the underlying performance and it’s clearly better than Q1. So very good momentum for us this quarter and we want to continue that in the second part of the year.

Our next question is from Hamza Fodderwala with Morgan Stanley.

Two quick clarifying questions for me. Yaki, to follow up on Rob’s question earlier, did you say that you were seeing more new deals currently in Europe or no?

Yes. Europe, yes.

When did that start?

It started in Q2. So just during Q2, we saw more scrutiny but thankfully, also, you see the scrutiny but customers are buying. But definitely, there is no C-level scrutiny.

Okay. And then for Guy, you said the FX headwind for the -- in your full year guidance was over $10 million for 2022. When you go back to your -- the full year guide that you gave back in May, what were you assuming for FX headwind back then if you recall?

The over $10 million is versus the February guidance that we provided. And with the Russia impact, you get to approximately $15 million of headwind.

Right. I’m just asking, when you reported Q1 in May, what were you assuming for FX headwind for the full year outlook?

So the additional FX compared to last quarter's reported number is approximately $2.5 million of additional headwinds.

Our next question is from Shebly Seyrafi with FBN Securities.

So we’re currently in the seasonally stronger federal quarter. And I think in the past, it was like mid-single digits or insignificant. Can you give us an update on how large it is now? And what are your prospects for federal in the current quarter?

There is a very good pipeline entering this quarter and it's continuing with the existing customers and we believe it should perform very well.

Okay. And just looking at the geo segmentation, your adjusted for FX in Russia, your Europe growth decelerated from 29% Q1 to 25% in Q2 but your North America growth stayed strong at 31%. And you just made a comment that you're seeing additional deal scrutiny in Europe. I just want to be clear because some other companies have reported about – basically stating that they’re seeing some incremental softening in the enterprise. Are you – I just want to be clear here, you’re not seeing any kind of softening in U.S. enterprise spending?

At this point, no.

I’m sorry?

No.

And our next question is from Joshua Tilton with Wolfe Research.

Just a clarification for me as well. I think you mentioned an enterprise license agreement purchased in the quarter. How does the duration of that ELA compared to your traditional licenses?

So we've actually seen sales cycles stay the same. And if you -- it's not just with the ELA, what's very good and very positive for us is that since we sold licenses under the perpetual model and you kind of look at the additional licenses that we sell under the subscription model, significantly higher number of licenses sales cycles have actually stayed the same which is very positive for us. So we're seeing customers consuming way more licenses, both new and existing and sales cycles have actually stayed the same.

Just to follow up on that. And putting sales cycles aside, what about the duration of the actual contract. Is the ELA a longer duration contract versus your traditional time frame?

We see the same duration as the -- on those contracts.

We have reached the end of our question-and-answer session. I would like to turn the conference back over to James for closing comments.

So thank you, everyone, for joining tonight and we look forward to speaking with you throughout the quarter. Have a good evening.

Thank you. This does conclude today's conference. You may disconnect your lines at this time and thank you for your participation.