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Edited Transcript of VRNS earnings conference call or presentation 28-Oct-19 9:00pm GMT

Q3 2019 Varonis Systems Inc Earnings Call

New York Oct 31, 2019 (Thomson StreetEvents) -- Edited Transcript of Varonis Systems Inc earnings conference call or presentation Monday, October 28, 2019 at 9:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Guy Melamed

Varonis Systems, Inc. - CFO & COO

* James Arestia

Varonis Systems, Inc. - Director of IR

* Yakov Faitelson

Varonis Systems, Inc. - Co-Founder, Chairman, CEO & President

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Conference Call Participants

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* Chad Michael Bennett

Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst

* Daniel Harlan Ives

Wedbush Securities Inc., Research Division - MD of Equity Research

* Erik Loren Suppiger

JMP Securities LLC, Research Division - MD & Senior Research Analyst

* Gur Yehudah Talpaz

Stifel, Nicolaus & Company, Incorporated, Research Division - Analyst

* Jonathan Blake Ruykhaver

Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst

* Matthew George Hedberg

RBC Capital Markets, LLC, Research Division - Analyst

* Melissa A. Franchi

Morgan Stanley, Research Division - VP and Research Analyst

* Rishi Nitya Jaluria

D.A. Davidson & Co., Research Division - Senior VP & Senior Research Analyst

* Saket Kalia

Barclays Bank PLC, Research Division - Senior Analyst

* Shaul Eyal

Oppenheimer & Co. Inc., Research Division - MD & Senior Analyst

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Presentation

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Operator [1]

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Greetings. Welcome to the Varonis Systems, Inc. Third Quarter 2019 Earnings Conference Call. (Operator Instructions) Please note, this conference is being recorded. I would now like to turn the conference over to your host, James Arestia, Director of Investor Relations. Thank you. You may begin.

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James Arestia, Varonis Systems, Inc. - Director of IR [2]

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

During this call, we may make statements related to our business that would be considered forward-looking statements under Federal Securities Laws, including projections of future operating results for our fourth quarter and fiscal year ending December 31, 2019.

Actual results may differ materially from those set forth in such statements. Important factors, such as risks associated with anticipated growth in our addressable market, competitive factors, including; increased sales cycle time; changes in the competitive environment; pricing changes; transition and sales from perpetual licenses to a subscription-based model; and increased competition; the risk that we may not be able to attract or retain employees, including sales personnel and engineers; general economic and industry conditions, including expenditure trends for data and 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 resell our 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 people 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 third quarter 2019 earnings press release, which can be found at www.varonis.com in the Investor Relations section. Also, please note that an updated investor presentation, as well as a webcast of today's call, are available on our website in the Investor Relation section.

With that, I'd like to turn the call over to our Chief Executive Officer, Yaki Faitelson. Yaki?

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Yakov Faitelson, Varonis Systems, Inc. - Co-Founder, Chairman, CEO & President [3]

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Thanks, James, and good afternoon, everyone. Our third quarter results demonstrated the power of the Varonis Data Security Platform. Total revenues were $65.6 million and 74% of our license revenues were from subscriptions compared to guidance of 55%.

We are proud that even with substantially higher subscription mix, we exceeded the high end of our revenues guidance.

At the beginning of 2019, only 3 quarters ago, we announced our transition from a perpetual to subscription-based model. We said moving as quickly as possible is our top priority. And we now expect that the transition will be substantially complete in the next few quarters.

Let's discuss why our subscription offering resonating so well with our customers. The growth of data and increased awareness around data security, together with an evolving regulatory environment align perfectly with our use cases. As a result, we are achieving a high level of customer engagement and unleashing the potential of our platform.

Here are some examples. A large bank turned to Varonis to gain visibility into their data, reduce open access to sensitive data and monitor their on-premise and cloud environments for threats. They purchased subscription for 7 of our licenses, and we finally gained control of their data stores. They will identify and limit access to sensitive at-risk data, repair and file system permissions in a matter of weeks and monitor for threats across the hybrid environment, all in a single pane of glass. This is just one example of a customer making a larger initial investment with Varonis using the flexibility of our subscription model.

Another example was a federal agency that has been relying on Varonis for years to secure its sensitive information. They initially started with DatAdvantage, the foundation of our Data Security Platform. Over the years, they added Data Classification Engine and the DatAlert suite. In Q3, the agency again expanded their investment in Varonis, via our subscription offerings. They added DatAdvantage for Directory Services, Automation Engine and Data Transport Engine. Now the agency will receive alerts to unusual activity around Active Directory, reduce risk by finding and fixing excessive permissions faster than ever, and help ensure sensitive files remain where they should be.

This is also a good example how existing customers benefit from our subscription model. Examples like that confirm the value of our platform technology and its alignment with the need to reduce risk, detect and respond to threats and improve regulatory compliance whether through broader initial deployments or the expansion of existing deployments. Customers add more telemetry from data stores, Active Directory and perimeter devices. As a result, our alerts become much more sophisticated, allowing customers to detect and investigate threats more quickly and conclusively than ever before. As our platform has evolved, we have seen the growth of budgets focused on data protection inside of threats, advanced persistent threats and regulation.

This growth, combined with the ease of consumption from our subscription model, is helping make the sales process much more predictable and coupled with the scale and speed of the transition should drive substantial customer lifetime value extension.

We think that Varonis' transition can be a case study in how companies can successfully manage and facilitate a rapid business model change of such magnitude.

We believe that our place in the market is unmatched as Varonis is the only viable solution for the problems we help solve, and that we are making substantial progress towards our $1 billion target. We are delivering on customer demand, unleashing the potential of our platform and building a stronger company with great long-term value for stockholders. With that, let me turn the call over to Guy. Guy?

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Guy Melamed, Varonis Systems, Inc. - CFO & COO [4]

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Thanks, Yaki. Good afternoon, everyone. The highlights this quarter are: first, 52% year-over-year growth in ARR to $178.9 million; second, a 74% subscription mix, more than 10x the percentage a year ago; third, even with the substantially higher-than-guided subscription mix, revenues of $65.6 million also comfortably beat the high-end of our guidance; and lastly, we are pleased that our disciplined approach has resulted in a transition being close to substantially complete in a much faster time than we originally anticipated.

Now let's turn to results. As mentioned, total revenues for Q3 were $65.6 million. Third quarter license revenues were $31.6 million, which included $23.3 million of subscription revenue.

Subscription adoption for both new and existing customers remained strong. New customers continue to buy an average of between 4 and 5 licenses in the initial deal as opposed to purchasing between 2 and 3 licenses under the perpetual model.

And like we saw in previous quarters, existing customers are embracing our subscription model and realizing greater value from their purchases.

Normalized results grew approximately 30% this quarter compared to Q3 2018. We calculate normalized results by applying a conversion factor of 2.2, which estimates the value of subscription sales had they been sold as perpetual license. This reflects the 3-year breakeven period we saw across all subscription deals in the quarter, consistent with what we have seen in the past.

We adopted the conversion factor in our Q1 earnings call in response to multiple requests from analysts and investors to provide a means of analyzing our business during the transition. As you know, the conversion factor has been commonly used by other companies during their transitions. But we understand that the SEC is not going to permit the use of the conversion methodology anymore. As a result, this will be the last quarter that we will provide normalized results.

We have always believed that ARR is the most important KPI when assessing the health of a subscription business. Given that our transition has progressed far more quickly than we originally anticipated and that we now expect the subscription mix in Q4 to be approximately 75% and the subscription mix in fiscal 2020 to be plus or minus 80%, we view ourselves as a subscription company and will be focused on ARR as our leading KPI going forward.

ARR, which is the annualized value of active term-based subscription licenses plus maintenance contracts related to perpetual licenses in effect at the end of each quarter was $178.9 million at the end of Q3 and grew 52% compared to last year.

This significant increase correlates with a much greater contribution we are seeing from subscription revenues, a more predictable and recurring revenue stream and reflects the underlying health of our business.

Turning back to our income statement. Maintenance and services revenues were $34.1 million, increasing 10% compared to the same period last year.

As our subscription mix stays at these high levels, we expect less perpetual license revenues and therefore, less associated maintenance revenue. We continue to move professional services work to our channel partners while offering licenses that provide greater automation.

As a result, the Maintenance and Services line will not show the same growth levels we have seen in the past. Maintenance renewal rates on perpetual license once again exceeded 90% and we expect them to stay at these high levels.

Looking at the business geographically, North America revenues were $47.4 million or 72% of total revenue. In EMEA, revenues were $16.7 million, representing 26% of total revenue. Rest of World revenues were $1.5 million or 2% of total revenue.

During the quarter, we added 148 new customers and we ended Q3 with approximately 6,900 customers. In line with our strategy, the difference in the year-over-year Q3 new customer adds was associated with the smallest user group, companies with fewer than 500 employees.

In Q3, we saw our new customers make larger initial commitments to Varonis as they were responsible for 50% of our license and first year maintenance revenues compared to 47% in Q3 of 2018.

As of September 30, 75% of our customers had purchased 2 or more product families, up from 72% at the same time last year. 43% of our customers purchased 3 or more product families compared with 39% in Q3 of 2018.

Turning back to the income statement. I'd like to point out that I'll be discussing non-GAAP results going forward unless otherwise stated, which for Q3, excludes $11 million in stock-based compensation expense and approximately $200,000 of related payroll tax expense.

Also excluded are foreign exchange losses of approximately $900,000 related to FX differences from the revaluation of assets and liabilities denominated in non-U. S. dollar.

Gross profit for the third quarter was $57.5 million, representing a gross margin of 87.6% compared to 90.2% in the third quarter of 2018. Consistent with the first half of the year, our Q3 gross margin was slightly lower than in previous years due to the higher mix of subscription revenue.

Operating expenses in the third quarter totaled $62.3 million. As a result, our operating loss was $4.7 million or an operating margin of negative 7.2% for the third quarter compared to operating income of $2 million or an operating margin of 3% in the same period last year.

We feel very good about the state of the business and the market opportunity, and we will continue to invest to drive future growth while planning to show margin expansion.

The transition continues to have a short-term impact on our financial results, but we have been and remain committed to profitability. As we have said all along, the faster we move through the transition, the quicker we believe we can show healthier margins and the stronger our financial position will become.

During the quarter, and similar to the third quarter of 2018, we had financial income of approximately $400,000, both primarily due to interest income. Our guidance does not consider any potential impact to the financial and other income and expense associated with interest income or any impact related to foreign exchange gains or losses as we don't estimate movement in foreign currency rate.

Our net loss was $4.8 million for the third quarter of 2019 or a loss of $0.16 per basic and diluted share compared to net income of $1.8 million or $0.06 per diluted share for the third quarter of 2018. This is based on $30.4 million basic and diluted shares outstanding for Q3 2019 and $32.5 million diluted shares outstanding for Q3 2018.

Turning to the balance sheet, we ended the quarter with $131.4 million in cash and cash equivalent, marketable securities and short-term deposits. Through the first 9 months of 2019, we used $10.7 million of cash from operations compared to generating $16.3 million of cash from operations in the same period last year.

As a reminder, we are collecting on annual contract value amounts in this transition, and therefore, we continue to see a short-term impact on cash flow. We ended the quarter with 1,506 employees, a 9% increase from the third quarter of 2018.

Before we open for Q&A, I'll discuss our guidance for the remainder of 2019. Our updated full year guidance includes the Q3 revenue will be offset by the headwind from the significant increase in the Q4 subscription mix guidance to approximately 75% from 40%. Without this increase in the subscription mix, we would've shown a meaningful raise to our Q4 and full year guidance we provided last quarter.

For the fourth quarter of 2019, we expect total revenues of $70.5 million to $73.5 million. We expect our non-GAAP operating loss to range between negative $3.5 million to negative $1.5 million and non-GAAP net loss per basic and diluted share in the range of $0.13 to $0.07. This assumes a tax provision of $400,000 to $600,000 and 30.5 million basic and diluted shares outstanding.

Given the higher Q4 mix, which now assumes approximately $29 million of subscription revenues, we now expect the full year subscription mix will be approximately 62%, up significantly from our prior guidance of 45%, and even more drastically from our 10% guidance at the beginning of the year.

Our updated full year 2019 guidance is as follow: we now expect total revenues in the range of $252 million to $255 million. We expect our full year non-GAAP operating loss to be in the range of negative $28.5 million to negative $26.5 million, a non-GAAP net loss per basic and diluted share in the range of $0.96 to $0.90. This assumes the tax provision of $2 million to $2.2 million and $30.3 million basic and diluted shares outstanding.

While we will provide our full financial guidance for 2020 when we report our Q4 results, here are a couple of things to think about. First, for fiscal 2020, as previously mentioned, we expect the transition to be substantially complete with subscription levels at plus or minus 80% for the year.

Second, I want to remind everyone that in the first half of 2020, the subscription mix will be significantly higher than in the first half of 2019 when we were at the beginning of the transition.

And finally, as we feel good about the business, we will continue to invest while balancing growth and profitability, which has been our philosophy for many years.

In summary, we're extremely pleased with our Q3 results, particularly with our 52% growth in ARR, which reflects the strengthening fundamentals of our business. Subscription is unleashing the full potential of our platform, and we believe that we will be able to leverage our new model to the benefit of our customers, employees and stockholders. With that, we'd be happy to take questions. Operator?

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from the line of Matt Hedberg with RBC.

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Matthew George Hedberg, RBC Capital Markets, LLC, Research Division - Analyst [2]

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Congrats on the strong results. Yaki, I wanted to talk about growth. ARR grew 52%. And I believe you said, on a normalized basis, revenue grew 30%. I guess I'm wondering from a high level, can you remind us of how fast do you think your underlying markets are growing? I guess I'm trying to get a sense for maybe how fast we should think about growth post transition.

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Yakov Faitelson, Varonis Systems, Inc. - Co-Founder, Chairman, CEO & President [3]

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The overall market is -- always was everybody, but the key is that the subscription really unleash the potential of the platform. The 3 use cases that we are catering for, the data protection, detection of cybersecurity, internal threats and regulation are top priority for our customers. And what is happening is they can buy more right off the bat, and they -- we can really expand with them. And what we see that it's just becoming a top priority for almost every organization out there.

The sales cycle is becoming much more predictable and more strategic and simpler because it's -- most of it's under the CSO.

The cloud is a big driver. As I said, regulation is a big driver and everything that is happening in the cyberspace, once you bypass the perimeter of security, really unmatched with our ability to detect this cybersecurity threats and just working extremely well. So we really believe that just the friction and our ability to capture market share, the efficiency of the sales process are working very well, and we believe that the -- with this transition to subscription, we can grow fast, and we can do it for many years and being very efficient in doing so.

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Matthew George Hedberg, RBC Capital Markets, LLC, Research Division - Analyst [4]

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That's great. And maybe one for Guy. In your prepared remarks, you noted that post transition, you plan to show margin improvement, your main committed to profitability. Obviously, the margins today are being impacted negatively by the model transition. But can you help us think about sort of -- obviously, you guys are going to continue to invest for growth, but what's the right way to think about margin expansion post the transition?

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Guy Melamed, Varonis Systems, Inc. - CFO & COO [5]

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So you're right, Matt. The transition continues to have a short-term impact on our financial results. But we have been and really remain committed to profitability. And to give some color for 2020, we'll obviously provide guidance in our Q4 results. But just to give some color on how we think about next year. Next year really is a year of 2 halves, you have kind of the first part, the first 6 months of the year, where the subscription mix will be significantly higher than kind of the first half of 2019. And then the second part of the year when the subscription mix is expected to be kind of within the similar ranges.

And when you look at kind of how we think about expenses, we feel good about the business. So we want to continue to invest really while we're balancing growth and profitability, which really has been kind of our philosophy for many years. So I think in summary, we really have a track record of commitment to profitability and plan to continue on that path.

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Operator [6]

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Our next question comes from the line of [Flint] with Jefferies.

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Unidentified Analyst [7]

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You mentioned product attach is higher in subscription than you saw in perpetual. I'm curious if you could just comment on where you're seeing strongest product attach in perhaps the strongest opportunities going forward?

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Yakov Faitelson, Varonis Systems, Inc. - Co-Founder, Chairman, CEO & President [8]

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It's just -- it's all over. We see a lot with the data protection with the automation engine. The cloud is huge for us. So just the hybrid world works very well for us. The cloud is a big driver. Everything that's related with 365. And [Azure] works extremely well. Classification because of regulation and you tie everything to the cybersecurity, they're alerting the forensics that we are doing, we'll see it from all over. So a lot of this success is from the -- coming from customer demand.

The customer need and the understanding that they need more and more of the licenses in the platform and the automation around it. Once you're bringing it to the customer with relatively little effort, they get a lot of value. And once they're adding more platforms, they're having much better data protection, they are more in compliance and the alerting and the detection that we are providing of just increasing in accuracy in orders of magnitude. So we're really hitting on all cylinders in terms of the platform and unleashing the potential of the platform and it's timed perfectly to customer demand, which -- it's all coming from the customer.

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Guy Melamed, Varonis Systems, Inc. - CFO & COO [9]

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Just to give some data points. What we used to see under the perpetual model is that customers would buy on their first initial purchase between 2 to 3 licenses. And what we see under the subscription model is that new customers are buying between 4 to 5 licenses. So it ties to what Yaki is saying that they're consuming more of the product and buying this as a platform. So...

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Yakov Faitelson, Varonis Systems, Inc. - Co-Founder, Chairman, CEO & President [10]

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The platform still works very well in the initial deal and working very well in the expansion.

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Unidentified Analyst [11]

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And just a quick follow-up. Just from a global perspective, is the sales force now all on board and up to speed on the shift to subscription? It would seem with the numbers they are, but any pockets left to get the sales force on board with this go-to-market model?

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Yakov Faitelson, Varonis Systems, Inc. - Co-Founder, Chairman, CEO & President [12]

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Yes, they are. And the subscription is just the top priority. Obviously, in EMEA, we did some changes to make sure that everybody are on board, but we are in the right direction, and we're really becoming a subscription business. As far as we know, this is one of the fastest transitions in history of enterprise software to subscription. And everybody want everybody on board, and it's also working very well with the customers. Most of the customers, the vast majority, this is what they want. And they'll get much more value from us selling them in a subscription model.

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Operator [13]

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Our next question comes from the line of Saket Kalia with Barclays Capital.

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Saket Kalia, Barclays Bank PLC, Research Division - Senior Analyst [14]

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Guy, maybe just to start with you. It's obviously early to get a good sample size here. But I think you should have started to see at least some of your early subscription pilot customers come up for renewal. So I was wondering if you can just talk about what you're seeing from that first cohort of subscription customers that signed a year ago and maybe even Q4 of last year and their willingness to renew under the new pricing model.

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Guy Melamed, Varonis Systems, Inc. - CFO & COO [15]

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Yes, you're right. Q3 last year is really when we started kind of the pilot, and that ran for Q3 and Q4. We're very happy with the renewal rate for our Q3 pilot.

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Saket Kalia, Barclays Bank PLC, Research Division - Senior Analyst [16]

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Yaki maybe just my follow-up for you. Lots of traction on subscription, as I think we all see. For the customers that are still on maintenance, can you just talk about how you envision that base sort of evolving over time? I think we've seen companies transition this -- transition their maintenance base to subscription using various methods. Curious how you think about that base long term.

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Yakov Faitelson, Varonis Systems, Inc. - Co-Founder, Chairman, CEO & President [17]

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Yes, there is so much just to sell and the value is coming from the platform, and this is what the customers want. So our focus to be -- to move faster subscription, it's not to go and convert the maintenance but as it is it's recurring revenues, what we are doing is selling them new licenses. This is how it works. We are not going to the base and converting just maintenance, we are going and selling additional licenses and make sure that we are platform plan -- played to the base and as we said before, the platform is working very well with new customers with expansion.

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Operator [18]

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

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Shaul Eyal, Oppenheimer & Co. Inc., Research Division - MD & Senior Analyst [19]

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Congrats on the consistent execution, and without a doubt, the improved outlook. One for Yaki. One for Guy. So Europe bounced back, it would appear. And I know you addressed it absolutely coherently over the course of the past few quarters. What's driving that improvement vis-à-vis from macro concerns about a moderating European economic environment?

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Yakov Faitelson, Varonis Systems, Inc. - Co-Founder, Chairman, CEO & President [20]

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We don't see -- we see the same sales cycles, we see overall Europe, good demand. Everything for us in Europe and for the company. To move so fast is not easy, this is hard work to take a company, and in 3 quarters, to move in this kind of rates.

And also for the fourth quarter, the whole focus is to move it to subscription. And with Europe, we needed to do some changes, make sure that everybody on board. And it's -- overall, it's moving in the right direction. But we just -- we see very good market there. Historically, we did very well. And also in the fourth quarter, the top priority is just to move to subscription and the increase the ARR.

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Shaul Eyal, Oppenheimer & Co. Inc., Research Division - MD & Senior Analyst [21]

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Understood. And Yaki, while we have you maybe on that topic and trying maybe to expand it a little bit. So clearly the strategy has been unfolding better than expected, customers are coming for more modules that the platform gets expanding. And without a doubt, the name becomes much more recognizable out there in the market. So do you think that down the road in the quest to the $1 billion target, do you think we might start to see 7-digit transactions potentially becoming more of a routine rather than exception down the road?

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Yakov Faitelson, Varonis Systems, Inc. - Co-Founder, Chairman, CEO & President [22]

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I don't know. I just know that at this point, what I know it's becoming a top priority for organizations. So everything that is happening in the marketplace works very well for us. The explosion of data and with a lot of automation that we introduced, the ability for customers to solve very fast with very little human intervention, the biggest risk in data protection. What we have done is just cybersecurity, once you bypass the perimeter. The way that we are doing this user behavior analytics, it's working extremely well.

And regulation, so I just think that it's going to be a top priority for customers out there from every size and the -- to focus more on the enterprise who give larger initial deals and very good expansion. So I don't know in terms of one deal or the other, but I just think that the initial deal and the overall customer lifetime value make a lot of sense.

We'll be able to focus a lot on our customers, make sure that they are extracting a lot of value from the platform, and we're starting to see that the up-sells are really related to usage. So if they're using the products more with relatively little effort because we have this automation in each one of the use cases. So just -- I would just believe that everything will become much more efficient and, over time, our ability to get more from our customers will just increase.

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Operator [23]

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

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Chad Michael Bennett, Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst [24]

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Phenomenal job on the quarter, guys. So maybe a question for Guy first. I know you don't want to give specifics necessarily on next year. But considering where we're at in the transition and now we're going to annualize on those numbers, specifically in the March quarter, how should we think about seasonality there just because we haven't really seen it yet? Seasonality of the March quarter in terms of subscription revenue and license revenue compared to when you were a peer license company?

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Guy Melamed, Varonis Systems, Inc. - CFO & COO [25]

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So without boring you to death with the accounting treatment. The 606 really requires that subscription deals for on-prem are recognized similar to perpetual. So we expect the same kind of seasonality where Q1 is kind of our lowest -- smallest quarter in terms of -- in dollar terms, and then Q4 being kind of the largest. But again, kind of going back to the way we look at 2020, it really will be kind of a year of 2 halves, where the Q1 -- when we -- Q1 '19 is really when we started the transition. And the subscription mix is lower. And Q1, 2020, subscription mix should be significantly higher. So it won't really be apples-to-apples in terms of Q1 and also Q2 of 2020. And but as we get to the second part of the year, the second half, it will be much more of an apples-to-apples comparison on a top line basis.

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Chad Michael Bennett, Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst [26]

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And maybe this is just a more blunt way of asking it, do you expect to return to revenue growth in the March quarter overall year-over-year?

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Guy Melamed, Varonis Systems, Inc. - CFO & COO [27]

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So we'll provide our guidance in Q4 of this year, and we'll give much more color on the 2020 line item and how we see that. But conceptually, we'll just have to break it into those 2 years, the first and second half. And from an expense perspective, because the business is doing well, we want to continue to invest.

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Chad Michael Bennett, Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst [28]

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Okay. And maybe a couple of segment questions. I think you touched on EMEA, and we have the overall revenue. Can you just give us a sense for how EMEA performed in terms of subscription revenue sequentially?

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Guy Melamed, Varonis Systems, Inc. - CFO & COO [29]

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We were happy with the adoption of the subscription mix in EMEA. I think the team there is on board, understand the value that it provides customers, and we expect that to continue in Q4.

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Chad Michael Bennett, Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst [30]

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Okay. One last one for me. Just fed. You highlighted the substantial deal in the quarter. Is there any way to indicate how fed performed for you guys in terms of bookings or revenue this quarter compared to any quarter historically, then I'll jump off.

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Yakov Faitelson, Varonis Systems, Inc. - Co-Founder, Chairman, CEO & President [31]

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We saw a nice contribution from fed, we're very proud of the team. And we are very happy with the subscription adoption as well.

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Operator [32]

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

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Gur Yehudah Talpaz, Stifel, Nicolaus & Company, Incorporated, Research Division - Analyst [33]

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Congrats on the quarter. Based on what you're seeing, do you see a point where you'd be comfortable ripping the band-aid off, so to speak, and only selling subscriptions? I know you gave initial color for 2020, but given just the rapid growth you've seen here in subscription, is there a point where you kind of say, you know what, we're good to here, we're comfortable, we're only going to sell subscription going forward?

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Yakov Faitelson, Varonis Systems, Inc. - Co-Founder, Chairman, CEO & President [34]

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We are all about the customers. You see the results, we can't be more committed to subscription, and it's working extremely well. And -- but we're 3 quarters into it. And at the right time, we will consider it, but we're definitely in the right direction with subscription and very committed to sell subscription and as much as we can subscription only.

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Gur Yehudah Talpaz, Stifel, Nicolaus & Company, Incorporated, Research Division - Analyst [35]

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That's helpful. And then if you look at sort of initial sales with subscription, are you seeing customers buying more DatAdvantage for different storage areas? I mean, are you seeing them deploy DatAdvantage across broader parts of the network than they would have done with perpetual, not just additional solution module adoption, but really just the core DatAdvantage solution? Or you think that's being deployed across a broader part of the network?

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Yakov Faitelson, Varonis Systems, Inc. - Co-Founder, Chairman, CEO & President [36]

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Yes, definitely. Without a doubt. We see they're deploying more DatAdvantage. We see a lot of strong adoption of the DatAdvantage to all the 365 environment. But it's just working with all the licenses. They can really consume the platform and have all the automation, get much more value and then buy more.

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Gur Yehudah Talpaz, Stifel, Nicolaus & Company, Incorporated, Research Division - Analyst [37]

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That's helpful. And maybe if I can throw one more in there for Guy. Guy, you talked about 4 to 5 licenses at initial deal versus 2 to 3 for perpetual. How should we think about potential customer LTV here and differences between the 2, given that you've got a few quarters now under your belt of subscription selling?

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Guy Melamed, Varonis Systems, Inc. - CFO & COO [38]

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So I think what we see is definitely the -- how this transition and how the sale of subscription has unleashed the potential of the platform. Customers are consuming this and purchasing licenses much more as a platform play, and that's really beneficial because the more licenses they have, the more value they can generate from our products. So we believe and we see the additional purchases of license is a very positive thing for customers where they can continue to buy more licenses after that.

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Operator [39]

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

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Melissa A. Franchi, Morgan Stanley, Research Division - VP and Research Analyst [40]

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Yaki, looking beyond the change to subscription. Have your customers ask for more cloud-based offerings from you all versus your on-premise offerings? And is that something that you have given a consideration to?

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Yakov Faitelson, Varonis Systems, Inc. - Co-Founder, Chairman, CEO & President [41]

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Our customers, if they want to install the platform, they can install it. In Azure, they can install it in AWS. So if they have cloud infrastructure, they don't have an issue to install it. But primarily, what they're asking for us is to support more of this data repository in the cloud, and this is what we are doing, and it's driving a lot of growth for us.

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Melissa A. Franchi, Morgan Stanley, Research Division - VP and Research Analyst [42]

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Okay, got it. So I just want to follow-up on the earlier question on renewal rates. And I know that it is early, but Guy, is your assumption that the renewal on the subscription will be similar to maintenance?

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Guy Melamed, Varonis Systems, Inc. - CFO & COO [43]

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Yes.

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Operator [44]

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Our next question comes from the line of Daniel Ives with Wedbush.

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Daniel Harlan Ives, Wedbush Securities Inc., Research Division - MD of Equity Research [45]

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Can you talk about regulatory, especially GDPR, some of the signs? And even what's happening here in the U.S. from a state perspective, how that's driving sales cycles and maybe activity?

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Yakov Faitelson, Varonis Systems, Inc. - Co-Founder, Chairman, CEO & President [46]

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Regulation, primarily, what it's doing, it's just helping the organizations out there to understand how to treat data and cybersecurity and elevating the awareness to the senior executives on the Board on the risk and the need to protect the data and infrastructure just as a trust foundation to function. So it's definitely -- it's helping us. But this is something that works over a long time. It's just an educational process that organizations are having a -- just a lot of regulation in the generating a lot of need, but this is something that's just building up over time.

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Daniel Harlan Ives, Wedbush Securities Inc., Research Division - MD of Equity Research [47]

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Great. And when -- have you scheduled a date for the seminar on how to do a subscription transition yet? When you're officially going to do that seminar?

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Guy Melamed, Varonis Systems, Inc. - CFO & COO [48]

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We'll send the link.

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Daniel Harlan Ives, Wedbush Securities Inc., Research Division - MD of Equity Research [49]

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Okay. Yes, just let me know when the link's out.

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Operator [50]

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Our next question comes from the line of Erik Suppiger with JMP.

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Erik Loren Suppiger, JMP Securities LLC, Research Division - MD & Senior Research Analyst [51]

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Congrats. First off, can you talk a little bit about deal size? I understand the number of subscriptions or services that customers -- new customers are buying moves up from 2 to 3 to 4 to 5. But in light of the move to subscription, it's hard for us to gauge what the overall deal size is for a new customer. Can you talk a little bit about how the dynamics around that have changed with the move to subscription?

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Guy Melamed, Varonis Systems, Inc. - CFO & COO [52]

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So we provide our ASP on an annual basis. Providing it on a quarterly basis can be slightly confusing because historically Q4 has been our largest quarter for the year. So in the next earning call when we report Q4 numbers, we'll provide more color on the ASP.

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Erik Loren Suppiger, JMP Securities LLC, Research Division - MD & Senior Research Analyst [53]

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Okay. And then lastly, on the number of new customers, when do you think that's going to reverse and start growing again? I understand you're shifting to larger customers, but when do you think that the new adds will start to accelerate?

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Guy Melamed, Varonis Systems, Inc. - CFO & COO [54]

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The way we look at the new customer adds is that it's really working in line with our strategy. When you look at the delta between the Q3 adds year-over-year, it's all related kind of to the less than 500-employee companies, so like the lowest user group. And it really fits well with our strategy. So we're not just focused about bringing new customers, but also kind of the quality of those customers and the larger customers where we can later on sell more license. So it's really working very well for us. And we will continue in that strategy.

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Operator [55]

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Our next question comes from the line of Jonathan Ruykhaver with Baird.

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Jonathan Blake Ruykhaver, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [56]

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Yes. I'm kind of curious, when you look at the data, security issues around GDPR, Active Directory and Office 365, in particular. Can you just talk about how those use cases is right for Varonis in terms of demand trends? And then which one do you see driving a greater platform opportunity for the company?

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Yakov Faitelson, Varonis Systems, Inc. - Co-Founder, Chairman, CEO & President [57]

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It's all of them. Just you have this unstructured data that it's very hard to align the right people to access the right data. And once you're going to the cloud with all of the added collaboration features, it's becoming much bigger. And in one single pane of glass to control everything and every regulation, talking about data protection, data classification and the ability to stop and alert on any cyber attacks. So it's all -- they're all data security platform that we added a lot of telemetry, and it's become -- a lot of it related to Edge devices and infrastructure. It's -- everything works very well in terms of your classified data and remediate the risk, making sure the data is in the right places and alert on any abnormal behavior. This is exactly the platform play. And the fact that you have a lot of data in the cloud and on-prem and its users in every organization are accessing it wherever it lives and you have this information and data spot works very well for us. It's just make the playing so much bigger.

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Jonathan Blake Ruykhaver, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [58]

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Would it be safe to assume that Office 365 is the larger of those 3 use cases?

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Yakov Faitelson, Varonis Systems, Inc. - Co-Founder, Chairman, CEO & President [59]

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It's a big use case.

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Jonathan Blake Ruykhaver, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [60]

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Right. Okay. And then my final question, when you look at cloud data stores versus on-premise. Do you see any notable emphasis by customers on one or the other when you look at the business mix today? Or are those security concerns influence your opportunity equal across on-premise and cloud today?

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Yakov Faitelson, Varonis Systems, Inc. - Co-Founder, Chairman, CEO & President [61]

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It's equal in on-premise and cloud, but in the cloud, if you're doing a mistake and you open it for the whole world is -- it's more than just your employees. And some of these technologies have a lot of productivity tools for the end user, but that it's much easier for him to do a mistake and open these data stores to much more -- to many more people than they intended. So it's equal opportunity, but sometimes in the cloud, the problem can be bigger.

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Jonathan Blake Ruykhaver, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [62]

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Are you seeing faster growth with your products that address cloud security data stores today?

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Yakov Faitelson, Varonis Systems, Inc. - Co-Founder, Chairman, CEO & President [63]

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The cloud is big for us, but it's the same. When a customer wants to solve the problem, usually they want to solve it on-prem. Most of the data is still on-prem. I will say, well over 90% of the data is still on-prem, but it's starting to gain volume of data in the cloud, and there is more data -- they have more data in the cloud. They definitely see more acute need to use Varonis, always was data growth really fuel Varonis growth.

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Operator [64]

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

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Rishi Nitya Jaluria, D.A. Davidson & Co., Research Division - Senior VP & Senior Research Analyst [65]

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Maybe just one or two for Guy. First, just thinking about the normalized growth calculation that you provided, which is really helpful. It looks like you're using a different calculation this time than you did on the slide deck last quarter when I pulled that up, where you're actually kind of taking the delta between subscription this quarter, subscription of the year-ago quarter and then adding back in the subscription from a year-ago quarter, and you're doing that again for Q3 of last year. Can you maybe help us understand the difference in your calculations now versus what we got 90 days ago? And is that the new calculation that you should be using going forward? And I think retrospectively as well? And then kind of a follow-up, just on the ARR side, naturally, got a huge uplift sequentially in ARR from your subscription mix. Just how should we be thinking about that ARR line going forward?

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Guy Melamed, Varonis Systems, Inc. - CFO & COO [66]

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Sure. So there's a couple of questions there, I'll try and break them one by one. First of all, in terms of the change in kind of the way we're calculating it. This is -- really the first quarter, we're taking into consideration the pilot amounts, and we don't want to double count. So we're being very responsible on every metric we're providing. And that's why the conversion factor is only being applied to the incremental subscription.

Kind of the second part that you asked about how we would apply it going forward. So we adopted the conversion factor in our Q1 earning call, really in response to kind of the multiple requests from analysts and investors that provide the means of analyzing the business during the transition. And as you know, the conversion factor has been commonly used by other companies during their transition. But we understand that the SEC is not going to permit the use of that conversion methodology anymore. So as a result, this is really the last quarter that we will provide normalized results. But we have always believed that ARR is the most important KPI when assessing the health of a subscription business. And as such, the ARR will be the focus metric going forward.

So given the transition has progressed much quicker than we originally anticipated. With the expected subscription mix of 75% in Q4. And with our guidance for subscription mix in 2020 of plus or minus 80%, we really are a subscription company, and we'll be focused on ARR as our leading KPI going forward.

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Operator [67]

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Since there are no further questions in the queue, I would like to pass the floor back over to management for any closing remarks.

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Yakov Faitelson, Varonis Systems, Inc. - Co-Founder, Chairman, CEO & President [68]

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Before we end the call, we would like to thank all of our employees for their hard work and contribution to our success this quarter. We also like to thank all of our customers and partners for their continued support. Thank you all for joining us today. And we're looking forward to talk to you soon.

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Operator [69]

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This concludes today's teleconference. You may now disconnect your lines at this time. Thank you for your participation and have a wonderful day.