Q4 2023 Varonis Systems Inc Earnings Call
Participants
Tim Perz Perz; Director of IR; Varonis Systems, Inc.
Yaki Faitelson; Co-Founder, Chairman, CEO & President; Varonis Systems, Inc.
Guy Melamed; CFO & COO; Varonis Systems, Inc.
Matthew Hedberg; Analyst; RBC
Saket Kalia; Analyst; Barclays Capital Inc.
Hamza Fodderwala; Analyst; Morgan Stanley
Brian Essex; Analyst; JPMorgan Chase & Co
Joel Fishbein; Analyst; Truist Securities, Inc.
Andrew Nowinski; Analyst; Wells Fargo Securities, LLC
Fatima Boolani; Analyst; Citigroup Inc.
Roger Boyd; Analyst; UBS Investment Bank
Chad Bennett; Analyst; Craig-Hallum Capital Group LLC
Jason Ader; Analyst; William Blair & Company LLC
Joseph Gallo; Analyst; Jefferies LLC
Shrenik Kothari; Analyst; Robert W. Baird & Co. Incorporated
Erik Suppiger; Analyst; JMP Securities
Brian Colley; Analyst; Stephens Inc.
Rudy Kessinger; Analyst; D.A. Davidson
Rob Owens; Analyst; Piper Sandler
Joshua Tilton; Analyst; Wolfe Research
Presentation
Operator
And so Greetings and welcome to the Varonis Systems Inc. fourth quarter 2023 earnings conference call. At this time, all participants are in listen only mode. A brief question and answer session will follow the formal presentation. Anyone should require operator assistance during the conference, please press star zero on your telephone keypad. As a reminder, this conference is being recorded is now my pleasure to introduce your host, Tim Powers. You may begin.
Tim Perz Perz
Thank you, operator. Good afternoon. Thank you for joining us today to review Verona Pharma's Fourth Quarter and Full Year 2014 Financial Results. With me on the call today are Yaki Faitelson, Chief Executive Officer, Guy Melamed, Chief Financial Officer and Chief Operating Officer of Veronate. After preliminary remarks, we'll 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 first quarter and full year ending December 31st, 2024 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. Our own is expressly disclaims any obligation 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 2023 earnings press release and investor presentation, which can be found at www.varonis.com on the Investor Relations section. Lastly, please note that a webcast of today's call is available on our website in the Investor Relations section. With that, I'd like to turn the call over to our Chief Executive Officer, Yaki Faitelson. Yaki?
Yaki Faitelson
Thanks,z Tim, and good afternoon, everyone. Thank you for joining us to discuss our fourth quarter and full year 2023 performance today, like to view of fast transition progress and discuss key drivers of our business. In 20 24,000 since one year ago. We discuss our initial excitement on the loan itself. So the time we talked about how we have invested heavily for you to build a world-class cloud native SaaS offering, which allows our customers to secure data, automatically simplified our packaging to include automation that we know our customer needs.
We have confidence in our product, our team in our plan, but it was early and you have a lot of growth despite ongoing market challenges. Thus, we will go from several million dollars in 2022 to approximately 125 million at the end of 2022. We are a part of the momentum we have achieved so far and how that set us up for 20 to 24 and beyond.
Fourth quarter results reflects the sustained momentum of our SaaS platforms, and I'm happy to announce that suffered a represents approximately 23% of total Company up for Q&A. Progress give us the confidence to accelerate our transition time line, which we now expect to complete by the end of 2026 years earlier than our initial launch fourth quarter assessment scheme at 66% for the core guidance of 60%, ARR growth, 17% year-over-year, $543 million, and we generated $54.3 million of free cash flow in 2020, up from $0.5 million last year.
The macro environment remained stable during Q4, and we continued to see a high level of scrutiny with multiple level of approval. Overall, we are excited by the progress of our SaaS transition Against these headwinds. Guy will review our Q4 results in our 2020 for guidance in more detail, we are still in the early innings with our transition to SaaS delivery model. In the benefits we expect to realize Provigil and 23 overall marked a strong fit in the right direction, and I'm very grateful to the entire loan scheme for how they have executed so phone.
Turning now to our strategic priorities for 2024. Of course, continuing our transition to SaaS will be a primary focus is to briefly remind you, there are three key benefits of SaaS platform provides to our customers. Customers can achieve automated outcome, which means we can ensure that data is protected with very little effort. Stuff is quicker to deploy and operationalize because of significantly lower infrastructure and personnel investments in SaaS is easier to maintain.
And obviously, additionally, there are three key benefits that we realize. They are shorter sales cycles larger in Xiamen and margin benefits over time. So we started to see evidence of this benefit in 2023 and expect them to continue in 2024. In addition to executing on our SaaS transition, the dangerous environment is creating increased awareness for data security. So using that backdrop, we see three additional drivers, revenue manage data detection and response service, which we call MDF adoption of enterprise.
Generally the way I like, quote, pilots and Einstein and increasing compliance requirements and such the new SEC disclosure rules around cyber events. With that, let's tackle the overall environment in each of these drivers in more detail, foundation for innovation has been sentenced to follow the data and automate SaaS. We have been able to innovate much faster. We have gone wider is more coverage of Enterprise Data Storage when we have gone people adding more automation so that our customers can achieve their business outcomes with very little effort.
But this is just the beginning one year ago, so introduced for active incident response systems from our world class incident response to today, we are introducing the next evolution of this offering with the world's first manage data detection response service, which come with an SLA and 24 by seven coverage. Varonis area is a paid service that takes responsibility of managing Varonis out of our customers' hands in places it with U.S. customers no longer have to monitor.
This one is sales instead of team to leverage behavioral analysis, machine learning automation. Now we may commit the data domestically to protect them screen to reduce the service because no security teams are 16 MCDL builds upon the automation enabled by our SaaS platform in maximizes the return on investments in other driver for us in the year ahead will be the impact of generated the eye in our language models. We spent some time last quarter.
Can you discussing what the sterling means for volumes, but to briefly review generate EVA represents most of the opportunity in risks for companies, the goal, Sophie, I think the potential generate significantly more data and also significantly more with which in turn, increases the need for automated data security without to about data security strategy, a resume sensitive data to their own machines and people most generated a item utilize existing access controls, which leaves organizations over exposed to this company will also need to ensure that sensitive data is not being used when timing elements, how can we leverage these tools to cost better efficient in St. Malo or even search for data once inside an organization.
Simply put generally BRL is forcing organizations to take a hard look at their data and they are realizing that access control must be correct to ensure sensitive data can be exposed. These are core use cases for volumes. In support of these two weeks, psychosocial companies safely harness the power of Microsoft copilot leasing integration. Fixed customers improve their Microsoft three 65 data security posture before during and after becoming copilot is the result of increasing risks and regulation.
We are seeing data security become multiple geographies. Varonis unique position to capitalize on this is we help organizations protect their data like a bank watches six months, nine spot financial crime, my analyzing financial transactions, Sony spokes, cybercrime. By analyzing data transaction, our customers have voice watching the data from the infrastructure close to it, which limits the likelihood of damage. In addition to watching data usage will locate sensitive data visualize access to it in automatically.
Loyalty does is allows companies to realize more value from the data leverages safely and keep it protected. The world has never been more reliant on data than it is today. And if you dissect every major breach, one common thread is that nobody watching the data set. For example, our covenant allowed ridesharing company with a very sophisticated security stocks, but no data security platform, a group of teenagers was able to bypass multifactor our syndication, Axos Financial's in steel clinical data.
It wasn't until you have a positive messages in Slack for the new dual breached, the biggest threats from come from inside of thinking about WikiLeaks Snowden from the Pentagon, which is which is highlight the damage that can happen when inside of and access to far too much data in the perimeter sales and you have building side, we are best positioned to catch it. Data breaches in the danger flying soil used to be something we had to explain.
And today every organization, no, they are at risk environment, lead governments to enact regulation. For example, Security and Exchange Commission rules, which took effect in December, require public companies to disclose cyber security breaches in a Form eight K within four business days after determining because as a material impact on the business, it also puts more structure into our they disclose this cyber security risk management strategy in governance, while also detailing management in the both the voice and expertise in handling these risks.
This increased scrutiny on U.S. listed public companies raise awareness for cyber security, and we believe the launch is well positioned to help companies comply with regulations. With that, I would like to briefly discuss a couple key customer wins from Q4 real estate company with 5,000 employees became a new customer. This quarter. Organization had an executive mandates, time-sensitive data because it's hybrid environments doing the risk assessment.
Our team discovered over 250,000 vehicles containing PI.s and thousands of employment contracts in mortgage documents that were open to everyone in the organization. Our incident response team even stopped multiple data breaches attempts. This customer evaluated Varonis and to other vendors. But ultimately, Varonis was the only one who could automatically into the data was protected. As a result, they purchased Varonis such package for Windows micros of 65 HAWS. and S.
We continue to see strong interest from customers wishing to convert to go on SaaS. one example is a large municipal governments that became Evonik on-prem subscription customers in 2018. Let's enter data into monitor abnormal user behavior in single deposit. The success of this organization is protecting the on-prem environment enabled our team to the mandate for the Bordeaux municipal organization. This quarter, they converted to the one side has expanded from just 500 users to 25,000 users.
dThus the ideal speak for them because for automated remediation, improved scalability and infrastructure savings. The purchase such package for Windows Microsoft 65 active directory in Exchange Online, which will allow them to protect the data, is out signing the security piece. Finally about in months ago, Fred, our sales kickoff event here in New York with the amount of changes in magnitude of innovation we had in 2023. It was important for us to bring a team together, and I cannot speak enough about the level of energy and enthusiasm during the event, and we'd like to thank our team for their tireless efforts is none of this will be possible result. We are excited about the reception of our SaaS platform in the momentum of our business.
Live. me optimistic is able to hit not only to 2024 because to beyond as we approach a $1 billion target. With that, let me turn the call over to Guy guys. Thanks, Jackie, and good afternoon, everyone.
Guy Melamed
Thank you for joining us today. We are pleased with our fourth quarter results, which reflect the strong adoption trends of reserves against the challenging but stable macro backdrop. Our SaaS transition continues to gain momentum. And after just one year in the transition, Data now represents approximately 23% of our total company, et al.
As a result of this momentum, we now expect to complete our SaaS transition in 2026, which is one year earlier than previously outlined. As a reminder, our transition will be kind of total. These ARR is coming from SaaS. As we've described, the transition is occurring in two phases. Phase 1 began when we introduced the product and is the phase where we focus on selling sent to our new customers. Phase two of the transition, which is converting our installed base of on-prem subscription customers to our SaaS platform is planned to begin in earnest during the second half of this year.
We expect that the ramp-up of this phase will not be linear and anticipate growing momentum in each quarter of 2024 and further accelerating in 2025 and 2026. We ended the year with ARR of $543 million, which increased 17% year over year. We generated $54.3 million of free cash flow in 2023, up from $0.5 million last year. These metrics illustrate our ability to drive top line growth, margin leverage and cash flow generation. Even in the fourth year of transition, our fourth quarter SaaS mix represented 66% of new business and net new upsell ARR versus our guidance of 60%, which led to a full year SaaS mix of 57% versus our guidance of 55%.
We again saw more of our existing customers converting to our SaaS offering. The fourth quarter, we had approximately $15 million in conversions of existing customers impacting our Q4 revenue. To be clear, this $15 million represents the renewal, though that was previously booked as on-prem subscription, but which converted to sales during the quarter because SaaS revenues are recognized ratably with these $15 million worth of customer renewals convert from on-prem subscription SaaS. It causes a headwind to our reported revenue and operating margins.
The $15 million revenue impact from this quarter does not include the uplift that we realize that these conversions, which is accretive to ARR and free cash flow. We ended the year with approximately 14% subscription customer over year. Our dollar-based net retention rate for subscription customers was 107% at the end of 2023. Adjusting for FX. Turning now to our fourth-quarter results in more detail. As a reminder, air, our free cash flow and a are our contribution margins are the leading indicators for this transition. The shift from on-prem subscription licenses were approximately 80% of the deals value is recognized upfront to SaaS delivery model with fully ratable revenue recognition will cause additional headwinds for the traditional income statement metrics.
As we said previously, the faster we progress through the transition, the more headwinds we will experience to our traditional income statement metrics. We view these headwinds in a positive light in the fourth quarter, we continued to see deals would be with multiple levels of improvement, which are still impacting our results. But if I had to describe the environment in one word, I would use the same word I used last quarter, which is stabilization. Q4 total revenues were $154.1 million up 8% year over year. During the quarter as compared to the same quarter last year, we had approximately a 16% headwind to our year over year revenue growth rate as a result of increased SaaS sales in our bookings, which are recognized ratably versus the upfront recognition of our on-premise subscription.
Our subscription revenues were $129.2 million, and maintenance and services revenues were $24.9 million as our renewal rates were again over 90%. Moving down the income statement, I'll be discussing non-GAAP results going forward. Gross profit for the fourth quarter was $136.4 million, representing a gross margin of 88.5% compared to 89.9% in the fourth quarter of 2022, despite significant revenue headwinds, which were largely offset by a SaaS platform efficiency operating in expenses in the fourth quarter.
As a result, fourth quarter operating income was $27.2 million or an operating margin of 17.7%. This compares to operating income of $26 million or an operating margin of 18.2% in the same period last year. During the quarter as compared to the same quarter last year, we had approximately a 10% headwind to our operating margin as a result of having increased sales in our bookings mix, which are recognized fully ratable versus the upfront recognition of our on-prem subscription product. Q4 ARR contribute margin was 13.4%, up from 4.5% last year.
The significant leverage improvements even during the early stages of the transition reflects our ability to drive strong incremental margin while growing ARR and transitioning to SaaS. During the quarter, we had financial income of approximately $8.1 million, driven primarily by interest income on our cash deposits and investments in marketable securities. Net income for the fourth quarter of 2023 was $34.3 million, or $0.27 per diluted chair compared to net income of $26.1 million or net income was $0.21 per diluted share for the fourth quarter of 2022.
This is based on $126.1 million at 126 million diluted shares outstanding for Q4 2023. In Q4 2022, respectively. As of December 31, 2023, we had $744.8 million in cash, cash equivalents, short-term deposits and marketable securities. For the 12 months ended December 31, 2023, we generated $59.4 million of cash from ops operations compared to $11.9 million generated in the same period last year. And CapEx was $5.1 million compared to $11.4 million last year.
I will now briefly recap our full year 2023 results. Total revenues grew 5% to $499.2 million in 2023. As compared to 2022, we had approximately a 12% growth as a result of having increased sales in our booking mix, which are recognized ratably versus the upfront recognition of our on-prem subscription products. Our full year operating margin was 5.8% compared to 6.2% for 2020 to 2023.
As compared to 2022, we had approximately a 10% headwind to our operating margins as a result of adding increased sales in our booking mix, which are recognized fully radical versus the upfront recognition of our on-prem subscription products. Turning now to our 2024 for guidance, we continue to take a responsible approach to our guidance philosophy, which include factoring in the continuation of longer deal cycles and multiple layers of deals we did throughout 2024 for our commitment to balancing top line growth, margin leverage and cash flow generation has not changed age while at the same time, we also see an opportunity to invest in order to capture the longer-term opportunity that we see and capitalize on the secular tailwinds that you actually discuss.
These investments are already baked into our guidance, which shows our ability to invest in the business while generating improvements in our North Star metric. When we launched this transition, we committed to being transparent and also the providing metrics that accurately measure the health of the business. As we turn our attention towards the final phase of this transition, our main focus is now completing this transition, which we SaaS is 70% to 90% of total ARR.
In an effort to provide metrics that help you monitor our progress throughout the next phase, we will be providing SaaS revenue and also sense as a percentage of total ARR on a quarterly basis. At the same time, this will be the final time that we provide test mix is that metric measures the progress of Phase 1 of the transition. Going forward. We expect the vast majority of new customers to purchase our SaaS offering. For the first quarter 2024, we expect total revenues of $111 million to $150 million, representing growth of 3% to 7%, non-GAAP operating loss of negative $15 million to negative $13 million, and non-GAAP net loss per basic and diluted share in the range.
This assumes 110.1 million basic and diluted shares outstanding. For the full year 2024. Forward, we expect ARR of $617 million to $625 million, representing growth of 14% to 15%, free cash flow of $70 million to 75 million. Total revenues, $536 million to $546 million, representing growth of 7% to 9%, non-GAAP operating income of $7.5 million to $12.5 million. Non-gaap net income per diluted share in the range of $0.11 the $0.13. This assumes 127.7 million diluted shares outstanding.
In summary, we are excited by the progress of our SaaS transition, which is benefiting our three Northstar metrics. A are our free cash flow and our contribution margin. The momentum of our transition, coupled with the tailwinds of NDDR., the adoption of generative AI. and increased data centric regulation gives us confidence as we finish the initial stage of the transition and look to grow new customers and convert existing ones to our SaaS platform. In 2024 and beyond.
With that, we'll be happy to take questions. Operator.
Question and Answer Session
Operator
Thank you. We'll now be conducting a question and answer session. I'd like to ask a question, please press star one on your telephone keypad. Confirmation tone will indicate your line is in the question. Can you may press star two if you'd like to move in question from Kim For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. In the interest of time. We ask that you please limit to one question. one moment, please. Thank you.
Matthew Hedberg, RBC.
Matthew Hedberg
Great, guys. Thanks for taking my questions. First off, congrats on the results. See the SaaS momentum is impressive, but equally interesting is to be free cash. I guess one question on Yaki, can you talk a bit more about the specifics of Microsoft partnership? I know there were some some news releases this past quarter, maybe a little bit more about the go-to-market function. It's in the channel. But any way to think about sort of the momentum maybe the pipeline generation that Microsoft is generating? Thanks.
Yaki Faitelson
It's still early innings. But essentially coal pilot for for Microsoft is a tremendous productivity opportunity for organizations must be coming with a lot of risk. So what happened is that the copilot for business is going to digest any data that they can get and the data that they can get these access control is related to access control. This is a security similar model they are using. And without a product like us, 90% of the data on average that users can access is not relevant for them. So I think what we have and they will create a staggering rate, high value information products, completely out of policy, not labeled that you've done, you know where they are, and this is a this is massive risk.
So they recognize that in order to close the blast radius automatically, you need us. And the other thing, if I told you that is in the hands of bad actor, it seemed inflict massive damage on organizations. So we are teaming with them. We are teaming with those cells in order to make sure that we will be the foundation of this of of getting a good control over the data before you're going to unleash this to unleash this tools. It's important to understand that it's still early innings. There are still not been mass distribution with this reserve. A with this product is coming up in every conversation.
But we think that is they are going to release stated an organization. We really understand the power of lease and also the risks that come with it. But they really need to make sure that the way ahead of the risk and we are well positioned to do very well. We are very excited about the opportunity.
Operator
Saket Kalia, Barclays.
Saket Kalia
Okay. Great, guys. Thanks for taking my question here and I echo the congrats on the quarter. Yaki, maybe for you a little bit of a higher level question. Saas transitions in other areas of software have also expanded the the total addressable market and understanding that it's still early here in Verona SaaS transition, wonderfully anecdotes that you can see out there where you think your SaaS products are expanding our customer spending, our data protection. I think you mentioned a couple of a couple of customer examples, but I know you spent a lot of time with customers. Do you see some of that TAM expansion starting here with the move to SaaS.
Yaki Faitelson
Of course, and it's very tangible. So the way to distribute feature is stemming from the value proposition. And first is just tremendous amount of automation. And with is we can cover many mobile data repositories, but also with the MDR, the automation, the detection and response, the classification and data protection, we can do some small for customers, so is a viable bioproduct. Now we can really take all the while not all, but a lot of the operational load on us and make sure that every world-class security team that is completely oriented to data and the expansion of the timing innovation.
And, you know, if you will also see it with the with what we are going to release in the future. But you see the very aggressive, if you will, release cycles and you see now, you know, Snowflake in no way a more coverage is organization going to have more more clinical data repositories and they will hit the critical mass in the marketplace. We are going to we are going to protect it in terms of the value today, if you have Varonis, most probably will not have a data breach and you will not ever data breach automatically without without any efforts you just need to buy the platform.
So it's from every well from the value from the way that you can expand from the data repositories. Our coverage of automation is just increasing our TAM drastically drastically. And also in terms of innovation, it's much easier for us to take a short, fully distributed to the marketplace. We are very excited about the our ability to innovate and the situation that is related to data. You see things like copilot copilot to have more connectors and stuff, stuff like that. So definitely expanding mini.
Saket Kalia
Makes sense. Thanks, guys.
Operator
Hamza Fodderwala, Morgan Stanley.
Hamza Fodderwala
Great. Thanks for taking my question. Yes. Question for you. We're obviously seeing a lot of focus on the company's getting their data prep for these generative. I deployments of big focus on on data security and governance around that. I'm just curious, as you're having more conversations with your customers and prospective customers, how often is are coming up for Veronate? And how do you expect that composition to ramp throughout the year and ultimately drive more sales per business? Thank you.
Yaki Faitelson
Thanks for the question. So it's really coming coming up with every single conversation. And I think that if you will take almost every system and ask them what is your main objective, they will tell you that the launch of the objective is to avoid a data breach and the other parties to make sure that the infrastructure, obviously how they are the application. We have uptime, everything can really deliver a service and flash with all the SaaS. We really can make sure that you will most probably will not have a data breach. God forbid, you have a data breach.
The potential damage will be very small and we'll get to the root cause superfast the reality today, an organization, they affect everybody to you guys understand extremely well. It's almost always about the data is organization has a very sophisticated, more modern security stack global, very smart people that manage security, but the bypass the perimeter and they don't see anything. It's all about the data, then they need to bring an IoT company. They pay them sometimes, you know, sometimes it millions of dollars. And I can say what damage our downhole understanding spent constantly to spend more security and they have more data breaches. And the way that you can you noted in the way that they have a credit card issuer can say, give you four detection results in the transaction.
We will never do a business with the bank that can provide the ledger and can tell you if you have other identities or devices when your account now age, it's the same with data. So we definitely see that a organizations understand it. And definitely things like copilot accelerated because they it's really it's like ransomware, exposing the it's exposing the problem. You know, once somebody one on auto thousands organization, we get into 100 organizations, I see that everybody will get copilot. So copilot is going to really expose the blast radius. So we feel that it say it can be over time, very good opportunity for us. And we're also excited that we are joining forces with Microsoft.
Hamza Fodderwala
Thank you.
Operator
Brian Essex, JPMorgan.
Brian Essex
Hi, good afternoon and thank you for taking the question. I guess, maybe for guide, would you mind unpacking your net dollar retention rate above that and how might we think about that? And that's, I guess, factors that go into calculating that, whether it's customer growth, cross-sell, upsell? And how might we expect back to Dr. kind of a better better traction as we look into fiscal 24?
Yaki Faitelson
Absolutely. When you look at kind of NRR. in 2023, there were basically two factors that had an impact. The first one was the friction related to the transition in the first six months of the year. If you remember, we started the year was sitting here today at 23% and SaaS mix. It's out of total ARR. And it only happened in one year. But if we had to go through a live and the first six months definitely had an impact in terms of the friction there. And I second, the second factor was the macro environment, which we talked a lot of bells and D&A, and that's definitely the kind of the second factor that impacted NRR.
I think as we look at kind of the opportunity, both some with the customer lifetime value that we're generating with our existing customers, converting them to staff. And that generates a tremendous opportunity for us to continue to sell to them and make them better protected on additional platforms were very excited about that. It's happened kind of the whole conversion of in 2023 happened in a natural way and has been very, extremely encouraging for us. We believe with that can accelerate in 2024.
But even in terms of new customers, you look at the land there, the larger lands with SaaS offering and as with the simplicity of the products and the fact that we are now offering the MDDR., which is really a game changer for us in terms of the offering to our customers in terms of having them better protected in a much easier way. All of those are an opportunity for us to go grow our NRR into the larger and higher levels.
Brian Essex
That makes sense. Congrats on the progress. Thanks very much.
Operator
Joel Fishbein, Truist Securities.
Joel Fishbein
Thanks for taking the question. And again, good strong execution arm. It was a good segue that previous question. The mine, um, I wanted to ask Guy, I want to absolutely MPHMDDRR. offering. Um, can you just give us a little color on how that will be priced? And then what do you see here? The adoption curve looks like in terms of time to revenue?
Yaki Faitelson
It's a very good question. When you look at kind of our offering to date, we've we've offered the proactive incident response team for quite some time now. And the reception the way customers have received, it has been extremely positive for we're doing right now is charging for the service that we've provided for quite some time. And I think there is as you look at kind of the MDDR., we expected to generate a healthy uplift in terms of the ASP. and what we can generate from our customers. So we don't we don't have company. We believe that over time we can generate and DDR that is in a license software margins.
And we feel that not only is it extremely beneficial for our customers, but it can also help with increased and improved renewal rates over time. It can help with the opportunity to upsell additional platforms that a customer would see the value and would want to be we protected on on multiple platforms and it at the same time it so appealing and for our customers that it can actually help with closing rates. So I think the MDDR. has an option on all of those fronts. And the way we've structured the company in 2020 through 2024 makes it a no-brainer for our reps to introduce into our customer sites. I expect the adoption to be extremely healthy this year. And I think we it's a benefit for our customers, but also a significant benefit for us as an organization.
Joel Fishbein
Thank you very much.
Operator
Andrew Nowinski, Wells Fargo.
Andrew Nowinski
Thank you for taking the question on banks for ethanol next quarter. So I wanted to ask about total ARR guidance on you guys have outlined so many different positive growth drivers tonight on the mix of your SaaS revenue is 23% of the fastest pace we've seen over the last four quarters. You're getting that 25% to 30% price uplift on SaaS. You're getting larger lands. As you mentioned. You got the new Integra, of course, have Microsoft and the MDDR. service, what your outlook for ARR. implies a fairly steep deceleration. And I'm just given those growth drivers, why would we expect a deceleration in your ARR growth this year?
Yaki Faitelson
So when you look at kind of the math and I think that the numbers that you look at them and I completely understand the math that you're doing it and it makes sense. I think when you look at the prepared remarks, we had extremely bullish tone on. And I do want to reconcile that with the guide since that we've provided so well, when you look at us sitting here today, we've never had so many things working in our favor. You know what we have been for years. There is additional drivers and tailwinds that we've really never seen before that he talked about the copilot cybersecurity, SEC regulation and also what we believe is a game changer for us, which is the MDDR., which we just introduced.
But you have to remember, our sales cycles are three months on the shorter end and up to 12 months on the larger deals. So when when you look at Canada that are sitting here right now and looking at the philosophy that we've guided and for in the past for many, many years, and it's not something that we have done in the past to begin positive assumptions into our guidance without seeing the data that supports it. So it's really a starting point for the year. We're sitting here in February, and there's a long year ahead of us. We believe that we will see those trends that I've talked about kind of work in our favor over the year.
And as we have done in the past, we'll be happy to update our guidance as the year progresses. But as I mentioned, there's a lot of things that are working in our favor that we we haven't seen in the past.
Andrew Nowinski
Yes, it certainly seems like that. All right. Thank you very much.
Operator
Fatima Boolani, Citi.
Fatima Boolani
Thank you and good afternoon, and thank you for taking my questions on why this one's for you. I was hoping you could help unpack for us how much of the expected operating margin degradation that you're anticipating this year, which is more due to the fact that the transmission and functionally accelerating because you did call follow at that time line.
So I certainly appreciate the at the mechanical P and L P & L impact to match up at home. Much of that tax obligation on a year-over-year basis is tied to construct mechanical artifact versus some of your comments in my prepared remarks, pertaining to a desire to reinvest in certain parts of the business, a $0.2 and contain a great investment. So just some directional help on that front would be great. Thank you.
Guy Melamed
That's a very good question. And I think it's a combination of some of the accounting in terms of the cloud cost and the way they're recognized in terms of the expense in a radical way versus kind of the a. r. ir where you recognize it up on the day of the sounding. There's a tremendous opportunity ahead of us, and we want to say the advantage of it. So when you look at kind of our philosophy over the last couple of years, we've been very focused on the top line growth and wanted to make sure that we show margin leverage and free cash flow generation. As we sit here today, we feel extremely confident about kind of the or the guidance that we provided during the Investor Day in March of 2023, about a 20% ARR contribution margin by 2027. So kind of when you look at the progression in terms of free cash flow, we've shown improvement from 22 to 23. And even in the guidance of 2024, there's a significant improvement there as well. A are our contribution margin moved up significantly from 2022 levels, the 2023 levels and the 2020 for guidance as an improvement as well. So I think some of the investments that we're making today are ahead of what we wanted to see a return to the AR., our top line growth of kind of the 20 plus percent. So I think we're definitely making the investments to take advantage of a larger opportunity. We believe that with the tailwinds that we've talked about, there's a tremendous opportunity for us to take advantage of.
Fatima Boolani
Thank you.
Operator
Roger Boyd, UBS.
Roger Boyd
Thank you for taking the question and congrats on a quarter guy, when we go back to the conversion mass, you converted a little over $30 million from term licenses, SaaS share with weather really without any sort of formal go to market behind us. Apologies. I missed it. I think you noted that you're expecting that to accelerate, but any any rough cut assumptions on what you're expecting in terms of conversions in 2024? And alternatively, kind of the puts and takes here around renewal timing, the sales ramp up, but you know, there will be kind of skew towards the back half of the year. Thanks.
Guy Melamed
Absolutely. We finished 2023 with 23% and SaaS out of total ARR. And so at $125 million a foot is that we will finish at 46% SaaS percentage of total ARR. That basically means $285 million SaaS by the end of 2024. So a significant increase. That basically means $160 million for SaaS ARR in 2024, significant increase versus the one $120 million of SaaS that we are we have generated in 2023. So. So obviously, our assumptions are that there will be some significant increase in in the conversions themselves, but also that the percentage of SaaS sold to new customers would be pretty significant as well.
I think the overall understanding and the feedback that we're getting from our customers is that they prefer the SaaS offering because it's a better product. And in terms of a from a commission perspective, our reps retire quota on anything on top of that renewal. So on and on the uplift that they get from an existing customer in that conversion that goes towards quota retirement. So it's actually a win-win, a win win for it's a win for our customers, and it's a win for our sales team. And that's the best way to kind of incentivized. And that's why the 2023 has been a great surprise in the level of conversions that we saw.
And our expectation is for an Excel operation in 2024, which route would bring us to that $285 million of SaaS by the end of this year.
Roger Boyd
Very helpful. Thank you.
Operator
Chad Bennett, Craig-Hallum.
Chad Bennett
Thanks for taking my questions. Have guy, I maybe just a prior question. When you when you talked about MDDR. opportunity and the ASP. difference, is there any way to kind of quantify kind of how how material that uplift is there or just the deal size difference you see the NMDDR. versus in our traditional SaaS deal?
Yaki Faitelson
Tell you, even as we sit here today and we just spoke to our sales teams about it during the scale that we had a couple of weeks ago, we've already seen that they've adopted it in a very healthy and positive way. We've actually seen some of the quotes where they go back and get an uplift. I don't want to put a number quite yet just because it's so early on. But the MDDR. does allow us to generate a pretty significant, a nice uplift. But at the same time, provide customers the value with with the less of a need of people to actually be protected. And at the end of the day, that's the best thing that a win-win with our customers.
And the win-win is that if there is, you know, many customers are choosing managed security service providers and at times get better value in terms of data breaches and they can be completely protected with us. So there are no budgets fleet in the auto seeing in order to get the most from the MDR, you need a good footprint of the year from the platform as much as you have more licenses with us, if you will, more bundled, you get you get more value. And regarding our AI capabilities, we invested tremendous effort with a C&I, not just for our customers, but also for analysts. We are selling software.
So we will do all boats and interfaces to make sure that our the people that provide incident response and professional services can be much, much, much more productive. And we learned very fast, you know, the system around what they are doing repeatedly and really build the what's been the Aalberts behind it. So we think that this offering tremendous opportunity to Madison attachment to budgets. It say it, but I will to buy more bonders. It's just the beginning. But we think that it's something that is very unique in the first the managed detection and response that the data oriented. And obviously, it goes through the year and just to touch on as we go through the year and kind of the sample size becomes much more meaningful will be happy to provide more color about what we see in terms of the MDMDDR. and D. and the uplift that we see.
Guy Melamed
And then maybe just one quick follow-up. Just now that we've set transition and we have a decent amount of critical mass in that business and deal flow and whatnot. Sumit, Kishore, Yaki, just in terms of I know that 25% to 30% uplift on deals and conversion, but Justice, are you seeing, you know, is there any quantification of new data repositories or or new use cases of now that you are, you know, you have seen a pretty good volume of SaaS deals that may be outside of the Microsoft ecosystem. You're realizing more of these opportunities from a data repository use-case standpoint is there are two or three that, you know, are significant.
Yaki Faitelson
The three things that we are doing extremely well is making sure that only the right people can access their data that ore body remediation of access control without breaking any be any business processes, which is the holy grail of data protection, threat detection and response that these data oriented. And then obviously a very accurate sophistication of data and to give you context and then we are doing international depositary. You know, we have this amazing product for sales folks, sales force, invokes and Google, but we are going now into the Eyeglass World. And you know, with AWS, all the databases, all the RBS. And you know, I see and you know, in Azure and Azure, Robin, we just moving very, very, very fast, really two Neonode to do everything we have done with on-prem data.
We storage and the biggest not devices of the world and unstructured and then went to Stu application and some stock German e-mail and the SaaS application. And now they say it data repositories in AWS and Azure. And we will move very fast and everywhere we go, we bring the say these are three use cases. But the other thing is also, as you have more data, you have more enrichment because if you look at most of the breaches, almost all of them, they always go from one day be coming in the time to get credentials. They are becoming a user and then they are moving from one data repository, a data repository to the auto. And we'll certainly in the best position bleach and we are doing it automatically now even in the places that they need to put some effort we are taking it on ourselves, suggest need to help us set it up in some monies to answer the phone. This is the level four automation we are getting to and any deposits that we are going to protect this is the level of protection you would guess.
Got it. Thank you much. Thank you.
Operator
Jason Ader, William Blair.
Jason Ader
Thank you, Tom, and good afternoon, guys. Just wanted to ask in terms of the conversion process in practice, how does it work with your existing customers? Do you wait for the term exploration kind of a little bit ahead of that? The Chinese industry to switch over to the SaaS version for how much incentives to provide for them. I know you have a 25% to 30% price uplift. That doesn't seem like much of incentives should any of our customers. So it was what are some specific things that you're doing as you think about 2024, especially second half? Were you talked about accelerating the are kind of sort of some of the activity with the existing customer base?
Yaki Faitelson
So, Jason, I'd start by saying that that 25%, 30% uplift is actually a significant incentive for our customers to convert because the total cost of ownership and saves them money. So yes, they pay more on our price list. But at the end of the day, they save on the hardware and they save on the people and they're getting a much, much better products. And especially with the MDR, it could see them even more in terms of the offering. So it's definitely an incentive as we look at our offering. And when we look at kind of the renewals and if we really take the Q from our customers, some customers want to wait until the renewal period and then they would they would they don't want to wait. They have a renewal that's ahead of time, but they won SaaS and they want it now now we work with our customers to make sure that they would be protected in the way that they feel most comfortable.
And I can tell you that getting a renewal on the on-prem subscription side is a pretty automatic process. You've asked whether I know you get the PO and there's not too much conversation going on. And obviously you want to position in terms of the upsell, but it's just getting a pure renewal is pretty straightforward. Getting a conversion requires understanding what types of offering would make the most sense for them. I'm kind of talking about the price uplifts, but how it saves them money and over the TCO. in general. So so there is more of an effort there is not happening and automatically, but it's a much better product is providing better protection to our inverter sets them up for additional upsell opportunity because they'd be protected on additional platforms and they see the value and they would want to purchase more. So it's a win-win and it's time very well spent from our perspective.
And that's why we're so focused on that. Obviously, as you look at kind of the seasonality, we have historically way more renewals happening in the second part of the year. That's why we talked about the Phase 2 and the conversions happening accelerating towards the second part of the year for obvious reasons. But we also see the canal versions accelerating within the year. So every single year, we expect to have more and more conversions in dollar terms as this picks up. And but I think as we sit here today and with our expectation of getting to $285 million of SaaS by the end of this year, we're in affecting our customers to convert at a higher pace than we saw in 2023.
Jason Ader
Great. Thank you.
Operator
Joseph Gallo, Jefferies.
Joseph Gallo
Hey, guys. Thanks for the question. You guys have launched many new products recently and Snowflake protection. You've upgraded protection for sales force, algae, bolster GA cloud. Can you just talk qualitatively about the traction you're seeing in DDA cloud and then quantitatively, any metrics or size growth profile? And then just how do we should think about the mix as a percentage of ARR over time from DA. cloud? Thanks.
Guy Melamed
So, Joe, if you remember for quite some time now we're looking at our SaaS offering as a whole. And we're definitely seeing that in terms of the conversations with customers where they not only by the SaaS offering on the platforms that we used to have on-prem, but they're also talking about additional platforms that we have through the polarize acquisition and the offering there. So I think overall, the adoption, as we saw in Q4 was healthy and it's definitely helping. In terms of the conversations of view, actually, we think we can do much better. And we've talked about the fact that it takes time to introduce new new products until they kind of take off as we saw with the office, the 65 and the Automation Engine.
But we're very happy with the progress so far. And we believe that we can we can increase it in 2010 for our reps are very much in line with this that I understand the benefits there are customers are asking about it and talking to us about it. So overall, we're happy with the progress so far.
Joseph Gallo
Thanks.
Operator
Shrenik Kothari, Baird.
Shrenik Kothari
Thanks for taking my question and congrats on great execution. So Yaki, you talked about the sales kickoff event on the call and the level of energy or turned around. So just one follow-up to the previous question about the second half ramp for for Phase 2. Regarding the US sales force incentives, best Weatherly, our so far, they are uplift from SaaS kind of naturally was a momentum due to higher commissions. And as of yet, you had not implemented any any additional monitoring Sentosa VersaLink SaaS conglomerate motion around adjusting the sales force incentive dynamics are related timelines? And also, how does these incentives of kind of drive incremental OpEx, which are tying into our margin guidance framework and assumptions for the first half and second half?
Guy Melamed
So I'll take this question. In terms of the incentives for 2024, we've definitely seen some very positive momentum on the conversions in 2023. And we talked a lot about it throughout the year and the fact that it's happening in a natural way. We had discussions internally have whether it makes sense to incentivize the conversions in 2024. And I can tell you that with the momentum and the fact that it's happening in a natural way, we didn't see any reason to at this current stage to put additional dollars to work from a commission perspective because what the reps are actually benefiting from is the uplift on the conversion. So anything on top of that renewal amount goes towards their quota retirement.
And we've definitely seen some healthy uplift. There is a 25%, 30% uplift. But if that conversion requires additional user is additional licenses and additional plant. And then those increases are actually higher than that 25%, 30%, and that's very beneficial for our reps. So we didn't start with any incentives in 2024 related to that. Obviously, if we see a need money to work there, we will. But I currently don't see any need to do that because the way the structure is happening is benefiting our customers and it's benefiting our sales force with those up. I think as we increase those uplift, the magnitude in dollar terms kind of Phase 2 accelerating within the year. And also as we see that Phase 2 accelerating within the actually has more of conversions versus the previous year. I think it puts us in a very good position to upsell to those customers and provide them a product that is much better because the SaaS offering is a better product and indeed, the order for us because it provides value where customers don't necessarily need to have the same teams in place, they can have less people and be better protected, and we can benefit from that and provide the protection to our customers and if we can provide in the past. And so I think all of those are positive that we want to take advantage of.
Shrenik Kothari
Very helpful. Thanks a lot, guys.
Operator
Erik Suppiger, JMP Securities.
Erik Suppiger
Yes, thanks. Thanks for taking the question. On the MDDR. service side, did you say that you would or you would not need to add additional people? Is that just going to be using the IR team that you have? And if you look longer term, what type of penetration Jason do you think you can get with that across across your customer base?
Yaki Faitelson
Facility early in terms of the penetration we will communicate is this thing is moving forward. But in terms of people, obviously when we'll have the service will need more people. But the productivity forefront of in IoT using AI and from the cloud is significantly better. You know, you're talking about it can be buyback, small, more feedback, small way productive. So this is the key for us, but for us to make sure that we are using the software to provide too many customers, a premium service with an SLA with a very strict SLA. M&a will have they will have follow them a world class analyst fully partially analyst.
It will be a lot of it will be a robust. So this is the way that it works is the software is augmenting deep will be much, much more productive.
Guy Melamed
And I want to give them some additional color on kind of the expense side. As we look at this, obviously, our expectation in terms of the investments are already baked into our guidance. And so we definitely built in some additional investment in customer success. And I are, but we have provided diffractive incident response team and for a couple of years now how dynamic in terms of margins. So as I mentioned before, we're still a software company. We don't see us changing that and we expect that MDDR. over time, we'll have software-like margins.
Erik Suppiger
Okay. Very good. Thank you.
Operator
Brian Colley, Stephens.
Brian Colley
Hey, guys, thanks for taking my question here. So I'm curious if you've seen any uptick in the pipeline is directly related to customers that are looking to enhance their data security before deploying Gen-i. So in our eyes are still early, but just trying to to CMC what you all think in terms of how G&A I could impact the growth rate?
Yaki Faitelson
But what we can say with a lot of confidence with a lot of confidence that it comes up almost in every conversations, people understand that it's a big opportunity with a lot of risks and they need to be ahead of it. We need to do you never know. But the way that we think that it's going to move forward and with these stores will be in the hands of many end users will be just be, you know, people will just realize it on a daily basis.
And you know, God forbid if it's going to bad actors, but it's definitely coming up with every with every conversation is NOA., I commonly security risk security relief for data risks. The number one is this overexposed data in terms of excessive access control, and we are uniquely positioned to solve this performance.
Brian Colley
Got it. Thank you.
Operator
Rudy Kessinger, D.A. Davidson.
Rudy Kessinger
Hey, thanks for squeezing me in our guy. I know you're not giving exact color, but it's $15 million and converted air are the kind of starting point for Q. one? And then with your sales reps, given you're giving them quarter relief on the upper to mount on renewals, does that impact their ability to focus on net new customers and new deals?
Guy Melamed
So I'll start with the second part of your question. I think we've been extremely focused on on acquiring new customers. The SaaS offering allows us to tap into markets and verticals and customers that we've never had the opportunity to sell to. I can tell you that the way that 2024 comp plan is set up is that account managers will not be able to make significant money if they don't sell to new customers. So that's been at the forefront of our philosophy over the last couple of couple of years. And I can tell you that in 2024, we've actually doubled down on the importance of the new customer acquisitions in terms of the conversions, we hope to convert our customers as well because there is a lot of leverage with the SaaS offering for us from a financial perspective.
And the SaaS offering is a much better products and provides the opportunity to update those that product in and much more seamless way. So there is a benefit for us and it's a much better product for our customers. So I am not sure that $50 million is the right starting point. You have to remember that there is a seasonality within our business where Q4 is the largest quarter of the year. And then in dollar terms, Q1 one on historically has been the lowest in terms of dollar terms. So it starts with a small dollar term quarter in Q1 and then it picks up throughout the year. So that needs to be baked into the consideration. But I think a good starting point and should expect kind of the same progression of Q1, Q2, Q3 and Q4 that we signed 2023 as a starting point for 2024 as well.
Just in dollar terms, the actual dollar terms that we expect to get to with our SaaS offering by the end of this year is expected to be significantly higher than the $125 million we finished with. We wanted to get to that guidance assumes $285 million at the end of this year.
Operator
Rob Owens, Piper Sandler.
Rob Owens
Grow a little bit on your comments are noting that the net new subscription numbers tick down year over year, and frankly, if you have to account for the last four years, so to that end, was it the way the sales force was incentivized with quarter retirement is the churn? Because I know in some of your comments earlier guy, you did talk about friction with regard to the SaaS change or is this just more sales cycle and timing around the shift to SaaS? Just curious for color, I guess in terms of new customer acquisition throughout the year? z
Guy Melamed
I think no matter how you look at the business. There are strong underlying trends. And I think that our philosophy in terms of new versus existing has been very, very much kind of a mix of both with our existing customers. There's definitely kind of an increased customer lifetime value that we're seeing with the SaaS offerings. But as I mentioned before, the new business opportunity has never been greater for us. And that's why in 2024, we've kind of structured our comp plan where account managers will not be able to make significant money if they don't sell to new customers. I think it's important to note that it's not a simple Excel where we put in a 25%, 30% uplift. You plug it in and you get and you get the PO from renewals happen in an automatic way when you get that on-prem subscription renewal.
But when you trying to convert a customer, you have to talk to them about the benefits you have to talk to them about the cost, an exercise that requires time.
Yaki Faitelson
It is a different contract terms of the different security review, this transition, the largest stage, so many moving parts. So we said that in terms of the value proposition, it's completely different thing that, you know, the Common Ground is the logo logistics order of Martin return in terms of the automation, the way it works. The overall platform is a fraction of the support ticket. This self-hosted. If this is the SaaS considering here today, I will tell you that it's so far moving much faster than we anticipated, but if you need to do it with great, great attention to be sorry, just so many things to do in order to make sure that it will walk through why that you will cater to the customers suggested you need to have a laser focus on the way the way you're doing.
Guy Melamed
And just to touch on kind of a new customer adds, I think it's still early, but SaaS does open up kind of opportunity for us to new markets and new customers that we haven't been able to sell to before. As you look at kind of the ASB., they are higher when we sell to are the new customers through SaaS offering, which is a very healthy. And I think that, as you know, look at kind of the years ahead on the SaaS offering allows us will allow us to continue to take advantage and generate additional fuel that will support the growth for this business in the years ahead.
Rob Owens
Fine. Thanks for the color. Thank you.
Operator
Joshua Tilton, Wolfe Research.
Joshua Tilton
Hey, guys, this is Patrick on for Josh. Just a quick clarification one for me. With the transition time line being moved up here, does that change the way we should think about the path to the 2027 long-term targets provided at the Analyst Day? And are you all now targeting roll 40 exiting the transition now and two 26? And what should the composition of that look like? Thanks.
Guy Melamed
When we laid out kind of the plan in March of 2023, we talked about the transition lasting five years. We're bringing that one year shorter, and we're very happy about that. We're not actually not changing that $1 billion target, and that's still at 2027. But I think we're extremely excited to reduce this. So the whole transition period by and cut it by one year to four years. So the rest is kind of staying intact.
Joshua Tilton
Thanks.
Operator
Thank you. There are no further questions at this time. I would like to turn the floor back over to Tim Powers for closing comments.
Tim Perz Perz
So the interest in Verona as we look forward to meeting with all of you at conferences this quarter.
Operator
Goodbye. This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.
