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Varonis Accelerates Its Shift to Subscriptions

Timothy Green, The Motley Fool

Data security and analytics provider Varonis Systems (NASDAQ: VRNS) reported its first-quarter results after the market closed on April 29. The company's shift to subscriptions began to take a toll, with sluggish revenue growth and substantial losses caused by the move away from perpetual licenses.

The pain will last for the rest of this year, with Varonis cutting its guidance to reflect quicker subscription adoption. Here's what investors need to know.

Varonis results: The raw numbers

Metric

Q1 2019

Q1 2018

Year-Over-Year Change

Revenue

$56.4 million

$53.5 million

5.3%

Net income (loss)

($22.6 million)

($14.5 million)

N/A

Non-GAAP earnings per share

($0.38)

($0.22)

N/A

Data source: Varonis.

What happened with Varonis this quarter?

  • Varonis is transitioning to a subscription-based business model, putting pressure on its first-quarter results.
  • Perpetual license revenue was $15.5 million, down 35.6% year over year. This decline reflects the company's efforts to move customers to subscriptions.
  • Subscription revenue was $7 million, up 554% year over year. Subscription revenue is recognized over the lifetime of the subscription, not all up front.
  • Maintenance and services revenue was $33.8 million, up 19.3% year over year.
  • Annualized recurring revenue at the end of the quarter was $138.7 million, up 35% year over year.
  • Varonis added 133 new customers during the first quarter, down from 275 customer adds in the fourth quarter of 2018. The number of new customers grew in North America, but customers were slower to adopt subscriptions in Europe, the Middle East, and Asia (EMEA).
  • Revenue in North America rose 20% year over year to $37.8 million; revenue in EMEA declined 19% year over year to $16.4 million; and revenue in the rest of the world grew 35% year over year to $2.1 million.
  • 73% of customers had purchased two or more product families, and 41% had purchased three or more product families. Those percentages stood at 73% and 40%, respectively, at the end of 2018.
  • Varonis had $163.6 million of cash, cash equivalents, marketable securities, and short-term deposits at the end of the quarter, up from $158.9 million at the end of 2018.
  • The company generated $14.1 million of operating cash flow in the first quarter, down from $17.4 million in the prior-year period.
A person looking at charts on a screen.

Image source: Getty Images.

What management had to say

During the earnings call, CEO Yaki Faitelson talked about the slow subscription growth in Europe:

Our guidance contemplated that the adoption of subscription by our sales teams in Europe would be slower. However, the results in the quarter lag even our expectation. Some of this was because of resistance to change, which caused a necessary distraction and took the focus off selling. We have made a couple of changes, and we already see improvement in EMEA in the second quarter in embracing this model and its advantages.

CFO and COO Guy Melamed went over some of the numbers related to the subscription transition:

To remind you, our subscription price list is set as 40% to 45% of the perpetual price list, including first-year maintenance, which equals the three-year break-even period. This quarter, the payback period overall for subscription sales to both new and existing customers was three-year. This is a number we're happy with.

Looking forward

Melamed added: "Given the success we are having with subscription adoption, we are now meaningfully increasing our expectation for subscription mix as a percentage of license revenue. For the second quarter and full-year 2019, we now expect this to be 25%, up from our previous guidance of 10%." 

Varonis provided the following guidance for the second quarter:

  • Revenue between $61.5 million and $63 million, which is between a 1% decline and a 1% increase on a year-over-year basis.
  • A non-GAAP operating loss between $8.5 million and $9.5 million, and a non-GAAP EPS loss between $0.30 and $0.33.

For the full year, Varonis expects:

  • Revenue between $271 million and $278 million, ranging from flat to 3% higher than 2018.
  • A non-GAAP operating loss between $10 million and $14.5 million, and non-GAAP EPS loss between $0.42 and $0.54.

Varonis' full-year guidance is substantially lower than its previous guidance, but that's due to the accelerated shift to subscriptions.

Once Varonis has completed its transition to subscriptions, revenue should start growing again as license revenue is no longer being replaced with subscription revenue, which is more spread out in time. Earnings may take longer to recover, as the company has to spend up-front to win new subscription customers.

While Varonis's results and guidance appear weak, the company believes the short-term pain will be worth it in the long run.

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Timothy Green has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Varonis Systems. The Motley Fool has a disclosure policy.