VARONIS-SYSTEMS Earningcall Transcript Of Q2 of 2024
and Guy Melamed, chief financial officer and chief operating officer of Varonis. After preliminary remarks, we will open the call to a question-and-answer session. During this call, we may make statements related to our business that would be considered forward-looking statements under federal securities laws, including projections of future operating results for our third quarter and full year ending December 31, 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. Varonis expressly disclaims any obligation or undertaking to release publicly any updates or revisions to any forward-looking statements made here. 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 second quarter 2024 earnings press release and investor presentation, which can be found at www.varonis.com in 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 -- Co-Founder and Chief Executive Officer Thanks, Tim, and good afternoon, everyone. Thank you for joining us today to discuss our second-quarter results, our SaaS transition progress, and the tailwinds impacting our business. First, I would like to remind you why Varonis exists and how we help our customers. Today, the purpose of almost any cyberattack is to steal data, but the purpose of the security solutions most organizations deploy are to protect their endpoints and their perimeters. These technologies are very important, but they aren't enough to protect data. To protect data, you must have a data-first solution and a data-first approach. Varonis' data-first approach helps companies locate their sensitive data, visualize who has access to it, automatically lock it down, and then detect and respond to threats on it. Clear and simple example, credit card companies keep making it harder for bad actors to get your credit card number, but they know credit card numbers will still sometimes be stolen. So, they also watch the credit card transactions and compare them to what they know normal usage looks like to detect and stop fraudulent transaction. Varonis uses the same approach of protecting data, make it harder for the wrong people to access it, and monitor the data transactions to spot and stop anything abnormal like ransomware insider threats or AI abuse. With our SaaS platform and recently released MDDR offering, we have a sophisticated and automated solution that enable customers to protect their data with very little time and effort. This allows companies to collaborate safely while also managing risks. Innovation has always been at the core of Varonis, and in late June, we achieved the FedRAMP In Process designation, which represents an important step toward enabling us to provide the benefit of our SaaS platform to our federal government customers. I would like to take a moment to thank everyone involved in the process. Now, I would like to turn to our second quarter results, which reflect the growing momentum of our SaaS platform and recently introduced MDDR offering. These offerings are driving strong new customer addition and healthy convergence activity from existing customers. ARR grew 18% to $584.2 million, and year to date, we generated $67.3 million of free cash flow versus $40 million generated last year. SaaS ARR now represents approximately 36% of total ARR. Guy will review our Q2 results and our updated guidance in more detail shortly. This was a harder quarter of strong execution by our team that has risen to the challenge of a stable but a challenging environment still with elevated levels of deal scrutiny. The transition to SaaS delivery model is progressing quickly because of the many benefits that our customers realize. Customers can achieve automated outcomes, which means they can ensure that data is protected with very little effort. SaaS is quicker to deploy and operationalize because of significantly lower infrastructure and personnel investments, and SaaS is easier to maintain and upgrade. Additionally, there are three key benefits that we realized. They are shorter sales cycle, larger initial lands, and margin benefits over time. I would now like to turn to a couple of tailwinds that we believe will drive momentum in our business. The first is our Managed Data Detection and Response offering, which we call MDDR. This is the first managed service for monitoring and protecting critical data and is only available for our SaaS customers because of the visibility and automation that is built into our SaaS platform. MDDR was only introduced in Q1 and is already becoming a key driver of new business wins and existing customer conversion to SaaS. And we believe that we are just scratching the surface with this opportunity. We continue to see that CISOs don't have the resources to monitor and investigate alerts fast enough. With MDDR, we ended this problem. If we see a threat, we can stop it and simply notify the customer after the threat has been neutralized. We pioneered the use of machine learning to perform user behavior analysis and build highly accurate threat models. Our team leverages this significant automation plus our unique telemetry to efficiently detect if data is under attack and to catch threats are missed by others. Bottom line, the early proof points that we are seeing leaves us excited about what the future holds for MDDR. The second tailwind, we see generative AI. This technology is top of mind for many organizations and is a key theme in nearly all conversations with prospects and customers. The productivity benefits that GenAI brings are widely understood, but GenAI also worsens the data access risk companies already face. Take for example a bank that was piloting a GenAI tool with users on their trading flow. They wanted to make trade more productive and earn the bank more money. The traders started to use it for research. They started searching for answers on questions like what stocks do our employees invest in. The problem is the tool started showing names, Social Security numbers, 401(k) positions, and account numbers. The security team immediately turned it off because they were going to face major fines and sanctions, and it wasn't because those traders were acting maliciously. They were just trying to use the tool and ended up finding extremely sensitive data that was mistakenly opened to everybody in the company. We believe that GenAI adoption within enterprises will serve as a catalyst that exposes their underlying data security risks, and this is the very problem that Varonis was built to solve. As a result, we expect that, as companies adopt GenAI, they will be forced to make addressing those risks a top priority. Without Varonis, rightsizing access control is extremely challenging. We mitigate these risks by automatically ensuring only the right people can access the data necessary for their job function. Companies are thoughtfully considering these risks before expanding from pilots into broad rollouts. The feedback we are hearing from customers continue to strengthen the conviction we have in our ability to benefit from enormous secular tailwinds, and we are seeing a healthy pipeline build with respect to this opportunity. With that, I would like to briefly discuss a couple of key customer wins from Q2. A large Midwest hospital system became a Varonis customer this quarter. This organization was concerned about where its sensitive data was located, who had access to it, and how they will respond to a ransomware attack. During the risk assessment, we detected attacks already in progress, including an attack on their CEO account coming from outside the organization. The company was able to prevent it and ensure that account was secured. The second attack that occurred was a business email compromise that began when an employee clicked on a phishing link that came from a malicious email, and the account started accessing files from an unusual geolocation. Luckily, our team was able to confirm. They would detect and stop this compromise before any sensitive data was accessed. Because we have a conclusive record of the data transaction and prevent any damage from being done, they purchased Varonis SaaS for their hybrid environment with MDDR protection and were able to avoid material breach that could require them to publicly file any data breach disclosures. We continue to see healthy demand from existing customers converting from our self-hosted platforms to Varonis SaaS. One example of this is a multinational commercial real estate firm that has been a Varonis customer since 2014. They wanted to decrease their infrastructure spend and reduce the time spent maintaining and upgrading their software. Moving to Varonis SaaS allowed them to immediately cut their server footprint and reduce their ongoing maintenance requirements. In addition to these operational savings, they will automatically remediate overexposure in Microsoft 365. They also purchased the Varonis SaaS hybrid package through the Azure Marketplace, which simplified their procurement process. In summary, the adoption of our SaaS platforms and MDDR offering are driving positive business momentum. And we are just scratching the surface of our long-term opportunity. We are excited to enter the second half of 2024 from a strong position to capitalize on the tailwind of MDDR GenAI in increasing data-centric compliance regulation. With that, let me turn over to Guy. Guy? Guy Melamed -- Chief Financial Officer and Chief Operating Officer Thanks, Yaki. Good afternoon, everyone. Thank you for joining us today. Our second-quarter performance gives us increased confidence in our full-year trajectory, driven by our SaaS platform and MDDR offering. At the end of Q2, SaaS ARR increased to approximately $210 million or 36% of our total company ARR, driven by strong contribution from new logos and existing customer conversions. This momentum, coupled with the tailwinds Yaki mentioned, allows us to raise our full-year ARR and free cash flow guidance and also to increase our SaaS ARR expectations. The key drivers of our business this quarter were SaaS and MDDR. With each passing quarter, our story becomes more strategic and simpler for customers. SaaS eliminates the two biggest prospects of not wanting hardware or having the head count to manage the platform. That obviously requires less hardware and meaningfully simplifies maintenance and upgrades. And MDDR removes the need for people to review alerts since we do it all for them. We're seeing that the value proposition of our platform, together with the simplicity of our story, is shortening deal cycles when compared to on-prem subscription deals. Generative AI remains a theme in nearly every customer conversation we are having and reinforces our view that this will become a secular tailwind. Our pipeline continues to be healthy as a result. And as we discussed in the past, we are still not seeing material contribution to our reported metrics derived from it. Consistent with our prior comments, we have not included the impact of material GenAI adoption in our guidance. As we enter the second half of the year, we look forward to converting more of the installed base of on-prem subscription customers to our SaaS platform. Pricing continues to be in line with our price list increase of 25% to 30%. And in some cases, we see deal sizes increase in excess of that as customers consume more of the platform upon conversion to our SaaS platform. We expect that the ramp-up of this phase will not be linear and momentum should grow in each quarter with further acceleration in dollar terms in 2025 and 2026. In the second quarter, ARR grew 18% year over year to $584.2 million. And year to date, we generated $67.3 million of free cash flow, which was up from $40 million generated over the same period last year. These metrics demonstrate our commitment to balancing top-line growth with improving cash flow generation during the transition. Turning now to our second-quarter results in more detail. As a reminder, the leading indicators of our transitions are ARR, free cash flow, and ARR contribution margin. As we have said many times, the faster we progress through the transition, the more headwinds we will experience to our traditional income statement metrics. But we view this in a positive light. As compared to three months ago, we feel increasingly confident in the trajectory of the business following our second quarter results. While the macro environment remains challenging, it is also stable, and SaaS and MDDR are resonating well in this market to drive positive business momentum. Q2 total revenues were $130.3 million, up 13% year over year. During the quarter, as compared to the same quarter last year, we had approximately a 6% headwind to our year-over-year revenue growth rate as a result of having increased SaaS sales in our booking mix, which are recognized rapidly versus the upfront recognition of our on-prem subscription products. In the second quarter, SaaS revenues were $44.8 million. Term license subscription revenues were $62.7 million. And maintenance and services revenues were $22.8 million as our renewal rate were, again, over 90%. Moving down the income statement, I'll be discussing non-GAAP results going forward. Gross profit for the second quarter was $109.6 million, representing a gross margin of 84.1% compared to 87.1% in the second quarter of 2023. Gross margin continued to be strong, and the year-over-year change is due to the revenue headwind associated with a higher mix of SaaS sales, increased head count to support the transition, and increased hosting costs. Operating expenses in the second quarter totaled $107.5 million. As a result, second quarter operating income was $2.1 million or an operating margin of 1.6%. This compares to operating income of $0.9 million or an operating margin of 0.8% in the same period last year. During the second quarter, as compared to the same quarter last year, we had approximately a 5% headwind to our operating margin as a result of having increased SaaS sales in our booking mix, which are recognized ratably versus the upfront recognition of our on-prem subscription products. Second quarter ARR contribution margin was 14.9%, up from 8.2% last year. The significant leverage improvement even during the early stages of the transition reflects our ability to drive strong incremental margins while growing ARR and transitioning to SaaS. During the quarter, we had a 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 second quarter of 2024 was $6.8 million or $0.05 per diluted share compared to net income of $1.1 million or net income of $0.01 per diluted share for the second quarter of 2023. This is based on 128 million and 127.3 million diluted shares outstanding for Q2 2024 and Q2 2023, respectively. As of June 30, 2024, we had $790.3 million in cash, cash equivalents, short-term deposits, and marketable securities. For the six months ended June 30, 2024, we generated $68.4 million of cash from operations compared to $42.6 million generated in the same period last year. And capex was $1.1 million compared to $2.6 million last year. Turning now to our updated 2024 guidance in more detail. It is important to note that our guidance now assumes 48% of total company ARR will come from our SaaS platform by year-end. As it relates to our quarterly revenue guidance, there are more conversions embedded in our Q4 guidance versus our Q3 guidance because we have more renewals in Q4 from a seasonal perspective. And the third quarter is federal's largest quarter, and we still expect to sell on-prem subscription in that vertical. For the third quarter of 2024, we expect total revenues of $140 million to $143 million, representing growth of 14% to 17%; non-GAAP operating income of $7 million to $8 million; and non-GAAP net income per diluted share in the range of $0.07 to $0.08. This assumes 128.2 million diluted shares outstanding. For the full year 2024, we now expect ARR of $629 million to $635 million, representing growth of 16% to 17%; free cash flow of $80 million to $85 million; total revenues of $544 million to $552 million, representing growth of 9% to 11%; non-GAAP operating income of $18 million to $21 million; non-GAAP net income per diluted share in the range of $0.22 to $0.24. This assumes 128.1 million diluted shares outstanding. In summary, our second quarter performance, coupled with the many tailwinds in our business, gives us confidence to raise our full-year ARR and free cash flow guidance and also to increase our SaaS ARR expectations. We look forward to driving continued momentum as we move through the second phase of our SaaS transition and unlocking meaningful value for our customers, our company, and our shareholders. With that, we will be happy to take questions. Operator? Operator Questions & Answers: |
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