Varonis Systems Inc (NASDAQ: VRNS)Q1 2019 Earnings CallApril 29, 2019, 5:00 p.m. ET

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Prepared RemarksQuestions and AnswersCall ParticipantsPrepared Remarks:

Operator

Greetings, and welcome to Varonis First Quarter 2019 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. (Operator Instructions) Please note that this conference is being recorded.

I would now like to turn the conference over to your host, Jem Arestia, Director of Investor Relations. Thank you, you may begin.

James Arestia — Director of Investor Relations

Thank you, operator. Good afternoon. Thank you for joining us today to review Varonis's first 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 second 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 the anticipated growth in our addressable market; competitive factors, including increased sales cycle time; changes in the competitive environment; pricing changes; transitioned in sales from a 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 reseller 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 important risk factors are described more fully in our reports filed with the Securities and Exchange Commission. We encourage all investors to read our SEC filings.

These statements reflect our views only as of today and should not be relied upon as representing our views as of any subsequent date. Varonis' expressly disclaims any application or undertaking to release publicly any updates or revisions to any forward-looking statements made herein.

Additionally, non-GAAP financial measures will be discussed on this conference call. A reconciliation for the most directly comparable GAAP financial measures is also available in our first quarter 2019 earnings press release, which can be found at www.varonis.com in the Investor Relations section. Also, please note that a webcast of today's call will be 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 — Chief Executive Officer

Thanks, Jamie. And good afternoon, everyone. Q1 was a success for Varonis. As you know, it was our first full quarter of selling subscription licenses across the company and we significantly outperformed our expectations, with 31% of license revenues or $7 million coming from subscription, while it is early in the process, we are very pleased with what we're seeing so far.

Feedbacks from our customers, for our sales persons, from our channel partners has been very positive. We'll talk more about the transition shortly, but let's start with our results. First quarter total revenues were $56 million. Q1 perpetual license revenues and subscription were $23 million, while maintenance on a perpetual license and services revenues were $74 million. Our reported license revenues this quarter were clearly impacted by the greater mix of subscription revenues, but we see this short-term cost is very small, relatively to the long-term value we are creating for the business.

We estimate that this subscription mix being in line with our initial expectation, our Q1 reported revenues would have been approximately $62 million, nicely above the high-end of our guidance range. Guy will discuss this in great detail in few minutes.

The strong subscription adoption in the first quarter further reinforced that this change was the right one for our customers and for Varonis. We are particularly pleased with the adoption in North America, and so the sales team begin to fully embrace this new sales methodology. Our guidance contemplated that the adoption of subscription by our sales teams in Europe would be slower. However, the result in the quarter lag even our expectation. Some of this was because of resistant to change, which caused a necessary distraction and took the focus of 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.

While, we are only one quarter into the transition which will take time and which will not be linear, I want to convey that moving to subscription model as quickly as possible is our top priority.

The move to subscription is driven by customer demand for more protection and was our way to unleash the platform potential. To better protect the organization, our customers require more licenses off the back and our subscription model provides exactly that, while leaving room for expansion over time.

Consistent with the pilot, in the first quarter customers purchased higher number of licenses than what we typically see with the perpetual model. Let me give you some examples. A large independent medical group with over a 0.5 million patients in dozens of locations turned to Varonis, because they were concerned their data wasn't (inaudible) and they wouldn't be able to detect insider threat, which could have result in heap of fine with serious damage to their reputation and they were also in the process of acquiring an additional medical practice and our risk assessment show exposed PII on the newly acquired server. 90% of their files are open to everyone in the company.

When we offer the subscription model, we were able to sell them the product they originally wanted, plus they are (inaudible) support for books, six products in total. The customer embrace the subscription model and it was a win for everyone.

Another new customer in the quarter is a major professional sports league that start to monitor their file shares for accountability and security and to classify and protect sensitive data. The customer was impressed by Varonis ability to monitor the critical business data (inaudible) and they are now positioned to protect data and other platforms. The customer will leverage data advantage for Windows, OneDrive and SharePoint Online, Data Classification Engine and GDPR Pattern for data visibility and control and to define their data permission process with business owners. Both of these are great example of customer group with the perpetual model would have likely purchased two or three licenses in the initial sale.

With our subscription model, they purchase additional licenses to protect themselves in a hybrid environment, realizing more value and using the large OpEx budget. At the same time, both customers can buy many more licenses down the road, be it financing alerting capabilities or remediation or protection for additional data stores. In those examples, our subscription offering are accelerating the process where our customers can benefit from greater protection and we can unleash the full value of our platform for them.

This case study validate our plan to play a more sizable (inaudible) security and compliance strategies, and we believe this is — well, our advanced technology and sophistication of our products are second to none. Specifically, the machine learning, connection to data and comprehensive forensic (ph) capabilities on top of our Metadata Framework allow our platform to detect spreads that other technology miss, with very few first positives and accelerated investigation and time to resolution.

Our customers detect and conclusively investigate insider threats, external attacks, advanced persistent threat and malware. For example, one investigation led to a discovery of a new variant of Qbot, a strain of malware that enables financial fraud.

Our efforts are particularly focused on our larger customers. We have an existing customer base that has moved rapidly up the adoption curve and realize that we can help them with among others data protection in the cloud and on-prem, which is critical in a hybrid world and compliant with new and pending regulations. We remain underpenetrated and we want to buy more of the platform play. And by elevating ourselves within these larger customers, we can deliver on their demand. The more value we can show, the more product they buy.

The results from the pilot and first quarter proved that the economics make sense for them to do so through subscription. As I said, moving to subscription as quickly as possible is our top priority. This transition is not something we can be half committed to and the discipline in making this move is where we're focused. There were deals in slide in the first quarter that we needed to convert from perpetual, and we expect this dynamic to continue over the next few quarters.

We also saw outside revenue growth in Europe in the first half of 2015 that we are cycling past. Regardless, the more rapidly we move through the transition, the more momentum our flywheel gains from the compounding benefit of the subscription model and the stronger underlying business. In short, we are extremely pleased with our first quarter results. The transition to subscription is well under way, and we expect this momentum to continue in Q2 and for 2019.

With that, let me turn the call over to Guy. Guy?

Guy Melamed — Chief Financial Officer & Chief Operating Officer

Thanks, Yaki . Good afternoon, everyone. I'll begin today by recapping our Q1 results, followed by an update on the first full quarter of our transition to subscription. I'll then discuss our second quarter and full-year 2019 guidance before we open for Q&A.

When we announced the transition last quarter, we told you we will provide more detail on adoption trends at they unfold. And that's what I want to go through today. Specifically, I'll discuss the impact of the business mix, our expected breakeven periods for selling subscription versus perpetual, ARR metrics and the potential impact on revenues, if subscription is higher-than-expected in future quarters.

For Q1, total revenues were $56.4 million, an increase of 5% year-over-year. First quarter license revenues were $22.5 million, which included over $7 million of subscription revenues. This number, which far exceeded our expectations validates why the move to subscription make so much sense for our customers and for Varonis.

We were pleased to see strong subscription license adoption during the quarter for both new and existing customer. New customers who purchased subscription products purchased a higher number of licenses compared to perpetual, in line with the pilot we ran in the second half of 2018. We were also pleased with the subscription purchases from existing customers, which again exceeded our expectations.

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 breakeven 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. We expect the payback period to remain around these levels for the next several quarters. But believe, it can improve as we go through course that have been introduced under perpetual price. To remind you, our sales cycle are three to nine months and can be closer to 12 months for larger deals.

Turning back to our results. License revenues decreased 10% from the first quarter of 2018 due to the much higher-than-expected mix of subscription. As Yaki mentioned, 31% of license revenues during the first quarter was subscription, compared to 4% in the first quarter of 2018 and a significant increase over our 10% guidance at the beginning of the year.

We understand that the faster we transition to subscription business, the greater the near-term headwinds to reported revenue will appear (ph), but the stronger the underlying trends for the business. Incorporating will appearthe payback period math I just discussed, we estimate that the higher-than-expected subscription mix reduced Q1 total revenues by approximately $5.4 million as compared to the guidance, impacting our license revenues. In other words, as Yaki mentioned, had the subscription mix been in line with our 10% guidance, our revenue would have been nicely above the high-end of the guidance range.

Maintenance and services revenues were $33.8 million, increasing 19% compared to the same period last year. Our maintenance renewal rate was again over 90%. Annualized recurring revenues or ARR defined as the annualized value of all recurring revenues related to active contract at the end of each period was $138.7 million at the end of the first quarter compared to a $103 million last year, representing growth of 35%.

ARR excludes revenues related to deals that are not renewable, such as perpetual license and professional service. Before I discuss our first quarter operational and financial results in greater detail, I would like to make two housekeeping points related to the subscription revenue. The first is to remind everyone that maintenance on subscription revenues is recognized ratably and will appear as part of our subscription line item we now break out in the financial statements. And the maintenance related to perpetual license appears in the maintenance and services line. Second, we have added a slide to our investor presentation, providing an example of the way in which we recognize subscription and associated maintenance revenues for the subscription deal.

Turning back to our results. Looking at the business geographically, North America revenues increased 20% to $37.8 million or 67% of total revenue. In EMEA, revenue decreased 19% to $16.4 million, representing 29% of total revenues, do in part to the challenging comp we faced in the first quarter of 2018 where we grew 60%, as well as the subscription transition issues Yaki noted. While the pipeline in Europe is healthy and customer demand in the region is strong, I would like to remind you that we again face a difficult comp in the second quarter. However, we do see improvement in the adoption of subscription with our sales team in that region.

Lastly, Rest of World revenues were $2.1 million or 4% of our total revenue. For the first quarter, existing customer license and first-year maintenance revenue contribution was 56%, up from 49% in Q1, 2018. During the quarter, we added 133 new customers and we ended Q1 with approximately 6,700 customer. While we saw the total and 1K plus number of new customers grow nicely in North America, the overall lower number of new customers is due to the distractions caused by the adoption of the subscription model in EMEA.

As of March 31, 2019 73% of our customers had purchased two or more product families, up from 70% as of the same date last year. 41% of our customers purchased three or more product families, compared with 37% in Q1 of 2018.

Moving 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 the first quarter of 2019 exclude a total of $9 million in stock-based compensation expense and $1.9 million of payroll tax expense related to stock-based compensation. Also excluded are foreign exchange losses of $600,000 related to new leasing accounting standard, ASC 842 adopted in the first quarter of 2019. We exclude foreign exchange gains or losses associated with the revaluation of financial lease liabilities in foreign currencies as they do not reflect the true performance of the company.

Gross profit for the first quarter was $48.8 million, representing a gross margin of 86.5% compared to 89.1% in the first quarter of 2018. This was slightly lower, given total revenues were lower due to the transition and as a result of investment in our teams that are supporting it.

Operating expenses in the first quarter totaled $59.9 million. As a result, our operating loss was $11.1 million or an operating margin of negative 19.8% for the first quarter, compared to an operating loss of $6.7 million or an operating margin of negative 12.5% in the same period last year.

As you're aware, the move to subscription does impact our reported revenues, while our cost basis is relatively fixed, which is putting downward pressure on our operating margin during the transition. We do expect this to continue throughout the transition, but our philosophy and commitment to profitability has not changed. The faster we move through the transition, the quicker we believe we can show healthy, positive, improving margins and the stronger our long-term position will become.

During the quarter, we had financial income of $454,000, primarily due to interest income compared to financial income of $978,000 in the first quarter of 2018, primarily due to foreign exchange gain. As you know, foreign exchange gains and losses can fluctuate. Our guidance does not consider any potential impact to financial and other income and expense associated with foreign exchange gains or losses, as we don't estimate movements in foreign currency rates.

Our net loss was $11.2 million for the first quarter of 2019 or a loss of $0.38 per basic and diluted share compared to a net loss of $6.3 million or $0.22 per basic and diluted share for the first quarter of 2018. This is based on $29.8 million and $28.4 million basic and diluted shares outstanding for Q1, 2019 and Q1, 2018, respectively.

Turning to the balance sheet. We ended the quarter with approximately $164 million in cash, cash equivalents, marketable securities and short-term deposits. One reminder, as we discuss the balance sheet, deferred revenues do not include multi-year subscription contract with an automatic renewal component for which the associated revenues have not been recognized and the customer has not yet been invoiced.

For the quarter, we generated operating cash flow of $14.1 million, compared to operating cash flow $17.4 million in the first quarter of 2018. We ended the quarter with 1,451 employees, a 10% increase from the first quarter of 2018.

Moving to guidance. 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%. For the second quarter of 2019, we expect total revenues of $61.5 million to $63 million, representing flat year-over-year growth at the midpoint. We expect our non-GAAP operating loss to range between $9.5 million and $8.5 million, and non-GAAP loss per basic and diluted share in the range of $0.33 to $0.30. This assumes a tax provision of $500,000 to $700,000 and 30.3 million basic and diluted shares outstanding.

As for our new estimate for the full-year 2019 subscription mix. I would like to remind everyone that Q4 is still CapEx heavy, and we are factoring this into our full-year subscription mix expectation. In addition, while we are still gathering customer adoption trends and metric, we currently estimate that for every incremental $1 million of subscription revenues we generate versus our guidance, we will see $1.2 million to $1.5 million headwinds to reported revenue. This is consistent with the breakeven math I discussed and assumes the payback period trends we currently see continue for the next few quarters.

At the same time, even though we are aggressively managing expenses given that our expenses base is relatively fixed, we expect incremental subscription adoption on top of our 25% guidance to impact our non-GAAP operating profit by the same amount. As a result, for the full-year 2019, we now expect total revenues in the range of $271 million to $278 million, representing year-over-year growth of approximately 2% at the midpoint. We now expect our full-year non-GAAP operating loss to be in the range of $14.5 million to $10 million and non-GAAP net loss per basic and diluted share in the range of $0.54 to $0.42. This assumes a tax provision of $2.2 million to $3.2 million and 30.2 million basic and diluted shares outstanding.

In summary, Q1 subscription results greatly exceeded our expectations, and we are pleased with the adoption of customers, buying (ph) of our sales force and the excitement of our partners. While we understand that we are still in the early stages of this transition, this quarter gives us confidence to be able to execute against our targets this year.

Moving forward, we expect to become a subscription-based software company with a growing platform for our customers, while generating greater value for our stockholders.

With that, we'll be happy to take questions. Operator?

Questions and Answers:

Operator

Thank you. At this time we'll be conducting a question-and-answer session. (Operator Instructions) Our first question comes from the line of Matt Hedberg with RBC Capital. Please proceed with the question.

Dan Bergstrom — RBC Capital — Analyst

Hey. It's Dan Bergstrom in for Matt Hedberg. Thanks for taking our questions. So in the subscription transition you got off to a nice start with money better traction than expected. Just curious, if anything surprised you or was different than your assumptions, given the strong initial adoption?

Yaki Faitelson — Chief Executive Officer

Yeah, Hi. We didn't know at the beginning exactly what to expect, but as the quarter starting to — when we started Q1, we just understood several things. The first thing we understood very well is that, we need to be very disciplined with it, we really need to make sure that we are very discipline and we are converting a lot of the deals. Remember, we are entering — enter the year with multi-hundred million dollars of perpetual pipeline. We also understood very fast that all the assumptions regarding the adoption curve of the platform were right. And that — it was also the right time. So overall we — it's still not earmarked, but our customer has many budget — buckets of budgets for Varonis insider threats, data protection, compliance budgets under the CECL and a lot of them becoming more and more OpEx. So the timing and the discipline, the budget and the platform, everything worked very well and we have high level of confidence that we can be as fully — a very strong recurring revenue business.

Dan Bergstrom — RBC Capital — Analyst

Great, thanks. And then you mentioned some changes in Europe, following some softer new customer additions there with the subscription model. Could you elaborate on those a bit?

Yaki Faitelson — Chief Executive Officer

Yeah. So Europe was slow to adopt, it's something that we definitely anticipated. But Q1 was below expectation, we saw some resistance to change. Overall, it was a great quarter, 31% mix in terms of subscription was over and beyond our largest expectation, but we had — couple of managers we needed to change and some reps just to make sure that everybody will be on board understand very well to over communicate, without a doubt we are in the right direction and we are pleased with the pace and everything that's going on new.

Dan Bergstrom — RBC Capital — Analyst

Thanks, Yaki. Great job.

Operator

Our next question comes from the line of John DiFucci with Jefferies. Please proceed with your question.

Joseph Gallo — Jefferies — Analyst

Hi, guys, This is Joe on for John. Thanks for the question. It was great to hear your overall commentary that results would have exceeded the high-end of the revenue range for the quarter, and thanks for the reconciling to the 10% subscription mix. So taking it a step further, when we're trying to think about the equivalent license growth, as compared to last year. We calculate, the business was a little shy of 20% license growth, approximately in line with what we saw last quarter. Is that roughly correct? And then, in line with what you're seeing as far as business momentum?

Guy Melamed — Chief Financial Officer & Chief Operating Officer

Hi. How are you? When we finished Q4, a lot of investors and a lot of the analysts were asking for some information and to provide some of the metrics that we're providing now. But we didn't have the same supporting and the same data that we have now. So when we look at that three-year breakeven and when we look at how we price that? The subscription prices being at 40%, 45% of the perpetual and first-year maintenance purchase. When we do that and use that factor into our Q4 numbers, we feel very good with license that would have been north of 20%. That 2.2 to 2.5 factor that we see throughout 2019, we feel very good with that breakeven period.

Joseph Gallo — Jefferies — Analyst

Great. That's very helpful. And then just moving on. You briefly touched on why 4Q would be impacted by it. But you reported 31% of license for subscription this quarter, but guided 25% next quarter and for the year. So just wondering why you now expect a lower percentage for next quarter and the year? And the reason we ask is, the business momentum appears to be holding steady. So I'm just wondering optically whether next quarter have to raise the percentage of subscription again and then lower estimates for the year?

Guy Melamed — Chief Financial Officer & Chief Operating Officer

No problem. So first of all, 31% is the number we're very, very proud of. And if you've asked us 90 days ago, it's definitely not number we would have thought of. So in essence, the move from 10% to the guidance of 25% for the year basically means we're a year ahead of the transition, and we're really aiming to rip the band-aid off this quickly as we can. With that said, Q1 is still our smallest quarter, we have deals in flight and we're trying to convert with the sales cycle there is between three to nine months. The way we're looking at this from a breakdown in terms of the quarters, we see Q2 being 25%, Q3 being slightly higher, and just like I said in the prepared remarks, Q4 is still kind of CapEx heavy. So we are baking that in with some caution. But, overall, we're very happy with kind of the uplift and how quickly we are moving with this transition.

Joseph Gallo — Jefferies — Analyst

Great. Thanks for the color.

Guy Melamed — Chief Financial Officer & Chief Operating Officer

Thank you.

Operator

Our next question comes from the line of Saket Kalia with Barclays. Please proceed with your question.

Saket Kalia — Barclays — Analyst

HI, guys. Thanks for for taking my questions here. Maybe first for you Yaki. Just sticking on a little bit more on subscription. I think you talked last quarter about some of the different subscription bundles to really drive that more adoption of different tools through — using subscription pricing. Now that you've had a full quarter of really a full effort. Can you just recap what some of those bundles are? And maybe qualitatively, which ones are maybe doing a little bit more successful than the others?

Yaki Faitelson — Chief Executive Officer

Yeah. We have many bundles and really we sold all the configuration, but some of the more popular ones are the security bundle, the DLS, directory Services and edge, everything that's related to Office 365 protection, with Classification, Automation Engine, a lot of them just work together and definitely for new customer, they can buy more right off the bat. In terms of the upsells, we also sometimes because we have so many deals in flight, we are really converting apples-to-apples in terms of the number of the actually licenses, but all the bundles worked well and overall they plan to move to subscription, the way that we executed and how we are positioning it, and the way the customers want to consume the platform working according to plan.

Saket Kalia — Barclays — Analyst

Got it. Maybe for my follow-up, for you Guy. And I think you touched on this in the last question. I'll just ask it slightly differently. Obviously, the subscription mix as a percentage of licenses after a faster start than I think, any of us expected. But I think the guide for Q2 being at 25%, still much healthier than the 10% we expected at the very beginning of the year, but down sequentially. You touched on what that cadence looks like through the year, Q2, 25%, maybe Q3 slightly higher, and then Q4 being a little more CapEx heavy on perpetual. But why there is sequential downtick in Q2? Is that related to sort of the deals in flight or any color you would shed on Q2, specifically?

Guy Melamed — Chief Financial Officer & Chief Operating Officer

Absolutely, Saket . So first of all, talking about the transition for a second, the fact that we put so much thought and it was so detailed in terms of the process and we really worked hard over the last year and a half. And I think the 31% really proves how much thought was put into this. We wouldn't have reached that percentage otherwise. But when I look at Q2, and the fact that Q1 is still historically the smallest quarter of the year. When you look in absolute dollar terms, we are still seeing a meaningful number with that 25%. And just looking at the evolution, we are trying to move as quickly as we can. And just to point out, this 31% is only from selling to new and existing customers, we're not converting the maintenance portion. So that 31% is just for new deals. We feel very good about the transition and how quickly we can — do that transition. But we're just being very cautious, because Q1 has been historically the lowest quarter of the year.

Saket Kalia — Barclays — Analyst

Very helpful. Thanks guys.

Guy Melamed — Chief Financial Officer & Chief Operating Officer

Thank you.

Yaki Faitelson — Chief Executive Officer

Thank you.

Operator

Our next question comes from the line of Alex Henderson with Needham & Company. Please proceed with your question.

Alex Henderson — Needham & Company — Analyst

Great, thanks. I was hoping you could talk a bit about the pipeline of deals in flight that are perpetual and how that declines over the course of the year? I assume that you came into the year with virtually everything being deals in flights that are perpetual and that gradually as we move through the year fewer and fewer perpetual deals are started and therefore the mix rapidly over the course of the year changes to a pipeline that's predominantly the subscription related transactions. Can you talk to — those percentages of the pipeline? Do you think you'll exit the year with no perpetual deals in flight or will it be still a meaningful percentage?

Yaki Faitelson — Chief Executive Officer

We are — first we are giving guidance and the guidance is what is important in terms of the percentage. And this is what we can talk about in confident. But, Alex, what we see now is, really that we can be a subscription business and a very strong one. A platform play subscription business, we have massive pipeline. So as we are cycling through this and converting this massive pipeline, we don't want to do — to run the business in any way and to harm critical stakeholders, which are the customer. Having said that, we are extremely disciplined and the top priority is to move to subscription. So as we move throughout the year, yes, a lot of the pipeline, more and more of the pipelines will be subscription, but to tell you exactly how it will play out, we'll provide more insight as we have it in 90 days, it's a lot time and so far the transition is — overall is really moving forward with flying colors. And I think that you guys have every benchmark of companies big transition and so far it's very strong and we anticipate that it will continue to be strong, but again, massive pipeline, a lot of customers, well over a decade that we sell perpetual, we just want to make sure that we are careful.

Alex Henderson — Needham & Company — Analyst

Okay. We didn't really address that question. Let me try a different angle. If we look at the deals that you've closed that are subscription based and have include the Automation Engine in them, as well as data alert. I would assume that you're getting faster time to install and therefore time to value and significantly more value for your customer. Can you talk a little bit about whether you're seeing faster installations, because the automation is included upfront as opposed to the other — the traditional model that usually sold out as an add-on?

Yaki Faitelson — Chief Executive Officer

In terms of the automation engine, specifically, yes, when we put automation engine, there is just tremendous acceleration in the excessive permission remediation. But this works both in perpetual and subscription.

Guy Melamed — Chief Financial Officer & Chief Operating Officer

And just to add to that, Alex. In terms of the sales cycle, we still see the sales cycle being three to nine months. And for the larger deals up to 12 months, we haven't seen any change in the sales cycle with selling subscription.

Alex Henderson — Needham & Company — Analyst

But does the installation time get reduced?

Guy Melamed — Chief Financial Officer & Chief Operating Officer

No, we are selling on-prem subscription, so it's basically the same process, we're selling the same licenses just for a different time period.

Alex Henderson — Needham & Company — Analyst

Okay. Thanks.

Guy Melamed — Chief Financial Officer & Chief Operating Officer

Thank you.

Operator

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

Shaul Eyal — Oppenheimer — Analyst

Thank you. Hi, good afternoon, gentleman. Similar to what you had seen in the West Coast, that was back in the third quarter of last year. Do you think this is a similar situation currently taking place in Europe or is it different dynamics. I know you mentioned some resistance change, but can you provide us with a little bit of more color in that respect? And do you think you should be able to over turn that as quickly as you've done last year?

Guy Melamed — Chief Financial Officer & Chief Operating Officer

Hi, Shaul. So let me give some color as to what the impact of the transition was on Europe. And basically we expected a slower adoption in Europe and it was baked into our guidance. But when we roll the plan globally, we could provide the same incentives as we did when we kind of did the pilot. So it's definitely still a year where reps can make significant amounts of money, but from our commission perspective, in the pilot we paid on TCV and when we roll this out, we paid on ACV on year one and then on auto-renewal on year two we paid 50% and on the third year auto-renewal we paid another 50%.

Some of the other changes that we had were kind of introducing a concept of a grading system where reps, they make more money if they sell at the right discount and they get penalized if they sell at hefty discounts. And all of this together with kind of the payment terms that we have with the subscription where we pay 50% in year one, and 50% in year two, all of that caused a lot of kind of commotion with the rest. We had a lot of conversations with the European teams, unfortunately, that resulted in distractions and kind of thinking the eye off the ball. But the positive thing is that, the teams in Europe now better understand the opportunity. I think they're seeing how well North America sales teams are doing and that's absolutely a motivating factor and we believe that subscription adoption in Europe will be better in Q2.

Yaki Faitelson — Chief Executive Officer

And Shaul, overall, yes. We know how to solve problem very fast, the teams are good, customer are great, the overall demand is very strong. Remember, Q2 last year it was 60% growth, but we are in the right direction in Europe to do this transition and to do the transition aggressively, it's the big undertaking. You need to be very disciplined and you need to make sure that everybody are on board and this is the top priority. The top priority is to move to subscription as fast as possible. And really to build this flywheel — very early we understood that this is what we need to do and to make sure that (inaudible) everybody on board and everybody will execute in lock step. We just didn't want to be just in between, we are committed to subscription and this is where we are going.

Shaul Eyal — Oppenheimer — Analyst

Thank you. This is the great color both Guy and Yaki. And my second question, I think in your prepared remarks you've mentioned a number — I think, you brought up a number of examples of customers shifting to a higher number of subscriptions. I believe one of them even adopted six subscriptions, if I'm not mistaken. But do you have currently some sort of average number of products per customer if you aggregate. I know it's been such a long duration, but any updated thoughts or even numbers on products for customers?

Guy Melamed — Chief Financial Officer & Chief Operating Officer

Absolutely. So I'll give you some color and also kind of on the three-year breakeven, I'll tie them together. Well, when we built the price list for subscription, it was priced as 40%, 45% of the perpetual price list including that first year maintenance. And when we — the whole intention of moving to subscription was to unleash the potential. So what we saw selling to new customers is that, we very much mimic what we saw during the pilot. We were able to sell to new customers between four to five licenses where initially under the perpetual license, the initial purchase usually was with between two to three licenses. So very nice improvement there, which basically brings kind of the breakeven period to be shorter. On the flip side, the upsell that worked very well in the pilot also continue to work very well with our existing customers, selling more licenses to them. But that really — that breakeven period was slightly higher. So the kind of the mix of both is a three-year breakeven, which by the way, we're very happy with that number.

Shaul Eyal — Oppenheimer — Analyst

Understood. Thank you for that color.

Guy Melamed — Chief Financial Officer & Chief Operating Officer

Thank you.

Yaki Faitelson — Chief Executive Officer

Thanks.

Operator

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

Melissa Franchi — Morgan Stanley — Analyst

Great. Thanks for taking my question, and congrats on the subscription transition. Yaki, thinking about the 30% or 31% of license that came as subscription. How does that business wasn't in the original pipe that was going to come in perpetual license? And do you feel it's like clearly net new just simply due to the subscription offering?

Yaki Faitelson — Chief Executive Officer

Hi, Melissa. A lot of it was perpetual the we converted. A lot of it was perpetual that we converted and North American team did unbelievable job, and our leadership really were behind it and executed. We — the other thing that is very important to understand is the overall adoption curve. With new customers that want more a licenses right of the bat, and for the current customer the heavy path to consumer — that they (inaudible) several years to consume the whole platform. They want to go with us to the cloud and every regulation that have they want to make sure that all vast security analytics features are working. So it's really the adoption curve where we sit within our customers, very strategic to the system, a lot of automation and our ability to execute on this market demand. I can't tell you that at the beginning of the quarter is saw 31, we didn't think that something like that is possible. But we really saw that a lot of the pipeline we can convert and we have a lot of, lot of confidence that we can do very well with the subscription.

Melissa Franchi — Morgan Stanley — Analyst

Okay, great. And then you talked a lot sales force selling the subscription, particularly they are fully ramped in the US. But can you talk about the channel engagement here and subscription and how they're coming on board, because I know that most of your business comes (inaudible) are they fully (inaudible) subscriptions at this point?

Yaki Faitelson — Chief Executive Officer

(inaudible) Subscription.

Guy Melamed — Chief Financial Officer & Chief Operating Officer

Because the recurring revenues for the subscription are high (inaudible) it's like a much, much bigger renewal business and it makes a lot of sense and the way that we are catering to this new hybrid world works very for the channel partners. So it just works for everybody. It works for our customers, first and foremost, works for the channel partner and works for our sales force and we believe that it can work very well also for the shareholders. So it just work for the whole food chain of the stakeholders.

Melissa Franchi — Morgan Stanley — Analyst

Got it. Thank you very much.

Yaki Faitelson — Chief Executive Officer

Thank you.

Operator

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

Gur Talpaz — Stifel — Analyst

Great. Thank you for taking my questions. Yaki, last quarter you mentioned sort of the notion of sticker shock being an issue with some of the license sales. Is it fair to say now with what you've seen in the last 90 days or so that at least a good portion of that has been ameliorated with this migration to subscription?

Yaki Faitelson — Chief Executive Officer

Yes, without a doubt. Customer now — they understand very well that they can get more licenses right off the bat and they can also plan and say OK, this is what I want from Varonis. For the next three years, this is how it works. We have a big OpEx budget for it and it's much better to do multi-year planning. So — and as I said, with the adoption curve and the features that they want and the lot of automation (inaudible) platform, the model works very well.

Gur Talpaz — Stifel — Analyst

A question for both you and Guy. I know it's early, but obviously the migration is happening faster than you anticipated. Is there a period when you kind of foresee ripping the band-aid off and going fully to subscription and what would you be looking for to kind of make a decision like that?

Yaki Faitelson — Chief Executive Officer

We are not a management of statements, but our commitment is for subscription. This is where we are going, this is — we are very disciplined, but we need to cater to our customers, but we know that subscription is the the recipe for happiness, for our customers and for us, for everybody.

So this is what we are going to do, we're going to be very, very, very focused, but to come now and tell you when we are not going to sell perpetual, it's not something irresponsible. So give us some time every 90 days, we will have more color and just think what happened in the last 90 days. We are sitting here, look at the results, look at the level of confidence, how we can talk about what is working, what we need to do. We have done a lot of just — derive decisions and introduce a lot of discipline and it's really different place in terms of the subscription and our ability to build this flywheel and execute. Every 90 days we will give you more color as we see, as we have more visibility of how these things play out.

Gur Talpaz — Stifel — Analyst

Great. Thanks, Yaki.

Operator

Our next question comes from the line of Dan Ives with Wedbush. Please proceed with your question.

Dan Ives — Wedbush — Analyst

Yeah. Thanks. So my question, what maybe surprised you as you went through this transition, both good and bad. I mean in terms of your conversations with customers sales throughout the last 90 days?

Yaki Faitelson — Chief Executive Officer

It's — what — the main thing that — you always know it, but like two years ago we sell completely on discretionary funds and CapEx is how much budget the customer have. As I said, it's still clear mark but there are these big budget. Also the ability for customers to plan, we're doing a lot of EBC's (ph) with customer and what we call value Qbot and we're just becoming more strategic for our customers and once you have it, it makes more sense to spend time with them. And the overall business is becoming more predictable. I think, what surprised me more than anything else is the overall speed and also we learned — like mid-February that it will be very disciplined about it. The market is ready for it, so the customers are ready, there is a lot of the demand. This is how they — a lot of this stuff — a lot of this stuff are related to us, we need to be very disciplined, we need to make sure that everybody are executing the plan. But, overall, the surprise was the market reaction to the move.

Dan Ives — Wedbush — Analyst

Yeah, OK. And then just maybe a follow-up, I think it was Malissa that asked it, but do you find now the transition that there is deals that are starting to come into the pipeline or maybe deals that six months ago were kind of cold that are now — customers are come back to you. I guess in terms of like new deals because of the transition ?

Yaki Faitelson — Chief Executive Officer

Not the actual transitions customer, some customers that wanted more licenses and needed to — and had more OpEx budget can definitely — can definitely buy. But I just think that overall the adoption curve, we have the Automation Engine and Edge and 365 which is huge for us. So customers can come and sell more on the security side, so a lot of it is the cyber security and alerting, it's compliance reporting on all the platform and then effective remediation, customers understand that they can really buy and use OpEx and subscription to cover all the infrastructure and the data reported there.

Dan Ives — Wedbush — Analyst

Great. Solid quarter managing this transition. Thanks.

Yaki Faitelson — Chief Executive Officer

Thank you.

Operator

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

Erik Suppiger — JMP Securities — Analyst

Yeah. Thanks for taking the question. Can you talk a little bit about what kind of billings we could factor in, your deferred revenue declined from $88 million to $82 million, sequentially. How can we think of the contribution from billings in the deferred revenue?

Guy Melamed — Chief Financial Officer & Chief Operating Officer

So first of all, in terms of the deferred, I think the right way to look at it is Q1, 2019 versus Q1, 2018. Remember, that Q4 is the largest quarter of the year. So obviously, the deferred there, if you compare Q4 to Q1 would be slightly skewed. And when you look at Q1, 2019 to Q1, 2018, it was close to 20%. And that only includes the ACV portion. So the fact that we sell three years with year two and year three auto-renewed, it's not part of our deferred. And now the only part of the deferred — and we have a slide in the investor deck that kind of breaks down the recognition and the deferred portion. The deferred pipe is only of that, first year, the maintenance part that hasn't been recognized. So it's actually very good growth in terms of the deferred.

Erik Suppiger — JMP Securities — Analyst

Okay. And then secondly, given the customers have some flexibility using a consumption based model. Has that made a difference in terms of the initial deal size. Do customers scale back the initial purchase more than they would have with the perpetual license or has that made a difference?

Guy Melamed — Chief Financial Officer & Chief Operating Officer

So in one of the previous questions I talked about the fact that, the new customers really unleashing the potential bought more licenses under the subscription model than what they usually bought in that initial purchase under the perpetual license. So it was close to — it was between four to five license on the subscription where we use to see on the perpetual between two to three licenses, which — that basically shortens that three-year breakeven period. On the flip side, on the upsell side, which we were very happy during the pilot seeing our existing customers taking advantage of this model and we continue to see that in Q1. Many of our existing customers bought more licenses through that model, and they are happy to unleash the potential and buy licenses through that as well. When we look at the breakeven period for the upsell, that was slightly over three years and the mix of those two together puts aside a three-year breakeven period, which we're very happy with. It's a very good number for us.

Erik Suppiger — JMP Securities — Analyst

Very good. Thank you.

Guy Melamed — Chief Financial Officer & Chief Operating Officer

Thank you.

Operator

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

Jonathan Ruykhaver — Robert W. Baird — Analyst

Yeah. I'm wondering if you could talk about Version 7.0 of the Varonis Data Security Platform. And in particular, some of the enhanced functionality within the three dashboards and what products do customers need to buy. If they don't have it we will deliver on that full functionality within the dashboard. My understanding is that, it could be a catalyst to higher ASPs. Is that true?

Yaki Faitelson — Chief Executive Officer

Version 7.0 was a monumental milestone for us in terms of the overall infrastructure and the dashboard, the directory services dashboard and everything that related to GDPR. But so far it's working very well and exceeding our expectations. That is also a lot of enhancements to Office 365. So once you have it, obviously, we have Edge (inaudible) on this platform on top of (inaudible). So it's working very well, and we believe that it has tremendous potential.

Jonathan Ruykhaver — Robert W. Baird — Analyst

Do you see a higher attach rate around SharePoint, DatAdvantage for Office 365, Data Classification, OneDrive which are all relevant to that Office 365 dashboard?

Yaki Faitelson — Chief Executive Officer

Yes, I think so — time we see a very strong attach rate.

Jonathan Ruykhaver — Robert W. Baird — Analyst

Okay, good. And how quickly would you anticipate the installed base upgrade to Version 7.0, would that happen rather quickly?

Yaki Faitelson — Chief Executive Officer

Yes, I think that — that overall, yes. But it give us — we are starting to do it, it's going well, but give me another 90 days and I will have more empirical evidence, and I will be able to talk about it in the actual upgrades in more confidence, but the version so far is working great and just exceeding our expectations. As I said, it's just a monumental milestone for us and give customers so much value.

Jonathan Ruykhaver — Robert W. Baird — Analyst

That's good to hear. Thank you.

Operator

Our next question comes from the line of Rishi Jaluria with D. A. Davidson. Please proceed with your question.

Rishi Jaluria — D. A. Davidson — Analyst

Hi, guys. Thanks for taking my questions. And I really appreciate all the disclosures and details. And with that, let me start with ARR. I guess, first, in a housekeeping perspective, this is (inaudible) just on subscription license, subscription maintenance and then perpetual maintenance, correct? No other buckets that will be considered recurring, nothing like recurring services. Is that a fair statement?

Yaki Faitelson — Chief Executive Officer

Yes.

Rishi Jaluria — D. A. Davidson — Analyst

Okay, great. And then — so the last two quarters ARR is been low to mid 30s grower. Directionally, how should we think about ARR growth rates going forward?

Guy Melamed — Chief Financial Officer & Chief Operating Officer

So, as you know, this is the first quarter we are providing ARR as we said we would as part of the transition and we're looking at this metric and happy to share with investors and with the analysts. Looking at kind of the progress and obviously our desire is to move as quickly as we can through this transition and Yaki talked about that we're very committed in doing so, and obviously the more we can sell subscription the higher that ARR number will be. So we're very happy with the number we have in Q1, but expect that number to continue to grow throughout the year as we are increase the subscription mix, so it's hard for me to give you an exact guidance right now, but as we progress and we'll look at the numbers and hopefully and as we expect they will continue to grow.

Rishi Jaluria — D. A. Davidson — Analyst

Got it. That's helpful. And then just on the perpetual maintenance line with, I know it's concluded, along with professional services as well, but that still meaningfully grew year-over-year in the quarter I understand there's not a conversion element just yet, but is there a certain point at which we should expect this to meaningfully decelerates or even turn negative just any color you can give directionally on that line item will be really helpful. Thanks.

Guy Melamed — Chief Financial Officer & Chief Operating Officer

That's a great question. Now that we're breaking out the subscription line item in the financial statements and we are including both the license of the subscription and the maintenance of the subscription and the higher we sell subscription and the higher that mix, obviously the maintenance line item that is the maintenance of perpetual should be impacted, so I would expect that line item on the maintenance side for perpetual to be affected and it definitely depends on how quickly we can transition and the pace that we go there.

Rishi Jaluria — D. A. Davidson — Analyst

Got it. That's helpful. Thank you so much.

Yaki Faitelson — Chief Executive Officer

Thank you.

Operator

Ladies and gentlemen, we have reached the end of our question-and-answer session and now I would like to turn the call back over to the Management for closing remarks.

Yaki Faitelson — Chief Executive Officer

I would like to thank all of our customers and partners for their continued support. Thank you for joining us today. We are looking forward to speaking with you soon again.

Operator

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

Duration: 59 minutes

Call participants:

James Arestia — Director of Investor Relations

Yaki Faitelson — Chief Executive Officer

Guy Melamed — Chief Financial Officer & Chief Operating Officer

Dan Bergstrom — RBC Capital — Analyst

Joseph Gallo — Jefferies — Analyst

Saket Kalia — Barclays — Analyst

Alex Henderson — Needham & Company — Analyst

Shaul Eyal — Oppenheimer — Analyst

Melissa Franchi — Morgan Stanley — Analyst

Gur Talpaz — Stifel — Analyst

Dan Ives — Wedbush — Analyst

Erik Suppiger — JMP Securities — Analyst

Jonathan Ruykhaver — Robert W. Baird — Analyst

Rishi Jaluria — D. A. Davidson — Analyst

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