Varonis Systems - Q1 2018

Transcript

Speaker 14

Thank you, Operator. Good afternoon. Thank you for joining us today to review Varonis' first quarter 2018 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'll open up the call to a question-and-answer session. During this call, we may make statements related to our business that will 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, 2018. Actual results may differ materially from those set forth in such statements.

Important factors such as risk associated with anticipated growth in our addressable market, competitive factors including increased sales cycle time, changes in the competitive environment, pricing changes, 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 and data and cybersecurity solutions, risk 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, risk associated with international operation, 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 are other important risk factors that 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 2018 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 (President and CEO)

Thanks, Jamie, and good afternoon, everyone. Q1 was a very strong start to 2018, with licensed revenues increasing 39% year over year. Total revenues for the first quarter were $53.5 million and increased 35% year over year, strong across both North America and Europe. We continued to add a meaningful number of new customers and sell more to our existing ones. We provide a solution for company-wide problems that are getting board-level attention, reducing risk, preventing breaches, and compliance. Our results for the quarter reinforce that the steps we are taking to build a durable company with growth and scale are working. Over a decade ago, Varonis recognized that enterprise capacity to create and share data far exceeded its capacity to protect it.

We believe that the vast movement of information from analog to digital mediums, combined with increasing information dependence, will change both the global economy and the risk profile of corporations and governments. Since then, our focus has been on using innovation to address the cyber implications of this movement, creating software to track and protect data wherever it's stored. We offer our customers an industry-leading platform that is built to protect the world's most valuable and most vulnerable data from both internal and external threats. Our platforms eliminate repetitive manual cleanup projects and automate manual protection routines, so we bring security and cost savings together, providing understaffed security and IT departments with the solution they need. As data continues to grow on-premises and in the cloud, the complexity of data protection increases.

Combined with new regulation, the C-suite and board of directors realize that they must implement a strategy to manage and protect their data and are looking for partners that can solve evolving needs. With our focus on innovation, including our enhancements to DatAlert and our Data Security Platform, and more recent additions such as GDPR Patterns, Automation Engine, and Varonis Edge, we are more and more becoming a partner of choice. Our operational journey, Detect, Prevent, Sustain, is really a journey of value for our customers. By deploying and using our products, they unleash their potential to be more secure, more efficient, and more productive. When we are talking about risk reduction, preventing breaches, or complying with regulation like GDPR, our operational journey provides context that helps our customers think about their business and their data protection efforts more holistically and drives our land and expense strategy.

We added 183 new customers in Q1, and 49% of our license and first-year maintenance came from existing customers, up from 46% in the year-ago period. 70% of our customers now have two or more product families, compared with 66% in the year-ago period, and 37% of customers now have three or more product families, up from 31% a year ago. Once our customers start their journey and begin using our products, they usually realize that they need to use them more. We are training our sales teams to use our operational journey to better identify new opportunities and increase product usage, find and strengthen ties with new stakeholders, and build stronger relationships with customers. We believe that our operational journey gives us an advantage as data protection and compliance projects like GDPR come together and is leading to both broader initial deployments and expansions of existing deployments.

For example, during Q1, a new customer and global retailer knew it needed to protect file system data to prepare for GDPR. A Varonis data risk assessment on their U.S. and EU data stores was an eye-opening, uncovering EU citizen data and payment card information in folders open to everyone in the organization. After reviewing the risk report, the customer's IT, security, legal, and auditing teams were convinced they needed Varonis. They purchased DatAdvantage for Windows, a DatAlert Suite, Data Classification Engine for Windows and SharePoint, and GDPR Patterns to find GDPR and other sensitive data, monitor permission, and alert to suspicious user activity. Where consultants and other companies could at best provide one-time static snapshots of their file shares, Varonis made it possible for companies to take continuous action.

As we have said consistently, while GDPR helps with awareness and presents opportunities that we believe we are well-positioned to capture, we don't lean on compliance alone. We focus on the broader value that comes with adopting our comprehensive Data Security Platform to reduce risk, prevent breaches, and/or simplify compliance. In Q1, we continue to see more senior-level executives realize that they have to take ownership and control of their data. Too many organizations have overexposed and unprotected files and emails on corporate networks worldwide. This is something security and IT have known for a long time, and now we see the tide turning. More executives are paying attention when they see how exposed they are through the Varonis risk assessment.

A recently published Varonis data security report revealed that, on average, 21% of an organization's folders were accessible to every employee, and 41% of companies had at least 1,000 sensitive files open to all employees in the organization. Those included unmanaged, stale, and sensitive data regulated by SOCs, HIPAA, PCI, GDPR, and other standards, and users with passwords that never expire. The Varonis data risk report puts front and center why companies are being breached, why data-related regulations are being enacted, why boards need to be very concerned, and why we believe our solutions are so critical to solving these problems. To give you an idea of the magnitude of the problem, our risk report reveals that 58% of companies have over 100,000 folders open to every employee in the organization, when they should have barely a handful. Almost all of them need to be fixed.

Think about what it means from a risk perspective, and now think about what it means that fixing a single folder without breaking everything can take six to eight hours if you try to fix it without Varonis. This explains why demand is so strong for our Automation Engine. The Automation Engine was built to fix these folders automatically. Projects that would have taken months and quarters are now being completed in days or weeks. Executives are beginning to understand that with our solution, they significantly decrease the likelihood of a breach and dramatically reduce the scope of potential damage. The Automation Engine adoption was very strong again this quarter and is a key differentiator for us. As an example of how compliance and risk reduction come together, a global corporate law firm understood the impact of GDPR deadlines could have on the organization.

In Q1, they contacted Varonis for a data risk assessment to gain insight into sensitive data on their file servers and prepare for GDPR. During the data review, we walked them through our potential journey, explaining how it would help to reduce risk and simplify compliance at the same time. Varonis identified GDPR data residing on their network and folders open to every employee. The firm estimated that it would take 200 days to fix these folders manually. The Automation Engine fixed them in five days. In addition to purchasing the Automation Engine, the firm is now monitoring file activity and user behavior with DatAdvantage and gaining visibility into those sensitive files with Data Classification Engine and GDPR Patterns.

In addition to compliance, data breaches, and risk reduction, we have also been talking about the cloud, and now we believe that we are especially well-positioned to address challenges in hybrid environments. Here is an example. In Q1, an employee in a large U.S. energy firm fell for a phishing attack, compromising dozens of Office 365 accounts. Attackers then configured account rules so user email would forward to an unknown outside address. After struggling to understand the scope and impact of this attack with native auditing tools in Office 365 and customers' PowerShell scripts, the company called Varonis. Varonis installed DatAdvantage for SharePoint and OneDrive and successfully removed the threat within a few hours. They were already using DatAdvantage, DatAlert, Data Classification Engine, and DataPrivilege for their on-premises data stores and have now added support for their Office 365 environment.

They are now equipped to track future incidents and keep their data safer both on-premises and in the cloud. This quarter, we again saw accelerated adoption of our Office 365 solution. Preventing data breaches in cloud and on-premises data stores continues to be a major, major concern. We see no slowdown in damaging high-profile cyber attacks. These attacks continue to reinforce awareness and continue to make DatAlert a very important part of our portfolio. Recently, we had a customer analyze a brute force attack when DatAlert detected hundreds of accounts being locked out. During the investigation, we were able to familiarize them with some of our sophisticated features, like how they could analyze past events with our behavior-based threats model, and this led to an absolute opportunity.

When customers operationalize DatAlert, we see how quickly it strengthens our relationship and improves our ability to sell additional products like Varonis Edge. Varonis Edge is our newest addition, which enables enterprises to correlate events and alerts from DatAlert to track potential data leaks and spot vulnerabilities at the point of entry. We are excited about our recent Data Security Platform upgrades and features. Our results this quarter reinforce our belief that our strategy is working well. Our technology provides the platform to help prevent data breaches, reduce risk, and achieve compliance. In our operational journey, we show our customers how to use our technology to its fullest extent. Our focus on innovation enables us to solve more of our customer data security needs and strengthen our relationship with them.

This has driven our learn and expense strategy and provides us a path for a durable, scalable growth over the long term. I remain confident that we have the strategy and team to build a billion-dollar revenue business. With that, I will turn the call over to Guy.

Guy Melamed (CFO and COO)

Thank you, Yaki. Before I begin, I would like to remind you that our Q1 results are in accordance with the new 606 accounting standard, which we adopted according to the full retrospective method. Total revenues for the first quarter were $53.5 million, an increase of 35% year-over-year and 32% on a constant currency basis and above our guidance. License revenues were $25.1 million. This represents a 39% increase from the first quarter of 2017 and 32% on a constant currency basis.

Our maintenance and services revenues were $28.5 million, increasing 32% on both a reported and constant currency basis compared to the first quarter of 2017. These results reflect our consistently high maintenance renewal rates that were once again above 90%. Looking at the business geographically, we continue to see strong growth. North America revenues increased 24% to $31.6 million, or 59% of total revenues. EMEA revenues came in at 38% of total revenues, or $20.3 million, an increase of 60%. Rest of World revenues represent 3% of total revenues, or $1.6 million. For the first quarter, existing customer license and first-year maintenance revenue contribution was 49%, up from 46% in the first quarter of 2017. During the quarter, we added 183 new customers.

While similar in number to Q1 2017 new customer addition, these new customers made larger initial commitments, and with our focus on the customer journey, we believe there is a meaningful opportunity for them to extend with us over time. This is in line with our strategy to target companies with 1,000 or more employees while at the same time increasing revenues from our existing customer base. We ended the first quarter with approximately 6,000 customers, which excludes roughly 400 DatAnywhere-only customers. To remind you, as of February 2018, in order to focus our resources on our data security portfolio, we no longer sell DatAnywhere to new customers, and we do not expect renewals or sales of the product to our existing customers. I would also like to note that DatAnywhere revenue contribution was minimal in previous year's results.

In addition, as discussed in our last earnings call, beginning in 2018, DatAlert and Varonis Edge became a new product family. The attach rates and customer counts as of March 31, 2018 and 2017 reflect these changes. As of March 31, 2018, 70% of our customers had purchased two or more product families, up from 66% as of March 31, 2017. 37% of our customers had purchased three or more product families compared with 31% in Q1 of 2017. These trends validate Yaki's description of our customers' behavior. Once they start their journey with Varonis and begin using our products, they typically realize how valuable our products are to them, which drives our land and expand strategy. This also supports our R&D investment strategy as we extend our capabilities to help our customers reduce risk, prevent breaches, and comply with regulation.

Before moving on to the profit and loss items, I would like to point out that I'll be discussing non-GAAP results going forward unless otherwise stated, which for the first quarter of 2018 excludes a total of $6.9 million in stock-based compensation expense and $1.9 million of payroll tax expense related to stock-based compensation. We report non-GAAP results in addition to, and not as a substitute for, financial measures calculated in accordance with GAAP. Please note that a detailed GAAP to non-GAAP reconciliation can be found in the tables of our press release, which is available on our website. Gross profit for the first quarter was $47.7 million, representing a gross margin of 89%, in line with our gross margin in the first quarter of 2017.

Turning to operating expenses, in line with our stated strategy, we increased our investments in our go-to-market initiatives to drive our global growth and support our customers' journey of value. We also increased investments in R&D to continually improve our products, enabling our customers to be more secure, more efficient, and more productive. Operating expenses totaled $54.4 million in the first quarter compared to $42.3 million in the first quarter of 2017. As a result, our operating loss was $6.7 million, or an operating margin of negative 12.5% for the first quarter, an improvement compared to our operating loss of $7.1 million, or an operating margin of negative 18% in the same period last year. During the quarter, we had financial income of $978,000 compared to $469,000 in the first quarter of 2017, primarily due to foreign exchange gains in each of the periods.

As you know, foreign exchange gains and losses can fluctuate. Our guidance does not consider any additional potential impact to financial and other income and expense associated with foreign exchange gains or losses, as we do not estimate movements in foreign currency rates. Our net loss was $6.3 million for the first quarter of 2018, or a loss of $0.22 per basic and diluted share, an improvement compared to our net loss of $6.9 million, or a loss of $0.25 per basic and diluted share for the first quarter of 2017. This is based on $28.4 million and 27,000,000 basic and diluted shares outstanding for Q1 2018 and Q1 2017, respectively. If we look at the balance sheet, we ended the quarter with approximately $153.7 million in cash, cash equivalents, and short-term investments.

During the quarter, we generated positive operating cash flow of $17.4 million, compared with $8.3 million in Q1 2017. This year-over-year improvement is keeping with our strategy to scale our business, delivering increasing levels of cash flow from operations. We ended the quarter with 1,318 employees, a 15% increase from 1,148 at the end of the first quarter of 2017. From the previous quarter, this is an addition of 67 people. We continue to increase our headcount to grow the business and realize productivity improvement as we scale. Moving to guidance. For the second quarter of 2018, we expect total revenues of $61.5 million-$62.5 million, representing year-over-year growth of approximately 24%-26%. We expect our non-GAAP operating loss to range between $1.5 million and $0.5 million and non-GAAP loss per basic and diluted share of $0.07-$0.04.

This assumes a tax provision of $500,000-$700,000 and 28.8 million basic and diluted shares outstanding. For the full year 2018, we are raising both our revenue and profit guidance. We now expect total revenues in the range of $264 million-$268.5 million, representing year-over-year growth of approximately 23%-25%. We now expect our non-GAAP operating income to be in the range of $2 million-$4.5 million and non-GAAP income per diluted share to range between $0.01 and $0.07. This assumes a tax provision of $2.7 million-$3.2 million and 32.3 million diluted shares outstanding. In closing, this was a strong quarter for Varonis. We are executing well on our growth strategy, making progress towards our 2018 goal of delivering solid profits and improving cash flow from operations.

Our investments in innovation are proving themselves as we further extend our competitive differentiation and increase the attach rates across our customer base. We are well-positioned to deliver a solid 2018. With that, we would be happy to take questions you have. Operator.

Operator (participant)

At this time, we will be conducting a question-and-answer session. If you would like to ask a question, please press Star 1 on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press Star 2 if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment, please, while we poll for questions. Our first question comes from John DiFucci, Jefferies. Please proceed with your question.

Thank you. Nice job, Yaki and Guy. I have two questions.

John DiFucci (Managing Director)

The first one, it sounds like, listen, you've hesitated to say GDPR was going—I mean, it's going to be a benefit, but not the only driver here, and we understand that. The strength in Europe looks really strong here. The question I have, though, is not about that. It's more about U.S. government. It seems like that could also be just a significant customer, especially for what you're providing here. Can you talk a little bit about that? Have you focused on U.S. federal government at all as a potential customer? Are there any certifications you need to become a trusted government vendor?

Yaki Faitelson (President and CEO)

Hi, John. Yes, we're definitely investing in the federal market. We have strong leadership and very strong teams, and we feel that this business can perform very well for us and just also get to a significant scale with time.

In general, I think the theme is really what is happening in the world, in an economy and a society that is completely digital and what it means that you have a data breach, that you cannot protect the data. I think what GDPR did primarily, it just provided a very comprehensive framework of how to think about governance and how to think about cybersecurity and how to think about dealing with personal and critical information. Everybody understands in order to benefit from the tremendous productivity gains and the progress that these technologies are bringing, we need to get control over the data. If not, the downside will be huge. We all strongly believe that Varonis is going to be a critical component to make sure you can realize all the benefits with very little risk. It is just becoming much more relevant to the discussion.

When you look at overall, you're looking at your assets and where damage can happen, we are protecting the most critical information with the largest volumes that is the most vulnerable.

John DiFucci (Managing Director)

Okay. I get it, Yaki. This applies across anywhere. It doesn't matter. The government, Europe, U.S., anywhere. I just have a quick question for Guy. Guy, I think you said that you're not going to take any renewals of DatAnywhere. I know you said something right after that that I'm not sure your exact words, but that it wasn't material. Can you give us any more detail on that just because it would be kind of like a little bit of a headwind? Was it less than $5 million in revenue that you're not going to take renewals on, or approximately how much was it?

Yaki Faitelson (President and CEO)

Or less than $3 million, less than $10 million, something like that?

Guy Melamed (CFO and COO)

Yes. As part of the 10-K, we actually put some—we put some color there. There was approximately 400 DN customers, standalone DN customers that we're not including. The revenue coming from DN was not material, much less than that. When we look at the reason, it's really not strategic for the data security platform. We're not expecting any renewals. We're not expecting any upsells from DatAnywhere, and that's kind of the reason we're excluding those customers. Okay. Okay. You say much less than that? I'm sorry. I threw out a bunch of numbers. The lowest number I threw out was $3 million. It said much less than that. Sorry. It's less than $1 million. It's less than $1 million. The expectation for 2018 is less than $1 million.

John DiFucci (Managing Director)

Okay. Great. Great job, guys. Thanks.

Guy Melamed (CFO and COO)

Thank you.

Yaki Faitelson (President and CEO)

Our next question comes from Matt Hedberg, RBC Capital Markets. Please proceed with your question. Our next question comes from Saket Kalia, Barclays. Please proceed with your question.

Saket Kalia (Managing Director and Senior Equity Research Analyst)

Hey, guys. How are you? Thanks for taking my questions here. Hi, Saket. Hey, Yaki. Hey, Guy. Hey. Maybe first for you, Guy, can you just talk a little bit about the seasonality of deferred revenue a little bit? I think we've all sort of seen it down usually from the fourth quarter to the first quarter. It was down just a little bit more than what we've seen. Can you just talk about some of the moving parts in that line out of the FX and maybe DatAnywhere could have played a role?

Can you just kind of walk us through maybe how that line ebbed and flowed this quarter and what some of the moving parts were?

Guy Melamed (CFO and COO)

Absolutely. As you know, Q4 is usually the largest dollar value selling quarter for the year, and Q1 is usually the quarter with the most collection, which is part of the reason we have such great cash flow from operations in Q1. The deferred revenue was not impacted by DatAnywhere, but it has been pretty consistent and fluctuates from quarter to quarter, but there was not anything material there, and we are happy with the numbers. Got it. Got it. Maybe for you, Yaki, a little bit higher level, can you just talk a little bit about Automation Engine versus some of the other products that Varonis has kind of introduced in terms of ramp? You have talked about it as being a differentiator.

Saket Kalia (Managing Director and Senior Equity Research Analyst)

Of course, it's still relatively early. Perhaps qualitatively, how do you think about the success of Automation Engine versus your other new products at sort of this stage of their life cycle, if that makes sense?

Yaki Faitelson (President and CEO)

So far, the signs are very positive from just every KPI, the volume, the overall revenues, but primarily from the value that customers get. Today, if you think about excessive access control on file systems, this is the problem, this is the main problem for a lot of the malware and insider threats. The first thing that people are doing, they are going to file shares and trying to take data that is not theirs. The easiest way for a malware is to go on network shares and try to steal data.

We are going to organizations, show them that many times thousands and thousands of critical files are open to everybody in the organization. You need to remember that access control is a business process. People need to access the data. If you're going to break it in a way that it's not sensible, you will break business processes and you will harm productivity. It is just to come in, to show you all the exposure, and then in a fraction of the time, it took with DatAdvantage. I'm not talking without it, that it's virtually impossible. You reduce the risk without any additional spend. This is really just the ultimate example of risk reduction and savings. It works just extremely well for us. Access control, excessive access control remediation is in the core of every security program.

The ability to find critical data and excessive access and just make sure that only the right people can access it without breaking any processes is just a tremendous value proposition. From every angle, in terms of the overall value, the way that it's working on DatAdvantage, and the net impact on revenues, it's working very well. Very helpful.

Saket Kalia (Managing Director and Senior Equity Research Analyst)

Thanks, guys.

Yaki Faitelson (President and CEO)

Thank you.

Guy Melamed (CFO and COO)

Thank you.

Operator (participant)

Our next question comes from Matt Hedberg, RBC Capital Markets. Please proceed with your question.

Matthew Hedberg (Director of Equity Research)

Hey, guys. Thanks for taking my question. Yaki, you guys have been having success with larger customers, higher seat counts. Guy mentioned it in his prepared remarks. I'm curious, can you talk about what's driving some of the momentum? When you get into some of these larger customers, do any of them ask for ELA-type contracts? Yes. First, it's very important.

Yaki Faitelson (President and CEO)

We as a company, because of the fact that our sales motion is becoming more strategic and simpler, and there are more and more budgets, we can have a more targeted approach. We are really focusing on 1,000-plus employees. One of the things that happened in terms of customer lifetime value and many times initial sale, we are selling in 1,000-plus to the same customers we sold before, but we sell them more, and over time, they have much better and more predictable customer lifetime value. We still have not done any ELAs. Customers are talking to us about it, there is a lot of value, and more and more customers need a lot of the products that we have. In terms of content, I mean product content, there is so much that we can offer.

With time, we'll find we can consume over time more value in a predictable way. Just again, we are focusing on 1,000-plus and selling initial deals and overall customer lifetime value, just bigger because we have more products, and we have products that deliver immediate time to value. Customers are really understanding very well the journey of value. They want to make sure that they have all the pillars and the building blocks, and we have this multi-year relationship with our customers, and we make sure that they can protect their data and constantly improve their overall security posture. That's super helpful.

Matthew Hedberg (Director of Equity Research)

A quick one for Guy. It sounds like you guys are now breaking out DatAlert and Varonis Edge as separate products. I'm wondering if you could give us the attach rate of DatAlert in your base?

Guy Melamed (CFO and COO)

Absolutely.

The attach rate for DatAlert in Q1 2018 was 48.1%, and that's versus 42.4% in Q1 2017. That's helpful. I assume Varonis Edge is a lot less than that. It was just launched, though. We provide it as a product family. Obviously, the Edge is very initial, so this is as a DatAlert product family, it's mostly DatAlert currently.

Matthew Hedberg (Director of Equity Research)

Got it. Super helpful. Congrats to you, guys.

Guy Melamed (CFO and COO)

Thank you.

Operator (participant)

Our next question comes from Gur Talpaz, Stifel. Please proceed with your question.

Gur Talpaz (Equity Research Analyst)

Great. Thanks for taking my question. Yaki and Guy, congrats on the quarter. I am going to ask about EMEA. I mean, growth here was stellar at 60%. Yaki, I know you want us to look at things on a multi-quarter basis, but still, the number itself is impressive.

In the past, you've talked about using GDPR as a way in the door inside of customers, inside EMEA. Is that still the case today? Can you talk about the selling motion into European customers? Thank you.

Yaki Faitelson (President and CEO)

The selling motion into European customers and customers just in the U.S. are the same. People understand the implications of not protecting data. Without a doubt, what happened with GDPR, you can think about it like the ultimate marketing program for Varonis on steroids. It provided a framework for boards and management to think about data security, compliance, and cybersecurity, and to see it and really say, "Where are the assets?

What are the problems? The other thing that is happening in Security Gur, which is phenomenal for us, and we tried to illustrate it in the customer examples, is that we are in a place that we need to prove quality. You can have alerts. They need to be the right alerts. You need to catch bad things when they happen. You need to remove excessive access control without breaking business process. You need to classify data without false positives. Everything works very well for us. It really elevated. Also, GDPR elevated in many multinationals in North America, the overall discussion. What you see, and also what you see with what happened with Facebook, these things are happening, and everybody is looking at it and saying, "We need to act.

We need to understand what is going on. When you have a thoughtful process about where are your assets, how to protect them, and where you need to allocate your capital, and what processes your organization can digest in order to be protected on-prem and in the cloud, this overall discussion benefits Varonis tremendously. This is what you see.

Gur Talpaz (Equity Research Analyst)

That's helpful. In the prepared remarks, you talked a bit more about the cloud and deploying in Office 365 and OneDrive in cloud environments, more so than you've talked about in prior quarters. Can you talk about what you're seeing now as far as your deployments in cloud-based environments or in hybrid cloud environments? Is something fundamentally shifted quarter on quarter that's pushing you into more of these deployments now?

Yaki Faitelson (President and CEO)

The customers are pushing us.

What we see, it's very interesting, is that we see more data in the cloud. Interestingly enough, we don't see full file servers going to the cloud. We see SharePoint online, and definitely a lot of Exchange and Active Directory in OneDrive. There are many, many incidents. We see sometimes more incidents than on-prem. It's another big platform. You have a lot of data. Customers understand they need a single pane of glass, and they need to be protected. Our support for Office 365 and Azure is just gaining tremendous momentum. We are very happy, but it's primarily for market conditions. This is becoming another platform with critical mass of data, very hard to manage permissions. You need very effective alerting. The data is all over the place. This whole situation is extremely beneficial for Varonis.

Gur Talpaz (Equity Research Analyst)

That's helpful, Yaki. Thank you so much.

Congrats on the quarter.

Operator (participant)

Our next question comes from Alex Henderson, Needham & Company. Please proceed with your question.

Alex Henderson (Managing Director and Senior Research Analyst)

Thanks. You guys were pretty busy on the new product development front, not just out at RSA, but prior to that, with the extensions to DatAdvantage, the geolocation, GDPR stuff, and the Automation Engine enhancements. Can you talk about what response you had to those and how you're pricing those? I know that you've historically been sort of underpriced to the value of your product and have had a bias to upward trajectory in pricing at ASP as you've added additional feature functionality. Is that the case here?

Yaki Faitelson (President and CEO)

Last year, we were very busy, and the Automation Engine is doing very well. All the enhancements for 365, everything that we did with GDPR and classification and the new features is going very well. Edge is still early stages.

From the beta, we have very good momentum. We feel that we price it in the right way, and it is just adding a lot of value. With all the products that we have, it is something that customers can consume effectively, and it is priced correctly. If we see that it is not priced correctly, we can always increase prices, and it is something that we have done in the past. We believe that we executed very well. Our three themes are security analytics, remediation, and management and classification, and we were able to increase materially the value we bring to our customers in each area of our innovation. You talked a little bit about larger deal sizes. Did not really quantify it, but indicating that you are seeing solidly larger deal sizes. Usually, when that happens, that also results in some extension of the time to close transactions.

Alex Henderson (Managing Director and Senior Research Analyst)

Can you talk a little bit about that trade-off? Are you seeing any extension of the time it takes to close deals, or is the deal time staying the same as the deal sizes are going up?

Yaki Faitelson (President and CEO)

Primarily, we're talking about customer lifetime value. We are not talking about ASPs. What is happening is that we sell to customers with the same size. If you look at our business that is 1,000-plus, we're just focusing on it. The sales cycles are the same because in terms of the complexity of getting deals and consensus and getting to the champions, it stayed the same. It still always involves some challenges and pains because this is how enterprise software works, but it stayed the same.

Also, with time, we see more and more budgets that are earmarked towards the problem that we solve, like insider threat and compliance and all of this stuff, malware detection. It is still not earmarked towards just a bucket like a firewall or a storage element or something of this nature, but definitely, there are budgets. I think in this condition, even if they are by more upfront, the market conditions help us to justify it relatively in the same sales cycles that we experienced before.

Alex Henderson (Managing Director and Senior Research Analyst)

One last technical question. The share count, if you had been profitable in the quarter, what would have been the fully diluted share count number as opposed to the basic and fully diluted being the same as a result of the fact you had a loss?

Guy Melamed (CFO and COO)

The share count, we provided actually for the guidance for the full year because we are expecting to be operating margin profit for the year. That would be the share count is about 32.3 million on a fully diluted basis for the full year.

Alex Henderson (Managing Director and Senior Research Analyst)

Great. Thanks.

Guy Melamed (CFO and COO)

Thank you.

Operator (participant)

Due to time constraints, please limit for one question and one follow-up question. Thank you very much. Our next question comes from Melissa Gorham, Morgan Stanley. Please proceed with your question.

Speaker 13

Great. Thanks for taking my question. Yaki, I'm wondering if you can maybe just comment on how you're feeling about sales capacity right now, particularly in EMEA, and if you feel like you need to make significantly more incremental investments in that region to fully take advantage of GDPR.

If you can just give us a sense of growth in the number of sales heads, either quantitatively or qualitatively, that would be helpful.

Yaki Faitelson (President and CEO)

Hi, Melissa. We are operating in just a massive market. We virtually can sell to everyone. Obviously, to fulfill our potential, we need sales capacity. We're constantly adding seller and sales engineers and customer success people. We're just doing it in the right way. We want to make sure that there is management in place and we can enable them and they get the right support, and we slice and dice territories in the right way. We're just balancing it. After our IPO, we grew aggressively, and we said we needed to get to a certain capacity, and after that, we can do it in a more measured way, and this is what we are doing now.

Make sure that people that we are bringing on board, they will have all the chances and all the support to be very successful. A big part of the strategy is to add sales capacity. We're just doing it in a measured, responsible way.

Speaker 13

Okay. Got it. Just one follow-up for Guy. Just looking at the operating income guidance for the full year, Q1, you saw a big beat in operating income, but the full-year guide did not move up as much as the Q1 beat. I'm just wondering if you could maybe talk about where you're hoping to kind of put that reinvestment into the business for the rest of the year.

Guy Melamed (CFO and COO)

Sure. This is very consistent with what we discussed last quarter. As you remember, we discussed on our R&D investments.

Part of the beat in Q1, when we look at the guidance for the year, we're planning to put some of it back in the business because we see the great opportunity that we have ahead of us. When you look at on a non-GAAP basis, and if you exclude the FX headwind that we discussed last quarter, we still plan to show leverage on the operating margin compared to 2017. We're continuing with the same philosophy.

Speaker 13

Thank you.

Thank you.

Operator (participant)

Our next question comes from Shaul Eyal, Oppenheimer. Please proceed with your question.

Shaul Eyal (Managing Director of Research)

Good afternoon, guys. Congrats on a strong start to the year. Guy, I want to start actually with you. As you guys probably know better than I do, recent ruling by the Israeli tax authorities has some implications in regards to the deductibility of stock-based compensation.

Yaki Faitelson (President and CEO)

I think it implies for foreign companies with Israeli R&D subsidiaries. How are you thinking about it? Are you anticipating any one-time future charges down the road? I know we improved it to Quan back on Thursday. What's the view here?

Guy Melamed (CFO and COO)

We reviewed and studied the court ruling, and we believe we have sufficient provision to address the court ruling.

Shaul Eyal (Managing Director of Research)

Got it. Okay. Good, good. My second question. Yaki, existing customers as well as new customers seem to be pushing you towards new directions, positive directions. Are you seeing in that context any new resellers, distributors you had no access to historically, revisiting their Varonis relations? Any new opportunities to expand in the various regions you operate through new distribution channels?

Yaki Faitelson (President and CEO)

We definitely see that much more attention. We are starting to hit scale. We are very relevant to the cloud.

As you know, there is a lot of pressure on infrastructure valve. We see a lot of attention. We built very good, robust distribution, partner distributions throughout the years, but they just can do much more with us. They can do professional services, and they are benefiting tremendously when they are introducing us into their customers. We definitely see that they are embracing us much more. We are more strategic for them, and there is a lot of appetite to push our products and introduce them to their customers.

Shaul Eyal (Managing Director of Research)

Got it. Good job. Good luck.

Yaki Faitelson (President and CEO)

Thank you.

Our next question comes from Greg McDowell, JMP Securities. Please proceed with your question.

Greg McDowell (Managing Director and Senior Research Analyst)

Great. Thank you very much. Guy, just one quick one for you.

I think one number that really stood out to me was your operating cash flow and free cash flow performance, which was more than double last year. I was hoping you could just maybe talk us through some of the puts and takes for the Q1 outperformance and as we think about cash flow for the rest of the year, maybe how we should be thinking about it. Thanks.

Guy Melamed (CFO and COO)

If you remember, the way our business works, Q4 is the largest revenue from a dollar perspective, which kind of generates Q1 to be the largest from a collection perspective. If you look at the cash flow from operations last year, you'll see very similar trends. We're very happy with the cash flow from operations, the number we generated this quarter. I think it's a great indication of how strong the business is.

Yaki Faitelson (President and CEO)

We feel very good with the momentum and believe that we can continue to generate significant cash flow going forward.

Greg McDowell (Managing Director and Senior Research Analyst)

Q2, typically, you burn cash in the last couple of years. I guess predictable patterns for the next couple of quarters is what I'm trying to get at.

Guy Melamed (CFO and COO)

Since Q1, from a dollar perspective, a selling perspective is the lowest for the year, the cash flow generated from operations in Q2 is significantly lower than the numbers in Q1. Yeah.

Greg McDowell (Managing Director and Senior Research Analyst)

Great. Fair enough. Thanks a lot, Guy. Appreciate it.

Operator (participant)

Our next question comes from Srini Nanduri, Summit Insights Group. Please proceed with your question.

Srini Nandury (Managing Director and IT Hardware and Software Analyst)

Thank you. Thank you for taking my question. Yaki, of all of the 6,000 customers you have, can you give us some qualitatively or quantitatively how many of these customers have at least 1,000 employees or more? Thank you.

Guy Melamed (CFO and COO)

Hi, Srini. How are you?

Very good, sir. This is Guy. Good. We actually do not break down the number of customers that are over 1,000. What I want to emphasize is that even though we are focused on customers with more than 1,000-plus and we have seen that from a customer lifetime value, we are able to generate more through those customers, we have not neglected the customers that are below 1,000. We have an inside sales team that focuses on them as well. We try to sell them through WebEx and over the phone. Out of the 6,000, it is still the majority that are below 1,000, which just emphasizes the potential that we still have in targeting the larger customers. We are very focused on the 1,000-plus but have not neglected the ones under that.

Srini Nandury (Managing Director and IT Hardware and Software Analyst)

Perfect. Thank you.

Operator (participant)

Thank you. Our next question comes from Mark Schappel, The Benchmark Company. Please proceed with your question. Hi.

Mark Schappel (Director of Equity Research)

Thank you for taking my question. Nice job on the quarter. Guy, just one question. With respect to the incremental investments you plan to put back into the business from the first quarter upside, where do you plan to direct those investments?

Guy Melamed (CFO and COO)

We really feel the opportunity and what we see in making this company become a billion dollars in sales in the future, we need to make some R&D investments. As you know, we're very focused on both growing the business and on the bottom line. The philosophy hasn't changed. We're doing the exact same thing we've done in the past. Most of the investments that we plan to do and kind of what we're bringing from the beat of Q1 will be focused in R&D, but we'll make investments in other places if we find them appropriate.

But we're very focused on the top-line growth and bringing some of it to the bottom line.

Mark Schappel (Director of Equity Research)

Thank you.

Guy Melamed (CFO and COO)

Thank you.

Operator (participant)

Our next question comes from Rishi Jaluria, D.A. Davidson. Please proceed with your question.

Rishi Jaluria (D.A. Davidson)

Hi. Hey, thanks, guys, for taking our questions. Just really quickly, I guess, first, as you focus more specifically on organizations with 1,000-plus employees, have you seen any impact on churn with maybe the smaller-sized customers? I know you've talked about the 90%+ maintenance renewal rates as a whole, but just curiously on the lower side of customers, have you seen any impact on churn with that many folks? And then quick follow-up.

Yaki Faitelson (President and CEO)

No. We see across the board very strong renewal rates.

Rishi Jaluria (D.A. Davidson)

Okay. That's helpful.

Just coming out of RSA a couple of weeks ago, I mean, definitely saw a lot of companies messaging both around GDPR and as well messaging some sort of language around data governance or user behavior analytics. Just kind of wanted to understand from your perspective, has the competitive environment been relatively maintained, or have you seen any sort of changes as some of these larger organizations, at least from a marketing perspective, start messaging stuff that sounds similar to what you do?

Yaki Faitelson (President and CEO)

No. The competitive landscape didn't change. We are coming in the same sales motion. It's a very visual sale. We show them our demo, and then we are selling it via POC. Once we are doing it, everything is clear. We are selling on the value of the product that people are touching with their hands and not marketing soundbites.

It just works very well for us, and we do not see any changes in the competitive landscape.

Rishi Jaluria (D.A. Davidson)

Okay. Great. Thank you so much.

Operator (participant)

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

Yaki Faitelson (President and CEO)

Before we end the call, I would like to thank all of our employees for their hard work and contribution to our success this past quarter. I would like to thank all of our customers and partners for the continued support. Thank you for joining us today, and we are looking forward to talking to you again soon.

Operator (participant)

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