Q3 2024 Earnings Summary
- Strong momentum in SaaS transition, with SaaS Annual Recurring Revenue (ARR) now representing approximately 43% of total ARR, or about $260 million. The company expects to reach approximately 50% of the business coming from SaaS within two years into the transition, demonstrating accelerated customer adoption of their SaaS platform.
- MDDR (Managed Data Detection and Response) offering is gaining significant traction, driving new customer wins and contributing to strong performance. The shorter sales cycles and elimination of customer pushbacks with SaaS and MDDR are leading to increased adoption and sales momentum.
- Early contributions from Generative AI, with Generative AI being front and center in every customer conversation, and the company starting to see some deals close related to this. This positions Varonis favorably to capitalize on the growing demand for data security solutions in the context of AI adoption.
- The federal business underperformed by several million dollars and has been underperforming for several years, indicating ongoing challenges in this segment.
- Management is cautioning against relying on traditional financial metrics due to the SaaS transition, introducing uncertainty regarding revenue growth and operating margins for 2025.
- The adoption of Generative AI is attracting more competitors into the data security market, potentially eroding Varonis's competitive advantage. Despite management asserting no change in the competitive landscape, analysts express concerns about increasing competition.
| Metric | Period | Guidance | Actual | Performance |
|---|---|---|---|---|
Total Revenue | Q3 2024 | $140 million to $143 million | 148.068 million | Beat |
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Gen AI Contribution
Q: How is Gen AI impacting your business and outlook?
A: Management noted that while it's still early, they have started to see deals close related to Gen AI, particularly with Microsoft's Copilot and internally built LLMs like Salesforce Einstein. Though the contribution is currently immaterial, Gen AI is front and center in every customer conversation, and they believe adoption will increase over time, becoming a significant tailwind.
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SaaS Transition Progress
Q: Can you update us on the SaaS transition and ARR guidance?
A: The company reached 43% of total ARR being SaaS, approximately $260 million. They expect to end the year at 49% SaaS mix, slightly above the prior guidance of 48%. Conversions from existing customers are progressing but take time, and momentum is driven by new business and their MDDR offering.
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Federal Business Underperformance
Q: Why did the federal business underperform this quarter?
A: The federal segment underperformed by several million dollars and accounts for mid-single-digit percentages of total ARR. Management attributed this to several years of underperformance and has brought in a new management team. They expect that upcoming FedRAMP authorization next year will help capture the market opportunity.
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MDDR Adoption and Impact
Q: Can you quantify the impact of MDDR on your business?
A: Management stated that MDDR is driving growth but hasn't quantified its size yet. Customers are buying more of the platform, leading to increased ASPs. MDDR was introduced at the beginning of the year and is well adopted by both customers and the sales force.
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2025 Guidance and Outlook
Q: Any early thoughts on 2025 revenue and margins?
A: Management emphasized focusing on ARR, contribution margin, and free cash flow rather than revenue and operating margin due to the SaaS transition. They plan to provide more color after Q4 but believe they can continue to grow and generate healthy free cash flow.
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Competitive Landscape with Gen AI
Q: How is Gen AI affecting competition in data security?
A: The company sees no change in the competitive landscape despite increased interest in data security due to Gen AI. They believe their data security platform is well-positioned, and while there's more noise and awareness around data security, they haven't observed new competitive pressures.
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Convertible Notes and M&A Strategy
Q: How does the convertible notes offering affect your M&A plans?
A: The recent upsized convertible notes offering provides strategic flexibility. While M&A is a potential avenue, they are considering opportunities that align with their core data security focus. The capital allows them to look at slightly larger acquisitions without changing the risk profile of the business.
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Gross Retention and Conversions Impact
Q: How are gross retention rates and conversions trending?
A: Gross retention rates remain consistently over 90%. Conversions from maintenance of perpetual customers to SaaS have increased, contributing to revenue growth. However, the momentum this quarter was driven by new customers and MDDR adoption.
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Small Acquisition Details
Q: Can you elaborate on the recent small asset purchase?
A: The company acquired a small team of programmers for $6.7 million to accelerate their roadmap. The expense is reflected immediately in the income statement under non-GAAP R&D expense. They do not expect any ARR or material expense impact due to the acquisition's small size.
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Q4 Guidance and Budget Flush
Q: Should we expect any budget flush or changes in Q4 guidance?
A: The company's guidance philosophy remains unchanged, and they haven't included additional Gen AI contributions in Q4. They do not anticipate a budget flush, as it's not something they've seen historically. Q4 is expected to be the largest quarter of the year due to regular seasonality.