Varonis Systems (VRNS) Q4 2022 Earnings Call Transcript

Varonis Systems (VRNS 0.18%)
Q4 2022 Earnings Call
Feb 06, 2023, 4:30 p.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Greetings, and welcome to the Varonis Systems, Inc. fourth quarter 2022 earnings conference call. [Operator instructions] And it is now my pleasure to introduce to you, Tim Perz, with investor relations. Thank you.

Tim, you may begin.

Tim Perz -- Investor Relations

Thank you, operator. Good afternoon. Thank you for joining us today to review Varonis' fourth quarter and full year 2022 financial results. With me on the call today are Yaki Faitelson, chief executive officer; and Guy Melamed, chief financial officer and chief operating officer of Varonis.

After preliminary remarks, we will open the call to a question-and-answer session. During this call, we may make statements related to our business that would be considered forward-looking statements under federal securities laws, including projections of our future operating results for our first quarter and full year ending December 31, 2023. Due to a number of factors, actual results may differ materially from those set forth in such statements. These factors are set forth in the earnings press release that we issued today under the section captioned forward-looking statements.

And these and other important risk factors are described more fully in our reports filed with the Securities and Exchange Commission. We encourage all investors to read our SEC filings. These statements reflect our views only as of today and should not be relied upon as representing our views as of any subsequent date. Varonis expressly disclaims any 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 fourth quarter 2022 earnings press release and investor presentation, which can be found at www.varonis.com in the investor relations section. Lastly, please note that a webcast of today's call is available on our website in the investor relations section. With that, I'd like to turn the call over to our chief executive officer, Yaki Faitelson.

Yaki?

Yaki Faitelson -- Chief Executive Officer

Thanks, Tim, and good afternoon, everyone. Thank you for joining us to discuss our first quarter and full year 2022 performance. I would also like to provide an update on our new SaaS offering and updated outlook. We're at a very exciting time in our story as we introduced Varonis SaaS to the world nearly 100 days ago.

The Varonis SaaS is as big a milestone for us as the first version of DatAdvantage, the birth of our company. At the same time, there is a lot of uncertainty in the world, whether it is inflation, raising interest rates, growing layoffs announcements, or just general economic slowing. In the midst of all of this uncertainty, one thing is certain. Whatever will happen in the world, people will eat, sleep, and create data, and the data needs to be protected.

Turning to our fourth quarter results. It is still very early, but the initial reception to our new SaaS platform was encouraging and that business performed better than we expected, though, of a very small sample size. At the same time, the slowing macro environment continued to impact our customers. Our fourth quarter ARR came in above the high end of our guidance range we provided you last quarter, although, our reported growth remains below the goals we had at the start of the year.

I will review the quarterly results and our outlook in more detail. But the initial performance of Varonis SaaS gives us additional confidence in our ability to weather this growing economic environment and emerge from this transition with healthy growth and profitability on our path to achieving 1 billion ARR. Now, I would like to take a step back and take a moment to remind you of the importance of what we do. Data is the most valuable assets for any company, second only to its people.

If you have data, someone wants it. Everything depends on it. But data is completely out of control. Companies don't know what data they have or where it lives.

Employees have too much access to way too much data on too many systems. This is a problem for every organization today, regardless of size, industry, or geographic location. When we started, we needed to evangelize the problem. Today, everyone know that data security is important, but without Varonis, they struggle to locate those sensitive data, see who has access to it, and safely lock it down without stopping their business.

Securing data continue to be touted as massive unemployment cloud repository goal. In the past few years of hybrid role, cloud and remote device usage exploded and together expanded the attack surface by order of magnitude. Whether it is APTs, cybercriminals, or rogue insiders, there will always be a vulnerable system somewhere in this massive attack surface. And all it takes is one compromised useable machine to inflict significant amount of damage.

While the means, attack used will change, the end target data is always the same. You can replace an endpoint, you can rebuild an infrastructure. But once an attacker gets to the data, it is all over. You can't enrich data.

This is why data protection is the most important security problem to solve. With SaaS, we reduce the customer effort needed to solve this problem with significant automation that is built into the software. Although there are many benefits customers get from our SaaS platform, I would like to outline the top three. First and most important, customers are much better protected with much less effort.

Varonis has much more automation to find and lock down exposures that comes from oversharing, unneeded access and misconfiguration. We have more visibility into usage and behavior on all data stores that matter the most, which enhances our ability to detect and respond to threats. With our enhanced visibility, we now offer proactive incident response for SaaS customers, providing another layer of protection, again, reducing customer effort. Continual automatic updates enable customers to stay informed of new and evolving threats in regulation.

And all of this is delivered faster. Second, SaaS is easier to deploy and has significantly lower infrastructure cost and should result in quicker time to value. And third, SaaS is easier to maintain an upgrade which saves our customers time and headcount, two of the scarcest resources for any season. I would like to spend another moment diving deeper into our active incident response, which is a key differentiator for Varonis SaaS software.

As part of the Varonis SaaS subscription, customers get air cover from our world-class incident response team, who actively watch suspicious activity, investigate alerts, and notify customers of potential incidents. This will reduce the pressure on customer security teams and improve their ability to stop threats. And the ability to provide this across our entire SaaS customer base make the service orders of magnitude more powerful. On top of these critical benefits, we are making it easier to consume Varonis as we are doubling down on the bundling strategy we introduced at the beginning of last year.

We have seen great reception from customers who receive Varonis platform protection upfront, and from our sales force, who benefits from a simple pricing discussion, both in the initial deal and the renewals. The new strategy is a win-win for our customers. And in our company, our customers receive more value from our platform in the initial deal. For our sales force, it is an easier story to tell.

Our customers know that Varonis protect their largest and most important data stored in application. They know the business outcomes that Varonis helps them achieve. This is what matters to our customers and why we are doubling down on a platform-setting approach. Our updated packaging ensure that customers receive an autonomous data security platform that will help them achieve their business outcome on day one.

Now, that I have provided you with an update of how we are making it easier for our customers to see value on the Varonis platform, let me review some of the benefits that we should realize through our SaaS offering. First, we expect SaaS will result in a shorter sales cycle. Risk assessments, the core of our go-to-market motion, are expected to be quicker and easier to deploy because customer infrastructure requirements are greatly reduced. Along this, our updated product packaging should help simplify the pricing discussion, which we also think will result in shorter sales cycle.

Second, our new customer lens should be largely driven by platform-selling approach and a 25% to 30% pricing uplift, which is justified by the product total cost of ownership if compared to on-premises subscription offering. We expect that quicker time to value and improved customer satisfaction will lead to greater customer lifetime value and even better renewal rate in these larger initiatives. And third, SaaS helps us to innovate faster and support our customers more easily, which we expect should benefit our margin profile as we scale. It is still very early in the transition, but we are beginning to see initial proof of these benefits.

Before I turn the call to Guy, I want to briefly discuss a couple of key customer wins in Q4 that illustrate it. A global packaging company, over 4,000 employees, became a Varonis customer this quarter. This organization wanted to improve its ability to detect and respond to threats to sensitive data and intellectual property and comply with GDPR and CCPA privacy requirements. This deal was originally an OPS deal that was switched to a SaaS deal during the fourth quarter because of infrastructure and resource cost savings they could realize.

They purchased packages to protect Windows Microsoft 365 and Active Directory, and we're already in discussion to supplement their detection capabilities with Edge and to protect their Exchange Online and Box environments. At the same time, existing customer base continued to serve as a key growth driver. A couple of weeks ago, a healthcare organization, originally, a customer who purchased a double-digit number of perpetual and OPS licenses, upgraded to our SaaS platform and will protect its hybrid Windows environment with the power of Varonis SaaS. This renewal was a win-win for the customer and Varonis.

The customer will benefit from greater automation and will reduce its total cost of ownership due to low infrastructure costs. We will recognize an uplift in ARR as a result of the conversion. We are excited by the initial reception of the Varonis SaaS and look forward to sharing how we see this driving our durable growth in the coming year at our investor day on March 14. Finally, I would like to thank our team for their tireless efforts this past year, and we are excited to make this transition is success in 2023.

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

Guy Melamed -- Chief Financial Officer

Thanks, Yaki. Good afternoon, everyone. In addition to providing more color on our fourth quarter performance and updating our 2023 full year outlook, I plan to focus my time today on the initial progress of our SaaS transition and update to our views of how the macro environment is affecting our customers. Let's start with the early signs we're seeing from our new SaaS rollout.

As Yaki mentioned, while it's still very early in the transition, the behavior we're seeing from our customers and our sales force during the fourth quarter gives us increased confidence in our anticipated trajectory of this transition as compared to when we first made the announcement nearly 100 days ago. Regarding the macro environment, we did see a deterioration, but it was slightly more benign than what we assumed in our guidance. Despite the softening of the macro environment, our fourth quarter results came in above the top end of the guidance on both ARR and the bottom line. We ended the year with ARR of $465.1 million, up 20% year over year, or 24% adjusting for FX in Russia.

In the fourth quarter, we were approximately free cash flow breakeven, which was up from negative $6 million last year, reflecting the inherent operating leverage in the business model and the measures we took to manage our expenses. In the fourth quarter, SaaS as a whole performed better than we expected and represented approximately 10% of new business and upsell ARR. For the year, we sold approximately $3.5 million of DA cloud, which was slightly below our expectations. But we believe the number was impacted by the announcement of our new SaaS product as reps gravitated toward selling Varonis SaaS once we introduced the product.

It's still very early stages, but we are very pleased with the behavior seen in the fourth quarter, which leaves us cautiously optimistic about our 2023 outlook. Now, I'd like to elaborate on what we saw in the fourth quarter from a macro perspective. As we assumed in our Q4 guidance, economic softness continued to negatively impact our European business, and worsening of the macro environment began to impact our North America business as well. Across the board, we saw additional deal scrutiny and longer sales cycle.

Some of the deals that slipped in Q4 have since closed, but we expect deal cycles to continue to lengthen as a result of the ongoing additional budgetary scrutiny. Despite this, our pipeline continues to build as the deals that have slipped were not lost to competition and remained in the pipeline. In spite of the uncertainty in the economy and widely publicized focus on optimizing cloud spend, we continue to see healthy new customer interest and engagement from our existing customers. As of December 31, 2022, 78% of our customers with 500 or more employees purchased four or more licenses, up from 73% a year ago and 63% two years ago.

Fifty percent of those customers purchased six or more licenses, up from 41% last year and 30% two years ago. Due to the SaaS packaging changes that Yaki discussed earlier, this will be the last quarter that we provide these metrics. We plan to introduce new KPIs to help you better understand the trends in our business at our investor day next month. Lastly, our dollar-based net retention rate for subscription customers was 115% at the end of 2022, or 117% adjusting for FX in Russia.

Turning now to our fourth quarter results in more detail. Before I get into the numbers, I'd like to take a moment to remind you of the importance of ARR. You've heard me talk about ARR is the leading metric for the past six quarters. We talked about this because we saw this was the direction that the company was moving.

And going forward, this metric will only become even more important. During the transition period, the shift of our business from term licenses were approximately 80% of the deal value was recognized upfront to a SaaS model with fully ratable revenue will make our income statement metric less indicative of the health of the business than they have been in the past. Throughout this transition period, ARR and free cash flow will be our and your north stars because they are not impacted by the speed of the transition. To help you better understand the differences in accounting treatment process versus on-prem subscription deals, we've included a slide in our investor presentation.

Now, on to the numbers. Q4 total revenues were $142.6 million, up 13% year over year or 17% adjusting for FX in Russia. During the quarter, as compared to the same quarter last year, we had approximately a 2% headwind to our year-over-year revenue growth rate as a result of having increased SaaS sales in our booking mix, which are recognized fully ratable versus the upfront recognition of our on-prem subscription products. Subscription revenues were 116.7 million, and maintenance and services revenue was 25.9 million, as our renewal rates again were over 90%.

When looking at our reported maintenance and services growth rate on a year-over-year basis, I'd like to call out three headwinds which impact the comparability: a, FX with a 200 basis-point headwind; b, the exit of our Russia business with another 200 basis points of headwind; and c, the conversion of perpetual maintenance to on-prem subscription was 100 basis points, for a total of approximately 500 basis points. In North America, revenues grew 17% to $104.3 million, or 73% of total revenue, reflecting a slowdown in the economy in the region and a headwind from the SaaS mix shift. In EMEA, revenues grew 1% to 34.4 million, or 24% of total revenues. Adjusting for FX in Russia, growth was 16%.

Rest of world revenues grew 19% to $3.9 million, or 3% of total revenue. Moving down the income statement. I'll be discussing non-GAAP results going forward. Gross profit for the fourth quarter was 128.3 million, representing a gross margin of 89.9% compared to 89.6% in the fourth quarter of 2021.

Operating expenses in the fourth quarter totaled 102.3 million. As a result, fourth quarter operating income was $26 million, or an operating margin of 18.2%. This compares to operating income of $22.4 million, or an operating margin of 17.7% in the same period last year. After accounting for the 50 basis-point headwind related to our shekel hedging program, the expansion was 100 basis points.

During the quarter, as compared to the same quarter last year, we had approximately a 1.5% headwind to our operating margin as a result of having increased SaaS sales in our booking mix, which are recognized fully ratable versus the upfront recognition of our on-prem subscription products. During the quarter, we had financial income of approximately $5.2 million, driven by interest income on our cash and short-term investments. Net income for the fourth quarter of 2022 was $26.1 million, or income of $0.21 per diluted share, compared to net income of $18.5 million, or income of $0.16 per diluted share, for the fourth quarter of 2021. This is based on 126 million and 118.6 million diluted shares outstanding for Q4 2022 and Q4 2021, respectively.

As of December 31, 2022, we had $732.5 million in cash, cash equivalents, marketable securities, and short-term deposits. For the 12 months ended December 31, 2022, we generated $11.9 million of cash from operations compared to $7.2 million generated in the same period last year. FX for 2022 was $11.4 million compared to $10.5 million last year. Free cash flow improved from negative $3.3 million in 2021 to $0.5 million in 2022 despite an approximate $4 million headwind from the Tax Cuts and Jobs Act capitalization of R&D provision.

During the fourth quarter, we repurchased 2.9 million shares at an average purchase price of $19.37, and we have $43.6 million remaining on our share repurchase authorization. We ended the year with approximately 2,150 employees, a decrease from the third quarter, which reflects the 5% headcount reduction measures taken, which were completed in the fourth quarter. I will now briefly recap our full year 2022 results. Total revenues grew 21% to $473.6 million, or 25% adjusting for FX in Russia.

Our full year operating margin was 6.2% compared to 6.5% for 2021. After adjusting for the 200 basis-point headwind from our shekel hedging program, the expansion was 170 basis points. Turning to our guidance in more detail. From a macro perspective, we are factoring in a continued worsening of economic conditions across the board, which assumes four quarters of softness in both the EMEA and North America versus 2 to 2.5 and one quarter, respectively, in 2022.

This also continues to factor in additional budgetary scrutiny, longer sales cycles, and an increase in unemployment expectations among a worsening of other economic conditions. From a SaaS transition standpoint, we are factoring in a six-month ramp-up period, which began in early January when the new sales comp plan was introduced. Our guidance also assumes increased sales force turnover in the first half of the year; lower sales productivity, as our sales force gains comfort in selling the new product; as well as longer sales cycles as on-prem subscription deals in the pipeline may convert to SaaS. These assumptions will primarily impact the first and second quarters and are based on learnings from our last transition.

While all of these factors create a level of uncertainty, this is already contemplated in our guidance. Before I get into the numbers, our first quarter and full year guidance now assume a 15% SaaS mix of new business and upsell ARR, up from 5% previously. This reflects the encouraging initial reception from our customers and our sales force to our new SaaS product in the fourth quarter. We have a two-phased approach to the transition.

In phase 1, which we just initiated, we are focused on selling SaaS to new customers. And this metric will help you gauge the success of this initiative. Phase 2, which is converting our base of existing customers to SaaS, will come later on. But if an existing customer wants the benefit of our SaaS earlier, we will, of course, work with them as we always do.

To be clear, the SaaS mix calculation is SaaS new business and upsell ARR, divided by total new business and upsell ARR. For example, if we had a renewal of $100,000 that converts to SaaS at $150,000, then we would only include the incremental $50,000 of upsell in the numerator and denominator of the SaaS mix calculation. Now, turning to our guidance. For the first quarter of 2023, we expect total revenues of $106 million to $108 million, representing growth of 10% to 12%.

Non-GAAP operating loss of negative $7 million to negative $6 million, and non-GAAP net loss per basic and diluted share in the range of negative $0.05 to negative $0.04. This assumes 108.5 million basic and diluted shares outstanding. For the full year of 2023, we expect ARR of 513 million to 523 million, representing year-over-year growth of 10% to 12%; free cash flow of 20 million to 25 million, which includes the $6 million to $8 million headwind related to the TCJA capitalization of R&D provision; total revenues of 519 million to 529 million, representing growth of 10% to 12%; non-GAAP operating income of $36 million to $41 million; and non-GAAP net income per diluted share in the range of $0.33 to $0.35. This assumes a 127.3 million diluted shares outstanding, and capex is expected to be $8 million to $10 million.

In summary, we remain laser-focused on execution on our SaaS transition and thoughtfully managing our business for long-term growth under any economic conditions, which, in turn, will unlock significant value for all Varonis stakeholders. Thanks for joining us today. I look forward to seeing you all in person at our investor day on March 14 in New York. With that, we would be happy to take questions.

Operator?

Questions & Answers:

Operator

[Operator instructions] And our first question comes from the line of Matt Hedberg with RBC Capital Markets. Please proceed with your question.

Matt Swanson -- RBC Capital Markets -- Analyst

Yeah. Thank you. This is Matt Swanson on for Matt. And, you know, congratulations, guys, on the quarter in this macro, especially on that SaaS transition.

I guess, you know, guys, you made a comment about your guidance that you're using some of the insights you learned from your subscription transition. And I think, just given the rapid pace and success of that subscription transition, it might be helpful for us to hear a little more about what you're seeing that's the same and maybe what's different in these early stages of the SaaS transition based on your conversations with customers and with your sales force.

Guy Melamed -- Chief Financial Officer

That's a great question. I think when we when we look at the introduction of the SaaS offering that we really only introduced 100 days ago, the feedback that we're receiving from both our customers and our sales team is very positive. With that said, it's very, very early in the transition, so there's a lot of lessons that we've taken from the previous transition. And that's why when we built the guidance, we factored in, you know, some deterioration in the macroeconomic environment, and we factored a lot of kind of longer sales cycles and more deal scrutiny.

But from the SaaS perspective, we factored in a six-month ramp-up period. And that really just started in January when we introduced the new comp plan. But on top of that, we also kind of assumed increased sales force turnover in the first half of the year; lower sales productivity as our sales force gained comfort in selling the new product; and on top of that, we also assumed that our sales teams are going to try and convert some of the deals that are in the pipe as on-prem subscription and try and convert them to SaaS. All of these assumptions are baked into our guidance.

And the expectation is that they will impact us mostly in the first six months of the year. But I can tell you that, overall, the feedback that we've received has been extremely positive.

Operator

Thank you. And the next question comes from the line of Hamza Fodderwala with Morgan Stanley. Please proceed with your question.

Hamza Fodderwala -- Morgan Stanley -- Analyst

Hi, guys. Good evening. Thank you for taking my question. Just a couple of quick clarifying questions.

It seemed like EMEA, the growth rate there on a constant currency basis was pretty consistent with what you saw in Q3. Is it fair to say that region came in a little bit better than you expected? And then, Guy, you talked about doubling down on the bundle strategy. Can you talk a little bit about how you're thinking about discounting into '23 to drive that SaaS adoption? Are we thinking about those maybe going up a bit to get that SaaS adoption up front? Or are they more or less staying the same versus a year ago? Thank you.

Yaki Faitelson -- Chief Executive Officer

All right. You know, overall, the adoption in Europe was what we expected. And regarding the bundles, we just thought about the value. With the bundles, customers will get just a lot of automation and just works extremely well with our SaaS strategy.

The SaaS is still in the early innings, and we need to see how it will evolve. But so far, the initial reaction is very, very good.

Guy Melamed -- Chief Financial Officer

And just to touch on the actual percentages, EMEA revenue was at 1% in Q4. And, yes, as you mentioned, when you factor in the FX, the effect of the FX and the exit of the Russia business, when you kind of look at it on a constant currency basis, excluding Russia, we were at 16%. With that said, we definitely saw kind of the macroeconomic environment in Europe with longer sales cycles, more deal scrutiny. And we definitely saw that in Q4, as well as in Q3.

And when we look at the 2023 guidance, we baked in, kind of continued the deterioration from this point kind of for the rest of the year, and the fact that we're ramping up kind of the SaaS transition and taking that into consideration as well.

Operator

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

Saket Kalia -- Barclays -- Analyst

OK, great. Hey, guys. Thanks for taking my question here. Yaki, maybe I'll direct it to you.

You know, so a lot of fun stuff here with SaaS in the early days. But I was wondering if you could just share some of the early customer feedback that you've gotten. You know, you went through some of them. But I'm curious, are customers buying this because it's easier to support, right, because Varonis is hosting it? Or is it because Varonis cloud maybe covers more applications, or something else? And again, understanding that it's still very early.

What do you think the main selling points have been early on from a customer perspective?

Yaki Faitelson -- Chief Executive Officer

The main selling point is, without a doubt, the outcomes. We thought it's a complete game changer regarding the outcomes. We have -- when we built it, we had the rule, and we said 10% of the effort contains more value. And we managed to fulfill the vision, you know, end to end.

When you are coming, it's very easy to install. But then the ability to classify data automatically and understand what data is critical and overexposed. And now with 365, the Varonis robot us doing the rightsizing of the permissions completely automatically that we see all the abnormal behavior in our cloud. And proactively, we are doing it for the customers.

Customers, Saket, can realize massive value with doing nothing. It's completely, completely automatic. Having said that, also, the overall time to value your [Inaudible] requirements. So, yes, there is a lot of data on-prem, and it's going.

But you just, you know, you need a collector. So, the setup is fraction of the time and everything that's related to our ability to also to find attacks that are closer to the data served early in the kill chain works extremely well. So, we're able to fulfill the vision. We are very, very excited from everything we see now, from the outcomes, the automation, the stability, our ability to solve problems.

Definitely, so far, many, many very encouraging signs.

Operator

[Operator instructions] Our next question comes from the line of Fatima Boolani with Citi. Please proceed with your question.

Fatima Boolani -- Citi -- Analyst

Hi. Good evening. Thank you for taking my questions. Guy, this one's for you.

You talked about introducing a new compensation program and sales incentives to drive selling behavior around the SaaS platform. I'm curious, does that mean that you've completely de-emphasized and more or less created disincentives around selling term business? I mean, are you sunsetting that entire program entirely to shift 100% to SaaS selling? Any clarification there would be great. I'd appreciate it. Thank you.

Guy Melamed -- Chief Financial Officer

Fatima, it's a great question. When we build kind of the comp plan, we try and align it to what the company is trying to do from a strategic perspective. So, we worked a lot on trying to align them. And when you think about where the company is going, it kind of goes back to the color that we gave about phase 1 and phase 2, having kind of -- phase 1, targeting new customers and trying to sell them SaaS.

So, building the comp plan is really kind of -- it's a combination of an art and a science. We try to align having our reps focused on selling SaaS to new customers. And if they do that, there's a lot of carrots there. Obviously, we want to see how this progresses, and we'll give more color as we go along.

But the whole concept of the comp plan is to align where we want the company to go, and that's focusing on that phase 1, selling SaaS to new customers.

Operator

And the next question comes from the line of Joel Fishbein with Truist Securities. Please proceed with your question.

Joel Fishbein -- Truist Securities -- Analyst

Thank you. And thank you for taking my question. And I guess this is for both of you, guys. Yaki, you talked about, you know, that the SaaS is really selling bundles of the platform.

And I'm just curious if you can share -- I know it's early, but share how the -- you know, it's like for like, you know, what you are selling on-prem with the SaaS issue that would, you know, justify a 25% to 75% uplift in price. I think that's on a lot of people's minds with regard to, you know, how that transition actually works.

Yaki Faitelson -- Chief Executive Officer

I think that even unrelated to the bundle, it's very easy for us to justify because just the total cost of ownership on-prem. And, you know, we build a very sophisticated and coherent calculator, and we can show it to the customer. You know, so far, they understand it very well. In terms of buying the bundles, it's easy for the customer because, at the end of the day, they want automation.

You know, if you take a step back, in security, there is an end and means to an end. The end is always data. The issue is that data protection is very hard. And once you provide the load of automation, you're really taking the bottleneck out of the process.

And the only way to get automation is really to buy all the bundles. And with the bundles, the licenses, it's one plus one equals five many times. So, in most cases, it works very well. Total cost of ownership and just a lot of automation just provides very good ROI.

Everybody understand that they need to protect data. So, so far, we see that the offering is very compelling.

Guy Melamed -- Chief Financial Officer

And just to touch on the bundling, like Yaki said, we're basically doubling down on the success that we saw with the on-prem subscription bundling. So, customers, they'll see more value in the initial deal. And they'll buy more over time, which really increases the initial deal size, but also the retention metrics and the customer lifetime value. But it also helps our sales force because, really, it's a simpler discussion both on the initial deal and on the renewals as well.

So, we're not trying to sell 40 different products. We're trying to sell the outcomes. We're trying to sell the Varonis platform. And that really both helps our customers and helps our sales force.

Yaki Faitelson -- Chief Executive Officer

But the discussion is, you know, just about the value, and then, you can represent it with one SKU and say, "This is a license. That is a license." People are trying to solve problems, and this is what we have them to do.

Operator

And the next question comes from the line of Brian Essex with JPMorgan. Please proceed with your question.

Brian Essex -- JPMorgan Chase and Company -- Analyst

Great. Thank you. Good evening, and thank you for taking the question. Maybe I have one question for Yaki, if you will.

It sounds like guidance is kind of on the conservative side, if you're modeling in kind of incremental deterioration. And conversations with CIOs that we're having indicate kind of more back-half weighted seasonality is they're taking a cautious approach to spending this year. Could you help us understand, you know, what your conversations with customers are like with regard to spending intentions for the year? It sounds like your backlog is building quite nicely. And how to think about -- how they might be prioritizing data security within this, I guess, stratification of security spending that they have.

Where does that fall on a priority scale? And are you just assuming deferrals into the back half of the year and then deterioration on top of that? Or what might your outlook be for like, you know, better-than-expected spending environment at the second half as it relates to customer conversations that you're having?

Yaki Faitelson -- Chief Executive Officer

Most of the customers security efforts, the objective is to protect their digital assets. And now, we have the technological platform with the SaaS to do it completely automatically. So, trying to solve something that is hard, many times, they will postpone it, and what we see now is the SaaS. But it's still early stages, but we see that it's much easier for us to get budgets, to show value.

And customers don't need to put a lot of effort. So, we believe that with time, when the sales force will know how to sell it in the right way, the customer will understand it. We really reduced so much friction in every step in the sales motion and in the value journey of our customers. So, this is very exciting.

The other thing that we saw historically is that many times, it is hard times, organizational sitting and really analyzing and scrutinizing where they need to put the dollars. And we always benefit from it. Because you want to protect data. And in this environment, after COVID, it's very hard for almost -- very easy for almost every organization, very easy to understand where the critical data and what do you need to do with it.

So, where you have critical data with a lot of collaboration, all the directly services. So, today we can say yes on almost all the automation, and we support almost all the critical data repositories on-prem and in the cloud. So, I think that, over time, we believe that there is a high probability that more and more budget will come toward us because this is the problem that the customers are trying to solve. And you can do it automatically.

It just should be a top priority for most of them. I see many customers, and I can tell you the data protection, protecting the digital assets is a top priority for almost every organization out there. And I also believe that, with time, you see that it's a strong secular trend. And many other security line items are more cyclical than that.

So, you know, data is going and going in many repositories, and this is what bad actors want. If it is always insider, ransomware attacks, this is the objective, to get data. And once customers get the data, it's all -- you can't enrich data. So, we are just in the right place, and we have the right technology to do it almost effortlessly for the customers.

Operator

Thank you. And our next question comes from the line of Roger Boyd with UBS Securities. Please proceed with your question.

Roger Boyd -- UBS -- Analyst

Great. Thank you for taking my question, and congrats on the quarter. Guy, you talked about sales force's attention maybe drifting to the Varonis SaaS offering over DatAdvantage cloud in the quarter. I'm just curious like what sort of synergies are there for DatAdvantage cloud to be sold now that Varonis SaaS has been launched? Is there a broader bundling opportunity there? And then, as you think about the 50% SaaS mix for calendar '23, how should we think about DA cloud versus Varonis SaaS contributing there? Thanks.

Guy Melamed -- Chief Financial Officer

I'm trying to address the subquestion within the question. First of all, we increased the SaaS mix from 5% 100 days ago to 15%. Going forward, we're going to talk about SaaS sales as a whole. We definitely see reps and our account managers trying to sell to customers, both the Varonis SaaS and the DA cloud.

I've talked a lot about the fact that the DA cloud takes time from an adoption perspective. And we've seen that in the past with other licenses where, you know, until -- it takes some time, and we saw that with the Office 365, where it took some time. And then it started becoming a major contributor. We feel very positive about the DA cloud being a tailwind for us in the years ahead.

I think when you look at kind of the synergies there, the fact that we protect data, wherever it resides, is a great advantage. And, you know, we can enter into new customers that had applications that we couldn't support before, and now, we can support them. And that, combined with Varonis SaaS, gives a significant value to our customers that Yaki talked about before.

Yaki Faitelson -- Chief Executive Officer

And I think if you look at what we are supporting, very easy to understand what is the adoption of these SaaS applications in the cloud data repositories. And you see that it's something that almost every organization has. So, what is happening today is that Varonis is really protecting data, and we want to protect critical data wherever you have it, with all the access, all the data flows, you know, that users are doing and application APIs, and to do it automatically. So, we believe that the whole platform is something that almost every organization is in.

Operator

[Operator instructions] And our next question comes from the line of Shaul Eyal with Cowen and Company. Please proceed with your question.

Shaul Eyal -- Cowen and Company -- Analyst

Thank you. Hi. Good afternoon, guys. Congrats on the SaaS -- on the rapid progress.

Are you seeing similar SaaS buying behavior between U.S. and EMEA? Or is SaaS, for some reason, more pronounced in the U.S.?

Yaki Faitelson -- Chief Executive Officer

So, in Q4, we did it only in terms of the Varonis SaaS. We've done it only in the U.S. We open it now in EMEA, and the pipeline is encouraging. And so, you know, we will give you more details as this is progressing.

But in general, we just see that it's just no way -- in terms of the objections, you know, I don't have time, I don't have hardware, or I don't have people. It's -- we really eliminated all the major objections. If you have critical data and you want to protect it, the way to do it is to use our platform.

Operator

And our next question comes from the line of Joseph Gallo with Jefferies. Please proceed with your question.

Joe Gallo -- Jefferies -- Analyst

Hey, guys. Appreciate the question. I just wanted to follow up on DA cloud since I think that's such an important growth factor for you, guys. Guy, you had mentioned that it takes time.

You specifically mentioned the Office product. What is it that takes time? Is it a product feature issue? Is it an awareness issue? Is it a sales comfortability issue? Just kind of curious if you could provide a little more detail on that.

Yaki Faitelson -- Chief Executive Officer

It's Yaki. In terms of the DA cloud, we just wanted to make sure that the product is very mature, and we have all the feature set. And if you can see all the releases we have done in the fourth quarter, they are tremendous. You know, in each one of the use cases, detection and response, data protection, we have a lot of configuration management there and also classification.

Once you have everything, it's also -- you know, you take sometimes the sales force knows how to sell it, and we have done it. What Guy mentioned is that in the fourth quarter, when you have Varonis SaaS, when you are always -- when you release something like that, and you're introducing SaaS, there is some kind of friction. This is why we told you that every time we are doing something major like that, it takes us just two quarters to get our ducks in a row, if you will. But DA cloud is -- we believe that it's a tremendous growth engine for us.

You know, we have a lot of data in this repository, very complex commission structure, a lot of configuration, also a lot of API connectivity. These are tremendous platforms that introduce a lot of risks. And our very unique intellectual property works very well there. And we believe that DA cloud is a massive opportunity for the company moving forward.

And we have done all the right things in terms of development, enablement to make sure that we can realize great gains from this platform in the future.

Operator

And our next question comes from the line of Rob Owens with Piper Sandler. Please proceed with your question.

Rob Owens -- Piper Sandler -- Analyst

Thanks for taking my questions. Curious on the roadmap for the SaaS solution. And are you currently at feature parity with on-prem? And what's to come down the pike in the near term? Thanks.

Yaki Faitelson -- Chief Executive Officer

Hi, Rob. Thanks for the question. So, we are not in complete digital parity, but they are starting the SaaS stuff that are much more advanced than on-prem. Some things in the on-prem, we need to be on parity.

We are moving very, very fast with the cloud. It's a feat to 70%, 80% of the Varonis on-prem customers, and it's a feat for every new customer will get to parity. We also have many new advancements in this platform, so we really prioritize. The other thing, you know, the beauty of the cloud is that we can see the usage.

We can see how -- you know, stuff that we are doing affecting our customers, and we can prioritize effectively.

Operator

And our next question comes from the line of Chad Bennett with Craig-Hallum. Please proceed with your question.

Chad Bennett -- Craig-Hallum Capital Group -- Analyst

Great. Thanks for taking my question. So, maybe for Guy. Just -- it seems like you're obviously seeing pretty significant early traction in the SaaS platform.

And so, you upped kind of your sales mix or ARR mix from 5 to 15. And assuming that that price lift sticks of 25 to 30, I think you effectively reiterated ARR for this year relative to what you talked about before. Wouldn't that be, you know, an uplift or a tailwind to overall ARR if, in fact, you know, you're seeing a higher mix of SaaS ARR that's higher priced?

Guy Melamed -- Chief Financial Officer

Hi, Chad. Like you're saying, we definitely saw a lot of great traction with the SaaS introduction, which gave us the confidence to increase the SaaS mix from 5% to 15%. With that said, we're very early in this transition. And that's why when you look at kind of the ARR number, when you look at the overall number, it didn't move much.

We did increase it slightly, but it didn't move much. This is because we're at the beginning of the year. We wanted to start. We talked about kind of the six-month ramp-up time that we factored in.

But we feel very good about the SaaS offering. And over the last 100 days, we gained a lot of great feedback from both our customers and our sales force.

Operator

And our next question comes from the line of Andy Nowinski with Wells Fargo. Please proceed with your question.

Andy Nowinski -- Wells Fargo Securities -- Analyst

All right. Thank you. I just had a question in the SaaS mix also. So, I think you generated 10% of the new business from SaaS in Q4.

And then, you said 15% in Q1 and 15% for the year. So, I'm wondering, why wouldn't the mix continue to increase throughout the year as more sales reps get ramped up and etc.? So, just wondering why it's staying flat at 15% after Q1.

Guy Melamed -- Chief Financial Officer

You know, 100 days ago, it was a 5% mix and we get -- we gained -- like I said before, we gained a lot of confidence. But again, we're very early in this process. And we do expect some friction that will happen in the first six months of the transition, which is already baked in the guidance. We will obviously update everyone as we progress through this transition, and we'll give more color as we see kind of the pipeline build.

But because we're so early in this transition, we moved it up from 5% to 15%. And we want to start with this. And then we'll update and give -- we'll be as transparent as possible throughout the transition and give metrics that can allow everyone to see the progress and the progression within the transition.

Operator

And our next question comes from the line of Shrenik Kothari with Robert W. Baird. Please proceed with your question.

Shrenik Kothari -- Robert W. Baird and Company -- Analyst

Hey. Good evening. Great to hear about the SaaS progress. And thanks for taking my question.

So, one for Yaki, and then a quick follow-up for Guy. So, Yaki, you mentioned about the slowing macro continuing to impact customers, continued worsening of conditions across the board, both EMEA and spillover into North America. Just comparing with your commentary last quarter, you cited, of course, EMEA revenues. But there was also some weakness in the U.S.

federal. Can you comment on the U.S. federal trends? Is it trending above your expectations now, or in line? Just quick commentary. And then, very quickly on the operating margins, you mentioned about 1.5% headwinds.

Just wanted to know the breakdown between hosting and support cost versus sales incentive structure related headwinds. Thank you.

Yaki Faitelson -- Chief Executive Officer

We are building a very healthy pipeline in the federal market. The sector, in general, has a lot of critical data that they need to protect and many bad actors that want the data. If you want to protect these massive data flow, you need a solution like ours. And we believe that we can do very well in the federal market.

And, you know, when you have an economic slowdown, it's usually impacting IT spend. But again, if you have critical data, someone wants it, it's just essential for every business. So, we believe that with the SaaS we're doing, we can weather any economic slowdown very effectively.

Guy Melamed -- Chief Financial Officer

In terms of the margins, one of the things that we've talked a lot about, and you've probably heard me talk about ARR being the leading indicator for the last six quarters, we wanted to make sure that everyone understands that when we're shifting our business from term license, where we recognize approximately 80% of the deal's value upfront to a SaaS model with kind of a fully ratable revenue, it will make our income statement metric less indicative of the health of the business than it's been in the past. So, the headwind that we're talking about is obviously impacted the most by the way revenue is recognized between the two models. And that's why we said that throughout the transition, ARR and free cash flow will be our north stars because they are not impacted by the speed of the transition. So, obviously, as we announced our investor day happening on March 14, we'll give more color.

We'll give more color, not just on the headwinds, but we'll give color on KPIs. And we'll try and be as transparent as possible to allow analysts and investors to walk with us during this transition.

Operator

[Operator instructions] Our next question comes from the line of Joshua Tilton with Wolfe Research. Please proceed with your question.

Joshua Tilton -- Wolfe Research -- Analyst

Hey, guys. Can you hear me?

Guy Melamed -- Chief Financial Officer

Yup.

Joshua Tilton -- Wolfe Research -- Analyst

Great. So, just one quick one for me. I think we all walked away from that [Technical Difficulty] 4Q guidance and the initial 2023 guidance were derisked. But you guys, I know, may be 5%.

And there was no real change in the growth outlook for 2023. So, I guess, is the message still to same, like, should we walk away with the feeling that you guys are kind of derisked the growth outlook for 2023?

Guy Melamed -- Chief Financial Officer

The line is very hard to hear, but I think I understood the question of whether we feel more confident about our guidance, and have we still factored in macroeconomic uncertainties. And if that's the question, the answer is basically yes to both. We feel more confident about where we are today versus where we were 100 days ago. The reception of the SaaS offering has been extremely positive.

I thought we talked about that, both from our customers and our sales force. With that said, when we look at the guidance for 2023, we did bake in additional worsening of the economic conditions across the board. We assumed softness in EMEA and North America. We assumed budgetary scrutiny for longer sales cycles, basically, worsening of the economic conditions.

So, we feel better about the business. But as we guide today for 2023, we wanted to account for both macroeconomic deterioration and some of the friction that might occur with the introduction of the SaaS offering. And that would -- ramp-up time of basically six months.

Operator

And our next question comes from the line of Erik Suppiger with JMP Securities. Please proceed with your question.

Erik Suppiger -- JMP Securities -- Analyst

Yeah, thanks for taking the question. Can you just talk a little bit about the linearity that you saw through the quarter? It sounds like things may be eroded. So, did the end of the quarter slow? And then, you also talked about some turnover in the sales organization. Can you comment on what kind of turnover are you expecting in the sales organization?

Guy Melamed -- Chief Financial Officer

So, the quarter actually behaved very similar in terms of seasonality. We didn't see any abnormal behavior. When we look at kind of the seasonality, we're similar to other software enterprise businesses. We do have a large component of the business come in the last couple of weeks of every quarter.

So, we didn't see any major trends there. In terms of the turnover, I can tell you that the reception of the SaaS offering, as we've mentioned several times on this call, has been extremely positive. But some of the lessons that we've taken from kind of the move from perpetual to the on-prem is some increased turnover, which we baked into our guidance and factored that in. So, that's kind of the way we thought about it.

But as of now, everything's kind of going in line with our expectations.

Operator

And our final question comes from the line of Shebly Seyrafi with FBN Securities. Please proceed with your question.

Shebly Seyrafi -- FBN Securities -- Analyst

Yes. Thank you very much. So, I want to delve into the 13-point deceleration in North America growth from 30% to 17%. How much of that was the SaaS headwind? Can you talk about like the different trends you saw between the large customers and smaller customers? And finally, did you see, in January, February -- early February, this month, a notable pickup in North America business versus the end of last year?

Guy Melamed -- Chief Financial Officer

When we gave guidance last quarter, we said that we expected to see some spillover from the macroeconomic conditions in EMEA to North America with some increased deal scrutiny and longer sales cycles in the region. And that was in line with our expectations. So, the results that we saw in Q4 were kind of in line of how we saw it when we guided last quarter. There was about 300 basis points of headwind from the SaaS mix shift that impacted our North America reported revenue in Q4.

And in terms of January and February, February only just started, but I can tell you we gave guidance. We feel good with the guidance that we have provided. And we'll update as we kind of progressed, and we'll give some color on the SaaS transition during our investor day on March 14.

Operator

At this time. There are no further questions. Now, I would like to turn the floor back over to Tim Perz for any closing comments.

Tim Perz -- Investor Relations

Thanks for joining us today. We look forward to seeing you all at our investor day on March 14th in New York.

Operator

[Operator signoff]

Duration: 0 minutes

Call participants:

Tim Perz -- Investor Relations

Yaki Faitelson -- Chief Executive Officer

Guy Melamed -- Chief Financial Officer

Matt Swanson -- RBC Capital Markets -- Analyst

Hamza Fodderwala -- Morgan Stanley -- Analyst

Saket Kalia -- Barclays -- Analyst

Fatima Boolani -- Citi -- Analyst

Joel Fishbein -- Truist Securities -- Analyst

Brian Essex -- JPMorgan Chase and Company -- Analyst

Roger Boyd -- UBS -- Analyst

Shaul Eyal -- Cowen and Company -- Analyst

Joe Gallo -- Jefferies -- Analyst

Rob Owens -- Piper Sandler -- Analyst

Chad Bennett -- Craig-Hallum Capital Group -- Analyst

Andy Nowinski -- Wells Fargo Securities -- Analyst

Shrenik Kothari -- Robert W. Baird and Company -- Analyst

Joshua Tilton -- Wolfe Research -- Analyst

Erik Suppiger -- JMP Securities -- Analyst

Shebly Seyrafi -- FBN Securities -- Analyst

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