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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
____________________
FORM 10-Q
____________________
(Mark One)

☒ | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2023
or

☐ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to
Commission File Number: 001-36324
____________________
VARONIS SYSTEMS, INC.
(Exact name of registrant as specified in its charter)
____________________

Delaware |  | 57-1222280 |
(State or other jurisdiction of incorporation or organization) |  | (I.R.S. Employer Identification No.) |
1250 Broadway, 28th Floor | New York | NY | 10001 |
(Address of principal executive offices) |  | (Zip Code) |

(877) 292-8767
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:

Title of each class | Trading Symbol(s) | Name of each exchange on which registered
Common Stock, par value $0.001 per share | VRNS | The NASDAQ Stock Market LLC

____________________
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities and Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. ý Yes ¨ No

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). ý Yes ¨ No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer | ý | Accelerated filer | ¨
Non-accelerated filer | ¨ | Smaller reporting company | ☐
|  | Emerging growth company | ☐

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). ☐
Yes ý No
As of April 28, 2023, there were 109,712,572 shares of common stock, par value $0.001 per share, outstanding.

TABLE OF CONTENTS

PART I. FINANCIAL INFORMATION | 1
Item 1. | Financial Statements | 1
Consolidated Balance Sheets as of March 31, 2023 (unaudited) and December 31, 2022 | 1
Unaudited Consolidated Statements of Operations for the Three Months Ended March 31, 2023 and 2022 | 3
Unaudited Consolidated Statements of Comprehensive Loss for the Three Months Ended March 31, 2023 and 2022 | 4
Unaudited Consolidated Statements of Changes in Stockholders’ Equity as of March 31, 2023 and 2022 | 5
Unaudited Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2023 and 2022 | 6
Notes to Unaudited Consolidated Financial Statements | 7
Item 2. | Management’s Discussion and Analysis of Financial Condition and Results of Operations | 20
Item 3. | Quantitative and Qualitative Disclosures About Market Risk | 31
Item 4. | Controls and Procedures | 32
PART II. OTHER INFORMATION | 32
Item 1. | Legal Proceedings | 32
Item 1A. | Risk Factors | 32
Item 5. | Purchase of Equity Securities | 57
Item 6. | Exhibits | 58
SIGNATURES |  | 59
EXHIBIT INDEX |  | 60

PART I. | FINANCIAL INFORMATION

Item 1. | Financial Statements

VARONIS SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)

| March 31, 2023 |  | December 31, 2022
| (unaudited) |  |
Assets |  |  |
Current assets: |  |  |
Cash and cash equivalents | $ | 248,585 |  |  | $ | 367,800 |
Marketable securities | 280,835 |  |  | 236,338 |
Short-term deposits | 226,850 |  |  | 128,350 |
Trade receivables (net of allowances of $3,431 and $3,453 at March 31, 2023 and December 31, 2022, respectively) | 75,393 |  |  | 135,979 |
Prepaid expenses and other current assets | 44,381 |  |  | 37,190 |
Total current assets | 876,044 |  |  | 905,657 |
Long-term assets: |  |  |
Operating lease right-of-use asset | 55,692 |  |  | 56,772 |
Property and equipment, net | 37,643 |  |  | 39,043 |
Intangible assets, net | 2,406 |  |  | 2,788 |
Goodwill | 23,135 |  |  | 23,135 |
Other assets | 16,400 |  |  | 16,337 |
Total long-term assets | 135,276 |  |  | 138,075 |
Total assets | $ | 1,011,320 |  |  | $ | 1,043,732 |
Liabilities and stockholders’ equity |  |  |
Current liabilities: |  |  |
Trade payables | $ | 708 |  |  | $ | 2,962 |
Accrued expenses and other short-term liabilities | 107,338 |  |  | 115,231 |
Deferred revenues | 109,297 |  |  | 110,550 |
Total current liabilities | 217,343 |  |  | 228,743 |
Long-term liabilities: |  |  |
Convertible senior notes, net | 249,339 |  |  | 248,963 |
Operating lease liability | 55,993 |  |  | 57,627 |
Deferred revenues | 1,382 |  |  | 1,503 |
Other liabilities | 5,985 |  |  | 4,771 |
Total long-term liabilities | 312,699 |  |  | 312,864 |
Stockholders’ equity: |  |  |
Share capital |  |  |
Common stock of $0.001 par value - Authorized: 200,000,000 shares at March 31, 2023 and December 31, 2022; Issued and outstanding: 109,791,863 shares at March 31, 2023 and 107,673,052 shares at December 31, 2022 | 110 |  |  | 108 |

1

Accumulated other comprehensive loss | (14,381) |  |  | (9,557) |
Additional paid-in capital | 1,077,327 |  |  | 1,055,048 |
Accumulated deficit | (581,778) |  |  | (543,474) |
Total stockholders’ equity | 481,278 |  |  | 502,125 |
Total liabilities and stockholders’ equity | $ | 1,011,320 |  |  | $ | 1,043,732 |

The accompanying notes are an integral part of these consolidated financial statements.
2

VARONIS SYSTEMS, INC. AND SUBSIDIARIES
UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except share and per share data)

| Three Months Ended March 31, |  |
| 2023 |  | 2022 |  |  |  |
Revenues: |  |  |  |  |  |  |
Subscriptions | $ | 82,974 |  |  | $ | 68,985 |  |  |  |  |
Maintenance and services | 24,361 |  |  | 27,276 |  |  |  |  |
Total revenues | 107,335 |  |  | 96,261 |  |  |  |  |
Cost of revenues | 17,637 |  |  | 17,809 |  |  |  |  |
Gross profit | 89,698 |  |  | 78,452 |  |  |  |  |
Operating expenses: |  |  |  |  |  |  |
Research and development | 44,732 |  |  | 43,570 |  |  |  |  |
Sales and marketing | 68,393 |  |  | 64,787 |  |  |  |  |
General and administrative | 19,689 |  |  | 18,180 |  |  |  |  |
Total operating expenses | 132,814 |  |  | 126,537 |  |  |  |  |
Operating loss | (43,116) |  |  | (48,085) |  |  |  |  |
Financial income, net | 7,773 |  |  | 736 |  |  |  |  |
Loss before income taxes | (35,343) |  |  | (47,349) |  |  |  |  |
Income taxes | (2,961) |  |  | (1,414) |  |  |  |  |
Net loss | $ | (38,304) |  |  | $ | (48,763) |  |  |  |  |
Net loss per share of common stock, basic and diluted | $ | (0.35) |  |  | $ | (0.45) |  |  |  |  |
Weighted average number of shares used in computing net loss per share of common stock, basic and diluted | 108,387,402 |  |  | 108,204,960 |  |  |  |  |

The accompanying notes are an integral part of these consolidated financial statements.
3

VARONIS SYSTEMS, INC. AND SUBSIDIARIES
UNAUDITED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
(in thousands)

| Three Months Ended March 31, |  |
| 2023 |  | 2022 |  |  |  |
Net loss | $ | (38,304) |  |  | $ | (48,763) |  |  |  |  |
Other comprehensive loss: |  |  |  |  |  |  |
Unrealized income (loss) on marketable securities, net of tax | 150 |  |  | (10) |  |  |  |  |
Income on marketable securities reclassified into earnings, net of tax | 6 |  |  | — |  |  |  |  |
| 156 |  |  | (10) |  |  |  |  |
Unrealized loss on derivative instruments, net of tax | (2,332) |  |  | (2,759) |  |  |  |  |
Income on derivative instruments reclassified into earnings, net of tax | (2,648) |  |  | (420) |  |  |  |  |
| (4,980) |  |  | (3,179) |  |  |  |  |
Total other comprehensive loss | (4,824) |  |  | (3,189) |  |  |  |  |
Comprehensive loss | $ | (43,128) |  |  | $ | (51,952) |  |  |  |  |

The accompanying notes are an integral part of these consolidated financial statements.
4

VARONIS SYSTEMS, INC. AND SUBSIDIARIES
UNAUDITED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
(in thousands, except share data)

| Common stock |  | Additional paid-in capital |  | Accumulated other comprehensive income (loss) |  | Accumulated deficit |  | Total stockholders’ equity
| Number |  | Amount |  |  |  |
Balance as of December 31, 2021 | 107,509,096 |  |  | $ | 108 |  |  | $ | 1,018,005 |  |  | $ | 6,083 |  |  | $ | (427,603) |  |  | $ | 596,593 |
Effect of adoption of ASU 2020-06 | — |  |  | — |  |  | (30,794) |  |  | — |  |  | 8,647 |  |  | (22,147) |
Stock-based compensation expense | — |  |  | — |  |  | 35,998 |  |  | — |  |  | — |  |  | 35,998 |
Common stock issued under employee stock plans | 2,057,101 |  |  | 2 |  |  | 6,109 |  |  | — |  |  | — |  |  | 6,111 |
Taxes paid related to net share settlement of equity awards | — |  |  | — |  |  | (28,825) |  |  | — |  |  | — |  |  | (28,825) |
Unrealized loss on derivative instruments | — |  |  | — |  |  | — |  |  | (3,179) |  |  | — |  |  | (3,179) |
Unrealized loss on available for sale securities | — |  |  | — |  |  | — |  |  | (10) |  |  | — |  |  | (10) |
Net loss | — |  |  | — |  |  | — |  |  | — |  |  | (48,763) |  |  | (48,763) |
Balance as of March 31, 2022 | 109,566,197 |  |  | $ | 110 |  |  | $ | 1,000,493 |  |  | $ | 2,894 |  |  | $ | (467,719) |  |  | $ | 535,778 |

| Common stock |  | Additional paid-in capital |  | Accumulated other comprehensive income (loss) |  | Accumulated deficit |  | Total stockholders’ equity
| Number |  | Amount |  |  |  |
Balance as of December 31, 2022 | 107,673,052 |  |  | $ | 108 |  |  | $ | 1,055,048 |  |  | $ | (9,557) |  |  | $ | (543,474) |  |  | $ | 502,125 |
Stock-based compensation expense | — |  |  | — |  |  | 35,811 |  |  | — |  |  | — |  |  | 35,811 |
Common stock issued under employee stock plans | 2,218,811 |  |  | 2 |  |  | 5,851 |  |  | — |  |  | — |  |  | 5,853 |
Taxes paid related to net share settlement of equity awards | — |  |  | — |  |  | (16,864) |  |  | — |  |  | — |  |  | (16,864) |
Repurchase of common stock | (100,000) |  |  | — |  |  | (2,519) |  |  | — |  |  | — |  |  | (2,519) |
Unrealized loss on derivative instruments | — |  |  | — |  |  | — |  |  | (4,980) |  |  | — |  |  | (4,980) |
Unrealized gain on available for sale securities | — |  |  | — |  |  | — |  |  | 156 |  |  | — |  |  | 156 |
Net loss | — |  |  | — |  |  | — |  |  | — |  |  | (38,304) |  |  | (38,304) |
Balance as of March 31, 2023 | 109,791,863 |  |  | $ | 110 |  |  | $ | 1,077,327 |  |  | $ | (14,381) |  |  | $ | (581,778) |  |  | $ | 481,278 |

The accompanying notes are an integral part of these consolidated financial statements.
5

VARONIS SYSTEMS, INC. AND SUBSIDIARIES
UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)

| Three Months Ended March 31,
| 2023 |  | 2022
Cash flows from operating activities: |  |  |
Net loss | $ | (38,304) |  |  | $ | (48,763) |
Adjustments to reconcile net loss to net cash provided by operating activities: |  |  |
Depreciation and amortization | 2,891 |  |  | 2,679 |
Stock-based compensation | 35,811 |  |  | 35,998 |
Amortization of deferred commissions | 3,462 |  |  | 6,120 |
Noncash operating lease costs | 2,367 |  |  | 2,326 |
Amortization of debt issuance costs | 376 |  |  | 370 |
Amortization of premium and accretion of discount on marketable securities | (1,293) |  |  | — |
Changes in assets and liabilities: |  |  |
Trade receivables | 60,586 |  |  | 53,575 |
Prepaid expenses and other current assets | (7,236) |  |  | (2,575) |
Deferred commissions | (3,033) |  |  | (6,942) |
Other long-term assets | (589) |  |  | 359 |
Trade payables | (2,254) |  |  | (553) |
Accrued expenses and other short-term liabilities | (15,794) |  |  | (12,502) |
Deferred revenues | (1,374) |  |  | (5,646) |
Other long-term liabilities | 1,214 |  |  | 96 |
Net cash provided by operating activities | 36,830 |  |  | 24,542 |
Cash flows from investing activities: |  |  |
Proceeds from sales and maturities of marketable securities | 16,650 |  |  | — |
Investment in marketable securities | (59,555) |  |  | (28,372) |
Proceeds from short-term and long-term deposits | 4,000 |  |  | 1,850 |
Investment in short-term and long-term deposits | (102,500) |  |  | (1,853) |
Purchases of property and equipment | (1,110) |  |  | (3,495) |
Net cash used in investing activities | (142,515) |  |  | (31,870) |
Cash flows from financing activities: |  |  |
Proceeds from employee stock plans | 5,853 |  |  | 6,111 |
Taxes paid related to net share settlement of equity awards | (16,864) |  |  | (28,825) |
Repurchase of common stock | (2,519) |  |  | — |
Net cash used in financing activities | (13,530) |  |  | (22,714) |
Decrease in cash and cash equivalents | (119,215) |  |  | (30,042) |
Cash and cash equivalents at beginning of period | 367,800 |  |  | 805,761 |
Cash and cash equivalents at end of period | $ | 248,585 |  |  | $ | 775,719 |
Supplemental disclosure of cash flow information: |  |  |
Cash paid for income taxes | $ | 351 |  |  | $ | 507 |
Cash paid for interest | $ | 1,608 |  |  | $ | 1,582 |
Supplemental disclosure of non-cash activities: |  |  |
Lease liabilities arising from obtaining right-of-use assets | $ | 997 |  |  | $ | 248 |

The accompanying notes are an integral part of these consolidated financial statements.
6

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1: GENERAL

a. | Description of Business:

Varonis Systems, Inc. ("VSI" and together with its subsidiaries, collectively, the “Company” or "Varonis") was incorporated under the laws of the State of Delaware on November 3, 2004, commenced operations on January 1, 2005 and has twelve wholly-owned subsidiaries.
The Company's software specializes in data protection, threat detection and response, data privacy and compliance. Varonis software enables enterprises of all sizes and industries to protect data stored on-premises and in the cloud including: sensitive files and emails; confidential personal data belonging to customers, patients and employees; financial records; source code, strategic and product plans; and other intellectual property. Recognizing the complexities of securing data, the Company has built an integrated platform for security and analytics to simplify and streamline security and data management.
The Company offers coverage for more than 40 of the most mission-critical on-premises and cloud data stores and applications. Over the last two years, the Company began to offer Software-as-a-Service ("SaaS") solutions to its customers, including its (i) flagship Data Security Platform as a SaaS that was previously only sold as an on-premises solution, which offers simpler deployment, faster time-to-value, and groundbreaking new automation capabilities, (ii) DatAdvantage Cloud hosted solution that centrally monitors and protects data across multiple cloud data stores, SaaS applications and Infrastructure-as-a-Service ("IaaS") environments and (iii) Data Classification Cloud to help automatically identify sensitive information.
The Varonis Data Security Platform helps enterprises protect data against cyberattacks from both external and internal threats. The Company's products enable enterprises to analyze data, account activity and user behavior to detect and prevent attacks. Its software platform prevents or limits unauthorized use of sensitive information, detects and prevents potential cyberattacks and limits potential damage by automatically locking down data, allowing access to only those who need it and automating the removal of stale data when it is no longer useful. The Company's products efficiently sustain a secure state with automation and address additional important use cases including data protection, data governance, Zero Trust, compliance, data privacy, classification and threat detection and response. The Varonis Data Security Platform is driven by a proprietary technology, our Metadata Framework, that extracts critical metadata, or data about data, from an enterprise’s information technology ("IT") infrastructure. The Varonis Data Security Platform uses this contextual information to map functional relationships among employees, data objects, systems, content and usage. In doing so, the platform provides real-time intelligence about an enterprise’s massive volumes of data, making it more secure, accessible and manageable.

b. | Basis of Presentation:

The accompanying unaudited consolidated interim financial statements have been prepared in accordance with Article 10 of Regulation S-X, “Interim Financial Statements” and the rules and regulations for Form 10-Q of the Securities and Exchange Commission (the “SEC”). Pursuant to those rules and regulations, the Company has condensed or omitted certain information and footnote disclosure it normally includes in its annual consolidated financial statements prepared in accordance with U.S. generally accepted accounting principles (“GAAP”).
In management’s opinion, the Company has made all adjustments (consisting only of normal, recurring adjustments, except as otherwise indicated) necessary to fairly present its consolidated financial position, results of operations and cash flows. The Company’s interim period operating results do not necessarily indicate the results that may be expected for any other interim period or for the full fiscal year. These financial statements and accompanying notes should be read in conjunction with the 2022 consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for its fiscal year ended December 31, 2022 filed with the SEC on February 7, 2023 (the “2022 Form 10-K”). There have been no changes in the significant accounting policies from those that were disclosed in the audited consolidated financial statements for the fiscal year ended December 31, 2022 included in the 2022 Form 10-K, unless otherwise stated.

c. | Revenue Recognition:

The Company generates revenues primarily in the form of subscription licenses, SaaS revenues and maintenance and services fees. Subscription license revenues are sold on-premises and are comprised of time-based licenses whereby customers use the Company's software (including support and unspecified upgrades and enhancements when and if they are available) for a specified period. In the second half of 2021, the Company launched its first SaaS offering, introducing new products and
7

support for cloud applications and infrastructure. On October 31, 2022, the Company announced the availability of the Varonis Data Security Platform as a SaaS, which was previously only sold as a self-hosted solution. Maintenance and services primarily consist of fees for maintenance of perpetual license sales (including support and unspecified upgrades and enhancements when and if they are available) and to a lesser extent professional services, which focus on both operationalizing the software and training its customers to fully leverage the use of the Company's products, although the user can benefit from the software without our assistance. The Company sells its products worldwide to a network of distributors and value-added resellers, and payment is typically due within 30 to 60 calendar days of the invoice date.
The Company recognizes revenues in accordance with ASC No. 606, “Revenue from Contracts with Customers.” As such, the Company identifies a contract with a customer, identifies the performance obligations in the contract, determines the transaction price, allocates the transaction price to each performance obligation in the contract and recognizes revenues when (or as) the Company satisfies a performance obligation.
Subscription software that is sold on-premises is recognized at the point of time when the software license has been delivered and the benefit of the asset has transferred. Maintenance associated with subscription licenses is recognized ratably over the term of the agreement and is included within the subscriptions line of the consolidated statements of operations. The Company's SaaS offerings allow customers to use hosted software, and its revenue is recognized ratably over the associated contract period. As these solutions were only recently offered to customers, and given that revenue is recognized ratably over the contract period, the total associated revenues are not yet significant. Should a customer request to convert from a license sold on-premises to the Company’s SaaS offering, the Company will accommodate the request on a pro-rata prospective basis.
The Company recognizes revenues from maintenance agreements ratably over the term of the underlying maintenance contract. The term of the maintenance contract is usually one year. Renewals of maintenance contracts create new performance obligations that are satisfied over the new term with the revenues recognized ratably over the period.
Revenues from professional services consist mostly of time and material services. The performance obligations are satisfied, and revenues are recognized, when the services are provided or once the service term has expired.
The Company enters into contracts that can include combinations of products and services, which are generally capable of being distinct and accounted for as separate performance obligations. The license is distinct upon delivery as the customer can derive the economic benefit of the software without any professional services, updates or technical support. The Company allocates the transaction price to each performance obligation based on its relative standalone selling price out of the total consideration of the contract. For maintenance, the Company determines the standalone selling prices based on the price at which it separately sells a renewal contract. For professional services, the Company determines the standalone selling prices based on the price at which it separately sells those services. For software licenses, the Company uses the residual approach to determine the standalone selling prices due to the lack of history of selling software license on a standalone basis and the highly variable sales price.
Trade receivables are generally recorded at the invoice amount mostly for a one-year period, net of an allowance for credit losses.
Deferred revenues represent mostly unrecognized fees billed or collected for maintenance. Deferred revenues are recognized as (or when) the Company performs under the contract. Pursuant to these contracts, customers are not invoiced for subsequent years until the annual renewal occurs. The amount of revenues recognized in the period that was included in the opening deferred revenues balance was $42,878 for the three months ended March 31, 2023.
The Company does not grant a right of return to its customers, except for one of its resellers. In 2022 and for the three months ended March 31, 2023, there were no returns from this reseller.
For information regarding disaggregated revenues, refer to Note 7.

d. | Contract Costs:

The Company pays sales commissions to sales and marketing and certain management personnel based on their attainment of certain predetermined sales goals. Sales commissions earned by employees are considered incremental and recoverable costs of obtaining a contract with a customer. Sales commissions paid for initial contracts, which are not commensurate with sales commissions paid for renewal contracts, are capitalized and amortized over an expected period of benefit. Based on its technology, customer contracts and other factors, the Company has determined the expected period of benefit to be
8

approximately four years. Sales commissions for renewal contracts are capitalized and then amortized on a straight-line basis. Amortization expenses related to these costs are included in sales and marketing expenses in the accompanying consolidated statements of operations.

e. | Derivative Instruments:

The Company’s primary objective for holding derivative instruments is to reduce its exposure to foreign currency rate changes. The Company reduces its exposure by entering into forward foreign exchange contracts with respect to operating expenses that are forecasted to be incurred in currencies other than the U.S. dollar. A majority of the Company’s revenues and operating expenditures are transacted in U.S. dollars. However, certain operating expenditures are incurred in or exposed to other currencies, primarily the New Israeli Shekel (“NIS”).
The Company has established forecasted transaction currency risk management programs to protect against fluctuations in fair value and the volatility of future cash flows caused by changes in exchange rates. The Company’s currency risk management program includes forward foreign exchange contracts designated as cash flow hedges. These forward foreign exchange contracts generally mature within 12 months. Over the last several quarters, the Company has closed forward foreign exchange contracts beyond 12 months to capitalize on more favorable rates. In addition, the Company enters into forward contracts to hedge a portion of its monetary items in the balance sheet, such as trade receivables and payables, denominated in Euro and Pound Sterling for short-term periods (the “Fair Value Hedging Program”). The purpose of the Fair Value Hedging Program is to protect the fair value of the monetary assets from foreign exchange rate fluctuations. Gains and losses from derivatives related to the Fair Value Hedging Program are not designated as hedging instruments. The Company does not enter into derivative financial instruments for trading or speculative purposes.
Derivative instruments measured at fair value and their classification on the consolidated balance sheets are presented in the following table (in thousands):

| Assets (liabilities) as of March 31, 2023 (unaudited) |  | Liabilities as of December 31, 2022
| Notional Amount |  | Fair Value |  | Notional Amount |  | Fair Value
Foreign exchange forward contract derivatives in cash flow hedging relationships included in accrued expenses and other short-term liabilities | $ | 140,171 |  |  | $ | (10,189) |  |  | $ | 136,426 |  |  | $ | (7,221) |
Foreign exchange forward contract derivatives in cash flow hedging relationships included in long-term other liabilities | $ | 139,165 |  |  | $ | (3,181) |  |  | $ | 107,210 |  |  | $ | (2,060) |
Foreign exchange forward contract derivatives for monetary items included in prepaid expenses and other current assets and accrued expenses and other short-term liabilities | $ | 17,236 |  |  | $ | 18 |  |  | $ | 32,066 |  |  | $ | (226) |

The unaudited consolidated statements of operations reflect a loss of $2,648 and a gain of $420 for the three months ended March 31, 2023 and 2022, respectively, related to the effective portion of the cash flow hedges. No material ineffective hedges were recognized for the three months ended March 31, 2023 and 2022 in operating expenses in the consolidated statement of operations.
For the three months ended March 31, 2023 and 2022, the unaudited consolidated statements of operations reflect a loss of $300 and a gain of $741, respectively, in financial income, net, related to the Fair Value Hedging Program.

f. | Income Taxes:

The Company operates in the U.S. and in foreign jurisdictions and is subject to taxes in each country or jurisdiction in which it conducts business. Earnings from its non-U.S. activities are subject to local country income tax and may be subject to U.S. income tax.
Because of its history of operating losses, the Company has established a full valuation allowance against potential future benefits for deferred tax assets, including loss carryforwards.
9

Accounting for income taxes for interim periods generally requires the provision for income taxes to be determined by applying an estimate of the annual effective tax rate for the full fiscal year to “ordinary” income or loss (pretax income or loss excluding unusual or infrequently occurring discrete items) for the reporting period. For the three months ended March 31, 2023 a discrete effective tax rate method was used in jurisdictions where a small change in estimated ordinary income has a significant impact on the annual effective tax rate.
In some foreign tax jurisdictions, the Company bases its interim tax accruals on the annual estimated effective tax rate applicable to the Company and its subsidiaries, adjusted for items which are considered discrete to the period. In each quarter, the Company updates its calculation and makes a year-to-date adjustment to its tax provision as necessary.
The Company's fiscal 2023 annual effective rate differs from the U.S. statutory rate primarily due to R&D capitalization under the terms of Section 174 and utilization of carry forward net operating loss (“NOL”) resulting in an increase to current provision expense without an offset to deferred expense as the Company remains in a valuation allowance on its U.S. deferred tax assets. For the three months ended March 31, 2023 and 2022, the Company recorded income tax expense of $2,961 and $1,414, respectively.
The Company's income tax provision could be significantly impacted by estimates surrounding its uncertain tax positions and changes to its valuation allowance in future periods. The Company reevaluates the judgments surrounding its estimates and make adjustments as appropriate each reporting period.
The Company remains open to federal and state examination to the extent net carry-over unused operating losses and tax credit attributable to those years remain unutilized. As of March 31, 2023, the Company's federal tax returns for the years 2010 through the current period, excluding the 2016 tax year which was audited by the Internal Revenue Service, and most state tax returns for the years 2009 through the current period, are still open to examination.
In addition, the Company is subject to the regular examinations of its income tax returns by different tax authorities. The Company regularly assess the likelihood of adverse outcomes resulting from these examinations to determine the adequacy of its provision for income taxes.

g. | Cash, Cash Equivalents, Marketable Securities and Short-Term Investments:

The Company accounts for investments in marketable securities in accordance with ASC No. 320, “Investments—Debt and Equity Securities” and ASC No. 326, “Financial Instruments—Credit Losses.” The Company considers all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents. Cash and cash equivalents consist of cash on hand, highly liquid investments in money market funds and other securities.
The Company considers all investments purchased with original maturities at the date of purchase greater than three months but less than one year to be short-term. Marketable securities are classified as available for sale and are, therefore, recorded at fair value on the consolidated balance sheet, with any unrealized gains and losses reported in accumulated other comprehensive income, which is reflected as a separate component of stockholders’ equity in the Company’s consolidated balance sheets, until realized. The Company uses the specific identification method to compute gains and losses on the investments. The amortized cost of securities is adjusted for amortization of premiums and accretion of discounts to maturity. Such amortization and accretion is included as a component of financial income, net in the consolidated statement of operations. Cash, cash equivalents, marketable securities and deposits consist of the following (in thousands):
10

| As of March 31, 2023
| (unaudited)
| Amortized Cost |  | Gross Unrealized Gains |  | Gross Unrealized Losses |  | Fair Value
Cash equivalents |  |  |  |  |  |  |
Money market funds | $ | 162,911 |  |  | $ | — |  |  | $ | — |  |  | $ | 162,911 |
Total | $ | 162,911 |  |  | $ | — |  |  | $ | — |  |  | $ | 162,911 |
Marketable securities |  |  |  |  |  |  |
US Treasury securities | $ | 205,728 |  |  | $ | 118 |  |  | $ | (152) |  |  | $ | 205,694 |
US Agencies securities | 55,976 |  |  | *) |  | (88) |  |  | 55,888 |
Commercial paper | 14,816 |  |  | 8 |  |  | (5) |  |  | 14,819 |
Corporate bonds | 4,436 |  |  | 1 |  |  | (3) |  |  | 4,434 |
Total | $ | 280,956 |  |  | $ | 127 |  |  | $ | (248) |  |  | $ | 280,835 |
Short-term deposits |  |  |  |  |  |  |
Term bank deposits | $ | 226,850 |  |  | $ | — |  |  | $ | — |  |  | $ | 226,850 |
Total | $ | 226,850 |  |  | $ | — |  |  | $ | — |  |  | $ | 226,850 |

*) Represents an amount lower than $1

| As of December 31, 2022
| Amortized Cost |  | Gross Unrealized Gains |  | Gross Unrealized Losses |  | Fair Value
Cash equivalents |  |  |  |  |  |  |
Money market funds | $ | 278,022 |  |  | $ | — |  |  | $ | — |  |  | $ | 278,022 |
Total | $ | 278,022 |  |  | $ | — |  |  | $ | — |  |  | $ | 278,022 |
Marketable securities |  |  |  |  |  |  |
US Treasury securities | $ | 159,165 |  |  | $ | 2 |  |  | $ | (211) |  |  | $ | 158,956 |
US Agencies securities | 55,967 |  |  | 5 |  |  | (72) |  |  | 55,900 |
Commercial paper | 13,679 |  |  | — |  |  | — |  |  | 13,679 |
Corporate bonds | 7,804 |  |  | 4 |  |  | (5) |  |  | 7,803 |
Total | $ | 236,615 |  |  | $ | 11 |  |  | $ | (288) |  |  | $ | 236,338 |
Short-term deposits |  |  |  |  |  |  |
Term bank deposits | $ | 128,350 |  |  | $ | — |  |  | $ | — |  |  | $ | 128,350 |
Total | $ | 128,350 |  |  | $ | — |  |  | $ | — |  |  | $ | 128,350 |

All the marketable securities have a stated effective maturity of less than 12 months as of March 31, 2023 and 2022.
The gross unrealized gains and losses related to these short-term investments was due primarily to changes in interest rates. Available for sale debt securities with an amortized cost basis in excess of estimated fair value are assessed using the Current Expected Credit (CECL) losses model to determine what portion of that difference, if any, is caused by expected credit losses. Expected credit losses on available for sale debt securities are recognized in financial income, net on the consolidated statements of operations. As of March 31, 2023 and December 31, 2022, the Company did not recognize an allowance for credit losses on available for sale marketable securities.
11

h. | Revolving Credit Facility:

On August 21, 2020, the Company entered into a credit and security agreement with KeyBank National Association (the “Credit and Security Agreement”), for a three-year secured revolving credit facility of $70,000 (the “Credit Facility”). The Credit Facility maturity date is the earlier of August 21, 2023 or 90 days prior to the scheduled maturity of any convertible debt securities. The fees incurred in connection with entering into the Credit and Security Agreement are amortized on a straight-line basis over the contractual term of the arrangement. Ongoing fees and interest paid on the used and unused portions of the Credit Facility are expensed as incurred and included within financial income, net on the consolidated statement of operations. The Credit Facility is secured and the Credit and Security Agreement contains customary covenants and customary events of default provisions.
As of March 31, 2023, the Company had no balance outstanding on the Credit Facility and was in compliance with all financial covenants and non-financial covenants.

i. | Basic and Diluted Net Loss Per Share:

Basic net loss per share is computed by dividing net loss by the weighted-average number of shares of common stock outstanding during the period.
Diluted net loss per share is computed by giving effect to all potentially dilutive securities, including stock options, restricted stock units, performance stock units and the shares related to the conversion of the 1.25% Convertible Senior Notes issued by the Company on May 11, 2020 and due August 2025 in an aggregate principal amount of $253,000 (the "2025 Notes"), to the extent dilutive.
Basic and diluted net loss per share was the same for each period presented as the inclusion of all potential shares of common stock outstanding would have been anti-dilutive. There were 9,561,916 and 9,194,862 potentially dilutive shares from the conversion of outstanding stock options, restricted stock units and performance stock units that were not included in the calculation of diluted net loss per share for the period ending March 31, 2023 and 2022, respectively. Additionally, 8,239,254 shares underlying the conversion option of the 2025 Notes are not considered in the calculation of diluted net loss per share as the effect would be anti-dilutive for the period ending March 31, 2023 and 2022, respectively.

j. | Recently Issued Accounting Pronouncements Not Yet Adopted:

The Company has reviewed recent accounting pronouncements and concluded that they are either not applicable to its business or that no material effect is expected on the consolidated financial statements as a result of their future adoption.
NOTE 2: FAIR VALUE MEASUREMENTS
The Company evaluates assets and liabilities subject to fair value measurements on a recurring basis to determine the appropriate level to classify them for each reporting period. There have been no transfers between fair value measurements levels during the three months ended March 31, 2023. The carrying amounts of cash and cash equivalents, marketable securities, trade receivables, short-term deposits and trade payables approximate their fair value due to the short-term maturity of such instruments.
The authoritative guidance on fair value measurements establishes a consistent framework for measuring fair value on either a recurring or nonrecurring basis whereby inputs, used in valuation techniques, are assigned a hierarchical level. The following are the hierarchical levels of inputs to measure fair value:
•Level 1: Observable inputs that reflect quoted prices (unadjusted) for identical assets or liabilities in active markets.
•Level 2: Observable inputs that reflect quoted prices for identical assets or liabilities in markets that are not active; quoted prices for similar assets or liabilities in active markets; inputs other than quoted prices that are observable for the assets or liabilities; or inputs that are derived principally from or corroborated by observable market data by correlation or other means.
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•Level 3: Unobservable inputs reflecting the Company’s own assumptions incorporated in valuation techniques used to determine fair value. These assumptions are required to be consistent with market participant assumptions that are reasonably available.
The following table sets forth the Company’s assets and liabilities that were measured at fair value as of March 31, 2023 and December 31, 2022 by level within the fair value hierarchy (in thousands):

| As of March 31, 2023 |  |
| (unaudited) |  | As of December 31, 2022
| Level I |  | Level II |  | Level III |  | Total |  | Level I |  | Level II |  | Level III |  | Total
Financial assets: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Cash equivalents: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Money market funds | $ | 162,911 |  |  | $ | — |  |  | $ | — |  |  | $ | 162,911 |  |  | $ | 278,022 |  |  | $ | — |  |  | $ | — |  |  | $ | 278,022 |
Marketable securities: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
US Treasury securities | 205,694 |  |  | — |  |  | — |  |  | 205,694 |  |  | 158,956 |  |  | — |  |  | — |  |  | 158,956 |
Agencies | 55,888 |  |  | — |  |  | — |  |  | 55,888 |  |  | 55,900 |  |  | — |  |  | — |  |  | 55,900 |
Commercial paper | — |  |  | 14,819 |  |  | — |  |  | 14,819 |  |  | — |  |  | 13,679 |  |  | — |  |  | 13,679 |
Corporate bonds | — |  |  | 4,434 |  |  | — |  |  | 4,434 |  |  | — |  |  | 7,803 |  |  | — |  |  | 7,803 |
Prepaid expenses and other current assets: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Forward foreign exchange contracts | — |  |  | 18 |  |  | — |  |  | 18 |  |  | — |  |  | — |  |  | — |  |  | — |
Financial liabilities: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Accrued expenses and other short-term liabilities: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Forward foreign exchange contracts | — |  |  | (10,189) |  |  | — |  |  | (10,189) |  |  | — |  |  | (7,447) |  |  | — |  |  | (7,447) |
Long-term other liabilities: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Forward foreign exchange contracts | — |  |  | (3,181) |  |  | — |  |  | (3,181) |  |  | — |  |  | (2,060) |  |  | — |  |  | (2,060) |
Total financial assets (liabilities), net | $ | 424,493 |  |  | $ | 5,901 |  |  | $ | — |  |  | $ | 430,394 |  |  | $ | 492,878 |  |  | $ | 11,975 |  |  | $ | — |  |  | $ | 504,853 |

See Note 5 “Convertible Senior Notes and Capped Call Transactions” for the carrying amount and estimated fair value of the Company's 2025 Notes as of March 31, 2023.
NOTE 3: LEASES
The Company has various operating leases for office space, vehicles and office equipment that expire through 2032. The lease agreements generally do not contain any material residual value guarantees or material restrictive covenants. Below is a summary of the Company's operating right-of-use assets and operating lease liabilities (in thousands):

| March 31, 2023 |  |
| (unaudited) |  |
Operating right-of-use assets | $ | 55,692 |  |  |
Operating lease liabilities, current | $ | (9,846) |  |  |
Operating lease liabilities, long-term | (55,993) |  |  |
Total operating lease liabilities | $ | (65,839) |  |  |

Operating lease liabilities, current are included within accrued expenses and other short-term liabilities in the consolidated balance sheet.
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Some leases include one or more options to renew. The exercise of lease renewal options is typically at the Company's sole discretion; therefore, the majority of renewals to extend the lease terms are not included in our right-of-use assets and lease liabilities as they are not reasonably certain of exercise. The Company regularly evaluates the renewal options, and, when it is reasonably certain of exercise, it will include the renewal period in its lease term. New lease modifications result in remeasurement of the right-of-use asset and lease liability.
Some of the real estate leases contain variable lease payments, including payments based on a Consumer Price Index ("CPI"). Variable lease payments based on a CPI are initially measured using the index in effect at lease adoption. Additional payments based on the change in a CPI are recorded as a period expense when incurred.
The Company has deposit guarantees issued by a financial institution to secure various operating lease agreements in connection with its office space.
Minimum lease payments for the Company's right-of-use assets over the remaining lease periods as of March 31, 2023, are as follows (in thousands):

| March 31, 2023
| (unaudited)
2023 | $ | 8,831 |
2024 | 10,650 |
2025 | 9,731 |
2026 | 9,502 |
2027 | 9,708 |
Thereafter | 23,784 |
Total undiscounted lease payments | $ | 72,206 |
Less: Imputed interest | (6,367) |
Present value of lease liabilities | $ | 65,839 |

The weighted average remaining lease terms and discount rates for all operating leases were as follows as of March 31, 2023:

Remaining lease term and discount rate: |
Weighted average remaining lease term (years) | 7.11
Weighted average discount rate | 2.81 | %

Total operating lease cost for the three months ended March 31, 2023 and 2022 was $2,292 and $2,309, respectively, inclusive of sublease income of $463 and $100, respectively.
N OTE 4: GOODWILL AND INTANGIBLE ASSETS
Goodwill
Goodwill represents the excess of the purchase price over the identifiable tangible and intangible assets acquired less liabilities assumed arising from business combinations. The Company believes the goodwill represents the synergies expected from expanded market opportunities when integrating with its offerings.
There were no additions, impairments or any other changes to the carrying amount of goodwill during the three months ended March 31, 2023 or during prior periods.
Intangible Assets
Total cost and amortization of intangible assets is comprised of the following (in thousands, except useful life):
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| Estimated Useful Life |  | March 31, 2023 |  |
Intangible assets, net | (in years) |  | (unaudited) |  |
Developed technology & trademarks | 4 |  | $ | 6,110 |  |  |
Total intangible assets |  |  | 6,110 |  |  |
Less: Accumulated amortization |  |  | 3,704 |  |  |
Total intangible assets, net |  |  | $ | 2,406 |  |  |

Intangible assets are expensed on a straight-line basis over the useful life of the asset. The Company recorded amortization expense of $381 for the three months ended March 31, 2023 and 2022.
The following table summarizes estimated future amortization expense of our intangible assets as of March 31, 2023 (in thousands):

Years ending December 31, | Amount (unaudited)
2023 | $ | 1,143 |
2024 | 1,263 |
Total future amortization expense | $ | 2,406 |

NOTE 5: CONVERTIBLE SENIOR NOTES AND CAPPED CALL TRANSACTIONS
On May 11, 2020, the Company issued the 2025 Notes pursuant to an Indenture dated May 11, 2020 (the “Indenture”). The offering totaled $253,000 aggregate principal amount. The net proceeds to the Company after the initial purchaser discount and issuance costs were approximately $245,158. The Company used $29,348 of the net proceeds from the offering to pay the cost of the capped call transactions described below.
The 2025 Notes will mature on August 15, 2025, unless earlier converted, redeemed or repurchased. Interest will be payable semi-annually in arrears on February 15 and August 15 of each year, at a rate of 1.25% per year.
The initial conversion rate for the 2025 Notes is 32.5668 shares of the Company’s common stock for each $1,000 principal amount of the 2025 Notes, which is equivalent to an initial conversion price of approximately $30.71 per share. The conversion rate is subject to adjustment in specified events. The 2025 Notes are convertible into shares of the Company’s common stock, at the option of a holder, prior to the close of business on the business day immediately preceding February 15, 2025, under certain conditions. In addition, on or after February 15, 2025, a holder may convert all or any portion of its 2025 Notes at any time.
The 2025 Notes are not redeemable at the Company’s option prior to August 20, 2023. On or after August 20, 2023, the Company may redeem the 2025 Notes for cash, at its option, subject to the terms and conditions provided in the Indenture.
Prior to the adoption of ASU 2020-06 on January 1, 2022, the Company separated the 2025 Notes into liability and equity components. Following the adoption of ASU 2020-06 on January 1, 2022, which the Company elected to adopt using a modified retrospective approach, the Company no longer separates the 2025 Notes into liability and equity components. The cumulative effect of the accounting change as of January 1, 2022 was a decrease to accumulated deficit of $8,647, a decrease in additional paid-in capital of $30,794 and an increase in liabilities of $22,147 on its consolidated balance sheets. Comparative prior year periods were not adjusted. In connection with the adoption, the Company calculated an effective interest rate of 1.87%.
The net carrying amount of the 2025 Notes was as follows (in thousands):

| March 31, 2023 |  |  |  |  |
| (unaudited) |  |  |  |  |
Principal | $ | 253,000 |  |  |  |  |  |
Unamortized issuance costs | (3,661) |  |  |  |  |  |
Net carrying amount | $ | 249,339 |  |  |  |  |  |

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The interest expense recognized related to the 2025 Notes for the three months ended March 31, 2023 and 2022 was as follows (in thousands):

| Three Months Ended March 31, |  |
| 2023 |  | 2022 |  |  |  |
| (unaudited) |  |
Contractual interest expense | $ | 791 |  |  | $ | 791 |  |  |  |  |
Amortization of debt issuance costs | 376 |  |  | 369 |  |  |  |  |
Total | $ | 1,167 |  |  | $ | 1,160 |  |  |  |  |

As of March 31, 2023, the total estimated fair value of the 2025 Notes was approximately $271,525. The fair value was determined based on the closing trading price per $100 of the 2025 Notes as of the last day of trading for the period. The fair value of the 2025 Notes is primarily affected by the trading price of our common stock and market interest rates. The fair value of the 2025 Notes is considered a Level 2 within the fair value hierarchy and was determined based on inputs that are observable in the market or that could be derived from, or corroborated with, observable market data, quoted price of the 2025 Notes in an over-the-counter market.
Capped Call Transactions
In May 2020, in connection with the pricing of the 2025 Notes, the Company entered into privately negotiated capped call transactions (the “Capped Call Transactions”). The Capped Call Transactions are generally expected to reduce the potential dilution to the Company’s common stock upon any conversion of the 2025 Notes and/or offset any cash payments the Company is required to make in excess of the principal amount of converted 2025 Notes, as the case may be, with such reduction and/or offset subject to a cap initially equal to $47.24 (the "Cap Price").
The Capped Call Transactions are separate transactions and are not part of the terms of the 2025 Notes and will not change the holders’ rights under the 2025 Notes. As the Capped Call Transactions are considered indexed to the Company's stock and are considered equity classified, they are recorded in stockholders’ equity on the consolidated balance sheet and are not accounted for as derivatives. The cost of the Capped Call Transactions was approximately $29,348 and was recorded as a reduction to additional paid-in capital in 2020.
NOTE 6: STOCKHOLDERS’ EQUITY
a. Stock plans:
On December 30, 2005, the Company’s board of directors adopted the Varonis Systems, Inc. 2005 Stock Plan (the “2005 Plan”). As of December 31, 2013, the Company had reserved 14,139,957 shares of common stock available for issuance to employees, directors, officers and consultants of the Company and its subsidiaries. The awards generally vest over four years. No awards were granted under the 2005 Plan subsequent to December 31, 2013, and no further awards will be granted under the 2005 Plan.
On November 14, 2013, the Company’s board of directors adopted the Varonis Systems, Inc. 2013 Omnibus Equity Incentive Plan (the “2013 Plan”) which was subsequently approved by the Company’s stockholders. The Company initially reserved 5,713,899 shares of common stock for issuance under the 2013 Plan to employees, directors, officers and consultants of the Company and its subsidiaries. The number of shares of common stock available for issuance under the 2013 Plan was increased on January 1, 2016 and has been, and will be, increased on each January 1 thereafter by four percent (4%) of the number of shares of common stock issued and outstanding on each December 31 immediately prior to the date of increase (rounded down to the nearest whole share), but the amount of each increase will be limited to the number of shares of common stock necessary to bring the total number of shares of Common Stock available for grant and issuance under the 2013 Plan to five percent (5%) of the number of shares of common stock issued and outstanding on each December 31. Since January 1, 2016, the share reserve under the 2013 Plan has been automatically increased by an aggregate of 27,579,672 shares. Awards granted under the 2013 Plan generally vest over four years. Any award that is forfeited or canceled before expiration becomes available for future grants under the 2013 Plan.
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On October 22, 2020, and as part of the Polyrize Security Ltd. ("Polyrize") acquisition, the Company’s board of directors approved the assumption of a certain portion of Polyrize Options pursuant to the terms and conditions of the Polyrize 2019 Share Incentive (“Polyrize Plan”).
A summary of employees’ stock options activities during the three months ended March 31, 2023 is as follows:

| Three Months Ended March 31, 2023 (unaudited)
| Number |  | Weighted average exercise price |  | Aggregate intrinsic value (in thousands) |  | Weighted average remaining contractual life (years)
Options outstanding as of January 1, 2023 | 691,573 |  |  | $ | 7.533 |  |  | $ | 11,347 |  |  | 1.901
Granted | — |  |  | $ | — |  |  |  |  |
Exercised | (39,371) |  |  | $ | 6.518 |  |  |  |  |
Forfeited and expired | (2,100) |  |  | $ | 7.192 |  |  |  |  |
Options outstanding as of March 31, 2023 | 650,102 |  |  | $ | 7.596 |  |  | $ | 11,971 |  |  | 1.727
Options exercisable as of March 31, 2023 | 645,311 |  |  | $ | 7.610 |  |  | $ | 11,874 |  |  | 1.689

The aggregate intrinsic value in the table above represents the total intrinsic value that would have been received by the option holders had all option holders exercised their options on the last date of the period. Total intrinsic value of options exercised for the three months ended March 31, 2023 was $776. As of March 31, 2023, there was $136 of total unrecognized compensation cost related to non-vested share-based compensation arrangements granted under the 2005 Plan, 2013 Plan and Polyrize Plan. This cost is expected to be recognized over a weighted-average period of approximately 0.916 years.
b. The options outstanding as of March 31, 2023 (unaudited) have been separated into ranges of exercise price as follows:

Range of exercise price |  | Options outstanding as of March 31, 2023 |  | Weighted average remaining contractual life (years) |  | Weighted average exercise price of options outstanding |  | Options exercisable as of March 31, 2023 |  | Weighted average remaining contractual life (years) |  | Weighted average exercise price of options exercisable
$ | 4.157 |  |  | — |  | 5.682 |  | 88,384 |  |  | 3.702 |  |  | $ | 5.565 |  |  | 83,593 |  |  | 3.520 |  |  | $ | 5.558 |
$ | 6.503 |  |  | — |  | 8.077 |  | 423,016 |  |  | 1.299 |  |  | $ | 7.111 |  |  | 423,016 |  |  | 1.299 |  |  | $ | 7.111 |
|  | $9.960 |  |  |  | 120,180 |  |  | 1.896 |  |  | $ | 9.960 |  |  | 120,180 |  |  | 1.896 |  |  | $ | 9.960 |
|  | $13.287 |  |  |  | 18,522 |  |  | 0.975 |  |  | $ | 13.287 |  |  | 18,522 |  |  | 0.975 |  |  | $ | 13.287 |
|  |  |  |  |  | 650,102 |  |  | 1.727 |  |  | $ | 7.596 |  |  | 645,311 |  |  | 1.689 |  |  | $ | 7.610 |

c. | Options issued to consultants:

The Company’s outstanding options granted to consultants for services as of March 31, 2023 (unaudited) were as follows:

| Number of options outstanding and exercisable as of March 31, 2023 |  | Range of exercise price per share |  | Exercisable through
August 2013 - February 2016 | 22,650 |  |  | $ | 5.623 |  |  | — |  | $ | 13.287 |  |  | August 2023 - February 2026

d. | Restricted stock units ("RSUs") and performance stock units ("PSUs"):

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A summary of RSUs and PSUs for employees, consultants and non-employee directors of the Company for the three months ended March 31, 2023 (unaudited) is as follows:

| Number of shares underlying outstanding RSUs and PSUs |  | Weighted- average grant date fair value
Unvested balance - January 1, 2023 | 8,340,732 |  |  | $ | 41.82 |
Granted | 3,476,735 |  |  | $ | 28.49 |
Vested | (2,547,676) |  |  | $ | 38.44 |
Forfeited | (380,627) |  |  | $ | 42.25 |
Unvested balance – March 31, 2023 | 8,889,164 |  |  | $ | 37.59 |

As of March 31, 2023, there was $293,507 of total unrecognized compensation cost related to employees and non-employees unvested restricted stock units and performance stock units which is expected to be recognized over a weighted-average period of 2.945 years.

e. | 2015 Employee Stock Purchase Plan:

On May 5, 2015, the Company’s stockholders approved the Varonis Systems, Inc. 2015 Employee Stock Purchase Plan (the “ESPP”), which the Company’s board of directors had adopted on March 19, 2015. The ESPP became effective as of June 30, 2015. The ESPP allows eligible employees to purchase shares of the Company’s common stock at a discount through payroll deductions of up to 15% of their eligible compensation, at not less than 85% of the fair market value of the Company’s common stock on the first day or last trading day in the offering period, subject to any plan limitations. The Company initially reserved 1,500,000 shares of common stock for issuance under the ESPP. The number of shares available for issuance under the ESPP was increased on January 1, 2016 and has been, and will be, increased each January 1 thereafter, by an amount equal to the lesser of (i) one percent (1%) of the number of shares of common stock issued and outstanding on each December 31 immediately prior to the date of increase, except that the amount of each such increase will be limited to the number of shares of common stock necessary to bring the total number of shares of common stock available for issuance under the ESPP to two percent (2%) of the number of shares of common stock issued and outstanding on each such December 31, or (ii) 1,200,000 shares of common stock. Since January 1, 2016, the share reserve under the ESPP has been automatically increased by an aggregate of 3,402,705 shares. The ESPP will continue in effect until the earlier of (i) the date when no shares of common stock are available for issuance thereunder or (ii) June 30, 2025; unless terminated prior thereto by the Company’s board of directors or compensation committee, each of which has the right to terminate the ESPP at any time.

f. | Stock-based compensation expense for employees and consultants:

The Company recognized stock-based compensation expense in the consolidated statements of operations as follows (in thousands):

| Three Months Ended March 31, |  |
| 2023 |  | 2022 |  |  |  |
| (unaudited) |  |
Cost of revenues | $ | 2,500 |  |  | $ | 3,087 |  |  |  |  |
Research and development | 12,523 |  |  | 12,600 |  |  |  |  |
Sales and marketing | 12,762 |  |  | 13,096 |  |  |  |  |
General and administrative | 8,026 |  |  | 7,215 |  |  |  |  |
Total | $ | 35,811 |  |  | $ | 35,998 |  |  |  |  |

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g. | Share Repurchase Program:

In October 2022, the Company's board of directors authorized a share repurchase program of up to $100,000 of the Company’s common stock (the “Share Repurchase Program”). Under the Share Repurchase Program, the Company is authorized to repurchase shares through open market purchases, privately-negotiated transactions or otherwise in accordance with applicable federal securities laws, including through Rule 10b5-1 trading plans and under Rule 10b-18 of the Exchange Act. The Share Repurchase Program will expire on October 31, 2023. The number of shares to be purchased and the timing of purchases will be based on the Company's trading windows, available liquidity, and general business and market conditions.
The Company has repurchased and subsequently retired 3,014,446 shares under its Share Repurchase Program, for a total of $58,964. At March 31, 2023, the Company had $41,036 of capacity remaining under its Share Repurchase Program.
NOTE 7: GEOGRAPHIC INFORMATION AND MAJOR CUSTOMER DATA
Summary information about geographic areas:
ASC 280, “Segment Reporting,” establishes standards for reporting information about operating segments. Operating segments are defined as components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision maker in deciding how to allocate resources and in assessing performance. The Company manages its business on the basis of one reportable segment and unit and derives revenues mainly from subscription licensing, SaaS revenues and maintenance and services fees (see Note 1 above for a brief description of the Company’s business). The following is a summary of revenues within geographic areas (in thousands):

| Three Months Ended March 31, |  |
| 2023 |  | 2022 |  |  |  |
| (unaudited) |  |
Revenues based on customer’s location: |  |  |  |  |  |  |
North America | $ | 81,249 |  |  | $ | 69,141 |  |  |  |  |
EMEA | 22,918 |  |  | 24,209 |  |  |  |  |
Rest of World | 3,168 |  |  | 2,911 |  |  |  |  |
Total revenues | $ | 107,335 |  |  | $ | 96,261 |  |  |  |  |

For the three and three months ended March 31, 2023 and 2022, respectively, there were no sales to a single customer exceeding 10% of total revenues.
The following is a summary of long-lived assets, including property and equipment, net and operating lease right-of-use assets, within geographic areas (in thousands):

| As of |  | As of
| March 31, 2023 |  | December 31, 2022
| (unaudited) |  |
Long-lived assets by geographic region: |  |  |
United States | $ | 38,901 |  |  | $ | 40,304 |
Israel | 37,986 |  |  | 38,385 |
Ireland | 14,576 |  |  | 15,019 |
Other | 1,872 |  |  | 2,107 |
| $ | 93,335 |  |  | $ | 95,815 |

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Item 2. | Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and related notes appearing elsewhere in this Quarterly Report on Form 10-Q and our Annual Report on Form 10-K for our fiscal year ended December 31, 2022.
Special Note Regarding Forward-Looking Statements
This report contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those discussed in the forward-looking statements. The statements contained in this report that are not purely historical are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Forward-looking statements are often identified by the use of words such as, but not limited to, “anticipate,” “believe,” “can,” “continue,” “could,” “estimate,” “expect,” “intend,” “may,” “plan,” “project,” “seek,” “should,” “strategy,” “target,” “will,” “would” and similar expressions or variations intended to identify forward-looking statements. These statements are based on the beliefs and assumptions of our management based on information currently available to management. Such forward-looking statements are subject to risks, uncertainties and other important factors that could cause actual results and the timing of certain events to differ materially from future results expressed or implied by such forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those identified below and those discussed in the section titled “Risk Factors” included under Part II, Item 1A below. Furthermore, such forward-looking statements speak only as of the date of this report. Except as required by law, we undertake no obligation to update any forward-looking statements to reflect events or circumstances after the date of such statements.
The Transition to a SaaS-Based Business Model
Companies around the world are focused on the elevated risks associated with its workforce collaborating on multiple platforms, which has fueled the secular trends that drive demand for our products, including the expansion to the cloud; increase in cybercrime; and compliance with data-driven regulations. As companies of all sizes and industries are increasingly facing cyberattacks, they understand that a data-centric approach to security is critical and that the aforementioned elevated risks are here for the long-term. Enterprises now use many different combinations of on-premises and cloud data stores, SaaS applications and IaaS environments and this complexity requires a greater level of automated protection. We believe our offering provides comprehensive data coverage and we aim to keep pace with the relentless growth and complexity of data. We started in 2005 with coverage for just Windows file shares, but today we offer coverage for many mission-critical on-premises and cloud data stores and applications.
In the second half of 2021, we launched our first SaaS offering, introducing new products and support for cloud applications and infrastructure, including AWS, Box, GitHub, Google Drive, Jira, Okta, Salesforce, Slack and Zoom. On October 31, 2022 we announced the availability of our flagship Varonis Data Security Platform as a SaaS, which was previously only sold as a self-hosted solution. The benefits of SaaS delivery are widely established for both customers and providers, and we believe this evolution of a SaaS delivery option for the Varonis Data Security Platform will be transformational for several reasons: customers can more quickly and easily deploy and maintain our solutions with reduced infrastructure requirements and a lower total cost of ownership; risk assessments, the core of our sales motion, are quicker to deploy; we are able to offer Proactive Incident Response, which offers our customers additional protection with less effort; we have better ability to spot threats quickly, which better informs our innovation; customers benefit from continual threat model updates that help them stay ahead of evolving threats; and the SaaS model allows us to deliver additional features and functionality to customers more efficiently.
Given these benefits, we plan to transition our business to a predominately SaaS-based company over the next several years. We expect our flagship Varonis Data Security Platform as a SaaS to grow significantly over this time and become the primary driver of our revenues.
Overview
Varonis is a pioneer in data security and analytics, fighting a different battle than conventional cybersecurity companies. We are pioneers because more than 15 years ago we recognized that enterprise capacity to create and share data far exceeded its capacity to protect it. We believed that rapid data growth combined with increasing information dependence would change both the global economy and the risk profiles of corporations and governments and our conviction has only strengthened over time. Since our founding, our focus has been on using innovation to address the cyber-implications of these trends, creating software that provides new ways to track, alert and protect data wherever it is stored.
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We sell substantially all of our products and services to channel partners, including distributors and resellers, which sell to end-user customers, which we refer to in this report as our customers. We believe that our sales model, which combines the leverage of a channel sales model with our highly trained and professional sales force, has and will continue to play a major role in our ability to grow and to successfully deliver our unique value proposition for enterprise data. While our products serve customers of all sizes, across industries and across geographies, the marketing focus and majority of our sales focus is on targeting organizations with 1,000 users or more who can make larger initial purchases with us and, over time, have a greater potential lifetime value. Our customers span leading firms in the financial services, public, healthcare, industrial, insurance, technology, consumer and retail, energy and utilities, construction and engineering and education sectors. We believe our existing customer base serves as a strong source of incremental future revenues given our broad platform of products, their growing volumes and complexity of enterprise data and related security concerns. We will continue our focus on targeting organizations with 1,000 users or more who can make larger purchases with us initially and over time. We are also focused on maintaining a high renewal rate by focusing on the quality and reliability of our customer service and support to ensure our customers receive value from our products and providing software upgrades and enhancements when and if they are available. Our self-hosted product suite currently contains more than 40 licenses and our renewal rate continued to be over 90% for the three months ended March 31, 2023.
We believe there is a significant long-term growth opportunity in both domestic and international markets, which could include any organization that uses file shares, SaaS applications, intranets and email for collaboration. For the three months ended March 31, 2023, approximately 76% of our revenues were derived from North America, while approximately 21% of our revenues were derived from EMEA and approximately 3% from ROW. Additionally, total revenues grew approximately 12% for the three months ended March 31, 2023 compared with the three months ended March 31, 2022. We continue to expect sales growth in North America and international expansion to be key components of our long-term growth strategy. During 2022, however, our operations in EMEA were negatively impacted by the broader macroeconomic conditions in the region, including a higher inflation environment, the weakening of the Euro and the Pound Sterling and the exit of our Russia business. In addition, in the fourth quarter of 2022, our operations in North America were impacted by some of the same macroeconomic conditions including, among other things, a higher inflation and interest rate environment and a general economic slowdown. As a result, we have seen changes in customer buying patterns including, some increased budgetary tightening and longer sales cycles, a trend which may continue for the foreseeable future. We have taken measures to tie our level of investment in the business to the sales we plan to achieve and to mitigate the impact of foreign currency fluctuations.
We continue to expand our domestic and international operations as part of our long-term growth strategy. While the expansion of our domestic operations is focused primarily on our underpenetrated territories, the expansion of our international operations depends in particular on our ability to hire, integrate and retain local sales personnel in these international markets, acquire new channel partners and implement an effective marketing strategy. Given the nominal amount of our ROW revenues, our ROW revenue growth rates have fluctuated in the past and may fluctuate in the future based on the timing of deal closures. In addition, the further expansion of our international operations will increase our sales and marketing and general and administrative expenses and will subject us to a variety of risks and challenges, including those related to economic and political conditions in each region, compliance with foreign laws and regulations, and compliance with domestic laws and regulations applicable to our international operations.
Since inception, we have continued to scale our business and execute on strategic initiatives which we believe have positioned us for durable long-term growth. For the three months ended March 31, 2023 and 2022, subscription revenues were $83.0 million and $69.0 million, respectively, representing year-over-year growth of 20%. For the three months ended March 31, 2023 and 2022, our total revenues were $107.3 million and $96.3 million, respectively, representing year-over-year growth of 12% despite the revenue headwinds associated with the transition to a predominately SaaS business model. For the three months ended March 31, 2023 and 2022, we had operating losses of $43.1 million and $48.1 million and net losses of $38.3 million and $48.8 million, respectively.
Key Performance Indicators and Recent Business Highlights
Transition to SaaS-Based Business Model
Over the last two years, we have increasingly offered SaaS solutions to our customers. The benefits of SaaS delivery are widely established for both customers and providers, and, given these benefits, we plan to transition our business to a predominately SaaS-based company over the next several years. Due to differences in revenue recognition, shifts in SaaS mix and existing customer conversions to SaaS may produce significant variation in the reported revenues for a given period compared to the same period in the previous year.
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Annual Recurring Revenues
Annual recurring revenues is a key performance indicator defined as the annualized value of active term-based subscription license contracts, maintenance contracts and SaaS contracts in effect at the end of that period. Subscription license contracts, maintenance contracts and SaaS contracts are annualized by dividing the total contract value by the number of days in the term and multiplying the result by 365.
As of March 31, 2023 and 2022, ARR was $478.1 million and $404.5 million, respectively, an increase of 18% period over period. The annualized value of contracts is a legal and contractual determination made by assessing the contractual terms with our customers. The annualized value of maintenance contracts is not determined by reference to historical revenues, deferred revenues or any other GAAP financial measure over any period. ARR is not a forecast of future revenues and can be impacted by contract start and end dates and renewal rates. We expect ARR to continue to increase in absolute dollars.
Components of Operating Results
Revenues
Subscription Revenues. Subscription revenues consist primarily of subscription licenses and SaaS revenues. Subscription licenses are sold on-premises and are recognized at the point of time when the software license has been delivered and the benefit of the asset has transferred. Maintenance associated with subscription licenses is recognized ratably over the term of the agreement. Over the last two years, the Company began to offer SaaS solutions to its customers, including its (i) flagship Data Security Platform as a SaaS that was previously only sold as an on-premises solution, (ii) DatAdvantage Cloud hosted solution and (iii) Data Classification Cloud. Each of these products allow customers to use hosted software, and the related revenue from these products is recognized ratably over the associated contract period. As we only introduced these solutions recently, and given that revenue is recognized ratably over the contract period, the contribution to total revenues is not yet significant. Over the next several years, we expect SaaS revenues to grow considerably and become the primary driver of our revenues. Should a customer request to convert from a license sold on-premises to our SaaS offering, we will accommodate the request on a pro-rata prospective basis. Due to the timing of renewals, renewal rates and the transition to a predominately SaaS business model, we could produce significant variation in the revenues we recognize in a given period.
Maintenance and Services Revenues. Maintenance and services revenues consist of revenues from maintenance agreements of perpetual license sales and, to a lesser extent, professional services. Customers with maintenance agreements are entitled to receive support and unspecified upgrades and enhancements when and if they become available. We recognize the revenues associated with maintenance ratably over the associated contract period. We measure the renewal rate for our customers over a 12-month period, based on a dollar renewal rate for contracts expiring during that time period. Our renewal rate for each of the three months ended March 31, 2023 and 2022 continued to be over 90%. We have seen and expect to continue to see insignificant perpetual license revenues in the future and, therefore, we expect the associated maintenance and support to continue to decline despite the strong renewal rates. We also offer professional services, generally provided on a time and materials basis, focused on training our customers in the use of our products. We recognize the revenues associated with these professional services as we deliver the services, provide the training or when the service term has expired. Professional services have always been a small percentage of our total revenues and we expect it to continue to be a small percentage as our newer solutions can provide remediation in more automated ways. As such, our overall maintenance and services revenues is also expected to continue to decline.
The following table sets forth the percentage of our revenues that have been derived from subscription licenses and maintenance and services revenues for the periods presented.

| Three Months Ended March 31, |  |
| 2023 |  | 2022 |  |  |  |
| (as a percentage of total revenues)
Revenues: |  |  |  |  |  |  |
Subscriptions | 77.3 | % |  | 71.7 | % |  |  |  |
Maintenance and services | 22.7 |  |  | 28.3 |  |  |  |  |
Total revenues | 100.0 | % |  | 100.0 | % |  |  |  |

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Our products are used by a wide range of enterprises, including Fortune 500 corporations and small and medium-sized businesses. Our customers span a broad array of industries and are located in over 90 countries.
Cost of Revenues, Gross Profit and Gross Margin
Our cost of revenues consists of cost of maintenance and services revenues. Cost of maintenance and services revenues consist primarily of salaries (including payroll tax expense related to stock-based compensation), employee benefits (including commissions and bonuses) and stock-based compensation for our maintenance and services employees; amortization of acquired intangible assets; third-party hosting fees; travel expenses; and allocated overhead costs for facilities, IT and depreciation. We recognize expenses related to maintenance and services as they are incurred. We expect that our cost of maintenance and services revenues will increase in absolute dollars as we continue to invest in our customer success and support teams, move to a SaaS-based business model and support the underlying programs that play a critical role in maintaining our high renewal rate.
Gross profit is total revenues less total cost of revenues. Gross margin is gross profit expressed as a percentage of total revenues. As the majority of our expenses are relatively fixed quarter over quarter and due to the seasonality of our business, the first quarter typically results in the lowest gross margin as our first quarter revenues have historically been the lowest for the year. Conversely, the fourth quarter typically results in the highest gross margin as our fourth quarter revenues have historically been the highest for the year. As we transition to a predominately SaaS-based company, we expect this seasonality to decrease.
Operating Expenses
Our operating expenses are classified into three categories: research and development, sales and marketing and general and administrative. For each category, the largest component is personnel costs, which consists of salaries (including payroll tax expense related to stock-based compensation), employee benefits (including commissions and bonuses) and stock-based compensation. Operating expenses also include allocated overhead costs for facilities, IT and depreciation. Allocated costs for facilities primarily consist of rent and office maintenance. Operating expenses are generally recognized as incurred. As a company, we have always aimed to tie our level of investment in the business to the revenues we expect to achieve and we actively manage expenses across the business. We expect personnel costs to continue to increase in absolute dollars as we continue to grow our business.
Research and Development. Research and development expenses primarily consist of personnel costs attributable to our research and development personnel, as well as allocated overhead costs. We expense research and development costs as incurred. We expect that our research and development expenses will continue to increase in absolute dollars as we further strengthen our technology platform and invest in the development of both existing and new products through the hiring of talented and capable employees.
Sales and Marketing. Sales and marketing expenses are the largest component of our operating expenses and consist primarily of personnel costs, as well as marketing and business development costs, travel expenses, third-party hosting fees, training and education and allocated overhead costs. We expect that sales and marketing expenses will continue to increase in absolute dollars as we plan to expand our sales and marketing efforts, both domestically and internationally. We also expect sales and marketing expenses to continue to be our largest category of operating expenses.
General and Administrative. General and administrative expenses primarily consist of personnel and facility-related costs for our executive, finance, legal, human resources and administrative personnel. Other expenses are comprised of legal, accounting and other consultant fees and other corporate expenses and allocated overhead. We expect that general and administrative expenses will increase in absolute dollars as we expand our operations.
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Financial Income (Expenses), Net
Financial income (expenses), net consists primarily of foreign exchange gains or losses, amortization of debt issuance costs, interest expense and interest income. Foreign exchange gains or losses relate to our business activities in foreign countries with different operational reporting currencies. As a result of our business activities in foreign countries, we expect that foreign exchange gains or losses will continue to occur due to fluctuations in exchange rates in the countries where we do business. Amortization of debt issuance costs relate to the 2025 Notes we issued in May 2020 and the Credit Facility we entered into in August 2020. Interest expense consists of the contractual interest expenses associated with the 2025 Notes. Interest income represents interest received on our cash, cash equivalents, marketable securities, deposits and amortization of premiums and accretion of discounts related to our investment in available for sale marketable securities.
Income Taxes
We operate in several tax jurisdictions and are subject to taxes in each country or jurisdiction in which we conduct business. Earnings from our non-U.S. activities are subject to local country income tax and may be subject to U.S. income tax.
Because of our history of operating losses, we have established a full valuation allowance against potential future benefits for deferred tax assets, including loss carryforwards. Our income tax provision could be significantly impacted by estimates surrounding our uncertain tax positions and changes to our valuation allowance in future periods. We reevaluate the judgments surrounding our estimates and make adjustments as appropriate each reporting period.
In addition, we are subject to the regular examinations of our income tax returns by different tax authorities. For example, we are currently subject to tax audits in Israel and a state tax audit in the United States. We regularly assess the likelihood of adverse outcomes resulting from these examinations to determine the adequacy of our provision for income taxes.
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Results of Operations
Comparison of the Three Months Ended March 31, 2023 and 2022
The following tables are a summary of our consolidated statements of operations for the three months ended March 31, 2023 and 2022 in dollars and as a percentage of our total revenues.

| Three Months Ended March 31,
| 2023 |  | 2022
| (unaudited) (in thousands)
Statement of Operations Data: |  |  |
Revenues: |  |  |
Subscriptions | $ | 82,974 |  |  | $ | 68,985 |
Maintenance and services | 24,361 |  |  | 27,276 |
Total revenues | 107,335 |  |  | 96,261 |
Cost of revenues | 17,637 |  |  | 17,809 |
Gross profit | 89,698 |  |  | 78,452 |
Operating expenses: |  |  |
Research and development | 44,732 |  |  | 43,570 |
Sales and marketing | 68,393 |  |  | 64,787 |
General and administrative | 19,689 |  |  | 18,180 |
Total operating expenses | 132,814 |  |  | 126,537 |
Operating loss | (43,116) |  |  | (48,085) |
Financial income, net | 7,773 |  |  | 736 |
Loss before income taxes | (35,343) |  |  | (47,349) |
Income taxes | (2,961) |  |  | (1,414) |
Net loss | $ | (38,304) |  |  | $ | (48,763) |

| Three Months Ended March 31,
| 2023 |  | 2022
| (as a percentage of total revenues)
Statement of Operations Data: |  |  |
Revenues: |  |  |
Subscriptions | 77.3 | % |  | 71.7 | %
Maintenance and services | 22.7 |  |  | 28.3 |
Total revenues | 100.0 |  |  | 100.0 |
Cost of revenues | 16.4 |  |  | 18.5 |
Gross profit | 83.6 |  |  | 81.5 |
Operating expenses: |  |  |
Research and development | 41.7 |  |  | 45.3 |
Sales and marketing | 63.7 |  |  | 67.3 |
General and administrative | 18.4 |  |  | 18.9 |
Total operating expenses | 123.8 |  |  | 131.5 |
Operating loss | (40.2) |  |  | (50.0) |
Financial income, net | 7.3 |  |  | 0.8 |
Loss before income taxes | (32.9) |  |  | (49.2) |

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Income taxes | (2.8) |  |  | (1.5) |
Net loss | (35.7) | % |  | (50.7) | %

Revenues

| Three Months Ended March 31, |  |
| 2023 |  | 2022 |  | % Change
| (unaudited) (in thousands) |  |
Revenues: |  |  |  |  |
Subscriptions | $ | 82,974 |  |  | $ | 68,985 |  |  | 20.3 | %
Maintenance and services | 24,361 |  |  | 27,276 |  |  | (10.7) | %
Total revenues | $ | 107,335 |  |  | $ | 96,261 |  |  | 11.5 | %

| Three Months Ended March 31,
| 2023 |  | 2022
| (as a percentage of total revenues)
Revenues: |  |  |
Subscriptions | 77.3 | % |  | 71.7 | %
Maintenance and services | 22.7 | % |  | 28.3 | %
Total revenues | 100.0 | % |  | 100.0 | %

Subscription revenues increased 20% from $69.0 million for the three months ended March 31, 2022 to $83.0 million for the three months ended March 31, 2023. The increase in subscription revenues was driven by existing customers expanding their licenses, new customer acquisitions and our high renewal rate. Total revenues increased approximately 12% for the three months ended March 31, 2023 as compared to 2022 despite the revenue headwinds associated with the transition to a predominately SaaS business model. ARR was $478.1 million and $404.5 million as of March 31, 2023 and 2022, respectively, representing an increase of 18%. The anticipated decrease in maintenance and services revenues was due to churn and the conversion of existing customers to subscription licenses despite our renewal rate continuing to be over 90% for each of the three months ended March 31, 2023 and 2022, as well as newer solutions providing remediation in more automated ways, requiring less professional services time. As a result, we expected, and continue to expect less associated maintenance and services revenues in the future.
Cost of Revenues and Gross Margin

| Three Months Ended March 31, |  |
| 2023 |  | 2022 |  | % Change
| (unaudited) (in thousands) |  |
Cost of revenues | $ | 17,637 |  |  | $ | 17,809 |  |  | (1.0) | %

| Three Months Ended March 31,
| 2023 |  | 2022
| (as a percentage of total revenues)
Total gross margin | 83.6 | % |  | 81.5 | %

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The decrease in cost of revenues was primarily related to a decrease of $0.6 million in salaries and benefits and stock-based compensation expense. This is partially offset by a $0.4 million increase in facilities and allocated overhead costs.
Operating Expenses

| Three Months Ended March 31, |  |
| 2023 |  | 2022 |  | % Change
| (unaudited) (in thousands) |  |
Operating expenses: |  |  |  |  |
Research and development | $ | 44,732 |  |  | $ | 43,570 |  |  | 2.7 | %
Sales and marketing | 68,393 |  |  | 64,787 |  |  | 5.6 | %
General and administrative | 19,689 |  |  | 18,180 |  |  | 8.3 | %
Total operating expenses | $ | 132,814 |  |  | $ | 126,537 |  |  | 5.0 | %

| Three Months Ended March 31,
| 2023 |  | 2022
| (as a percentage of total revenues)
Operating expenses: |  |  |
Research and development | 41.7 | % |  | 45.3 | %
Sales and marketing | 63.7 | % |  | 67.3 | %
General and administrative | 18.4 | % |  | 18.9 | %
Total operating expenses | 123.8 | % |  | 131.5 | %

The increase in research and development expenses was primarily related to a $1.0 million increase in facilities and allocated overhead costs and an increase of $0.2 million in salaries and benefits and stock-based compensation expense resulting from increased headcount as part of our focus on enhancing and developing our existing and new products.
The increase in sales and marketing expenses was primarily related to an increase of $1.6 million in facilities and allocated overhead costs and a $1.2 million increase related to general sales and marketing expenses, including increased travel and marketing events. The increase was also due to a $0.8 million increase in salaries and benefits and stock-based compensation expense due to increased headcount to expand our sales force and commissions on increased customer orders.
The increase in general and administrative expenses was primarily related to an increase of $1.7 million in salaries and benefits and stock-based compensation expense primarily due to increased headcount to support the overall growth of our business. The increase was also due to a $0.6 million increase in general company expenses. This was partially offset by a $0.7 million decrease in bad debt expenses primarily related to the write off of our Russia business in the first quarter of 2021.
Financial Income, Net

| Three Months Ended March 31, |  |
| 2023 |  | 2022 |  | % Change
| (unaudited) (in thousands) |  |
Financial income, net | $ | 7,773 |  |  | $ | 736 |  |  | 956.1 | %

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The increase in financial income, net was primarily due to higher interest income, partially offset by less foreign currency gains.
Income Taxes

| Three Months Ended March 31, |  |
| 2023 |  | 2022 |  | % Change
| (unaudited) (in thousands) |  |
Income taxes | $ | (2,961) |  |  | $ | (1,414) |  |  | (109.4) | %

Income taxes for the three months ended March 31, 2023, including the increase in income taxes, were comprised of U.S. and foreign income taxes.
Liquidity and Capital Resources
The following table shows our cash flows from operating activities, investing activities and financing activities for the stated periods:

| Three Months Ended March 31,
| 2023 |  | 2022
| (unaudited) (in thousands)
Net cash provided by operating activities | $ | 36,830 |  |  | $ | 24,542 |
Net cash used in investing activities | (142,515) |  |  | (31,870) |
Net cash used in financing activities | (13,530) |  |  | (22,714) |
Decrease in cash and cash equivalents | $ | (119,215) |  |  | $ | (30,042) |

On March 31, 2023, our cash and cash equivalents, marketable securities and short-term deposits of $756.3 million were held for working capital purposes. We believe that our existing cash and cash equivalents, marketable securities, short-term deposits and cash flow from operations will be sufficient to fund our operations and capital expenditures for at least the next 12 months. Our future capital requirements will depend on many factors, including our rate of revenue growth, timing of renewals and renewal rates, the expansion of our sales and marketing activities, the timing and extent of spending to support product development efforts and expansion into new geographic locations, the timing of introductions of new software products and enhancements to existing software products, the continuing market acceptance of our software offerings and our use of cash to pay for acquisitions or share repurchases, if any.
Operating Activities
Our operating activities are driven by sales of our products less costs and expenses, primarily payroll and related expenses, and adjusted for certain non-cash items, mainly depreciation and amortization, stock-based compensation, amortization of deferred commissions, noncash operating lease costs, amortization of debt issuance costs and amortization of premium and accretion of discount on marketable securities, and changes in operating assets and liabilities. Changes in operating assets and liabilities are driven mainly by collection of accounts receivable from the sales of our software products.
For the three months ended March 31, 2023, cash inflows from our operating activities were $36.8 million. We have observed two seasonal patterns that impact our net cash provided by operating activities. First, a majority of our sales are made during the last three weeks of the quarter. Second, the highest dollar amount of sales of our products and services occurs in the fourth quarter. Consequently, we end the fourth quarter with our highest accounts receivable balance of any quarter which in turn generates the greatest amount of collections in the following quarter. In addition, there is negative sequential sales in the first quarter, which results in a relatively lower amount collected during the second quarter. These seasonal trends also impact our operating loss because the majority of our expenses are relatively fixed in the short-term. For the three months ended March 31, 2023, cash inflows were $5.3 million from our net loss excluding non-cash charges. Additional sources of cash inflows were from changes in our working capital, including a $60.6 million decrease in accounts receivable. Our days’ sales
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outstanding (“DSO”) for the three months ended March 31, 2023 was 64. Other sources of cash inflows were from a $1.2 million increase in other long-term liabilities. This was partially offset by a $15.8 million decrease in accrued expenses and other liabilities, a $10.3 million increase in prepaid expenses and other current assets (including deferred commissions), a $2.3 million decrease in trade payables, a $1.4 million decrease in deferred revenues and a $0.6 million increase in other long-term assets.
For the three months ended March 31, 2022, cash inflows from our operating activities were $24.5 million. For the three months ended March 31, 2022, sources of cash inflows were from changes in our working capital, including a $53.6 million decrease in accounts receivable. Our DSO for the three months ended March 31, 2022 was 63. Other sources of cash inflows were from a $0.4 million decrease in other long-term assets and a $0.1 million increase in other long-term liabilities. This was partially offset by $1.3 million from our net loss excluding non-cash charges, a $12.5 million decrease in accrued expenses and other liabilities, a $9.5 million increase in prepaid expenses and other current assets (including deferred commissions), a $5.6 million decrease in deferred revenues and a $0.6 million decrease in trade payables.
Investing Activities
Our investing activities consist primarily of capital expenditures to purchase property and equipment, including leasehold improvements, purchase and sale of deposits and changes in our marketable securities. In the future, we expect to continue to incur capital expenditures to support our expanding operations.
During the three months ended March 31, 2023, net cash used in investing activities of $142.5 million was primarily attributable to net investments of $98.5 million in net deposits, $42.9 million in marketable securities and $1.1 million in capital expenditures to support our growth during the period including hardware, software, office equipment and leasehold improvements mainly in connection with office space.
During the three months ended March 31, 2022, net cash used in investing activities of $31.9 million was primarily attributable to investments of $28.4 million in marketable securities and $3.5 million in capital expenditures to support our growth during the period including hardware, software, office equipment and leasehold improvements mainly in connection with office space.
Financing Activities
For the three months ended March 31, 2023, net cash used in financing activities of $13.5 million was attributable to $16.9 million in taxes paid related to net share settlement of equity awards and $2.5 million of repurchases of common stock, partially offset by $5.9 million of proceeds from employee stock plans.
For the three months ended March 31, 2022, net cash used in financing activities of $22.7 million was attributable to $28.8 million in taxes paid related to net share settlement of equity awards, partially offset by $6.1 million of proceeds from employee stock plans.
Revolving Credit Facility
On August 21, 2020, we entered into the Credit and Security Agreement, for a three-year secured revolving credit facility of $70.0 million. For information regarding the revolving credit facility, refer to Note 1 of our consolidated financial statements.
As of March 31, 2023, we had no balance outstanding on the Credit Facility and we were in compliance with all financial covenants and non-financial covenants.
Convertible Notes
On May 11, 2020, we issued $253.0 million aggregate principal amount of the 2025 Notes. The net proceeds from the offering, after deducting initial purchaser discount and issuance costs, were approximately $245.2 million. In connection with the issuance of the 2025 Notes, we entered into the Capped Call Transactions. We used $29.3 million of the net proceeds from the 2025 Notes to purchase the Capped Call Transactions, as further discussed in Note 5 of our consolidated financial statements.
Share Repurchase Program
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In October 2022, our board of directors authorized a share repurchase program of up to $100.0 million of the Company’s common stock (the “Share Repurchase Program”). Under the Share Repurchase Program, we are authorized to repurchase shares through open market purchases, privately-negotiated transactions or otherwise in accordance with applicable federal securities laws, including through Rule 10b5-1 trading plans and under Rule 10b-18 of the Exchange Act. At March 31, 2023, we had $41.0 million of capacity remaining under our Share Repurchase Program which will expire on October 31, 2023. The number of shares to be purchased and the timing of purchases will be based on our trading windows, available liquidity, and general business and market conditions.
Contractual Payment Obligations
Our principal commitments primarily consist of obligations under leases for office space and motor vehicles. Aggregate minimum rental commitments under non-cancelable leases as of March 31, 2023 for the upcoming years were as follows:

| Payments Due by Period
| 2023 |  | 2024 |  | 2025 |  | 2026 |  | 2027 |  | Thereafter |  | Total
| (in thousands)
Operating lease obligations | $ | 8,831 |  |  | $ | 10,650 |  |  | $ | 9,731 |  |  | $ | 9,502 |  |  | $ | 9,708 |  |  | $ | 23,784 |  |  | $ | 72,206 |

We have obligations related to unrecognized tax benefit liabilities totaling $19.1 million and others related to severance pay, which have been excluded from the table above as we do not believe it is practicable to make reliable estimates of the periods in which payments for these obligations will be made. We also have a contractual minimum purchase commitment with a service provider through August 31, 2025 totaling $0.6 million due in the next 12 months and $6.3 million due thereafter and an additional $66.2 million contractual minimum purchase commitment with another service provider through December 31, 2026 with no specified annual commitments. We expect to fund these obligations with cash flows from operations and cash on our balance sheet.
Off-Balance Sheet Arrangements
As of March 31, 2023, we did not have any off-balance sheet arrangements.
Critical Accounting Policies and Estimates
We prepare our consolidated financial statements in accordance with generally accepted accounting principles in the United States. The preparation of consolidated financial statements also requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, costs and expenses and related disclosures. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. Actual results could differ significantly from the estimates made by our management. To the extent that there are differences between our estimates and actual results, our future financial statement presentation, financial condition, results of operations and cash flows will be affected. We believe that the accounting policies discussed below are critical to understanding our historical and future performance, as these policies relate to the more significant areas involving management’s judgments and estimates. Critical accounting policies and estimates are those that we consider the most important to the portrayal of our financial condition and results of operations because they require our most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of the matters that are inherently uncertain.
Recently Issued Accounting Pronouncements Not Yet Adopted
We have reviewed recent accounting pronouncements and concluded that they are either not applicable to our business or that no material effect is expected on the consolidated financial statements as a result of their future adoption.
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Item 3. | Quantitative and Qualitative Disclosures About Market Risk

Market risk represents the risk of loss that may impact our financial position due to adverse changes in financial market prices and rates. Our market risk exposure is primarily a result of fluctuations in foreign currency exchange rates. We do not hold financial instruments for trading or speculative purposes.
Market Risk
We are exposed to certain financial risks, including fluctuations in foreign currency exchange rates and interest rates. We manage our exposure to these market risks through internally established policies and procedures. Our policies do not allow speculation in derivative instruments for profit or execution of derivative instrument contracts for which there are no underlying exposures. We do not use financial instruments for trading or speculative purposes, and we are not a party to any leveraged derivatives. We monitor our underlying market risk exposures on an ongoing basis and, where appropriate, may use hedging strategies to mitigate these risks.
Foreign Currency Exchange Risk
Approximately one quarter of our revenues for the three months ended March 31, 2023 were earned in non-U.S. dollar denominated currencies, mainly in the Euro and Pound Sterling. Our expenses are generally denominated in the currencies in which our operations are located, primarily the U.S. dollar and NIS, and to a lesser extent the Euro, Pound Sterling, Canadian dollar and Australian dollar. Our expenses denominated in foreign currencies consist primarily of personnel and overhead costs from our international operations. Our consolidated results of operations and cash flow are, therefore, subject to fluctuations due to changes in foreign currency exchange rates and may be adversely affected in the future due to changes in foreign exchange rates. We enter into financial hedging strategies to reduce our exposure to foreign currency rate changes. During 2023, the effect of a hypothetical 10% change in foreign currency exchange rates applicable to our business, after considering foreign currency hedges, would not have had a material impact on our consolidated financial statements.
For purposes of our consolidated financial statements, local currency assets and liabilities are translated at the rate of exchange to the U.S. dollar on the balance sheet date and local currency revenues and expenses are translated at the exchange rate at the date of the transaction or the average exchange rate during the reporting period.
Historically, we have used derivative financial instruments, specifically foreign currency forward contracts, to manage exposure to foreign currency risks, by hedging a portion of our forecasted expenses denominated in NIS generally expected to occur within 12 months. Over the last several quarters, we have closed forward foreign exchange contracts beyond 12 months to capitalize on more favorable rates. The effect of exchange rate changes on foreign currency forward contracts is expected to offset the effect of exchange rate changes on the underlying hedged item. We also enter into forward contracts to hedge a portion of our monetary items in the balance sheet, such as trade receivables and payables, denominated in Pound Sterling and Euro for short-term periods to protect the fair value of the monetary assets and liabilities from foreign exchange rate fluctuations. The effect of exchange rate changes on foreign currency forward contracts is expected to offset the effect of exchange rate changes in the underlying hedged item which impacts financial income (expenses), net. We do not use derivative financial instruments for trading or speculative purposes.
Interest Rate Risk
We had cash and cash equivalents, marketable securities and short-term deposits of $756.3 million as of March 31, 2023. We hold our cash and cash equivalents, marketable securities and short-term deposits for working capital purposes. Due to the short-term nature of these instruments, we believe that we do not have any material exposure to changes in the fair value of our investment portfolio as a result of changes in interest rates. Declines in interest rates, however, would reduce our future interest income. The effect of a hypothetical 100 basis point increase in interest rates would not have a material impact on our consolidated financial statements.
In May 2020, we issued $253.0 million aggregate principal amount of 1.25% convertible senior notes due in 2025. The 2025 Notes have fixed annual interest rates at 1.25% and, therefore, we do not have economic interest rate exposure on our 2025 Notes. However, the values of the 2025 Notes are exposed to interest rate risk. Generally, the fair market value of our fixed interest rate 2025 Notes will increase as interest rates fall and decrease as interest rates rise. In addition, the fair values of the 2025 Notes are affected by our stock price. The fair value of the 2025 Notes will generally increase as our common stock price increases and will generally decrease as our common stock price declines in value. Additionally, we carry the 2025 Notes at face value less unamortized costs on our balance sheet, and we present the fair value for required disclosure purposes only.
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As of March 31, 2023, we had no outstanding obligations under our credit facility. To the extent we enter into other long-term debt arrangements in the future, we would be subject to fluctuations in interest rates which could have a material impact on our future financial condition and results of operation.

Item 4. | Controls and Procedures

Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures (as that term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended ("Exchange Act")) that are designed to ensure that information required to be disclosed in our reports under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including its Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosures. Any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures as of the end of the period covered by this report. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures as of the end of the period covered by this report were effective to accomplish their objectives at the reasonable assurance level.
Changes in Internal Control over Financial Reporting
There was no change in our internal control over financial reporting that occurred during the three months ended March 31, 2023 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
We regularly seek to identify, develop and implement improvements to our technology systems and business processes, some of which may affect our internal control over financial reporting. These changes may include such activities as implementing new, more efficient systems, updating existing systems or platforms, automating manual processes or utilizing technology developed by third parties. These system changes are often phased in over multiple periods in order to limit the implementation risk in any one period, and as each change is implemented, we monitor its effectiveness as part of its internal control over financial reporting.

PART II. | OTHER INFORMATION

Item 1. | Legal Proceedings

We are not currently a party to any material litigation.

Item 1A. | Risk Factors

Investing in our common stock involves a high degree of risk. You should carefully consider the following risks and all other information contained herein, including our consolidated financial statements and the related notes thereto, before investing in our common stock. The risks and uncertainties described below are not the only ones we face. Additional risks and uncertainties that we are unaware of, or that we currently believe are not material, also may become important factors that affect us. If any of the following risks materialize, our business, financial condition and results of operations could be materially harmed. In that case, the trading price of our common stock could decline, and you may lose some or all of your investment.
Summary Risk Factors
Our business faces significant risks. In addition to the summary below, you should carefully review the Risk Factors in this Quarterly Report on Form 10-Q. We may be subject to additional risks and uncertainties not presently known to us or that we currently deem immaterial. Our business, financial condition and results of operations could be materially adversely affected by
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any of these risks, and the trading price of our common stock could decline by virtue of these risks. These risks should be read in conjunction with the other information in this report. The following is a summary of the principal risks of our business:
•the fact that the market for software that analyzes, secures, governs, manages and migrates enterprise data may not continue to grow or grow at the same pace;
•prolonged economic uncertainties or downturns;
•currency exchange rate fluctuations;
•increased competition;
•security breaches, cyberattacks or other cyber-risks and failure to comply with legal requirements, contractual obligations and industry standards regarding security, data protection and privacy;
•fluctuation in our quarterly results of operations due to variability in our revenues;
•our expansion into cloud-delivered services;
•our ability to predict renewal rates and manage growth effectively;
•our limited operating history at our current scale, which makes it difficult to evaluate and predict our future prospects;
•our history of losses;
•our ability to maintain strong relationships with our channel partners, including distributors and resellers, to whom we sell substantially all of our products and services;
•risks inherent in our international operations, including the effect of export and import controls and the risk of a violation or alleged violation of applicable anti-corruption or anti-bribery laws;
•collection and credit risks;
•our ability to maintain or enhance our brand recognition or reputation;
•our ability to retain, attract and recruit highly qualified personnel;
•our dependency on the continued services and performance of our co-founder, Chief Executive Officer and President;
•our ability to continually enhance and improve our technology;
•the fact that we derive substantially all of our revenues and cash flows from sales of licenses from a single platform of products;
•the fact that, if we experience interruptions or performance problems with our products, or if our software is not perceived as being secure, customers may reduce the use of or stop using our products;
•our ability to protect our proprietary technology and intellectual property rights;
•the fact that our tax rate may vary significantly depending on our stock price;
•our ability to fully utilize our net operating loss carryforwards;
•our indebtedness; and
•stock price volatility.
Risks Related to the Industry in which we Operate
The market for software that analyzes, secures, governs, manages and migrates enterprise data may not continue to grow or grow at the same pace.
We believe our future success depends in large part on the continued growth of the market for software that enables enterprises to analyze, secure, govern, manage and migrate their data. In order for us to market and sell our products, we must successfully demonstrate to enterprise IT, security and business personnel the potential value of their data and the risk of that data getting compromised or stolen. Despite a number of high-profile cyberattacks around the world, we must still persuade customers to devote a portion of their budgets to a unified platform that we offer to analyze, secure, govern, manage and extract value from this resource. Enterprises may not recognize the need for our products or, if they do, may not decide that they need a solution that offers the range of functionalities that we offer. Software solutions focused on enterprise data may not yet be viewed as a necessity, and accordingly, our sales effort is and will continue to be focused in large part on explaining the need for, and value offered by, our solution. The market for our solution may not continue to grow at its current rate or at all. The failure of the market to continue to develop would materially adversely impact our results of operations.
Prolonged economic uncertainties or downturns could materially adversely affect our business.
Our business depends on our current and prospective customers’ ability and willingness to invest in IT services, including cybersecurity projects, which in turn is dependent upon their overall economic health. Negative conditions in the general economy both in the United States and abroad, including inflationary pressure, recession, currency fluctuations and a higher interest rate environment, changes in gross domestic product growth, potential future government shutdowns, the federal government’s failure to raise the debt ceiling, financial and credit market fluctuations, the imposition of trade barriers and restrictions such as tariffs, political deadlock, restrictions on travel, natural catastrophes, warfare, including geopolitical turmoil and sanctions caused by the war between Russia and Ukraine, and terrorist attacks, could cause a decrease in business
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investments, including corporate spending on enterprise software in general and negatively affect the rate of growth of our business. For example, our operations, and the operations of our customers and partners, were affected by the COVID-19 pandemic and efforts to control its spread, including by mandatory business closures and capacity limitations imposed by the jurisdictions in which we operate. Similar restrictions in the future could negatively affect our business.
Uncertainty in the global economy makes it extremely difficult for our customers and us to forecast and plan future business activities accurately. This could cause our customers to reevaluate decisions to purchase our product or to delay their purchasing decisions, which could lengthen our sales cycles and negatively impact our results. For example, in the beginning of 2022, in connection with the war between Russia and Ukraine and related sanctions, we made the decision to exit our Russia business. As 2022 progressed, the European economy began to experience increased economic turmoil that has caused the devaluation of local European currencies (specifically, the Euro and the Pound Sterling), inflationary pressures and general economic uncertainty. As a result, there has been increasing budgetary tightening and we have started to see longer sales cycles in the region which may negatively impact our results of operations. In the United States, we have also experienced a higher inflationary environment, which may put pressure on discretionary spending by our customers, and we may in the future see further lengthening of our sales cycle in the region which could negatively impact our results.
A downturn in any of our leading industries, or a reduction in any revenue-generating vertical, may cause enterprises to react to worsening conditions by reducing their spending on IT. Customers may delay or cancel IT projects, choose to focus on in-house development efforts or seek to lower their costs by renegotiating maintenance and support agreements. To the extent purchases of licenses for our software are perceived by customers and potential customers to be discretionary, our revenues may be disproportionately affected by delays or reductions in general IT spending. In addition, consolidation in certain industries may result in reduced overall spending on our software. If the economic conditions of the general economy or industries in which we operate worsen from present levels, our business, results of operations and financial condition could be adversely affected.
Overall economic uncertainty has resulted in, and may in the future give rise to, a number of risks, including, but not limited to, the following:
• reduced economic activity could lead to a prolonged recession, which could negatively impact spending by our customers or the ability of consumers to pay for our services and in return could severely impact our business operations, financial condition and liquidity;
• an impairment of our ability to continue to show the positive trends at the levels we have shown in the last several quarters for certain key performance metrics, such as renewal rates and annual recurring revenues;
• a negative effect on our customer success efforts, our ability to enter into new markets and our ability to acquire new customers, in part due to potentially lower conversion rates on risk assessments and delay and lengthen our sales cycles;
• a reduction in the number of users as customers terminate and furlough employees;
• an increase in bad debt reserves as customers face economic hardship and collectability becomes more uncertain, including the risk of bankruptcies;
• variability with forward-looking guidance and financial results, including management’s accounting estimates and assumptions; and
• our ability to raise capital.
The challenges posed by and the full impact of negative conditions in the general economy on our business and our future performance are difficult to predict and there is a risk that any guidance we provide to the market may turn out to be incorrect.
We may face increased competition in our market.
While there are some companies which offer certain features similar to those embedded in our solutions, as well as others with whom we compete in certain tactical use cases, we believe that we do not currently compete with a company that offers the same breadth of functionalities on the number of platforms and application that we cover. Nevertheless, we do compete against a select group of software vendors that provide standalone solutions, similar to those found in our comprehensive software suite, in the specific markets in which we operate. We also face direct competition with respect to certain of our products, specifically Data Transport Engine, DatAnswers and DatAdvantage for Directory Services. As we continue to augment our functionality with insider threat detection and user behavior analytics and as we expand our classification capabilities to better serve compliance needs, such as GDPR, CCPA and other data privacy laws, we may face increased perceived and real competition from other security and classification technologies. As we expand our coverage and penetration in the cloud, we may face increased perceived and real competition from other cloud-focused technologies. In the future, as customer requirements evolve and new technologies are introduced, we may experience increased competition if established or emerging
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companies develop solutions that address the enterprise data market. Furthermore, because we operate in an evolving area, we anticipate that competition will increase based on customer demand for these types of products.
In particular, if a more established company were to target our market, we may face significant competition. They may have competitive advantages, such as greater name recognition, larger sales, marketing, research and acquisition resources, access to larger customer bases and channel partners, a longer operating history and lower labor and development costs, which may enable them to respond more quickly to new or emerging technologies and changes in customer requirements or devote greater resources to the development, promotion and sale of their products than we do. Increased competition could result in us failing to attract customers or maintain licenses at the same rate. It could also lead to price cuts, alternative pricing structures or the introduction of products available for free or a nominal price, reduced gross margins, longer sales cycles, lower renewal rates and loss of market share.
In addition, our current or prospective channel partners may establish cooperative relationships with future competitors. These relationships may allow future competitors to rapidly gain significant market share. These developments could also limit our ability to obtain revenues from existing and new customers.
Our ability to compete successfully in our market will also depend on a number of factors, including ease and speed of product deployment and use, the quality and reliability of our customer service and support, total cost of ownership, return on investment and brand recognition. Any failure by us to successfully address current or future competition in any one of these or other areas may reduce the demand for our products and adversely affect our business, results of operations and financial condition.
We are subject to a number of legal requirements, contractual obligations and industry standards regarding security, data protection and privacy, and any failure to comply with these requirements, obligations or standards could have an adverse effect on our reputation, business, financial condition and operating results.
Privacy and data information security have become a significant issue in the United States and in many other countries where we have employees and operations and where we offer licenses to our products. The regulatory framework for privacy and personal information security issues worldwide is rapidly evolving and is likely to remain uncertain for the foreseeable future. The U.S. federal and various state and foreign government bodies and agencies have adopted or are considering adopting laws and regulations limiting, or laws and regulations regarding, the collection, distribution, use, disclosure, storage and security of personal information. For example, the CCPA, which went into effect on January 1, 2020, requires, among other things, covered companies to provide new disclosures to California consumers and afford such consumers new abilities to opt-out of certain sales of personal information. Consumer rights and obligations under the CCPA were expanded by the California Privacy Rights Act (CPRA) on November 3, 2020. The CPRA took effect on January 1, 2023, along with the Virginia Consumer Data Protection Act. In addition, the Colorado Privacy Act, the Utah Consumer Privacy Act and the Connecticut Act Concerning Personal Data Privacy and Online Monitoring are all set to go into effect in 2023. These laws impose similar obligations on businesses with regard to the use, disclosure and security of personal information, and grant additional rights in that personal information to consumers.
Internationally, virtually every jurisdiction in which we operate has established its own data security and privacy legal framework with which we or our customers must comply. Laws and regulations in these jurisdictions apply broadly to the collection, use, storage, disclosure and security of data that identifies or may be used to identify or locate an individual, such as names, email addresses and, in some jurisdictions, Internet Protocol addresses. These laws and regulations often are more restrictive than those in the United States and are rapidly evolving. For example, the European Union’s (“EU”) data protection regime, the GDPR, became enforceable on May 25, 2018. Additionally, the United Kingdom has enacted legislation that substantially implements the GDPR, but the United Kingdom’s exit from the EU (which formally occurred on January 31, 2020), commonly referred to as “Brexit,” has created uncertainty with regard to the regulation of data protection in the United Kingdom. In particular, the United Kingdom’s government has announced that it is considering revising some aspects of its domestic data protection regime to move further away from the EU approach, and it is unclear how the two regimes will interact after that. In addition, the United Kingdom is reviewing its data transfer rules with respect to transfers to the United States and other jurisdictions, and has issued its own UK-specific International Data Transfer Agreement, together with a UK Addendum to the EU Standard Contractual Clauses. Depending on how these measures are implemented, and how they are enforced, they may result in substantively different compliance obligations with respect to transfers of personal data out of the United Kingdom and the EU, respectively. Complying with the GDPR or other laws, regulations or other obligations relating to privacy, data protection or information security may cause us to incur substantial operational costs or require us to modify our data handling practices. Non-compliance could result in proceedings against us by governmental entities or others, could result
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in substantial fines or other liability, and may otherwise adversely impact our business, financial condition and operating results.
Some statutory requirements, both in the United States and abroad, include obligations of companies to notify individuals of security breaches involving particular personal information, which could result from breaches experienced by us or our service providers. Even though we may have contractual protections with our service providers, a security breach could impact our reputation, harm our customer confidence, hurt our sales or cause us to lose existing customers and could expose us to potential liability or require us to expend significant resources on data security and in responding to such breach.
In addition to government regulation, privacy advocates and industry groups may propose new and different self-regulatory standards that either legally or contractually apply to us. We also expect that there will continue to be new proposed laws and regulations concerning privacy, data protection and information security, and we cannot yet determine the impact such future laws, regulations and standards may have on our business. New laws, amendments to or re-interpretations of existing laws and regulations, industry standards, contractual obligations and other obligations may require us to incur additional costs and restrict our business operations. Because the interpretation and application of laws and other obligations relating to privacy and data protection are still uncertain, it is possible that these laws and other obligations may be interpreted and applied in a manner that is inconsistent with our existing data management practices or the features of our software. If so, in addition to the possibility of fines, lawsuits and other claims, we could be required to fundamentally change our business activities and practices or modify our software, which could have an adverse effect on our business. We may be unable to make such changes and modifications in a commercially reasonable manner or at all, and our ability to develop new features could be limited. Any inability to adequately address privacy concerns, even if unfounded, or comply with applicable privacy or data protection laws, regulations and policies could result in additional cost and liability to us, damage our reputation, inhibit sales and adversely affect our business.
Furthermore, the costs of compliance with, and other burdens imposed by, the laws, regulations and policies that are applicable to the businesses of our customers may increase the costs associated with, limit the use and adoption of, and reduce the overall demand for, our products. Privacy and personal information security concerns, whether valid or not valid, may inhibit market adoption of our products particularly in certain industries and foreign countries.
Risks Related to Our Operations
Security breaches, cyberattacks or other cyber-risks of our IT and production systems could expose us to significant liability and cause our business and reputation to suffer and harm our competitive position.
Our corporate infrastructure stores and processes our sensitive, proprietary and other confidential information (including as related to financial, technology, employees, marketing, sales, etc.) which is used on a daily basis in our operations. In addition, our software involves transmission and processing of our customers’ confidential, proprietary and sensitive information. We have legal and contractual obligations to protect the confidentiality and appropriate use of customer data. Being a leading pioneer in the cyber industry, we may be an attractive target for cyber attackers or other data thieves.
High-profile cyberattacks and security breaches have increased in recent years, with the potential for such acts heightened as a result of the number of employees working remotely due to many companies adopting a hybrid working model. Security industry experts and government officials have warned about the risks of hackers and cyberattacks targeting IT products and enterprise infrastructure. Because techniques used to obtain unauthorized access or to sabotage systems change frequently and often are not recognized until launched against a specific target, we may be unable to anticipate these techniques or to implement adequate preventative measures. As we continue to increase our client base and expand our brand, we may become more of a target for third parties seeking to compromise our security systems and we anticipate that hacking attempts and cyberattacks will increase in the future. We may not always be successful in preventing or repelling unauthorized access to our systems. We also may face delays in our ability to identify or otherwise respond to any cybersecurity incident or any other breach. Additionally, we use third-party service providers to provide some services to us that involve the cloud hosting, storage or transmission of data, such as SaaS, cloud computing, and internet infrastructure and bandwidth, and they face various cybersecurity threats and also may suffer cybersecurity incidents or other security breaches. Despite our security measures, our IT and infrastructure may be vulnerable to attacks. Threats to IT security can take a variety of forms. Individual and groups of hackers and sophisticated organizations, including state-sponsored organizations or nation-states, continuously undertake attacks that pose threats to our customers and our IT. These actors may use a wide variety of methods, which may include developing and deploying malicious software or exploiting vulnerabilities in hardware, software, or other infrastructure in order to attack our products and services or gain access to our networks, using social engineering techniques to induce our employees, users, partners, or customers to disclose passwords or other sensitive information or take other actions to gain access to our data
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or our users’ or customers’ data, or acting in a coordinated manner to launch distributed denial of service or other coordinated attacks. Inadequate account security practices may also result in unauthorized access to confidential and/or sensitive data or loss of SaaS platform availability.
Security risks, including, but not limited to, unauthorized use or disclosure of customer data, loss of availability of our SaaS platform offering, cyberattack on our cloud providers theft of proprietary information, theft of intellectual property, theft of internal employee’s PII/PHI information, theft of financial data and financial reports, loss or corruption of customer data and computer hacking attacks or other cyberattacks, could require us to expend significant capital and other resources to alleviate the problem and to improve technologies, may impair our ability to provide services to our customers and protect the privacy of their data, may result in product development delays, may compromise confidential or technical business information, may harm our competitive position, may result in theft or misuse of our intellectual property or other assets and could expose us to substantial litigation expenses and damages, indemnity and other contractual obligations, government fines and penalties, mitigation expenses, costs for remediation and incentives offered to affected parties, including customers, other business partners and employees, in an effort to maintain business relationships after a breach or other incident, and other liabilities. We are continuously working to improve our IT systems, together with creating security boundaries around our critical and sensitive assets. We provide advanced security awareness training to our employees and contractors that focuses on various aspects of the cybersecurity world. All of these steps are taken in order to mitigate the risk of attack and to ensure our readiness to responsibly handle any security violation or attack. If an actual or perceived breach of our security occurs, the market perception of the effectiveness of our security measures and our products could be harmed, we could lose potential sales and existing customers, our ability to operate our business could be impaired, we may incur significant liabilities, we could suffer harm to our reputation and competitive position, and our operating results could be negatively impacted.
Our quarterly results of operations have fluctuated and may fluctuate significantly due to variability in our revenues which could adversely impact our stock price.
Our revenues and other results of operations have fluctuated from quarter to quarter in the past and could continue to fluctuate in the future. Historically, the fluctuation was partially due to the front-loaded revenue recognition nature of our business. Additionally, as the Company transitions to a predominantly SaaS-based business model that recognizes revenue ratably, we will no longer front-load revenue and, as a result, may present reduced revenues as compared to prior periods. As a result, comparing our revenues and results of operations on a period-to-period basis may not be meaningful, and should not be relied on for any particular period. Our revenues depend in part on the conversion of enterprises that have undergone risk assessments, which can be performed remotely, into paying customers; however, these risk assessments may not be converted at the same historical rates. At the same time, the majority of our sales are typically made during the last three weeks of every quarter. We may fail to meet market expectations for that quarter if we are unable to close the number of transactions that we expect during this short period and closings are deferred to a subsequent quarter or not closed at all. In addition, our sales cycle from initial contact to delivery of and payment for the software license generally becomes longer and less predictable with respect to large transactions and often involves multiple meetings or consultations at a substantial cost and time commitment to us. The closing of a large transaction in a particular quarter may raise our revenues in that quarter and thereby make it more difficult for us to meet market expectations in subsequent quarters and our failure to close a large transaction in a particular quarter or any renewals may adversely impact our revenues in that quarter. Moreover, we base our current and future expense levels on our revenue forecasts and operating plans, and our expenses are relatively fixed in the short-term. Accordingly, we would likely not be able to reduce our costs sufficiently to compensate for an unexpected shortfall in revenues and even a relatively small decrease in revenues could disproportionately and adversely affect our financial results for that quarter.
The variability and unpredictability of these and other factors, many of which are outside of our control, could result in our failing to meet or exceed financial expectations for a given period and may cause the price of our common stock to decline substantially.
If the transition to a SaaS-based business model fails to yield the benefits that we expect, our results of operations could be negatively impacted.
We successfully completed our transition to a subscription-based business model and are currently transitioning our business to a SaaS-based business model. It is uncertain whether this transition will prove successful. Market acceptance of our products is dependent on our ability to include functionality and usability that address certain customer requirements. Additionally, we must optimally price our products in light of marketplace conditions, our costs and customer demand. This transition may have negative revenue and earnings implications, including on our quarterly results of operations.
This SaaS strategy may give rise to a number of risks, including the following:
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•our revenues and operating margins may fluctuate more than anticipated over the short-term as a result of this strategy;
•if new or current customers desire only self-hosted licenses our SaaS sales may lag behind our expectations;
•the shift to a SaaS strategy may raise concerns among our customer base, including concerns regarding changes to pricing over time and access to data once a subscription has expired;
•we may be unsuccessful in maintaining or implementing our target pricing or new pricing models, product adoption and projected renewal rates, or we may select a target price or new pricing model that is not optimal and could negatively affect our sales or earnings;
•our shift to a SaaS business model may result in confusion among new or existing customers (which can slow adoption rates), resellers and investors;
•if our customers do not renew their subscriptions or do not renew them on a timely basis, our revenues may decline and our business may suffer;
•we may incur sales compensation costs at a higher than forecasted rate if the pace of our subscription transition is faster than anticipated; and
•our sales force may struggle with the transition which may lead to increased turnover rates and lower headcount.
The expansion of cloud-delivered services (as opposed to traditional on-premises delivery of our products) has and will introduce a number of risks and uncertainties unique to such a shift, which could adversely affect our business, results of operations and financial condition.
We recently launched cloud offerings that allow customers to use hosted software. This launch required, and any future expansion of our cloud-delivered services may require, a considerable investment in resources, including technical, financial, legal, sales, information technology and operation systems. Additionally, market acceptance of such offerings is affected by a variety of factors, including but not limited to: security, reliability, scalability, customization, performance, current license terms, customer preference, customer concerns with entrusting a third party to store and manage their data, public concerns regarding privacy and the enactment of restrictive laws or regulations. It is possible that demand for our cloud offerings will not be as strong as anticipated. Moreover, expansion of our cloud offerings may cause a decline in revenue of our existing products and services that is not offset by revenue from the new products or services. For example, customers may delay making purchases of products and services to permit them to make a more thorough evaluation of these new products and services or until industry and marketplace reviews become widely available. In addition, the transition to a SaaS-based business model, and the additional demands involved in selling multiple products as well as new product offerings, has increased the complexity and to some extent imposed new challenges in finding, hiring and retaining qualified sales force members. We may be unable to realize the benefits of our investments, or the resources we have committed, toward launching or expanding our cloud-delivered services.
An increasing number of jurisdictions are imposing data localization laws, which require personal information, or certain subcategories of personal information, to be stored in the jurisdiction of origin. These regulations may deter customers from using cloud-based services, and may inhibit our ability to expand into certain markets or prohibit us from continuing to offer services in those markets without significant additional costs.
Our hosted offerings rely upon third-party providers to supply data center space, equipment maintenance and other colocation services and rely upon the ability of those providers to maintain continuous service availability and protect customer data on their services. Customers of our cloud-based offerings need to be able to access our platform at any time, without interruption or degradation of performance, and we provide them with service level commitments with respect to uptime. Third-party cloud providers run their own platforms that we access, and we are, therefore, vulnerable to their service interruptions. Although we have entered into various agreements for the lease of data center space, equipment maintenance and other services, third parties could fail to live up to their contractual obligations. The failure of a third-party provider to prevent service disruptions, data losses or security breaches may require us to issue credits or refunds or indemnify or otherwise be liable to customers or third parties for damages that may occur, and contractual provisions with our third-party providers and public cloud partners may limit our recourse against the third-party provider or public cloud partner responsible for such failure. Additionally, if these third-party providers fail to deliver on their obligations, our reputation could be damaged, our customers could lose confidence in us, and our ability to maintain and expand our hosted offerings would be impaired. Lastly, our cloud product offering and pricing is new and hosting and other costs may be more expensive to us than anticipated.
We may not be able to predict renewal rates and their impact on our future revenues and operating results.
Although our subscription solutions are designed to increase the number of customers that purchase our solutions and the number of products purchased by existing and new customers to create a recurring revenue stream that increases and is more
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predictable over time, our customers are not required to renew their subscriptions for our solutions and they may elect not to renew when, or as we expect, or they may elect to reduce the scope of their original purchases or delay their purchase. We cannot accurately predict renewal rates given our varied customer base of enterprise and small and medium size business customers and the number of multiyear subscription contracts. Customer renewal rates may decline or fluctuate due to a number of factors, including offering pricing, competitive offerings, customer satisfaction and reductions in customer spending levels or customer activity due to economic downturns, the adverse impact of import tariffs, inflation, the pandemic or other market uncertainty. If our customers do not renew their subscriptions when or as we expect, or if they choose to renew for fewer subscriptions (in quantity or products) or renew for shorter contract lengths or if they renew on less favorable terms, our revenues and earnings may decline, and our business may suffer.
We have been growing and expect to continue to invest in our growth for the foreseeable future. If we fail to manage this growth effectively, our business and results of operations will be adversely affected.
We intend to continue to grow our business and plan to continue to hire new sales employees either for expansion or replacement of existing sales personnel. If we cannot adequately and timely hire new employees and if we fail to adequately train these new employees, including our sales force, engineers and customer support staff, our sales may not grow at the rates we project and/or our sales productivity might suffer, our customers might decide not to renew or reduce the scope of their original purchases, or our customers may lose confidence in the knowledge and capability of our employees or products. We must successfully manage our growth to achieve our objectives. Although our business has experienced significant growth in the past, we may not be able to continue to grow at the same rate, or at all.
Our ability to effectively manage any significant growth of our business will depend on a number of factors, including our ability to do the following:
• satisfy existing customers and attract new customers;
• adequately and timely recruit, train, motivate and integrate new employees, including our sales force and engineers, while retaining existing employees, maintaining the beneficial aspects of our corporate culture and effectively executing our business plan;
• successfully introduce new products and enhancements;
• effectively manage existing channel partnerships and expand to new ones;
• improve our key business applications and processes to support our business needs;
• enhance information and communication systems to ensure that our employees and offices around the world are well-coordinated and can effectively communicate with each other and our growing customer base;
• enhance our internal controls to ensure timely and accurate reporting of all of our operations and financial results;
• protect and further develop our strategic assets, including our intellectual property rights;
• continue to capitalize on the transition to a subscription-based business model and manage our introduction of cloud-based solutions; and
• successfully manage and integrate any future acquisitions of businesses, including without limitation, the amount and timing of expenses and potential future charges for impairment of goodwill from acquired companies.
These activities will require significant investments and allocation of valuable management and employee resources, and our growth will continue to place significant demands on our management and our operational and financial infrastructure. We may not be able to grow our business in an efficient or timely manner, or at all. Moreover, if we do not effectively manage the growth of our business and operations, the quality of our software could suffer, which could negatively affect our brand, results of operations and overall business.
We have a limited operating history at our current scale, which makes it difficult to evaluate and predict our future prospects and may increase the risk that we will not be successful.
We have a relatively short history operating our business at its current scale. For example, we have increased the number of our employees and have expanded our operations and product offerings. This limits our ability to forecast our future operating results and subjects us to a number of uncertainties, including our ability to plan for and model future growth. We have encountered and will continue to encounter risks and uncertainties frequently experienced by growing companies in new markets that may not develop as expected. Because we depend in part on the market’s acceptance of our products, it is difficult to evaluate trends that may affect our business. If our assumptions regarding these trends and uncertainties, which we use to plan our business, are incorrect or change in reaction to changes in our markets, or if we do not address these risks successfully, our operating and financial results could differ materially from our expectations and our business could suffer. Moreover, although we have experienced significant growth historically, we may not continue to grow as quickly in the future.
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Our future success will depend in large part on our ability to, among other things:
• successfully transition to a SaaS-based business model and manage our introduction of cloud-based solutions;
• maintain and expand our business, including our customer base and operations, to support our growth, both domestically and internationally;
• develop new products and services and bring products and services in beta to market;
• renew customer agreements and sell additional products to existing customers;
• maintain high customer satisfaction and ensure quality and timely releases of our products and product enhancements;
• increase market awareness of our products and enhance our brand;
• maintain compliance with applicable governmental regulations and other legal obligations, including those related to intellectual property, international sales and taxation;
• hire, integrate, train and retain skilled talent, including members of our sales force and engineers; and
• our ability to successfully manage and integrate any acquisitions of businesses.
If we fail to address the risks and difficulties that we face, including those associated with the challenges listed above as well as those described elsewhere in this “Risk Factors” section, our business will be adversely affected, and our results of operations will suffer.
If we are unable to attract new customers and expand sales to existing customers, both domestically and internationally, our growth could be slower than we expect, and our business may be harmed.
Our success will depend, in part, on our ability to support new and existing customer growth and maintain customer satisfaction. Our sales and marketing teams host in-person events and have, and in the future may continue to engage with customers online and through other communications channels, including virtual meetings. Our sales and marketing teams may not be as successful or effective in building relationships. If we cannot provide the tools and training to our teams to efficiently do their jobs and satisfy customer demands, we may not be able to achieve anticipated revenue growth as quickly as expected.
Our future growth depends upon expanding sales of our products to existing customers and their organizations and receiving renewals. If our customers do not purchase additional licenses or capabilities, our revenues may grow more slowly than expected, may not grow at all or may decline. Our efforts may not result in increased sales to existing customers (“upsells”) and additional revenues. If our efforts to upsell to our customers are not successful, our business would suffer.
Our future growth also depends in part upon increasing our customer base, particularly those customers with potentially high customer lifetime values. Our ability to achieve significant growth in revenues in the future will depend, in large part, upon the effectiveness of our sales and marketing efforts, both domestically and internationally, and our ability to attract new customers. Our ability to attract new customers may be adversely affected by newly enacted laws that may prohibit certain sales and marketing activities, such as legislation passed in the State of New York, pursuant to which unsolicited telemarketing sales calls are prohibited. If we fail to attract new customers and maintain and expand those customer relationships, our revenues may be adversely affected, and our business will be harmed.
We have a history of losses, and we may not be profitable in the future.
We have incurred net losses in each year since our inception, including a net loss of $38.3 million for the three months ended March 31, 2023 and net losses of $124.5 million and $116.9 million in each of the years ended December 31, 2022 and 2021, respectively. Because the market for our software is rapidly evolving and has still not yet reached widespread adoption, it is difficult for us to predict our future results of operations. We expect our operating expenses to increase over the next several years as we hire additional personnel, expand and improve the effectiveness of our distribution channels, and continue to develop features and applications for our software.
If we are unable to maintain successful relationships with our channel partners, our business could be adversely affected.
We rely on channel partners, such as distribution partners and resellers, to sell licenses and support and maintenance agreements for our software and to perform some of our professional services. In 2022 and for the three months ended March 31, 2023, our channel partners fulfilled substantially all of our sales, and we expect that sales to channel partners will continue to account for substantially all of our revenues for the foreseeable future. Our ability to achieve revenue growth in the future will depend in part on our success in maintaining successful relationships with our channel partners.
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Our agreements with our channel partners are generally non-exclusive, meaning our channel partners may offer customers the products of several different companies. If our channel partners do not effectively market and sell our software, choose to use greater efforts to market and sell their own products or those of others, or fail to meet the needs of our customers, including through the provision of professional services for our software, our ability to grow our business, sell our software and maintain our reputation may be adversely affected. Our contracts with our channel partners generally allow them to terminate their agreements for any reason upon 30 days’ notice. A termination of the agreement has no effect on orders already placed. The loss of a substantial number of our channel partners, our possible inability to replace them, or the failure to recruit additional channel partners could materially and adversely affect our results of operations. If we are unable to maintain our relationships with these channel partners, our business, results of operations, financial condition or cash flows could be adversely affected.
Finally, even if we are successful, our relationships with channel partners may not result in greater customer usage of our products and professional services or increased revenue.
Our long-term growth depends, in part, on being able to continue to expand internationally on a profitable basis, which subjects us to risks associated with conducting international operations.
Historically, we have generated the majority of our revenues from customers in North America. For the year ended December 31, 2022 and for the three months ended March 31, 2023, approximately 74% and 76%, respectively, of our total revenues were derived from sales in North America. Nevertheless, we have operations across the globe, and we plan to continue to expand our international operations as part of our long-term growth strategy. The further expansion of our international operations will subject us to a variety of risks and challenges, including:
• sales and customer service challenges associated with operating in different countries;
• increased management travel, infrastructure and legal compliance costs associated with having multiple international operations and a lack of travel due to pandemics;
• difficulties in receiving payments from different geographies, including difficulties associated with currency fluctuations, payment cycles, transfer of funds or collecting accounts receivable, especially in emerging markets;
• variations in economic or political conditions between each country or region;
• economic uncertainty around the world and adverse effects arising from economic interdependencies across countries and regions;
• the uncertainty around the effects of global pandemics on our business and results of operations;
• uncertainty around a potential reverse or renegotiation of international trade agreements and partnerships;
• compliance with foreign laws and regulations and the risks and costs of non-compliance with such laws and regulations;
• ability to hire, retain and train local employees and the ability to comply with foreign labor laws and local labor requirements, such as representations by an internal labor committee in France which is affiliated with an external trade union and the applicability of collective bargaining arrangements at the national level in certain European countries;
• compliance with laws and regulations for foreign operations, including the U.S. Foreign Corrupt Practices Act of 1977, as amended (the “FCPA”), the U.K. Bribery Act of 2010 (the “UK Bribery Act”), import and export control laws, tariffs, trade barriers, economic sanctions and other regulatory or contractual limitations on our ability to sell our software in certain foreign markets, and the risks and costs of non-compliance;
• heightened risks of unfair or corrupt business practices in certain geographies and of improper or fraudulent sales arrangements that may impact financial results and result in restatements of financial statements and irregularities in financial statements;
• reduced protection for intellectual property rights in certain countries and practical difficulties and costs of enforcing rights abroad; and
• compliance with the laws of numerous foreign taxing jurisdictions and overlapping of different tax regimes and digital tax imposed on our operations in foreign taxing jurisdictions.
Any of these risks could adversely affect our international operations, reduce our revenues from outside the United States or increase our operating costs, adversely affecting our business, results of operations and financial condition and growth prospects. There can be no assurance that all of our employees, independent contractors and channel partners will comply with the formal policies we have and will implement, or applicable laws and regulations. Violations of laws or key control policies by our employees, independent contractors and channel partners could result in delays in revenue recognition, financial reporting misstatements, fines, penalties or the prohibition of the importation or exportation of our software and services and could have a material adverse effect on our business and results of operations.
We are exposed to collection and credit risks, which could impact our operating results.
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Our accounts receivable and contract assets are subject to collection and credit risks. These agreements may include purchase commitments for multiple years of subscription-based software licenses and maintenance services, which may be invoiced over multiple reporting periods increasing these risks. For example, our operating results may be impacted by significant bankruptcies among customers and resellers, which could negatively impact our revenues and cash flows. Although we have processes in place that are designed to monitor and mitigate these risks, we cannot guarantee these programs will be effective. If we are unable to adequately control these risks, our business, operating results and financial condition could be harmed.
If currency exchange rates fluctuate substantially in the future, our results of operations, which are reported in U.S. dollars, could be adversely affected.
Our functional and reporting currency is the U.S. dollar, and we generate the majority of our revenues and incur the majority of our expenses in U.S. dollars. Revenues and expenses are also incurred in other currencies, primarily Euros, Pounds Sterling, Canadian dollars, Australian dollars and the New Israeli Shekel. Accordingly, changes in exchange rates may have a material adverse effect on our business, results of operations and financial condition. The exchange rates between the U.S. dollar and foreign currencies have fluctuated substantially in recent years and may continue to fluctuate substantially in the future. Furthermore, a strengthening of the U.S. dollar could increase the cost in local currency of our software and renewals to customers outside the United States, which could adversely affect our business, results of operations, financial condition and cash flows.
We incur expenses for employee compensation and other operating expenses at our non-U.S. locations in local currencies. The weakening of the U.S. dollar against such currencies would cause the U.S. dollar equivalent of such expenses to increase which could have a negative impact on our reported results of operations and our ability to attract employees in such non-U.S. locations due to the actual increase in the compensation to be paid to such employees. We use forward foreign exchange contracts to hedge or mitigate the effect of changes in foreign exchange rates on our operating expenses denominated in certain foreign currencies. However, this strategy might not eliminate our exposure to foreign exchange rate fluctuations and involves costs and risks of its own, such as cash expenditures, ongoing management time and expertise, external costs to implement the strategy and potential accounting implications. Additionally, our hedging activities may contribute to increased losses as a result of volatility in foreign currency markets and the difference between the interest rates of the currencies being hedged.
Our business is highly dependent upon our brand recognition and reputation, and the failure to maintain or enhance our brand recognition or reputation may adversely affect our business.
We believe that enhancing the “Varonis” brand identity and maintaining our reputation in the IT industry is critical to our relationships with our customers and to our ability to attract new customers. Our brand recognition and reputation are dependent upon:
• our ability to continue to offer high quality, innovative and error- and bug-free products;
• our ability to maintain customer satisfaction with our products;
• our ability to be responsive to customer concerns and provide high quality customer support, training and professional services;
• our marketing efforts;
• any misuse or perceived misuse of our products;
• positive or negative publicity;
• our ability to prevent or quickly react to any cyberattack on our IT systems or security breach of or related to our software;
• interruptions, delays or attacks on our website; and
• litigation or regulatory-related developments.
We may not be able to successfully promote our brand or maintain our reputation. In addition, independent industry analysts often provide reviews of our products, as well as other products available in the market, and perception of our product in the marketplace may be significantly influenced by these reviews. If these reviews are negative, or less positive than reviews about other products available in the market, our brand may be adversely affected. Furthermore, negative publicity relating to events or activities attributed to us, our employees, our channel partners or others associated with any of these parties, may tarnish our reputation and reduce the value of our brand. If we do not successfully enhance our brand and maintain our reputation, our business may not grow, we may have reduced pricing power relative to competitors with stronger brands, and we could lose customers or renewals, all of which would adversely affect our business, operations and financial results. Moreover, damage to our reputation and loss of brand equity may reduce demand for our products and have an adverse effect on our business, results
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of operations and financial condition. Any attempts to rebuild our reputation and restore the value of our brand may be costly and time consuming, and such efforts may not ultimately be successful.
Moreover, it may be difficult to enhance our brand and maintain our reputation in connection with sales to channel partners. Promoting our brand requires us to make significant expenditures, and we anticipate that the expenditures will increase as our market becomes more competitive, as we expand into new markets and geographies and as more sales are generated to our channel partners. To the extent that these activities yield increased revenues, these revenues may not offset the increased expenses we incur.
Our success depends in part on maintaining and increasing our sales to customers in the public sector.
We derive a portion of our revenues from contracts with federal, state, local and foreign governments and government-owned or -controlled entities (such as public health care bodies, educational institutions and utilities), which we refer to as the public sector herein. We believe that the success and growth of our business will continue to depend on our successful procurement of public sector contracts. Selling to public sector entities can be highly competitive, expensive and time consuming, often requiring significant upfront time and expense without any assurance that our efforts will produce any sales. Government demand and payment for our products and services may be impacted by public sector budgetary cycles, or lack of, and funding authorizations, including in connection with an extended government shutdown, with funding reductions or delays adversely affecting public sector demand for our products and services. Factors that could impede our ability to maintain or increase the amount of revenues derived from public sector contracts include:
• changes in public sector fiscal or contracting policies;
• decreases or elimination of available public sector funding;
• non-compliance with or an inability to attain the proper certification to conduct business in the public sector;
• changes in public sector programs or applicable requirements;
• the adoption of new laws or regulations or changes to existing laws or regulations;
• potential delays or changes in the public sector appropriations or other funding authorization processes;
• the requirement of contractual terms that are unfavorable to us, such as most-favored-nation pricing provisions; and
• delays in the payment of our invoices by public sector payment offices.
Furthermore, we must comply with laws and regulations relating to public sector contracting, which affect how we and our channel partners do business in both the United States and abroad. These laws and regulations may impose added costs on our business, and failure to comply with these or other applicable regulations and requirements, including non-compliance in the past, could lead to claims for damages from our channel partners, penalties, termination of contracts, and temporary suspension or permanent debarment from public sector contracting. Moreover, governments routinely investigate and audit government contractors’ administrative processes, and any unfavorable audit could result in the government refusing to continue buying our products, which would adversely impact our revenue and results of operations, or institute fines or civil or criminal liability if the audit uncovers improper or illegal activities.
The occurrence of any of the foregoing could cause public sector customers to delay or refrain from purchasing licenses of our software in the future or otherwise have an adverse effect on our business, operations and financial results.
We are subject to governmental export and import controls that could subject us to liability or impair our ability to compete in international markets.
We incorporate certain encryption technology into certain of our products and, as a result, are required to comply with U.S. export control laws and regulations, including the Export Administration Regulations administered by the U.S. Department of Commerce’s Bureau of Industry and Security (“BIS”). We are also subject to Israeli export control laws on encryption technology. These export control laws and regulations prohibit, restrict, or regulate our ability to, directly or indirectly, export, re-export, or transfer certain products to certain countries and territories, entities, and individuals for certain end uses. If the applicable U.S. or Israeli legal requirements regarding the export of encryption technology were to change or if we change the encryption means in our products, we may (i) be unable to export our products, (ii) need to apply for new licenses or (iii) be unable to rely on certain license exceptions. Furthermore, various other countries regulate the import of certain encryption technology, including import permitting and licensing requirements, and have enacted laws that could limit our ability to distribute our products or could limit our customers’ ability to implement our products in those countries.
We are also subject to U.S. and Israeli economic sanctions laws, which prohibit the shipment of certain products to embargoed or sanctioned countries, sanctioned governments and sanctioned persons. Like with export controls, we take precautions to
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prevent our products from being provided in violation of these laws, including requiring our business partners to commit to compliance through contractual undertakings. However, if our business partners were to provide our products to certain countries, governments, or sanctioned persons in violation of these laws, such provision could have negative consequences, including government investigations, penalties and reputational harm.
Any change in export or import regulations, economic sanctions or related legislation, shift in the enforcement or scope of existing regulations, or change in the countries, governments, persons or technologies targeted by such regulations, could result in decreased use of our products by, or in our decreased ability to export or sell our products to, existing or potential customers with international operations. Moreover, any new export or import restrictions, new legislation or shifting approaches in the enforcement or scope of existing regulations, or in the countries, persons or technologies targeted by such regulations, could result in decreased use of our products. Any decreased use of our products or limitation on our ability to export or sell our products would likely adversely affect our business, financial condition and results of operations.
Our business in countries with a history of corruption and transactions with foreign governments increase the risks associated with our international activities.
As we operate and sell internationally, we are subject to the FCPA, the UK Bribery Act and other laws that prohibit improper payments or offers of payments to foreign governments and their officials and political parties for the purpose of obtaining or retaining business. We have operations, deal with and make sales to governmental customers in countries known to experience corruption, particularly certain emerging countries in Eastern Europe, South and Central America, East Asia, Africa and the Middle East. Our activities in these countries create the risk of unauthorized payments or offers of payments by one of our employees, consultants, channel partners or sales agents that could be in violation of various anti-corruption laws, even though these parties may not be under our control. While we have implemented safeguards to prevent these practices by our employees, consultants, channel partners and sales agents, our existing safeguards and any future improvements may prove to be less than effective, and our employees, consultants, channel partners or sales agents may engage in conduct for which we might be held responsible. Violations of the FCPA or other anti-corruption laws may result in severe criminal or civil sanctions, including suspension or debarment from government contracting, and we may be subject to other liabilities, which could negatively affect our business, operating results and financial condition.
Acquisitions could disrupt our business and adversely affect our results of operations, financial condition and cash flows.
As we continue to pursue business opportunities, we may make acquisitions that could be material to our business, results of operations, financial condition and cash flows. Acquisitions involve many risks, including the following:
• an acquisition may negatively affect our results of operations, financial condition or cash flows because it may require us to incur charges or assume substantial debt or other liabilities, may cause adverse tax consequences or unfavorable accounting treatment, including potential write-downs of deferred revenues, may expose us to claims and disputes by third parties, including intellectual property claims and disputes, or may not generate sufficient financial return to offset additional costs and expenses related to the acquisition;
• we may encounter difficulties or unforeseen expenditures in integrating the business, technologies, products, personnel or operations of any company that we acquire, particularly if key personnel of the acquired company decide not to work for us;
• an acquisition may disrupt our ongoing business, divert resources, increase our expenses and distract our management;
• an acquisition may result in a delay or reduction of customer purchases for both us and the company we acquired due to customer uncertainty about continuity and effectiveness of service from either company;
• we may encounter difficulties in, or may be unable to, successfully sell any acquired products;
• an acquisition may involve the entry into geographic or business markets in which we have little or no prior experience or where competitors have stronger market positions;
• challenges inherent in effectively managing an increased number of employees in diverse locations;
• the potential strain on our financial and managerial controls and reporting systems and procedures;
• potential known and unknown liabilities or deficiencies associated with an acquired company that were not identified in advance;
• our use of cash to pay for acquisitions would limit other potential uses for our cash and affect our liquidity;
• if we incur debt to fund such acquisitions, such debt may subject us to material restrictions on our ability to conduct our business as well as financial maintenance covenants;
• the risk of impairment charges related to potential write-downs of acquired assets or goodwill in future acquisitions;
• to the extent that we issue a significant amount of equity or convertible debt securities in connection with future acquisitions, existing stockholders may be diluted and earnings per share may decrease; and
• managing the varying intellectual property protection strategies and other activities of an acquired company.
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We may not succeed in addressing these or other risks or any other problems encountered in connection with the integration of any acquired business. Our ability as an organization to successfully acquire and integrate technologies or businesses is limited. The inability to successfully integrate the business, technologies, products, personnel or operations of any acquired business, or any significant delay in achieving integration, could have a material adverse effect on our business, results of operations, financial condition and cash flows.
Risks Related to Human Capital
A failure to maintain sales and marketing personnel productivity or hire and integrate additional sales and marketing personnel could adversely affect our results of operations and growth prospects.
Our business requires intensive sales and marketing activities. Our sales and marketing personnel are essential to attracting new customers and expanding sales to existing customers, both of which are key to our future growth. We face a number of challenges in successfully expanding our sales force. Our transition to a SaaS-based business model, and the additional demands involved in selling our platform, has increased the complexity and to some extent imposed new challenges in finding, hiring and retaining qualified sales force members. We must locate and hire a significant number of qualified individuals, and competition for such individuals is intense. In addition, as we expand into new markets with which we have less familiarity and develop existing territories, we will need to recruit individuals who have skills particular to a certain geography or territory, and it may be difficult to find candidates with those qualifications. We may be unable to achieve our hiring or integration goals due to a number of factors, including, but not limited to, the challenge in remotely recruiting employees and adequately training them, the number of individuals we hire, challenges in finding individuals with the correct background due to increased competition for such hires, increased attrition rates among new hires and existing personnel as well as the necessary experience to sell the Varonis Data Security Platform rather than individual software products. Furthermore, based on our past experience in mature territories, it can take up to 12 months before a new sales force member is trained and operating at a level that meets our expectations. We invest significant time and resources in training new members of our sales force, and we may be unable to achieve our target performance levels with new sales personnel as rapidly as we have done in the past, or at all, due to larger numbers of hires or lack of experience training sales personnel to operate in new jurisdictions or because of the remote hiring and training process. Our failure to hire a sufficient number of qualified individuals, to integrate new sales force members within the time periods we have achieved historically or to keep our attrition rates at levels comparable to others in our industry may materially impact our projected growth rate.
Failure to retain, attract and recruit highly qualified personnel could adversely affect our business, operating results, financial condition and growth prospects.
Our future success and growth depend, in part, on our ability to continue to recruit and retain highly skilled personnel and to preserve the key aspects of our corporate culture. Because our future success is dependent on our ability to continue to enhance and introduce new products, we are particularly dependent on our ability to hire and retain engineers. Any of our employees may terminate their employment at any time, and we face intense competition for highly skilled employees. Competition for qualified employees, particularly in Israel, where we have a substantial presence and need for qualified engineers, from numerous other companies, including other software and technology companies, many of whom have greater financial and other resources than we do, is intense. Moreover, to the extent we hire personnel from other companies, we may be subject to allegations that they have been improperly solicited or may have divulged proprietary or other confidential information to us. If we are unable to timely attract, retain or train qualified employees, particularly our engineers, salespeople and key managers, our ability to innovate, introduce new products and compete would be adversely impacted, and our financial condition and results of operations may suffer. Lastly, equity grants are a critical component of our current compensation programs. If we reduce, modify or eliminate our equity compensation programs or if there is a decline in our stock price, which will result in the value of our equity compensation being lower, we may have difficulty attracting and retaining employees.
We are dependent on the continued services and performance of our co-founder, Chief Executive Officer and President, the loss of whom could adversely affect our business.
Much of our future performance depends on the continued services and continuing contributions of our co-founder, Chief Executive Officer and President, Yakov Faitelson, to successfully manage our company, to execute on our business plan and to identify and pursue new opportunities and product innovations. The loss of Mr. Faitelson’s services could significantly delay or prevent the achievement of our development and strategic objectives and adversely affect our business.
Risks Related to our Technology, Products, Services and Intellectual Property
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Our failure to continually enhance and improve our technology could adversely affect sales of our products.
The market is characterized by the exponential growth in enterprise data, rapid technological advances, changes in customer requirements, including customer requirements driven by changes to legal, regulatory and self-regulatory compliance mandates, frequent new product introductions and enhancements and evolving industry standards in computer hardware and software technology. As a result, we must continually change and improve our products in response to changes in operating systems, application software, computer and communications hardware, networking software, data center architectures, programming tools, computer language technology and various regulations. Moreover, the technology in our products is especially complex because it needs to effectively identify and respond to a user’s data retention, security and governance needs, while minimizing the impact on database and file system performance. Our products must also successfully interoperate with products from other vendors.
While we extend our technological capabilities though innovation and strategic transactions, including our recently announced cloud-based solutions, we cannot guarantee that we will be able to anticipate future market needs and opportunities or be able to extend our technological expertise and develop new products or expand the functionality of our current products in a timely manner or at all. Even if we are able to anticipate, develop and introduce new products and expand the functionality of our current products, there can be no assurance that enhancements or new products will achieve widespread market acceptance.
Our product enhancements or new products could fail to attain sufficient market acceptance for many reasons, including:
• failure to accurately predict market demand in terms of product functionality and to supply products that meet this demand in a timely fashion;
• inability to interoperate effectively with the database technologies and file systems of prospective customers;
• defects, errors or failures;
• negative publicity or customer complaints about performance or effectiveness; and
• poor business conditions, causing customers to delay IT purchases.
If we fail to anticipate market requirements or stay abreast of technological changes, we may be unable to successfully introduce new products, expand the functionality of our current products or convince our customers and potential customers of the value of our solutions in light of new technologies. Accordingly, our business, results of operations and financial condition could be materially and adversely affected.
If our technical support, customer success or professional services are not satisfactory to our customers, they may not renew their agreements or not buy additional products in the future, which could adversely affect our future results of operations.
Our business relies on our customers’ satisfaction with the technical support and professional services we provide to support our products. Our customers have no obligation to renew their agreements with us after the initial terms have expired. Our customers have an option to renew their agreements and, for us to maintain and improve our results of operations, it is important that our existing customers renew their agreements, if applicable, when the existing contract term expires. For example, our renewal rate for the year ended December 31, 2022 and for the three months ended March 31, 2023 continued to be over 90%. Customer satisfaction will become even more important as almost all of our licensing has shifted to subscription license agreements.
If we fail to provide technical support services that are responsive, satisfy our customers’ expectations and resolve issues that they encounter with our products and services, then they may elect not to purchase or renew contracts and they may choose not to purchase additional products and services from us. Accordingly, our failure to provide satisfactory technical support or professional services could lead our customers not to renew their agreements with us or renew on terms less favorable to us, and therefore have a material and adverse effect on our business and results of operations.
Because we derive substantially all of our revenues and cash flows from sales of licenses from a single platform of products, failure of the products in the platform to satisfy customers or to achieve increased market acceptance would adversely affect our business.
In 2022, and for the three months ended March 31, 2023, we generated substantially all of our revenues from sales of licenses from DatAdvantage, DatAlert, Data Classification Engine, DataPrivilege and Data Transport Engine. We expect to continue to derive the majority of our revenues from license sales relating to these products in the future. As such, market acceptance of these products is critical to our continued success. Demand for licenses for our platform of products is affected by a number of factors, some of which are outside of our control, including continued market acceptance of our software by referenceable accounts for existing and new use cases, technological change and growth or contraction in our market. We expect the
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proliferation of enterprise data to lead to an increase in the data analysis demands, and data security and retention concerns, of our customers, and our software, including the software underlying the Varonis Data Security Platform, may not be able to scale and perform to meet those demands. If we are unable to continue to meet customer demands or to achieve more widespread market acceptance of our software, our business, operations, financial results and growth prospects will be materially and adversely affected.
Interruptions or performance problems, including associated with our website or support website or any caused by cyberattacks, may adversely affect our business.
Our continued growth depends in part on the ability of our existing and potential customers to quickly access our website and support website. Access to our support website is also imperative to our daily operations and interaction with customers, as it allows customers to download our software, fixes and patches, as well as open and respond to support tickets and register license keys for evaluation or production purposes. We have experienced, and may in the future experience, website disruptions, outages and other performance problems due to a variety of factors, including technical failures, cyberattacks, natural disasters, infrastructure changes, human or software errors, capacity constraints due to an overwhelming number of users accessing our website simultaneously and denial of service or fraud. In some instances, we may not be able to identify the cause or causes of these performance problems within an acceptable period of time. System failures or outages, including any potential disruptions due to a period of increased global demand on certain cloud-based systems or disruptions of our cloud-based solutions, could compromise our or our customer’s ability to perform day-to-day operations in a timely manner, which could negatively impact our business or delay our financial reporting. It may become increasingly difficult to maintain and improve the performance of our websites, especially during peak usage times and as our software becomes more complex and our user traffic increases. If our websites are unavailable or if our users are unable to download our software, patches or fixes within a reasonable amount of time or at all, we may suffer reputational harm and our business would be negatively affected.
If our software is perceived as not being secure, customers may reduce the use of or stop using our software, and we may incur significant liabilities.
Our software involves the transmission of data between data stores, and between data stores and desktop and mobile computers, and will increasingly involve the storage of data. We have a legal and contractual obligation to protect the confidentiality and appropriate use of customer data. Any security breaches with respect to such data could result in the loss of this information, litigation, indemnity obligations and other liabilities. The security of our products and accompanied services is important in our customers’ decisions to purchase or use our products or services. Security threats are a significant challenge to companies like us whose business is providing technology products and services to others. While we have taken steps to protect the confidential information that we have access to, including confidential information we may obtain through our customer support services or customer usage of our products, we have no direct control over the substance of the content. Security measures might be breached as a result of third-party action, employee error, malfeasance or otherwise. We also incorporate open source software and other third-party software into our products. There may be vulnerabilities in open source software and third-party software that may make our products likely to be harmed by cyberattacks. Moreover, our products operate in conjunction with and are dependent on products and components across a broad ecosystem of third parties. If there is a security vulnerability in one of these components, and if there is a security exploit targeting it, such security vulnerability may adversely impact our product vulnerability and we could face increased costs, liability claims, reduced revenue, or harm to our reputation or competitive position. Because techniques used to obtain unauthorized access or sabotage systems change frequently and generally are not identified until they are launched against a target, we may be unable to anticipate these techniques or to implement adequate preventative measures.
The limitations of liability in our contracts may not be enforceable or adequate or otherwise protect us from any such liabilities or damages with respect to any particular claim. While we maintain insurance coverage for some of the above events, the potential liabilities associated with these security breach events could exceed the insurance coverage we maintain.
Any or all of these issues could tarnish our reputation, negatively impact our ability to attract new customers or sell additional products to our existing customers, cause existing customers to elect not to renew their maintenance and support agreements or subject us to third-party lawsuits, regulatory fines or other action or liability, thereby adversely affecting our results of operations.
Our use of open source software could negatively affect our ability to sell our software and subject us to possible litigation.
We use open source software and expect to continue to use open source software in the future. Some open source software licenses require users who distribute open source software as part of their own software product to publicly disclose all or part of the source code to such software product or to make available any derivative works of the open source code on unfavorable terms or at no cost. We may face ownership claims of third parties over, or seeking to enforce the license terms applicable to,
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such open source software, including by demanding the release of the open source software, derivative works or our proprietary source code that was developed using such software. These claims could also result in litigation, require us to purchase a costly license or require us to devote additional research and development resources to change our software, any of which would have a negative effect on our business and results of operations. In addition, if the license terms for the open source code change, we may be forced to re-engineer our software or incur additional costs. Finally, while we implement policies and procedures, we cannot provide assurance that we have incorporated open source software into our own software in a manner that conforms with our current policies and procedures and we cannot assure that all open source software is reviewed prior to use in our solution, that our programmers have not incorporated open source software into our solution, or that they will not do so in the future.
In addition, our solution may incorporate third-party software under commercial licenses. We cannot be certain whether such third-party software incorporates open source software without our knowledge. In the past, companies that incorporate open source software into their products have faced claims alleging noncompliance with open source license terms or infringement or misappropriation of proprietary software. Therefore, we could be subject to suits by parties claiming noncompliance with open source licensing terms or infringement or misappropriation of proprietary software. Because few courts have interpreted open source licenses, the manner in which these licenses may be interpreted and enforced is subject to some uncertainty. There is a risk that open source software licenses could be construed in a manner that imposes unanticipated conditions or restrictions on our ability to market or provide our solution. As a result of using open source software subject to such licenses, we could be required to release proprietary source code, pay damages, re-engineer our solution, limit or discontinue sales or take other remedial action, any of which could adversely affect our business.
False detection of security breaches, false identification of malicious sources or misidentification of sensitive or regulated information could adversely affect our business.
Our cybersecurity products may falsely detect threats that do not actually exist. For example, our DatAlert product may enrich metadata collected by our products with information from external sources and third-party data providers. If the information from these data providers is inaccurate, the potential for false positives increases. These false positives, while typical in the industry, may affect the perceived reliability of our products and solutions and may therefore adversely impact market acceptance of our products. As definitions and instantiations of personal identifiers and other sensitive content change, automated classification technologies may falsely identify or fail to identify data as sensitive. If our products and solutions fail to detect exposures or restrict access to important systems, files or applications based on falsely identifying legitimate use as an attack or otherwise unauthorized, then our customers’ businesses could be adversely affected. Any such false identification of use and subsequent restriction could result in negative publicity, loss of customers and sales, increased costs to remedy any problem and costly litigation.
Failure to protect our proprietary technology and intellectual property rights could substantially harm our business.
The success of our business and competitive position depends on our ability to obtain, protect and enforce our trade secrets, trademarks, copyrights, patents and other intellectual property rights. We attempt to protect our intellectual property under patent, trademark, copyrights and trade secret laws, and through a combination of confidentiality procedures, contractual provisions and other methods, all of which offer only limited protection and may not now or in the future provide us with a competitive advantage.
As of March 31, 2023, we had 87 issued patents in the United States and 9 pending U.S. patent applications. We also had 60 patents issued and 38 applications pending for examination in non-U.S. jurisdictions, and four pending PCT patent applications, all of which are counterparts of our U.S. patent applications. We may file additional patent applications in the future. The process of obtaining patent protection is expensive and time-consuming, and we may not be able to prosecute all necessary or desirable patent applications at a reasonable cost or in a timely manner all the way through to the successful issuance of a patent. We may choose not to seek patent protection for certain innovations and may choose not to pursue patent protection in certain jurisdictions. Furthermore, it is possible that our patent applications may not issue as granted patents, that the scope of our issued patents will be insufficient or not have the coverage originally sought, that our issued patents will not provide us with any competitive advantages, and that our patents and other intellectual property rights may be challenged by others or invalidated through administrative process or litigation. In addition, issuance of a patent does not guarantee that we have an absolute right to practice the patented invention. Our policy is to require our employees (and our consultants and service providers that develop intellectual property included in our products) to execute written agreements in which they assign to us their rights in potential inventions and other intellectual property created within the scope of their employment (or, with respect to consultants and service providers, their engagement to develop such intellectual property). However, we may not be able to adequately protect our rights in every such agreement or execute an agreement with every such party. Finally, in order to benefit from patent and other intellectual property protection, we must monitor, detect and pursue infringement claims in certain circumstances in relevant jurisdictions, all of which is costly and time-consuming. As a result, we may not be able to obtain adequate protection or to enforce our issued patents or other intellectual property effectively.
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In addition to patented technology, we rely on our unpatented proprietary technology and trade secrets. Despite our efforts to protect our proprietary technologies and our intellectual property rights, unauthorized parties, including our employees, consultants, service providers or customers, may attempt to copy aspects of our products or obtain and use our trade secrets or other confidential information. We generally enter into confidentiality agreements with our employees, consultants, service providers, vendors, channel partners and customers, and generally limit access to and distribution of our proprietary information and proprietary technology through certain procedural safeguards. These agreements may not effectively prevent unauthorized use or disclosure of our intellectual property or technology and may not provide an adequate remedy in the event of unauthorized use or disclosure of our intellectual property or technology. We cannot provide assurance that the steps taken by us will prevent misappropriation of our trade secrets or technology or infringement of our intellectual property. In addition, the laws of some foreign countries where we operate do not protect our proprietary rights to as great an extent as the laws of the United States, and many foreign countries do not enforce these laws as diligently as government agencies and private parties in the United States.
We have registered the “Varonis” name and logo and “DatAdvantage,” “DataPrivilege,” “DatAlert,” and other names in the United States and, as related to some of these names, certain other countries. However, we cannot provide assurance that any future trademark registrations will be issued for pending or future applications or that any registered trademarks will be enforceable or provide adequate protection of our proprietary rights.
Despite our efforts to protect our proprietary technology and trade secrets, unauthorized parties may attempt to misappropriate, reverse engineer or otherwise obtain and use them. In addition, others may independently discover our trade secrets, in which case we would not be able to assert trade secret rights or develop similar technologies and processes. Further, the contractual provisions that we enter into may not prevent unauthorized use or disclosure of our proprietary technology or intellectual property rights and may not provide an adequate remedy in the event of unauthorized use or disclosure of our proprietary technology or intellectual property rights. Moreover, policing unauthorized use of our technologies, trade secrets and intellectual property is difficult, expensive and time-consuming, particularly in foreign countries where the laws may not be as protective of intellectual property rights as those in the United States and where mechanisms for enforcement of intellectual property rights may be weak. We may be unable to determine the extent of any unauthorized use or infringement of our solution, technologies or intellectual property rights. If we are unable to protect our intellectual property rights and ensure that we are not violating the intellectual property rights of others, we may find ourselves at a competitive disadvantage to others who need not incur the additional expense, time and effort required to create the innovative products that have enabled us to be successful to date.
Assertions by third parties of infringement or other violations by us of their intellectual property rights, whether or not correct, could result in significant costs and harm our business and operating results.
The industries in which we operate, such as data security, cybersecurity, compliance, data retention and data governance are characterized by the existence of a large number of relevant patents and frequent claims and related litigation regarding patent and other intellectual property rights. From time to time, third parties have asserted and may assert their patent, copyright, trademark and other intellectual property rights against us, our channel partners or our customers. Successful claims of infringement or misappropriation by a third party could prevent us from distributing certain products, performing certain services or could require us to pay substantial damages (including, for example, treble damages if we are found to have willfully infringed patents and increased statutory damages if we are found to have willfully infringed copyrights), royalties or other fees. Such claims also could require us to cease making, licensing or using solutions that are alleged to infringe or misappropriate the intellectual property of others or to expend additional development resources to attempt to redesign our products or services or otherwise to develop non-infringing technology. Even if third parties may offer a license to their technology, the terms of any offered license may not be acceptable, and the failure to obtain a license or the costs associated with any license could cause our business, results of operations or financial condition to be materially and adversely affected. In some cases, we indemnify our channel partners and customers against claims that our products infringe the intellectual property of third parties. Defending against claims of infringement or being deemed to be infringing the intellectual property rights of others could impair our ability to innovate, develop, distribute and sell our current and planned products and services.
Risks Related to our Tax Regime
Our tax rate may vary significantly depending on our stock price.
The tax effects of the accounting for stock-based compensation may significantly impact our effective tax rate from period to period. In periods in which our stock price is higher than the grant price of the stock-based compensation vesting in that period, we will recognize excess tax benefits that will decrease our effective tax rate, while in periods in which our stock price is lower than the grant price of the stock-based compensation vesting in that period, our effective tax rate may increase. The amount and
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value of stock-based compensation issued relative to our earnings in a particular period will also affect the magnitude of the impact of stock-based compensation on our effective tax rate. These tax effects are dependent on our stock price, which we do not control, and a decline in our stock price could significantly increase our effective tax rate and adversely affect our financial results.
Multiple factors may adversely affect our ability to fully utilize our net operating loss carryforwards.
A U.S. corporation’s ability to utilize its federal net operating loss (“NOL”) carryforwards is limited under Section 382 of the Internal Revenue Code of 1986, as amended (the “Code”), if the corporation undergoes an ownership change.
As of December 31, 2022, we have accumulated a $224.3 million federal NOL since inception. Future changes in our stock ownership, including future offerings, as well as changes that may be outside of our control, could result in a subsequent ownership change under Section 382, that would impose an annual limitation on NOLs. In addition, the cash tax benefit from our NOLs is dependent upon our ability to generate sufficient taxable income. Accordingly, we may be unable to earn enough taxable income in order to fully utilize our current NOLs.
Changes in our provision for income taxes or adverse outcomes resulting from examination of our income tax returns could adversely affect our results.
We are subject to income taxation in the United States, Israel and numerous other jurisdictions. Determining our provision for income taxes requires significant management judgment. In addition, our provision for income taxes could be adversely affected by many factors, including, among other things, changes to our operating structure including a review of our intellectual property (“IP”) structure, changes in the amounts of earnings in jurisdictions with different statutory tax rates, changes in the valuation of deferred tax assets and liabilities and changes in tax laws. Significant judgment is required to determine the recognition and measurement attributes prescribed in Accounting Standards Codification 740-10-25 (“ASC 740-10-25”). ASC 740-10-25 applies to all income tax positions, including the potential recovery of previously paid taxes, which if settled unfavorably could adversely impact our provision for income taxes. Our income in certain countries is subject to reduced tax rates provided we meet certain employment criteria. Failure to meet these commitments could adversely impact our provision for income taxes.
We are also subject to the regular examination of our income tax returns by the U.S. Internal Revenue Services and other tax authorities in various jurisdictions. Tax authorities may disagree with our intercompany charges, cross-jurisdictional transfer pricing, IP structure or other matters and assess additional taxes. While we regularly assess the likelihood of adverse outcomes resulting from these examinations to determine the adequacy of our provision for income taxes, there can be no assurance that the outcomes from these regular examinations will not have a material adverse effect on our results of operations and cash flows. Further, we may be audited in various jurisdictions, and such jurisdictions may assess additional taxes against us. Although we believe our tax estimates are reasonable, the final determination of any tax audits or litigation could be materially different from our historical tax provisions and accruals, which could have a material adverse effect on our results of operations or cash flows in the period or periods for which a determination is made.
The adoption of the U.S. tax reform and the enactment of additional legislation changes could materially impact our financial position and results of operations.
On December 22, 2017, the Tax Cuts and Jobs Act (the "TCJA") that significantly reforms the Code was enacted. The TCJA, among other things, includes changes to U.S. federal tax rates, imposes significant additional limitations on the deductibility of certain expenses and adds certain limitations to the use of net operating loss carryforwards arising after December 31, 2017. Due to the expansion of our international business activities, any changes in the U.S. taxation of such activities may increase our worldwide effective tax rate and adversely affect our financial position and results of operations. Further, foreign governments may enact tax laws in response to the TCJA that could result in further changes to global taxation and materially affect our financial position and results of operations. Effective in 2022, the TCJA requires all U.S. companies to capitalize, and subsequently amortize R&E expenses that fall within the scope of Section 174 over five years for research activities conducted in the United States and over fifteen years for research activities conducted outside of the United States, rather than deducting such costs in the year incurred for tax purposes. Although Congress may defer, modify, or repeal this provision, potentially with retroactive effect, we have no assurance that Congress will take any action with respect to this provision. As of the first quarter of 2023, we have accounted for an estimate of the effects of the R&E capitalization, based on interpretation of the law as currently enacted, and have estimated that our $224.3 million accumulated federal NOL as of December 31, 2022 should offset most of the effects of the R&E capitalization requirement in 2023. To the extent that this provision is not deferred, modified or repealed, and once our available NOLs are fully utilized, we would incur a significant increase in our tax expenses and a decrease in our cash flows provided by operations.
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We conduct our operations in several jurisdictions worldwide and report our taxable income based on our business operations in those jurisdictions. Therefore, our intercompany relationships are subject to transfer pricing regulations administered by taxing authorities in various jurisdictions. While we believe that we are currently in material compliance with our obligations under applicable taxing regimes, the relevant taxing authorities may disagree with our determinations as to the income and expenses attributable to specific jurisdictions and may seek to impose additional taxes on us, including for past sales. If such a disagreement were to occur, and our position were not sustained, we could be required to pay additional taxes, interest and penalties, which could result in one-time tax charges, higher effective tax rates, reduced cash flows and lower overall profitability of our operations.
The Organization for Economic Cooperation and Development (“OECD”) introduced the base erosion and profit shifting project which sets out a plan to address international taxation principles in a globalized, digitized business world (the “BEPS Plan”). During 2018, as part of the BEPS Plan, more than 80 countries chose to implement the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent BEPS (“MLI”). The MLI significantly changes the bilateral tax treaties signed by any country that chose to implement the MLI. In addition, during 2019 the OECD, the EU and individual countries (e.g., France, Austria and Italy) each published an initiative to tax digital transactions executed by a non-resident entity and a local end-user or local end-consumer. Under each initiative, the local payer is obligated to withhold a fixed percentage from the gross proceeds paid to the non-resident entity as a tax on executing a digital transaction in that territory, provided the entity’s sales in that territory exceeds a certain threshold (“Digital Service Tax”). As a result of participating countries adopting the international tax policies set under the BEPS Plan, MLI and Digital Service Tax, changes have been and continue to be made to numerous international tax principles and local tax regimes. Due to the expansion of our international business activities, those modifications may increase our worldwide effective tax rate, create tax and compliance obligations in jurisdictions in which we previously had none and adversely affect our financial position.
Risks Related to the 2025 Notes and Credit Facility
We have incurred substantial indebtedness that may decrease our business flexibility, access to capital, and/or increase our borrowing costs, and we may still incur substantially more debt, which may adversely affect our operations and financial results.
In May 2020 we issued the 2025 Notes. As of March 31, 2023, we had $253.0 million outstanding aggregate principal amount of 2025 Notes. In addition, on August 21, 2020 we entered into a credit and security agreement with KeyBank National Association and other parties thereto (the “Credit and Security Agreement”) for a three-year secured revolving credit facility of $70.0 million, with a letter of credit sublimit of $15.0 million and an accordion feature under which the Company can increase the credit facility to up to $90.0 million (the “Credit Facility”). Our Credit Facility contains customary restrictive, negative and financial covenants and is secured by a first priority security interest. If we are unable to comply with the restrictive and financial covenants in our Credit Facility, there would be a default under the terms of that Credit and Security Agreement, and this could result in an acceleration of payment of funds that have been borrowed. As of March 31, 2023, we had no outstanding obligations under our Credit Facility. Our indebtedness may limit our ability to borrow additional funds for working capital, capital expenditures, acquisitions or other general business purposes, limit our ability to use our cash flow or obtain additional financing for future working capital, capital expenditures, acquisitions or other general business purposes, require us to use a substantial portion of our cash flow from operations to make debt service payments, limit our flexibility to plan for, or react to, changes in our business and industry, place us at a competitive disadvantage compared to our less leveraged competitors and increase our vulnerability to the impact of adverse economic and industry conditions.
Our debt obligations may adversely affect our ability to raise additional capital and will be a burden on our future cash resources, particularly if we elect to settle these obligations in cash upon conversion or upon maturity or required repurchase.
Our ability to meet our payment obligations under the 2025 Notes and any outstanding indebtedness under our Credit Facility depends on our future cash flow performance. This, to some extent, is subject to general economic, financial, competitive, legislative and regulatory factors, as well as other factors that may be beyond our control. There can be no assurance that our business will generate positive cash flow from operations, or that additional capital will be available to us, in an amount sufficient to enable us to meet our debt payment obligations and to fund other liquidity needs. If we are unable to generate sufficient cash flow to service our debt obligations, we may need to refinance or restructure our debt, sell assets, reduce or delay capital investments, or seek to raise additional capital. Our ability to refinance our indebtedness will depend on the capital markets and our financial condition at such time. We may not be able to engage in any of these activities or engage in these activities on desirable terms, which could result in a default on our debt obligations. As a result, we may be more vulnerable to economic downturns, less able to withstand competitive pressures and less flexible in responding to changing business and economic conditions. In addition, our Credit Facility limits our ability to incur additional indebtedness under certain
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circumstances. If we are unable to obtain capital on favorable terms or at all, we may have to reduce our operations or forego opportunities, and this may have a material adverse effect on our business, financial condition and results of operations.
We may issue additional shares of our common stock in connection with conversions of the 2025 Notes, and thereby dilute our existing stockholders and potentially adversely affect the market price of our common stock.
In the event that the 2025 Notes are converted and we elect to deliver shares of common stock, the ownership interests of existing stockholders will be diluted, and any sales in the public market of any shares of our common stock issuable upon such conversion could adversely affect the prevailing market price of our common stock. In addition, the anticipated conversion of the 2025 Notes could depress the market price of our common stock.
The fundamental change provisions of the 2025 Notes may delay or prevent an otherwise beneficial takeover attempt of us.
If the Company undergoes a “fundamental change,” subject to certain conditions, holders may require the Company to repurchase for cash all or part of their 2025 Notes at a fundamental change repurchase price equal to 100% of the principal amount of the 2025 Notes to be repurchased, plus accrued and unpaid interest to, but excluding, the fundamental change repurchase date. In addition, if such fundamental change also constitutes a “make-whole fundamental change,” the conversion rate for the 2025 Notes may be increased upon conversion of the 2025 Notes in connection with such “make-whole fundamental change.” Any increase in the conversion rate will be determined based on the date on which the “make-whole fundamental change” occurs or becomes effective and the price paid (or deemed paid) per share of our common stock in such transaction. Any such increase will be dilutive to our existing stockholders. Our obligation to repurchase the 2025 Notes or increase the conversion rate upon the occurrence of a make-whole fundamental change may, in certain circumstances, delay or prevent a takeover of us that might otherwise be beneficial to our stockholders.
The Capped Call Transactions may affect the value of the 2025 Notes and our common stock.
In connection with the issuance of the 2025 Notes, we entered into Capped Call Transactions with certain financial institutions. The Capped Call Transactions are expected generally to reduce or offset the potential dilution upon conversion of the 2025 Notes and/or offset any cash payments we are required to make in excess of the principal amount of converted 2025 Notes, as the case may be, with such reduction and/or offset subject to the Cap Price, subject to certain adjustments under the terms of the Capped Call Transactions.
From time to time, certain financial institutions (with which we entered into the Capped Call Transactions) or their respective affiliates may modify their hedge positions by entering into or unwinding various derivatives with respect to our common stock and/or purchasing or selling our common stock or other securities of ours in secondary market transactions prior to the maturity of the 2025 Notes. This activity could also cause or avoid an increase or a decrease in the market price of our common stock.
The potential effect, if any, of these transactions and activities on the price of our common stock or 2025 Notes will depend in part on market conditions and cannot be ascertained at this time. Any of these activities could adversely affect the value of our common stock.
We are subject to counterparty risk with respect to the Capped Call Transactions.
All or some of the financial institutions (which are counterparties to the capped call transactions) might default under the Capped Call Transactions. Our exposure to the credit risk of the counterparties will not be secured by any collateral. Past global economic conditions have resulted in the actual or perceived failure or financial difficulties of many financial institutions. If an option counterparty becomes subject to insolvency proceedings, we will become an unsecured creditor in those proceedings with a claim equal to our exposure at the time under the capped call transactions with such option counterparty. Our exposure will depend on many factors but, generally, an increase in our exposure will be correlated to an increase in the market price and in the volatility of our common stock. In addition, upon a default by an option counterparty, we may suffer adverse tax consequences and more dilution than we currently anticipate with respect to our common stock. We can provide no assurance as to the financial stability or viability of the option counterparties.
Risks Related to our International Operations
We face risks associated with operating in international markets that may limit our ability to develop and sell our products, which could result in a decrease of our revenues.
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We operate on a global basis and political, economic and security conditions in countries in which we operate may limit our ability to develop and sell our products. Specifically, we do business and have operations in Brazil and Ukraine. Continued political instability and war in these regions, and any other areas in the world where we have operations, may affect our business and operations in those and other neighboring regions.
In March 2022, in response to the war between Russia and Ukraine, a number of countries, including the United States, imposed sanctions and export controls on Russia, which in turn imposed counter-sanctions in response. While sales in Russia represented a very small percentage of our overall business, and while our operations in Russia and Ukraine have historically been a small portion of our overall workforce, the conflict is complex and evolving and subjects us to additional regulatory risk and compliance costs. As of March 31, 2023, we do not have any employees or contractors in Russia. We have no way to predict the progress or outcome of the situation, including any impact on the rest of the world, as the conflict and government reactions are rapidly developing.
Our principal research and development facility, which also houses a portion of our support and general and administrative teams, is located in Israel. Since the establishment of the State of Israel in 1948, a number of armed conflicts have taken place between Israel and its neighboring countries, as well as incidents of terror activities and other hostilities, and a number of state and non-state actors have publicly committed to its destruction. Political, economic and security conditions in Israel could directly affect our operations. We could be adversely affected by hostilities involving Israel, including acts of terrorism or any other hostilities involving or threatening Israel, the interruption or curtailment of trade between Israel and its trading partners, a significant increase in inflation or a significant downturn in the economic or financial condition of Israel. Any on-going or future armed conflicts, terrorist activities, tension along the Israeli borders or with other countries in the region, including Iran, or political instability in the region could disrupt international trading activities in Israel and may materially and negatively affect our business and could harm our results of operations.
Certain countries, as well as certain companies and organizations, continue to participate in a boycott of Israeli companies, companies with large Israeli operations and others doing business with Israel and Israeli companies. The boycott, restrictive laws, policies or practices directed towards Israel, Israeli businesses or Israeli citizens could, individually or in the aggregate, have a material adverse effect on our business in the future.
Some of our employees in Israel are obligated to perform routine military reserve duty in the Israel Defense Forces, depending on their age and position in the armed forces. Furthermore, they have been and may in the future be called to active reserve duty at any time under emergency circumstances for extended periods of time. Our operations could be disrupted by the absence, for a significant period, of one or more of our officers or key employees due to military service, and any significant disruption in our operations could harm our business.
Our insurance does not cover losses that may occur as a result of an event associated with the security situation in the Middle East or for any resulting disruption in our operations. Although the Israeli government has in the past covered the reinstatement value of direct damages that were caused by terrorist attacks or acts of war, we cannot be assured that this government coverage will be maintained or, if maintained, will be sufficient to compensate us fully for damages incurred and the government may cease providing such coverage or the coverage might not suffice to cover potential damages. Any losses or damages incurred by us could have a material adverse effect on our business.
The tax benefits available to our Israeli subsidiary terminated in 2020 and we expect our Israeli subsidiary to become subject to an increase in taxes.
Our Israeli subsidiary has benefited from a status of a “Beneficiary Enterprise” under the Israeli Law for the Encouragement of Capital Investments, 5719-1959, or the Investment Law, since its incorporation. As of March 31, 2023, the tax benefit that we have been utilizing for our Israeli subsidiary terminated. A tax rate of 16% should be paid by our Israeli subsidiary per such eligible income under the terms of the Investment Law, subject to meeting various conditions. To the extent we do not meet these conditions, our Israeli operations will be subject to a corporate tax at the standard rate of 23%. If the Israeli subsidiary is subject to a corporate tax at the standard rate, it may adversely affect our tax expenses and effective tax rates. Additionally, if our Israeli subsidiary increases its activities outside of Israel, for example, through acquisitions, these activities may not be eligible for inclusion in Israeli tax benefit programs. The tax benefit derived from the Investment Law is dependent upon the ability to generate sufficient taxable income. Accordingly, our Israeli subsidiary may be unable to earn enough taxable income in order to fully utilize its tax benefits.
Risks Related to the Ownership of our Common Stock
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Substantial future sales of shares of our common stock could cause the market price of our common stock to decline.
Sales of a substantial number of shares of our common stock into the public market, or the perception that these sales might occur, for whatever reason, including as a result of the conversion of the outstanding 2025 Notes or future public equity offerings, could depress the market price of our common stock and could impair our ability to raise capital through the sale of additional equity securities. We are unable to predict the effect that such sales may have on the prevailing market price of our common stock.
As of March 31, 2023, we had options, restricted stock units (“RSUs”) and performance stock units (“PSUs”) outstanding that, if fully vested and exercised, would result in the issuance of approximately 9.6 million shares of our common stock. All of the shares of our common stock issuable upon exercise of options and vesting of RSUs and PSUs have been registered for public resale under the Securities Act. Accordingly, these shares will be able to be freely sold in the public market upon issuance as permitted by any applicable vesting requirements.
Our stock price has been and will likely continue to be volatile.
The market price for our common stock has been, and is likely to continue to be, volatile for the foreseeable future, and is subject to wide fluctuations in response to various factors, some of which are beyond our control. These factors, as well as the volatility of our common stock, could affect the price at which our convertible noteholders could sell the common stock received upon conversion of the 2025 Notes and could also impact the trading price of the 2025 Notes. The market price of our common stock may fluctuate significantly in response to a number of factors, many of which we cannot predict or control, including the factors listed below and other factors described in this “Risk Factors” section:
• actual or anticipated fluctuations in our results or those of other companies in our industry;
• the financial projections we may provide to the public, any changes in these projections or our failure to meet these projections;
• failure of securities analysts to maintain coverage of our company, changes in financial estimates by any securities analysts who follow our company, or our failure to meet these estimates or the expectations of investors;
• ratings changes by any securities analysts who follow our company;
• announcements of new products, services or technologies, commercial relationships, acquisitions or other events by us or other companies in our industry;
• new announcements that affect investor perception of our industry, including reports related to the discovery of significant cyberattacks;
• changes in operating performance and stock market valuations of other technology companies generally, or those in our industry in particular;
• price and volume fluctuations in certain categories of companies or the overall stock market, including as a result of trends in the global economy;
• the trading volume of our common stock;
• investor confusion with respect to the Company's results of operation during the SaaS transition;
• changes in accounting principles;
• sales of large blocks of our common stock, including sales by our executive officers, directors and significant stockholders;
• additions or departures of any of our key personnel;
• lawsuits threatened or filed against us;
• short sales, hedging and other derivative transactions involving our capital stock;
• general economic conditions in the United States and abroad, including inflationary pressures and higher interest rates;
• changing legal or regulatory developments in the United States and other countries;
• conversion of the 2025 Notes; and
• other events or factors, including those resulting from war, incidents of terrorism, pandemics, natural disasters or responses to these events.
In addition, the stock markets have experienced extreme price and volume fluctuations that have affected and continue to affect the market prices of equity securities of many technology companies. Stock prices of many technology companies have fluctuated in a manner unrelated or disproportionate to the operating performance of those companies. In the past, stockholders have instituted securities class action litigation following periods of market volatility. If we were to become involved in securities litigation, it could subject us to substantial costs, divert resources and the attention of management from our business
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and adversely affect our business, results of operations, financial condition and cash flows and may cause a significant increase in the premium paid for our directors and officers insurance.
We do not intend to pay dividends on our common stock, so any returns will be limited to the value of our stock.
We have never declared or paid cash dividends on our common stock. We currently anticipate that we will retain any future earnings and do not expect to pay any dividends in the foreseeable future. Any determination to pay dividends in the future will be at the discretion of our board of directors and will be dependent on a number of factors, including our financial condition, results of operations, capital requirements, share repurchases, general business conditions and other factors that our board of directors may deem relevant. In addition, the Credit and Security Agreement for our Credit Facility contains a prohibition on the payment of cash dividends. Until such time that we pay a dividend, stockholders, including holders of our 2025 Notes who receive shares of our common stock upon conversion of the 2025 Notes, must rely on sales of their common stock after price appreciation, which may never occur, as the only way to realize any future gains on their investments.
Anti-takeover provisions in our charter documents and under Delaware law and provisions in the indenture for our 2025 Notes and Credit Facility could make an acquisition of us, which may be beneficial to our stockholders, more difficult and may prevent attempts by our stockholders to replace or remove our current management, thereby depressing the trading price of our common stock and 2025 Notes.
Provisions in our amended and restated certificate of incorporation and amended and restated bylaws may delay, discourage or prevent an acquisition of us or a change in our management, including transactions in which stockholders might otherwise receive a premium for their shares, or transactions that our stockholders might otherwise deem to be in their best interests. These provisions include:
• authorizing “blank check” preferred stock, which could be issued by the board without stockholder approval and may contain voting, liquidation, dividend and other rights superior to our common stock, which would increase the number of outstanding shares and could thwart a takeover attempt;
• a classified board of directors whose members can only be dismissed for cause;
• the prohibition on actions by written consent of our stockholders;
• the limitation on who may call a special meeting of stockholders;
• the establishment of advance notice requirements for nominations for election to our board of directors or for proposing matters that can be acted upon at stockholder meetings; and
• the requirement of at least 75% of the outstanding capital stock to amend any of the foregoing second through fifth provisions.
In addition, because we are incorporated in Delaware, we are governed by the provisions of Section 203 of the Delaware General Corporation Law, which limits the ability of stockholders owning in excess of 15% of our outstanding voting stock to merge or combine with us, unless the merger or combination is approved in a prescribed manner. Although we believe these provisions collectively provide for an opportunity to obtain greater value for stockholders by requiring potential acquirers to negotiate with our board of directors, they would apply even if an offer rejected by our board were considered beneficial by some stockholders. In addition, these provisions may frustrate or prevent any attempts by our stockholders to replace or remove our current management by making it more difficult for stockholders to replace members of our board of directors, which is responsible for appointing the members of our management.
In addition, if a “fundamental change” occurs prior to the maturity date of the 2025 Notes, holders of the 2025 Notes will have the right, at their option, to require us to repurchase all or a portion of their Convertible Notes. If a “make-whole fundamental change” (as defined in the Indenture) occurs prior the maturity date, we will in some cases be required to increase the conversion rate of the 2025 Notes for a holder that elects to convert its 2025 Notes in connection with such “make-whole fundamental change.” These features of the 2025 Notes may make a potential acquisition more expensive for a potential acquiror, which may in turn make it less likely for a potential acquiror to offer to purchase our company, or reduce the amount of consideration offered for each share of our common stock in a potential acquisition. Furthermore, the Indenture prohibits us from engaging in certain mergers or acquisitions unless, among other things, the surviving entity assumes our obligations under the 2025 Notes. Last, under our Credit Facility we cannot sell or transfer or otherwise dispose of any assets of the Company to any person or entity subject to certain exceptions and we cannot merge, amalgamate or consolidate with any other entity.
General Risks Factors
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Real or perceived errors, failures or bugs in our software could adversely affect our growth prospects.
Because our software uses complex technology, undetected errors, failures or bugs may occur. Our software is often installed and used in a variety of computing environments with different operating system management software, and equipment and networking configurations, which may cause errors or failures of our software or other aspects of the computing environment into which it is deployed. In addition, deployment of our software into computing environments may expose undetected errors, compatibility issues, failures or bugs in our software. Despite testing by us, errors, failures or bugs may not be found in our software until it is released to our customers. Moreover, our customers could incorrectly implement or inadvertently misuse our software, which could result in customer dissatisfaction and adversely impact the perceived utility of our products as well as our brand. Any of these real or perceived errors, compatibility issues, failures or bugs in our software could result in negative publicity, reputational harm, loss of or delay in market acceptance of our software, loss of competitive position or claims by customers for losses sustained by them. In such an event, we may be required, or may choose, for customer relations or other reasons, to expend additional resources in order to help correct the problem. Alleviating any of these problems could require significant expenditures of our capital and other resources and could cause interruptions or delays in the use of our solutions, which could cause us to lose existing or potential customers and could adversely affect our operating results and growth prospects.
We may require additional capital to support our business growth, and this capital might not be available on acceptable terms, or at all.
We continue to make investments to support our business growth and may require additional funds to respond to business challenges, including the need to develop new features or enhance our software, improve our operating infrastructure or acquire complementary businesses and technologies. Accordingly, we may need to engage in equity or debt financing to secure additional funds. If we raise additional funds through future issuances of equity or convertible debt securities, our existing stockholders could suffer significant dilution, and any new equity securities we issue could have rights, preferences and privileges superior to those of holders of our common stock. Any debt financing that we may secure in the future could involve restrictive covenants relating to our capital raising activities and other financial and operational matters, which may make it more difficult for us to obtain additional capital and to pursue business opportunities, including potential acquisitions. We may not be able to obtain additional financing on terms favorable to us, if at all. If we are unable to obtain adequate financing on terms satisfactory to us when we require it, our ability to continue to support our business growth and to respond to business challenges could be significantly impaired, and our business may be adversely affected.
Our business is subject to the risks of fire, power outages, floods, earthquakes, pandemics and other catastrophic events, and to interruption by manmade problems such as terrorism.
A significant natural disaster, such as a fire, flood or an earthquake, an outbreak of a pandemic disease or a significant power outage could have a material adverse impact on our business, results of operations and financial condition. In the event our customers’ IT systems or our channel partners’ selling or distribution abilities are hindered by any of these events, we may miss financial targets, such as revenues and sales targets, for a particular quarter. Further, if a natural disaster occurs in a region from which we derive a significant portion of our revenue, customers in that region may delay or forego purchases of our products, which may materially and adversely impact our results of operations for a particular period. In addition, acts of terrorism could cause disruptions in our business or the business of channel partners, customers or the economy as a whole. Given our typical concentration of sales at each quarter end, any disruption in the business of our channel partners or customers that impacts sales at the end of our quarter could have a significant adverse impact on our quarterly results. All of the aforementioned risks may be augmented if the disaster recovery plans for us and our channel partners prove to be inadequate. To the extent that any of the above results in delays or cancellations of customer orders, or the delay in the development, deployment or shipment of our products, our business, financial condition and results of operations would be adversely affected.
Changes in financial accounting standards may adversely impact our reported results of operations.
New accounting pronouncements and varying interpretations of accounting pronouncements have occurred and may occur in the future. Changes to existing rules or the questioning of current practices may adversely affect our operating results or the way we conduct our business.
If securities or industry analysts do not publish research or reports about our business, or publish negative reports about our business, our stock price and trading volume could decline.
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The trading market for our common stock depends in part on the research and reports that securities or industry analysts publish about us or our business, our market and our competitors. We do not have any control over these analysts or their expectations regarding our performance on a quarterly or annual basis. If one or more of the analysts who cover us downgrade our stock or change their opinion of our stock, our stock price would likely decline. If we fail to meet one or more of these analysts’ published expectations regarding our performance on a quarterly basis, our stock price or trading volume could decline. If one or more of these analysts cease coverage of our company or fail to regularly publish reports on us, we could lose visibility in the financial markets, which could cause our stock price or trading volume to decline.
We are obligated to develop and maintain proper and effective internal control over financial reporting. These internal controls may not be determined to be effective, which may adversely affect investor confidence in our company and, as a result, the value of our common stock.
We are required, pursuant to Section 404 of the Sarbanes–Oxley Act, to furnish a report by management on, among other things, the effectiveness of our internal control over financial reporting on an annual basis. This assessment includes disclosure of any material weaknesses identified by our management in our internal control over financial reporting. We are also required to have our independent registered public accounting firm issue an opinion on the effectiveness of our internal control over financial reporting on an annual basis. During the evaluation and testing process, if we identify one or more material weaknesses in our internal control over financial reporting, we will be unable to assert that our internal control over financial reporting is effective.
If we are unable to assert that our internal control over financial reporting is effective, or if our independent registered public accounting firm is unable to express an opinion on the effectiveness of our internal control over financial reporting, we could lose investor confidence in the accuracy and completeness of our financial reports, which could cause the price of our common stock to decline, and we may be subject to investigation or sanctions by the SEC.
Future sales and issuances of our capital stock or rights to purchase capital stock could result in additional dilution of the percentage ownership of our stockholders and could cause our stock price to decline.
Future sales and issuances of our capital stock or rights to purchase our capital stock could result in substantial dilution to our existing stockholders. We may sell common stock, convertible securities and other equity securities in one or more transactions at prices and in a manner as we may determine from time to time. If we sell any such securities in subsequent transactions, investors may be materially diluted. New investors in such subsequent transactions could gain rights, preferences and privileges senior to those of holders of our common stock.

Item 5. | Purchase of Equity Securities by Issuer and Affiliated Purchasers

In October 2022, our board of directors authorized a share repurchase program of up to $100.0 million of our common stock (the “Share Repurchase Program”). Under the Share Repurchase Program, we are authorized to repurchase shares through open market purchases, privately-negotiated transactions or otherwise in accordance with applicable federal securities laws, including through Rule 10b5-1 trading plans and under Rule 10b-18 of the Exchange Act. The Share Repurchase Program will expire on October 31, 2023. The number of shares to be purchased and the timing of purchases will be based on the Company's trading windows, available liquidity, and general business and market conditions.
The following table summarizes the share repurchase activity during the quarter ended March 31, 2023:

Period |  | Total Number of Shares Purchased (in thousands) |  | Average Price Paid Per Share (1) |  | Total Number of Shares Purchased as Part of Publicly Announced Programs (in thousands) |  | Approximate Dollar Value of Shares that May Yet Be Purchased Under the Program (in thousands)
January 1 - January 31 |  | 72 |  |  | $ | 24.85 |  |  | 72 |  |  | 41,766 |
February 1 - February 28 |  | 8 |  |  | $ | 25.70 |  |  | 8 |  |  | 41,560 |
March 1 - March 31 |  | 20 |  |  | $ | 26.23 |  |  | 20 |  |  | 41,036 |

(1) Average price paid per share includes costs associated with the repurchases.
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Item 6. | Exhibits

The exhibits listed below in the accompanying “Exhibit Index” are filed or incorporated by reference as part of this Quarterly Report on Form 10-Q.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

| VARONIS SYSTEMS, INC. |
May 2, 2023 | By: | /s/ Yakov Faitelson |
|  | Yakov Faitelson |
|  | Chief Executive Officer and President (Principal Executive Officer)
May 2, 2023 | By: | /s/ Guy Melamed |
|  | Guy Melamed |
|  | Chief Financial Officer and Chief Operating Officer (Principal Financial and Accounting Officer)

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EXHIBIT INDEX

Exhibit Number | Description of the Document
3.1(1) | Amended and Restated Certificate of Incorporation
3.2(2) | Amended and Restated Bylaws
10.1† | Employment Agreement, dated as of March 2, 2023, by and between Varonis Systems Ltd. and Guy Melamed
10.2† | Varonis Systems Severance Plan Filed as Exhibit 10.9 to the Company’s Annual Report on Form 10-K filed with the SEC on February 7, 2023 and incorporated herein by reference.
31.1 | Rule 13a-14(a) Certification of Chief Executive Officer of the Company in accordance with Section 302 of the Sarbanes-Oxley Act of 2002
31.2 | Rule 13a-14(a) Certification of Chief Financial Officer of the Company in accordance with Section 302 of the Sarbanes-Oxley Act of 2002
32.1* | Section 1350 Certification of Chief Executive Officer of the Company in accordance with Section 906 of the Sarbanes-Oxley Act of 2002
32.2* | Section 1350 Certification of Chief Financial Officer of the Company in accordance with Section 906 of the Sarbanes-Oxley Act of 2002
101 | The following materials from the Company’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2023, formatted in inline XBRL (eXtensible Business Reporting Language): (i) the Consolidated Balance Sheets, (ii) the Unaudited Consolidated Statements of Operations, (iii) the Unaudited Consolidated Statements of Comprehensive Loss, (iv) the Unaudited Consolidated Statements of Changes in Stockholders' Equity, (v) the Unaudited Consolidated Statements of Cash Flows and (vi) related notes to these consolidated financial statements, tagged as blocks of text and in detail
104 | Cover Page Interactive Data File - (formatted as Inline XBRL and contained in Exhibit 101)

____________

† | Indicates management contract or compensatory plan or arrangement.
* | Document has been furnished, is not deemed filed and is not to be incorporated by reference into any of the Company’s filings under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended, irrespective of any general incorporation language contained in any such filing.
(1) | Filed as Exhibit 3.1 to the Company’s Quarterly Report on Form 10-Q filed with the Securities and Exchange Commission on May 8, 2014 (File No. 001-35324) (the “Company’s First Quarter 2014 Form 10-Q”) and incorporated herein by reference.
(2) | Filed as Exhibit 3.2 to the Company’s Annual Report on Form 10-K with the Securities and Exchange Commission on February 8,2022 (File No. 001-36324) and incorporated herein by reference.

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