Greetings. Welcome to Varonis Systems Incorporated second quarter 2020 earnings conference call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. Please note this conference is being recorded. I will now turn the conference over to your host, James Arestia, so you may begin.
Thank you, operator. Good afternoon. Thank you for joining us today to review Varonis' second quarter 2020 financial results. With me on the call today are Yaki Faitelson, Chief Executive Officer, and Guy Melamed, Chief Financial Officer and Chief Operating Officer. After preliminary remarks, we will open up the call to a question-and-answer session. During this call, we may make statements related to our business that would be considered forward-looking statements under federal securities laws, including projections of future operating results for our third quarter ending September 30th, 2020. Due to a number of factors, actual results may differ materially from those set forth in such statements. These factors are set forth in the earnings press release that we issued today under the section captioned Forward-Looking Statements, and these and other important risk factors are described more fully in our reports filed with the Securities and Exchange Commission.
We encourage all investors to read our SEC filings. These statements reflect our views only as of today and should not be relied upon as representing our views as of any subsequent date. Varonis expressly disclaims any application or undertaking to release publicly any updates or revisions to any forward-looking statements made herein. Additionally, non-GAAP financial measures will be discussed on this conference call. A reconciliation for the most directly comparable GAAP financial measures is also available in our second quarter 2020 earnings press release, which can be found at www.varonis.com in the Investor Relations section. Also, please note that an updated investor presentation, as well as a webcast of today's call, are available on our website in the Investor Relations section. With that, I'd like to turn the call over to our Chief Executive Officer, Yaki Faitelson. Yaki?
Thanks, Jamie, and good afternoon, everyone. Thank you for joining us to discuss our second quarter 2020 results. I will cover three topics today before I turn the call over to Guy. First, an update of our business for Q2. Second, what we are seeing in the current environment, and finally, how we believe the trends we are seeing will benefit Varonis over the long term. While COVID-19 continue to impact many, and our thoughts are with those who have been affected, I'm proud of our team, which delivered strong financial results in the second quarter across all regions. The team is executing well in this virtual environment, and our customers and prospects are extremely engaged. Virtual risk assessment and online activities are working well, and we continue to see strong inbound interest.
As always, we remain diligent in monitoring the business, and we believe that the return to more normal purchasing patterns we saw in Q2 will continue in the second half of 2020. As we enter the second part of the year, it is clear that from a competitive and financial standpoint, Varonis has never been in a better position. We believe our unique platform is a must-have in this new world, and the transition to a subscription company in one year is allowing us to navigate the current environment from a much stronger position. With a 99% subscription mix in the second quarter, almost all our revenue today is recurring, providing us better visibility, and over time, serving as a tailwind to profitability. I would like to turn now to the current environment and how we plan to capitalize on the long term on the trends we are seeing globally.
As we discussed in April, companies have now pivoted from emergency spend related to employee safety and business continuity and are laser focused on the continued elevated risk on a work-from-home environment. The powerful data security platform make us uniquely positioned to address this risk inherent to this new normal. The risks stemming from overexposed sensitive data are not new, but reducing them is even more urgent today. As an example, prior to COVID, a Varonis customer had to worry about five offices for their 1,500 users, with a handful of remote employees. Today, the CISO of that company has to worry about 1,500 vulnerable home offices. Remote employees frequently use unsecured computer to access critical data, both in Teams and Office 365 and on-prem through VPN. This opens a company's sensitive data to enormous risks, and CISOs worldwide across all industries are facing the same elevated problems.
At the same time, the threat environment is more dangerous than ever. Companies face extremely sophisticated and Advanced Persistent Threats from external bad actors and hackers, as well as growing threats from insiders. Organized hackers routinely bypass perimeters and endpoints, attack weaknesses in Active Directory, then steal and threaten to expose data and hold it for ransom. At the same time, employees are worried about job security, and our customers are seeing more alerts, a warning of employees accessing sensitive data outside of their normal habits. This is why our platform is resonating with both new and existing customers, as we believe it provides unmatched data protection, alerting, and investigation capabilities.
We are seeing that Varonis is very high on the list of priority spending for our customers, and the path to double-digit license per customer is clearer now than it was just a few quarters ago. Before I turn the call to Guy, I want to highlight a few important customer wins this quarter that demonstrate the enormous opportunity we have in front of us. We signed a large global manufacturer in Q2 that needed to shore up data security and ensure compliance with GDPR. During our virtual risk assessment, Varonis was able to demonstrate our superior architecture and integration. This new customer purchased more than 10 licenses to support an on-prem and Office 365 cloud environment, addressing data protection, threat detection and response, and compliance.
This is just one example of a new customer making larger initial investment in the Varonis platform and more quickly deriving value because of our transition to a subscription model. While we see meaningful increases in adoption rates by new customers, we remain significantly under-penetrated with our own existing customer base, which represent a significant go-forward opportunity for the company. A good example of lifetime value expansion is an agency at a large U.S. county who became a perpetual customer in 2017, buying four licenses to cover several departments. In 2019, they took advantage of our subscription offering to expand the Varonis platform across all employees. In January, they confirmed plans to migrate to Office 365, with 500,000 folders in the cloud that were open to everyone.
When the migration timeline sped up due to COVID, they renewed all current licenses and purchased seven additional ones ahead of the renewals. This includes DatAdvantage data classification for their cloud data stores, as well as Automation Engine, allowing them to quickly remediate their open access issues and providing incremental protection. This is an excellent example of how our subscription offering, coupled with our strategy to engage larger customers who can buy more from us over time, is fueling the expansion opportunity within our base. We believe this crisis has cemented the need for our platform, and the trend we are seeing should drive greater adoption. As we look to the back half of the year, we are very encouraged by our unique ability to solve problems that have only intensified with COVID and capitalize on this long-term opportunity. With that, let me turn the call over to Guy. Guy?
Thanks, Yaki. Good afternoon, everyone. Thank you for joining us today. I hope you and your families are all safe and healthy. Last quarter, given the uncertainty from COVID, I spent time on the earnings call providing some insight into how we think about the business, focusing on our recurring revenues. ARR grew 52% compared to the second quarter of 2019, driven by our execution across the three pillars that drive our business. First, landing new customers. Second, our expansion over time with existing customers, where we are still extremely under-penetrated. Finally, the renewals of both subscription and maintenance of our perpetual licenses. On the new customer front, we continue to see greater license adoption on average compared to the perpetual model.
This is partially due to the ease of consumption under our subscription model, but also due to the fact that we are executing on our strategy of acquiring high-quality new logos. We now see the average number of licenses for a new subscription customer is close to five, roughly double what we saw under the perpetual model. On the expand side, our strategy of acquiring high-quality new logos is also generating greater lifetime value, and there continues to be a strong level of engagement from existing customers. As of June 30th, 58% of our customers with 500 employees or more purchased four or more licenses, up from 48% a year ago, and 24% purchased six or more licenses, up from 16% a year ago. The rapid growth of these metrics speaks volumes to the value our customers see from a larger adoption of our platform.
Turning to product families, 77% of all customers now purchase two or more, up from 74% a year ago, and 47% purchase three or more, up from 42% a year ago. Finally, the recurring portion of our revenues allows us to move through this time of uncertainty from a much stronger position. 98% of our total Q2 revenues were recurring in nature. As I mentioned, ARR at the end of Q2 grew 52% year-over-year, and renewal rates of maintenance on perpetual licenses continues to be above 90%. Our dollar-based net retention rate, or NRR, was greater than 120% at the end of Q2. As of this quarter, NRR now accounts for the growth in ARR from all customers, and we plan to provide NRR on an annual basis. Turning to our second quarter results.
Total revenues were $66.6 million, up 12% despite the headwind from the much higher subscription mix this quarter. Second quarter license revenues were $34.3 million, which included $34.1 million of subscription revenues, or a 99% subscription mix. Maintenance and services revenues were $32.2 million. To remind you, this line item was impacted by our strategic decision to have our channel partners take on more professional services work. Looking at the business geographically, North America revenues grew 15% to $45.8 million, or 69% of total revenues. In EMEA, revenues grew 7% to $18.7 million, representing 28% of total revenues. Rest of world revenues were $2 million, or 3% of total revenues. Turning back to the income statement, I'd like to point out that I'll be discussing non-GAAP results going forward, which continues to exclude stock-based compensation and associated payroll tax, as well as FX gains and losses.
This quarter and going forward, non-GAAP results also exclude the amortization of debt discount and issuance costs related to our convertible notes issuance in May. Gross profit for the second quarter was $57.6 million, representing a gross margin of 86.5%, compared to 87.3% in the second quarter of 2019. Operating expenses in the second quarter totaled $61.6 million. As a result, our operating loss was $4 million, or an operating margin of - 6% for the second quarter, compared to an operating loss of $8.9 million, or an operating margin of - 15% in the same period last year. Our Q2 operating margin was well ahead of our guidance as we, A, meaningfully outperformed on the top line, B, benefited from COVID-related cost savings, primarily due to travel and marketing activities, and C, continued prudent management of expenses across the business.
During the quarter, we had financial expense of approximately $296,000, primarily due to interest expense on our convertible notes, partially offset by interest income. Our net loss was $4.7 million for the second quarter of 2020, or a loss of $0.15 per basic and diluted share, compared to a net loss of $9 million, or a loss of $0.30 per basic and diluted share for the second quarter of 2019. This is based on 31.5 million basic and diluted shares outstanding for Q2 2020, and 30.3 million basic and diluted shares outstanding for Q2 2019. We ended the quarter with $326.1 million in cash and cash equivalents, marketable securities, and short-term deposits, which includes $215.8 million of net proceeds from the successful convertible debt offering we placed in early May, strengthening an already healthy balance sheet.
For the first six months of 2020, we used $10.8 million of cash from operations compared to generating $3 million of cash from operations in the same period last year, reflecting the revenue shortfall in the first quarter due to the impact of COVID and the headwind from the subscription transition. We ended the quarter with 1,574 employees, a 9% increase from the second quarter of 2019. Moving to our guidance for the third quarter of 2020. We expect total revenues of $68 million-$71 million. We expect our non-GAAP operating loss to range between $ -3 million to $ -2 million and non-GAAP net loss per basic and diluted share in the range of $0.14-$0.11. This assumes a tax provision of $500,000-$700,000, interest expense associated with the convertible notes of approximately $800,000, and 31.6 million basic and diluted shares outstanding.
To provide more color on guidance, first, the low end of guidance considers the possibility of a broader macroeconomics volatility for the foreseeable future, given the potential direct and indirect effects of COVID. With that said, given Q2 results and what we see in the market, we plan to gradually resume investments in the business for 2020. Second, I want to remind everyone that we will be more apples-to-apples in the second half of the year, starting in Q3 with a subscription mix with 74% in 2019. As a result, ARR percentage growth will naturally be impacted. In summary, our philosophy of running the business has not changed. We want to take advantage of the opportunities in front of us in order to accelerate growth while showing non-GAAP operating margin improvements as well as cash flow generation.
We are pleased with our second quarter results, and as we look to the back half of the year, the team is focused on executing on a strong close to 2020. Thanks for joining us today, and we hope you and your loved ones remain safe and healthy. With that, we would be happy to take questions. Operator?
At this time, we will be conducting a question-and-answer session. If you would like to ask a question, please press star one on your telephone keypad. A confirmation tone will indicate that your line is in the question queue. You may press star two if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment please while we poll for questions. Also, we do ask each participant in queue to please limit themselves to one question and one follow-up question as well. Our first question is from Sterling Auty with JPMorgan. Please proceed with your question.
Yeah, thanks. Hi, guys. Yaki, I'm wondering if you could give us a little bit more color on your statement that the priority for spending on Varonis solutions has started to increase. I'm particularly interested, I understand the environment and the demand for it, but is this existing budget that was already there for Varonis solutions that are now just closing in deals, or are you seeing that companies are actually taking budget from other projects to purchase your solutions?
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We just saw that after a lot of urgency from work from home to add VPN capacity and urgency around laptops and things of this nature, a lot of adoption of Office 365 and Teams, we're starting to have this just acute risk of people working remotely can access a lot of data in many repositories on-prem and in the cloud. Customers understand that in order to not to have diminishing returns from this very fast digital transformation, with scarcity of talent, they need tremendous visibility and automation, and that really at this point, we are the only one that provides it. In terms of the budgets, it's not completely earmarked, but we just see that the organizations have a lot of budget for data protection and insider risk and cloud security, and almost always we can fund a Varonis project from one of these budgets.
Every day that goes by, it's becoming a bigger priority, and you see all the workloads in the cloud connected to the on-prem and the data sprawl, and organizations understand if they don't have something like that in place, they have huge risk.
That makes sense. One follow-up for Guy, for you. Just give us a little bit of compare around what you saw with the linear. Obviously, given the pandemic, we would expect that to push some of the business later in the quarter. Just given the strong revenue and subscription results, can you comment anything to linearity as a whole?
There was nothing unusual in terms of linearity. Like similar enterprise companies, we're back-end loaded, but there was nothing unusual this quarter compared to our norm.
Great. Thank you.
Thank you.
Our next question is from Saket Kalia from Barclays. Please proceed with your question.
Okay, great. Hey, guys. Thanks for taking my questions here. Maybe first for you, Yaki, longer term product question, but I guess now that the transition to subscription is largely complete, I think you said a 99% mix in the quarter, how are you sort of thinking about new product introductions in the next 6- 12 months as part of this sort of easier consumption model? What areas could they sort of touch on from a high level?
Yeah, for us as a company, what we do most is innovate, and thankfully, we are in a space where there is just so much meat on the bone. We believe that there is more ahead of us than behind us. You have different platforms, and also you can go very deep in each one of the use cases that we cater to and integration between the products. We put a lot of effort on 365 and Azure, which is massive problem for our customers. There is a lot on content automation and any abnormal behavior with User Behavior Analytics. Really, in terms of innovation, we feel that we are firing on all cylinders and most of the areas we play on, they have a lot of ways that we can innovate and add value to our customers and also integrate all the functionalities.
The other thing that is happening is that every repository that's starting to have a lot of data that users are using, we can apply the same game plan of the whole platform. With DatAdvantage, classifying data, analytics, and so forth. We feel that we can innovate a lot, and we have a lot of innovation that will come in the next few years.
Got it. Maybe my follow-up for you, Guy. Good to see the net revenue retention at 120%. Can you just maybe touch on, anecdotally of course, what you're sort of seeing from customers on gross retention? What licenses are perhaps driving a bigger part of the upsell, cross-sell performance? Does that make sense?
Absolutely, Saket. Thanks for the question. We're very happy with the Q2 NRR being larger than 120%, and I think it's indicative of what we've said kind of all along. The fact that existing customers are not just renewing but are expanding, and our move to subscription really allows our existing customers to consume more of the platform. We see many customers buy Office 365 licenses. There are a lot under the DatAdvantage product family, whether it's Automation Engine. Our 26 licenses offering really allows our existing customers to continue to buy. Overall, I think it really reflects kind of the commentary on the environment and really the needs of the platform. Also, at the same time, it shows the tremendous opportunity we have to expand within our existing customer base. Overall, we're pleased with those results.
Very helpful. Thanks, guys.
Thank you.
Thank you.
Our next question is from Brent Thill with Jefferies. Please proceed with your question.
Thank you. Yaki, just curious if you could talk a little more around the work from home portfolio and what tailwinds you're seeing there. For Guy, just on EMEA, obviously the growth rate's a lot slower than what you're seeing in North America. Can you just talk about how you see a follow-through coming potentially for that region in the back half of the year, and what you think needs to happen for growth to accelerate? Thanks.
For the work from home, there are just several critical aspects. One is a massive adoption of 365 and Teams, and behind Teams is a client that enables a lot of collaboration on top of OneDrive, SharePoint, and a lot of configuration in Azure AD, which our customers and every organization in the world that use it have no visibility whatsoever, and it's much harder to manage the data protection and understand everything that's going on. The other thing that we see is, with Azure and AWS, is a lot of the organizations really working on the IaaS environment, running a lot of workloads there that connected to the on-prem and through RDP and other mechanics are open to the world, and it creates tremendous problems for our customers.
This is something in terms of data protection and infrastructure protection that is urgent for our customers to manage. With the 365 repository, they're just growing very fast. Something that would have taken three, four years take now six months, and in parallel, the data is growing rapidly on-prem. The other issue is that customers working from home offices that are unsecured, people are online a lot of the time. There are a lot of Advanced Persistent Threat. This is really heaven for cybercrime. We see a lot of compromised machines. It's very easy for sophisticated hackers, very easy to bypass the endpoint. Within the user space, the user permissions, they are trying to access and steal a lot of data. We really see that from all of these aspects, organizations understand that they have this risk that is here.
We call it stationary risk that is constantly increasing, and they need to do something in order to fix it. For us, what happened is that, it's just this 365 that we have many licenses there, two classification licenses, SharePoint, OneDrive, Exchange and Azure AD. This is a big platform sale. We can go to customers and do fairly larger deals for the whole 365 and Azure environment. This is huge. Also protect the data on-prem that is going and all the connectivity to the cloud. We just see an environment that you need to really collaborate, people accessing data from all over the place. The last thing that we see, unfortunately, a lot of the times is, insiders, employees are scared that they're going to lose their jobs. In this kind of environment, sometimes they're doing things with data that they shouldn't do.
Organizations are very much afraid of it. They want to make sure that they can maintain the customers and employees and business partners' data protected, and they will protect their competitive edge. If insider is taking a lot of data with him when he leaves or, God forbid, get fired, this is a huge problem for the organization. This is another thing that we see, is just at times, very problematic behavior from insiders and sometimes even privileged users, administrators, and DevOps people. This is just an environment, if you don't have something like Varonis, it's virtually impossible to protect these digital assets and core infrastructure.
Just to give some color on the second question on EMEA. EMEA in Q2 actually grew 7%. If you look at kind of the history of EMEA through the subscription transition, when we announced the transition at the beginning of 2019, the European team was slightly slower to adopt, and we gave a lot of commentary on that last year. The North American team was much quicker to adopt the transition. Obviously, we're starting to see now kind of the flywheel effect on both territories, but we're very happy with the pipeline in Europe. We're happy with the team there, and we feel that we have a tremendous opportunity to capture market share.
Thanks.
Our next question is from Rob Owens with Piper Sandler. Please proceed with your question.
Great, thank you guys for taking my question. Wondering if you could update us relative to hiring, and specifically sales capacity. If we are seeing this inflection around your business, do you have the capacity to meet demand in the second half? I guess to that end of this work from home environment, maybe you could also talk about sales productivity. Thanks.
We started to hire across every department in the company, in sales, support, customer success, engineering. We feel there is a lot of demand. What changed? The company changed completely within a year. We became almost 100% subscription business with high renewals. The platform play is really working. We have a clear path to get many of our customers to get more than 10 licenses. We spend more time with them. We're starting to see this direct correlation between the value that we give them and how much they buy. We want to keep innovating. We want to make sure that customer success is working very well. The short answer is that we are hiring across all the organization. We have a great team in place, and they adapted fast to working from home. So far, we don't see any impact to productivity.
Just to give some color on the quota-carrying reps, when we talked at the end of Q1 about the hiring freeze, we continued to hire quota-carrying reps across the different geographies because we saw the opportunity ahead, and we will continue to do that going forward. We feel we have the right capacity to meet demand, and we will continue to do that.
Great. Thank you.
Our next question is from Matt Hedberg with RBC Capital Markets. Please proceed with your question.
Hi, guys. Thanks for taking my questions. Yaki, when we talk to partners, it showed that you're increasingly being brought into deals in a post-COVID world. I think one of the bigger drivers that we hear from is expanded use of collaboration tools, which you've talked about on this call. I'm wondering, can you give us a few examples of how customers that move to applications like Microsoft Teams are then made aware of Varonis? Might partners start to increasingly drive demand for you guys?
Yes. When you're starting to use extensively Microsoft Teams, you have channels in OneDrive and a lot of data in SharePoint Online and a lot of just automation and configuration in Azure AD that it's configuration, that it's not like a human even will do the configuration that are so hard to maintain on-prem. It's like a computer doing it. It's just impossible to understand who can access what. People can access from outside the organization. Once you're starting to have a lot of data, organizations understand that they have zero visibility. They have no ability to remediate the data to understand what is critical, and they are coming to us. They are coming to us through a lot of organic web search, and our webinars are working very well. We see a lot of interest there.
In terms of the partners, I think what happened was, is with not a big impact to average sales price and a drastic increase in customer lifetime value, we became a subscription business. Think about them. If they did a $100,000, and then they got $20,000 in the next year before. If they will do whatever, choose a number, $60,000, $70,000, this is what the customer will buy every year. Then they can buy another $60,000 and another $60,000, and three years later, this is $200,000 a year. It's very strategic. Customers are willing to spend a lot of time with it so they can really implement professional services. We just see that the partner ecosystem understand it, and they understand that this is where the market is going. This is a top priority for organizations.
Once you install it, the customers understand that they really get a lot of value, and we are virtually non-contested. You're coming, you can maintain the margin. The pricing is working very well. I think that it's a market that is evolving, but it's a big market. Customers understand it, partners understand it, and over time, we can get a lot of revenues from customers that most of the time they are delighted with the value that they get. We know it's thankfully, it's working well for everyone.
That's great. Guy, when you guided the Q2 quarter, there was a fair amount of conservatism, just based off a lot of the unknowns in COVID. Now, obviously, you're coming off a very strong quarter, I assume. July has been strong as well. Has your methodology on guides changed since last quarter? I mean, effectively, how do you think about the potential risk of COVID or uncertainty relative to kind of how you guided the Q2 quarter?
Well, to remind everyone, we've always guided in a thoughtful and responsible way. You're right. When we guided in Q2, the guidance was much more of an extrapolation of the end of Q1 and not so much the improvement we saw in April because there were a lot of uncertainties when we guided, and that was really reflected in Q2. Q3 guidance is much more based on the Q2 customer behavior. We're really pleased with the performance we saw in Q2. At the same time, there's always kind of that thoughtful and responsible way in the way we guide. Kind of if you think about the third quarter, if there's incremental macroeconomic volatility that could impact us, it's reflected in the low end of the guidance. With that being said, I can tell you we're going into Q3 with much more confidence than Q2.
Super helpful. Congrats on the results, guys.
Thank you.
Our next question is from Alex Henderson with Needham. Please proceed with your question.
Great. Thank you very much. I was wondering if you could talk about what the risk assessment pipeline looks like and what the appetite in the field is. Are you still seeing record numbers of assessment requests? And how does the close rate look on that? The second piece of it was, I was hoping you could give us an update on the Automation Engine uptake rate. I know you've given us a lot of detail on various subscriptions, but that's a key piece of it, and I didn't see any data on it.
I'll try and cover all of those components. First of all, one thing to note, and I know we talked a lot about that throughout the quarter, is that the risk assessments that we are holding are virtual. We've done that before COVID. We're doing it now. Obviously, all of our risk assessments now are being done virtually, but we haven't seen any impact. Our pipeline is really strong, very healthy. We feel very good about the second part of the year with the pipeline that we have generated. In terms of the closing, if you remember, our kind of sales cycle is between three to nine months, and on the larger deals, it's up to 12 months. As expected, only a small portion of that pipeline that was related to COVID was closed in Q2. The pre-COVID pipeline was closed in kind of similar sales cycle.
We haven't seen much of a change there, and that was very encouraging. In terms of the Automation Engine, Automation Engine is consumed by customers very nicely. It's part of the DatAdvantage product family, so we don't provide the attach rates, but I can tell you that part of the reason that we moved to the subscription model was because customers wanted to consume more of our licenses that were geared towards automation, and the Automation Engine was a big component of that. We're seeing customers enjoying the value of that product, and we plan to continue to sell that going forward, and customers are definitely enjoying it.
Great. Thank you very much for the clarity. Thanks for the great quarter.
Thank you.
Thank you.
Our next question is from Shaul Eyal from Oppenheimer. Please proceed with your question.
Thank you. Good afternoon. Good afternoon, guys. Congrats on the quarter. Yaki, last quarter, I've asked you about ASP trends or any unusual discounting. Can you provide us with the latest update? I think also in light of your commission strategy, I think I mentioned that last time, whereby salespeople could be penalized if they provide too high of a discount. Any change on that front? What's the latest?
Regarding the pricing, the pricing is holding extremely well. We were very surprised how well when customers already decide to buy and they understand that they need it, obviously they're negotiating, but almost all the time we get the price that we want. The pricing is really holding very, very well.
Shaul, just to give some color on the grading system that you mentioned. You're right. When we announced this transition at the beginning of 2019, we also introduced a grading system where reps can make more than what they sell if they sell at the right discount, or they get penalized if they're selling at a higher discount. I can tell you that that grading system has worked very well for us. It allows our reps to do the right thing for the company and allows them to make more money when they do things that are in favor of the company. That's been holding very well for us.
Got it. Yaki, I've got like another one. Could be a little tricky. Really long-term here. I'm talking about the road to $1 billion revenue. You might have spoken about it in the past, like three some years back, without committing to a specific timeframe. In the meantime, the model has changed. COVID appeared more recently. It would appear actually to be benefiting you, as unreasonable as it may sound. Are you still thinking longer term about this revenue threshold? Again, without committing specifically to a timeframe. Could be seven years, could be 10 years, who knows? Could even get accelerated a little bit.
We think about it all the time, and I think that the main thing is, what happened with the subscription and just all the innovation and the ability that we increased so much the customer lifetime value and we need less volume in order to get there. I believe that we have a lot of the investments and a big part of the organization that needs to be in place in order to get to this billion-dollar goal are already in place. I think that the fact that we moved in one year to be a subscription business and the cloud platforms work very well for us and regulation is in our favor and we see these APTs that giving a lot of hard time to just traditional security.
I believe that we increased drastically our ability to get to the billion-dollar strategic goal. This is something that we think about 24 /7 .
Thank you. Good luck.
Our next question is from Hamza Fodderwala from Morgan Stanley. Please proceed with your question.
Hi, guys. Thank you for taking my question. I wonder if you could comment a little bit more about early pipeline trends you're seeing in Q3, and what was specifically the decision around not giving a full year or I guess, a Q4 guidance?
I think that COVID, we talked a lot about that through kind of the results of Q1 and throughout Q2. COVID initially, at the end of March, when customers were kind of focused on the work from home and the VPNs, we were impacted. Then we started seeing the pipeline build. We started seeing the purchasing pattern go back to the normal trends that we used to see. I think Q2, the results are reflective of those trends continuing. With that said, there's still uncertainty with COVID. That's why we're giving guidance for Q3. I think the guidance that we're providing is in kind of the same manner, in a responsible and thoughtful way. We're looking at the pipeline for the second part of the year. We're very optimistic and going into Q3 with much more confidence than we had going into Q2.
Got it. Clearly the NRR was really strong. Could you comment a little bit more about the new customer business growth? Did that still decline year-on-year? When would you expect that to maybe rebound to year-on-year growth? That's it from me. Thank you.
Our strategy is to go to bigger customers with a 1,000+ , and it's worked very well. We also have a massive customer base that is under-penetrated that need our products, and we're really balancing market penetration and expansion, and we feel very comfortable and fairly happy with the way that it's working so far.
Just to add to that, in last year results, we still had a 56% subscription mix. When you compare this quarter to last quarter, it's still not apples-to-apples. Like Yaki said, the strategy is to go to larger customers and that's working very well.
Thank you.
Our next question is from Jason Ader with William Blair. Please proceed with your question.
Yeah, thanks. Good afternoon, guys. Is there any change in the mix in the quarter between enterprise and SMB? Also, if you could comment on average deal size and the outlook for U.S. federal for Q3.
When we look at the strategic type customer that we have, we shifted about three years ago to customers with more than 1,000 employees. The shift was mainly because conducting a risk assessment for a 400-user shop and a 1,500-user shop basically takes the same time, yet obviously the customer lifetime value from the larger customer is much greater. That was really the reason of us going up end and being able to sell more of the licenses and have those customers consume more. We obviously have a small business, but just to keep in mind, the reps that are selling to that small business, and I would say about companies with less than 500 employees, part of their selling process is to train and improve their selling ability so they can then move out to the field and sell to the larger enterprises.
We've not neglected the small business, but it's a small portion of our business. That strategy has been working very well. In terms of federal, Q3 is their largest quarter. We have a very good team in place, and we will obviously provide more commentary at the end of the quarter.
What happened also in the last two, three years is that the sales process, the sales campaign is becoming more strategic, a bit simpler and much more predictable. It makes sense for us to go up market and spend time with this customer that is buying much more, it lasts several years.
Do you see evidence of that in your trends on average deal size over the last three years?
Well, in terms of ASPs, obviously, with this transition, it's not truly apples-to-apples, but I can tell you that when you think about new customers and the way they bought perpetual licenses, in the initial sale, they would buy between two to three licenses. What we're seeing now is that with the subscription model that we're offering new customers, they're buying closer to five licenses. Almost double that. Our existing customers, they're embracing this transition, and they're embracing this model, and they're buying a lot of the licenses, they're buying it through subscription. Overall, I would say that we're very happy with this change because it allows us to sell more over time to our customers.
Thanks.
Our next question is from Gur Talpaz with Stifel. Please proceed with your question.
Okay. Great. Thanks for taking my questions. Yaki, you talked about the path to double-digit licenses. Can you walk us through what that path looks like? Then Guy, a follow-up to that, how should we think about customer lifetime value in the age of subscription? Thank you both.
Yeah, I think that customers, a lot of them need almost everything that we have. As I said, with 365, you can have these five, six licenses. This is after you have five, six licenses to your on-premise environment for Windows and Unix and classifying the data. All the User Behavior Analytics that we have. It's really a lot of the same functionality for different data stores. Because of the fact that we are not selling it in silo to IT, and a lot of it coming from the CISO as a policy to protect the whole enterprise, it's much easier for us to expand. With this subscription and the way that they receive the platform now, we see this multi-year budgeting and much more predictable adoption rate across the enterprise.
Just to add on the customer lifetime value. One of the things that kind of drove this transition was the fact that we saw customers wanting to consume double-digit licenses. What we have seen over the last couple of years is, we started seeing customers getting there, but it was much harder under the perpetual model. With this shift to subscription and the fact that the initial purchase has been close to five, which is a great number to start with for our customers because it provides them that automated license at least, and they can see the value of the product. It also allows them to continue to consume those licenses in the years following that.
NRR being greater than 120% just is indicative of how our existing customers are consuming more of these licenses and how we can generate higher customer lifetime value over time with this model.
Thank you.
Our next question is from Nick Mattiacci with Craig-Hallum. Please proceed with your question.
Hi, this is Nick Mattiacci on for Chad Bennett. Thanks for taking my questions. How should we think about the ARR growth for Q3 and throughout the second half of the year now that we are comping off a higher mix of subscription? How should we think about contribution from new versus existing customers in terms of the guide for Q3? Thanks.
In terms of the ARR growth, one of the things that we talk throughout the year is the fact that when you move so quickly through this transition, and you get closer to the second part of the year, ARR should have an impact because we're starting to be more apples-to-apples. We have a 74% subscription mix in Q3 2019, and ARR would obviously have an impact because it's much more apples-to-apples. In terms of the new and existing customers, I can tell you that we're happy with both of their contribution. If we're thinking about new customers, I talked about this in some of the other previous questions, we're seeing increased number of licenses, which is very healthy, and our existing customers, with kind of the NRR being larger than 120% is also indicative of how they're consuming.
I think the metric that kind of points out how much more we have to sell to our existing customer base is the number of customers with more than 500 employees who have four or more licenses or six or more licenses. When you look at that growth, it's grown very nicely over the last year. 58% for four or more licenses versus 48% last year, 24% on the six or more licenses versus 16% last year. Very nice growth there. At the same time, and not less important, it shows how much more we have to sell to our existing customer base.
Got it. Thank you.
Our next question is from Erik Suppiger from JMP. Please proceed with your question.
Yeah, thanks for taking the question. One, can you talk a little bit about timing to get to breakeven? Do you have any thoughts in terms of when we might see breakeven earnings? If you don't want to share the timing, can you talk a little bit about your criteria for balancing between your growth investments, and how you're making that decision?
Profitability is always something that is very important for us, and we try to strike the right balance between growth and profitability. Obviously, the move to subscription is really give us the flywheel to be, over time, much more profitable in a more predictable way. And this is something that we are going to do. We'll not give now just a timeline, but I think that you see how we behave. We are always adjusting spend to the top line. What's going on now is that every sale that we have with this high renewal rate ensure our profitability in the future, and we just want to make sure that we can do it at a larger scale.
Okay. You also talked about how you have much higher confidence in the pipeline entering Q3. Can you quantitatively compare the size of the pipeline from Q3 to Q2 at all? Any metrics around that?
I think that the commentary is that the pipeline is healthy. We feel good about it. We don't really quantify the pipeline. I can tell you that going into this quarter, we are feeling more confident than we did last quarter. I think it's reflective of kind of the Q2 purchasing patterns that we saw and how we've kind of increased in that line of customers that need the product and are purchasing us. I think overall, we feel very good about the second part of the year pipeline.
Very good. Thank you.
Our next question is from Srini Nandury with Summit Redstone Partners. Please proceed with your question.
All right. Thank you for taking my question. Guys, I'm looking at the competitive landscape a bit. Are you seeing any of the new vendors such as Fasoo out of Korea showing up in any of your deals? What about companies such as Broadcom , Zscaler, Palo Alto Networks, or even Proofpoint that have DLP as well as CASB solutions, which are actually going after the insider threats? Any color would be helpful. Thank you.
Hi. No, we don't see them. Everything that related to just the data itself and any attacks or data protection or classifying it at scale, 90% of the time, even more, we are alone and we don't see the CASB vendors unless there is a confusion. So far, we don't see any change in the competitive landscape.
Thank you.
Thank you.
Our next question is from Daniel Ives with Wedbush Securities. Please proceed with your question.
Yeah, thanks. My question, just in regards to when you start to think about your licenses and some of the trajectories, does it still feel like 8-10 types of licenses that we can get to in terms of those metrics for a typical customer?
I don't think we heard you clear. Did you ask if we can get to double-digit licenses within customers?
Yeah.
Yeah, I think the path to double-digit licenses per customer is much clearer now than what it was when we had the perpetual model. I think the fact that new customers are consuming more in that first initial purchase, and we're seeing our existing customers consume licenses through that model as well, has given us way more confidence in our ability to get to double-digit licenses per customer.
The adoption of 365 and Azure due to COVID make it much faster because you have very fast adoption and customers understand that they need protection for all the data stores, and they need real protection because the risk is huge. This is something that accelerating, this is another platform sale that you can go and sell four or five licenses in one chunk as an upsell or renew, and this is something that really is a big shortcut to get our customers to more than 10 licenses.
Yeah, just on that point, guys, brought up, with Azure and AWS and just you're seeing even for the next step of the cloud transition, is that more and more when you think about what you're seeing with both new and existing customers, just a massive ripple effect where you guys benefit?
This is one, but not only that, all the access from VPN, from unsecure networks, this is another huge one. You see very sophisticated Advanced Persistent Threats and malware, and ransomware became so much more dangerous. You have a lot of sophistication of bad actors today that are, at the end of the day, 90% of the time, what they are trying to get is the data, and the data that is exposed is unstructured data. If I look at just the demand drivers, there are just many, and each one of them becoming stronger and stronger. It's all of them.
With 365, you have this tremendous acceleration in adoption, and this is work integrated with just the on-prem, and you have this information sprawl, and in the mix, sometimes you have Microsoft Teams that increasing the security problem, and this is where we really benefit that we just see that customers are coming and in an upsell can buy four or five licenses, which maybe before they will do two one year and then another two and then another two. This is, as I said, it's a shortcut. In terms of the demand, the demand is coming from everywhere. The demand is coming from the fact that data is all over the place, people accessing from home networks. There is a lot of load on IT, and you need a lot of visibility and automation.
Everything that was a demand engine just increased and became so much more powerful.
Great. Thanks.
We have time for one final question, and that last question from Rishi Jaluria with D.A. Davidson. Please proceed with your question.
Hey, guys. Thanks for sneaking me in at the end. Two just really quick ones. With your services mix decreasing, totally makes a lot of sense to offload more onto the partners. From your perspective, how do you do that without having a meaningful impact on customer success or customer satisfaction? What have you seen so far? On the NRR number, last quarter, I think you had mentioned 105%, but that was for subscription customers. It's 120% for all. Can you just help us understand the difference in what you provided us as an NRR last quarter versus this quarter? Thank you.
Regarding customer success, customer success was a tremendous focus for us in the last year when we moved to the subscription. What we did, we really architected a lot of processes that can work with the partners just to make sure that they can adhere to all the standards that we demand from our customer success. It's working well for us. We managed to just architect a working model with just all the checks and balances to make sure that the customers are happy, the projects are advancing according to plan.
In terms of the NRR, Q1 NRR showed year-over-year expansion of subscription ARR, and the Q2 NRR accounts for subscription ARR and maintenance of perpetual, and it really accounts for timing. Q2 is a much larger sample and therefore is much more reflective of the overall of the business.
Great. That's helpful. Thank you, guys.
Thank you.
We have reached the end of the question-and-answer session, and I will now turn the call over to James Arestia for closing remarks.
Thank you all very much for your interest today. We hope everyone's safe and healthy, and we look forward to speaking with all of you soon. Have a good night. Thank you.
This concludes today's conference, and you may disconnect your lines at this time. Thank you for your participation.