NOTE

GENERAL

a. Varonis Systems, Inc. (“VSI” and together with its subsidiaries, collectively, the “Company”) was incorporated under the laws of the State of Delaware on

November

2004

and commenced operations on

January

2005.

VSI has

seven

wholly-owned subsidiaries: Varonis Systems Ltd. (“VSL”) incorporated under the laws of Israel on

November

24,

2004;

Varonis (UK) Limited (“VSUK”) incorporated under the laws of England on

March

14,

2007;

Varonis Systems (Deutschland) GmbH (“VSG”) incorporated under the laws of Germany on

July

2011;

Varonis France SAS

(“VSF

”) incorporated under the laws of France on

February

22,

2012;

Varonis Systems Corp. (“VSC”) incorporated under the laws of British Columbia, Canada on

February

19,

2013;

Varonis Systems (Ireland) Limited incorporated under the laws of Ireland on

November 11, 2016;

and Varonis Systems (Australia) Pty Ltd (“VSA”) incorporated under the laws of Victoria, Australia on

February 28, 2017.

The Company’s software products and services allow enterprises to manage, analyze and secure enterprise data. The Company specializes in creating software that manages and protects enterprise data against insider threats, data breaches and cyberattacks by detecting and alerting on deviations from known behavioral baselines, identifying and mitigating exposures of sensitive data, and automating processes to secure enterprise data. Enterprise data under our scope is typically comprised of sensitive information that is stored in spreadsheets, emails, word processing documents, presentations, audio files, video files, text messages and any other data created by employees. This data often contains an enterprise’s financial information, product plans, strategic initiatives, intellectual property and numerous other forms of vital information. Through its products, DatAdvantage (including DatAlert and the Automation Engine), DataPrivilege, IDU Classification Framework, Data Transport Engine and DatAnswers, the software platform allows enterprises to protect sensitive data from insider threats and cyberattacks and realize the value of their enterprise data.

VSI markets and sells products and services mainly in the United States. VSUK, VSG, VSF, VSC and VSA resell the Company’s products and services mainly in the UK, Germany, France and rest of Europe, Canada and Australia, respectively. The Company primarily sells its products and services to a global network of distributors and Value Added Resellers (VARs), which sell the products to end user customers.

Basis of Presentation:

The accompanying unaudited consolidated interim financial statements have been prepared in accordance with Article

of Regulation S-

“Interim Financial Statements” and the rules and regulations for Form

-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

2016

consolidated financial statements and notes thereto included in the Company’s Annual Report on Form

-K for its fiscal year ended

December 31, 2016

filed with the SEC on

February 9, 2017 (

the

“2016

Form

-K”). There have been

changes in the significant accounting policies from those that were disclosed in the audited consolidated financial statements for the fiscal year ended

December

31,

2016

included in the

2016

Form

-K, except as follows:

Effective as of

January 1, 2017,

the Company adopted Accounting Standards Update

2016

09,

“Compensation—Stock Compensation (Topic

718

)” (“ASU

2016

09”

) on a modified, retrospective basis. ASU

2016

permits entities to make an accounting policy election related to how forfeitures will impact the recognition of compensation cost for stock-based compensation: to estimate the total number of awards for which the requisite service period will

not

be rendered or to account for forfeitures as they occur. Upon adoption of ASU

2016

09,

the Company elected to change its accounting policy to account for forfeitures as they occur. The change was applied on a modified, retrospective basis with a cumulative-effect adjustment to retained earnings of

$2,616

(which increased the accumulated deficit) as of

January 1, 2017.

ASU

2016

also eliminates the requirement that excess tax benefits be realized as a reduction in current taxes payable before the associated tax benefit can be recognized as an increase in paid in capital. Approximately

$7,131

of federal net operating losses and

$718

of state net operating losses, neither of which was included in the deferred tax assets recognized in the statement of financial position as of

December 31, 2016,

have been attributed to tax deduction for stock-based compensation in excess of the related book expense. Under ASU

2016

09,

these previously unrecognized deferred tax assets will be recognized on a modified, retrospective basis as of the start of the year in which the ASU

2016

is adopted; in this case as of

January 1, 2017.

The U.S. federal and state net operating losses and credits that were recognized as of

January 1, 2017

have been offset by a valuation allowance. As a result, there is

cumulative-effect adjustment to retained earnings as of

January 1, 2017.

Additionally, ASU

2016

addresses the presentation of excess tax benefits and employee taxes paid on the statement of cash flows. The Company is now required to present excess tax benefits as an operating activity on the statement of cash flows rather than as a financing activity. The Company adopted this change prospectively.

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 forecast to be incurred in currencies other than the U.S. dollar. A majority of the Company’s revenues and a majority of its 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

months, and, as of

June 30, 2017,

the Company had entered into such contracts until

January 2018.

The Company does

not

enter into derivative financial instruments for trading purposes.

Derivative instruments measured at fair value and their classification on the consolidated balance sheets are presented in the following table (in thousands):

	Assets as of June 30, 2017 (unaudited)				Liabilities as of December 31, 2016
	Notional Amount		Fair Value		Notional Amount		Fair Value

Foreign exchange forward contract derivatives in cash flow hedging relationships - included in other current assets and accrued expenses and other short term liabilities	$	24,780	$	2,138	$	46,116	$	(479	)

For the

three

and

six

months ended

June 30, 2017,

the unaudited consolidated statements of operations reflect a gain of approximately

$653

and

$918,

respectively, related to the effective portion of foreign currency forward contracts. For the

three

and

six

months ended

June 30, 2016,

the unaudited consolidated statements of operations reflect a gain of approximately

$154

and

$82,

respectively, related to the effective portion of foreign currency forward contracts. There was

ineffective portion for the

three

and

six

months ended

June 30, 2017

and

2016.

Cash, Cash Equivalents and Short-Term Investments:

The Company accounts for investments in marketable securities in accordance with ASC

No.

320,

“Investments—Debt and Equity Securities”. 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 various deposit accounts.

The Company considers all high quality investments purchased with original maturities at the date of purchase greater than

three

months to be short-term investments. Investments are available to be used for current operations, and are, therefore, classified as current assets even though maturities

may

extend beyond

one

year. Cash equivalents and short-term investments 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 (loss), 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 and short-term investments consist of the following (in thousands):

	As of June 30, 2017 (unaudited)
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Loss			Fair Value

Cash and cash equivalents
Cash	$	40,083	$	-	$	-		$	40,083
Money market funds		12,456		-		-			12,456
US Treasury securities		1,000		-		*	)		1,000
Total	$	53,539	$	-	$	-		$	53,539

Short-term investments
US Treasury securities	$	32,946	$	-	$	(10	)	$	32,936
Term bank deposits		35,103		-		-			35,103
Total	$	68,049	$	-	$	(10	)	$	68,039

*) Represents an amount lower than $

All the US Treasury securities in short-term investments have a stated effective maturity of less than

months as of

June 30, 2017.

	As of December 31, 2016
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Loss		Fair Value

Cash and cash equivalents
Cash	$	42,175	$	-	$	-	$	42,175
Money market funds		6,140		-		-		6,140
Total	$	48,315	$	-	$	-	$	48,315

Short-term investments
Term bank deposits	$	65,493		-		-	$	65,493
Total	$	65,493	$	-	$	-	$	65,493

The gross unrealized loss related to these short-term investments was due primarily to changes in interest rates. The Company reviews its short-term investments on a regular basis to evaluate whether or

not

any security has experienced an other than temporary decline in fair value. The Company considers factors such as length of time and extent to which the market value has been less than the cost, the financial condition and near-term prospects of the issuer and its intent to sell, or whether it is more likely than

not

the Company will be required to sell the investment before recovery of the investment’s amortized cost basis. If the Company believes that an other than temporary decline exists in

one

of these securities, the Company writes down these investments to fair value. For debt securities, the portion of the write-down related to credit loss would be recorded to other income (expense), net in the Company’s consolidated statements of operations. Any portion

not

related to credit loss would be recorded to accumulated other comprehensive income (loss), which is reflected as a separate component of stockholders’ equity in the Company’s condensed consolidated balance sheets. During the

six

months ended

June 30, 2017,

the Company did

not

consider any of its investments to be other-than-temporarily impaired.

e. Recently Issued Accounting Pronouncements:

May 2014,

the FASB issued ASU

No.

2014

09,

“Revenue from Contracts with Customers”, an updated standard on revenue recognition

and issued subsequent amendments to the initial guidance in

March 2016,

April 2016,

May 2016

and

December 2016

within ASU

2016

08,

2016

10,

2016

12,

2016

20,

respectively

. The new standards provide enhancements to the quality and consistency of how revenue is reported while also improving comparability in the financial statements of companies reporting using IFRS and US GAAP. The core principle of the new standard is for companies to recognize revenue to depict the transfer of goods or services to customers in amounts that reflect the consideration (that is, payment) to which the company expects to be entitled in exchange for those goods or services. The new standard also will result in enhanced disclosures about revenue, provide guidance for transactions that were

not

previously addressed comprehensively (for example, service revenue and contract modifications) and improve guidance for multiple-element arrangements. ASU

2014

was initially scheduled to be effective for annual and interim reporting periods beginning after

December 15, 2016

and

may

be adopted either on a full retrospective or modified retrospective approach. However, on

July 9, 2015,

the FASB approved a

one

year deferral of the effective date of ASU

2014

09.

The revised effective date is for annual reporting periods beginning after

December 15, 2017

and interim periods thereafter, with an early adoption permitted as of the original effective date. The Company is in the process of evaluating the effect the new revenue recognition standard will have on its consolidated financial statements and related disclosures but has

not

completed its evaluation and implementation process. The Company intends to complete this process in

2017

and will adopt the new standard on

January 1, 2018,

using the full retrospective method. Based on its preliminary evaluation to date, the Company believes adoption of the new standard

may

have a material impact on its consolidated financial statements.

May 2016,

the FASB issued ASU

2016

11,

“Revenue Recognition: Customer Payments and Incentives”, which clarifies the guidance in recognizing costs for consideration given by a vendor to a customer as a component of cost of sales. This ASU is effective for annual and interim periods beginning after

December 15, 2017.

The Company is currently evaluating the impact of this standard on its consolidated financial statements and related disclosures.

February 2016,

the FASB issued ASU

2016

02,

“Leases”, on the recognition, measurement, presentation and disclosure of leases for both parties to a contract (i.e., lessees and lessors). The new standard requires lessees to apply a dual approach, classifying leases as either finance or operating leases based on the principle of whether or

not

the lease is effectively a financed purchase by the lessee. This classification will determine whether lease expense is recognized based on an effective interest method or on a straight line basis over the term of the lease, respectively. A lessee is also required to record a right-of-use asset and a lease liability for all leases with a term of greater than

months regardless of their classification. Leases with a term of

months or less will be accounted for in a manner similar to the accounting under existing guidance for operating leases today. The new standard requires lessors to account for leases using an approach that is substantially equivalent to existing guidance for sales-type leases, direct financing leases and operating leases. ASC

842

supersedes the previous leases standard, ASC

840,

"Leases". The guidance is effective for the interim and annual periods beginning on or after

December

15,

2018,

and early adoption is permitted. The Company is currently evaluating whether to early adopt this standard and the potential effect of the guidance on its consolidated financial statements.

November 2016,

the FASB issued ASU

2016

18,

“Statement of Cash Flows (Topic

230

): Restricted Cash”, which requires companies to include amounts generally described as restricted cash and restricted cash equivalents in cash and cash equivalents when reconciling beginning-of-period and end-of-period total amounts shown on the statement of cash flows. This ASU is effective for annual and interim periods beginning after

December 15, 2017

and early adoption is permitted. The Company is currently evaluating whether to early adopt this standard and the potential effect of the guidance on its consolidated financial statements.

May 2017,

the FASB issued ASU

2017

09,

Compensation - Stock Compensation: Scope of Modification Accounting

, which clarifies when changes to the terms or conditions of a share-based payment award must be accounted for as modifications. Under the new guidance, modification accounting is required only if the fair value, the vesting conditions, or the classification of the award changes as a result of the change in terms or conditions. ASU

2017

will be applied prospectively to awards modified on or after the adoption date. The standard is effective for fiscal years beginning after

December 15, 2017,

and interim periods within those fiscal years. Early adoption is permitted. The Company is currently evaluating the impact of adoption of this standard on its consolidated financial statements.