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 3, 2004 and commenced operations on January 1, 2005.

VSI has nine 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 6, 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; Varonis Systems (Australia) Pty Ltd (“VSA”) incorporated under the laws of Victoria, Australia on February 28, 2017; Varonis Systems (Netherlands) B.V. ("VNL") incorporated under the laws of the Netherlands on March 13, 2018; and Varonis U.S. Public Sector LLC incorporated under the laws of the State of Delaware on May 14, 2018.

The Company’s software products and services allow enterprises to manage, analyze and secure enterprise data. Varonis focuses on protecting enterprise data: sensitive files and emails; confidential customer, patient and employee data; financial records; strategic and product plans; and other intellectual property. Through its products DatAdvantage (including the Automation Engine), DatAlert (including Varonis Edge), Data Classification Engine (including GDPR Patterns and Data Classification Labels), DataPrivilege, Data Transport Engine and DatAnswers, the software platform enables enterprises to protect sensitive data from insider threats and cyberattacks and realize the value of their enterprise data in ways that are not resource-intensive and easy to implement.

VSI markets and sells products and services mainly in the United States. VSUK, VSG, VSF, VSC, VSA and VNL resell the Company’s products and services mainly in the UK, Germany, France, Canada, Australia and Netherlands and Belgium, 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.



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 2017 consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for its fiscal year ended December 31, 2017 filed with the SEC on February 13, 2018 (the “2017 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, 2017 included in the 2017 Form 10-K, except as follows:

Effective as of January 1, 2018, the Company adopted Accounting Standards Update 2014-09, “Revenue from Contracts with Customers” (“Topic 606”) on a full retrospective basis which requires the Company to restate its historical financial information for fiscal year 2017 and to be consistent with the new standard in 2018. The Company implemented internal controls and key system functionality to enable the preparation of financial information upon adoption. Topic 606 provides 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 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 most significant impacts of the standard to the Company relate to the timing of revenue recognition for arrangements involving term licenses and sales commissions. Under Topic 606, the Company is required to recognize term license revenues upon the transfer of the license and the associated maintenance revenues over the contract period, as opposed to the Company’s prior practice of recognizing both the term license and maintenance revenues ratably over the contract period. In addition, the Company is required to capitalize and amortize incremental costs of obtaining a contract, such as certain sales commission costs, over the remaining contractual term or over an expected period of benefit, which the Company has determined to be approximately four years. Previously, the Company did not capitalize sales commission costs but rather recognized these costs when they were incurred.

Adoption of the standard results in a reduction of revenues of $1,974 for the year ended December 31, 2017 primarily due to the net change in term license revenue recognition. As of December 31, 2017, the adoption of the standard results in an increase in deferred commission of $13,486, a decrease in short-term deferred revenues of $398, a decrease in long-term deferred revenues of $426 and an increase of $1,246 in deferred tax liabilities. This is a result of the capitalization of sales commission costs and the upfront recognition of license revenues from term licenses. The cumulative impact to the Company’s accumulated deficit as of December 31, 2017 is a reduction of $13,064.

Adoption of the standard related to revenue recognition had no impact to cash from or used in operating, financing or investing activities on the Company’s consolidated statements of cash flows.

The Company adjusted its consolidated financial statements from amounts previously reported due to the adoption of Topic 606. Select consolidated statement of operations, consolidated balance sheet and consolidated statement of cash flows, which reflect the adoption of the new standard are as follows:



	Three Months Ended June 30, 2017
	As Reported			Adjustments			As Adjusted
Revenues:
License revenues	$	28,420		$	(1,110	)	$	27,310
Maintenance and service revenues	21,754			367			22,121
Total revenues	50,174			(743		)	49,431
Cost of revenues	4,878			3			4,881
Gross profit	45,296			(746		)	44,550
Operating costs and expenses:
Research and development	11,498			—			11,498
Sales and marketing	32,560			20			32,580
General and administrative	6,582			(3		)	6,579
Total operating expenses	50,640			17			50,657
Operating loss	(5,344		)	(763		)	(6,107		)
Financial income, net	950			—			950
Loss before income taxes	(4,394		)	(763		)	(5,157		)
Income taxes	(641		)	61			(580		)
Net loss	$	(5,035	)	$	(702	)	$	(5,737	)



	Six Months Ended June 30, 2017
	As Reported			Adjustments			As Adjusted
Revenues:
License revenues	$	47,575		$	(2,173	)	$	45,402
Maintenance and service revenues	42,979			643			43,622
Total revenues	90,554			(1,530		)	89,024
Cost of revenues	9,550			24			9,574
Gross profit	81,004			(1,554		)	79,450
Operating costs and expenses:
Research and development	21,907			—			21,907
Sales and marketing	63,371			123			63,494
General and administrative	12,095			(7		)	12,088
Total operating expenses	97,373			116			97,489
Operating loss	(16,369		)	(1,670		)	(18,039		)
Financial income, net	1,419			—			1,419
Loss before income taxes	(14,950		)	(1,670		)	(16,620		)
Income taxes	(964		)	184			(780		)
Net loss	$	(15,914	)	$	(1,486	)	$	(17,400	)



	December 31, 2017 Balance Sheet Data
	As Reported			Adjustments			As Adjusted
Assets
Current assets:
Prepaid expenses and other current assets	$	7,130		$	7,216		$	14,346
Long-term assets:
Other assets	$	973		$	6,270		$	7,243

Liabilities and stockholders’ equity
Current liabilities:
Deferred revenues	$	73,891		$	(398	)	$	73,493
Long-term liabilities:
Deferred revenues	$	7,034		$	(426	)	$	6,608
Other liabilities	$	6,561		$	1,246		$	7,807
Stockholders’ equity:
Accumulated deficit	$	(122,454	)	$	13,064		$	(109,390	)



	Statement of Cash Flows Six Months Ended June 30, 2017
	As Reported			Adjustments			As Adjusted
Cash flows from operating activities
Net loss	$	(15,914	)	$	(1,486	)	$	(17,400	)
Amortization of deferred commissions	$	—		$	6,041		$	6,041
Deferred commissions	$	—		$	(5,902	)	$	(5,902	)
Deferred revenues	$	(694	)	$	1,532		$	838
Other long term liabilities	$	(547	)	$	(185	)	$	(732	)
Net cash provided by operating activities	$	7,384		$	—		$	7,384



c.	Revenue Recognition:

The Company generates revenues in the form of software license fees and related maintenance and services fees. License fees include perpetual license fees and term license fees which provide customers with the same functionality and differ mainly in the duration over which the customer benefits from the software. Maintenance and services primarily consist of fees for maintenance services (including support and unspecified upgrades and enhancements when and if they are available) and to a lesser extent professional services which focus on both deployment and training the Company’s customers to fully leverage the use of its products although the user can benefit from the software without the Company’s assistance. The Company sells its products worldwide directly to a network of distributors and VARs, and payment is typically due within 30 to 60 calendar days of the date the Company issues an invoice.

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.

Software license revenues are recognized at the point of time when the software license has been delivered.

The Company recognizes revenues from maintenance ratably over the term of the underlying maintenance contract term. The term of the maintenance contract is usually one year. Renewals of maintenance contracts create new performance obligations that are satisfied over the term with the revenues recognized ratably over the term.

Revenues from professional services consists 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.

In contracts with multiple performance obligations, the Company accounts for individual performance obligations separately if they are distinct. The Company allocates the transaction price to each performance obligation based on its relative standalone selling price out of total consideration of the contract. For maintenance and support, the Company determines the standalone selling price based on the price at which the Company separately sells a renewal contract. The Company determines the standalone selling price for sales of licenses using the residual approach. For professional services, the Company determines the standalone selling prices based on the price at which the Company separately sells those services.

Trade and other receivables are primarily comprised of trade receivables that are recorded at the invoice amount, net of an allowance for doubtful accounts.

Deferred revenues represent mostly unrecognized fees billed or collected for maintenance and professional services. Deferred revenues are recognized as (or when) the Company performs under the contract. The amount of revenues recognized in the period that was included in the opening deferred revenues balance was $47,811 for the six months ended June 30, 2018.

The Company does not grant a right of return to its customers, except for one of its resellers. In 2017 and for the six months ended June 30, 2018, there were no returns from this reseller.

The Company pays commissions to sales and marketing and certain management personnel based on their attainment of certain predetermined sales goals. Sales commissions are considered incremental costs of obtaining a contract with a customer and are deferred and amortized. The Company is required to capitalize and amortize incremental costs of obtaining a contract, such as certain sales commission costs, over the remaining contractual term or over an expected period of benefit, which the Company has determined to be approximately four years. Amortization expenses related to these costs are included in sales and marketing expenses in the accompanying consolidated statements of operations.

For information regarding disaggregated revenues, please refer to note 5.



d.	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 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. 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):



	Liabilities as of June 30, 2018 (unaudited)					Assets as of December 31, 2017
	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	$	35,290	$	(2,913	)	$	1,746	$	163

For the three and six months ended June 30, 2018, the unaudited consolidated statements of operations reflect a loss of approximately $948 and $900, respectively, related to the effective portion of foreign currency forward contracts. 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. Any ineffective portion of foreign currency forward contracts is recognized in financial income (expense), net in the consolidated statement of operations. No material ineffective hedges were recognized in other income (expenses) for the three and six months ended June 30, 2018 and 2017.



e.	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, 2018
	(unaudited)
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Loss			Fair Value
Cash and cash equivalents
Cash	$	66,535	$	—	$	—		$	66,535
Money market funds	7,101		—		—			7,101
Total	$	73,636	$	—	$	—		$	73,636

Short-term investments
US Treasury securities	$	39,835	$	1	$	(16	)	$	39,820
Term bank deposits	45,225		—		—			45,225
Total	$	85,060	$	1	$	(16	)	$	85,045

All the US Treasury securities in short-term investments have a stated effective maturity of less than 12 months as of June 30, 2018.



	As of December 31, 2017
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Loss			Fair Value

Cash and cash equivalents
Cash	$	49,819	$	—	$	—		$	49,819
Money market funds	6,870		—		—			6,870
Total	$	56,689	$	—	$	—		$	56,689

Short-term investments
US Treasury securities	$	39,758	$*)		$	(27	)	$	39,731
Term bank deposits	40,137		—		—			40,137
Total	$	79,895	$*)		$	(27	)	$	79,868

*) Represents an amount lower than $1

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, 2018, the Company did not consider any of its investments to be other-than-temporarily impaired.



f.	Restricted Cash:

In November 2016, the Financial Accounting Standards Board (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. ASU 2016-18 is effective for annual and interim periods beginning after December 15, 2017. The Company adopted this standard effective December 31, 2017 using the retrospective transition method, as required by the new standard. The adoption of this standard had an immaterial impact on the Company’s consolidated statements of cash flows.

The following table provides a reconciliation of cash and cash equivalents, and long term restricted cash reported within the consolidated balance sheets that sum to the total of such amounts in the consolidated statements of cash flows:



	June 30, 2018		June 30, 2017
Cash and cash equivalents	$	73,636	$	53,539
Long term restricted cash included in other assets	520		537
Cash, cash equivalents and long term restricted cash shown in the consolidated statement of cash flows	$	74,156	$	54,076



g.	Recently Issued Accounting Pronouncements:

In January 2016, the FASB issued ASU 2016-13, “Financial Instruments – Credit Losses on Financial Instruments”, which requires that expected credit losses relating to financial assets measured on an amortized cost basis and available for sale debt securities be recorded through an allowance for credit losses. ASU 2016-13 limits the amount of credit losses to be recognized for available for sale debt securities to the amount by which carrying value exceeds fair value and also requires the reversal of previously recognized credit losses if fair value increases. The new standard will be effective for interim and annual periods beginning after January 1, 2020, and early adoption is permitted. The Company is currently evaluating the potential effect of this standard on its consolidated financial statements.

In 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 12 months regardless of their classification. Leases with a term of 12 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. The new standard 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 the potential effect of the guidance on its consolidated financial statements and expects to adopt this standard effective January 1, 2019.

In January 2018, the FASB released guidance on the accounting for tax on the global intangible low-taxed income (“GILTI”) provisions of the Tax Cuts and Jobs Act (“TCJA”). The GILTI provisions impose a tax on foreign income in excess of a deemed return on tangible assets of foreign corporations. The guidance indicates that either (i) accounting for deferred taxes related to GILTI inclusions, or (ii) treating any taxes on GILTI inclusions as period cost, are both acceptable methods subject to an accounting policy election. In accordance with SEC Staff Accounting Bulletin No. 118, and as the Company is not yet able to reasonably estimate the effect of the GILTI tax, as described in note 9 of the Company’s 2017 consolidated financial statements included in the 2017 Form 10-K, the Company has not yet adopted an accounting policy with respect to the GILTI tax.

In June 2018, the FASB issued ASU No. 2018-07, “Compensation - Stock Compensation (Topic 718): Improvements to Nonemployee Share-Based Payment Accounting.” These amendments expand the scope of Topic 718, Compensation - Stock Compensation (which currently only includes share-based payments to employees) to include share-based payments issued to nonemployees for goods or services. Consequently, the accounting for share-based payments to nonemployees and employees will be substantially aligned. This ASU supersedes Subtopic 505-50, Equity - Equity-Based Payments to Non-Employees. The guidance is effective for the interim and annual periods beginning after December 15, 2018, and early adoption is permitted. The Company is currently evaluating whether to early adopt this standard and the potential effect on its consolidated financial statements.