Allot - Earnings Call - Q1 2019

Transcript

Speaker 0

Ladies and gentlemen, thank you for standing by. Welcome to Allot's First Quarter twenty nineteen Results Conference Call. All participants are at present in a listen only mode. Following management's formal presentation, instructions will be given to the question and answer session. As a reminder, this conference is being recorded.

You should have all received by now the company's press release. If you have not received it, please contact Allot's Investor Relations team at GK Investor and Public Relations at +1 64080559 or view it in the News section of the company's website at www.allot.com. I would now like to hand over the call to Mr. Gabriel Frohain of GK Investor Relations. Mr.

Frohain, would you like to begin, please?

Speaker 1

Thank you, operator. Welcome to Allot's first quarter twenty nineteen conference call. I would like to welcome all of you to the conference call and thank Allot's management for hosting this call. With us on the call today are Mr. Erez Antebi, President and CEO and Mr.

Alberto Sessa, CFO. Erez will summarize the key highlights followed by Alberto who will review Allot's financial performance of the quarter. We will then open the call for the question and answer session. Before we start, I'd like to point out that this conference call may contain projections or other forward looking statements regarding future events or future performances of the company. These statements are only predictions, and Allot cannot guarantee that they will in fact occur.

Allot does not assume any obligation to update that information. Actual events or results may differ materially from those projected, including as a result of market changing market trends, reduced demand, and the competitive nature of the security systems industry, as well as other risks identified in the documents filed by the company with the Securities and Exchange Commission. And with that, I would like to now hand over the call to Erez.

Speaker 2

Erez, please go ahead. Thank you, Gabriel. I'd like to welcome all of you to our conference call, and thank you for joining us today. I would like to start with some key financial parameters for the first quarter. The first quarter was another quarter of solid growth.

Our revenues grew 17% year over year for the first quarter. Our non GAAP gross margins improved from 70% in the first quarter twenty eighteen to 72% for the first quarter twenty nineteen, and our operational loss in the first quarter twenty nineteen improved compared with the 2018. All this while continuing to grow and invest in our long term growth through key R and D, marketing and sales investments. I am very pleased with the results we achieved during the first quarter, and the main message is that we are on track with our plan. We see a growing number of opportunities.

We are continuing to win new deals and grow our revenues, and we expect this trend to continue throughout 2019. While Alberto will provide more details on our financials later, I did want to start with our financial performance because it shows that we are on track and successfully continuing to execute on our plan. I would like to turn now to a discussion on our business, starting with the visibility and control domain. We are continuing to see an active market here, with a growing pipeline of opportunities for our Allot Smart product line. We see similar use cases to what we saw in previous quarters: smart traffic optimization, quality of experience, analytics, and regulatory compliance.

During the past few months, we announced deals from several different regions. In Japan, we announced earlier today that we partnered with Rakuten Mobile to provide their greenfield mobile network with several Allot products, including our traffic management software, network secure, and DDoS secure products. Rakuten Mobile, a subsidiary of Rakuten Inc, is a global leader in Internet services. Rakuten Mobile's fully virtualized cloud native mobile network plan is targeted to launch in Japan in October. In The US, we announced our agreement with Mobilium, a global roaming provider, to provide Allot Traffic Management, or DPI, system to ensure quality of roaming for a tier one US operator.

This deal is in addition to a previously announced deal for IoT security to a different tier one operator in The US. In Africa, we announced a deal with Safaricom, the largest mobile operator in Kenya, to provide a low traffic management, network security, and DDoS security for their fixed network. It is noteworthy that while our Allot Smart Traffic Management products and our Allot Secure security products are separate and used for different purposes, some operators choose to acquire and use products from both families, as evidenced by Rakuten Mobile and Safaricom deals. These wins are particularly important for a couple of reasons. First, we are expanding our customer base and we are entering new territories such as Japan and The U.

S. In which we had little presence in the past. And second, new wins with new operators provide a base for potential future revenue in expansions, renewals and services. Increased opportunities resulting from CSP move to NFV environment, additional regulatory requirements posed by governments, and the expected rollout of five gs in certain geographies are contributing to our continued growth in the DPI business. Overall, we see a healthy pipeline for such visibility and control deals.

As I mentioned in previous calls, this is good news as it enables us to continue growing even before the security domain comes into full effect. Let's turn now to the security market, which we believe is our longer term main growth engine. As I mentioned in previous calls, we see a growing number of CSPs who understand the value in providing secure broadband services at a premium and understand that this is a combination of three elements: one, an important enhancement to their brand value two, a potentially large new source of revenue and three, a key element in their customer satisfaction. There are a growing number of CSPs issuing formal RFIs or RFPs, and at the same time, we are working on a growing number of potential deals that do not have such a formal process. This growing interest is across the breadth of the Allot Secure product family, including Network Secure, IoT Secure, Home Secure, DDoS Secure, and the combination with our partners Endpoint Secure.

I would like to remind you all that Allot's ability to provide protection at several locations in the network while seamlessly providing the same service across customer location and platforms is one of Allot's key advantages. We are participating in a growing number of opportunities that combine two or even three different products of the Allot Secure family. This is a strong testament that our strategy of enabling operators the capability to provide anywhere, any device, any threat, unquote, protection to the consumer and SMB market is gaining their acceptance. In January, we announced a deal with a tier one European operator with approximately 2,500,000 subscribers. This operator plans to launch a security offering, a security as a service offering based on the Allot Network Secure product to its residential and SMB customers starting this summer.

Once the service is launched, I expect to be able to share more details. Rakuten Mobile, as I just mentioned earlier, expects to launch the service in Japan in October. This deal includes a traffic management component, a DDoS secure product to protect the network itself, and a network secure solution to protect end user Internet access. I believe the Japanese market, with its large size, relatively high ARPU, and consumer willingness to pay for value, has large potential for CSP secure broadband offerings. This win with Rakuten could potentially open the door for Allot to additional opportunities in the region.

Recently, we also announced a deal with Safaricom Kenya to provide, among else, network secure for their fixed broadband customers. Although ARPU in Africa is generally lower than in The US, Japan, or Europe, there is a significant portion of customers who pay much more than the average ARPU, and these are the target customers for the security service in Safaricom. In Vodafone, our largest security customer, penetration rates and the number of paying subscribers continues to grow, albeit at a slower rate than before. As disclosed previously, Telefonica Niji's security services based on the Allot Network Secure product were launched in December 2018 in Spain. Telefonica decided to launch a bundled service where they bundle speed, capacity, and security together.

Initial reception has been positive, and the number of subscribers is steadily growing. It is, however, still too early to analyze results and penetration rates. Telefonica plans to launch similar services, including security, in Brazil, Argentina, and Peru in the coming months. I remind you that both Vodafone and Telefonica deals were based on sales of perpetual licenses per subscriber. We are striving to change this model with future customers and are offering OpEx or recurring revenue based deals.

Not all operators will accept this model. Rakuten Mobile, for example, demanded a long term based license agreement. However, we are encouraged to see that more and more operators are open to an OpEx model, and this is the model in an increasing number of deals we are discussing. Another example for an OpEx deal that we closed last year is with Telefonica Spain for the SMB market. The SMB customers enjoy network based security provided by Allot Technology together with endpoint app protection provided by McAfee.

In this deal, the security revenue is shared between Telefonica Spain, Allot and McAfee. I am glad to inform you that the service was finally launched several days ago. OpEx deals like this contribute little to to bookings and revenues in the short term, so security bookings and revenues may appear not to grow enough. However, it is these types of deals that will ensure recurring revenues, potential long term revenue growth, and success for the business overall. Our goal is to build a substantial base of CSPs with whom we have OpEx or revenue share security deals, and then work together with them to grow the number of end customers subscribing to the security service, thereby generating a significant amount of recurring revenues.

We are engaged at several stages with a large number of additional operators for more security deals on all the various elements of the Allot Secure family, and I am very encouraged by the size of our pipeline and the interest within the CSPs to launch such security services for the mass market. Looking at the initial security OpEx deals we signed, the growth in tenders and RFPs that were issued, and the healthy pipeline we have in hand, I am confident that we are heading in the right direction and am optimistic about this market segment and our future growth in it. As you know, working with CSPs takes time, with sales cycles typically exceeding twelve months. So it still takes a bit longer than we would have liked to close these deals. To help us measure the potential of the aggregated security OpEx deals we signed and our progress in this area, I introduced in the previous earnings call a metric we use internally that we call maximum annual revenue, or MAR for short.

I would like to repeat the definition and explanation of this metric. MAR reflects the annual revenue Allot will receive should 100% of the CSP's relevant customer base sign up for the security service. Of course, we do not expect 100% of the operators' customers to sign up for the security service, So the actual revenues Allot will get are expected to be the MAR multiplied by whatever the penetration rates will be. In Vodafone case, penetration rates of the service after three years vary from 15, one-five percent, up to 50, five-zero percent, and more, depending on the go to market strategy and the emphasis put on the service. To clarify by way of a hypothetical example, assume we sign a deal with a hypothetical mobile operator that has 5,000,000 postpaid customers, and we target the security service for all postpaid customers.

Assume further that based on the agreement with the operator, Allot expects to receive half a dollar per subscriber per month. The MAR of this hypothetical opportunity will be 5,000,000 times half a dollar times 12 equals $30,000,000 If we reach in any given year average penetration of 20% of the subscriber base, the actual revenues for Allot in that year will be 20% of $30,000,000 equals $6,000,000 I would now like to summarize the overall picture and the key messages. We are proceeding according to plan and growing the business. I believe our first quarter numbers are a testament to that. In the visibility and control area, we have a growing number of opportunities in several areas.

We see longer term opportunities as operators move to NFV, as five gs networks are deployed, and as government demand more regulation on Internet access. Based on the pipeline, I expect this growth to continue into 2019. In the security area, which we see as our major long term growth engine, we have signed additional initial deals for Allot Secure products, including several security OpEx deals. Our pipeline of security OpEx deals is very encouraging, it is expanding, and most operators are accepting of the OpEx or revenue share model we offer. I expect we will sign additional security OpEx deals throughout 2019.

From a product perspective, we are progressing well and achieving advantages over our competition such as in NFV capability. We are also investing more intelligence and machine learning technologies to create further technological differentiation in both visibility and control and security domains. Based on our results so far and on the growing and strong pipeline of new deals, I would like to reaffirm our expectations for 2019 revenues to be between $106,000,000 and $110,000,000 with the second half of the year higher than the first half. We expect book to bill for the full year 2019 to be above one. Regarding security OpEx deals, I believe we are on track towards our goal to sign security OpEx deals with an aggregate MAR of $100,000,000 during 2019.

And now I would like to hand the call over to Alberto Sessa, our CFO. Alberto, please go ahead.

Speaker 3

Thank you very much, Erez. Before I begin reviewing the financial results for this quarter and for the year, I would like to inform everyone that on this call, unless otherwise noted, I will refer entirely to the non GAAP financial measure when discussing operational results, which is what we use internally to judge the performance of our business. Non GAAP financial measures differ in certain respects from the generally accepted accounting principle and exclude share based compensation expenses, expenses related to M and A activities, amortization of certain intangible assets, change in deferred tax, and exchange rate differences related to the revaluation of assets and liability denominated non dollar currencies, with regard to the financial results. Revenue for the 2019 were $25,300,000 growing by 17% compared with those of the 2018. Regarding the details of the revenue breakdown and diversification, the geographic breakdown of revenues for the 2019 was as follows: Americas with $4,800,000 or 19% of revenues EMEA with $10,700,000 or 42% of revenue and Asia Pacific with $9,800,000 or 39% of revenues.

Product revenues for the quarter accounted to $16,000,000 or 63% of total revenues compared to $13,000,000 in Q1 twenty eighteen. Professional service revenue were 800,000 or 3% of total revenues, compared to $900,000 in Q1 twenty eighteen. Support and maintenance revenue were $8,500,000 or 34% of total revenues, compared to $7,800,000 in Q1 twenty eighteen. Communication Service Provider, or CSP, revenues were 83% in the 2019, compared to 75% as reported in the 2018. I note that revenue breakdown, whether geographical or by product segment or other, may fluctuate from quarter to quarter depending on the specific revenue and deals recognized in the specific quarter.

Our top 10 end customer made up 62% of revenues and and this is compared with a concentration of 56% last year. Gross margin for the quarter was 72.4% compared to 69.6 in the 2018. The main reason for the increase in gross margin is related to specific deals with high profitability recognized during the 2019. Going forward, it's important to understand that we expect gross margin on a quarterly basis to fluctuate even significantly as a result of recognition of certain hardware intensive deals we already have in our backlog. Operating expenses for the quarter were $20,200,000 compared to $17,500,000 as reported in the 2018.

The increase in operating expenses is mainly due to increase in headcounts. The total number of full time employees as of March 3139 were five thirty six, up 12 since the December. Non GAAP operating loss for the quarter was reduced to $1,800,000 compared with an operating loss of $2,300,000 in the 2018. Net loss for the quarter improved to $1,900,000 or $05 per share versus $2,400,000 loss or $07 per share in the 2018. Turning to the balance sheet.

Our cash revenues comprised of cash our cash reserves, sorry, comprised of cash, cash equivalents and investments as of March 3139 remained strong and totaled $101,500,000 compared to $103,900,000 at the December 2018. The number of basic share for the 2019 was $34,000,000 and the number of fully diluted share was $35,700,000 In terms of guidance, as Urs mentioned, we are reaffirming our guidance and expect revenue to grow to between 106,000,000 and $110,000,000 in 2019, with the second half of the year higher than the first, representing continued year over year revenue growth. We also continue to expect book to bill for the year to be above one. We expect gross margin for 2019 to be approximately 70%. As I mentioned in our last call, we will also continue to invest in those areas that will serve the growth of the company, mainly sales and marketing and R and D.

And that concludes my remarks. We would be happy to take your question now. Operator?

Speaker 0

Thank you. Ladies and gentlemen, at this time, we will begin the question and answer session. Your questions will be polled in the order they are received. Please stand by while we poll for your questions. The first question is from Alex Henderson of Needham and Company.

Please go ahead.

Speaker 4

Hey, thanks. This is Roger Boyd on for Alex. Pretty nice results in the quarter. I'm wondering how does this affect the second quarter? Was there any timing related shifts in the quarter?

And then on gross margin, was this mainly a factor of more software focused deals coming through? I know you'd spoken in the past about maybe some hardware intensive upfront cost affecting the first half. I'm wondering if maybe that could shift to the second quarter. And then similarly with, Rakuten, if if there's a hardware build out prior to October that might affect margins as well. Okay.

Speaker 3

So first of all, regarding the gross margin, you mentioned gross margin of increasing gross margin. And as I said earlier, the main reason for that increase in gross margin this quarter is the recognition of deal with high profitability during the quarter. Going forward, as I said before, it will be important to understand that we expect gross margin on a quarterly basis to fluctuate. And those kinds of deals that you mentioned that are heavily hardware related with a lot of hardware, recognition of them is still to be recognized, meaning that we still have that on the backlog from a timing point of view, those kinds of they will be recognized probably in the next quarter or the quarter to come. And that will affect the gross margin.

Overall, as I said in my as I said earlier, we do expect on a yearly base to be on a 70% gross margin.

Speaker 2

And just to address, Alex, your question on Rakuten. Rakuten is is building a completely virtualized core network. So we will be providing software, professional services support, but we will not be selling any hardware to Rakuten.

Speaker 4

Okay. Makes sense. And then maybe just qualitatively, I know you spoke a little bit about it, but any other details on customer reception towards SaaS OpEx proposals? Do you think that customers are more likely to use kind of the split approach where Telefonica is using SaaS for their SMB business? A Is similar trend you're seeing?

Or I mean, I guess you'd you'd like to see the whole deal, but any thoughts there?

Speaker 2

If I understood the question correctly, I don't I don't think I can differentiate between customers who are looking at different approach for a consumer versus their SMB customers. Think it's I think least what I'm seeing is that there are simply customers that are more more comfortable with an OpEx type deal, some customers are more comfortable with revenue share, and some really want more of a capital expense. So it's not so much dependent on the market segment, meaning consumer, SMB or enterprise, it's more depending on the operator itself.

Speaker 4

Okay, makes sense. That's it for me.

Speaker 0

The next question is from Mark Silk of Silk Investments. Please go ahead.

Speaker 5

Thanks for taking my questions and great progress. On let's say long term, three to five next three to five years out, on your security offerings, what's your goal for recurring revenue, like, going forward? Like 50%, 25%?

Speaker 2

It should be I think it should be a very significant portion of our revenues. I don't wanna give you an exact percentile for three years out and five years out and so on, but since this is the main growth engine and I expect us to continue to grow at the current pace or even more and most of it will come from recurring revenues, then yes, this should take up an increasingly growing percentage of our revenues and should be very substantial.

Speaker 5

That's a fair answer. And then but it sounds like some of your customer base, like you said, does not necessarily wanna do the revenue share. So it's kind of gonna kinda be up to the customer going forward. Is that

Speaker 2

That's correct. Because, honestly, if a customer comes to us and is willing to offer a is willing to do a deal with us, but there's a fair value there for us and for them, and they're only willing to do it in a CapEx mode. And we, at the end, they will be practical. We won't say no. We won't turn them down.

But but I but I expect that the way I look at it now, I think the majority of customers will opt for some form of OpEx or revenue share agreement.

Speaker 5

That's exciting. And my last question on Deepak oh, sorry.

Speaker 2

No. Was just saying it's a lower risk it's a lower risk offering for them, and they they and most operators I'm familiar with today have significant CapEx constraints. So that's why it feeds into that.

Speaker 5

Yeah. Because I think the recurring revenue is gonna be, you know, better for on your multiple going forward. So my last question is on deep packet inspection. I know you may you know, you're surprising us on on that. It's not it's obviously not dead.

Can you kinda let us fill us in, like, what's going on in The United States? Because I know there's still question marks as far as how how how thorough people wanna use DPAC inspection until it's you know, they have a finite answer from the government.

Speaker 2

Well, we're seeing we're seeing more interest on DPI in The United States than at least we saw a year ago, but still this is not something and, you know, we we just just told you there you know, we announced the deal with Mobilium. It is a DPI deal. It is for a US tier one operator. So, evidently, there is movement in The US, but it's not a it's not huge. I don't see all the major carriers going out and starting to acquire DPI or demand it and so on.

We're seeing more interest, but I don't think these are very significant numbers yet for The US market.

Speaker 5

Thanks for taking my questions. Keep up the good work.

Speaker 6

Thank you.

Speaker 4

Thank you.

Speaker 0

If there are any additional questions, please press 1. If you wish to cancel your request, please press 2. The next question is from Jeff Bernstein of Cowen. Please go ahead.

Speaker 7

Hi, guys. Just a quick one. You talked about the Telefonica launch in Spain being part of a speed capacity and security kind of bundled offering. Do you have any visibility on what the plans are for Brazil, Argentina, Peru? Are are are they also gonna be in in some kind of bundle like that?

Speaker 2

We have some visibility, but and that and, yes, that I mean, we have business. I'll I'll rephrase that. Sorry. We have visibility since we're talking to Telefonica, and they're sharing with us at least some of their ideas. On the other hand, I can't tell you for sure if that's exactly what they're going to launch, and I'm not sure that they have themselves decided finally exactly how it's going to go.

I would expect that most of them will be similar, will be a similar bundle, but I cannot tell you that for sure.

Speaker 7

Gotcha. And then a couple questions about other stuff going on around the industry, around what you're doing. I guess there was something out about Telefonica and its launching its own IoT cybersecurity unit and and, a business called ElevenPaths. You know, what does that kinda mean to you? Do you just take that as an elevation of interest in this kinda thing for carriers, etcetera?

And then I had one more.

Speaker 2

EleventhAS is is a subsidiary or a business unit of Telefonica that deals in various things, but mostly around around security. We're working very closely with EleventhAS. A lot of the work that was done on the Niji security service, which they have launched in Spain and expect it to launch in other places, was originated by eleven Path, and we worked with eleven Path on the definitions for that, on how bundle would work, how it would work technically, and so on. And one of their initiatives, and one of the things that they're working on and that we're talking to them about, is also how to provide IoT security.

Speaker 7

Gotcha. That's great. Thank you. And then, lastly, you you have a a quasi competitor, Cyan AG, German company, that that's focused, I guess, more, on DDoS, etcetera, and and they want a pretty big deal with Orange. Just interested in in kinda what went on there and and and what your thoughts are about that segment, etcetera.

Speaker 2

I think Cian indeed won a deal with Orange. As they won a deal, I I'm not sure that they won anything on DDoS. I may be mistaken, but that's not what I'm familiar with. I think they won a deal for the small medium businesses, security with Orange. And, yes, it's, you know, the the it's it's unfortunate that our competitor of ours won a won a deal.

I think fortunate part of it is that you see that more and more operators are indeed going to provide security services to their customers, and we're seeing more traction in the market. And that will obviously bring competitors, whether direct or with this so with a different offering. Overall, the market, it's good news. What went on there, I think we just we were not we were not doing, I think, our sales job as properly as we should have probably in Orange, but we have not given up.

Speaker 7

Gotcha. And and I'm sorry. I think I misspoke. I think it was more that their their security technology is more DNS based rather than DPI based.

Speaker 2

Yes, is. It's more DNS based. The DNS based technology is one which is inferior in its security capabilities to the in line security capabilities that we are offering. It is, however, easier to install in the network. So there's a trade off there.

I think that as time goes by, we will see less and less we'll see less operators willing to go with DNS, because I think honestly it's less future proof than the in line offering that we are providing. But time will tell.

Speaker 6

That's great. Thank you.

Speaker 0

The next question is from Nacho Moshitz. Please go ahead.

Speaker 6

Hello. How are doing, Mr. Terry? Thank you very much for taking my call. And congratulations for the great quarter and the the growth.

I wanted to ask you, when you gave the anticipation, you anticipated the growth for the year. It it was about 4.14%, but not expected. That was, you know, when you reported the the whole year of 02/2018, the fourth quarter of of two thousand and eighteen. And, actually, now now you're close to the, growth of 17%. So, I wanted to know what does it mean?

Maybe does it mean that in the rest of the year, you anticipate, like, a slower growth? Or maybe, that means that that the you you'll give a higher anticipation for the year. And if yes, so when do you think you're gonna higher up the anticipation?

Speaker 2

Well, I mean, the the numbers for the course for the first quarter are what they are, and that was a 17% growth, as we said. For the full year, you know, it's the full year is affected by various parameters, and we gave our guidance to finish the year at between 106 to $110,000,000 so it's not a specific growth number. If you do the math, it'll simply be a range. And we are we still believe that that's we believe that that's the range we will be in. I'm not sure how to further address your question.

Speaker 6

What what I mean is that you anticipated a a 14% growth. Now you gave 17%. So would would it be the same the same percentage of growth in the rest of the year?

Speaker 2

No. I didn't but we didn't never said a 14% growth in 02/2019. We said that the end result will be 01/2006 to 01/2010, which will give a range that, you know, we can calculate in a second, but I didn't didn't yet. And we said that the second half will be stronger than the first half. But again, I don't know numerically how to add any more information.

Speaker 6

Okay. Great. Thank you very much. Keep up the good work.

Speaker 2

Thank you.

Speaker 0

There are no further questions at this time. Mister Entebbe, would you like to make your concluding statement?

Speaker 2

Yes. Thank you. On behalf of myself and the management of Lot, I would like to thank you for your interest and long term support of our business. Alberto, our CFO, will be in The U. S.

Next week meeting investors in Chicago and attending the Needham Emerging Technologies Conference in New York. If you would like to meet him, please contact our Investor Relations team. We'll be happy to meet with you. And I look forward to talking to you on the next quarter. Thank you, and have a good day.

Speaker 0

Thank you. This concludes the Allot first quarter twenty nineteen results conference call. Thank you for your participation. You may go ahead and disconnect.