Allot Ltd (ALLT) 2007 Q3 法說會逐字稿

Thank you for standing by and welcome to the third quarter earnings call. At this time, all participants are in a listen-only mode. There will be a presentation followed by a question-and-answer session (OPERATOR INSTRUCTIONS). I must advise you this conference is being recorded today, Wednesday, the 7th of November, 2007.

I would now like to hand the conference over to your speaker today, Jay Kalish. Please go ahead, sir.

Thank you very much. Thank you all for joining us today. During this call, we will discuss Allot's financial results for the third quarter of 2007. With us on today's call are Allot's President and CEO, Mr. Rami Hadar, as well as Mr. Doron Arazi, our Chief Financial Officer.

On the call, Rami will first provide some color on our third quarter performance. Doron will then walk you through the financial results, after which Rami will provide an overall strategic update including progress we are seeing with the new Service Gateway Omega Series.

Before we begin, let me remind you that certain statements made on the call today may be considered forward-looking statements which reflect management's best judgments based on currently available information. I direct your attention to the risk factors contained in today's press release and in the annual report on Form 20-f filed by Allot with the U.S. Securities and Exchange Commission on June 28, 2007.

I would now like to turn the call over to Rami.

Thank you, Jay. I would like to welcome everyone who has joined us today on the call. While our numbers came in lower than expected for this quarter, we had several significant highlights during the quarter. We've continued to see an increase in orders from large accounts, as we received 13 orders in the quarter; 5 from new customers. We received a $2 million order from a tier 1 operator in Central America/Latin America region, further increasing our worldwide large customer base. We anticipate that revenues from this order may be recognized over an extended period of time, most likely commencing during 2008.

We are pleased to announce the first commercial deployment of the Service Gateway Omega 10G system with a major carrier in the A-PAC region. I am happy to report that a second deployment began this week in the EMEA region. The tier 1 and tier 2 trials of the Service Gateway began on schedule during the quarter with additional trials in the pipeline. I will go into a bit more in detail regarding our strategic focus in a few minutes, but [I would like] to turn the call over to our new CFO, Doron Arazi, for his financial review of the quarter. Doron, please go ahead.

Thank you, Rami. Good morning, everyone. Let me take a few minutes to analyze the results we published earlier today. I will be discussing non-GAAP numbers which exclude the expensing of stock options required by FAS 123R and certain legal fees related to a lawsuit filed against the Company earlier this year. We have provided a reconciliation between the GAAP and non-GAAP numbers in a table accompanying the press release that was issued earlier today. Now let's take a look at the third quarter results.

Revenues for the third quarter totaled $7 million, a 19% decrease from the second quarter of $8.6 million results and a 21% decline from the $8.9 million revenue reported in the third quarter of 2006. On a geographical basis, revenues for the third quarter broke down as follows -- EMEA, 35%; America's [34%]; and A-PAC 31%, in line with the level [of] the same figures in previous quarters.

Out of total revenue during the quarter, (inaudible) comprised 73% and services 27%. Services revenue were higher as a percentage of total revenues due to lower sales in the quarter. For the long-term assuming the services will be around 20% of the quarterly revenues.

Gross margins for the third quarter were 74%, lower than the 76% level in the second quarter. This was mainly due to lower sales levels while fixed costs remains relatively stable. We continue to believe that our long-term model for gross margin will be between 75% to 78%.

Net R&D expenses in the third quarter totaled $2.2 million, similar to the second quarter and were 32% and 25% of revenues, respectively. The level of spending is in line with our model as we continue to support activities relating to developing and rolling out the Service Gateway.

Sales and marketing expenses totaled $4.2 million in the third quarter as compared to $4.6 million in the second quarter, 61% and 53% of revenues, respectively. The decline in dollar terms is due primarily to the low tradeshow activity during the third quarter as compared with the much higher activity during the second quarter. General expenses totaled $1.2 million in the third quarter, similar to the level in the second quarter -- 18% and 14% of revenues, respectively. The SG&A expenses again reflect SOX compliance activity and regional professional services expenses.

As a result of all this, our operating growth for the third quarter was $2.5 million as compared with $1.3 million loss in the second quarter. Our net loss for the quarter totaled $1.7 million or $0.08 per share as compared with a net loss of $299,000 or $0.03 per share for the second quarter.

On the balance sheet side, total cash, cash equivalents and marketable securities totaled $77.8 million, a decline from $78.5 million at the end of last quarter. Total receivables declined significantly during the quarter as a result of increased collections and totaled $7.9 million at the end of the quarter as compared with $9 million at the end of the second quarter. This resulted in 102 day sales outstanding level as compared with 95 days in the second quarter. You should bear in mind that the receivables include the $2 million order which we received and partially invoiced, but was not recognized during the quarter from a Latin American tier one operator. If we deduct this portion of the order from total receivables, the DSO level would decline by more than 10 days.

Deferred revenues at the end of the quarter amounted to $7.5 million, of which $4.7 million were short term. This represented a $1 million increase over the previous quarter. This relates primarily to the $2 million order received and partially invoiced for the Latin America operator I discussed.

That concludes my remarks and now I turn it back to you, Rami.

Thank you, Doron. Total revenues were affected by three main trends. First, the traditional seasonal weakness of the third quarter affected our sales, mainly in EMEA during the summer vacations. The second factor is the $2 million order from a tier one operator in the [Kallah] region. While winning this account in Q3 is an important milestone for Allot, it did not contribute to our quarterly revenues. The third element is the rapid migration to 10G network interfaces by a number of our tier 2 customers.

While our new Service Gateway was initially designed to meet the needs of tier one carriers, the fast pace of bandwidth expansion by some of our tier two customers led to greater demand for 10G systems quicker than we had originally anticipated. While this product position is affecting our short term results, we believe that we are setting the groundwork for long-term success.

The first commercial deployment of our Service Gateway to a major service provider in the Asia-Pacific region marks an important milestone for Allot. We believe that our new product has a number of significant competitive advantages, which include the following -- the Service Gateway has a higher performance in other competing products, designed to support two 10G lines and up to 25 gigabits of aggregated traffic. It was designed with the carrier class platform with no single point of failure. Investment protection -- this is a solution based on top of a standard ATCA platform and designed to be expanded both in speed and in add-on applications and services without the need for focused upgrade while minimizing management and operational costs.

Over the past few months, we have seen misconceptions about the vital role of deep packet inspection based products in service provider networks. I would like to take a moment to explain how are low cost technology translates into important value propositions for our service provider customers.

Allot's technology is about identifying a huge number of Internet protocols and applications quickly and efficiency. Allot continues to invest heavily in updating its protocol identification capabilities worldwide. This expertise is rather sophisticated as protocol is [well] over time varies from region to region, and sometimes encrypted to avoid identification. We enable our customers to gracefully manage prioritization among the various applications so that overall quality of the experience for all users increases.

This additional best effort approach is simply not adequate in a time where many content and communication services are converging onto the Internet. Our approach is quite advanced in that we identify most of the applications running on the network and do not simply concentrate on one specific application such as peer-to-peer.

We then enable the upgraders to manage priorities by allowing them to configure the DPI system priorities in accordance with their business strategies. For example, we allow them to increase the priority of time sensitive services such as Voiceover IP and video streaming, thus enhance the quality of experience for all subscribers. We also believe that the future of deep packet inspection with our Service Gateway approach will enable operators to offer new value-added services to their subscribers, thereby increasing operator's revenues for their networks.

Moving forward, we are continuing to focus on the carrier markets where we believe that larger facilities are still in front of us. With the commercial availability of our 10G Service Gateway, we are well positioned to support the ongoing tier 1 and tier 2 trial activities, and empower them to continue to increase our worldwide penetration into tier 2 and tier 1 and tier 3 service providers. We look forward to sharing these fruits of this strategy with you going forward.

We will now take your questions. Operator, please.

(OPERATOR INSTRUCTIONS). Glen Anderson.

A couple of things. The gross margin weakness in the quarter, can you provide just a little more color on that? And then I have a follow-up question.

Yes. Basically the main reason for this is the fixed expenses we have in our cost of goods sold, that remains stable as opposed to the relatively high decrease in our revenues. And that [creating] our gross profit percentage much lower.

Okay. So this isn't the Service Gateway weighing on the results? Would we expect -- I mean, since it's a new product, I'm assuming that the Service Gateway is going to out-the-gate have lower gross margins, but then over time it's going to be a higher gross margin product. Is that the right way to think about it?

That's exactly correct, Glen.

The follow-up question -- as far as your guidance, I think it's probably no secret just given the unpredictability in your results over the past several quarters that there is a bit of a credibility problem in terms of what investors will expect from the guidance. Can you give us any more color as far as what's driving your thoughts with respect to the guidance? Do you have better visibility into potential tier 1 deals? Do you have potential -- do you have a better visibility into the orders that you're going to book revenue for in Q4? Just some color there would be great.

Well, in terms [relaying] our expectations into Q4 and thus, the overall guidance for the year, the way we predict the revenues in our future performance is always limited by the fact that DPI in the service provider space is a relatively young market, undergoing changes and trends and therefore always susceptible to variation.

Having said that, our projections are a combination of several factors. One is whatever backlog we have coming into a new quarter, that's the [EV] costs. The other element obviously is our bottoms up funneling approach supplied to me by our two VP of Sales, one in the Americas and one in the international markets. And the third is we do use obviously to our smaller end orders, we always say and apply extrapolation of what trends we have seen in the past quarters and the previous quarters in the past years, and take that into anticipation into Q4.

Basically, when it comes to our large accounts -- in our definition, any account over $100,000 -- there we constantly keep track by account-by-account basis. And we have a notion of which account will become commercial in the coming quarter. But on the other hand, everything else, our smaller accounts, the first orders we get from channels, these are hard to track on a name-by-name basis and usually are done by extrapolation method. And whatever feedback they give us, our channels, coming into a quarter.

Got it, okay. So, in terms of the tier one, in terms of potential tier one wins, any better visibility there? Are tier one accounts on track to make decisions on the timeline that you expected or are there delays there?

Yes. So, basically, first thing, as we had said in the past and this is correct to our new guidance for the rest of the year, we have not baked any assumptions on tier one revenues for [a] 2007. Nevertheless, we talk about tier one accounts -- the one that we have won in the [Kallah] region, this starts contributing revenues to us as both Doron and I mentioned. Unfortunately, we're not able to recognize revenues, but we did book a nice significant PO and we expect to get more from this account.

There are two other accounts that I'm aware of, tier one accounts, that are participating that they will make decisions before the end of the quarter. One is the EMEA-based, one is in the U.S. Carriers have known to push back sometimes on those decisions. But these two are doing just all the right steps to meet their own schedule. There is one major tier one carrier in the U.S. which stated that they would push back the decision into Q2 of next year. So that's kind of the landscape of what's going on.

There was one account that we were not yet ready with our Service Gateway 10G approach. And we did not make the shortlist. So you have about six there between getting close to making decisions, pushing out to next year. So, basically a combination of tier one accounts.

All right, okay. That's clear. All right, thanks, guys.

Inder Singh.

I just wanted to ask a follow-up on that in terms of what the selling cycle is like at these tier ones? It sounds like a few of them are moving forward quite rapidly. The [Kallah] one that you mentioned, for example. So do you feel that maybe the selling cycle is perhaps not as long as you originally envisioned? I suppose there are one or two exceptions you mentioned in North America, but on average, it would seem that the selling cycle is perhaps several months as opposed to a couple of -- four or five quarters. Is that a fair statement or is it too early to judge that yet?

Not to say that I haven't seen a tier one move within several months, certainly they are really motivated to achieve total [effective] their new offering or a major improvement of efficiency on the network, but I would say that is the rare exception. Most of these cases, and again, when I am talking tier one, these are major tier ones; usually the sales cycle is one to two years.

The ones that I mentioned that I do anticipate that will make decisions, we have been involved in over several quarters. So these are not concepts that came to attention a quarter or two ago and all of a sudden are ready to make a decision. Did that answer your question?

Okay. He's actually just disconnected. Okay. Your next question comes from Daniel Meron. Please ask your question.

So, couple of quick questions. If you can give us a sense on how should we look at 2008. Are we going to see kind of a flattish start for the year on the fourth quarter number? And then kind of see the ramp up? How should we think about 2008 in general? And then also on the margin structure. Thank you.

Basically, given our non-accurate forecast for 2007, we want to be really careful about 2008. I'd like to get closer to the end of 2007 before we give any guidance. So at this point, no further information.

Okay. And the size of the deals that you kind of quoted before, how is that compared to, say, a few months ago? I mean, is it pretty much the same size of opportunity here that we're talking about? Or the opportunity has shrunk?

Are you referring to the $2 million PO from [Kallah]?

Now, it's actually from the tier 1 operator that you'd mentioned that you're working with. Where do you think -- how big are those opportunities? Are they pretty much the same thing or is it just a matter that they got pushed out and now been contracted?

Okay, basically it's all over the place. I mean, there are certainly tier one carriers that at least on the quantity stated there are fees referred to $10 million or $20 million projects. Another end -- there's a tier one that [did in our fee] through one of their smaller subsidiaries and the wins there could maybe be only $1 million or $2 million. The tier one PO we got from the [Kallah] region, the $2 million, I expect that is kind of an ongoing project. The [never earned] 100% of the project [to answer you] in one single quarter. We have yet to see exactly the ability and the plans of this carrier and how much of that will be repeated. So no comments on that account just yet.

And then last one. You had a project that you announced last week with an ISP in Asia. Can you quantify the project, how big was it and just give us more color on that carrier? Thank you.

On a very high level I can say that the Service Gateway delivery was part of the project that we delivered throughout the course of 2007. That project was a combination of both our [AT2500] devices, our SAP [social] platforms [to discover] management. And the tail end of that project was the delivery of the Service Gateway. That project, both parts is about a $1 million project.

Scott McCabe.

This is Scott from Lehman Brothers. I had a follow-up to Inder's questions. He got dropped off. Your guidance kind of implied 8.2 to 11.2 for December. So at the low end, that would be a $1.2 million increase quarter-over-quarter. It's the biggest going back in 12 quarters from what I can see. What gives you confidence in such an increase, given the troubles you've had so far this year? And then what are the swing factors in getting above the low end?

Okay, in terms of confidence of increase, as I stated in the factors that affected our Q3 numbers, Q3 is one of the two slowest quarters of the year. Q4 is the strongest quarter of the year. We are seeing a strong [in follow] so that gives me confidence that we can get within the range that we gave out.

In terms of achieving the high side, what will help us achieve and get to the higher portion of the range is if we will be able to recognize revenues on the Service Gateway 10G deliverable. As we have said, we have started delivering the product but it's now ongoing acceptance testing by the customers. And it is going to be tight if we end up recognizing revenues or not on these shipments.

Okay. And then if you could, give us more insight on gross margin going forward. I know that it dropped and I know you explained that, but how would you expect it to bounce back in December?

Basically I believe that for the year 2007, we will end up with around -- within the range that we have stated in the past, that means 75% to 78%. For 2008, there might be a slight decline due to the new (inaudible) of Service Gateway that usually occurs -- more occurs at the beginning before going to mass production. But long-term I believe that we will be able to stay within the borders of 75% to 78%.

Inder Singh.

Yes, thanks, gentlemen. I apologize, I got dropped off, I was on a cell phone earlier and I dialed into our wireline here. I just wanted to ask you a little bit about the competitive environment. And in terms of who you're running into, are you running into any of the larger vendors at this point? It seems to me your solution is quite differentiated from what perhaps the Juniper's and the Cisco's can offer. If I imagine that your competition is from smaller vendors. Can you talk about that a little bit in terms of what you see in Europe and then maybe what you see in North America as well? Thanks.

Maybe I'm [splitting] our competition into two main categories -- the first is the existing players in our market and then maybe the ones who have made some announcements, primarily larger companies that have made some announcements about having some DPI from (inaudible) existing boxes. One, we have not seen any of them in the marketplace so far. And it's hard to say when they will arrive. They've made announcements but again, no commercial appearance yet.

We always said it in the past that deep packet inspection device was identification capabilities, packet service capabilities, the way it needs to be maintained, upgraded and provisioned at 10G interfaces, it will be very hard functionality to embed into an existing router or a VRoute. So again that's kind of analyzing what might happen. So far we haven't seen these show up in any of the accounts.

Regarding our current competition, without getting into names, there is one large competitor and two or three smaller ones or outside the array of smaller. What I can say there is that on tier one accounts, on the major RFP's, [all four] players that typically show up, the ones who don't have a 10G solution get dropped very quickly. And the rest is a combination obviously of the features and capabilities and carrier class features.

We have come recently to the arena with our 10G solution which as you said, we feel strongly is very differentiated. But we're just now starting to get into these trials and baking contests, so I will see the fruits of that in the coming quarters.

Outside of the U.S. in the tier 2 and tier 3 accounts, stereotypically we are either going in there alone or maybe with only one of our competitors. And it's easier for us. This is why we continue investing in the tier 2 and tier 3 marketplace and expand our worldwide footprint of customers.

Thank you for taking my question.

[John Tredgett].

Could you just confirm -- the client, the $2 million contract that might be recognized in '08 and maybe into '09, is that a tier one [LAP-cam] customer?

Yes, definitely. It is a tier one carrier in [Kallah], yes.

Okay, I guess, just as a follow-up to that, if I'm right, I think you guys classify tier ones as broadband providers that have over 2 million subscribers. I guess the question is, 2 million seems like a very -- you assume that most of these broadband providers are going to spend at least, I don't know, $8 to $10 per broadband sub on DPI. 2 million seems like a very small contract for a tier 1 customers. Or should we expect that this is just the start of a potential stream of revenue from that customer?

Well, first your latter assumption is right, although again, I say that carefully as we get to sit down and grasp the whole scope of the project. But I do want to -- I'll correct -- say one thing. We have shown in the past where we have penetrated actually tier one accounts, such as [Channel] Telecom and others. Nevertheless, sometimes they decide to deploy (inaudible) region or certain point of presence. And then wait for a couple of quarters and see how that meets their business goals. And then, and only then decide to move forward or not. So not only -- in our customer [base] we have numerous tier one accounts. And only one of them so far (inaudible) are returning to greater than a $10 million account.

So your observation about a definition is correct. We're talking about large, incumbent telco operators in the countries with 1 million or 2 million broadband subscribers. But again, not all the same, do we penetrate it immediately, we get a $10 million PO. And actually again for the specific operator we're talking about, the $2 million order is actually not the first order we got, it's the [Salan] order. And I guess this will be one of the main factors in our 2008 -- what more do we anticipate from this specific operator.

Okay, thank you. And just as a follow-up, are you really seeing whether or not you will be cash flow break even in the fourth quarter? I know you've given revenue guidance.

No, we have not. Thank you very much.

Stephen Silk.

Over the last two quarters you mentioned that you've had customers that were delaying until the new product was available. Could you quantify that with a number of how many customers were waiting for that? And what would be the status? Have any started testing or trials yet?

Yes, I guess it's really hard to be very specific here. It is hard to differentiate between customers delaying decisions because of internal reasons and just using the 1 to 10G transition as an excuse versus the ones who are really serious about it. But we have seen a -- five to 10 name of our current tier 2 customers stating that they would like to avoid any more 1 gigabit deployments and move -- and their next decisions will be only 10 gigabit deployment. As an example, as I said before, the first inclination of that is this one customer in A-PAC that did result in approximately $1 million projects throughout 2007. And the latter part of that project was the deployment with Service Gateway. And there are numerous others, both new accounts and existing accounts. And remember, existing accounts are very important to us. I know that we said in the past in 2006, about 60% of our revenues came from existing accounts. And I expect 2007 to be in the same ballpark.

So this migration from 1 gigabit to 10 gigabits is both with new accounts and with existing ones that we otherwise maybe be coming back to buy 1 gigabit products or coming back and saying, okay, I'd like to talk to you about the 10 gigabit products.

And that somewhat leads into my next question. You were talking about the increasing value-added services that these tier one carriers can now think about deploying. Could you talk about what those services might be? And as more and more applications are added, is that what will drive additional 10 gigabit products into existing customers?

Yes. First your first question, an example, there's numerous, but one [exact] example that comes up in many of the requirements of our [fees] is enhanced security capabilities, whether it's, for example, a mitigating denial of services tax onto the carriers, their networks; whether it's being able to identify affected users in their networks, what people might call a bad net is a traditional requirement receipt. Another one would be to be able to offer adult content filtering, very much like what's available on cable networks. We call that feature URL filtering. It's a service [downfall].

These services can be either used just to increase the efficiency of the carrier network, like for example, avoiding [tax] on the network, increasing the efficiency, avoiding customer calls, or it could be also on the enhanced service, pay $1 per month and we will filter adult content for you kind of solution. I would like to emphasize that this quarter, our Service Gateway [conform] is out and it's reaching the speed and feed that we encountered. And it will be base. But value-added services will grow on it in the coming quarters.

(OPERATOR INSTRUCTIONS). There are no further questions at this time. I would now like to hand the call back to your speaker.

Thank you very much for joining us today. We look forward to speaking with you and meeting with you during the quarter, and of course, speaking to you again after the fourth quarter results.

And that does conclude our conference for today. Thank you all for participating. You may all disconnect.