Allot Ltd (ALLT) 2016 Q2 法說會逐字稿

Good day, and welcome to the Q2 2016 Allot Communications Limited Earnings Conference Call. Today's conference is being recorded. At this time, I'd like to turn the conference over to Gavriel Frohwein. Please go ahead, sir.

Thank you, very much and thank you all of you for joining us on our second quarter [2016] conference call. My name is Gavriel Frohwein, and joining me today are, Allot's President and CEO, Andrei Elefant, as well as our Chief Financial Officer, Shmuel Arvatz.

The press release enhancing our second quarter results is available on the Investor Relations section of our website, www.allot.com. Our results and expectations we review on the call are on a non-GAAP basis, unless otherwise described as GAAP. Non-GAAP net income defined as non-GAAP net income after including deferred revenues related to fair value adjustments resulting from our purchase accounting and excluding stock-based compensation expenses, amortization of our provision related to intangible assets, deferred tax asset updates and acquisition related expenses. Please note that all of earnings per share announced are on a fully diluted basis. A reconciliation of each non-GAAP measures to its nearest GAAP equivalent is available on the press release containing our second quarter results.

Before we begin, let me remind you that certain statements made during the call may be considered forward-looking statement, which reflect management's best judgments based on current available information. I refer specifically to the discussion of our expectations and beliefs regarding our pipeline and final potential future business. Our actual results may differ materially from those projected in these forward-looking statements. Certain material factors or assumptions are also applied in drawing the conclusions or making the forecast or projection as reflected in such forward-looking information. I direct your attention to the risk factors contained in the Annual Report on Form 20-F filed by Allot with the United States Securities and Exchange Commission and those referenced in today's press release, most of which detail factors which could cause our actual results to be materially different from those projected in the forward-looking statement.

With that, I will now turn the call over to Andrei. Andrei?

Thank you, Gavriel and thank you all for joining us today. In today's call, I will highlight Allot's results and share with you some of the achievements for the second quarter of 2016. After my summary, I will hand over the call to our CFO, Shmuel Arvatz, for a review of our financial performance for the quarter. Q2 Financial performance was below expectations on the topline, with the bottom line above expectations. Though the topline is not where we would like it to be, improvement in the bottom line reflects the cost efficiency measures that we instituted since the beginning of the year. Going into Q3 and Q4, we will see the results of the reorganization and vision of efficiency measures we began implementing at the beginning of this quarter to further improve profitability. I will discuss this in greater details a bit later.

Before drilling down into the quarter, I would like to review with you our ongoing strategy and plan, which remains on track [and] we're confident based on the traction we've seen. We continue to execute on our long-term plans, leveraging our growth engine, security and monetization, which continues to be validated by our customers as a highly valued service. In line with our strategy, I am proud to report that we signed a strategic partnership agreement with Intel McAfee, a leading security endpoint player, to provide a unique comprehensive security offering to the consumer and small business market. The solution is called McAfee Unified Security Powered by Allot, and will be marketed by both companies. With this collaboration, we will be able to leverage faster on the market opportunity, and it also validates the significant value that Allot provides as a player in the Security as a Service domain, protecting users anywhere, anytime.

We also recently announced that we are continuing to expand our Security as a Service used by CSPs and have (inaudible) the 15 million-subscriber milestone. This represents a growth rate of 50% in less than six months. Another important customer win that we announced this quarter is VOO, a European broadband cable service provider, which deployed our Service Gateway Tera, with our latest solution, the ServiceProtector and CMTS congestion management solution. As part of our engagement with VOO, they shared with us their challenge to protect their network against recent attacks, which was negatively impacted the user experience and their customers.

Once the ServiceProtector sensor was activated, VOO saw that network often sustained 20 to 40 cyber attacks per day, with volumes reaching 60 gigabits per second per attack and completed saturating network resources, using the ServiceProtector to mitigate the attacks, VOO has freed up bandwidth and more importantly, they have eliminated service outages. Today, we can real-time alerts notify VOO when the threat is detected and when it has been mitigated.

Now for the quarter's results. Revenues for the second quarter of 2016 came in at $23 million, up 6% year-over-year and flat on a sequential basis. As I mentioned, topline is somewhat below expectations, however, we were profitable with net income reaching $0.4 million. Though that was greater than last year, with book-to-bill for the last 12 months above 1, the book-to-bill for the quarter was below 1.

It is important to remember that we're dependent on large projects. In our yearly planning, we expected a number of large orders from two specific Asian customers to land in mid-year. It now appears that these projects will be postponed to next year. Based on the backlog, the specific large orders and the general business environment, we have updated our revenue guidance for 2016 and expect it now to be in the range of $90 million to $94 million. Since we have been executing on our strategy to streamline expenses, even though we are lowering our guidance, we expect minimal impact on bottom line.

As I mentioned earlier, and in our result strategy, we went through a reorganization and implemented additional efficiency measures this quarter to further improve profitability. We consolidated various units, specifically in R&D, increasing their ability to focus on security and monetization, our growth engines, and to leverage synergies on the infrastructure. On the sales side, we identified and reduced expenses in regions that we're not profitable. We also made specific regions to take better advantage of local resources. These changes might slightly impact our topline revenue level, but will contribute to increasing profitability. In addition, as our growth engine becomes a more significant portion of our overall business, we will see greater leverage.

Translating what we had into the numbers, we expect to achieve an OpEx of $15 million to $16 million run rate by year-end. This new OpEx level should (inaudible) fully by Q4 though we will see a one-time restructuring fee in Q3.

Shmuel will go into further details in a few more minutes. Looking at the P&L, gross margin improved and came in at 73%, bringing it back from 70% last quarter. Operating income was $0.8 million and net income was $0.4 million on a non-GAAP basis. Cash reserves at the end of the quarter totaled at $116.6 million with negative cash flow of $1.2 million from operations.

In the value-added services business, value added services was 27% of bookings during Q2, with security representing about 50% of the total VAS, and increasing year-over-year. In dollar value, for the first half of the year, we grew security VAS by 39% year-over-year. Based on our product booking classification breakdown, security booking for the quarter were about 30% of total product booking. As security represents our growth -- solid opportunity, we continue to invest in this segment, both in R&D and sales, leveraging our core technology and helping our offering. Large deals reached 14 in total, eight of which came from mobile operators, five from fixed-line service provider and one from cloud operator.

Before signing off, I will turn the call over to Shmuel to review our financial results. Shmuel, please?

Thank you, Andrei. As Andrei mentioned, revenue came in below our expectations. However, we are happy with the fact that we generated operating and net income, on non-GAAP basis, which is a result of the cost reduction measures that were implemented in the past quarters, better aligning our cost base with our topline level. I will elaborate on this later in my script.

Before begin reviewing the financial result for this quarter, I would like to inform everyone that on this call, unless otherwise noted, I will refer entirely to the non-GAAP financial measures 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 principles and excludes share-based compensation expenses, revenue adjustment due to acquisitions, expenses related to M&A activity, amortization of certain intangible assets, and changes in deferred tax.

Turning to our second quarter results. Revenue for the quarter was $23 million, up 6% year-over-year and the same level as in the previous quarter. The geographic breakdown of revenues was as follows; Americas, $4.4 million or 19% of revenues; EMEA, $10.4 million or 46% of revenues; and Asia Pacific with $8.2 million or 35% of revenue. Product revenues for the quarter accounted for 61% of revenue, while service revenues were 39%. This is compared to 56% and 44% split in the second quarter of 2015. The higher percentage of product revenue this quarter was as a result of recognition of revenues from a large project that was booked last year. Book-to-bill ratio in the quarter was below 1. During the quarter, we had two customers and we booked in greater than $1 million.

Moving on, gross margin for the quarter was 73% of revenue, down 1% compared to the second quarter of last year and up 3% sequentially. Gross margin can fluctuate on a quarterly basis. However, this is in line with our expectation to improve the gross margin from the level of Q1 2016.

Operating expenses for the quarter were $16 million, down 15% year-over-year and down 12% sequentially. The sequential reduction in operating expenses was mostly due to lower labor and related cost resulting from cost reduction measures implemented since the beginning of the year as well as lower sales and marketing expenses. As Andrei mentioned, at the beginning of Q3 2016, we implemented a reorganization plan, which include, among other measures, an additional reduction in our headcount. These measures are aimed at streamlining our operations and alignment of our cost base with our topline in order to improve profitability.

In Q3 2016, we expect to record approximately $1 million in one-time restructuring cost, representing mostly severance and other employee-related cost. We expect our OpEx to continue to decrease throughout the remainder of the year. Operating income for the quarter was $785,000 or 3% of revenues compared to operating loss of $3 million in the second quarter of 2015. Net income for the quarter was $431,000 or $0.01 per diluted share compared to net loss of $3 million or $0.09 per diluted share in the same quarter last year.

Turning to the balance sheet, our cash reserves comprised of cash, cash equivalents and investments totaled $116.6 million, down $4.1 million compared to the previous quarter. During the quarter, we recorded negative operating cash flow of $1.2 million. DSO was 92 days, up one day from the previous quarter.

We continue to execute on our buyback program. During the second quarter, we acquired approximately 466,000 shares for a total of $2.3 million. In total, we have bought back $3.5 million in shares. We plan to continue with the $15 million buyback program, in line with our initial plan.

To conclude, while 2016 is shaping up to be weaker year for us, we have taken steps, which we believe position us well in the coming years. We have realigned our business to focus on the security amortization growth engines. Our expenses level in the second half of the year and going into next year is significantly below that of last year. All these steps, we believe, will enable us to profit from the traction we expect to see from our growth engines over the coming years.

With that I will turn the call back to Andrei.

Thank you, Shmuel. To wrap up, regarding guidance, we updated our guidance based on visibility going forward and remain confident in our ability to improve efficiencies which should positively impact our bottom line. We have implemented the wide ranging reorganization of our business both in R&D and in sales. We believe these changes will go a long way forward streamlining operations and enabling us to improve execution of our strategy. And lastly, the partnership we announced today, leverages our market opportunity and positions us as a significant player in the Security as a Service domain.

With that I will open the call to Q&A. Operator?

(Operator instructions) James Kisner, Jefferies.

Hi, this is Timur Ivannikov asking for James Kisner today. So the first question we have is regarding the APAC customer orders push outs. So were you giving any reason for the delay of orders, was it the same reasons for each customer? And can you talk about the kinds of applications that were associated with those orders and why you think they'll come back next year?

Each case, James, each case of these two customers is a little bit different. One of them has -- originally was supposed to allocate budget for this year, eventually this budget was not allocated to this project and it was decided that the budget will be allocated for next year. So we expect to continue to get orders from this customer, but not this year. Probably, we will get the large order we expected sometime next year. We will know better by the end of the year.

The other big order is a project we are working on, this is a new customer, we are well positioned there and they expected to initiate the project at the middle of this year. Now it seems that the project was postponed towards the end of the year. So we believe that either we'll get the order around end of the year or beginning of next year. Overall, this is a typical situation that we see today in the market that operator sometimes postpone their projects or projects may shift from quarter to quarter. And on the other hand, we do see that these projects will continue to happen and we continue to work with both the customers. So we do expect to get the orders, but in a different time frame.

And what about the types of applications those orders were for?

Again, two different cases. One of them is focusing on visibility, and DDoS protection and this should have been an expansion to an existing deployment that we had. This is a customer that we have for few years, typically they place large orders almost every year. And we were supposed to do together another expansion that was postponed to next year, this is visibility and the DDoS protection.

The other project is on traffic management with some additional of security capabilities. And this is a use case for the new customer.

And then -- so the -- your guidance, now it implies another year of revenue declines, and so should we be thinking of this, you know Allot's business, just declining, a secular decline, so I don't know if you can give us an indication for 2017, should we be modeling revenues flat, declining, any thoughts will be depreciated or any theories as to why revenue has been declining. Thank you.

Regarding 2017, I think it's too early now to give a guidance for 2017. However, as we said in previous calls, we are focusing our efforts on areas where we see the growth opportunities, which is security monetization that as I said in my script, are growing. We do see decline in some other areas, mainly on the optimization areas. I believe that the growth on the security, going forward, the growth in the security monetization will compensate. However, saying exactly when it will balance, it's too early to say. We see a healthy pipeline and we believe that we'll be back to growth in 2017, but it's too early to give very accurate guidance for next year.

George Iwanyc.

So just following up on the regional question or the regional comments, can you give us some color on the weakness that you're seeing in the Americas as well? And then what gives you confidence that Europe will hold up in a stronger position like it has been?

So as we said, the weaker regions where Americas and APAC on our bookings side. And we do see stable business from Europe. We believe that -- in the Americas, we believe that will be able to grow our business without security offering. We also signed today, as I mentioned, an important partnership with Intel McAfee that are very strong in the region. And we believe that with our security offering, we'll be able to expand our business in the Americas.

Regarding APAC, I would say that this is a temporary issue related to a specific project and I believe that we will be able to recover in APAC on the longer term. We do see the opportunities there, we have won some significant customers last year, so I believe that we'll be able to recover in APAC.

And expanding on the opportunity with Intel, how long do you think it would take for that partnership to start to contribute to the topline?

I believe that we'll see this partnership starting contributing at 2017. We're already going together to customers, so we already started the process, but the processes with the carriers take typically six months to nine months to materialize. So I believe that most significant business will be there in 2017.

And is that primarily an Americas-driven opportunity or is there opportunities outside of the Americas as well?

It's global, the partnership is a global one and we're working with all the teams globally. But for us it's a good opportunity to increase the potential that we see in Americas and in North America, and we're confident that this partnership will yield results and improve our Americas operation.

Security has been about 30% of product bookings for the last couple of quarters. When do you expect that to start to tick up and can you give us some color on the good Security as a Service traction that you're seeing?

So security, on the product analysis in this quarter was 30%, previous quarter to remind you, it was 48%, so we do see improvement versus last year. This quarter was less than what we saw in the first quarter, but overall, we do see that security is taking bigger part of our business. We believe that with the Security as a Service, we identified an important market opportunity, or a significant market opportunity, we see also some strategic players that are also looking in this space and this is how the partnership with Intel McAfee formed up. We believe that with this partnership, and also by our standalone operation, we'll be able to penetrate into new customers with this service. Again in the telco market, the processes may take six months to nine months to materialize, but we do see the interest from our partners.

Joseph Wolf, Barclays.

Just couple of questions that I think are related to questions that were just asked. But if I think about the peak revenues and where the revenue run rate is right now, can you give us just an update on what you think the natural growth rate is for the businesses that you're investing in? I don't expect you to get back to $117 million anytime soon, but I'm just wondering how you're thinking about natural growth rates?

We believe that the security has the potential to grow 15% to 20% year-over-year. We saw even greater increase, as I said in the script of 39% increase. This is -- seeing a 20% to 30% increase on the security side is something that we should see see going forward, but it will take time, until it will become the majority part of our business. And by then, I think it will start contributing more significantly to our topline.

As I look at the OpEx levels right now, you talked about it -- have you done the -- I don't want to call it the easy part, but if you look at the amount of dollars that have to be spent to remain competitive in an area like security, and you've talked about that target of $15 million to $16 million in OpEx by the end of the year, where does that come from on a percentage basis going forward? Does the G&A come down further where is there a little bit more flexibility that doesn't influence the long-term opportunity for the Company?

All the savings that we did are coming from areas that we have identified that are not part of the growth engine. So we haven't touched the security product lines, we haven't increased the investments there, we are investing also in monetization and on the sales cycle, we -- on the sales side, we reduced investments in areas that were not producing. So these are the areas where we did the cut. We believe that with some -- with the partnership that I mentioned and other ways to address the market, we'll have a greater return on the investments and therefore we decided to reduce investment in areas that were not producing for a long time, this is on the sales side.

And then just finally on the Intel McAfee opportunity, you're going to sell that through the service providers and they're going to offer package to customers, is that sort of an add-on package? What's the pricing mechanism? How are you splitting that? What is the Intel investment there, and what kind of agreement do you have going forward?

Okay, so from what I can share with you, the agreement is about the subscription that when we are selling it to our customers, we are sharing the revenues with the CSPs and then we have the split between McAfee and the lot in different ratios dependent on the scenario. But in general, the projects of the modeling should be a subscription type of arrangement.

Okay. So it will be user acceptance?

It was based on the number of subscribers that are registering to the service, and each one of the parties can lead the project. So it might, in some cases, we might lead the selling, in some cases, it will be led by their research team and then there is a difference for each scenario. And again this is in a subscription model type of business.

So those sale cycle right now is getting approved and certified to become an option on a Verizon, Sprint, or AT&T network?

Yes. The solution leverage is the network based security that we believe together with the endpoint security that is being delivered by Intel McAfee. And the power of integrating the two is the ability to get faster acquisition of new subscribers into the service.

(Operator instructions) Alex Henderson, Needham.

Could you give us the year ending headcount?

Yes. So about end of Q2, we have slightly above 500 and towards the end of the year following the reduction in headcount, we aim at above 450.

That was my second question, thanks. Can you guys give us the Security as a Service percent VAS again and what the percent of VAS was in the quarter?

So as I mentioned in the script, the VAS was 27%, 50% out of that was the security licenses.

So the VAS number is down quite a bit sequentially. What caused that?

It depends on the type of VAS that you're looking at. On the security side, we actually went up and if you look at the breakdown, there are some other VASs that in this quarter were not producing as they were producing last year, but as I mentioned in the script, the security VAS has increased both in Q2 and in Q1, and if I combine Q1 and Q2 compared to last year, we increased by 39%.

But your security VAS of 50% to 27% has got a long way to go to offset any declines in the 75% of your business that's not VAS, and I assume that the predominant piece of your business is the optimization that's reflected in non-VAS. How rapidly do you expect the optimization segment to roll over, if that other 75% is coming down at say, 5% a year, is that enough -- is that what we should be looking at in terms of the rates of decline or is it steeper than that? There's obviously two pieces to this, it's what's growing and it's what's declining.

Yes. So I wouldn't take from one quarter and we mentioned that also in previous calls that one quarter VAS does not represent a trend. And just to remind you, Q4 was close to 50% value-added services. So and it increased quarter-after-quarter over the last year. We had, in some of the value-added services, a decline at the beginning of the year. In general, to answer the question, we do see a decline on the optimization part, and as I mentioned, we believe that towards the end of the year of 2017, I believe that we'll be able to see that security fully compensate for the decline of the optimization part.

So could you just give us a sense what do you think the rate of decline in the optimization part is? Is it in the 5% to 10% range or is it less than that?

Yes, I would assume something in that area. Yes.

A question on the tax rate. Obviously, you're kind of bouncing around near breakeven here, I was a little surprised how large the tax line was in the quarter. Should we be using 200 to 300 per quarter assuming near breakeven numbers?

Yes. More towards 200. 200 to 300, that's correct.

And just going out to the gross margin line, you did recover from the 70% in the quarter, but it's obviously down from 75% last year. Are we expecting the margin on the VAS segment and specifically the Security as a Service deliverables to be able to sustain that 73% level or is the trajectory still a modest downward trajectory on the margins?

Based on the current topline -- reduced topline, I would expect lower than last year, 72%, 73%, this is the range that we are now expecting.

Is that a reasonable range to project out in the 2017 or is the trajectory a downwards -- a slight downward slope because of the mix?

No. This is the range.

(Operator instructions) As there are no further questions at this time, I would now like to turn the call back over to the speakers. Thank you.

Thank you all for joining us today. Thank you very much.

Thank you. That will conclude today's conference call. Thank you for your participation, ladies and gentlemen, you may now disconnect.