Allot Ltd (ALLT) 2017 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by.

Welcome to Allot Technology's Second Quarter 2017 Results Conference Call.

(Operator Instructions) 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 Investor Relations team at GK Investor and Public Relations at 1 (646) 688-3559, or view it in the News section of the company's website, www.allot.com.

I would now like to hand over the call to Mr. Ehud Helft of GK Investor Relations.

Mr. Helft, would you like to begin please?

Thank you, operator.

Welcome to Allot's second quarter of 2017 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 line today are Mr. Erez Antebi, President and CEO; Mr. Alberto Sessa, the 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 the future performance of the company.

These statements are only projections and Allot cannot guarantee that they will, in a 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 changing market trend, reduced demands and the competitive nature of the security system 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 now to hand over the call to Erez.

Erez go ahead, please.

Thank you, Ehud.

I'd like to welcome all of you to our conference call, and thank you for joining us today.

During the previous earnings calls, I laid out the basic strategy for growth that we plan to follow.

I would like to start by reiterating it briefly.

I believe the main growth engine for Allot going forward will be providing network security products that communication service provider or CSPs can use and provide as a service to their customers, both consumers and businesses.

This will be based primarily on our WebSafe Personal or WSB product, which is currently providing services for Vodafone and is currently being installed in Telefónica.

Our interaction with the market over the past few months has served to strengthen our belief that this strategy is in line with where CSPs are heading.

Several CSPs in different regions are showing a growing interest in network-based security such as Allot offers.

While it is too early to provide any specifics or any timeline, we are encouraged by CSP interest in network-based security.

WSP is not our only security product for the CSP market.

In addition, we have an excellent product that can protect CSP networks against Distributed Denial of Service or DDoS attacks.

Our product has the capability to defend networks against very high-volume attacks from outside the network and to defend others by blocking attacks originating from within the network.

All this in a matter of a few minutes while at the same time protecting servers from crashing.

Another element we will be providing to the CSPs is, of course, visibility of -- and control of their network.

This is currently where our core is.

We have a strong product in this domain and we will continue to develop it.

Although CSPs are our primary market, we will continue to pursue the enterprise market with our multiservice platform.

We believe our product combining network visibility, security, and anti-DDoS protection has a valuable market within a sector of enterprises, and we plan to expand our success here as well.

Over the past few months, we planned and executed some changes we'll send the company with several objectives in mind.

One, align the company better to execute our strategy as I outlined.

Two, become a more customer-centric organization.

Three, focus our teams with very clear and measurable roles and responsibilities.

And four, create a base for growth.

Various changes have already been accomplished and others are currently being implemented to achieve these goals.

I will mention a few.

Restructuring of the sales and delivery organization.

We have created several customer-facing units that have integrated sales and delivery functions focused on specific customer groups.

For example, all our enterprise sales and delivery is now in a single worldwide enterprise unit and all the other customer facing units will focus on CSPs only.

We believe this change makes our sales and delivery units much more aligned towards the customers, whom they are serving.

Also, as I had indicated in the previous earnings call, we created a security strategic account team.

This team will function as a professional overlay sales team for potential large network security customers.

It will also ensure we leverage experience from WebSafe Personal sales in one market to help us, and the service provider, succeed in another.

To lead this new team, we have brought onboard Hagay Katz.

In addition, resources were shifted to the security area from other areas to better align with our major growth engine.

We also modified some of our internal processes, such as how we issue proposals to customers and how we manage demos.

I believe this will help us do a more professional job with faster response to customer needs.

On top of this, we're also making some changes in nonexecutive management levels, to allow us to better execute on our plans.

As I said before, I believe that a significant part of our role as management is to improve on the company's execution, and to realize its full potential.

I am confident that the changes I discussed, and the additional changes we're contemplating, will help us achieve that.

While we expect our OpEx in 2017 to remain at a similar level to that of 2016, we expect to spend a onetime amount of under $2 million in this restructuring.

Now I would like to briefly touch on our second quarter results.

Our revenues grew compared to the first quarter of the year and in addition it is the second consecutive quarter we have a book-to-bill ratio larger than 1. This is a positive indication for us, going forward.

The number of consumers enjoying our security technology is continuing to grow steadily.

Another indication that our strategy is aligned with market needs.

Our Telefónica projects are also moving ahead as planned.

In the current quarter, we started working to deploy our solution in some entities in Europe and South America, where Telefónica plans to launch services soon.

We see Telefónica's choice to launch a consumer-oriented security service offering with Allot as both a strong validation of the market for network-based security and a validation of Allot as the leading vendor in this market.

The unified security product we are developing jointly with McAfee achieved general availability status a few weeks ago.

While I cannot get into the details or any projections, I can say we are working with McAfee on several customer opportunities.

In summary, I want to repeat what I said previously.

I see Allot as a company with much potential and I believe Allot will establish itself as an important player in the communications security market in the coming years.

As you can see, in the past few months we have taken significant steps which will allow the company to better perform, execute and grow.

And I expect to see the results in the coming quarters.

As we look ahead, we are reiterating our guidance for 2017 revenues in the range of $80 million to $84 million, and expect the second half to be better than the first half, with a yearly book-to-bill ratio larger than 1.

And now I would like to hand the call over to Alberto, our CFO.

Please go ahead.

Thank you, Erez.

Before I begin reviewing the financial results 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 measure when discussing operational results, which is what we use internally to judge the performance of our business.

Non-GAAP financial measure differ in certain respects from the generally accepted accounting principles and exclude share-based compensation expenses, revenue adjustment due to requisitions, restructuring expenses, expenses related to M&A activities, amortization of certain intangible assets and change in deferred tax.

Now with regard to our financial results.

Revenues for the second quarter 2017 were $19.5 million compared with $18.5 million in the first quarter of 2017.

I would like to give some details regarding the company revenue diversification.

The geographic breakdown of revenues was as follows: Americas with a $3.8 million or 19% of revenues; EMEA with a $12.3 million or 63% of revenue; and Asia Pacific with $3.4 million or 18% of revenues.

Product revenues for the quarter accounted for 61%, while service and maintenance revenue accounted for 39%.

This is compared to a 55% and 45% split in the first quarter of 2017.

Enterprise revenue represent 22% of total revenue, both in the second quarter of 2017 and in the year-to-date accumulate calculation.

In terms of customer concentration, our top 10 customer made up 61% of our revenues.

Book-to-bill ratio in the quarter was above 1 for the second consecutive quarter.

Gross margin for the quarter was 67.6% compared to 67.5% in the first quarter of 2017.

The lower level of margin in the first 2 quarters of '17, compared to 2016 are mainly a result of the decrease in the revenue level.

In addition, the new deal that was announced with Telefónica Global in Q1 2017 create some pressure on the gross margin.

Since initial orders are primary low gross margin hardware platform with a bulk of software licenses to be ordered later.

Operating expenses for the quarter were $15.6 million compared with $16.1 million in the first quarter of 2017.

The decrease in operating expenses compared to the previous quarter is mainly due to the fact that in the Q1 2017, we recorded marketing expenses for 2 major events.

Looking ahead, we expect the full year operating expenses level to be similar to the level reported in 2016.

Operating loss for the quarter was $2.4 million, down from an operating loss of $3.6 million in the previous quarter.

Net loss for the quarter was $2.3 million or $0.07 per share, an improvement from a net loss of $3.6 million or $0.11 per share in the first quarter 2017.

Turning to the balance sheet, our cash and cash reserves comprise of cash, cash equivalents and investments as of June 30, 2017 totaled $111.3 million.

The company recorded a positive operating cash of $0.9 million during the quarter.

That concludes my remarks.

We would be happy to take your questions.

Operator?

(Operator Instructions) The first question is from Alex Henderson of Needham & Company.

This is Dan Park on for Alex.

Just a couple of things, first off, just around the visibility around gross margins.

Sounds like there is a mix of fixed and variable cost that obviously change with revenue levels.

Now as you start getting to the $20 million revenue levels, should we think about this, I guess, being consistent with the 70%, 71%, 72% that we've seen in the past?

Okay.

Regarding the gross margin, what we forecast is the level which is a little bit lower than the 70% that you mentioned.

There are a couple of reasons there; first of all, the level of revenue is lower than what was last year.

I mean, we recorded this quarter a revenue of $19.5 million, which is lower than what was recorded in 2016.

On top of that, there is the initial deployment of the Telefónica.

The Telefónica bill is being implemented, deployed actually, now in several affiliating European Latam.

The deal is comprised of software license, hardware professional services and maintenance.

The gross margin are actually affected, but particularly in the first deployment by the hardware supplied.

The margin on hardware is, of course, lower than on software.

So as the initial order from hardware mainly, we see some pressure on the margin, and this should be corrected after service is launched and softwares orders will come in.

Okay.

That was really helpful.

Just one last question, so going down to the OpEx lines seems like OpEx as a percentage of revenues came down sequentially after the spike you had in the first quarter.

Should we expect a similar range over the back half of the year?

I know you mentioned the onetime restructuring efforts in sales and marketing.

Is that really a third quarter effort?

As we said before, I mean, first of all we do expect operating expense level to be very similar to what was in line -- in 2016.

The reason why we saw this quarter a reduction compared to the previous quarter is, again, those 2 marketing events that we held in the first quarter.

But again, I mean we want to reiterate our guideline, our operating expense are very similar to last year, in 2017.

Now -- and on top of that, as Erez mentioned before, we will record, due to the restructuring that we are doing, up to $2 million onetime expenses.

Okay.

And that's really going to be a third quarter event?

It's probably mainly to be third quarter.

Yes, mainly third quarter.

The next question is from Joseph Wolf of Barclays.

Question about the product mix, how much color can you give us on the percentages or the trends within the security business and if we think about the makeup of the book-to-bill, which you are confident stays above 1, what kind of product mix are we talking about?

And how long would you expect that current backlog or -- to be this?

And when you -- what's the book-to-bill, what is that indicative of?

The next 12 months of revenue?

Should most of that come out over the next 12 to 18 months, how should we be thinking about that given you have a mix of products?

Okay.

I think that they -- I mean, most of our revenues today are still in our core business, they come from the DPI market, a traditional market of Allot.

And security is still the smaller portion of our revenues and also the smaller portion of our bookings.

But I think, it is growing.

We're seeing that both in terms of number of subscribers that are enjoying this service.

And that draws -- and that requires of course licenses and product and so on.

And we're seeing growing interest, which have not been translated to order from other customers in the market.

So I think that we are seeing a trend of increasing but I think it's premature to talk about significant number changes or anything like that.

As to the book-to-bill of over 1, these are -- I mean, these are the factual numbers as for the first quarter, second quarter like we said.

And we did indicate that most of our orders come from a product rather than services revenue.

Now if you take a look at that, typically we would recognize product revenues over a shorter period of time.

Say, I don't know, typically less than a year probably.

It could vary widely but it will be within 2, 3 quarters, something like that and service revenues could take longer.

I hope that addresses your question.

Yes, that's helpful.

Maybe as a follow-up, as you've considered the security business and maybe you can -- I was hoping you could spend a little bit more time going into the -- I guess the value side of the DDoS opportunity, meaning if this is going to be a software approach, a hardware approach.

How are you guys going to compete with the other DDoS vendors or whether this is also -- the security offering that you are talking about seems to be subscriber driven in terms of personal mobile security offered by the service provider but what would the DDoS be?

Is that something that they would also be offering to each of their customers sort of in a hosted way?

And how that would work and do we -- is it too early also to think about perhaps moving to a subscription model and the business model which would shift the mix of revenues and timing?

Okay.

Obviously, the WebSafe Personal and the DDoS -- sorry, the anti-DDoS product are two separate products and they are marketed to different customers.

The WebSafe -- I mean, we sell them both to the communication service provider but they provide that in a different way.

The WebSafe Personal is a product where these -- the operators such as, for example Vodafone offers its customers, consumers throughout Europe.

Offers them the ability to sign on, pay an extra say EUR 1 a month, and get a clean pipe solution where Vodafone makes sure that their phones don't get contaminated when they are on the network.

DDoS is something really that is there to help the operator, the communication service operator itself, protect its own network.

Protects it either from attacks from outside or protect something originating inside their network from attacking somebody else and causing them to be, God forbid, blacklisted or something like that.

So this is -- the DDoS is really something that the network operations people and the operator buy and use.

And the WebSafe Personal is something that the marketing and sales arms of the operators sale and provide as a service to their customers.

Now regarding the model, I think we've indicated it in the past, we are looking to -- currently our business model is really one where the operators pay us out of their CapEx budget.

They buy upfront equipment, they buy licenses up front, et cetera.

Of course, they buy maintenance and so on, but primarily our model -- the current model is such the operators pay us out of their CapEx budget.

And we are in discussions with various operators to see how we can move that to both our benefits, honestly, to a more subscription-based model or perhaps even a recurring type model.

But that is not in the numbers at this point.

Okay.

And then just finally, I think I understood this but I was hoping maybe you can review it.

It sounds like you're separating the sales force so that the enterprise unit takes care of itself and runs itself and the larger service provider organization runs itself.

And so there is no overlap, did I understand that properly?

No overlap is always a very, very strong term.

But I would say there's -- yes, you understood the principle very properly.

The enterprise unit is going to take care of itself.

Service provider units are -- actually there are several of them.

It's not one.

So they're spread geographically and they're broken down but they will focus only on service providers and not on enterprise customers.

And there is only one unit global that deals with all the enterprise customers worldwide.

And there is not going to be an overlap.

We -- there's always bound to be some boundary questions but basically, no, no overlap.

So the change is that there used to be, I suppose, geographically certain people doing both and you are stopping that?

Is that the change?

That's correct.

There are -- typically the -- until now, the way the sales organization was built was by pure geographical division.

Does that meant that -- no, in any given country, a salesperson and there is a resale team that worked with him, would be working with both enterprise and service providers, regardless.

What we've -- when we've analyzed this, we found that what we're selling to enterprise customers and what we're selling to service providers, is more -- is very different.

The use case for service providers, the value that we provide to them for example, like I gave you with the WebSafe Personal product protects the communication to your consumers.

Or even with visibility and control, manage your network properly, the service provider has a very large, widely dispersed network that he has to manage bandwidth, he has to understand what's happening there but he has, to an extent, very limited ability to control either for regulatory reasons and so on.

So we're selling a different derivative of the product with different use cases and different value proposition.

Enterprise customers look at it differently.

It's really we have a separate product that's based on our same technology.

But it's adapted to the enterprise world, they are a lot more interested in control, they have a lot less capacity, their use cases are different, so we think that it's better to focus people on one type of customer, to go after that customer, understand very, very well the competition, the use cases, the value proposition and so on and be more expert in that, rather than try and do multiple things.

And that's the rationale.

But that's only on the sales side.

I said at the same -- in the same sentence I said that it's not the only change we did there.

We had totally separate sales organization and totally separate delivery and support organization.

In the customer facing unit, we're putting both sales and delivery and support.

And what that results in is that there's a team of people that will now be aligned all through the process from even the initial contact with the customer, through getting the orders, through implementation and through a further service and they will be very well familiar with that customer and not be in a situation where they transition all the time and deal with similar issues across different customers around the world.

So I think, this is -- it's a more complex change, but I think it will make us a lot, a lot more customer focused.

The next question is from James Kisner of Jefferies.

So just a quick housekeeping.

I assume you're going to pro forma out that $2 million in restructuring and that you said it was going to hit in Q3 but that's not going to flow through the P&L, is it?

Right.

That's not going to be in P&L.

This is non-GAAP.

From a non-GAAP point.

Of course, on the GAAP point of view, it's going to be there.

I mean when we are going to make our non-GAAP result, those onetime restructuring will be taken out.

Okay.

So separately you're -- did you -- read your comments on margins in this deal that create a lot of pressure in the near term.

Wondered if you might be able to sort of quantify like you said 200 basis points, is this 100, like how much is that impact and when do you think that, that is going to abate, like should we start to seeing improvements in Q2 and Q3 from that?

Are you seeing software licenses as soon as that or it's going to take longer?

I think that what we can see right now, it's only the next quarter or 2 and in those quarter, I mean until the end of 2017, we do believe that our gross margin will be stable to the level that we're in Q1 and Q2.

Those -- this is the period in which we see the pressure coming from the Telefónica deal and the deployment of the entity in Telefónica.

So we do foresee in this short-term period, I mean, 2 quarter of 2017, to continue to have similar margin on what we had until now.

I think that later on during 2018, when the additional software order will come in, then we will be able to see some improvement in margins.

So is that pretty much all of it?

I mean, I'm looking, 3 quarters ago or 2 quarter ago, you were at almost 71% and 2 quarters ago you were 70%, that's about 250 basis points lower right now.

Is that pretty much all the deal, or is there additional pricing pressure in the marketplace?

But can you comment on just the competitive environment?

Yes, what I can say is that, of course, we do not see any price pressure in the market.

And again, as I said before, the main 2 reason of the reduction in the gross margin so far is due from the reduction in level of revenues and on the pressure from the Telefónica deal, that's all.

Maybe just to clarify, there's always price pressure in the market, right?

That's not the -- but we don't see anything unusual.

Okay.

That helps.

I guess lastly, just regarding your comments on book-to-bill greater than 1. I mean, you're also sort of commenting here, you're talking a lot about the narrow security solution, it sounds like that's pretty small.

I'm kind of wondering if that's what's really driving that book-to-bill greater than 1 or is it really more of a broad demand improvements across the board or regionally like -- any insights into what's really driving that book-to-bill greater than 1?

I think it's a bit hard to really segregate it over a period of 2 quarters into really the exact rationale, I think it's a mixture.

Some of it is just executing a little bit better, some of it is getting more -- more traction, let's say with security.

I think, it's a bit -- really a mixture.

The next question is from George Iwanyc of Oppenheimer and Co.

So just following up on the book-to-bill and the type of visibility.

Last quarter you gave us a sunset, you felt security could be a growth driver in 2018.

Do you feel that the pipeline is building where it could be a meaningful growth driver at that point?

I think that -- yes.

I think that this is in my opinion, this will be the main gross driver of the company.

And I definitely expect to see that starting in 2018.

Okay.

And then do you feel as you add more CSP customers next year that they would follow in the Telefónica type of ramp where initial sales will be lower margin hardware sales?

And then, follow-on quarters would come with the software and services?

Very hard to say.

I think, it will be -- each one will have his own way of wanting to do the deal.

Like I mentioned before, we will try and offer more -- a more subscription-based OpEx type deals.

We don't know to what extent that will -- we will be successful in that, we don't know to what extent it will catch on and will really be.

Each deal I think, will look a little bit different.

And perhaps, as we add more deals we can share with you what they were.

But at this point, it's very hard for me to predict.

Okay.

And when you look at the top 10 contribution, do you expect that to tick down a bit and get a more diversified CSP customer base or will it typically be a bit top heavy?

I honestly don't know to answer that.

I don't think I have that kind of forecast.

I think, today, we're doing the top 10 or...

I think our -- you mentioned that before.

At 61%.

Yes, we're putting our 61%.

It's not really that top-heavy, I think.

And then just can you give us a sense of how the initial reaction to the -- that the GA of the McAfee product has been so far and how the enterprise sales force is positioning that product?

Not at this point.

Like I said, I don't like -- I really can't get into any specifics at this point beyond saying that we are out there talking to customers about it.

And I think that generally there is interest.

Can't say much more than that.

Right.

Just one last question on the headcount.

Can you give us where it is right now?

Regarding the headcount, the full-time employee at the end of quarter, I mean, there was no -- any major change.

Compared to last quarter there are approximately 470 employee in the company.

The next question is a follow-up question from Alex Henderson.

Whilst we just asked on the headcount side, will the restructuring lower the headcount and if so, what should we expect ahead in the year at?

Nothing material.

Like we said, the -- we don't expect any significant changes in the OpEx level.

It's really moving around people, changing responsibilities and in some instances, changing the personnel, but there's not -- no material effect on the headcount itself.

And can you identify what the impact of exchange rate was in the quarter and whether you -- what you're assuming into the third quarter?

I guess first of all at the end of -- I mean the -- in the second quarter of 2017, the exchange rate of the shekel compared to the dollar, the shekel get much stronger.

We did add some hedging with actually.

And we actually were able to mitigate some of the impact of this devaluation of the dollar.

So you're fully hedged in the third quarter and fourth quarter then?

At these levels?

We are not commenting on our hedge level.

We do from time to time.

When we do believe that it's appropriate to make some hedge but we are not actually disclosing any detail regarding that.

Okay.

Can you talk about how many 10% customers you had in the quarter?

I know you gave the top 10 concentration but what about the number of top 10 percenters?

Yes, during Q2 '17 we had just 1 top -- more than 10% customer.

So going back to the question around gross margins, and this large deployment of hardware that's causing your gross margins to be less.

So generally speaking, as I understand it, hardware revenues are larger than services and software revenues in these projects.

So as the hardware revenues roll off, should we anticipate then that your revenue contribution will be less from these projects and the gross margins rebound?

Or is there enough acceleration in the uptake of the product in the field that you are able to offset the mix shift back to software, which helps your margins to recover by having further growth?

I don't think I fully agree with your assumption that the hardware revenues are the big piece.

Our value as a company is in the software that we provide, software and system, of course and design and so on.

The general trend, and Allot is part of that, is to move away from a customized hardware that we develop ourselves to software that we do develop ourselves, design and then provide, running on standardized hardware platforms.

And as we go more and more into standardized hardware platforms to the extent that we deliver them, the margins are going to be tight for obvious reasons.

But there are going to be a -- they are not going to be the primary reason for our revenues.

So I don't see it that way.

So you did not expect revenue to edge lower once the hardware is fully deployed?

As we go out over the next 2 or 3 quarters?

Look, over the next 2 quarters, we told you what our guidance was.

Which obviously necessitates our revenues to be higher to meet those numbers.

And -- so the answer is no.

All right.

So going back to the deploy side of it as we go out into 2018, then we should expect the margins to rebound towards the normal 70%, 71%, 72%, and then continue to see the benefit of these deployments driving some acceleration in revenue in '18.

Is that the right thought process?

I think your -- look, I think that it's -- what we said -- I said that we're -- that we expect to grow in 2018.

And I expect that to be an accumulation of several things.

Some of that is going to be simply executing better on what we need to do, on driving more business and some of that's going to be -- getting better numbers from what I believe is our growth engine, and that's our security business.

So I'm not quite sure how to answer your question but I do expect growth in 2018 and with that growth I would expect both because this specific hardware deal is going to probably be -- the hardware portion is going to be less important plus the fixed element in the cogs is going to be less significant as revenues go up.

I do expect then that we'll have better margins, but beyond that, I am not sure I know what to say.

Just one last question, then I'll cede the floor.

The value-added services calculation doesn't seem to be something you guys were offering up on these calls anymore.

Is that something that we should just stop tracking?

Or is that -- are you still using that as a metric, or what should we be thinking about that?

And if you guys continue to use it, what was the number?

I mean, we're reporting the same measure that we are measuring the company's side.

And this is not something that we are continue measuring inside.

So we're not reporting that anymore.

(Operator Instructions) There are no further questions at this time.

Before I ask Mr. Erez Antebi to go ahead with his closing statement, I would like to remind participants that a replay of this call is scheduled to begin in 2 hours.

In the U.S., please call 1 (866) 276-1485.

In the U.K., please call 0800-917-1246.

In Israel, please call 03-9255-928.

Internationally, please call (9723) 9255-928.

Mr. Erez Antebi, would you like to begin -- would you like to make your concluding statement?

Thank you.

I just want to thank everyone for participating in this call and taking interest and supporting in -- of our company.

Thank you very much.

And I look forward to talking to you again in our next quarterly earnings.

Thank you and goodbye.

Thank you.

This concludes the Allot Technology's second quarter 2017 results conference call.

Thank you for your participation.

You may go ahead and disconnect.