Allot Ltd (ALLT) 2017 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by.

Welcome to Allot Communications' Third 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's Investor Relations team at GK Investor and Public Relations at 1 (646) 688-3559 or viewed in the News section of the company's website at www.allot.com.

I would now like to hand the call over to Mr. Gavriel Frohwein of GK Investor Relations.

Mr. Frohwein, would you like to begin?

Thank you, operator.

Welcome to Allot's third 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 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 put out that -- point out that this conference call may contain projections or other forward-looking statements regarding future events or future performance 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 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 the call over to Erez.

Erez, please go ahead.

Thank you, Gavriel.

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

In the third quarter of 2017, we again saw our revenues grow compared to the preceding quarter.

And for the fourth -- for the third quarter in a row, our book-to-bill ratio was larger than 1. I expect both these trends to continue into our fourth quarter as well.

As I shared with you in previous calls, we are making some changes that we believe will lead to continued improvement in our results.

I would like to explain some of the internal changes that we have already made and are still making.

One, during the third quarter, we reorganized our sales and customer success teams into customer-facing units or CFUs.

This enables us to focus both the sales and delivery teams on the customers, understand their needs better and serve them more efficiently.

Two, also during the third quarter, we closed some product lines that were based on Allot designed hardware and replaced them with products that deliver enhanced performance using commercial off-the-shelf hardware or COTS.

This is part of Allot's ongoing transition to a software company.

Three, we replaced some key people in management and sales.

During the third quarter, our new Senior Vice President of R&D, Nir Pery joined us.

Nir joins us from Verint, where he was Senior VP, Global R&D and Senior VP of the product house.

In addition, we were also joined by several new regional VPs heading up CFUs globally.

Four, we modified and improved our sales processes and the way we handle tenders and customers.

We are in a continuous process to enhance our execution and internal processes as well as bringing onboard strong people in all departments and at all levels within the company.

This is an ongoing activity.

The expenses due to the restructuring in the third quarter were approximately $2.2 million, and Alberto will discuss this later in the call.

I would like now to turn to the market and talk about what we see there.

As I have stated before, we believe that communication service providers, or CSPs, will play a growing and significant role in providing security services to their customers.

CSPs are in a primary position to secure customers' access to the Internet and prevent customer end devices from being infected by malware, ransomware and other threats.

Allot's position as a technology providing company that enable CSPs to provide such services puts us in a great position to grow as CSPs deliver these new services and expand their footprint.

The engagement tools that Allot has developed enables operator -- operators working with our technology to reach penetration rates of 40% and even higher for their customer base who will sign on to the security service.

As we look at the CSP security market, I am encouraged by what I see.

The number of subscribers using our network security in Vodafone continues to grow in almost all countries where it is deployed.

Telefónica is nearing the launch dates of network-based security services in several countries in both Europe and Latin America.

And we are seeing growing interest in major CSPs to provide network-based security or unified security to increase their revenues and create differentiation.

As a result, we see a growing pipeline of CSP security deals.

While these can take some time to close and generate revenues, it is a further validation of our strategy.

As network security is expanding, it will shortly be linked to the IoT world.

As part of our transformation to become a major player in the security market, we identified a major market need for the security of IoT devices.

Although IoT is becoming prevalent in all areas of business and life, IoT device security remains a major concern both in the enterprise world and at home.

By their nature of being low resource devices, IoT devices are usually not secure, and on many of them, it is difficult to place effective security software.

We believe that CSPs, as owners of the communication channel, are best positioned to provide IoT security.

And Allot has a big advantage in providing network-based security for IoT devices connected to the operator's network.

As we discuss these possibilities with various CSPs, we see a keen interest in what we have to offer.

Moving to our more traditional market for CSP visibility and control or what is also called DPI, we see a growing pipeline here as well.

These potential deals cover various use cases such as analytics and bandwidth management.

These results give us confident that the decisions we have made to date are moving us in the right direction.

In summary, this has been a quarter in which we focused on the restructuring of our organization and implementing our plans.

Our confidence in the company's growth strategy is continuously increasing.

And I believe that we will see the results in 2018 and beyond.

While the deals we are pursuing in our pipeline may take time to materialize, I believe they are a good market validation for our strategy.

I believe in the fourth quarter, we will see further sequential growth in our top line as we have seen throughout this year.

I would like to reaffirm our guidance for 2017, expecting full year revenues of between $80 million to $84 million, trending towards the middle of the range.

This, obviously, implies sequential growth in Q4.

Regarding operating expenses, we expect to end 2017 with a total yearly level similar to that of 2016.

We are working on the detailed plan for 2018, and we will share our guidance plan with you in the Q4 results call.

We can share that we plan for 2018 to be a year of growth.

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

Alberto, 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 principle and exclude share-based compensation expenses, revenue adjustment due to acquisitions, restructuring expenses, expenses related to M&A activities, amortization of certain intangible assets and change in deferred tax.

And now with regard to the financial results.

Revenue for the third quarter of 2017 were $20.9 million, growing sequentially by 7% versus $19.5 million in the prior quarter.

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

The geographic breakdown of revenues was as follows: Americas with $5.6 million or 27% of revenues; EMEA with $12.1 million or 58% of revenues; and Asia-Pacific, with $3.2 million or 15% of revenues.

Product revenues for the quarter accounted for 64%.

While service, maintenance and professional service revenues were 36%.

This is compared to a 55% and 45% split in the third quarter of last year.

CSP revenues were 84% in the third quarter of 2017 compared to 81% in the third quarter of 2016.

It is important to 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.

In terms of customer concentration, our top 10 customers made up 67% of our revenues.

Our top 3 customer made up 54% of our revenues.

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

Gross margin for this quarter was 8 -- was 68.2% compared to 67.6% in the prior quarter.

While we saw an improvement versus the previous quarter, the current level of gross margin reflects an increased weight of hardware in our revenue mix, as the initial order from specific subsidiary of Telefónica Global tend to be hardware.

Additional order of software license are expected later once the products will be deployed and launched.

Operating expense for the quarter were $15.5 million around the same level at $15.6 million as reported in the prior quarter.

On a GAAP basis, we had $2.2 million in restructuring expenses.

This were primarily related to closing some of our custom hardware product lines, employment termination costs and extra commission we expect to pay due to the reassignment of deals as part of the sales restructuring.

Operating loss was reduced compared to the previous quarter.

Operating loss for the quarter was $1.3 million compared with an operating loss of $2.4 million in the prior quarter.

Net loss for the quarter was $1.3 million or $0.04 per share, an improvement from a net loss of $2.3 million or $0.07 per share in the prior quarter.

Turning to the balance sheet.

Our cash reserve comprised of cash, cash equivalents and investments as of September 30, 2017, totaled $109.9 million.

The company recorded a negative operating cash flow of $1 million during the quarter.

In terms of guidance, as Erez mentioned, we have reiterated the revenue guidance for the full year of between $80 million to $84 million tending more towards the middle of that guidance range.

That concludes my remarks.

We would be happy to take your questions now.

Operator?

(Operator Instructions) First question is from George Iwanyc of Oppenheimer & Co.

So looking at the Vodafone ramp, can you give us a sense of the pace of that ramp and which regions are seeing the largest attach rates and how much growth do you expect over the next couple quarters?

While the exact subscriber numbers and how many are taking every month and so on is really Vodafone proprietary, so I can't really share that.

I can tell you that we're operating the security services now in -- I think, it's over 8 different countries and in almost all of them.

There may be 1 where it's not growing, but in almost all of them, it's growing.

All of them are in Europe.

The very high rates that we achieve are in the countries that started first, which are Spain and Italy, that started over 2 years ago, so we're reaching penetrations there.

That was public information made in a Spanish newspaper that Vodafone put out that they reached -- that they exceeded the 40% penetration rate there.

And rest of the countries started out later, and they're now growing.

Right.

Are those new countries matching the type of ramp that Italy and Spain did for the same point of time of the ramp?

It's a bit hard to say because some are growing faster, some are growing a bit slower.

I would say that on average, it's similar.

But I can tell you that they're really tracking on a monthly basis.

Okay.

And can you give us a sense of how close we are to Telefónica launching?

And how many countries are involved in the initial wave?

Again, that's -- it's a service launch by Telefónica.

So I think I'm not familiar that they have released the date that they plan to launch, so I don't want to release it for them.

But it's pretty soon, I would say.

It's in, let's say, months or so.

And it will be gradual across the various countries.

We're talking about 5 or 6 different countries.

Okay.

Looking at the pipeline with the CSPs at this point.

How many significant deals do -- are you working right now?

And are we looking at a 6- to 12-month type of time line for the deal work?

Or is it extending beyond that?

Some deal -- well, look, the CSPs tend to have very long sales cycles.

So some of them will be 6 to 12 months, some of them could be even longer than that.

We're looking at -- we're working on quite a few deals that are for us significant.

And I'm not sure I can share much beyond that.

All right.

And just overall pricing trends, competitive environment, how do you feel about the current landscape?

Look, there's a -- I mean, this is a telephone business.

There's so in -- so in a lot of senses, there is always pricing pressure, but I don't see anything extraordinary or different than usual.

All right.

And just as my last question.

On the OpEx levels, are we at a sustainable level when we look into 2018?

Or is the first blush for 2018 year-over-year kind of flattish?

Or do you anticipate growth in any significant amount?

From a OpEx point of view, I mean, first of all, regarding this year, as we said before, I mean, we expect 2017 to be very similar to 2016 level.

Regarding next year, we are currently working on our [higher] operating plan.

And of course, we will be able to give some guidance in the next call.

However, we can expect some slight increase in our OpEx level towards 2018.

The next question is from of [Abba Horovitz] of OS Capital.

It's very encouraging, the progress you're making.

I was wondering if you could talk about the breakeven level for the company in terms of cash flow?

Regarding breakeven, at the current yearly OpEx level and if I assume a gross margin of 68%, which -- it's actually what is -- was the average year-to-date in 2017, I mean, the breakeven point is approximately around $95 million, I would say.

So that's actually what we do believe breakeven point should be.

Okay.

And given that, I guess your focus is on software.

Should we -- will 2018, will we see a higher gross margin potentially because of software focus?

I think that gross margin has many things that contribute to that.

I mean, one of those, as you mentioned, is the software portion, which we do believe that will grow.

We want to be a software company, and our software portion probably will grow.

On the other hand, we have also to take into consideration the product mix and new deals coming in.

So it's very difficult at this point of time to see any trend for 2018.

And as I said before, I mean, we're right now working on the plan, and we will be able to share with you soon some guidelines also regarding that.

Okay.

And just in terms of recurring revenue, would it be fair to say that on a certain level, you now have recurring revenue coming into the company?

I would say that the recurring revenue that we have coming into the company is related to maintenance and services.

It's not yet OpEx model deals that we would like to have in the future.

But aren't people going to renew?

Isn't the anticipation that every year they're going to be renewing the security features that you are providing?

Well, let's say, we -- I think we've talked about this in previous calls, but I can repeat that both Vodafone and Telefónica, which are the 2 main security deals that we've talked about, in both of them, these are -- from a customer perspective, these are CapEx-based deals, where they buy a perpetual license on a per subscriber level.

Now those license, although they are perpetual, do come with an ongoing recurring maintenance fee, support fees and so on.

But they are not recurring revenue -- so there is an element of recurring revenues, but it's not that they are paying the same amount every year to sustain the license because they have initially bought a perpetual license for that subscriber.

I hope I was clear.

Yes.

No, no.

And just in terms of restructuring charges, do you feel that Q4 -- will we see in Q4 a restructuring charge?

Or is this pretty much it for restructuring?

It's pretty much it.

I mean, all the restructuring charges are included in the Q -- in this quarter, in Q3.

Okay, wonderful.

And just the cash...

I do want...

Sorry?

Sorry.

I do wanted to add one thing to my response earlier on the recurring is that, we do want as a company to move more towards an OpEx-based model, or a, if you like, software as a service type model.

So we are offering that to customers, not all of them will be interested.

It will take some time.

But we do want to transition from CapEx one-time perpetual license deals to recurring payment for those licenses.

Okay.

Just on that note, are there others that are doing that on a recurring revenue basis or SaaS model right now in that space?

Well, the traditional security companies that -- like McAfee, Symantec, those guys, definitely, yes.

That's the way much of their pricing is.

Our direct competitors in the -- in our legacy area like Sandvine, not to the best of my knowledge.

Okay.

And just finally, the $100 million-plus $109 million of cash that you have on the balance sheet, can you use that for acquisition?

Or is that right now more important for you to show the cash on your balance sheet given the kinds of customers that you're getting currently?

I think it's -- can we use it for acquisition?

Well, I think we can definitely use some of it.

It's -- you correctly stated that it's very important for us to show it on our balance sheet, given the kind of customers that we're going after.

They want to see a stable company that's going to be here for the long run.

And this is, from their perspective, a very important metric for that.

But as I've stated before, I think we're -- we could -- we will need to do acquisitions after we put our house a little bit more in order.

And we go -- and we get into good organic growth, and we will look more seriously at other options for the cash.

Congratulations on the progress.

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

I just wanted to clarify a few things.

Could we start off what the headcount is post -- at the end of the quarter and post the restructuring?

Yes.

Our headcount at the end of this quarter post restructuring is 475 people.

Right.

And so as a result of the restructuring actions taken and completed during the third quarter, is there a sequential decline in operating expenses?

Or are you essentially saying OpEx is flat at these levels sequentially into the fourth quarter?

I would say that it's approximately flat.

And yes, we do not see any decrease or increase significantly in OpEx.

And so is it just a matter of the people that have left and the cost cuts that were made are being reinvested in areas that are focusing on your future growth?

Is that the right way to think about that?

First, I would like to make a note regarding my previous answer regarding OpEx.

One important thing that we have to take into consideration is the exchange rate.

Because, I mean, while the dollar compared to the shekel is changing, (inaudible) to shekel is becoming stronger and stronger, I mean, this had some impact in our OpEx.

And we will have to take this into consideration.

I mean, the exchange rate is going down.

We did hedge some of our expense in 2017.

And if this trend of exchange rate would continue, so we may see some impacts on our OpEx level.

So assuming a flat dollar, you have some hit to the exchange as a result of the hedges rolling off?

Yes, this is correct.

All right.

Okay.

When I look at the guidance on the top line, just so that I understand the mechanics around it, you've typically had a seasonally strong fourth quarter, if I look back over time.

Is it reasonable to think that we're kind of at a $20 million to $21 million quarterly run rate as we sit here today, and this is a little bit of a seasonal pop in the fourth quarter that will go back to a seasonal weakness in 1Q?

Just trying to get some sense of the structure of the revenues based on the current business conditions you're looking at.

I think, definitely, there is the seasonal element in Q4, because Q4 is traditionally stronger, as you correctly noted.

But I think you also have to look at it that Q4 comes on the back of 3 consecutive quarters with a book-to-bill ratio of over 1. So we're building backlog through the quarters and part of that will show itself in Q4 as well, irrespective of the seasonality.

And as for how we should expect whether this is a typical quarter or not, that really refers to our guidance for 2018, which I prefer to hold off on until the next earnings call.

Right.

But I mean, just seasonally, we should be still thinking the first quarter is seasonally weak and this is seasonally strong, is the right way to think about it?

Yes?

In general, you're right.

Because we sell to communication service providers and their budget plans are usually on a yearly basis, and they tend to spend a bit more towards the end of the year than they do at the beginning.

So as we shift to a business that's driven off of subscription sales, does that -- what I'm trying to get at is, does that change the seasonal pattern as the revenue start to accrue based off of new subscriber adds as opposed to large -- capital expenditure timing frameworks?

And the second question, you did indicate that you'd eliminated some product areas that were more legacy and not consistent with where you're going and were moving away from hardware.

Is there any reduction in the revenue business associated with those products that we could quantify to understand the baseline?

Okay.

On the first question, regarding what happens when we start getting more subscription-based revenues.

First of all, that's going to take time to build up.

We have to not only propose the deals, we have to win them and then the number of subscribers has to start growing.

So it will take time for that to impact our numbers.

That's not going to be anytime soon, and it will grow over time.

And that portion, once it starts growing, that portion will probably not be subjected to seasonality because it's simply number of subscribers, which hopefully, is going to trend upwards continuously.

Regarding the products that we have discontinued and replaced, you should -- I think from a revenues perspective, I don't think this should make any material change, because what we've essentially done is, our products -- think of our product -- I'll paint it maybe a bit -- a bit oversimplify it just so it's more clear, think of our product as really a software package.

And until now, it was running on -- for certain applications, it was running on Allot designed and built customized hardware, and now we are taking that same package with the appropriate adaptations and moving it onto a standard hardware platform that we can buy from HP or somebody else that's a off-the-shelf hardware.

So we would still in many cases -- actually most cases, we'd still be providing an appliance with our software, but it's no longer our appliance.

We can just go and buy it on the free market, which eliminates our need to design hardware, keep improving it in some, because that happens any way without our need to invest in it, and therefore, performance keeps growing without us spending the investments required there.

So it makes for a better product.

It makes for a better upgradability, but we will still be providing appliance-based devices to our customers, because that's what they still want.

And we'll be investing our R&D and resources in software.

So just to follow up on that line of logic.

Does that change the gross margin structure of the combined offering with the COTS hardware costing you less to purchase, and therefore, more of a software mix, so a gradual shift to higher margin.

Is that the right way to think about that?

I wouldn't think in those terms in the short term.

I think longer term, that -- it could probably true, but that will take time.

(Operator Instructions) The next question is from Joseph Wolf of Barclays.

A question about the -- I guess, you've talked about the book-to-bill and the sequential and some of the seasonality in the last question, but could you give us a rough, I guess, rule of thumb given in a way -- given the current mix of product, how long something would sit?

Or how long that greater than 1 takes to flow-through over the next couple of quarters?

I mean, do we have 3 quarters of visibility, 4 quarters?

Is it 6 quarters, given the kinds of contracts that you're signing now?

I mean, generally speaking, you are asking actually regarding our backlog.

I will -- how and in which period it will be recognized.

So most of the backlog is recognized within the first 4 quarter.

And there is a certain percentage certainly related to maintenance or mainly related to maintenance I would say, that it's over that period.

But I think that majority of our backlog is recognizable during the first 4 quarter.

Okay.

And then, you touched on this with the, I guess, the goal of turning towards a more subscription-based or a SaaS type of model.

But as you -- could you walk us through you've got Vodafone, you've got Telefónica, what kind of products are they offering their customers?

And is there an opportunity for you to layer in another service that would be added to that and that you would get, I guess, they are still structuring this as a perpetual license, but you would get 2 licenses per user from them?

Or how do you sell an update, meaning, you're protecting more, you've got a new update?

How does that work with the current model?

And how would that work for SaaS?

With the current model, a customer like Vodafone would -- has -- is providing -- let's take Vodafone as an example, okay.

They are providing network security to their customer.

A customer signs on to Vodafone, because their customer, of course, pays them a certain amount, typically EUR 1 per month for the service.

They would buy a perpetual license from us and some associated hardware for that customer.

And they would pay us an initial -- some initial amount that was agreed upon.

And then over the next years, they will pay us for maintenance services, upgrades, because we come out with new software, so they have the right to upgrade it, but they pay for that.

That's a part of their maintenance and renewal fees.

In a SaaS model, it will be different.

It will be that they will not -- any new operator that signs up to us with a SaaS model will just pay us on an annual basis for the use of the license for that customer for that year, and if -- and he will not pay us anything upfront.

Now, do we have a chance to offer new services to somebody like Vodafone and get additional license?

I can't say that there is no chance, but the key is, in order to get more revenue from an existing like Vodafone or more new type of revenue, they would have to offer a new type of service to their customer.

And so it's not -- and that's not trivial.

The fact -- that's the fact that the service gets better and we offer better services and so on, that's part of the regular upgrade that they pay for through the renewal and maintenance fees.

Okay.

So it would have to be something significant.

Yes.

And then just geographically, you've got -- with these services right now with Vodafone and Telefónica, you've got, I guess, European and LATAM exposure.

Can you talk about the other regions, North America, APAC?

If you look at the communication service provider end market, are you seeing the same kinds of pipeline for these kinds of product globally?

Or do you expect your next couple wins to -- or is the pipeline still a European and LATAM kind of customer-focused base?

No.

We're seeing a pipeline for these deals also outside of Europe and LATAM.

But I will say immediately that, these -- since we talked about in one previous question, these kind of deals take time.

And we just -- we reorganized the sales force during the third quarter.

We brought new heads of sales to the regions during the third quarter, this takes time, but we are definitely seeing deals like this or interest, I would say, more actually interest in deals like this outside those geographies.

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

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

Yes.

I just want to thank all of you on behalf of Allot and the management team for your interest and support of our company.

I look forward to talking to you in the next quarter.

Have a good day, and thank you very much.

Thank you.

This concludes the Allot Communications third quarter 2017 results conference call.

Thank you for your participation.

You may go ahead and disconnect.