Allot Communications' (ALLT) CEO Andrei Elefant on Q4 2015 Results - Earnings Call Transcript

| About: Allot Communications (ALLT)

Allot Communications Ltd. (NASDAQ:ALLT)

Q4 2015 Results Earnings Conference Call

February 9, 2016 08:30 AM ET

Executives

Rami Rozen - AVP, Corporate Development

Andrei Elefant - President and CEO

Shmuel Arvatz - CFO

Analysts

James Kisner - Jefferies

Matt Robison - Wunderlich

Joseph Wolf - Barclays

Catharine Trebnick - Dougherty & Company

Operator

Good day and welcome to the Q4 2015 Allot Communications Limited Earnings Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Mr. Rami Rozen. Please go ahead sir.

Rami Rozen

Thank you very much and thank you all for joining us on our fourth quarter 2015 conference call. My name is Rami Rozen, and joining me today are Allot’s President and CEO, Andrei Elefant, as well as our Chief Financial Officer, Shmuel Arvatz. The press release announcing our fourth quarter results is available on the Investor Relations section of our website at www.allot.com.

All results and expectations we review on the call are on a non-GAAP basis, unless otherwise described as GAAP. Non-GAAP net income and non-GAAP net income per share excludes stock-based compensation expense, revenue adjustments due to acquisitions, expenses related to M&A activity, amortization of certain intangibles and inventory write-offs. Please note that all earnings per share amounts are on a fully diluted basis. A reconciliation of each non-GAAP measure to its nearest GAAP equivalent is available in the press release containing our fourth quarter results.

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 judgment based on currently available information. I refer specifically to the discussion of our expectations and beliefs regarding our pipeline and final expectations of 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 conclusion or making the forecast or projections 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 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 statements.

With that, I would now like to turn the call over to Andrei.

Andrei Elefant

Thank you, Rami, 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 in the fourth quarter and for the year. Before I drill down into the quarterly results, I would like to take a moment to say that and share with you what we identified as a large opportunity for Allot and how we are leveraging it. Let’s start with industry trend and their impacts on service providers and cloud operators.

On one hand we have seen businesses and consumers increasing spend on security services. Businesses are transitioning to solutions on the cloud while also looking to address the security needs of the mobile users. On the other hand our customers the communication service providers or cloud operators are challenged by the traditional services becoming a commodity. Security services and their increasing demand creates an opportunity for service providers and cloud operators to differentiate themselves and improve profitability. To respond to this growing demand and large market opportunity, Allot leveraged its core technology and now provides the superior solutions that enables our customers to gain comparative advantage in their markets.

Since identifying these industry shifts in mid 2014 we have made significant progress with our security offering. We have completed the acquisition and integration of Optenet which helped us deliver security related bookings to around 30% of total product booking and positions us as a leading player in this domain. We believe that our vision of leveraging our technology into security services for end users and enterprises is gaining traction as evidenced by the 10 million end users we are already serving and today we are seeing in the market. Our security monetization and analytics offering go hand in hand and are key drivers for growth going forward.

We are entering 2016 with the positive momentum with bookings in the fourth quarter at record levels. After I complete my part, I will hand over the call to our CFO, Shmuel Arvatz, for a short review of our financial performance for the quarter and for the year.

Now for the quarterly results. During the quarter we continue to execute on our growth strategy. Q4 was a record quarter for our value added services accounting for over 50% of bookings with strong bookings on security amortization services. We landed more than $10 million follow on expansion order providing [another] visibility and enhanced monetization opportunities for tens of millions of subscribers. We announced this win at the beginning of the quarter.

Revenues for the fourth quarter continue to grow sequentially and came in at $25.7 million with net profit of $0.7 million or $0.02 per share. [Non-GAAP] revenues came in at $100.3 million and net income was zero. Looking at the top line, annual revenues were at the lower end of guidance mainly impacted by ForEx headwind which Shmuel will discuss in further detail. Gross margin during the quarter was a healthy 74% and 75% for the entire year, which was in line with our expectation. Net cash was positive with a cash flow of $1.5 million during the quarter.

Now let’s look at our bookings. As I mentioned, in Q4 we reached record bookings. Book-to-bill was above 1 for the quarter and above 1 for the entire year. Our backlog is stronger than a year ago which really will support growth in 2016. Large deals in the quarter reached 22 in total; 3 of which represent new customers, 13 came from mobile operators and 9 from fixed line service providers.

In the value added services business, we had a record quarter with VAS contributing 62% of overall Q4 bookings, continuing the positive strength. For the entire 2016, our VAS business contributed 44% of our overall business compared to 31% in 2014. In absolute figures, we reached 30% growth year-over-year. To remind you, our VAS category is divided into four groups; security, monetization, analytics and optimization. In Q4 security and monetization continued to grow there, with monetization reaching 59% and securities 25%. For the entire 2015, monetization accounted for 48% and security 31%.

Recently we decided to add an additional layer to currently measure our business drivers by breaking down our product bookings both the platforms and the VAS into the four key groups I just mentioned. The [drop] down is done based on the main catalysts that initiated the transaction. We believe that this will provide another way for the market to annualize the specific contribution of securities in our overall yearly bookings going forward. Based on this new measurement, security bookings for the year accounted for about 30% of total products bookings.

Moving into OpEx. We continue to maintain tight control on expenses and intend to continue efficiencies across the business. This resulted in 12% improvement in OpEx compared to the same quarter last year, even after integrating the Optenet team. As part of our overall strategy and in line with market trends of our legacy business, we are realigning our expense into faster growth areas. Through the quarter we decreased our investment in the optimization product line, which may impact our top line in the near and the short term, while increasing our investments and strengthening our dividend and investment portfolio.

Now for some product update. On the products front we are continuing to invest in our virtualized product line. During the quarter, we launched the Allot's Service Gateway - Virtual Edition. This revolutionary concept enables software operators to strengthen our strategic roll out of new services in an [indiscernible] environment. The Service Gateway - Virtual Edition can run in any virtual environment while maintain proper [format]. In addition we are launching today a new Service Gateway platform the SG-9500 which leverages the Service Gateway for future sets and high performance metrics while running over a common office shelf platform. This is an important milestone for us as this will help us to [accelerate our bookable] markets for the Service Gateway.

Moving on to 2016 guidance, we expect revenues to be in the range of $102 million to $108 million. We expect the [indiscernible] utilization segment to contribute and to lead the growth while optimization segments may have slow down overall. As part of this we expect our efficiency measures to drive higher operating leverage to our bottom line. Important to remember we are still dependent on large projects and while we increased our backlog, [this is not] comparison with revenue which is in line within this time. Currently we have one mega project in our backlog which we are in the process of delivering. We expect to recognize revenue for the second half of 2016 which will raise the H2 revenue than rest of the H1.

Before summing up, I will turn the call over to Shmuel for a review of our financial results.

Shmuel Arvatz

Thank you, Andrei. During the second half of 2015, we had a nice pick up in our bookings which is a record booking level during the fourth quarter. We have completed the integration of Optenet and are very pleased with the progress we made in the security segment. We continue to invest in developing new product and launch a range of Advanced Virtualized Service Gateway Edition to enhance our standing in the NFV world. We are seeing increased demand for our value added services mainly in security and monetization and we expect this trend to continue into 2016.

Before I begin reviewing the financial results for the quarter, I would like to inform everyone that on this call, unless otherwise noted we will refer entirely to the non-GAAP financial measures when discussing operational results. Non-GAAP financial measures differ in certain respects from generally accepted accounting principles and exclude share-based compensation expenses, revenue adjustment due to acquisitions, expenses related to M&A activity, amortization of certain intangible items, changes in differed tax and certain tax charges.

Turning to our fourth quarter results. Revenue for the fourth quarter was $25.7 million, up 9% sequentially and down 16% year-over-year. The geographical breakdown of our revenues was as follows. EMEA $13.3 million or 52% of revenues, APAC $5.3 million or 21% of revenues and Americas $7.1 million or 27% of revenues. For full year 2015 revenues in EMEA were $48.9 million or 49% of revenues, APAC with $28.8 million or 29% of revenues and Americas $22.6 million or 22% of revenues. Product revenues for the quarter accounted for 60% of total revenues, while service revenues were 40%. On an annual basis product revenues accounted for 62% of total revenues while service revenues were 38%. This compares to 66% and 34% split in 2014.

Moving on, gross margin for the quarter was 74% of revenues and 75% for the entire year. On a GAAP basis gross margin was 48% of revenue and was impacted by an impairment charge of $5.8 million resulting from the write off of intangible assets connected with our Ortiva and Oversi acquisitions. This is in line with our current estimate that future revenues from video optimization and caching products will be minimal and our decision to minimize future investments in this product line.

Operating expenses during the quarter were $18 million, a $2.5 million reduction for the year and similar to the previous quarter. We continue to streamline our operations into 2016 as well. During the fourth quarter, we recorded a tax expense on a GAAP basis of $3 million. This amount includes $2.6 million on account of differed tax assets and prepay tax expenses write off. FX assets write off was a result of our estimated utilization of these assets, is not expected in the foreseeable future. Net income for the quarter was $700,000 or $0.02 per diluted share compared to $3.4 million or $0.10 per diluted share in the same quarter last year.

Now I’ll return to the full year results. The revenue for 2015 decreased by 14% to $100.3 million. This came in at the lower end of our guidance mostly due to FX effects. During the second half of 2015 our booking recovered significantly compared to the first half and we reached a record booking level in the fourth quarter. The strong performance of our booking during the second half enable us to open 2016 with higher backlog than the year ago. However it is noted that our backlog includes in part large deals also from new customers that will take longer period of time to convert into revenues.

Gross margin during the year was 75% in line with our expectations. Our operating expenses for 2015 decreased by 4% year-over-year totaling $74.3 million, the reduction is despite the acquisition of Optenet during the first quarter which increased our expense base. As a result of our efficiency measure we were able to return to positive operating margin in the fourth quarter. Net income for the year was about zero compared to $10.5 million during 2014.

Turning to the balance sheet, our cash and cash equivalent reserve totaled $123 million. During 2015 we generated about $4.4 million from operations. DSO was 86 days within our typical range of 75 days to 90 days. Upon receiving the annual cost authorization we began to buyback our shares. So far we have purchased about 73,000 shares and we continue to be active in the market.

To conclude, while 2015 financial results came below our expectations, we continue to execute in accordance with our strategic plan. We are encouraged by the progress we made in the security segment and looking forward to productive 2016.

With that I’ll turn the call back to Andrei.

Andrei Elefant

Thank you, Shmuel. To summarize, bookings continue to grow significantly reaching record levels even with the challenges of slow [gear] sale cycle. VAS represented over 50% of overall bookings, while security and monetization continue to be the prime drivers for our business. Security contributed greater percent of 2016 forward booking and we finish 2015 with book-to-bill above 1. Moving into 2016 we expect to achieve top line growth as well as improved profitability.

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

Question-and-Answer Session

Operator

Thank you. [Operator Instruction]. Okay we will now take our first question from James Kisner of Jefferies. Please go ahead your line is open.

James Kisner

I guess, first is [comment] on the overall environment and where are you seeing the increase costs from customers, recently obviously the equity markets are showing investor concerns and what does your outlook for [indiscernible] assume in terms of the spending environment?

Andrei Elefant

So in general what we see in the market is that the investments done by service providers are moving from investing in solutions that optimizes the network into solutions that have been seen to bring additional value for their end-users and generate additional revenues, open new streams of revenues from their customer base. We are aligning our offering exactly into that direction with the security offering where they can sell Security-as-a-Service. They achieve all those things that I mentioned both increasing the value of the service that they provide and [indiscernible] increase our prepared users. And this is exactly in the areas where operators and mobile operators mainly are looking to spend their money. So overall it might be that they are overall reducing spends, in certain segments they are actually investing more and we are aligning our offering to those areas.

James Kisner

But you clearly you haven't seen any sort of broad iteration in the environments or any increased investor caution of late in many of your regions?

Andrei Elefant

We have seen less investment on the optimization side and as I mentioned we are decreasing our investments in those product lines. On the other side as I mentioned we see an increase on the security offering and on the monetization offerings because this is in line with our strategy and though we don’t see any decline, in fact we see [showing] an increase in investment.

James Kisner

So, just another one here on gross margins, they were down sequentially. I know inside your --I guess roughly inside your target range, but that was despite a high proportion of VAS bookings. I'm just wondering what drove the sequential decline, are you seeing any incremental pricing pressure, are there any sort of mix factors that I'm missing?

Shmuel Arvatz

So, as we mentioned last quarter that result of Q3 was exceptionally high due to one specific deal and I think that the Q4 results are more typical within the range we expect. There are some price pressures in certain territories, but I wouldn't say this is the main parameter for Q4. As I mentioned Q4 is within the expectation and Q3 was a low -- very high and exceptional in our business model.

James Kisner

Last one and I'll pass, just recently India have banned Facebook's Free Basic service and that was to support their neutrality policy. What is the price to you and can you comment on your exposure in India, and do you expect any impact to your business in India or other geographies from changes to the regulatory environment?

Andrei Elefant

So, regulation in some countries supports us, there are use cases [indiscernible] in some cases it blocks some of their use cases. As you mentioned India just recently announced their -- the fact that they won't allow Facebook and similar services. However in our portfolio there are many services that can help operators like for example in many countries the regulator will demand different security offering to be offered by the operators. So, these services actually go in line with our offering. We have projects offerings in India and in many other countries, but we have a big variety of use cases. So we've found -- we're finding the right use cases as per territory based on the regulation in that specific country.

Operator

Thank you. We will now take our next question from Matt Robison at Wunderlich. Please go ahead, your line is open.

Matt Robison

Thanks for taking my question and congrats on the progress for your transition. First of all if you could comment on how much impact as far as the year-over-year decline and the headwinds you expect for optimization, how much of that relates to the transition of general web traffic to encryption?

Andrei Elefant

You're right Matt, one of the reasons why we're seeing decline in the optimization for the plan is related to the type of the encrypted web traffic. It reduces the value of [indiscernible] at specific use cases. We still see some projects in that domain but overall we see decline in the demand for that. One of the reasons is encryption, that reduces the value or reduces their amount of savings that we can provide and I would say also in general all operators are less keen to find way to optimize their network. In general they did their investments and they're more looking for ways to deliver additional services on top of their network. But to answer your specific question, yes that impacted also the demand on the optimization product. This is one of the reasons why we are reducing investments in that area.

Matt Robison

For the optimization outlook that you have is, is there a regional component where you're expecting more sales simply because the traffic is not yet encrypted in those regions or is it pretty uniform globally?

Andrei Elefant

It's -- we see the fact that there is a bigger proportion of encrypted traffic globally and usually what makes the business case to buy the optimization solution and is the cause of them with even with the encrypted traffic, we still provide such a level of optimization and it really depends on the cost of bandwidth for that specific country or for that specific operator. That would be the main criteria for whether it makes sense for them to deploy an optimization solution or not.

Matt Robison

Does the encryption impact your value added or your monetization -- I should say it more specifically, does it impact your monetization or security sales?

Andrei Elefant

With significantly in a less extent, in fact with on the security side in some cases the end users are enabling or making these security solutions to open the encryption in order to gain the traffic and this is a typical way that all the security products are working and we'll do the same. So, actually with the security product it has begun and there are some use cases that there is certain impact but most of the impact I would say is on the optimization for the [indiscernible].

Operator

Thank you. We will now take our next question from Joseph Wolf at Barclays. Please go ahead, your line is open.

Joseph Wolf

I’d a question, and thank you for the more transparency on some of these bookings. On the last pricing model, can you talk about the security? It's mainly a mobile application still and is there any movement on the ability to perhaps levy some per user fee from some of your customers rather than a flat fee from the operator or service provider?

Andrei Elefant

Let’s start with first part of the question. So we are offering here two types of solutions, one we call network based security which includes mainly our DDoS offering and content filtering that protects their network as a network and we see increase in demand on that part as well. The other part of our security offering is what we call security of the service where we provide Web security to the end users and there the pricing more than that we have is based on the [indiscernible] subscriber that is using the facility. We are moving now from professional licenses into term licenses in our model because we see the value on the service and we know that once we win a customer they will stay with us for a longer time. So we are transitioning in that sense. We already have some initial bookings with term licenses and I believe that going forward we’ll continue with that trend.

Joseph Wolf

Question on just the new option or the option repricing, you gave some details in the release. But were the employees you got can't move that, what kind of milestones and who qualifies for the repricing of the options, was it simply a question of the price of the option rather than or seniority with the company rather than on milestones?

Andrei Elefant

It's not milestone, it's for certain employees in certain territories that call their option with an excess price above $7 and we exchange basically those options to new options with new [addressing] period which is two years, which will serve also the purpose for retention as well as compensation which is now almost zero with the high exercise price.

Joseph Wolf

And then finally with this new product launch today and you mentioned that it's part of a virtualized platform. Can you talk about is it available as an appliance and could you talk about the difference, is this a enterprise and a service provider model and what’s the difference in both of those scenarios in terms of what you’re selling and how the progression of taking this new product looks for a customer?

Andrei Elefant

The Service Gateway, SG-9500 is part of our move into the digitalized environment and common platform. We spend the last year and half to evolve ourselves into an income based platform and in order to make it available on different platforms not only on our hardware. And we have now two offerings, one is the [pure cost] virtualized version of our Service Gateway that we can [indiscernible] share on any common server and we are offering also the Service Gateway functionality as an appliance and this is what we released today. So we released today a platform that is an appliance, which is an income based appliance running our Service Gateway functionality on that platform. The advantage of this platform is that it can act to expand our addressable market because it's a smaller form factor and allows us to get into additional type of customers, can be enterprises, can be cloud operators, very small service providers, any type of customers that for them the Service Gateway will be a novelty and they are looking for the Service Gateway functionality but package in a smaller form factor. So they are getting now everything packaged in a small form factor and by that we extend our market reach with the Service Gateway functionality.

Joseph Wolf

And the initial sales are moving in which direction?

Andrei Elefant

Most of the opportunities that we have for these product lines, our customers they have in the past they both, the AD product line, the NetEnforcer product lines, but those product lines were lacking some of the Service Gateway functionality. Today they will get more features including security capabilities and we will be able to be deploy them in those enterprises or smaller service providers.

Operator

[Operator Instructions] We will now take our next question from Catharine Trebnick of Dougherty & Company. Please go ahead.

Catharine Trebnick

Thank you and thanks for taking my question. Can we just go back to some of the headwinds and get more detail especially within the different regions. North America versus EMEA, this is persistent it seems for the last 24 months that we've had -- you have had in the last three quarters actually good book-to-bill but you still have these persistent headwinds. So can we have a little bit more maybe detail on, is it CapEx, is it the pivot to NFV with the carriers, et cetera and by region? Thank you.

Andrei Elefant

So Catherine just to make sure that we understood correctly. You are asking about what we mentioned the targets impacts on our revenues and did we see that or just in general terms. So let me touch and address that and you can ask follow-on questions there if I'm not covering that correctly. And so in general at the beginning of the year, the first half, we talked about the products impact on our revenues and since we gave guidance after the second quarter, we expected to see revenues between $100 million to $105 million and we did see an impact of ForEx headwinds also on the second half of the year. And doing a calculation from the point of that we gave the guidance to the end of the year, we saw that there was an impact of about $2.5 million and it's contributing due to changes in currencies, since we gave the guidance, based on the actual revenues that we achieve. So I believe that without that impact we would have been exactly on the point even, slightly above the point that we targeted. In general I would say I'll take your question maybe broader in that on the more economical impact, we do see that in several regions, the power of buying there reduced due to the currency change and we discussed that in the previous calls. We are adjusting today the expectations for next year based on what we see the most, so the numbers that we are giving today is based on the power of buying that we see I think today in the market.

Catharine Trebnick

Okay. I get the foreign currency, but are there a different -- there is a shift obviously because you are pivoting to the subscriber base and you are pivoting to your Security-as-a-Solution and the monetization over optimization. But isn’t that also driven by the shift by the big carriers to also move away from traditional architectures to more cloud-based and at the end has that caused you some pains also with some of your larger carrier customers?

Andrei Elefant

Okay. So we do see shift in where operators are willing to spend. Yes, they are looking for solutions that can be deployed on their cloud or on their networks and to deliver different services from their network and we see our Security-as-a-Service as a perfect fit for that specific trend. They are looking for a solution that is a true software, can be deployed on their cloud and they can deliver prudent network security offerings among the other offerings that many are trying to have monetize the network, and this is exactly the area [of growth] that we are investing. We are seeing less deployment of solutions that are very [indiscernible] to optimize the existing networks. They are looking for more social oriented solutions running in virtualized environments and delivering services that they can monetize and this is exactly what they are doing and this is exactly what we see the growth.

Catharine Trebnick

Okay. And one final question you had announced last quarter that Check Point relationship and I assume that was for more enterprise growth, can you update us on that relationship?

Andrei Elefant

Yes. So exactly as I just mentioned, it is exactly a great example of how we [begin] develop solutions, we help operators deliver servicing from their network. What we've done with the integration with the Check Point firewall solution is that we demonstrated how a traditional enterprise service can run in an NFV environment at the service provider cloud, leveraging our Service Gateway Virtual Edition. We took our Service Gateway Virtual Edition put on top of that the Check Point firewall that is running in virtualized environment and by doing that integration the firewall functionality is now available as a service to all the customers of that operator. And what we are doing in that part of -- in that solution is that we are helping connecting the Check Point functionality into the infrastructure of the operator, connecting it to the policy control and as I said to the NFV infrastructure and by that allowing the operator rolling out this specific service in most sites. That was presented in one of the trade shows in Q4. And we are continuing to work together on opportunities in that area.

Catharine Trebnick

All right. Thank you.

Operator

Thank you. That will conclude today's conference call.

Andrei Elefant

Thank you, Catharine.

Operator

Thank you for your participation. Ladies and gentlemen, you may now disconnect.

Andrei Elefant

Thanks, everyone.

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