Allot Communications Ltd. (ALLT) CEO Erez Antebi on Q3 2018 Results - Earnings Call Transcript

|
About: Allot Communications Ltd. (ALLT)
by: SA Transcripts

Allot Communications Ltd. (NASDAQ:ALLT) Q3 2018 Earnings Conference Call November 6, 2018 8:30 AM ET

Executives

Erez Antebi - President and CEO

Alberto Sessa - CFO

Analysts

Alex Henderson - Needham & Company

Georgia Iwanyc - Oppenheimer & Co.

Joseph Wolf - Barclays

Jeff Bernstein - Cowen

Operator

Welcome to Allot's third quarter 2018 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 for 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 may contain projections and other forward-looking statements regarding future events or the 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 with the Securities and Exchange Commission.

And with that, I would like to now hand over the call to Erez. Erez, please go ahead.

Erez Antebi

I'd like to welcome all of you to our conference call and thank you for joining us today. I would like to start with some key financial parameters for this quarter. Our third quarter was another quarter of growth. Revenues grew to $24.2 million, a 16% increase compared to the third quarter of 2017. Our non-GAAP gross margins improved to 71% compared to 68% in the third quarter of 2017. Our R&D expenses grew this quarter.

We see significant opportunities in the market and we are investing in our products to take advantage of these opportunities and generate substantial growth -- excuse me, sustainable growth. I would note that part of the growth and R&D is a result of staffing up in our new low-cost center in Belarus, which will enable us in 2019 and beyond to increase product development capabilities at a lower cost. Our book-to-bill was less than 1 this quarter, mainly due to some delays in closing orders due to the summer months.

However, our book-to-bill for the first nine months of the year is above 1, and we expect our book-to-bill for the year to be above 1 as well. The main message here is that we are on track with our plan. We see a growing number of opportunities. We're continuing to win new deals and grow our revenues, and we expect this trend to continue.

While Alberto will provide more details on our financials later, I did want to start with our financial performance, because it shows that we are successfully continuing to execute on our plan. I would like to turn now to a discussion on our business, starting with the visibility and control domain.

We are seeing an active market here, with a growing pipeline of opportunities. We continue to see the same used cases we saw in previous quarters. Smart track experience to effectively handle congestion and reduce connectivity costs, quality of experience, where communication service providers or CSPs can understand what the real user experience on the network is, even on encrypted traffic, such as YouTube or Netflix.

Analytics, to enable the CSPs to get significant, detailed and actionable analytics on their network and to properly planned network build and configuration, and regulatory compliance to allow governments to block malicious or illegal sites.

I note that regulatory compliance has been especially strong lately, and we expect to see a lot more potential for this use case. Recently, we won several competitive bids for visibility and control systems, for operators in APAC, EMEA and Latin America, some was Tier 1 operators. These ones are important for a couple of reasons.

First, they show, we can successfully take market share from our competition. Second, these new wins with new operators, provide a base for potential future revenue and expansions, renewals and services. The visibility and control domain have been growing nicely in 2018.

Overall, the value of the new deals we won during the first three quarters of 2018 is approximately double of that, which we won during all of 2017. These new customers are creating a strong foundation for sustainable growth; this is good news, as it enables us to continue growing even before the security domain comes into full effect.

Let's turn now to the security market, which is our main growth engine. As I mentioned in the previous calls, we see a growing number of CSPs who see the value and providing secure broadband services at a premium and understand that this is a potentially very large new source of revenue for them and also, key to their customer satisfaction. This interest is across the breadth of the Allot secure product family, including NetworkSecure, IoT secure, HomeSecure, DDoS secure, and the combination with our partners endpoint secure.

I would like to remind you all that Allot’s ability to provide protection at several locations in the network, while seamlessly providing the same service across customer locations and platforms is one of Allot's key advantages.

It is important to note that we are responding to several RFPs that combine two or even three different products of the Allot secure family. This is a strong testament that our strategy of enabling operators with the capability to provide “anywhere, any device, any threat” protection to the consumer and SMB market is gaining acceptance with operators.

Our HomeSecure product, which we acquired in Netonomy acquisition is in technical trials with several operators, and we expect to have first deal for this product in the coming months. In Vodafone, our largest security customer, penetration rates and the number of paying subscribers continues to grow. Telefonica, while slow to launch the security service, now plans to launch it in the next few months in Spain, and several countries in Latin America.

I remind you that both Vodafone and Telefonica deals were based on sales of perpetual licenses per subscriber. We are striving to change this model with future customers and are offering OpEx or recurring revenue based deals. We are encouraged to see that more and more operators are open to such a model, and that this offering is meeting a positive response in most cases.

For example, we recently announced a deal with Swiftel of Australia to provide DDoS protection to other ISPs. This deal is based on sharing the monthly revenues from those subscribing to the service between Swiftel and Allot.

I believe we will see more recurring revenue based deals close in the coming months -- in the coming few months. Deals like this contribute little to bookings and revenues in the short term. So, security bookings and revenues may appear not to grow enough. However, it is these deals that ensure potential long-term revenue growth and success for the business overall.

Our goal is to build a substantial base of CSPs with whom we have OpEx or revenue share securities deals and then work with them to grow the number of end customers subscribing to the security service, thereby, generating a significant amount of recurring revenues.

This is all very encouraging and gives me confidence that we are heading in the right direction. Unfortunately, as you know, working with CSPs takes time, with sales cycles typically exceeding 12 months.

While we are advancing with the CSPs we're currently working with and starting to work with more CSPs on these exciting security offerings, it still takes a bit longer to close than we would like.

I would like to say a few words on the technologies we are developing for both visibility and control domain and the security domain. As mentioned in previous calls, operators are moving to virtualized environments and we are modifying our products to this new NFV environment. I'm proud to say that we have an NFV product already deployed in the network.

I'm also very happy to say that we were recently awarded an IoT security deal based to a very large extent on our ability to deliver an NFV solution, which our competition would not permit to.

In addition to virtualization, we should understand that operators are changing the sophistication level they require for the network and for the services they provide. For example, operators prefer to manage their networks based on the instantaneous quality of experience their customers seek, rather than by a fixed set of predetermined rules.

These kinds of changes mean that previous methodologies are no longer sufficient. In order to deliver quality products with state-of-the-art performance, Allot is investing today significantly in artificial intelligence and machine learning technologies.

Based on our results so far and a strong and growing pipeline I see of new deals, I would like to increase our guidance for the full-year revenues for 2018 to be between $93 million to $95 million. Furthermore, I expect to continue with a double-digit rate of revenue growth in 2019 as well and expect to reach breakeven late in 2019.

In summary, I would like to emphasize the key points. We are progressing in booking and revenues per our plan and expect to continue to do so. In the visibility and control domain, we are growing nicely, winning new operators and capturing market share.

Market acceptance of our security offering is growing. A growing number of operators, which to offer network-based security services and they are willing to agree on recurring payments rather than perpetual license purchases. This is very encouraging, and I believe it will secure the long-term growth for Allot.

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

Alberto Sessa

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 respect from the Generally Accepted Accounting Principles and exclude share-based compensation expenses, revenue adjustment due to acquisitions, restructuring expenses, expenses related to M&A activities, amortization of certain intangible asset, change in tax related items and change in deferred tax, with regards to the financial results.

Revenues for the third quarter of 2018 were $24.2 million, growing by 16% compared with those of the third quarter of last year. In the first nine months of 2018, revenue was $69.0 million compared to $58.8 million in the same period in 2017, an increase of 17%.

Now, I would like to give some details regarding the revenue breakdown and diversification. The geographic breakdown of revenues for the third quarter of 2018 was as follows. Americas with $2.2 million or 9% of revenues, EMEA with $16 million or 66% of revenues, and Asia-Pacific with $6 million or 25% of revenues.

Product revenues for the quarter accounted for 57%, while service, maintenance, and professional services revenue were 43%. This is compared to a 64% and 36% split in the third quarter of last year. Communication service providers or CSPs revenue was 83% in the third quarter compared to 84%, as reported in the third quarter last year.

I note that revenue breakdown, whether geographically 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, we see increased diversification compared with last year. Our top 10 customer made up 63% of our revenue in the third quarter and this is compared with a higher level of concentration amounting to 67% in the third quarter last year.

Gross margin for the quarter was 70.7% compared to 68.2% in the third quarter of 2017. This represents an improvement and was due to the sales mix in the quarter, which favored higher margin software. As you are aware and as seen in previous quarters, gross margin on a quarterly base may fluctuate depending on the specific deals recognized in the specific quarter.

Operating expenses for the quarter were $18.2 million compared to $15.5 million, as reported in the third quarter of 2017. The number of full-time employees at the end of Q3 2018 was 532 compared to 504 at the end of the previous quarter. The increase is mainly due to the increase in R&D and more specifically, due to our new R&D center in East Europe.

We see the increase in operating expenses as an investment in our growth potential. We are allowing this to capitalize on the growth opportunities into end-markets we are addressing. Non-GAAP operating loss for the quarter improved to $1.1 million compared with an operating loss of $1.3 million in the third quarter of 2017. Net loss for the quarter improved to $1.1 million or $0.03 per share versus $1.3 million loss or $0.04 per share in the third quarter of 2017.

Turning to the balance sheet. We remain in a strong position with cash for working capital purpose as well as capital to execute on our ongoing growth plans. Our cash reserve comprised of cash, cash equivalents and investments as of September 30, 2018, was $104.7 million compared to $105.9 million at the end of last quarter.

As you may have noticed, our inventive growth of this quarter to approximate $12 million compared to approximate $8 million in the previous quarter. This is mainly due to the portion of a statement for customers needed to fulfill some specific order received. We do expect in the next two quarters, the inventory will decrease, as we delivered the system and recognize the revenue related to this order.

In terms of guidance, we have shown continuous year-over-year growth throughout 2018, and we expect this trend to continue into the fourth quarter. On a yearly base, we increased our revenue guidance to between $93 million to $95 million. Finally, we expect the overall book-to-bill ratio for the full year to be above 1.

In terms of operating expenses, as I mentioned, last quarter, OpEx in the full-year 2018 will be higher compared to the full year 2017 for three main reasons; additional investment in R&D, marketing and sales, additional investment required as a result of the acquisition of Netonomy for the unsecured products; and the strength of the Israeli Shekel versus the dollar, which increases our Israeli based cost in U.S. dollars.

In summary, we iterate what Erez mentioned, we are happy with our financial results and our progress in the third quarter, and we remain on-track with our plans. That concludes my remarks. We would be happy to take your questions now. Operator?

Question-and-Answer Session

Operator

[Operator Instructions] The first question is from Alex Henderson of Needham & Company. Please go ahead.

Alex Henderson

I apologize, but I didn't catch some numbers you throughout. I think it was 69 million in the quarter, up 17%. What was that referring to?

Alberto Sessa

That was the year-over-year growth in revenue, I think, the 9 months, yes, year-to-date.

Alex Henderson

Is that product revenues?

Alberto Sessa

No, it's total revenue.

Alex Henderson

The second question I had was just book keeping question. Can you tell us what the fully diluted share count would be if you were profitable currently for evaluation purposes?

Alberto Sessa

It's approximately $33.6 million, but I will get back to you with the exact numbers. It slightly above the number that share we have right now, I mean, there's no big difference between the current status and the status in which we are fully profitable.

Alex Henderson

I thought it was more like 36., is that the right ballpark?

Alberto Sessa

Let me back -- get back to you with that number.

Alex Henderson

And then you made a comment, you're still getting hurt by the shekel, shekel the 52 weeks low, obviously, that's a functioning of your hedging policies. Can you remind us, what your hedging policies are?

Alberto Sessa

Yes, we're hedging on our declining scale actually four quarters ahead, while the first quarter is, of course, the quarter in which we hedge most of our expense and that is declining over the four different quarters. Overall, on an average, I would say that we're hedging approximately 50% of our revenue in the next 12 months.

Alex Henderson

And if you were to hold the exchange rates steady at these current levels, that would be a significant positive to your cost structure, would it not?

Alberto Sessa

Yes, that is correct, but you have to take into consideration the difference in interest rates, which right now, if I want to add -- if I want to buy a forward, I will have to provide the difference -- I would have to pay the difference interest rate and which make almost impossible to keep the current rate.

Alex Henderson

And so in terms of the tax line as we go out in the 2019. Should we be assuming a little bit of an increase in the tax rate over the -- tax paid over the year? Obviously, you're -- most people are not forecasting it to be profitable, so I assume that's local outside of Israel?

Alberto Sessa

No, I mean, you have to understand that this tax line is mainly withholding tax that we're paying due to the fact that we're working in country, which with all tax, is not the income tax since -- I mean we are losing money. And this number may fluctuate, depending on the deal that are recognized in a specific quarter. On an average, I would assume that the level will remain the same, but again, it's very much depending on the specific deals recognized.

Alex Henderson

Just wanted to go back to the comment in the press release about 2x the orders. I assume that is only relating to the DPI segment of your business and not including the security side, is that an accurate statement?

Erez Antebi

First of all, it's not 2x of the total order, the saving was 2x on the new -- on the orders that we have from new customers, that was the comparison that was made. So, we're getting a lot more orders from new customers and yes, it's primarily on the DPI.

Alex Henderson

So it's referring to both DPI and to the security piece then?

Erez Antebi

Yes, primarily on the DPI.

Alex Henderson

And that's against the -- so that's not against your total orders, would not be indicative of a doubling of revenues, but rather, just sort of - what is the base of that on? Can you give us a sense of -- is that meaningful portion of your total bookings?

Alberto Sessa

It's a significant portion. And again, it's not indicative of doubling revenues or anything like that. And we don't mean to incur anything like that. It's -- it merely says that, we're bringing on board many more new customers with significant deals than we were in the past. And we're building a stronger base going forward. That was the -- first of all, that’s the fact and that was the intent of the statement.

Operator

The next question is from Georgia Iwanyc of Oppenheimer & Co. Please go ahead.

Georgia Iwanyc

Erez, if I remember correctly, I think you had previously talked about maybe four to five new carrier deals in 2019. Is the pipeline still at that type of level? Or is it starting to add more breadth and more regions?

Erez Antebi

I think that I was asked if that's a reasonable number and I said that is reasonable. But I think we're definitely talking to more than that. Our pipeline is much larger than four or five operators, I would expect something in that vicinity to actually close in 2019.

Georgia Iwanyc

And when you look at the visibility, it seems like you have a lot of confidence in that double-digit growth. How much is coming from new security business? And how much is little bit stronger visibility into the visibility area?

Erez Antebi

I think the visibility from a visibility perspective, we're seeing a lot more -- I feel more confident in the numbers and the actual numbers for growth in the visibility and [indiscernible] because we see the funding of deals, and when we book a deal there, we book a deal in a certain time and within, I don't know, three, six, nine months, whatever, we recognize revenue depending on the deal.

In the security area, where we're moving to an OpEx based deals, that even though, I see a very healthy funnel and I’m very confident that we’ll start closing deals, we will take bookings and incur revenues as subscribers actually sign up to the service and start paying, and that's a gradual increase over time. So I think the -- when we look at the forecast and say, okay, pretty confident of double-digit growth into 2019. it's a primarily based on the DPI, even though, I see strong foundation for security OpEx deals and security area as well.

Georgia Iwanyc

And this might be a question for you Alberto, maybe two ways of asking it. One, when you're look at your OpEx expectations for next year, are you expecting another quarter or two of building out Belarus facility? And then kind of stabilizing at that level? And then, kind of looking at the sales and marketing, you added a lot of headcount there, are you expecting to add more? And what type of productivity levels are you seeing from the new hires over the last several quarters?

Alberto Sessa

So, in terms of operating expenses for 2019, we do expect those to be higher than what was on a yearly basis to what was in 2018. We are currently working on the detail of our annual operating plan, and I'm sure that during next quarter, we will be able to talk a little bit about that.

We did increase a little bit, as you said, both R&D and sales and marketing, especially in R&D. As we mentioned before, we open our low-cost center in East Europe, so there is additional headcount and we are investing in the product and from a sales point of view, we are actually cover more and more territory, so we did increase. We do believe that again, in 2019, operating expenses will grow a little bit, at this point of time, I don't have a number to thrown on the table.

Georgia Iwanyc

And a last question for me, just on the gross margin side. Are we kind of looking at a stable number at this 70%, 71% mix that you have right now?

Alberto Sessa

Look, as I said, I mean, gross margin may vary significantly from quarter-to-quarter, depending on the deal that are recognized in the specific quarter. But overall, on a yearly basis, I do believe that 70% should represent the average number. Regarding next quarter, I do believe that the numbers should be between 69% to 70%, having a total of 2018 around 70% again.

Operator

The next question is from Joseph Wolf of Barclays. Please go ahead.

Joseph Wolf

This maybe longer term, but just based on some of the positive commentary you made. As you think about the potential per subscriber base profit sharing or revenue sharing, what's the right way to think about what that target should be or mix that you're thinking about? Or is it even too early to be thinking about that on a 12- to 24-month timeframe?

Erez Antebi

I'm not sure, I fully understood the question.

Joseph Wolf

Meaning not all of your deals are going to be subscriber, but some of them are. And what you think the business mix looks like when you've got a few good wins under your belt?

Erez Antebi

Well, I would -- it's a bit early to say because after we've got five or six deals, I can be more confident on that mix. I would say that as I would expect that to have long term more than half our deals on the security OpEx basis. And to -- just to qualify that, that's security OpEx deals, right. In DPI segment, visibility and control, we will remain with CapEx deals as it was. We're not looking to change that.

Operator

The next question is from Jeff Bernstein of Cowen. Please go ahead.

Jeff Bernstein

Just on the sales execution front, I think you thought that you were sort of under earning in a couple of geographies and that could be improved upon. Where are we in that process?

Erez Antebi

I think you can see that from the revenues split, you can see that we're seeing growth in APAC. And I think we're doing very well there. I think we are not yet seeing the growth we would like to see in the Americas, and I would expect that that -- I would hope and expect that will change during the next year.

Jeff Bernstein

And I'm just curious on the U.S. market in terms of the use of traffic shaping or QoS. Any change there with net neutrality or just in general is there, you think there'll be any catalyst overall for traffic shaping and QoS from 5G et cetera?

Erez Antebi

Well, there is no dramatic change in the U.S. market despite the reversal of net neutrality. We are talking to operators about Traffic Shaping, there is -- I would say, there's more discussions around them, there is more thinking around that, but I don't see any dramatic change to run and implement it. I think that in 5G that may change, we are seeing RFIs come out now with questions and sections about traffic management in 5G, but that will take more time to materialize, these are longer-term processes.

Operator

We have a follow-up question from Alex Henderson of Needham & Company. Please go ahead.

Alex Henderson

I just wanted to go back to the new customer's orders for a second. So, I mean, clearly, the base of your business is predominantly from existing customers not from new customers. Is it reasonable to think that new customers represent relative to the orders not the reported revenues, something under 25% of your revenues in any given period?

Alberto Sessa

Honestly, I don't know to answer that. I'd have to look at the numbers and get back to you on that.

Alex Henderson

Sounds like that's at least in the general ballpark now?

Alberto Sessa

I really would prefer to look at the numbers and get back to you with a responsible answer.

Alex Henderson

So in the comments post my prior question, I thought I heard you imply that you felt comfortable with double-digit top-line growth in 2019, did I hear that correctly?

Alberto Sessa

Yes.

Alex Henderson

So, within that mix, if we see a sharper acceleration of OpEx related deals that are more SaaS oriented, would you expect that even under that scenario you'd still be able to achieve that? Or would that be a headwind to that target?

Alberto Sessa

The security OpEx deals that we're aiming at are a new base of new additional revenues, they're not replacing any of the existing revenues that we're seeing. So, when I'm looking at growth into 2019, I could separate that into several parts, one is, okay, what can we grow from the existing installed base, be it security or DPI, mostly DPI and a little bit of security like Telefonica and Vodafone both behaving as CapEx, and what can we expect to grow on that.

Working what additional new revenues will we see from new customers as we go into 2019, that are CapEx type deals in the DPI sectors. And how much of the security OpEx deals that we sign up. How much of that will translate into actual bookings and revenues in 2019 and this is on top of the other two that I mentioned. So, yes, I think we -- it's not one at the expense of the other. So, looking at all those together, I do see double digit -- I do feel confident in looking at double-digit growth in 2019.

Alex Henderson

And going back to the DPI segment, visibility segment for a second. Obviously, the merger between Sandvine and Procera has altered the competitive landscape. You've talked in the past about picking up bars and distribution. Can you update us on where we are on that? Whether that's starting to level off? Or you're still seeing meaningful gains? How -- what's the trajectory look like there?

Alberto Sessa

We're still seeing meaningful gains for us. We participated and are participating in quite a few deals where we compete head-to-head with Sandvine, and we're taking market share from them. We're seeing bars and distributors continuing to come to us and say, okay, look guys we're looking for an alternative, we're seeing customers come to us saying that they're looking for an alternative. Sometimes they chose us, not always, but it does give us additional revenues and it is working in our favor.

Alex Henderson

And how are they reacting over there, I know now that's in the private equity hands. Are they holding the line on pricing? What's the competitive environment feel like from that perspective?

Alberto Sessa

I'm a bit hesitant because, obviously, I'm not privy to their internal decisions and discussions on what they do. There is a -- I would say that there are places where we see a strong competition from them, and there are places where we would have expected stronger competition and we see less of it.

Alex Henderson

So, pricing is generally stable then?

Alberto Sessa

Yeah, I don't think that there's -- I don't see any material change in the pricing levels.

Alex Henderson

That's what I was looking for.

Operator

[Operator Instructions] There are no further questions at this time. Mr. Antebi would you like to make your concluding statement?

Erez Antebi

Thank you. I'd like to thank you all for your interest and long-term support of our business. I will take the opportunity to point out that I'll be attending several conferences and non-deal investor road shows in the coming months, I hope to see some of you there. I'll be next week in the Needham Conference in New York, November 13, the Ideas Conference in Dallas, November 14, and in the LD Micro Conference in Los Angeles, December 4. So look forward to seeing whomever is interested there, and thank you very much, look forward to talking to you next quarter. Thank you.