Allot Ltd. (NASDAQ:ALLT) Q2 2023 Earnings Call Transcript

Allot Ltd. (NASDAQ:ALLT) Q2 2023 Earnings Call Transcript August 31, 2023

Allot Ltd. beats earnings expectations. Reported EPS is $0.49, expectations were $0.16.

Operator: Ladies and gentlemen, thank you for standing by. Welcome to Allot’s Second Quarter 2023 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 EK Global Investor Relations at 1-212-378-8040 or view it in the news section of the company’s website at www.allot.com. I would now like to hand over the call to Mr. Kenny Green of E.K. Global Investor Relations. Mr. Green, please begin.

Kenny Green: Thank you, operator. Welcome to Allot’s second quarter 2023 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; and Mr. Ziv Leitman, CFO. Erez will summarize the key highlights, followed by Ziv, who’ll 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 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 now like to hand the call over to Erez. Erez, please go ahead.

Erez Antebi: Thank you, Kenny. I’d like to welcome all of you to our conference call. Thank you for joining us today. Our second quarter revenues were $25 million, 24% lower than the comparable quarter last year. In June 2023, our SECaaS ARR was $9.7 million, 4% higher than our SECaaS ARR in March 2023 and 41% higher than our SECaaS ARR for June 2022. The first half of 2023 was challenging for us. The transition of the business into SECaaS recurring revenue model has proven to be slower than we originally anticipated. In addition, our core DPI business is experiencing some macro-related headwinds. While we don’t expect these challenges to disappear in the near term, given the challenging economic backdrop, we continue to make progress with the aspects of the business that we can control.

I remain optimistic about our future. During today’s call, I will discuss the challenges we are facing, the opportunities we see and why I am confident in the future. During the second quarter, our cash balance fell by $11 million as a result of Allot’s inventory increase and accounts payable decrease. This cash burn is, of course, higher than we would like it to be. As our cost-cutting efforts come into effect partially in the fourth quarter and in full in 2024, together with a projected increase in revenues, we expect to improve our cash flow and we are reiterating our expectations to be profitable in 2024. Our gross margin in the second quarter was 71% due to our deal mix. We continue to target a gross margin of 70% for 2024 despite expecting a lower gross margin in Q3 as a result of the specific deal mix.

In July, we announced an increase of approximately $14 million in the allowance for credit losses relating to receivables arising from sales in three African countries. We have been assessing the collectibility of these accounts receivable on a quarterly basis, and in our most recent assessment, the company determined that these accounts previously disclosed as outstanding would not with reasonable certainty be collected. We are continuing our efforts to collect these amounts and believe we should be able to collect them. However, as I said, we could no longer state this with reasonable certainty, so we took an allowance for credit losses. As we announced in July, given the challenges facing our business, the Board formed an executive committee that has worked with management to identify and recommend opportunities for further improvement with a focus on driving sustainable profitability and enhancing shareholder value.

The executive committee and management agreed that the right direction is to maintain SECaaS as our main growth engine. In this area, we will continue to focus on network native security solutions. In our traffic management and analytics solutions, we are modifying our initiatives to prioritize profitability. In order to conserve cash, reach profitability in 2024, and ensure that we have staying power even as SECaaS takes longer to ramp up, we are implementing a cost reduction plan. Specifically, our actions will result in a reduction of approximately 20% from our current employee headcount as well as other cost reductions. We expect this cost-cutting effort to save approximately $15 million per year. The relevant employees that may be affected have already been notified.

This cost reduction plan will have a onetime cost of approximately $2 million, which will be booked in the third quarter. Now, I would like to discuss our different product lines. I would like to start by discussing our traffic management and analytics business addressed by our Allot Smart product line. The main use cases we see today in CSP continues to be in traffic management, congestion management, quality of user experience, especially for video, policy and charging control and digital enforcement. As governments look to fight crime and terrorism, we see a growing interest globally and being able to block illegal activities such as drug trafficking, child phonography and terrorism. We have solutions that address these issues, and we are seeing growing interest in our products.

We will continue to pursue this direction as we believe this is a segment that will continue to grow. In CSPs, we see the need for analytics continuing. In traffic management use cases, such as fair use, policy-based charging and congestion management, we still see quite a few opportunities from low ARPU countries, some of which are to replace a competitive product. In our enterprise business, we continue to see demand for on-prem systems such as ours from enterprises in developing countries where bandwidth is relatively expensive. In developed countries, such as North America and Europe, we see reduced demand from enterprises that are moving to the cloud, with growing demand from government entities that require monthly for security reasons, on-prem solutions.

Currently, after our deal with Broadcom, we remained the major solution provider for this need. Overall, we recognize that we are facing several challenges that continue to make it more difficult for us to forecast our business over short timeframes. First, as we discussed in previous earnings calls, due to tighter headwinds and tighter expense control by the CSPs, it is taking longer to close DPI deals than in the past. And the total number of DPI bids for CSPs we are seeing is not growing. Second, the move of CSPs to 5G standalone port is very slow, negatively impacting our ability to grow our 5G NetProtect product. Third, in the enterprise market, we believe the growth we saw as a result of the Broadcom deal has peaked. As we stated in our last earnings call, while we continue to have a strong pipeline of large deals for the remainder of the year, the dynamics I just mentioned, together with the potential lumpiness of large deals, makes it challenging to forecast our DPI business over short timeframes.

I want to turn your attention now to what we see in our cybersecurity business and how the market is developing. As I have said previously, Allot is transforming into a cybersecurity company and this is where we see most of our future growth coming from. Our SECaaS revenues are growing steadily, albeit not at the pace we would like, as we continue to see slower deployment than expected. Nevertheless, there are quite a few positive notes worth highlighting. I would like to start with the North American market. I am very happy to announce that a couple of months ago, Verizon Business launched their network native security service, which incorporates Allot NetworkSecure. I am very excited about this offering from Verizon, which provides protection services for segments of Verizon’s fixed wireless broadband business customers and help defend them against cyberthreats.

This cybersecurity service puts a layer of defense at the Internet [indiscernible], intersecting threats before they can even reach devices. Verizon believes that simple zero-touch solutions like ours are especially helpful for small businesses, which might not have in-house expertise to manage more complicated security measures. The service is being well received, and we are discussing with Verizon various ways to expand its reach. I will note that Verizon did not generate any SECaaS revenues for Allot during the second quarter, but Verizon will begin contributing to revenues in the third quarter. As I stated in earlier calls, I continue to believe that the Verizon opportunity is our single largest signed SECaaS opportunity. Furthermore, as other CSPs see Verizon’s success, I believe some will follow suit.

We are already getting enhanced interest from other operators to better understand what Verizon is doing and how they might do the same. On a bittersweet note, one of the operators we signed was a Canadian CSP, has decided not to launch the SECaaS service for now, as they are refocusing their business following a major network issue they had unrelated to Allot. This CSP is also an Allot Smart customer and have recently expanded significantly the [indiscernible] business they have with us. Cancellation of this SECaaS launch is a significant contributor to the reduction in our ARR forecast for the year. In APAC, we are also progressing well. Recently, we signed two additional SECaaS deals in APAC. One is a relatively small deal, where we deploy NetworkSecure in a small Pacific Island.

The other is a DNS Secure deal with a major Tier 1 telecom operator with more than 50 million subscribers, most of whom are prepaid. The services will initially be offered to their postpaid customers and potentially later to other high-value customers. I believe these deals are a testament to the importance CSPs see in providing business and consumers with network-based security services. Also in Asia, Far EasTone, or FET, in Taiwan has experienced a very successful launch. Since the launch in December of 2022, the service has been expanding rapidly and we are now in the process of expanding the capacity to handle more subscribers. I will note that our ARR from FET has not been growing even as the number of subscribers has ramped because FET committed to a minimum payment per month from day one.

That minimum has been exceeded, so we should start seeing ARR growth as the number of subscribers grow. FET and their presidents look at security service as strategic and important to their brand image and in line with their core commitments to their customers. As we discussed in the past, this is an excellent example of how successful SECaaS can be when the CSP aligns security with its strategy. It is noteworthy that this FET experience shows that on average, the security services blocked 47 attacks per user per month. I believe this is a strong validation of the importance and value of the network native security solution. As we look at the market, we see that the direction and momentum of operators interested in launching network-based security services continues to be positive.

We see that in many markets, with various operators provide services that are on par with respect to speed, coverage and reliability. As they look for differentiation, network-based security is emerging as an important element. Because it is a service native to the operator’s network, network security is directly coupled to the access network itself. There are several Tier 1 operators who have reached the conclusion of providing network-based security to their customers is of significant importance to them and they are discussing with us how to do so. In addition, we are in discussions with several other operators globally, where we hope to be able to conclude deals over the coming months. I would like to say a few words about convergence. CSPs worldwide, have been talking about convergence for quite a few years, mostly combining their fixed and mobile services.

Unfortunately, many CSPs have been struggling to bring tangible value to their customers and basically provide unified billing and discounts. The Allot Secure platform combine security enforcements in the core on the DNS line and in the router under a unified management system and protocol. This is perhaps one of the few tangible convergence value CSPs can bring to their customers, offering a unified experience on both mobile and fixed access. We don’t see CSPs starting with a convergence offering but we are in discussions with several CSPs in Europe that have launched our SECaaS service to mobile customers and are looking to expand it to a converged mobile plus fixed offering. As we discussed in previous calls, I want to remind you that we changed our strategy for the Allot Secure business.

We are putting more emphasis on large strategic accounts that can have a high revenue impact, while in small to medium deals, we are looking for minimum revenue thresholds. These changes reduce the number of new CSPs we can sign up. However, it allows us to focus our resources on the smaller number of CSPs that see more strategic value in the SECaaS service, which should drive profitable revenue growth for Allot. We remain excited about our SECaaS opportunity as we have a differentiated, scalable solution for CSPs. Our SECaaS revenues for the second quarter were $2.4 million and the SECaaS ARR at the end of the second quarter was $9.7 million, a significant growth year-over-year. As of June 30, 2023, we have 28 signed customers, but seven of them have been canceled and discontinued mainly due to our strategy to focus on large customers.

Unfortunately, only 14 have started to generate revenues. Most of them are relatively small operators and the majority of them launched the service only to a portion of their subscriber base. There are a few more launches planned for this year. Looking ahead, I want to summarize our expectations for 2023. We expect SECaaS revenues for 2023 to be around $11 million. We expect the SECaaS ARR for December ’23 to be between $12 million and $14 million and our total ARR, including support and maintenance, to be between $51 million and $55 million. Regarding our total revenue, operating loss and cash flow guidance, we are providing a wide range because of a specific large expansion deal we expect to close this year. We expect our total revenues for the full year 2023 to be between $95 million and $110 million.

Non-GAAP operating loss to be between $38 million and $44 million, including the $14 million doubtful debt reserve. And cash burn for the whole year to be between $24 million and $44 million. As I stated, we remain committed to reach profitability for the full year 2024. This will be achieved through some revenue growth, mainly in SECaaS combined with tight expense control. We expect the third quarter revenues to be approximately $25 million, but with a lower-than-average gross margin of 50% due to the specific expected deal mix. Our strategy remains the same. While we believe that our DPI business has limited growth potential and the lumpiness of the business makes it difficult to forecast over short timeframes, we think we can maintain a stable level of revenues through new use cases and market share gains, and we are using DPI’s profitability and cash flow generation to invest in our SECaaS business, because our SECaaS business is where we see significant future growth opportunities.

While our SECaaS revenues are being recognized later than we would have liked and later than we expected, I remain convinced of the large potential of this business and I’m confident that it will grow significantly in the coming years. I have full faith in our company, our team and our products, and I believe the actions we are taking to make our goal — and I believe in the actions we are taking to make our goals achievable. And now, I would like to open the call for questions and answers. And Ziv and myself will be available to take your questions. Operator?

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Q&A Session

Operator: Thank you. [Operator Instructions] The first question is from Eric Martinuzzi of Lake Street. Please go ahead.

Eric Martinuzzi: I have a question regarding the bad debt write-off, the $14 million credit allowance. Are we still doing business with the reseller or resellers in Africa that were responsible for that write-off?

Ziv Leitman: Hi, Eric. We are not doing new business with this reseller, but we are making an effort to collect the money. But we don’t have any new deals.

Eric Martinuzzi: All right. The strategy examination that you announced on July 17, are we complete with that? Or is that still an ongoing process? Obviously, we’re focused on growth on SECaaS and a return to profitability. But does that say that the strategic examination is complete?

Erez Antebi: I would say that we’ve done a lot of work over the past few weeks on this. We’ve reached some high-level conclusions both on the general strategic direction that we are continuing to focus on the SECaaS opportunities because we believe in it. We’ve reached the conclusion that we need to significantly reduce our cost structure, which we are implementing already. And I think that we will continue to work to see how we both implement this and continue to bring the company back to growth in the future. So I wouldn’t say it’s complete. I would say it’s a work in process, but we’ve done a lot until now.

Eric Martinuzzi: Okay. And I appreciate the color on the full year outlook as well as the Q3 revenue of $25 million and I think you said it was 50% on the gross profit. What should we be thinking about for a normalized operating expense post the restructuring?

Ziv Leitman: So, as we said, the total cost reduction is supposed to be around $15 million on a yearly basis. And let’s assume the baseline could be Q2 expenses, most of this will be in the OpEx, smaller part, it will be in the core. But all together, as we said, we are positive — will be positive in 2024.

Eric Martinuzzi: Understand. Thanks for taking my questions.

Operator: The next question is from Nehal Chokshi of Northland Capital Markets. Please go ahead.

Nehal Chokshi: Yes. Thanks. Ziv, I’m sorry, I couldn’t hear you that well. What was the comment — what was the detail on the OpEx run rate that you had just given out? Could you say that again? I’m sorry.

Ziv Leitman: So, the baseline is the Q2 expenses, and the $15 million reduction in cost, most of it will be in expenses and in smaller part will be in the core. But all together, this should bring us to be profitable in 2024. But as was mentioned, we will see the full effect of this cost cutting on the results at the end of the year.

Nehal Chokshi: Okay. Understood. And when you say profitable in calendar ’24, does that mean profitable in each quarter of calendar ’24, profitable for the full year ’24, or just profitable by the end of calendar ’24?

Ziv Leitman: It means full year of 2024, doesn’t mean each one of the quarter, as we mentioned already in the previous quarter.

Nehal Chokshi: Okay. And so, looking into the September quarter, what’s the worst-case scenario you see transpiring with respect to the DPI business?

Ziv Leitman: Not quite sure how to answer that. I know that’s — and honestly, I’m not quite sure of the question. We gave you the forecast for the revenue — or the guidance, I would say, for the revenues in third quarter. So, maybe if you can elaborate what you’re looking for, I can try and help.

Nehal Chokshi: Yes. Okay. Let me be a little bit more explicit. So, your full year guidance of $95 million to $110 million, that’s a big range given that you have two quarters left. And what I’m trying to figure out is, if — you basically see this $25 million that you did in the June quarter as a sustainable level given your order book and the uncertainty is with whether or not you have an inflection in DPI within the December quarter, or is there uncertainty with respect to even the September quarter revenue level?

Ziv Leitman: So, Nehal, as we talked about this issue also in previous quarter. Even at this point, one month before the end of the quarter, we don’t have all the revenues in hand. So, when we say that’s our focus for the third quarter, the $25 million, this is our focus. We don’t have it in hand. So for June, we don’t have all the revenues of Q2 in hand. So, when we said that the range is $95 million to $110 million, this is our forecast. It doesn’t mean that we have in hand the $95 million and we are just waiting for [the uptick] (ph). This is the normal course of the business. It was the same situation also a year ago and two years ago.

Nehal Chokshi: Okay. Understood. And how do you know that the DPI softness is definitively macro related as opposed to say, hey, encryption is reducing irrelevant to the DPI market or some other market phenomenon that might be going on?

Erez Antebi: Again, I think it’s very hard — it’s hard for me to really differentiate what the macro level consists of. I do see the operators tightening very much their budgets and expenses. You’ve seen operators in the U.S. announced layoffs and reduction in costs. We’ve seen that in operators in Europe. So this affects, I think, not only Allot, I think it probably affects other technology providers who are selling to the operators. Now, I don’t think that there’s — I don’t see technically a material change in the ability of DPI to provide value because of encryption or something like that. We’re dealing with increased encryption and we have certain algorithms and I would say, certain algorithms, some of them [indiscernible] some of them based on AI and machine learning to help us cope with that.

I don’t think that, that’s a major contributor, but the macro environment is definitely harder for operators today and as a result for companies providing them with the technology.

Nehal Chokshi: Okay. Great. Thank you for answering my questions.

Operator: The next question is from Marc Silk of Silk Investment Advisors. Please go ahead.

Marc Silk: Excuse me. Thanks for taking my questions. I had questions on the July 20 announcement of a Tier 1 with more than 50 million, mostly prepaid customers. So, you’re initially offering it to the postpaid customers and then potentially to other high-value customers. Does that include the prepaid customers? Or that’s basically something that’s not a product for prepaid?