Allot Communications (ALLT) Q1 2019 Earnings Call Transcript

Allot Communications (ALLT -1.86%)
Q1 2019 Earnings Call
May 14, 2019, 8:30 a.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Ladies and gentlemen, thank you for standing by. Welcome to Allot's first-quarter 2019 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've not received it, please contact Allot's investor relations team at GK investor, and public relations at 1 (646) 688-3559, or view it in the news section of the company's website at www.allot.com. I would now like to hand over the call to Mr. Gavriel Frohwein of GK investor relations. Mr.

Frohwein, would you like to begin, please?

Erez Antebi -- Investor Relations

Thank you, Gavriel. 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 the first quarter. The first quarter was another quarter of solid growth.

Our revenues grew 17% year over year for the first quarter. Our non-GAAP gross margins improved from 70% in the first quarter 2018 to 72% for the first quarter 2019, and our operational loss in the first quarter 2019 improved compared with the first quarter of 2018. All this, while continuing to grow and invest in our long-term growth through key R&D, marketing and sales investments. I'm very pleased with the results we achieved during the first quarter, and the main message is that we are on track with our plan.

We see a growing number of opportunities, we are continuing to win new deals and grow our revenues and we expect this trend to continue throughout 2019. 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 on track and 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're continuing to see an active market here, with a growing pipeline of opportunities for our Allot Smart product line.

We see similar use cases to what we saw in previous quarters. Smart traffic optimization, quality of experience, analytics and regulatory compliance. During the past few months, we announced deals from several different regions. In Japan, we announced earlier today that we partnered with Rakuten mobile to provide their Greenfield mobile network with several Allot's products, including our traffic management software, Networksecure and DDoS secure products.

Rakuten mobile, a subsidiary of Rakuten Inc. is a global leader in internet services. Rakuten mobiles fully virtualize cloud-native mobile network, and plan is targeted to launch in Japan in October this year. In the U.S., we announced our agreement with Mobilium, a global roaming provider, to provide Allot traffic management or DPI system to ensure quality of roaming for a Tier one U.S.

operator. This deal is in addition to a previously announced deal for IoT security to a different Tier one operator in the U.S. In Africa, we announced a deal with Safaricom, the largest mobile operator in Kenya to provide Allot traffic management, network security and DDoS security for their fixed network. It is noteworthy that while our Allot Smart traffic management products, and our Allot Secure security products are separate and used for different purposes, some operators choose to acquire and use products from both families, as evident by Rakuten mobile and Safaricom deals.

These wins are particularly important for a couple of reasons. First, we are expanding our customer base and we are entering new territories, such as Japan and the U.S. in which we have little presence in the past. And second, new wins with new operators provide a base for potential future revenue in expansions, renewals and services.

Increased opportunities resulting from CSP move to NFV environment, additional regulatory requirements posed by governments, and the expected rollout of 5G in certain geographies are contributing to our continued growth in the DPI business. Overall, we see a healthy pipeline for such visibility and control deals. As I mentioned in previous calls, this is good news as it enables us to continue growing even before the security domain comes in to full effect. Let's turn now to the security market, which we believe is our longer-term main growth engine.

As I mentioned in previous calls, we see a growing number of CSPs who understand the value in providing secure broadband services at a premium and understand that this is a combination of three elements: one, an important enhancement to their brand value; two, a potentially large new source of revenue; and three, a key element in their customer satisfaction. There are a growing number of CSPs issuing formal RFIs -- or RFPs, and at the same time, we're working on a growing number of potential deals that do not have such a formal process. This growing interest is across the breadth of the Allot Secure product family, including NetworkSecure, IoT secure, HomeSecure, DDoS secure, and a 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 location and platforms is one of Allot's key advantages.

We are participating in a growing number of opportunities that combine two or even three different products of the Allot Secure family. This is a strong testament that our strategy of enabling operators the capability to provide "anywhere, any device, any threat" protection to the customer and SMB market excuse me -- to the consumer and SMB market is gaining their acceptance. In January, we announced a deal with a Tier one European operator with approximately 2.5 million subscribers. This operator plans to launch a security offering -- a security as a service offering based on the Allot network secure product to its residential and SMB customers starting this summer.

Once the service is launched, I expect to be able to share more details. Rakuten mobile, as I just mentioned earlier expects to launch the service in Japan in October. This deal includes the traffic management component, a DDoS Secure product to protect the network itself and the NetworkSecure solution to protect end-user internet access. I believe the Japanese market with its large size, relatively high ARPU, and consumer willingness to pay for value has large potential for CSP-secure broadband offerings.

This win with Rakuten could potentially open the door for Allot to additional opportunities in the region. Recently, we also announced a deal with Safaricom, Kenya, to provide among else, NetworkSecure for their fixed broadband customers. Although, ARPU in Africa is generally lower than in the U.S., Japan or Europe, there is a significant portion of customers who pay much more than the average ARPU and these are the target customers for the security service in Safaricom. In Vodafone, our largest security customer penetration rates and the number of paying subscribers continues to grow, albeit at a slower rate than before.

As disclosed previously, Telefonica Madrid security services based on the Allot network secure products were launched in December, 2018 in Spain. Telefonica decided to launch a bundled service where they bundle speed, capacity and security together. Initial reception has been positive and the number of subscribers is steadily growing. It is however, still too early to analyze results and penetration rates.

Telefonica plans to launch similar services including security in Brazil, Argentina and Peru in the coming months. I remind you that both Vodafone and Telefonica deals were based on sales of perpetual licenses per subscriber. We're striving to change this model with future customers and are offering opex or recurring revenue-based deals. Not all operators will accept this model.

Rakuten mobile for example, demanded a long-term base license agreement. However, we are encouraged to see that more, and more operators are open to an opex model and this is the model in an increasing number of deals we're discussing. Another example for non-opex deals that we closed last year is with Telefonica Spain for the SMB market. The SMB customers enjoy network-based security provided by Allot technology together with endpoint app protection provided by McAfee.

In this deal, the security revenue was shared between Telefonica Spain, Allot and McAfee. I'm glad to inform you that the service was finally launched several days ago. Opex deals like this contribute little to bookings and revenues in the short term. So securities bookings and revenues may appear not to grow enough.

However, it is these types of deals that will ensure recurring revenues, 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 security deals and then work together with them to grow the number of end customers subscribing to the security service thereby generating a significant amount of recurring revenues. We are engaged at several stages with a large number of additional operators for more security deals on all the various elements of the Allot secure family and I'm very encouraged by the size of our pipeline and the interest within the CSPs to launch such security services for the mass market. Looking at the initial security opex deals we signed, the growth and tenders and RFPs that were issued and the healthy pipeline we have in hand, I'm confident that we are heading in the right direction and optimistic about this market segment and our future growth in it.

As you know, working with CSPs takes time, with sales cycles typically exceeding 12 months. So it's still takes a bit longer than we would've liked to close these deals. To help us measure the potential of the aggregated security opex deals we signed and our progress in this area, I introduced in the previous earnings call a metric we use internally that we call maximum annual revenue or MAR for short. I would like to repeat the definition and explanation of this metric.

MAR reflects the annual revenue Allot will receive should 100% of the CSPs relevant customer base sign up for the security service. Of course, we do not expect 100% of the operators customers to sign up for the security service. So the actual revenues Allot will get are expected to be the MAR multiplied by whatever the penetration rates will be. In Vodafone's case, penetration rates of the service after three years vary from 15% up to 50%, and more depending on the go-to-market strategy and the emphasis put on the service.

To clarify by way of a hypothetical example, assume we signed a deal with a hypothetical mobile operator that has 5 million postpaid customers, and we target the security service for all postpaid customers, assume further that based on the agreement with the operator, Allot expects to receive $0.5 per subscriber per month. The MAR of this hypothetical opportunity will be 5 million times $0.5 times 12 equals $30 million. If we reach in any given year average penetration of 20% of the subscriber base, the actual revenues for Allot in that year will be 20% of the $30 million, equals $6 million. I would now like to summarize the overall picture of the key messages.

We are proceeding according to plan and growing the business. I believe our first-quarter numbers are a testament to that. In the visibility and control area, we have a growing number of opportunities in several areas. We see longer-term opportunities as operators move to NFV as 5G networks are deployed, and as government demand more regulation on internet access.

Based on the pipeline, I expect this growth to continue into 2019. In the security area, which we see as our major long-term growth engine, we have signed initial deals for Allot Secure products including several security opex deals. Our pipeline of security opex deals is very encouraging, it is expanding, and most operators are accepting of the opex or revenue share model we offer. I expect we will sign additional security opex deals throughout 2019.

From a product perspective, we are progressing well, and achieving advantages over our competition, such as in NFV capabilities. We're also investing more in artificial intelligence and machine learning technologies to create further technological differentiation in both visibility and control, and security domains. Based on our results so far, and on the growing and strong pipeline of new deals, I would like to reaffirm our expectations for 2019 revenues to be between $106 million and $110 million with the second half of the year higher than the first half. We expect book-to-bill for the full year 2019 to be above one.

Regarding security opex deals, I believe we are on track toward our goals to sign security opex deals with an aggregate MAR of $100 million during 2019. And now I would like to hand the call over to Alberto Sessa, our CFO. Alberto, please go ahead.

Alberto Sessa -- Chief Financial Officer

Thank you very much, Erez. Before I begin reviewing the financial results for this quarter, and for the year, I would like to inform everyone that on this call unless otherwise noted, I will refer entirely to the non-GAAP financial measures when discussing operational results, which is what we use internally to judge the performance of our business. Non-GAAP financial measures differ in certain respects from the generally accepted accounting principle, and exclude share-based compensation expenses, expenses related to M&A activities, amortization of certain intangible assets, change in deferred tax and exchange rate differences related to the revaluation of assets, and liabilities denominated non-dollar currencies with regard to the financial results. Revenue for the first quarter 2019 were $25.3 million, growing by 17% compared with those of the first quarter of 2018.

Regarding the details of the revenue breakdown and diversification. The geographic breakdown of revenues for the first quarter of 2019 was as follows: Americas with $4.8 million or 19% of revenues; EMEA with $10.7 million or 42% of revenues; and Asia Pacific with $9.8 million or 39% of revenues. Product revenues for the quarter accounted to $16 million or 63% of total revenues compared to $13 million in Q1 2018. Professional service revenue were $0.8 million or 3% of total revenues compare to $0.9 million in Q1 2018.

Support and maintenance revenue were $8.5 million or 34% of total revenues compare to $7.8 million in Q1 2018. Communication service provider or CSP revenues were 83% in the first quarter of 2019 compared to 75% as reported in the first quarter of 2018. I note that revenue breakdown whether geographical or by product segments or other may fluctuate from quarter to quarter depending on the specific revenue and deals recognized in the specific quarter. Our top 10 end customer made up 62% of revenues, and this is compared with a concentration of 56% last year.

Gross margin for the quarter were 72.4% compared to 69.6% in the first quarter of 2018. The main reason for the increase in gross margin is related to specific deals with high profitability recognized during the first quarter 2019. Going forward, it is important to understand that we expect gross margin on a quarterly basis to fluctuate, even significantly as a result of recognition of certain outgoing currency build we already have in our backlog. Operating expenses for the quarter were $20.2 million compared to $17.5 million as reported in the first quarter 2018.

The increase in operating expenses is mainly due to increase in headcounts. The total number of full-time employees as of March 31st, 2019 were 536, up 12 since the end of December. Non-GAAP operating loss for the quarter was reduced to $1.8 million compared with an operating loss of $2.3 million in the first quarter of 2018. Net loss for the quarter improved to $1.9 million or $0.05 per share versus $2.4 million loss or $0.07 per share in the first quarter of 2018.

Turning to the balance sheet. Our cash revenues comprised of cash -- our cash reserves, sorry, comprised of cash, cash equivalents and investments as of March 31st, 2019 remain strong and total $101.5 million compared to $103.9 million at the end of December, 2018. The number of basic shares for the first three months of 2019 was $34 million and the number of fully diluted shares was $35.7 million. In terms of guidance, as Erez mentioned, we are reaffirming our guidance, and expect revenue to grow to between $106 million and $110 million in 2019, with the second half of the year higher than the first, representing continued year-over-year revenue growth.

We also continue to expect book-to-bill for the year to be above 1. We expect gross margins for 2019 to be approximately 70%. As I mentioned in our last call, we will also continue to invest in those areas that will serve the growth of the company, mainly sales and marketing and R&D. And that concludes my remarks.

We will be happy to take your questions now. Operator?

Questions & Answers:

Operator

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

Roger Boyd -- Needham and Company -- Analyst

Hey, thanks. This is Roger Boyd on for Alex. Pretty nice results in the quarter. I'm wondering, how does this affect the second quarter, was there any timing-related shifts in the quarter? And then on gross margin, was this mainly a factor of more software-focus deals coming through? I know you'd spoken in the past about some hardware-intensive upfront cost affecting the first half, I'm wondering, maybe, if that could shift to the second quarter? And then similarly, with Rakuten, if there is a hardware built out prior to October that might affect margins as well?

Alberto Sessa -- Chief Financial Officer

OK. So first of all, regarding the gross margin, you mentioned the gross margin of increasing gross margin, and as I said earlier, the main reason for that increase in gross margin this quarter is the regulation of bill with high profitability during the quarter. Going forward, as I said before, it would be important to understand that we expect gross margin on a quarterly basis to fluctuate, and those kind of deals that you mentioned that are early hardware related with a lot of hardware, our recognition of them is still to be recognized meaning that we still have debts in the backlog. From a timing point of view, those kind of deals will be recognized probably in the next quarter or the quarters to come, and that will affect the gross margin.

Overall, as I said in my -- as I said earlier, we do expect on a yearly base to be on a 70% gross margin.

Erez Antebi -- Investor Relations

And just to address, Alex your question on Rakuten. Rakuten is building a completely virtualized core network so we will be providing software, professional services support, but we will not be providing -- we will not be selling any hardware to Rakuten.

Roger Boyd -- Needham and Company -- Analyst

OK, makes sense. And then maybe just qualitatively, I know you spoke a little bit about it, but any other details on customer reception toward the SaaS, opex proposals? Do you think that customers are more likely to use kind of the support approach where Telefonica is using SaaS for their SMB business, is that a similar trend you're seeing or -- and I guess, you'd like to see the whole deal, but any thoughts there?

Erez Antebi -- Investor Relations

If I understood the question correctly, I don't think I can differentiate between customers who are looking at different approach for consumer versus their SMB customers. I think at least what I'm seeing is that, there are simply customers that are more comfortable with an opex-type deal, some customers are more comfortable with revenue share and some really want more of a capital expense. So it's not so much dependent on the market segment, meaning consumer SMB or enterprise, it's more depending on the operator itself.

Roger Boyd -- Needham and Company -- Analyst

OK. Makes sense. That's it for me.

Operator

The next question is from Marc Silk of Silk Investments. Please go ahead.

Marc Silk -- Silk Investments -- Analyst

Thanks for taking my questions, and great progress. On -- Let's say long-term, next three to five years out, on your security offerings what do you look -- what's your goal for recurring revenue like going forward, like 50%, 25%?

Erez Antebi -- Investor Relations

I think it should be a very significant portion of our revenues. I don't want to give you an exact percentile for three years out and five years out, and so on but since this is the main growth engine and I expect us to continue to grow at the current pace or even more, and most of it will come from recurring revenues, then yes, this should take up an increasingly going percentage of our revenues and should be very substantial.

Marc Silk -- Silk Investments -- Analyst

That's a fair answer. And then -- but it sounds like some of your customer base, like you said, does not necessarily want to do the revenue share, so it's kind of going to be up to the customer going forward, is that --

Erez Antebi -- Investor Relations

That's correct. Because honestly, if a customer comes to us and is willing to offer -- is willing to do a deal with us but there's a fair value there for us and for them and they're only willing to do it in the capex mode than we think they will be practical, we won't say no, we won't turn them down. But I expect that the way I look at it now, I think the majority of customers will opt for some form of opex or revenue share agreement.

Marc Silk -- Silk Investments -- Analyst

That's exciting. And my last question on DPI -- oh, sorry.

Erez Antebi -- Investor Relations

No, I was just saying, it's a lower risk offering for them, and most operators I'm familiar with today have significant capex constraints. So that's why it feeds into that.

Marc Silk -- Silk Investments -- Analyst

Yeah, because I think recurring revenue is going to be better than your multiple going forward. So my last question is on deep packet inspection, I know you make -- you're surprising us on that, it's not obviously not dead. Can you comment on what's going on in the United States because there are still question marks as far as how thorough if you want to use deep packet inspection until they have a finite answer from the government?

Erez Antebi -- Investor Relations

Well, we're seeing more interest in DPI in the United States then at least we saw a year ago. But still, this is not something -- and you know, we just told you that we announced a deal with Mobilium, it is a DPI deal, it is for a U.S. Tier one operator, so evidently there is movement in the U.S., but it's not huge. I don't see all the major carriers going out and starting to acquire DPI or demand it and so on.

We are seeing more interest, but I don't think these are very significant numbers yet for the U.S. market.

Marc Silk -- Silk Investments -- Analyst

Thanks for taking my questions. Keep up the good work.

Erez Antebi -- Investor Relations

Thank you.

Alberto Sessa -- Chief Financial Officer

Thank you.

Operator

[Operator instructions] The next question is from Jeff Bernstein of Cowen. Please go ahead.

Jeff Bernstein -- Cowen Inc. -- Analyst

Hi, guys. Just a quick one. You talked about the Telefonica launch in Spain being part of a speed, capacity and security kind of bundled offering, do you have any visibility on what the plans are for Brazil, Argentina, Peru? Are they also going to be in some kind of bundle like that?

Erez Antebi -- Investor Relations

We have some visibility, but -- and that -- and yes, I mean, we have a difference. I'll rephrase that, sorry. We have these abilities, since we're talking to Telefonica, and they're sharing with us at least some of their ideas. On the other hand, I don't -- I can't tell you for sure if that's exactly what they're going to launch.

And I'm not sure that they have themselves decided finally exactly how it's going to go. I would expect that most of them will be similar, will be a similar bundle. But I cannot tell you that for sure.

Jeff Bernstein -- Cowen Inc. -- Analyst

Gotcha. And then a couple of questions about other stuff going on around the industry, around what you're doing. I guess there was something out about Telefonica and its launching its own IoT cyber security unit, and business called ElevenPaths. You know, what does that kind of mean to you? Or you just take that as an elevation of interest in this kind of thing for carriers etc.? And then I had one more.

Erez Antebi -- Investor Relations

ElevenPaths is a subsidiary or a business unit of Telefonica that deals in various things but mostly around security. We're working very closely with ElevenPaths. A lot of the work that was done on the ne-ge security service, which they have launched in Spain and expected to launch in other places was originated by ElevenPaths, and we worked with ElevenPaths on the definitions for that on how the bundle would work, how it will work technically and so on. And one of their initiatives or one of the things that they're working on and that we're talking to them about is also how to provide IoT security.

Jeff Bernstein -- Cowen Inc. -- Analyst

Gotcha, that's great. Thank you. And then lastly, do you have quasi competitors Cyan AG, a German company that's focused I guess more on DDoS, etc. and they won a pretty big deal with Orange.

Just interested in kind of what went on there, and what your thoughts are about that segment, etc.?

Erez Antebi -- Investor Relations

I think the Cyan indeed won a deal with Orange. As they won a deal, I'm not sure that they won anything on DDoS, I may be mistaken, but that's not what I'm familiar with, basically they won a deal for the small and medium businesses, security with Orange. And yes, it's unfortunate that a competitor of ours has won a deal. I think the fortunate part of it is that you see that more and more operators are indeed going to provide security services to their customers and we are seeing more traction in the market, and that will obviously bring competitors whether direct or with a different offering.

Overall for the market, it's good news. What went on there I think we just -- we were not, we were not doing I think our sales job as properly as we should have probably in Orange. But we have not given up.

Jeff Bernstein -- Cowen Inc. -- Analyst

Gotcha. And I'm sorry, I think, I misspoke, I think it was more that their security technologies is more DNS-based rather than DPI-based?

Erez Antebi -- Investor Relations

Yes, it is, it's more DNS-based. It's -- the DNS-based technology is one which is inferior in its security capabilities to the in-line security capabilities that we are offering. It is however, easier to install into network. So there's a trade-off there.

I think that as time goes by, we will see less and less -- we will see less operators willing to go with DNS because I think honestly, it's less future proof them in-line offering that we are providing. The time will tell.

Jeff Bernstein -- Cowen Inc. -- Analyst

That's great. Thank you.

Operator

The next question is from Nahum Mosette. Please go ahead.

Unknown speaker

Yeah. How are you doing? I'm [Inaudible]. Thank you so much for taking my call, and congratulations for the great quarter and the growth.I wanted to ask you, when you gave the anticipation, you anticipated growth for the year, it was about 14% expected. That was very important to whole year 2018, fourth quarter of 2018, and actually now you posted a growth of 17%.

So I wanted to know, what does it mean, does it mean that the rest of the year you anticipate a slower growth? Or maybe does it mean that you will give a higher anticipation for the year, and if yes what do you think is the higher anticipation?

Erez Antebi -- Investor Relations

Well, I mean the numbers for the first quarter are what they are, and that was a 17% growth as we said. For the full year, you know is affected by various parameters, and we gave our guidance to finish the year between $106 million to $110 million, so it's not a specific growth number, if you do the math it will simply be a range. We still believe that that's the range we will be in. I'm not sure how to further address your question.

Unknown speaker

What I mean is, if you anticipated a 14% growth, how you gave 17%, so will it be the same percentage of growth in the rest of the year?

Erez Antebi -- Investor Relations

No, I didn't -- but we didn't, never said a 14% growth in 2019, we said that the end result will be $106 million to $110 million which will give a range that we can calculate in a second, but I didn't yet. And we said that the second half will be stronger than the first half but again, I don't know numerically how to add any more information.

Unknown speaker

OK. Great. Thank you very much, and keep up the good work.

Erez Antebi -- Investor Relations

Thank you.

Operator

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

Erez Antebi -- Investor Relations

Yes. Thank you. On behalf of myself and the management of Allot, I would like to thank you for your interest, and long-term support of our business. Alberto, our CFO will be in the U.S.

next week meeting investors in Chicago, and attending the Needham emerging technologies conference in New York. If you would like to meet him, please contact our investor relations team, we will be happy to meet with you. And I look forward to talking to you in the next quarter. Thank you and have a good day.

Operator

[Operator signoff]

Duration: 41 minutes

Call participants:

Erez Antebi -- Investor Relations

Alberto Sessa -- Chief Financial Officer

Roger Boyd -- Needham and Company -- Analyst

Marc Silk -- Silk Investments -- Analyst

Jeff Bernstein -- Cowen Inc. -- Analyst

Unknown speaker

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