Allot Ltd

NASDAQ:ALLT

Earnings Call Analysis

Earnings Call Transcript 2023-Q3

[Operator]

Ladies and gentlemen, thank you for standing by. Welcome to Allot's Third Quarter 2023 Results Conference Call. [Operator Instructions] I would now like to hand over the call to Mr. Kenny Green of EK Global Investor Relations. Mr. Green, would you like to begin?

[Kenny Green]

Welcome to Allot's Third Quarter 2023 Conference Call. I would like to welcome all of you to the conference call, and I'd like to 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 provide an opening statement and summarize the key highlights of the quarter. We will then open the call for the question-and-answer session, and both Erez and Ziv will be available to answer those questions. You can also find the financial highlights and [indiscernible] discussed on the conference call in the earnings release issued last year. Before we start, I'd like to point out the following safe harbor statement. This conference call contains projections or other forward-looking statements regarding future events or the future performance of the company. These statements are only predictions, and a lot cannot guarantee that they will, in fact, occur. Allot does not assume any obligation to update as actual events or results may differ materially from those projected, including as a result of changing market trends too the launch of services by customers, reduced demand or the competitive nature of the security services 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, executive]

Thank you, Kenny. I'd like to welcome all of you to our conference call. Thank you for joining us today. Our third quarter revenues were $22.6 million, 10% lower than the comparable quarter last year. In September 2023, our SECaaS ARR was $10.6 million, 9% higher than our SECaaS ARR in June 2023 and 52% higher than our SECaaS ARR for September 2022. 2023 continues to be very challenging for us. The transition of the business into SECaaS recurring revenue model has proved to be slower than we originally anticipated. In addition, our core DPI business is experiencing 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. During the third quarter, our cash balance fell by $5.5 million, mostly as a result of the operating loss and decrease in accounts payable. Cash burn continues to be a major area of focus for us. As our cost-cutting efforts come into effect partially in the fourth quarter and in slow in 2024, we expect to improve our cash flow. While our visibility remains challenged, we remain committed to reaching profitability in 2024. Our gross margin in the second quarter was 48% due to our deal mix. We continue to target 70% gross margins for 2024, consistent with our historical performance. As we announced in July, given the challenges facing our business, the board formed an executive committee that has worked less management to identify and recommend opportunities for further improvement with focus of driving sustainable profitability and enhancing shareholder value. The executive committee and management continue to work together to prepare the budget and operating plan for 2024. As we discussed in the previous call, in order to conserve cash, reach breakeven profitability in 2024, and ensure that we are staying power even as SECaaS takes longer to ramp up. We implemented a cost reduction plan towards the end of the third quarter. We reduced approximately 30% from our employee headcount from the end of the third quarter of 2022 to the end of 2023 while also implementing other cost reductions. Our third quarter numbers include a one-time with cost of approximately $1.5 million. As you know, Allot operates in two business lines; Allot Smart and Allot Secure. On the Allot Smart front, while we continue to see growing interest globally from government as they look to block activities such as direct trafficking, child pornography and terrorism, our CSP and enterprise businesses remain soft. While some of the weakness is due to cutbacks in spending, we also recognize the need to continue shifting our resources and focus to developing countries and governments as developed countries and enterprises embrace the cloud. On the Allot Secure front, while spending by CSPs remains challenging, our SECaaS revenues are growing steadily. While we are not seeing the pace of growth we had expected given the slower deployment, there are quite a few positives who are siding. I would like to start with the North American market. Verizon business has successfully launched their network native security service, which incorporates our wealth network secure. The launch is going well. The number of customers is growing, and we are discussing with Verizon several expansion opportunities to different customer segments. While we cannot be assured of our success in adding additional customer segments, I believe Verizon is the largest signed SECaaS opportunity for ours. 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. In APAC, we recently launched another SECaaS service in Tonga. As this is a small deal, we guaranteed the revenue for a lot regardless of penetration as per the revised direction we have previously explained. We remain excited about our SECaaS opportunities as operators continue to be interested in launching network-based security services, and we have a differentiated, scalable solution for CSPs. Looking ahead, I want to summarize our expectations for 2023. We expect SECaaS revenues for 2023 to be around $10.5 million to $11 million. We expect to SECaaS ARR for December 2023 to be between $12 million and $13 million. And our total ARR, including support and maintenance, to be between $51 million and $53 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 $89 million and $94 million; non-GAAP operating loss to be between $42 million and $44 million, including the $14 million doubtful debt reserve and cash burn for the whole year to be between $31 million and $38 million. As I stated, we remain committed to reaching profitability in 2024. We expect the fourth quarter revenues to be $20 million to $25 million. 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 time frames, 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, a full face in our company, our team, and our products. And I believe the actions we are taking the actions we are taking, make our goals achievable. And now I would like to open the call for questions and answers. Ziv and myself will be available to take your questions. Operator?

[Operator]

Thank you. Ladies and gentlemen, at this time, we will begin the question-and-answer session. [Operator Instructions] The first question is from Max Michaels of Lake Street. Please go ahead.

[Max Michaels, analyst]

My first question is looking out at 2024, just with the visibility being fairly cloudy. I just want to get a sense of what you're seeing in the market and to be confident in getting a 2024 guidance.

[Erez Antebi, executive]

At this point, we're not giving a 2024 guide. We will be giving guidance on once we finish our AOP and budget for year '24. It should be towards the end of this year. And the next earnings call, I expect we'll be able to provide guidance on 24. The challenge you stated is correct. The visibility is tough. And yes, we are going to guide to the best of our ability, and we're going to focus very hard to turn profitable '24.

[Max Michaels, analyst]

And then my next question here is just on gross margin. A little bit of a downtick here in Q3. I think this adjusted gross margin is around 48%. What's giving you guys the confidence you can get back up to that 7% level in Q4 and then maybe going to what caused that down to Q3.

[Ziv Leitman, executive]

Max, as we said in our previous conference call, we were expecting around gross margin around 50% this quarter. So, 48% is in the same range. And the reason was a few deals with a very low growth margin. As we explained sometimes, we decided to take deals with a very low gross margin when it's competitor replacement. When it's a strategic deal for us when we expect future expansion and also bear in mind that we can get a larger deal amount that we recognized in the first quarter is much lower than the total deal because it includes also support and maintenance for future years. So, we care about the amount of support and maintenance, which will be recognized later at a higher man. Now until Q3 for the last 20 years, our gross margin was around 70%, also in the first half of 2023. And we do believe that in spite of the low gross margin in the second half of 2023, we will be able to come back to the 70% gross margin next year.

[Operator]

The next question is from Nehal Chokshi of Northland Capital Markets.

[Nehal Chokshi, analyst]

It sounds like given that you have limited visibility, the buildup of how you're guiding has changed A is that correct? B; if so, how as it changed?

[Erez Antebi, executive]

I'm not sure I followed the question now, sorry.

[Nehal Chokshi, analyst]

Yes, let me try to clarify. So for example, in prior quarters, your guidance may consist of some bottoms-up basis where you're looking at your pipeline and semi close rate. Going forward, have you changed that process or change the parameters that you utilize that process?

[Erez Antebi, executive]

No. I think we're still building a bottom-up from what we see. And, we're trying to accurately forecast what the results are going to be, and we do that in a very detailed bottom-up process that we do internally, a follow-up on Phase II weekly. And it's true that over the past couple of years, our ability to forecast the probability and timing of closing deals has diminished. So, our forecast has become less accurate, but the process itself has not changed. It simply becomes harder for us to nail the numbers correctly.

[Ziv Leitman, executive]

Nehal, please remember that in previous years, till like two years ago, we had a much larger backlog. So, it was easier to forecast the quarterly revenues. Now, when the backlog is much lower, we are depending on the same quarter bookings. So, we have a challenge to forecast the revenues with a high degree of [indiscernible].

[Nehal Chokshi, analyst]

That's helpful. And just to be clear, I mean, given the commentary around limited visibility, are you using lower probabilities to compensate for that visibility and lower probabilities of closing rather.

[Ziv Leitman, executive]

We believe the south forecast is realistic and achievable. But it's not conservative, and it's not aggressive. We think it's realistic and iterate. To directly answer your question, then yes, we're assuming lower probabilities are things because it becomes harder to forecast.

[Nehal Chokshi, analyst]

Okay. And then I think you mentioned that you're looking to drive profitability. And it sounds like the main driver to drive that profitability continue to rightsize the OpEx version of the overall business. And while most of your OpEx is commingled between the SECaaS and the DPI, is there some amount of minimal investment that you're going to want to maintain strategically on the SECaaS portion?

[Erez Antebi, executive]

We will definitely maintain what we -- I don't know if the word minimal is the right, we will maintain a balance between our investment on the SECaaS portion and our drive to reach profitability. And it will limit the amount that we're able to invest. So, no doubt, we'll be investing less than we had this year and definitely less than we invested in the year before. You are correct that a significant part of our drive to reach profitability has and continues to be expense control. Because when we look at the top line, again, I would expect SECaaS revenues like we have been showing over quite a few last quarter is consistently growing. So, I would expect them to continue to grow into next year, which will help us. But the absolute numbers themselves are not very high. So, we remain with trying to forecast and see how much can we count on the DPI or Allot Smart segment for revenues, that area, which relies heavily on operator spending is still affected by significant headwinds and cost reductions in operators' budgets. So, while I think we are roughly around the general sense without stating any numbers, I think we've roughly reached the bottom of the curve here. I don't think we can rely on a significant growth in our DPI or Allot Smart segment. So, the combination of that leads us to reach profitability and by reducing the OpEx, which is what we have been doing so far.

[Nehal Chokshi, analyst]

Just to be clear, would you be able to cut your OpEx further if you believe you needed to indicate that PPA does not stabilize here?

[Ziv Leitman, executive]

We didn't prepare our '24 budget yet. So, we don't know. And as I said, it will be a combination between the revenues, which we think will be achievable and the right level of OpEx, and we keep our goal to be breakeven next year.

[Nehal Chokshi, analyst]

Last question for me. So as you mentioned, you had announced a special committee to explore options for Allot. And subsequently, you announced your founder retiring from the Chairman position and a new Chairman. Does that represent the conclusion of that commercial committee? Or is that still ongoing? And then what do you expect the new Chairman bring?

[Erez Antebi, executive]

So see a couple of things. One is that the committee was formed and reiterate what I said committee is formed to work with management to identify and recommend opportunities for improvement for further improvement with a focus on driving sustained profitability and enhancing shareholder value. The work between the executive committee and management. One of the results was that that was OpEx reduction and fast cutting that we implemented during the third quarter in late August. And that work continues, like I said earlier in this call, continues to work together with management to figure out what is the right operating plan goals and expense levels, and budget for 2024. Now Yigal, who was our Chairman recently, we decided to resign for his own reasons, has nothing to do with the executive committee and he's not a derivative of that in any way, shape or form.

[Nehal Chokshi, analyst]

And do you expect a new Chairman to bring anything different here?

[Erez Antebi, executive]

I think the new Chairman, feel free to ask him yourself if and when you meet them. But I think anybody that has, definitely, they are new Chairman, the advice has vast industry and operational experience. And I think anybody that brings with them a fresh load, different perspective, can bring significant value to the company, and that's what I believe they produce.

[Operator]

The next question is from Marc Silk from Silk Investment Advisers.

[Marc Silk, analyst]

So earlier in the process on the SECaaS deals a few years ago, you would basically lay out your capital with no commitment. So, can you explain how going forward that's going to be? Like are you going to before you spend penny #1, you're going to get a commitment if you hit benchmarks. It's just trying to clarify your spending in risk-reward in regards to obtaining more SECaaS customers.

[Erez Antebi, executive]

Okay. So, I'll give you a bit more detailed answer maybe. You're right that that's how what we were doing with our network security product in the past. Now, when we look at it again about 1.5 years or so ago, we still the first table factor. We are outlaying capital without getting a firm commitment from the operators, and that may take a long time to launch, and they take a long time to ramp up and generate revenue and so it's not a good way to go forward. So, for most new deals definitely for the smaller ones, we are looking for a firm commitment for revenue before we take upon ourselves any commitment to invest capital or deploy the network and so on. And the investment capital is not just hardware, right? No hardware, professional services, things like that. Now it's not all operators are created equal. I can tell you, I don't think it's any secret horizon was not willing to give us a firm upfront commitment for revenues. But I think the opportunity has proven itself, and that was right of us to sign this team and launch with them, even though they didn't make an upfront minimum revenue commitment to us. So, I would expect that there could be other such operators in the future, but we will strive 100% with the small home and medium-sized operators, with the large ones we may need to be more fragmented, but we will strive with the other ones to get them in [indiscernible].

[Operator]

The next question is from Todd Felte of 88 Management, LLC. The questioner is not asking his question. We'll continue to Rory Wallace from Outerbridge Capital Management, LLC

[Rory Donald Wallace, analyst]

I was wondering if you could elaborate at all on the launch at Verizon, how they're thinking about the offering in terms of their strategy around cybersecurity, maybe how they would view potentially expanding the deal. Obviously, for a lot, it would be wonderful to expand outside FWA since the opportunity there is an order of magnitude larger outside that footprint? And do you think that Verizon is viewing this solution is something that's very additive both to revenue to churn or in other strategic ways that would give them a real impetus to expand the deal.

[Erez Antebi, executive]

Okay. I'll try to respond and our trend likely. First of all, rising is very, very large corporate. And there are many, many people at Verizon, but I'll try and state what I believe from my interaction with many people at Verizon, what I believe the general consensus could be. First of all, the launch is perceived to the security services launch seems to be going very well. I believe that it is something that their customers value and that salespeople find are comfortable in selling it because the customers perceive value when it's good. Second, I would say that, yes, it's definitely showing nice revenues for Verizon. And I think that we are overall happy with the way it's going, not just technically but also commercially. I would add to that, that we are hearing sentences from people in Verizon, which says things like okay, they understand that they, as an operator are losing more and more the grip on the end-user devices as people bring a wide range of devices, doing different things from different services and so on. And here is a value that is from the network. It's network connective. It's on the network. It's a value of the Verizon network, which is in the network itself is their price. So, this fits very well along with that. And we're discussing with quite a few people in Verizon options of where to take this further because it's considered something that is inherent to the Verizon and inherent value that can be either to the Verizon network. It's valued by customers, and there are many different segments that can enjoy. So, without getting too much into details, I think the opportunities there are large, like I said in the call, though we cannot guarantee that they will eventually expand this to other segments but we are in serious discussions on it. And I think it's a big potential.

[Rory Donald Wallace, analyst]

And with Far EasTone, they've announced they've hit 550,000 subs, which take 10% or so of their postpaid base within one year. It seems like a great curve of growth. Are they doing anything really unique as far as how they're approaching the service? I think the answer is probably yes. But can that be replicated elsewhere with future launches? Or where do you see them taking it next? I know they're merging with another telecom carrier they're acquiring another Taiwanese telecom carrier. Do you think there's an opportunity to continue to grow that at a rapid rate within FET?

[Erez Antebi, executive]

I think that is different from other operators is, I would say, the attitude of the executive management. The person who took FET, who took what are the initiative on this and as their CEO, she decided that FET should be viewed she wants to make FET considered as the most secure operator was in Taiwan, which is our market, of course. Now by doing that, then she has decided to their go-to market to be very aggressive. So, they are selling security at almost every touch point, I think on every touch point, I'll say, cautiously almost every touch point, they have with customers, whether it explores advertisement, the cost et cetera, which is it's pushing the results. And that's what creates what generates at the end, the sales and the uptake in the service. Can this be replicated? I would certainly hope so. I think we discussed it in previous calls. I think that when there is an alignment of the strategic interest of the operator, which security or rephrase that, when the operators security as aligned with their strategic interest, that drives many things internally in the operator and the way they go to market and the port they put on this, et cetera, and that then drives adoption with revenue mentioned just to put some color on it that we initiated actually last a few weeks ago, several weeks ago, we initiated a marketing conference in Europe, where we had marketing people from various operators using our product meet with each other and compare on what exactly they're doing, what they should do, how somebody else is doing something better, what their takeaways are and so on and so forth. That's a role that our marketing department has been doing sharing the information as best possible between them. But this time, we give them a platform to do it with each other directly. I think we was very encouraging. We got quite a few operators who walked away and come to us in a not just housing the value. We're saying, okay, we learned that this other operator is doing this on that. And we think that's a good idea. So we're going to see how we can implement it and drive higher adoption and revenues in our market. And we have quite a few of those. So we're trying definitely to get that to happen.

[Rory Donald Wallace, analyst]

Yes, it sounds positive. And thinking about the CCS revenue going into next year, it's clearly going to grow. I think you can't control the adoption curve, but Verizon is going to be almost all incremental next year and then FET should generate decent growth, I would say, if you just model out what they've been doing. So is there anything we should think about on the flip side with SECaaS, why it wouldn't grow at a rapid rate next year? And taking it to the next level, when does that business really reach a profitable scale in your opinion? And obviously, subject to change, but I think it's important to consider when that business might become cash generative and what it would take to get there, if it's Verizon expanding a deal or if it's winning several new operators? And how do you see that evolving over the next year.

[Erez Antebi, executive]

I think you're asking the right questions. And I think that those are the answers we need to answer ourselves as we're building our plan and budget for next year. And I would like to be a bit more cautious, and I prefer to address those questions more in more detail after we have our plan budgeted numbers for next year, and I feel more confident to give you more detail on that.

[Rory Donald Wallace, analyst]

That's fair. And then just a couple of questions on the model. One is on product revenue. This year, it looks like it will probably be the lowest product revenue you've had in 10 years or more. And I guess, versus the expectations you had coming into the year, what is your gut feel about how much of the miss was driven by macro? We know it's a very bad carrier spending backdrop. Everyone has confirmed that outside of you versus some of these secular issues or even execution issues, frankly, that might have contributed to the revenues coming in lower?

[Erez Antebi, executive]

I think the majority has to do with the macro. We did a loss analysis of the deals during this year. We went one by one; everything that we were working on and did not materialize into it is not still in process. We haven't or say -- most of the business did not close did not close because of macro-related issues, budget issues, expense cuts on the operator things like that. I think our competitive positioning this year was strong. And I think the number of execution-related problems they exist. I'm not saying they don't, we do always put on execution, but I don't think it would have made a materially different results. But most of it is macro.

[Rory Donald Wallace, analyst]

Got it. And then with the expense structure, you mentioned there's $1.5 million of OpEx related to the risk. Where does that show up in operating expenses? I wasn't sure looking at the release.

[Ziv Leitman, executive]

This is part of the OpEx because it relates to the people that they were the one-time stance of the rig.

[Rory Donald Wallace, analyst]

Is that shown on the press release, I'm not sure?

[Ziv Leitman, executive]

So for instance, if [indiscernible] people were read from R&D, so the relevant onetime is expenses is in R&D. If there are people who have SG&A. So it will be shown in G&A. In the same place, we book the salary. So, we didn't break it out on software.

[Rory Donald Wallace, analyst]

Yes. $1.5 million.

[Ziv Leitman, executive]

No, the $1.5 million is not in separate line. It's embedded in the R&D, SG&A costs, and so on.

[Rory Donald Wallace, analyst]

Understood. Understood. And it wasn't shown separately. That's just what I wanted to confirm. And then if I adjust for the $1.5 million, it gets me roughly $21 million or a little under $21 million of base recurring OpEx in Q3. And then we should expect that there's a $15 million expense reduction that will flow through the P&L over the coming quarters, which should reduce expenses by around a little shy of $4 million a quarter. Is that a reasonable way of looking at the model and where expenses should land?

[Ziv Leitman, executive]

I'm not sure it's the right number, but we would like to sell to those numbers only in February after we finalize the budget process, and we will be ready our 2024 guidance.

[Rory Donald Wallace, analyst]

Got it. And one last question. Thank you in with my question. So you mentioned a large deal that was potentially going to drive a variance in cash flow in Q4. Is that a revenue deal? Or is that a booking with the prepayment and the revenue shifts outside of the quarter?

[Ziv Leitman, executive]

I would say that it could go either well. So that tends to be at a wide range. Let's see where we are [indiscernible] if we close it, it's how it goes.

[Operator]

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

[Erez Antebi, executive]

Yes. I want to thank everyone for joining us on the call today. Thank you for your support during these nontrivial times. For those of you in the U.S., I'd like to wish you a happy Thanksgiving weekend, and I look forward to seeing you either at latest in our next call and if not before that, perhaps in person. Thank you very much.

[Operator]

Thank you. This concludes the Allot Third Quarter 2023 Results Conference Call. Thank you for your participation. You may go ahead and disconnect.