Allot Ltd. (ALLT) Q4 2016 Earnings Report, Transcript and Summary

Welcome to Allot Technology's Fourth Quarter and Full Year 2016 Results Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. You'd have all received by now the company's press release. If you have not received it, please contact, Allot's Investor Relations team at GK Investor and Public Relations at 1-646-688-3559, or view the News section of the company's website, www.allot.com. I'd now like to hand the call over to Mr. Gavriel Frohwein of GK Investor and Public Relations. Gavriel, please go ahead.

Thank you, operator. I would like to welcome all of you to Allot's Fourth Quarter and Full Year 2016 Conference Call and thank Allot's management for hosting this call. With us today on the call are Mr. Erez Antebi, President and CEO; and Mr. Alberto Sessa, CFO. Erez will summarize the key highlights of the quarter and of the year followed by Alberto, who will review Allot's financial performance over these periods. We will then open the call for question-and-answer session. Before we start, I'd like to point out that this conference call may be -- 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 trend, reduced demand or the competitive nature of securities within the industry, as well as other risks identified and the documented filed by the company with the Securities and Exchange Commission. And with that, I would like to now hand over the call to Erez. Erez, please go ahead.

Thank you, Gavriel. I'd like to welcome all of you to our conference call, and thank you for joining us today. Having just joined Allot, I have been meeting with people in the company and bringing myself up to speed. I can share with you that I'm impressed with much of what I see. Most notably, the quality and professionalism of the people. I look forward to working with the team and taking the company to the next level. As you may know, there have been a number of important changes over the past few months. Yigal Jacoby, a co-founder of Allot, took over as Chairman of the Board as of November 10, 2016. Alberto Sessa took over as CFO on January 1, and I joined the team as CEO on February 1. These changes provide a refresh at the top and enables Allot to execute on the strategy ahead with renewed vigor and focus. Andrei Elefant who will remain with us in a strategic role succeeded in shifting the company's strategy towards the security market. We expect this global growing market to account for an increasing portion of our revenue mix in the coming years. I believe a significant part of the role of the new management team will be to improve on the company's execution and to realize its full potential. I would now like to share with you some of my initial observations and discuss why I believe Allot is such an interesting company with great long-term growth potential. As the telecom world continues to evolve, the need to manage the application layer in communication grows with it. This means that as pure connectivity is increasingly commoditized, the need to identify the users and their applications at a high level of granularity increases. As we all know, network intelligence and traffic control are the core of Allot's business for years, and these enable us to provide and support a growing number of services that are required by cellular and fixed-line operators as well as large enterprises. Our ability to gather real-time network intelligence on very broad data pipes of Terabits per second allows us to offer services such as consumer security on cellular networks, prevention of distributed denial of service attacks as well as network analytics, traffic shaping, application-based charging and others. Some of the legacy services, such as traffic shaping have not grown, but still, make up a significant portion of our revenue. Other services, such as consumer security on cellular networks are projected to grow significantly over the next few years, and this is where I see an important growth engine for Allot. Allot has developed a platform that encompasses both high-capacity, real-time network intelligence and all the applications I mentioned in a single integrated product. This capability and product line are an excellent fit for both the current and developing needs of the telecom markets. Allot enjoys a large global and installed base with thousands of customers, including hundreds of operators, some of which are top tier. Additionally, our strategic partnership with McAfee, a leading global networking and network security company, with whom we are building a joint product offering, presents a significant opportunity. I believe that the combination of the right products and technology, focused on the right markets together with our large customer base and the people in the company are the foundation on which we will build Allot's future growth. In the coming quarters, I hope to further elaborate on my long-term vision and execution plans for Allot, with a goal towards solid growth by 2018. Now, let's move to the results of the fourth quarter of last year. The company reported fourth quarter revenue slightly ahead of guidance at $23.5 million and operating income of $1.8 million for the quarter. For the full year of 2016, revenues were $90.5 million and operating income was $0.4 million. Value-added services were 42% of booking during Q4, with security representing 42% of total value-added services bookings. The number of large deals in the fourth quarter was 19. 10 of them came from mobile operators, 7 from fixed line service providers, and 2 from a cloud operator. Out of the total, 2 deals were from new customers. Five of these deals were over $1 million each. Looking ahead, we anticipate revenues in the $80 million to $84 million range for 2017, with the second half of 2017 stronger than the first half. My goal for 2017 is to bring the book-to-bill ratio to above 1, and position the company for a return to solid growth in 2018. I further expect that quarterly operating expenses in 2017 will be at a slightly higher average rate than in the fourth quarter of 2016, while total OpEx for 2017 should be below the OpEx for 2016. We intend to closely monitor these expenses going forward. And now, Alberto will take you through the financials, and then I will sum up.

Thank you, Erez. I'm also pleased to be joining Allot and look forward to working together with the team to take Allot to the next level. I'd like to note that unless otherwise stated, I will be referring to non-GAAP financial measures when discussing operational results. Non-GAAP financial measures differs in certain respects from the Generally Accepted Accounting Principles and excludes share-based compensation expenses, revenue adjustment due to acquisitions, expenses related to M&A activities, amortization of certain intangible assets and changes in deferred taxes. Revenues for Q4 2016 were USD 23.5 million. This compares to $25.7 million in Q4 last year. For the full 2016, revenues were $90.5 million compared to $100.3 million in 2015. The geographic breakdown of revenues was as follows: Americas at $4.1 million or 18% of revenues; EMEA at $11.8 million or 50% of revenues; and Asia Pacific with $7.6 million or 32% of revenues. Product revenues for the quarter accounted for 61% of revenues, while service revenues were 39%. This compares to 40% -- to 60% and 40%, respectively, in Q4 2015. Book-to-bill ratio in the quarter was below 1. Gross margin for the quarter was 71% of revenue, as compared to 74% for the same quarter last year and 70% in Q3 2016. I'd like to point out that gross margin fluctuates on a quarterly basis depending on the mix. Operating expenses for the quarter were $14.8 million compared with $18 million in the fourth quarter last year. The decrease in OpEx was mainly due to the headcount-related expenses, resulting from the cost reduction measures implemented in the middle of 2016. Operating income for the quarter was $1.8 million compared to $900,000 in Q4 2015. Net profit for the quarter was $1.2 million or $0.03 per share compared to $0.7 million or $0.02 per share in the same quarter of 2015. For the year, net loss was $0.73 million or 2% per share compared with a loss of $0.13 million or $0.00 per share last year. Turning to the balance sheet. Cash reserves, including cash, cash equivalents and investments totaled $113.7 million, up $2.8 million compared to the previous quarter. During the quarter, we recorded positive operating cash flow of $4.2 million. DSO was 95 days, down 23 days from the previous quarter. And now, Erez will sum up, and we will open the call for questions.

Thank you, Alberto. I see Allot as a company with much potential. And I believe, it will -- that it will establish itself as an important player in the communications security market in the coming years. As I said before, I believe the combination Allot has of the right products and technology, the right people and the large customer base is a strong foundation on which we can build Allot's growth in 2018 and beyond. I'd like to open the call for questions now.

[Operator Instructions] The first question is from James Kisner of Jefferies.

Welcome, Erez and Alberto to the company. I guess, I just wanted to start with your comments -- yes, with you -- the comments about driving book-to-bill greater than 1 this year. I'm just curious, what would give you the confidence you can achieve that? Are there early indications that this is achievable? Or is there a lot of work that must be done to fill the sales funnel? Are there any particular geographies where you expect that recovery to come from?

Well, as you can appreciate from the time we are with the company, we are still in the learning curve. But we have spent the time, as I said, talking to people, going through the funnel, understanding what the opportunities are, who the customers are. And as a result of that, I think that although we have a lot of work ahead of us, definitely in the -- in terms of the execution, like I said, I think that we can achieve this target.

So I guess, a couple of things. First of all, traffic shaping, can you give us, again, an update on what portion of the business you think that is? I assume that's -- that refers to optimization was parts -- price was around optimization business. And then just related to net neutrality -- so in the United States, we are seeing some really big changes with the SEC in terms of leadership with incoming Trump administration. I guess I'm just wondering if there's any early indications of new interest from U.S. customers in optimization or other applications as a result of changes in the government here.

Unfortunately, I don't know to address your question on traffic shaping specifically, how much it was and so on. We can certainly take a note and try and get back to you on that. With regard to the expected changes in net neutrality in the U.S., we are obviously monitoring it closely. It's not -- as far as I understand, it's not done yet. It's expected, but it's not done yet. And this could perhaps be an opportunity, but I don't have -- I don't really have a solid view right now of how large or small of an impact this may be.

Okay. That helps. Just one last one, just a general question on just you're in the new management team, I guess, I'm just curious on -- perhaps, I know you've only been there a little while. So you can -- or early -- in your early thoughts on new areas of focus or major changes in direction or just new areas of emphasis from your perspective versus prior leadership?

I -- no, I think from what I've seen, I think that the emphasis is going -- on going into the security market and providing a network-based security to cellular operators and hopefully, also to fixed-line operators and so on. I think that's an excellent direction. I think there is a -- I mean, we know that Vodafone is doing this very successfully. They have 15 million paying customers today that are paying for this service in, I think, quite a few countries, more than 10 countries that they are operating this. So we've announced that we've done this here in Israel with telephone, and there are other operators that are looking at this. I think this is the right direction. This is something that the operators -- they should be able to materialize this -- on. This is something where we are seeing penetration rates as with somebody like Vodafone that's doing this. Penetration rates are in the 10s of percent, depending on the country. So it's something that is required, it's out there, Allot has the right product for it. And I think this is a very good direction we should continue on. And we have some challenges ahead of us. Basically, I think on execution, and we'll work hard on it. And I think we'll be successful.

The next question is from Joseph Wolf of Barclays.

I guess, just as a sort of a follow-on, as you think about the kinds of data that you've -- that prior management teams of Allot have provided to investors. Are you thinking at all about providing a little bit more transparency, especially as you look at some of these newer business line opportunities? And in line with that, could you give us a little bit more granularity on the other things that are within the value in the VAS you said it was 42% of bookings and security was 42%. What else is going on in the value-added services of interest right now?

We are definitely going to look at and take a fresh look at what exactly we're reporting, and what we do not report. And we may change something in the next quarter. Right now, we've simply stuck to the same format and same reporting format and the same metrics that were provided by previous management and those are the details that we have right now. I'm not sure I could give you much more than that at this point. But we'll be taking a fresh look over the next couple of months on the metrics that we think are more valuable to the investment analyst communities. And we'll be talking about that in the next conference call.

But can you give us any granularity on the value-added services that you can at least talk about or when you say security, is that the -- can you breakdown parental control or anything else that you may be seeing some interest in right now?

I can't provide granularity on it. And I'm not sure that we actually track in the company. Forgive me if I'm not that knowledgeable on exactly what we are tracking right now in the company or not. I'm not sure that we actually track dollars on each and every use case. But we -- and I can tell you that, I know that in different operators they have different use cases. Some of them are more interested in parental control, some of them are more interested in other types of security. But I don't have any further granularity that I can really provide at this point.

Okay. Just then -- just final question. As you think about gross margin, I don't want to push you into giving guidance for the year, and where the breakeven is right now. You generated cash flow from operations on around that -- on the $23.5 million number. What should we be thinking about, in terms of mix margin and breakeven, as we think about 2017 as sort of a rebuilding year?

Now, this is Alberto. Regarding the gross margin, as I said, I mean, it fluctuates very much depending on the buildings. I mean right now, we are looking to that. We do believe that in 2017, we will be able to be approximately, I mean, what we get this year, what we reached for this year. I mean, we will have to look at March [indiscernible] on that. I mean, it's very -- too early -- it's much too early, I mean, for us to give any guidance regarding gross margin of 2017.

The next question is from Matt Robinson of Wunderlich.

Can you comment on the backlog level exiting 2016 versus the level of it that you had at exiting 2015?

Yes. I mean, as you can see, I mean, the backlog exiting 2016, as you can note, it is much lower than 2015. And this was mainly due for a very large deal that was booked actually in 2015 and was inside the backlog in -- at the end of 2015, which does not appear anymore in 2016.

Okay. And what -- when you -- what gives you the -- your sense of order level for 2017?

Again, I think I addressed it, but maybe I wasn't clear. We spent the time, not just talking to people internal on the company, we spent a lot of time with the sales force -- with the salespeople -- sorry, going through the various accounts, understanding what's in the funnel, what is close to closing, what is not. Where are the large opportunities. We've looked through the numbers on this, we've made our estimates. And based on that, we've reached our estimates on where 2017 should end up.

But what was capital spending in 2016? Where do you expect it to go in 2017? And where is headcount? Where do you expect that to go?

Capital spending for -- in 2016, it was approximately $1.5 million, $1.6 million. We do not expect any substantial change looking forward in 2017.

And on the headcount?

As you understood -- as you know, I'm sure in 2016 there was a -- sometime during the middle -- during the year, there was a -- previous management did a cost-cutting effort that resulted in reduction of headcount. I do not expect right now that the headcount itself will materially change in 2017. Because, like I said, we intend to keep a very close watch on our expenses so that the operating expenses for the company in '17 will be lower than those in '16.

The next question is from George Iwanyc of Oppenheimer.

When you look at your visibility into 2017, how much of the year-over-year pressures in March do you expect and potentially another decline in the June quarter? And then, can you also give us an update on the pricing environment?

I think I'll make 2 comments maybe on that. One is that, again, that the risk of being repetitive, we are still learning a bit and getting a better feel for what's going on and what will go on. I don't think that we can give you any kind of real color on the quarter-by-quarter basis. I think the quarters will fluctuate based on the specific timing of any specific deal and the revenue recognition of those specific deals, especially in the large unit operators. I do, however, expect based on -- based again on the funnel review and going through where the opportunities are and so on, I do expect that the second half will be better than the first half.

Okay. And just on the current pricing environment, is it relatively stable?

I don't know how to say anything different. But as you can understand, I don't really have a much of a historic perspective right now. So I have not heard anything to the contrary.

And just on the McAfee partnership. How is that integration going and just a general feedback you're getting from McAfee as well as customers?

Well, again, I've had limited visibility to it. I've met with McAfee, but I have not yet met with the customers on this. I think the integration here is going well. It's going per plan, and we're continuing with that. And I think McAfee is fully committed to this, and they're investing the resources and efforts that are required. And they have very high hopes for it and so do I.

The next question is from Marc Silk of the Silk Investment Advisors.

My question is kind of can you maybe expand on us your management style. Just so we can see how you would be going forward? And how did you come to the company, did the board search you out, just a little bit of background, as far as I'm asking, sir, it will be appreciated?

Okay. How I came to the company? Yes, the board had a search committee and they interviewed various candidates and they decided to choose me. My management style, that's -- I'm not quite sure how to answer that. But I tend, I think, to be a very hands off. I tend to spend a lot of time with the customers, and I tend to be very open. And I hope to do the same also with the investors and shareholders in the company.

And lastly, I know you've expressed predictions as far as where expenses are going to go. Do you -- you've really been there not that long, I mean could it be a shot 3 months from now, you basically are able to say, "Well, you know what? There's a layer of management and this and that, that doesn't makes sense" so you -- would it not shock as if you see some more cuts as far as overhead line up with your revenues going forward?

I'm not -- I apologize, I'm not sure what the question was.

Again, you are only been here for a month or so, and you've talked about expenses but...

Yes. I spent...

I think you need be here longer, do -- could we expect you, as time goes on, you might see some inefficiencies or such maybe some dead weight there, because as your revenues have come down, it's always good to see that you can continue to generate, let's just say, profitability by making sure your expenses line up with your revenues, before the revenues start taking off again. Somewhat meaning -- could there be some more open areas that you could look to see where you could cut some overhead?

Well look, I think anything could be. But to be honest, I think previous management did a very serious cost-cutting effort in 2016. I don't -- I do not see any very significant redundant layers of management or things like that in the company right now. And I'll look, like I said, Alberto and I will continue to take a very serious look at the expenses. We may decide that we need to shift expenses, change them, do some other things. It's too early for me to make any serious comment on this at this point. And just to put that -- just to be accurate, I have not been on board for nearly a month, I started last Wednesday. So we're quite new.

And last question. I know if we're focusing on your business strategy going forward, back to net neutrality. So if net neutrality ever gets reversed in The United States, as an investment thesis now detect inspection instead of being like a middling technology, this could really turn out to be a growth driver for Allot, would that be accurate?

There is a possibility of that. But before I can responsibly answer that, yes, that's a possibility. I would have to look at things, like, okay, what do the operators currently have. What are -- should net neutrality be a reverse, what exactly will be the regulations in place then, how long will it take the operators to adapt to them, what would be the schedule. Since I have not looked at all of these, and the reversal has not yet happened, I don't feel it would be responsible for me to say something definitive in this direction at this point.

The next question is from Alex Henderson of Needham & Company.

Going back to the headcount question from earlier, what was the ending headcount?

I don't think that we are providing that number.

If historically, given that it was 450 last quarter, is it flat?

It's okay, yes, it's about 450. It's around that area.

Second, can you give us some sense of what you think is going to happen on the tax line? It looks like you're going to be producing losses over most of the quarters. Should we be using a couple of hundred thousand dollars in the tax line based on your international exposure? Or how do we think about that?

Look, I mean, most of the stuff that you can see our withholding tax, we should -- due to the fact that we work with many countries in which we are not able to recover. And one of the things that I will take it for myself is actually to look at the tax regime and try to minimize those withholding tax as much as we can.

Is it reasonable think it's in the $1 million to $1.5 million range, what we need to hold out?

It's really too early to say that. I mean, I would like to learn and what is the structure of the company, and what are the opportunities that we have to reduce these numbers. Certainly, a lot of work is needed there. I'm not in a position to say right now, what is reasonable and not reasonable to forecast.

All right. So I realized that you guys have a lot of constraints on how you want to talk about the guide, but it does look like you're talking sub $20 million numbers for the first half of the year, particularly if you're at the lower end of the range. And it looks like you're probably down year-over-year on the top line in each of the 4 quarters, as well as producing operating losses on a non-GAAP basis, on at least 3 out of 4 of the quarters. Is that a reasonable way to think about the year at this point? And if so, do you expect to burn cash over the course of the year?

Look, at the -- on the overall level, it's -- we said that 2017 is going to be down versus 2016. So -- and the second half is going to be stronger than the first half. So I think the numbers will turn out into ballpark, no matter what -- no matter how you look at it. I think this is a year where we expect to take a very, very serious look at both our plans and our operating expense, how we execute. And then really grow the company into 2018 and that's what we plan to do. Beyond that, I'm afraid that really at this point, we can't give you much more guidance than that. Because that's really the level at which we can understand it right now.

And one last question. Obviously, M&A is a potentiality for the company. How do you think about M&A, in terms of the willingness to take dilution? And how much of your cash would you be willing to engage in to -- trying to change the company's architecture based off of an M&A move. You've got a very high percentage of your cost going into R&D, and the cash balances are holding the stock up. So how do you think about those 2 elements?

We need -- we're definitely looking at the cash, and what we can do with the cash flow of the company. We don't have any specific plans right now and that's really, all I can say at this point.

Next question is from [indiscernible]

Most of the questions have been answered, but just look at the cash balance, you got a $150 million in cash. Why wouldn't you just buyback $60 million -- use $60 million to buyback stock, in reality you can grow the company, produce -- increase operating income, I mean, why wouldn't you just buy a lot of stock back? It looks pretty cheap.

As you know, there was a buyback program that was approved by the board and has expired. And like I said, we are aware that we have the cash, of course, and we're looking at what to do with that. And that's one of the options and that will have to be looked at and decided.

Okay. All right, it sounds good. And you've just seen that -- if you do believe in your strategy, if you do believe you can grow the company. And you do believe you can increase the operating income, I mean, it was like how much cheaper is the stocks going to get while you wait? Why wouldn't you do it now? That would just be my question.

[Operator Instructions] There are no further questions at this time. Before I hand to Erez, I'm happy to go ahead with this closing statement. I would like to add to participants that the replay of this call is scheduled to being in 2 hours. In the U.S. please call, 1-888-269-0005. In the UK, please call, 08-00917-1246. In Israel, please call, 03-925-5921. Internationally, please call, 972-3925-5921. Mr. Antebi, would you like to make concluding statement.

Yes. I just want to thank, everybody, for joining the call and for your interest in Allot. And I look forward to talking to you in the next conference calls and hopefully, meeting at least some of you over the next few months. Thank you very much.

Thank you. This concludes the Allot Technologies Fourth Quarter 2016 Results Conference Call. Thank you for your participation. You may go ahead and disconnect.