Allot Ltd. (ALLT) Q1 2014 Earnings Report, Transcript and Summary

Good day ladies and gentlemen, and welcome to the 2014 First Quarter Results Conference Call. For your information today's conference is being recorded. And at this time, I would like to turn the call over to Rami Rozen. Please go ahead.

Thank you very much, and thank you all for joining us on our first quarter 2014 conference call. My name is Rami Rozen and joining me today are Allot's President and CEO, Rami Hadar; as well as our Chief Financial Officer, Nachum Falek. The press release announcing our first quarter results is available on the Investor Relations section of our Web site at www.allot.com. All results and expectations, we review on the call are on a non-GAAP basis unless otherwise described as GAAP. Non-GAAP net income and non-GAAP net income per share excludes stock-based compensation expense, revenue adjustments due to acquisitions, expenses related to M&A activity, deferred tax assets and amortization of certain intangibles. Please note that all earnings per share amounts are on a fully diluted basis. A reconciliation of each non-GAAP measure to its nearest GAAP equivalent is available in the press release containing our first quarter results. Before we begin, let me remind you that certain statements made on the call today may be considered forward-looking statements, which reflects management's best judgment based on currently available information. I refer specifically to the discussion of our expectations and beliefs regarding our pipeline and funnel of potential future business. Our actual results may differ materially from those projected in these forward-looking statements. I direct your attention to the risk factors contained in the Annual Report on Form 20-F filed by Allot with the U.S. Securities and Exchange Commission and those referenced in today's press release, both of which detail factors which could cause our actual results to be materially different from those projected in the forward-looking statements. Allot ClearSee and WebSafe are trademarks of Allot Communications. All other trademarks are the property of their respective owners. With that, I’d now like to turn the call over to Rami Hadar.

Thank you, Rami, and thank you all for joining us today. In today’s call, I will highlight Allot results and achievements for the first quarter of fiscal year 2014, and then I will hand over the call to Nachum, our CFO for a short review of our financial performance for the first quarter of 2014, after I will make a short personal statement. Our first quarter results came in at $28.3 million up 17% year-over-year and 3.5% sequentially. We have achieved sequential growth and reached record revenue level for first quarter despite seasonal weakness associated with first quarter. Book-to-bill during the quarter was once again overwhelming. We continue to experience strong demand for our value added service offering mainly in categories such as video network, security and analytics. The demand for our DPI platform as well as for our value added service offering continues to come mainly from mobile service providers. However, the booking portion of fixed line service providers continues to grow well. During the quarter, we have made nice progress in the fixed service provider segment mainly with cable companies and DSL. The strength in booking as well as encouraging business environment were further demonstrated by the high number of large orders received from service providers during the quarter, 25 in total, of which five are from new customers. During the quarter, we had two 10% customers. I would like to provide some insights regarding new customers won on a given quarter and to quantify the significance of these wins and large booking figures. In any given quarter, we provide information about the number of large deals made by new customers. The actual number of new customers per quarter is typically higher. However, some of these new customers don’t fall under our Allot definition of large deals, which…

Thanks Rami, and welcome everyone. Let me take a few minutes to review the results we published earlier today. I will be discussing non-GAAP numbers which exclude the impact of share-based compensation, revenue adjustment due to acquisition, expenses related to M&A activity, deferred tax assets and amortization of certain intangibles. Full reconciliation of the pro forma results discussed in this call to GAAP results is currently available for review on our Web site and in the press release issued today. Now let me walk you through the results for the quarter. Revenues for the first quarter, on a non-GAAP basis, were $28.3 million, up 4% versus the fourth quarter of 2013. As a percentage of our revenues, sales in America accounted for 15%, EMEA 57%, and Asia-Pacific 28%. During the quarter, we had two 10% customers. Out of total revenues during the quarter, products were 65% and services 35%. Gross margin for the first quarter was 73%. Our operating expenses were $18.6 million versus $17.7 million in the fourth quarter. The increase in our OpEx was mainly due to higher commission and wages accruals, higher investment in R&D related to our new analytics tool and the changes in the exchange rate of the U.S. dollars versus the Israeli shekel and our hedge rate for those currencies. For the quarter, we reported earnings per share of $0.06. On the balance sheet side, cash balances were $122 million. As for our cash flow, we were cash flow positive and during the first quarter we generated $3 million from operating activities. Our DSOs was 68 days versus 57 days we had last quarter. Deferred revenues went up by $1 million during the quarter mainly due to prepaid invoices which were not recognized yet. That concludes my remarks, and I will now transfer the call back to Rami for a personal note.

Thank you, Nachum. Before we move to the Q&A session, I want to make a personal note. As you have already read today after serving as Allot’s CEO for the last eight years, I shall retire during the second quarter and will transition my responsibility to Mr. Andrei Elefant currently Allot’s VP of Product Management and Marketing. I will continue to serve as Board member. Andrei is a great leader with whom I worked closely and in whom I have great confidence to take Allot to the next level. Andrei has been a key player in Allot’s exceptional growth and industry leadership over his 14 years in Allot. With Andrei charge backed by Allot’s seasoned Board of Directors, professional management team and excellent workforce, I have great confidence in the company’s ability to leverage the many opportunities in the growing broadband data market continue to deliver great products and solutions to the world’s largest mobile operators and continue its rapid growth in profitability history. All of our growth and accomplishments in the recent years is due to our extremely talented and motivated employees. I’m confident that with Andrei’s leadership, our greatest achievements are still ahead of us. Let me also add my personal appreciation for the support and the vote of confidence that you all shareholders have given us. It is a vote which we do not take lightly, we wake everyday determined to do our best to earn it and continue to build a great company. The spirit and confidence will continue under the new leadership. Thank you and good luck.

Operator, we will move to the Q&A.

(Operator Instructions) And we take our first question from Ittai Kidron of Oppenheimer. Please go ahead.

Thanks. Congratulations on a good numbers and Rami, it’s been a pleasure working with you for the last eight years, enjoy your retirement.

Thank you, Ittai.

Thanks. I wanted to talk a little about the gross margin, again, so it’s clear that it was one big deal that impacted that business. But is it also again fair then to announce unless to assume that if there is no other such big deals transpiring in the second quarter in June, you would expect gross margin to rebound very quickly here?

In general, yes. To the best of my knowledge and the current funnel, we have – we are not seeing any similar deals with the kind of gross margins we have seen in that specific one. So in general, yes, we without giving guidance, we expect to get back to our normal 75%, 76% range.

Got it. And can – Rami, can you talk about the analytics tool, what kind of traction that you had with that in the field, how should we think about the contribution of that value added services to your business?

Yes. We [aided] (ph) during the Mobile World Congress in Barcelona, lots of interest, couple of trials are going on mainly with mobile operators and I’m happy to say that we got one first commercial win at the latter part of Q1. This is $1 million part of the $5 million mobile Tier-1 EMEA operator, we announced in the recent press release. So we have now commercial revenues in a couple of trials going on.

Very good. Then lastly for me Nachum on the OpEx side, can you give us some direction on how should we think about the progression of OpEx through the year?

Yes. We have mentioned mainly this quarter (indiscernible) coming from the OpEx side that was coming from a few different places, currency, exchange rates, higher revenue then booking and plans. And obviously, the investment we did into R&D and Rami mentioned our new analytics tool. We are not giving any guidance, but I think the OpEx from that level will stay kind of flat going forward. Obviously, we are seeing very nice opportunities and we will continue to built out and invest. So I’m sure that at the end of the day we will see some minor increase in OpEx as well.

Very good. Congratulations and good luck.

Thanks.

Thank you, Ittai.

We now come to our next question from Tal Liani of Bank of America Merrill Lynch. Please go ahead.

Hi, guys. This is actually Kiera calling in for Tal, this morning. Just a few quick ones, first, I think I may have missed the percent of value add services that you mentioned, if you could just repeat that. And then second, if you could maybe talk about – there seems to be a big differential in terms of the product growth versus the services growth. So if you could just provide some color on what’s causing the large differential that would be great? Thank you.

Kiera, so I will take the percentage again. Products was 55% and services 35%. In general, services include both the maintenance and warranty, which is kind of steady growing quarter-to-quarter into the install base and the news we are getting from customers. And the changes from quarter-to-quarter of the geography, in this quarter for example, it is coming mainly from professional services largely deployment and charges we are getting from our customers really hopeful going forward.

And to your first question Kiera, the value added services were 28% of total bookings.

Thanks. Thank you and good luck.

Thank you, Kiera.

Thanks.

We take the next question from Matt Robison of Wunderlich Securities. Please go ahead.

Thanks for taking the question. Rami, that’s been great working with you. Going all the way back to CTP systems, can you give a little color on the timing for the transition and I obviously got some follow-up on this quarter.

Yes. Thank you, Matt. It has been a pleasure working with you all of these years. So the timing is simple as we noted in the press release, over the Q2 timeframe I will be overlapping with Andrei. Obviously, Andrei knows the company very well both inbound and outbound. But nevertheless, the transitioning zeroing Q2 timeframe and he will be in the hot seat coming July 1st.

I guess I was looking for a little different context of timing but I will skip that for now. So when you get these deals where you are looking at sort of a price forward pricing scenario, are you doing anything in terms of commission's comp that makes them a little bit better for the economics later on, or maybe a thinner amount of commissions for those sorts of deals?

No. We have – I’m aware of these arrangements. I’m a big believer in simple commission plans because as you can make them more sophisticated intelligent. There are always exceptions and considerations. I mean does the company want to take on an aggressive deal and price, or doesn’t it -- is it the sales person responsibility that the environment is competitive, is it the company? So we don’t have such deals, it wasn’t the big issue up until now. I hope it won’t be a big enough issue to consider such arrangements.

Is this the kind of customers that can be 5% plus customer this year?

It was a multi-million dollar deal already. So for them to take 2 points away from our gross margin. So you can imagine that its $7 million customer. Can it be a 5% customer over this year, are probably on the very, very high-end. But, if it does happen, it will be a good news as we stated. We’re already following the order with the improved gross margin. We had here a double-whammy one, it was a competitive environment, I’m proud that Allot prevailed in one of the deals. This is a very large Telco in APAC. So we are – the first one, the deal under competitive environment. We then had to meet the price target that was one element and the other is, this is a very large territory and thus the need for a more than usual hardware platform. So the mix was also hardware oriented.

I think the prior question was a very good one about the relative growth of services versus products. It looks like products was in single digits whereas services like more than 40% growth if my quick arithmetic is right. Was the professional services piece a factor in the margins this quarter?

Again, we don’t have specific math about margin and professional services, remember that its part of new deals that we recognized, so its not like saying the renewals were growing faster than product or something like that. The growth was coming from all over the place. In terms of margin, yes, on the new, we are getting better margins than on professional services supporting general better margin than our first deployment.

Okay. I will yield the floor. Thanks.

Thank you, Matt.

The next question comes from Mark Sue of RBC Capital Markets. Please go ahead.

Hi, Mark.

Please ensure that the mute function on your telephone is switched off. It seems Mr. Sue has stepped away. I will proceed with the next question, which comes from Catharine Trebnick of Dougherty & Company. Please go ahead. Catharine Trebnick - Dougherty & Company: Oh, thank you for taking my question. And Rami, we will miss you.

Yes. Catharine Trebnick - Dougherty & Company: One, but I’m looking forward to working with the next one. So the quick question is, America was down 15% total revenue, can you gives us any color on how you are doing in North America and why that was only 15% and where you think it might go in the next year with the neutrality changes?

Yes. It is a fairly slow quarter for America on a relative basis to other region, as you can figure out, the large deals came in other territories. We totally hope to continue our success with penetrating Q1 mobile operators in the U.S. So I would not read into one quarter of fluctuations between the regions. And obviously, we do see the long waited net neutrality proposals are positive for Allot probably more on a mid to long-term, but definitely positive. So as I said, to think and to analyze a lot regional positioning, I think one needs to look at four quarters an average out of year and not in a single quarter that a large deal can skew one region to another. Catharine Trebnick - Dougherty & Company: And then other question on net neutrality is, what types of revenue sharing would an interconnect agreement; let’s just use this for example between Netflix and Verizon which was announced this week. How – what type of equipment hypothetically would they need from Allot? And then what would you hypothetically except them to do for revenue sharing on that?

It’s a good question. In one hand, the way I see it, have we seen service providers and content providers strike a deal, even if it’s on the interconnection points of the network, it has to do with net neutrality despite some opinions out there. Because at the end of the day, what we are seeing for the second time, content providers willing to step up and incentivize and pay service providers to provide a better quality of service whether its because they are investing more in infrastructure, whether its because they are giving them high priority, whatever the case maybe. But, I think that’s very encouraging to see service providers and content providers come together with business arrangements, it could be simple work. Netflix paying Verizon, it could be answer that data or the content provider pays for the users the traffic and their content to Web site. Or it can be some kind of a revenue share, let’s say a music streaming application we have been talking about that for several years. And it’s finally coming together. Now, from Allot’s point of view, we sit more towards the customer side of the network between the core and the access portion of the network. So we are not sitting in transit points. We are on policy control, provisioning, ability to do application-based charging is other side of the network not that the transitioning point. I think it’s more about simple outright done with but more on the access side of the network. And we are yet to see deals happen there. So data will happen on the access side when it happens. Catharine Trebnick - Dougherty & Company: All right. Thank you so much.

Thank you, Catharine.

And next question comes from Alex Henderson of Needham. Please go ahead.

Thanks. I just wanted to go back to that gross margin issue for a second. The $9 million in chassis-based product, is the embedded gross margin in that order lower than the corporate averages, therefore as that plays out over the next couple of quarters on deliveries that there would still be a little bit of a bias to that to gross margin pressure? Or is that really only a one quarter phenomenon? And you did say that you had a follow-on order from the large customer that caused some of the margin pressure in the quarter. So is that at higher margin, or is it back to normal margin on the second order?

I’m happy to say that the two, the $9 million orders associated with Tera was a good gross margin and inline with our usual form of business both on the pricing we have and also from the ratio between the amount of hardware versus software. So the large deal I was referring to APAC does not relating to the $9 million orders of Tera unit. Having said so, to give you a broader understanding in every deal, we have a combination of hardware and software. Obviously, we like the software content to be higher. The specific deals that we took in APAC was to the other side because of a large geographical distribution. And finally, the expansion order we got is net positive because here there was a more software bias in the margins of this customer already improved. We expect moving forward, once they buy into a value added services and features like analytics gross margin will improve even further.

And then, just wanted to ask a general question about conditions. Is it your sense looking at the RFP activity in the deal sizes and the pipe that business is starting to accelerate as a result of a combination of net neutrality commentary in the U.S., improving conditions in Europe and more activity in Asia? Am I hearing that correctly?

It’s more related to European economy stabilizing and some of our key customers getting back into growth modes and expansions and LTE roll out. I believe that we will – we are having a preliminary discussions based on the new net neutrality regulation. But, I think these discussions will turn into a commercial value only within a couple of quarters. These are nice things that happen overnight.

But the point is that there is an acceleration in RFP activity that you are seeing in the field? Is that correct?

Yes. Alex Henderson – Needham: Great. Rami, thank you for your service.

Thank you very much. It’s been a pleasure working together.

We now come to the next question from Peter Misek of Jefferies. Please go ahead. Mr. Misek…

This is Jason North for Peter Misek.

This is Peter Misek. No, no, I’m sorry. Hey, Rami, it’s Peter Misek. Just wanted to congratulate you for all the years that you have been with Allot. Thanks for that. I’m sure it’s been a fun ride. Wanted to ask about value added services, it was 28% of total bookings this quarter 36% in Q4. How should we think of the dynamic going forward as a percent? Wanted to chat about commissions, how should we be thinking of commissions and scaling for sales and marketing in terms of revenue? And then, what was the loan provided to the third party of $2.6 million and as it relates to working capital, you guys obviously had really good DSOs this quarter, wanted to try and understand how we should be thinking of that going forward as well? Thank you.

Okay. I will take the first question. And Nachum will take the question about the commissions and loan. So value added services climbs very quickly to the range of being 30% plus or minus of our business. I think moving forward, you can assume that maybe in general a third of our business were coming from value added and service. And services, remember that value added services usually come somewhat in the early when we penetrate the customer and more when we install, when we do the first installation so many of them are actually follow-on deal. Will it continue to grow beyond that? It will be again a combination of new customers versus current one. Expansion tend to be more VAS oriented, new deals, first we need to get into – you need to buy to the infrastructure and then you get into value added services. So for now, for the next few quarters, assume it 30% plus or minus couple of points. But again, a very important part of our business, we deepen our penetration, it’s sticking. These are usually strategic initiatives, we talk about monetization and creating a new revenue stream for the service providers which is also – which is a very good part of the business you want to be on with the customer. Regarding commission and loan, I will now hand over to Nachum.

Yes. So in terms of commission, we have simple commission plan, basically shares are variable so the manager has his own quota. And he is getting his own target, based on reaching the quota. He can either advance versus the booking, but at the end of the day, as we mentioned, based on collection, some times especially in the first quarter when people can do a [variable] (ph) quarter and therefore you are seeing general higher commission accrual versus other quarters. And its all based on other internal plans what does it mean, if we are doing better than the plan obviously, our expenses will increase. So that’s for commission. In terms of short-term probably not more than three years along as we get to our business partner. We usually don’t tend to do it, but at this time we felt that they made sense for us to keep the relationship close and help business partner. He already by the way started to repay it.

Perfect. Thank you.

Thanks Peter.

Thank you, Peter.

(Operator Instructions) And the next question comes from Sanjit Singh of Wedbush. Please go ahead.

Congratulations, Rami, on your retirement. It was great working with you. A couple of questions. The number of large deals, 25 large deals, that is the most I have seen in almost a couple of years now. So I wanted to understand what is driving that. Is that just improved kind of general economic activity in Europe? Is it better sales execution, better sales coverage? And the mix between fixed and mobile, it seems like we are seeing a lot of momentum on fixed. When does mobile start to come back online?

Yes. So regarding the amount of larger deals, you are right, I think this is the record number on specially a nice surprise in the Q1 quarter which some times susceptible to seasonality. Now having said, I think it’s – I cannot see anything coming through, just good execution in many regions by the sales team and couple of nice deals coming together. Like I always say with Allot, one quarter doesn’t make a trend. So I like to see that that new number achieved in the following quarters to announce victory. But, certainly a good start and it’s a module to a good business environment into 2014. Regarding a vertical split, what we mentioned on the script that mobile remains a majority portion of our business and wins. Fixed is an important part, roughly it’s a between 20% and 30% of our business in a given quarter. I did mention on the script that we have seen a nice uptick actually on the fixed side. This large customer in APAC which has challenging gross margins was actually a fixed customer of DSL. And we are seeing some interesting funnel develop on the cable side as well. I will share the news with you when the things come together. So it was always been about both fixed and mobile. Again, mobile is excited about its growing, but fixed is holding it’s own in terms of percentage.

Great. I had one follow-up question regarding competition. Both with respect to this Asian fixed line deal as well as kind of overall, was the Asian service provider deal was that – was there a bake-off between your traditional pure play guys that included some integrated players? Are you seeing F5 out in the market? It has been about a year now since they came out with their DPI solution. Can you just talk about the overall competitive environment and maybe some pricing dynamics versus the last couple of quarters?

So that specific deal was indeed competitive and was a bake off process, all pure play players then showed up and one or two integrators as well. And we prevailed. And I now want to emphasize that not because of pricing, it was first a technical decision on the merits of the players. And only then pricing negotiations, which is a habit in a way they do business in APAC. So it’s not like we bought the deal. Regarding your second question, we haven’t seen them any pure DPI RFP. Now, having said, I caution, we don’t have perfect worldwide coverage, it could be that they are showing in certain locations. And we are not aware of it. But, we haven’t ran into them in a straight out RFP. It seems to me sitting on the sidelines, I’m just more focused on doing a good job on security front. And it seems that they are complaining of their progress in DPI and policy control and charging functions. It could be just me but this is me kind of watching their statements and public discussions. So overall nothing drastic in competitive environment. I would say subjectively that in deals that we show up and in deals that there is a fair competitive bake off process. We tend to do a very well. I won’t say we win 100% of these deals, but we tend to definitely win more than we lose. Note that we as promised delivered on one new platform and two new relevant value added services, I think our competitive position has improved.

Thank you very much and best of luck to you.

Thank you, Sanjit, was great working with you.

Ladies and gentlemen that will conclude today’s conference call. Thank you for your participation. You may now disconnect.