Allot Ltd. (NASDAQ:ALLT) Q3 2023 Earnings Conference Call November 22, 2023 8:30 AM ET
Company Participants
Kenny Green – IR, E.K. Global IR
Erez Antebi – President & CEO
Ziv Leitman – CFO
Conference Call Participants
Max Michaelis – Lake Street
Nehal Chokshi – Northland Capital Markets
Marc Silk – Silk Investment Advisors
Rory Wallace – Outerbridge Capital
Operator
Ladies and gentlemen, thank you for standing by. Welcome to Allot’s Third Quarter 2023 Results Conference Call. All participants are at present in listen-only mode. Following managements formal presentation, instructions will be given for the question-and-answer session. As a reminder, this conference is being recorded. You should have all received by now the company’s press release. If you have not received it, please contact Allot’s Investor Relations team at EK Global Investor Relations at 1-212-378-8040 or view it in the news section of the company’s website at www.allot.com.
I would now like to hand over the call to Mr. Kenny Green of E.K. Global Investor Relations. Mr. Green, 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 metrics, including those we discussed on the conference call, in the earnings release issued last week.
Before we start, I’d like to point out the following safe harbor statements. 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 Allot cannot guarantee that they will in fact occur. Allot does not assume any obligation to update that information. Actual events or results may differ materially from those projected, including as a result of changing market trends, delays in the launch of services by customers, reduced demands and 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
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 account 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 full 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 with management to identify and recommend opportunities for further improvement with focus on 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 break-even profitability in 2024, and ensure that we have 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 lift a 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 governments as they look to block illegal activities such as drug 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 a slower deployment, there are quite a few positives worth highlighting. I would like to start with the North American market. Verizon business has successfully launched their network native security service which incorporates Allot NetworkSecure. 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 Allot. 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 let 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 the 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. I have full faith 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. And Ziv and myself will be available to take your questions. Operator?
Question-and-Answer Session
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 Michaelis of Lake Street. Please go ahead. Max?
Max Michaelis
Sorry, I was on mute. That’s my fault. When we look at — my first question is, looking at our 2024, just with the visibility being fairly cloudy, I mean, are you comfortable that you guys will be able to guide kind of [indiscernible]? Thank you.
Erez Antebi
I’m sorry, can you repeat the — your last, really the last sentence? Are we comfortable we’re able to guide?
Max Michaelis
Yeah. Here — so just given visibility just kind of like something we’re seeing market [indiscernible] giving 2024 guide?
Erez Antebi
At this point, we’re not giving a 2024 guide. We will be giving guidance once we finish our AOP and budget for 2024 which will be towards the end of this year. In 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 yet we are going to guide to the best of our ability and we’re going to focus very hard to turn the profitable in ‘24.
Max Michaelis
And then the next question here is just on gross margin, a little bit of a down-tick here in Q3, I think this adjusted gross margin is around 48%. What’s giving you guys confidence you there, you can get back up to that 70% level in Q4 and then into 2024? And then maybe go into what caused that down tick in Q3 (ph)?
Ziv Leitman
Hi, 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 few deals with a very low growth margin. As we explained, sometimes we decide to take deals with a very low gross margin when it’s a competitive 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, but the amount that we recognize in the first quarter is much lower than the total deal, because it includes also support and maintenance for future years. So we carried out the amount of support and maintenance, which will be recognized later at the higher margin. Now, until Q3, for the last many 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.
Max Michaelis
All right. Thanks for taking my questions.
Operator
The next question is from Nehal Chokshi of Northland Capital Markets. Please go ahead.
Nehal Chokshi
Yeah. Thank you. And Erez, good to hear that there are some [indiscernible]. It sounds like, given that you have limited visibility, the buildup of how your guiding has changed, A, is that correct, and B, if so, how has it changed?
Erez Antebi
I’m not sure I follow the question now, sorry. How?
Nehal Chokshi
Yeah. Let me try to clarify. So for example, in prior quarters, your guidance may consist of some sort of bottoms-up basis where you’re looking at your pipeline and assuming some sort of close rate. Going forward, have you changed that process or changed the parameters that you utilized that process?
Erez Antebi
No, I think we’re still building it 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 and follow up on basically 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’s simply become harder for us to narrow the numbers correctly.
Ziv Leitman
Nehal, please remember that in previous years, like two years ago, we had a much larger backlog. So it was easier to focus the quarterly revenues. Now when the backlog is much lower, we are dependent on the same quarter booking. So we have a challenge to focus the revenues. So I agree with accuracy.
Nehal Chokshi
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 lower visibility and lower probabilities of closing [indiscernible]?
Erez Antebi
We believe that our forecast is realistic and achievable, but it’s not conservative and it’s not aggressive. We think it’s realistic and achievable.
Ziv Leitman
And to directly answer your question, then yes, we’re assuming lower probabilities on things because it’s become harder to forecast.
Nehal Chokshi
Okay. Thank you. And then, I think, you mentioned that you’re looking to drive profitability, and it sounds like the main driver of drive-out profitability’s to continue to right-size the OpEx portion 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
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 will be investing less than we have 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 had and continues to be expense control. There is — because when we look at the top line then I would expect SECaaS revenues like we’ve been showing over quite a few last quarters, it’s still 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 operator’s budgets. So while I think we’re roughly around the, in a general sense without stating any numbers, I think we’ve roughly reached sort of the bottom of the curve here. I don’t think we can rely on the significant growth in our DPI or Allot Smart segment. So the combination of that leads us to reach profitability by reducing the OpEx, which is what we have been doing so far.
Nehal Chokshi
Just to be clear, would you be able to cut your OpEx further if you believe you needed to in the case that DPI does not stabilize here?
Erez Antebi
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
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 social committee or is that still ongoing? And then what do you expect the new Chairman to bring?
Erez Antebi
So I’ll say a couple of things. One is that the committee was formed, and I’ll reiterate what I said, the committee was 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 the OpEx reduction and cost 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 until recently, 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
And do you expect a new |Chairman to bring anything different here?
Erez Antebi
I think the new Chairman, you feel free to ask him yourself, if and when you meet him, but I think anybody that has a different leader or new Chairman, David Reis has, vast industry and operational experience. I think anybody that brings with them a fresh flow, different perspective, can bring significant value to the company and that’s what I believe they’re using for their needs.
Nehal Chokshi
Thank you for taking my questions.
Operator
The next question is from Marc Silk, Silk Investment Advisors. Please go ahead.
Marc Silk
Thank you. So, earlier in the process of SECaaS deals a few years ago, you would basically lay out your capital with no commitment. So, can you kind of explain how going forward that’s going to be? Like, are you going to, before you spend penny number one, you’re going to get a commitment if you hit benchmarks? It’s just trying to clarify, you’re kind of spending in this reward in regards to obtaining more SECaaS customers?
Erez Antebi
Okay. So I’ll give you a bit more detailed answer maybe. You’re right that that’s how we were doing with our network security product in the past. Now when we look at it, we looked at it again about a year and a half or so ago, and we said that okay, the fact that we are outlining capital without getting a firm commitment from the operators and then they take a long time to launch and they take a long time to wrap up and generate revenue and so on, it’s not a good way to go forward.
So for most new deals, definitely for the smaller ones, we’re 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 investing capital is not just hardware, right? It can be 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, Verizon was not willing to give us a firm upfront commitment for revenue.
But I think the opportunity has proven itself and it was right of us to sign this deal 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 and medium-sized operators. With the large ones, we may need to be more pragmatic, but we will strive with the other ones to get the main hall commitment.
Marc Silk
All right. Thank you for taking my questions.
Operator
The next question is from Todd Felter (ph) of [indiscernible] Management LLC. Please go ahead. Todd, are you on the line? Todd, would you like to ask a question? The questioner is not asking his question. We’ll continue to Rory Wallace from Outbridge Capital. Please go ahead.
Rory Wallace
Hi, Erez. Good to hear you’re feeling better. 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. It’s obvious that for a lot, it would be wonderful to expand outside FWA since the opportunity there’s an order of magnitude larger outside that footprint. And do you think that Verizon is viewing this solution as something that’s very additive both to revenue to turn or in other strategic ways that would give them a real impetus to expand the deal?
Erez Antebi
Okay, I’ll try to respond and I’ll tread lightly here. First of all, Verizon is a very, very large corporate, right? There are many, many people at Verizon and they have to use. 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 is perceived to be going very well. They believe it is something that their customers value and that their salespeople find are comfortable in selling it because the customers perceive value and it’s good for them.
Second, I would say that yes, it’s definitely showing nice revenues for Verizon and I think that they are overall happy with the way it’s going, not just technically but also commercially. I would add to that, that we’re hearing sentences from people on Verizon which say 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 sources and so on. And here’s a value that is from the network, it’s network native, it’s on the network, it’s a value of the Verizon network, which is and the network itself is their pride, 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, an inherent value that can be added to the Verizon network. It’s valued by customers and there are many different segments that can enjoy this. So, without getting too much into details, I think the opportunities there are large. But like I said in the call, 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 Wallace
Thanks. And with Far EastTone, they’ve announced they’ve hit 550,000 subs, which I think is 10% or so, of their post-paid base within one year. 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 cannot 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
What FET is doing, I think that is different from other operators is, I would say, the attitude of the executive management. The person who took with – in FET, the initiative on this is their CEO. And she decided that FET should be viewed. She wants to make FET considered as the most secure operator within Taiwan, which is her market of course. Now by doing that then she has decided to go-to-market to be very aggressive. So they are selling security at almost every touchpoint, think on every touch point I’ll say cautiously almost every touch point they have with customers whether it’s stores, advertisement, the call centers, excuse me et cetera., which is 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 this in previous calls. I think that when there is an alignment of the strategic interests of the operator with security or I’ll rephrase that, when the operator sees security as aligned with their strategic interest, that drives many things internally in the operator and the way they go-to-market and the priority they put on this, et cetera., and that then drives adoption of revenue. I mentioned just as a, just to put some color on it that we initiated actually last 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 notes on what exactly they’re doing, what they should do, how is 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 gave them a platform to do it with each other directly, I think was very encouraging. And we had quite a few operators walk away and come to us, not just spouting the value, but saying, okay, we learned that this other operator is doing this and 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 Wallace
Thanks. Yeah. That sounds positive. And thinking about the SECaaS 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 kind of model out what they’ve been doing. So is there anything you 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 you see that evolving over the next year or two?
Erez Antebi
I think you’ve asked, Rory, — 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 with — I would like to be a bit more cautious and I prefer to address those questions in more detail after we have our plan, budget and numbers for next year and I feel more confident and can give you more detail on that.
Rory Wallace
That’s fair. Thanks. And then just a couple of questions on the model. One is on product revenue. This year, it looks like it’ll 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 does 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
I think the majority has to do with the macro. We did a loss analysis on the deals during this year. We went one by one and everything that we were working on and did not materialize into a deal and is not still in process. We haven’t, or say most of the business that did not close, did not close because of macro-related issues, budget issues, expense cuts on the operators, things like that. I think our competitive positioning is still strong and I think the number of execution related problems, they exist. I’m not saying they don’t, we can always improve on execution, but I don’t think it would have made a material with different results. Most of it is macro.
Rory Wallace
Got it. And then with the expense structure, you mentioned there’s $1.5 million of OpEx related to the RIF (ph). Where does that show up in operating expenses? I wasn’t sure looking at the release.
Ziv Leitman
This is part of the OpEx because it relates to the people that there were RIFs. It’s like the one-time expense of the risk. So if
Rory Wallace
But would that actually be shown on the press release? I’m not sure.
Ziv Leitman
Yeah. So for instance, if X people were risked from R&D. So the relevant one-time rate expenses is in R&D. If there are people from SG&A, so it will be shown in SG&A. In the same place where we book the salaries.
Erez Antebi
You didn’t break it down to separate lines.
Rory Wallace
Yeah, you didn’t break it down. Yeah.
Ziv Leitman
It’s a 1.5, no? No, the 1. 5, it’s not in separate lines. It’s embedded in the R&D, SG&A, COGS and so on.
Rory Wallace
Understood. And it wasn’t shown separately. That’s just what I wanted to confirm. And then if I adjust for the 1.5, 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
I’m not sure it’s the right number, but we would like to refer to those numbers only in February, after we finalize the budget process and we will be ready with our 2024 guidance.
Rory Wallace
Got it. And one last question. Thank you for being patient 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 a prepayment and the revenue ships outside of the quarter?
Erez Antebi
I would say that it could go either way, so that tends to be a wide range. Let’s see where we end up there. If we close it, then how we close it.
Rory Wallace
Okay. Thanks a lot for taking my questions.
Erez Antebi
Thank you, Rory.
Operator
[Operator Instructions] There are no further questions at this time. Mr. Antebi, would you like to make your concluding statement.
Erez Antebi
Yes. I want to thank everyone for joining us on the call today. Thank you for your support during these non-trivial 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.
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