Gavriel Frohwein - Director of Corporate Communications Andrei Elefant - President and CEO Shmuel Arvatz - CFO.

Brian Finneran - Barclays James Kisner - Jefferies George Iwanyc - Oppenheimer Matt Robinson - Wunderlich.

Good day and welcome to the Q3 2016 Allot Communications Limited Earnings Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Gavriel Frohwein. Please go ahead sir..

Thank you very much and thank you all of you for joining us on our third quarter 2016 conference call. My name is Gavriel Frohwein, and joining me today are Allot’s President and CEO, Andrei Elefant, as well as our Chief Financial Officer, Shmuel Arvatz.

The press release announcing our third quarter results is available on the Investor Relations section of our website 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 defined as GAAP net income after including deferred revenues related to the fair value adjustment resulting from our purchase accounting and excluding stock-based compensation expenses, amortization of our provision related to intangible assets, deferred tax assets update, restructuring expenses and acquisition-related expenses.

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 on the press release containing our third quarter results.

Before we begin, let me remind you that certain statements made during the call today may be considered forward-looking statements, which reflect management’s best judgment based on currently available information. I refer specifically to the discussion of our expectations and beliefs regarding our pipeline and final potential future business.

Our actual results may differ materially from those projected in these forward-looking statements. Certain material factors or assumptions are also applied in drawing the conclusion or making the forecast or projections as reflected in such forward-looking information.

I direct your attention to the Risk Factors contained in the Annual Report on Form 20-F filed by Allot with the United States Securities and Exchange Commission and those referenced in today’s press release, most of which detail factors which could cause your actual results to be materially different from those projected in the forward-looking statements.

With that, I will now like to turn the call on to Andrei.

Andrei?.

Thank you, Gavriel and thank you all for joining us today. In today's call I will highlight Allot’s results and share with you some highlights of the third quarter of 2016. After my remarks, I will hand over the call to our CFO Shmuel Arvatz for a review of our financial performance for the quarter.

This quarter we had been very busy with continuing the transition together with alining costs in line with our longer-term strategy to become an important player in the security and monetization domain. Third-quarter financial performance was somewhat below expectations, which was disappointing. Revenue for the quarter came in at $21 million.

The operating expenses’ improvements that we implemented during the quarter are already showing results as we are ending the quarter with a slight net loss. Going into 2017, the positive impact of the reorganization and additional efficiency measures we look should contribute to better results.

Before drilling down into the quarter, I'd like to review our ongoing strategy and plan which is gaining traction.

Just this week in a Spanish newspaper El País, Vodafone described the benefits of the Secure Net solution provided by Allot which are [indiscernible] and I quote, in the first nine months of 2016 the solution blocked 50,000 ransomware attacks to 4 million subscribers who use this service.

A typical ransom demanded by an attacker ranges from EUR100 to EUR200. The benefit of the service both to the end user and to the operator is clearly demonstrated in this example.

This and other wins provide us with a confidence as we leverage our growth engine security and monetization which is clearly validating our early adopting customers and highly valued service. We anticipate that other carriers would follow.

In line with this strategy, our strategic partnership agreement with McAfee which I mentioned in our last call was signed during the quarter and we are moving forward full steam. Our sales teams are already working together towards promoting the combined solution.

Our joint goal is to deliver a unique comprehensive security offering to the consumer and small business market. This solution is called McAfee Unified Security powered by Allot and will be marketed by both companies.

This collaboration enables us to accelerate catchy market share capitalizing on the significant value that Allot provides as a player in the network-based security-as-a-service domain protecting users anywhere anytime. We expect to see revenues from this venture in 2017.

Additionally, a couple of weeks ago we announced a release of our secured service gateway, a product series that combines application based visibility and control with web security and DDoS protection in a single, scalable appliance.

With mobility and cloud migration, large enterprises require scalable platform that provides both network intelligence and security and control capabilities. Our Secured Service Gateway has businesses meet this need with all-inclusive solution.

During the quarter, we announced the release of our advanced network analytic tools which includes new dashboards real-time monitoring capabilities and new metrics, all managed from a newly released unified business intelligence interface.

This combination of tools enables real-time monitoring self-service analysis, network investigation, and advanced Quality of Experience analytics. Our actionable analytics have already enabled operators to enhance the offering they provide to their customers, improve quality of experience and stop revenue leakage by uncovering and reducing fraud.

Now for the quarter's results. Book to bill for the quarter was below one. The low booking rates is tied to seasonality which we typically see. In previous years, it was offset by a mega order that generally came in during Q3. As we stated in the last call, we expect this customer to place its order into 2017.

In the past years, we had high dependency on fewer customers that place large orders. Today, our revenue mix represents greater diversification of customers. Large deals reached 13 in total, five of which came from mobile operators, six from fixed line service providers and two from cloud operators.

Please note that three of these were seven digit orders. Out of this 13, three orders were for new customers; one in Europe, one in Africa and one in Latin America. Winning new customers continues to be a major focus for us. As we mentioned at the beginning of the call, revenues came in at $21 million.

Though we had good reasons to be confident in our long-term strategy and results, we believe at this time in the transition process it is important to be conservative and we are therefore lowering our guidance to $87 million to $90 million for the year. Now let's look at the OpEx.

During the quarter, we continued to improve efficiencies by consolidating various units and increasing focus on security and monetization, and reducing expenses in regions that were not profitable taking better advantage of local resources and economics of scale.

This efficiency is contributed to increasing profitability, provide additional leverage with revenue growth. Together with these efficiencies, we increased our investment in areas that serve our long-term strategy, casing point, the development investment in the joint effort with McAfee.

Moving forward, we expect full-year expenses to be at a yearly run rate of around $60 million to $62 million. In the value-added service business, value-added services were 31% of bookings during Q3, with security representing about 30% of total VAS.

Based on our product booking certification break down, security bookings for the quarter were about 26 of total product bookings. Before summing up, I will turn the call over to Shmuel for review of our financial results. Shmuel, please..

Thank you, Andrei. Before beginning reviewing the financial results of this quarter I would like to inform everyone that on this call unless otherwise noted I will refer entirely to the non-GAAP financial measure when discussing operating results which is what we use internally to judge the performance of our business.

Non-GAAP financial measures differ in certain respect from the Generally Accepted Accounting Principle and exclude share-based compensation expenses, revenue adjustment due to acquisition, expenses related to M&A activities, amortization of certain intangible assets, restructuring expenses and changes in deferred tax.

As it is clear, the revenue and profitability were below our expectation. However, our operating expenses have now been reduced significantly to a full-year run rate of around $60 million to $62 million positioning us well going forward. More specifically, turning to our third-quarter results, revenues for the quarter were $21 million.

This is a year-over-year decline of 10%. The decline in revenue was mainly due to the weakness in our APAC region and due to the fact that we had no significant contract in the quarter. The geographic breakdown of revenues was as follows.

Americas $3.9 million or 18% of revenue, EMEA $10.3 million or 49% of revenues, and Asia Pacific with $6.9 million or 33% of revenues. Product revenues for the quarter accounted for 55% of revenue, while service revenues were 45% this is compared to 64% and 36% split in the third quarter of last year.

book to bill ratio in the third quarter remained below one. During the quarter, we had 13 large customers, three of which were new customers and three of which were customers with bookings greater than $1 million.

Gross margin for the quarter was 70% of revenues versus 77% in the third-quarter - period of last year and 73% in the second quarter this year. The lower level of gross margin this quarter compared to the previous quarter was mostly due to unfavorable product mix.

Operating expenses for the quarter were $15 million compared with $18 million in the third quarter of last year. The reduction in operating expenses was mostly due to lower labor and related costs resulting from the cost reduction measures implemented.

As Andrei mentioned, at the beginning of third quarter we implemented a reorganization plan which included among other measures an additional reduction in our headcount. These measures were aimed at streamlining our operations and alignment of our cost base with our topline.

On a GAAP basis, we recorded a restructuring cost of about $1.3 million, which is connected to our reorganization plan implemented and related mostly to employee’s severance and similar expenses. Operating loss for the quarter was $311,000 compared to operating income of $218,000 in the third quarter of 2015.

Net loss for the quarter was $474,000 or $0.01 per share compared to net loss of $741,000 or $0.10 per share in the same quarter of last year. Turning to the balance sheet, our cash reserves comprised of cash, cash equivalents and investments totaled $110.9 million, down $5.7 million compared to the previous quarter.

During the quarter, we recorded negative operating cash flow of $5 million, a negative cash flow is attributable mostly to delays in collection from two strategic customers amounting to about $5.5 million. Since the beginning of the quarter we collected about $1.5 million of this amount and expect to collect the remaining amount during this month.

As a result, DSO was 118 days, up 26 days from the previous quarter. To conclude, 2016 has been a weak year for us, however, the steps we have taken position us well for the years to come with a significantly lower expenses base. In addition, we are realigning our business to focus on our security amortization growth engine.

This step will believe will enable us to profit from the traction we expect to see from our growth engine over the coming quarters and years. With that, I will turn the call back over to Andrei..

Thank you, Shmuel. To sum up, during the past quarter we made significant progress in lowering expenses while continuing to invest in our longer term strategy enabling us to maintain profitability for our business transition. Guidance for the full-year revenue is conservative at between $87 million to $90 million.

And our partnership with McAfee as well as the success of our early adopting customers give both us and our partners great confidence and contribute to our positioning and recognition as a significant player in the security-as-a-service domain. With that I will open the call to Q&A.

Operator?.

[Operator Instructions] And we can now take our first question from Joseph Wolf from Barclays. Please go ahead..

Hi, guys. This is -- it's Brian Finneran on for Joe.

First question I guess, you guys had mentioned that orders have been of a smaller scale and a bit more diversified in 2016, is this because the nature of your new products or has the customer's behavior shifted?.

Hi, Brian. Thank you. So I believe it's a combination of both. We typically, in previous years, had, during the year, have had one or two megaprojects or megadeals that came together with the smaller deals that we see today. So overall, we used to have also those smaller deals in previous years.

What we are mixing this year is mainly those megadeals that we still see in the pipeline. However, the timing of these deals having following today, these first three quarters, but we’re working closely with this strategic customers and we do have plans to get those big orders going forward.

And now in parallel, what we are aiming and I mentioned that also in my script is that we want to win additional customers and we are building some products at the Service Gateway that is targeting large enterprises, where we see a need for technology like ours and now it's the combination of both the visibility, network intelligence, control, and the security aspects of adding into this Service Gateway.

We believe this will be able to capture a greater installed base, also with smaller customers, both in the enterprise area, large enterprises and small service providers..

Great, thanks.

And then, are more of your sales success based at this point mainly determined by individual end user take rates and not by large box or appliance sales?.

Sorry, can you repeat?.

Are your sales more determined by individual end-user take rates and not by sort of large box or appliance sales?.

It depends on the type of service, so if look at the security as a service, then we are dependent in the take rate of the service, meaning that we sell typically our solution to operators that offer security as a service to their installed base and as a result, we get revenues from license sales and subscription to the service.

On top of that, we have the business on the traffic management and visibility where we are selling more boxes to the operator and then it’s more on a box level transaction..

Great.

And then just one housekeeping, you said VAS, as a percentage of total bookings, was that 36%?.

31%..

31%. All right, thank you..

And we can now take our next question from James Kisner from Jefferies. Please go ahead..

Hi, thank you. I was hoping you talk again more about gross margin.

Obviously this is a new lower level, was there any pricing pressure at all affecting your gross margin this quarter and what do you think it might look like in the coming quarter, could it improve?.

I think as I mentioned on the beginning, compared to last quarter, we had product mix, which is unfavorable, mainly more hardware than software on a sequential basis. However, in order to improve this level of gross margin, we need probably to improve the top line.

If we go back to the level of revenue at least as we saw last quarter, I believe that we will see or we expect to see some improvement in the gross margin from this level..

So no incremental pricing pressure at all?.

I would say again, the main reason for the lower gross margin is because of the lower revenues we have in, on the COGS, we have the fixed part that is fixed and contributes the same level, no matter what is the revenue and since we had low revenue this quarter, it impacted also the gross margin..

Okay.

So you had nice OpEx for all this quarter, and I mean have all the benefits of restructuring been realized, should we think about this as kind of a good near-term level for the next few quarters?.

Yes. We expect $15 million to $15.5 million, this kind of level, in the next quarter..

And just finally, I mean, obviously you explained your cash burn, but going into Q4, what do you expect in cash from operations to look like, are you expecting to get back to positive cash generation? Thank you..

Assuming we collect the overdue amount that I mentioned and all other collections are on track based on past record, I assume that we will turn back to positive cash flow..

Okay, thank you..

[Operator Instructions] We can now take our next question from George Iwanyc from Oppenheimer. Please go ahead..

Thank you.

Can you give us an idea of the type of visibility you have into 2017 overall, I’d say from a regional perspective and then with regards to the McAfee partnership as well?.

Regarding 2017, in general, we are not providing yet guidance for next year. And with regards to McAfee as stated, we expect to see revenues from this partnership in 2017. We are already working together on some projects. There is a pipeline and we believe that we will start to see revenues in 2017..

Okay.

And, in general, how long do most of the deals in that pipeline take? Are they 6 to 9 months, a little bit longer? And then on the megadeal pipeline, what type of visibility do you have into that into 2017?.

The nature of the deals with McAfee is similar to the other projects that we have, and I would say 6 to 9 months would be a good estimate and so that is from the deals with McAfee.

Regarding the megadeals, we have with some of our strategic customers, we are working on projects, most of them are into 2017, but this is exactly the budget period and we are working with them on this project.

So I believe that once we’ll conclude the process with them, we will have better visibility into the type of orders that we expect in 2017, and we’ll report that as part of our general guidance to 2017..

All right.

And have you seen stability return in your Americas bookings at this point?.

We do see stability in the Americas bookings. It’s slightly lower than where we expected it to be, but again we have nice pipeline. Some of it has come from the partnership that I mentioned earlier with McAfee..

Okay. And one last question, just on the hardware-software mix, should we expect it to kind of stay at the current levels for the next quarter or two..

No. If we improve the topline levels and we get some economies of scale in the model, we can expect a slight improvement also in the gross margins, this is what we expect right now..

Okay. Thank you very much..

[Operator Instructions] And we will now take our next question from Matt Robinson from Wunderlich. Please go ahead..

Thanks.

First on the Secure Gateway and the move towards budgeter prices, small service providers, how are you going to accomplish that without disturbing your expense reduction game plan? I know your sales in Americas at 18% doesn't imply a lot of reach in that market, so how do you expect to address those customers?.

In terms of the management of the OpEx, so we looked at two areas where we did improvements. One is some consolidation we did on the product side, grouping different products together and one of it resulted by assuming both the security and the service gateway teams into one unified team. We got also the benefit of releasing a joint product.

And the other area is on the sales side, we looked at the different regions and we more selectively invest in specific regions where we identify the potential to grow. So there were areas that we decided to use the investments and we gained some reduction there.

On the other hand, we are investing more in other areas, including investments in building channels in areas that we identify the growth potential. So it is more pinpointed to certain geographies where we identify the potential and we believe that with time, we would be able to expand to other geographies as well..

On your services revenue, is there a component to that that reflects some of your security and modulation initiatives in terms of term licensing or is that, would that go into the product category and it services entirely a function of maintenance type revenue?.

Those revenues are still mainly on the CapEx type of revenues. We do have some subscription, however, it’s not material enough yet to separate that. However, going forward, the direction we’re taking is definitely in that direction.

We’re going to more subscription-based type of projects and the projects that we have in the pipeline are built in this model. Also, the partnership that we are doing with Intel is designed on a subscription model and not on a CapEx model..

As you make that transition and it starts to be meaningful to revenue, will you have a third revenue category and if not, which category will that revenue go in to?.

I believe that once it’s material enough, we’ll separate that and mention that separately as a separate metric..

But for now, it goes into products, correct?.

Yes..

Okay.

So when you look at the services component of, what is the range of ageing, those are maintenance contracts, right, the services component?.

It's a combination of professional services and maintenance, and this is the main contributor..

Has there been a change in the mix towards professional services?.

I believe that over the last year, not a major change from the services, I would say around 25% to 30% is professional services and the rest is maintenance..

Okay.

So if you look at the maintenance revenue, which I guess is about 30% of your sales, is that probably a little bit more, how is ageing of the products of those contracts addressed? Is the bulk of it for products that are 5 plus years old, is there any way to characterize that?.

Typically, the contracts that we have is between 1 to 3 years. We have some strategic customers that they also buy it for five years. And so after that period, they typically either renew the service contract. And in some cases, there is an upgrade to the Neo platform and then the maintenance starts from the beginning..

Okay, great.

One last question, why did the deferred revenue go down in the quarter?.

Deferred revenues are mostly maintenance contracts and the timing of renewal and collection are influencing the level of deferred revenues. So it's a matter of timing of renewals and collections..

Do you expect that effect to be reversed in the current quarter?.

Not in the third, but maybe in the one, because in the first quarter, there are more heavy renewals pattern than in the rest of the year..

Okay. Thanks for giving the time on the call..

And we have no further questions in the line at this time..

Thank you very much. Thank you everybody..

Thank you. That concludes today's conference call. Thank you for your participation, ladies and gentlemen. You may now disconnect..

Thank you..