Welcome to Allot’s Fourth Quarter 2019 Conference Call. I would like to welcome all of you to the conference call and thank Allot’s management for hosting this call. With us on the call today are Mr. Erez Antebi, President and CEO; and Mr. Ziv Leitman, the CFO.

Erez will summarize the key highlights followed by Ziv who will review Allot’s financial performance of the quarter. We will then open the call for the question-and-answer session.

Before we start, I’d like to point out that this conference call 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 would, 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, reduced demands and the competitive nature of the security systems 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 over the call to Erez. Erez, go ahead, please..

One, malware protection, as we provide with our NetworkSecure; two, DDoS protection, as we provide with our DDoS secure offering; and three, firewall protection which is part of our IoT secure offering. All of these solutions are telco grade.

They are scalable to very high capacity, are operating in the virtualized environment of operators and have multi-tenancy capabilities. They can be deployed in the core, as well as at the edge.

Our solutions fit extremely well for operators wishing to provide enterprise SMB and consumers with fixed wireless and very high broadband connectivity, while providing all of these protections as a service from the network.

Since the primary use of 5G is expected to be provision of fixed broadband access to SMBs and consumers, we see a large opportunity for Allot here. As additional operators are looking to launch 5G networks, we are actively engaged with several operators with 5G plans. I will now like to summarize the overall picture.

We are proceeding according to plan and growing the business. I believe our fourth quarter numbers including year-end backlog and signed recurring security revenue deals are a testament of that. In the visibility and control area, we have a growing number of opportunities in various areas.

We see longer term opportunities as 5G networks are deployed and as governments demand more regulation on internet traffic. In the security area, which we see as our major long-term growth engine, we have signed several deals for Allot Secure products, including several security OPEX deals.

Adoption rates in the services already launched are encouraging. Our pipeline of recurring security revenue deals with CSPs is encouraging as well. It is expanding, and most operators we talk to are accepting of the recurring revenue or revenue share model we offer.

In addition to the deals we already signed, we were selected already by several additional operators for recurring security revenue deals and/or in contract negotiations with them. Looking further ahead, we see further opportunities on growth possibilities, providing security for 5G-fixed wireless connectivity.

Based on our current backlog and on our pipeline of new deals that is growing and strong, our 2020 revenues expectations are between $135 million and $140 million. In addition, we expect to sign additional recurring security revenue deals within MAR of at least $140 million in 2020. Ziv will provide further details on our expectations for 2020.

And now, I would like to hand the call over to Ziv Leitman, our CFO. Ziv, please go ahead..

product revenue accounting for $67.6 million compared to $56.2 million last year, professional services revenues were $8.5 million compared to $6.3 million in 2018, support and maintenance revenues were $34 million compared to $33.3 million in previous year.

The portion of communication service providers revenues out of the total revenues were 76% in the fourth quarter compared to 81% in the fourth quarter of 2018, 81% of total revenues for the full year of 2019 compared to 80% in 2018.

Security revenues in 2019 were $26.2 million or 24% of total revenue compared to $24.5 million or 26% of total revenue in 2018. I would like to reiterate that while the long-term potential for ongoing revenue from the recurring security revenue deals are significant.

This deal will take time to ramp, as they are typically six to 12 months between signing with the customer and the product launch. After that, revenue slowly ramped over many months, as the subscriber sign on to the new service and penetration increases.

Also, please note that the revenue breakdown, whether geographical or product line by any other, may fluctuate from quarter-to-quarter depending on the specific revenue and deals we recognized in the specific quarter. Our customer base remains diversified.

Our top 10 end customers made up 56% of our revenue in 2019 compared with 53% in 2018, while the largest consumer – customer – sorry, the customer in 2019 accounts for approximately 16% out of total revenues versus 22% in 2018. The 2019 booking were significant, reaching $179 million, which led to a record high book-to-bill ratio of 1.63%.

Gross margin for the quarter was 68.7% compared to 70.3% in the fourth quarter of 2018. Gross margin for 2019 was 70.2% compared to 70.7% in 2018. The variation between the quarters from flat to the product mix or deal mix sold in that particular quarter and is not an indicative of any specific trend.

Operating expenses for the quarter were $22.8 million compared to $19 million as reported in the fourth quarter of 2018. For 2019, operating expenses were $85.3 million compared to $72.6 million in 2018, the increase of which mainly reflects the increase in the number of employees.

The total worldwide number of full-time employees as of December 31, 2019, were 594, this is an increase of 70 FTE compared with that of the end of 2018, which stood at 524. Non-GAAP operating loss for the quarter was $1.8 million compared with non-GAAP operating loss of $99,000 in the fourth quarter of 2018.

Non-GAAP net loss for the quarter was $1.7 million or $0.05 per share versus $455,000 or $0.01 per share in the fourth quarter of 2018. Non-GAAP net loss for 2019 was $7.5 million or $0.22 per share versus $5.1 million or $0.15 per share in 2018.

Even though 2019 revenues increased by 15%, the net loss increased by $2.4 million due to a strategic decision by the management to increase OpEx by 18% in order to support the long-term growth strategy due to the opportunities we currently see in the market. Turning to the balance sheet.

Our cash reserves comprised of cash, cash equivalents and investments as of December 31, 2019, were $117.6 million compared to $114.8 million at the end of the last quarter and $103.9 million in December 31, 2018.

I note that the increase in the third and fourth quarter was primarily driven by large deals in which the upfront payment was relatively large. $34 million out of the total cash balance is restricted due to advanced payments from customers, margin required for foreign currency hedging activities and other collaterals.

For the three months ended December 31, 2019, the number of basic shares were $34.5 million and the number of fully diluted shares for the same period was $36.5 million. Since we expect to recognize over 70% of the current backlog as revenues in 2020, we have relatively good visibility into the 2020 revenues.

In terms of guidance, as Erez mentioned earlier, we are expecting revenue to grow significantly in 2020 to between $135 million and $140 million, representing accelerated year-over-year revenue growth of 25% at the midpoint.

This growth rate will likely not to be constant on a quarterly basis, and there may be fluctuations in the actual revenue level from one quarter to another. We expect gross margin for 2020 to average around the same level as we have seen in previous years, at around 70%.

However, I reiterate that on a quarterly basis, the gross margin may fluctuate as a result of the deal mix and revenue recognition.

As we continue to invest in sales and marketing and R&D to facilitate the growth of the company, we expect operating expenses in 2020 to be in the range of $95 million to $98 million, representing year-over-year growth at the midpoint of $11 million or 13% over 2019.

Since the increase in OpEx, we plan to be at a lower rate than that of the revenue growth, we are expecting to become profitable in the fourth quarter of 2020. We are expecting a negative net cash flow, a few million dollars, for the entire 2020, of course, excluding any potential M&A activities.

However, the net cash flow in the beginning of the year is expected to be significantly less than the net cash flow towards the end of the year, mainly received significant high level of advance payment in 2019.

Regarding the bookings, we believe that it will be higher than 2019 revenues but lower than the 2020 revenues, while 2019 CapEx bookings were exceptionally high. We are also more focused on signing additional recurring security revenue deals that produce little to no booking in 2020, but will build a strong foundation for future revenue growth.

As Erez mentioned, for 2019, we achieved a total MAR of $85 million. And we believe that in 2020, we will sign additional deals, which will exceed an MAR for the year of 2020 of $140 million.

As I mentioned earlier, since it takes some time from contract day to commercial launch, we are expecting initial recurring security revenues in 2020, which will amount to a few million dollars with a much more significant amount next year.

The combined effect of our backlog, our expected booking in 2020 and the expected recurring security revenues, leaves us to expect revenues to continue to grow also in 2021, but at a lower rate than the expected growth of 2020. However, it is too early to anticipate the growth rate in 2021. That concludes my remarks.

We would be happy to take your questions now.

Operator?.

Thank you. Ladies and gentlemen, at this time, we will begin question-and-answer session. [Operator Instructions] The first question is from Alex Henderson of Needham & Company..

Hey, thank you. This is Roger Boyd on for Alex. Congrats on a nice quarter.

Wondering if you could talk about the strong 2020 revenue guidance? And what gives you confidence in that? Is it a stronger demand in DPI or quicker ramping OpEx deals that you signed last year or maybe more CapEx deals or a combination of the three?.

It’s a – I think, it’s like we said. It’s a combination. We’re entering 2020 with a very strong backlog. We have a very strong pipeline for additional deals. And we are going to – we expect to start seeing a few million dollars from the recurring security revenue deals that we signed.

So it’s a combination of all those that lead us to our guidance for 2020..

Okay, great. And then one follow-up.

With recruiting, am I thinking about – am I thinking about it right in that it’s a CapEx deal that was mostly recognized in 2019? Or is that shifted with the delay in their network? And then I think you talked about a potential OpEx component of that after the network goes live?.

I’m sorry, could you repeat the question? I couldn’t hear you well..

Sorry. It was about Rakuten.

Am I right in thinking about, it was a CapEx deal that was mostly recognized in 2019? Or is there an OpEx component that you benefit from after the network goes live?.

It’s basically a – if I remember correctly, it’s a term license deal. So we recognize this– we recognize revenues in 2019 from Rakuten. And as the network goes live, there will be additional upsides later on or we expect at least to be..

Okay. Thank you very much. Nice quarter..

The next question is from Marc Silk of Silk Investment Advisers. Please go ahead..

Congrats on just great progress and great guidance. So the product for the internet security is like something, me as an American consumer would love to see. Can you kind of talk about, like, if you’ve talked to, like, U.S.

carriers and kind of what the conversations are?.

Well, I can talk to it to a certain degree. First of all, we would like you to see this internet security as well as a U.S. customer, and we’re working to make that happen. Look, we’ve announced previously that we have signed deals with the two U.S.

Tier 1 operators, one of them in the DPI area and the other one was IoT security, which obviously will not be relevant so much for consumers. So we’re – I think – I can say that we’re actively engaged with those operators and with additional operators in the U.S. These– if operators in general, take time. U.S.

operators take a longer time, mostly due to their size and the complexity, but then the fruits of being successful there are larger. So we’re continuing to engage with them. I think we’re making progress, and I’m optimistic..

Okay. And so, one thing to clarify on your product on the internet security, so if I’m a customer, I don’t need to download an app, your application is basically on the network. So basically, if I was like, let’s say, a Vodafone customer, Vodafone, all they have to do is flip a switch, and it’s already there for me.

So the customer doesn’t really need to do anything.

Is that – can you clarify that for me?.

Yes, you’re absolutely correct. Our – the software sits in the core of the operator’s network. So you as a consumer, if you were a Vodafone customer, and you wanted to sign up for their, what they call SecureNet. That’s the brand that they give this service in various countries, all you would have to do is agree to pay.

You would not have to download anything, configure anything or anything of that sort. Vodafone would flip a switch, speaking virtually, in the network. And you will – and your traffic will be filtered and secured from the network itself..

So that’s very important because, like as consumers, sometimes they have a download an app or they have to do something. It really affects penetration because sometimes they can’t figure it out or like no, I’m too lazy. So this is really kind of a game changing technology. So having said that – you can comment on that.

Because I think that’s really important, which it just makes this even a more compelling investment..

I think you are right that it is very important. We know from many operators that we talk to that resale security apps that could – that users have to download onto their phone or computer and configure it and so on. That a typical penetration rates for apps that are downloaded is about 5% – 3%, 5%, if they get to 5%, 6%, they’re really happy.

And one of the big advantages of having a network-based security that is provided by the operator to the consumer or a small business as a pure service without the consumer or business having to do anything other than agreed to pay for it, of course, is that penetration rates become very high.

It’s a primary reason, together with our – the engagement tools and how we show the value and so on, but it’s a primary factor in getting penetration rates into the 20%, 30%, 40% and even 50% for different operators. I agree with you on that..

Okay. So now, I know you’re going to have a vast amount of customers for the – again, sticking with the internet security. Are you – are they able to like access your information, like Vodafone, you say, has a 50% penetration rate. Even though we don’t get the recurring revenue, at least you’ve learned a lot.

So do these carriers, kind of, pick your brain and say, what do we need to do to get that 50% penetration? Or they, kind of, have their internal, like we know what we’re doing type of attitude?.

Well, as you can imagine, it varies from operator to operator. But what we’ve setup – in our marketing team, we’ve setup a specific group that is specializing on understanding what is the right way to market these kinds of services to consumers and small businesses.

And when we sign up with an operator such as Hutchison Drei in Austria, such as MEO in Portugal, a part of the package, part of the value that we bring them is this is the knowledge that this group has, to sit with their marketing teams with the operators’ marketing teams and show them what kind of go-to-market schemes work better, what kind of work not as well, what is the experience from other operators and so on and help them design their go-to-market processes, help them design their campaigns and so on to achieve higher penetration rates..

So now that you’re hitting new highs, and you were a value stock and turning to a growth stock, have you basically been talking to other analysts as far as coverage?.

We have been talking to other analysts. As you may – as you probably know, getting additional analyst coverage is challenging. We would welcome any help you can give us on that..

Well, the Silk Investment Advisers has you as a strong buy, how’s that. And I know because you need investment banking money, but with your balance sheet, I get it. So if you remember, a few conference calls ago, when your stock was $7, and I said, it kind of makes sense, you could use a little bit of money to buy back shares at 7%.

I think now that the stock where it is now, I think that offer’s off the table. I think you just sit back and see what happened. So I was supposed to meet you in Boston, but I met Ziv about a month ago. So this is for Ziv. Ziv, I know you really don’t even need this job because you’ve been successful in your previous jobs.

Why did you decide to come to Allot?.

As I told you, it’s because of two reasons. First of all, I believe in the market and I see huge potential for growth for the company. And the second reason is the people. I met many of the management and the board member before I joined and I came to the conclusion that with these kind of people, we can be a winning team.

And Allot can be a huge success story..

Maybe, Erez, one day, you’ll get to Boston. But I think you guys are going in the right direction in an environment where there’s not many growth companies. This is going to be an exciting next – this decade should be very exciting for Allot. So congratulations on the progress and continued good luck..

Thank you very much..

The next question is from [indiscernible]. Please go ahead..

Yes. Thanks for taking my call. Congratulations on the good year and the great guidance. Well, actually, you did talk about it a little before I hand Erez, to the guy who talk with you beforehand, I forgot his name. But maybe some – a little more clarification.

Maybe if you can elaborate, you seem to have a lot of activity, and deals are mainly signed in Europe and Asia.

And I wanted to ask, do you have any chance to penetrate the American market? Even – I mean, you have 15% or 14% of your revenues are from there, but maybe do you plan to have more? What are you doing to get it – to get there?.

Well, like I said, we signed a couple of deals with two of the Tier 1 U.S. carriers, one for DPI and one for IoT security, both of which are not very large, but I think they’re an important start. We are definitely focusing a lot more efforts in the North American market. I think there’s a tremendous potential there.

And from my perspective, I see it as a significant potential for growth for us, and we’re definitely investing resources to get there..

Okay. That’s great. It’s good to hear that. And keep up the good job..

Thank you very much..

Thank you very much..

The next question is from Jeff Bernstein of Cowen. Please go ahead..

Hi, guys. My congratulations on a great year and a great outlook. Just a couple of questions on competition.

I think I heard you say that you had replaced or added on top of a competitor that was already in place with a DNS based product, and I wanted to understand a little bit more about that and how you see your technology versus DNS kind of playing out here, first..

Maybe I’ll clarify a bit more what happened there. This is a group of companies that in one of their operations, they have deployed DNS security. And then when they looked at us, they understood that the security level that we can provide with in-line security is significantly better than what DNS security can do.

And therefore, they decided to work with us in other markets. Now it’s – the rationale is very simple, right? DNS security is a nice offering, but it’s very easy to buy pass and it doesn’t capture many cases of either fishing or bot attacks or things like that.

So it’s – and our technology simply provides a much more secure and better service to the end users. And I think that many operators are realizing that. However, it’s still a lot easier to deploy DNS security.

So as I said before, there are going to be operators that look at this and say, okay, I don’t care really if the level of security is good or bad. I just want it to be really easy for me. And we’ll use DNS security. But I see many operators that understand that you can’t do so-so security. You have to do something serious.

And those operators will go with an in line solution like we provide..

Great.

So it sounds like for the time being, we’re happy for DNS providers to raise the consciousness about security products and at some point, those folks will come your way, looking for more robust solution?.

It’s hard for me to say if they will come our way. They won’t. I think we’ll continue to work with the market and explain and prove to them that our solution is superior.

And I think that overtime, more people and more operators will understand that security is something very serious, and you need to provide a serious and good solution, and I believe in this direction..

Great. And then a question just on virtualization. Wondering if you have seen your competitor offer virtualization yet and sort of demonstrate at scale? And then on the 5G demands. It seems like it’s even more important. It does sound like your machine learning and AI capabilities become more important.

Just talk a little bit about the defensibility of your technical position in that market versus what had become more commoditized in DPI for a few years in the past..

Look, I’ll start – the first question was whether our competitors are deploying a virtualized solution. And the answer is yes. I think we’re starting to see them. We’re definitely seeing them offer it. I assume they’re starting to deploy it. I’m not sure I’ve seen them deployed in a massive scale yet, at least I’m not aware.

It doesn’t mean that they haven’t. It just means that I’m not aware of it. But everybody is moving in that direction. So they will get there as well. I think we have a leg up on them, and I think we’re doing a better job, but I think everybody is going out. So all our competition is going in that direction as well.

Regarding – I’m sorry, your second question….

That was about 5G and sort of greater requirements?.

Yes, yes. Look 5G – the 5G is going to be – many operators are starting to roll out 5G in the U.S. I think Verizon definitely is, AT&T is and other operators are starting to think about it. You’re starting to see operators in Europe think about 5G, even in Asia. So 5G is happening.

And like I said, I think what we’re doing is, we have many elements that are very important and added a tremendous value to a 5G delivery, especially in security, but not only security, but really, most of it in security but also in DPI.

Now what we’re doing with machine learning and artificial intelligence is just applying these techniques and this kind of technology to the problem of identifying protocols, identifying malware, doing things like identifying other things of interest in the telecommunication network. It’s not so much – you asked about defending it.

I don’t think it’s so much an issue of specific patents around that. It’s simply putting in the work, providing a good product, focusing on the needs of operators in these fields. And delivering value to them on what we’re doing.

And there are going to be many other people that are doing machine learning and artificial intelligence for a variety of means. Our focus is delivering it to operators to be used for both DPI and some visibility and security applications..

Great. Thank you..

[Operator Instructions] There are no further questions at this time. Mr.

Antebi, would you like to make your concluding statements?.

Yes. I’d like to thank you all for listening in, and I’d like to thank you for your support in Allot. And I look forward to seeing you in the coming weeks and months, wherever we are. Thank you very much. Bye-bye..