Ladies and gentlemen, thank you for standing by. Welcome to Allot's First Quarter 2023 Results Conference Call. All participants are at present in a listen-only mode. Following management's 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 EK Global Investor Relations. Mr. Green, please go ahead..

Thank you, Operator. Welcome all to Allot's first quarter 2023 conference call. I'd like to welcome all of you to this conference call and I'd like to 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, 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 all find the financial highlights and metrics including those we typically discuss on the conference call in today's earnings press release. Before we start, I'd like to point out the Safe Harbor statement.

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 the impact due to the COVID-19 pandemic, changing market trends, delays in the launch of services by customers, reduced demand 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 the call over to Erez Antebi. Erez, please go ahead..

Thank you, Kenny. I'd like to welcome all of you to our conference call. Thank you for joining us today. Our first quarter revenues were $21.1 million, 34% lower than comparable revenues last year. In March, 2023, our SECaaS ARR was $9.3 million, slightly above our SECaaS ARR in December 2022 and 58% higher than our SECaaS ARR for March 2022.

The beginning of 2023 was challenging for us. The transition of the business into SECaaS recurring revenue model has proven to be slower than we originally anticipated. In addition, our core DPI business experienced some headwinds.

While we don't expect those challenges to disappear in the near-term, given the tough economic backdrop, we continue to make progress with the aspects of the business that we can control. I remain optimistic about our future.

During today's call, I will discuss the challenges we are facing, the opportunities we see, and why I am confident in the future. As we discussed in our previous earnings call, we remain committed to reaching profitability for the full-year 2024.

While our OpEx may fluctuate from quarter-to-quarter, because there are many factors that affect the total OpEx, we intend to continue tightly controlling our expenses in order to reduce our loss in 2023 as we look forward toward reaching profitability for the full-year 2024.

Our OpEx in the first quarter was $22.4 million, a reduction of 19% compared to our OpEx in the fourth quarter of 2022, some of which was due to one-time items. During the second quarter, we implemented another reduction of our workforce to further control our expenses, the impact of which we will start seeing in the third quarter.

During the first quarter, our cash balance fell by $9.1 million. We experienced some delays in collections as a result of some of our customers implementing tighter cash controls. I see this as a timing issue and I do not see a risk in these collections.

This cash burn is of course higher than we would like it to be, and we expect to lessen the cash burn during the third and fourth quarters of this year. Specifically, as our cost cutting efforts come into effect, together with a projected increase in revenues, we expect to reduce our operating loss and improve our cash flow.

Our gross margin in the first quarter was 67% due to lower revenues and our deal mix. We continue to target the gross margin of 70% for 2024. Now I would like to discuss our different product lines. I would like to start by discussing our traffic management and analytics business addressed by our Allot Smart product line.

The main use cases we see today in CSPs continue to be in traffic management, congestion management, quality of user experience, especially for video, policy and charging control and digital enforcement.

As governments look to fight crime and terrorism, we see a growing interest globally and being able to block illegal activities such as drug trafficking, child pornography and terrorism. We have solutions that address these issues and we are seeing growing interests in our products. Many CSPs today are re-looking at their network needs.

In developing countries, we see a growing number of opportunities where CSPs are looking to replace end-of-life DPI products. In developed countries, we are seeing some rethinking of network needs as CSPs look at deploying new 5G standalone “cores”.

We continue to see multiple opportunities globally where CSPs currently using our competitors' products are considering a change. We are working closely with quite a few such CSPs to win their trust and business becoming their next choice for DPI.

Most of these processes are through a competitive bidding process and some are potentially negotiated deals. In addition, we are working on expanding deals that we previously won. Specifically, during the first quarter, we won a project in EMEA to install a DPI system for a new customer that did not have such a system before.

As we stated on the last earnings call, while we continue to see in our pipeline a similar combination of replacement opportunities and new deals, and while we remain excited about these opportunities, we also recognized that we are facing several challenges that continue to make it more difficult for us to provide a definite forecast.

First, as discussed in previous earning calls, it is taking us longer to close DPI deals than in the past. And the total number of DPI bids for CSPs we are seeing is not growing. I believe this has to do with the general economic environment and tighter expense control by CSPs.

Second, in the enterprise market, we believe the growth we saw as a result of the Broadcom deal has peaked and we do not expect further growth in this market.

As we stated during our last earnings call, while we have a strong pipeline of large deals for the year, the dynamics I just discussed together with potential lumpiness of large deals makes it challenging to predict the timing of revenue recognition for our DPI business. And as a result, we do not expect to see growth in our DPI segment for 2023.

However, we also do not believe that the contraction will be more than 5% to 10% in 2023. Our receivables will reduce this quarter by $4.5 million. In the previous earnings call, I noted that we had some growth in our receivables from sales to resellers in Africa and Latin America who are late on their payments to us.

While we have not yet collected these amounts, we reassess the late payments and determined that the payments remain collectible. I want to turn your attention now to what we see in our cybersecurity business and how the market is developing.

As I have said in previous calls, Allot is transforming into a cybersecurity company and this is where we see most of our future growth coming from. We are engaged worldwide with CSPs that are looking to provide their customers with network-based SECaaS.

As we look at the market, we see that the direction and momentum of operators interested in launching network-based security services continues to be very positive. We see that in many markets. The various operators provide services that are on par with respect to speed, coverage and reliability.

As they look for differentiation, network-based security is emerging as an important element. Because it is a service native to the operator’s network, network security is directly coupled to the access network itself.

There are several Tier 1 operators who have reached the conclusion of providing network-based security to their customers is of significant importance to them, and they are discussing with us how to do so.

The largest signed SECaaS opportunity for Allot was a Tier 1 operator is the contract we signed with Verizon business, which we discussed previously. Recently, we announced that we signed a deal with a Tier 1 fixed broadband operator in Latin America to provide security services to their customers.

In addition, we announced that PPF Group in Central and Eastern Europe is expanding its cooperation with us. Following a successful service launch in Bulgaria, PPF decided to expand and provide security services in four other European countries.

I believe these deals are a testament to the importance CSPs in providing businesses and consumers with network-based security services. In addition, we are in contract negotiations with several other operators globally where we were awarded deals, but have not yet signed the contracts.

On top of that, we are in serious discussions with additional operators where an award has yet to be provided. As we discussed in previous calls, I want to remind you that we changed our strategy for Allot Secure business.

We are putting more emphasis on strategic accounts that can have a high revenue impact, while in small to medium deals we are looking for some customers' assurance in setting minimum revenue thresholds. While this approach might affect a number of deals we signed, it will allow us to get to profitability sooner.

We remain excited about our SECaaS opportunity as we have a differentiated and scalable solution for CSPs. Our SECaaS revenues for the first quarter were $2.3 million, and the SECaaS ARR at the end of the first quarter was $9.3 million, a significant growth year-over-year.

As of March 31, 2023, we have 27 signed customers, but eight of them are canceled and discontinued mainly to our strategy to focus on large customers. Unfortunately, only 14 have started to generate revenues and most of them are relatively small operators and most of them launched the service only to a portion of their subscriber base.

There are several more launches planned for this year. As we have discussed previously, our main challenge today in SECaaS business is to translate the contracts we signed into revenues. The first challenge is to launch the service. This process involves many stakeholders on the CSP side, technical, operational, marketing, purchasing and more.

They all have multiple other tasks and priorities. Often integration of our products with different internal IT systems is required. A major challenge we have is the marketing aggressiveness of the CSP when launching the SECaaS service.

Aggressive go-to-market approaches can include among others, proactively offering the service in every customer interaction, bundling the security offering in the price plan for some or all of the customers, et cetera.

The willingness of the CSP to commit to an aggressive go-to-market approach in the contract is to a degree, an indication of how strategic this service is to them. These discussions sometimes take time and further delay the launch, but I think they are very important to our long-term success, as well as to the CSP success in this field.

I believe Far EasTone in Taiwan is a strong testimony to the value generated when the CSP views security as a strategic offering and the executive decision is to launch the service aggressively. In only three months from the service launch, Far EasTone reached nearly 200,000 subscribers and service, and the numbers is continuing to grow rapidly.

As we discussed in the previous earning call and in line with what I discussed above, we changed certain elements of our approach to the market. One, we shifted our focus from "land grab" for market share and number of CSPs – to CSPs that have significant revenue potential. Two, we are approaching the CSPs as partners, not as customers.

We are pushing very hard to have CSPs we engage with, contractually commit to an aggressive go-to-market strategy.

CSPs of medium size that will not commit to an aggressive go-to market approach and small CSPs regardless of their planned go-to-market approach, our offered commercial terms where our revenues are not dependent on their marketing success. We expect some of these CSPs may agree to this and some may not.

I expect these changes will reduce the number of new CSPs we sign-up. However, it will allow us to focus our resources, smaller number of CSPs that see more strategic value in the SECaaS service which should drive profitable revenue growth for Allot.

As they look at the deals we signed and those that are in the pipeline, I am convinced that the size of the market remains huge. While I am disappointed with the current pace at which our revenues are materializing, I remain confident in our ability to achieve our long-term goals. Looking ahead, I want to summarize our expectations for 2023.

As I stated, we remain committed to reaching profitability for the full-year 2024. This will be achieved through some revenue growth, mainly in SECaaS, combined with tight expense control. We continue to believe our net cash reduction in our operating loss for the year 2023 will be between $15 million and $20 million.

We expect SECaaS revenues for 2023 to be between $11 million and $13 million. We expect the SECaaS ARR for December 2023 to be between $15 million and $20 million and our total ARR including support and maintenance to be between $56 million and $63 million.

We expect our total revenues for the full-year 2023 to be between $110 million and $120 million. Regarding the second quarter, we expect the second quarter revenues to be approximately $25 million. Given the lumpiness of the DPI business that we mentioned earlier, we do expect notably higher quarterly revenues as we move into the second half of 2023.

Our strategy remains the same. While we believe that our DPI business has limited growth potential, we think we can maintain a stable level of revenues through new use cases and market share gains. However, the lumpiness of the business makes it difficult to forecast over short timeframes.

Our SECaaS business is where we see our significant future growth. 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 to make these goals achievable. And now, I would like to open the call for Q&A, and Ziv and myself will be available to take your questions.

Operator?.

Thank you. Ladies and gentlemen, at this time we will begin the question-and-answer session. [Operator Instructions] The first question is from Eric Martinuzzi of Lake Street. Please go ahead..

Congrats on the Q1 results. I wanted to talk about the Q2 guide with regard to the full-year guide on the revenue. If I look at, assuming we achieve the Q2 revenue guidance of $25 million, that would put you at $46 million for the front half implying, incremental $69 million for the back half to get to the midpoint of the guided revenue range.

Obviously that implies a pretty substantial step up. You'd be looking at $34.5 million per quarter on average in Q3 and Q4. And I understand there maybe a difference between the two quarters, but we'd be averaging that $34 million to $35 million range.

So given that large step up, I'm curious to know, what do you see in the pipeline that supports that substantial step-up?.

So we think that we have a healthy pipeline. And currently, we feel comfortable that we will achieve those revenues. But I cannot see more specific about names and timing..

Okay.

But you're pretty confident that there's – I mean, it would imply there's a substantial number of deals that are just – that are there, that are pretty close and that we're comfortable they're going to cross the finish line in the back half?.

This is our assumption that we will be able to sign new deals. And those deals, we will recognize as revenue in the second half of the year. Some of the revenue will come from deals back there that we expect to sign and we feel very comfortable that we will sign.

And some of it will come from deals that were already signed and we expect to recognize in the second half..

Okay. And then shifting over to the SECaaS side of the house, one of the tactical moves you made or talked about making on the fourth quarter call was a focus on sales efforts across just a handful of meaningful carriers to really go after the SECaaS business. I'd like to get an update on those handful of carriers.

Do you feel like you are making progress there? Has there been evidence of penetration at those targeted carriers?.

I think the answer is, yes, we've made progress, at least in the planning stages, I would say, because evidently from the numbers, you see it's not yet reflected in the ARR number. I think that the basic understanding that, okay, there's no point in launching something that is small and not aggressive and so on, I think that's very clear.

And I think that we're seeing that operators who are, how should I say it, who accept that the network-based security is of strategic value, show that they – not only show – sorry, first of all, decide on it and then when they go and implement, at least those that have done so far, show significant growth.

And the example I gave is Far EasTone from Taiwan. I can tell you that they view network-based security as a key element for them as an operator. They think it's a differentiator. They think it's very important, that's from the executive level.

And therefore, from the executive level down and we're seeing the very fast growth rate that they are experiencing..

Understand. Last question for me comes to the OpEx. You had operating expenses of $22.4 million in Q1. You said you have reduced your expense.

What could we look for either on an annualized basis or if you want to give an operating expense maybe not in Q2, but in Q3? What should that $22.4 million look like in Q3?.

First of all, as we said, we had some one-time items in Q1, so probably in Q2 the number will be a little bit higher, but in Q3 we will have the effect of the measure that we took already and then it will go down again. Regarding the yearly number, it depends what will be the revenues and whether there will be other measures.

But as we said over and over, we are committed to finish the year in such an OpEx platform that will enable us to be profitable in 2024..

Yes. I'm sorry. Could you restate that? You said there were one-time items in Q1.

I assume those were expense items that would not recur, but you said Q2 operating expense would be higher or lower than Q1?.

I guess that the Q2 OpEx might be higher, but the Q3 will be lower..

Got it. Thank you for taking my questions..

The next question is from Nehal Chokshi of Northland Capital Markets. Please go ahead..

Yes. Thank you. On the DPI market, Erez, you talked about how you believe that this can stabilize and be flattish.

Are you talking about from calendar 2022 levels or calendar 2023 levels?.

Okay. Looking on 2023 levels, we said we might even expect the contraction of 5% to 10%. But I would say on a multi-year level, I think we should look at it as flattish..

From the calendar 2022 level?.

Yes. I would say, I would think so..

Okay.

And then on the SECaaS ARR, why was that effectively flat Q-o-Q?.

At the end, it's blended into the ARR and of course, the revenues. But the ARR is a blended due to what is the penetration with the customer. How much did it go up, a lot or a little? What happened to the exchange rate? And we're starting to get different, let's say, currencies.

And there's also an effect which I think will create – will make the growth less flat, which is that we're signing up customers today and we talked about it, that we'll sign up customers with a minimum recurring revenue to us. So when a customer like that launches, then we see an immediate jump in the ARR because they have to pay a minimum fee.

But then their customer base starts at zero obviously when the launch starts growing. And yet the ARR from that customer does not grow because they're paying a minimum fee. And it will start growing again only once they cross that minimum threshold.

So we can and I would expect to see sometimes like jumps in the ARR and then a bit flattening and then again jumps and so on..

What was the impact of FX on SECaaS ARR on a Q-o-Q basis?.

Not sure. Could you repeat the question? I'm not sure I understood it..

How much of a headwind was FX or currency on a Q-o-Q basis for SECaaS ARR?.

From Q4 to Q1, it was a very small number, not significantly..

Okay.

Are you seeing elevated levels churn within your customer base, within the customers customers?.

Yes. I don't think – first of all, let's understand what we know, what we see and can measure. Mobile operators, less so fixed operators, but mobile operators have relatively high churn rates of their customer base irrespective has nothing to do with security. They have relatively high churn rates as customers move from one mobile operator to another.

What we don't know if a specific customer has turned off our network or not. What we know is the total number at the end of every month. Are there cases where customers are – where that number is reduced for security services? Yes, there are, but I think in the vast majority, they continue to grow..

Okay.

And then coming back to the DPI business, can you explain the Broadcom dynamic with a little bit more detail here?.

Sure. So I'm repeating or reminding things that we talked about in previous calls. We signed the agreement with Broadcom – three years ago, so 2020. And the essence was Broadcom had acquired the company that I think was Symantec.

And through a series of acquisitions, Broadcom ended up with a product line of Packeteer, which was a competitor of Allot in the enterprise business. And Broadcom ended up with that through a series of acquisitions. And the deal we signed with Broadcom, Broadcom wanted out of that business. It's not synergetic to or strategic to them.

And what they wanted was the continuity for their customer base, not to basically screw their customers. So the deal we signed with them is that they would refer the value-added resellers, distributors and the end customer. They will tell them, okay, that they brought commerce discontinuing the Packeteer product line.

And if somebody wants a replacement or to continue with a similar service, here's the recommendation, work with Allot, contact Allot and Allot will provide you a good product that will replace the Packeteer-1.

So we had a nice bump in sales during a couple of years, where we had new VARs joining our distribution chain, new VARs, new resellers, we had a bunch of customers, quite a lot actually, replacing their end-of-life Packeteer product with an Allot product.

But there's only so much, sort of – there are only so many customers you can replace and then they become our customers and we can serve them, but we're not selling them new equipment. And that's why we saw a nice growth in the enterprise sales and now that is quieting down. And I think that that's reached more or less its peak..

And what was the contribution on an annualized basis at peak levels?.

I'm not sure I have the number off the top of my head, but it's probably around, I don't know, but I would estimate it's around $5 million, $7 million from the Broadcom deal on an annual basis, something like that..

Got it. Very good. Okay. Thank you for taking my questions..

Sure..

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

Thank you for taking my questions. I want to start, let's build down on the future of the Allot Smart Connect product line.

In the past, you've mentioned that the CIPs are basically reexamining the composition of their network, moving to 5G, need to replace end-of-life products, traffic and congestion management, quality of user experience, governments looking to fight crime and terrorism and blocking illegal activities.

Granted, because of the slowing economy, it appears like it is a slow-growing business for now, but in a few years, could this business surprise on the upside based on all the solutions discussed in the past?.

It may. I think that in DPI, there's definitely, in the whole concept of monitoring and managing traffic intelligently on the network based on what application it is, what is it doing, what are user requirements, how to handle congestion and so on. I think there's tremendous value in that for the operators.

So it may very well – sometime in the future, it may very well grow again. But right now as we look at this year, we look at next year, I can't say that I see that, so that’s the guidance that we give..

Okay.

So having said that, would you say that this business is worth more or less than it was five years ago, assuming, again, that three to five years from now it could be some future growth?.

Yes. The value of the business is a somewhat subjective term. It maybe more about, depends how much you believe in what will be, how much you would look at the short-term, what the market valuations are. Other than quoting you the current stock price, I don't know how to answer your question..

All right. So I guess the point I'm making is, five years ago, one of your competitors bought out at 2.8x sales, which would be, like, based on your business, $7-plus a share. And it's just – there's a disconnect between the pieces of your business and the fact that you're selling at 0.5x sales minus the cash.

So I just think that it's frustrating as, again, whether it's the perception that maybe you haven't hit your numbers or what, but it's just – it's frustrating that there's a business there that's worth a hell of a lot more than your stock is trading for. So that was kind of my point on that.

So moving on, the recent deal – the recent announcement in March 9, Taiwan, Far EasTone, reached about 200,000 subscribers in three months.

Is any of that revenue – did that revenue start in the second quarter or the first?.

No, we already saw that revenue in the first quarter. We saw some of it..

Okay.

Can you utilize this where other – you can show this to your other customers, what they've done and how quickly they've been able to ramp-up? Has that been a benefit to you?.

Yes. I mean, that was the main rationale behind issuing the press release, to be able to share it with other customers and show them, look, this is what they're doing. Look how quick it is. And discuss with them what means Far EasTone did in order to achieve such results.

And I'm happy to say that Far EasTone was willing for us to share this information with other customers. Not many operators are willing to let us share specific numbers and detailed information, because they're worried of their own competition.

Far EasTone, in this case, they started with a press release in Taiwan, in Chinese, stating all this and they allowed us simply to repeat the information to the rest of the world..

Okay. That's great.

So can you give us color on the fact that you brought this to your other customers and what has their reaction been?.

Look, it's part of a picture, right? It's not a standalone, okay, they heard this and now they're going to change their mind. They see that Far EasTone is doing this and doing this successfully. They see that Verizon has decided to launch this service to their SMB customers.

It's the culmination of this, I think, is what is bringing us both new deals, new – and what is enabling us to have, I would say, significant backing and proof points when we come and discuss with various operators to go to market.

And we tell them why we believe that they should be committing to a stronger go-to-market, not just because we like it, but because it really works. And it's not a one-for-one equation, but I think it's a significant piece of the proof points that we assemble.

We have in a lot – and I think I talked about this in previous calls, we have in a lot within our marketing team, we set up a group.

We call them CVMs or Customer Value Managers, that what they do is they assemble the information that we have from all the various customers on what their go-to-market is, how successful it is, what are the rates of growth, et cetera, et cetera, et cetera. And then they work with specific customers that they are assigned to. It's a group of people.

Each one has a specific customer base that they work with. And they work with their marketing department to show them how they can get there. And in many cases, we're able to influence, not in all, but in many cases, we're able to influence the marketing teams of other operators and show them, here's what other operators have done.

Therefore, if you will do it, you will be more successful. And where we're successful in convincing them, they actually implement it. Now most of the time, the information is anonymized. In a case like Far EasTone, it's less anonymized, which is good..

Okay. That's great. And to add on to another positive is Verizon. So I would think that that deal brings you more credibility than you ever had based on their due diligence and basically who they are.

How has that impacted your potential future business? And then also when can we see dollar won from that deal?.

So unfortunately, I cannot reveal what the Verizon launch plans are for the service because they consider that confidential information from their perspective. How does this affect our future business? I think I agree with you that this is a very, very strong, I would say, not only testament, it's more than that.

I've talked to – at least talked to several customers that once they saw what Verizon is doing, their level of interest went up significantly because if Verizon is doing it, it must be the smart thing, so let's take a much, much closer look at it. So I think it's a very big positive..

That is exciting. All right. So on May 11, you announced a deal with the Tier 1 fixed broadband provider in Latin America. Congratulations on that.

So I know you're going to the bigger customers, but also is just a combination of also going to customers that are going to show, let's just say, the desire to get this to market sooner, or this is – or that's not necessarily the case?.

It's not necessarily the case. I would say that in Latin America, things sometimes take longer than in the rest of the world. So I'm not sure that they will take this to market sooner. I think they're working on it. They will take it to market and I believe they will take it to market.

I think it's a very large opportunity for us, but I'm not really building on it for the short-term..

Okay. And my last question is, so you said, so the 19 SECaaS deals, 14 generating revenue, all small. What doesn't add up is since 2022, there's been eight announcements of Tier 1. Some of these are in small businesses. I'm not going to go through all the press releases.

So did some of these just never materialize?.

Again, those that have not launched and are not producing revenue, we don't count on as ones that have launched. We did say that we had some deals that we signed, even some that we announced that we signed and then we later canceled because they were not going to launch. They were not committed. It didn't make sense to continue to pursue them..

Marc, as already said, the number of times the 27 customer agreements, eight are discontinued, and out of the 19, 14 started to generate revenue, but it doesn't mean that they launched the service to their entire installed base..

Okay. Well, good luck and thank you for taking the questions..

Thank you..

Thank you..

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

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

Sure. I want to thank you all for joining us today. I want to thank you for your interest and your long-term support in Allot. And I look forward to talking to you on our next quarterly call. Thank you very much..

Thank you. This concludes the Allot first quarter 2023 results conference call. Thank you for your participation. You may go ahead and disconnect..