Allot Ltd.

Ladies and gentlemen, thank you for standing by. Welcome to Alot's third quarter 2021 results conference call. All participants are present in 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 Alot's Investor Relations Team at GK, Investor and Public Relations at 1- Thank you, Operator. Welcome to the last third quarter 2021 Conference Call.

I would like to welcome all of you to the conference call, and I'd like to thank Allox 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 your questions. You can all find the financial highlights and metrics included those we typically discuss in the conference call in today's earnings press release. Before we start, I'd like to point out the same part of the 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 a lot of 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. Erez, please go ahead.

Thank you, Kenny. I'd like to welcome all of you to our conference call and thank you for joining us today. Our third quarter was another quarter of solid growth. Revenues grew 10% year over year for the third quarter and reached $38.2 million. In the third quarter, we also achieved non-GAAP operating profit of $0.3 million This is our 15th straight quarter of revenue growth year over year, and I am very pleased with the results we achieved during the third quarter. Also during the third quarter, we succeeded in signing several recurring security revenue deals for several of our Alok Secure product lines. In addition, we recently signed a security as a service deal with DISH in the U.S., to deliver cybersecurity to their 5G customers. I am very pleased with these results and I believe it shows we are successfully executing on our plan. Our business is expanding across our product lines and markets and we are increasing our market share especially in the cybersecurity business as I will describe in more detail. As we see our opportunities grow, we continue to invest in order to capitalize on the significant number of opportunities We'd like to start by discussing our visibility and control business addressed by our Alot Smart product line. Revenue from this business is continuing to grow well for us in 2021. The main use cases we see today in CSPs are in traffic management, congestion management, quality of user experience, especially for video, policy and charging control, and digital enforcement. During the third quarter of 2021, we were awarded several deals with operators requiring traffic management, in addition to quite a few expansions of existing customers. In a deal we won in APAC, we will be replacing a direct competitor's product that is installed. In addition to replacing the existing DPI solution with our Alok Smart product, That operator also signed a deal with us to launch security as a service using Alot Secure to its customer base. We are discussing multiple other opportunities with other CSPs currently using our competitor's product and are working on expanding deals that we won before. As governments look to fight crime and terrorism, we see growing interest globally to be able to block illegal activities such as drug trafficking, child pornography or terrorism. We are seeing growing interest in our products in this area as well. Our enterprise business is continuing to grow, reaching revenue of $6.6 million in the third quarter. The deal we signed in the beginning of 2020 with Broadcom to position Alote as the replacement for their Packeteer product, which is at end of life. is contributing a significant portion of this growth. We expect continued double-digit growth of the enterprise business in the remainder of this year. I want to say a few words on the 5G market and what we believe it holds in store for Alok Smart product line. Many operators worldwide are deploying 5G networks. Most of these are using 5G frequencies and radios but continuing to use a 4G core. However, a growing number of operators are deploying a 5G core. Many of them plan to deploy this core in a cloud environment. AT&T, Verizon, DISH, and Rakuten are examples of operators who chose in whole or in part to deploy their core in the cloud environment. We believe the growth in traffic volumes that is expected in 5G networks together with the need for high quality control of the traffic creates an opportunity for Alok Smart in this growing market segment. Not all clouds are the same. Some work with AWS, some with Azure, and some, like Rakuten, use their own version. We are in the process of deploying our products in networks we contracted with, such as Dish and Rakuten, and are investing what is required to adapt our products to the various containerized cloud-native environment to take advantage of this growing market opportunity. To summarize, I believe the demand for a low-smart product line, including congestion management, traffic management, analytics, digital enforcement, and enterprise use cases will remain healthy with growth in the main use cases I described. I want to turn our attention to what we see in our cybersecurity business and how the market is continuing to change favorably. 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. There is a revolution happening in the consumer cybersecurity market. Responsibility on securing the consumer, the family, small business lies today with the Each person is responsible to protect himself or herself and their families and small businesses. To do this, they need to find a security app, buy it, download it, and install it on every one of their devices. The problem is that regardless how good or bad a security app is, more than 90% of consumers don't do what I just described and are left unprotected. This means that the current solution with endpoint security apps is not accessible enough to most people. End users, consumers, and SMBs are looking for a simple zero-touch quote-unquote cybersecurity service. They prefer a simple security service and not have to do anything technical like downloading an app to each device and configuring it. Over the last few months, we increasingly engaged with tens of CSPs and are working closely with the customers that sign Security as a Service deals with us. We have learned a lot more about this market and its dynamics and recognize that there are quite a few challenges in translation of signed contracts into short-term revenues. These challenges include technical issues, delays in the CSP's commercial launches and CSP's initial go-to-market strategies. As we look at the market, we clearly see that the direction and momentum are very positive. We see that the number of engagements, the level of engagements, the total addressable market size of our pipeline, the allot win rate, and the acceptance and scope of service by consumers and SMBs are all improving and getting stronger. We see evidence of all of these in the rate and size of the deals we sign. Today, I want to share with you our main observations from customer engagements, the dynamics of the market and the lessons we learned, and why our views of the market are very bullish. We have signed to date 18 security as a service deals, seven of which have launched the service. We were expecting three more CSPs to launch their services during the past few months but these launches were delayed further although two of them are currently expected to be launched towards the end of this calendar year. Our team is working closely with the customers and we see there is a strong appetite by the CSPs to launch but there are also challenges and delays. The reasons for launch delays in these CSPs and the expected launch of additional CSPs vary, but I believe they are a combination of four main reasons. One, COVID related. This includes many CSP employees working from home and resulting delays in implementations and ability to launch new services in general. Two, CSP related IT delays that are not connected to security as a service. IT teams in CSPs many times have complex large projects that are also highly dependent on third party companies. We are working with quite a few CSPs that have ongoing unrelated IT projects creating a large load on already committed resources and the need to integrate security as a service with their OSS BSS systems is delaying pending completion of their other IT projects. Delays due to difficulties in integrating our home secure and business secure agent on the router. I want to elaborate on this point a bit. Our home secure product requires installing our security agent on the CSP router. As we are now working on deploying our first home secure networks, we find that CSPs want to launch the service with a larger variety of routers than we originally expected. which we need to integrate with before launch. While we form partnerships with some leading router manufacturers, not all router manufacturers are equally forthcoming in their willingness to share technical information required for the integration. As we progress, we are integrating more routers from more manufacturers as well as automating and shortening the integration time and effort. For now, it is taking more time than we originally expected, but we fully expect to enable faster home secure launches in the future. Four, CSP integration and training efforts. Prior to launch, the operator needs to design and modify their IT systems to deal with the new service and work with ALOC to integrate our system into their OSS BSS systems. This work involves various departments within the CSP. and despite CSP management intention to do this quickly, this may be delayed due to various other internal priorities. In addition, there are several other factors that are unfortunately contributing to delay in a look generating security as a service revenues. One, CSPs are launching or planning to launch security services with long free service periods up to three months as they are used to launching other VAS solutions such as Netflix or Spotify. I believe that as CSPs launch and see for themselves the high attach rate and the lower churn rate, these free periods will shorten. However, for now, they are causing a delay of revenues to alope. Many operators prefer a gradual limited rollout that allows them to test the message and message and refine it. For example, one operator launched initially only for existing customers but is not offering the service to new customers while another operator plans to focus on new customers and not offer it to the existing base. As the service progress, we expect most operators to expand the reach and offer security service to all customers and fully exploit The revenue potential and customer's high satisfaction. But for now, this introduces delays in our revenues. Three, different operators launch with different go-to-market service plans. Some start aggressively by bundling the security service into the plan while others start with try-and-buy campaigns requiring the customer to take action twice before paying for the service. Some operators sell the service in stores while others choose to start with only digital means. We are spending significant efforts with marketing departments and executives within the operators to persuade them to go for more aggressive go-to-market plans that result in higher revenues for both of us. I can share with you that one of the operators who already launched the service started with a digital only channel which did not yield good results. After joint work with us, We convinced them to offer the service for sales in stores and customer adoption grew very significantly. So the CSP management is looking now at the security service as a strategic solution to increase ARPU. These factors together result in a delay of approximately six months in ALUF recognizing recurring security revenues compared to our previous guidance. The divergence between how operators launch and market their new services, the relatively small sample of operators that actually launched the service, and what we saw with the more mature Vodafone launches led us to a more optimistic projection on the timeline between signing the deal and actually recognizing revenue, meaning getting paying customers. During the past few months, We spent considerable efforts with all the operators we signed with or expect to sign with to get a better and much more detailed understanding of their service launch dates, their internal prerequisites, initial target segments, length of free service, and go-to-market plans. While many of these parameters are still undecided and may still change, we feel we have today a better understanding of what is expected to happen and as a result, we are able to build a more accurate bottom-up security as a service revenue model. On our side, we learned to insist during contract for much more concrete and aggressive go-to-market commitments from the CSP. It prolongs the negotiations but helps to make a better launch and reach better penetration in the short and medium term. As we meet CSPs worldwide, we are continuing to see growing interest in launching security service to consumers and SMBs. Our pipeline is continuing to grow as we continue to sign additional deals with CSPs. To date, we have signed security as a service deals with 18 different operators, 11 of which have not yet launched the service. Nine of these operators have signed with us deals to launch services with more than one product of Elote Secure to different segments of their customer base. Of the signed customers, one is a group level agreement with the intent to deploy in several of the group operators and seven others are with operators that belong to a group with opportunity to expand the service to other operators in that group. In addition, We were awarded six additional deals with CSPs for which we are currently in contract negotiations and expect to sign within the next few months. As we look at CSP interest worldwide in security service, I am very encouraged with our prospects despite the delay in revenues I discussed earlier, and this for several reasons. One, our pipeline is bigger than ever. A growing number of CSPs understand they need to launch security services to their customers, and as a result, we see continued growth in number of RFPs and number of operators we are in direct engagement with. To me, this indicates growth of the network-based security market. Two, adoption rates of consumers and SMBs. When the service is launched with good go-to-market approach, Adoption rates are very high, as we discussed in previous calls. Not only is the adoption rate high, but customers stay with the service even when they can opt out. The lifetime operators calculated for a consumer is around three years. Three, a growing number of CSP CMOs, or Chief Marketing Officers, understand that security needs to be part of the brand promise and are building it into their core offerings. Some CSPs still look at security services as a VAS, a Value Added Service, but a growing number view it as a core service. One CSP, Chief Marketing Officer I spoke with only a few weeks ago, explained to me that he sees security as part of his core offering and he wants all his customers eventually to be protected. Another SVP Products from a North American mobile operator I met with plans on offering it free of charge to all his premium customers, but that operator will pay a lot of course, to incentivize consumers to move to higher tier plants. A European based fixed and mobile operator with operations in several countries with whom we have signed already, looks at security services as their differentiation from competition. Viewing security as a core service. rather than Avast leads to more aggressive go-to-market and higher penetration rates. The North American market is very interested now in network-based security services. As I mentioned in previous calls, several North American operators are actively looking to launch such a service. In April, we announced that we signed an agreement with DISH in the U.S. to protect their new 5G network and that we expect to sign an agreement where DISH will provide security services to their customers on the 5G network when it launches. As I mentioned before, we recently signed a security as a service deal with DISH to protect their customers and the agreement includes multiple products of the Alok Secure family. In addition, I can share we are in advanced discussions with two additional North American operators One for a security service to their entire customer base and another for their SMB customers. Five, we have a high win ratio. During the past year, by our account, we won most of the deals that were awarded for CSP network-based security to consumers. To me, this shows our market leadership and the strength of our offering. We are winning due to A comprehensive 360 product offering that enables unified security across mobile and fixed access, across all devices and against many threats. Our commercial partnership model, where we share the risk and reward with the operators. Our value add, sharing best marketing and sales practices, helping them position and launch the service. and D, our track record that can be shared proving that when launched correctly adoption rates and revenues are very high. As I mentioned earlier, seven of the operators we signed with have launched the service already. We expect additional two to launch before the end of this calendar year. Accounting for what we know of the launch timing of the deals we signed, and of those we were awarded and in addition what we are told by other CSPs we have not yet won but we are currently engaged with. We expect an additional 12 to 18 CSPs to launch security services based on the LUT products during 2022. Network based security services are a relatively new type of service for CSPs. As we sign with more operators and move to the detailed planning phase before launch, and as we follow changes in adoption rates post-launch, we learn more about what affects the results and how to better forecast and predict the process. We also learn how to influence things in early days to yield faster and better results. The MAR indicator which we have put forward as an indication for future revenues is not good enough to forecast revenues, especially in the short term. It doesn't take into account the high variance on launch timing and marketing strategies, especially over a small base of launched operators. There are many variances, some of which we were aware of, like the difference between prepaid and postpaid customers and some we learned to appreciate more recently. I will mention several of them. Different countries have different regulatory requirements that affect adoption. For example, in some countries, postpaid customers have contract terms of a finite period, such as no more than three years. This means that every year, at least one-third of the customer base need to renew their mobile contracts and are therefore in touch with the operator. This is a great time to sell security and leads to high adoption rates. In other countries, service plans are indefinite and churn is relatively low compared to other geographies. This results in fewer opportunities to engage with the customer, so even while take-up rates are high, adoption rises more slowly. As we take in these and other understandings, we try to see how we can better forecast our revenues. While in the past, we had to make predictions using a top-down approach with MAR as a guideline to revenue potential, We now understand better the differences between operators, and we can base our predictions on a bottom-up approach analyzing each customer separately. Of course, over time, over a large customer base, over many operators, and with our influence on the go-to-market strategies, averages will work, and I believe our assessment of 25% penetration rate of the target customer base can be achieved. We therefore think the MAR metric we use till now to try and indicate short-term future revenues is too simplistic, and I think we should provide additional metrics to help investors track our progress. We will continue to provide information on MAR. We will also continue to track the number of signed deals and the number of launched services. In addition, we will report every quarter the ARR achieved based on the last month of the quarter. We define the ARR, or annual recurring revenue run rate, as the monthly recurring security revenues we achieved during the last month of the quarter multiplied by 12. We will also provide guidance on what we expect the ARR at the end of the year to be. I do want to remind you that while our main growth engine is in recurring security revenue deals, We do have security revenues from some CapEx deals like Vodafone and from security products protecting the network itself such as DDoS and 5G Net Protect. As I explained before, we are now expecting a delay of approximately two quarters in the amount of security as a service revenue versus the previous projection. In view of this, our expectations for recurring security as a service revenue are revised to the following. 4.1 million to 4.3 million dollars for full year 2021. 10 million to 15 million dollars for full year 2022. 20 million to 30 million for the 12 months of July 22 to June 23. In addition, I want to provide you past information and expectations on our ARR. In December 2019, our ARR was $0.5 million. In December 2020, our ARR was $2.7 million. In September 2021, our ARR was $4.6 million. We expect our ARR in December 2021 to be between $5 million to $6 million. We expect our ARR in December 2022 to be between $20 to $30 million. While the MAR metric is not accurate enough to predict short-term revenues, I believe it does provide the ability to indicate longer-term revenue potential and we will continue to provide it. We expect to meet and exceed the $180 million MAR target for 2021 and an additional $180 million MAR for 2022. I would now like to summarize the overall picture and the key messages. In the AlotSmart product line, we see a strong pipeline. Multiple use cases such as congestion management, digital enforcement and the enterprise business are growing. Overall, we see a solid demand for AlotSmart. The security area is where we see our long-term growth. We are very encouraged by the pipeline growth we see and by the consumer and SMB take-up rates as they sign up for the service. Overall, while we would have preferred not to have the six-month delay in achieving our recurring revenue targets, I believe the network-based cybersecurity market is emerging as a high-growth market. We are winning most deals, and I am confident of our future success in the direction we are pursuing. We know better how to work with CSPs to achieve high penetration rates, and I am very optimistic on our recurring revenue outlook. Looking at our backlog, the market demand as we see it now, the pipeline of deals that we are working on, and accounting for the delays in security as a service recurring revenue, we expect 2021 revenues to be between $145 to $146 million. We are currently working on our budget and annual operating plan for 2022. I thought it important to share with you our guidance for recurring security revenues in advance, while other elements of the guidance we will be able to share in the next earnings call once we finish our budget. It is worth noting at this time that the combination of additional positions we need to take advantage of opportunities such as those I mentioned in 5G, The change in exchange rates and the general high demand for technical people worldwide are creating pressure on our expenses for 2022. Now, I would like to open the call for questions and answers, and Ziba and myself will be available to take your questions.