Allot Ltd.

Ladies and gentlemen, thank you for standing by. Welcome to Allot's second quarter 2023 results conference call. All participants are at 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 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.alot.com. I would now like to hand over the call to Mr. Kenny Green of EK Global Investor Relations. Mr. Green, please begin.

Thank you, Operator. Welcome to a lost second quarter 2022 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 line today are Mr. Erez Entebbe, President and CEO, and Mr. Ziv Leitman, 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 a lot cannot guarantee that they will in fact occur. A lot 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 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. Thank you for joining us today. Our second quarter revenues were $25 million, 24% lower than the comparable quarter last year. In June, 2023, our CCAS ARR was $9.7 million, 4% higher than our CCAS ARR in March, 2023 and 41% higher than our CCAS ARR for June, 2022. The first half of 2023 was challenging for us. The transition of the business into CCAS recurring revenue model has proven to be slower than we originally anticipated. In addition, our core DPI business is experiencing some macro related headwinds. While we don't expect these challenges to disappear in the near term, given the challenging economic backdrop, we continue to make progress with the aspects of the business that we can control. 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. During the second quarter, our cash balance fell by $11 million as a result of the loss, inventory increase, and account payable decrease. This cash burden is, of course, higher than we would like it to be. As our cost-cutting efforts come into effect partially in the fourth quarter and in full in 2024. Together with a projected increase in revenues, we expect to improve our cash flow and we are reiterating our expectations to be profitable in 2024. Our gross margin in the second quarter was 71% due to our deal mix. We continue to target a gross margin of 70% for 2024 despite expecting a lower gross margin in Q3 as a result of the specific deal mix. In July, we announced an increase of approximately $14 million in the allowance for credit losses relating to receivables arising from sales in three African countries. We have been assessing the collectability of these accounts receivable on a quarterly basis, and in our most recent assessments, the company determined that these accounts previously disclosed as outstanding will not, with reasonable certainty, be collected. We are continuing our efforts to collect these amounts and believe we should be able to collect them. However, as I said, we can no longer state this with reasonable certainty, so we took an allowance for credit losses. As we announced in July, given the challenges facing our business, The board formed an executive committee that has worked with management to identify and recommend opportunities for further improvement with a focus on driving sustainable profitability and enhancing shareholder value. The executive committee and management agreed that the right direction is to maintain CCAS as our main growth engine. In this area, we will continue to focus on network-native security solutions. In our traffic management and analytics solutions, we are modifying our initiatives to prioritize profitability. In order to conserve cash, reach profitability in 2024, and ensure that we have staying power even as CCAS takes longer to ramp up, we are implementing a cost reduction plan. Specifically, our actions will result in a reduction of approximately 20% from our current employee headcount as well as other cost reductions. We expect this cost cutting effort to save approximately $15.15 million per year. The relevant employees that may be affected have already been notified. This cost reduction plan will have a one-time cost of approximately $2 million, which will be booked in the third quarter. 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 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 in 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 interest in our products. We will continue to pursue this direction, as we believe this is a segment that will continue to grow. In CSPs, we see the need for analytics continuing. In traffic management use cases, such as fair use, policy-based charging, and congestion management, we still see quite a few opportunities from low R2 countries some of which are to replace a competitor's product. In our enterprise business, we continue to see demand for on-prem systems such as ours from enterprises in developing countries where bandwidth is relatively expensive. In developed countries such as North America and Europe, we see reduced demand from enterprises that are moving to the cloud, but growing demand from government entities that require, mostly for security reasons, on-prem solutions. Currently, after our deal with Broadcom, we remain the major solution provider for this need. Overall, we recognize that we are facing several challenges that continue to make it more difficult for us to forecast our business over short timeframes. First, as we discussed in previous earnings calls, due to tighter headwinds and tighter expense control by the CSPs, it is taking longer to close DPI deals than in the past. and the total number of DPI bids for CSPs we are seeing is not growing. Second, the move of CSPs to 5G standalone core is very slow, negatively impacting our ability to grow with our 5G Net Protect product. Third, in the enterprise market, we believe the growth we saw as a result of the Broadcom deal has peaked. As we stated in our last earnings call, While we continue to have a strong pipeline of large deals for the remainder of the year, the dynamics I just mentioned, together with the potential lumpiness of large deals, makes it challenging to forecast our DPI business over short timeframes. 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 previously, although this transforming into a cybersecurity company, And this is where we see most of our future growth coming from. Our CCAS revenues are growing steadily, albeit not at the pace we would like, as we continue to see slower deployment than expected. Nevertheless, there are quite a few positive notes worth highlighting. I would like to start with the North American market. I am very happy to announce that a couple of months ago, Verizon Business launched their network native security service, which incorporates Alloc Network Secure. I am very excited about this offering from Verizon, which provides protection services for segments of Verizon's fixed wireless broadband business customers and helps defend them against cyber threats. This cybersecurity service puts a layer of defense at the internet gateway intercepting threats before they can even reach devices. Verizon believes that simple, zero-touch solutions like ours are especially helpful for small businesses, which might not have the in-house expertise to manage more complicated security measures. The service is being well received, and we are discussing with Verizon various ways to expand its reach. I will note that Verizon did not generate any CCAS revenues for Alot during the second quarter, but Verizon will begin contributing to revenues in the third quarter. As I stated in earlier calls, I continue to believe that the Verizon opportunity is our single largest signed CCAS opportunity. Furthermore, as other CSPs see Verizon's success, I believe some will follow suit. where we are already getting enhanced interest from other operators to better understand what Verizon is doing and how they might do the same. On a bittersweet note, one of the operators we signed with, a Canadian CSP, has decided not to launch the CCAST service for now as they are refocusing their business following a major network issue they had unrelated to Alot. This CSP is also an Alot smart customer and they have recently expanded significantly the CapEx business they have with us. The cancellation of this CCaaS launch is a significant contributor to the reduction in our ARR forecast for the year. In APAC, we are also progressing well. Recently, we signed two additional CCaaS deals in APAC. One is a relatively small deal where we deploy network secure in a small Pacific island. The other is a DNS secure deal with a major tier one telecom operator with more than 50 million subscribers, most of whom are prepaid. The services will initially be offered to their postpaid customers and potentially later to other high-value customers. I believe these deals are a testament to the importance CSPC in providing business and consumers with network-based security services. also in Asia, Far East, or FET, in Taiwan, has experienced a very successful launch. Since the launch in December of 2022, the service has been expanding rapidly, and we are now in the process of expanding the capacity to handle more subscribers. I will note that our ARR from FET has not been growing, even as the number of subscribers has ramped, because FET committed to a minimum payment per month from day one. That minimum has been exceeded, so we should start seeing ARR growth as the number of subscribers grow. FET and their president look at security service as strategic and important to their brand image and in line with their core commitments to their customers. As we discussed in the past, this is an excellent example of how successful CCAS can be when the CSB aligns security with its strategy. It is noteworthy that this FET experience shows that on average, the security service blocked 47 attacks per user per month. I believe this is a strong validation of the importance and value of the network-native security solution. 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 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 that providing network-based security to their customers is of significant importance to them, and they are discussing with us how to do so. In addition, we are in discussions with several other operators globally where we hope to be able to conclude deals over the coming months. I would like to say a few words about Convergence. CSPs worldwide have been talking about convergence for quite a few years, mostly combining their fixed and mobile services. Unfortunately, many CSPs have been struggling to bring tangible value to their customers and basically provide unified billing and discounts. The iLockSecure platform Yellow secure platform combines security enforcement in the core, on the DNS line, and in the routers under a unified management system and portal. This is perhaps one of the few tangible convergence values CSPs can bring to their customers, offering a unified experience on both mobile and fixed access. We don't see CSPs starting with a convergent offering, but we are in discussion with several CSPs in Europe that have launched our CCAS service to mobile customers and are looking to expand it to a converged mobile plus fixed offering. As we discussed in previous calls, I want to remind you that we changed our strategy for the Elote Secure business. We are putting more emphasis on large strategic accounts that can have a high revenue impact while in small to medium deals, we are looking for minimum revenue thresholds. These changes reduce the number of new CSPs we can sign up. However, it allows us to focus our resources on the smaller number of CSPs that see more strategic value in the CCAS service, which should drive profitable revenue growth for ALOC. We remain excited about our CCAS opportunity as we have a differentiated, scalable solution for CSPs. Our CCAS revenues for the second quarter were $2.4 million, and the CCAS ARR at the end of the second quarter was $9.7 million, a significant growth year over year. As of June 30th, 2023, we have 28 signed customers, but seven of them have been canceled and discontinued, mainly due to our strategy to focus on large customers. Unfortunately, only 14 have started to generate revenues. Most of them are relatively small operators, and the majority of them launched the service only to a portion of their subscriber base. There are a few more launches planned for this year. Looking ahead, I want to summarize our expectations for 2023. We expect CCAS revenues for 2023 to be around $11 million. We expect the CCAS ARR for December 23 to be between $12 million and $14 million, and our total ARR, including support and maintenance, to be between $51 million and $55 million. Regarding our total revenue, operating loss, and cash flow guidance, we are providing a wide range because of a specific large expansion deal we expect to close this year. We expect our total revenues for the full year 2023 to be between $95 million and $110 million, non-GAAP operating loss to be between $38 million and $44 million, including the $14 million doubtful debt reserve, and cash burn for the whole year to be between $24 million and $44 million. As I stated, remain committed to reach profitability for the full year 2024. This will be achieved through some revenue growth, mainly in CCAS, combined with tight expense control. We expect the third quarter revenues to be approximately $25 million, but with a lower than average gross margin of 50% due to the specific expected deal mix. Our strategy remains the same. While we believe that our DPI business has limited growth potential and the lumpiness of the business makes it difficult to forecast over short timeframes, we think we can maintain a stable level of revenues through new use cases and market share gains, and we are using DPI's profitability and cash flow generation to invest in our CCAS business because our CCAS business is where we see significant future growth opportunities. While our CCAS 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 year. I have full faith in our company, our team, and our products, and I believe in the actions we are taking to make our goals achievable. And now I would like to open the call for questions and answers. And Ziv and myself will be available to take your questions. Operator?