Allot Ltd.

Ladies and gentlemen, thank you for standing by. Welcome to Alot's third 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 Alot's investor relations team at ekglobalinvestorrelations at 1-212-378-8040 or view it in the news section of the company's website at www.allote.com. I would now like to hand over the call to Mr. Kenny Green of EK Global Investor Relations. Mr. Green, would you like to begin?

Welcome to Allot's third quarter 2023 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 Entebbe, 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 the earnings release issued last week. Before we start, I'd like to point out the following safe harbor statement. This conference call contains projections of 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 those statements. Actual events or results may differ materially from those projected including as a result of changing market trends, delays in the launch of services by customers, reduced demands on the competitive nature of the security services industry, as well as other risks identified in the documents filed by the company with the Securities and Exchange Commission. And with that, I'd 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 third quarter revenues were $22.6 million, 10% lower than the comparable quarter last year. In September 2023, our CCAS ARR was $10.6 million, 9% higher than our CCAS ARR in June 2023, and 52% higher than our CCAS ARR for September 2022. 2023 continues to be very 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 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. During the third quarter, our cash balance fell by $5.5 million, mostly as a result of the operating loss and decrease in account payable. Cash burn continues to be a major area of focus for us. As our cost-cutting efforts come into effect partially in the fourth quarter and in full in 2024, we expect to improve our cash flow. While our visibility remains challenged, we remain committed to reaching profitability in 2024. Our gross margin in the second quarter was 48% due to our deal mix. We continue to target 70% gross margins for 2024, consistent with our historical performance. 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 continue to work together to prepare the budget and operating plan for 2024. As we discussed in the previous call, in order to conserve cash, reach break-even profitability in 2024 and ensure that we have staying power even as CCAS takes longer to ramp up. We implemented a cost reduction plan towards the end of the third quarter. We reduced approximately 30% from our employee headcount from the end of the third quarter of 2022 to the end of 2023, while also implementing other cost reductions. Our third quarter numbers include a one-time RIF cost of approximately $1.5 million. As you know, Allot operates in two business lines, Allot Smart and Allot Secure. On the Allot Smart front, while we continue to see growing interest globally from governments as they look to block illegal activities such as drug trafficking, child pornography, and terrorism, our CSP and enterprise businesses remain soft. While some of the weakness is due to cutbacks in spending, we also recognize the need to continue shifting our resources and focus to developing countries and governments as developed countries and enterprises embrace the cloud. On the a lot secure front, while spending by CSPs remains challenging, our CCAS revenues are growing steadily. While we are not seeing the pace of growth we had expected given a slower deployment, there are quite a few positives worth highlighting. I would like to start with the North American market. Verizon Business has successfully launched their network native security service, which incorporates a lot network secure. The launch is going well, the number of customers is growing, and we are discussing with Verizon several expansion opportunities to different customer segments. While we cannot be assured of our success in adding additional customer segments, I believe Verizon is the largest signed CCAS opportunity for Alot. Furthermore, as other CSPs see Verizon's success, I believe some will follow suit. We are already getting enhanced interest from other operators to better understand what Verizon is doing and how they might do the same. In APAC, we recently launched another CCaaS service in Tonga. As this is a small deal, we guaranteed the revenue for Alok regardless of penetration as per the revised direction we have previously explained. We remain excited about our CCaaS opportunities as operators continue to be interested in launching network-based security services, and we have a differentiated, scalable solution for CSPs. Looking ahead, I want to summarize our expectations for 2023. We expect CCAS revenues for 2023 to be around $10.5 to $11 million. We expect the CCAS ARR for December 2023 to be between $12 and $13 million, and our total ARR, including support and maintenance, to be between $51 million and $53 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 $89 million and $94 million, non-GAAP operating loss to be between $42 and $44 million, including the $14 million doubtful debt reserve and cash burn for the whole year to be between $31 and $38 million. As I stated, we remain committed to reaching profitability in 2024. We expect the fourth quarter revenues to be $20 to $25 million. 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 years. I have full faith in our company, our team, and our products, and I believe the actions we are taking make our goals achievable. And now, I would like to open the call for questions and answers. Ziva 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. If you have a question, please press star 1. If you wish to cancel your request, please press star 2. If you are using speaker equipment, kindly lift the handset before pressing the numbers. Your questions will be polled in the order they are received. Please stand by while we poll for your questions. The first question... is from Max Michaels of Lake Street. Please go ahead. Max?

Sorry, I was on mute. That's fine. My apologies. When we look at, my first question is, looking out at 2024, just with the visibility being fairly cloudy. I mean, are you confident you guys will be able to get a guide coming to you for March 4? Thank you.

I'm sorry, can you repeat your last, really the last sentence? Are we confident we're able to guide?

Yeah, yeah, yeah. So just given visibility, just kind of want to get a sense of what you're seeing in the market and be confident in giving a 2024 guide.

At this point, we're not giving a 2024 guide. We will be giving guidance once we finish our AOP and budget for 24, which will be towards the end of this year. In the next earnings call, I expect we will be able to provide guidance on 24. The challenge you stated is correct. The visibility is tough. And yet we are going to guide to the best of our ability, and we're going to focus very hard to turn profitable in 24.

And then my next question here is just on gross margin. A little bit of a downtick here in Q3. I think the stress of gross margin was around 48%. What's giving you guys the confidence you can get back up to that 70% level maybe in Q4 and then into 20? And then maybe go into what caused that downtick in Q3.

Hi, Max. As we said in our previous conference call, we were expecting a gross margin around 50% this quarter. So 48 is in the same range. And the reason was a few deals with a very low gross margin. As we explained, sometimes we decide to take deals with a very low gross margin when it's a competitor replacement, when it's a strategic deal for us, when we expect future expansions. And also bear in mind that we can get a larger deal, but the amount that we recognize in the first quarter is much lower than the total deal because it includes also support and maintenance for future years. So we care about the amount of support and maintenance, which will be recognized later at the higher margin. Now, until Q3, for the last many years, our gross margin was around the 17%, 70%, 7-0, also in the first half of 2023. And we do believe that in spite of the low gross margin in the second half of 2023, we will be able to come back to the 70% gross margin next year. All right, thanks for taking my questions, guys.

All right.

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

Yeah, thank you. And, Erez, good to hear that you are sounding healthy. It sounds like, you know, given that you have limited visibility, the buildup of how your guiding has changed? A, is that correct? And B, if so, how has it changed?

I'm not sure I follow the question. Yeah, sorry.

Yeah, let me try to clarify. So for example, in prior quarters, your guidance may consist of some sort of bottoms-up basis where you're looking at your pipeline and assuming some sort of close rate. Going forward, have you changed that process or changed the parameters that you utilize in that process?

No, I think we're still building it bottom-up from what we see. And, you know, the... We're trying to accurately forecast what the results are going to be, and we do that in a very detailed bottom-up process that we do internally and follow up on basically weekly. And it's true that over the past couple of years, our ability to forecast the probability and timing of closing deals has diminished. So our forecasts have become less accurate. But the process itself has not changed. It's simply become harder for us to nail the numbers correctly.

Aniel, please remember that in previous years, like two years ago, we had a much larger backlog. So it was easier to forecast the quarterly revenues. Now, when the backlog is much lower, we are dependent on the same quarter bookings, so we have a challenge to forecast the revenues with a high degree of accuracy.

I see. That's helpful. And just to be clear, I mean, given the commentary around limited visibility, are you using lower probabilities to compensate for that lower visibility? And lower probabilities of closing, rather.

We believe that our forecast is realistic and achievable. But it's not conservative and it's not aggressive. We think it's realistic and achievable.

And to directly answer your question, then yes, we're We're assuming lower probabilities on things because it's becoming harder to forecast.

Okay, thank you. And then, I think you mentioned that you're looking to drive profitability, and it sounds like the main driver to drive that profitability is to continue to right-size the OpEx portion of the overall business. And while most of your OpEx is commingled between the CCAS and the DPI, is there some amount of minimal investment that you're going to want to maintain strategically on the CCAS portion?

We will definitely maintain what we... I don't know if the word minimal is the right word. We will maintain a balance between our investment on the CCAS portion and our drive to reach profitability. And it will limit the amount that we're able to invest. So no doubt we will be investing less than we have this year and definitely less than we invested in the year before. It's... You know, that's... You are correct that a significant part of our drive to reach profitability has and continues to be expense control. Because when we look at the top line, then I would expect CCAS revenues, like we've been showing over quite a few last quarters, they're consistently growing. So I would expect them to continue to grow into next year, which will help us. But the absolute numbers themselves are not very high. So we remain with trying to forecast and see how much can we count on the DPI or a lot small segment for revenues. That area, which relies heavily on operator spending, is still affected by significant headwinds and cuts and reductions in operators' budgets. So while I think we are roughly around the general sense without stating any numbers, I think we've roughly reached sort of the bottom of the curve here. I don't think we can rely on significant growth in our DPI or a lot smart segment. So the combination of that leads us to to reach profitability by reducing the OPEX, which is what we have been doing so far.

Just to be clear, would you be able to cut your OPEX further if you believe you needed to in the case that DPIA does not stabilize here?

We didn't prepare our 24 budget yet, so we don't know. And as I said, it will be a combination between the revenues, which we think will be achievable, and the right level of OPEX. And we keep our goal to be breakeven next year.

Last question for me. So, as you mentioned, you had announced a special committee to explore options for a lot and subsequently you announced your founder retiring from the chairman position and a new chairman. Does that represent the conclusion of that special committee or is that still ongoing? And then what do you expect a new chairman to bring?

So I'll say a couple of things. One is that the committee was formed And I'll reiterate what I said. The committee was formed to work with management to identify and recommend opportunities for further improvement with a focus on driving sustained profitability and enhancing shareholder value. The work between the executive committee and management, one of the results was that. of that was the OPEX reduction and cost cutting that we implemented during the third quarter in late August. And that work continues, like I said earlier in this call, continues to work together with management to figure out what is the right operating plan, goals, and expense levels and budget for 2024. Igal, who was our chairman until recently, decided to resign for his own reasons. It has nothing to do with the executive committee and is not a derivative of that in any way, shape, or form.

Do you expect a new chairman to bring anything different here?

I think the new chairman, you know, if Feel free to ask him yourself if and when you meet him. But I think anybody that has, and definitely our new chairman, David Weiss, has vast industry and operational experience. I think anybody that brings with them a fresh look, different perspective, can bring significant value to the company. And that's what I believe David will contribute.

Thank you for taking my questions.

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

Thank you. So earlier in the process of the CCAS deals a few years ago, you would basically lay out your capital with no commitment. So can you kind of – explain how going forward that's going to be. Like, are you going to, before you spend penny number one, you're going to get a commitment if you hit benchmarks? It's just, you know, trying to clarify, you know, your kind of spending and risk reward in regards to obtaining more CCAS customers.

Okay. So, I'll give you a you know, a bit more detailed answer maybe. You're right that that's how we, that's how what we were doing with our network security product in the past. And now, you know, when we look at it, we looked at it again, you know, about a year and a half or so ago, and we said that, okay, the fact that we are outlaying capital without getting a firm commitment from the operators, and then they take a long time to launch and they take a long time to ramp up and generate revenue and so on. It's not a good way to go forward. So for most new deals, definitely for the smaller ones, we are looking for a firm commitment for revenue before we take upon ourselves any commitment to invest capital or deploy the network and so on. And investment capital is not just hardware, right? It can be hardware, professional services, things like that. Now, it's not that all operators are created equal. I can tell you, I don't think it's any secret, Verizon was not willing to give us a firm upfront commitment for revenues. But I think the opportunity has proven itself and it was right of us to sign this deal and launch with them, even though they didn't make an upfront minimum revenue commitment to us. So I would expect that there could be other such operators in the future, but we will strive. 100% with the small and medium-sized operators. With the large ones, we may need to be more pragmatic, but we will strive with the other ones to get to minimum commitment.

Thank you for taking my question.

The next question is from Todd Felter of 8-8 Management, LLC. Please go ahead. Todd, are you on the line? Todd, would you like to ask your question? The questioner is not asking his question. We'll continue to Rory Wallace from Outbridge Capital. Please go ahead.

Hi, Rez. Good to hear you're feeling better. I was wondering if you could elaborate at all on the launch at Verizon, how they're thinking about the offering in terms of their strategy around cybersecurity, maybe how they would view potentially expanding the deal. It's obvious that for a lot, it would be wonderful to expand outside FWA since the opportunity there is an order of magnitude larger outside that footprint. And do you think that Verizon is viewing this solution as something that's

very additive both to revenue to churn or in other strategic ways that would give them a real impetus to expand the deal okay i'll i'll i'll try to respond and i'll tread lightly here now first of all verizon is a very very large corporate right and there are many many people in verizon and they have a and they have different views But I'll try and state what I believe from my interaction with many people at Verizon, what I believe the general consensus to be. First of all, the launch is perceived to – the security services launch is perceived to be going very well. They believe it is something that their customers value and that their salespeople find – comfortable in selling it because the customers perceive value and it's good for them. Second, I would say that yes, it's definitely showing nice revenues for Verizon and I think that they are overall happy with the way it's going, not just technically but also commercially. I would add to that that we're hearing sentences from people in Verizon which which say things like, okay, they understand that they as an operator are losing more and more the grip on the end user devices as people bring wide range of devices, doing different things from different sources and so on. And here's a value that is from the network. It's network native. It's on the network. It's a value of the Verizon network, which is... And their network itself is their pride, so this fits very well along with that. And we're discussing with quite a few people in Verizon options of where to take this further because it's considered something that is inherent to the Verizon, an inherent value that can be added to the Verizon network. It's valued by customers, and there are many different segments that can enjoy this. So, you know, I Without getting too much into details, I think the opportunities there are large. But like I said in the call, we cannot guarantee that they will eventually expand this to other segments. But we are in serious discussions on it. And I think it's a big potential.

Thanks. And with Far East Tone, they've announced they've hit 550,000 subs, which I think is 10% or so of their postpaid base within one year. Seems like a great curve of growth. Are they doing anything really unique as far as how they're approaching the service? I think the answer is probably yes, but can that be replicated elsewhere with future launches, or where do you see them taking it next? I know they're merging with another telecom carrier. They're acquiring another Taiwanese telecom carrier. Do you think there's an opportunity to continue to grow that at a rapid rate within FET?

What FET is doing, I think that is different from other operators, is I would say the attitude of the executive management. The person who took within FET, who took the initiative on this, is their CEO. and she decided that FET should be viewed, she wants to make FET considered as the most secure operator within Taiwan, which is her market, of course. Now, by doing that, then she has decided to go to market to be very aggressive, so they are They are selling security at almost every touch point. I think every touch point, I'll say cautiously, almost every touch point they have with customers, whether it's stores, advertisement, call centers, excuse me, et cetera, which is pushing the results. And that's what generates at the end the sales and the uptake and the service. Can this be replicated? I would certainly hope so. I think we discussed it in previous calls. I think that when there is an alignment of the strategic interests of the operator with security, or I'll rephrase that, when the operator sees security as aligned with their strategic interests, that drives many things internally in the operator and the way they go to market and the priority they put on this, et cetera, and that then drives adoption and revenue. You know, I'll mention just to put some color on it that we initiated actually a few weeks ago, several weeks ago, we initiated a marketing conference in Europe where we had marketing people from various operators using our product meet with each other and compare notes on what exactly they're doing, what they should do, how somebody else is doing something better, what their takeaways are, and so on and so forth. That's a role that our marketing department has been doing, sharing the information as best possible between them, but this time we gave them a platform to do it to do it with each other directly, I think was very encouraging. And we had quite a few operators walk away and come to us at the end of that, not just touting the value, but saying, okay, we learned that this other operator is doing this and that, and we think that's a good idea, so we're going to see how we can implement it and drive higher adoption and revenues in our market. And we had quite a few of those. So we're trying definitely to get that to happen.

Thanks. Yeah, that sounds positive. And thinking about the CCAS revenue going into next year, it's clearly going to grow. I think you can't control the adoption curve, but Verizon is going to be almost all incremental next year. And then FET should generate decent growth, I would say, if you just kind of model out what they've been doing. So is there anything we should think about on the flip side with CCAS, why it wouldn't grow at a rapid rate next year? and taking it to the next level, when does that business really reach a profitable scale in your opinion? And obviously subject to change, but I think it's important to consider when that business might become cash generative and what it would take to get there if it's Verizon expanding a deal or if it's winning several new operators and how you see that evolving over the next year or two.

I think you've asked, Rory, I think you're asking the right questions, and I think that those are the answers we need to answer ourselves as we're building our plan and budget for next year. I would like to be a bit more cautious, and I prefer to address those questions in more detail after we have our plan, budget, and numbers for next year in my field. more confident and can give you more detail on that.

That's fair. Thanks. And then just a couple questions on the model. One is on product revenue. This year it looks like it'll probably be the lowest product revenue you've had in 10 years or more. And I guess versus the expectations you had coming into the year, what does your gut feel about how much of the miss was driven by macro? We know it's a very bad carrier spending backdrop. Everyone has confirmed that outside of you versus some of these secular issues or even execution issues, frankly, that might have contributed to the revenues coming in lower.

I think the majority has to do with the macro. We did a loss analysis on the deals during this year. We went one by one and everything that we were working on and and did not materialize into a deal and is still in process. Most of the business that did not close, did not close because of macro related issues, budget issues, expense cuts on the operators, things like that. I think our competitive positioning is still strong. And I think the number of execution-related problems, they exist. I'm not saying they don't. We can always improve on execution. But I don't think it would have made a materially different result. Most of it is macro.

Got it. And then with the expense structure, you mentioned there's 1.5 million of OPEX related to the RIF. Where does that show up in operating expenses? I wasn't sure looking at the release.

This is part of the optics because it relates to the people that there were rifts. It's like the one-time expense of the rift.

So if... Was that actually shown on the press release? I'm not sure that I saw that.

So for instance, if X people were rifts from R&D, So the relevant one-time RIF expenses, it's in R&D. If there are people from FG&A, so it will be shown in FG&A. In the same place where we book the salaries. But we didn't break it out on separate lines. Yeah, you didn't break it out. No, the 1.5, it's not in a separate line. It's embedded in the R&D, FG&A, COGS, and so on.

Understood. Understood. And it wasn't shown separately. That's just what I wanted to confirm. And then if I adjust for the 1.5, it gets me roughly, you know, 21 million or a little, you know, under 21 million of base recurring OpEx in Q3. And then we should expect that there's a $15 million expense reduction that will flow through the P&L over the coming quarters, which should reduce expenses by, around a little shy of $4 million a quarter. Is that a reasonable way of looking at the model and where expenses should land?

I'm not sure it's the right numbers, but we would like to refer to those numbers only in February after we will finalize the budget process, and we will be ready with our 2024 guidance.

Got it. And one last question. Thank you for being patient with my question. So you mentioned a large deal that was potentially going to drive a variance in cash flow in Q4. Is that a revenue deal or is that a booking with the prepayment and the revenue shifts outside of the quarter?

I would say that it could go either way. So that tends to have a wide range. Let's see where we end up. If we close it and how we close it.

Okay. Thanks a lot for taking my questions.

Thank you, Rory.

If there are any additional questions, please press star 1. If you wish to cancel your request, please press star 2. Please stand by while we poll for more questions. There are no further questions at this time. Mr. Antebi, would you like to make your concluding statement?

Yes. I want to thank everyone for joining us on the call today. Thank you for your support during these non-trivial times. For those of you in the U.S., I'd like to wish you a happy Thanksgiving weekend, and I look forward to seeing you either at latest in our next call, and if not before that, perhaps in person. Thank you very much.

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