Ladies and gentlemen, thank you for standing by. Welcome to Allot's second quarter 2019 results conference call. All participants are at present in the 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 GK Investor Relations at 1-646-688-3559, 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. Gavriel Frohwein of GK Investor Relations. Mr. Frohwein, would you like to begin, please.
Thank you, operator. Welcome to Allot's second quarter 2019 conference call. I would like to welcome all of you to the conference call and thank Allot's management for hosting this call. With us on the call today are Mr. Erez Antebi, President and CEO, and Mr. Alberto Sessa, CFO. Erez will summarize the key highlights, followed by Alberto, who will review Allot's financial performance for the quarter. We will 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 this company. These statements are only predictions. 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 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. With that, I would like to now hand over the call to Erez. Erez, please go ahead.
Thank you, Gavriel. Welcome everyone to our conference call, and thank you for joining us today. I would like to start with some key financial parameters for the second quarter. The second quarter was another quarter of solid growth. Our revenues grew 15% year-over-year for the second quarter, and our gross profit grew 12% year-over-year for the second quarter. This is our sixth straight quarter of double-digit growth year-over-year. I'm very pleased with the results we achieved during the second quarter, and the main message is that we are on track and successfully executing our plan. We see a growing number of opportunities, and we are continuing to close new deals, win against competition, and grow our revenues. We expect this trend to continue through the second half of 2019 and beyond.
While Alberto will provide more details on our financials later, I did want to start with the highlights that demonstrate our growth. I would like to turn now to a discussion on our business. We are making great progress in many areas, and I would like to take this opportunity and discuss today in a bit more detail Allot's progress in the U.S., which has traditionally not been a strong market for Allot. Previously, we announced that we signed deals for two tier 1 operators in the U.S. With one of the operators, we are providing our Allot Smart DPI product to enhance the quality of roaming services. With the other operator, we are providing our IoT Secure product to protect IoT devices on their network.
While processes for selection and eventually orders with CSPs in the U.S. are typically long and can stretch over two or more years, it is encouraging to see that we were recently selected to run several additional proofs of concepts or POCs. Some of these POCs are in the security domain and some in DPI, some with an existing customer and some with new customers. While there is no guarantee that any of these POCs will result in an order, I think this demonstrates the interest in the U.S. market for Allot products, and I view it as important progress, and I'm very encouraged by it. Our progress is not limited to the U.S. Overall, we are signing new customers at a growing rate. During the first half of 2019, our bookings from new customers were 75% higher than during the first half of 2018.
This is very good, as it shows we are winning new business and building a strong base for continued growth and expansion. As we work with more tier 1 operators worldwide, we take upon ourselves additional commitments that span product development, delivery, and customer support. This is the reason we are investing further in our R&D and customer success organizations. I believe this is the right thing to do, as this investment enables us to fuel our growth and catch up on certain product gaps we still have. While today, the rate of growth in our expenses is similar to our rate of growth in revenues, I believe that next year, the rate of growth of expenses will be lower than that of revenues. I will now discuss a bit the visibility and control domain.
We are continuing to see an active market here, with a growing pipeline of opportunities for our Allot Smart product line. We see similar use cases to what we saw in previous quarters, such as smart traffic and analytics. We also see a growing need of governments to curtail illegal traffic on the internet, which results in regulations imposed on the operators, who then require technology such as ours. The type of illegal traffic targeted by these means includes, for example, child pornography and VPNs used by criminal organizations. We see a growing market here with more RFPs coming out globally. During the first half of 2019, we won several such new deals. While our main focus is on CSPs, a portion of our revenues comes from sales to the enterprise market. Two years ago, we established a customer-facing unit, or CFU, focused on the worldwide enterprise market.
The enterprise business is signing up new customers every quarter. During the second quarter, I am glad to note that we won our largest enterprise deal in over two years for a national post office network. Overall, we see a strong pipeline for our Allot Smart product line, serving the visibility and control domain, and are comfortable with our continued growth in this area. I would like to now turn our attention to the security domain, which, as we stated in the past, is our main long-term growth engine. As I mentioned in previous calls, we see a growing number of CSPs who understand the need in providing secure broadband services and see value in three elements. One, an important enhancement to their brand value, becoming a secure broadband provider. Two, a potentially large new source of revenue. Three, a key element in their customer satisfaction.
The number of RFP and RFI processes we are addressing continues to grow, as well as the number of CSPs we are engaging without a formal process. This growing interest is across the breadth of the Allot Secure product family, including NetworkSecure, IoT Secure, HomeSecure, DDoS Secure, and the combination with our partners, EndpointSecure. I would like to remind you that Allot's ability to provide protection at several locations in the network while seamlessly providing the same service across customer location and platforms is one of Allot's key advantages, and that we see a growing number of opportunities that combine two or even three different products of the Allot Secure family. This is a strong testament that our strategy of enabling operators to provide, quote, "anywhere, any device, any threat," unquote, protection to the consumer and SMB markets is gaining acceptance.
In Vodafone, our largest security customer, total number of subscribers is continuing to grow, albeit at a lower rate than before, as some markets reach saturation levels. In markets where security services were launched in recent years, such as the U.K., Turkey, and Germany, we are seeing healthy, consistent growth every month. Telefónica Spain, which launched the Movistar Conexión Segura for consumers in December of 2018, is seeing good growth. This is a service that bundles speed, capacity, and security together. Recently, Telefónica launched the service in Argentina, and similar services are scheduled for launch by Telefónica in Brazil later this year. For the SMB segment, Telefónica Spain launched the security service about three months ago. I will remind you that Telefónica Spain SMB customers enjoy network-based security provided by Allot Technology, together with endpoint app protection provided by McAfee.
In this deal, the security revenue is shared between Telefónica Spain, Allot, and McAfee. It is worth noting that the conversion rate from customers trying the service to those signing up and paying for it is in the tens of %. This is very encouraging and is a testament to the appeal of security services to SMB customers. Six months ago, we announced signing a NetworkSecure revenue share deal with a tier 1 European mobile operator. In the three months that passed, the system was installed and tested. We expect the service to be launched very shortly. We are engaged at various stages with a large number of additional operators for more security deals on all the various elements of the Allot Secure family.
I am very encouraged by the size of our pipeline, the continuous growth, the number of CSPs we are engaging, and the interest within the CSPs to launch such security services for the mass market. Working with CSPs takes time, typically exceeding 12 months and often more time than we would like it to take. While we are engaging with more CSPs, we are still challenged by the time it takes to close the deals. To view this market, I look at the combination of several indicators, including, one, the initial security OpEx deals we signed. Two, the growth in tenders and RFPs that are being issued. Three, the healthy pipeline we have in hand. Four, the penetration rates and speed of adoption where the service is launched.
Looking at all the above, I am confident that we are heading in the right direction, and I'm optimistic about this market segment and our future growth in it. As a reminder, to help us measure the potential of the aggregated security OpEx deals we signed and our progress in this area, I introduced in the previous earnings call a metric we use internally that we call maximum annual revenue, or MAR for short. MAR reflects the annual revenue Allot will receive should 100% of the CSP's relevant customer base sign up for the security service. Of course, we do not expect 100% of the operator's customers to sign up for the security service, so the actual revenues Allot will get are expected to be the MAR multiplied by whatever the penetration rates will be.
Building a base of this size with operators deploying security as a service for their customers is extremely important. Upon signing the deal, we don't record bookings or revenues, but as the service is launched and penetration levels grow, a recurring long-term revenue stream is gradually built. These deals should form a base for continued and sustainable growth of Allot. I would now like to summarize the overall picture and the key messages. We are proceeding according to plan and growing the business. I believe our second quarter numbers are a testament to that. In the visibility and control area, we have a growing number of opportunities in various areas. We see long-term opportunities as operators move to NFV, as 5G networks are deployed, and as government demand more regulation on internet access. Based on the pipeline, I expect this growth to continue into 2019 and 2020.
In the security area, which we see as our major long-term growth engine, we have signed initial deals for Allot Secure products, including several security OpEx deals. Our pipeline of security OpEx deals is very encouraging. It is expanding, and most operators are accepting of the OpEx or revenue share model we offer. I expect we will sign additional security OpEx deals in the second half of 2019. From a product perspective, we are progressing well in achieving advantages over our competition, such as in NFV capability. As discussed on previous calls, we are also investing more in artificial intelligence and machine learning technologies to create further technological differentiation in both visibility and control, and security domains.
Based on our results so far, and on the growing and strong pipeline of new deals, I would like to reaffirm our expectations for 2019 revenues to be between $106 million and $110 million. We expect book-to-bill for the full year 2019 to be above one. Regarding security OpEx deals, I believe we are on track towards our goal to sign security OpEx deals with an aggregate MAR of $100 million during 2019. Now, I would like to hand the call over to Alberto Sessa, our CFO. Alberto, please go ahead.
Thank you, Erez. Before I begin reviewing the financial results for this quarter, I would like to inform everyone that on this call, unless otherwise noted, I will refer entirely to the non-GAAP financial measure when discussing operational results, which is what we use internally to judge the performance of our business. Non-GAAP financial measure differ in certain respects from the Generally Accepted Accounting Principles and exclude share-based compensation expenses related to M&A activities, amortization of certain intangible assets, change in deferred tax, and exchange rate differences related to the revaluation of assets and liability denominated in non-dollar currencies. With regard to the financial results, revenues for the second quarter of 2019 were $26.6 million, growing by 15% compared with those of the second quarter of 2018.
Regarding the details of the revenue breakdown and diversification, the geographic breakdown of revenues for the second quarter of 2019 was as follows. Americas, with $2.3 million, or 9% of revenues. EMEA with $14.4 million or 54% of revenues, and Asia Pacific with $9.9 million or 37% of revenues. The breakdown of revenues by type were as follows. Product revenues for the quarter accounted to $16.8 million or 63% of total revenues, compared to $12.8 million or 56% of total revenue in Q2 2018. Professional services revenue were $2 million or 7% of total revenues, compared to $2.1 million or 9% in Q2 2018. Support and maintenance revenue were $7.8 million or 30% of total revenue, compared to $8.1 million or 35% in Q2 2018. Communication service provider or CSP revenues were 86% in the second quarter of 2019 compared to 79% as reported in the second quarter of 2018.
I note that revenue breakdown, whether geographical or by product segments or other, typically fluctuate from quarter to quarter, depending on the specific revenue and deals recognized in the specific quarter. On the second quarter of 2019, our top 10 end customer made up 71% of our revenues, and this is compared with 61% in Q2 2018. Gross margin for the quarter was 69.8%, compared to 72.2% in the second quarter of 2018. Overall, while the gross margin may fluctuate from quarter to quarter based on the deal recognized in the specific quarter, we do expect an average of around 70% over this current full year period. Operating expenses for the quarter were $20.6 million, compared to $17.9 million as reported in the second quarter of 2018. The increase in operating expenses is mainly due to the increase in head count, particularly in R&D and customer success departments.
The total number of full-time employees as of June 30, 2019, was 551, up 16 full-time employees since the end of the last quarter. Non-GAAP operating loss for the quarter was $2.1 million, compared with an operating loss of $1.3 million in the second quarter of 2018. At the end of this quarter, we reevaluate the earn-out provision for the Optenet acquisition, which we completed in 2015. This revaluation brings into account that in projecting the security OpEx deal, revenue will be recognized only when subscribers actually enjoy the service. As a result of the revaluation, a reduction in the earn-out estimation of approximately $1.9 million was recorded, generating this quarter a reduction in G&A expenses for the same amounts. I note that this transaction, since it is part of an M&A activity, is excluded from our non-GAAP financial statements.
Net loss for the quarter amounted to $2.1 million, or $0.06 per share. This is compared with $1.2 million loss, or $0.04 per share in the second quarter of 2018. Turning to the balance sheets, our cash reserve comprised of cash equivalents, and investment as of June 30, 2019, totaled $101.6 million, compared to $101.5 million as of March 31st, 2019. The number of basic shares for the second three months of 2019 was 34.2 million, and the number of fully diluted shares was 36.1 million. In terms of guidance, as Erez mentioned, we are reaffirming our guidance and expect revenue to grow to between $106 million and $110 million in 2019, with the second half of the year higher than the first, representing continued year-over-year revenue growth.
Due to the potential opportunities we see ahead, Allot is increasing its investments in those area that will serve the growth of the company, mainly R&D and customer success. We are recruiting more resources, as a result of that, we expect the operating expenses for the full year 2019 to be slightly above $83 million. That concludes my remarks. We would be happy to take your question now. Operator.
Thank you. Ladies and gentlemen, at this time, we'll begin the question-and-answer session. If you have a question, please press star one. If you wish to cancel your request, please press star two. If you're using speaker equipment, kindly lift the handset before pressing the numbers. Your questions will be pulled in the order they are received. Please stand by while we pull for your questions. The first question is from Alex Henderson of Needham & Company. Please go ahead.
Yeah, thanks. I just want to talk a little bit about the gross margins in the quarter and the commentary for the full year. As I understood it, the June quarter had a little bit more hardware in it than normal, and therefore, you were expecting quite a bit lower gross margins in the quarter. It came in nicely above what we'd modeled. I am assuming that maybe that shifted out a little bit. Is that why you're giving a little lower gross margin guidance implied in the back half of the year by the 70% for the full year?
As you mentioned, and I mentioned, when I said before, I think that gross margin depends very much on the deals that are recognized during the quarter. We were able, this quarter, to have a mix of deals that brought us to not have this downside in gross margin that we did expect. We still have a few deals in our backlog, which are hardware related, probably that will be recognized in the future quarter. Overall, we are satisfied with the fact that we succeed also this quarter to keep our gross margin around the 70%, which we believe it is the level of the full year.
As we look out into the following year, I assume that the percentage going out as hardware will gradually decline. Is that reasonable to expect a gradual improvement in gross margins over time?
I think yes. Look, as customers order from us more software and less hardware, either because they're going to NFV topology or they are deciding to buy their own hardware or whatever, I think that over the years, we should see some improvement on gross margins, although I'll admit it's very hard to forecast these numbers accurately.
I believe you guys signed a fairly interesting contract with the guys over at Rakuten. I was hoping you could just describe whether that was a pure CapEx transaction or whether it had elements of OpEx in it, given the expected ramp of that kicking in as a customer rolls out their services in the fourth quarter and into 2020. How is that contract structured over time? Is it all OpEx or excuse me, all CapEx, or is there a piece that will shift to OpEx over time?
I think it's something in the middle, I would say, between OpEx and CapEx. Mainly it's a CapEx deal, but it's limited in time. It's not based on the usage or subscription on a specific quarter or year, but it's a CapEx deal limited in time. Of course, what Rakuten bought from us is limited to a certain number of subscribers. The deployment of network will succeed, and they will have additional subscribers. We may expect to have additional order for the software we sold.
If I could, the OpEx deals sound like they're running a little bit stronger in the pipeline. I know you haven't given the guidance beyond the $100 million mark this year, is it reasonable to think that given the strengthening pipeline, that that would be a low watermark for 2020, and that additional transactions would be similar or more than that in 2020? Are you building enough of a head of steam to think that way?
I think that that's what the pipeline would show. Yes. I think we should be able to sign in 2020 deals of larger impact or larger value, I would say, than what we'll sign in 2019.
Perfect. Let me step out of line and let somebody else get in. Thanks.
Thanks. Thank you, Alex.
The next question is from Marc Silk of Silk Investments. Please go ahead.
Thanks for taking my question. It's nice to see continued progress. I just have one quick question. When you are on the side of security, if your end customer, let's say someone is a customer of a phone company, is that something that this is going to be added to their offering, like a package, or it's going to be something that they're going to have to buy on their own through the phone company? I'm just trying to check out the potential penetration of the product to the end user.
It depends on the go-to-market of the operator, right? I think that the main theme here is that this is a service offered by the operator as an operator-branded service to their customers. They will get this from the operator, whoever their operator is. Now, there are a couple of ways to do this. One way, which is what Vodafone is doing today, they tell their customers, "Here's a new service you can get. Instead of broadband, you can get secure broadband. For that secure broadband, the end user customer will be charged an additional, in this case, €1 per month for the security services." Telefónica is doing it in a different way. They're bundling the security service with higher packages and with speed. They're offering a bundle that way.
There can be operators that decide to just include it as part of their baseline service offering to customers. At the end, if you look at the penetration rates, I think the best example is, again, Vodafone, because they've been doing this for the longest time. We're seeing penetration rates that go anywhere after three years, they go anywhere from countries that have not pushed this aggressively and do not have a good go-to-market strategy, so they get penetration rates of 15%, one five percent, and countries that have been more aggressive about it, took a better go-to-market approach, are getting penetration rates of 50%, five zero percent, and above. I hope I answered your question.
No, no, that gives me some good clarity for the future. The last thing is, obviously you have basically minimal analyst coverage, although it's good coverage. I've been in this position for building it for over four years. My question is this, and I think that having that big balance sheet is fantastic, but it sounds like, when I look at something like CrowdStrike that's going crazy, and it's in, obviously, the security space. If you're seeing that your stock is way undervalued, and you see yourself really getting to sustained profitability and the stock stays at these levels, it wouldn't be the worst thing to use about $10 million to buy back shares.
I'm not saying that's an urgent thing, but I think in the back of your mind, if you're upset with where your stock price is based on what you guys see, announcing a stock buyback for a small portion of your cash on hand is not the worst thing, because I think you're one of the most undervalued stocks out there on Wall Street, and that's kind of my last comment. Thanks.
Okay. Thank you.
If there are any additional questions, please press star one. If you wish to cancel your request, please press star two. Please stand by while we pull for more questions. The next question is from Jeffrey Bernstein of Cowen. Please go ahead.
Hi. Thanks, guys. Just wondering, with all the controversy about network equipment from different providers being allowed into specific networks, are people starting to look at your technology just for monitoring of equipment and making sure that there's no rogue communication going on with equipment? Is that going to be a market?
That's not a segment that we serve. Our products don't do that.
Okay, thanks.
The next question is from Alex Henderson of Needham & Company. Please go ahead.
Yeah, I wanted to go back to the comment you made on the call that the first half of the year, you saw bookings that were 75% greater than your bookings in the first half of 2018. I was looking back through my notes, and you made the comment after the third quarter of 2018 that your bookings were 2x that of all of 2017. Seems like your book-to-bill is not just over one, but way over one. Could you give us a little bit more qualification around that? What was the book-to-bill in the quarter, per se?
Okay. Let me first correct a bit the statement you made. What I said was that our bookings in the first half from new customers, not the total bookings, but the bookings that come from new customers in the first half, were 75% larger than the bookings that came from new customers in the first half of 2018. In my opinion, it's more an indication that we're winning business and growing in the number and value of new customers, and it's less an indication on the total bookings as such.
We think that bookings on any specific quarter are not necessarily the right indication, and like we said at the end of last year, we're going to give you our book-to-bill ratio for the year, and we're going to give you our target for the year, but we're not going to spell it out each and every quarter. Our target for the year is book-to-bill over one, and we believe that we will meet that.
Okay. Second question. The shekel has been strong. Obviously, that has implications for your cost structure. Can you talk about to what extent you're hedged, to what extent that's a factor in your thinking on the OpEx outlook?
First of all, I mentioned that in previous calls, we generally hedge something like 6 months ahead of time. The shekel has been stronger lately, up to now, we have not had any hit out of that because we were hedged due to the hedge structure that we did the last quarter and the quarter before. We do not see right now any impact as of today in the stronger shekel. Going forward, it will be much depending on how the shekel will continue to be evaluated compared to the U.S. dollar. We do have some exposure. As you know, some of our expenses, mainly the salary expenses, are here in Israel and are certainly exposed to exchange rate changes. Again, up to now, we did not suffer of this in our numbers.
Going back to the competitive landscape for a second. Can you talk a little bit about what's going on with the competitors that have now merged and whether you're gaining share against them as a result of that, picking up distribution, picking up competitive wins where the customer might not want to have ownership by a private equity firm? Can you talk a little bit about what's going on with Sandvine and Procera?
Sure. As you know, Sandvine and Procera have merged. They're called Sandvine now, and that's our main competitor in the visibility and control domain or the DPI domain. We are winning deals against them. We are winning more deals than not against them. We are, in some cases, even replacing their installed base where they have a customer that has already Sandvine installed, and there's a refresh required or whatever, that we have won deals to actually replace their systems. Yes, we're also picking up distribution channels because in some areas, Sandvine had one distribution partner, Procera had another distribution partner. Now that they've merged, one of them is looking for a product, and we are a very, very good candidate to fill that. We're feeling very strong against them, and by our count, we're taking up market share from them.
Have you seen any change in their competitive response and behavior as a result of those share losses, or is it fairly stable? How are they responding?
I don't think I can characterize an overreaching view worldwide. I think it's really more dependent on each salesperson or each region, to what degree they have suffered from us, or to what degree they are seeing us or not seeing us, and the result of that. Generally, one of the things that I would say honestly, we have not seen from them, we have not seen any, for example, significant price drop around the market. I don't see that as any kind of general response of that sort.
Great. Thank you very much.
Sure.
We have a follow-up question from Jeffrey Bernstein. Please go ahead.
Just following up on that subject, have you seen any NFV product from them yet? Is NFV becoming a real differentiator in more deals?
NFV is definitely becoming a more and more important requirement. I think with all the major operators, we have to be, if not NFV-compliant today, we have to have a full commitment. We or anybody, right? Have to have a full commitment to NFV in the future. Whether it's current or future, and to what degree, depends on where that operator is with their own NFV plans, right?
Yeah.
There's some, I would say, confusion between NFV and virtualized. Those words seem similar, in the market, people sometimes get confused by them. Virtualized really means that, if you want to sort of simplify it really means I can run on a standard platform.
Yeah.
NFV means that, okay, you can have software that requests an orchestrator to bring it up, to tear it down.
Yeah
provide more resources, less resources, and so on. The fact that we know how to run on NFV and we're installed in several operators on NFV systems, and that we're doing that right now, I think that's a differentiator for us, yes.
Gotcha. You talked about the differences in penetration of security products depending on the carriers go-to-market, and I'm wondering if you have enough experience now to really know best practices. I would guess maybe there are cultural differences in different areas about what the best go-to-market is, but have you guys enough statistical experience to be able to go to the customer and say, "Listen, if you do it this way, you're going to be very successful. If you do it another way, you're not going to be," and can impact what kind of penetration you get?
I think, the word enough, when you say enough experience, it's hard for me, but we definitely have a lot of experience with it, and I would say significant. Within our marketing team, we've put together a small group that is focusing on B2C marketing for cellular operators, and that's exactly their value. When we work with an operator, we bring this team on to sit with their marketing people and tell them, "Here is the best practices. Here's what we know works, here's what we know doesn't work. Here are ideas that were tried. Here are ideas that were not tried," et cetera. Of course, the go-to market is dependent on the operator itself at the end. It's not ours to choose.
Sure.
It's their branded service. We do have a group that we've recruited and built to do exactly that. Bring those best practices to bear and work with the operators so they know how to approach this better.
That's great. Thank you.
There are no further questions at this time. Mr. Antebi, would you like to make your concluding statement?
Thank you. On behalf of myself and the management of Allot, I'd like to thank you for your interest and long-term support of our business. Alberto will be in the U.S. in the next week or so, meeting with investors in Boston and New York. If you'd like to meet him, please contact our investor relations team. Thank you very much for joining us today, and I look forward to talking to you in the next quarter. Thank you very much.
Thank you. This concludes the Allot second quarter 2019 results conference call. Thank you for your participation. You may go ahead and disconnect.