Ladies and gentlemen, thank you for standing by. Welcome to Allot's first quarter 2019 results conference call. All participants are at present in a listen-only mode. Following management's formal presentation, instructions will be given for the question and answer session. As a reminder, this conference is being recorded. You should have all received by now the company's press release. If you have not received it, please contact Allot's Investor Relations team at GK Investor & Public 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 first 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 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 future performances of the customer. 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 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. I'd like to welcome all of you to our conference call, and thank you for joining us today. I would like to start with some key financial parameters for the first quarter. The first quarter was another quarter of solid growth. Our revenues grew 17% year-over-year for the first quarter. Our non-GAAP gross margins improved from 70% in the first quarter 2018 to 72% for the first quarter 2019, and our operational loss in the first quarter 2019 improved compared with the first quarter of 2018. All this while continuing to grow and invest in our long-term growth through key R&D, marketing, and sales investments. I am very pleased with the results we achieved during the first quarter, and the main message is that we are on track with our plan. We see a growing number of opportunities.
We are continuing to win new deals and grow our revenues. We expect this trend to continue throughout 2019. While Alberto will provide more details on our financials later, I did want to start with our financial performance because it shows that we are on track and successfully continuing to execute on our plan. I would like to turn now to a discussion on our business, starting with 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: smart traffic optimization, quality of experience, analytics, and regulatory compliance. During the past few months, we announced deals from several different regions.
In Japan, we announced earlier today that we partnered with Rakuten Mobile to provide their greenfield mobile network with several Allot products, including our traffic management software, NetworkSecure, and DDoS Secure products. Rakuten Mobile, a subsidiary of Rakuten, Inc., is a global leader in internet services. Rakuten Mobile's fully virtualized cloud native mobile network plans is targeted to launch in Japan in October this year. In the U.S., we announced our agreement with Mobileum, a global roaming provider, to provide Allot traffic management or DPI system to ensure quality of roaming for a tier 1 U.S. operator. This deal is in addition to a previously announced deal for IoTSecure to a different tier 1 operator in the U.S. In Africa, we announced a deal with Safaricom, the largest mobile operator in Kenya, to provide Allot traffic management, NetworkSecure, and DDoS Secure for their fixed network.
It is noteworthy that while our Allot Smart traffic management products and our Allot Secure security products are separate and used for different purposes, some operators choose to acquire and use products from both families, as evidenced by Rakuten Mobile and Safaricom deals. These wins are particularly important for a couple of reasons. First, we are expanding our customer base, and we are entering new territories such as Japan and the U.S., in which we had little presence in the past. Second, new wins with new operators provide a base for potential future revenue in expansions, renewals, and services. Increased opportunities resulting from CSP move to NFV environment, additional regulatory requirements posed by government, and the expected rollout of 5G in certain geographies are contributing to our continued growth in the DPI business.
Overall, we see a healthy pipeline for such visibility and control deals. As I mentioned in previous calls, this is good news as it enables us to continue growing even before the security domain comes into full effect. Let's turn now to the security market, which we believe is our longer-term main growth engine. As I mentioned in previous calls, we see a growing number of CSPs who understand the value in providing secure broadband services at a premium, and understand that this is a combination of 3 elements. 1, an important enhancement to their brand value. 2, a potentially large new source of revenue. 3, a key element in their customer satisfaction. There are a growing number of CSPs issuing formal RFIs or RFPs, and at the same time, we are working on a growing number of potential deals that do not have such a formal process.
This growing interest is across the breadth of the Allot Secure product family, including NetworkSecure, IoTSecure, HomeSecure, DDoS Secure, and the combination with our partners, EndpointSecure. I would like to remind you all 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. We are participating in 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 the capability to provide anywhere, any device, any threat, unquote, protection to the customer and SMB market, excuse me, to the consumer and SMB market is gaining their acceptance. In January, we announced a deal with a tier 1 European operator with approximately 2.5 million subscribers.
This operator plans to launch a security as a service offering based on the Allot NetworkSecure product to its residential and SMB customers starting this summer. Once the service is launched, I expect to be able to share more details. Rakuten Mobile, as I just mentioned earlier, expects to launch the service in Japan in October. This deal includes a traffic management component, a DDoS Secure product to protect the network itself, and a NetworkSecure solution to protect end user internet access. I believe the Japanese market, with its large size, relatively high ARPU, and consumer willingness to pay for value, has large potential for CSP secure broadband offerings. This win with Rakuten could potentially open the door for Allot to additional opportunities in the region. Recently, we also announced a deal with Safaricom Kenya to provide, among else, NetworkSecure for their fixed broadband customers.
Although ARPU in Africa is generally lower than in the U.S., Japan, or Europe, there is a significant portion of customers who pay much more than the average ARPU, and these are the target customers for the security service in Safaricom. In Vodafone, our largest security customer, penetration rates and the number of paying subscribers continues to grow, albeit at a slower rate than before. As disclosed previously, [Telefónica Niji] security services based on the Allot NetworkSecure product were launched in December 2018 in Spain. Telefónica decided to launch a bundled service where they bundle speed, capacity, and security together. Initial reception has been positive and the number of subscribers is steadily growing. It is, however, still too early to analyze results and penetration rates. Telefónica plans to launch similar services, including security, in Brazil, Argentina, and Peru in the coming months.
I remind you that both Vodafone and Telefónica deals were based on sales of perpetual licenses per subscriber. We are striving to change this model with future customers and are offering OpEx or recurring revenue-based deals. Not all operators will accept this model. Rakuten Mobile, for example, demanded a long-term base license agreement. However, we are encouraged to see that more and more operators are open to an OpEx model, and this is the model in an increasing number of deals we are discussing. Another example for an OpEx deal that we closed last year is with Telefónica Spain for the SMB market. The 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. I am glad to inform you that the service was finally launched several days ago.
OpEx deals like this contribute little to bookings and revenues in the short term, so security bookings and revenues may appear not to grow enough. However, it is these types of deals that will ensure recurring revenues, potential long-term revenue growth, and success for the business overall. Our goal is to build a substantial base of CSPs with whom we have OpEx or revenue share security deals, and then work together with them to grow the number of end customers subscribing to the security service, thereby generating a significant amount of recurring revenues. We are engaged at several stages with a large number of additional operators for more security deals on all the various elements of the Allot Secure family, and I am very encouraged by the size of our pipeline and the interest within the CSPs to launch such security services for the mass market.
Looking at the initial security OpEx deals we signed, the growth in tenders, and RFPs that were issued, and the healthy pipeline we have in-hand, I am confident that we are heading in the right direction, and am optimistic about this market segment and our future growth in it. As you know, working with CSPs takes time, with sales cycles typically exceeding 12 months. It still takes a bit longer than we would've liked to close these deals. 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. I would like to repeat the definition and explanation of this metric.
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, the actual revenues Allot will get are expected to be the MAR multiplied by whatever the penetration rates will be. In Vodafone case, penetration rates of the service after three years vary from 15% up to 50% and more, depending on the go-to-market strategy and the emphasis put on the service. To clarify by way of a hypothetical example, assume we sign a deal with a hypothetical mobile operator that has 5 million post-paid customers, and we target the security service for all post-paid customers.
Assume further that based on the agreement with the operator, Allot expects to receive half a dollar per subscriber per month. The MAR of this hypothetical opportunity will be 5 million times half a dollar times 12 equals $30 million. If we reach in any given year average penetration of 20% of the subscriber base, the actual revenues for Allot in that year will be 20% of $30 million equals $6 million. 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 first quarter numbers are a testament to that. In the visibility and control area, we have a growing number of opportunities in several areas. We see longer-term opportunities as operators move to NFV, as 5G networks are deployed, as government demand more regulation on internet access.
Based on the pipeline, I expect this growth to continue into 2019. 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 throughout 2019. From a product perspective, we are progressing well and achieving advantages over our competition, such as in NFV capability. 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.
Now, I would like to reaffirm our expectations for 2019 revenues to be between $106 million and $110 million, with the second half of the year higher than the first half. 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. And now, I would like to hand the call over to Alberto Sessa, our CFO. Alberto, please go ahead.
Thank you very much, Erez. Before I begin reviewing the financial results for this quarter and for the year, 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 principle, 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 non-dollar currencies with regard to the financial results. Revenue for the first quarter of 2019 were $25.3 million, growing by 17% compared with those of the first quarter of 2018.
Regarding the details of the revenue breakdown and diversification, the geographic breakdown of revenues for the first quarter of 2019 was as follows. Americas, with $4.8 million, or 19% of revenues, EMEA with $10.7 million or 42% of revenue, and Asia Pacific with $9.8 million or 39% of revenues. Product revenues for the quarter amounted to $16 million or 63% of total revenues, compared to $13 million in Q1 2018. Professional service revenue were $0.8 million or 3% of total revenues, compared to $0.9 million in Q1 2018. Support and maintenance revenue were $8.5 million or 34% of total revenues, compared to $7.8 million in Q1 2018. Communication service provider or CSP revenues were 83% in the first quarter of 2019, compared to 75% as reported in the first quarter of 2018.
I note that revenue breakdown, whether geographical or by product segment or other, may fluctuate from quarter to quarter, depending on the specific revenue and deals recognized in the specific quarter. Our top 10 end customer made up 62% of revenues, and this is compared with a concentration of 56% last year. Gross margin for the quarter was 72.4%, compared to 69.6% in the first quarter of 2018. The main reason for the increase in gross margin is related to specific deals with high profitability recognized during the first quarter of 2019. Going forward, it's important to understand that we expect gross margin on a quarterly basis to fluctuate even significantly as a result of recognition of certain hardware-intensive deals we already have in our backlog. Operating expenses for the quarter were $20.2 million compared to $17.5 million as reported in the first quarter of 2018.
The increase in operating expenses is mainly due to increase in headcounts. The total number of full-time employee as of March 31st, 2019, were 536, up 12 since the end of December. Non-GAAP operating loss for the quarter was reduced to $1.8 million, compared with an operating loss of $2.3 million in the first quarter of 2018. Net loss for the quarter improved to $1.9 million or $0.05 per share, versus $2.4 million loss or $0.07 per share in the first quarter of 2018. Turning to the balance sheet. Our cash revenues comprise of cash-
Reserve.
Our cash reserves, sorry, comprise of cash equivalents and investments as of March 31st, 2019, remain strong and total $101.5 million compared to $103.9 million at the end of December 2018. The number of basic share for the first three months of 2019 was 34 million, and the number of fully diluted share was 35.7 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. We also continue to expect book-to-bill for the year to be above one. We expect gross margin for 2019 to be approximately 70%.
As I mentioned in our last call, we will also continue to invest in those areas that will serve the growth of the company, mainly sales and marketing and R&D. That concludes my remark. We would be happy to take your question now, 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 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 polled in the order they are received. Please stand by while we poll for your questions. The first question is from Alex Henderson of Needham & Company. Please go ahead.
Hey, thanks. This is Roger Boyd on for Alex. Pretty nice results from the quarter. I'm wondering, how does this affect the second quarter? Was there any timing related shifts in the quarter? On gross margin, was this mainly a factor of more software-focused deals coming through? I know you'd spoken in the past about maybe some hardware-intensive upfront costs affecting the first half. I'm wondering if maybe that could shift to the second quarter, and then similarly with Rakuten, if there's a hardware build-out prior to October that might affect margins as well.
First of all, regarding the gross margin, you mentioned increase in gross margin. As I said earlier, the main reason for that increase in gross margin this quarter is the recognition of deal with high profitability during the quarter. Going forward, as I said before, it will be important to understand that we expect gross margin on a quarterly basis to fluctuate, and that those kind of deal that you mentioned that are heavily hardware-related with a lot of hardware, recognition of them is still to be recognized, meaning that we still have deals on the backlog there from a timing point of view, those kind of deal will be recognized probably in the next quarter or the quarters come. That will affect the gross margin. Overall, as I said earlier, we do expect on a yearly basis to be on a 70% gross margin.
Just to address, Alex, your question on Rakuten. Rakuten is building a completely virtualized core network. We will be providing software, professional services support, but we will not be selling any hardware to Rakuten.
Okay. Makes sense. Maybe just qualitatively, I know you spoke a little bit about it. Any other details on customer reception towards the SaaS OpEx proposals? Do you think that customers are more likely to use kind of the split approach where Telefónica is using SaaS for their SMB business? Is that a similar trend you're seeing? I guess you'd like to see the whole deal. Any thoughts there?
If I understood the question correctly, I don't think I can differentiate between customers who are looking at the different approach for a consumer versus their SMB customers. I think at least what I'm seeing is that there are simply customers that are more comfortable with an OpEx type deal. Some customers are more comfortable with revenue share. Some really want more of a capital expense. It's not so much dependent on the market segment, meaning a consumer SMB or enterprise, it's more dependent on the operator itself.
Okay. Makes sense. That's it for me.
The next question is from Silk Investment Advisors . Please go ahead.
Thanks for taking my questions and great progress. On long-term, next three to five years out, on your security offerings, what's your goal for recurring revenue? Going forward, 50%, 25%?
I think it should be a very significant portion of our revenues. I don't want to give you an exact percentile for three years out and five years out and so on. Since this is the main growth engine, I expect us to continue to grow at the current pace or even more, most of it will come from recurring revenues, yes, this should take up an increasingly growing percentage of our revenues and should be very substantial.
That's a fair answer. It sounds like some of your customer base, like you said, does not necessarily want to do the revenue share. It's going to be up to the customer going forward. Is that correct?
That's correct. Honestly, if a customer comes to us is willing to do a deal with us, there's a fair value there for us for them, they're only willing to do it in a CapEx mode, they will be practical. We won't say no. We won't turn them down. I expect that the way I look at it now, I think the majority of customers will opt for some form of OpEx or revenue share agreement.
That's exciting. My last question on Deep Packet. Oh, sorry.
No, I was just saying it's a lower risk offering for them, and most operators I'm familiar with today have significant CapEx constraints. That's why it feeds into that.
Yeah, because I think the recurring revenue is going to be better on your multiple going forward. My last question is on Deep Packet Inspection. I know you're surprising us on that. It's obviously not dead. Can you let us fill us in, like what's going on in the United States, because I know there's still question marks as far as how thorough people want to use Deep Packet Inspection until they have a finite answer from the government.
Well, we're seeing more interest on DPI in the United States than at least we saw a year ago. Still, this is not something. We just told you we announced the deal with Mobileum. It is a DPI deal. It is for a U.S. tier 1 operator. Evidently, there is movement in the U.S., but it's not huge. I don't see all the major carriers going out and starting to acquire DPI or demand it and so on. We're seeing more interest, but I don't think these are very significant numbers yet for the U.S. market.
Thanks for taking my questions. Keep up the good work.
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, guys. Just a quick one. You talked about the Telefónica launch in Spain being part of a speed, capacity, and security bundled offering. Do you have any visibility on what the plans are for Brazil, Argentina, Peru? Are they also going to be in some kind of bundle like that?
We have some visibility. I'll rephrase that, sorry. We have visibility since we're talking to Telefónica, and they're sharing with us at least some of their ideas. On the other hand, I can't tell you for sure if that's exactly what they're going to launch. I'm not sure that they have themselves decided finally exactly how it's going to go. I would expect that most of them will be a similar bundle, but I cannot tell you that for sure.
Got you. A couple of questions about other stuff going on around the industry, around what you're doing. I guess there was something out about Telefónica and it's launching its own IoT cybersecurity unit and a business called ElevenPaths. What does that mean to you? Do you just take that as an elevation of interest in this kind of thing for carriers, et cetera? I had one more.
ElevenPaths is a subsidiary or a business unit of Telefónica that deals in various things, but mostly around security. We're working very closely with ElevenPaths. A lot of the work that was done on the Niji security service, which they have launched in Spain and expected to launch in other places, was originated by ElevenPaths, and we worked with ElevenPaths on the definitions for that, on how the bundle would work, how it would work technically, and so on. One of their initiatives, and one of the things that they're working on and that we're talking to them about, is also how to provide IoT security.
Got you. That's great. Thank you. Lastly, you have a quasi-competitor, Cyan AG, German company, that's focused, I guess, more on DDoS, et cetera, and they won a pretty big deal with Orange. Just interested in what went on there and what your thoughts are about that segment, et cetera.
I think that Cyan indeed won a deal with Orange. They won a deal. I'm not sure that they won anything on DDoS. I may be mistaken, but that's not what I'm familiar with. I think they won a deal for the small medium businesses security with Orange. Yes, it's unfortunate that a competitor of ours won a deal. I think the fortunate part of it is that you see that more and more operators are indeed going to provide security services to their customers, and we're seeing more traction in the market, and that will obviously bring competitors, whether direct or with a different offering. Overall, for the market, it's good news. What went on there, I think we were not doing, our sales job as properly as we should have probably in Orange. We have not given up.
Got you. I'm sorry, I think I misspoke. I think it was more that their security technology is more DNS-based rather than DPI-based.
Yes, it is. It's more DNS-based. The DNS-based technology is one which is inferior in its security capabilities to the inline security capabilities that we are offering. It is, however, easier to install in the network. There's a trade-off there. I think that as time goes by, we'll see less operators willing to go with DNS, because I think honestly, it's less future-proof than the inline offering that we are providing. Time will tell.
That's great. Thank you.
The next question is from Nachum Moshes. Please go ahead.
How are you doing, Mr. Antebi? Thank you very much for taking my call, and congratulations for the great quarter and the growth. I wanted to ask you, when you gave the anticipation, you anticipated growth for the year. It was about 14%, if I'm not mistaken. That was when you reported the whole year of 2018, the fourth quarter of 2018. Actually, now you posted a growth of 17%. I wanted to know, what does it mean? Maybe does it mean that in the rest of the year, you anticipate historic growth? Or maybe does it mean that you will give a higher anticipation for the year? If yes, when do you think you're going to hire up the anticipation?
Well, I mean, the numbers for the first quarter are what they are, and that was a 17% growth, as we said. For the full year, the full year is affected by various parameters, and we gave our guidance to finish the year at between $106 million-$110 million. It's not a specific growth number. If you do the math, it'll simply be a range. We believe that that's the range we will be in. I'm not sure how to further address your question.
What I mean is that you anticipated a 14% growth. Now you gave 17%. Will it be the same percentage of growth for the rest of the year?
No, we never said a 14% growth in 2019. We said that the end result will be 106 to 110, which will give a range that we can calculate in a second, but I didn't yet. We said that the second half will be stronger than the first half. Again, I don't know numerically how to add any more information.
Okay, great. Thank you very much and keep up the good work.
Thank you.
There are no further questions at this time. Mr. Antebi, would you like to make your concluding statement?
Yes, thank you. On behalf of myself and the management of Allot, I would like to thank you for your interest and long-term support of our business. Alberto, our CFO, will be in the U.S. next week meeting investors in Chicago and attending the Needham Emerging Technology Conference in New York. If you would like to meet him, please contact our investor relations team, we'll be happy to meet with you. I look forward to talking to you on the next quarter. Thank you and have a good day.
Thank you. This concludes the Allot first quarter 2019 results conference call. Thank you for your participation. You may go ahead and disconnect.