Allot (ALLT) Q2 2023: CCaaS ARR Climbs 41% as Cost Cuts Target 2024 Profitability

August 31, 2023 | By EarningsIQ Research

Allot’s Q2 revealed a business in transition, with CCaaS annual recurring revenue (ARR) up sharply but legacy DPI pressured by macro headwinds. Significant cost reductions and a sharpened focus on high-value cybersecurity contracts underpin management’s conviction in returning to profitability next year. Investors face a near-term cash burn and execution risk, but the Verizon launch and Tier 1 APAC wins signal a path to scalable growth if adoption accelerates.

Summary

• Cybersecurity Focus Deepens: CCaaS is now the core growth engine, with Verizon and APAC Tier 1 launches validating the strategic pivot.
• Cost Structure Reset: A 20% headcount reduction and $15M in annual savings aim to stabilize cash flow and fund growth initiatives.
• Profitability Commitment: Leadership reiterates a 2024 profitability target, hinging on CCaaS ramp and disciplined expense control.

Business Overview

Allot provides network intelligence and cybersecurity solutions for communication service providers (CSPs) and enterprises. Revenue is generated from two main segments: Deep Packet Inspection (DPI), which supports traffic management and analytics, and Cybersecurity-as-a-Service (CCaaS), a recurring revenue model offering network-native security to CSPs and their customers. The company’s legacy DPI business delivers stable but limited growth, while CCaaS is positioned as the primary driver of future expansion.

Performance Analysis

Allot reported a 24% year-over-year revenue decline, reflecting continued softness in its legacy DPI segment as CSPs tightened budgets and delayed deal cycles. Gross margin remained robust at 71% in Q2, but is expected to dip to 50% in Q3 due to a less favorable deal mix and large, lower-margin contracts. The company’s cash balance declined by $11 million, driven by operating losses, inventory build, and a reduction in accounts payable.

CCaaS ARR reached $9.7 million, up 41% year-over-year, though the growth rate slowed sequentially. Notably, CCaaS revenues comprised $2.4 million in Q2, with management forecasting $11 million for full-year 2023. The pipeline is increasingly concentrated in large, strategic accounts, as evidenced by the Verizon Business launch and a Tier 1 APAC telecom deal. However, the cancellation of a Canadian CSP contract and a $14 million credit loss reserve on African receivables weighed on outlook and investor sentiment.

• Legacy DPI Drag: Revenue from DPI remains pressured by elongated CSP sales cycles and limited new bid activity, constraining overall topline growth.
• Cash Burn and Credit Loss: Cash outflows accelerated, exacerbated by a substantial credit loss provision tied to African receivables, highlighting working capital and counterparty risk.
• CCaaS Momentum: Despite slower-than-hoped ramp, CCaaS customer wins with Verizon and APAC Tier 1s demonstrate product-market fit and a scalable opportunity set.

Management’s commitment to cost discipline and a pivot toward high-value recurring contracts is clear, but execution risk remains elevated given macro uncertainty and the need for accelerated CCaaS adoption.

Executive Commentary

Strategic Positioning

1. CCaaS as the Core Growth Engine

Allot’s strategic pivot centers on CCaaS, which transforms security from a one-time product sale to a recurring service. The Verizon Business launch and APAC Tier 1 wins validate the solution’s relevance, though most contracts are still in early revenue stages. Management is prioritizing large, strategic accounts to maximize ARR leverage and profitability.

2. DPI Business Deprioritized but Still Cash-Generating

The DPI segment, focused on traffic management and analytics, faces constrained demand as CSPs delay investment and deal cycles lengthen. Allot is maintaining DPI as a stable cash generator to fund CCaaS growth, but acknowledges limited upside and forecasting difficulty due to deal lumpiness and macro headwinds.

3. Cost Structure Overhaul and Profitability Path

With a 20% headcount reduction and $15 million in annual savings, Allot is aggressively resizing its cost base to match current revenue realities. The one-time restructuring charge of $2 million will impact Q3, but management expects the full benefit to materialize in 2024, supporting the path to profitability even if CCaaS ramps slower than initially hoped.

4. Customer Concentration and Strategic Account Focus

By narrowing focus to high-value CSPs and requiring minimum revenue thresholds for new contracts, Allot is concentrating resources on fewer, larger opportunities. This is intended to drive higher-margin, more predictable revenue, though it introduces greater dependency on successful execution with marquee accounts like Verizon and Tier 1 APAC operators.

5. Product Differentiation and Convergence Strategy

Allot’s network-native security, delivered at the operator level, positions it as a differentiator for CSPs seeking to add value beyond connectivity. The platform’s ability to unify security across fixed and mobile (convergence) is gaining traction, especially in Europe, where CSPs are exploring bundled offerings to drive ARPU and reduce churn.

Key Considerations

Allot’s Q2 underscores a business in flux, with both risk and opportunity tightly coupled to the pace of CCaaS adoption and cost discipline. The following considerations are central to the investment case:

Key Considerations:

• Verizon Launch as Proof Point: Early success and potential expansion at Verizon could serve as a catalyst for broader Tier 1 CSP adoption and revenue scale.
• Cash Flow Sensitivity: High cash burn and a significant credit loss in Africa highlight the importance of working capital management and counterparty diligence.
• Execution on Cost Cuts: Realizing the full $15 million in annual savings is critical for bridging to 2024 profitability, especially if revenue recovery lags.
• Deal Lumpiness and Forecasting Risk: Large, infrequent contracts and delayed launches (e.g., Canada) make near-term results difficult to predict and introduce volatility.
• Strategic Account Dependence: Focus on fewer, larger CSPs increases both upside and risk if marquee launches underperform or are delayed.

Risks

Allot faces elevated execution risk as it navigates a transition from legacy DPI to CCaaS, with profitability dependent on both new deal wins and strict cost control. Counterparty risk remains acute, as evidenced by the $14 million credit loss. Macro headwinds, elongated CSP sales cycles, and deal lumpiness introduce further revenue unpredictability. The company’s concentrated customer strategy amplifies the impact of any single contract delay or cancellation.

Forward Outlook

For Q3 2023, Allot guided to:

• Revenue of approximately $25 million
• Gross margin of about 50% due to deal mix

For full-year 2023, management provided a wide range:

• Total revenue between $95 million and $110 million
• Non-GAAP operating loss between $38 million and $44 million (including credit loss)
• Cash burn of $24 million to $44 million
• CCaaS ARR by year-end between $12 million and $14 million

Management reiterated a commitment to full-year profitability in 2024, driven by CCaaS growth and the full impact of cost reductions. They highlighted:

• Potential revenue upside from large expansion deals in the pipeline
• Continued uncertainty in DPI and timing of large contract launches

Takeaways

Allot’s transformation hinges on CCaaS adoption, disciplined cost management, and successful execution with Tier 1 CSPs. The Verizon launch and APAC Tier 1 win are positive signals, but near-term risks remain elevated.

• CCaaS Pipeline Is Key: Scalable recurring revenue from high-value CSPs is the path to long-term growth, but adoption must accelerate to offset legacy pressures.
• Cost Discipline Is Non-Negotiable: $15 million in annual savings and a leaner operating structure are essential to achieving 2024 profitability.
• Execution and Customer Concentration: Investors should monitor launch progress at Verizon and other Tier 1s, as well as working capital trends and cash flow stabilization.

Conclusion

Allot’s Q2 marks a critical inflection in its business model, with the pivot to CCaaS validated by marquee wins but still in early innings. The company’s ability to deliver on cost cuts and convert pipeline into ARR will determine whether it can deliver on its profitability promise in 2024. Execution risk remains high, but the strategic direction is now clear.

Industry Read-Through

Allot’s results reinforce several sector-wide realities for network security and telecom technology vendors. CSPs are increasingly prioritizing network-native security to differentiate in commoditized connectivity markets, but budget constraints and elongated sales cycles are common. The shift to recurring, service-based models is slow but gaining traction, especially as Tier 1 operators seek convergence across fixed and mobile. For peers, the ability to prove product-market fit with large, referenceable customers—as Allot is attempting with Verizon—will be a key determinant of scaling ARR and sustaining margin. Cash discipline and working capital management are critical as macro uncertainty persists and deal lumpiness remains a challenge across the sector.

ALLT Technology Cybersecurity Recurring Revenue Telecom Cost Reduction ARR Network Security