Senstar Technologies Corp Q3 FY2020 Earnings Call

Greetings and welcome to the Magal Security Systems Ltd Third Quarter 2020 Earnings Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. As a reminder, this conference call is being recorded. It is now my pleasure to introduce your host, Kim Rogers with Hayden IR. Thank you. You may begin.

Thank you, operator. Welcome to Magal's third quarter 2020 earnings conference call. I would like to welcome all of you to the conference call and thank Magal's management for hosting this call. With us on the call today is Mr. Dror Sharon, CEO of Magal; and Mr. Kobi Vinokur, CFO. Dror will summarize key financial and business highlights, followed by Kobi, who will review Magal's financial results for the third quarter. We will then open the call for questions-and-answers session. Before we start, I would like to point out that this conference call may contain projections or other forward-looking statements regarding future events or the future performance of the company. These statements are only predictions and Magal cannot guarantee that they will, in fact, occur. Magal 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, the unanticipated and unknown effect of the coronavirus including on our operations and our clients, as well as other risks identified in the documents filed by the company with the Securities and Exchange Commission. In addition, during the conference call, we will describe certain non-GAAP financial measures which should be considered in addition to and not in lieu of comparable GAAP financial measures. Please note that in our press release we have reconciled our non-GAAP financial measures to the most directly comparable GAAP measures in accordance with Reg G requirement. You can also refer to our website at www.magalsecurity.com for the most directly comparable financial measures and related reconciliations. And with that, I would now hand the call over to Dror. Dror, please go ahead.

Thank you, Kim. I would like to thank everyone for joining us today to review our third quarter results. In my comments, all the comparisons are year-over-year referring to the third quarter of 2019. Globally, the Magal team is executing well. Despite the impact of COVID restrictions, we continue to develop new business relationships, build the pipeline, and close sales. We are closing sales in both of our divisions: Magal Integrated Solutions, our project division, and the Senstar Product division. As a result, backlog in the third quarter rose to a record level, with reduced operating expenses by over 9% and a total EBITDA of $1.3 million. Year-to-date, we have lowered operating expenses by $3.2 million. Magal has maintained profitability without restricting investment in sales and R&D, or primarily driving growth in assets that are crucial to our future growth post-COVID. Ongoing investment in new products and upgrades to our platform enables the company to maintain a competitive advantage and grow our business. As a percentage of total consolidated revenue, Magal Integrated Solution was 54%, while Senstar was 46%, in line with previous quarterly performance to date in 2020. Both business segments continue to be impacted by COVID-19 in the third quarter. On a positive note, we announced two key contracts in the quarter. In order, we issued a press release stating that a global organization awarded Senstar a $6.5 million U.S. contract to provide equipment to secure deployable military assets. This award recognizes technological differentiation and the scope of Senstar's deployable security solutions. In early October, we announced a large contract to secure a governmental body principal premises in one of Africa's largest capitals. Magal’s estimated share in this project is $10.5 million, and we anticipate increasing revenue during the course of the project. This is an excellent example of how both of Magal's divisions cooperate to deliver competitive advantages. The state-of-the-art security system includes a comprehensive range of Magal’s proprietary products and platforms. As a project core, it is focused on command control which is Magal's proprietary physical security information management system, or the PSIM. This new generation PSIM supports underground perimeter intrusion detection systems (PIDS) and Senstar Symphony Video Management Software (VMS). The VMS includes intelligent video analytics capabilities. The project also features electronic access control hardware and software, and a secure communication network that supports the systems integration and operation. These are proprietary solutions that are primarily created in-house by Magal Integrated. Senstar revenue declined by 5% compared to the 2019 third quarter. While we were down year-over-year, Senstar delivered almost 5% sequential growth. The division’s largely transactional revenues, along with geographical and product line diversity, have remained relatively stable in 2020. In the third quarter, Magal Integrated Solution continued diversifying its revenue stream with an increasing number of key accounts, continuing transactional business from smaller contracts and deals across new territories such as recent large contracts we won in Africa. Compared to the same period last year, Magal Integrated Solution was down 26%, in line with how the division has performed since the COVID outbreak. Shifting to an update of our four key verticals: energy, contract facilities, critical infrastructure, and logistics. Energy continues to be impacted by this uneven recovery in the global economy that has decreased demand for oil and gas and depressed commodity prices. This is causing delays in both large projects and new investments in the sector that were in the works before COVID. We began to see improvement in the energy vertical in the last few months. Projects are starting to come back to the table. As a result, we anticipate closing new deals, which will pick up by year-end or the first quarter of 2021. Production in the U.S. continues to be a strong vertical for us. We anticipate this strength to continue into the fourth quarter, and new solutions that are being tested to track natural light entering sensitive areas in aerospace are also being targeted for our facilities. We expect to expand our offerings in innovative technology. Critical infrastructure continues to be a major vertical for us, covering seaports and airports in Latin America, Asia Pacific, Africa, and Europe. We have had recent wins in these verticals. Logistic facilities worldwide are poised to meet increased demand related to the upgrade in online shopping. These large, complex logistics facilities have greater security and operational needs. To meet these needs, we are launching an updated version of Symphony, our VMS Software, to provide a comprehensive solution for securing logistics facilities and for specific operational capabilities such as package tracking and movement management. This enhanced solution improves the ROI for our logistic customers' security investments. Currently, two large logistics providers are utilizing our new solution. The second project in Europe is being finalized for possible movement using our new VMS software and the intelligent video analytics features. Another innovative product we recently launched is Safe Spaces. This new video management solution is a timeline VMS platform that is agnostic and allows businesses to ensure they are maintaining COVID-related public safety requirements. Safe Spaces quickly identifies individuals not wearing masks and monitors social distancing, occupancy limits, and sanitation standards in public spaces and buildings. We will shift units to several sites for testing and see encouraging interest in this solution. Customers like Safe Spaces integrate with any VMS on the market and can be rapidly installed and deployed. The Safe Spaces hardware and software are developments completed by the company in a very short time. Shifting to an overview of our performance by region: North America, mainly in the U.S., continues to be stable and is tracking through our internal plan. India is starting to recover, but it is mixed depending on the country. Latin America continues to struggle. Magal maintains a strong balance sheet with net cash and related cash position of $53.4 million, and we have remained positive year-to-date despite the decline in revenue. We have focused our use of capital on three areas: retaining our experienced team, which is critical in supporting our growth; continuing our R&D investments; and looking for M&A opportunities. We prioritize investing in technology because it is an essential differentiator for Magal in the global security industry. Magal Integrated Solution is more than a system integrator. We develop our software in-house and are now launching a new version of Fortis, our PSIM control, which is the backbone of our integrated solutions platform. Magal has developed technology for its customers, like the optical tester for the Israeli Ministry of Defense, which is incorporated into our launch system that I referred to earlier. Our launch system is an entirely in-house developed solution that has numerous applications across our key verticals. Similarly, at Senstar, we continue to invest in enhancements to our software, adding new features and capabilities, and also upgrading our ideas and plans further. Another priority for capital use is M&A. Current M&A opportunities are targeting technologies that align with our existing capabilities, bringing innovation and new expertise. We are currently discussing a few competitive bidding processes, and I hope to close one shortly. Lastly, we received shareholders’ approval for a framework to offer a cash dividend of up to $25 million. We are obligated to pay this dividend to shareholders, but it is subject to the approval of the Israeli district court. The final amount of any dividend payment would be decided by the Magal Board of Directors. I want to thank the global Magal team for their contributions. I recognize the challenges we are all facing in our various roles at Magal and appreciate everyone's dedication and performance. With a strong balance sheet and industry-leading technological expertise, as well as our backlog, Magal is positioned for recovery and growth post-COVID. We are confident in our ability to execute our long-term strategy, which is to improve profitability and close M&A opportunities. Now I would like to hand the call over to Kobi to summarize the financial results. Kobi, please go ahead.

Thank you, Dror. Revenues for the third quarter of 2020 were $18.3 million, a decline of 18% compared with $22.2 million in the third quarter of 2019. The geographical breakdown as a percentage of revenue for the third quarter was as follows: Israel 24% versus 23%, North America 25% versus 33%, Latin America 7% versus 3%, Europe 21% versus 24%, Africa 16% versus 17%, Asia and the rest of the world 8% versus 10%. The breakout between Magal Integrated Solutions and Senstar product revenue was 44% product and 56% project. Magal Integration Solutions Division revenue declined by 26% year-over-year and Senstar’s product division revenue declined by 5% year-over-year. Third quarter blended gross margin was 41.8% of revenue versus 45.1% last year. The gross margin decrease was primarily due to the increase in project revenue that carried a lower gross margin, partially offset by higher gross profit contribution from Senstar sales and cost savings in the quarter. Our operating expenses were $6.8 million, a 9% reduction from the prior year third quarter operating expenses of $7.5 million. The reduction in operating expenses is primarily attributable to payroll-related actions, such as delays in hiring, the reduction in location liability, as well as the reduction in other expenses such as travel and marketing, and subsidies received from the Canadian government. Again, I want to emphasize that we delivered these reductions while maintaining our continuous investments in R&D and sales personnel, our most important assets. Our employee headcount remained mostly unchanged. Operating income was $0.9 million in the third quarter of 2020 compared to $2.5 million in the third quarter of 2019. Financial income was $6,000 compared to financial expense of $0.6 million in the third quarter of last year. This quarter, due to relative stability in forecast markets, we did not record a non-cash expense as a result of the end of period valuation of monetary assets and liabilities. EBITDA for the third quarter was $1.3 million versus EBITDA of $3.1 million in the third quarter of last year. Net income attributable to Magal’s shareholders in the quarter was $0.6 million or $0.01 per share, versus a net income of $1.3 million or $0.06 per share in the prior year's third quarter. Cash and cash equivalents, short-term deposits, and restricted cash and deposits as of September 30, 2020 increased to $53.4 million or $2.31 a share, compared with cash and short-term deposits of $51.6 million or $2.23 per share as of the end of 2019. Our working capital decreased by $0.4 million as of September 30, 2020 in comparison to the end of last year, and the majority of the decrease is driven by trade receivables collection. We're happy to take your questions now. Operator, to you please.

Our first question comes from Mike Disler with MNX Holdings. Please proceed with your question.

Good morning, gentlemen. Thank you for providing the information regarding the continued R&D investment. I think that's critical for the future of the company. As you know, I'm a very long-term shareholder. Just a quick item: you said that I guess resolution number three was approved this morning at your board meeting. And in light of the investment expense, R&D over time and any potential acquisitions down the road, for the last several years the cash funds have been sitting on the books while gathering some dust, has always been there for basically R&D and acquisition. And my question is, and I suspect the Board did this, but I just thought I'd ask both of you is in light of the fact that we've had that cash hoard sitting there for R&D and for potential acquisitions, wouldn't it be a more prudent use instead of just returning it in the form of a dividend whereby the funds will have been taxed twice, meaning at the corporate level by Magal as paying the tax on earnings as well as the shareholders who would then receive those distributions, at least in the United States, who would have to pay a tax? Would it be slightly more prudent to use some of the small portion of those funds, I have mentioned this before, to repurchase shares, which does two things: one, you're able to buy them at a substantial discount to probably fair market value, certainly book value; two, thereby reducing the outstanding share count, which would drive earnings; and three, not subjecting the shareholders receiving a dividend to any sort of taxation by whatever government would tax them. I'm just pointing that out. And I know that you guys have been careful stewards of that cash and, in fact, during the last two quarters, it’s remarkable that you didn't really have to dip into it at all and remain profitable throughout this 2020 period. So my hat's off to you there. I just wanted you to consider the alternative use of that cash in light of what I just laid out? Thank you.

Hi, Mike, I would take the question. So basically, at this point of time, the Board of Directors is still discussing the different ways of designating the use of capital. In light of, as we mentioned before, the M&A opportunities that are on the table, as well as the continuous investment in the company and the strategic goals of the company. From the corporate law perspective, both repurchases of shares or dividend distributions are regarded essentially as the same from a reduction of shareholders' equity standpoint. Therefore, based on the Israeli corporate law, we are required to obtain approval from the Israeli court since the company doesn't have a significant retained earnings to distribute. So currently, we are in this preliminary stage of removing this limitation. Once we get the approval from the Israeli court, the Board of Directors will have to reconvene and consider all the different components, different options, both what should stay and what should be returned to the shareholders and in which manner.

Okay Kobi, thank you very much, that was very thorough. Finally, I just wanted to say, keep up the good work. I do understand that by purchasing shares back, you are actually also reducing some of the liquidity in the marketplace, which is not necessarily a good thing with only say 23 million plus or minus a million shares available, not including the FEMI holdings, the total outstanding. And therefore, that would probably limit the number of shares available in the marketplace, which is not necessarily a good thing in terms of the size of institutions that can then seek to purchase shares. They need a certain amount of liquidity, as you are aware. So I fully understand the tightrope, the balancing act that you are doing, and I appreciate your full explanation. Thank you very much. And I look forward to hearing from you next quarter. Do well.

Thank you.

Our next question comes from Sam Rebotsky with SER Asset Management. Please proceed with your question.

Yes, good morning Dror and Kobi. Good afternoon. The backlog, you say, is the highest ever. What percentage did it increase from the prior quarter?

Hi, Sam, it is Dror. It is about 20% or so. Even close to 70%.

So how much did it increase?

Close to 30%.

30%, that's wonderful. That's wonderful. And you expect to close on an acquisition, presumably to be a cash acquisition shortly, is that in the $10 million range?

I assume we are looking at a few in the range of again between $10 million to $13 million in revenue.

That's wonderful. Alright, hopefully that this COVID will end soon as they keep discovering vaccines and you could get on with business. Good luck, guys.

Thank you, Sam.

There are no further questions in the queue, I'd like to hand the call back to management for closing remarks.

Okay, thank you operator. On behalf of the management of Magal, I would like to thank you for your continued interest and long-term support of our business. I look forward to updating you next quarter. Have a good day. And keep safe. Thanks.

Ladies and gentlemen, this does conclude today's teleconference. Thank you for your participation. You may disconnect your lines at this time and have a wonderful day.