Senstar Technologies Corp Q1 FY2021 Earnings Call

Greetings and welcome to the Magal Security Systems Ltd. First Quarter 2021 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 is being recorded. I would now like to turn the call over to your host, Mr. Brett Maas of Hayden IR. Thank you. You may begin.

Thank you, operator. I would like to welcome everyone to the conference call and extend my gratitude to Magal’s management for organizing it. Joining us today is Dror Sharon, CEO of Magal, and Kobi Vinokur, CFO. Dror will provide a summary of key financial and business highlights, after which Kobi will discuss Magal’s financial performance for the first quarter. We will then have a question-and-answer session. Before we begin, I want to mention that this conference call may include projections and forward-looking statements concerning future events or performance of the company. These statements are merely predictions, and Magal cannot ensure that they will actually occur. Magal does not take on any responsibility to update this information. Actual results may differ significantly from those projected due to changes in market trends, decreased demand, and the competitive landscape of the security systems industry, as well as the unpredicted impacts of the coronavirus on our operations and our clients, alongside other risks noted in documents filed with the SEC. Additionally, during this call, we will discuss certain non-GAAP financial measures, which should be viewed alongside, but not as replacements for, equivalent GAAP financial measures. Please note that our press release has reconciled our non-GAAP financial measures to the most directly comparable GAAP measures in line with Reg G requirements. You can also visit our website at magalsecurity.com for the relevant financial measures and reconciliations. Now, I will hand the call over to Dror. Dror, the floor is yours.

Thank you, Brett. Thank you all for joining us today. The results for the first quarter were satisfactory given that many areas are still facing COVID restrictions that limit business activities. Despite these challenges, we approached the previous quarter's performance in terms of revenue and gross margins. This quarter, we classified Magal Integrated Solutions as a discontinued operation. Since we still control the Magal segment, it is regarded as a related party. Consequently, the reported revenue of $6.5 million does not include Senstar sales to Magal Integrated Solutions of $0.6 million. Once the divestiture is completed, we will include ongoing sales from Magal in our reported revenue. My following comments will address the company's results, including sales to Magal. Based on this, Senstar's sales in the first quarter, which includes Magal Integrated revenue, totaled $7.5 million, marking a 9% decrease from Q1 2020's Senstar revenue. This decline is primarily attributable to the effects of COVID on our target sectors in the U.S., APAC, and Latin America. In the first quarter of 2021, we began to see a return to normalcy in business activities, especially in Europe, though we have yet to fully recover. The outlook for the second quarter and the remainder of the year is optimistic based on our pipeline and closing ratio. An increase in vaccinations and a decrease in COVID-19 infection rates should facilitate the reopening of borders and the return of employees to their workplaces, alleviating many of the constraints that have affected our results for the past 14 months. Senstar's gross margin in the first quarter was 65%, consistent with the first quarter of last year, including gross profit from sales to Magal Integrated Solutions. This year, we have seen an uptick in hardware sales compared to software. Hardware generally has a lower margin than software license revenue; nonetheless, it is crucial for selling software, and our model will always seek a balance between these two elements. For the rest of 2021, we anticipate rising costs for certain materials, particularly semiconductors. We are pursuing long-term procurement agreements to ensure supply and mitigate potential price hikes. However, we expect supply chain challenges to modestly exert pressure on gross margins in 2021 and possibly into the first half of 2022. Therefore, we are targeting a gross margin in the low 60% range for the year. Senstar's EBITDA margin for the first quarter was 12%, slightly above that of Q1 2020. Generally, the first quarter is our weakest seasonally. Looking ahead, we anticipate a typical revenue pattern in the remaining quarters, with the second, third, and fourth quarters being the strongest. We also expect operating expenses to remain stable throughout the year, which will lead to improved EBITDA by the fourth quarter. We predict public company costs and amortization to remain the same or decrease for the component entity each quarter, resulting in better reported operating performance by the latter half of 2021 with positive net income by year-end. Now, let's discuss Senstar's growth strategy. For 2021, our growth will be driven by increasing sales from our key verticals, establishing sales distribution, converting R&D investment into sales, and acquiring technology to develop differentiated products and software. To boost sales from our key verticals—energy, production, logistics, and critical infrastructure—we are implementing KPIs across the company to prioritize and achieve revenue growth from these segments. We have established new management teams in all regions to enhance customer support, especially in crucial markets. As a result, approximately 50% of our employees are now customer-facing. We also plan to expand our presence and add new sales distribution to foster growth. We see possibilities to streamline our current sales process and implement better initiatives to broaden our pipeline. After the divestiture, we plan to explore new geographic regions. We are evaluating territories for potential entry and considering additional distribution avenues, such as resellers, to reach customer relationships that might be difficult for us to access. The security market is vast and fragmented, and partnering with distributors makes sense for increasing sales and raising awareness of Senstar's capabilities. Our other growth drivers—R&D and M&A—are linked to our capital allocation priorities. We are careful with our cash allocation and investments, prioritizing current R&D investment to drive future growth, targeted technology acquisitions, and returning cash to shareholders when excess cash allows. Regarding converting R&D investments into sales, we have invested over $10 million in R&D over the past three years for UPI DSPs and software products and solutions. One outcome of this investment is an expanded hardware offering. Recently, we introduced several new products, including a new version of our Fire Patrol and the Safe Spaces Solution to help businesses return to normalcy post-COVID. A prototype of a multi-sensor project should be ready by the end of this year, and in early 2022, we plan to launch a new Fire Patrol Short Range and Optimization Solution. Additionally, we aim to increase software sales, crucial for improving long-term gross margins. In Q2, we will release version 8 of our Symphony common operating platform, with ongoing releases throughout the year. Symphony 8 will serve as an SMS, providing functionalities beyond traditional VMS platforms, integrating analytics, access control, video, and input from our PIDS product. Senstar Fusion will be an integral part of this system, expected to hit the market in the coming months, offering enhanced intelligence from perimeter statuses by integrating inputs from our various products. We aim to leverage this refined platform to establish ourselves as a solution provider, blending SMS capabilities with top-tier product systems tailored for integrators and end-users. This strategy should attract new customers, increase contract values, and broaden revenue streams. Our fourth growth driver, M&A, focuses on acquiring differentiated technology. We continue seeking technology or products to enhance our offerings in key verticals that will enable us to expand adjacent capabilities and attract new clients. To conclude the discussion on capital allocation, we expect to finalize the divestiture of Magal Integrated Solution by the end of June. Following this transaction, we will have about $60 million in cash, allocated for R&D investments and M&A. If the Board determines that a dividend policy aligns with Senstar's interests, we will communicate that decision to shareholders, likely providing an update in the second half of 2021. Post-divestiture, our focus will be on growth in key verticals, supported by a tactical plan designed to streamline our solution offerings and enhance sales efforts. We aim to refresh the company’s image while utilizing our leadership position to offer enhanced technological solutions. Additionally, we intend to cross-sell and upsell within our existing customer base and increase our business pipeline through new channel distribution with OEMs, system integrators, and end users. We will continue to innovate our products and vision to execute this strategy. Our technological advancements and scalable cost platform analytics will serve as a foundation, with our Symphony 8 platform acting as a key element. We are currently developing products to bolster our differentiation. One example is a multi-sensor device designed to gather data from various sensors at existing sites. Another innovative product controls both long and short distances, providing unique market advantages, especially with its short-range capabilities. This will offer performance exceeding current market solutions. We are also working on data fusion technology to enhance correlations between sensor activities for a comprehensive security solution. The Senstar brand represents differentiation and innovation. We plan to design vertical solutions and extend our offerings beyond security. Our ambition is to lead the market while leveraging our technology, our people, and our brand for business expansion. The cornerstone of our offering is Symphony 8, which we believe will open new opportunities and enhance our brand. An essential asset of Senstar remains our people. Throughout 2020, amid the global pandemic, we retained nearly our entire global workforce while achieving positive EBITDA in every quarter. Keeping most of our staff allows us to support customers across all regions with both sales and technical support. We maintained our R&D team and continued focusing on meeting R&D goals despite last year's business slowdown. As a result, we are exiting the COVID-19 phase stronger than before, positioning ourselves to accelerate growth and profitability. We are confident in achieving the revenue targets set for Senstar in 2021. To facilitate this growth, our workforce is now 50% customer-focused, dedicated to sales, marketing, and technical support, with 26% focused on R&D. This means half of our employees are committed to supporting current sales efforts, while a quarter is dedicated to developing future sales. In conclusion, I’d like to express gratitude to all our employees worldwide for their dedication and hard work. Together, we are committed to driving growth, enhancing profitability, and ultimately delivering value to shareholders. Now, I’d like to turn the call over to Kobi to summarize the financial results. Kobi, please proceed.

Thank you, Dror. We are reporting this quarter the results of continuing operations, which are primarily based on Senstar's standalone revenue and the corporate costs of the public platform. Additionally, we show a separate line on our P&L for the net result of Magal Integrated Solutions, reflecting the net loss from discontinued operations. Until the divestiture is formally completed, aimed for the end of Q2, the Integrated Solutions or project division remains a controlled operation and is therefore considered a related party. This means that sales from Senstar to the Magal project division and total project division sales are eliminated from the top line for this quarter. This will affect how Senstar's revenue is reported until the closing of the divestiture transaction. After the sale of the project division, Senstar sales to Magal as an unrelated external customer will be included in reported revenue and gross margin. For clarity, I will first cover the reported results for the first quarter and then discuss Senstar's revenue, gross profit, gross margin, and EBITDA, including sales to Magal's projects. Since we expect the Magal Integration division to continue as Senstar's customer at similar volumes post-divestiture, the pro forma revenues and profitability that include sales to the project division better represent the potential revenue levels of the company thereafter. Our results from continued operations include two components: the results of Senstar's operations on a standalone basis and the operating costs of the public platform, which include corporate HQ costs, legal and financial advisor fees related to public activity, NASDAQ listing fees, and expenses. I will later review the breakdown of both components from the results of continuing operations. Our reported revenue for Q1 2021 was $6.5 million, a decline of 14% compared to $7.6 million in Q1 2020. The decrease in revenue was mainly due to COVID-19's impact in areas with strict travel and social distancing limitations, while Q1 2020 was not significantly affected by the pandemic. I would also like to remind you that the first quarter is typically our weakest. The geographic breakdown of revenue for Q1 was as follows: North America 50% versus 54%, Europe 35% versus 23%, APAC 13% versus 20%, Latin America 2% versus 3%. The gross margin reported for Q1 was 62.1% of revenue compared to 64.8% last year, primarily due to the mix of Senstar hardware and software products sold during the quarter. Our reported operating expenses were $4.7 million, which is an 8% reduction from last year's $5.2 million in Q1. This reduction is mainly due to decreased business and sales expenses such as travel and marketing, along with contributions from payroll subsidies granted by the Canadian government. Our reported operating loss for Q1 was $681,000 compared to a loss of $214,000 in the same period last year. The overall company's EBITDA loss for continuing operations in Q1 was $369,000 compared to an EBITDA of $80,000 in Q1 last year. Financial income was $19,000 compared to $744,000 in the previous year's first quarter. This is a regular accounting effect arising from adjustments to our monetary assets and liabilities in currencies other than the operational entities' functional currency. As Dror mentioned, thanks to our operating leverage and anticipated growth in quarterly revenue, we expect to see improving operating performance in each quarter, aiming for a positive net income from continuing operations by year-end. The net loss attributable to Magal shareholders for the quarter was $2 million or $0.09 per share, compared to a net income of $438,000 or $0.02 per share in Q1 last year. The reported net loss includes a $1.2 million loss from discontinued operations versus $35,000 of income in the same period last year. The net results from discontinued operations incorporate the loss of the Integration division and certain transactional expenses. I mentioned the two components contributing to the results; Senstar's standalone contribution and corporate expenses. I will refer to this result as pro forma. Senstar's first-quarter pro forma revenue, including sales to Magal's project division, was $7.1 million compared to $7.8 million in Q1 2020. The 9% decline was primarily due to COVID-related restrictions in key geographies. Pro forma gross profit was $4.6 million, reflecting a 65% gross margin for Q1 2021 versus $5.1 million or 66% gross margin for the previous year. Senstar's pro forma Q1 2021 operating income was $705,000 compared to $689,000 last year. The pro forma Q1 2021 EBITDA was $822,000 compared to $789,000 in the same period last year, representing 12% versus 10% of revenue. The second component impacting Senstar's operational contribution includes public platform expenses and amortization of intangible assets from past acquisitions. The corporate expenses in Q1 2021 were $0.8 million, and amortization expenses were $0.2 million, compared to $0.7 million and $0.2 million in the same quarter of 2020, respectively. Consequently, the pro forma operating loss from continuing operations for Q1 2021 was $0.3 million, up from an operating loss of $0.2 million the previous year. This resulted in group EBITDA for Q1 2021 of $32,000 versus $125,000 in the same quarter last year. Looking ahead to how the sale of the Magal Integrated Solutions division will affect our P&L and balance sheet, it's important to note that the sale will result in a capital gain. As of March 31, 2021, Senstar's cash, cash equivalents, short-term deposits, and restricted cash totaled $25.9 million or $1.12 per share. Our working capital increased by $0.7 million at March 31, 2021, compared to the end of last year. In the first quarter, assets attributed to discontinued operations were $42.6 million, with liabilities of $21.1 million, compared to assets of $50.5 million and liabilities of $25.41 million as of December 31, 2020. We recorded positive cash flow from operations of $0.3 million for the quarter. That concludes my remarks. We are now happy to take your questions.

Thank you. At this time, we'll be conducting a question-and-answer session. Thank you. Our first question comes from the line of Mike Distler with Amnx Holdings. Please proceed with your question.

Good afternoon, gentlemen. I hope you are doing well. As a long-time shareholder, I appreciate the thorough conversation you had with shareholders this morning. I know it must have been challenging to navigate through all that. My question is about the future: is there an expiration date or a time limit on when Magal will stop seeking to purchase Senstar materials, software, products, and so on? Additionally, do you think the ongoing concern will be renamed Senstar? That seems appropriate, but I was hoping you might have an update on that. So, it’s really a two-part question. Thank you for your time.

Hi Mike, thank you. First, I believe Magal will remain a customer of Senstar for many years to come. As long as the products are of good quality and reasonably priced, I feel Magal will continue to purchase those solutions from Senstar. There is nothing in the agreement that prevents them from using Senstar as their product supplier. Regarding your second question, we are currently discussing the name update internally, and once it receives approval from the Board of Directors, we will communicate it to the market.

I assume you understand everything we discussed. In closing, I want to emphasize the importance of keeping all of your long-term shareholders informed, not just the major stakeholder. It's crucial to maintain communication and keep everyone updated like you have been doing over the past few years. Remember, information is powerful. Thank you for today's updates, and I look forward to our next call in three months. Wishing you continued success.

Thank you, Mike.

Thank you. Our next question comes from Sal DeTurris, Private Investor. Please proceed with your question.

Good afternoon, gentlemen. Yes, I had a question last conference call and I had the same question again, on the foreign tax withheld on the Magal dividend in December of 2020, it was noted that there would be an instruction letter posted on the Magal website to see if one could qualify for an exemption or a lower tax rate. Can you give me an update on the status of that instruction letter?

Yes, unfortunately, there's been a delay that is out of our control, as the process involves the Israeli tax authorities. We are working with our tax consultants on this issue. The tax authorities in Israel have their own timeline, and there have been delays due to COVID lockdowns and recent political issues. We are promised updates regularly, and it's quite unusual given the simplicity of the matter. I hope that within the next month, we will be able to issue this letter. We are actively working on it.

Okay. Thank you very much.

Thank you.

Thank you. Ladies and gentlemen, there are no further questions at this time. I'll turn the floor back to Mr. Sharon for any final comments.

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 safe and good day.

Thank you. This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation.