Earnings Call Transcript - SNT Q1 2020

Operator, Operator

Greetings, ladies and gentlemen and welcome to the Magal Securities First Quarter 2020 Earnings Conference Call. It is now my pleasure to introduce your host, Mr. Brett Maas of Hayder IR. Thank you, sir. You may begin.

Brett Maas, Host

Thank you, operator. I would like to welcome all of you to the conference call and thank Magal’s management team 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 first quarter. We will then open the call to questions and answers. 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 future performance of the company. These statements are only predictions as 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 on 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 course of 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 magalsecurity.com for the most directly comparable financial measures and related reconciliations. With that, I would like to now turn the call over to Dror. Dror, please go ahead.

Dror Sharon, CEO

Thank you, Brett. I would like to welcome you all to our call, and thank you for joining us today. I hope that everyone’s families and friends are safe and healthy. For the first quarter of 2020, we reported revenue of $17.4 million by reducing operating expenses by 9% to deliver operating income of $237,000. Year-over-year, we improved net income by almost $1 million to $439,000, primarily due to currency valuation changes in the quarter, and reduced EBITDA of $723,000 for an EBITDA margin of 4.1%. We delivered another quarter of positive cash flow with $4.7 million in cash from operations. I am pleased with my team’s efforts to support our customers’ closing business and manage our cost structure. The first quarter is typically a seasonally weaker quarter due to limited outdoor access in Europe, North America and Asia. This year’s first quarter was also impacted by several million dollars of revenue from the Latin America project completed in the first quarter of 2019. During the quarter, we implemented several key initiatives focusing on the safety of our stakeholders while also providing our business continuity and opportunities. These measures have allowed us to remain profitable for the quarter. In recent years, we have improved the operational performance of the business, increased cash generation, and improved our EBITDA margin, key indicators of our business performance that drive shareholder value. We have made several organization changes, including creating two business divisions to improve the business structure and facilitate growth from new verticals and geographies. Our strategy has improved margin and profitability. Higher gross margin is primarily related to the increase in Senstar’s gross profit, driven by Symphony, our video management solutions software, and our enhancement to this robust flexible platform that has increased its appeal to customers. Lastly, we made new additions to the sales team and other investments for our future goals. One of our midterm goals is maintaining operating expense growth below revenue growth, which will improve profitability as we grow. Our goal for the remainder of 2020 is to manage our costs and to maintain annual profitability while positioning the company for recovery. Magal is in solid financial standing and our leadership team has great confidence in our ability to deliver on our long-term strategy to grow revenue and improve profitability. As I mentioned earlier, the COVID-19 crisis began impacting our operations in late January in APAC and early March in other regions. As a result, the impact on our first quarter was limited. Nevertheless, the company’s leadership put considerable focus on rapidly responding to navigate the crisis effectively. We anticipate a larger impact in the second quarter and potentially in the second half of 2020. The actions taken give us flexibility to manage operations, operating expenses and preserve profitability for the remainder of the year. Our strategy of revenue stream diversification across verticals and territories has been effective in mitigating the risks related to COVID-19 and its impact on our global business. Due to the impact of the pandemic, we are experiencing some delays in closing new large deals and in the execution of some projects due to restrictions related to health and safety measures. While diversification has reduced overall risk associated with the crisis, the geographies that we are present in have had different responses from their respective governments. The variation from country to country has a wide-ranging impact on the economy in general and on our relevant verticals. While verticals in some countries have suffered a significant slowdown or work stoppage, in other geographies where the business environment is less impacted, we have been able to continue operating. That said, we are watching these areas carefully as we have relatively low visibility for the next few quarters. Previously, we announced that we would focus on four verticals: the oil and gas, corrections, logistics, and critical infrastructure. During the first quarter, the oil and gas sector, a focused vertical that we have successfully developed, was affected by the dramatic decline in oil prices and reduced demand related to COVID-19, causing delays in large projects. We remain engaged with those customers and continue to see some purchase orders. Promotional and other market segments where we have experienced substantial growth recently were impacted mainly in Canada by facility closures. Logistics, particularly in EMEA, has grown nicely, but currently, our project is on hold as the customer is focused on meeting the increased demand in their business for package delivery. Critical Infrastructure continues to operate in many territories, and our activities in this sector vary from region to region. Looking at our territories, starting in North America, we saw nice growth in our product operation during the quarter. Product deliveries in the U.S. have mostly continued to focus on security or critical therapies considered as essential services. The vertical is also impacted in Canada, particularly with our correctional facilities and oil and gas segments. We have a backlog of orders, which we will fulfill if the restrictions in the country are lifted. EMEA has seen a diverse impact; with many areas establishing strict public health restrictions in March, in Israel, the impact of the crisis has been minimal since the Ministry of Defense is a major customer and has continued their essential operations. Africa is largely in lockdown with many places unable to receive and process project equipment. However, we have had some recent wins in this region. The Magal Integrated Solutions division rendered a new seaport security system design and installation in Djibouti, a new territory that we are excited to open since seaports are considered essential services. Spain is among the countries where we have not seen impact yet. APAC went into lockdown in late January. However, the nice level of backlog generated in the previous quarter helped us to support these sales in the region during Q1. Latin America is another region where COVID-19 restrictions impact our project business. One example is our project with a Mexican bank, which is on hold as we are not permitted access to the site. This project is expected to come back online once access restrictions are lifted. On the product front, we are continuously improving the Symphony platform with new access control features. Our R&D spending is delivering competitive advantages to help us win new business. Using electronic access control software code that we acquired in late 2019, our R&D team is integrating access control capabilities as a module for our existing video management solution platform and planning to release the consolidated version in Q4 this year. I apologize for the aside, but this is a great example of our continuous innovation in technology, specifically in Safe Spaces, our newest product. This new video analytics solution can utilize our Symphony VMS platform or any other VMS platform with minor adjustments to enable businesses to reopen while maintaining public safety requirements. This solution features mass detection and monitoring of social distancing, occupancy and hand sanitation scanning. This platform will allow businesses and people to resume work, consumer and social activities with increased confidence and reduced risk of exposure to COVID-19. The M&A targets in our line of sight would bring technology that can leverage our existing platform’s capabilities and bring new technological innovations and expertise. We hope to close at least two in 2020 to support our key verticals and capabilities expansion goals. Earlier this year, we were in advanced stages with several acquisition targets. However, due to the ongoing crisis, we have experienced delays in the process. Targets are now on hold due to the flight ban, the fallout from the oil and gas price decline, and overall uncertainty related to COVID-19. I have highlighted how the crisis is affecting our business. To maintain cash and preserve profitability, we have established cost-cutting measures and expenses management guidelines. That said, we feel employee retention is essential for the company’s recovery post-crisis. Another essential expense is the continuous investment in R&D, which we plan to hold. We believe that keeping our experienced team on board to provide support for our customers and continue to improve our products, solutions and software is a competitive advantage that enables us to preserve the midterm and long-term strategic direction of Magal. These resources are also crucial to the company’s ability to exit the crisis in a position of strength, recovering revenue that has shifted to the future and closing deals that have stalled in the pipeline. Magal is well positioned with our net cash and related cash balance of $54 million and no debt to respond to the challenges and opportunities ahead. We are fortunate to have an active revenue stream and a strong balance sheet with no pressure to service our debt. I want to thank the entire Magal team for their performance in the quarter and their resilience in the face of the unique circumstances under which they had to work while still supporting customers and growing our pipeline of business. I’m confident that with our strong balance sheet, our backlog of business, and our skilled team, we will emerge strong and positioned for growth. And now, I would like to hand the call over to Kobi to summarize the financial results. Kobi, please go ahead.

Kobi Vinokur, CFO

Thanks, Dror. Revenue for the first quarter of 2020 was $17.4 million, a decline of 17.7% compared with the revenue of $21.2 million in the first quarter of 2019. The decline in the first quarter revenue was primarily due to the commencement of large projects in Mexico in the first quarter of last year, and partially due to the impact of COVID-19 on our Magal Integrated Solutions and Senstar Product Division sales. I note that usually the first quarter is our seasonally weakest quarter, which I will break down as a percentage of revenue for the first quarter was as follows: Israel, 21% versus 23%; North America, 25% versus 22%; Latin America, 5% versus 21%; Europe, Africa, 20% versus 6%; Asia and the rest of the world, 12% versus 11%. The breakout between Magal’s Integrated Solutions and Senstar Product revenue was 58% for products and 42% for projects. Magal Integration Solutions division revenue declined 24% year-over-year and Senstar Products Division revenue declined 6% year-over-year. First quarter blended gross margin was 45.8% of revenue versus 42.3% last year. This gross margin increase was primarily driven by high gross profit contribution related to the mix of sensors and software products sold during the quarter. Operating expenses were $7.8 million, an 8.8% reduction from the prior year first quarter operating expenses of $8.5 million. The reduction in operating expenses is attributable primarily to payroll-related actions, such as delays in hiring and reduction in vacation liability, as well as reductions in other expenses such as travel and marketing. Operating income was $237,000 in the first quarter of 2020 compared to $471,000 in the year-ago period. Financial income was $470,000 compared to a financial expense of $731,000 in the first quarter last year. This is an accounting effect we regularly experience due to the adjustment of our monetary assets and liabilities denominated in currencies other than the functional currency of the operational entities in the group. At the end of the period, the change in currency valuation of monetary assets and liabilities is recorded as a non-cash financial expense or income. Therefore, we use EBITDA, a non-GAAP metric, to even out the variable impact of foreign exchange fluctuations and other non-cash factors. We believe that EBITDA is a better gauge of the company’s performance. Net income attributable to Magal’s shareholders in the quarter was $439,000 or $0.02 per share versus a net loss of $553,000 or $0.02 per share in the first quarter of last year. EBITDA for the first quarter was $723,000 versus EBITDA of $999,000 in the first quarter of last year. Cash and cash equivalents, short-term deposits, and restricted cash and deposits as of March 31, 2020, were $54.4 million or $2.35 per share. Our working capital decreased by $3.8 million at March 31, 2020, in comparison to the end of last year. The majority of the decrease is driven by the trade receivables collection related to the high billing level in Q4 2019. We also delivered positive cash flow from operations of $4.7 million for this quarter, which is excellent. As Dror mentioned, in this fluid environment, where we have less visibility than in normal business, we have the operational flexibility to maintain our cash and preserve profitability for the remainder of the year. That concludes my remarks. We are happy to answer questions now.

Operator, Operator

Thank you. Our first question comes from Todd Schefflin, a private investor. Please go ahead with your question.

Todd Schefflin, Private Investor

Good day, everybody. I wanted to ask you two questions. One is what can we expect from Senstar in the coming months as far as PR to educate the public and the different end-users about the products that Senstar has for non-governmental, mainly in the multifamily real estate and other real estate arenas? And two, can you also shed light on any activity with the United States government regarding the electronics portion of the border wall?

Dror Sharon, CEO

Okay. So thank you for the question. Regarding the first one, after we started today, we held a very large webinar, with hundreds of participants, to reveal our new Symphony feature that I just discussed during the call. Later this year, we’ll do more sessions like this, including PR to showcase our new technology and offering to different verticals and open it to the market. So probably you can see a new PR that we just launched describing this new product added to our portfolio. For your second question, you asked about the southern border and the U.S. government. We addressed this in our previous call. It’s not currently in our focus. It wasn’t in our pipeline for 2020. We understood that the amount of investment required is too high. There is nothing firm from the U.S. government side regarding adding technology to the wall. There are some agencies that adopt our technology, but others have failed to pass in the past. So we decided, frankly, not to pursue it and will wait to see if there is a tender, allowing us to participate if possible. Currently, as far as we know, the investment in technology at the southern border is minimal.

Operator, Operator

Thank you. Our next question comes from the line of Sherman Willis, Private Investor. Please proceed with your question.

Sherman Willis, Private Investor

Thank you for taking my questions. Excellent quarter under the circumstances. I have two questions. The first question is, where are you seeing opportunities for growth in this environment, in other words, closing business pipeline growth? Can you specifically speak to your announcement on the Safe Spaces video analytics solution and what that might provide in terms of revenue? And then I have a follow-up question.

Dror Sharon, CEO

Okay. Regarding your first question, we see opportunities for growth in a few verticals. In the short term, the logistics sector is crucial. The amount of packages flowing around the world is enormous, as people are increasingly buying online. We have already closed a few deals with logistics providers worldwide. Just at the end of last year, we secured contracts to protect almost 20 sites for one of the major logistics providers; however, we cannot disclose their name. This market is growing, with or without the COVID-19 impact. We are focusing on this area and training our sales team and technical support to pursue this market. Our focus on the Senstar side, through our video management tool, is what we announced as Safe Spaces. We see there’s an opportunity to support different industries by adding this unique capability to their VMS, whether it's our VMS or a competitor’s. By doing so, we enable these organizations to return to business in a safer manner. As for the revenue potential from this new solution, it's too early to tell. After a week or so, when people begin to download this feature from our website and we see some traction, we'll be able to better gauge future business opportunities. But it was a significant effort from our R&D team in Canada, and we appreciate how quickly they executed it.

Sherman Willis, Private Investor

You didn’t address the announcement regarding potential revenue. Could you provide any insight on that?

Dror Sharon, CEO

It's premature to quantify our revenue expectations for the newly launched platform. We recently conducted a webinar to showcase its capabilities. As we observe user engagement in the coming days, we will be in a better position to assess revenue generation potential based on interest levels.

Sherman Willis, Private Investor

Thank you. My second question is about your stock trading at $2.90. What are your thoughts on the company’s repurchase program? I believe buying back stock at this price might show investors faith in the company and serve as a better use of cash.

Kobi Vinokur, CFO

Thurman, this is Kobi. I completely agree with you. Our stock deserves a higher valuation than it is right now, especially with it being closely tied to our cash position. We have proven year after year that it’s a stable business. We carry a strong backlog and we're improving our profitability margins. Operationally, we continue investing in our future. As you noted, we've discussed stock repurchase internally. It’s indeed an option that we’re evaluating. However, at our current stage, our priority remains on our midterm and long-term goals, which include executing M&A transactions to enhance the business both inorganically and organically. Given the uncertainty in the economic environment, we are cautiously prioritizing cash management over immediate repurchases.

Sherman Willis, Private Investor

Thank you for your detailed response. I will get back in the queue, but I’ll have a stronger reason to back your stock in the future.

Dror Sharon, CEO

Thank you, Sherman.

Operator, Operator

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

Sam Rebotsky, SER Asset Management

Good morning, Dror. Good morning, Kobi. I hope everybody is doing well. Magal seems to be holding its own. Regarding the backlog, has backlog decreased from the previous quarter? What measures are being taken to improve it?

Kobi Vinokur, CFO

Specifically, this quarter, we saw some decrease in backlog, a reduction of $2 million. Even after this decrease, we continue to maintain strong profit levels compared to previous years. However, we did start seeing some delays in order bookings by the end of the quarter, as a result of the COVID-19 crisis. This led to lower-than-planned order bookings compared to our revenue levels.

Sam Rebotsky, SER Asset Management

That makes sense. You mentioned closing on two acquisitions during the current year. Can you provide a range in the sales of these acquisitions? And are you getting a better deal based on the current economic climate?

Kobi Vinokur, CFO

Yes, size-wise, Dror?

Dror Sharon, CEO

We are looking at acquisitions in the range of $10 million to $20 million in revenue. We have several potential candidates in sight. However, the current situation is causing a pause as people are reevaluating valuations. We want to wait to meet and discuss these companies face-to-face when it's feasible. Furthermore, we need to reassess the valuations of these companies, as their focus may be shifting in response to the crisis. Therefore, our goal remains to acquire at least two in this range, but we’ll have to see how things evolve in the world and in the verticals we’re exploring.

Sam Rebotsky, SER Asset Management

Understood. Have they indicated any changes in their finances?

Dror Sharon, CEO

We are familiar with the financials of these companies, but information typically takes time to gather, especially for private companies.

Kobi Vinokur, CFO

To add to Dror's point, while we’re in contact with these entities regarding potential acquisitions, we have not yet observed significant impacts on valuations for solid assets. For now, we still do not see immediate opportunities for attractive COVID-19 related deals, but our strong cash position puts us in a good position as a buyer when the right opportunity arises.

Sam Rebotsky, SER Asset Management

Sounds good; it’s true that cash is indeed king. You'll need to wait and see how the attractiveness of the potential acquisitions evolves in light of current circumstances. Best of luck, and keep up the good work.

Dror Sharon, CEO

Thank you.

Operator, Operator

Our next question comes from the line of Ken Liddy with Oppenheimer. Please proceed with your question.

Ken Liddy, Oppenheimer

Are you seeing any new potential for other acquisitions, or is it too early to tell? By new acquisitions, I mean companies you previously had your eye on.

Dror Sharon, CEO

As of now, we haven't identified any new acquisition opportunities that we weren't already aware of. We have an established pipeline of targets that we've approached, and for a few of them, we are further along in our discussions. However, everything is currently paused due to the pandemic. We haven’t seen any new COVID-19 opportunities where companies are looking to sell quickly for cash.

Ken Liddy, Oppenheimer

What about the subsidiaries that you acquired recently? Have you looked into thermal cameras and equipment that could be used at the U.S. border?

Dror Sharon, CEO

The thermal imaging technology we acquired was for military applications, not for border security. We acquired a 55% stake in a company in Israel about two years ago. While they do have those capabilities, there are ample suppliers of such technologies within the U.S. and what we can contribute, should there be a procurement process, would be more focused on our Senstar products.

Ken Liddy, Oppenheimer

Are you considering increasing your stake in the 55%-acquired company?

Dror Sharon, CEO

Yes, we are open to increasing our stake when the time is right.

Operator, Operator

Thank you. Our next question comes from the line of Sherman Willis, Private Investor. Please proceed with your question.

Sherman Willis, Private Investor

Regarding your thoughts on getting bought out, I see you’re trading at cash levels. I believe it’s crucial to boost investor education and relations to avoid that. You’ve hired a strong IR company, and I think it’s important to proceed with biweekly calls with wealth managers and participate in virtual conferences.

Kobi Vinokur, CFO

We are indeed collaborating with Hayden IR. We have a strategy to increase our outreach to new investors and wealth management teams. Our initial plan included attending conferences in-person, which was disrupted by COVID-19. We plan to participate in virtual conferences and are evaluating their effectiveness. We intend to reach out to existing and new potential investors after this quarterly release to share our narrative.

Sherman Willis, Private Investor

So, you’re not waiting until the end of COVID-19, correct? Are you moving forward with virtual updates now?

Kobi Vinokur, CFO

Yes, we are not waiting. The idea is to begin virtual meetings and client calls with new investors to tell our story.

Sherman Willis, Private Investor

However, I am concerned about being bought out while trading at these levels. If I were in your position, I would move quickly to keep the stock price up.

Kobi Vinokur, CFO

I appreciate your feedback. Our focus is on improving business fundamentals and delivering value, while also working on enhancing our stock valuation through strategic marketing efforts.

Sherman Willis, Private Investor

Thank you for the opportunity to speak. I continue to believe you are the most undervalued stock I follow, and enhancing transparency will aid your stock price.

Kobi Vinokur, CFO

Thank you.

Operator, Operator

Our next question comes from the line of Holdings. Please proceed with your question.

Unidentified Analyst, Analyst

Yes, good afternoon gentlemen. I hope you and your families, employees, and everyone at Magal is doing well. Many long-term holders share the sentiment of frustration expressed by Mr. Willis. To increase valuation, you need to ensure shares can serve as a currency for future acquisitions. It would also be beneficial to implement a small stock repurchase program to set a floor price and boost confidence in the marketplace.

Kobi Vinokur, CFO

Thank you very much for your insightful perspective. We appreciate your points.

Dror Sharon, CEO

Thank you very much.

Operator, Operator

Ladies and gentlemen, this concludes today’s Q&A session. I would like to turn the floor back to management for closing comments.

Dror Sharon, CEO

On behalf of the management, again, I’m very pleased that we have a strong, committed team that can navigate these challenges together. It’s not simple, but on behalf of the management team at Magal, I would like to thank you for your continued interest and long-term support of our business. We look forward to updating you next quarter. Hopefully, everyone will feel safe and well. Thank you. Have a good day.

Operator, Operator

Thank you, ladies and gentlemen. This concludes today’s teleconference. You may disconnect your lines at this time. Thank you for your participation.