Senstar Technologies Ltd. (SNT) Q2 2017 Earnings Report, Transcript and Summary

Ladies and gentlemen, welcome, and thank you for standing by. Welcome to Magal's Second Quarter 2017 Results Conference Call. [Operator Instructions] 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 Magal's Investor Relations team at GK Investor and Public Relations at 1 (646) 688-3559 or view it in the News section of the company's website, www.magal-s3.com. I would now like to hand over the call to Mr. Gavriel Frohwein of GK Investor Relations. Mr. Frohwein, please go ahead.

Thank you, operator. Welcome to Magal's Second Quarter 2017 Conference Call. I'd 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 are Mr. Saar Koursh, CEO; and Mr. Kovi Vinokur, CFO. Saar will summarize the key highlights of the quarter, followed by Kovi, who will review Magal'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 the future performance of the company. These statements are only projections, 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, as well as other risks, identified in the documents filed by the company with the Securities and Exchange Commission. And with that, I would like to now hand over the call over to Saar. Saar, please go ahead.

Thank you, Gavriel. I would like to welcome all of you to our conference call and thank you for joining us today. We have reported revenue of $13.3 million, marginally weaker than that of last year by 3%, and obviously, it is below what we have hoped for, for the quarter. The increase in revenue from geographic outside of North America partially offset the current weakness we experienced in the North American market. The slow business in North America was quarter of our revenue in the second quarter, while last year, amounting at about half of our revenues. What we have experienced is a delay in many projects and budgets, including state budgets, as they await clarity from the federal homeland security budget. This follows a change in the U.S. administration at the start of the year, as well the change in homeland security priorities. However, since this administration sees investment in homeland security as a high priority, we do expect the budget to be released soon. While we cannot pinpoint exactly when this will happen, we do believe we have the right products and technologies to meet this trend demand of the U.S. government and related agencies. On the positive side, our gross margin came in at 50.2% versus 44.5% in the second quarter of last year, representing a strong improvement. I note that over the past few quarters, we have done much work to improve our gross margins. Apart from shifting revenue mix more to our product sales, we also placed strong focus on increasing the gross margin on our projects revenue. The project we are currently working on are indeed more profitable than those we have worked in the past. While total operating expenses were at a similar level to those of last year, our improved gross margin in the quarter enable us to show a lower level of operating loss. In the second quarter, we also took some important steps, which will not only bring us increased synergies within our existing business, it will allow us to lower our operating expense footprint on an ongoing basis, which will become apparent later this year. Until the second quarters, Aimetis was operating as independent subsidiary of Magal. During the quarter, we fully amalgamated from both legal and operational standpoint, Aimetis, with our North American subsidiaries and stock. While we will -- some one-time restructure-related expenses in second quarter and some of more expenses expected in the third quarter, the step we have taken has allowed us to eliminate duplicated costs in both the G&A and sales and marketing. It also provide us with some tax savings. The contribution of these effects we'll see primarily in the fourth quarters and onwards. The amalgamation also allow us to better cross-sell the Aimetis video product within our existing product portfolio and vice versa. By having one customer-focused sales team, selling PIDS video and several products line as part of a unified product portfolio under the Senstar brand. We expect that our moves will allow us to increase sales of our video products, while reducing our operating expense level. Taken together, these measures that we have recently implemented, position us well for profitability growth once the anticipated recovery in the U.S. high-end security market, which we expect to start in the second half of 2017, begins to halt. We are also in the process of launching some of new and interesting product, which will bring us increased addressable market and revenue upside in the future. One particular that I would like to highlight is our new pipeline leak detection system. The system was developed as an add-on to our portfolio of fiber optic sensor for buried application. The product line includes fiber-optic buried perimeter detection sensor, using a buried fiber optic cable and centrally located sensor units, enabling our technology to provide the covert detection for intruder vehicles and tunneling for up to 72 kilometer. Several products in the lines are a fiber pipeline infrastructure monitoring sensor for third-party interference detection and our newest fiber-optic pipeline leak detection sensor that can identify and detect and locate location of liquid or gas leaks from buried pipelines, which otherwise were very hard to find by reducing potential environment consequences and operational downtime when the leaks are detected. This product can demonstrate a very rapid return on investment for pipeline operators. We are planning to launch the new product in the next few weeks, having recently finalized testing on this third-party facility. I would like to talk more in detail about some of the trends we saw in this quarter in the various region in which we operate. As I already discussed, in North America, the second quarter was slow, with business being about half of what we would normally have expected in the quarter due to delay in projects and budget throughout the United States. We do see very strong interest for protection of critical sites, such as correctional facility, prisons, power station and airports, using our products and technology. However, this potential orders have not yet been booked, as our customer wait to receive budget approval. We do hope that we will have more clarity in the upcoming weeks, as some of the projects that we have been selected for move to the execution phase. With regard to the U.S. southern border project or President Trump's wall, as it's better known, we are in ongoing contract with both of the U.S. customer and border protection, CBP and the U.S. Department of Homeland Security, DHS, as well with a number of integrator, which are pursuing this project. At this point of time, CBP has not yet decided which technology they are going to use for monitoring the wall on the southern border. As the leading perimeter intruder detection technology provider, we see ourselves in a strong position for our product to be selected for use in this project. In Israel, the southern border project continue on track, and business in general in this region is robust. You should recall early in the year, we announced $8.5 million in orders for the supply integration and support of a new innovative border and perimeter protection solution. This project include the latest perimeter technologies we are -- which are the outcome of our ongoing R&D effort, and we believe it's an improvement showcase for other border projects we are competing for, including the U.S. southern border of the United States. We expect additional orders for the Israeli border projects in the upcoming months. In Africa, we won orders to provide integrated security solution for seaports, which we are in the execution phase. This orders fall on from our very strong experience over the years in supplying port security system in many countries and in Africa, especially. Many seaports globally now entrust their security to Magal, recognizing our specialized port offering. In Europe, we see stable business overall with more project expected to move ahead in the second half of the year. Two strategic partnership with major European OEMs signed earlier this year are providing early sales, and we expect this to ramp-up later this year. Additionally, as we announced in July, we won in orders to provide an integrated security solution and maintenance for the Port of Huelva in Spain, the largest in the Spanish seaports system, involving intrusion detection smart fences and advanced CCTV cameras. Huelva becomes a further reference for us in seaport security, and we look forward to receive further orders such as this in the upcoming future. In Asia, we saw a strong growth in the second quarter even though that the absolute number are still small in comparison to other regions. Our APAC support center in the Philippines is now fully operational, with several engineers and support staff on site. Recently, we were selected for international airports perimeter upgrade project in Asia, and we are optimistic that others will follow. In April, we signed a cooperation agreement with Dynamatic Technologies in India. This new cooperation aims to meet the market demand for high-security product and solution for critical infrastructure in that region. It also aims to provide combined integrated border management solution to address the challenging securities in securing India's borders. While we have not yet seen orders through this JV, we believe there is a significant potential there. In summary, while the first half of 2017 has been challenging, we do see strong opportunities maturing in our end markets. Despite the slowness in North America, it is still our most important market and when budget do free up, we expect significant upside. We are working closely with several very strategic account, each of which operate a large number of critical sites, and are demonstrating strong interest in our solution. Our products are currently under test with these customer, and we hope to see the fruits of our investment in the coming quarters. Together, with our strong balance sheet, with $48 million in net cash, we are very well positioned to continue to invest, and positioning ourselves for growth to the current challenging market condition and into our typically strongest second half of this year. And now over to you, Kovi. Please go ahead.

Thanks, Saar. The revenues for the second quarter of 2017 were $13.3 million, 3% below those of the second quarter of 2016. Geographies revenue breakdown for the quarter was fairly evenly spread across all regions as follows: Africa, 11%; North America, 23%; Israel, 20%; Latin America, 13%; Europe, 19%; Asia and the rest of the world, 15%. Second quarter gross margin improved to 50.2% of revenues versus 44.5% last year. Operating loss in the quarter was $1.7 million compared with the profit of a -- sorry, with a loss of $2.2 million last year. Financial expenses for the second quarter of 2017 were $1.4 million compared with financial income of $303,000 in the second quarter of 2016. There was a noncash financial charge of $1.3 million in second quarter. If you remember last quarter, we saw a similar noncash charge, amounting to $2.4 million. The cost was again a further strengthening of the shekel versus the U.S. dollars. The functional currency of Magal's Israeli entity is the Israeli shekel, and under accounting rules, we recognize and include in our P&L any changes in value of this entity's monitory assets and liabilities. This includes foreign-currency holdings, which in this case, are our U.S. dollar holdings. Because the U.S. dollar declined in value by 9.1% against the Israeli shekel between the end of 2016 and the end of June 2017, we recorded a non-cash financial expense due to the accounting valuation of our cash and short-term deposits in both the first and the second quarters, which are held mostly in the US dollars. Although this valuation expense reflects the reduction of the cash deposits value in terms of the Israeli currency, the original U.S. dollar value of the deposits actually does not change and even increases due to the U.S. dollar interest earned. So we maintained the dollar purchasing power of our cash deposits. I'll note that in the third quarter, so far, the shekel dollar rate has been stable. Net loss in the quarter was $3.3 million or $0.14 per share. Net loss in the second quarter of last year was $2 million or $0.12 per share. EBITDA in the second quarter of 2017 was a negative $1.2 million compared to a negative EBITDA of $1.7 million in the second quarter of 2016. Cash, short-term deposits and restricted deposits as of June 30, 2017, was $47.9 million or $2.08 per share versus $52.5 million or $2.29 per share on December 31, 2016. As of June 30, 2017, we have no bank debt in Magal. That concludes my remarks. We would be happy to take your questions now. Operator?

[Operator Instructions] The first question is from Sam Rebotsky of SER Asset Management.

Tell me, it's the end of August, so we're 2 months into the third quarter. What is the third -- what does this look like? Have -- the business that you didn't get in the second quarter, what has appeared in this third quarter?

So good morning to you, and this is a very good question. We see an increase of business outside of the United States. I must tell you that the U.S. has not yet recovered, definitely not in the pace that we have anticipated. We are seeing in the last few weeks, the market is moving, but still not in the same level that we have expected for.

But did the rest of the -- in other words, the backlog or the contracts -- so the only contracts is the United States that you haven't started to see? Your business is moving along the way you expect. The subsidiary in Canada, the acquisition that you made, that's producing additional business? Or what's the story there?

So as we mentioned, the North America, the U.S. market last year was about half of our revenue comparing to this quarter, the second quarter, which was less than a quarter of our revenue. In the third quarter, we still -- the U.S. has not recovered yet to the levels we have expected for. We still have a few more weeks for the quarter, but yes, we are seeing a growth in other regions, but you must remember that the U.S. is our biggest market by far, and the most profitable one.

So as far as your plan, you raised the funds and you were talking about acquisitions. Would these acquisitions be in the U.S.? Or where would they be or is anything going on in that area?

We are still looking on several opportunities. I cannot give you more detail at this stage, but I can tell you, it's not going to be in Israel. It's going to be outside of Israel.

And as far as -- at this point in time, what are your expectations for profitability, going forward, for the rest of the year? I mean, we had the 2 months of incomplete. We haven't gotten business in the U.S. At some point, the business will come back in the U.S. or increase. Do you expect to be profitable for the year?

So it may be important to mention there a few things. First, when we're analyzing the U.S. market and the reason for the reduction in revenue in the U.S. market, we don't see that we lost business to the competition. So it's not that the competition has 1 project and it went away from us. We also don't see any alternative technologies that were not in our core business. So the business didn't go there as well, and so we are seeing more and more projects are shifting gear to the right. Currently, according to our analysis, the second half of the year should be profitable. Again, it's initial analysis. It's too early to say the level of profitability for the second half of the year.

The next question is from Ken Liddy of Wells Fargo.

Saar, you mentioned that you had a shortfall of execution in some of your backlog. Does the backlog stand higher today than it did at the end of last quarter?

The backlog is still very strong. The backlog -- again, the backlog is mostly related to our projects business. As you recall, we are pretty much 50-50 in terms of project versus product. So in the project business, the backlog is strong. In the product business, the cycle are very short. Usually, we have a cycle a few weeks in terms of product. So in product, it's -- since the cycle are short, there is not really a real value for the backlog in the product business.

Okay. Related to that, have there been orders that you received in the last year that because of their sensitivity, you haven't been able to make a public announcement due to security or whatever?

Of course, we are assuming all those everyday, and of course, we are not report on all of them. Some are because of the size, some of them because of the sensitivity. We are trying to report major orders, and of course, order stuff. We don't have any clearance issues with the [ LTOs ] or with the customers.

Have you been able to report all your major orders? Or have there been some major orders that because of the sensitivity you thought it was not an [indiscernible]

So in fact, it's by a major order, and I think regulation of defining major order, everything above 10% of our area revenue. So on that, we are reporting every order that is above 10% of our area revenue.

Understood, and you talked a bit about the -- I forgot what you call it, the new pipe...

Fiber product line? Okay...

Yes. How does it compare to your PipeGuard? It sounds like it's a lot more expensive or is it not in the same family of sensors?

It's not in the same family of sensors. It's much more Advanced Technology than the one that we've used before. The technology actually came from the acquisition we did 4 years ago of [indiscernible] for fiber-optic solution. Since then, we have reinvested quite a lot of efforts in the R&D, in improving the product, and now with the announcement of the leak detection, we are entering to a new market. It's not just for the security market. It's more for the safety application of that market, but in the end, they bring synergies between the 2 to the end user.

And you mentioned that you have been doing excessive testing. Did you have like a pilot order with an agency or a corporation?

We are running on several demos. In parallel, what I mentioned was test that we did in the U.S. in a third-party facility that is specializing in testing similar technology. By the way, the test was excellent. We got an excellent feedback on our product, and we are quite convinced that we have a very unique technology, and that we are ready to go to the market in the upcoming weeks.

Early in the year, you gave an update on an order. You talked about with -- I believe it was the Israeli government and RoboGuard, and that had passed extensive testing. Have you seen any type of interests in that product?

Yes, we do. We actually -- we are expected to assume additional orders for RoboGuard from the Israeli government still this year. This is one of the projects that we are currently working on. On top of that, we are working with additional international customers, and hopefully, we'll see the first export project in the upcoming months.

Now is that a product that can use that border or just for perimeter security?

It's mainly for a critical site security. We did -- however, we did several testing in a specific segments of the border. It's not for a long border. It can cover specific areas, which are problematic on the border, but this is not to secure hundreds of kilometers of border.

Understood, and how many -- each unit, how long of a distance can it cover?

It's not an easy answer because it depends on the operational scenario, and the level of funding that the customer has, but typically, it range between 500 to 1 kilometer per each system.

And one last question, with regards to the U.S. government's budget, just to clarify, so you have orders that are in backlog that haven't started because of budget delays, and then you also have potential orders that you expect to close after everything's cleared up in Washington. Is that correct?

We have project that we have been selected in North America. Hopefully, they are going to move forward in the upcoming weeks, and hopefully, in the upcoming weeks, we'll have some good news to share with you guys. And of course, there are projects that we are expecting, but currently are not initiated because of the budget issues that you guys have in the U.S.

[Operator Instructions] The next question is from [ Doron Levin ] of Magal.

There are 2 things I just can't separate on investments I make. One is the repetition of errors that continue on and on, and the one in particular that's crawling is this move to the U.S. dollar issue, which you report in shekels, and we have a weakening U.S. dollar. That was a source of major problems in the previous quarter, and it persists in this quarter, and it just sounds like you're sitting on your hands without any kind of strategy of rectification. Maybe you're just sitting and praying to God, saying, "Gee, I sure hope the product change is close." We're not going to do anything. We're just going to sit on our hands, and hope that something changes dramatically, but nothing is changing. The dollar's weakening. So are you going to have another financial loss next quarter? Because if that's the case, you have a terrible financial operations development. The other thing that I find very galling is something that's very dynamic in one case, where we've seen all kinds of news, press releases about its investments, developments, corporate developments. And then all of a sudden, the same company becomes silent. No releases of any kind, then you never hear from them. They were once very dynamic, and now all of a sudden, they're sitting on their hands in terms of assets in product development, but they have excuses. They say, well, we have sensitive projects or there are things we can't talk about. In both issues, gentlemen, you're failing, and you're failing badly. Why should anybody continue remaining investing in your company?

So just -- I will start by answering your first question. The first question, the reason that we are sitting on the dollars is because we are planning to use this cash for acquisition outside of Israel. So we don't really need to convert it to Israeli shekel. If we convert it, maybe it will look nicer in the books, but in the end of the day, the currency would be devaluated. So we don't see any reason. We are not a financial institution, so we don't see any reason for us to do any financial exposure. And yes, you might see in the -- from an accounting perspective, but definitely, there is no impact on the real cash or on the EBITDA or whatever. Again, I'm not sure that you understand the issue with the accounting that relates between the U.S. dollar and the Israeli shekel related to the cash that we have.

I think I understand. I just don't understand you're allowing the additional status quo to persist. That's what I don't understand.

Again, it's non-cash transaction. In the end of the day, if we had the $50 million in the bank, as Yaacov mentioned before, the $50 million gained interest. So yes, it actually increased. The only thing that you see from a financial perspective, you see the translation into Israeli shekel, and then it goes to the P&L. But from a cash period perspective, there is no influence, whatsoever. So we don't see any reason to change strategy on that, and we are bringing it on purpose. It's not that we are sitting. This is the right things to do.

Well, like so many people on this conference call, we look at the stock price. And during one of the most incredible stock market, bull market that exists, your stock is acting like a bear market stock. So you're obviously not doing something right. Wouldn't you say?

Definitely, we don't like to see a loss, and what interest us the most is operational loss, and definitely, this is something that we are working to change. As we mentioned before during this call, the major reason for such a loss was the reduction in revenue in the U.S. and in North America. We saw project shifting to the right. From last year, as I mentioned, the U.S. accounted for 50% of our revenue. Today, it's less than half of that, and the project didn't go away. The security problem unfortunately didn't disappear. We are seeing a freezing -- we see the market, the security market, the project were shifting to the right, and the project will come again. If you look on our main vertical, for example, the main vertical is correctional facility currently because of the unclarity of the budget. There is almost no investment in project for the correctional vertical market, but eventually, things will go back and will improve. It's not that we lost to competition. It's not that we lost to different technology. It's just a situation that, currently, the market -- the projects are shifting. In the meantime, of course, we are not standing still. As we already mentioned, we are doing -- we took some action. We reduced our expenses dramatically. We reduced manpower all across our organization, mainly in the U.S. We reduced more than 10% of our workforce in the last few months in order to make sure that we are in a better position. And yes, the market eventually will recover, and I think we are in great shape to be in that market.

My final corollary comment was just that America is undergoing a major boom economically right now, and it just seems very baffling that your company is somehow suffering during a major U.S. economic boom. I just find that very strange...

Just maybe, just one other remark again. If you look on the security market, and if you look on the similar security companies that are public, so I can refer you to several companies, including flare system that just published 2 weeks ago their financial and they're suffering and they are restructuring all their security division. You can look on the telco that just announced that they're going to lay off another 200 people in the U.S. You can look on our biggest competitor in the PIDS market, which is FFT. It's also a public company. They published a report just this week, and they lost $7.5 million. Again, it's not a comfort from us -- for us. We understand that you guys, our shareholders, looking for return on your investment, and we are doing everything we can in order to bring the company back to profitability even in this challenging times.

The next question is from a [ Amir Shan ].

Is there any development in the 2 pilot, the India border with Pakistan and Bangladesh, over 6,000 kilometer north?

Unfortunately, I cannot comment on a specific project at this point.

Okay. It was published in the Indian newspaper about the 2 pilot above, above the Israeli border fence technology, and I wonder if we are employed in the 2 pilot?

As I mentioned, unfortunately, I cannot comment specifically on this specific or any specific project. Definitely, we have business in India. We are working on several project, but I cannot comment on one project or another.

The next question is a follow-up question from Sam Rebotsky of SER Asset Management.

Further, Saar, I'm a very patient investor, and sometimes, stocks do not work. Magal is not a trading stock. Sometimes, it becomes a trading stock when you put out a very positive announcement and everybody jumps in, but their time horizon is very short. Is there a -- have you been going around trying to tell your story about your products and about what you're doing, so there's more understanding that you convert the impatient investors to patient investors?

Yes, we are doing, and maybe not in the right amount that we need to do it. Currently, we have other challenges, as you can see, and currently, we are focusing more to bring the company back to profitability, which is our main task at this point. But definitely, we are going also for some investors meetings again, maybe not enough. But the first challenge is to bring it to profitability, and then I think we'll be in a better position to spread the word.

Where were you appearing? What kind of Investor Conferences are you doing?

We have been -- participated in Roth in the beginning of the year, and we are planning to be -- to present by the end of the year in New York City in Investor Conference.

Okay. I think, I guess, I mean, the key really is to getting contracts and the U.S. is an unusual situation with the change of administration and the structure and all the different things that are going on, and -- but clearly, you need to get more investor coverage. And as people understand, you need -- your products and sales, and to extent that you're not cutting expenses because the expenses are needed to get more business that may need to be. The currency, as you sort of explained, you're looking at acquisitions. How close are you to acquisitions? I mean, is it in the next quarter? In the next 6 months or the next -- how close are -- and what size are you looking at?

So we are looking on the size that is pretty much in the same size that we acquired Aimetis last year, so it's somewhere in the range between, let's say, 10 million to 20 million. This is the range. And how close we are, it's a great question. It can happen very quick or it can be delayed. On such specific deals, you cannot forecast when things are going to be closed. We are monitoring closely, and we are in the discussions with more than one company, but I cannot forecast for sure when things will be closed.

And the companies you're looking at, I presume they're profitable, so -- or that you're going to reduce costs and combine products and there'll be synergies and you could increase profits more significantly. Is that what you're looking at?

You're absolutely correct, yes.

There are no further questions at this time. Before I ask Mr. Koursh to go ahead with his closing statement, I would like to remind participants that a replay of this call will be available in 3 hours on Magal's website, www.magal-s3.com. Mr. Koursh, would you like to make your concluding statement?

Yes. On behalf of the management of Magal, I would like to thank you for your continued interest and long-term support of our business. Have a good day. Thank you.

Thank you. This concludes the Magal Security Systems Second Quarter 2017 Results Conference Call. Thank you for your participation. You may go ahead and disconnect.