Senstar Technologies Corporation (SNT) Earnings Call Transcript & Summary

Greetings. Welcome to the Magal Security Systems Ltd. conference call. [Operator Instructions] Please note, this conference is being recorded. I will now turn the conference over to your host, Brett Maas with Hayden IR.

Thank you, operator. 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 Kobi Vinokur, CFO. Dror will outline the company's and the Board of Directors' rationale for the divestiture of their project division. Following Dror's comment, Kobi will discuss the impact on the income statement and the balance sheet. Then we will open the call for questions-and-answer session. Before we start, I'd like to point out that this conference call may contain projections or otherwise forward-looking statements regarding future events or future performance of the company. These statements are only predictions, and Magal cannot guarantee they will, in fact, occur. Magal does not assume any obligation to update this 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 unknown effect of the coronavirus, including on our operations, our clients as well as other risks identified in the documents filed with 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 requirements. You can also refer to our website at magalsecurity.com for the most directly comparable financial measures and related reconciliations. And with that, I'd now like to hand the call over to Dror. Dror, please go ahead.

Thanks a lot, Brett. I want to thank everyone for joining us today to discuss our recent announcement. I'm glad to have the opportunity to walk you through our rationale for the project division divesture and the anticipated the benefit to Magal. As we announced on Monday, we have entered into an asset purchase agreement to sell the Integration Solution Division or our project division to Aeronautics Ltd. for approximately USD 35 million. Aeronautics is a subsidiary of RAFAEL Advanced Defense Systems Ltd., Israeli leading defense company. The transaction is expected to be completed by the end of the second quarter of 2021 and is subject to customary closing conditions, including regulatory approvals. The deal is a win-win for both companies. For Aeronautics, they gained the integrated solution global footprint of customers and its highly experienced, knowledgeable and well-connected team on the ground in multiple geographies. They also gained the division propriety new generation focus, the command control and other innovative propriety security solution. Aeronautics as part of RAFAEL can leverage the technological synergies. With RAFAEL’s advanced, air, land and naval defense capabilities and Magal additional capabilities and team, Aeronautics can further increase its global presence in the homeland security market. Now with Senstar, the company can focus on growing its technology reach product business and identify strategic acquisitions. With Senstar, Magal will continue to target the 4 key verticals where they have established track record: Energy, logistics, critical infrastructures and correctional facilities. These verticals provide the maximum opportunity to increase the company's product and solution offerings. While expanding our customers' base, Magal will continue to manage Senstar from its head headquarters in Israel and retain its development and manufacturing facilities in Canada. We will maintain sales offices in the U.S., EMEA, APAC and the Latin America. Post-divesture, we anticipate the business will continue to grow organically and have a stronger balance sheet. We plan to leverage Senstar industry-leading position in the security sector as a technology platform to optimize future strategic acquisitions and achieve incremental growth in our global markets. The Magal brand will remain associated with the project division, once it moves over to Aeronautics. After the close of the transaction, we will rebrand our company under a new name and logo. Our future lies in continuing Senstar track record of growth. The Senstar team is continuously innovating, improving product lines and developing new products that set standards for quality, innovation and reliability in the industry. Senstar profitability is highly scalable with a significant operating leverage. The divesture of gives us -- give our business model greater visibility and stronger balance sheet to stay on track with our long-term growth strategy. I will now hand over the call to Kobi Vinokur, our CFO, who will review the financial implications of the divestiture. Kobi, please go ahead.

Thank you, Dror. The stand-alone company, which upon closing, will be based primarily on Senstar's revenue. We'll continue to have a high gross margin contribution. And as Dror stated, is anticipated to continue growing organically in line with prior years. The project division represented slightly less than 50% of the consolidated revenue, yet the segment delivered approximately 2/3 of the consolidated gross margin. Historically, Senstar has had high EBITDA contribution despite carrying a higher percentage of the operating expense. The operating expenses as a percentage of revenue carried by the stand-alone entity following the divestiture of the project's revenue will be initially higher due to the following reasons: First, the current corporate structure and the public company costs will be borne by the stand-alone company only, while currently they are shared between the two divisions. Secondly, we will see a higher percentage of R&D and sales and marketing expenses out of revenue as compared to the consolidated company. This is in line with financial characteristic of a growing and scalable tech business operating high gross margins. Looking specifically at the R&D expense level, Senstar's R&D budget supports its broad portfolio of technology-rich products and has been crucial to its revenue growth. Senstar's R&D during the last 12 months represented 12% of its revenues as compared to 8% of the consolidated company. We will continue prioritizing R&D investments because it is an essential differentiator for Senstar. This will include continued enhancement of Senstar Symphony VMS software with new features and capabilities as well as upgrades to our PIDS line. We anticipate increased operating expenses as a percentage of revenue for the stand-alone company following the divestiture of the project's revenue and with revenue coming only from Senstar. Although EBITDA margin for 2021 could experience a potential -- slight and temporary decline, Senstar's EBITDA margin, excluding the corporate expenses, will continue to be in the range of mid to high teens. In parallel, as the business scales, we expect a continuous improvement in the overall company's profitability primarily due to Senstar's high gross margin contribution and the operational leverage of the company, allowing us to grow revenue and gross profit on the basis of the current operating expenses. Due to the high gross margin and assuming continued organic growth, up to 55% of the gross margin contribution is expected to fall to the bottom line. With this level of operating leverage, we anticipate in the next couple of years that EBITDA margin for the overall company, including the corporate structure, will improve and exceed the prior year levels, which have historically been in the range of 8% to 9% for the consolidated company that included the project business. Given the low CapEx for Senstar, we also anticipate positive cash flow for the company. In addition, we plan to augment our growth with strategic acquisitions. The company has a pipeline of acquisitions, and we anticipate closing one deal in 2021 that could potentially add 20% to 25% to the topline and between 100 to 200 basis points of EBITDA. Turning to the balance sheet. Immediately post-divestiture, Magal will maintain a strong balance sheet with a high net cash position. The transaction strengthens our balance sheet and gives us sufficient capital to execute our long-term growth strategy. Since we anticipate being profitable in 2021, despite lower revenue and the absence of the contribution from the project division, we remain focused on deriving the greatest shareholder value from our cash. We will continue to prioritize the uses of capital on retaining our experienced team critical to supporting our growth. Throughout 2020, our employee headcount remained mostly unchanged. Secondly, continuing our R&D investments, which I discussed earlier. M&A, our current M&A pipeline target technology that leverages existing capabilities while bringing innovation and new expertise. And lastly, evaluating the benefiting of dividend to shareholders. I will now hand the call back to Dror for his closing statements.

Thanks a lot, Kobi. I want to thank the Magal project team for the excellent work. Thanks to the dedication and performance, we can combine the industry-leading talent with a large growing industry leader that can maximize the Integration Solution Division long-term opportunity. I would like also to recognize the fantastic team at Senstar and express my enthusiasm to continue working with this talented group. Now with a strong balance sheet, industry-leading technology expertise and knowledgeable and expertise and the excellent team, Magal is well positioned for future growth. I'm confident in our ability to execute our long-term strategy to grow revenue, improve profitability and close M&A opportunities. Operator?

[Operator Instructions] And our first question is from Sam Rebotsky with SER Asset Management.

I'm sorry. I didn't understand what kind of gain is on this transaction?

Excuse me, Sam. Can you please repeat the question?

Yes. What kind of gain will we be recording on this transaction? And what kind of cash...

$35 million.

Just to clarify, Sam, the gain you referred to is strategic gain or capital gain?

What kind of cash gain will we record on the sale of the $35 million? And what will we net after this transaction?

Right. So in terms of capital gain -- first of all, we will report capital gain. I can't tell you right now the exact number, because it will be -- the exact number will be driven by the timing of the closing. But I do believe it's going to be somewhere in high teens of millions of dollars of capital gain that will be recorded as a result of the transaction.

[Operator Instructions] And our next question is from Mike [indiscernible] Holdings.

Thanks for updating the shareholders. I think that's prudent and as usual, well done. One quick question, not for nothing, which I think may highlight something I'm unaware of, when you close, when Aeronautics takes over the projects division, is there some sort of mechanism by which you can designate that they continue to use Senstar's equipment or rather software exclusively wherever possible? Or will you then -- on any equipment/software that they would be utilizing intercompany previously would then, in essence, I don't know it would, in essence, allow themselves to bid it out rather than to try to direct that flow to Senstar products?

Mike, it's Dror. In the first 2, 3 years after the transaction, we'll maintain the supplier customer relations between Magal and Senstar and vice versa. Of course, there are places where Magal is buying Senstar products and sometimes Senstar is using Magal's product. So for the next 2 years, it will be -- it will remain the same.

Okay. That's really just -- I wanted to stress how important that would be for we, long-term shareholders, as well as current management. I wish you continued success and good luck on this venture. I think it's probably about time that we moved forward. And I appreciate all your efforts. So thank you very much.

Our next question is from Ken Liddy with Oppenheimer.

I have a few questions. First of all, what brought you to this point, you talked about making acquisitions for quite some time, and now you decided to divest the project company. Could you just elaborate a little bit?

I'm sorry, Ken, but your line is broken. I didn't hear the question at all. Kobi, did you hear the question?

No. Ken, maybe you could improve the quality of the line.