Senstar Technologies Ltd (SNT) 2008 Q4 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the Magal Security Systems fourth-quarter 2008 results conference call. (Operator Instructions). As a reminder, this conference is being recorded, July 13, 2009.

I would like to remind everyone that forward-looking statements for the [respective] Company's business, financial condition and results of its operations are subject to risks and uncertainties which could cause actual results to differ materially from those contemplated. Such forward-looking statements include but are not limited to product demand, pricing, market acceptance, changing economic conditions, risks in product and technology development and the effect of the Company's accounting policies, as well as certain other risk factors which are detailed from time to time in the Company's filings with the various securities authorities.

If you have not received a copy of today's press release and would like to do so, please call Gelbart-Kahana Investor Relations at 1-866-704-6710 or 9-723-607-4717.

I would now like to hand over the call to Mr. Ehud Helft of GK Investor Relations. Mr. Helft, would you like to begin?

Yes, thank you, operator. Good morning to all of you. I would like to welcome all of you to the conference call and thank Magal's management for hosting this call.

With us today on the call are Mr. Yoav Stern, Acting President and CEO, and Mr. Zev Morgenstern, the CFO. Yoav will provide a brief opening summary, followed by Zev, who will review and explain Magal's financial results for 2008. Yoav will then elaborate further on the business environment. We will then open the call to a question-and-answer session.

Please be aware that some of the financial figures discussed in this conference call will include some non-GAAP metrics, which the Company believes better reflect the performance of the underlying business. Note that all GAAP numbers can be found in today's press release. Zev will elaborate in a few minutes.

And with that, I would like to hand over the call to Mr. Yoav Stern. Yoav, go ahead, please.

Thank you very much, Ehud, and good day to everybody. The last six to eight months, maybe even nine months, of Magal has been very transitory -- big changes and major events, all instigated from the inside, escorted by a market that's not very friendly to all of us, but so be it. We have to do it, and we are doing it.

As a result of that -- we will speak about it later -- we had a change in management, which started by a CEO replacement in somewhere the end of last year, continued with a replacement of CFO, continued with an addition of a General Manager to Israel, the replacement of Senior VP of Marketing, replacement of Senior VP, R&D, and a replacement of Senior VP, Operations. In parallel to that, there were extreme changes in strategy and some changes in geography that we will talk about later.

All this led to us knowingly deciding somewhere around three to four months ago to delay our results, realizing that what we want to do this time is not leave any stone unturned in order to prepare the Company for the future, not only with new strategies and new management, but also with a financial status that is right for the operations we expect to see over the next few years.

With the arrival of the new CFO, Zev -- which you will hear from him in a second -- we took the position that we will file the results together with our 20-F annual statement, as requested and required by the SEC, until latest July 15. And we will do it together, both 20-F and financial audit, financial results together. That led us to do something that we were not used to and not have the results somewhere around March or April, as we used to.

We feel that our decision was right. We know today that the financial results are really expressing the status of the Company in the most accurate way. And we intend to get into next year with trying to keep financial reporting in a way that is similar to an American filer rather than a foreign filer, and we are a foreign filer. We will try to have the 20-F and the annual financial statement release similar to the 10-Qs of American -- sorry, the 10-Ks of American companies. And we will try to release the quarters as we did in the past. Mostly we don't file them, but we don't have 10-Qs, but we do news release similar to the time -- at similar times to 10-Qs of American companies.

The last thing before I let Zev speak, or last couple of things, is we will, as we mentioned before, not release the third quarter because we are already after the half-year. We will release the half-year results on or before the end of August, and so you will see six-month results for 2009. You will later during the year also be able to see the first quarter, because we will finish it and release it, but for comparison reasons. And again, next year, 2010, we, both for Q3 2009 and Q4, Q1 and Q2 2010, we intend to go back to the quarterly results release.

Before I let, again, Zev to speak, one thing that I want to draw your attention to. I'm sure the questions came up to you when you looked at three quarter's results for 2008 at $70 million revenue, fourth quarter at about $29 million of revenue, and the total year at $70 million of revenue. It begs the question, how come this doesn't count or sum up?

The answer is, actually, page 5 in your news release, you will see a condensed consolidated statement of the four quarters, and you will see the numbers of the first three quarters a bit different than what you saw in the Q3 financial news release last year. The reason is the change in certain accounting methods that Zev will speak about, which is to do with revenue conditions. But it does explain that if you have the first three quarters at $13 million, $11 million, $15 million each, summarized to $40 million, and the last quarter is around $30 million, that makes it the $70 million. The difference is revenue that was not recognized this year and have a potential to be recognized in 2009 and forward, and Zev will speak about that. So that's the key thing that could be seen. And without further ado, I will let Zev please follow up.

Thank you, Yoav. 2008 was a year full of challenges. [Fearing] the worldwide slowdown in the economy and reduced spending in North American and European markets, I would like to summarize our full-year 2008 results and explain the changes in financial results compared with 2007. You may find the annualized full breakdown of our results in the press release issued earlier today.

Revenues for 2008 were $70.4 million, 2.8% less than 2007. The decrease is primarily attributable to the lower revenues generated by our Latin American subsidiary and a reduction in revenues in the United States. Revenues generated in Israel represented 17% of our total revenues. North America was 22%, Europe 19%, Africa 20%, Latin America 7% and the rest of the world 15%.

As Yoav mentioned, we generally recognize revenue based on percentage of completion method as we have the ability to make reasonable, dependable estimates of the extent of progress towards completion of projects. However, for certain projects, when we cannot make reasonable, dependable estimates or its [inner and others] make estimates doubtful, we use the completed contract method. Under the completed contract method, billing and costs are accumulated on the balance sheet under costs incurred on long-term contracts while the contract is in progress, but no revenue is recognized until the contract is completed or substantially completed.

During 2008, we concluded that projects in Africa, which are being managed by our European subsidiary acquired in September 2007, are not typical when compared to other projects in our business, and we identified [inner] and others related to these projects, including a delay in payment from the customers. As a result, we chose to be conservative and concluded that based on the difficulty of making reasonable and dependable estimates, in order to calculate a percentage of completion of these projects, we should apply the completed contract method to these projects and revise the results of the operation for the first three quarters of 2008.

Gross margin for the year totaled $21.2 million, 27% less than the $28.9 million reported last year. Gross margin was negatively affected by a number of factors. Among them, we may mention the impact of the weakness of the US dollar against the Israeli shekel during 2008 compared with 2007; the change in revenue mix with an increase in large-scale integration projects with lower gross margins; and inventory write-offs of $2 million compared with $646,000 in 2007 following the cancellation of a project in Latin America and the write-off of certain products and equipment in the Company's North American R&D and manufacturing activities.

In terms of ongoing operating expenses, net R&D expenses were $6.2 million or 8.8% of revenues. Selling and marketing were $17.2 million or 24.4% of revenues. And G&A expenses were $10.9 million or 15.5% of revenues.

Ongoing operating expenses increased by 36.1%, from $25.2 million in 2007 to $34.3 million in 2008. The increase in operating expenses is attributable to the appreciation of the shekel, the Israeli currency, against the US dollar in 2008, which increased the US dollar value of our shekel-denominated expenses by roughly 12.8%; and the consolidation of our new European subsidiary, which accounted for four months of operation in 2007 compared with a full year of operation in 2008.

In addition, as a result of an increase in our 2008 European subsidiary's revenues, the amortization of customer-related intangible assets recorded in 2008 was higher than the amortization recorded in 2007.

The increase in operating expenses in 2008 are further attributable to an increase in our allowance for doubtful accounts of approximately $1.3 million as a result of the recent global economic downturn, which had an adverse effect on the liquidity of some of our customers, and to an increase in sales commissions due to a different mix of revenues recorded in 2008 compared with 2007.

During 2008, we also took a goodwill and other intangible assets impairment charge of $12.9 million. $10.1 million of this was an impairment charge we took with regard to the European subsidiary we acquired in September 2007. This amount is comprised of a goodwill impairment of $8.4 million and an impairment of $1.7 million related to customer-related intangible assets. An additional impairment charge was of $2.4 million, writing down the goodwill at our US subsidiary. This impairment is attributable to a decrease in the operating activities and the slowdown in the business of our US subsidiary.

In addition, we recorded an operating charge of $2.6 million in postemployment and termination benefits of senior employees that have recently resigned or retired. A $1.7 million charge was due to Magal's former CEO, which resigned in November 2008 in [lieu] of his 25 years of service, and a remaining $900,000 was for retirement benefits related to other former senior employees. Total operating expenses in 2008, including these two one-time operating charges of $15.5 million, totaled $49.7 million.

Operating loss for 2008 was $28.6 million compared with an operating income of $2.8 million in 2007. Excluding the above one-time charges, the operating loss in 2008 was $30.1 million. Net loss for 2008 was $32.6 million or $3.14 per basic share compared with net income of $1.9 million in 2007 or $0.18 per diluted share. We should bear in mind that the 2007 net income incorporates an income from discontinued operations of about $1.7 million.

As of December 31, 2008, cash, cash equivalents, marketable securities and short-term bank deposits were $19 million. In addition, we held $5.5 million in restricted and long-term cash deposits.

In spite of the net loss of $32.6 million in 2008, we had a net cash provided by operating activities in 2008 of $700,000 compared with a net cash provided by operating activities of $9.9 million in 2007. Bear in mind that this figure incorporates roughly $900,000 which were offset in this figure from discontinued operations. So the total contribution from ongoing operating activities was actually $1.5 million.

I would like to hand the call back to Mr. Yoav Stern to continue this conference call. Yoav?

Thank you very much. The next chapter, we're going to have a little bit of a discussion of business status. I'm trying now not to refer to 2008 at all. I will speak mostly about maybe the last month 2008, and especially the first two quarters 2009.

What we see is a very clear picture of a very slow year, or at least very slow half-year, in Canada and the United States. If you want to compare it to historical years, while our first half-year is always weaker than the second half-year almost everywhere around the world, the difference here is much bigger. The last seven years of North America, which are seven years [as comprehends] have been in similar size, we are down 22% comparing to the average of the last seven years, and we are down 40% in the first half-year if you compare it to last year. This last year happened to be a strong first quarter. So between 20% to 40% reduction in the first half-year is definitely extreme. That's as much as North America.

Mexico is a funny country. Mexico and India are two, what I believe, two major markets, developing markets for our business and strong markets. However, there is a very big difference between the two. Mexico is very erratic and tail-heavy, and India is much more stable and ongoing on a quarterly basis, much more organized.

The Mexican market is typical by having three quarters of almost no business and the last quarter of having most of the business of the year. That was the case in the last few years. Obviously, you'll remember that last year the Company had announced a big project that was canceled at the end, but also that project was in the fourth quarter of the year.

So this year is no different. We will know within the next quarter if we are going to have a very strong year in Mexico or very, very weak year in Mexico. The prognosis, the way it looks, is the three very, very large projects, or maybe four projects that may make it a very good year, but the flu they had there, which the effect was more than the rest of the world, actually held things back for at least eight to 12 weeks. So we're waiting.

As far as our European markets, UK is in a good shape, and Central Europe is seeing a slowdown similar to North America. However, the numbers in Europe, UK and Central Europe are small numbers in comparison to the rest of the Company. So obviously, the effect is not as huge.

So that leaves us with what we're doing from Israel for Magal. In Magal in Israel, rather than Senstar, which is the name of the rest of our operations, is mostly in the project business. And the project business from Israel is actually having a not-so-bad year at all. The projects we are doing from Israel, which are basically in the following areas -- it's Eastern Europe, Africa, Southeast Asia, one or two in North America. And that's about -- and some Australia. So actually, that's about it. Mostly -- oh, sorry, India, of course.

Those are the markets that we do projects. And we have, if you remember, we released $8.5 million of new backlog that we had during the month of May, which is a very strong May, which leads us to today probably one of the largest backlogs the Company ever had in projects. And when I say backlog, again, just to make it clear, it's signed contracts that were not executed yet. So if we have a large backlog today and expect it to be executed for the rest of the year and maybe even spilling into 2010, that's the meaning of backlog.

So not a bad year at all, and it's about half of the business of the Company. However, margin behavior is very different, because when we talk about projects which are having not a bad year, we're talking about low-margin business. All the rest of the markets I spoke with you about -- that includes Canada, the United States, even Mexico, for sure the European markets -- are mostly sales of products or what we call in the 20-F [a referral], which is products and very small projects. It's almost like product and product installations.

That area has much higher gross margins, and that area is the area that's very weak this year. So if you will end up looking at this year and will end up with a topline actually being compensated, the strong compensating the weak. However, in the margin line, the strong is a weak margin, and the weak is a potentially large margin. So we have an issue with margins.

That leads me to the next subject, which is expense reduction. Because of what you just heard from me, and we have seen it earlier in the year -- somewhere in December, we start to see it, November to December, I already saw what's happening -- we decided to go on an expense-cutting campaign, which included merging very extreme steps, if I would say. Just before we merge our North American subsidiaries, the US subsidiary operations market manufacturing and R&D were merged into the Canadian operations. Another one, we closed operation in California and we moved everybody to Washington, which was a much smaller and less expensive, more efficient location. In Israel, we reduced 10% of the workforce, reduced to the rest of the workforce 10% in their salary, close to 10%, 8.5%. In Canada, we are doing the same thing right now -- most reduction, similar reduction in workforce and similar reduction in salaries.

So all in all, if you look at what we achieved, and that took obviously three or four months, especially because of the geographic moves, so all in all we saved on an annual basis about $3.4 million. Now, that's a major number, because if you look at the Company, let's say our Company is in $70 million, $80 million revenue base, and let's say if we are running our business well, we should bring $7 million to $9 million today with that level. If we managed to cut, within the last six months, $3.4 million run rate on an annual basis, we increase our EBITDA by 50%. And that's a major change.

Obviously, this year, we will not see a reflection of all of it because we just -- we are still in the process. So I hope to see two quarters of it kicking in. That hopefully will balance this year -- margin squeeze out. Plus, I want to tell you, I believe that the overhead of the Company still have enough fat in it to squeeze out moving forward. And in a funny way, when you have turnarounds like this and tough years like this, if you do the things right, you get out of it much more leaner, meaner and efficient.

I wouldn't expand more on that because it will make the call a bit too long. But if you want to ask questions about technology, new products, M&A activity, which is intensive, marketing -- new marketing positions, please ask in the Q&A session and we'd be happy to answer.

At this point, I would like to call for the operator to start the Q&A session.

(Operator Instructions). Kenneth Liddy, Wells Fargo.

Could you talk a little bit about how large your backlog is?

Well, the backlog is obviously larger than $8.5 million because that was only the new business that we brought in May. And we don't release backlog numbers for -- especially for competitive reasons. But it's a backlog that if we completed all this year, we will have not a bad year at all, even if we don't bring new business at all. But we will bring new business still; we have six months. From the other side, backlogs have a tendency to spread over more than six months sometimes.

So that's what I can give you. It's a number that I will tell you that it's a bigger backlog than we had in the beginning of the year. In the beginning of the year, we had not a bad backlog also, and it's bigger than most of the last five years' backlog.

And as far as the margin improvement, you expect that the second half of 2009 and into 2010?

I actually don't expect margin improvement. If you're asking me about margin improvement on the overall Company, or you're speaking margin improvement per product or per project? What are you asking exactly?

Basically, from the reductions that you made in overhead earlier this year?

Okay. This is not the gross margin improvement. This is improvement of the, yes, net margin. The answer -- I understand your question. I'm sorry. The answer is, the effect of the expense cuts are I would say 70%, 80% are already in effect starting in the month of June. And the rest will be done during the next two, three weeks.

So during, let's say, the last five months of the year, five and a half months of the year, there will be a full effect of those cuts. So if you take $3.2 million, $3.4 million on an annual basis, on a semiannual, you save half of it. And it will start next month. It's already actually in effect for a month and a half.

What type of projects are you bidding on in Mexico? Are they similar to the previous business that was booked and then canceled?

No. The businesses were canceled are very, very different than what we are bidding. We are bidding now on businesses -- on projects that are very typical infrastructure, security and safety, strategic locations, command and control -- very, very different. It's about three projects right now, two that are very close to -- supposedly very close to signing. We don't -- again, until it's signed, it's not signed. And a couple of others.

They are all around what Mexico is trying to do on the -- with the war with the drugs and what the -- Mexico built their own homeland security office. And it's all initiative that's coming from there. So it's different than the last year's project that was canceled. But I must tell you, Kenny, that the project that was canceled last year, more of this kind will be coming up. That's what we see. But it takes longer to execute them, to execute the tender, because it's going through cities and the budgets have three more loops to go through until it gets to the bottom line.

And you look at Mexico as one of the big growth drivers as far as regions of the world?

Yes. I believe that the two regions of the world that are what I will call emerging markets, if you wish, to compare to the financial terms, are Mexico and India. I'm not talking about China at this point, because we're not strong enough in China. We don't know the market in China as well. And China is by itself -- sorry. But India definitely, and Mexico, we are very strong in both. And both markets show very strong signs of expansion in the next I would say three to four years.

With regards to the accounting changes that you made on the first three quarters, that business, is that now included in your backlog, or how are you recognizing that?

Okay, Zev, do you want to answer that or do you want--?

Well, it is in the -- I may say it is in the backlog. What we did is actually deferred the recognition to a later time. We have decided that only projects that have been completed will be recognized this year, in -- all the rest have been incurred in the balance sheet and definitely is part of the backlog.

Let me put it to you this way, Ken. The numbers I referred to before in the backlog, which are the numbers I am managing the Company by, does not include the deferment of revenue as a result of the change of the accounting policies. That's on top of what I told you before.

So that could give you a giant boost to numbers sometime in the next 12 months?

Yes. If the deferment of revenue that we took upon ourselves because of changing the recognition method will occur during the next six months, that is an additional revenue that I didn't take into consideration as backlog in the operating backlog that I discussed with you. After the six months, it will still be recognized, but it will be recognized when we will actually either complete the project or be paid in cash as an interim payment.

(Operator Instructions). There are no further questions at this time. Before I ask Mr. Stern to go ahead with his closing statement, I would like to remind participants that a replay of this call will be available in three hours on Veidan's website, www.veidan.co.il.

Before we go to the follow-up -- the closing statement, we have a follow-up question from Kenneth Liddy of Wells Fargo. Please ask your question.

Could you talk about some of the M&A activity that you referred to?

Yes. What we see in M&A is we see two types of M&A. We see companies that are similar to us, however, smaller, but are mostly either one-product or two-product companies that are encountering issues similar to what we're encountering, but are less well-financed and therefore are looking for a home, if you want to call it. And we're talking to these companies.

And obviously, there the issue of the M&A is very much a price issue, because we are very familiar with the business. We are usually very familiar with the products, because they are competitors, so we know them. And the issue is, how much do we want to pay for market share?

That type of M&A that we're looking, and I've already worked on over the last three months, are more strategic M&A, where the companies are in adjacent market to us with adjacent products that complement our product and replace products that we sometimes get from third parties. And instead of that, we're considering acquisition or merger with a company that's in technologies that we need.

Plus, we are usually interested in this case that this company will have distribution channels that are complementary to our distributions also, because if you remember, our distribution channels are really between two -- pretty straightforward. One is our projects which go to the end user, and one are products which is going usually to system integrators and some distributors. And if we are acquiring a company with new technology, we want to see that some distribution channels are coming with it also. And then we can cross-reference the distribution channels between the companies and cross-reference the products. So that's the second kind of acquisitions we are looking at. And there is about one or two of each.

And what region of the world -- are you looking in North America? Are you looking in Latin America?

No. At this stage, North America.

North America?

Yes.

Could you talk a little bit about the opportunities you see for North America?

About -- sorry, say it again?

The opportunities for -- why you would pick North America. Is there particular business opportunities?

Yes, frankly, I believe we are pretty strong in Canada, but I believe that our USA operation is very weak, as much as our penetration. I'm seeing it even by looking at the M&A opportunities and understanding who ate Magal's [sense of lunch] over the last three years.

So the market is much larger. The potential is much larger. And we're just not good enough. So it's one of the largest markets in the world, and I don't want to start to break it down to vertical markets as much as -- airports, industrial facilities, etc., etc. The only market in the state that we are strongest is [business]. And there's many more beyond that. So I feel not that the opportunity is there because the market is growing, but the opportunity is there because we are much too small a player comparing to the size of the market.

Do you personally expect to have a role in helping Magal procure some of these opportunities as far as M&A activities?

I've been discussing it, and I was asked to consider it with the Board. And if the Board will be interested, then I will definitely consider it, especially to help them with the information and the knowledge I have now. I will be happy to help them.

Mr. Stern, would you like to make your concluding statement?

Sure. We'll just wait 30 more seconds and then we'll do it.

(Operator Instructions). There are no further questions at this time.

Okay, so I will move to the concluding statement. I would like to thank everyone for participating here today with us. Of course, you will be able to listen to this call on our website starting about 24 hours from now. And other than that, Zev, our CFO, and myself, you have both our e-mails and you have our phone numbers, cell numbers. Please feel free to call if you get to either new insights or new questions. We'd be happy to answer. Thank you very much again, and we'll speak with you at the next opportunity.

Thank you. This concludes the Magal Security Systems fourth-quarter 2008 conference call. Thank you for your participation. You may go ahead and disconnect.