Eitan Livneh - President and CEO Tomer Hay - Controller Kenny Green - CCG IR

Ladies and gentlemen, thank you for standing by. Welcome to the Magal Security Systems Second Quarter 2013 Results Conference Call. All participants are present in a listen-only mode. Following management's formal presentation, instructions will be given for the question-and-answer session. (Operator Instructions). As a reminder, this conference is being recorded, August 29, 2013. I would now like to hand over the call to Mr. Kenny Green of CCG Investor Relations. Mr. Green, would you like to begin?

Thank you, operator. Welcome to Magal's second quarter 2013 conference call. I would like to welcome all of you to this conference call and I'd like to thank Magal's management for hosting this call today. With us on the line today are Mr. Eitan Livneh, President and CEO; and Mr. Tomer Hay, Controller. Eitan will summarize the key highlights, followed by Tomer 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 predictions 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'd like to hand the call over to Eitan. Eitan, please go ahead.

I would like to welcome you and thank you for joining us today. 2013 has so far been a tough year for Magal. While our performance has been weaker compared with past two years, we have also increased our investment internally in order to bring our cyber solution to the market and expand our global footprint. We reported revenue of 12.2 million which is slightly below those of last quarter and 26% below those of second quarter of last year. Over the past two years we completed some major projects in the $20 million plus range in Africa and right now, we have no projects of this size replacing them. However, as a target region for us, Africa continues to provide us with a good level of business and our success in the region has provided us with very strong references going forward. We believe this will continue to be an important market for Magal as the countries in the region are increasingly placing importance on the security of the assets they are building. As I explained last quarter, we are seeing a delay in the revenues for Mexico following recent elections there and new government in Mexico has been established which has caused a temporary delay in the Homeland Security budget, which means revenues we were hoping to recognize in the second quarter were pushed out. While Mexico was weak, the Latin America region remains a key target for us. We are investing in our presence in Brazil, we are analyzing potential local integrators to invest in as we see significant potential for growth there in the coming years. We do believe the Latin America region remains a long-term growth engine for Magal. We are seeing solid improvements in our North American subsidiaries covering the United States and Canada which is balancing some of the reduction in revenue. In Israel, the southern border with Egypt we are part of the testing process while the timing is always uncertain when it comes to government constructs. We believe we are in a good position for winning some business here. I would like to highlight that while the business that we are in does mean lumpiness in revenue. Magal is in a different situation than it was only two years ago. One of the clearest developments in Magal is our financial strength. Our balance sheet is exceptionally strong for a company in our size with over 34 million in net cash, which is over half of the value of our market cap. It provides us with significant financial flexibility more so than we have ever had in the past. We are using the strongest cash position to invest in Magal's future. In January 2013 we purchased WebSilicon or CyberSeal as it is now called. We changed the name to CyberSeal. For 2.4 million we are currently investing more in order to bring out the complementary offering of monitoring solution for networks combining protection in both the physical and logical world. We have increased research and development within CyberSeal with the aim to bring out and to an integrated suite of solutions starting from 2014, and this will lead to an increased R&D expenses level for Magal. We have already had discussions with customers and they see interest in our integrated solution. The acquisition significantly extended our capabilities beyond physical security into network security, substantially increasing our addressable markets. Our new solution optimized for critical sites to monitor, detect and protect against abnormal network activity within close to protected sites. Our logical security solution protects the assets and network system and [entrusts] the security and video network which by itself may be vulnerable to cyber intrusions. We believe that our move into this market enables us to become a leader in the convergence of physical and cyber security. We are using our strong cash position to expand our presence in some key emerging economies Brazil, Russia and India. We see each of these regions separate as a growth engine for Magal and we believe that the establishment of a strong local presence enables us to better grow our business in those regions. By gaining a better understanding of the local market culture and people, it also enables better local support and closer relationship with customers and this in turn will create a virtual cycle of strong referrals for additional businesses. While increasing operating expenses, the return of investment will be significant and a strong presence in these emerging regions with increasingly critical security requirement is very important for Magal as we evolve our company to the next stage. While our 2013 [is a] more challenging year on the revenue side, we are leveraging our strongest position to capitalize on the emerging industry of cyber security as well as to expand our presence in key regions, especially Brazil. I will now hand over the call to Tomer for a financial review. Tomer?

Thanks, Eitan. Revenues for the second quarter of 2013 decreased by 26% to 12.2 million. This is compared with 16.4 million in revenues for the second quarter of 2012. Sales by geography in the quarter were as follows; North America 35%, Israel 22%, Africa 15%, Europe 13%, South and Latin America 4% and the rest of the world amounted to 11%. Gross profit in the quarter was $4.9 million or 39.8% of revenues, a decrease of 33% compared to gross profit of $7.2 million or 44.1% of revenues in the second quarter of 2012. The higher gross margin in the second quarter of last year was unusually high. Gross margin reflect changes between products and projects in the revenue mix. Our typical gross margin level is expected in the high 30. Operating expenses in the quarter amounted to $5.9 million. This is lower when compared with the $6.8 million that we reported in the second quarter of last year as we continue to keep tight control of our expenses in the quarter in light of the lower level of revenues. However, as Eitan mentioned, we are now investing in our cyber activities and expanding our global footprint which will increase operating expenses slightly in the coming quarters. The operating loss for the quarter was $1.1 million compared with an operating income of $474,000 in the second quarter of last year. Net loss in the quarter was $716,000 compared with a net income of $938,000 in the second quarter of 2012. Cash and short-term deposits net of current bank debt as of June 30, 2013 were $34.2 million or $2.12 per share compared with cash and short-term deposits net of current bank debt of $41 million or $2.65 per share on December 31, 2012. In the first half of 2013, Magal used $2.4 million in cash acquiring the cyber activities and further $0.7 million in capital investments. That concludes my remarks. We would be happy to take your questions now. Operator?

Thank you. Ladies and gentlemen, at this time we will begin the question-and-answer session. (Operator instructions). The first question is from (inaudible). Please go ahead.

Thank you. Eitan, my first question is regarding Brazil. Can you give a sense of the timeframe when you expect Brazil to be meaningful? And what does the macro environment in South America, how does that affect the timetable?

In Brazil we are in the process of looking for a local integrator to acquire and we are having in hand few alternatives. I believe that the full year end we will have the results, hopefully positive. We don't see any difficulties with the current environment that holds us from moving forward.

Okay, great. And my next question is regarding backlog, can you give a sense of backlog at the end of the quarter?

Well, backlog at the end of quarter is lower than expected. I will not refer to the number itself. It's divided between a project that we have in hand, product that we have to supply but definitely we are not happy with the backlog we have in hand and that is one of the main objectives for us for this quarter as well as for the last quarter to build up our backlog. I can tell you that as of June 30, in the last two months, we recognized some revenue already but at the same time we collect new orders which covers even more than what we have recognized. So we are in a better shape than we had been in June 30.

Okay, great. And then you were talking about improvements in the Americas. Do you see that as being sustainable? Does the company plan to deploy more resources in North America, U.S. and Canada? And finally do you also think that deal size in those regions might increase?

We operate North American companies separated from Latin America, of course, so for us Americas has been an improvement. We see on the North American operation in Canada and the U.S., yes, we see that sustainable improvement and we believe that this will help us to be better in the second half of this year, hopefully also next year.

Okay. And my final question, you were talking about CyberSeal about additional investments in R&D, what kind of trend do you see for revenue in 2014 from CyberSeal and do you expect that in 2014, CyberSeal won't be an (inaudible) business to Magal?

Yes, we expect CyberSeal to create revenue not only on the legacy system that they have in hand from day one but based on the development of new product that is undergoing, this will start in 2014. The company will grow into 2014 on its own revenue. Whether it will become significant within Magal group, I hope that the group will grow by itself in the traditional securities, so the CyberSeal company will still remain small in the group but will grow by itself.

And do you expect the business to be accretive to the P&L in 2014?

I don't know yet. I hope it will but I cannot give you a solid answer to that.

Okay. Thank you. I will pass.

Thank you.

The next question is from [Thurman Willis]. Please go ahead.

Thank you for taking my question. You alluded in your press release about the last half of the year being somewhat profitable or more profitable with the first half. Can you put a little color on your statement relative – of course we share losses not profit, so does that mean that we can expect profitability in Q3 and Q4?

When we said that we foresee a better Q2, 3 and 4 compared with 1 and 2, yes, we – according to what we focused and we have in hand and again it very much depends on the mix between our product and project activities, but we believe that the third and the fourth quarter will be better. Will it make the year profitable? I don't know yet.

Okay. Then the second point of my question is that your backlog you said is not what you had hoped and that it was better than June 30. So was the backlog smaller than the company is accustomed to? What gives you excitement where you commented that you're excited about the future, what gives you excitement that we may have some profitability? And I'm not saying that you said that. You said we may or may not be profitable, but we can have improvement over the last backlog.

First of all I know my backlog and the backlog gives me – very confident about the profitability within the backlog. Second, I expect some new orders to come in the coming four months and with that, I'm still concerned but I'm optimistic to see an improvement. Definitely projects that we will get in the second half or in the remaining part of the year will not be recognized in this year, only if at all by a very little. So that helps me to be enthusiastic with a lower growth potential knowing our strategic plan in those regions that I referred to, yes I think there is a reason to be optimistic.

A question relates to the cash burn. We have decreased our cash from 255 to 212, yes we have made a purchase for 2.4 million but you see this cash level, the burn decreasing or is our investment in cyber going to peel this away rather rapidly?

Well, the decrease in cash came from three main activities. One is the investment in the new company, CyberSeal; the investment in capital and the ongoing business in our case, yes, we have spent some cash in order to cover the expenses. So all-in-all, we reduced the cash position not dramatically but we did. And we don't see the next two quarters in a worst situation. Even we can say it will be a little bit better.

Okay. So I would hope that we – whatever we spend our cash for that it would be accretive just like the cyber, I'm hoping that that would be accretive sooner than later as we build for the future.

Yeah, I'm hoping as well but definitely such activity at the first year at this will need investment and not making or creating positive cash by itself.

Thank you for taking my questions.

Thank you very much.

The next question is from [Mike Dissler of Amanox]. Please go ahead.

Yes. Hello, gentlemen. How are you all? As a loyal long-term shareholder well over a decade of Magal, my question is really a statement again. Some of the last quarter's call and that's regarding the structure of any sales organization you may or may not pursue in Brazil, I just want to point out; I know you said that you doing about 4% in Latin and Central America and that included the Brazil area or not. And just again I'm a long-term shareholder and I caution how you proceed with new purchase or joint venture with Brazilian companies. I'm concerned about the hiring of Brazilian sales force where reps sue the parent corporations and have received favorable treatment in the courts in Brazil. So I just warned that perhaps you look at opening independent offices outside of Brazil using letter of credits for purchase orders, et cetera and that's really it. I wish you continued success. I know you're trying to build something long-term here and I approve of the CyberSeal effort and I just want to point that I'm very concerned about the nature of how business proceeds in that country. Thank you very much.

Thank you again for your comment.

Okay.

The next question is from [Spencer Lemon], a financial investor. Please go ahead.

Yes. I came in a little late so if you had addressed this question, excuse me, but with all the turmoil going on in the region, I'm just wondering if we might expect security contracts from Israel? And if you did get those, would those be confidential or could you announce them?

First of all, the turmoil in the region at your end or at your side of the world looks much severe than it is, so you can calm down. Second, there is no direct impact on the day-to-day activity. Yes, there is some processes I referred to that earlier about the southern border and in general the (inaudible) we are part of the process. We hope that that will happen due to the circumstances earlier than later but still it's a long process. And once we will get such an order that will not be confidential – the details will be confidential but the fact that we got a contract for that will be announced. But it's not coming in the next 60 days unfortunately.

Okay. Thank you.

Thank you.

(Operator Instructions). There are no further questions at this time. Before I ask Mr. Eitan Livneh 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 Magal's website, www.magal-s3.com. Mr. Livneh, would you like to take a follow-up question?

Of course.

Okay. Following the follow-up question from Thurman Willis, please go ahead.

Can you compare your price of your stock relative to your cash position that of your competition appears from me from back of the envelope calculations that you trade at a much less market cap than would be some of your competitors? And if I am correct on that, why do you think that is?

First of all, we are traded – we have cash in hand of $2.12 per share. That's the number. Second, we are traded at a cap which is lower than we would like to but I don't know to what competitors you compare us because to me it's a clue what you have in mind.

Well, I just think that you trade under your competitors; that your competitors trade at a higher multiple than you do. I mean basically you're trading at a $1.60 when you take the cash out, and so I was just curious about that. And then if you could just follow-up on what the $4 million in goodwill that was added to the books from December 31, '12 to June 30, '13?

Well, the competitors that you are speaking about I don't know who they are, so I cannot comment with that. As for the goodwill that comes from our investment in the cyber business within the new company CyberSeal.

Did you plan any investments seminars to better – I'm going to complete as a private investor and a person who's watched this company for a long time. The reason that you trade at a less multiple and a lower market cap is that the public is not as well educated on your company as they might be other companies and if you got more exposure through investment conferences/better PR because on the last call (inaudible) and I don't even get a return call sometimes. So if there are other investors that's looking into this company, I think you and Board need to consider a better strategy not to spike the stock or promote the stock but to educate the public. Here you have your large investor that just paid $5 a share a few months ago for approximately 5%, 6%, 7% of the company and you're trading at $3.72. That just tells me that the education that is out there that there's not enough emphasis put on education and investor contact. Many companies are managed very well but then their ability to relate to Wall Street which ultimately determines their price of course with earnings, but your relationship with Wall Street and other fund investors that you're just not known. Also this is evident from the lack of volume in your stock and your market maker ability to move the stock $0.20 on 100 shares, I just think you need to focus more on investor contact with the Street because I do not think they're familiar with this company because one of the callers alluded to the fact that you just are – I don't think you're exposed out there to the extent that you need to in this environment. In this environment that we're in today it stands to reason that your stock ought to be trading double the price that it's trading today with the potential probabilities of negative situations occurring in the world. So lastly, I would just say I think your Board should do a better job with investor relations whether it be in North America, in New York, et cetera, because I just don't think they have a clue about your company. And there's 7,000 companies out there and if you don't promote your company or I should say that was not the right word, if you don't educate the public about your company, you're going to continue to suffer from a low stock price and your stock price dictates the currency that you can use to grow the company. So a higher stock price means a better ability to grow the company with less dilution to the shareholders. So I just want to emphasize one more time I do not think we have a good PR firm and I do not think that they do their job and I think that you should look to improve that in a dramatic way.

First of all, I appreciate your words. We will look into the comment that you have raised and we will try to improve. Thank you for that.

Thank you. And I thank you for taking my call and accepting the criticism.

Thank you very much. Are there any additional questions in line?

There are no more questions. Would you like to make a concluding statement?

Yes, I will. On behalf of the management of Magal I would like to thank you for your continued interest and long-term support of our business. If you have any questions, please feel free to call me or our IR team whose contact details are on the press release. I do look forward to speaking with you and updating you again next quarter. Have a good day and those of you that are celebrating next week the New Jewish Year, L'Shana Tova. Thank you all.

Thank you. This concludes the Magal Security Systems Second Quarter 2013 Results conference call. Thank you for your participation. You may go ahead and disconnect.