Ladies and gentlemen, thank you for standing by. Welcome to Magal Second Quarter 2019 Results Conference Call. All participants are at present in a listen-only mode. Following management’s formal presentation, instructions will be given for the question-and-answer session. 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.magalsecurity.com. I would now like to hand over the call to Mr.

Kenny Green of GK Investor Relations. Mr.

Green would you like to begin please?.

Yes. Thank you, operator. Welcome to Magal's second quarter 2019 conference call. 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 line today are Mr. Dror Sharon, CEO of Magal; and Mr. Kobi Vinokur, CFO.

Dror will summarize some key highlights followed by Kobi 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.

In addition, during the course of the conference call, we will discuss 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 www.magalsecurity.com for the most directly comparable financial measures and related reconciliations.

And with that, I would now like to hand the floor over to Dror. Dror, please go ahead..

Thank you, Kenny. I'd like to welcome all of you to our conference call and thank you for joining us today. As you know there are two aspects to our results the product revenues and the project revenues. This view is aligned with our new organizational structure of operating through two divisions.

Focusing first on our project revenues, they can vary widely between quarters depending on project execution. While our second quarter results were not as strong as those of our last year, this was primarily due to execution of some large projects we had in the second quarter last year, particularly in Latin America and Canada.

In the second quarter of this year, we experienced a general delay in starting new security projects in those territories. This was mainly due to pause around the election delays and new budget approvals related to our core verticals in those territories.

With that said, our projects as well as the project pipeline are more geographically and vertically diverse than in the past in different territories and different verticals. I want to point out that our project business in other geographies such as Israel, Africa, and Spain performed well this quarter and even exceeded some of the plans that we had.

In terms of product revenues, looking at the longer term trend, they grew by 8% in the first half of the year continuing a growth trend for the second year in a row. Our higher gross margin on product sales continued longer term their growth trend. This was due to the increased portion of our video software sales out of the total product revenues.

In terms of expenses, as always, we are focused on keeping them tightly controlled. We continue to look to improve efficiencies and we are working on some consolidations and increasing synergies with our European operation.

Our operating expense were at $8.2 million level, a level we are happy with and it's 8% below the total second quarter of last year. On the bottom-line, we posted another quarter of profitability with EBITDA of US$716,000. In terms of our balance sheet, we remain in very strong position ending the quarter with $52.2 million in net cash and no debt.

As you know our goal is to leverage this strong cash position for value-adding acquisitions. We are actively engaged in seeking either technology products or newer markets, leveraging our current business platform to bring increased sales and open new -- up -- and open up new sales channels.

Our aim is to use our existing platform to address a larger total market. We are currently in various stages of discussions with potential targets and I do hope to close on acquisition by early 2020. In terms of the outlook, which represents an indication for future revenues, it is slightly ahead over that of the prior quarter.

This demonstrates that we are winning new business which we expect to benefit from later this year and beyond. As I mentioned, we are realigning Magal's two divisions that of projects and that of products. And also, we have started reporting the revenues break out of both those two divisions, so you can better understand our operations.

Each division has an increased focus on its technology and the customers that it's selling to operating the on-payload go-to-market strategy. This new structure enable us to better share our expertise and technology across our global operation, while increasing the focus of our customers -- on our customers.

In parallel, we have identified growth verticals which we're investing in both in R&D and business development. This means, bringing on the right people and tailor our solutions to clients' needs.

Our target verticals are the oil and gas market and the -- as well as the logistic and transportation market and we are already beginning to see some traction and even some POs. Our pipeline remains broad with full potential opportunities including some in those verticals.

We are hopeful that -- to be able to cover -- to convert some of the pipeline into orders and ultimately revenue in the coming quarters.

Looking closely -- more closely at our products, our video management software the VMS Senstar and Symphony, we continue to upgrade and advance that product while tailoring it to certain verticals and applications to which we are selling to increase its effectiveness to customers and potential customers.

Last quarter, we announced the release of our new access control product which is modularly incorporated into our Symphony VMS product. In only a few months, our solution has gained solid interest and we are in discussion with potential customers.

The access control capabilities further expand our addressable market and are highly synergistic with the solutions we are already providing to our customers. In terms of the U.S. southern border project, the U.S. authorities are continuing to test our product along the southern U.S. border.

Unfortunately, I cannot elaborate too much about it because we are under an NDA with the U.S. government. Looking at our product business more closely. Our pipeline continues to get more and more diverse and we are bidding on many opportunities in many regions.

In June, we announced the $5.5 million order for our perimeter intrusion detection technology and solution which will be used to prevent infiltration across an international border. In some places, the border will be protected by sensors and in other concrete wall.

This follows the $6.7 million contract which we announced in April for the maintenance of perimeter intrusion sensors on an international border fence covering over 200 kilometers. This order is an example of how decades-long experience and the capability of providing systems that have more than proven themselves in the field.

It is clear our system having had -- continue to successfully protect international borders and the volatile ones at that Magal solution system which are critical components work really well and are trusted in this field worldwide.

Just like the U.S., countries around the world are increasingly prioritizing securing their borders and physical infrastructure and as they realize that their physical structure by itself without technology is an inadequate solution. Our experience place us in a good position to provide a sensor for any border globally.

We believe global borders will mark future growth engine for Magal. We also received our first PO for a new $1 million in the oil and gas vertical from a large strategic global customer. We see this as an important breakthrough in one of our new strategic verticals with the potential to be long-term growth engine for Magal.

In summary the overall trends are moving in the right direction for us and we continue to see positive future for Magal. Our financial position as well as the backlog remains strong and our pipeline is broad with many potential opportunities. And now I would like to hand over to Kobi to summarize the financial results. Kobi, go ahead..

Thank you, Dror. Good day everyone. Revenues for the second quarter of 2019 were $19.7 million 22% below those of the second quarter of the last year. The geographic revenue breakdown for the quarter was quite diverse as follows, Israel 23%, North America 23%, Latin America 9%, Europe 19%, Africa 16%, Asia and the rest of the world 10%.

The breakout between project revenues and product revenues which also include video were 38% products and 62% projects. Product revenues were $7.5 million while project revenues were $12.2 million combined a total of $19.7 million in revenues. Product revenues this quarter were 4% down year-over-year and project revenue declined 31% year-over-year.

However on the year-to-date basis, the product revenues increased by 8%, while the project revenues declined by 10% for the reasons explained earlier by Dror. Second quarter blended gross margins was 43% of revenues versus 44% last year.

The product gross margins improved to 68% compared with 60% in Q2 last year and the project gross margins were 27%, compared with 36% last year. Our operating expenses were $8.2 million, 10% below the $9 million in the second quarter of the last year.

Operating income was $0.2 million versus operating income of $2.1 million in the second quarter of 2018. EBITDA, which we feel is the most representative measure of the performance and profitability of our business, continued to remain positive.

EBITDA in the quarter was $0.7 million compared with EBITDA of $2.6 million in the second quarter of the last year. Financial expenses in the quarter at $0.4 million compared to financial income of $0.5 million in the second quarter of 2018. This is mainly driven by the strong depreciation of the U.S.

dollar against the new Israeli shekel and Canadian dollar, as well during the second quarter lowering the value of the company's U.S. dollar-denominated monetary assets and thus leading to a higher level of non-cash financial expenses.

This led to a net loss attributable to Magal shareholders in the quarter of $0.2 million or $0.01 per share, versus the profit of $1.7 million or $0.08 per share in Q2 last year. Cash, short-term deposits and restricted deposits as of June 30, 2019, were $52.2 million or $2.26 per share.

As at December 31, 2018, we had $55 million or $2.38 per share in net cash. 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 Sam Rebotsky of SER Asset Management. Please go ahead..

Good afternoon, good morning, Dror and Kobi. As far as the Canadian and Latin American business, could you quantify that? Have they approved this to go forward? Have we started this business in the current quarter? And is the backlog still what it was and we would proceed on schedule? Thank you..

Thank you, Sam. I understand you're referring to the Canadian and the Latin America project business.

Am I right?.

Yes, yes..

So as I mentioned earlier, the main reason is the delays in projects that occurred due to election government issues over there that postponed the budget to 2020..

It's to 2020.

Could you quantify -- I mean do we have this business? Can you quantify the size of this business?.

Its millions of dollars, but it wasn't ours. We were bidding on it, but they pushed the tenders to 2020..

I see, I see.

But is this the reason for the drop-off in the sales in the current quarter?.

Yes. Exactly, this is the main reason, especially in those two territories. The other territories did pretty well and even exceed the -- some of them even exceed the targets that we gave them. But those two we didn't anticipate that the election issues will cause such a dramatic influence on our project business..

Could you quantify the size of that business? Is it $10 million, $20 million? Or, I mean, you say several million? Is it small -- in other words, would you have been able -- if you've got that business, you were expecting it and -- but is that the only reason why your sales are off compared to the previous year?.

Basically, yes. It should have been much more than that $10 million..

Okay, okay.

So do we have any other issues like this going forward? Do you expect to have sales and profits in the subsequent quarters without these issues now? And will they be able to at least meet or exceed the business you had so that you could be profitable?.

Again, since we are dealing with projects, security projects, it vary from quarter-to-quarter. We are doing -- taking some measures in order to, on one hand, reduce cost. On the other, to find other ways to close the gap that occur in those two territories..

So the business that you're trying to buy, is it more even-scaled where you could have more predictable sales and profitability? In other words, you're negotiating to buy some businesses.

Will -- the businesses that you're trying to buy will that be more -- make your revenue and profits more predictable or the same type of business that you have now?.

Again around 40% of the business today is much more predictable, because it's based on products. And the product division prediction is much more accurate than the projects. The projects are varying between quarters. The new acquisitions that we are looking for and focusing in are more related to technology-led projects.

So hopefully, once we close it, we will be able to predict in a much better way. I hope Sam, this answers your question..

Okay. That -- it helps it.

And at this point based on the backlog, do we expect it to be profitable going forward?.

Yes. So in terms of profitability Sam EBITDA which is in our view is the metric that reflects profitability in the best way, I would say that we're definitely targeting a profitable EBITDA year.

However, on the net income level, it's -- it would be a bit more difficult to predict since operations and especially our cash balances are exposed significantly to the FX and we don't know yet what would be the impact so far or direction of the U.S. dollars versus major currencies..

All right. Hopefully you achieve the goals and you make it more profitable on EBITDA and net income. Good luck..

Thank you..

Thanks, Sam..

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

Thank you for taking my question.

The follow-up on the last gentleman's question, would we buy a business that was dilutive? Or would we buy business that is accretive?.

Hi, Thurman. For sure our -- I would say sweet spot of M&A is accretive business. As Dror mentioned technology-driven, high predictability, hopefully high recurring revenue. I mean, it's all on our list and definitely accretive from a profitability perspective. But this is just a wish list.

So we -- obviously while trying to optimize this, sometimes you're compromising something and then manage to grow the business and profitability. And actually looking back at the Aimetis acquisition, which was a loss-making company when we acquired, now we see that video operation is growing nicely and is accretive to our bottom line.

So definitely, there is something that you desire and something that you eventually can get..

Of the $55 million, we have in cash reserves, what portion of that do you think we would spend in buying a business? I mean, would we spend the entire $55 million? Will it be a portion thereof? Or can you put a little color on that?.

I would say that we do need to retain some portion of it for working capital. We operate globally and in several locations, so we have operational cash flow needs. However, the majority of the cash that we have on our balance sheet could and should be used for acquisition -- for growth via acquisitions..

The last statement you made was what? I didn't understand..

I said that the majority -- we do need cash flow to support our working capital in various locations. However, the majority of the $50-plus million that we have in cash should and could serve us for acquisitions..

Can you speak to changes -- could you speak a little bit, is this your first oil and gas contract? And can you put a little color on exactly what you're doing there? And would that not offer tremendous potential going forward in the oil and gas business?.

Yeah. We cannot elaborate too much about the customer. It's – it doesn't allow us to reveal its name. Anyhow, it's the first project that we have with them, a basic one that can lead us to much higher tens of millions of dollars, hopefully in the next – in the following – in this – not only this year, but at least the beginning of next one.

In parallel, we are pushing or promoting our solutions with a few other main well-known names in the oil and gas industry to provide them a full security solution on one hand and through the project division of Magal.

And also, we are doing the same to Senstar the product division pushing our sensors to different system integrators that are working in the oil and gas market. So –.

But can you give us a range of the contract size of these types of working with the oil and gas? Can you give us a range of the revenues you expect?.

Look it's so – it's vary between millions to tens of millions. So, any number between them is the right one but we are targeting – since, it's a very close community once you are there and certified then you can – it can be a very nice growth engine for the company. This is why we invest in it.

Part of the efforts, we are putting on M&A is to find partners that on one hand have technology that suit this market and not just what we have. On the other hand, because they are already selling in this market, so we will gain not only technology we will gain also market share..

And the size of this project was how much?.

Which one? The one which we are bidding on?.

Yes. No, the one you – yes the one you – the one you bid – your first one, yes..

First one is about several millions..

Okay. And my last question. And again, thank you for taking my questions.

I know you said, you've signed a non-disclosure agreement with the southern border relative to the fence, but could you put a little color on that as to whether we're doing well there, we're being considered strongly? Or can you put any more color than just say that you're working with them?.

First, we passed already a few months ago one test which is what's important. There are – there is different technologies that compete on this solution, and I'm talking as a product provider not a project provider. Currently, we are pushing our fiber technology into these – into those requirements.

There are a few competitors that are also in this stage not too many. I think two or three different operators competing on this fiber solution. I think we are in a good shape. But on the other hand, there are competitors and there is also – then there is also competing technology. So, you can get the same solution using different technologies.

If the fiber will be one of the technology of choice then we are competing with other two – two other competitors, and I think we're in good shape. We have good algorithms and good product, but not many – many parameters will be evaluated in the next few months by the U.S. government, before we can – before we'll know if we are there or not.

Another issue is that, we are not familiar yet with the budget that the U.S. government allocated to this project technology-wise. I think they are already investing in some infrastructure either, it's going to be a fence or a concrete wall, we don't know yet, but they didn't put too much money yet on technology..

Okay. And lastly, let me ask one other question, if I could.

Going forward with our backlog, am I understanding you to say that your backlog is adequate for Q3 and Q4 for us to get back to a $25 million level run rate per quarter?.

Because of our project's business volatility, it's very difficult to speak in terms of revenue run rate on a quarterly basis. We can compare probably year-over-year, because there is also some seasonality there.

So, I understand the question and understand, of course, it's a very valid question, if this year we're -- our revenue volume will exceed very high last year's revenue volume of $93 million. So I would say that definitely last year was a very strong year. If you remember we recorded 44% growth year-over-year, which is from a guidance was a big jump.

And actually there was just on the project business the year-over-year growth was 60%, above 60% actually. So we are half year now with -- in 2019. There's still a half year to go. The product business we see a very nice growth year-over-year project.

We mentioned before on one hand the diversity of the pipeline and very nice backlog, but also challenges in specific areas. So, on the year-over-year basis we do see 2019 as again a strong year from revenue perspective.

We're definitely not in the areas of $60-plus million of revenue that this company had for many years in 2016 and 2017, but -- and even if we won't reach specifically this year the same level of -- the same very high level of 2018 revenue on the long-term basis the trend is a growth trend.

And given our pipeline diversity and backlog and our investments in strategic and critical verticals, we do see on the long-term this company growing..

[Operator Instructions] The next question is from Dan Weston of Westcap Management. Please go ahead..

Yeah. Hi. Thank you very much.

Kobi most of the questions have been answered, but could you give us the recurring revenue percentage for the quarter please?.

Yeah. We are at around 20%, one-fifth..

Okay. Great.

And what gross margins are you seeing on the recurring revenue portion?.

Typically the recurring revenue gross margins are higher than usual. We have recurring revenue in both projects and video and products.

So the gross margins of each of them are different, right? So and I would say that it all depends on what sorts of recurring revenue is it, but typically it will be the higher end of the segment or type of revenue stream that it belongs to..

Okay. Great. That's all for me. Thank you very much, Kobi..

Thanks..

The next question is from David Dansby of Janney Montgomery Scott. Please go ahead..

Thanks for taking my question. I don't want to delve too much into the details of the last three acquisitions, but based on the stock price and volume of the year, it's fair to say the market has been very under whelmed. So shareholders have not been rewarded at all for a long time, and so in previous calls, you have all been asked about buybacks.

And we have heard about acquisitions and that's great, but those two things don't have to be mutually exclusive. My question is very simple.

Why is the company not using 10% to 20% of the cash to buyback their stock?.

Hi David. We assess on a continuous basis our cash requirement cash need. When we look at few type of needs and directions, of course, we need cash for -- to support our operations and the project business requires cash for working capital depending on the size of the projects. We also -- and then the majority of the cash is needed for acquisitions.

Buybacks is an option. There are companies that are doing this. Currently based on our projections and pipeline for both projects and acquisition targets, we do aim to spend the capital that we have during, I would say the next year or two.

On acquisitions, we are talking about more than one target and the idea is not to do buybacks and afterwards start looking for capital that could be sometimes also expensive if it's external financing et cetera.

So at the moment once we will feel that we do have some excess, and actually we don't need all this cash to support our operations, organic growth and acquisitions buyback is definitely a valid option to consider..

Okay. Thank you..

The next question is from Ken Liddy of Oppenheimer. Please go ahead..

Hi, good afternoon.

Could you tell us what region of the world, the oil and gas tenders and business is?.

Again, Ken, I cannot tell you exactly what is the country because I'm tied with those customers. But it's -- currently it's mainly Eastern Europe, Africa through Europe, through Europe partners and also U.S. We have a partner over there in the U.S. We have a partner in Europe and we have partners in Eastern Europe..

And one other question. With regards to the southern border, in the last call you mentioned you may be testing more than one technology at the southern border.

Is that still something that's possible, probable? Are you looking at other products or technologies active southern border?.

It may, but currently we're focusing on the best solutions or technologies we can provide that suits, their requirement is based on our fiber-optic technology. So this is what we are focusing on. We are increasingly improving our algorithms and capabilities using the fiber optics and this is where -- and there we are putting our minor efforts..

And how long have you been testing at the southern border? And how long do you think the testing may continue?.

They've tested it already a few months ago. It's not a continuous test. They are doing a test for a week or a few weeks and then they're going back home and they're doing their own evaluation. So we did one and we are pretty close to -- we are starting a new one in a few weeks..

And will you be able to release anything to investors regarding any of these tests as far as the press release?.

About the previous one?.

No about testing at the southern border.

Any type of color regarding some of these opportunities or anything?.

Not more than what I already elaborated. Sorry..

Are any of these like potential revenue generating tests themselves?.

No. There's no revenue from the tests themselves. Tests are being done on our own account, not getting anything out of it. If they start, hopefully they start some pilots on the border itself then I assume that will be revenue attach rates. But currently everything is our own investment..

And taking a step back with regards to the North American also in Israel.

How is business overall looking? Activity, backlog, pipeline?.

Again the North America is strong and growing. Israel is growing. The backlog as we said is pretty stable even higher than what we had in the previous quarter. I think -- I don't know if it answers your question, but that may -- need some more [ph] details..

Understood. Also I saw that one of the -- a senior people from Senstar is back at the company the last couple of months.

Is that true?.

What -- again what from Senstar?.

A senior product person. I saw something with regards to someone coming back to the company..

In North America we are putting lots of efforts to grow the business. One senior manager came back to the company after -- who left us, I think, something like a year ago. But other than that it's pretty stable and nothing more than that..

Understood.

And could you talk about your cannabis business? Is that growing? Does that continue to grow? Do you see a pipeline growing there, as far as with security?.

Cannabis. The cannabis business is not -- we thought, it's going to be a major issue for us, but worldwide they reduced dramatically the requirements and many moms-and-pops dealers and integrators are doing those projects. We still have a few in Canada and mostly in the U.S.

We have some in Europe but it's not -- it does look like a major vertical in the future. Again, they reduced the requirements and they don't need the true high-end technology, the same we are providing. So you can buy in Walmart a few cameras, simple software and you can have a security system for your cannabis farm.

Unfortunately, this is what -- this is the direction currently..

Understood. Okay. Thanks for taking my questions..

You're welcome. Thank you..

The next question is from Nakhum Moschitz [ph]. Please go ahead..

Hello. Thank you very much for taking my call. Actually, the last guy, he asked all the questions I had and answered. And anyway, please go ahead and keep up the good job. Thank you very much. Have a nice day..

Thank you, Nakhum..

There are no further questions at this time. Before I ask Mr. Sharon to go ahead with his closing statement, I would like to remind participants that a replay of this call will be available on Magal's website www.magalsecurity.com. Mr.

Sharon would you like to make your concluding statement?.

Yes. Thank you very much. Again, on behalf of the management of Magal, I would like to thank you for your continued interest and long-term support of our business. And I look forward to updating you in the next quarter. Have a good day and a nice weekend..

Thank you. This concludes the Magal Security Systems second quarter 2019 results conference call. Thank you for your participation. You may go ahead and disconnect..