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Executives

Ehud Helft – CCG Investor Relations

Eitan Livneh – President and Chief Executive Officer

Ilan Ovadia – Chief Finance Officer

Analysts

Thurman L. Willis – Thurman Willis, Inc.

Fred Ehrman – BMI Capital LLC

Kenneth W. Liddy – Wells Fargo Advisors, LLC

Magal Security Systems Ltd. (MAGS) Q3 2013 Earnings Conference Call November 27, 2013 10:00 AM ET

Operator

Ladies and gentlemen thank you for standing by. Welcome to the Magal Security Systems Third 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 November 27, 2013.

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, marketing 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.

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

Ehud Helft

Good day to all of you. Welcome to Magal’s third quarter 2013 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 today on the call are, Mr. Eitan Livneh, President and CEO; and Mr. Ilan Ovadia, the Chief Finance Officer. Eitan will summarize the key highlights of the quarter followed by Ilan who will review Magal’s financial performance of the quarter. We will then open the call for the question-and-answer session.

And with that I would like to turn over the call to Eitan. Eitan, go ahead please.

Eitan Livneh

Thank you, Ehud. First, I would like to apologize on my voice. I’m almost lost my voice. I would like to welcome you all and thank you for joining us today. 2013 has been tough year for Magal, while I’m not happy with our weaker performance. I am encouraged by the recent increase in our backlog and the strong pipeline that we see ahead of us. In addition, we are maintaining a tight control over our expenses despite lower revenue and increased spending money on our cyber activities and our increased presence in some key geography.

Our net loss has remained kept and our net cash level has remained strong. We reported revenue of $12.8 million, a slight improvement over the last quarter revenue of $12.2 million, but below revenue of $23 million in the third quarter of last year. As I explained last quarter, Mexico has been much weaker this year due to the delays in Homeland Security budget. I do note that the Latin American region overall remains a key target for us and we are investing in it.

At the same time, we are treating carefully and we are looking for synergistic acquisition targets, which will blast the local Brazilian presence. I do hope that during 2014, we will be able to further this strategy. In Columbia, we recently announced an order to secure oil and gas facility there, the first order from the region that we are very pleased with. We see significant potential for growth in the coming years and the Latin American region as a whole remains a long-term growth engine for Magal.

Europe also remained weak in the quarter due to the economy situation in the region. With regard to Africa, the continent continues to provide us with a good level of business. While during 2012 and the beginning of 2013, we completed some major project in the region. The new project we got this year has been smaller and more diverse. As you can see from the press release, we put out a few weeks ago announcing $6 million in two orders, one a follow-on at the port of Mombasa, Kenya and the second new order in different country. Business has remained robust and our pipeline in Africa remains strong.

Our North American subsidiaries covering the United States and Canada continue to perform well, balancing a portion of the shortfall in revenue from the weaker geographies. In Israel, the pilot phase of the protecting the southern border was completed successfully and we won an order for the second testing phase. We believe this prestigious work has to – has the potential to lead to sustainable revenue over prolonged periods while the timing is always uncertain when it comes to government contracts, we believe we are in the strong position here.

I would like to highlight that while the business that we are enduing means lumpiness in revenue. Magal is in a different situation that it was only a two years ago. One of the clearest developments in Magal is our financial strength. Our balance sheet is exceptionally strong for company of our size was over $35 million in cash, slightly up from last quarter and it is over half of the value of our current market capitalization. It provides us with significant financial flexibility more so than we’ve ever had in the past and we are using this strong cash position to invest in Magal’s future for R&D and mergers and acquisitions.

On the M&A front, we have been actively examining opportunities and have been discussion with potential candidates that have not yet materialized, but we expect that some will do in 2014. We have also completed a strategic review with an external consultant to identify M&A opportunities in earlier adjusted to our core business that will expand over addressable market and we intend to execute this strategy during 2014.

In terms of research and development, I would like to share with you some of our recent developments. We are very pleased with this progress that CyberSeal has made. We continue to work hard on bringing out complementary offering of monitory solution for networks, combined protection in both the physical and logical world. We have already made many discussions with customers and we’re seeing interest in our integrated solution.

We just completed the patent-pending filed network switch which we can plug and play into ordinary Ethernet networks, providing a high level of cyber security. We will officially launch this product in the first quarter next year and we are already seeing interest from some of the integrator we work with. Our efforts in the cyber security space underline our strategy to become a leader in the convergence of physical and cyber security.

RoboGuard is the new product we recently developed and we are seeing significant interest from customers. RoboGuard is a robot that runs on the elevated monorail along the perimeter of protected sites, all borderlines, carrying an assortment of sensor and potential payloads. Your robot can response promptly and rush to the exact zone of a location where an intrusion is suspected. It can automatically patrol and inspect the fence integrity, looking for holes or suspicious nearby objects, by using sophisticated video analytics algorithms. We have a video on our website on how this system works and I urge you to look at it.

RoboGuard is a better choice for sensitive unattended perimeter of critical sites, where the customer cannot afford to man enough first-response units in order to respond promptly to security events. RoboGuard can be used in order to prioritize the scarce manned patrols and mediate the initial interaction with intruders. The system is useful to airports, seaports, military and other sensitive sites such as prisons and border fences. In prison and border for example, the system can be used to perform the routine burden of regular inspection of the perimeter fence.

2013 will soon be behind. And looking ahead to 2014, we have much to be optimistic about. We recently announced a number of orders, which have increased our backlog, contribute to our 2014 results. We are also seeing improved prospects in our current pipeline. Furthermore, 2014 will be the year in which we will begin to see the fruits of our recent R&D effort particularly our investment in the CyberSeal, our Cyber Security – our Cyber Security activity. I remain excited about our future and long-term potential.

I will now hand over the call to Ilan for the financial review. Ilan, please.

Ilan Ovadia

Thanks Eitan. Revenues for the third quarter of 2013 were $12.8 million, a decrease of 45% compared with the $23.5 million in revenues for the third quarter of 2012. Sales by geography in the quarter were as follows; North America 26%, Israel 22%, Africa 25%, Europe 10%, South and Latin America 2% and the rest of the world amounted to 15%.

Gross profit in the quarter was $6.2 million, or 47.9% of revenues, a decrease of 37% compared to gross profit of $9.7 million, or 41.3% of revenues in the third quarter of 2012. The high gross margin in the quarter was due to the recognition of deferred revenues from a large project which was completed in the quarter as well as function of changes in the revenue mix. Our typical gross margin level is expected in the high 30s.

Operating expenses in the quarter amounted to $6.3 million. This is lower when compared with $8 million that we reported in the third 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 investing firmly in our R&D activities and our R&D expenses is $1.3 million were slightly higher than the average of the past few quarters.

The operating loss for the quarter was $124,000 million compared with an operating income of $1.7 million in the third quarter of last year. Net loss in the quarter was $316,000 compared with a net income of $1.8 million in the third quarter of 2012. Cash and short-term deposits net of current bank debt as of September 30, 2013 were $35.4 million, or $2.2 per share compared with cash and short-term deposits net of current bank debt of $34.2 million, or $2.12 per share, on June 30, 2013.

That concludes my remarks. We would be happy to take your question now. Operator?

Question-and-Answer Session

Operator

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

Thurman L. Willis – Thurman Willis, Inc.

I would just like to congratulate you on your strategy and what you have done at the expenditures you made, your past gain and future gain. So I salute all of management and the company for what you have done. So congratulations on the quarter and congratulations on your formula for success. Will you able to hear me okay?

Eitan Livneh

Yes, thank you very much.

Thurman L. Willis – Thurman Willis, Inc.

One of the thing and this may come unusual, but I know you are in an acquisition mode and – own MAGS, I think it’s one of the best security companies in this environment. I’ll just make a very short remark, it will be short and then I will get back in the queue. I would say that in your consolidation, I would encourage you to look at an American company with a 45-year-old history named MACE. I’m sure you have heard of the pepper spray MACE and all I would say is if you would read the press release yesterday, see the successes that they have had, low price that their stock is selling for, the fact that they are the only non-lethal gel spray in the market.

I think a combination of you acquiring MACE would add tremendously to your potential because it is a household name and it has exclusives with Sports Authority series came out Auto Zone, Ace and Dick’s sporting goods and many, many good things. They have cleaned up the company and I’m not trying to sell MACE to you as much as I’m trying to say that I think MAGS and MACE would make a tremendous combination. And so, I’ll just leave you of that and ask you to respectfully thoroughly review this company, it is selling at a cheap price and it has no debt and I think their sales are getting ready to explode because of the consumer request for pepper spray and a gun of 20 feet plus of security equipment.

And I don’t think any of your products overlap with theirs and I think it would just add to your company and MACE in a tremendous way. So I just make that as a comment as a company that I would like for you to look at. Again, I appreciate you taking my question and just congratulations on our – what I considered it is going to be a really good 2014.

Eitan Livneh

Thank you very much for your comments and we were looking to that MACE Company. I’m not familiar with the company, but we will review it. Thank you very much for your idea.

Thurman L. Willis – Thurman Willis, Inc.

Thank you, thank you.

Operator

Your next question is from Fred Ehrman. Please go ahead.

Fred Ehrman – BMI Capital LLC

Good afternoon gentlemen. Nice 2014 projection, hopefully the execution will meet the expectations. One quick question. In your press release as well as your comments, opening comments, you talked about having a little over $35 million in cash. Looking at the balance sheet on September 30th, I see $27.9 million in cash and cash equivalents and $15.8 million of a short-term bank deposit that adds up to $43 million. What’s the disparity? How do you reconcile those two numbers?

Ilan Ovadia

When we mentioned the figure of – that you mentioned it was a net of short-term bank credit which amounted to around $5.5 million.

Fred Ehrman – BMI Capital LLC

All right, so you are – yes, $5.6 million, I see that on the liability side so that that brings it down to about $37 million, $38 million…

Ilan Ovadia

That is about $39 million and then we have long-term bank debt of $2 million, so $37 million.

Fred Ehrman – BMI Capital LLC

Right, okay, I would just suggest in the future when you report generally those kinds of calculations aren’t done, if you say this is the amount – or you’re saying net cash…

Ilan Ovadia

Yes.

Fred Ehrman – BMI Capital LLC

It kind of droves the meter off a little bit. I would say that maybe that should go – you should go into detail a little more and how that numbers has arrived at?

Ilan Ovadia

Okay.

Fred Ehrman – BMI Capital LLC

Okay, thank you very much.

Eitan Livneh

Thank you very much.

Operator

The next question is from [indiscernible]. Please go ahead.

Unidentified Analyst

Hi, thank you and hi Eitan and Ilan, so a few short questions for me. The first question is you mentioned weakness in Mexico to homeland security spending. What do you see in 2014, do you see that improving?

Eitan Livneh

Well, we expect Mexico have been gone through change of administration at the beginning of this year, there were election and then the President enter this office and the Homeland Security Department of Ministry have been gone through a very major organizational change. The change in the structure of responsibilities and we expected that it stabilized now actually at the very last moment of the [indiscernible] and we hope to see some better business in the next year, yes we do.

Unidentified Analyst

Okay, great. And then you also mentioned that backlog improved. Can you give anymore specifics of backlog higher than it was at the end of last quarter? Is it the highest as it’s been so far this year? Can you maybe say a little bit more?

Eitan Livneh

As we announced lately about the recent orders and I can say that the backlog was at this point is better than it was three months ago definitely. It is the orders that we have been expected for many months and it’s in the high 20s I would say. I don’t want to refer to the specific number because just in order not to bring bad luck for…

Unidentified Analyst

Right, right, right, okay.

Eitan Livneh

Next two month expectation.

Unidentified Analyst

Great, excellent. And then I know that in the last couple of years, early results were affected by very large deals, but outside of that, what do you see in terms of seasonality. I mean is Q4 usually better than Q3 or is it Q3 supposed to be stronger because it’s a government year-end, is there any patterns to your business or is it…

Eitan Livneh

Well, we don’t have any cruel in our behavior. In some years we have the better Q4, in some lower than Q3, to do a lot on the projects in the hands. Those projects that we have announced lately will have a very little if at all any impact on this year because most of them just started and the recognition of project takes time. So we will have fourth quarter which will not show much better numbers. But we are looking towards the execution of those projects in the next year and as I mentioned very little impact on the fourth quarter.

Unidentified Analyst

Okay, great. And one last question from me, this is about CyberSeal. I believe that you’ve mentioned that you expect to see deals in 2014. Do you have a sense of deal size and the gross margin for CyberSeal?

Ilan Ovadia

No, we expected that CyberSeal will start selling the products. And we expected higher margin than on our regular numbers, but the deal size will – I doubt if we will call in this in beginning. Once we will make a project that will implement the convergence that we are trying to push into the market then the CyberSeal will come as a part of the overall solution Magal is – offer. So in general, yes, we expect higher numbers with CyberSeal both on the revenue as well as in the margins.

Unidentified Analyst

Okay, great. That’s it from me. Thank you.

Eitan Livneh

Thank you very much.

Operator

Your next question is from Ken Liddy of Wells Fargo. Please go ahead.

Kenneth W. Liddy – Wells Fargo Advisors, LLC

Good afternoon. You mentioned in your press release that you are a part of a group that’s going to be securing the southern border of Israel. Could you talk a little bit more about that?

Eitan Livneh

We will not talk as a group, we are [indiscernible] and we are competing with others. The Ministry of Defense is expected, they choose three companies out of four and following the test and these three companies are taking part of the next step and that’s it.

Kenneth W. Liddy – Wells Fargo Advisors, LLC

So, three out of the four companies are going to be joining the border?

Eitan Livneh

No, no three, I don’t know out of how many, three were chosen and qualified to go for the next test phase, not yet…

Kenneth W. Liddy – Wells Fargo Advisors, LLC

Okay.

Eitan Livneh

Any announcement on the results of the operational test, it’s already in process.

Kenneth W. Liddy – Wells Fargo Advisors, LLC

And if you do – when business stands there, would that be something will impact 2014 or 2015 or beginning and later 2014 or…?

Eitan Livneh

As Magal experienced in the Israeli border goes back over 30 years, we are looking at that as a potential business for the coming 20 years. So we will refer to this as a strategy challenge to us and we expect the decision on vendors will come sometimes late 2014. And as in the past, there is more likely that they will pickup at least two maybe three, the three will become vendors qualified, but if the three will be there we will be there. We hope that we will be there anyhow and this business will be with us on a yearly basis, not big numbers, but every year for the coming decade at least.

Kenneth W. Liddy – Wells Fargo Advisors, LLC

When you say not big numbers, are you talking about $5 million to $10 million or $2 million to $5 million?

Eitan Livneh

I don’t know yet but the first phase will be higher because that comes with the relations of the new solution on the new barriers and thereafter it will become like ongoing in the lower edge of the numbers.

Kenneth W. Liddy – Wells Fargo Advisors, LLC

Okay, as far as the recent wins that you had quite a few in the last 45 days. Is there any macroeconomic reason that it all kind of just started flowing like this or is there any type of a renewed interest in securing sites because of their recent terrorists bombing especially in Kenya?

Eitan Livneh

Well I have the same information on that level as you have. Yes, I can imagine that in Kenya some of the processes was moving faster in the last two months or lately due to the terrorist attack [Indiscernible], but I can see some of the projects delayed until the last quarter due to slow moving with the government budgets, but once the – and goes all over the world people realize that the year comes to its end and they are trying to materialize their chance, but no I don’t have any specific economy understanding that bring that in the last 45 days.

Kenneth W. Liddy – Wells Fargo Advisors, LLC

Do you see the momentum continuing as far as wins in next few months?

Eitan Livneh

Not the same momentum because we are not expecting this level of new orders, but we see some additional – that size order will come and we will have those in the next three months or so and of course we will announce on them when they’ll come.

Kenneth W. Liddy – Wells Fargo Advisors, LLC

As far as looking at 2014, is there anything that you particularly saw in the pipeline, is there anything out there that you are particularly looking for as far as larger contracts?

Eitan Livneh

We are expecting 2014 to continue the – and improve over 2014 as I mentioned. We cannot refer to any specific large order or small order. We are doing our efforts on both. If there are large opportunities, we try to be competitive and we’re looking after the relatively small, if you speak about $2.5 million to $5 million build project, but they are taking the advantage of ourselves being in many territories considered as a local domestic player like in Latin America. Well in Africa Magal Israel gain some reputation that helps us a lot, but other than that there are not – nothing special that we expected.

Kenneth W. Liddy – Wells Fargo Advisors, LLC

As far as your North American subsidiary, it seems like it’s been quiet for sometime there, do you expect any sort of rebound in that division?

Eitan Livneh

We do not see any major change in the North American market. We are happy with the fact that we have succeeded in 2013 to improve overall our 2012 North American numbers and we expected – we expect to see some increase also in next year, that not of any major change.

Kenneth W. Liddy – Wells Fargo Advisors, LLC

Has there been any progress with the U.S. border and Mexico and Canada…

Eitan Livneh

Tell about.

Kenneth W. Liddy – Wells Fargo Advisors, LLC

Is that still an active pipeline issue?

Eitan Livneh

Yes, but you know more better than I about the U.S. authorities are facing in the border was Mexico mainly. We are looking after that. We have placed our proposal with one of the large American enterprises and we are still waiting inline with others.

Kenneth W. Liddy – Wells Fargo Advisors, LLC

The third quarter – you really had a dramatically lower third quarter this year than last year in revenue, did any revenue fall into the fourth quarter and today it seems like….

Eitan Livneh

No, we don’t see any major force between the third and the fourth quarter. Some of the projects that were delayed this year and we’ve announced on them lately will have a better – we will enjoy the portion in our 2014, but not necessarily or very little of that in 2014 fourth quarter. And so 2014…

Kenneth W. Liddy – Wells Fargo Advisors, LLC

And the other dramatic thing is, it is shocking that if lowered your overhead as much as you have, how have you done that, I mean the numbers are battling that your – basically breakeven at the $12 million level. Could you talk a little bit about that?

Eitan Livneh

You can see the part of it has to do with the reduction of our revenue that has an impact on our sales and marketing expenses. And the other part of our G&A or our overhead, this was planned and this is including our policy to keep as tight as possible on that level because we are familiar with the instability coming from our projects and we try to keep ourselves I would call it athletics.

Kenneth W. Liddy – Wells Fargo Advisors, LLC

Previously you mentioned about being profitable in the second half of the year, do you still think that you can achieve profitability for the second half of the year?

Eitan Livneh

It looks now following the results of the third quarter, it looks different and I assume we will not be profitable.

Kenneth W. Liddy – Wells Fargo Advisors, LLC

Okay. And when would you be expecting the recent orders starting to hit revenue like the second and third quarter of next year?

Eitan Livneh

I can imagine a part of them even on the first one.

Kenneth W. Liddy – Wells Fargo Advisors, LLC

Okay, okay, great. Thanks for answering my question.

Eitan Livneh

Thank you very much.

Operator

(Operator Instructions) We have a follow-up question from Ken Liddy of Wells Fargo. Please go ahead.

Kenneth W. Liddy – Wells Fargo Advisors, LLC

Just one more question. Do you plan on doing any type of road show talking to investors in the near future?

Eitan Livneh

That will – I think will be a part of our activity in the mergers and acquisitions domain and that will come together. Once we will have something in hand then we will make something different than we are doing now.

Kenneth W. Liddy – Wells Fargo Advisors, LLC

And with your CyberSeal, how is the reception of your existing customers with that product – the idea of that product?

Eitan Livneh

As I mentioned, most of the people we speak on the idea whether they are consultant all over the world, customers in certain regions in the world and their reaction was very positive, but it did not turn yet to any real request for proposal or a tender, that will take time and we know that from day one, it’s not a surprise to us.

Kenneth W. Liddy – Wells Fargo Advisors, LLC

How much do you think that – in 2013, 2015 how much do you think that could add to your revenue and profits?

Unidentified Company Representative

That’s too early to say, I’m sorry.

Kenneth W. Liddy – Wells Fargo Advisors, LLC

Okay, I understood. Okay thanks again.

Unidentified Company Representative

Thank you very much.

Operator

There are no further questions at this time. Before I ask Mr. 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 make your concluding statement?

Eitan Livneh

Just before making my concluding statement, I would like to invite you all to visit Magal website. We have added some videos and reports on events which will give you an idea of the latest marketing activity we have done here in Israel with the exposure or the presentation of our new technology and new product. And with that I would like to thank you all for continued – show continued interest and long-term support of our business. If you have any questions, please feel free to call me or my Investor Relations team whose contact details on our press releases. I do look forward to speaking with you and updating you again next quarter. Have a good day. Thank you very much.

Operator

Thank you. This concludes the Magal Security Systems third quarter 2013 results conference call. Thank you for your participation. You may go ahead and disconnect.

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