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Edited Transcript of MAGS earnings conference call or presentation 16-Nov-17 3:00pm GMT

Thomson Reuters StreetEvents

Q3 2017 Magal Security Systems Ltd Earnings Call

Yahud Jan 4, 2018 (Thomson StreetEvents) -- Edited Transcript of Magal Security Systems Ltd earnings conference call or presentation Thursday, November 16, 2017 at 3:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Gavriel Frohwein

GK Investor & Public Relations - IR

* Saar Koursh

Magal Security Systems Ltd. - CEO and President

* Kobi Vinokur

Magal Security Systems Ltd. - CFO

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Conference Call Participants

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* Bruce Tuchman

BofA Merrill Lynch Wealth Management - Financial Advisor

* Kevin Darryl Dede

H.C. Wainwright & Co, LLC, Research Division - MD & Senior Technology Analyst

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Presentation

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Operator [1]

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Ladies and gentlemen, thank you for standing by. Welcome to Magal's Third Quarter 2017 Results Conference Call. (Operator Instructions) 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.magal-s3.com.

I would now like to hand over the call to Mr. Gavriel Frohwein of GK Investor Relations. Mr. Frohwein, would you like to begin, please?

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Gavriel Frohwein, GK Investor & Public Relations - IR [2]

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Thank you, operator. Welcome to Magal's Third Quarter 2017 Conference Call. I'd like to welcome all of you to the conference call and thank Magal's management for hosting this call. With us on the call today are Mr. Saar Koursh, CEO; and Mr. Kobi Vinokur, CFO. Saar will summarize the key highlights of the quarter, 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 projections, and Magal cannot guarantee that they will, in fact, occur. Magal does not assume any obligation to update this information. Actual events or results may differ materially from those projected, including as a result of changing market trends, reduced demand or 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 would like -- I would now hand over the call to Saar. Saar, please go ahead.

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Saar Koursh, Magal Security Systems Ltd. - CEO and President [3]

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Thank you, Gavriel. I would like to welcome all of you to our conference call and thank you for joining us today. In today's call, I would like, firstly, to provide a brief overview of our financial results. I would like to talk about the recent improvements in orders we have seen in the quarter and beyond. I will discuss some of the improvements we made to our business structure and the resulting improved cost structure we have seen in the quarter and finally, discuss some of the new products, which we believe will contribute to our sale over the coming years.

We reported revenue of $13.7 million. While this is a slight improvement over the last quarter, it still reflects the ongoing weakness revenue from North America. While our revenue level from this region has improved this quarter by 27% sequentially, it is still below last year levels due to the impact of critical infrastructure budget delays in the U.S.

The improvement in the financial performance in the North American region that we've seen this quarter is driven by 2 aspects: first, the development and execution of diversified revenue streams that are not directly related to the federal and state budgets such as the medical field, retail sector and logistics; second, we took measures and made adjustment to our operational cost structure in North America, the initial effect of which is already reflected in the third quarter results and the full effect will be visible in the next quarter and beyond. As a result, over this quarter, we delivered breakeven EBITDA in comparison to the negative $1.2 million EBITDA last quarter.

I want to spend a few moments discussing some of the recent orders we have won, which led to a much improved backlog as of the end of the third quarter. We believe that this set up for the fourth quarter and into 2018. We see ongoing interest for protection of critical sites such as correctional facility, prisons, power station and airport using our products and technologies. While we have shown some recent wins, we are also in the final stages with a good chance of receiving some further critical infrastructure protection contracts.

In terms of some of the recent wins which contributed to our backlog, in September we received a $5 million order to provide security solution for correctional facility. The orders include the supply of advanced video solutions and perimeter detection smart solution, including Omnitrax buried cable sensor, all of which will be delivered over the coming year. We also recently launched a new vertical for security solution for the medical marijuana industry in North America, which is tightly regulated from a security standpoint. In the last few months, we have seen a number of orders in this field covering several sites, and each site amounts to a few hundreds of thousands of dollars. As the market mature, we expect to see more such orders soon.

Last week, we announced $3.5 million in orders for integrated security solution and maintenance for several major international airports. These include Munich Airport, one of the largest European airport that has been using our video solution over the past few years and is now extending their use of our system. We also won new orders with Ben Gurion Airport in Israel, Indira Gandhi International Airport in New Delhi as well as Barcelona Airport in Spain, which is a new customer for us.

The orders include video management and analytics systems, PID system and Fortis4G as well as the framework order for maintenance. Delivery on these orders has started already in Q4 and will continue into the next year. These customers, which are a mix of both new and returning customer, recognize our unique offering and are important references for us in both the airport security vertical as well as the correctional facility vertical.

Another important aspect of our third quarter results that I would like to highlight is a significant decrease in our operational expense level by $1.3 million or 15% below that of the previous quarter. Until the end of the second quarter, our recently acquired subsidiary, Aimetis, was operating as independent subsidiary of Magal. Over this summer, we fully amalgamated this subsidiary with our North American subsidiary, Senstar. The cost savings are already very apparent in our third quarter results. It has allowed us to eliminate some of duplicated costs in G&A and sales and marketing and is planned to bring us some tax saving as well. We will continue to experience the positive effect and the lower operating expense level in upcoming quarters.

Beyond the savings, the amalgamation also enabled us to be much more focused of the North American division rather than through reducing management time and investments. Furthermore, it allowed us to better cross-sell the newly acquired video product within our existing product portfolio and vice versa by having one customer-focused sales team selling PIDS, video and several product lines as part of a unified product portfolio under the Senstar brand.

Finally, we have continuously launched new products throughout this year, which we believe provide us with a number of potential growth engine for the coming years. As a company, we spend around 12% of revenue on an ongoing basis on R&D in order to maintain the strong market position we have in many in our markets while building future growth engines.

I would like to highlight a new product that we have released, and for those interested, you can see it on our subsidiary Senstar's website. We launched the LM100, which combined 2 key security functions in 1 product. It detects intrusion attempts through fence perforation while at the same time provides intelligence perimeter illumination at fence line. The system form a wireless mesh and can work together as a security sensor as well as seamlessly integrated and communicate with the security management system.

I recently attended the ASIS security show in Dallas where we launched the product, and there were many potential customer in attendance. We saw significant interest in combination of these 2 favorites provides significant ROI and ease of installation. I do expect to see growing orders and increased contribution to the revenue from this product in the coming year.

In summary, while 2017 has been a challenging year so far, given our much improved cost structure as well as an increased order flow and backlog, we believe we will show improvements in the coming quarters. North America is still our most important market, and we are gradually recovering through the diversification of our revenue stream and by the cost efficiency measures we took there. When federal and state budget do free up, we expect significant upside.

And now over to you, Kobi. Please go ahead.

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Kobi Vinokur, Magal Security Systems Ltd. - CFO [4]

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Thanks, Saar. Revenues for the third quarter of 2017 were $13.7 million, 3% above those of the previous quarter and 36% below those of the third quarter of 2016. The geographic revenue breakdown for the quarter was fairly evenly spread across all regions as follows: North America, 28%, an improvement from 23% last quarter; Israel, 18%; Europe, 18%; Africa, 13%; Latin America, 13%; Asia and the rest of the world, 10%.

Third quarter gross margin was 47.7% of revenues versus 51.1% last year and 50.2% in the previous quarter. The low margin in the quarter was due to the mix of products and projects sold in the quarter, which favored a comparatively lower margin. Operating loss in the quarter was $528,000 compared with a loss of $1.7 million last quarter and a profit of $1.6 million last year.

During the quarter, we saw a financial income of $532,000. This is compared to a financial expense of $491,000 in the third quarter last year and an expense of $1.4 million in the previous quarter. The financial income and expenses mostly relate to the noncash financial charges generated by the U.S. dollar-denominated deposits.

Net loss in the quarter was $193,000 or $0.01 per share. Net profit in the third quarter of the last year was $647,000 or 4% (sic) [$0.04] per share. Net loss in the previous quarter was $3.3 million or $0.14 per share.

EBITDA in the third quarter of 2017 was just near breakeven. This is compared to a negative $1.2 million EBITDA in the prior quarter and $2.1 million positive in the third quarter of 2016.

Cash, short-term deposits and restricted deposits as of September 30, 2017, was $48 million or $2.09 per share versus $52.5 million or $2.29 per share on December 31, 2016. As of September 30, 2017, we have no bank debt in Magal.

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

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Questions and Answers

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Operator [1]

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(Operator Instructions) The first question is from Kevin Dede of H.C. Wainwright.

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Kevin Darryl Dede, H.C. Wainwright & Co, LLC, Research Division - MD & Senior Technology Analyst [2]

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So just a couple of things, I guess. I'm curious, given the slew of airport orders and correctional facility orders, I was wondering -- I know that you're working on them already. I'm just wondering how you'd expect to recognize revenue from them.

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Saar Koursh, Magal Security Systems Ltd. - CEO and President [3]

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So thank you, Kevin. I will start by saying that the deliveries of all these orders are already in process during this quarter, fourth quarter. And obviously, some of them will be also throughout the first half of 2018.

Kobi, anything specifically on the revenue recognition side?

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Kobi Vinokur, Magal Security Systems Ltd. - CFO [4]

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Those orders that relate to turnkey project type of activity are recognized on the basis of per percentage of completion, while product revenue is recognized on the basis of deliveries. So overall, on the both types of activities, we expect the revenue to be recognized over Q4 this year and Q1 next year.

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Kevin Darryl Dede, H.C. Wainwright & Co, LLC, Research Division - MD & Senior Technology Analyst [5]

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Okay. So Saar, it seems that -- and per your comments, you're thinking that you've got great exposure to changes in the budget in North America. And I'm just curious to know what sort of feedback you're getting from your contacts in North America. How do you think the market looks? What do you think the chances are things change? And then if they do, what sort of time frame do you think? And -- I mean, to the extent that you can talk to it, how significant would the change be relative to your -- sort of the $13 million to $14 million run rate that we're at now?

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Saar Koursh, Magal Security Systems Ltd. - CEO and President [6]

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So let's differentiate between the budgets that are dependent mostly on the government budget, either a federal or state budget, to the public sector. In public sector, there is no -- there is actually a growth that we see in North America. And this is one of the main reason that we started diversify from just being focused on the high end of the market, government correctional facility, airport, et cetera, to more industrial commercial sites.

In the government budget, we do see some start of the recovery, but still some of the project are being delayed and delayed. Definitely, they cannot be delayed forever. We do expect that a budget will be released. Still, some of them still by -- we still have a few more weeks to do. But mostly, we'll see recovery in 2018 because they cannot hold budgets forever. There are things that need to be done, and we are very optimistic on the growth of the market.

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Kevin Darryl Dede, H.C. Wainwright & Co, LLC, Research Division - MD & Senior Technology Analyst [7]

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Okay. That helps. Is there any way that you can characterize how you think it might change your revenue run rate to the extent that you can or are comfortable?

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Saar Koursh, Magal Security Systems Ltd. - CEO and President [8]

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We would like very much to go back to previous year. If you look on the previous -- in 2016 second half of the year, we were in a run rate which is about $20 million in terms of revenue. And this is definitely our goal to be back to that number.

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Kevin Darryl Dede, H.C. Wainwright & Co, LLC, Research Division - MD & Senior Technology Analyst [9]

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Okay. Based on some recent conversations, I understand there could be some interesting developments with your VMS capabilities. I know that it's primarily designed for security implementation, but I understand that there could be applications outside of that, perhaps in the auto industry or in retail. And I was wondering if you might be able to add some color around that.

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Saar Koursh, Magal Security Systems Ltd. - CEO and President [10]

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Yes. I think it's a good point. First, I must say that this quarter, we saw an increase in our VMS revenue. Even though that they are still relatively small portion of our overall business, we do see strong growth over the third quarter and on. As you said, the VMS is not used only for security. There are many other types of application, mainly using the analytic that you can provide the proactive actions and definitely a business intelligence as well.

We already signed several contracts with such customers, for example, with some of the retail company that the system will provide them both for security purposes and for business intelligence from basic things like able to analyze how many people got into the store, what time, what are the queue to the cashiers, density, heat map, et cetera. There are endless type of analytics that you're able to use in order to generate business intelligence.

And once they made the investment, the initial investment, in the cameras and, of course, in the VMS and the software, this is relatively a simple add-on that we can provide our customers in the retail and other segments as well. So I guess we are definitely looking to expand that capabilities and not just to be focused on security.

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Kevin Darryl Dede, H.C. Wainwright & Co, LLC, Research Division - MD & Senior Technology Analyst [11]

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Okay. Can you talk to how those contracts are structured? Are -- is it sort of a SaaS model? Or do you sell a license? How does the business model tie to the financial model?

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Saar Koursh, Magal Security Systems Ltd. - CEO and President [12]

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We are using all of the above. We are using both. We are selling channel, and we also sell services. It's also important to mention that we see growth quarter-over-quarter in our recurring business, mainly in the VMS portion of that. Today, more than 20% of our business in the VMS is recurring business. It means that we are signing long-term contract anywhere between 36 months over to 5 years that we provide a service that include also the maintenance and support for the license.

So we are very, very flexible, and we try to adopt the business model to the customer needs. And in many opportunities, the customer is -- has the most frictions on the CapEx but have more flexibility on the OpEx. And we are very open and flexible to offer our customers such models.

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Operator [13]

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The next question is from [Ken Liddy] of Oppenheimer.

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Unidentified Analyst [14]

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I was wondering if you could talk a little bit about the opportunity you see in the medical marijuana space.

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Saar Koursh, Magal Security Systems Ltd. - CEO and President [15]

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Yes, definitely. Medical marijuana is a new vertical market for us. As you know, today, North America, it's booming, and they are building tens and hundreds of new sites for medical marijuana. All of these sites are regulated to some degree. And this represents great opportunities for us as we tailor specific solution, a close solution that combined all the different element that we have in-house, including our video management, including our analytics, include our perimeter sensors. And we are providing the different integrator with a complete package that they can basically copy paste to other solution. This solution was approved by some of the security consultant that specialize in the medical marijuana field, and it's growing. We just started it early this year, and so far, we already received several sites, and we expect to receive many more in the upcoming months.

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Unidentified Analyst [16]

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It sounds to me that your acquisition, Aimetis, may have added to some diversification in your customer base. Is that something you're -- you would concur?

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Saar Koursh, Magal Security Systems Ltd. - CEO and President [17]

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Yes, definitely. And by the way, related to the medical marijuana field, it's not coming from the Aimetis side, but definitely, we are using our solution and products from our recent acquisition of Aimetis as a complementary solution to our traditional PIDS solution. So now we are able to provide the complete solution that offer both the sensors and the video management.

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Unidentified Analyst [18]

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And with your recent order with the airports, is much of that order the Aimetis? Or is that a combination of products?

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Saar Koursh, Magal Security Systems Ltd. - CEO and President [19]

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Actually, that specific press release that we issued last week, it's a combination of several orders that we received over the last few weeks that came from both sides of our operational. Some of them use just perimeter sensors. Some other use just the VMS, and we do have some combination of the both. So for example, if we talk about the Delhi Airport, this is a great example when the solution that we are providing the Delhi Airport, combines both solution of perimeter and video. In some others, we are providing either or one of the solutions.

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Unidentified Analyst [20]

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And then one last question with regards to the U.S. border with Mexico. I'm sure you've seen some of the recent documents that were, I guess, leaked regarding the Rio Grande and elsewhere. And wanted to see if you are encouraged by some of the use of the data of sensors at the U.S border and what that might mean for Magal if money is found in the budget for that?

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Saar Koursh, Magal Security Systems Ltd. - CEO and President [21]

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Yes. So CBP is running several process in parallel. One of the -- or the main process is on the physical barrier. And obviously, all of us saw that the last test, the last demonstration they did early this week or previous week on the different 8 prototype of wall. As we said from the beginning, this is not something that's in our interest. We are not building walls, and we are not building sensors. We are into the technology part of this business. In parallel, the CBP initiated a process related to the technology, and we are definitely engaged with that process.

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Operator [22]

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The next question is from Bruce Tuchman of Merrill Lynch.

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Bruce Tuchman, BofA Merrill Lynch Wealth Management - Financial Advisor [23]

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This is Bruce Tuchman. I've been a longtime shareholder, and I have no issues with your technology end of the business. I think you've done a great job and very innovative in all the areas that you pursue. My only questions relate to your sales of your products and how you sell around the world, whether you have sales offices in different cities around the world, whether you sub it out to sales representatives unrelated to Magal or whether you work out of central locations because I feel that, that's probably the weakest part of your corporation.

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Saar Koursh, Magal Security Systems Ltd. - CEO and President [24]

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Thank you, Bruce. Definitely, it's something that we are working on to improve. The go to market is different between the 2 division that we have. Just to remind you, Magal is divided to 2 different division. The first one is Magal Group, which is an integrator selling end-to-end solution mainly for Magal Israel. We have some other establishment in Latin America where we are approaching the end customer directly and sometimes with cooperation with other integrators like we do, for example, in India when we have a strategic cooperation with one of the many integrators in India.

On the product side, which my sense is that the go to market is different. There we work directly with the system integrators. And it's important to note that we are not working in the same geographical areas on both division. It means that in North America and in Europe and APAC, we are working through our product division, Senstar. And in emerging market, the Africa, Eastern Europe and Latin America, we work through Magal division.

I think we are always improving our go to market. And as you can see from -- as we saw the -- in the third quarter, our booking was strong. And definitely, this growth will be reflected in the fourth quarter revenue and on.

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Bruce Tuchman, BofA Merrill Lynch Wealth Management - Financial Advisor [25]

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Okay. No, I mean that's -- I've called in a couple of times before, and I've been probably a 15-, 20-year shareholder. And as you're aware, it's not always been a total picnic. But as I said earlier, your technology, I think, is fantastic, and I just think that you need to get your sales force stepped up a couple of notches. And I think you have a great company there, and I wish us all lots of good luck going forward.

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Saar Koursh, Magal Security Systems Ltd. - CEO and President [26]

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Thank you very much, Bruce.

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Operator [27]

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The next question is a follow-up question from [Ken Liddy] of Oppenheimer.

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Unidentified Analyst [28]

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I just wanted to see where your backlog is in relation to this time last year compared.

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Saar Koursh, Magal Security Systems Ltd. - CEO and President [29]

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[Ken], can you please repeat the question?

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Unidentified Analyst [30]

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Yes, I just wanted to see where your backlog was in relationship to the same time last year. Is it higher than...?

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Saar Koursh, Magal Security Systems Ltd. - CEO and President [31]

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Yes, it is higher than previous year, definitely.

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Unidentified Analyst [32]

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And is it much higher than it was at the beginning of the year -- or I should say last quarter?

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Saar Koursh, Magal Security Systems Ltd. - CEO and President [33]

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Yes, it is.

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Operator [34]

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(Operator Instructions) The next question is from [Mike Distiller].

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Unidentified Shareholder [35]

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My only quick question is I know that through the years -- and I too am a long-term shareholder -- even over the last 1 to 2 years, you've been talking about increasing the level of recurring revenue streams. And in light of this quarter's revenue numbers compared to last year's, I was wondering if that's showing a decline in those recurring revenue streams or the recurring revenue is still moving up as a percentage of total revenue.

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Saar Koursh, Magal Security Systems Ltd. - CEO and President [36]

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Yes. So I think it's -- thank you for the question. Definitely, the recurring revenue is increasing. It's increasing, by the way, in all 3 segments, both in the project business, in the product and in the video cycle. So definitely, this is very encouraging for us for the upcoming future.

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Operator [37]

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There are no further questions at this time. Before I ask Mr. Koursh to go ahead with his closing statements, I would like to remind participants that a replay of this call will be available on Magal's website, www.magal-s3.com. Mr. Koursh, would you like to make your concluding statement?

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Saar Koursh, Magal Security Systems Ltd. - CEO and President [38]

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Yes, thank you. On behalf of the management of Magal, I would like to thank you for your continued interest and long-term support of our business. We will be attending the Imperial Capital Investor Conference on December 8, 2017, in New York; and at the ROTH Capital Conference in California in March. If you wish to meet me at one of those conferences, please contact my Investor Relation team or the conference organizers. Thank you for joining us today, and have a good day.

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Operator [39]

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Thank you. This concludes the Magal Security System's Third Quarter 2017 Results Conference Call. Thank you for your participation. You may go ahead and disconnect.