On Track Innovations Ltd. Q2 2009 Earnings Call Transcript

| About: On Track (OTIV)

On Track Innovations Ltd. (NASDAQ:OTIV)

Q2 2009 Earnings Call

August 25, 2009 9:00 am ET


Oded Bashan – Chairman and Chief Executive Officer

Ohad Bashan – President

Tanir Horn – Chief Financial Officer


Jay M. Meier - Feltl & Co

Marc Silk - C. Silk and Sons

Greg [Spanna] – [Spanna] Dunn Research


Good morning, good afternoon, to all OTI investors, analysts, and other interested parties worldwide on our first half and second quarter of 2009 conference call.

As a reminder, the conference call is being recorded today and a replay of the call will be available until September 1 and a transcript of the prepared statements will be available on our website at www.otiglobal.com in the Investor Relations section.

With me today on the call are Oded Bashan, OTI’s Chairman and CEO; Ohad Bashan, OTI’s President, and Tanir Horn, OTI’s CFO. You should have received a copy of the press release issued before the market opened this morning. If you are not on our distribution list, please contact us at info@otiglobal.com and we’ll be happy to add you for future information.

Our statements today contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and other federal securities laws. Whenever we use words such as believe, expect, anticipate, intend, plan, estimate, or similar expressions, we are making forward-looking statements. Because such statements deal with future events and are based on OTI’s current expectations, they are subject to various risks and uncertainties and actual results, performance, or achievements of OTI could differ materially from those described in or implied by these statements.

For example, forward-looking statements include statements regarding our goals, beliefs, future growth strategies, objectives, plans, revenues, targets, or current expectations. Forward-looking statements could be impacted by the effects of the protracted evaluation and validation period in the U.S. and other markets for contactless payment cards, market acceptance of new and existing products, and our ability to execute production on orders, as well as other risks and uncertainties, including those discussed in the risk factors section and elsewhere in our annual report on Form 20-F for the year ended December 31, 2008 and in subsequent filings with the Securities and Exchange Commission.

Although we believe that the expectations reflected in such forward-looking statements are based on reasonable assumptions, we can give no assurance that our expectations will be achieved. Except as otherwise required by law, OTI disclaims any intention or obligation to update or revise any forward-looking statements which speak only as of the date hereof, whether as a result of new information, future events or circumstances, or otherwise.

At this point, I would like to turn the call over to Ohad Bashan, President of OTI to discuss the results.

Ohad Bashan

Thank you all for joining today’s conference call. I will give an overview of the results and business developments and we will then open the call for questions, which Oded, Tanir and I will address.

The first six months of 2009 presented challenges resulting from the global economic crisis which has strengthened our commitment to successfully execute our focused and clear strategy.

Our results show continued improvement in gross margin and further reduction in operating expenses which have helped us to further reduce our net loss despite the lower-than-expected revenues. The decline in revenues is mainly from our OEM and payment business segments which was strongly impacted by the global economic crisis.

We see a change of direction in the second half of the year with orders building up in both segments. We focus on commercial projects in ID, petroleum and Park Ease. It yields high margins in current revenues. We see deals that we have been working on for a long time coming into fruition in different geographical areas.

We're making headway and involved in a number of opportunities that are what I call company-changing projects. Each of these opportunities can provide OTI with significant revenues over the next three to five years.

In the first half of 2009 we took several steps to help us cope with the global economic crisis and reach our goal of reducing operating expenses on a non-GAAP basis to $25 million annually. These steps include successful execution of the cost cutting program as well as joining a government sponsored program in Germany.

The cost cutting program includes the reduction in the company's head count, a 10% pay cut to executives, reduction in employee benefits, closure of certain development activities for low-margin product and consolidation of production centers.

In Germany our subsidiary InterCard has joined the program that is sponsored by the German government to subsidize and [inaudible] salaries by paying the difference between the actual work time and their original salary. Joining this program has significantly helped us to minimize the impact of the sharp decline in InterCard's revenues and is enabling us to be prepared for the time the OEM business picks up again.

We continue to monitor our operating expenses level. We constantly assess the contribution of each business segment, including revenue contribution, operating cost impact and cash burn. With regards to OTI's share repurchase program, OTI's Board of Directors has recently approved a detailed plan. Execution of the plan should be subject to applicable laws.

And given the financial results in detail, the first half results demonstrate OTI's strategy which focuses on improving margins, reduction in operating expenses, specifically in R&D and G&A and continued focus on marketing efforts, all resulting in further decrease of the operating and net loss.

For the first half of 2009, gross margin significantly improved to 46% compared to 36% last year mainly as the result of our product line revenue mix which also resulted in a 6% increase in our gross profit for $7.7 million. Our efforts have significantly reduced our non-GAAP net loss to $6.4 million, a 20% decreased compared to $8 million in '08.

Non-GAAP operating loss was $6.1 million, a 17% decrease compared to $7.3 million in the first half last year. Non-GAAP operating expenses were in line with our projections reaching $13.8 million, a 5% decrease compared to $14.5 million in the first half of 2008.

Our revenues for the first half decreased more than we expected. The decrease is a result of several factors including the global economic crisis which has mainly impacted our OEM and payments business segments as well as delayed the customer project span table.

We've seen a decline in revenues in our OEM business of approximately 50% from the same period last year. This trend is changing for the second half with orders building up again in both OEM and payments segments.

The global economic situation is also impacting the level of operations in our existing projects. For example, we have received transaction fee from our petroleum project in South Africa. We have seen a decrease of approximately 30% in diesel consumption in the first half of the year which obviously affected our transaction fees revenues from this project.

Our revenue breakdown for the first half is consistent with our strategy to increase focus on ID, parking and petroleum. The smart ID market increased to 39% of total revenues. Payments market decreased to 36%. Petroleum market generated 9% and OEM sales represented 16% of total sales.

The geographic mix of revenues of the first half was as follows. [Inaudible] was 33%, the Americas 32%. Asia accounted for 14%, Africa 11% and Israel represented 10% of total revenues. In our press release we include the comparison between the first half and second quarter of 2009 with those of first half of 2008 on a non-GAAP basis. And the reconciliation of GAAP to non-GAAP results in our P&L FAS-123(r) and EIPF96-18 had barely an impact on costs.

It did, however, have an impact on operating expenses. The impact of FAS-123(NYSE:R) and EIPF96-18 on the first half of 2009 operating expenses were about $3 million. Amortization of intangible assets was $515,000. The impact on the second quarter of 2009 operating expenses was about $1 million. Amortization of intangible assets was $251,000.

Now I would like to briefly share with you an overview of our progress in the different business segments. OTI provides superior contact to Smart Card products technology and solutions in three primary vertical markets, Payment, Petroleum and ID.

Our offerings in the Payments market include solutions for contact with banking cards, mass transit solutions and the new vehicle parking meter called Easy Park. We offer card readers a production mechanism based on years of experience and a significant IP portfolio that results in superior product in terms of durability, performance and throughput.

OTI's offering to the contractors’ banking market is unique in that we provide both card and reader solutions for both the Visa and MasterCard contractors’ program. Our focus in the contractors’ banking card program is to support MasterCard [inaudible] in the different regions.

We continue to work for market regions to integrate our reader technology with that product as well as work in bringing compromises to offer card solutions to financial institutions.

We see existing markets like Turkey where OTI is the leading provider of contractors’ payment solution, expanding the usage of contractors’ payment and new issuers and merchants adopting the technology.

South Africa is quickly becoming an important market in the adoption of contractors’ payment and new additional markets are expected to start as well. New developments offer a great opportunity for OTI.

In line with our strategy of focusing on projects that generate both product savings and growing high margin and recurring revenues we continue the marketing efforts of EasyPark. We have more than 600,000 users in Israel and we are involved in three new international markets, France, Italy and most recently Bermuda.

We are working on signing up their distributors. We are exhibiting at trade shows and putting more effort in marketing the EasyPark product. In Poland, our subsidiary asset has completed the first stage of the infrastructure installations for Warsaw City Card, which is a multi application system using contractors’ cards.

OTI acts as an in-ticketing and parking operator for Warsaw City Card. Infrastructure for the project includes hundreds of automated ticket vending machines and terminals installed in subway and train stations, buses and tram transfer hubs and in areas frequently visited by tourists.

The completion of this stage allows OTI to accelerate the direct revenues generated from the transaction fees which are expected to aggregate more than $10 million over the next five years.

In the ID market our product offering includes and end-to-end ID solution for electronic passports, motor crossings, national ID and medical cards. The mixed solution is based on significant IP and clearly the parts and portfolios that covers manufacturing techniques, application processing and more.

The system is based on OTI's Magna, a marginal platform that offers short implementation and quick integration with a country's existing border control system and provides external interfaces to the country's central electronic certificate storage for signature verification.

Regarding [Airporter], I'm pleased to report that we met and exceeded the contract requirements with providing new electronic ID cards before the national elections took place in Ecuador. This was a very demanding and successful team effort that demonstrated OTI's capability and the value of being able to provide the complete suite of ID solutions.

We remain committed to providing the best support, solutions and products to the Rigistro Civil, the registry office of the government of Ecuador. Regarding our ID project in China, as previously reported, we have received an initial order for an e-passport project which we produced and delivered.

In our view, the Chinese opportunities comprised of a series of projects and initiatives which are governed by different governmental regulations and industries. Each one of these initiatives is large, complex, sophisticated and involves integration of multiple subsystems. That takes a long time. They experience delay in implementations and requires constant support. OTI has been working with some strong local partners in order to be able to establish local products which supports the Chinese opportunity.

MediSmart is our marginal health IT solution which transforms the patients of a joint health record to a portable medium, enables sophisticated patients and provider authentication, implement secure encryption and provides integration with legacy health IP systems.

MediSmart is another successful implementation of our business model in which revenues are generated not only from the product sales but also from transaction and licensing fees. The MediSmart is one of the more exciting products we offer where we generate both product and license fee revenues. Usually the MediSmart projects are characterized by long sales structures and a long implementation cycle due to the complexity of implementation and infrastructures to integrate with.

OTI is involved with a consortium that has been awarded with a national scale medical card for [one] and I'm happy to report that phase two of the project which includes design and buildup of the system has commenced. This is a major opportunity for OTI.

In the petroleum market, our offerings include comprehensive petroleum payment and overall field management solution for oil companies, fleets, and retail customers, all in the same infrastructure, wireless, cashless, cardless and paperless. EV2 is based on OTI's extensive technology providing multi application SmartCard technology platform.

In the second quarter we announced EasyFuel is going to be installed by one of the largest container terminal operators in the southern part of China. The new installation demonstrates that OTI’s EasyFuel solution is relevant across a number of market sectors including retail and commercial fueling as well as the industrial and mining sectors.

A typical fourth side includes a large number of dividers and equipment to automate the site. It can range between the equivalent of about 10 to 20 gas stations and about 1,000 to 5,000 vehicles all depending on the size and the site of the operation.

Based on the higher-than-expected decline in revenues in the first half, which is mainly attributed to the revenue reduction in the OEM and Payments business and is delayed in customers projects span table, we are updating our project revenues for this year to $34 million.

Our main and most important goal is to bring OTI to an operating break even position as quickly as possible. We plan to get there by further reducing our operating expenses, focusing on high-margin projects with returning revenues, building a strong [likely] portfolio and product line and focusing on successful execution of projects that will contribute to OTI growth over the next 12 to 24 months.

Now we will be pleased to take your questions.

Question-and-Answer Session


(Operator Instructions) Your first question comes from Jay M. Meier - Feltl & Co.

Jay M. Meier - Feltl & Co

I have a few questions for you. We go through this routine generally with every quarterly report. You list a series of opportunities and you don’t give a whole lot of visibility into when you expect them to start actually generating revenue. I wondered if you could add any more color on China for example. When would you expect that to start becoming a meaningful part of your business?

Ohad Bashan

First in China, we have started to recognize revenues. As we’ve indicated in the call, the Chinese opportunity is one of a very complex one which requires a lot of patience and constant support and we are totally dependent on the customer’s time table here.

We believe that we will be able to start generating significant revenues from China over the course of the coming quarters. I cannot point out exactly which quarter and at this point we prefer to be more conservative with our approach and [inaudible] significant revenues once we know that they are coming for sure.

Jay M. Meier - Feltl & Co

How long have you been discussing China?

Ohad Bashan

In China we are involved with multiple opportunities. In the past year we were involved in one major opportunity that we’ve indicated was delayed significantly. We are now involved in other opportunities as well. From what we see right now, some of these opportunities will take place faster than others. I cannot point out at this point and I know you are looking for a straight answer here, but I cannot point out exactly when the level of revenues that we are getting from these opportunities is going to increase significantly what we are getting today and today we are getting mainly revenues in supporting small [inaudible] prior to the customer going in [inaudible] so there’s no clear answer if it’s going to pass in Q4 or Q1 next year. We know it’s going to happen because this is what the customer is indicating to us, but I prefer at this point not to mention any specific time table.

Jay M. Meier - Feltl & Co

It’s worth noting that some of your competition actually are growing their credentialing businesses pretty rapidly right now. Can you pinpoint anything in particular that allows them to grow while you apparently are struggling?

Ohad Bashan

I believe that that our [inaudible] business is growing as well. We have multiple business segments. The business segments that were significantly impacted by the global economic [inaudible]. One is the OEM parts which provides solutions to the automotive industry mainly in Germany and as we all know there was a sharp decline in business coming from that part. The other one is payments. The other parts of our business, the credentialing part of the business, has been going very nicely and steadily. This is the main reason that we are able to show such gross margins and that we were able to increase the gross profit even though are revenues have been significantly declined from the other business segments. So I don’t share the same view. I share the view that we are struggling on the payments and the OEM business which is the lowest margin business for us but we are excelling in the credentialing business and the ID business which is one of the best business segments for us.

Jay M. Meier - Feltl & Co

You mentioned your interest in achieving operating break even as soon as possible. Can you quantify that at all? What do you expect will be operating break even revenue run rates and when do you anticipate getting there?

Ohad Bashan

One thing is for sure, we are adamant about getting to operating break even as quickly as possible as you’ve pointed out and as we’ve pointed out in our call. At this point I cannot commit to a specific quarter about getting there. Our plan is to get there as quickly as possible and the target is to get there by next year but I cannot say it’s going to happen Q1 or Q2 next year. I can point out one thing for sure. We are very sensitive to the operating level of the company and we are very sensitive to the level of revenues and operations that the company is getting and we are planning to take further actions in reducing our operating expenses and making sure that we will bring this company to break even, even if it means downsizing the activities. But our intentions are very clear.

Jay M. Meier - Feltl & Co

You have quite a bit of cash remaining on the balance sheet although your run rate continues to eat away at that. There comes a point where cutting costs and cutting efforts to penetrate two markets, it’s a double edged sword, right? You’re trying to reduce your operating expenses and get down to operating break even, but at the same time you hamper your ability to compete against companies like Jimalto and so there is a time frame we need to be cognizant of, and I’m trying to get a sense of when you expect to see that change and it sounds like you’re talking about next year but won’t pin that down. Is that fair?

Ohad Bashan

It’s a fair statement. The only thing I would add is that right now we see OTI becoming break even not from the future activities but from the existing opportunities that [inaudible] already and I think this is a major difference because I don’t think getting to break even will get us from entering into new market and continuing investments in new markets but executing on the existing opportunities we have in hand will get us there.

Jay M. Meier - Feltl & Co

Without offering us some sense of what you expect your revenue run rate to be at that breakeven level, you could slash your overhead dramatically today and get to break even. That doesn’t necessarily mean you’re going to grow the business, right? So I’m trying to get a sense of what your goal is here. Is it simply to conserve cash or is it actually to streamline the company and expand your market opportunities and every day that goes by, and every dollar that you consume along the way, hampers your ability to do one, so I’m starting to get concerned about that.

Ohad Bashan

Our operating plan is to grow the business and get to break even as quickly as possible. That’s all I have to say right now. We will take any necessary steps to get there but obviously getting to break even is not causing many activities and staying at the same revenue line. It’s increasing revenue line and staying in good gross margins as we are showing here and [inaudible]. Also further reducing operating expenses. These things take time. I have to say that we will, as we’ve indicated, the declining revenues in the first six months was higher than what we’ve expected initially. We did not expect a 50% decrease in our OEM business line which is usually very, very stable and every year provides constant contribution of revenues which is very similar so we have seen it happen and right now we are totally focused on getting the company to break even, reducing the change in the second half, specifically in the segments that were significantly hurt in the first half.


Your next question comes from Marc Silk - C. Silk and Sons.

Marc Silk - C. Silk and Sons

Let’s see. Back in February 19, 2008, you guys came out with a press release that OTI is to supply end to end electronic passport and border control systems to be implemented in a European country. Can you kind of give us an update on how that’s going, what kind of revenues you’re expecting?

Ohad Bashan

It’s going well and as we’ve indicated then when we put the press release, this was not a major revenue opportunity. The project has been completed from our side last year. We are now in a support mode.

Marc Silk - C. Silk and Sons

Going forward, will you be able to break out the overall parking revenue so at least that way we can see the progression of that part of the business quarter-over-quarter?

Ohad Bashan

Right now the parking is [inaudible] revenue section. We will be able to shed more light on the parking business level of operations if this is what you mean. I don’t see a problem with that. Right now from our financial results, it’s under the payments section.

Marc Silk - C. Silk and Sons

Just because going forward with whatever cash you have left, and some of your businesses, the pieces are worth a lot more than the whole price of the stock and I think by breaking that out, at least you can kind of see what’s worth what in this company because obviously it’s disappointing as far as not seeing profitability and I think the way people have to analyze this company, kind of seeing what your true value is. How much was shipped to Ecuador in Q2?

Ohad Bashan

The project in Ecuador, the initial order was for $4 million as we’ve indicated. I have to say that we have completed the project successfully. In Q2 it was approximately about $1 million that we shipped to Ecuador and we continue to support the Ecuador government in their efforts to put a national ID system and we are committed to their success.

Marc Silk - C. Silk and Sons

Do you think we’ll have an update on that the second half of the year regarding if they want to go further or that might be too soon?

Ohad Bashan

I think it is totally dependent on the government of Ecuador’s plans and execution of the project. I’m hopeful that their plan will be to move forward as soon as possible and that OTI will be included in these plans.

Marc Silk - C. Silk and Sons

On the subject of high margin business, SuperCom, have you thought of offering your SuperCom technology to maybe another company being a partnership that maybe they’re bidding in a country that you don’t feel like you want to be a part of that, offering the whole solution?

Ohad Bashan

We’re trying to [inaudible] partners that we are joining forces with on bidding, on multiple opportunities, then we are absolutely doing it. As a company we are not able to go to every opportunity and bid independently on every opportunity and for us it’s one of the most important things to leverage, relationships to bid together in countries where we don’t have the unique advantage, so the answer is absolutely yes, we are doing it, and we’re getting business from it as well.

Marc Silk - C. Silk and Sons

Any progress in [Harrah]?

Ohad Bashan

We are continuing to put marketing efforts on the production lines. Any acquisition decision or the production line is of a large magnitude and takes a long time and quite significant diligence so from that side we have to be patient and continue to support our customers’ operations and support our marketing efforts in that area.


Your next question comes from Greg [Spanna] – [Spanna] Dunn Research.

Greg [Spanna] – [Spanna] Dunn Research

We have been sitting here quarter to quarter and holding the stock and lots of us who have millions of dollars invested in your company are concerned and would like to get some idea of profitability. Now you had mentioned that you expect to get to break even with existing business. Now if I was a stockholder and I did not know, and I’m not talking about me, I’m talking about all stockholders, and I sell the stock because I don’t know when you’re going to get to profitability. There’s certain kind of fiducial responsibility that you said you can get to profitability with the existing business you now have.

Ohad Bashan

I said we can get to profitability from the growth in the existing opportunities that we have. I did not say that we… I definitely did not say that we are going to get to profitability from $34 million in revenues, so I have to correct you here.

Greg [Spanna] – [Spanna] Dunn Research

If you say that you can get to profitability with growing the existing business then there is a way of projecting when that profitability is going to occur. And I think that if I sell the stock today based on the information you gave me and I find out in six months that you know when the profitability is, you are not meeting your responsibility to the stockholders. So my feeling is what you should do is go back to the drawing board, write out when you think you’re going to hit profitability, and then issue it to the stockholders. I’m not asking for it today, but at some point, you’re going to have to do this. I don’t hear a response.

Ohad Bashan

The response is the following. As I indicated to Jay in his previous question, he was the first caller that asked questions, we are planning to get to profitability next year. This is our plan. We will do every possible thing within our capability to get there. We believe that we can get there from growing the existing opportunities and I am very, very specific in my words. So the plan is, if it will happen in Q1 or Q2 or Q3, I am not able to tell you right now. We have all intentions of being very clear in providing investors with the specific time frame as much as we can but on the other hand I don’t want to mislead any investor and if I miss by one quarter, we definitely don’t want that to happen. We are a company that has lumpiness in revenues still because of the stages of our projects, very early stages, opportunities are very large but in other cases, the opportunities are in the very early stages and revenue stands to be lumpy between one quarter to the other. So looking at OTI as a six month period is better. But we have all intentions that when we can see getting to profitability to come out and say to investors as soon as we can.


There are no further questions at this time. Before I ask Mr. Bashan to go ahead with his concluding statement, I would like to remind participants that a replay of this call will be available two hours after the conference ends. In the US please dial 1-888-326-9310. In Israel, please dial 1-800-286-285. Internationally, please dial 9723-925-5930.

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

Ohad Bashan

Thank you all for joining our call today and looking forward to talk to you again in our next quarter. Thank you. Have a good day.


Thank you. This concludes OTI’s second quarter 2009 results conference call. Thank you for your participation and you may go ahead and disconnect.

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