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On-Track Innovations (NASDAQ:OTIV), which designs, develops and markets secure contactless microprocessor-based smart cards, disappointed investors on Wednesday with a weaker quarter than analysts had expected. The company reported an adjusted loss of $2.5 million, or 14 cents a share, on revenue of $10.4 million. Analysts expected a loss of 6 cents a share on revenue of $10.1 million. To make matters worse, gross margins decreased to 39% for the 1st quarter, which is down from 49% for the same period in 2006. Factor in the fact that the company’s stock price is down 40% from last July, when they lost a U.S. government tender for electronic passport production, and the picture isn’t pretty.

OTIV develops smart cards for three vertical markets: petroleum payment solutions, micropayments for small ticket items and SmartID for credentialing, identification and verification of individuals. Its EZ-Park has eliminated the need to carry around small change to plug a meter when parking. You just load up your EZ-park machine at any one of a number of machines located at gas stations, and then depending on the city you are in and the amount of time you plan on parking, you set the machine to those parameters, and hang it from your window. That’s it. If you set it for 2 hours and you only park for part of that time, then you only pay for the actual time used.

With all the bad news, it’s hard to see a turnaround in the horizon. But after listening to the conference call and going through the financials, I got the sense that the company is poised for a very strong second half in 2007, and a strong 2008. That being said, we still have another quarter in the first half to suffer through.

Commenting on the results, Oded Bashan, Chairman, President & CEO of OTI, said,

“During the first quarter we increased our revenues by 15% to $10.4M while increasing the contribution from the ID and the petroleum markets, which was in line with our expectation that revenue growth this year will be driven mainly by the petroleum and ID markets. While quarter to quarter lumpiness is characteristic of the early-stage markets in which we participate, we expect the second half to be significantly stronger than the first half. Our first quarter results were impacted by the weakness of the dollar. Because the trend continues, we are considering steps to mitigate the influence of currency on our results.”

The company estimated that the strong Israeli Shekel against the U.S. Dollar added ten percent to R&D expenses because its R&D is located in Israel, and the employees get paid in the local currency. I personally believe that by year's end we will see the dollar strengthen against the shekel, thus improving the expense line.

A deal with the Polish government for passport identification has earned OTIV half the market in Poland, and it appears that another European governmental deal is imminent. The installation at over 100 locations of EasyFuel pay at the pump solutions, should start paying dividends in the second half of 2007 as well.

OTIV has $46 million in cash, and with the stock trading in the low to mid $7’s, with some patience to allow the turnaround to take place, this has the potential to provide nice returns in the next 6-12 months.

Disclosure: The author’s fund is long OTIV as of May 30, 2007.

OTIV 1-yr chart
OTIV 1-yr chart

Source: On-Track Innovations Poised for a Strong Showing in the Last Half of 2007