On Track Innovations Ltd (NASDAQ:OTIV) Q3 2018 Earnings Conference Call November 7, 2018 9:00 AM ET
Greg Falesnik - IR
Shlomi Cohen - CEO & Director
Assaf Cohen - CFO
Jaeson Schmidt - Lake Street Capital Markets
Paul Penney - Northland Capital Markets
Michael Latimore - Northland Capital Markets
John Nobile - Taglich Brothers
Greetings, and welcome to the On Track Innovations Third Quarter 2018 Corporate Update Call. [Operator Instructions]. As a reminder, this conference is being recorded. I'd now like to turn the conference over to Greg Falesnik, Managing Director for MZ North America, OTI's Investor Relations firm. Thank you, you now -- may now begin.
Thank you, Operator. Earlier this morning, OTI released financial results for the third quarter ended September 30, 2018. The release is available on the investor section of the company's website at www.otiglobal.com. Please be advised that certain information discussed in this conference call may contain, express or implied forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and other federal security laws. Such statements can be identified by the use of terms such as may, will, expect, believe, plan, potential and other comparable terms. For example, forward-looking statements, include statements regarding to our expectation to continue growing sales and profitability, to continue to ramp up in ATM sales and deployment, expected revenue increases in certain segments, adjusted EBITDA and expected margins and revenues, momentum in growth, initiatives, our expectations regarding future growth into new and existing markets, such as the Canadian and U.S. markets, our expected future deliveries and install base and our expectations regarding our outlook and opportunities.
While forward-looking statements reflect good faith, belief and best judgment based on current information, there are not guarantees of future performance or results. They are subject to known and unknown uncertainties and risk factors, including those detailed from time-to-time in the company's filings, periodic reports and registration statements filed with the SEC.
OTI assumes no obligation to update any forward-looking statements or information, which speak as of their respective dates. To full state harbor provision, they're set forth in the earnings press release we issued this morning. Investors are cautioned not to place undue reliance on forward-looking statements.
OTI's CEO, Shlomi Cohen is your host today and he will introduce the rest of the team joining on their call. With that, I'll turn the call over to you, Shlomi.
Thank you, Greg. And thank you to everyone joining us on today's call. I am pleased to announce another quarter of continued operational execution, highlighted by our year-over-year revenue growth. We continue to make notable progress on several key fronts, primarily through successful sales both in Japan and the United States.
Alongside success in our existing markets, we continue to expand our efforts to other newer international markets and broaden our footprint. As evidenced through the granting of the new certification in Russia, where we delivered almost 8,000 advanced contactless readers in the third quarter as well the Interac certification in Canada. Both of these certifications are important to successfully operating in these countries, allowing our sales team to allow focus their efforts on a new and very exciting payment market. On the financial front, we experienced our fourth consecutive quarter of positive adjusted EBITDA while increasing year-over-year revenues by 39% to USD 6.5 million, which represents the highest third quarter revenue achieved since 2013.
We also expanded our recurring revenue base by 19% on absolute dollar basis to $1.5 million third quarter, compared to $1.2 million for the same period a year ago and reduced our debt by 89% during the quarter compared to the second quarter.
With total debt now standing at just of $0.5 million. But before going further, I would like to turn the call over to our CFO, Assaf Cohen, to walk us through our financial results for the third quarter. Assaf?
Thank you, Shlomi. Before the markets opened today, we issued a press release with the financial results for third quarter ended September 30, 2018. A copy of the release is available in the Investor Relations section of our website. Revenue in the third quarter of 2018 grew 39% to $6.5 million compared to $4.7 million of revenues for the third quarter of 2017. And growth of over 5% when compared to revenue of $6.2 million in the second quarter of 2018.
In the third quarter of 2018, the recurring revenues increased by 19% on an absolute dollar basis to $1.5 million compared to $1.2 million in the same year ago period. To provide an overview of where our revenues were derived in the third quarter of 2018, retail and mass transit ticketing revenues were $4.7 million, or 73% of sales, petroleum revenues were $1.3 million, or 20% of sales, and MediSmart revenues were $420,000, or 7% of sales.
Looking at geographic breakdown in the third quarter, the Americas accounted for $1.4 million or 22% of total revenue. Europe accounted for $2.5 million or 39%. Africa accounted for $1 million or 15% and APAC accounted for $1.6 million or 24%. Gross profit for the third quarter of 2018 totaled $3.4 million or 53% of revenue compared to gross profit of $2.5 million or 53% of revenue in the same year ago period.
In the third quarter of 2018, operating expenses increased to $3.5 million when compared to $2.9 million in the third quarter of 2017. Net loss from continuing operations in the third quarter of 2018 was $158,000, or 0 per share compared to a net loss from continuing operation of $573,000, or a loss of $0.01 per share in the same year ago period.
Now turning to our non-GAAP results. We use adjusted EBITDA from continuing operation and non-GAAP metric as we believe would provide a useful indication of our operating results. Positive adjusted EBITDA in the third quarter of 2018 was $362,000 compared with an adjusted EBITDA loss of $74,000 in the same year ago period. The third quarter of 2018 marks our fourth consecutive quarter of positive adjusted EBITDA after ending 2017 with positive EBITDA for the first time in the company's 28-year history. We view this as a significant achievement and positive indication to our focus on higher margin, recurring revenues as well as our continued strength across all business units. Please see today's earnings release on our website for further details about this non-GAAP metric, including our consideration of adjusted EBITDA to our comparable GAAP results.
Now turning to the balance sheet. Cash, cash equivalents and short-term investments on September 30, 2018, were $5.9 million. This compares with $8.8 million at June 30, 2018, and $8.7 million at September 30, 2017. The decrease in cash during the third quarter of 2018 was mainly due to a pay down of our debt, which decreased by 89% in the third quarter of 2018 to $0.5 million compared to $4.5 million in the end second quarter of 2018. This completes my financial summary. For a more detailed analysis of our financial results, please reference our quarterly reports on Form 10-Q, which we plan to file by November 14, 2018.
With that, let me now turn the call back to Shlomi.
Thank you, Assaf. As I noted in my opening remarks, our business has remained on track and healthy, both operationally and financially. After achieving 4 consecutive quarters of positive adjusted EBITDA, our first in the company's 28 years history, while aggressively reducing debt and growing revenues, our momentum has certainly carried through into the third quarter of 2018. We remain laser focused on growing revenue, our recurring revenues in particular and we are proud to announce that recurring revenues now represents $1.5 million of our total quarterly revenues, a 90% year-over-year increase on an absolute dollar basis.
Our strategy of moving from being a product company to a company that utilizes software and offers complete turnkey solution is now paying off. This strategy was designed to provide us with a stable customer base with predictable revenues and with much higher margins. In our retail and mass transit segment, we have made tremendous progress in several categories, collectively, this segment grew over 46% in the third quarter of 2018 alone, compared to the same year ago period.
I will touch on a few noteworthy items here. A key growth area for the company in the automated retail space's ATMs, where we continue to increase sales and deployment around the world. In 2017, we delivered over 10,000 systems. In 2018, we will deliver over 16,000 systems. This trend is a testament to our superior product offering and the value proposition it provides to our customers.
Japan continues to be a very attractive opportunity for OTI. During the quarter, we delivered total of more than 3,000 advance payment systems to Japan.
Finally, we continue to expand our footprint in key geographics. First, in Canada. In October, we received the Interac certification, in Canada, allowing Canadian business to integrate OTI's secure cashless payment solutions into vending machines, kiosks and other unattended devices throughout the significant Canadian market. Interac is one of the Canada's leading payment brands and it's chosen an average of 16 million times daily to pay and exchange money. Canada has over 59,000 ATMs and over 450,000 merchant locations accessible through the Interac Network, making this certification essential to doing business in Canada.
Second, in Russia. In Russia, we delivered almost 8,000 advanced contactless readers to the Russian retail self-service market in the third quarter and expect to see continued growth in this exciting new region. As part of these efforts, we also applied for and received the Russian MIR certification, a payment system established by the Central Bank of Russia.
Having now obtained approval for this certification, we expect much greater penetration of the Russian market as we move forward. Over the long term, we believe Russia will be a top 3 strategic market for us, as there is significant potential for growth with trusted cashless payment provider like OTI. We continue to maintain our status as a pioneer and a leader in the cashless payment solution arena, while diligently managing our expenses and as a result, I believe, we will -- we're well positioned to continue revenues growth and shareholders value creation over the long-term.
Now before providing my closing remarks, I would like to open the lines for Q&A and return it back over to the operator. Operator, please.
[Operator Instructions]. Our first question comes from Jaeson Schmidt with Lake Street Capital Markets.
I was wondering if you could first comment on, if you've seen visibility significantly increase or decrease given the macro backdrop over the last 3 months here.
I'm not sure that I understand the question, Jaeson. Can you repeat it please?
Yes. I am just curious of given the macro backdrop, you've seen your visibility significantly decreased over the past 3 months?
Okay. So I think it's a little bit early to speak about the next quarter, actually the current quarter that we're having, but definitely, we are expecting to continue with this positive momentum that we are having. There's a lot of challenges, needless to say, but if you're working by the way on the trend that we are having since beginning of the year, this is the first year that we are presenting a linear growth quarter-over-quarter.
If in the previous year, I think that there were a lot of comments for the investor side regarding the fact that we are having a lumpiness in business, I think this is the first year that we can see a growth from Q1 to Q2 to Q3 and we are expecting to continue with this positive trend. But I think it's too early to speak about Q4. I think that we are actually not even in the middle of this quarter and when you're looking on the previous year, this is the most busiest quarter that we're having.
Okay, that's helpful. And look at Russia, I know you highlighted that as a key strategic market going forward and you had good traction in Q3. How should we look at that continued rollout throughout 2019?
Yes, we are very positive regarding the Russian market. We begin to be one of the leaders that came with the relevant certification. The first vertical that we decided to tackle is actually the mass transit over bill and most of the deliveries that we were doing so far, I'm speaking about the last 8,000 contactless systems that we delivered to the Russian market is related to this vertical. In parallel to that, of course, we are working on other verticals as well and that's the reason that I'm quite positive regarding the focus for 2019 with Russia.
Okay. And the last one for me and I'll jump back into queue. When we think about operating expenses in 2019, should we expect anything out of the ordinary as far as OpEx growing or any sort of certifications we should be aware of? Or any kind of additional OpEx spend related to some of these opportunities?
I think that if we speak about this topic, the main place that we will continue to invest and needless to say that we will see a growth over there, it will be related to the front side of the business. Meaning that sales, marketing and business development, this part of our budget will continue to increase. You know we are fueling the positive momentum that we are having, but I think that in all the other parts in our budgets, we will keep the same level, almost the same level like in '18.
[Operator Instructions]. The next question comes from Mike Latimore from Northland Securities.
This is Paul on for Mike Latimore. I had a couple of questions. First question is like, which verticals or application will be the biggest driver over the next year? And I have a follow-up, please.
Yes, so first of all, let's net the relevance of the verticals of our unattended payment markets. So OTI is active in vending, kiosks, EV charges, ATMs and laundromat, those are the major verticals that OTI is actually active in. Now if I need to look on the most exciting one for us, it will be definitely, we bid the ATM together with the EV chargers, electric vehicle chargers. With the electric vehicles chargers, we did not reach to the same level that we are having with ATM. ATM will continue to bid, let's say, one of the most fast-growing verticals in our business and I think by the way, if you analyze what we achieved in the ATM verticals, so it's going like that, in '16, we were selling less than 2,000 systems to the ATM markets, in '17, it was 5x more, 10,000. And this year, we're presenting a growth of 60% year-over-year. EV chargers, we have a fifth installation already in the city of London and I believe that during '19, we should see some kind of quantum related to the EV chargers. Now to choose between the 2, I will say that for the very long run, the EV chargers will be kept to be a significant vertical. For the next 2 years, I believe that the ATM will increase by double-digit on annual basis, I'm saying about a high level of double-digit on annual basis. Those are the most let's say, 2 exciting verticals that we're having. But, again, as a reminder, still the biggest vertical I believe also in the next two years will continue to be the vending.
Okay. And my second question is, like, which regions will show the most growth over the next year? The same thing like this.
Yes. I think that if I need to disregard from the verticals and I need to speak only about the region, our expectation that Japan will be the fast growing one during 2019. But in absolute numbers, needless to say, that U.S. will continue to be the major market for us. But the major role, we -- probably, we are going to see in Japan.
The next question comes from John Nobile from Taglich Brothers.
I just want to know, your product sales this quarter, they were the highest so far this year and what's typically a slow quarter. I was curious if there was anything that was anomalous to this quarter? Or do you see this a sustainable or even growing from this level?
No, look, our -- maybe few words about Q3. Q3, in average, I would say, it's one of the weakest quarter that we are having, but despite the fact that we are having a lot of holiday season in song, this was an amazing quarter for us. And as I mentioned before, this quarter is the best Q3 quarter since 2013, actually, in the last 5 years. I think that one of the strengths that you can see is, I mentioned the fact that we have the linear growth since the beginning of the year and this is the -- it's a big achievement and this is, by the way, mainly related to the fact that we increased the recurring revenue portion in our revenue. I believe that we will continue to increase the recurring revenue, mainly because we are selling more and more solution and less and less product, okay? Now, our expectation is that the lumpiness that we saw in the previous year will be out of the game, this is our expectation at least, and this is the focus that we are having. And I think that all-in-all, one other thing that you need to pay attention is to the fact that if three years ago, our sales were actually between 3 to 4, then it became to be in average, I'm speaking third quarter, it became to be now to 4.5 and later on, it switched to 5 to 6 and now we are speaking about 6 to 7. And I think that this trend will continue to be stable. We're expecting that this trend that we are facing now will continue. Because if you analyze the last 3 -- the last few years, this is actually the trend, despite of the restructuring that we are doing, the fact that we established a new sales strategy and I think that our investor will continue to see a significant improvement year-over-year, not only with sales, but also with our profitability and the fact that we were able to reduce dramatically the debt as well.
That's good to know. Thank you for that. And could you talk a little about how the recent certifications in Russia, in Canada will benefit your sales in those areas and how large of a market do you perceive for those areas in relation to the Americas?
Yes. So it's going at -- first of all in -- just to explain in nutshell, we have the entire certification that are relevant for the entire region, I'm speaking about Master Card, Visa, American Express, Discover, Apple Pay and Google Pay, but on top of it, you have also, I will call it, regional certification, such as MIR in Russia, Interac in Canada, FeliCa in Japan. Now those are actually important because it's not enough that you have Master Card and Visa that they are considered to be the most popular, you need also the regional one as well. At the moment that you're having the regional, you have the combination and then you are able to cover actually every possible transaction in those relevant markets. In parallel to that, we're also investing in our front side that in one of the previous question, I was mentioning the fact that we will continue to see growth in our sales and marketing budget, it means that we already recruited team members in the relevant markets in order to accelerate the business over there. In most of the cases, we are recruiting local team members, but they are doing a terrific job. Needless to say, that when you're giving them the right ingredients to win, we consider as the same thing like in Japan and also in Russia and I believe that soon, we'll see it also in Canada and other markets as well. Definitely, those certifications are crucial in order to be successful in those markets.
Okay. And in regard to the line item, you're licensing and transaction fee revenue, I know you don't break it down in your financial statements, but I was hoping you might be able to break it down on this call, either absolute numbers or percentage, what is actually coming from transaction fees? And what are we looking at as far as licensing fees?
Yes, I think that as you probably imagine, I'm not going to dig in into this icon, but I would say that at least in the last 18 months, the biggest portion of this item, and it will continue to increase by the way, is the recurring revenue business. The business model that we are having is that we are selling solution and on top of it, we are actually charging per machine, per month, it doesn't matter if its EV charger or vending or kiosk. Now in the past, I agree that we were having a mix of elements in this section, but you can assume that the majority of it is actually based on recurring revenue that's part of the solution sales that we're doing. I believe that in next year, probably it will be almost 100% based on recurring revenue. And then the question will be less relevant.
Okay. Now, recurring -- the transaction fees reoccurring, licensing also recurring, I was hoping to find out, which one of these 2 is actually the greater generator of revenue for that line item?
We prefer, at the moment, not to give such kind of guidance regarding this element.
Okay, fair enough. Just one final question. Where do you perceive the most growth coming from in future quarter years, is it product sales? Licensing? Or transaction fees? And I was hoping if you could give some reasons that would support this answer.
Yes, our expectation is to continue saying that we are selling more and more solutions. So I know that in your category, you're trying to put hardware, software services or something like that, but at the end of the day, since we actually changed our sale strategy, we're selling more and more solution and only solutions that are actually generating for us recurring revenue, this is the change in our strategy in the last 2.5 years. Now set for that like we were doing 3 years ago, didn't generate to recurring revenue. If you're analyzing, by the way, our results 3 years ago and now, you can see that the recurring revenue was small part of our business. And today, it's almost reaching, it's somewhere between 20% to 25% of our revenue is based on recurring revenue. So this is our strategy, we will continue in this direction and I believe that you will continue to see growth, not only percentage-wise, but also absolute -- in absolute number as well.
There are no further questions. I will now turn the call back over to Shlomi Cohen for closing remarks.
Thank you, operator. Thank you, everyone. I would like to add that throughout the next few months, we expect to remain active in our investor awareness activities. If you're interested in setting up a meeting, please contact our IR field NZ group. As a pioneer and a leader in the cashless payment solution arena, we strongly believe our technology will continue bringing tremendous amount of values to our industry while resulting in predictable, high margin recurring revenue for the company and a great value for you, our shareholders. In conclusion, we thank you for your continued support. Thank you for your attendance.
The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.