OTIV On Track Innovations Ltd

Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Forward - Looking Statements

The statements contained in this Quarterly Report on Form 10-Q, or Quarterly Report, that are not historical facts are "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995 and other federal securities laws. Such forward-looking statements may be identified by, among other things, the use of forward-looking terminology such as "believes", "intends", "plans", "expects", "may", "will", "should", or "anticipates" or the negative thereof or other variations thereon or comparable terminology, and similar expressions are intended to identify forward-looking statements.  We remind readers that forward-looking statements are merely predictions and therefore are inherently subject to uncertainties and other factors and involve known and unknown risks that could cause the actual results, performance, levels of activity, or our achievements, or industry results, to be materially different from any actual future results, performance, levels of activity, or our achievements, or industry results, expressed or implied by such forward-looking statements. Such forward-looking statements may appear in this Item 2 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” as well as elsewhere in this Quarterly Report and include, among other statements, statements regarding the following:

The factors discussed herein, including those risk factors expressed from time to time in our press releases or filings with the Securities and Exchange Commission, or the SEC, could cause actual results and developments to be materially different from those expressed in or implied by such statements. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak and are made only as of the date of this filing.

Our business and operations are subject to substantial risks, which increase the uncertainty inherent in the forward-looking statements contained in this Quarterly Report. Except as required by law, we undertake no obligation to release publicly the result of any revision to these forward-looking statements that may be made to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events. Further information on potential factors that could affect our business is described among others under the heading “Risk Factors” in Part I, Item 1A of our Annual Report on Form 10-K for the fiscal year ended December 31, 2015 filed with SEC. Readers are also urged to carefully review and consider the various disclosures we have made in that report.

As used in this Quarterly Report, the terms "we", "us", "our", “the Company”, and "OTI" mean On Track Innovations Ltd. and our subsidiaries, unless otherwise indicated or as otherwise required by the context.

All figures in this Quarterly Report are stated in United States dollars, unless otherwise specified in.

Overview

We are a pioneer and leading developer of cutting-edge secure cashless payment solutions, providing global enterprises with innovative technology for over two decades. We currently operate in two main segments: (i) Petroleum and (2) Retail and Mass Transit Ticketing (following the divesture of our Parking Business, see below). In addition to our two reportable segments, products of our MediSmart solutions and other secure smart card solutions are classified under “Other” in segment analyses appearing in this Quarterly Report.

Our field-proven suite of cashless payment solutions is based on an extensive IP portfolio, including registered patents and patent applications worldwide. Since our incorporation in 1990, we have built an international reputation for reliability and innovation, deploying hundreds of solutions for banking, mobile network operators, vending, mass transit and petroleum.

We operate a global network of regional offices, distributors and partners to support various solutions deployed across the globe.

We focus our efforts on our core business of providing innovative cashless payment solutions based among other things on our contactless NFC technology. We have increased our efforts to further develop existing and new products and solutions, including among others by the introduction of our new telemetry and Internet of Things, or IoT, technology, and increased our sales and marketing activities and taskforce. We also focus on developing strategic channel partnerships around the globe to increase our revenues and on maximizing the value of our IP through licensing, customized technology solutions, strategic partnerships and enforcing our patent portfolio. Recently, we have significantly cut costs and reduced operating expenses, in part by outsourcing part of our manufacturing activities.

RESULTS OF OPERATIONS – THREE MONTHS ENDED SEPTEMBER 30, 2016 COMPARED TO THREE MONTHS ENDED SEPTEMBER 30, 2015 , AND NINE MONTHS ENDED SEPTEMBER 30, 2016 COMPARED TO NINE MONTHS ENDED SEPTEMBER 30, 2015

This discussion and analysis should be read in conjunction with our interim condensed consolidated financial statements and notes thereto contained in “Item 1.  Financial Statements” of this Quarterly Report.  

Results of Operations

Discontinued operations . In December 2013, we completed the sale of certain assets, certain subsidiaries and IP directly related to our SmartID division. On September 14, 2016, we closed an Asset Purchase Agreement with Atrinet Ltd. and certain subsidiaries thereof, or collectively, Atrinet, pursuant to which we sold to Atrinet our former parking business, including ongoing operations, transfer of related employees, as well as IP directly related thereto, for a non-material amount. The results from such operations and the cash flows for the reporting periods are presented in the statements of operations and in the statements of cash flows, respectively, as discontinued operations separately from continuing operations. All the data in this Quarterly Report that are derived from our financial statements, unless otherwise specified, exclude the results of those discontinued operations .

Three months ended September 30, 2016, compared to the three months ended September 30, 2015

Sources of Revenue

We have historically derived a substantial majority of our revenues from the sale of our products, including both complete systems and original equipment manufacturer components. In addition, we generate revenues from licensing and transaction fees, and also, less significantly, from engineering services, customer services and technical support. During the three months ended September 30, 2016 and September 30, 2015, the revenues that we derived from sales and licensing and transaction fees were as follows (in thousands):

Sales. Sales increased by $1.3 million, or 57%, in the three months ended September 30, 2016, compared to the three months ended September 30, 2015. The increase in 2016 is mainly attributed to an increase in Retail and Mass Transit Ticketing segment sales in the United States.

Licensing and transaction fees . Licensing and transaction fees include single and periodic payments for distribution rights for our products. Transaction fees are paid by customers based on the volume of transactions processed by systems that contain our products. Our licensing and transaction fees in the three months ended September 30, 2016, compared to the three months ended September 30, 2015, increased by $938,000, or 78%. This was mainly due to an increase in licensing of our intellectual property rights to third parties in the United States (including licenses granted pursuant to settlements of legal actions to enforce patent rights).

We have historically derived revenues from different geographical areas.  The following table sets forth our revenues (in thousands) and as a percentage of revenues in different geographical areas, in the three months ended September 30, 2016 and September 30, 2015:

Our revenues from sales in Africa increased by $206,000, or 24%, in the three months ended September 30, 2016, compared to the three months ended September 30, 2015, mainly due to an increase in sales of Petroleum products.

Our revenues from sales in Europe increased by $404,000, or 32%, in the three months ended September 30, 2016, compared to the three months ended September 30, 2015, mainly due to an increase in Retail and Mass Transit Ticketing segment products.

Our revenues from sales in Asia decreased by $258,000, or 47%, in the three months ended September 30, 2016, compared to the three months ended September 30, 2015, mainly due to a decrease in sales of Petroleum products and a decrease in sales of access control products.

Our revenues from sales in Americas increased by $1.8 million, or 252%, in the three months ended September 30, 2016, compared to the three months ended September 30, 2015, mainly due to an increase in sales of NFC readers in the United States and an increase in licensing of our intellectual property rights to third parties in the United States.

Our revenues derived from outside the United States, which are primarily received in currencies other than the U.S. dollar, will have a varying impact upon our total revenues, as a result of fluctuations in such currencies’ exchange rates versus the U.S. dollar.

The following table sets forth our revenues (in thousands) and as a percentage of revenues by segments, during the three months ended September 30, 2016 and September 30, 2015:

Our revenues in the three months ended September 30, 2016, from Petroleum increased by $43,000, or 4%, compared to the three months ended September 30, 2015, mainly due to an increase in sales of Petroleum products in Africa.

Our revenues from Retail and Mass Transit Ticketing in the three months ended September 30, 2016, increased by $2.3 million, or 145%, compared to the three months ended September 30, 2015, mainly due to an increase in sales of NFC readers in the United States and an increase in licensing of our intellectual property rights to third parties in the United States.

Our revenues in the three months ended September 30, 2016, from our Other segment decreased by $152,000, or 19%, compared to the three months ended September 30, 2015, mainly due to a decrease in sales of access control products in Asia.

Cost of sales .  Cost of revenues relating to sales consists primarily of materials, as well as salaries, fees to subcontractors and related costs of our technical staff that assemble our products.  The increase of $1 million, or 65%, in the three months ended September 30, 2016, compared to the three months ended September 30, 2015, resulted primarily from an increase in revenues.

Cost of licensing. Cost of licensing revenues do not have directly attributable cost of revenues the three months ended September 30, 2015. The increase in the three months ended September 30, 2016 is due to transaction costs in connection with the increase in licensing of our intellectual property rights to third parties in the United States.

Gross margin. Gross margin in the three months ended September 30, 2016, compared to the three months ended September 30, 2015, remained consistent.

Operating expenses

Our operating expenses in the three months ended September 30, 2016 and September 30, 2015, were as follows (in thousands):

Research and development.   Our research and development expenses consist primarily of the salaries and related expenses of our research and development staff, as well as subcontracting expenses. The decrease of $177,000, or 23%, in the three months ended September 30, 2016, compared to the three months ended September 30, 2015, is primarily attributed to a decrease in the number of research and development employees due to our cost cutting plan.

Selling and marketing.   Our selling and marketing expenses consist primarily of salaries and substantially all of the expenses of our sales and marketing subsidiaries and offices in the United States, South Africa and Europe, as well as expenses related to advertising, professional expenses and participation in exhibitions and tradeshows. The decrease of $223,000, or 15%, in the three months ended September 30, 2016, compared to the three months ended September 30, 2015, is primarily attributed to a decrease in employment expenses of selling and marketing employees who left the Company by the end of 2015. Our selling and marketing expenses may increase in the future as we continue to expand our local sales and marketing efforts, open new offices and in the event that we hire additional personnel.

General and administrative.   Our general and administrative expenses consist primarily of salaries and related expenses of our executive management and financial and administrative staff. These expenses also include costs of our professional advisors (such as lawyers and accountants), office expenses, insurance, general and administrative expenses and provision for doubtful accounts. The decrease of $241,000, or 24%, in the three months ended September 30, 2016, compared to the three months ended September 30, 2015, is primarily attributed to a decrease in employment expenses and to a decrease in professional expenses.

Patent litigation and maintenance expenses . Our patent litigation and maintenance expenses consist primarily of professional advisors related to our patents and other IP, such as lawyers or other consultants, as part of the Company's plan to maximize the value of our IP, and also consist of salaries and related expenses of our team of employees executing this strategy. The decrease of $348,000, or 99%, in the three months ended September 30, 2016, compared to the three months ended September 30, 2015, is primarily attributed to a decrease in employment expenses related to the termination of employment of one of our former directors as chief executive officer of our U.S. subsidiary, who led the Company's efforts to maximize the value of our patents portfolio until August 2015.

Other expenses. Our other expenses in the three months ended September 30, 2015 consist of partial compensation expenses related to the termination of employment of our former Chief Executive Officer, Mr. Ofer Tziperman, according to his employment terms, following his resignation from the Company and its subsidiaries on February 10, 2015 and compensation expenses related to the termination of employment of our former Director and Chief Executive Officer of our U.S. subsidiary, Mr. Dimitrios Angelis, on August 3, 2015. In addition, on September 4, 2016, we sold our headquarters building in Rosh Pina, Israel to a third party. As a result of this sale, we recorded a loss of $83 under other operating expenses in the three months ended September 30, 2016.

Financing expenses, net

Our financing expenses, net, in the three months ended September 30, 2016 and September 30, 2015, were as follows (in thousands):

Financing expenses consist primarily of interest payable on bank loans, bank commissions and foreign exchange losses. Financing income consists primarily of foreign exchange gains and from interest earned on investments in short-term deposits. The increase in financing income in the three months ended September 30, 2016, compared to the three months ended September 30, 2015, of $79,000, is mainly due to exchange rate differentials and also to an increase in interest earned on investments in short-term deposits. Financing expenses in the three months ended September 30, 2016, compared to the three months ended September 30, 2015, remained consistent.

Net income (loss) from continuing operations

Our net income (loss)   from continuing operations in the three months ended September 30, 2016 and September 30, 2015, was as follows (in thousands):

The change of $2.5 million, in the three months ended September 30, 2016, compared to the three months ended September 30, 2015 is primarily due to an increase in our sales, an increase in our gross profit, a decrease in our operating expenses and a decrease in financing expenses, net, as described above.

Net income (loss) from discontinued operations

Our net income (loss) from discontinued operations in the three months ended September 30, 2016 and September 30, 2015, was as follows (in thousands):

In December 2013, we completed the sale of certain assets, certain subsidiaries and IP assets directly related to our SmartID division. Further, in September 2016, we completed the sale of certain assets and IP relating to our previous parking business.

The results from these operations for the reporting periods are presented in the statements of operations as discontinued operations separately from continuing operations.

The net income from discontinued operations of $391,000, in the three months ended September 30, 2015, is related to income from contingent consideration according to an earn out mechanism as part of our SmartID divestiture, partially offset by the loss from operations activity of our previous parking business. The net loss from discontinued operations of $279,000 in the three months ended September 30, 2016, is related to the operations activity and sale of certain assets and IP relating our previous parking business.

Net loss

Our net loss in the three months ended September 30, 2016 and September 30, 2015, was as follows (in thousands):

The decrease in net loss of $1.9 million, or 96%, in the three months ended September 30, 2016, compared to the three months ended September 30, 2015, is primarily due to an increase in our sales, an increase in our gross profit, a decrease in our operating expenses and a decrease in financing expenses, net, partially offset by the change in our results from discontinued operations as described above.  

Nine months ended September 30, 2016, compared to the nine months ended September 30, 2015  

Sales . Sales increased by $906,000, or 10%, in the nine months ended September 30, 2016, compared to the nine months ended September 30, 2015. The increase is mainly attributed to an increase in Retail and Mass Transit Ticketing segment sales in the United States and Europe.

Licensing and transaction fees . Our licensing and transaction fees in the nine months ended September 30, 2016, compared to the nine months ended September 30, 2015, increased by $1 million, or 29%. This was mainly due to an increase in licensing of our intellectual property rights to third parties in the United States (licensing including legal actions to enforce patent rights).

We have historically derived revenues from different geographical areas.  The following table sets forth our revenues (in thousands) and as a percentage of revenues in different geographical areas, in the nine months ended September 30, 2016 and September 30, 2015: