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, 2016 filed with the 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: (1) Retail and Mass Transit Ticketing; and (2) Petroleum (following the divesture of our parking business as specified below). In addition to our two reportable segments, certain products for the medical industry 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 a large number of solutions for the unattended retail, mass transit, banking, medical and petroleum industries.

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 near field communications, or NFC, technology. To this end, and in line with our efforts to focus on our core business, in September 2016 we completed the sale of the operations, including our employees, as well as intellectual property directly related to our parking business. We have increased our efforts to further develop existing and new products and solutions, including among others by the introduction of our new products and solutions for the unattended payment market and Internet of Payment Things, or IoPT, technology. We have also increased our sales and marketing activities and resources.

RESULTS OF OPERATIONS -THREE MONTHS ENDED MARCH 31, 2017 COMPARED TO THREE MONTHS ENDED MARCH 31, 2016

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

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 March 31, 2017 and March 31, 2016, the revenues that we derived from sales and licensing and transaction fees were as follows (in thousands):

Sales. Sales decreased by $582,000, or 17%, in the three months ended March 31, 2017, compared to the three months ended March 31, 2016. The decrease is mainly attributed to a decrease in Retail and Mass Transit Ticketing segment sales in the United States and to a decrease in Petroleum segment sales in South America, partially offset by an increase in sales of readers and our otiMetry solution in Europe.

Licensing and transaction fees. Licensing and transaction fees include single and periodic payments for distribution rights for our products as well as licensing our IP rights to third parties. Transaction fees are paid by customers based on the volume of transactions processed by systems that contain our products. Our licensing and transaction fees increased by $30,000, or 2%, in the three months ended March 31, 2017, compared to the three months ended March 31, 2016. The increase is mainly attributed to licensing and transaction fees related to our otiMetry solution in Europe.

We have historically derived revenues from different geographical areas.  The following table sets forth our revenues, by dollar amount (in thousands) and as a percentage of quarterly revenues in different geographical areas, for the three months ended March 31, 2017 and March 31, 2016:

Our revenues from sales in Americas decreased by $1.5 million, or 69%, in the three months ended March 31, 2017, compared to the three months ended March 31, 2016, mainly due to a decrease in sales of readers to the U.S. market and a decrease in sales of Petroleum products to the South American market.

Our revenues from sales in Europe increased by $761,000, or 52%, in the three months ended March 31, 2017, compared to the three months ended March 31, 2016, mainly due to an increase in Retail and Mass Transit Ticketing segment sales and an increase in our otiMetry solution in the European market.

Our revenues from sales in Africa decreased by $50,000, or 6%, in the three months ended March 31, 2017, compared to the three months ended March 31, 2016, mainly due to a decrease in sales of our MediSmart products, partially offset by an increase in sales of Petroleum products.

Our revenues from sales in the Asia-Pacific region, or APAC, increased by $235,000, or 235%, in the three months ended March 31, 2017, compared to the three months ended March 31, 2016, mainly due to an increase in sales of our access control products and an increase in sales of our otiMetry solution in Australia.

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

The following table sets forth our revenues by dollar amount (in thousands) and as a percentage of revenues by segments, for the three months ended March 31, 2017 and March 31, 2016:

Our revenues from Retail and Mass Transit Ticketing in the three months ended March 31, 2017 decreased by $158,000, or 5%, compared to the three months ended March 31, 2016, mainly due to a decrease in sales of readers in the United States, partially offset by an increase in readers and otiMetry solution sales in the European market.

Our revenues in the three months ended March 31, 2017 from Petroleum decreased by $291,000, or 26%, compared to the three months ended March 31, 2016, mainly due to a decrease in Petroleum products in South America, partially offset by an increase in sales of Petroleum products in Africa.

Our revenues in the three months ended March 31, 2017 from our Other segment decreased by $103,000, or 18%, compared to the three months ended March 31, 2016, mainly due to a decrease in sales of MediSmart products in East Africa, partially offset by an increase in access control products sales in Asia.

Cost of sales.   Cost of sales consists primarily of materials, as well as salaries, fees to subcontractors and related costs of our technical staff that assemble our products. The decrease of $449,000, or 20%, in the three months ended March 31, 2017, compared to the three months ended March 31, 2016, resulted primarily from the decrease in revenues mainly attributed to the decrease in Retail and Mass Transit Ticketing segment sales in the United States.

Gross margin. The increase in gross margin percentage in the three months ended March 31, 2017, compared to the three months ended March 31, 2016, is mainly attributed to a favorable change in our revenue mix and from a decrease in our consumption of materials for the production of our retail products.

Operating expenses

Our operating expenses for the three months ended March 31, 2017 and March 31, 2016, 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. Our research and development expenses in the three months ended March 31, 2017, compared to the three months ended March 31, 2016, remained consistent.

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. Our selling and marketing expenses in the three months ended March 31, 2017, compared to the three months ended March 31, 2016, remained consistent.

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 legal and accounting), office expenses, insurance, provision for doubtful accounts and patent maintenance expenses which consist of professional advisors of our patents and other IP. The decrease of $68,000, or 7%, in the three months ended March 31, 2017, compared to the three months ended March 31, 2016, is primarily attributed to a decrease in professional consulting expenses.

Financing expenses, net

Our financing expenses, net, for the three months ended March 31, 2017 and March 31, 2016, were as follows (in thousands):

Financing expenses, net consist primarily of financing expense related to interest payable on bank loans, bank commissions and foreign exchange differentials partially offset by financing income related to interest earned on investments in short-term deposits. The decrease in financing expenses, net of $22,000, or 24%, in the three months ended March 31, 2017, compared to the three months ended March 31, 2016, is mainly due to a decrease in banking fees.

Net loss from continuing operations

Our net loss   from continuing operations for the three months ended March 31, 2017 and March 31, 2016, was as follows (in thousands):

Our net loss   from continuing operations in the three months ended March 31, 2017, compared to the three months ended March 31, 2016, remained consistent primarily due to the increase in our gross margin, a decrease in our operating expenses and a decrease in financing expenses, net, as described above.

Net loss from discontinued operations

Our net loss from discontinued operations for the three months ended March 31, 2017 and March 31, 2016, was as follows (in thousands):

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

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

The decrease in net loss from discontinued operations of $61,000 in the three months ended March 31, 2017, compared to the three months ended March 31, 2016, is mainly due to a cessation in loss related to the sale of the parking business.

Net loss

Our net loss for the three months ended March 31, 2017 and March 31, 2016, was as follows (in thousands):

The decrease in net loss of $63,000, or 7%, in the three months ended March 31, 2017, compared to the three months ended March 31, 2016, is primarily due to an increase in our gross margin, a decrease in our operating expenses, a decrease in financing expenses, net, and a decrease in net loss from discontinued operations, as described above.  

Liquidity and Capital Resources

Our principal sources of liquidity since our inception have been sales of equity securities, borrowings from banks, cash from the exercise of options and warrants and proceeds from divestiture of part of our businesses. As of March 31, 2017 we had cash, cash equivalents and short-term investments representing bank deposits of $10.8 million (of which an amount of $1.5 million has been pledged as a security in respect of performance guarantees granted to third parties, loans and credit lines received from a bank), and $11.5 million as of December 31, 2016 (of which an amount of $1.5 million had then been pledged as a security in respect of performance guarantees granted to third parties, loans and credit lines received from a bank). We believe that we have sufficient capital resources to fund our operations for at least the next 12 months. We adhere to an investment policy which is intended to enable the Company to avoid being classified as a “passive foreign investment company,” or PFIC, under United States law. That said, we cannot provide complete assurance that PFIC status will be avoided in the future. In addition, our investment policy requires investment in high-quality investment-grade securities. As of March 31, 2017, our bank loans are denominated in the following currencies: Polish Zloty ($1.0 million, with maturity dates ranging from 2017 through 2019) and South African Rand ($641,000, with maturity dates ranging from 2017 through 2023). As of March 31, 2017, these loans bear interest at rates ranging from 3.6%-10.5% per annum.

The composition of our long-term loans as of March 31, 2017, was as follows (in thousands):

The composition of our short-term loans, bank credit and current maturities of long-term loans as of March 31, 2017 was as follows (in thousands):

Our and certain of our subsidiaries’ manufacturing facilities and certain equipment have been pledged as security in respect of a loan received from a bank. Our short term deposits in the amount of $1.5 million have been pledged as security in respect of guarantees granted to third parties, loans and credit lines received from a bank. Such deposits cannot be pledged to others or withdrawn without the consent of the bank.

As of March 31, 2017, we granted guarantees to third parties including performance guarantees and guarantees to secure customer advances in the sum of $323,000. The expiration dates of the guarantees range from October 2017 to June 2019.

For the three months ended March 31, 2017, we had a negative cash flow from continuing operations of $678,000

Operating activities related to continuing operations  

For the three months ended March 31, 2017, net cash used in continuing operating activities was $678,000 primarily due to a $782,000 net loss from continuing operations, a $693,000 decrease in trade payables, a $343,000 increase in inventory, a $234,000 increase in other receivables and prepaid expenses and a $26,000 decrease in accrued interest, partially offset by a $569,000 increase in other current liabilities, a $423,000 decrease in trade receivables, $281,000 of depreciation, a $90,000 expense due to stock based compensation issued to employees and others, a $9,000 increase in deferred tax and a $28,000 increase in accrued severance pay.

For the three months ended March 31, 2016, net cash used in continuing operating activities was $1.2 million primarily due to a $1.3 million increase in trade receivables, a $784,000 net loss from continuing operations, a $180,000 decrease in other current liabilities, a $146,000 decrease in accrued severance pay, and $7,000 decrease in accrued interest, partially offset by a $575,000 increase in trade payables, a $346,000 decrease in inventory, $308,000 of depreciation, a $16,000 increase in deferred tax, a $27,000 expense due to stock based compensation issued to employees and a $2,000 decrease in other receivables and prepaid expenses.

Operating activities related to discontinued operations

For the three months ended March 31, 2017, net cash used in discontinued operating activities was $68,000, related to the previous parking business and SmartID division.

For the three months ended March 31, 2016, net cash used in discontinued operating activities was $109,000, related to the previous parking business.

Investing and financing activities related to continuing operations

For the three months ended March 31, 2017, net cash provided by continuing investing activities was $1.6 million, mainly due to a $1.7 million change in short-term investments, net and $44,000 in proceeds from restricted deposit for employee benefits, partially offset by an $88,000 investment in capitalized product costs and $35,000 of purchases of equipment.

For the three months ended March 31, 2016, net cash provided by continuing investing activities was $764,000, mainly due to a $901,000 change in short-term investments, net, partially offset by $83,000 of purchases equipment and a $54,000 investment in capitalized product costs.

For the three months ended March 31, 2017, net used in continuing financing activities was $108,000, mainly due to a $222,000 repayment of long-term bank loans, partially offset by a $112,000 increase in short-term bank credit, net and $2,000 in proceeds from exercise of options and warrants.

For the three months ended March 31, 2016, net cash provided by continuing financing activities was $50,000, mainly due to a $286,000 increase in short-term bank credit, net and $27,000 of proceeds from long-term bank loans, partially offset by a $263,000 repayment of long-term bank loans.

Investing and financing activities related to discontinued operations

We had no cash flows provided by or used in discontinued investing activities in the three months ended March 31, 2017.

For the three months ended March 31, 2016, net cash used in discontinued investing activities was $61,000, related to the SmartID division.

We had no cash flows provided by or used in discontinued financing activities in the three months ended March 31, 2017 and March 31, 2016.

Off Balance Sheet Arrangements

We have no off balance sheet arrangements.