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Edited Transcript of OTIV earnings conference call or presentation 7-May-19 1:00pm GMT

Q1 2019 On Track Innovations Ltd Earnings Call

Rosh Pina May 30, 2019 (Thomson StreetEvents) -- Edited Transcript of On Track Innovations Ltd earnings conference call or presentation Tuesday, May 7, 2019 at 1:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Assaf Cohen

On Track Innovations Ltd. - CFO

* Shlomi Cohen

On Track Innovations Ltd. - CEO & Director

* Ehud Helft

GK Investor Relations - Managing Partner

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Conference Call Participants

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* John Nobile

Taglich Brothers, Inc., Research Division - Principal Equity Analyst

* Kevin Darryl Dede

H.C. Wainwright & Co, LLC, Research Division - MD of Equity Research & Senior Technology Analyst

* Michael James Latimore

Northland Capital Markets, Research Division - MD & Senior Research Analyst

* William Tennent Gibson

Roth Capital Partners, LLC, Research Division - MD & Senior Research Analyst

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Presentation

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Operator [1]

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Ladies and gentlemen, thank you for standing by. Welcome to On Track Innovations First Quarter 2019 Results Conference Call. (Operator Instructions) As a reminder, this conference is being recorded. You should have all received by now the company's press release. If you have not received it, please review it in the Investor Relations section of the company's website or contact the Investor Relations team at GK Investor & Public Relations. I would now like to hand over the call to Mr. Helft of GK Investor & Public Relations. Mr. Helft, would you like to begin?

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Ehud Helft, GK Investor Relations - Managing Partner [2]

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Thank you, operator. Welcome to On Track Innovations 2019 First Quarter Conference Call. I would like also to thank management for hosting this call. With us on the call today are Mr. Shlomi Cohen, the CEO; and Mr. Assaf Cohen, the CFO. Shlomi will provide some of the recent key highlights, and Assaf will briefly review OTI's financial performance for our 2019 first quarter. Following the prepared remarks, we will then open the call for the question-and-answer session.

Please be advised that certain information discussed on this conference call will contain forward-looking statements. They can be identified by the use of terms such as may, will, expect, believe, intend, plan and other comparable terms. While forward-looking statements reflect good faith, belief and best judgment based upon current information, they are not guarantees of future performance. They are subject to unknown -- to known and unknown uncertainties and risk factors, including those detailed from time to time in the company's filings with the SEC. OTI assumes no obligation to update any forward-looking statements or information which speaks as for their respective dates. The full safe harbor provision are set forth in the press release we issued this morning.

And with that, I would now like to hand over the call to the company's CEO, Shlomi Cohen. Shlomi, go ahead, please.

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Shlomi Cohen, On Track Innovations Ltd. - CEO & Director [3]

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Thank you, Ehud. Welcome all, and thank you for joining us today. As we had discussed during the last earning call, our first quarter of 2019 was weak from the revenue standpoint. The lower sales we experienced were mainly due to the impact of 10% U.S. tariff on Chinese-manufactured product, which started in Q3 of last year. This impacted our product sales to many of our customers.

As it became clear last year that our sales would be impacted, we began the process of shifting production out of China to another manufacturing zone, the Philippines, where there is no impact from U.S. tariff on imports. I am pleased to say that as of the end of first quarter, we had successfully completed the process. I recently returned from the new production facility in the Philippines, and it was up and running as of the beginning of second quarter. I therefore believe that this short-term issue is finally behind us.

While the recent lower revenue levels were indeed significant short-term negative for us at OTI, the slowdown was temporary and expect a return to revenue growth already in the second quarter and beyond. There are also few aspects of the results which we are indeed pleased about, which paints a more positive picture and we believe will benefit us ahead. First, the recalled portion of our revenue how to follow a long-term strategy continue to grow, increasing by 12% on an absolute basis compared with the previous quarter. And we expect that general trend of ongoing growth in recurring revenue will continue in the quarters ahead.

As this continues, we will enjoy the more predictable growth that it will be provide us within the quarters ahead. And due in part the higher level of recurring revenue as well as our focus on higher margin product sales, our gross margin benefited in the quarter, jumping significantly to 55% compared with 48% last quarter. Therefore, we see that the ongoing increase in our recurring revenue levels, together with the improvement in the gross margins, provide us with an improved platform for growth ahead as the business began its recovery in the second quarter and increases from thereon.

On the third front, at the beginning of April, we announced a 6,000 readers order for advanced payment system for use in Russian rail ticketing system. Actually, [mean] a long-term growth market for us in 2018, we already delivered 11,000 advanced contactless reader to the retail self-service market in the region.

In summary, it has not been an easy 6 months. However, the challenges we faced, I firmly believe, are now behind us, and the continued progress we have made on building recurring revenue as well as improvement to the gross margins better position us going forward. I look forward to our return to revenue growth in the coming quarters.

With that, I would like to hand over to Assaf, our CFO. Assaf, please go ahead.

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Assaf Cohen, On Track Innovations Ltd. - CFO [4]

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Thank you, Shlomi. Before the market opened today, we issued the results of the first quarter of 2019 in a press release. A copy of the release is available in the Investor Relations section of our website. I will be covering some non-GAAP metrics, including adjusted EBITDA from continued operation. We believe this provides a good understanding of our ongoing performance. Please see the earnings release on our website for further details about this non-GAAP metric, including a reconciliation of adjusted EBITDA to our comparable GAAP results.

In addition, as you know, we announced the sale of MediSmart in December 2018. The results of MediSmart are therefore included as discontinued operation, and all the prior-period information have been reclassified to conform with the current-period presentation.

Revenues in the first quarter of 2019 were $3 million. This is compared with $5.5 million in the first quarter of last year and $4.5 million in the prior quarter. As Shlomi explained, the lower level of revenues was due to the impact of import tariff of products manufactured in China affecting sales to many customers. We took steps to mitigate the tariff issue, which were completed at the end of the first quarter of 2019. In addition, the revenues were impacted also by the lower level of orders from the Asia Pacific region.

In terms of breakdown of where revenues were derived. For the first quarter, retail and mass transit ticketing revenues were $2.2 million or 73% of sales, and petroleum revenues were $0.8 million or 27% of sales. Looking at geographic breakdown in the first quarter. The Americas accounted for $0.6 million or 19%. Europe was $1.7 million or 57%. Africa was $0.6 million or 19%. And APAC was $0.9 million -- I'm sorry, $0.1 million or 5%.

Recurring revenues in the first quarter accounted for $1.3 million, which is 43% of total revenues. This is compared to $1.3 million or 23% of total revenues in the first quarter of last year and $1.2 million, 26% of total revenues in the prior quarter.

Gross margin in the first quarter was 55%, a solid improvement over the 52% reported in Q1 last year and 48% reported in the prior quarter. In the first quarter of 2019, operating expenses were $3.1 million versus $3.4 million in the first quarter of last year and $3 million in the prior quarter.

Net loss from continuing operations in the quarter was $1.6 million. This compares to $400,000 loss in the first quarter of last year and $862,000 loss in the prior quarter. Net loss in the quarter was $1.7 million or loss of $0.01 -- of $0.04 per share versus net loss of $333,000 or loss of $0.01 per share in the first quarter last year and net income of $533,000 or positive $0.01 per share in the prior quarter.

Now turning to our non-GAAP results. Adjusted EBITDA in the first quarter of 2019 was a loss of $1.1 million compared with an adjusted EBITDA loss of $104,000 in the first quarter of last year and adjusted EBITDA loss of $471,000 in the prior quarter.

Looking at our balance sheet, OTI remains in a strong position with very low debt. At March 31, 2019, cash, cash equivalents and short-term investments was $4.9 million and short and long-term debt was $0.5 million, giving us a net cash position of $4.4 million. At year-end 2018, we had $5.9 million in cash and equivalents and $0.3 million in debt, a net of $5.6 million.

This completes my financial summary. For a more detailed analysis of our financial results, please refer to our quarterly report on Form 10-Q, which we plan to file by May 15, 2019. And now I'd like to open the call for Q&A. Operator?

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Operator [5]

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(Operator Instructions) First question is from William Gibson from Roth Capital Partners.

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William Tennent Gibson, Roth Capital Partners, LLC, Research Division - MD & Senior Research Analyst [6]

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I want to look beyond the second half of this year. And if we look out to 2020 and 2021, is $25 million annual revenue a good number for 2020? Or what do you think? Higher, lower?

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Shlomi Cohen, On Track Innovations Ltd. - CEO & Director [7]

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I believe that it will be higher. Maybe one thing that will be a key factor for our activities not only for the second half of, let's say, to the last quarter and also the coming years ahead, is the fact that we actually presented 2 weeks ago during NAMA -- the NAMA Show in Vegas, this is actually the biggest event for automated retail machines, our state-of-the-art technology, the TRIO-IQ. It's going to answer the demand that's presented by the FDA and also requested by many of the kiosks and vending players in the market, in the worldwide market. And this is something that I believe is going to support our sales in the coming years. So therefore, $25 million and the fact that we are going to do recovery on our revenue following the production shift should take us to this number and even higher than that.

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Operator [8]

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The next question is from the line of John Nobile from Taglich Brothers.

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John Nobile, Taglich Brothers, Inc., Research Division - Principal Equity Analyst [9]

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Shlomi, if I could, you mentioned that you showcased the TRIO-IQ product at the NAMA Show in Vegas last month. I was hoping you could provide a little more detail on how the FDA regulations might actually be beneficial to sales of this product going forward.

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Shlomi Cohen, On Track Innovations Ltd. - CEO & Director [10]

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Yes. First of all, let's see what was actually the major request. The FDA for a long time is actually requesting from the vending operators and not only, I will say, automated retail machine, this should be the right term, to present the nutrition fact, the calorie for each product when you're actually choosing product in the automated retail machine. Let's -- just for the sake of it, if you are going to a vending machine and you're choosing, for example, a Coke. The idea is that the buyer will be able to see the calorie level of each product before he's actually pushing the button and he is buying the relevant product.

So how you are going to do that? We came out with a very powerful product called TRIO-IQ that actually consolidate the reader, the credit card reader, and the telemetry unit in one device. When the entire front of the product is actually touch screen and we are able to present a relatively huge amount of data regarding the relevant product. And not only that, when the machine is actually flipped, you can run a commercial. And this is another element that we are (inaudible). We, of course, having a long set of features in this product such as camera for QR codes and coupons. We have a proximity element that we are able to identify when a potential buyer is actually approaching the machine. And even before he's approaching the machine, we are able to inject to the audio and video promotion.

And there are a few other features, by the way, that are going to increase the revenue per machine. And this is actually the reason that I was saying that this is going to be one of our game-changer for the coming years. Needless to say that the ramp-up will be step by step, and the meetings that we already have during the NAMA Show was very positive. And we were able to set up a long list of meetings with potential accounts that we are not working with them today.

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John Nobile, Taglich Brothers, Inc., Research Division - Principal Equity Analyst [11]

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Okay. So this product is ready to be shipped? It's already obviously showcased with...

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Shlomi Cohen, On Track Innovations Ltd. - CEO & Director [12]

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In Q4, it will be available for commercial delivery.

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John Nobile, Taglich Brothers, Inc., Research Division - Principal Equity Analyst [13]

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Okay. So that's what's really setting up for the 2020 growth that you had mentioned prior. If I could get into the manufacturing from China to the Philippines, I'm not sure if you can actually quantify on this call how that might have impacted your first quarter sales. And is -- do you see any potential impact from this move to show up in the second quarter at all?

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Shlomi Cohen, On Track Innovations Ltd. - CEO & Director [14]

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I would say the following. First of all, I'm -- I want to be very careful but I will say that we definitely can see acceleration in our revenue in the coming quarters; definitely in Q2 compared to Q1. To tell you that we are going to close the entire gap that we actually created in Q1, the answer is no because I want to be totally transparent with the market. But from the other end, we can see a positive momentum that we are starting to gain. And I believe that this year, we will see some kind of menial growth quarter-over-quarter. And this is actually the sign that we are actually stepping out from this negative event. Needless to say that we are investing heavily now in our phone side of the business in order to make sure that the acceleration will be even faster.

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John Nobile, Taglich Brothers, Inc., Research Division - Principal Equity Analyst [15]

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Okay. Great. That's good to hear. And I was hoping that you could provide an update on the 6,000 payment systems you mentioned for Russia. Are they still on track for I think it was the second quarter, this quarter delivery? And I was wondering if you could quantify the revenue from what you expect from this in the second quarter.

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Shlomi Cohen, On Track Innovations Ltd. - CEO & Director [16]

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We believe that -- first of all, in the second quarter, we will continue to see growth in the Russian market. We definitely don't think that the purchase order that we got so far for the 6,000 systems in H1 is the final one for this year. As I mentioned before in the beginning, Russia is actually one of our strategic market, and we definitely see -- or we are going to see growth in our business in Russia also in the second half. All in all, OTI is actually positioned in the Russian market at this point of time in very positive place, not only for the ticketing that we mentioned before but also for the ATM as well.

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John Nobile, Taglich Brothers, Inc., Research Division - Principal Equity Analyst [17]

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Okay. And in regard to your partnership with Puma Energy, is [iFuel] -- the iFuel guard product, is that still expected to launch in the second quarter? I believe it was mentioned on a prior call or press release. And is there any talk about further expansion of this product into additional South African market?

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Shlomi Cohen, On Track Innovations Ltd. - CEO & Director [18]

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Yes. First of all, in South Africa, this is so far the biggest market that we are having for the EasyFuel technology. One of the -- I can say that -- okay. I want to say the name of the account but I'm thinking about the major energy company that we are working with them over there for a long time and we are generating with them with the EasyFuel technology our recurring revenue as well. And I believe that we will continue to see growth in this part of the world also in the coming years. I believe that also in '19 and '20, South Africa will continue to be one of our major markets for the EasyFuel technology.

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John Nobile, Taglich Brothers, Inc., Research Division - Principal Equity Analyst [19]

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Okay. That's great to hear. And I know you mentioned that your gross margins were up. Obviously, they were higher, a greater percentage of your revenue coming from recurring. But the product gross margins, they were down. They dropped to 20.4% in the first quarter. And I know with the manufacturing shifted complete, should we anticipate gross margins returning to the mid-30% range?

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Shlomi Cohen, On Track Innovations Ltd. - CEO & Director [20]

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I think I'm not sure that I understand the question because the gross margin that we were having in Q4 was 48%. The gross margin that we are having in Q1 is 55%.

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John Nobile, Taglich Brothers, Inc., Research Division - Principal Equity Analyst [21]

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I'm talking about the product gross margins, the sales line there. The gross margins, I see there were actually 20.4%. I mean it dropped significantly from last year's first quarter. So I know typically you usually have it in the mid-30%s. I'm just trying to get an expectation of what to anticipate in Q2. Do you feel that now, especially with the shift into the Philippines, we should look at gross margins and outlying -- more in line with the 30% -- mid-30% range?

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Shlomi Cohen, On Track Innovations Ltd. - CEO & Director [22]

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Okay. Sorry, my mistake. Yes. The answer is positive. We expect that the gross margin for that will go up in the second quarter. I think that part of the reason that we were facing this negative impact on our gross margin -- on our product gross margin was mainly related to the fact that we were having -- we were actually facing the production shift. And I believe that from Q2, you will see also acceleration in our gross margin as well.

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John Nobile, Taglich Brothers, Inc., Research Division - Principal Equity Analyst [23]

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Understood. That's what I expected that it really -- that shift actually impacted it; not just the level but the shift itself had an impact on it. Okay. And just one quick last question. I don't want to take up the whole call here, but the first quarter results that's in the books, you have your current backlog expectations for Q2 and beyond. Do you believe for the full year that On Track will actually be able to achieve top line growth? Because I know we're looking at -- in the first quarter, revenue was really down about $2.5 million. So looking at the whole year, should we anticipate positive growth for the full year, I mean what you have on the books now?

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Shlomi Cohen, On Track Innovations Ltd. - CEO & Director [24]

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It's like you were actually listening to our internal discussion in OTI in our management. But give me a few, let's say -- I think that by the end of this 6 months, we will be able to be in a position to present a more reliable forecast regarding the entire year because we just stepped out from this negative event that we were facing during Q4 and Q1. So at this point of time, it will be a little bit early to forecast the entire year. But we are doing quite a lot of steps in order to be in a position of presenting growth. But in order to be on the safe side, I prefer to postpone my forecast to end of June, beginning of July.

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Operator [25]

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(Operator Instructions) Next question is from the line of Mike Latimore from Northland Capital Markets.

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Michael James Latimore, Northland Capital Markets, Research Division - MD & Senior Research Analyst [26]

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Just to be clear. You're saying that you expect sequential growth in the second quarter, not getting back to year-over-year growth. Is that correct?

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Shlomi Cohen, On Track Innovations Ltd. - CEO & Director [27]

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Yes.

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Michael James Latimore, Northland Capital Markets, Research Division - MD & Senior Research Analyst [28]

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Okay. Got it. And you said that the supply chain was the impediment to revenue last couple quarters. Did those orders basically just go into backlog or -- and so you have a little more visibility because of that?

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Shlomi Cohen, On Track Innovations Ltd. - CEO & Director [29]

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Look, I will say that we have today much better visibility for the coming quarters compared to the beginning of this year or even compared to Q4. When you're looking on Q4, Q4 was not so bad. It was below our expectation. But I think that the major negative impact was actually during Q1. This was actually a very weak quarter for us, but this is actually behind us.

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Michael James Latimore, Northland Capital Markets, Research Division - MD & Senior Research Analyst [30]

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When you get back to scale on the hardware product, what kind of gross margins should we think about there now that you're in the Philippines instead of China? Is there much of a difference from once you get back to scale?

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Shlomi Cohen, On Track Innovations Ltd. - CEO & Director [31]

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I think that in some way, there is some kind of misunderstanding regarding the product gross margin because we're actually trying to calculate it in a different way. And I think that you actually taking the cost of sales and you're actually dividing it with -- I don't know with what. And this is another way that we are looking on that, and I will explain why. Because we are actually looking on the entire package that we are selling to the customer. Because don't forget that when we are selling the full solution, and this was actually part of our strategy of moving from being a product company to a solution company, we actually just -- we started to generate our recurring revenue. Now in our case in OTI approach is we are trying to inject as much more solution.

In other words, we are planning to inject as much more product to the market because the products are actually generating for us the recurring revenue. So you can look on the fact that we are actually injecting product or hardware or -- but this is not only (inaudible) because attached to services and also to software, we're actually generating the recurring revenue. Without doing that, we are not able to generate the recurring revenues. So we are not doing the split [of ours]. So when we are looking on the total gross margin that we are generating, it's going up. And by the way, it will continue to go up. I'm not saying about Q1 that it was a onetime event, but I'm actually looking on the entire strategy that we are having in order to increase the gross margin.

And by the way, when you're looking on Q1, one thing that is very important to emphasize is the fact that we continue to implement our strategy. And when you're looking on that, we actually went up from 26% of recurring revenue to 43% recurring revenue. And this is outstanding, by the way. Despite the fact, by the way, that we were having a low level of sales, but even in absolute number, not only on a percentage level, also in absolute number, we actually took the recurring revenue up. So we are still keeping the positive, the very positive momentum that we are having with our recurring revenue and therefore with our gross margin.

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Operator [32]

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The next question is from the line of Kevin Dede from H.C. Wainwright.

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Kevin Darryl Dede, H.C. Wainwright & Co, LLC, Research Division - MD of Equity Research & Senior Technology Analyst [33]

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Would you mind just diving a little bit on the TRIO-IQ? Are you -- do you think you've got some competitive differentiation from some of your -- from some of the other manufacturers? I mean you were just at NAMA. Do you think it's -- I guess how can you explain how it would be difficult for other manufacturers to match your FDA requirement?

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Shlomi Cohen, On Track Innovations Ltd. - CEO & Director [34]

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Okay. So basically, I'm not saying that it will be difficult to other competitors to match the FDA requirement. But this is not only related to the FDA. It's also related to other needs that the unattended payment market is actually generating such as the QR codes, proximity, the fact that you need to generate more revenue per machine, and we are able to do that with HDMI that we -- HDMI technology that we integrated on our TRIO-IQ. And when you're looking on our set of features, we're definitely presenting a competitive position compared to the other players in this market. And this is something that we are actually working on that for the last 18 months. And I believe that at the moment that this will be commercially available to the market, I think that you will see the advantage that we are actually presenting compared to others. I think by the way, if you're taking the entire players today in the market and you are generating a competitive analysis, we're quite confident that we are actually at least, I'm saying at least, in one level ahead compared to the best player in this market.

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Kevin Darryl Dede, H.C. Wainwright & Co, LLC, Research Division - MD of Equity Research & Senior Technology Analyst [35]

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Okay. Okay. Can you talk a little bit about the selling price and how -- yes, how it compares? I mean -- yes, just was curious about what the top line impact might be. And what would prevent some of your current customers, say, for instance, the 6,000 order from Russia. Why would that customer want that product and not wait for this one?

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Shlomi Cohen, On Track Innovations Ltd. - CEO & Director [36]

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Okay. So the TRIO-IQ is actually a very high hand for that, and it's actually related to the fact that if you want to consolidate or if you are actually taking the decision of buying the entire solution, meaning the telemetry, the machine-to-machine device, and today, we are having it as Telebox or GoBox and you'll need the reader as well, meaning, you need the entire solution together plus the entire set of features definitely is relevant. Now where it's most relevant?

It's relevant when you are actually approaching kiosks, micro market. This is very relevant. And here, we definitely have a huge advantage compared to the other players in this market. If you are taking the Russian case, although the idea is to generate some kind of a validate of -- to the -- for the mass transit. And the product is only contactless. Because although they're in the relevant vertical of the mass transit, they are doing only contactless transaction. So they don't need the entire package. They don't use the magnetic stripe and they are not using contact, only contactless. Okay.

This is something that we see a little bit less in the U.S. market that's still most of the transaction is actually done by magnetic stripe, okay? So -- but again, I'm saying, when you're looking on the fast-growing market of the kiosk, the payment kiosk in the U.S. market and not only in the U.S. market, in the Japanese market and also in Europe, the technology that we are actually presenting puts us actually in the front of this market.

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Kevin Darryl Dede, H.C. Wainwright & Co, LLC, Research Division - MD of Equity Research & Senior Technology Analyst [37]

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Okay. Are you -- do you still have payment settlement in your crosshairs? Is that something you're still considering targeting?

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Shlomi Cohen, On Track Innovations Ltd. - CEO & Director [38]

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What do you mean by payment settlement?

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Kevin Darryl Dede, H.C. Wainwright & Co, LLC, Research Division - MD of Equity Research & Senior Technology Analyst [39]

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Well, integrating the transaction with a credit card company itself and a bank?

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Shlomi Cohen, On Track Innovations Ltd. - CEO & Director [40]

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Yes, we are doing that. We are doing that with credit card, with Elavon, with AIB, with fixed payment, with all the giant in this market. Yes. We are doing that.

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Kevin Darryl Dede, H.C. Wainwright & Co, LLC, Research Division - MD of Equity Research & Senior Technology Analyst [41]

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Okay. So that falls into your -- in your recurring revenue. Last question for me. Are you considering white labeling this -- the TRIO-IQ? Is that still the plan?

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Shlomi Cohen, On Track Innovations Ltd. - CEO & Director [42]

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Of course. The answer is positive, yes.

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Operator [43]

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(Operator Instructions)

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Ehud Helft, GK Investor Relations - Managing Partner [44]

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And looks like we don't have any more questions. We can move to the closing statement.

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Operator [45]

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Sure. Thank you. As there are no further questions, I would now like to turn the conference back to Mr. Cohen for closing remarks. Over to you, sir.

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Shlomi Cohen, On Track Innovations Ltd. - CEO & Director [46]

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Thank you. On behalf of the management of OTI, I would like to thank you for your continued interest and long-term support for our business. I look forward to speaking with you next quarter and updating you on our progress. Thank you for your attendance. Have a good day.

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Operator [47]

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Thank you very much. Ladies and gentlemen, the conference call has now concluded. Thank you for attending today's presentation. You may now disconnect your lines.