Haivision Systems Q2 2024 Earnings Call Transcript

Quartr
Provided by Quartr
June 12, 2024

There are 7 speakers on the call.

Operator

Thank you for standing by.

Operator

My name is Christa, and I will be your conference operator today. At this time, I would like to welcome everyone to the HyVision Second Quarter 2024 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer session. Thank you.

Operator

I will now turn the conference over to Mikko Wyszka, Chairman and Chief Executive Officer. You may begin.

Speaker 1

Thank you, Christa, and good afternoon, everyone. Thank you, everyone on the call for joining us today to discuss our 2nd quarter 6 month results for our fiscal year 2024, which ended on April 30. Now, as demonstrated by the results we announced earlier today, our business fundamentals just keep getting stronger. We have been telling you that we will significantly increase our operational efficiency and adjusted EBITDA throughout the past 18 months and our Q2 performance continues in that direction with some noteworthy highlights. I'd like to begin with exciting news regarding our Control Room business transformation to a higher margin manufacturer model from the old bespoke full integrator model.

Speaker 1

Now this transition has exceeded our expectations and is progressing much quicker than previously planned. Now, we have always said that this transformation will be at the expense of top line. However, what is left is our proprietary high margin business, which is good business. This is something we've been planning for and working towards all year. And the great news is that we can see positive results already within the 1st 6 months of 2024.

Speaker 1

We expected this to be an 18 to 24 month transition, but it now looks like we'll accomplish the business transition within this fiscal year, which is great news. Our partners and resellers globally are very happy to see us embracing the partner model to scale this business and getting away from being an integrator and basically seen as a competitor supplying these complete custom installations, including selling the 3rd party screens, keyboards, networking equipment and even furniture. Now this time next year, the net positive revenue gain will be more apparent together with solid and consistent high gross margins. We expect to be training and preparing many of our strategic partners worldwide on the new Command 360 fully scalable platform by the end of this year in preparation for a full blown rollout in fiscal 2025, a full year ahead of schedule. Now let me briefly discuss some of the numbers.

Speaker 1

Our Q2 gross margins were significantly higher than last year's Q2, going from 68.9 to 71.7. We've been saying all along that we would deliver increased gross margins and once again we continue to deliver what we said we would. We also delivered an adjusted EBITDA of $5,100,000 which represents a whopping 92% improvement from our previous Q2. And the impressive 14.8 percent operating margin was also the 3rd quarter in a row we've seen the mid teens level of operational performance, again, exactly as we promised we would deliver. Also noteworthy to mention that our Q2 performance now gives us a 12 month trailing adjusted EBITDA of $20,300,000 another impressive metric we promised to deliver back in 2023.

Speaker 1

I can safely say that we are well on our path on delivering on our promise of a 2 year adjusted EBITDA nearly tripling the EBITDA performance from the $8,000,000 derived in fiscal 2022. I mean, I'd say not many tech companies can say that these days. Now we have also delivered yet another positive net income quarter with a noteworthy 162% increase over the last year's Q2. Again, demonstrating what we have been saying all along that we will show much higher increase in our profitability and we expect this trend to continue throughout 2024 2025. Let me also add that our balance sheet has never looked so strong.

Speaker 1

As we have been saying over and over, we are moving quickly towards achieving our goal of delivering 20 percent EBITDA performance. And with our Q2 performance, it should give you even more comfort that this is going to happen. Let me quickly touch on some of the latest U. S. Federal government budget delays and the continuing resolutions that marred the first half of the year for all federal government suppliers, not just HighVision.

Speaker 1

The constant political bickering and congressional delays in approving the budget has stalled or delayed projects within the military and federal government institutions throughout the U. S. Now we have seen many government suppliers feeling this pain throughout the industry. Now the good news for High Vision is that we didn't lose any deal and no deal that we're working on were canceled. Although several projects have been pushed to the right and have been delayed due to the inability for Congress to approve a timely budget.

Speaker 1

Unfortunately, I don't think we can expect to see any federal employees working overtime to catch up on the backlog. Thus, we should see the projects eventually coming back within the next few quarters. And the good news is that the money is starting to flow again, but will take a while to catch up to the normal levels expected at this time of the year. We do, however, anticipate the year end buying cycle to be strong for the government's September year end, which is especially typical during the election year. And we continue to see strong demand for our global security operational centers within the global financial banking industry, cyber security, police centers, federal installations, public safety, and in fact, all defense sectors, and the need for our customers to have real time mission critical and secure access to all their video sources and assets for real time analysis or situational awareness is even more critical.

Speaker 1

Our investments in additional salespeople and focused business development worldwide with strategic partners will set us up for solid growth in 2025 and beyond. Dan will go through all the finances in detail, but let me reiterate our annual guidance we gave back in January. Delivering an adjusted EBITDA in the mid teens is well on target, while delivering higher margins and growth in operational performance is also well on target. Now considering our planned transformation on the control room business is way ahead of schedule, some of the delays in federal spending, our top line will be lower than anticipated, but all of our profitability metrics are well on track. And this has been our main focus and the most important metrics for this fiscal year.

Speaker 1

And a better than expected transformation of controlling business will set us up for a much healthier and profitable business moving forward. All in all, a great performance. Now finally, we believe that Heibig has a very bright future ahead, As we have now delivered, not just promised, but delivered a trailing 12 month adjusted EBITDA of $20,300,000 as I said, that cannot be taken away from us. It is no longer a promise. It is our actual performance.

Speaker 1

We are committed to maximizing long term value for all of our shareholders. We are confident in our ability to execute on our strategic plan and deliver continued growth and even higher operational performance. And I hope that the investment community will finally realize that we are significantly undervalued in terms of both revenue and now even on our EBITDA multiples. So Dan, please feel free to continue with the detailed financials.

Speaker 2

Thank you. Now that Mirko has already stolen most of my thunder, I'm going to try to make the numbers a bit interesting. Revenue for the Q2 of fiscal 2024 was 34,200,000 dollars That's a modest decrease of $900,000 or 2.7 percent from the prior year. But as we've discussed on previous calls, we fully exited the managed services business focused on house and worship customers in April of 2023. The Q2 of 2023 revenues included $1,200,000 in cloud solutions revenue versus only $100,000 in the Q2 of fiscal 2024.

Speaker 2

That is a $1,100,000 decrease year over year. Normalizing to the decision to exit the House of Worship vertical, we did experience growth, albeit modest growth. But there is more to this revenue story. As Mirko alluded to, we have been transitioning our control room business away from that of a system integrator, where we provide bespoke solutions that include such low margin third party components like screens and in some cases even furniture to that of a manufacturer of proprietary hardware and software systems. This transition will enable us to scale the business much more quickly, particularly in international markets.

Speaker 2

We will also enable existing and new channel partners to offer those same third party components to end users and derive the benefit from the incremental margins that may result. In other words, it's an added incentive for those channel partners to want to work with high vision in this control room space. This transition, particularly in the public safety and enterprise verticals, is happening at a much faster rate than originally anticipated. We will likely see increasing gross margins in that space as it's difficult for us to charge a premium for these off the shelf 3rd party components. However, this transition will be at the expense of top line revenue, albeit at the expense of less profitable top line revenue.

Speaker 2

Additionally, we introduced a long term rental program, which was initially focused in the transmitter market. This initiative enables our customers to recognize an ongoing operating expense rather than a capital expense. It also enables them to future proof their purchases as they would have access to the newest technologies when available. The fact of the matter is that our competitors offer such a program in the transmitter space and those sales would not be otherwise available to us if we didn't offer a program that is very competitive to those of our competitors. However, for HiVision, there are additional benefits.

Speaker 2

First of all, it enables us to increase our recurring revenue posture, which is a key focus for us and it enables us to derive higher gross margins over the life of these agreements. We are happy to say that we've already experienced significant success having converted a high profile customer away from our competitors. Revenue for the 6 months ended April 30 was 68,700,000 dollars a very modest $400,000 decrease from the prior year comparative period. Again, this year over year comparison is impacted by the decision to exit the House of Worship vertical in April 2023. Year to date, we had cloud solutions revenues of only $300,000 compared to $3,200,000 in the prior year comparable period.

Speaker 2

That is a $2,800,000 decrease year over year. And normalizing for the decision to exit the House of Worship vertical, we actually experienced a growth of about 4%. And let's not forget that year to date results are also being impacted by our transition away from that of a system integrator in the control room space and our long term rental program. Recurring revenue, which we define as our cloud solutions and maintenance and support, was $6,500,000 in the 2nd quarter and about $12,900,000 on a year to date basis, representing approximately 19% of total revenue. As has been the case for the last 4 quarters, recurring revenue as a percentage of revenue is down from prior year comparative periods.

Speaker 2

However, we anticipated the decline once we exited the House of Worship vertical with our managed service offering. For this quarter, gross margins were 71.7%, a significant improvement from the 68.9% realized the prior year. And we are seeing similar improvements on a year to date basis. Gross margins on a year to date basis were 72.3% compared to 67.8% in the prior year comparative period. That is a 450 basis point improvement.

Speaker 2

Now I want to mention that gross margins for the last four quarters have been fairly consistent, averaging around 72.5%. At the risk of sounding like a broken record, the improvements can be attributed to 4 factors. First, our decision to exit the House of Worship vertical, which had high relative fixed costs and the margins for bandwidth and storage were being squeezed. Secondly, we have digested the majority of high priced difficult to procure components that we purchased to secure top line revenue. So we're seeing our margins on our proprietary products reverting to historical averages.

Speaker 2

We completed our migration of ERP systems at both MCS and Avi West, so our supply chain folks have more visibility to these day to day operations. And as more of our business transitions away from bespoke implementations or migrates to longer term rentals, margins may continue to improve just a bit. With that said, there is still some degree of seasonality with respect to the timing of revenues by vertical markets. Thus, we may continue to see some variability in gross margins based on the mix of solutions sold in any given quarter. To give you a sense of how the seasonality in our business may impact margins, our Q4 is commensurate with the U.

Speaker 2

S. Government's year end. Our revenues are typically disproportionately weighted to our performance hardware products like the Makita, which have robust gross margins. We will continue we will likely continue to see our 4th quarter margins being slightly better than that of other quarters. Total expenses for the 2nd quarter were $22,700,000 that's a decrease of $2,400,000 when compared to the same period in the prior year.

Speaker 2

As we've said before, our cost structure is heavily weighted towards compensation and related expenses. We ended the quarter with 365 employees compared to 380 employees a year ago. Approximately half of the year over year decrease can be attributed to compensation related expenses, particularly in the research and development and sales and marketing areas, the focus of recent restructuring efforts. The remaining year over year differences can be attributed to occupancy expenses as we continue to rationalize our space decisions, decreases in amortization and depreciation expense, decreases in professional services and technology and communications as our back office continues to become more efficient and the more efficient use of digital marketing. On a year to date basis, total expenses were $45,500,000 a decrease of $33,200,000 when compared to the prior year comparative period.

Speaker 2

The reason for the year to year decreases are similar. Compensation related expenses decreased by $2,200,000 while the remaining decreases could be found in amortization of depreciation, technology and telecommunications, marketing and professional services. The real news this quarter is that the result of higher gross margins and lower expenses is an adjusted EBITDA for the quarter of $5,100,000 That's a $2,400,000 improvement or a 92% improvement from the same prior year period. Further to the point, the adjusted EBITDA margin for this quarter was 14.8%, a notable improvement when compared to the 7.5% adjusted EBITDA for the prior year period. On an aside, this is the 3rd consecutive quarter with adjusted EBITDA in excess of $5,000,000 For the 6 months ended April 30, our adjusted EBITDA was $10,200,000 that's a $5,500,000 or 116% improvement from the same prior year period.

Speaker 2

And the adjusted EBITDA margin on a year to date basis is 14.9%, even more impressive improvement compared to the 6.9% in the same prior year period. As Mirko mentioned, our trailing 12 month adjusted EBITDA is 20,300,000 dollars and our adjusted EBITDA margin is securely in the mid teens as we promised to deliver over a year ago. It should become self evident that there is now a level of consistency in gross margins and adjusted EBITDA that should be well received by the investment community and it should become self evident that we are building a very valuable business that may not yet be reflected in today's stock price. Operating profit for the quarter was $1,800,000 That's a $2,800,000 improvement over the same prior year period or a 302% improvement. And when you look at it on a year to date basis, our operating profit was 4,100,000 dollars That's a $6,100,000 improvement over the same prior year period and that's also over a 300% improvement.

Speaker 2

Net income for the quarter was $900,000 That's a $2,400,000 improvement compared to the $1,500,000 loss that we incurred last year. And on a year to date basis, that's our net income was $2,200,000 and that's a $5,100,000 improvement when compared to the net loss of $2,900,000 in the prior year. But there is a very interesting trend that I want to point to. If you take a look at our full year net loss in 2021, it was $8,800,000 In 2022, our net loss was $6,200,000 In 2023, our net loss was $1,300,000 Here we are halfway through fiscal 2024 and our net income is a positive $2,200,000 With respect to the balance sheet, we ended the quarter with cash balances of about $11,200,000 that does represent a decrease of $1,900,000 from the prior quarter end. However, we ended the quarter with 1,700,000 dollars outstanding on the line of credit, which is also a decrease of $1,900,000 from the prior quarter end.

Speaker 2

The timing of revenue within any given quarter has an impact on our level of accounts receivable and the resulting cash generation in a given quarter. To illustrate the point here, in our Q1 of fiscal 2024, approximately 65% of our revenue was derived in the 1st 2 months of the quarter. Calendar year end spending accelerated the timing of revenue in that Q1 of 2024. Obviously, the earlier in the quarter we invoice, the higher the chances to collect those receivables within the same quarter. However, in our Q2 of this fiscal year, less than 50% of our revenue came in the 1st 2 months of the quarter.

Speaker 2

That's more typical of our intra quarter seasonality. The good news is that cash collections have been good and we should see the benefit by the time we report our next quarterly results. Total assets at April 30 were $140,300,000 That is a decrease of $3,800,000 from October 31, our fiscal year end. The decrease in assets during the 6 month period includes a $3,800,000 reduction in intangible assets, the result of ongoing amortization expenses, a $2,500,000 reduction in inventories as we continue to squeeze out efficiencies in our supply chain, a $1,500,000 reduction in trade and other receivables and a $900,000 reduction in the right of use assets, the result of ongoing rent obligations. These decreases were offset by the $2,900,000 increase in cash and the $1,600,000 increase in investment tax credit receivables.

Speaker 2

The story about liabilities is also compelling. Total liabilities at April 30 were $45,200,000 a decrease of $4,800,000 from October 31. This decrease in liabilities includes a $3,000,000 decrease in trade payables and other accruals, a $3,000,000 decrease in the line of credit as extended and a 1,400,000 dollars decrease in lease liabilities and term loans, again, the result of ongoing rent obligations and term loan repayments. Now these decreases were offset by an increase in deferred revenue by $2,500,000 another indicator of the efficacy of our maintenance and support programs. So, decreasing liabilities and increasing deferred revenue is a pretty solid story.

Speaker 2

In terms of expectations for fiscal 2024, we are revising our revenue guidance for the full year. Our revenue guidance for the full year now factors in the much quicker than anticipated transition away from the integrator model, which included those lower margin third party components in the control room space, the delayed approval of U. S. Federal budget and the resulting lethargy in government purchasing and our exit from the House of Worship vertical in April 2023. And to a lesser degree, our long term rental program, which exchanges longer term recurring revenue at the expense of short term product sales.

Speaker 2

Thus, we are now projecting revenues for this fiscal year to be between $140,000,000 140 $2,000,000 We still anticipate adjusted EBITDA margins in the mid teens has been our guidance the entire year and we still anticipate seeing 1 quarter this fiscal year knocking on the door of our long term adjusted EBITDA margin goal of 20%. That concludes my prepared remarks. So I'm going to pass the microphone back to you, Nirka, and then we'll open the floor to questions.

Speaker 1

Okay. Thanks, Nav. I guess we could open up the questions, Christa.

Operator

Your first question comes from Nick Corcoran. Please go ahead.

Speaker 3

Hey guys, thanks for taking my questions. My first question is just to do with U. S. Federal spending. I'm wondering what we should see in terms of the trend through the 3rd Q4 and with revenue?

Speaker 1

Well, good question. I mean, I think Q4 prepping up to be a pretty solid quarter because it is government year end. At the moment, we're just monitoring Q3 to see how quickly the money is trickling in. So we do see some softness in Q3. So it will be very similar to like our Q2, but it is picking up.

Speaker 1

So that's the good news. The question is how quickly can some of these people actually get back to work and get back to some of these projects. So I'm still feeling a little soft on Q3 from the government perspective, much better in Q4. But we still we feel that the guidance that Dan just gave should be bang on and we feel pretty confident.

Speaker 3

Yes, that's helpful. And maybe if we can just think about the organic growth by end market between government, enterprise and defense, what are you seeing there?

Speaker 1

Sorry, between government and defense or non government?

Speaker 3

Government, enterprise and defense and I guess broadcast as well. Sorry.

Speaker 1

So Dan, you want to take that one?

Speaker 2

Well, it's getting increasingly difficult for us to be sort of looking at this on vertical given the amount of cross selling that we're doing right now. And as we've kind of alluded to in the past, it's almost like we have a portfolio of vertical focus, again, broadcast, enterprise and defense. And sometimes we see strength in certain verticals and sometimes we see some weakness in certain verticals. In the 1st 2 quarters, obviously, we were seeing some weakness in the government defense spending, largely related to the budgets and the deferral a firm budget there. And we started seeing a pickup in the broadcast business, some of which is related to the Olympics this summer.

Speaker 2

I'd say that we're going to start seeing the government space, defense and government space picking up in the 3rd Q4, probably more so in the Q4 than in the 3rd quarter, although we are seeing sales increase in the Q3. And I'd say the other two businesses are relatively stable at the point at this point.

Speaker 1

Yes. I mean, I would just add to that, that we've been seeing good solid business. I mean, it is an Olympic year, right? We're doing a lot with some good broadcast business throughout last quarter, but also coming into this quarter. So that's actually been very, very healthy as is typical in a large sporting event here.

Speaker 3

That's helpful. And maybe one more question for me just on the M and A pipeline. Are you still actively pursuing the M and A pipeline? And could we potentially see a deal done in the next kind of

Speaker 1

12 to 18 months? Well, I mean, we're definitely continuing talking to people. And so we have not stepped off the gas on that except just but being realistic. I mean, there's nothing really, I would say, in the oven that that's hot that would even remotely close in a short period of time. So even if we started to have serious discussions, I don't even see anything closing this fiscal year.

Speaker 1

But I think within the next 12 to 18 months, I think it's very reasonable to think that we will be targeting an M and A event.

Speaker 4

Great. Thank

Speaker 2

you. If I could just sort of if I could add a tiny bit of color on that, right. I mean, obviously, we constantly are talking to people here, but our focus for 2024 obviously was to demonstrate the profitability of the business, the efficacy of the business and what have you. And one of our hopes is that the profitability of the business will be reflected in a buoyant stock price And that may give us yet another arrow in the quiver to use in our M and A endeavors, right? It's not going to stop us from doing the right thing for our business, the stock price, but it would be another tool that would be beneficial as we're talking to people.

Operator

Your next question comes from Robert Young. Please go ahead.

Speaker 4

Hi. I was hoping to get a little more detail around this transition from the integrator model more towards higher margin solution provider. Is there any way to maybe put a finer point around the margin impact from that, like the overall company margins?

Speaker 2

We've been toying with that quite a bit. I've been trying to sketch that out for some period of time. I'm not sure I have a tremendous amount of visibility as to how it's going to impact the overall organization. I do think that we may see an increase in our gross margin as a result of that initiative. Is it going to add a point?

Speaker 2

That would be I would think that's way over optimistic, maybe a half a point, but it will be better business for us. It will be it will enable us to deliver more timely. It will enable us to deliver more quickly and it will enable us to expand more aggressively.

Speaker 4

Okay. That's great to hear. I think last quarter you suggested something about a U. S. Focus on the development of a partner network around this initiative?

Speaker 4

I'm just curious, did I hear that right? Is this something a U. S. Focus? Is there an international opportunity with partners maybe to expand

Speaker 2

the control room market business?

Speaker 1

Absolutely. Great question. I mean, I think early on we talked about specifically the international, but it actually is global, which includes the U. S. So in fact, we are spending a lot of time on some very large U.

Speaker 1

S. Partnerships as we transform this model. And then once we get well advanced to that, we're going to basically carbon copy that and move it into international. So we are talking to a lot of international partners, but the first phase right now is to work with some of our big, big potential partners in the U. S.

Speaker 1

Where that's where the majority of the businesses. And remember, we already this has been a difficult challenge. And amazingly enough, it's going so much better than we anticipated because when you're we were perceived or Cinemasset was perceived before we bought them and even after we bought them as a competitor to all of these guys, right? I mean, as a full integrator, that's what these partners do. So we've been working hard to talk to these partners and explain to them.

Speaker 1

That's not what we want to do. We don't want to be an integration business. That's your business, and we want to work with you guys. So it's going to take a little bit more time, I think, to get their buy in, but we're actually seeing some pretty amazing progress and that is the only way you can sell internationally. I mean, it all has to be through partners.

Speaker 1

So the good news is we're ahead of the program and but it's still going to require training, rolling out, but starting at the end of this fiscal year, we're going to be on full blown rollout. At the same time, what we really haven't talked about is our development in our platform is really tackling the beauty of rolling out a partner friendly application software hardware platform. So we can we'll be able to scale much quicker than we ever could have imagined as an integrator. So it's setting us up really nicely for 2025 and but it starts with the U. S, right?

Speaker 1

I mean, you got to get the U. S. Right. That is the biggest market. And then we take it over internationally.

Speaker 4

Okay. And one more question on this thread would be around the partner development. I guess some of the comments, it suggests to me that you already have partners working with you on this given the training? Like is there anything maybe around the timing of that or any details you can share?

Speaker 1

Not too many details. I mean, the fact that we are adding more partners for sure. It's not like we want as many parts as possible. No, I mean, we're managing it by market, by segment, by territory, but we are working with all of the largest integrators. The training is going to obviously take some good time.

Speaker 1

I mean for the next two quarters, we're really focusing on building that trust, getting the people trained. So that's going to take about 2 quarters and then we're going to be rolling that out to the international market.

Speaker 4

Okay. Last question for me is just maybe clarify the rental component. I think you suggested it was to do the transmitter market. So maybe is that limited to the Abby West business?

Speaker 1

And Yes. That's the piece. Okay.

Speaker 4

I think you also suggested there was it was a strong benefit in the high event year. I assume that means the Summer Olympics, but is the Summer Olympics like a big driver of rental opportunity for you on like the AbiWeb products or the products just in general? Maybe you could just expand on that to better understand it and then I'll pass the line.

Speaker 1

Sure. No, that's a good question. Yes, absolutely. We have seen any major world event like the World Cup, like the Euro Cup that's going on, like the Olympics absolutely has a major rental component to it. And that's one of the reasons why we've been working on not just short term rentals, but we've been tackling a lot of the broadcasters for long term rentals, which is also part of the business.

Speaker 1

So yes, we've seen a nice pickup of that. In fact, we've converted 1 major account that we can't talk about from a major competitor over a 2 year long term rental is a big deal. So it's progressing very well. So the rental business is going up. It's something we have been investing in and it's part of the business going forward.

Speaker 1

As Dan alluded to, it is sacrificing short term revenue for longer term better revenue and the higher margin revenue going forward just like a SaaS model, right? It's the same thing. So that's progressing very well. But again, it's not significantly, it's not huge. But we have also been selling a lot of our products, not just rentals because of the Olympics and we're actually having a pretty significant technology demonstration at the Olympics.

Speaker 1

So again, we can't even talk about that because we're not allowed. The Olympics are very, very strict. But I think after they're finished, you'll be able to read up and see some of the really cool stuff that we're pushing the envelopes of low latency wireless 5 gs technology from the transmitter side. Very, very cool projects.

Speaker 4

Very neat. One last question for Dan. Oh, sorry, Dan. Go ahead, sir.

Speaker 2

I was just going to add. We've always been in the short term rental program, particularly in Europe and that business is expanding and that business does increase when there's big events like the Olympics and whatever the case may be. But we were specifically talking about a long term rental program where companies might rent our equipment for years on end, 1, 2 or 3 years. That is a different business model and that is the model that we initiated in the Q2 here.

Speaker 4

Okay, great. And then just last little question is just around the inventory. Down quarter, Corey, you've been doing some good work managing that over the last several quarters. Is there more to come down? Or should we expect that to start moving up given the comments around Q3 and Q4, the government business?

Speaker 4

And then I'll pass the line.

Speaker 2

Well, no, I think that the reason why the inventory went from our historical low levels to where to the 20 $2,000,000 $23,000,000 level at some point in time here is because we were buying inventory that we thought we might be able to sell, particularly in the MCS space, in the high vision MCS space. Our business has always been reliant on our ability to forecast the business and so we procure to forecast. And usually, we are able to sell that product very quickly within the same quarter that we procure it. So we're not I don't expect inventories to be going up. I don't see inventories going up because of the Q3 or the Q4 increase in revenues per se.

Speaker 2

I'd say that if the business goes up by $10,000,000 we're going to have a working capital need related to AR and inventories, but we're not talking about those kind of things in the next couple of quarters.

Speaker 4

Thanks a lot.

Operator

Your next question comes from Daniel Rosenberg. Please go ahead.

Speaker 5

Hi, Mirko and Dan. Thanks for taking my question. My first one comes around the sales mix. I'm just wondering how this channel partner strategy currently stands up in terms of direct sales versus sales coming through channel partners? And what does that look like into the future as you scale with channel partners?

Speaker 1

Well, it's again, we're talking about the control rooms, right? So, it's that specific market that has been going from an integrator more of a direct sales to partners. The other markets we do them, sorry, we deal with partners on an ongoing basis. So it's not a new concept for us. Remember, we fulfill through partners and integrators, both in defense, in ISR and in enterprises as well as broadcast, right.

Speaker 1

So but the control room market is a significant piece that was that I would say what more like 80%, 90% of the defense business was direct integrator business, probably about 60% of the enterprise was direct business, right. So we're transforming the defense and the government enterprise business to as much as possible partner model. And I think we're probably going to go down to less than 5% or 10% in the defense because some of the defense clients still require a little bit of an end to end solution from the manufacturer, but that's a longer term goal. So I don't know if you want to take give more clarity, Dan, on the numbers or percentages, but it's really hard to dissect because this is the total market that we're specifically talking about, right, which is not insignificant.

Speaker 2

I would say I would put it this way. We have always been a channel friendly company. The preponderance of our revenues are coming through channels one way or another. Now in the control space, it's a little bit more complicated because we still have channel partners there, but the complexity of the install, had results in delays in delivery, it results in complexities that we have to overcome. And we want to take out that complexity of give it to the experts, the system integrators that do this for a living and let us focus on the proprietary technology that feeds these control rooms.

Speaker 2

It will enable us to expand our breath much more quickly than we can do today.

Speaker 5

Okay, understood. And this transition, I mean, I imagine this is a multiyear process to get there or I mean, you said it's going faster than anticipated, but

Speaker 1

what does that look like? We're definitely way ahead of the cycle, right? I mean, we're expecting this to be at least a 2 year process. I would say this time next year, we're going to be very little doing direct integration business, if any at all. So I think this is a we're moving very, very quickly.

Speaker 1

It's more like a 12 month, let's say, maybe 18 month from when we started. So I would say next year 2025, you're going to see by far a majority of all of our controller business going through partners.

Speaker 5

Okay. Thanks. And I'm wondering as this occurs, is there any impact to kind of the maintenance and support revenue that you traditionally booked? Or is that a separate piece?

Speaker 2

It's a separate piece. I mean, it's difficult to charge maintenance and support on 3rd party screens as an example, when those screen manufacturers have their own warranties. So it will be it will not as a percentage of revenue, it will make it will be more robust and it will be more sound, it will be more consistent with our existing businesses. Perhaps we'll lose a little maintenance and support because we're not deriving the maintenance and support on those 3rd party components, but we couldn't really do very much in those areas anyways.

Speaker 5

Okay. And then lastly for me, so driving towards this long term 20% goal or approaching it in the coming quarters. So the drivers there, is it real it's a combination of scale and this transition that you speak of? Are there other levers that you're working with to get there?

Speaker 2

I would say it's a scale question at this point here. We've built an efficient operation. We probably have squeezed as much from our OpEx as we can at this juncture. We've become exceedingly efficient. There may be some small opportunities on the gross margin line, but it's going to be confusing to look at that gross margin line given the seasonality we may see in the business and suggest that the incremental gross margin is solely related to this transition to a manufacturing model of sorts.

Speaker 2

So I'm still looking at a 72.5% gross margin as a long term margin, very consistent to what our average has been over the last 3 or 4 quarters, say. I think the rest of it is really related to scale at this point.

Speaker 5

Okay, great. Thank you for taking my questions. I'll pass the line.

Operator

Your final question today comes from Venakata Vallagapudi. Please go ahead.

Speaker 1

That was good.

Speaker 2

That was good.

Speaker 6

Thanks Dan and Mirko, thanks for taking my question. Yes, I have a question on your gross margin in Q2, Dan. So it's easy to understand the increase in gross margin on a year on year basis. But how do we interpret a slight dip in gross margin in Q2? Is it something related to revenue mix or is there something else to look at?

Speaker 2

Well, you do have sort of an eagle eye on that. There is a small factor that did affect gross margins in the Q2 and that is we did increase our reserves for obsolescence and we did increase our scrap and that actually represented almost a 1% difference between Q2 of this year and Q2 of last year. And you may see that as part of the variation from the Q1 and the Q2. But again, our business is complex. We have lots of different products and lots of different margins.

Speaker 2

And it is hard for anyone to be able to look at that gross margin, say specifically it's related to mix or it's specifically related in this case to scrap. But I will tell you that second quarter did have a higher expense related to scrap or reserves than in prior quarters. That is going to disappear in the Q3. So we'll probably revert back to that 72.5% number that we've been talking about earlier.

Speaker 6

Okay. Thank you. And I have another question about your SG and A. Yes, as per your guidance, you guys have successfully managed to decline this line item consistently, roughly 500,000 per quarter over the last four quarters. So should we how do we interpret this going forward?

Speaker 6

Should we expect something in the same lines for the next two quarters? Or will it be much less significant?

Speaker 2

I kind of missed and asked, you said a 500,000. What were you referring to was a 500,000?

Speaker 6

In the quarter ending July last year, SG and A were 16.4, then 16, then 15.5, and in this quarter it's 15. So roughly you have managed to reduce this line item by 500,000 per quarter.

Speaker 2

Yes. No, I think that's I don't think there's a trend there that you should be looking at. I've been looking at OpEx on a general level here. And if you were to exclude the amortization and depreciation and some of the other things that are more accounting calculations than sort of the actual OpEx, our OpEx was flat in the second quarter to the 1st quarter. And so we believe that we've arrived at stability in terms of OpEx.

Speaker 2

The only variability that we might see in the OpEx is related to marketing initiatives and largely it's related to those large trade shows that we have in the second quarter and then again in the Q4. But beyond that, it's relatively fixed in the short term.

Speaker 6

Okay. Yes. And when you say the long term gross margin, you are looking at 72.5%. Are you looking at this year or is it something we should consider as long term target?

Speaker 2

I think it's more of a long term standing. I'm not prepared to suggest that it's going to deviate much from where we are these days. Mix will change things. We may see an increase in our Q4, but I'm a little bit more conservative as to whether this transition is going to result in that uplift immediately.

Speaker 6

Okay. Thank you, Dan, for taking my questions. That's it for me.

Operator

I will now turn it back over to Murgul for closing remarks.

Speaker 1

Thank you, Christa. I just want to thank all of our shareholders and all the analysts online today for their continued support of HiVision and look forward to speaking with all of you in mid September when we'll discuss the Q3 'twenty four results. And just a heads up, I'll be taking that call from Europe. We're going to do early morning before the market opens in September. So, we'll have to deviate from the usual after market close.

Speaker 1

But look forward to talking to all of you then. Thanks.

Operator

This concludes today's conference call. Thank you for your participation and you may now disconnect.

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Earnings Conference Call
Haivision Systems Q2 2024
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