Iteris, Inc. (NASDAQ:ITI) Q2 2023 Earnings Call Transcript

Iteris, Inc. (NASDAQ:ITI) Q2 2023 Earnings Call Transcript November 12, 2022

Operator: Good day and welcome to the Iteris Fiscal Second Quarter 2023 Financial Results Conference Call. . I would now like to turn the conference over to Todd Kehrli of MKR Investor Relations, please go ahead.

Todd Kehrli: Good afternoon everyone and thank you for participating in today’s conference call to discuss Iteris’s financial results for its fiscal 2023 second quarter ended September 30, 2022. Joining us today are Iteris’s President and CEO, Mr. Joe Bergera and the company’s CFO, Mr. Doug Groves. Following their remarks, we’ll open the call for questions from the company’s covering sell-side analysts. Before we continue, we’d like to remind all participants that during the course of this call, we may make forward-looking statements regarding events or future performance of the company, which statements are based on current information are subject to change and are not guarantees of future performance. Iteris is not undertaking an obligation to provide updates to these forward-looking statements in the future.

Actual results may differ substantially from what is discussed today and no one should assume that at a later date the company’s comments from today will still be valid. Iteris refers you to the documents that the company files from time-to-time with the SEC, specifically the company’s most recent forms 10-K, 10-Q and 8-K, which contain and identify important risk factors that could cause actual results to differ materially from those that are contained in any forward-looking statements. As always, you will find webcast replay of today’s call on the Investors section of the company’s website at www.iteris.com. Now, I’d like to turn the call over to Iteris’s, President and CEO, Mr. Joe Bergera. Joe, go ahead.

Joseph Bergera: Great, thank you, Todd and good afternoon to everyone. I appreciate all of you joining us today. For the fiscal 2023 second quarter, Iteris reported record total revenue of $39.3 million, representing an 18% increase year-over-year. This growth was due to the strong demand for our products and services, as well as the progress of our supply chain mitigation or improvement program that helped to unlock our quarterly Vantage sensor backlog. For reference, we reduced our fiscal 2023 second quarter unshipped Vantage backlog to $900,000. Because our supply chain management program enabled us to ship a record number of Vantage sensors, we were able both to continue to meet our customer commitments and to flush high cost inventory items from our balance sheet through the P&L.

This resulted in an extraordinary increase in the cost of goods sold in the second quarter. However, it will improve our inventory position going forward. Despite reports of a slowdown in the broader economy, customer adoption of our ClearMobility platform remains very positive. In the second quarter, we reported total net bookings of $42.2 million, representing a 15% increase compared to the same prior year period. This brings our trailing 12 month total net bookings to a record $167.6 million, representing a 33% increase relative to the same prior period. As a reminder, our trailing 12 month bookings figure does not include the large opportunity in front of us with the Infrastructure Investment and Jobs Act or IIJA. IIJA funds will flow to local entities through either formula or grant funding.

Formula funding is just beginning to show up in state and local budget in the first fiscal year after the law went into effect, which is October 1, 2022 for most state and local entities. With respect to grant funding, US DOT has not issued any intelligent transportation systems specific grant funding from the IIJA to date. The first wave of grants, which will start to be awarded early next calendar year will be dedicated to UST Safe Streets for All Initiative. At this time, we’ve submitted Safe Streets for all grant applications with 3 cities and various other state and local entities have included pricing from Iteris and their grant applications, even though we were not involved in the preparation of those grant applications. Additionally we’re beginning to work with customers to submit applications for the second wave of grants, which are designated for the strength in mobility and revolutionized transportation or smart program.

Due to sustained strong total net bookings, we ended the September 30 period with a record total ending backlog of $111.8 million, representing a 34% increase year-over-year and a 3% increase on a sequential basis. As always, our reported total net bookings and ending backlog figures reflect firm customer orders. The total value of customer contracts which varies from quarter-to-quarter averages on a historical basis about 200% of our total ending backlog. Fiscal 2023 second quarter product revenue increased 17% year-over-year to $20.8 million, even after 900,000 shipments slipped out of the quarter due to global supply chain constraints. Otherwise, products revenue would have been 900,000 higher or $21.7 million for the quarter, representing a 22% increase relative to the product revenue in the same prior year period.

Our January 1, 2022, Vantage sensor price increase contributed an estimated 3% to 5% to product revenue, meaning that underlying unit demand was the primary driver of second quarter product revenue growth. Our sensor portfolio continues to take market share primarily due to superior product performance. In the second quarter, we extended our performance lead with the release of enhancements to the artificial intelligence capabilities for our Vantage Apex sensors, introduction of new safety features for our next sensors that will address important Safe Streets for all priorities and completion of new Connected Vehicle Sensor prototype or a new Connected Vehicle Sensor prototype, do we intend to release to market in calendar year 2023. Because of our relentless focus on product performance, we continue to win virtually every large competitive resource detection sensor, fixed travel time sensor and cellular V2X sensor initiative across the country.

For example, our sensors were recently selected for the following smart mobility initiatives. Hybrid video and radar sensors to support the Florida Regional Advanced Mobility Elements or FRAME program in the Florida Department of Transportations or (FDOT) District 7. Connected Vehicle Sensors to support initial cellular V2X deployment for the I-4 FRAME program and (FDOT) District 2. Radar detection at John F. Kennedy International Airport which follows the recent announcement that our radar detection sensor radius was certified for use in New York State. Video sensors for intersection detection across a large transportation corridor in the City of Irvine, California, Connected Vehicle Sensors along the Berlin Turnpike connecting New Haven and Hartford Counties in the State of Connecticut.

And hybrid video and radar sensors for highway detection collection and analytics across a section of US Highway 50 in the State of California. During our last Investor Day, we discussed our intent to expand the total addressable market for our intersection detection sensors by enhancing the product portfolio to address 2 adjacent categories. First, the fixed sensor highway analytics market and second the infrastructure to vehicle integration market. We believe the I-4 FRAME, Berlin Turnpike, US Highway 50 and other recent new customer contracts validate the merits of our product strategy and demonstrate our ability to continue to expand our total addressable market. While our long-term strategic objective is to maximize the penetration of our sensors, our current priority is to renormalize the financial model of our sensor portfolio.

Therefore, we continue to devote substantial management attention to our global supply chain improvement program. In the quarter, we achieved the following program milestones. We released to manufacturing 2 alternative circuit boards, it will begin shipping this month with semiconductors at normalized component costs. Refactored the prototype for third alternative circuit board based on test feedback, the new prototype was subsequently released to manufacturing on November 7, 2022. Perform design validation for 6 alternative circuit board designs and for your reference we prioritize the release of alternative circuit boards based on the degree of financial impact. And as measured earlier — I mentioned earlier, we began to re-optimize our inventory by flushing certain high cost product components through the P&L and replacing them with alternative components at normalized inventory costs.

Now I want to review the performance of our service lines of business. Fiscal 2023 second quarter total service revenue was $18.5 million versus $15.5 million in the same prior year period, representing a 19% increase year-over-year. In addition to the strong service revenue growth, we recorded $20.8 million in net service bookings, representing a 24% increase over the same prior year period. Notable new customer agreements include a $4.9 million renewal from the Bay Area Metropolitan Transportation Commission for the continued use of our ClearRoute software. A $3 million task order from the Federal Highway Administration for our continued development and support of the nation’s ITS reference architecture now known as Architect Reference for Cooperative and Intelligent Transportation or ARC-IT; a $2.8 million task order to provide technical services to the San Bernardino County Transportation Authority or SBCTA to support the implementation of Corridor freight and express lanes on the I10; a $2 million task order from the Virginia Department of Transportation to use our CLEARASSET software and related asset management managed services; a $1.5 million task order to provide technical services to support the Los Angeles Metro Orange Line extension; a $1.3 million task order with the SBCTA to support the development of a smart county transportation plan and a $1 million task order with the Florida Department of Transportation District 5 to implement an Integrated Corridor Management Program.

As with our sensor portfolio, we continued in the second quarter to enhance our software-as-a-service, data-as-a-service and cloud-enabled managed service solutions to support sustained long-term bookings growth. Second quarter release milestones included enhancements to CLEARASSET to support the management of a transit signal prior — of transit signal prioritization assets which expands the addressable market for the SaaS product. Enhancements to clear data that publish historical, as well as real time data feeds to address a variety of new use cases for both clear data and ClearGuide which provides the visualization front end for clear data. And an integration of INRIX’s real time data feed with ClearMobility cloud to further enhance and differentiate our uniquely curated mobility datasets.

In summary, we are pleased with our second quarter as record total revenue record trailing 12 month total net bookings growth and record total ending backlog. All of which we believe demonstrate considerable progress we’ve made against our platform strategy. Additionally, our global supply chain management program achieved significant milestones that enabled us to start releasing alternative circuit boards to production and re-optimizing our inventory to include newly qualified components at normalized component costs. These actions had a significant impact on net cash flows and gross profit margins in the second quarter, however they position Iteris for a critical inflection point in the second half of fiscal 2023. On that note, I’d like to turn the call over to Doug to provide more color on the second quarter financials after which I’ll further discuss our second half expectations.

Douglas Groves: Thank you, Joe. Good afternoon, everyone. As a reminder, please see the company’s 10-Q filing and press release which are posted on the IR website for a further description of matters under discussion during the call today. As Joe mentioned and as we expected, we continue to face several supply chain challenges again this quarter that impacted both the top and bottom line results. We anticipated these challenge and we continue to see certain components that were not available through our normal channels. To that point, we spent approximately $8.4 million in inventory purchases from the secondary markets i.e. brokers, which was up from $5.6 million in Q1 and this negatively impacted the cost of sales by $7.8 million in the current quarter.

From a revenue standpoint, the amount of unshipped backlog decreased from $4.9 million at the end of Q1 to $0.9 million in Q2, however sourcing all the components we needed at reasonable prices continue to be a challenge with the cost of many components continuing to be 2 to 100 times their normal cost. If we had all the components we needed, the year-over-tear revenue growth would have been almost 21%. The orders that didn’t ship in the current quarter are expected to ship in Q3 and there were no order cancellations in the second quarter, which is why we expect the second half hardware revenue growth to be over 30% year-over-year. As Joe mentioned, we have many ongoing initiatives to improve the situation which is why we expect second half hardware gross margins to be in the mid 30% range, compared to only 14.8% in the first half of this year.

Demand for our products and services continues to be strong as evidenced by our once again strong bookings of $42.2 million and record backlog of $111.8 million. Now I’ll move on to the details of the second quarter results. Total revenue for the fiscal 2023 second quarter increased 18% to $39.3 million compared to $33.3 million in the same quarter a year ago. Our gross margins in the second quarter decreased 1,680 basis points to 16.7%, compared to 33.5% in the same quarter last year. Adjusting for the increased component costs of $7.8 million, the gross margins would have been 36.6% or up 310 basis-points compared to the same prior year quarter. As previously mentioned, our revenue continue to be constrained due to the unavailability of certain components and the gross margin pressure was due to higher cost for those components that had to be purchased through the broker market.

Turning to revenue mix, the product revenues increased 17% to $20.8 million compared to $17.7 million in the same quarter last year. Taking into account, the $0.9 million of revenue that was not recognized because of component shortages, the product revenue growth would have been 22% quarter-over quarter. The record revenue was a conscious decision made to meet our customers on time delivery expectations and take market share from competitors, but it did come at a significant cost to the gross margins. This strong demand underscores our market leading position in the sensor market and as Joe noted, we continue to win on large sensor deals. Product gross margins declined 4,570 basis points and were 3.7% compared to 49.4% from the same quarter last year due to the supply chain cost issues mentioned previously.

Our service gross revenues increased 19% to $18.5 million compared to $15.5 million in the prior year quarter, primarily driven by stronger software and managed services revenues. In the second quarter, 25% of total revenue was annual recurring revenue, as a reminder, annual recurring revenue is comprised of our software and managed services revenues. Service gross margins increased 1600 basis points to 31.3% compared to 15.3% from the same quarter last year. As a reminder, Q2 of fiscal year ’22 included a onetime nonrecurring charge of $2.8 million. So after adjusting for this, the gross margin decrease was 210 basis points, which was primarily attributable to increased labor cost and the timing of certain contract extensions and the contract mix.

Operating expenses in the second quarter were flat $13.5 million. General and administrative expenses were down $1.1 million or 18.5%, while R&D was up 400,000, driven primarily by the circuit board redesign efforts. Sales and marketing costs increased 800,000 which was related to our sales and product support headcount to support the higher sales going-forward. We reported a GAAP operating loss in the second quarter of $6.9 million compared with a GAAP operating loss of $2.4 million in the same quarter a year ago. The operating loss was solely attributable to the higher component costs as previously mentioned. The progress being made on the circuit board redesigns, we’re anticipating spending less than $1 million in broker components in Q3, which is down significantly from the $8.4 million spent in Q2.

The GAAP net loss from continuing operations in the second quarter was $7.4 million or a loss of $0.17 per share, which compares with a net loss from continuing operations of $2.1 million or $0.05 a share in the same quarter a year ago. Adjusted EBITDA for the second quarter was a loss of $5.2 million or 13.1% of revenue, which compares to EBITDA of approximately $2.3 million or 6.9% of revenue in the second quarter of last year. The GAAP operating loss, GAAP net loss and adjusted EBITDA loss were driven by the supply chain issues as previously noted. With the supply chain improvement plans outlined by Joe, we anticipate a progressive improvement in our supply chain position in the second half of this year, since it will take some time for the redesign of all the circuit boards to shift through to our customers.

With the 2 new circuit board designs already shipping to customers in the third quarter and one more that has already gone into production this week, this will largely mitigate our need to procure components in the broker markets as previously mentioned. These key redesign activities should return the product gross margins to about 40% by the fourth quarter of this year. Turning to liquidity and capital resources. Cash was $8 million at the end of the second quarter and net working capital was approximately $26 million. The $6.8 million decrease in cash quarter-over-quarter was a result of the net loss, which was driven by the higher component costs. As previously mentioned, we procured $8.4 million in components from the secondary markets, so we were unable to get meaningful extended payment terms, which is a normal business practice in these market to offset the inventory carrying costs and this also negatively impacted our working capital in the quarter.

With the expectation that third quarter parts purchased in the broker market will decrease to less than $1 million, this will substantially improve our working capital and we would expect to be cash flow positive in Q3 and continue to increase our cash position in Q3 and beyond as our circuit board redesign projects continue to progress. Lastly, we spent $190,000 in purchases of property and equipment in the second quarter, which was down from $269,000 in the same prior year second quarter. And we still expect the full year CapEx to be less than 1% of revenues, reflecting our asset-light business model. So in summary, we continue to be laser-focused on our supply chain challenges, as Joe mentioned, our multipoint plan is progressing well with the 3 new circuit board designs in production in the third quarter, we’re confident that we’ll weather the supply chain storm and come out even stronger on the other side with multiple circuit board designs for our market leading Vantage sensor products and without sacrificing any features and functionality that our customers have come to rely upon.

With that, I’ll turn the call back over to Joe. Joe?

Joseph Bergera: Great. Thank you, Doug. Although, COVID and subsequent supply chain constraints may have obscured visibility in the last several quarters, Iteris continues to strengthen its leadership position in the smart mobility infrastructure management market, which is a large dynamic market that represent significant opportunities given favorable secular trends and historic new investment from the IIJA, which among other benefit should provide a meaningful backstop should we enter a future recession. Therefore, we are extremely optimistic about the opportunity in front of Iteris and believe the current environment even improves our ClearMobility value proposition and competitive position. To capture this opportunity, Iteris is executing against an aggressive FY ’23 second half solutions roadmap to drive adoption of the ClearMobility platform, enhance the cross-sell of our ClearMobility offerings and improve the monetization of our mobility data sets.

Planned releases include a new connected vehicle safety alert for our Spectra CV sensor which is targeted at both public and private sector markets, new safety features for our Vantage Apex sensors that will further enhance our Safe Streets for all value proposition, new scalability features for Vantage Apex that will enhance our ability to better price differentiate based on certain intersection characteristics, new safety analytics and connected vehicle reporting features for ClearGuide, our mobility intelligence application and new features that enable Vantage Fusion to stream connected vehicle and detection data to ClearMobility Cloud. We believe our sales channels are the most productive in the industry. However, we continue to pursue additional opportunities to capitalize on the continuous enhancements to our platform capabilities and to maximize our market share gains.

In fiscal 2023, the second half of fiscal 2023, we’ll introduce an average 10% price increase for our Vantage Sensor portfolio, which actually went into effect on October 1, 2022, continue to optimize our distribution model, particularly in underserved regions such as the Intermountain area and implement various new programs to increase the attach rate of our everything-as-a-service or ex as a service offers to detection. We expect these and other ongoing initiatives to sustain strong bookings momentum, although typical seasonality due to the holidays may temper fiscal 2023 third quarter bookings. Simultaneously, we’ll continue to execute our supply chain improvement program to drive further reductions in unshipped advantage sensor backlog and accelerate overall backlog conversion.

For example, in the second half, we plan to release to production the remaining alternative circuit boards that represent high component scarcity and associated cost. As these alternative circuit boards come online, we will continue to further optimize our inventory, meaning we’ll replace aftermarket components with comparable components sourced to normalize costs through traditional channels, which offer standard payment terms. In turn, this will renormalize our working capital structure and cost of goods sold for our Vantage Sensor portfolio. Due to the combination of these various dynamics, we anticipate a dramatic positive improvement in the company’s financial performance beginning in the fiscal 2023 second half. More specifically, we anticipate second half revenue growth to be approximately 20% year-over-year due to sustained high levels of demand for our solutions and the benefits of Iteris’ supply chain improvement program.

Second half adjusted EBITDA to be in the range of $3.5 million to $4 million or 4.5% to 5% of revenue, with the compounding benefits of our global supply chain improvement program, enabling the company to exit the fiscal year at a run rate of approximately 10% adjusted EBITDA. And second half net cash flow to be in the range of $4 million to $6 million, as we renormalize our working capital structure and cost of goods sold for our Vantage Sensor portfolio. Based on these second half expectations, we are raising the low end of our full year fiscal 2023 revenue guidance to a range of $150 million to $155 million and we are lowering our full year adjusted EBITDA range to negative 1% to negative 3%, a full year fiscal 2023 revenue to reflect the impact of global supply chain constraints on our fiscal 2023 first half results.

In closing, we’ve experienced many challenges over the last several quarters due to COVID and subsequent global supply chain constraints. Nonetheless, we continue to execute against our platform-centric business strategy and extend our leadership position in the smart mobility infrastructure management market. Most recently, we made significant progress on our global supply chain improvement program, which will not only generate significant near-term benefits, but lasting value for the company. As a result, Iteris is positioned to realize a critical inflection point in our fiscal 2023 second half and deliver significant shareholder value creation as outlined by our Vision 2027 operating model going forward. So with that, we’d be delighted to respond to your questions and comments.

And so operator, let’s open up the line for that please.

Q&A Session

Operator: . Your first question for today is coming from Ryan Sigdahl at Craig-Hallum Capital Group.

Ryan Sigdahl: Really solid revenue bookings, et cetera, so I want to dig into the cost side here. The supply chain challenges, circuit board costs, bringing in 3 new circuit boards into production, all that sounds the same as last quarter. So I guess, pretty material change in expectation on EBITDA and margins for the rest of the year given those challenges. So I guess what changed in the last few months relative to what seemed like similar challenges last quarter and knowing those challenges?

Joseph Bergera: Well, Ryan, this is Joe, why don’t I front end that and then, Doug, I’ll pass it over to you. So one thing I wanted to clarify is that, when we had our last earnings call, we explained that we were — the plan was to complete the design and testing of 3 alternative circuit boards in each of the subsequent quarters. But following each quarter, we would introduce or release to production 3 circuit boards. So what that meant in terms of the September 30 period is, we had initially expected that we would have 3 — we would have already been shipping 3 of the redesigned circuit boards before the end of the September 30 quarter. Due to a number of factors, largely it was due to testing feedback that required some further enhancements to the refactoring for those circuit boards, the release dates got extended.

And the — and as a result, we didn’t realize the benefit that we expected from those 3 circuit boards in the September 30 period. Now we will realize that in the December 31 period as well we’ll realize the benefit of additional boards that will be released to manufacturing in the December 31 period, but we did lose a couple of months in the September 30 period. But anyway, Doug, with that background, do you want to provide any further response to Ryan’s question?

Douglas Groves: Sure. I think the only thing I would add, Ryan, is because it was a timing issue that we do still have about $5 million of that broker inventory in our inventory, so that will flush through in the third quarter. So margins will be compressed and don’t bounce all the way back until the fourth quarter when all that inventory has been flushed. So I think it really just became a timing issue from what we were expecting to happen in Q3 to happen in — excuse me, happen in Q2 will happen in Q3 and so everything just pushed to the right one quarter.

Ryan Sigdahl: And then as you think about targeting 10% exit rate on EBITDA margin this year, I guess, how much visibility and confidence do you have in that? What are the pinch points of things that we’re talking about now that weren’t expected over the last couple of months, but where is the risk in that? Or I guess how much confidence in that exit rate and improving from there next year?

Douglas Groves: Well, I’d say if you look at our operating expenses, we’ve got a really good handle on those, those were flat year-over-year as we exited the second quarter and we’re expecting that to be pretty similar for the remainder of this year. So really no risk there. It’s going to come down to just the continued evolution of the supply chain and getting all the components we need, the software business, the professional services business are all pretty consistent and with the visibility we have into the backlog that was referenced, I think the only risk would just be, as we’ve talked about the last 4 quarters would be in the supply chain, but we think with the redesign efforts that are completed and those that are ongoing that, that risk has largely been managed to give us the confidence that we can hit a 10% EBITDA number exiting the year.

Ryan Sigdahl: Last one for me, so you terminated your credit agreement in September, which was untapped, but had good liquidity option there. You have $8 million of cash and some ongoing headwinds, I know you’re modeling and guiding to positive cash flow in the back half. But how much cash reserve do you think you need to operate this business, just to give yourself some flexibility?

Douglas Groves: Well, we’ve certainly with the remix of the inventory, that’s going to be the biggest driver here because if you look at the reason for the decline in the cash balance, it’s all been related to these parts, we’ve had to purchase in the broker market where we don’t get any payment terms since we’re not going to have more than $1 million in the third quarter, high degree of confidence we’ll build cash and we only need really, I’ll say, $3 million to $4 million to operate the business. And we’re already seeing the cash balance start to build, I mean as of the end of October, our cash balance was back up to like $9.5 million. So I think it’s going to certainly get to that guidance that we outlined in the prepared remarks.

Ryan Sigdahl: Thanks, guys. Best of luck.

Douglas Groves: Thank you.

Operator: Your next question for today is coming from Jeff Van Sinderen at B. Riley.

Jeff Van Sinderen: Hi, everyone. Thanks for taking my question. Just wanted to ask about recurring revenue, I think you said 25% during the quarter, just wondering what that was in the prior quarter year-over-year, if you can remind us? And then what was the growth of recurring revenues? I’m not sure I caught that.

Joseph Bergera: Doug, do you want to take that?

Douglas Groves: Sure. Yes, no, it was pretty consistent as a percentage of total revenue year-over-year. So there was not significant growth year-over-year in the recurring revenue. But as Joe referenced, we did have some nice bookings that we’ll be adding to that as we head into the second half. So we are expecting to see some growth in the recurring revenue as a percentage of total revenue in the second half.

Joseph Bergera: So Jeff, this is Joe, I’ll just add a little bit to that. The — I think maybe the point that you’re getting at is that as a percent of revenue, recurring revenue was larger in the prior quarter than the most recent. But of course, we saw a huge increase in the amount of product revenue in the September 30 period, which impacted the proportion of recurring revenue. If you look at just the actual recurring revenue, it was up somewhere, I believe, between 15% and 20% on a year-over-year basis and also up on a sequential basis.

Jeff Van Sinderen: Okay. Good. Good to know, footfall 15% to 20% year-over-year growth in recurring. And what was the SaaS component of that, yes that…

Joseph Bergera: Yes, so — we haven’t in the past and at some point we will, but we haven’t in the past and we’re not prepared to explicitly break that out. But what we have said is that the split between SaaS revenue and managed service, which is what constitutes our total recurring revenue is about 50/50. I would say at this point that SaaS is probably about to if it hasn’t already overtaken managed services means that perhaps is in excess of 50% of the total annual recurring revenue at this time.

Jeff Van Sinderen: Okay. Good to know. And then I wanted to ask you, I wasn’t sure — I mean, we haven’t had a chance to kind of go through our projections for second half, but consolidated gross margin for second half, what’s implied in your guidance for that?

Douglas Groves: From a gross margin percentage, it’s — yes, it’s kind of mid — low to mid 30% gross margins in the second half.

Jeff Van Sinderen: For both quarters or?

Douglas Groves: Well that’s the second half. No, it’s going to be lower in the third quarter for the reasons I just mentioned on this remaining high-cost inventory we’ve got to flush through and then getting back to the more traditional margins in the fourth quarter. So the second half gross margin is in that low to mid 30% range.

Jeff Van Sinderen: Okay. So low 30 for second half, got it. And then SG&A, you said — I know — I think you said holding kind of flat. Are you saying that in dollars, you can keep the dollars close to what they were in Q2 for the remainder of the year for SG&A?

Douglas Groves: Yes, that’s the plan in absolute dollars. So as a percentage of revenue, it would come down because the revenue is greater in the second half than the first half.

Jeff Van Sinderen: Right. Okay. Good. And then just I think, Joe, you mentioned potential macroeconomic recession. Just any thoughts on kind of how the business might be impacted by a recession?

Joseph Bergera: Yes, well, we’ve been in an very unusual period the last couple of years. And so you never know what could happen at this moment in time. But that being said, generally, that when we’ve gone through recessionary cycles, we found that our end market has been less impacted than other sectors for a variety of reasons. We’ve also found that the impact — what impact there is tends to be not only muted but tends to show up oftentimes later, approximately 12 to 18 months after other sectors, which are maybe more interest rate sensitive are impacted. So all that being said, under the worst of circumstances or standard circumstances, we’d expect there to be a modest impact on our sector and as such potentially on Iteris.

That being said, we think that the IIJA provides a really strong backstop. So even in the event of recession, certainly the agency customers that we’re talking to are projecting an increase in their budgets over the next 5 years, even after they’re making some adjustment for potential reductions in tax revenues. I don’t know the extent to which they have factored potential recessionary cycle into their budget estimates. But again, net-net, they expect their budgets to remain the same or even to grow because of the IIJA more than compensating for any potential recessionary cycle. So again, we’re in uncharted waters here, Jeff, but we would expect the impact of recession to be modest, if any.

Jeff Van Sinderen: Okay. That’s helpful. All right. I’ll let someone else jump in. Thanks.

Operator: . Your next question for today is coming from Mile Latimore at Northland Capital.

Aditya Dagaonkar: This is Aditya on behalf of Mike Latimore.

Joseph Bergera: Hello.

Aditya Dagaonkar: So could you give some color on if you’re seeing any demand fluctuations due to the price increases?

Joseph Bergera: Yes, sure. It’s a great question. I do when I talk to our customers, what I’m hearing from them is that, unfortunately, because of cost increases, they’re able to buy less of meaning like fewer units of equipment, let’s say, a fewer number of sensors, fewer user licenses than they would have originally intended for the amount of budget that’s available. But I haven’t seen any reduction in the amount of budget or the amount of spending. So unfortunately, our customers are getting in some cases less, but we’re not seeing any reduction in the amount of budget that they’re committing to smart mobility projects, if that answers your question?

Aditya Dagaonkar: All right, all right. Fine. And also some color on what might be the operating cash flow for second half of this year?

Joseph Bergera: Sure. Doug, do you want to talk about that?

Douglas Groves: Sure. Yes, so yes, we would expect it to be in line with what we talked about $4 million to $6 million of positive cash flow in the second half as we optimize our inventory and return to profitability.

Aditya Dagaonkar: All right, fine. That’s helpful. Thank you, guys.

Douglas Groves: Of course.

Operator: There are no further questions in queue. I would like to turn the floor back over to Mr. Bergera for any closing comments.

Joseph Bergera: Great. Super. Well, thank you, operator. And as always, I appreciate everyone’s support and your thoughtful questions. On the Investor Relations front, I wanted to let you know that we’ll introduce a series of short investor updates starting this winter that will address a variety of business and technology topics. Additionally, we plan to be participating in various investor outreach events and as always, we’re available to speak with investors should you have any follow-up questions. In the meantime, we look forward to updating you again on our continued progress when we report our fiscal 2023 third quarter results. So this concludes today’s call. Thank you.