OSS - NASDAQ

Good day and thank you for joining us today to discuss One Stop Systems’ Financial Results for the Third Quarter ended September 30, 2023. With us today are the company’s President and Chief Executive Officer, Mike Knowles; and its Chief Financial Officer, John Morrison. [Operator Instructions] Before we conclude this call, I will provide some important information regarding the forward-looking statements made by management during this call. I would like to remind everyone that the call will be recorded and made available for replay in the Investors section of the company’s website. Now I would like to turn the call over to OSS President and CEO, Mike Knowles. Sir, please go ahead.

Thank you, Morgan, and good afternoon, everyone. I’ve successfully completed my first full quarter as CEO, and I’m pleased with the building momentum and confidence in the rugged Edge processing market. We are well positioned for future growth at OSS. My engagement with customers and participation in global trade shows over this past quarter reaffirmed our unique position in the robust growth markets driven by artificial intelligence and sensor fusion, particularly in rugged high-performance compute demand at the Edge. In many instances, OSS is recognized as an expert in these markets. And in fact, in October, I participated on a panel at the aerospace event in Washington, D.C. regarding the technical demand for high-performance compute for artificial intelligence applications in commercial and defense markets. In Q3, we secured several significant wins across commercial and defense markets. These successes align with our strategy to broaden the number of prime and customer contracts, increase our presence on more platforms and pursue multiyear contracts that can boost our pipeline and future revenue. These key wins include a liquid cooled server solution for sonar processing for a foreign navy submarine class. A follow-on win in hardware buy for an additional storage system product for the P-8, a new contract with an existing defense prime contractor for a new classified platform, a commercial order and win in a dynamic racing industry encompassing our product at this newest OSS customer. The award from the foreign navy submarine program is special noteworthy in how it exemplifies our key objectives. We successfully established a new military customer, a new defense prime and a new international customer while securing a position on a new platform. We believe this will lead to a multiyear product and support contract commencing as early as 2024. This sale is cultivated, captured and closed by our Bressner sales team with support from our OSS team, validating Bressner as a channel to market for OSS products. In addition to the key awards noted, our teams are actively engaged in multiple proposal and program pursuits. We are currently responding to an exclusive opportunity to design, develop, produce and support a rugged edge compute solution for the commercial aerospace market. This effort would add a new product through an existing customer and establish a multiyear contract. OSS has engaged in two potential exclusive opportunities in the commercial data center market with our latest PCI Express Gen 5 4UP, an internally developed UBM software. These efforts would broaden our customer base and provide for a multi-year hardware and software demand opportunity. The team is working to close a large competitive opportunity for design, development, production and support for a rugged computing storage system in autonomous trucking market that would expand our platform, position in the market and lead to another multiyear demand opportunity. We’re responding to a competitive opportunity for a rugged Edge processing solution for a military classified program. This capture involves a new prime, a new platform and provides a multiyear production and support opportunity. Also on the defense side, we are well engaged with the potential sole-source opportunity for rugged Edge processing and storage for a multi-vehicle platform support activity. This opportunity would be with a new organization within a branch of the U.S. Armed Forces. These represent a sample of the increased activity and pursuits our teams are diligently working. For competitive reasons, I haven’t provided specific technical information or contract value. Looking ahead, we remain committed to expanding our efforts to secure new prime contractors, vehicle platforms and multiyear contracts, both domestically and internationally. Our broad market activity is already increasing the number of customer engagements and requests for information and proposals bolstering our confidence in our strategy and our ability to grow a robust multiyear pipeline. Financially, our results in Q3 reflect the continued transition we embarked upon last year to focus more on rugged Edge and defense market opportunities. We successfully shifted away from our former low-margin media customer, and we’re concentrating resources on growth opportunities in Edge computing, driven by sensor processing, sensor fusion, artificial intelligence and machine learning. Despite the expected challenges, we achieved $13.7 million in revenue in Q3, while effectively executing our cost containment plan. There is more to discuss. But before I go further, I’d like to turn the call over to our CFO, John Morrison, to provide the financial details for the quarter. John?

Good afternoon, everyone. Thank you for joining us today. Earlier today, we issued a press release with our results for the third quarter ended September 30, 2023. A copy of the release is available in the Investor Relations section of our website at onestopsystems.com. For the third quarter, we reported consolidated revenue of $13.7 million. Of this, OSS contributed $5.5 million and Bressner contributed $8.2 million, inclusive of $377,000 of OSS products. Quarterly revenues reflect a reduction of $5.1 million or 26.9% compared to the same period in 2022. Approximately $4.3 million of such reduction was attributable to the loss of our former media customer from who we do not expect further revenue. The balance of the revenue reduction was associated with delays in certain customer orders for defense applications, lack of revenue from a bankrupt autonomous truck customer as well as a slowdown and general malaise in commercial markets. As most of you are aware, our [Technical Difficulty] comprise of two segments: OSS, which is located [Technical Difficulty] and Bressner, which is located in Munich, Germany. OSS is involved in the design, and manufacturer of high-performance, ruggedized Edge processing and storage systems and connectivity. Bressner operates as a system integrator with standard and custom all-in-one hardware systems and components. They also serve as a channel for OSS products to the European and Middle Eastern markets. Gross profit in the third quarter decreased to $3.7 million with overall gross margin percentage decreasing 40 basis points to 26.6% due to a higher mix of Bressner revenue. The gross margin for OSS business improved 1.7 percentage points to 32.4%, which was attributable to the absence of lower-margin sales to the customer’s former media customer and a higher mix of its rugged Edge processing products. However, the improvements to margin were offset by underutilization and absorption of production fixed costs due to excess capacity resulting from lower revenue. Bressner’s gross margin percentage improved 40 basis points to 22.6%, largely due to product mix, the sale of higher-margin OSS products and having sought after products readily available and sold at a premium. The company reduced operating expenses by 4.3% to $4.7 million through cost containment efforts implemented in the quarter. This is exclusive of a $2.9 million write-down attributable to an impairment of goodwill resulting from the overall financial performance as compared to plan, our increased focus on the defense industry and revised timing for our forecast of certain revenue opportunities. Loss from operations totaled $4 million compared to income from operations of $163,000 in the same period in 2022. This reduction was predominantly attributable to lower revenue and the write-down associated with the impairment of goodwill. Loss before income taxes in Q3 also included a onetime benefit of $418,000 attributable to the receipt of funds on the government’s employee retention credit program. Net loss on a GAAP basis was $3.6 million or $0.18 per share as compared to net income of $133,000 or $0.01 per share in the same period in 2022. Non-GAAP net loss was $597 million or a loss of $0.03 per share as compared to non-GAAP net income of $691,000 or $0.03 in the same period in 2022. Adjusted EBITDA, a non-GAAP metric, was negative $248,000, a decrease from positive adjusted EBITDA of $1 million in the year ago quarter. Each of these non-GAAP metrics excludes the $2.9 million impairment of goodwill and the $418,000 for the employee retention credit. Now moving to our year-to-date metrics. Our highlights compare – these highlights as compared to the same period in 2022. They include consolidated [Technical Difficulty] noting consolidated revenue was down 11.9% from $54.2 million to $47.7 million, predominantly due to a decrease of $10.5 million in media revenues. Gross margins were 28.3% compared to the prior year of 28.5%. Operating expenses, including the charge for goodwill impairment is up $1.3 million, inclusive of approximately $1.5 million attributable to 2023 CEO transition costs. Other income and expense includes $1.7 million for employee retention credits, resulting in net other income of $322,000. This is compared to net other expense of $106,000 from the prior year. Loss before taxes, excluding the goodwill impairment charge and the employee retention credit benefit was $1.6 million and contract income before taxes of $1.3 million in the prior year. Non-GAAP net loss was $592,000 or $0.03 per share. Adjusted EBITDA, a non-GAAP metric was $768,000. Now I’ll look at the balance sheet. On October 30, 2023, cash and short-term investments equaled $13.2 million. This combined total represents a decrease of $2.2 million as compared to Q2 2023. This decrease is primarily due to an increase in working capital requirements for inventory. Inventory continues to increase due to non-cancelable, non-returnable inventory orders placed in previous periods, which are now being delivered. We expect this inventory increase to be relieved in 2024. As the company continues to transition and have an evolving business from being largely dependent on media derived revenue, the company will operationally focus on maximizing gross profit contribution. In the near term, this may include accepting lower margin business that incrementally contribute to gross profits but may be inconsistent with our long-term objective of a decreasing consolidated gross margin percentage. The objective of this effort is to have sustainable cash flow as the company bridges our revenue model. Now looking forward to the fourth quarter of 2023, we expect revenue of approximately $13 million. We are witnessing some impact from the defense budget continuing resolution, manifesting late funding and awards on sole source opportunities. We could experience further impacts going forward as the budget approval continues to be delayed. We also continue to see a commercial slowness or general malaise that has manifested in delays and/or reduced awards. We have not seen signs of overall improvement and do not know when we may be able to see those. This will complete our financial review for the quarter. I would now like to turn the call back over to Mike. Mike?

Thank you, John. Last quarter, we announced the departure of two OSS directors as well as the appointment of Vice Admiral Mike Dumont and myself to the Board of Directors. We also reconfirmed our commitment to continue the reprofiling of the Board to align with the strategic path and desired skill sets of directors. As noted in the 8-K and earnings release, Joe Manko, Managing Member and Senior Principal at Horton Capital Management has been selected and appointed to serve on the Board effective November 10, 2023. Mr. Manko has been serving as a managing member of senior principal Horton Capital Management an investment fund since 2013. His prior asset management and investment banking experience, having served in executive positions at B

Thank you. [Operator Instructions] We’ll go to Brian Kinstlinger with Alliance Global Partners. Your line is open.

Hi, guys. Thank you for taking my questions. Is there any way, Mike, to quantify the pipeline? I am not sure if I heard it in Defense today compared to either when you joined, which I think was a little bit depleted or versus a year ago? I’m just trying to gauge how well you’re building pipeline since you’ve joined?

Yes. Prior announcements had the pipeline structure of opportunities around $800 million. It’s about $850 million. So with some of the additional work in the last quarter with validation and going through each of those efforts line by line, we’re comfortable now that our 5-year unfactored pipeline is in excess of $900 million.

How much of that – it’s such a big number, and it’s so far away. How much of that do you think is addressable or biddable say, through a next year?

Yes, Brian, when I – when I say a 5-year plan, so what we do is we build out 5 years of pipeline opportunity broken out by year. So the sum of those 5 years is the $900 million. So there are elements of that – that are biddable in as early as 2023, going through 2024. So that 5 years I discussed was really ‘24 through ‘28.

Great. And then maybe you talked pipeline within defense, but what about for your AI transportables in commercial? I know you talked about maybe some forward decisions right now on the commercial side. But how do you see that opportunity there in the near-term?

So the pipeline that I discussed was across both our commercial and defense market. So it’s all of the AI transportable, rugged Edge processing capabilities in products that we’re doing. I just don’t have the percentage mix between commercial and defense here with me. It’s probably fairly close to 50-50 based on the last time it came through. And then the second part of your question, again, Brian?

No, that was it. It was going to be just on that. But I guess now you’ve been there a full quarter as you evaluated your business, is there any investments you think are necessary to fill visible holes that you think are necessary to help you return to growth?

Yes. So as I mentioned earlier, with the engagement, the number of increased engagements we’re going. And I also mentioned seeing some more broad opportunity internationally. One of the areas we will be looking to augment and invest that will be to kind of continue to build out our sales team so we can get to capturing and executing against that – the resources against that $900 million pipeline. And we need the resources to help execute and convert that from pipeline into actual – capturable programs and elements that we can get. And then our product lines, as I mentioned, we released Rigel recently, Cernis & Donati has just come on the scene. So 3U SDS has been strong. So from a product perspective, we’re in a good place right now. We will be making investments in 2024 as we look to the next generation of our product line. So we continue to stay at the front end of the market in terms of technology. And then as I had mentioned, I think it was last earnings call, we will be looking to augment the team. We’re starting to get more discrete defense contracts now, so we will look to augment the team with some contract support, probably part time to start. And then also, we’ve – you’re talk about adding some additional program management to support running the programs as we win them and also to support our capture of these bigger, broader multiyear contracts.

Okay. Last one for me. This one is probably for John. The core OSS gross margin recovered nicely. I assume the P&L without your media customer was the major driver there. But then I also heard your comments on potentially taking on some lower-priced or lower margin business to improve the cash flow even if it’s just a little bit. So how should we think about where you are today or just report it in the core OSS gross margin, should we expect it will be softer in the coming quarters given your comments? Or given the mix, it’s indicative or even stronger as you book new business? Just help us from this new point without that media customer.

I would – at this point, we’re thinking it’s when we are projecting it’s going to be flat, largely because we are dealing with the underutilization in our production facility on revenue. We need to get back to more of it in line of doing about $9 million a quarter from OSS’ side to be totally be utilized. Many of these resources are resources that are involved in the planning, purchasing and management of inventory as well as obviously the production for people. But we have already gone through a reduction in force back in April of 2023. We believe that as we recover these resources will be fully utilized. But until then, it’s weighing down on the overall margin for OSS. And obviously, then the proportion to the resume revenue that’s increasing is having a significant impact on the consolidated margin percentage.

Sorry, I said I’d be done but one more. At $9 million fully utilized and just core OSS that gets you back to approaching 40% gross margin for that segment? Or is that a little too optimistic?

It’s more of the 35% to 40% range.

Great. Thank you, guys.

Thank you, Brian.

Your next question comes from David Williams with Benchmark. Your line is open.

Hey, good afternoon. Thanks for letting me asking question. I guess maybe, Michael, on just thinking about the defense industry, and it seems to have held in well during this down cycle. And it seems to suggest that we’re – spending still remains favorable. I know you touched on this in the script. But outside of the timing of the budgets and some of the approvals, it feels like you’re gaining some really good momentum. But could you talk maybe a little bit about the hurdles between here and going into production and just what does that timing look like? So we have a better understanding on how we should think these – progress through the channel here? Thank you.

Yes. Sure, David. I think if you’re – in one part, you are referencing the continued resolution of the CR we have a couple of sole source awards we’ve been looking to get and to be able to provide proposals on that have been held up for the CR. So we expect those near-term to come across as soon as the CR is resolved. That’s an issue it seems every year now that defense companies have to deal with. I think if you look at how does the defense elements come alive as we build out a lot of the efforts in all we’re doing now, we will see – we will find homes on new procurements in late ‘24, ‘25 and 2026. However, there are opportunities in there where we’re finding where if you can intercept a platform upgrade or tech refresh cycle, you have opportunity to make things happen a little bit faster. An example is the foreign navy submarine program that I talked about. They happen to be in a tech refresh cycle that we caught early, and we were able to get in there with our technology. And from the time we identified that opportunity through our Bressner unit to contract award was less than a year. That’s probably usually a lot of times unheard of in the defense market, but it is doable when you catch those time frames. There are a number of prime contractors in vehicles and platforms that we’re talking to and the defense services both in the U.S. and globally, where we have, in those discussions seen where their technology refresh upgrades are. And we’ve positioned ourselves to be in those competitions and then those discussions for the architecture upgrades. And those start to span the years from ‘24 through ‘26 and beyond. And then we – those are ones who would have identified, put into our pipeline and now have assigned a resource in to capture those going forward.

Great. Thank for that. And I intended to just say congrats earlier, but just on the success and acceleration, it seems like you’re gaining a lot of interest here, and it’s great to hear the enthusiasm and see the progress. I guess on that, Mike, just kind of given your time in the seat now, you’ve had some time to settle in and look through things. Is there anything today that you see that’s different than previously, either more positive or things that are just different than you had thought? Anything that gives you, I guess, more optimism today than you might have had as you came into the role? Thank you.

Yes. Great, David. So probably two things. First is we called it a little bit of the new norm around here. As I mentioned, the number of proposals we’re working on. I would say there is a heightened level of energy, excitement, activity, and sense of urgency in the business to grow and address the opportunities. We’re seeing them come in the defense market as we would have expected with the addition of Robert Kalebaugh, myself as we increase focus in doing so. But we’re seeing ample elements inside the commercial market, too, that are raising some interest and some activity for us. So I’m excited about the new normal, the pace that we’re working at here to get after growth, which I mentioned augmenting the team to continue to try to build upon that momentum. And I guess maybe another example from the defense side had the opportunity to spend a week on the Capitol in D.C. interfacing with Congress Health Appropriations Committee, and the House Armed Services Committee and be able to tell the OSS story. And I was quite enthused to find the – how well our story resonated with the opportunity to bring advanced high-performance compute, artificial intelligence, machine learning to the battlefield. And you can see, given the – given what’s going on in the world today, the opportunity to be able to arm warfighters right, is something that resonates in the Services. It’s resonating through the half and half and being able to tell our story there and see it resonates so well. Again, gives me optimism that we’re on a good track, and we’re going to have support not only from our customers but our government also.

Thanks for the color.

Your next question comes from Joe Gomes with NOBLE Capital. Your line is open.

Good evening, thanks for taking my questions.

Hi, Joe.

So just in your press release, you talked about an overall delay in deployment of the technology. I was wondering if we can get some more color on that statement. Is that more just due to the economy? Or is that potential customers just having concern about applying leading-edge technology? Is there something else going on there? Just wondering if you could add a little more color to that.

Yes, Joe. And I think we’ve talked earlier in the statements about the kind of general malaise in the commercial market. We’re seeing the defense market move out short of the continued resolution effects. On the commercial market side, I would say it’s absolutely not the slow adoption of the technology. There is – from the technical engineers and the applications, there is plenty of interest and discussion going on about how to move forward and utilize the benefits of compute and artificial intelligence, machine learning, get it out to the Edge. The malaise really comes along when you try to convert into getting a request for proposal and a funded program out the door to make a purchase and a buy. And what we’ve seen there is the kind of just general tendency to not have a sense of urgency to make it happen this month. It’s okay if it happens next month or next quarter. We don’t see people or companies or efforts looking to push things out by years. But there is just been kind of a malaise and general ability to wait or delay another month or quarter to put things to a line, if that makes sense.

Okay. And then last quarter, you talked about, you thought somewhere in the nature of $5 million to $6 million of defense work had been pushed out into 2024. Has that number grown since then?

It will be about that number. We will see how Q4 ends, but we will be in that – it will be that general range.

Okay, thank you for that. And congrats on getting the security clearance for the facility. Again, one of the issues that seems to be a repeating is the difficulty in finding and hiring people with security clearances. Just there is a big demand and limited supply, it appears. I’m just wondering how you guys are finding that and if that is an issue at all?

Yes, Joe, thanks for the question. So the – I think one of the benefits we have today is the kind of work we’re doing right now doesn’t require us to have the cleared individuals that would – that you might align with the market you’re talking about people with staff or SCI clearances, where we’re operating here in the near-term, we can get our own people cleared and/or the workforce, especially in San Diego or remote, you’ve had to remote, you can find individuals to fill that. And the reason is for right now with the products and the work we’re doing, the use of the clearance for us is really more about being able to get inside the understanding of the mission and the application of the technology, and that allows us to explore the ability to broaden our scope on an effort. We’ve had two such – actually more than two meetings probably in the last few months where myself, Robert both have clearances, where we’ve been able to explore more broadly what a platform does. And in doing so, we were able to come back and identify broader scope of work or effort that OSS could do and could bring with our technology. And that’s where we’re going to see the benefit here in the near-term over the next couple of quarters. As we build out into the years an established position, the use of a CIF – compute classified information facility and people with the clearance as I discussed, they would come along, but we will have some runway to be able to identify that.

Okay. Great. And one more for me, if I may. Historically, you guys have given the quarter end pipeline in terms of the number of opportunities for those $1 million plus. And I think in the last quarter, you were 33 opportunities. Do you have that same number for the end of the third quarter?

Yes, we don’t have that number. In part, we’re transitioning from kind of those prior definitions. We’re going to involve our – evolve our pipeline information and data here to start to give you insight into awards and we will be aligning along some of the themes I mentioned earlier in the earnings call, where we’re really key – strategic for us is adding new customers, new primes and then getting on additional platforms and getting multiyear contracts. So we will look to engage across all those elements a way to – to be able to provide enough information to give you maybe even a more in-depth sense of how we’re doing on securing orders.

Okay. Great, thank you.

Thanks, Joe.

Your next question comes from Max Michaelis with Lake Street Capital. Your line is open.

Hey, guys. Thanks for taking my questions. Just looking at the low looking at the slowing economy in Germany, how has this impacted your outlook on the Bressner business?

So to date, we haven’t seen a major impact of it slowing the business. We’re at the end of the quarter and the move we’re seeing some timing or alignment, but we haven’t seen the cancellation of orders or a downtick. The booking there continues to be generally online quarter-to-quarter. So at this point, we’re still seeing them be able to work through any slowness in Germany.

And then last one for me. Just given the push out in orders in the autonomous trucking space, I want to stick with the commercial market, maybe what are some areas you can highlight? I know you talked about win in the auto racing industry, but maybe some area – other areas in the commercial market, you’re pointing your sales force to that you’re seeing maybe pockets of strength. Thanks.

Sure, Max, thanks. And I mentioned two of them in the earnings release there on the commercial side that we’re quite excited about, two were in the data center space using our core UP expansion chassis. With the onslaught of the hyperscalers and others buying large massive amounts of GPUs, those GPUs need to go somewhere. And in areas where – there is some niche areas in data centers where they are looking to manage the utilization of those GPUs and mend them into servers. There is some interesting areas where a couple of companies we’re finding some good traction with. So we see that as a nice area for us to go and work through. In addition, I mentioned the multiyear contract that we’re working to finalize here in the commercial aerospace market, where we will be able to bring some Edge processing into that market. So we will be looking to provide more insight on both of those efforts. We see those as potentially good ones on the commercial side. And then as I mentioned, we are working on RFP now for autonomous trucking. We’re seeing vigil in that market. It’s had a lot of promise, just had some slowing. So I use the cautious optimism on it. We continue to refine. We work through these. Luckily for us, be it design and efforts and solutions we use for autonomous trucking are the same ones we use in a lot of the defense work. So we’re not having to invest special product development or anything in that market. So we can be quick to respond. And if anything, we’re finding a lot of the work we’re doing in defense market creates more flexibility in our offerings for the autonomous truck market. So we will continue to monitor them, but we – like I said, we use cautious optimism on that one.

Alright, thanks, guys.

At this time, we have no further questions. I’d like to turn the conference back to our speakers for any closing remarks.

Morgan, thanks for that. And we look forward to speaking with you again when we report in March, and we hope everybody has a great day.