One Stop Systems, Inc. (OSS) Q1 2023 Earnings Call Transcript

One Stop Systems, Inc. (OSS) Q1 2023 Earnings Conference Call May 11, 2023 5:00 PM ET

Corporate Participants

David Raun - President and Chief Executive Officer

John Morrison - Chief Financial Officer

Jim Ison - Chief Product Officer

Conference Call Participants

Eric Martinuzzi - Lake Street

Shervin Z - Alliance Global Partners

Joe Gomes - Noble Capital

Operator

Good afternoon and thank you for joining us today to discuss One Stop Systems Financial Results for the First Quarter ended March 31, 2023. With us today are the company's President and Chief Executive Officer, David Raun, and Chief Financial Officer, John Morrison, as well as the company's Chief Product Officer, Jim Ison. Following their remarks we will open the call to your questions, then before we conclude this call, I will provide some important information regarding the forward-looking statements made by management during the call.

I would like to remind everyone that the call will be recorded and made available for replay in the investor section of the company's website.

Now, I would like to turn the conference over to OSS, President and CEO, David Raun. Please go ahead, sir.

David Raun

Thank you, Chris, and good afternoon, everybody.

In the first quarter, our consolidated revenue totaled 16.8 million, slightly above our guidance of 16.6 million, excluding the lower margin media business, our OSS classic revenue increased 17% for the quarter compared to the same period a year ago. OSS Europe also had strong revenue growth increasing 26% that includes 1.2 million of OSS core product sales, as we engage with more industrial and military AI Transportable European customers.

In contrast, we sold approximately 180,000 of OSS products in Europe in the first quarter of 2022. Our overall gross margin was 30.2 in the first quarter, up from 27.3 last quarter, and a slight increase from the year ago. Driven by increased sales of OSS core products in the U.S. and Europe, as well as a planned reduction of low margin sales to our legacy media customer.

As you may recall that in February, we announced the execution of a $1.3 million contract directly with the U.S. Army for the design, development and prototypes for a rugged 360-degree visualization compute system for land vehicles, including the Stryker, Bradley and Abrams.

We expect to start to realize revenue from this contract in Q2. The program represents a significant revenue opportunity, while also potentially opening other applications within the Army. We are engaged with several Air Force opportunities both directly and through top 10 prime contractors. Early proof points with Air Force include yesterday's announcement plus we recently learned from another prime they want a contract that includes our flagship compact Supercomputer Rigel. We expect to announce more about this win and ship product later this year. In both cases, these were new prime contractors for OSS providing additional exposure and visibility to other key programs.

Additionally, in Q1, we continued advancing in multiple industrial markets, including autonomous trucks, and agriculture, and several other defense related opportunities throughout the DoD in the U.S. and Europe.

Before I comment further on our growth strategy and outlook, I've asked John to comment on the financials. And Jim to expand on these customer wins and opportunities. John?

John Morrison

Thank you, David, and good afternoon, everyone. Thank you for joining us today. Today we issued a press release with our results for the first quarter ended March 31, 2023. The release is available in the Investor Relations section of our website at onestopsystems.com. The following results for the first quarter 2023 as compared to the same period in 2022. Consolidated revenue declined 271,000 to 16.8 million. This included an expected $3 million reduction in revenue from our low-margin media customer, which was mostly offset by 21.8% growth increase in sales to other OSS customers.

As clarification, OSS Classic is defined as all shipments from U.S. operations delivered throughout the world. Similarly, OSS Europe is defined as all shipments originated from European operations. References to OSS core products are those products that are designed in the U.S. and sold through both operations and they tend to yield higher margins.

OSS classic revenue decreased 18.4% to 8.6 million for the quarter, representing 51% of total revenue. Excluding lower margin media customer revenue, OSS classic revenue increased 17.2%. Revenue from OSS Europe increased 26% to 8.2 million, including an incremental $1 million of higher margin OSS core products. OSS Europe represented 49% of total quarterly revenue.

Our overall gross profit in the first quarter was 5.1 million. Our margins increased 10 basis points and sequentially by 290 basis points to 30.2% attributable to a greater mix of AI transportable products. The gross margin for our OSS classic business increased 60 basis points to 36.3 attributable to greater mix of AI transportable products. Our OSS core, our OSS Europe's gross margin percentage improved 280 points to 223.8% compared to 21% due to OSS core product content being sold into European markets.

Overall, quarterly operating expenses increased 17.3% to 5.3 million, with operating expenses as a percentage of revenue increasing to 31.4% compared to 26.3%. This increase in operating expenses was primarily due to increases of 510,000 in general and administrative expenses, with 249,000 being attributable to CEO transition costs. Marketing and selling expenses increased 310,000 was approximately 100,000 attributable to severance costs associated with the recent realignment of sales resources to support our AI transportable strategy. The increase in operating expenses was partially offset by a decrease of 49,000 in R&D expense.

Loss from operations was 196,000 compared to income from operations of 650,000 in the same period in 2022. This difference was predominantly attributable to higher operating expenses.

Net loss on a GAAP basis was 401000 or negative a loss of $0.02 per share, as compared to net income of 579,000 or $0.03 per share. On a non-GAAP basis, the net income was $90,000, or $0.00 per share down from non-GAAP net income of 978,000 or $0.05 per share. Adjusted EBITDA, a non-GAAP metric was 530,000 or 3.2% of quarterly revenue, a decrease from 1.4 million.

Turning to our balance sheet as of March 31, 2023. cash and cash equivalents totaled 3.5 million, with short-term investments of 9.2 million for a combined total of 12.7 million. This represents a decrease of 547,000 compared to cash and cash equivalents and short-term investments as of December 31, 2022. Our cash decrease was attributable to strategic inventory purchases and working capital requirements. We believe the current financial resources available to OSS provides us with the stability and flexibility to be responsive to changes in business demands, and particularly those that require investment and working capital and order for us to be successful.

This completes our financial review for the quarter. I would like to now turn the call over to our Chief Product Officer, Jim Ison. Jim?

Jim Ison

Thank you, John and good afternoon, everyone. In Q1, we added seven new major program wins. We expect these wins to yield about $5 million in revenue this year. Three of these wins were in AI Transportables, including the Ruggedized Compute Visualization System for the U.S. Army, a U.S. Air Force anti-electronic warfare system, and a new autonomous truck server win. The remaining wins were in medical, finance, and industrial manufacturing application.

As Dave mentioned, we won a $1.3 million order from the U.S. Army in February. We will continue to work closely with the U.S. Army as we remain on track to deliver prototypes later this year. In addition to providing 360 degrees situational awareness systems as part of this contract, there are additional opportunities to broaden the AI transportable applications within this customer, including sensor acquisition, object recognition, and friend or foe identification.

We were chosen by the U.S. Army for our years of experience creating compact, rugged compute accelerators and connecting them with the latest generation of PCI Express Technology, providing a very low latency solution.

Yesterday, we also announced a $3.5 million U.S. Air Force program win procured through a new prime contractor for SDS storage servers. We see this design win, leading to other AI transportable applications inside this prime contractor, including similarly configured SDS servers for compute acceleration and data acquisition.

In addition to the two DoD wins, the other AI transportable win, including servers for a current autonomous truck customer, where we are actively deploying Centauri storage solutions. Our ability to win multiple designs within an account is key to our strategy as we build a leadership position in AI transportable application.

We also added three new pending major programs during the quarter. We expect such pending major programs to each generate a million dollars or more in revenue over four years, with a 60% or greater likelihood of closing.

Our pipeline of pending major programs at the end of Q1 totaled 34 with 18 of these involving AI transportable applications in the U.S., Asia Pacific, and Europe. On the product front, our innovative flagship product Rigel recently obtained full Nvidia certification and stands as the only certified rugged edge supercomputer based on Nvidia's HDX, A100 GPU. OSS and Nvidia announced the certification together at the AUVSI show earlier this week, where OSS sales engineers engaged with autonomous vehicle customers for trucks, drones and chips.

Both Rigel and our Gen 5 4U Pro accelerator system include the OSS proprietary unified baseboard management controller, or UBMC. The UBMC Software manages monitors and controls the telemetry of these OSS products using OSS developed software to provide customers with advanced features that set our systems apart. The secure software in the UBMC allows our customers to unify their systems management, providing unique benefits for using several OSS products on a vehicle, such as data acquisition, data storage, acceleration, and autonomous vehicle compute.

Our plan is to include the basic software in our products but provide additional capabilities and solutions via a recurring software revenue model. This strategy creates additional value, product stickiness and may eventually lead to a higher margin software revenue stream. More OSS products will contain the UBMC functionality and software moving forward.

Now with that, I'd like to turn the call back over to Dave.

David Raun

Thank you, Jim.

As communicated in our last call, 2023 is a transitional year for OSS on many fronts, ranging from reducing low margin business, increasing high margin AI transportable business, bringing down inventory levels, delivering more military proof points, and the addition of new talent.

We are projecting growth from our industrial portion of the business including autonomous trucks, cellular carrier trucks and agricultural equipment as well as multiple segments within the military. Our 2023 objective remains the same to offset the reduction of our lower margin media business with AI transportable growth and move back into an overall growth mode in 2024, as we did in 2021 and 2020.

As we have outlined in our investor presentation, we believe that AI transportable market has solid tailwinds with a push to add AI and autonomous capabilities in several industrial verticals and throughout the military market.

As with many companies, we identify opportunities and maintain a pipeline database. In our case, we include identified target opportunities that should need our products, which we are pursuing opportunities in which we are engaged with the customer, pending wins and confirmed program wins, many of which we project will generate revenue.

The current total identifiable value of these opportunities over the three years including 2024 through 2026, is approximately $850 million and growing. After we apply weighted and judge probabilities to these opportunities the outcome supports solid growth projections for 2024 and beyond, but estimated growth rates in the range of 20% to 30%. These opportunities represent a combination of industrial and military applications, with the percentage of military applications growing each year.

Last year, we announced a partnership with key autonomous truck companies utilizing our storage and servers product lines. Two of these truck companies rose to our top 10 customer list last year, as Jim outlined, we had another program win at one of the two customers this past quarter, we believe the segment of the market will continue to grow. Upon reaching a production state, the segment could produce a significant inflection point and upward revenues for OSS.

As we look forward, we see additional verticals leveraging similar OSS capabilities developing over time. For example, we have a pending win that is expected to close and provide Q2 revenue for an autonomous boat.

In parallel to the industrial progress. We have remained focused over the past two years on the pursuit of AI transportable opportunities within the Military Theater, which takes significantly longer to develop. Nevertheless, the Army, Navy, Marine Corps and Air Force are all deploying autonomous and or AI capabilities, create new opportunities and tailwinds for OSS. We believe these divisions of the military with a broad base of opportunities that drive higher margins and revenue, combined with the innovation OSS team will be the primary building blocks for value for our shareholders over the coming years.

Looking ahead for the second quarter 2023, we expect revenue of approximately 17.5 million. On Wednesday, May 17, we'll be holding our virtual annual stockholder meeting at 11am Pacific time. We encourage you to participate by voting as recommended by the Board of Directors. And finally, as previously disclosed, we've been running a rigorous search and selection process to identify a successor CEO and a VP of Sales with extensive military experience and contacts to accelerate the company's advancement to the next level.

The Board and I are pleased with the quality of the candidate. Their sincere interest in OSS and anticipate the finalists will win the support of you, our investors, as well as our employees and customers. We expect to remain on schedule to have a successor in place by the end of June. I look forward to working with the new CEO as a member of the Board of Directors on a smooth and productive transition. It has been an honor to be the CEO of OSS over the past three years. And get to know the great employees, investors and customers in the process. I appreciate your support and look forward to stay in contact through this transition and as a director.

Now with that, I'd like to open the call up to questions. Chris?

Question-and-Answer Session

Operator

Thank you. [Operator Instructions] Your first question comes from Eric Martinuzzi, Lake Street. Eric, please go ahead.

Eric Martinuzzi

Yes. Good job on the revenues there. I'll get to the expense side of the equation in one of my subsequent questions but wanted to start out with just kind of the outlook here for the first half of 2023 given the print in Q1 and the outlook for Q2, it looks like we're in sort of a minus 3% on the revenue growth year-on-year for the first half. And that's assuming you come in at 17.5 for Q2. Wanted to know what your expectation is for the back half, because you've laid out the plan, at least as of last quarter was to offset the M&A decline in revenue with other program wins. Is that still, is the expectation that we're going to be roughly flat for the year or is it, the back half like the front half, we could be down low single digits?

David Raun

Yes, thanks. Good question. So, Eric, yes, looks like the first half we were a little off. As far as the second half, we don't have as much visibility, as we do, the first, of course. Our objective is the same to replace that. It's a big challenge. There's no doubt about it. But that's the objective. And we're driving towards that. We do have programs in the pipeline allows us to do that as long as they come in, with some judgment. And so, again, our objective is to be as close as possible to last year's number.

Eric Martinuzzi

Okay. And then I did appreciate the kind of further look out the slide that you put up about the growth in 2024. And beyond that pipeline, that 850 million that you that you're talking about over the next three years. Can we -- do we have a frame of reference for that? What was that? If we jump back a year ago, what was that pipeline looking like? How much is it grown or maintained?

David Raun

Sorry, I don't have an exact number. It's definitely grown. And I will just, add a little color to that. I want to make sure everybody knows. I mean, that's a mixture of everything from solid design wins to identified targets and everything in between. And we've applied, judgments anywhere from a 2% probability and weighting coming out the other side to 90% depending on it. But it has steadily grown, I would guess, Eric, it's somewhere in the area 25% to 30%, larger than it was a year ago.

Eric Martinuzzi

I like the sound of 20% to 30% organic growth. I know you're not guiding to that. It's really more of a big picture analysis that you've given us. But certainly, it sounds like the media customer will be behind us as of FY 24. Is that correct?

David Raun

Yes, I think all assumptions should be that.

Eric Martinuzzi

Okay. And then on the operating expense side, I was a little bit off there. I appreciate the color you talked about, the three different puts intakes, two to the negative and one slight offset. What should we be thinking about for operating expense for the second quarter?

John Morrison

The second quarter with the current plan right now is that we will be accruing all severance related with the departure of David as of June 30. As previously disclosed in the 8k, his severance package includes approximately one year of income. So we will have be accruing that as of June 30. We also have additional costs or legal expenses and search costs. That could run in the neighborhood of an additional about $600,000 to $800,000.

Eric Martinuzzi

Okay. And then kind of normalized post -- maybe I should have asked what's Q3 look like? I'm just trying to figure out where do we normalize on the OpEx.

John Morrison

Q3, we're going to be right around 5.7.

David Raun

And I think they'll add to that is that the dynamics with the increased spending or is not something where we've opened floodgates to hiring people, we've hired very few. And we do have some hiring in the number that John just mentioned for Q3, we'll keep an eye on that, depending on how we progress on multiple fronts.

Eric Martinuzzi

Okay. And just a final comment, it's good to see those wins with the new prime contractors. I got to believe that there's more behind that as far as other program wins in the pipeline, that maybe we've kind of broken the logjam with some primes that we haven't worked with before. Is that a fair assessment?

Jim Ison

Yes, absolutely. I mean, we're very bullish on this front. It's just the frustration is just a long process in the military. I mean activities, just I shared last time is very strong in the military.

Operator

Thank you. Your next question comes from Brian Kinstlinger, Alliance Global Partners. Brian, please go ahead.

Shervin Z

This is Shervin on for Brian. Thanks for taking the question. It's great to see the growing pipeline of opportunities for the company 25% or 30%, larger, it's great to hear. I see that best figure is made up of targets opportunities pending wins and wins. Could you a, quantify the pipeline of just pending wins and wins? And then, b, a little bit more near-term focus, quantify the pipeline of bids submitted and planned opportunities you expect will generate revenue within the next 18 months? Thanks.

David Raun

Yes. I would say the pending and wins are about half the number as far as the left side of the funnel. And then it's about two-thirds of the number on the right side of the funnel. Meaning that two-thirds of what we see didn't drive 20% to 30% growth, two-thirds of that's already either in a pending or win category. And the balance would be between opportunities that we are engaged in and targets where we've recognized an opportunity. Hope that helps.

Shervin Z

Sorry, just to clarify and make sure I understood correctly. You're saying of 850 two-thirds on the right side of the funnel, pending wins and wins. And then of the remaining third half is between targets and opportunities.

David Raun

Yes, the third would be -- that to be on the right side of the funnel, that's approximate number. I'm just looking at numbers real quick.

Shervin Z

Yes. Just generally.

David Raun

And keep in mind, a pending win for us means that we think the probability is 60% or higher. You really think we're going to close it? It's just that some don't, of course.

Shervin Z

Okay. And then about the quantify, could you quantify the pipeline of bids, or planned opportunities bid submitted that you expect will generate revenue within the next 18 months?

David Raun

Could ask that question one more time?

Shervin Z

If you can quantify the pipeline of bids submitted or planned opportunities you expect will generate revenue within the next 18 months.

David Raun

I don't have a specific number to quantify it that way that says the next, I would just say that, the numbers as we rack and stack these things have produced the type of growth I mentioned already. I don't have any further clarification on that side.

Shervin Z

All right. Thank you. Next question. It's been great to see the inflow of program wins since you started this year, move on close a lot of great opportunities. Can we expect this rates to continue or pick up? I know you mentioned that these military contracts have long cycles. But have you seen any of the government turmoil recently spill into delaying decision-making, even further from the long sales cycles that we've seen for your military clients, which could slow down awards and revenue generation?

David Raun

I think it's in fact that some because definitely things are taking longer than we expected. And I'm sure that the combination of maybe just normal things get delayed, and maybe we were too optimistic combined with dynamics in the government. But in general, the overall theme and positiveness about the military market and its opportunity to generate revenue for us hasn't changed.

Shervin Z

Great. Thank you. And last question, over the past few quarters, your company just had around $13 or $14 million of cash on hand. Where is M&A on your priority list, high or low? And what are your plans in general for capital deployments, if any?

David Raun

I think in the short term are focused on organic opportunity. And although we have some cash that cash does not, wouldn't go that far on an acquisition. And we also believe that, when we do M&A, we better make sure it's really obvious to the investors why we're doing it, number one. And number two, it's sizable and worthwhile doing. We don't want to be doing $5 million deal [indiscernible] team and move away from organic growth. So for the most part, we're very laser focused on organic opportunity.

Operator

Thank you. [Operator Instructions] Your next question comes from Joe Gomes, Noble capital. Joe, please go ahead.

Joe Gomes

So, David, you talked about the CEO search in mid-June, you didn't mention really much anything more on the VP Sales search, just wondering if you give us a little update on that?

David Raun

Yes, absolutely. So a couple of things, what we've been doing is interviewing VP of Sales candidates. And what I'm really trying to do is have a handful of them that are qualified by not just myself, but some other individuals that we think are of the level that we should consider. And what I'd like to do is, once we have a new CEO in place, be able to quickly move to filling that spot. I think it's unless we get a guy that's just really, really clear that we should hire them under any circumstance, that's what we're doing. Get the CEO in here, let him get involved and be a key part of the decision-making process.

We've also had some of these candidates, they've indicated that they have some very strong VPs of Sale candidates that they can bring along. So that's the situation there. To answer that hopefully we get the CEO in place, and we get a VP of Sales in place in July.

Joe Gomes

Okay, great. And you mentioned in your commentary, one of the goals was to bring inventory levels down. And I think John mentioned that you increase inventory and are out there buying some inventory during the quarter and just trying to get a little better handle on the inventory situation today.

John Morrison

I'll address that question. I will first respond, break into two parts dressing the portion attributable to OSS, Europe, and then the portion that's attributable to OSS classic. With respect to OSS [indiscernible], they had a shipment from Taiwan go on the water about one-week earlier than anticipated. And that is done at FOB shipping point. So basically, the ship left a week earlier than anticipated. It was to be done in April, it left port in March. So that was all associated with product. For Q2, it's been identified and it will be sold in Q2 period. So that was a timing issue. And that was approximately $1.2 million of inventory that was on the water.

With respect to OSS classic represents about $1.6 million. It is as a result of some Gen 5 Broadcom chips being delivered in advance of the originally planned delivery date, we were required to take them otherwise, we would have had to get back in line with a 52-week lead time and an increase of 6% to 13% increase in price. So we went ahead and took those chips in advance of when they were originally planned to come in.

David Raun

So I would just add to that. So our intent is to bring down the inventory as we said. This caught us off guard. Fortunately, these are products we need. In the case of the Europe stuff, it'll be burned off pretty quickly. In the case of the switches, it'll take us a longer period of time, but their key to our products that go into almost everything.

John Morrison

Long-term by year end, we hope to bring inventory down to around $16 million.

David Raun

And in general, just if you're wondering about our concerns about inventory, we analyze this every quarter, internally and with our auditors and appropriately write off things as needed. And we do not believe we have a big exposure out there.

Joe Gomes

Okay. Thank you for that. And on OSS Europe in the selling significant increase in core OSS products being sold there? As you know, how did that kind of come about and how do you see that playing out here going forward? Do you see significant growth opportunity of selling some of the core OSS products through the European channel?

David Raun

Take it, Jim.

Jim Ison

Sure. Yes, it's been in the works for several years where we've put a team in place in the European operation focused on the OSS and AI Transportables product. So they're a key part of the strategy of AI Transportables in general. The growth is starting to show now, which is what the goal was.

I see it continuing down this path has they continue to bring on and you'll see some design wins coming out of AI Transportables from the European operation.

David Raun

Yes. This is good news. It's something we thought we would have in place a lot earlier. But anyway, it should be a trend that continues.

Operator

Thank you. There are no further questions at this time. I will now turn it back to our speakers for closing remarks.

David Raun

Thank you, everybody for joining us today. We've enjoyed sharing our latest progress at OSS with you today and believe the company strategy is solid and the future is bright. OSS management looks forward to speaking with you again in August, if not sooner. In the meantime, as always feel free feel free to reach out to John and myself at any time. With that, let's go ahead and wrap up the call.

Operator

Thank you.

Now, before we conclude today's call, I would like to provide the Company's Safe Harbor statement that includes important cautions regarding forward-looking statements made during today's call.

One Stop Systems cautions you that statements in the presentation that are not a description of historical facts are forward-looking statements. These statements are based on company' current beliefs and expectations. Such forward-looking statements include, for example, those regarding the Company's expectations for revenue growth generated by new products, future changes to its business objectives and members of management, design wins and M&A activity amongst other things. The inclusion of such forward-looking statements and others should not be regarded as a representation by OSS that any of its plans will be achieved.

Actual results may differ from those set forth in the presentation due to the risks and uncertainties inherent in our business, including, without limitation, that the market for our products is developing and may not develop as we expect, military conflicts, global pandemics and other disasters or public health concerns, and economic instability in regions of the world where we have operations, customers or source material or sell products may affect such market.

Our operating results could be negatively impacted by inflationary pressures, supply chain constraints, increased interest rates or other economic conditions. Our operating results may fluctuate significantly, which would make our future operating results difficult to predict and could cause operating results to fall below expectations or guidance.

If we are unable to offset anticipated future decreases in revenue in our media and entertainment space with other business, our operating financial results may be adversely affected.

Our ability to successfully integrate operation systems, technologies, product offerings and personnel with acquired companies, if any, may prove difficult and adversely affect our financial results.

Our products are subject to competition, including competition from the customers to whom we may sell and competitive pressure from new and existing companies may harm our business sales, growth rates and market share.

Our future success depends on our abilities to develop and successfully introduce new and enhanced products that meet the needs of our customers. The likelihood of our design proposals becoming design wins is uncertain and revenue may never be realized.

Our products fulfill specialized needs and functions within the technology industry and such needs or functions may become unnecessary or the characteristics of such needs and functions may shift in such a way as to cause our products to no longer fulfill such needs or functions.

New entrants into our market may harm our competitive position. We rely on the limited number of suppliers to support a manufacturer design process. And we cannot protect our proprietary design rights and intellectual property rights, our competitive position could be harmed or we could incur significant expenses to enforce our rights.

Our international sales and operations subject us to additional risks that can adversely affect our operating results and financial condition. We may not be able to accurately report our financial results and other risks described in our prior press release and in our filings with the Securities and Exchange Commission, SEC, including under the heading Risk Factors in our annual report on Form 10-K and any subsequent filings with the SEC.

You are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date of the conference call, and we undertake no obligation to revise or update this information to reflect events or circumstances after this date hereof. All forward-looking statements are qualified in their entirety by this cautionary statement, which is made under the Safe Harbor provision of the Private Securities Litigation Reform Act of 1995.

Before we end today’s conference, I would like to remind everyone that this call will be available for replay starting later this evening through May 25, 2023. Please refer to today's press release for dial-in and replay instructions available via the Company's website at ir.onestopsystems.com.

Thank you for joining us today. This concludes our conference. You may now disconnect.