One Stop Systems, Inc. (NASDAQ:OSS) Q3 2023 Earnings Call Transcript

One Stop Systems, Inc. (NASDAQ:OSS) Q3 2023 Earnings Call Transcript November 10, 2023

Operator: 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.

Mike Knowles: 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.

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Q&A Session

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?

John Morrison: 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.