One Stop Systems, Inc. (NASDAQ:OSS) Q4 2023 Earnings Call Transcript March 21, 2024
One Stop Systems, Inc. beats earnings expectations. Reported EPS is $-0.03, expectations were $-0.04. OSS isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).
Operator: Good afternoon, and thank you for joining us today to discuss One Stop Systems Financial Results for the Fourth Quarter and Full Year Ended December 31, 2023. With us today are the company’s President and Chief Executive Officer, Mike Knowles, and its Chief Financial Officer, John Morrison. Following their remarks, we will open the call to your questions. 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 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, Ina. Good afternoon, everyone, and thank you for joining today’s call. This is an exciting time at OSS as we completed the strategic transition away from lower-margin media revenue, established a new management team and refocused our strategic growth priorities on large and rapidly evolving global markets. Throughout 2023, we demonstrated continued progress in our efforts to pursue strategy focused on AI-centered high-performance computing at the edge, where platforms require data center level compute, storage and switching solutions. These solutions support AI and machine learning, sensor fusion, sensor processing and autonomy applications. We coined this market AI Transportables. We will continue these efforts throughout 2024, backed by the strong influence of AI and ML demand in both the commercial and defense markets.
Recent wins in both markets, combined with a growing pipeline of opportunities, continue to validate our strategic focus. We have also continued our efforts to strengthen our executive team and our Board of Directors, adding skills and experience that will help facilitate our strategy and enable the company to scale for growth. Financially, we were able to further offset revenue from our former media customer with higher-margin revenue aligned with our strategy. So, with this introduction, I want to provide an update on the growth strategies we are pursuing, our growing pipeline and recent wins that we believe will create lasting value for OSS and our shareholders. Commercial adoption of artificial intelligence and machine learning taking advantage of advanced sensor fusion and sensor processing is dramatically moving to the edge across almost all business segments.
Sensor systems and autonomous applications can rival those in modern defense implementations. We believe that our product portfolio and future roadmap position us to uniquely take advantage of this evolving technology environment. Strategically, we are focusing our efforts to expand the number of customers and platforms in our rugged edge processing portfolio and increasing our multiyear backlog by securing new long-term contracts. These efforts are supported by opportunities in both commercial and defense markets, where strong dynamics and growth are being driven by AI/ML adoption, sensor fusion, sensor processing and autonomy. The Department of Defense is making significant investments in next-generation capabilities that require edge computing.
While the overall defense budgets in the U.S. are expected to remain stable, we expect to see increased spend, especially for autonomy, artificial intelligence and machine learning. In fact, these represent some of the fastest areas of growth as the military looks to augment existing platforms with new sensors, platforms and weapon systems to maintain a technical and tactical advantage over our adversaries. We are continuing to pursue opportunities in both commercial and military segments where we can leverage OSS’ differentiated and technologically advanced capabilities by bringing enterprise and data center-class compute, storage and switching capabilities to the most challenging environments, delivering low latency, high throughput scalable solutions in real-time environments, delivering configurable off-the-shelf and custom high-performance solutions, and providing high technology readiness-level product availability to enable first-to-market AI at the edge.
We believe a balanced portfolio of commercial and military customers can serve as a strategic benefit as we focus on creating long-term value for our shareholders. Looking at our pipeline and recent wins in more detail, we made progress throughout the fourth quarter penetrating defense and commercial markets. We had three major new wins in composable infrastructure, aerospace and defense that totaled $2.7 million during the quarter. These wins reflect our continued leadership in high-speed PCIe interconnect technology and scalable AI GPU compute systems. Turning to a major defense win, we announced a multimillion-dollar program with Leidos’ Dynetics, a prime contract of mission critical solutions for the U.S. Government. Under this multi-year program, we will provide our proprietary transportable compute and storage technology designed to power an emerging specialized mobile AI signal collection application.
The award is the first multi-year win OSS has secured with Leidos, highlighting the growth, trust and confidence in OSS and our innovative technology and advanced engineering capabilities. We are also pleased to see the expansion of mission application and platform integration consistent with our growth strategies. Early this month, we announced a pilot project to provide a liquid immersion cool data storage system for use on a deployable ground station that was also contracted through Leidos. This project, for a major government intelligence agency, expands our market opportunity into the intelligence community. As the pilot progresses over the coming quarters, we expect this program will lead to follow-on production orders. This program also demonstrates our innovative thermal management technologies for cooling rugged high-performance computing solutions.
Our cooling solutions enable the highest level of GPU performance, which our customers need to support their AI and ML mission objectives. We anticipate this initial design win will lead to additional deployments with this customer and other customers in the future. During the fourth quarter, we also booked an additional award from the U.S. Army Ground Vehicle Systems Center, increasing our scope in the 360-degree situational awareness program to include the sensor processing for the video data input into the system. Within our commercial markets, we received an order from Daimler Truck partner Torc Robotics to develop a cooling solution for their existing compute system, expanding our relationship within the autonomous trucking software vendor.
We also finalized a multi-year deal with Thales in support of their inflight networking system for commercial airlines. With growing interest in AI and ML solutions, we are quickly expanding our outreach efforts. We expect that 2024 will be a year marked by pipeline expansion and conversion as demand increases and we execute on our strategic plan. Actions underway include: submitting a bid to provide a rugged high-performance compute solution for a classified program within the sector that is advancing AI implementation at the edge; establishing a sponsorship and collaborative relationship with Andretti Racing and Zapata AI, promoting edge applications for AI/ML and commercial and defense markets; engaging with companies in composable infrastructure market marked by leveraging our expansion chassis product line and our UBMC software capability for system control and monitoring; and continuing to advance our engagement and reach with large prime organizations such as Booz Allen Hamilton, BAE Systems, Leidos, General Dynamics, Lockheed Martin and General Atomics.
As the Pentagon prioritizes incorporating advanced technologies into their equipment, we expect engagements for our products in the military space covering various autonomy, sensor fusion and AI/ML applications for aircraft, drones, ships, helicopters and land vehicles will increase. Although we are seeing progress, it will continue to take time to pursue, secure and turn target opportunities into increased bookings and revenue. One way that we’ve been working to accelerate the opportunities with the U.S. Department of Defense is through lobbying efforts in Washington to advance the innovative solutions offered by OSS. Lastly, we continue adding commercial and defense trade show — attending commercial and defense trade shows to advance the OSS brand in the market and identify new and partner opportunities.
The result of our efforts has enabled us to expand our five-year unfactored pipeline to an excess of $1 billion. This growth reflects the initial success from our new sales infrastructure and talent as well as the rapid expansion across our commercial and defense markets for AI and ML solutions. We are actively engaged with current and potential customers to execute against these opportunities and convert our growing pipeline into multiyear, multimillion-dollar orders. Given our expanded engagements and growing pipeline, I’m pleased to announce that we have added Craig Powell as Business Development Executive. Craig served as an armored infantry officer in the Royal Canadian Armoured Corps and brings 22 years of experience in the high-performance compute, defense and commercial markets, having held senior positions at Systel, L3Harris, Rheinmetall, Haivision and Teledyne.
We believe his experience will support our efforts to expand sales into the Canadian market in addition to its primary focus on supporting sales efforts in the U.S. Turning to recent progress on the product and program front. At the beginning of 2024, we shipped our first AI transportable compute system for the motorsport industry to legendary motorsport champion, Andretti Global. The system includes OSS’ 3U SDS GPU accelerated server, powering advanced AI race analytics for Andretti, using Zapata AI’s industrial generative AI platform for the cloud and edge called Orquestra. The solution represents a new application of OSS technology and our first foray into the $5 billion motorsports industry. This milestone demonstrates our unique capabilities for powering generative AI technology at the edge.
Also at the beginning of this year, we announced commencement of a multi-year design and manufacturing collaboration for FLYHT Aerospace’s automated flight information reporting system, Edge family, including its new AFIRS Edge+. The expanded relationship ensures that FLYHT has access to OSS’ scaled capabilities as it launches the aviation industry’s first-to-market 5G-enabled avionics solutions. For OSS, the design and manufacturing agreement with FLYHT is valued at a minimum of $6 million over the initial five-year term. In Q4, we received $500,000 in revenue from the new FLYHT contract. We have successfully passed the critical design review and are entering the test phase of the program. We expect to complete testing and expect to begin production and shipments of AFIRS Edge+ as early as the second quarter of 2024.
This multi-year engagement expands our position in commercial aerospace and further strengthens our technology development and manufacturing platform. This opportunity also underscores our commitment to aviation safety and delivering mission-critical performance. We’ve also seen progress on several fronts in the defense industry. The Raytheon P-8 program has funded multiple development initiatives to incorporate hardware and software technology refresh and upgrade that will extend our product position and lifecycle through 2028. As a result, we expect annual revenue of $6 million in 2024 related to this program, which is at a similar level from 2023. We delivered our first shipments of the new Gen 5 short-depth server to Dynetics, a Leidos company, for the C4ISR Mobile Command Centers and to Thales for submarine, sonar and AI processing on a European Navy Submarine.
In addition, we received a contract amendment to add additional capability for time-sensitive networking, or TSN, to our 360-degree situational awareness solution for the Army Ground Vehicle Systems Center. This capability adds to the critical timing element required for contested environment operations and is an integrated capability for Joint All-Domain Command and Control, or JADC2, nodes. We continue to focus resources and capital to support our technology roadmap and maintain our strong market differentiation. As I’ve noted before, a key capability of ours is the ability to bring the newest and highest performing compute, storage and switching solutions to the market and facilitate the demanding requirements of AI/ML, sensor fusion, sensor processing and autonomy.
We’ve seen that our first-to-market strategy is key to our ability to win opportunities. As a result, we continue to develop new state-of-the-art products across a range of high-performance compute demand, providing a unique value proposition for our customers in the targeted spaces. In November, we unveiled our latest rugged Gen 5 short-depth server at Super Compute 23, the international conference for high-performance computing. Powered by NVIDIA H100 Tensor Core GPUs and high-performance NVMe storage, the OSS Gen 5 SDS addresses the growing demand for more powerful and lower latency rugged compute, storage and networking capability at the edge. This new OSS Gen 5 SDS server demonstrates our continued leadership in AI computing and high-speed PCIe interconnect technology.
We anticipate this hyperconverged data center-class computing server will be highly sought-after for demanded rugged edge, real-time AI applications and is already proving to be the workhorse of the OSS product portfolio. In fact, in February 2024, we showcased our specialized high-performance AI computing solutions at SCOS 2024, the premier naval conference and exposition on the West Coast, where we won the Best In Show award for our liquid cooled version of the rugged edge short-depth server. Since I joined over eight months ago, we have focused on enhancing our management team and Board of Directors. Recent efforts include in the third quarter of 2023, we appointed industry veteran Robert Kalebaugh as VP of Sales, bringing more than 36 years of award winning achievement in business development, sales and marketing in the commercial defense market.
Robert’s impact is already being seen in our market outreach, increased opportunities and growth. In the fourth quarter of 2023, we appointed retired U.S. Navy 3-star Vice Admiral Michael J. Dumont to the Board, bringing background and experience insights into technology and military operations. Mitchell Herbets was also added to our Board, bringing extensive strategic and technical experience as a C-suite executive serving technology and defense industries. Finally, we also appointed Joseph Manko to our Board, who is affiliated with one of our largest shareholders and brings extensive financial, capital markets, investor and governance experience to OSS. All these additions have substantially re-profiled our Board and enhanced their impact on supporting strategy, driving growth and delivering shareholder value.
In addition to enhancing our management team and the Board, we also have added talent to our growing program management capabilities with the addition of two seasoned professionals who bring over a decade of defense and commercial program management experience. I believe their experience will allow us to pursue even larger programs for development, production in defense and commercial markets. I’m extremely encouraged by the successful ongoing transformation we have completed to our business in 2023. As a result, we entered 2024 with strong momentum supported by a new highly-experienced leadership team, re-profiled Board of Directors and enhanced margin profile and a growing pipeline of significant revenue opportunities that we believe will support our business for many years to come.
I want to thank our team for their continued hard work and dedication as we pursue compelling growth strategies aimed at creating lasting value for our shareholders. With this overview, I’d like to turn the call over to our CFO, John Morrison, to review our fourth quarter and the full year 2023 financial results in more detail. John, please go ahead.
John Morrison: Thank you, Mike, and good afternoon, everyone. I am particularly excited by the level of activity underway, the direction we’re headed and the strategies we are pursuing to create value for our shareholders. We began 2023 with two objectives. The first was to substantially replace $18.5 million of low-margin legacy media revenue with higher-margin AI transportable product revenue. This was necessitated by our media customer moving away from ruggedized equipment to a less rugged cloud solution. Total media revenue in 2023 was $4.8 million, representing a difference of $13.7 million from last year. The second objective we had was to grow Bressner annual revenue. Although OSS strategy was implemented to replace the media business, during the year, we experienced a general hesitation by commercial customers to place orders because of the economic conditions.
We also experienced timing delays in some government programs. This all resulted in OSS being unable to fully replace the lost media revenue in 2023. However, I am pleased to report that Bressner met their annual objective by growing annual revenue by 10.1%. Bressner also improved both margins and profitability despite a challenging economy in Germany and throughout Europe. Our company’s business is really comprised of two segments: OSS, which is located and operates in the United States; and Bressner, which is in Munich, Germany and operates throughout Europe. OSS is primarily focused and involved in the design and manufacture of high-performance ruggedized edge processing, compute, storage, and connectivity systems. Bressner operates as a systems integrator with standard and custom all-in-one hardware systems and components.
They also serve as the channel for OSS products to the European and Middle East markets. The following comments are based upon comparison of fourth quarter 2023 results as compared to fourth quarter 2022. For the fourth quarter, we reported consolidated revenue of $13.2 million. Of this, OSS contributed $6.4 million and Bressner contributed $6.8 million, inclusive of OSS product content of $597,000. Consolidated quarterly revenue reflects a reduction of $5.1 million or 27.9%. Of this amount, OSS had a decrease of $4.9 million or 43.5% of OSS quarterly revenue, of which approximately $3.1 million of the decrease was attributable to a revenue reduction from the former media customer and from whom we do not expect any further revenue. Bressner had a decrease of $175,000 or 2.5%.
Consolidated gross profit in the fourth quarter decreased $544,000 to $4.4 million with overall gross margins improving and increasing to 33.7% from 27.3% due to decreased media revenue cost and a shift in product mix to our higher-margin rugged edge processing products. The gross margin for OSS business improved 14.5 percentage points to 45.9%, which is attributable to the absence of lower-margin media revenue and costs and the higher mix of the rugged edge processing products. Bressner’s gross margin percentage improved 1.6 percentage points to 22.2%, largely due to product mix, the sale of higher-margin OSS products, and having sought-after products readily sold at a premium. Overall, quarterly operating expenses increased 3% to $4.8 million, which was attributable to additional CEO transition and Board reprofiling costs.
Loss from operations totaled $331,000 compared to income from operations of $353,000 in the same period in 2022. Net loss on a GAAP basis was $278,000 or $0.01 per share as compared to a net loss of $3.3 million or $0.16 per share. Net loss in the fourth quarter of 2023 included a provision for income taxes of $42,000 as compared to a tax provision of $4.1 million in the fourth quarter of 2022 that included a significant increase in taxes being attributable to a write-down of our deferred tax asset of $3.8 million in 2022. Now, non-GAAP net income for Q4 2023 was $177,000 or $0.01 per diluted share compared to non-GAAP net loss in the prior year of $2.7 million or $0.14 per diluted share. Adjusted EBITDA, a non-GAAP metric, was favorable $353,000, a decrease from the adjusted EBITDA of $1.6 million in the prior year.
The following comments are based upon a comparison of the annual results for 2023 as compared to the annual results for 2022. Consolidated revenue was down $11.5 million or 15.9% from $72.4 million to $60.9 million, predominantly due to a decrease of $13.7 million in media revenue. OSS had revenue of $28.8 million or 47% of total revenue. And Bressner had a revenue of $32.1 million or 53% of total consolidated revenue. OSS experienced a decrease of $14.5 million or 33.4% with the — which decrease was offset by an increase by Bressner of $2.9 million or 10.1%. During the year 2023, revenues for OSS were fairly evenly balanced between commercial and defense applications. During the year 2023, consolidated gross margins were 29.5% versus the prior year of 28.2% due to less lower-margin media business being offset by an increase in higher-margin AI transportable products.
OSS gross margin was 35.6% as compared to 32.7%, an improvement of 2.9 percentage points. Bressner margin was 24% compared to 21.5%. Excluding the goodwill impairment charge of $5.6 million and CEO transition and Board re-profiling cost of $1.7 million, our operating expenses actually decreased 1.5% from the prior year. Other income and expense, including — excluding a one-time government-funded employee retention credit of $1.7 million, resulted in net other income of $417,000 compared to $626,000. Net loss was $6.7 million, or a loss of $0.32 per share, compared to $1.7 million — of which was inclusive of the $1.7 million employee retention credit compared to a loss of $2.2 million or loss of $0.11 per share in 2022. Non-GAAP net loss was $415,000 or loss of $0.02 per share as compared to a loss of $175,000 or $0.01 in 2022.
Adjusted EBITDA, a non-GAAP metric, was positive $1.1 million as compared to $5.2 million in 2022. Loss before the provision for income taxes on a pro forma basis, which excludes the impairment of the goodwill, the CEO transition and Board re-profiling costs, and the benefit of the employee retention credit results in a pro forma loss before income taxes of $165,000 as compared to income before taxes of $2.2 million in the prior year. Now, looking at the balance sheet, on December 31, 2023, cash and cash equivalents totaled $4 million, with short-term investments of $7.8 million, for a combined total of $11.8 million. Compared to the prior year, this represents a decrease of $1.4 million, which represents cash being deployed in working capital.
As the company continues to transition and evolve its 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 contributes to gross profits but may be inconsistent with our long-term objective of increasing our consolidated gross margin percentage. The objective of this effort is to have sustainable cash flow as the company bridges its revenue model. Looking forward to the first quarter of 2024, influenced by seasonal and U.S. Government continuing resolutions, we expect revenue of approximately $12.5 million, which represents an approximate 5% sequential decrease from Q4 2023 and a year-over-year decrease of approximately $4.3 million or 25%.
Of that decrease, $1.5 million of that is expected decline which is attributable to loss of media revenue. This completes our financial review for the quarter. Now with that, we’d like to turn the call back — turn the call and open up to your question. Operator? Ina?
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Q&A Session
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Operator: Thank you. Ladies and gentlemen, we will now begin the question-and-answer session. [Operator Instructions] Your first question comes from the line of Scott Searle from ROTH MKM. Please go ahead.
Scott Searle: Good afternoon. Thanks for taking my questions. Nice to see the continuing progress on the opportunity pipeline as well as the gross margins. Maybe that’s a good place to start. On the gross margins for the fourth quarter, John, I’m wondering, are there any one-time benefits that you saw on that? I think you said the number was 45%, 46% in the core OSS business. Can you help us understand from a mixed standpoint what’s going on and how we should think about the progression throughout 2024? You also had some comments in terms of maximizing gross profit contribution. So, it seemed to imply that there’s going to be some volatility there. Can you walk us through that a little bit?
John Morrison: Thank you, Scott. So, in the fourth quarter, it was very heavily weighted towards AI transportable products, specifically to the defense industry and in the sale of our data storage units, which tend to have a higher margin. So, that’s what skewed that in the fourth quarter. With respect to ensuring that we maintain our cash position, there is some pass-through revenue that we’re going to be accepting on an agent basis that has low margin but provides good cash opportunities for us.
Scott Searle: Got you. Okay. Thank you. And Mike, in terms of the opportunity pipeline, it seems like it’s continuing to build. The message that you’re getting out there in terms of AI/ML and sensor fusion continues to seem to get traction. I’m wondering if you could help for us frame near term when we start to see decisions getting made, how that will start to filter into the results? It sounds like it’s more geared towards 2025. And as part of that, I’m wondering if you could couple in the current discussion around the continuing resolution around the budget and how that impacts you guys over the course of 2024.
Mike Knowles: Yeah, sure. Thanks, Scott. Yeah, we’ve continued to grow and expand that pipeline. And really what it is, is really aligning — especially in the defense market, aligning our opportunities up with existing platforms that are going through tech refresh cycles or upgrades, so that we’re present for those that help develop and determine our timing, and then also on new starts being part of those, which are generally the longer runway approaches to those. So, we’ll use the 2024 to build back through the lost media revenue replacing with commercial and defense opportunities. Expecting the second half of the year, unless the media business, right, will start to see the momentum really start to pick up. For us, that whole effort will all be about the pipeline conversion, right?
We’ve got these opportunities out there. Now we need to convert them and potentially move them to the left. And that’s why I spoke, especially in the defense market, where we have opportunity to use our lobbying efforts to help move and make sure programs are funded and move out on time. And then, the second part of your question was what again, Scott?
Scott Searle: Sorry, related to the budget resolution.
Mike Knowles: Oh, the budget resolution. Yeah, so, well, a significant amount of our revenue isn’t tied up to government new starts, which can’t start under a CR. We do have a couple that bids currently that we have out that are being held up by continuous resolution. Not a significant number, but still some nonetheless. I just think I got a note from our lobbyists today that the last bid of CR defense budgets, we’re going to make it through approval. So, that should untie the logjam. Now, we’ll have to go through the period that usually follows that where the money moves and then the acquisition professionals have to put it on contract. That is not a fast pace either itself. It will take some weeks and months for that to flow through, but it’s positive that that’s made it through.
And this is something that we’ll continue to deal with in quarters and years to come. But it’s not uncommon anymore in the defense market. And we have pipeline and opportunities. We’ll plan for that and tend to try to update our forecasts around that also.
Scott Searle: Okay. Great. And one last one, if I could. Just in terms of moving the AI strategy along, I’m not sure if you mentioned it all about various software partners and go-to-market strategy on the front. I’m wondering if you could articulate where we stand on that front now and how that’s looking throughout the course of 2024. Thanks.
Mike Knowles: Thanks, Scott. So, I mentioned last year during 2023 we had expanded our outreach to multiple AI software companies really around two reasons. One, so that we had opportunity where our customers needed it to provide a more integrated solution rather than just a pure compute or storage or switching solution. And we wanted to establish those partnerships to provide some more discriminating capability to our solution. In addition, as we started engaging with a lot of these AI software companies, many of them were looking to find ways to standardize on hardware so that they could sell their software directly. So, we wanted to open up the pipeline for those discussions where we could become a standard provider to some AI software companies.
We have expanded that reach and continue to do so. Over the course of 2024, I think we should see a couple opportunities where we have aligned with a couple specific companies and some capture approaches and some collaborations in the market for both commercial and defense that we should start to see the fruits of some of those labors. I noted one in the earnings call that we’re doing with Zapata AI through works with Andretti. There’s some cross correlation to some defense markets and prime contractors who are very interested in a lot of the work that Andretti and Zapata are doing in vehicles and data analytics, and they’re all working that off of our compute systems. So, similar to that, we’ve got multiple instances like that across both markets that we think could help build future solutions.