One Stop Systems, Inc. (OSS) Earnings Call Transcript & Summary

Good afternoon, and thank you for joining us today to discuss One Stop Systems' financial results for the third quarter ended September 30, 2022. With us today are the company's President and Chief Executive Officer, David Raun, and Chief Financial Officer, John Morrison. Following their remarks, we will open the call to your questions. Then before we conclude this call, I will provide some important cautions 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'd like to turn the conference over to OSS' President and CEO, David Raun. Please go ahead, sir.

Thank you, James, and good afternoon, everyone. Q3 was another solid quarter at $18.8 million in revenue, setting a record for any quarter in company history. Growth was 18% over the same year ago quarter, and our year-to-date revenue of $54.2 million was also a record for the first 9 months of any year, with growth over the same period of last year up 23%. Our strong performance in Q3 was primarily attributable to the continued strength of our European unit Bressner, increased business in the media and entertainment space, as well as solid growth on the commercial side of our AI Transportable business. Shipments to customers in the autonomous trucking space, a strategic target of ours, was the key contributor for the AI Transportable growth in Q3. In fact, 2 of our autonomous trucking customers now rank in our top 10 customer list. While the autonomous truck market has continued to progress, including hundreds of thousands of miles driven to date using our products, it still must deliver a driverless solution to realize the full potential of the strong economics of this disruptive technology. We believe the market leaders in the best position to get to market first are those intent that utilize as much compute storage performance as possible at the challenge. During the past quarter, we invested considerable time focused on the compute storage needs of the autonomous trucks in production. Although there is some commonality between the various market leaders on the roadmap to production, they continue to search for the ideal solution. To this end, we have been developing and sharing a proposed production roadmap that we believe provides a superior cost-effective path. We believe we are uniquely well positioned to deliver solutions that can leverage our innovative PCIe, NVLink, ruggedization and cooling technologies for use in the space. In addition to the potential for the great growth in the autonomous truck market, we believe the products, the skills and proficiency we are building will also open up other AI Transportable verticals to us. Now, before I provide additional insight into our program wins, sales pipeline, as well as an outlook for the remainder of the year, I'd like to turn the call over to our CFO, John Morrison, who will take you through the financial details of the quarter. John?

Thank you, David, and good afternoon, everyone. Thank you for joining us today. Today, we issued a press release with our results for the third quarter and 9 months ended September 30, 2022. The release is available in the Investor Relations section of our website at onestopsystems.com. The following are our results for the third quarter ended September 30, 2022, as compared to the same year ago quarter. During the third quarter, OSS recognized revenue of $18.8 million, which was up 18% over the prior year quarter. Core OSS revenue was up 15%, contributing $10.7 million. This was largely due to the growth of our AI Transportable business, including autonomous trucks as well as our media and entertainment business. Revenue from our European subsidiary, Bressner, increased 21%, contributing a record $8.1 million, which was marginalized by a quarterly year-over-year devaluation of the euro of 14%. This exceptional growth for Bressner was attributable to increased market share that was made possible by strong sales efforts, customer expansion, and strategic inventory buys. Gross profit decreased $439,000 to $5.1 million. Overall, our aggregate gross margin was 27% for the third quarter, a decrease of 7.5 percentage points. This was due to strong lower-margin revenue from Bressner and our media and entertainment business as well as a temporary decrease in our high-margin military business. We experienced a deferral of military customer shipments due to a transition to a new storage product version. However, these products are now being shipped. Gross margin for our core OSS business decreased 10.3 percentage points from the same year ago quarter to 30.7%. This decrease was attributable to the concentration of lower-margin product sales to our media and entertainment customer and the delayed shipments of military storage products. For the fourth quarter of 2022, we expect a return to a higher mix of military storage business to improve our overall gross margin, both sequentially and as compared to the fourth quarter of 2021. Bressner's gross margin percentage decreased 3.4 percentage points to 22.2% in the third quarter. This decrease was primarily due to increased material and transportation costs as well as increased sales of a lower margin product line. Overall, quarterly operating expenses increased by $424,000 to $4.9 million, while operating expenses as a percentage of revenue decreased to 26.1% compared to 28.1% in the same year ago quarter. The dollar increase in operating expense was primarily due to our expenditures in marketing and selling activities and investments in the technology for the AI Transportable market. Income from operations decreased to $163,000 compared to $1 million in the third quarter of 2021. Net income on a GAAP basis was $133,000 or $0.01 per diluted share, a decrease from net income of $981,000 or $0.05 per diluted share in the prior year quarter. On a non-GAAP basis, net income was $691,000 or $0.03 per diluted share for the quarter, down from $1.5 million or $0.08 per diluted share. Adjusted EBITDA, a non-GAAP metric, was $955,000 or 5.1% of quarterly revenue as compared to $1.8 million or 11.3% of quarterly revenue. The following results are for the 9-month period ended September 30, 2022, and are compared to the same year ago period. Revenue for the 9 months totaled $54.2 million, a new company record, which was up 23%. OSS core revenue increased 18.5%, contributing $32 million. Bressner contributed $22.2 million of revenue, an increase of 29%. Gross profit improved $817,000 on incremental revenue of $10 million to $15.4 million or 28.5% of revenue. This compares to $14.6 million or 33% of revenue in the prior year period. Gross margin for our core OSS business decreased to 33.1% as compared to 38.5% in the prior year period. This is largely due to a temporary decrease in military revenue and revenue increases from our lower margin business. Bressner's gross margin decreased 21.8% due to higher transportation and material costs as well as increased sales of a lower margin product line as compared to 24.4% a year ago. Operating expenses increased 11% to $14.2 million. This increase is, again, primarily due to investments we have made in marketing and sales activity and the development of new standard products for the AI Transportable market. The increase in expenses was partially offset by a decrease in general and administrative expenses. Operating expenses as a percentage of revenue decreased to 26.2% compared to 28.9% a year ago. Income from operations was $1.2 million compared to $1.8 million from a year ago. Net income on a GAAP basis was $1 million or $0.05 per diluted share compared to $2.7 million or $0.14 per diluted share, which included a onetime benefit of $1.5 million or $0.08 per share due to the forgiveness of our PPP loans and related interest. After giving effect to this onetime benefit, on a pro forma basis, there was a year-over-year decrease of $170,000 of net income. Non-GAAP net income totaled $2.5 million or $0.12 per diluted share as compared to $3 million or $0.15 per diluted share. Adjusted EBITDA, a non-GAAP measure, totaled $3.5 million or 6.5% of revenue compared to $4.3 million or 9.6% of revenue. Non-GAAP net income and adjusted EBITDA both exclude the $1.5 million PPP loan and interest forgiveness. Now turning to our balance sheet. On September 30, 2022, cash and cash equivalents totaled $3.2 million and short-term investments totaled $9.5 million, totaling $12.7 million in capital resources. This represents a decrease of $1.7 million compared to our balances on June 30, 2022, primarily due to increases in working capital requirements. We believe the current financial resources available to OSS provide us the stability and flexibility to be responsive to changes in business demand and particularly those which require investments and working capital to be successful. This completes our financial review. Now I'd like to turn the call back over to David.

Thank you, John. As we have stated previously, sales to our largest media and entertainment customer have challenging margins, under 20%, and this is not aligned with our long-term objectives of 35% to 40% overall. Price pressure within the media and entertainment market is accelerating investment by our customer into cloud technology and a drive towards less intelligent compute capability at the edge to reduce the cost of their system. This is particularly true of the virtual products, which tend to be fixed installs and do not require the same level of ruggedization as live event systems, which typically operate in a harsh environment. These less intelligent computers will have a higher reliance on our customers' IT software, which is in development and is expected to eventually enable this real-time cloud solution. We anticipate this technology transition may start to impact our revenues as soon as the second half of 2023 as our customer transitions to lower cost commodity type equipment and a cloud-based cloud software solution. We do not anticipate any financial exposure with inventory on hand. Based upon the strategies integral to our business plan and projected revenue from our sales pipeline and new programs we are pursuing, we foresee being able to backfill potential declining revenue from this customer. Based on our strategic and sales planning over time, we will see the mix of our product sales move upward from the lower margin products towards higher-margin products on which we are focused and expect that our aggregate margin will improve as a result. To this end, we have added 6 new program wins in the third quarter, with 5 won in the AI Transportable space. The wins include 2 in autonomous trucks, 2 medical designs, and 2 mobile 5G AI applications. The first medical win in the quarter is for industrial dental manufacturing equipment in Europe. The second is for a GPU accelerated genome sequencing solution for a very large OEM. The mobile 5G AI application deploys an OSS SDS rugged server in trucks and vans for a cellular network market leader. These vehicles can gather and characterize data real time in the field and transport the data back to the hub where it is uploaded to the cloud and combined with larger data sets. This major program is expected to roll out to over 100 cities nationwide. Our pipeline of sales activity continues to grow, including in the autonomous truck space where we had 2 new wins with Embark Trucks announced last month. These 2 wins include one for our Centauri rugged PCIe storage expansion system, which has now been adopted by 2 autonomous truck customers, and another for our latest autonomous truck SDS rugged server. The new deployments involve equipping trucks from Embark's latest test fleet with the latest highest-performance rugged compute and transportable storage capability. Embark became one of our top accounts this quarter. As our strategic efforts continue to yield results, we ended the first 9 months of 2022 with 16 new program wins. 11 of them are for AI Transportable applications. In addition, our pipeline of the potential major programs or pending wins have now expanded at 30 with 18 of these involving AI Transportable applications. We believe the combination of building our sales pipeline, strong activity with higher margin military market, and other opportunities we're currently pursuing which are higher-margin businesses, should backfill the potential revenue downside in the media and entertainment business with quality, long-term, high-margin business. I'm pleased to share with you that our engagements on the military front have progressed over the past 90 days. For many years, OSS has been mostly dependent upon one prime contractor for most of its high-margin military revenue. Today, however, we are building relationships with several new prime contractors, and in parallel, are working more closely to the Department of Defense. We expect this to generate more OSS revenue, less seasonality, and significantly improve our margins and profitability over time. Our progress within the military is attributable to several factors, including an intense focus on defining and bringing to market a superior roadmap of products, contracting with well-positioned sales representatives, and adding strategic personnel to our advisory board. Our Advisory Board is comprised of retired high-ranking military officials and corporate executives with decades of experience in AI, unmanned vehicles, technology, high-performance computing, cooling technology, and M&A. Key to the strategy was the introduction of our flagship platform for the military that we call Rigel. As acknowledged by multiple key customers and partners, Rigel is currently the fastest, most compact supercomputer available. The growing interest in Rigel and the related design activity confirms that this powerful system can transform the use of real-time artificial intelligence for the most demanding vehicle, maritime, and aerospace edge applications throughout the military. We will provide additional information as we advance or win these programs. But for now, I'd like to give you a sense of the magnitude of our customer interactions in the space with some current examples. First, we are working directly with the Army to fund an OSS solution targeted for land vehicles. As one of my advisers commented, if OSS can get into land vehicles for the Army, this would be a huge win for the company as the volumes are very high. Second, we are working with multiple primes and the DoD directly on a major compute upgrade that would add significant capabilities for a well-known large airframe drone. Third, yet at another prime, we are being proposed in multiple aircraft programs, including one similar to the multi-million-dollar contract we've enjoyed with the Navy in the PA, but this is with a different branch of the service. I was in a meeting with this customer earlier this week where we had over 40 attendees, and we presented, in conjunction with NVIDIA, these solutions to a wider audience within their organization. Fourth, for years we've been selling our storage systems via a large multiyear contract to a prime and the Navy. In parallel to those shipments, we've been working with them to deploy a supercomputer to process the vast data in-flight rather than back at the Navy base. We recently heard that test flight accomplished its objectives and was considered a big success by the high-ranking officials involved. Last month, we showcased our latest products at AUSA, a military tradeshow in Washington, D.C., where we identified several new opportunities in major programs for Rigel. We look forward to attending Supercomputer 22 Conference being held in Dallas next week. It is the world's largest international conference for high-performance computing. We will be showcasing our AI Transportable products, including a demonstration of a disruptive additional capability of Rigel. We expect more information to follow in our press release next week. Looking ahead, we believe we are well on track for a strong final quarter of the year. In fact, our revenue outlook for the fourth quarter is approximately $19.2 million, which if achieved, would be another record revenue quarter. Also, as John mentioned, we expect significant margin improvement with the resumption of our military product shipment. Assuming $19.2 million in revenue for Q4, we expect to close the year up more than 18% to a record $73.4 million in revenue. Now with that, I'd like to open up the call and address your questions. Thank you.

[Operator Instructions] Our first question comes from Brian Kinstlinger with Alliance Global Partners.

This is [ Shervin ] on for Brian. Can you talk about how the testing is going with autonomous trucking companies as it relates to your technology? Has it been a smooth process where trucks are being tested? Or are there some challenges that are in OSS' control?

For the most part, the software that's involved with this is all theirs. It's the hardware we're providing. And they continue to progress. These trucks have been on the road, they're driving with somebody in the seat, but the person for the most part, is not touching the steering wheel or the pedals and they're successfully traveling hundreds of thousands of miles in these trucks. Now the big thing, which I mentioned, is to be able to eventually get that guy out of the truck because that's where the economics kick in. And I think the company is a little ways away from that. But I would anticipate that will take place sometime next year or the following year.

Great. And one more question. You were talking a lot about the government pipeline. It seems like it's going to be a catalyst for the future revenue growth. But do you know what the timeline might be like for this revenue, for revenue from the military, to make impact?

Yes. I mean first of all, fortunately, we're involved with some of the biggest, most premier seat after programs, so that's good. But like any military program, they take some time. The big revenue from it is multiple years out. But what we're seeing in parallel is people working on funding to get it going with us. And those can be fairly sizable. Some of them might be $0.5 million or $1 million or $1.5 million at a time. At least that gets it going, where they're bringing a Rigel into the lab and doing work on it. That will help our revenue, but the big part of it will be more probably in the last part of '23 into '24 and beyond.

Our next question comes from Joe Gomes with NOBLE Capital.

I just kind of want to follow-up on the last question. You're talking about the autonomous trucks and the big revenue opportunity there is once the driver is out of the truck, and that probably won't happen until '25 or later. Then you're talking about the revenue impact on the military side, and you said that's years out. And then we've got disguise that appears, sounds like that revenue stream, at least a significant part of it, is going to be coming to an end. And I'm just trying to figure out -- maybe you can walk us through how you're going to be bridging this gap on the revenue side?

Well, I think overall, in the transportable space and some of the other wins we have that don't fit that category, they will help a lot. Also, we have -- we're expecting a nice strong rebound with our current military business next year, and that's already starting to take place, as John mentioned. And then on top of that, we are aggressively working on closing some other deals on top of all of that, including some conversations between me and other CEOs where we could bring in some additional revenue in the short term. We have a lot of fronts that we're working on to address that.

And I would say that the autonomous truck thing, let's put that in perspective. First of all, we have 2 guys now in this prototyping phase or whatever you want to call it, and they're in our top 10 list. They will be -- they will get larger next year. There will be an inflection point at some point. It won't be '25. It will be before that. You're going to see quite a bit of revenue from these guys and then these military guys can also add up.

Okay. And on the gross margin, partly in the first half of the year, you had little in the way of the high-margin military revenue. In the first quarter, gross margin was 30.1%. Second quarter was 28.6%. This quarter, it's 27%. Just trying to get a better handle on what's going on there in the disguise and the Bressner business that is driving those margins even down further sequentially.

I'll let John add to this. But bottom line is, military disappeared for those 2 quarters for the most part, and now it's coming back strong. Primarily, the biggest programs, because of a revision change that got put on hold, but now again, we're getting the orders plus other programs are starting to layer in also. That's the biggest contributor on the margins. What else would you like to add, John?

I'd agree that with on the government side, on our data storage units, we're down about $5 million year-over-year, and that was just as a result of we are transitioning on a revision change, and we are now shipping that new revision starting in the fourth quarter. That is our strongest revenue driver and contributed over to margins. That's really what contributed to the difference there layered on with the improvement, significant increase from Bressner in their revenue, and the predominance of revenue from our media and entertainment space.

Okay. And one last one...

In other words, the number should not go down further. We're expecting a reversal of that starting in the fourth quarter.

Okay. You've mentioned in some of the previous calls about the supply chain, some of it going out 52 weeks for parts, inflation. Just wondering how that environment is looking today for parts and passing along costs from inflation increases?

Yes. In general, on the supply chain, I think what I'm hearing from a lot of people is it seems to be getting somewhat better. We haven't seen it get a whole lot better, frankly, but we continue to buy what we need. Our intent is to bring down the inventory levels over time. The vast majority of the inventory we have is secured by POs. We think it will slowly improve over the coming year.

[Operator Instructions] We'll hear from David Williams with Benchmark.

I guess quickly, I wanted to ask about the mobile 5G AI opportunity. That seems very interesting, and I think you said it's expected to roll out to 100 other cities. Can you tell us if you have the design there for those other 100 cities, and what you think those opportunities could mean for the business overall?

Yes. Basically, if we figured on only 1 vehicle per city, which is not necessarily the case, that would require at least 100 of our systems. These are expensive systems. But this is a multi, multimillion dollar opportunity for the company, probably will yield over several years, $10 million or more.

Okay. It is still...

In other words, we don't have to go win those other 100. That's what they're doing. They're planning to put these in these vehicles and trucks to cover those 100 cities with our product.

Okay. And then maybe just kind of thinking about on the gross margin side, you've got a lot of moving pieces here. Bressner is still a headwind, but you've got some tailwinds from the military and then also the media and entertainment falling off. What should we think about in terms of margin next year? Can you snap back to where you were previously? Or should we still expect it to kind of stay around this range with a steady plotting kind of improvement next year?

Yes, we expect it to snap back to what you've seen in the past, and we'll build off of that.

Any thoughts on cadence, that improvement?

First quarter, we're looking at pretty good -- will look good as we ship more military product. But I think it will be pretty consistent with what 2020 looked like.

That's helpful. And then one just last one for you really quick is, I know there's a lot of activity in China on the autonomous trucking side and use some high-end components in your product. But just kind of curious if you're seeing or thinking about anything from the China restrictions. Just kind of on the fringe, on the edges with the subsidiaries located there, are you seeing any pushback I guess? Or is there any tie or any relationship that we should be thinking about here in terms of restrictions going into China?

First of all, definitely, there's worldwide activity on this, primarily in the U.S. and China, but all our 3 customers that we're engaged with today are U.S.-based companies, so no issue there. And we're talking to other companies, which is a mixture of international, but for the most part, we don't see the China situation impacting us on that front.

[Operator Instructions] We'll hear from Max Michaelis with Lake Street Capital Markets.

Just given the solid opportunities you guys are seeing in the military space as well as the advisory board, are some of these opportunities maybe some you wouldn't have gotten in the past without the advisory board? Or how have they impacted some of these opportunities?

Great question. They've been very helpful. It's really the combination of the 3 things we've done. Rigel is just a great product, nothing like it out there, it's doing extremely well. But they've made introductions for us in places, especially directly with the DoD, that we did not have before. And so that helped. And they've been a great team to work with.

All right. And then just if you may, can you quantify the amount of military shipments that were deferred until Q4?

Could you repeat that? You broke up a little.

Sorry about that. The amount of shipments that you guys deferred to Q4 that are not being shipped, I was wondering if you could quantify the quarter.

Well, I would -- John made the comment that we're off about $5 million on military year-to-date. We're not implying that that's all going to catch up in the fourth quarter. 2022 overall will be a down year for the military, but it starts to recover in the fourth quarter, and we expect a solid 2023. We've got a couple of things in the works. Like for example, we'll double or triple what was shipped in this past quarter, and again, step up.

We have no more questions. I'd like to turn the conference back to our speakers for closing remarks.

Thank you. And thank you, everyone, for joining us today. We continue to believe the best is yet to come, and we look forward to meeting with you again in March and reporting our progress as we pursue the many opportunities ahead. Meanwhile, as always, please continue to stay safe, healthy and feel free to reach out to John and myself anytime. And let's go ahead and wrap up the call.

Thank you. Now before we conclude today's call, I'd 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 the company's 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, 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 or other disasters or public health concerns, including COVID-19, 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 the operations 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 a limited number of suppliers to support our manufacture and design process. And if 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 November 24, 2022. 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.