Earnings Call Transcript - OSS Q1 2021

Operator, Operator

Good afternoon and thank you for joining us today to discuss One Stop Systems' financial results for the first quarter ended March 31, 2021. With us today are the company's President and Chief Executive Officer, David Raun; and Chief Financial Officer, John Morrison. Also joining today is the company's Chief Sales and Marketing Officer Jim Ison. Following the remarks, we will open the call to your questions. Before we conclude today's call, I will provide some important cautions regarding the forward-looking statements made by management during the call. I'd also like to remind everyone that today's call will be recorded and will be made available for replay via the instructions in today's press release in the Investors section of the company's website. Now I'd like to turn the call over to OSS' President and CEO, David Raun. Please go ahead, sir.

David Raun, President and CEO

Thank you, James, and good afternoon, everyone. Thank you for joining us today. It's been encouraging to see the state of California and the country finally opening up over the last couple of months and life starting to return to normal. Likewise, it's also great to have our business returning to normal and we have some excellent results for the first quarter of 2021 to share with you today. First, we drove a $2 million improvement in adjusted EBITDA over the first quarter of 2020 on similar revenues. This result was a combination of increased gross margins of 7.9 percentage points and decreased expenses of $749,000, which generated positive adjusted EBITDA of $1.1 million, a record for OSS in the first quarter. We also produced first quarter GAAP net income, another first for the company. In addition, we exceeded our top line revenue expectations for the first quarter by more than $300,000, nearly matching last year's first quarter, which was a record first quarter for OSS, unhindered by the pandemic at the time. This was a direct result of continued improvement with some of our largest customers as well as progress on the diversification front. This strong performance was tied to the transformative steps we took last year that laid a new foundation for better bottom line execution and growth. These steps include new senior leadership and corporate reorganization, reduced spending, focused on margins and enhanced value proposition while also adding 3 new independent Board members. As shared with you during our previous earnings call, we are also executing on our new long-term strategic vision and product road map designed to create greater shareholder value. This multiyear plan will strengthen our market position and value proposition in a fast-growing segment of the edge computing market with the intent of clear leadership in what we call AI Transportables. AI Transportables are mobile, high-performance computing systems, delivering the latest in data acquisition, storage and accelerated computing for AI applications, particularly where actionable intelligence is required at the very edge. These tend to be applications that are in challenging or harsh environments, which plays to our strength. AI Transportable solutions are currently the fastest-growing, highest-margin segment of our business, and it contributed over 25% of the revenue in Q1. A perfect example is our recent win of a long-haul trucking program for our new AI Transportable EB4400 solution. This marks our second significant program win for autonomous vehicles and is an excellent example of the additional products we are developing to address this quickly expanding market. Earlier today, we posted a 15-minute video presentation to our website where I share more on AI Transportable strategy and the market opportunities ahead. After today's call, you can find it on the Investor Relations section of our website at onestopsystems.com. Jim Ison, our Chief Sales and Marketing Officer, will be giving you more insight about our AI Transportable strategy and related customer activity later in the call. Before I get into the outlook for the rest of the year, I'd like to turn the call over to our CFO, John Morrison, who will take you through the financial details for the first quarter. John?

John Morrison, Chief Financial Officer

Thank you, David, and good afternoon, everyone. I appreciate you joining us today. Earlier today, we issued a press release with our results for the first quarter ended March 31, 2021. The release is available in the Investor Relations section of our website at onestopsystems.com. As David mentioned, we generated strong revenue and improved profitability. We achieved this by realizing improved gross margins on sales of key products while reducing operating expenses through cost containment and efficiencies. All this resulted in greater profitability and positive cash flow. Overall, it was a quarter where the entire company executed on our CEO's focused vision. Now for the details. Looking at our statement of operations, we achieved revenue in the first quarter of $13.3 million, similar to the record first quarter of last year, which was not impacted by the pandemic, as mentioned by David. There was a notable change in customer and product mix that contributed to better overall margins in the current year. For the revenue breakout for our other segments, in Q1 our core OSS business increased to $8.6 million as compared to $8.4 million in the same year-ago period. Bressner, our European subsidiary, contributed $4.7 million in the first quarter as compared to $4.9 million in the same year-ago period. Our gross profit in the first quarter of 2021 was $4.4 million as compared to $3.4 million in the first quarter of 2020, an increase of $1 million. We had strong gross margins of 33.3%, an increase of 7.9 percentage points versus the same year-ago period. The significant improvement in quarterly margins was attributable to a higher mix of government business of $2 million generated by 3 of our 2020 design wins. These products included the Data Center in the Sky, Data Storage Units and 4U Pro. Gross margins for our core OSS business increased 10.4 percentage points over the same year-ago quarter to 37.9%. Likewise, Bressner's gross margin increased to 24.9% in the first quarter as compared to 21.9% in the same year-ago period. In both cases, this was attributable to predominance of customers purchasing a product mix that has higher gross margins and an increased focus through the organization on improving margins. Our overall operating expenses decreased 15.3% to $4.2 million in the first quarter of 2021. Our operating expenses as a percentage of revenue decreased to 31.2% in the first quarter compared to 36.7% in the same year-ago quarter. These improvements were primarily due to the cost reduction initiative that we implemented in April 2020, including streamlining and reorganizing the company and implementing new cost containment programs. Income from operations grew to $275,000 compared to a loss from operations of $1.5 million in the same year-ago quarter. Net income on a GAAP basis totaled $21,000 in Q1 2021. This compares to a net loss of $1.1 million or $0.07 per share in the same year-ago period. On a non-GAAP basis, net income improved to $643,000 or $0.03 per diluted share in Q1 2021. This is in comparison to our non-GAAP net loss of $714,000 or $0.04 per diluted share in the same year-ago period. Adjusted EBITDA, which is another non-GAAP metric, increased to $1.1 million in Q1 as compared to negative adjusted EBITDA of $957,000 in the same year-ago quarter. Now turning to our balance sheet. Our team worked hard to improve our accounts receivable collections and timed our accounts payable more closely to the days sales outstanding. As a result, $3.2 million in working capital was freed up in the quarter. In March of this year, you will recall we completed the registered direct equity offering that further fortified our cash position. We're also realizing significant cash gains through a combination of lower expenses, increased efficiencies and improvements in the working capital. All of this has resulted in cash and cash equivalents increasing to $13.3 million as compared to December 31, 2020. At the end of the quarter, the company had a cash balance of $19.6 million, the highest in the company's history. Recently, we also learned that our $1.5 million PPP loan that we received last year has been forgiven. Our strong cash position is enabling us to execute on our plan, investing wisely with strategic initiatives to fuel growth, including research and development of new products and technologies. This completes our financial review. I would now like to turn the call over to our Chief Sales and Marketing Officer, Jim Ison. Jim?

Jim Ison, Chief Sales and Marketing Officer

Thank you, John, and good afternoon, everyone. In Q1, we saw both near record revenue and strong bookings, along with 3 new major account wins. Major program wins are those expected to yield $1 million or more of revenue within 4 years. These 3 new wins include a mobile command center, a virtualized GPU compute platform and a rugged tablet point-of-sale system. 2 of the 3 wins are with new customers. As David mentioned earlier, our main sales focus of 2021 is AI Transportable solutions for rugged edge applications. Over half of the 2021 major accounts we are pursuing are in the AI Transportable market. We see this market is directly tied to our customer value proposition and key strengths. For us, AI Transportables are typically higher-margin business where we enjoy an unmatched competitive advantage. We are uniquely capable of providing high-performance AI platforms in the most harsh and challenging environments on the very edge. Our AI Transportable solutions deliver data center-like performance using the very latest in high-performance computing and NVMe storage technology, leading applications with no compromise. Our systems provide AI data capture, training of deep neural networks, and large-scale AI inference for some of the world's most demanding Edge AI applications. Our marketing engine is reenergizing as we resume in-person events later this year, even as we continue to expand our virtual events, which have been very effective targeting AI Transportable customers. In fact, we recently co-hosted a well-received webinar called "Turning Large Data Set IP into AI Gold" with a guest speaker from KIOXIA, our flash memory partner. The recording is available on our website. KIOXIA was formerly a division of Toshiba and is well aligned with our AI Transportable strategy as they provide the highest performance PCIe Gen 4, NVMe storage, which meets the certified encryption security requirements at the edge. In August, we plan to participate in live demo exhibits at SAE Aerospace, Defense and Security Equipment International, AI Summit and Supercomputing. Looking ahead, we continue to have our sights set on driving high-margin strategic sales, further diversifying our customer base and executing on our new AI Transportable market initiatives. We expect this focus to drive revenue growth and industry expansion opportunities for OSS. With that, I'd like to turn the call back over to David for our Q2 outlook.

David Raun, President and CEO

Thank you, John and Jim. During a challenging 2020, we focused on making the company stronger and better positioned for growth. We have made excellent progress in this regard and we expect to continue to see improvements in overall market conditions. In all, it was a robust first quarter, where our revenues were restored to pre-COVID levels while producing much better bottom line results and setting multiple new OSS records for the first quarter of the year. This includes the positive swing of over $2 million in adjusted EBITDA and delivering our first positive net income for a first quarter. Even our largest customer in the media and entertainment space has started to rebound nicely for the second quarter in a row with increased sales of their new virtual product line. Our cash position has grown from about $3 million a year ago to over $19 million today, providing us the strength and opportunity to invest in our future. Looking ahead, we'll continue to use our expertise and industry-leading capabilities to bring the performance of the data center to the very edge without compromise. As I mentioned earlier in the call, I encourage you to listen to my video presentation posted earlier today, which outlines how we plan to aggressively capitalize on this growing market and further carve out a leadership position in AI Transportable. And I look forward to updating you with our progress in this exciting fast-growing space that leverages our greatest strengths. Now that we're halfway through the quarter, we can provide a revenue expectation of about $14.4 million for the second quarter. This represents 24% growth over the second quarter of last year. We also expect the fundamental improvements we've made throughout the organization to continue to drive positive bottom line results and generate greater shareholder value. Assuming continued industry restoration, we see our progress gaining momentum on all fronts, including revenue growth. With that, I'd like to open it up to the call for questions. James?

Operator, Operator

I will go first to Scott Searle with ROTH Capital.

Scott Searle, Analyst

Nice job guys in a very difficult operating environment. Maybe for starters, could you just calibrate us in terms of your largest customer? How big they were in the quarter? Maybe give us some updated thoughts as well on component availability, particularly memory and GPUs, how you're positioned going into the second quarter and second half of this year? And it sounds like disguise has stabilized and started to recover. I think last year, it was about an $8 million headwind. I wonder if you could give us some thoughts in terms of what that's looking like for 2021.

David Raun, President and CEO

First of all, we have one major account in the military sector and then there's disguise. Let's focus on disguise first. For the second consecutive quarter, we've seen increased revenue from them, primarily driven by their virtual product line, which is performing very well. We've had recent discussions with them, and they anticipate that this product line will surpass their large gathering product line in size. We expect this trend to continue as the year progresses. In the second half, we expect the large gathering segment of their business to begin contributing, though that is not included in these numbers. These growing figures are a significant improvement compared to what we experienced at the lowest point last year. Regarding the supply of components, our team has done an outstanding job sourcing components, so it hasn't impacted our revenue severely. One notable shortage in the market is GPUs, particularly mid-range ones. However, since we're focused on the high-end market, this shortage doesn’t affect us as much. That said, we’re planning ahead and may increase our inventory, but we seem to be making the right choices so far.

Scott Searle, Analyst

Great. And Dave, how big was your largest customer in the quarter?

David Raun, President and CEO

Okay. Is that something we normally share? Yes. We did $3.3 million with them.

Scott Searle, Analyst

Okay. Great. And maybe, Jim, it sounds like you continue to get wins, particularly in new area of AI Transportables. I'm wondering if you could talk a little bit about the pipeline. I think in the past, you've given a number, I want to say in the fourth quarter, there were 24 various RFPs out there in different stages. Kind of how that's looking and how that's shaping up?

Jim Ison, Chief Sales and Marketing Officer

Yes, we generally approach these opportunities conservatively. We believe we have a 60% or better chance of closing some of them. Currently, we have about 24 in the pipeline. In the first quarter, we closed three of these, and we have already closed two in the second quarter. We'll provide more details about this in the next quarter. The wins are accumulating, and we are seeing success, particularly in the AI Transportable sector, where we have a stronger chance of winning at better margins.

David Raun, President and CEO

I would add to that, Scott, that one of the trends is because of the focus on margins and a focus on AI Transportable, and just the general culture of the company shifting, the quality of these wins is increasing. And so that's going to continue to pay dividends for us.

Scott Searle, Analyst

And lastly, if I could, from a high level, Dave, as you're looking at some of these newer opportunities and you've gone through the strategic review of AI Transportables. You've been running things very tightly over the last 12 months. Do you have to spend a little bit more now? Are there some different channels that you need to go after and/or technologies that are not currently part of the portfolio? And then maybe as part of that as well to wrap it up, what is the financial model looking for like for you guys now? You did a great job from a gross margin perspective in the first quarter. Should we be expecting the long-term targets in terms of gross margins and operating margins to be somewhat higher than we've seen historically?

David Raun, President and CEO

Definitely, our intent is to increase our overall gross margins year-over-year as well as our operating margins. The spending, we're watching very closely. We continue to be in a mode that we're willing to make investments, but I sit down with the exec staff and I want to see what the contribution of adding this additional person. We are currently looking to search for a senior salesperson to focus more on the military and we're currently, because of new programs coming in, looking for some additional engineering talent. We're going to run it tight, but we will not do it in a way where it puts at risk revenue. So I'm willing to make those investments as long as it ties and people can justify it. And that's how we're going to move forward. In the same net, I believe we can grow nicely in the future years and continue to be profitable in the process.

Operator, Operator

Next we'll hear from Joe Gomes with NOBLE Capital.

Joe Gomes, Analyst

One thing that everyone seems to want to understand better is the $1 million-plus revenue opportunities we've seen. We're trying to get a clearer picture of what those might mean for the future. Looking at your defense segment, you secured a 5-year $36 million contract for Poseidon, along with other military contracts you've mentioned in recent awards. Can you provide insight into the potential scale of those contracts? Are they similar in scope to the Poseidon contract? Any information on that would be appreciated. Additionally, you mentioned earlier that about $1 million in military revenue shifted from the fourth quarter to the first quarter of this year. Excluding that $1 million, did the military revenue meet your expectations or exceed them? If you could address these points, it would be helpful.

David Raun, President and CEO

Yes. Let me address that first, and then I'll turn it over to Jim. The wins vary, and we certainly have significant achievements like what you mentioned. Regarding the military sector, we anticipate growth from around 30% to between 40% or 50% in the coming years because of our concentrated efforts there and the heightened activity. Additionally, this area offers stronger margins. As for our general revenue goals, our aim, as previously stated, is to achieve double-digit growth this year, with a target of reaching a growth rate closer to 20% in the future. We believe the pipeline we are developing will support that growth. I seem to have forgotten the other part of your question; could you remind me what it was?

Jim Ison, Chief Sales and Marketing Officer

I think you were trying to assess the military segment of our business. In the first quarter, it accounted for approximately 25% of our total revenue. For OSS, military revenue was about 37% in Q1, which is higher than in previous periods. This provides some insight. Regarding the size of each win, they do differ. We often receive various single purchase orders from some programs, while multi-year contracts come with larger awards and set pricing. We are still preparing for some of these projects that have not yet gone into production, which could lead to significant opportunities when we secure those larger contracts.

David Raun, President and CEO

So let me add to that. Thanks for catching what I missed. But part of your question was about the $1 million moving into the quarter. Based on what Jim just said, we had other military business show up in Q1. I think what you're going to see is we'll still be the strongest in the second half, but because we have more accounts and a bigger percentage of that and growing, it will smooth out a little bit more and we're enjoying some of that now.

Joe Gomes, Analyst

Okay. Great. So you mentioned about all the cash on the balance sheet and the forgiveness of the PPE loan, do you still have some other debt on the balance sheet? Any thoughts of using some of that cash to clean that up? Or are you comfortable with the other debt that's on the balance sheet at this point?

John Morrison, Chief Financial Officer

There are two types of debt. The first is domestic debt, which amounts to $2.5 million in our senior secured debt. This debt is set to convert at a price of $2.50 per share, as stated in our financial statements. It's unlikely that this will not convert, and it's most probable that it will be converted to equity when it matures. The second type of debt is foreign debt related to Bressner, which is purely for working capital to finance inventory. We received these loans from the government at a very low interest rate.

David Raun, President and CEO

For the total, John?

John Morrison, Chief Financial Officer

$2.5 million domestic and then the difference is foreign.

Operator, Operator

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

David Raun, President and CEO

Thank you, James, and thank you, everyone, for joining us today. I'd like to express appreciation to all our team members for their dedication to the success of OSS and a commitment to quality and productivity, especially during the challenges OSS has faced over the past year. I'd also like to thank all our stockholders for their support and joining us on this journey of growth and innovation. We believe the best is yet to come, and we look forward to talking to you again in the near future and reporting our progress as we pursue the many great opportunities ahead. Meanwhile, feel free to reach out to John, Jim or me at any time. James, go ahead and wrap up the call.

Operator, 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 are not a description of historical facts or forward-looking statements. These statements are based on the company's current beliefs and expectations. Such forward-looking statements include those regarding the company's expectations for revenue growth generated by new products, design wins or M&A activity. Including 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, 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 may fluctuate significantly, which would make our future operating results difficult to predict and could cause operating results to fall below expectations or guidance. Our ability to successfully integrate the operations, systems, technologies, product offerings and personnel with acquired companies 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 a manufacturer design process. 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, and we fail to remedy material weaknesses in our internal controls or financial reporting, 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 risk 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 the date hereof. All forward-looking statements are qualified in their entirety by this cautionary statement, which is made under the safe harbor provisions 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 27. 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.