One Stop Systems, Inc.
Q4 2020 Earnings Call Transcript

Published: 25 Mar 2021

[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, 2020. 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 & Marketing Officer, Jim Ison. Following their 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 this call. I would 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.

[David Raun:]

Thank you, Jenny, and good afternoon, everyone. We're grateful you could join us today and I hope you've been all able to stay safe, healthy, and virtually productive. Before addressing the financial, operational, and strategic progress we've made during the fourth quarter, I'd first like to thank our shareholders, existing and new, for their tremendous support. We hope your patience has been rewarded by the strengthening performance in the stock over the past several months. In 2020, we seized the opportunity to take several transformative steps and have laid ground the cornerstones for a stronger foundation on which to build our future growth. These steps include a new senior leadership and corporate reorganization, reduced spending, three new independent Board members which also added to the Board diversity, and we directed more focus on our long-term strategic vision to increase shareholder value over time. Regarding our financials, we’re pleased to announce that we were able to exceed our Q4 2020 revenue outlook by $900,000. This was a direct result of our continued efforts to drive existing OEM business and our success in expanding our customer base, offsetting some of the downside from the pandemic. We see early indications of improvements with customers impacted by COVID. While we anticipate the impact will continue for some time in 2021, our energies are focused on a return to normalcy and the opportunities inherent in that improved environment. As previously stated, the pandemic impacted our top-line revenue growth in 2020 with several of our key customers. We identified about $14 million in lost or delayed business compared to our annual plan due to COVID-related matters. More than half of this loss or delayed revenue in 2020 was from our largest customer in the media and entertainment industry. During the fourth quarter, we saw an encouraging rebound by this customer, as their 3D virtual product line continues to develop traction in the market. Their product premiered last year on American Idol as the virtual performance stage in a Katy Perry music video. We expect their virtual platform to drive increased sales in the current and future quarters. The eventual return of live events should contribute additional revenue from their core products in the second half of the year. Earlier this month, we announced a direct offering which further fortified our cash position. In addition to this offering, we achieved significant cash gains through a combination of lower expenses, increased efficiency, and improvements in working capital. The result is we currently have a cash position of approximately $19 million. This gives us the ability to invest in key strategic initiatives that should fuel future growth.

[John Morrison:]

Thank you, David, and good afternoon, everyone. I’m glad you can join us today. Earlier today, we issued a press release with our results for the fourth quarter and the year ended December 31, 2020. The release is available in the Investor Relations section of our website at onestopsystems.com. Our revenue in the fourth quarter was $13.9 million, which was up 7% from the third quarter, resulting from improved shipments to Disguise and Raytheon. However, we were lower by 24% compared to the fourth quarter of last year, mainly due to pandemic-driven reductions, most significant was the quarterly revenue for Disguise , which was down $4.3 million, attributable to government restrictions on large group events. Approximately $1 million of flash storage array shipments to Raytheon were delayed to the first quarter of 2021, and we also had a one-time program valued at $1.1 million in the prior-year 2019. These reductions were partially offset by $1.2 million in sales of our new 4U Pro GPU accelerator being supplied to the U.S. Army. Revenues for the year totaled $51.9 million. This was down $6.4 million or 11% compared to the previous year. Most of the decrease is attributable to the reduction in shipments of $8.2 million to Disguise due to COVID restrictions on large gatherings. As David mentioned, we’re seeing encouraging signs with demand for their 3D virtual platform, and we should see a return of their core products in the second half of the year. Recently, The Carlyle Group purchased a 50% interest in Disguise providing them greater financial stability. Other reductions in revenue included Raytheon of $2.9 million, primarily due to the timing of different programs. Revenues were also down with other COVID-impacted customers and the elimination of a low margin, $2.4 million project with a former customer. The noted reductions however were partially offset by favorable results from our diversification efforts, which included $2.6 million to a new test and measurement company for our new PCIe Gen 4 products, over $1.9 million direct with the Navy for flash storage arrays, and the previously mentioned $1.3 million of our new 4U Pro to the Army. This was further supported by our ongoing project with Lyft, which saw $1 million of incremental revenue during 2020.

[Jim Ison:]

Thank you, John and good afternoon, everyone. During the fourth quarter of 2020, we closed four additional major OEM opportunities, including two industrial, one instrumentation and one Autonomous Driving Project. In 2020 the program wins totaled 16, which matched 2019 without the pandemic. As a reminder, we defined program wins as those expected to yield $1 million or more of revenue within four years. Our 32 program wins over the past two years contributed $18 million to 2020 revenue, including $12 million from new customers supporting our diversification initiatives. In addition to adding new customers in 2020, we expanded our breadth of project wins inside our most strategic customers. For example, we now have four major project wins within various divisions of Raytheon. After being awarded a Raytheon Premier Vendor Excellence Award in 2017, for a five-year $36 million contract for radar and sensor flash storage arrays designed for the Navy's P-8A Poseidon aircraft, we added project wins across the entire AI workflow landscape. This included a large format data center in Disguise, AI threat detection system, and a multi-server AI target recognition and threat detection cluster. These systems provide AI training and inference in the harshest environments. We were also awarded a multi-GPU missile simulation system with Raytheon for the Missile Defense Agency. These wins at Raytheon have led to the direct program awards with the Navy for flash storage arrays that John discussed earlier. In 2020, we primarily marketed in a virtual environment using social media, virtual events and webinars alongside strategic technology partners, NVIDIA and Marvell. Looking forward in 2021, we plan to use a hybrid format of virtual and in-person events based on the reopening plans for several trade shows in Q3 of this year. Our next hosted webinar in April will feature our Edge AI rugged server and data storage solutions supported by our flash memory partner, Kioxia. And later this fall, we plan live demo exhibits at sea, air, space, defense and security equipment international, AI summit and supercomputing. Despite the global challenges navigated in 2020, we’re focused on driving strategic sales, diversifying our customer base and executing upon our new go-to-market initiatives. We believe this strategy will drive future revenue growth and industry expansion opportunities for OSS. Now, I’d like to turn the call back over to David.

[David Raun:]

As John mentioned, we ended the year nearly $52 million in revenue while concentrating on building a strong foundation, fortified by financially solid balance sheet and a disciplined management strategy. A key initiative in 2020 was improving the bottom line by reducing costs on all fronts, and increasing operational efficiencies. The combination of these steps and our recent $9.3 Million raise puts our cash position at very comfortable levels.

[Operator:]

Thank you. And we will go first to Scott Searle of ROTH Capital.

[Scott Searle:]

Pretty good afternoon. Thanks for taking my questions. Before diving in on the Edge and AI transportables, I want to just clarify a couple of things on Disguise. I'm not sure if I heard a number in the fourth quarter. I'd love to hear that if you have it. And it sounds like you're starting to see a recovery now based on the newer 3D product before you start to see a recovery based on the traditional entertainment products in the second half of this year. So I was wondering if you could give us some color on the fourth quarter, what you're seeing going into the first quarter of that $13 million assumption is Disguise and kind of how you're thinking about them contributing over the course of 2021?

[David Raun:]

This is Dave. Couple of things. First of all, we saw what we believe was the bottom in the third quarter with them, so we saw increased growth in the fourth quarter that was primarily all in the new 3D virtual products, which are getting more traction. We expect that’s going to project growth into the current quarter and future quarters, and then the second half will layer back in the kind of business we've enjoyed in the past. So we think we'll be in pretty good shape later this year with our largest customer.

[John Morrison:]

I think you were asking the question on the number, we cited that we were down $4.3 million year-over-year on Disguise in the fourth quarter.

[Scott Searle:]

Okay, it was down $4.3 million. Okay. And if you could as well, just component availability, it’s obviously been a big issue throughout every supply chain globally right now. I’m wondering if you could give us some updated thoughts on that, what you're seeing particularly as it relates to things like GPUs and memory, and how that's impacting the outlook for the gross margins?

[David Raun:]

So, we definitely have seen it fortunately throughout 2020 and into 2021, which may look worse than the previous year. We've taken action quick, and it hasn't impacted our revenues in any significant or material way so far. So, we're staying on top of it. We believe that as far as price increases, those are things that we have to pass on to our channel and our customers. So, we don't expect it to impact our margins.

[Scott Searle:]

Okay, great. And lastly, if I could, just in terms of the pipeline of opportunities, I think in the past, you've given some idea in terms of the level of RFP activity. I'm not sure if you provided those numbers or I missed them. I'd love to hear some more color on that front. And then Dave, specifically as it relates to Edge and AI transportables, I’m wondering if you could delve in a little bit more in terms of how you're thinking about the ultimate market there in terms of how you go to market with partners, what additional incremental required investment looks like. And again, it sounds like this is a higher gross margin segment, more software content, so I’m trying to understand the investment required there, and ultimately, what that does to the financial model? Are we talking about you guys sustainably having 35%, 40% kind of gross margins, or what is the longer-term target on that front? Thanks.

[David Raun:]

So, I can help on the design win front. The outlook we’re going into this year, we were in the 21 opportunities, that's been growing even in the first quarter. We’re up at 24 as of today. So that's what we're tracking. And typically, we've seen anywhere from a 60% to 70% win rate on those projects. And others, we’ll layer in more over the year.

[John Morrison:]

Okay, and basically what we're saying is more than half of those are dead square on the AI transportable space. Let me – your other questions, first of all, our higher margin business tends to be things related to military and AI transportables. And so, that's really what we're focused. As far as additional investment, we're going to be careful with that. So we were not in a situation where we're just going to go and start spending $19 million. We're going to be very careful. I think we've proven that that's our methodology, but we will not hesitate to do it if we believe it can rapidly accelerate our growth. And so, we're looking for those opportunities.

[Scott Searle:]

Great, thank you.

[Operator:]

And we'll go to our next question from Ruben Roy of Benchmark.

[Ruben Roy:]

Thank you. And nice job guys, finishing up a challenging year. Dave, I wanted to pick up on the last question, and some of that, and get a little more context around how you're thinking about this strategic shift, maybe to this Edge area, I assume some of the stuff that you're doing with Raytheon, with the storage containers as well as what you're doing with Lyft would be kind of things that you're talking about here. So, I guess, can you tell us in terms of some of these new projects that you're working on with customers, what types of projects are they, are they Edge servers or any type of detail on the type of work that you're being asked to do? And if you've come up with some initial ideas of what the market TAM could look like over the next three to five years for OSS?

[David Raun:]

Yes, absolutely. So a couple of things, one is that, first of all, this plan is based about -- is a lot about focus. So we've already had success in this area, AI transportable, but when you look at the data in that space, it’s just very attractive versus other things we do. So again, part of it, that's what's nice is we're not starting from scratch, we're just getting the organization more focused on it, as we believe it'll provide a higher return to the company and shareholders. As far as Raytheon and Lyft, you mentioned those two yesterday would fit into that category, for sure. Pretty much anything that moves you said I think you said server on edge. If that server is sitting in a vehicle, or something that needs to move that has challenges, anything from heat space, cooling then it would be a step. But it's not fits in building with air conditioning, we're trying to make that really clear because historically, we used to try to chase that business, we'd end-up losing it because there's too many players, you end-up against the big boys, and it ends up being a price play. As far as market size, we're trying to still sizes, but we believe the market today is somewhere in the $200 million to $400 million range. Other people may not define it as AI transportables, we think that's a good name for it. And we think this is something that a number of years out could be $1 billion to $5 billion and at the next call, I'll try to hone that in a little bit more. We're doing work on that front. But it's an exciting space to be, I think the fastest growing space, it is the laggard in the edge computing space.

[Ruben Roy:]

Great, that's very helpful context. Thank you for that, Dave. I guess the follow-up question to that would be, when you're looking at your other products and assets, does this potentially entail some de-emphasis around some of the other areas that you guys have been working on, whether it's some of the stuff you integrated with CDI, or Bressner what have you?

[David Raun:]

I think the main thing to think about it is that we're not going to do anything that first of all impacts our customers. We're great customers. It's just really focus, where we look forward, where we put our greatest R&D dollars moving forward it’s going to be where the highest return is, we're not going to turn this battleship real quick. We got to build this over time and not hurt the revenue in the process.

[Ruben Roy:]

Okay, last question I had was just kind of more on the sort of the outlook for the rest of the year and physically around Disguise and kind of layering back into some of the core revenue. How do you see that working? I mean, is there inventory out there that they can work with once we start seeing some live events coming back? Or do you think that you're going to see a switch turn on and you guys are going to get a bunch of new orders as things get sort of going back into normal? Or, how are you thinking about that maybe for the second half of this year, maybe longer-term.

[David Raun:]

So first, I think we're going to have some nice results from the Virtual products, which is very encouraging, because there's a lot of pull in that area. And then the second half is where the large gathering events, and sure there's some inventory in the channel with them and stuff, but I think we'll see an impact of that as early as Q3, and most likely, it will be in Q3. So I think they're going to rebound to a pretty good customer for us this year.

[Ruben Roy:]

That's perfect. Thanks, guys.

[David Raun:]

Thank you.

[Operator:]

And we will go to our next question from Brian Kinstlinger, Alliance Global Partners.

[Brian Kinstlinger:]

Good evening, guys. Can you talk about -- how are you? As it relates to the AI portables, can you talk about the competitive landscape and how your technology stacks up? I believe you talked about using the latest NVIDIA Technologies, talk about what your peers are. And then for those that aren't using the technology that may be equals what you are, how are you identifying and what is your go to market strategy to replace and bring faster technology to those customers?

[David Raun:]

So I think really, you could look at the market in three different segments. First of all, you got inside design teams that will compete with, whether they're going to try to do design themselves. But that's the challenge there is like we've done it, Raytheon where we have to show our value, and they decide to use us over and over. Second, we've got the big players in the market, the growers, which would be the . They tend to go to market with more mature products for middle grade. And they're really good at doing that. But we see a demand that says that's great, but I need the latest technology, I need the commercially available products. How could you give me that that commercially available product is sitting in the data center, the latest and greatest and put in this harsh environment. And that's what we do. Okay and I think the players that do some of that didn't get really fragmented, no public companies that tend to be smaller ones. And this is where we really believe we can take an initiative and carve out a real leadership in this area and offer a lot of value.

[Brian Kinstlinger:]

And what is the sales cycle for a placement like that where someone might not be using the latest and greatest is it quick they realized they need faster speed or would take a long-time convincing because of the capital investment they've already made?

[David Raun:]

I think it's the same we've seen in the past commercials, and we're from six months to 12 months militaries and we work from nine months, 18 months general kind of thing. One of the things just to point out when Jim talks about having X number of opportunities, those are way down the path, they probably already bought some stuff from us the prototyping. I mean, it's not like, hey, that's the guy we want to go and pursue. And so that doesn't mean industrial, it takes that long to turn into revenue for us. And in some cases, we made these terms revenue with them already.

[Brian Kinstlinger:]

Great, thank you.

[Operator:]

And we'll go next to Christopher Scott of Noble Capital.

[Christopher Scott:]

Okay, so I'm sitting in for Joe, thanks for taking my questions. Congratulations on a solid quarter. A lot of my questions have been answered. But can you after the offering recently, what's the current fully diluted number of shares outstanding?

[John Morrison:]

18.5.

[Christopher Scott:]

18.5, thank you. And let's see. I think I've heard.

[John Morrison:]

That’s the number of shares, not fully diluted. I'm sorry to interrupt you. That is 18.5 fully outstanding, not fully diluted, that’s 18.5 million shares outstanding. And on the fully diluted, we would have about another 700,000 on top of that.

[Christopher Scott:]

Thank you. I heard some comments on Bressner and the margins being down, I think John made them, a little more detail on that, please. Is that related to Europe increasing ongoing lockdowns, COVID lockdowns.

[David Raun:]

So first of all the Bressner because they're more closer to bar type model, frankly. Their margins tend to be in the lower 20s. I don't think it was radically down. And it's just more the nature of the business.

[John Morrison:]

Product mix, 1.2 for the year.

[David Raun:]

Yes, and then as far as like margins overall, since our revenue was down, we're spreading overhead over a smaller number of dollars, which impacts gross margin number also. So we see positive things happening in this company creating a foundation so that when we pull out of this, which we think we're starting to do, there’s lots going to go much more to the bottom line.

[Christopher Scott:]

Great, okay. Thank you.

[David Raun:]

And one of the things I think I'd like to add to that is, as you know, we did guidance of $13 million for the current quarter. What's kind of interesting about that number is last year in Q1, we did $3.3 million, that's pre-COVID, we had no impact. Disguise was very strong. And, so we're in shooting distance of that in a COVID world, which really backs up that we've layered in new customers. And we've fought our way through this and setting up for the future.

[John Morrison:]

Chris, I’m sorry to interrupt David on that, I'm going to add $10 million to his number, 13.4. So I don't want to let go on that $10 million. So actually, that was 13.4 was an all-time record for first quarter for us last year. And as I say, we gave guidance this year about 13. So we also fill in, it’s not all the slides, it's more in this new strategy that we're focusing on.

[Christopher Scott:]

Thank you. That sounds great. And then the last question for me, just with some reports of improving employment. Has that impacted your ability to source employees, especially maybe engineers?

[David Raun:]

We've been pretty stable. I think we've created an environment that they're thriving in, they feel challenged and excited about our future. So we're doing pretty good.

[Christopher Scott:]

Great, thanks very much.

[David Raun:]

Thank you, Chris.

[Operator:]

And we have no more questions. At this time, I'd like to turn the conference back to our speakers for closing remarks.

[David Raun:]

Okay, sorry about that. This is second time I've done this. Thank you, Jenny and thank you, everybody for joining us today. We look forward to talking to each of you more in the future reporting on our progress. In the meantime, please feel free to reach out to John, Jim and me anytime. So Jenny, please go ahead and wrap up the call.

[Operator:]

Thank you. Now before we conclude today's call, I would like to provide the company's safe harbor statement that includes important cautions regarding forward-looking statements made during today's call. One Stop Systems cautions you that statements in the presentation 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 those regarding the Company's expectations for revenue growth, generated by new products, design wins or M&A activity. 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; 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 that may affect such markets; 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 operation 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 to the characteristics of such needs and functions may shift in such a way as to cause our products to no longer fulfill such needs or functions. New entrants into our market may harm our competitive position; we rely on the limited number of suppliers to support a manufacturer design process and 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 operation subject us to additional risks that can adversely affect our operating results and financial conditions 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 heading Risk Factors in our Annual Report on Form 10-K and any subsequent filings with the SEC. You’re 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 thereof. All forward-looking statements are qualified in the 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 a replay starting later this evening through April 8. 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.