ONE STOP SYSTEMS, INC. — Q1 2018 Form 10-Q
Reporting period: Three months ended March 31, 2018; unaudited. OSS designs and manufactures high-performance computing systems and components, including servers, compute accelerators and flash-storage products, and provides related support and cloud services. Comparisons are affected by the inclusion of SkyScale and Ion-related activity in 2018; the company says the periods are not directly comparable.
Financial performance and position
| Metric | Q1 2018 | Q1 2017 / comparison |
|---|---|---|
| Revenue | $7.12 million | $6.34 million; up 12.4% |
| Gross profit / margin | $2.21 million / 31.1% | $2.06 million / 32.5% |
| Operating income (loss) | $(0.70) million | $0.17 million |
| Net income (loss) | $(0.91) million consolidated; $(0.79) million attributable to common stockholders | $0.08 million |
| Adjusted EBITDA (non-GAAP) | $(0.24) million | $0.38 million |
| Operating cash flow | $(4.03) million | $1.20 million |
Revenue growth included $0.46 million from OSS, $0.20 million from Ion and $0.12 million from SkyScale. Gross margin declined 140 basis points. Management attributed pressure principally to SkyScale’s ramp-up and underutilization, and higher OSS inventory-obsolescence reserves. Operating expenses rose 54.8% to $2.91 million, reflecting higher public-company, selling and marketing, and product-development costs.
At March 31, cash and cash equivalents were $9.13 million, compared with $0.19 million at December 31, 2017. Current assets were $18.10 million and current liabilities $2.56 million (working capital $15.54 million). Total liabilities were $2.56 million; bank-line borrowings and term and related-party notes had been paid off, leaving no debt reported at quarter-end. Financing cash flow was $12.99 million, mainly reflecting the IPO, partly offset by debt repayment and issuance costs. Investing cash outflow was $0.01 million.
Material changes, outlook and risks
- IPO and capital structure: The February IPO and partial over-allotment generated reported net proceeds of approximately $17.95 million. OSS used proceeds to retire its line of credit and remaining notes; the CEO’s personal guarantees were released. Preferred shares converted into common stock. Common shares outstanding were 12,773,289 as of April 1, 2018.
- Liquidity outlook: Management believes cash and cash generated from operations should fund anticipated requirements for at least 12 months. It cautions that profitability is not assured and future external financing may not be available on acceptable terms. No specific revenue or earnings guidance is provided.
- Cash use and working capital: Operating cash flow deteriorated by $5.23 million year over year. The filing attributes the use principally to the quarterly loss and working-capital requirements, including payments of accounts payable and accrued liabilities.
- Tax and unusual items: OSS recorded a $217,124 income-tax provision despite a pretax loss; management explains this through its forecast negative annual effective tax rate. Other income included a $67,609 net amount, which management attributed to settlement of outstanding obligations. Debt-discount amortization/write-off also contributed to interest expense.
- Controls: Disclosure controls were deemed ineffective at the reasonable-assurance level because of material weaknesses in segregation of accounting duties and inventory costing/reserve controls. Remediation was underway, with completion targeted for Q2 2018; completion is not established by this filing.
- Concentration and execution risks: Three customers represented 54% of quarterly revenue and 63% of receivables. Three suppliers represented approximately 48% of materials purchased. $8.77 million of cash exceeded FDIC insurance limits. SkyScale recorded a $135,290 quarterly net loss; on April 30, 2018, the board approved a $300,000 intercompany loan to the joint venture.
- Other commitments: Operating lease commitments totaled $627,463 at quarter-end. Management reported no known pending, threatened or unasserted claims and believed ordinary-course legal matters would not materially adversely affect the company.
Investor verification points
- Reconcile IPO gross proceeds, net proceeds, issuance costs and warrant costs: the filing gives multiple presentations, including approximately $17.95 million net proceeds and $19.5 million gross proceeds.
- Assess whether revenue growth can translate into improved gross margin and operating profitability, particularly as SkyScale and Ion develop.
- Track operating cash flow, receivables collection, inventory levels and reserve adequacy; verify remediation of the disclosed material weaknesses.
- Monitor customer and supplier concentration, the SkyScale loan and funding needs, and cash held above insured limits.
- Review the effect of the negative quarterly tax provision and the company’s assumptions for its 2018 effective tax rate.