ONE STOP SYSTEMS, INC. (OSS) — Q3 2020 Form 10-Q
Reporting period: Three and nine months ended September 30, 2020. OSS designs and sells customized high-performance computing systems and components; its reportable segments are OSS and Bressner. CDI was integrated into OSS’s core operations effective July 1, 2020.
Financial results
| Metric | Q3 2020 | Q3 2019 | Nine months 2020 | Nine months 2019 |
|---|---|---|---|---|
| Revenue | $13.0 million | $14.9 million | $38.0 million | $39.9 million |
| Gross profit / margin | $4.9 million / 37.8% | $5.0 million / 33.7% | $11.6 million / 30.6% | $12.9 million / 32.2% |
| Operating income (loss) | $979,000 | $420,000 | ($938,000) | ($2.6 million) |
| Net income (loss) | $858,000 | $545,000 | ($250,000) | ($2.0 million) |
| Operating cash flow | Not separately reported for the quarter | ($1.4 million) | $388,000 |
Q3 diluted EPS was $0.05, versus $0.03; nine-month diluted loss per share was $0.02, versus $0.13. Q3 gross margin expanded mainly with a higher share of military data-storage sales and fewer lower-margin media and entertainment products. Nine-month margin contracted, principally reflecting lower military data-storage sales and lower Bressner margins. Operating expenses fell, helped by April cost reductions and, in the prior-year comparison, the absence of a $1.7 million goodwill impairment. The nine-month 2020 tax benefit includes $446,099 from early adoption of an income-tax accounting standard; the filing says this did not affect the expected full-year tax benefit or expense.
Management-reported non-GAAP adjusted EBITDA was $1.57 million in Q3 (versus $1.04 million) and $682,000 for nine months (versus $881,000). Free cash flow, a non-GAAP measure, was negative $2.05 million for nine months, compared with negative $1.67 million.
Liquidity, cash flow and debt
- At September 30, cash and cash equivalents were $5.52 million, working capital was $15.47 million, and current assets and current liabilities were $25.98 million and $10.52 million, respectively. $1.22 million of cash held at Bressner was unavailable to the parent under debt covenants.
- Nine-month operating cash use was $1.39 million, compared with $388,000 provided in 2019. Inventory increased by $2.63 million from year-end 2019; accounts receivable declined by $1.92 million.
- Net cash from financing was $2.33 million. Sources included $2.38 million net proceeds from the initial convertible-note financing and a $1.50 million PPP loan; cash use included debt repayments and employee equity-related tax payments.
- Reported debt liabilities totaled $5.48 million net of discounts and issuance costs: $3.08 million current and $2.40 million long-term. This includes a $2.20 million net convertible note and the $1.50 million PPP loan. The convertible note has monthly amortization provisions, potential conversion into common shares, and a further $3.0 million tranche available subject to conditions. The PPP loan had not been submitted for forgiveness as of the filing; the company intended to apply.
- Management said it believed liquidity was sufficient for at least the next 12 months, relying on cost reductions, cash forecasts, and potential financing. It cautioned that forecasts, cost savings, and access to acceptable financing were not assured.
Changes, outlook and material risks
- Revenue declined 13.1% in Q3 and 4.8% for the nine-month period. Management attributed weakness to COVID-19 effects on major customers and mature Bressner contracts. It cited new AI-on-the-fly business as a partial offset to OSS declines.
- The largest media and entertainment customer faced financial difficulties, reduced orders, and delayed payments. OSS established extended payment terms and reported that the customer was honoring the modified schedule. Three customers represented approximately 67% of trade receivables at quarter-end.
- Management estimated $1.5 million to $2.0 million of 2020 savings from workforce reductions and other cost controls. No specific revenue or earnings guidance was provided. Management said the duration and magnitude of COVID-19 impacts could not be determined.
- Risks include further customer or supplier disruption, delayed or uncollected receivables, weaker demand in media, entertainment and commercial aviation, and potential supply-chain and operational interruptions. The company stated it had not developed a comprehensive COVID-19 contingency plan.
- A former CEO filed a lawsuit alleging breach of contract and California labor-law violations, seeking unspecified damages and penalties. OSS said it intended to vigorously defend the claims.
- On February 15, 2020, Steve Cooper departed as CEO; David Raun became interim CEO and was appointed CEO in June. The company reported disclosure controls were effective at a reasonable assurance level and no material quarterly change in internal control over financial reporting.
Important facts for investors to verify
- Whether the largest customer continues to meet its modified payment schedule and how concentrated receivables remain.
- Actual operating cash flow, inventory levels, collections, and progress toward management’s cost-savings estimates.
- Terms and availability of the conditional additional convertible-note tranche, repayment or conversion outcomes, and resulting dilution risk.
- PPP forgiveness status and the company’s eventual repayment obligations.
- Developments in the former CEO’s lawsuit and any material change in management’s stated 12-month liquidity assessment.