One Stop Systems, Inc. — Q2 2018 Form 10-Q
Reporting period: Three and six months ended June 30, 2018. OSS designs and manufactures high-performance computing systems and components, and also provides software, support and cloud services. Comparisons include the Ion business and SkyScale, a consolidated 50%-owned joint venture; management cautions that periods are not directly comparable.
Financial performance
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Revenue | $5.89 million | $7.49 million | $13.01 million | $13.82 million |
| Gross profit | $1.64 million | $2.67 million | $3.85 million | $4.72 million |
| Gross margin | 27.8% | 35.6% | 29.6% | 34.2% |
| Operating income (loss) | $(1.12) million | $0.24 million | $(1.82) million | $0.42 million |
| Net income (loss) | $(1.62) million | $0.13 million | $(2.53) million | $0.21 million |
| Net income (loss) attributable to common stockholders | $(1.50) million | $0.26 million | $(2.30) million | $0.34 million |
| Basic and diluted EPS | $(0.12) | $0.05 basic; $0.03 diluted | $(0.20) | $0.06 basic; $0.03 diluted |
Q2 revenue fell 21.3%; first-half revenue fell 5.9%. Management attributed the declines mainly to lower OSS sales to OEM media and entertainment customers. Gross margin contracted 7.8 percentage points in Q2 and 4.6 points for the first half. Drivers included SkyScale underutilization, higher labor and overhead applied to cost of revenue, and first-half inventory obsolescence charges of $244,399. Research and development spending rose 58.3% in Q2 and 61.9% for the first half, including Ion development costs. Public-company costs contributed to higher general and administrative expense.
Adjusted EBITDA, a non-GAAP measure defined by the company, was $(576,478) in Q2 2018 versus $609,320 in Q2 2017, and $(813,045) for the first half versus $992,729.
Cash, debt and liquidity
At June 30, 2018, cash and cash equivalents were $9.27 million, versus $185,717 at December 31, 2017. Current assets were $17.54 million and current liabilities $2.75 million; total assets were $23.59 million, total liabilities $2.75 million and stockholders’ equity $20.84 million. The company reported no outstanding bank or term debt after using IPO proceeds to repay its borrowings.
For the first half, operating cash use was $3.85 million, investing cash use was $60,210, and financing provided $12.99 million. Financing included IPO proceeds and debt repayments. Management said existing cash and expected operating cash generation should cover anticipated requirements for at least the next 12 months, while noting that profitability and future external financing are not assured. The company reported $9.01 million of bank deposits above FDIC insurance limits.
Material developments, outlook and risks
- The February 2018 IPO sold 3.8 million shares at $5 per share; the company received $17.485 million net, plus $465,000 net from its portion of the partial over-allotment. Preferred shares converted into common stock. Shares outstanding increased from 5.51 million at year-end to 12.78 million at June 30.
- Q2 income tax expense was $555,629 despite a pretax loss; first-half tax expense was $772,752. Management attributed this to its forecast of a negative annual effective tax rate and said future pretax earnings could result in tax benefits under that forecast.
- Three customers represented 48% of Q2 revenue and 64% of receivables at June 30. Three suppliers represented 48% of Q2 purchases. Vendor-managed-inventory sales were $1.92 million in Q2; $1.48 million of products sold through June 30 remained held by the company under that program.
- SkyScale recorded a first-half net loss of $459,162. In Q2, OSS loaned it $300,000 at 12% annual interest; the disclosed amount owed at June 30 was $304,500. SkyScale’s losses and utilization are relevant to consolidated results.
- Management stated that no goodwill or long-lived-asset impairment was identified. It also disclosed that disclosure controls were not effective at the reasonable-assurance level because of material weaknesses in segregation of accounting duties and inventory labor/overhead and reserve controls. Remediation was underway.
- Management reported no pending, threatened or unasserted legal claims known to it and no material changes to the risk factors in the 2017 Form 10-K. The company cited ordinary-course legal matters and indemnities, with no liabilities recorded for the indemnities.
- A July 30, 2018 lease modification extends the principal-facility lease by six years and adds 6,121 square feet. The filing gives the effective date as “September 1, 2108,” which appears inconsistent and should be checked against the filed exhibit.
Important facts for investors to verify
- Whether the decline in core OSS customer orders and gross margins continued after Q2, especially in OEM media and entertainment.
- Cash burn, working-capital needs, and management’s 12-month liquidity assessment; the company was loss-making and used $3.85 million in operating cash in the first half.
- Customer, supplier and vendor-managed-inventory concentrations, including collection and revenue-recognition implications.
- SkyScale’s utilization, losses, related-party governance and repayment of its loan from OSS.
- Progress remediating material weaknesses and the effect of inventory reserves and labor/overhead costing on reported margins.
- The actual effective date and financial commitments under the amended facility lease.