One Stop Systems, Inc. — Q3 2018 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2018. OSS designs and manufactures high-performance computing systems and components. Results include CDI only from its August 31 acquisition, so periods are not fully comparable.
Financial performance
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Revenue | $9.63 million | $6.66 million | $22.65 million | $20.49 million |
| Gross profit (margin) | $3.17 million (32.9%) | $1.99 million (29.9%) | $7.02 million (31.0%) | $6.72 million (32.8%) |
| Operating income (loss) | $(280,000) | $(136,000) | $(2.10) million | $281,000 |
| Net income (loss) | $1.14 million | $(202,000) | $(1.38) million | $12,000 |
| Net income (loss) attributable to common stockholders | $1.28 million | $(119,000) | $(1.02) million | $217,000 |
| Operating cash flow | Not presented quarterly | $(5.13) million | $297,000 |
- Q3 revenue rose 44.6% year over year, driven mainly by increased flash-array sales on an airborne military contract and improved OEM media and entertainment sales. Nine-month revenue increased 10.5%.
- Q3 gross margin improved 3.0 percentage points year over year. Nine-month gross margin fell from 32.8% to 31.0%, with management citing SkyScale underutilization, inventory reserves and labor/overhead allocation adjustments.
- Operating expenses increased 62% in Q3 and 42% for the nine-month period, reflecting acquisition and public-company costs, sales and marketing activity, and product development. Nine-month operating results moved from income to loss.
- Q3 net income included a $1.45 million income-tax benefit despite a $306,000 pretax loss. Nine-month results included a $675,000 tax benefit. The tax benefit was an important driver of reported net income in Q3.
- Management’s non-GAAP Adjusted EBITDA was $674,000 in Q3 versus $196,000 in Q3 2017, and $(138,000) for the nine months versus $1.19 million in 2017.
Balance sheet, cash flow and capital
- At September 30, cash and cash equivalents were $7.06 million; current assets were $18.97 million and current liabilities $4.43 million, for working capital of approximately $14.54 million.
- The company reported no debt at September 30. IPO proceeds were used to repay its bank line and other outstanding notes; the CEO’s related personal guarantees were released.
- Nine-month operating cash use was $5.13 million, primarily reflecting working-capital needs, including higher receivables and payments of accounts payable. Investing cash use was $553,000, including CDI acquisition costs. Financing provided $12.56 million, principally from the IPO.
- The February 2018 IPO and over-allotment generated approximately $17.95 million in net proceeds to the company. Common shares outstanding were 14,073,234 at September 30 and 14,184,167 as of October 31.
Material changes, outlook and risks
- OSS acquired CDI on August 31 for $646,759 cash and 1,266,364 shares, with total stated consideration of $4.84 million. CDI’s preliminary purchase-price allocation includes $3.14 million of goodwill and $1.77 million of intangible assets; the accounting was not final at filing.
- After quarter-end, OSS’s German subsidiary acquired Bressner Technology GmbH on October 31 for €4.725 million in cash and 106,463 restricted shares. The transaction was not included in Q3 results.
- Management said existing cash and expected cash from operations should fund requirements for at least the next 12 months, but cautioned that profitability is not assured and additional financing may not be available on acceptable terms. No specific revenue or earnings guidance was provided.
- Customer and credit concentration is significant: three customers represented 72% of Q3 revenue and 78% of receivables at September 30. Three suppliers represented 48% of Q3 purchases. A large portion of revenue is recognized through a vendor-managed inventory program.
- Disclosure controls were deemed ineffective because of material weaknesses in segregation of accounting duties and controls over inventory costing and reserves. Remediation is underway, including hiring accounting personnel and implementing a new ERP system, expected to be completed by the end of Q2 2019, at an estimated cost of approximately $600,000.
- Other items to monitor include SkyScale’s losses and underutilization, inventory valuation and warranty estimates, CDI integration and purchase accounting, acquisition-related lease commitments, and foreign-exchange exposure following the Bressner acquisition. Management reported no material pending legal claims and no goodwill or long-lived-asset impairment for the periods presented.
Investor verification priorities
- Verify the nature, timing and realizability of the Q3 tax benefit and its effect on reported profitability.
- Track collections, receivables, inventory and operating cash flow to assess whether revenue growth converts to cash.
- Assess customer concentration and the criteria supporting revenue recognition under vendor-managed inventory arrangements.
- Review CDI’s finalized purchase-price allocation and Bressner’s funding, integration and post-acquisition performance.
- Monitor remediation of material control weaknesses and any subsequent changes to reported results or inventory reserves.