One Stop Systems, Inc.

Please continue to stand by. Your conference will begin shortly. Thank you. 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, 2023. With us today are the company's President and Chief Executive Officer, Mike Knowles, and its Chief Financial Officer, John Morrison. Following their remarks, we will open the call to your questions. Before we conclude this call, I will provide some important information regarding the forward-looking statements made by management during the call. I would like to remind everyone that the call will be recorded and made available for replay in the investor section of the company's website. Now, I would like to turn the call over to OSS President and CEO, Mike Knowles. Sir, please go ahead.

Thank you, Ina. Good afternoon, everyone, and thank you for joining today's call.

This is an exciting time at OSS, As we completed this strategic transition away from lower margin media revenue, established a new management team, and refocused our strategic growth priorities on large and rapidly evolving global markets. Throughout 2023, we demonstrated continued progress in our efforts to pursue strategies focused on AI-centered high-performance computing at the edge, where platforms require data center-level compute, storage, and switching solutions. These solutions support AI and machine learning sensor fusion, sensor processing, and autonomy applications. We coined this market AI transportals. We will continue these efforts throughout 2024, backed by the strong influence of AI and ML demand in both the commercial and defense markets. Recent wins in both markets, combined with a growing pipeline of opportunities, continue to validate our strategic focus. We have also continued our efforts to strengthen our executive team and our board of directors. adding skills and experience that will help facilitate our strategy and enable the company to scale for growth. Financially, we were able to further offset revenue from our forward media customer with higher margin revenue aligned with our strategy. So with this introduction, I want to provide an update on the growth strategies we are pursuing, our growing pipeline, and recent wins that we believe will create lasting value for OSS and our shareholders. Commercial adoption of artificial intelligence and machine learning, taking advantage of advanced sensor fusion and sensor processing, is dramatically moving to the edge across almost all business segments. Sensor systems and autonomous applications can rival those of modern defense implementations. We believe that our product portfolio and future roadmap position us to uniquely take advantage of this evolving technology environment. Strategically, we are focusing our efforts to expand the number of customers and platforms in our rugged edge processing portfolio and increasing our multi-year backlog by securing new, long-term contracts. These efforts are supported by opportunities in both commercial and defense markets, where strong dynamics and growth are being driven by AIML adoption, sensor fusion, sensor processing, and autonomy. The Department of Defense is making significant investments in next generation capabilities that require edge computing. While the overall defense budgets in the US are expected to remain stable, we expect to see increased spend, especially for autonomy, artificial intelligence, and machine learning. In fact, these represent some of the fastest areas of growth as the military looks to augment existing platforms with new sensors, platforms and weapon systems to maintain a technical and tactical advantage over our adversaries. We are continuing to pursue opportunities in both commercial and military segments where we can leverage OSS's differentiated and technologically advanced capabilities by bringing enterprise and data center class compute, storage, and switching capabilities to the most challenging environments, delivering low latency, high throughput, scalable solutions in real-time environments, delivering configurable off-the-shelf and custom high-performance solutions, and providing high-technology readiness-level product availability to enable first-to-market AI at the edge. We believe a balanced portfolio of commercial and military customers can serve as a strategic benefit as we focus on creating long-term value for our shareholders. Looking at our pipeline and recent wins in more detail, we made progress throughout the fourth quarter penetrating defense and commercial markets. We had three major new wins in composable infrastructure, aerospace, and defense that totaled $2.7 million during the quarter. These wins reflect our continued leadership in high-speed PCIe interconnect technology and scalable AI GPU compute systems. Turning to a major defense win, we announced a multimillion-dollar program with Leidos' Dynetics, a prime contract of mission-critical solutions for the U.S. government. Under this multi-year program, we will provide our proprietary transportable compute and storage technology, designed to power an emerging specialized mobile AI signal collection application. The award is the first multi-year win OSS has secured with Leidos, highlighting the growth, trust, and confidence in OSS in our innovative technology and advanced engineering capabilities. We are also pleased to see the expansion of mission application and platform integration consistent with our growth strategies. Earlier this month, we announced a pilot project to provide a liquid immersion-cooled data storage system for use on a deployable ground station that was also contracted through Leidos. This project for a major government intelligence agency expands our market opportunity into the intelligence community. As the pilot progresses over the coming quarters, we expect this program will lead to follow on production orders. This program also demonstrates our innovative thermal management technologies for cooling rugged high performance computing solutions. Our cooling solutions enable the highest level of GPU performance which our customers need to support their AI and ML mission objectives. We anticipate this initial design win will lead to additional deployments with this customer and other customers in the future. During the fourth quarter, we also booked an additional award from the U.S. Army Ground Vehicle Systems Center, increasing our scope in the 360-degree Situational Awareness Program to include the sensor processing for the video data input into the system. Within our commercial markets, we received an order from Daimler truck partner Torque Robotics to develop a cooling solution for their existing compute system, expanding our relationship within the autonomous trucking software vendor. We also finalized a multi-year deal with Thales in support of their in-flight networking system for commercial airlines. With growing interest in AI and ML solutions, we are quickly expanding our outreach efforts. We expect that 2024 will be a year marked by pipeline expansion and conversion as demand increases and we execute on our strategic plan. Actions underway include submitting a bid to provide a rugged, high-performance compute solution for a classified program within the sector that is advancing AI implementation at the edge, establishing a sponsorship and collaborative relationship with Andretti Racing and Zapata AI, promoting edge applications for AIML and commercial and defense markets, engaging with companies in the composable infrastructure market marked by leveraging our expansion chassis product line, and our UBMC software capability for system control and monitoring, and continuing to advance our engagement and reach with large prime organizations such as Booz Allen Hamilton, BAE Systems, Leidos, General Dynamics, Lockheed Martin, and General Atomics. As the Pentagon prioritizes incorporating advanced technologies into their equipment, we expect engagements for our products in the military space covering various autonomy, sensor fusion, and AIML applications. for aircraft, drones, ships, helicopters, and land vehicles will increase. Although we are seeing progress, it will continue to take time to pursue, secure, and turn target opportunities into increased bookings and revenue. One way that we've been working to accelerate the opportunities with the US Department of Defense is through lobbying efforts in Washington to advance the innovative solutions offered by OSS. Lastly, we continue attending commercial and defense trade shows to advance the OSS brand in the market and identify new and partner opportunities. The result of our efforts has enabled us to expand our five-year unfactored pipeline to an excess of a billion dollars. This growth reflects the initial success from our new sales infrastructure and talent, as well as the rapid expansion across our commercial and defense markets for AI and ML solutions. We are actively engaged with current and potential customers to execute against these opportunities and convert our growing pipeline into multi-year, multi-million dollar orders. Given our expanded engagements and growing pipeline, I am pleased to announce that we have added Craig Powell as business development executive. Craig served as an armored infantry officer in the Royal Canadian Armored Corps and brings 22 years of experience in the high-performance compute, defense, and commercial markets, having held senior positions at Sistel, L3 Harris, Rheinmetall, High Vision, and Teledyne. We believe his experience will support our efforts to expand sales into the Canadian markets in addition to his primary focus, on supporting sales efforts in the US. Turning to recent progress on the product and program front, at the beginning of 2024, we shipped our first AI transportable compute system for the motorsport industry to legendary motorsport champion Andretti Global. The system includes OSS's 3U SDS GPU accelerated server, powering advanced AI race analytics for Andretti, using Zapata AI's industrial generative AI platform for the cloud and edge called Orquestra. The solution represents a new application of OSS technology in our first foray into the $5 billion motorsports industry. This milestone demonstrates our unique capabilities for powering generative AI technology at the edge. Also at the beginning of this year, we announced the commencement of a multi-year design and manufacturing collaboration for Flight Aerospace's automated flight information reporting system, Edge Family, including its new AFERS Edge Plus. The expanded relationship ensures that flight has access to OSS's scaled capabilities as it launches the aviation industry's first-to-market 5G-enabled avionics solutions. For OSS, the design and manufacturing agreement with flight is valued at a minimum of $6 million over the initial five-year term. In Q4, we received $500,000 in revenue from the new flight contract. We have successfully passed the critical design review and are entering the test phase of the program. We expect to complete testing and expect to begin production and shipment of APERS Edge Plus as early as the second quarter of 2024. This multi-year engagement expands our position in commercial aerospace and further strengthens our technology development and manufacturing platform. This opportunity also underscores our commitment to aviation safety and delivering mission-critical performance. We've also seen progress on several fronts in the defense industry. The Raytheon P8 program has funded multiple development initiatives to incorporate hardware and software technology refresh and upgrades that will extend our product position and lifecycle through 2028. As a result, we expect annual revenue of $6 million in 2024 related to this program, which is at a similar level from 2023. We delivered our first shipments of the new Gen 5 short depth server to Dynetics, a Leidos company, for the C4ISR mobile command centers and to TALIS for submarine sonar and AI processing on a European Navy submarine. In addition, we received a contract amendment to add additional capability for time-sensitive networking, or TSN, to our 360-degree situational awareness solution for the Army Ground Vehicle System Center. This capability adds to the critical timing element required for contested environment operations and is an integrating capability for Joint All-Domain Command and Control, or JADC2, nodes. We continue to focus resources and capital to support our technology roadmap and maintain our strong market differentiation. As I've noted before, a key capability of ours is the ability to bring the newest and highest performing compute, storage, and switching solutions to the market and facilitate the demanding requirements of AIML, sensor fusion, sensor processing, and autonomy. We have seen that a first-to-market strategy is key to our ability to win significant opportunities. As a result, we continue to develop new state-of-the-art products across a range of high-performance compute demand, providing a unique value proposition for our customers in the targeted spaces. In November, we unveiled our latest rugged Gen 5 short-depth server at Super Compute 23, the International Conference for High-Performance Computing. Powered by NVIDIA H100 Tensor Core GPUs and high-performance NVMe storage, the OSS Gen5 SDS addresses the growing demand for more powerful and lower latency, rugged compute, storage, and networking capability at the edge. This new OSS Gen5 SDS server demonstrates our continued leadership in AI computing and high-speed PCIe interconnect technology. We anticipate this hyper-converged data center class computing server will be highly sought after for demanded rugged edge real-time AI applications and is already proving to be the workhorse of the OSS product portfolio. In fact, in February 2024, we showcased our specialized high-performance AI computing solutions at FCOS 2024, the premier naval conference and exposition on the West Coast, where we won the Best in Show Award for our liquid-cooled version of the rugged edge short-depth servers. Since I joined over eight months ago, we have focused on enhancing our management team and board of directors. Recent efforts include, in the third quarter of 2023, we appointed industry veteran Robert Calbaugh as VP of Sales, bringing more than 36 years of award-winning achievement in business development, sales, and marketing in the commercial defense market. Robert's impact is already being seen in our market outreach, increased opportunities, and growth. In the fourth quarter of 2023, we appointed retired U.S. Navy three-star Vice Admiral Michael J. Dumont to the board, bringing background and experience insights into technology and military operations. Mitchell Hurbis was also added to our board, bringing extensive strategic and technical experience as a C-suite executive serving technology and defense industries. Finally, we also appointed Joseph Manko to our board, who is affiliated with one of our largest shareholders and brings extensive financial, capital markets, investor, and governance experience to OSS. All these additions have substantially re-profiled our board and enhanced their impact on supporting strategy, driving growth, and delivering shareholder value. In addition to enhancing our management team and the board, we also have added talent to our growing program management capabilities with the addition of two seasoned professionals who bring over a decade of defense and commercial program management experience. I believe their experience will allow us to pursue even larger programs for development and production in defense and commercial markets. I'm extremely encouraged by the successful ongoing transformation we have completed to our business in 2023. As a result, we entered 2024 with strong momentum supported by a new, highly experienced leadership team, reprofiled board of directors, an enhanced margin profile, and a growing pipeline of significant revenue opportunities that we believe will support our business for many years to come. I want to thank our team for their continued hard work and dedication as we pursue compelling growth strategies aimed at creating lasting value for our shareholders. With this overview, I'd like to turn the call over to our CFO, John Morrison, to review our fourth quarter and the full year 2023 financial results in more detail. John, please go ahead.

Thank you, Mike. Good afternoon, everyone. I am particularly excited by the level of activity underway, the direction we're headed, and the strategies we are pursuing to create value for our shareholders. We began 2023 with two objectives. The first was to substantially replace 18.5 million of low margin legacy media revenue with higher margin AI transportable product revenue. This was necessitated by our media customer moving away from ruggedized equipment to a less rugged cloud solution. Total media revenue in 2023 was 4.8 million, representing a difference of 13.7 million from last year. The second objective we had was to grow Bresner annual revenue. Although OSS strategy was implemented to replace the media business, during the year we experienced a general hesitation by commercial customers to place orders because of economic conditions. We also experienced timing delays in some government programs. This all resulted in OSS being unable to fully replace the lost media revenue in 2023. However, I am pleased to report that Breschner met their annual objective by growing annual revenue by 10.1%. Breschner also improved both margins and profitability despite a challenging economy in Germany and throughout Europe. Our company's business is really comprised of two segments, OSS, which is located and operates in the United States, and Breschner, which is in Munich, Germany and operates throughout Europe. OSS is primarily focused involved in the design and manufacture of high-performance ruggedized edge processing, compute, storage, and connectivity systems. Regener operates as a systems integrator with standard and custom all-in-one hardware systems and components. They also serve as a channel for OSS products to the European and Middle East markets. The following comments are based upon comparison of fourth quarter 2023 results as compared to fourth quarter 2022. For the fourth quarter, we reported consolidated revenue of 13.2 million. Of this, OSS contributed 6.4 million and Breschner contributed 6.8 million, inclusive of OSS product content of 597,000. Consolidated quarterly revenue reflects a reduction of 5.1 million, or 27.9%. Of this amount, OSS had a decrease of 4.9 million, or 43.5% of OSS quarterly revenue, of which approximately 3.1 million of the decrease was attributable to a revenue reduction from the former media customer, and from whom we do not expect any further revenue. Breschner had a decrease of $175,000 or 2.5%. Consolidated gross profit in the fourth quarter decreased $544,000 to $4.4 million, with overall gross margins improving and increasing to 33.7% from 27.3% due to decreased media revenue costs and a shift in product mix to our higher margin rugged edge processing products. The gross margin for OSS business improved 14.5 percentage points to 45.9, which is attributable to the absence of lower margin media revenue and cost and the higher mix of the rugged edge processing products. Bresner's gross margin percentage improved 1.6 percentage points to 22.2% largely due to product mix, the sell of higher margin OSS products, and having sought-after products readily sold at a premium. Overall, quarterly operating expenses increased 3% to $4.8 million, which was attributable to additional CEO transition and board reprofiling costs. Loss from operations totaled $331,000, compared to income from operations of 353,000 in the same period in 2022. Net loss on a GAAP basis was 278,000 or one cent per share as compared to a net loss of 3.3 million or 16 cents per share. Net loss in the fourth quarter of 2023 included a provision for income taxes of $42,000 as compared to a tax provision of 4.1 million in the fourth quarter of 2022 that included a significant increase in taxes being attributable to a write-down of our deferred tax asset of 3.8 million in 2022. Now, non-GAAP net income for Q4 2023 was $177,000, or one cent per diluted share compared to non-GAAP net loss in the prior year of 2.7 million or 14 cents per diluted share. Adjusted EBITDA, a non-GAAP metric, was favorable $353,000, a decrease from the adjusted EBITDA of 1.6 million in the prior year. The following comments are based upon a comparison of the annual results for 2023 as compared to the annual results for 2022. Consolidated revenue was down 11.5 million or 15.9% from 72.4 million to 60.9 million, predominantly due to a decrease of 13.7 million in media revenue. OSS had revenue of 28.4 million $28.8 million, or 47% of total revenue, and Bresner had a revenue of $32.1 million, or 53% of total consolidated revenue. OSS experienced a decrease of $14.5 million, or 33.4%, which decrease was offset by an increase by Bresner of $2.9 million, or 10.1%. During the year 2023, revenues for OSS were fairly evenly balanced between commercial and defense applications. During the year 2023, consolidated gross margins were 29.5% versus the prior year of 28.2% due to less lower margin media business being offset by an increase in higher margin AI transportable products. OSS gross margin was 35.6% as compared to 32.7, an improvement of 2.9 percentage points. Pressure margin was 24% compared to 21.5. Excluding the goodwill impairment charge of $5.6 million and CEO transition and board reprofiling costs of $1.7 million, our operating expenses actually decreased 1.5% from the prior year. Other income and expense, excluding a one-time government-funded employee retention credit of $1.7 million, resulted in net other income of $417,000 compared to $626,000. Net loss was $6.7 million, or a loss of $0.32 per share, compared to 1.7 million, which was inclusive of the 1.7 million employee retention credit compared to a loss of 2.2 million or a loss of 11 cents per share in 2022. Non-GAAP net loss was 415,000 or a loss of 2 cents per share as compared to a loss of 175,000 or one cent in 2022. Adjusted EBITDA, a non-GAAP metric, was positive, $1.1 million as compared to $5.2 million in 2022. Loss before the provision for income taxes on a pro forma basis, which excludes the impairment of the goodwill, the CEO transition and board reprofiling costs, and the benefit of the employee retention credit results in a pro forma loss before income taxes of $165,000 as compared to income before taxes of 2.2 million in the prior year. Now, looking at the balance sheet, on December 31, 2023, cash and cash equivalents totaled 4 million with short-term investments of 7.8 million for a combined total of 11.8 million. Compared to the prior year, this represents a 1.4 decrease of $1.4 million, which represents cash being deployed in working capital. As the company continues to transition and evolve its business from being largely dependent on mediated bribed revenue, the company will operationally focus on maximizing gross profit contribution. In the near term, this may include accepting lower margin business that incrementally contributes to gross profits, but may inconsistent be inconsistent with our long-term objective of increasing our consolidated gross margin percentage. The objective of this effort is to have sustainable cash flow as the company bridges its revenue model. Looking forward to the first quarter of 2024, influenced by seasonal and U.S. government continuing resolutions, we expect revenue of approximately $12.5 million, which represents a deep which represents an approximate 5% sequential decrease from Q4 2023, and a year-over-year decrease of approximately 4.3 million, or 25%. Of that decrease, 1.5 million of that is expected decline, which is attributable to loss of media revenue. This completes our financial review for the quarter. Now, with that, we'd like to turn the call back, turn the call and open up to your questions. Operator, Ina?

Thank you. Ladies and gentlemen, we will now begin the question and answer session. Should you have a question, please press star, follow the one on your telephone keypad. And should you wish to cancel your request, please press star, follow the two. If you're using a speakerphone, please leave the handset before pressing any keys. One moment, please, for your first question. Your first question comes from the line of Scott Stern from Roth MKM. Please go ahead.

Good afternoon. Thanks for taking my questions. Nice to see the continued progress on the opportunity pipeline as well as the gross margins. Maybe that's a good place to start. On the gross margins for the fourth quarter, John, I'm wondering are there any one-time benefits that you saw on that? I think you said the number was 45%, 46% in the core OSS business. Can you help us understand from a mixed standpoint what's going on and how we should think about the progression throughout 2024. You also had some comments in terms of maximizing gross profit contribution. So it seemed to imply that there's going to be some volatility there. Can you kind of walk us through that a little bit?

Thank you, Scott. So in the fourth quarter, it was very heavily weighted towards AI transportable products, specifically to the defense industry and in the sale of our data storage units, which tend to have a higher margin. So that's what skewed that in the fourth quarter. With respect to ensuring that we maintain our cash position, there is some pass-through revenue that we're going to be accepting on an agent basis that has low margin but provides good cash opportunities for us.

Gotcha. Okay. Thank you. And, Mike, in terms of the opportunity pipeline, it seems like it's continuing to build. the message that you're getting out there in terms of AIML and sensor fusion continues to seem to get traction. I'm wondering if you could help us frame near term when we start to see decisions getting made, how that will start to filter into the results. It sounds like it's more geared towards 2025. And as part of that, I'm wondering if you could couple in the current discussion around the continued resolution around the budget and how that impacts you guys over the course of 24.

Yeah, sure. Thanks, Scott. Yeah, we've continued to grow and expand that pipeline. And really what it is, is really aligning, especially in the defense market, aligning our opportunities up with existing platforms that are going through tech refresh cycles or upgrades, so that we're present for those that help develop and determine our timing. And then also on new starts, being part of those which are generally the longer runway approaches to those. We'll use 2024 to build back through the lost media revenue, replacing with commercial and defense opportunities. I'm expecting the second half of the year, unless the media business, right, will start to see the momentum really start to pick up. And for us, that whole effort will all be about the pipeline conversion, right? We've got these opportunities out there. Now we need to convert them and potentially move them to the left. And that's why I spoke, especially in the defense market, where we have opportunity to use our lobbying efforts to help, you know, move and make sure programs are funded and move out on time. And then the second part of your question was what again, Scott?

Sorry, related to the budget resolution.

Oh, the budget resolution. Yeah, so while a significant amount of our revenue isn't tied up to government new starts, which can't start under a CR, We do have a couple that currently that we have out that are being held up by continuous resolution. Not a significant number, but still some nonetheless. I just think I got a note from our lobbyist today that the last bit of CR defense budgets, we're going to make it through approval. So that should untie the logjam. Now, we'll have to go through the period that usually follows that where the money moves and then the acquisition professionals have to put it on contract. That is not a fast process. pace either itself. It'll take some weeks and months for that to flow through, but it's positive that that's made it through. And this is something that we'll continue to deal with in quarters and years to come. But it's not uncommon anymore in the defense market. And we have pipeline and opportunities. We'll plan for that and tend to try to update our forecasts around that also.

Okay, great. And one last one, if I could. Just in terms of moving the AI strategy along I'm not sure if you mentioned at all about various software partners and go-to-market strategy on the front. I'm wondering if you could articulate where we stand on that front now and how that's looking throughout the course of 2024. Thanks. Yeah, thanks, Scott.

So, I mentioned last year during 2023, we had expanded our outreach to multiple AI software companies, really around two reasons. so that we had opportunity where our customers needed it to provide a more integrated solution rather than just a pure compute or storage or switching solution. And we wanted to establish those partnerships to provide some more discriminating capability to our solution. In addition, as we started engaging with a lot of these AI software companies, many of them were looking to find ways to standardize on hardware so that they could sell their software directly. So we wanted to open up the pipeline for those discussions where we could become a standard provider to some AI software companies. We have expanded that reach and continue to do so. Over the course of 2024, I think we should see a couple opportunities where we have aligned with a couple specific companies and some capture approaches and some collaborations in the market for both commercial and defense that we should start to see the fruits of some of those labors. I noted one in the earnings call that we're doing with Zapata AI through work with Andretti. There's some cross-correlation of some defense markets and prime contractors who are very interested in a lot of the work that Andretti and Zapata are doing in vehicles and data analytics. And they're all working that off of our compute systems. So similar to that, we've got multiple instances like that across both markets that we think could help build future solutions.

Great. Thanks so much.

Thank you, Scott.

Thank you. And your next question comes from the line of Brian Kinslinger from Alliance Global Partner. Please go ahead.

Great. Thanks so much for taking my questions. In the defense market, it's long been characterized as having long sales cycles, and you've talked about the late. Both of those are common. You mentioned you expect a return to growth in the second half of the year. Maybe if you could talk about how you think about sales, cycles for some of your new products and just some of your products in general, and how is that contemplated in expecting a return to growth in the second half of the year?

Sure. Thanks, Brian. So on the commercial side, with our standard product approach in a number of areas, you know, those turns tend to come a little bit quicker. We're seeing some increased activity in that composable cycle. market in Composable Data Center, a market that I was talking about. The contract, the five-year agreement with Flight was a good move for us. They were advancing a new product line based on projected future growth AC. So that was another one that we'll be developing a product and roll through to them. The defense side, it will continue to leverage our high technology readiness level products. That gives us a really good capability where we see a technology refresh cycle or upgrade opportunity on any vehicle or platform for us to be able to readily bid a highly mature and readily available solution. So that gives us some competitive edge in any of those competitions or allows us, if we have a unique discriminating capability, to justify a sole source acquisition to OSS. So those cycles, again, will prove to be short or long depending on when the vehicle upgrade cycles are. But we've begun to plot those into the timing into our pipeline so we can start to see those. And now we're starting to see the picture start to paint on when we'd expect the opportunities to come to market, which is why we're feeling the second half of 2024 we should start to see – You'll start to see some early bookings, wins, and then that will roll into revenue increases. So as we start to exit Q3 into Q4, we should see consolidated revenues increase over where we have been the last two quarters.

Got it. Okay. And then you've been there now for, I don't know, what is it, five, six months?

Nine months.

Nine months. Wow. So now that's plenty of time to take a look and evaluate the business of where you need to increase your investments to drive growth. Maybe talk about new product opportunities. You already talked about your increased pipeline. How do you bid on more, so to speak, or capture more of the market? Maybe anywhere you see investment opportunities to capture that.

Yeah, Brian. So as John mentioned, right, and part of the reason to bring in the – Lower margin programs would help to make sure we could facilitate keeping our products line going forward and keep stable cash in the program and the company. So we have a number of product development elements planned for the year that will continue to keep us on the forefront of compute storage and switching technology. We did just launch our Gen 5 SCS and our Gen 5 storage products. So those are both new in the market, so they'll have a product lifecycle run here for a bit of time. We'll be able to leverage that. And then the second half of your question again, Brian, was on?

Just on proposals, like the bidding proposal, how are you going to, with that growing market opportunity, go after more business, bid on more worth, so to speak?

Yeah, no, I appreciate that. So that's part of the reason why we take our pipeline and we assess the probabilities as we do so we can determine where to focus our resources on our highest probability of winning. And so that actually has been quite useful for us. We've kind of restructured and reprocessed how we use some of our tools internally to help facilitate getting more proposals out the door more efficiently and more effectively. And then, as I noted, we had the opportunity to add Craig Powell to our sales force. That will significantly increase not only our opportunity growth, but more ability of a seasoned veteran in terms of being able to respond to and conduct captures on programs in the defense market. And then, you know, outside of that, you know, other areas in terms of just general product line growth, there's interest in – Moving to some of the international defense and commercial opportunities, Craig will provide us the opportunity to expand additionally into Canada with an existing sales capability that we have. So I think we're well situated with priorities for our resources and a team to be able to tackle it.

Okay.

Thank you. Thanks, Brian.

Thank you. And your next question comes from the line of David Williams. from Benchmark. Please go ahead.

Hey, good afternoon, and thanks for letting me ask the question. Sure. So, Mike, maybe start off on the funnel. You've got over a billion-dollar pipeline here that you talked about. Can you help us understand how you're qualifying those programs and how you expect that to maybe materialize over the next several years? What is that conversion rate and just maybe what does it take to convert and how you think about that funnel overall?

Yeah, thanks for your question, David. So what we've done is, and that pipeline number is a five-year view. So what we do is we identify opportunities. We assess it in two probabilities. The first probability is what we call PGO, and that is the likelihood that an opportunity will emerge and actually go to acquisition or to the market, something that we can't readily control, but we can monitor. And we can influence, especially on the defense side, as I mentioned, lobbying efforts in Congress, our engagements with senior defense executives can help influence the funding and the timing of those efforts. The second probability we factor the pipeline by is probability to win. That is something we control. That determines, right, our capabilities, products, and services that we can deliver for solutions that lead us over our competitors. When we multiply those two together, we get what's called a probability of award. And it really sets a level at which we know above a certain level of percentage that it's highly likely that we should win, and we increase our efforts there to pull those forward. And then there's a mid area where we can determine whether the effort needs to be more on influencing a high probability of win product to emerge, or if we have to increase our P to win on a program that will definitely emerge, and we can identify resources, assets, or support to go do that. And then anything below that generally will be something we either have to determine, is it a future roadmap capability we need to develop? Is it a market we're fully interested in working through? And those tend to be longer-term views of how to move those probabilities of award up and higher in assessment. Because of the way we've got started, part of 2023 and 2024, we're doing a fair amount of positioning into those markets. The nearer-term ones, as I mentioned, were about getting into the upgrade cycles and defense customers and then finding commercial customers in similar situations who were looking to transition to higher-end process compute and storage. And then additionally, what it's done in terms of conversion, is let us identify future starts that would be in the future for which you want to start early on the capture so you can influence requirements to increase your probability of win. So we've now transitioned those into captures and campaigns inside the company. That will increase our focus where we go on those, and we'll be looking to capitalize and converting that pipeline to opportunity. And that's really where our measure will be on seeing the bookings, converting to revenue, and converting that pipeline.

Great. Thanks for the color there. And then maybe, John, if you could talk about your inventory levels. You talked about cash just now and having the working capital and maybe taking some lower margin business. But you've got, it looks like, a pretty significant days of inventory. How do you think about working those down and just that working capital that you could return for other investments? Thank you.

Thank you. Obviously, that's always been a concern of ours as we built inventory during the COVID period and later on as companies required us to have sometimes a 52-week lead time and demanded certain minimum order requirements in order to maintain pricing. So during that period of time, it was important for us to secure inventory, and we made certain non-cancellable, non-returnable commitments for inventory. That inventory still continues through this day to come in. We have still approximately about 3.4 million of inventory that will be coming in the door for which the orders were placed in 2001, 2002. However, we have gone through, we have analyzed all of that inventory. We believe that we will be able to actually free up about $2 million in working capital this year through the current plan that we have. We believe all of the inventory is sellable. We do not see any of the inventory being designed out, nor do we see it in a situation of being obsoleted or obsoleted. So yes, we do acknowledge that we have more inventory on the balance sheet than we would like, but we think we'll be able to free up about $2 million of that as we go throughout the year.

and bring it down to a more manageable level. Thank you. Thanks.

Thank you. And your next question comes from the line of Eric Martinetti from Lake Street. Please go ahead.

Yeah, I wanted to clarify the contribution from your media customer that's no longer with you. I have for 2022, I had them at 18.8 million. And then in 2023, I had them at 5.1 million. Are those two numbers correct? 18.5 and 4.8. 18.5 and 4.8. Okay. All right. And then, go ahead. Yeah, it's 18.504.

4858. Okay.

And then the guide for Q1, and I would expect the expectation for 2024, there's nothing in there for that media customer?

No, sir. We would not have any ongoing revenue at all.

Okay. And the second question is around the gross margins. It's really good to see that step up. not only for the full year at 130 bps, but for Q4, just a big step up with the 640 bps. Why should we be thinking about either address a full year basis for 2024 or maybe even just Q1? You know, a year ago, you had a 30.2% gross margin in Q1. Should we be expecting something similar, something better? What can you tell us about gross margin?

Gross margins will continue to grow just as a consequence of having lower margin business from the immediate customer go away. They were running about 19.7% gross margin. We have been replacing that consistently with sales of between 30% to 40%. That's pretty much our bottom line target is 30%. It really is different when you're looking at mix. Depending on how much of our data storage product we're selling in any given quarter, that tends to have a higher margin, which is actually what we saw in the fourth quarter. We had nearly $2.5 million of data storage and data storage replacement parts, which are very profitable for us, drive that margin. Long-term, we believe that we're going to be more consistent this year with what you saw in 2022 of the 32% to 33% margins on a consolidated basis.

Okay.

And then last question, really more on the product side. At a high level, Mike, what is the lag time between somebody like NVIDIA kicking off their latest and greatest chips and your customers expecting you to have designed that in and, you know, have it available for shipment for them. I'm talking specifically to this week's announcement regarding their new Blackwell chip GPU versus the prior generation, the Hopper. What's the lag time there for your product design?

Yeah, Eric, generally inside of a year, less than a year, we can go from product availability from NVIDIA to our product or the short-depth server with storage added. We can move to available product inside of a year. Now, we'll also have to work the lead times. There's a lot of major companies out there who are buying up the GPUs. So our customers are aware of that. and so actually we unique to probably OSS in this respect is because of our expertise and engineering capabilities we're actually able to sit down with the customer and work through two scenarios if they have a clear demand and desire for the newest and the latest and the greatest and they understand the lead times on that we can do that on the defense side we can use their defense ratings to help accelerate the supply chain on their orders. Alternatively, what we've done in some cases is we've worked with customers on what their exact AI or sensor fusion, sensor processing implementation is, and we'll help them with their compute, storage, and switching needs and performance parameters. And in some cases, we've actually been able to recommend alternative NVIDIA GPUs whose lead times might be measured in 6 to 12 weeks and we can still implement capability that exceeds their demand. We can offer them a faster lead time to get either an initial capability that they could upgrade to later with the higher-end GPUs, or if they're happy with that selection, then they can carry on with that configuration.

Got it. Thanks for taking my questions.

Thank you, Eric.

Thank you. And your last question comes from the line of Joe Combs from Noble Capital. Please go ahead.

Good evening. Thanks for taking the questions. I wanted to go back for a second to some of this lower margin pass-through revenue you've talked about. Did any of that show up in the revenue for the fourth quarter or in any of it projected for the first quarter, 12.5 million guidance?

There was nothing in the fourth quarter, and there is nothing right now planned or included in the guidance number in Q1.

Okay. Pardon me.

Thanks for that.

We will disclose it separately, so we're going to be very visible as to what those numbers are. Great.

And on the pilot program for the deployable ground station, you mentioned that you think you can get some future production orders from that. And I was wondering, maybe you could talk a little about, you know, the timing you think of those production orders and the size that could possibly be there in terms of revenue.

Yes, Joe. So in two cases, right on the kind of the ground station one where we're shipping our compute capability, these initial forays as they get instantiated and used are in the mid-hundreds of K range in terms of value. We would expect that follow-on orders could be double that for a couple years in that implementation. depending on how it grows into other similar type programs within the company or others, right? That's where we look for the add-on effect. The liquid immersion cooled one, also very similar in terms of application. That would be another one. That first one, a couple hundred thousand dollars for the first foray. But we would expect implementations, you know, double that, maybe a little bit more than double that. after they've gone in and validated their first fielding, if you will, happy and comfortable with the solution, then we would expect to see multiples of those values later this year, 2025, 2026. Great.

And just one more quick one for me. I know the last quarter you talked about you got the site facility clearance. I'm just wondering, have you been able to see that clearance turn into any new opportunities for you or anything particular more that you can tell us about that?

Right. It is opening up our opportunity for placement right now. So what it's allowed us to do is on some existing programs where we've just been providing a product to fulfill a compute requirement, we've been able to go in now and have a broader discussion on the operational problem that the platform is trying to solve. And that provides us a greater understanding of what the architecture on the platform is doing. And then that allows us now to be able to recommend a broader implementation of OSS products that could help facilitate If you were on a vehicle that was widely a sensor-integrating vehicle, the ability to move our processing up to the sensor for rapid processing at the sensor, that data needs to come back and be fused together into a common picture. Again, that's another need for high-end processing. And then if there's any generative learning off of that or autonomy based off that, yet another level of compute. So right now it's open that up. In addition, as I mentioned, a couple of classified programs we've delivered to. In the past, we would have just delivered to those set of requirements. Now we can actually figure out and understand, as I said, more broadly what's going on in the program. And then a couple prime contractors that we've spoken to in the last quarter have opened up access to us into their classified teams that are pursuing programs. So now we're starting to field initial forays into our capability, and we're able to respond to those now in a classified environment.

Great. Thanks for that. Appreciate it. Thanks, Joe. Thank you.

Thank you. We have no more questions. I'd like to turn the conference back to our speakers for closing remarks.

Thank you. Ina, and we appreciate having enjoyed sharing our latest progress with everybody today. I believe the company's strategy is solid and the future is bright. OSS Management looks forward to speaking with you again in May, if not sooner. In the meantime, as always, feel free to reach out to John or myself at any time. With that, let's go ahead and wrap up the call. Ina?

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 the statements in the presentation that are not description of historical facts are forward-looking statements. These statements are based on companies' current beliefs and expectations. Such forward-looking statements include, for example, those regarding the company's expectations for revenue growth generated by new products, penetration of the defense and AI transportable sectors, future changes to its business objectives, design wins, amongst other things. 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. Outshore 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. Military conflicts, global pandemics or other disasters or public health concerns and economic instability in regions of the world where we have operations, customers or source material or sell products may affect such market. Our operating results could be negatively impacted by inflationary pressures supply chain constraints, increased interest rates, US government, continuing resolution, or other economic conditions. 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. If we are unable to offset loss of revenue in our prior media and entertainment space with other business, our operating financial results may be adversely affected. 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 or 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 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 operations subjects ask to additional risk that can adversely affect our operating results and financial condition. We may not be able to accurately report our financial results and other risks as described in our prior press releases and in our filings with the Securities and Exchange Commission or SEC, including under the heading Risk Factors in our annual report on Form 10-K and any subsequent filings with the SEC. You are 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 day hereof. All forward-looking statements are qualified in their 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 replay starting later this evening through April 4, 2024. Please refer to today's press release for dial-in and replay instructions available via the company's website at ir.onestepsystems.com. Thank you for joining us today. This concludes our conference. You may disconnect.