One Stop Systems, Inc.

Good day and welcome to the One Stop Systems fourth quarter 2024 conference call on webcast. At this time, all participants are in the listen-only mode. Later, you will have the opportunity to ask questions during the question and answer session. As a reminder, this call is being recorded. As part of the discussion today, the representatives from OSS will be making certain forward-looking statements regarding the company's future financial and operating results including revenue growth, as well as business plans, objectives, and expectations. These statements are based on the company's current beliefs and expectations and should not be regarded as a representation by OSS that any of its plans or expectations will be archived or achieved. Please be advised that these forward-looking statements are covered under the safe harbor provisions of the Private Securities Litigation Reform Act of 1995 and that OSS desires to avail itself of the protections of the safe harbor for this statement. Please also be advised that actual results could differ materially from those stated or implied by the forelooking statements due to certain risks and uncertainties, including those describing a company's most recent annual report on Form 10-K, subsequent quarterly reports on Form 10-Q, and recent press releases. Please read these reports and other future filings that OSS will make with the SEC. OSS disclaims any duty to update or revise its forward-looking statements, except as required by applicable law. It is now my pleasure to turn the conference over to OSS President and CEO, Mr. Mike Knowles. Please go ahead, sir.

Thank you, Ludi. Good morning, everyone, and thank you for joining today's call.

As I mentioned on prior calls, we're working through a multi-year plan to transform the company and pursue growth opportunities driven by the increasing adoption of artificial intelligence, machine learning, sensor processing, and autonomy. While we are still early in our plan, our performance throughout 2024 highlights the progress we have made over the past two years repositioning the company for long-term success. In fact, OSS returned to consolidated year-over-year revenue growth for the fourth quarter, and sequential consolidated growth for every quarter in 2024. This important milestone is driven by strength across both of our operating segments, higher customer-funded development revenue, and a continued focus on converting our OSS segment's $1 billion pipeline to sales. As efforts to reposition the company for revenue growth gained momentum during 2024, we also made certain adjustments to legacy inventory and program-related issues. These efforts are aligned with our focus on improving operational efficiencies and driving profitability. Dan will provide additional color on these changes in his prepared remarks. With this introduction, I want to use my time today to review the progress we made in 2024 and highlight several near-term and longer-term opportunities we are pursuing that we believe will support the next phase of our growth. Looking at the progress of May 2024, from a revenue perspective, we experienced consolidated growth on a sequential basis in every quarter throughout the year, driven by growth in the OSS segment. As a reminder, a former media customer contributed $4.8 million to OSS segment revenue in 2023 that did not occur in 2024. Throughout 2024, we experienced greater adoption within our OSS segment from both defense and commercial end markets. These trends helped grow our customer base and broaden our customer concentration during the year. OSS segment growth in our defense market was from new and existing customers. We experienced demand from several programs within the U.S. Army, a renewal for the U.S. Navy P-8 program, a new HPC solution for a U.S. intelligence agency, and a new design win with a leading defense contractor in Asia for an autonomous maritime application. In our commercial end market, we saw customer demand for our solutions come from several sectors, including motorsport, autonomous trucking, commercial aerospace, and importantly, the data center markets. Growing customer-funded development revenue was an important objective this past year, and I'm pleased that we were able to increase this revenue stream by 118% in 2024 to $3.7 million. While still small numbers now, this customer-funded development is a great indicator that could lead to much larger revenues if our products are adopted in large-scale, multi-year programs, as it establishes OSS in an incumbent position on key military and commercial applications. From a booking standpoint, we lifted our annual book-to-bill ratio to 1.14 for our OSS segment, which includes a delay in certain orders in the fourth quarter, but we expect those opportunities to manifest through 2025. We believe that uncertainty related to business and government spending is likely to continue throughout the first half of 2025, but our embedded position remains strong with our customers, and the programs we have pursued are aligned with our customers' priorities. As a result, we believe it is not a question of if, but when these orders are placed. And we currently expect the 2025 annual book-to-bill ratio for our OSS segment to be on the order of 1.2. We plan to update investors on our book-to-bill ratio on an annual basis going forward. Overall, despite the current environment in Washington, we have seen market interest in our solutions strengthen over the past year as we continue to respond to increasing requests for information, proposals, and white papers. Across our global and defense and commercial markets, customers are looking for technology partners like OSS to support their expanding needs for rugged enterprise class compute solutions. Driving these trends are the emerging requirements for artificial intelligence, machine learning, autonomy, and sensor processing at the edge. The company's best-in-class hardware and software platforms bring the latest data center performance to harsh and challenging applications that we believe will allow OSS to take advantage of current and future demand trends. As we look to 2025, we expect certain development programs that we worked on during 2024 to transition to orders and sales. This includes commercial applications in data center, healthcare, and aerospace markets, combined with multiple opportunities across the U.S. Department of Defense. We have several orders that we believe will close shortly. On the commercial side, we have a new order from a healthcare customer that is expected to develop into significant production orders over the next five years. On the defense side, we are broadening our platform application with several defense contractors. One of these expanded relationships is expected to lead to a new program win with production orders in 2025. I look forward to updating investors on these near-term opportunities as they develop. I also want to highlight the progress we made in 2024 on potentially transformative opportunities underway across our commercial and defense markets. While none of these opportunities are a given and remain subject to fielding and funding decisions, they do represent transformative opportunities for OSS segment solutions. In the commercial space, the Composable Infrastructure for Data Centers represents what we expect to be a $200 million multiyear pipeline opportunity for OSS. Composable infrastructure is an architecture that connects compute, storage, and networking resources to optimize applications and improve performance. We are working with leaders in the space that have mandates from their end customers to increase the density of GPU processing capability within data centers. This specialized application supports users that need data center capabilities near their operations but lack the footprint to build a large-scale data center, representative of universities, corporations, organizations, or public service entities. The acceleration systems we built for this application utilizes our expertise delivering high GPU concentration solutions that effectively manage temperature, power, and optimize performance. These solutions also leverage our discriminating leadership in PCIe technology, which is a high-speed interface that connects computer components such as expansion cards and storage devices to a motherboard. In 2024, we announced an initial contract for 100 accelerator units with a customer. We expect our best-in-class solution will expand to multiple customers in 2025, leading to increased revenue potential for 2025 and beyond. On the defense side, we successfully delivered a rugged, 360-degree situational awareness system to the U.S. Army for their assessment and testing. This system provides military-spec, low-latency video processing to support on-vehicle video dissemination. The Army will test and assess the system for application to their combat vehicle inventory which we currently expect to occur sometime in the second half of 2025. OSS is uniquely positioned for this application as we developed and built a ruggedized compute visualization system using OSS's PCIe Gen4 switch fabric technology and NVIDIA Jetson AGX ORN system on modules. If as a result of test and assessment the Army chooses to fund and field the capability across one or multiple combat vehicles, classes, We estimate the value of such an opportunity could exceed $200 million in production orders over a three- to five-year period, with additional opportunities for follow-on logistics, support, and tech refresh options. Our product solution has also gained the attention of multiple defense prime contractors in the combat vehicle market, driving requests for information and proposal that would align with the Army opportunity. While it will take time for these opportunities to formulate and develop into potential production orders, We are working hard with our customers and Congress to ensure the fielding of this capability is funding and realized. The composable infrastructure and Army visualization programs will have important milestones over the next two years, and I look forward to providing updates in future calls. As we look to 2025, we are off to a good start in both segments and anticipate a projected consolidated revenue of $59 to $61 million for the full year of 2025. This includes inspected OSS segment revenue of approximately $30 million, representing over 20% year-over-year growth in the OSS segment. In addition, the company expects to be even a break-even for the full year of 2025. We expect revenue and profitability to improve at a higher rate in the second half of 2025 based on current trends and our expanding sales pipeline. While we expect some near-term volatility associated with budget delays and uncertainty related to impact tariffs we'll have on the economy, We feel good about our financial position and the potential for 2025. We believe we have the right products, the right team, and the right strategy in place to capture significant opportunities across defense and commercial markets as customers look for technology partners like OSS to support their expanding needs for rugged enterprise class compute solutions. With this overview, I'd like to now turn the call over to Dan. Dan?

Thank you, Mike, and good morning to everyone on today's call. I joined OSS in November of last year, and as I've gotten to know the company, I've been impressed by the differentiated technology, by the energy and dedication of the team, and by the robust opportunity pipeline. As Mike mentioned, in 2024, we adjusted certain legacy inventory and program-related issues as our transformation strategies gained momentum. With these adjustments behind us, we remain focused on driving growth increasing our operational efficiency and driving profitability. We incurred two main charges in 2024. First, OSS took a charge during the fourth quarter of 2024 related to contract losses of $1.2 million for incurred and anticipated costs to satisfy performance obligations on a customer-funded development contract that was entered into in 2022. While this charge negatively impacted our 2024 financials, Our efforts on this development program position us to compete for large multi-year production opportunities in 2025 and beyond. Second, OSS incurred $7.1 million of inventory charges in 2024 related to obsolete and slow-moving inventory associated with the transition of the company's business model and operating strategies, as well as slower adoption and movement in certain commercial and defense edge compute markets. These one-time charges reduced reported gross margin, net income, and adjusted EBITDA for the fourth quarter and full year of 2024. Importantly, we believe we have taken all appropriate measures, and we do not expect any further significant adjustments to costs related to the customer-funded development contract or to our inventory outside of normal historical trends. Turning to our fourth quarter financial results, for the fourth quarter, we reported consolidated revenue of $15.1 million. The 15.1% year-over-year increase in consolidated revenue was a result of double-digit growth across both our OSS and Breschner business segments. Consolidated gross margin in the fourth quarter was 15.7% compared to 33.7% in the prior year quarter. Gross margin excluding one-time charges was 23.8% compared to 33.7% in the same period last year. This decline reflects a less profitable mix of revenue in the quarter. We expect our consolidated gross margin to return to our target range in the low 30% in 2025 first quarter. On a segment basis, gross margin for the company's OSS segment for the fourth quarter was 9.4% compared to 45.9% for the same period a year ago. OSS segment gross margin, excluding the one-time charges, was 26.8% compared to 45.9% for the same period a year ago. This decline reflects a less profitable mix of OSS segment revenue. We expect OSS segment gross margin to improve in the first quarter of 2025 to our target range in the mid-to-upper 30% range. The company's Bresner segment had gross margin percentage of 21.2%, a one percentage point decrease from the same period last year. Total fourth quarter operating expenses increased 15.1% year over year to $5.5 million. This increase was predominantly attributable to increased general administrative costs related to planned marketing, sales, and program management investments that we made during the course of 2024. For the fourth quarter, the company reported a gap net loss of $3.1 million, or $0.15 per share, compared to a net loss of $278,000 or $0.01 per share in the prior year. It is important to note the GAAP net loss in the quarter included the $1.2 million one-time charge mentioned earlier. The company reported a non-GAAP net loss of $2.6 million or $0.12 per share compared to a non-GAAP net income of $219,000 or $0.01 per share for the same period last year. The 2024 fourth quarter net loss and non-GAAP net loss included the $1.2 million in one-time charges related to a loss on the contract that we entered into in 2022. Adjusted EBITDA, a non-GAAP metric, was a loss of $2.3 million, which included the above-mentioned $1.2 million in one-time charges compared to an adjusted EBITDA of $322,000 in the prior year fourth quarter. Turning to the balance sheet. As of December 31, 2024, OSS had total cash and short-term investment of $10 million, no borrowings outstanding on our $2 million revolving line of credit, and a consolidated balance outstanding on our term loans of $1 million. For the 12 months ended December 31, 2024, OSS used $108,000 in cash from operating activities compared to a use of cash of $440,000 for the 12-month ended December 31st, 2023.

This completes our prepared remarks. Operator, please open up the call to questions.

Thank you. Ladies and gentlemen, we will now begin the question and answer session. To ask a question, you may press the star followed by the number one on your telephone keypad. To withdraw your question, you may press the star followed by the number two. Once again, please press the star one to join the queue.

One moment, please, for your first question. And your first question comes from the line of Brian Kinslinger with AGP. Please go ahead.

Great. Thanks. Good morning. I wanted to start with the gross margin, which you addressed, but excluding the one-time charge that, like you mentioned, the OSS core segment gross margin was pressured, and you mentioned this is based on the mix. This also happened in the second quarter, I believe. So first, What was it about the mix? What is the lower margin revenue that's generated in Core OSS? And what gives you the confidence based on your comments that in the first quarter and maybe for 2025, you'll see those mid to higher 30% gross margins for that segment?

Thanks, Brian. I'll get started. Mike can jump in with any color. So for the OSS segment in particular, you know, especially given our scale, We do see variability in gross margin based on mix of products. We saw that in the 2024 fourth quarter, as you pointed out, as we shipped some of that lower margin work. You know, of course, that works both ways. In Q3 of 24, OSS segment gross margins, excluding the inventory charge, were about 43.2%, so well above that kind of target range in the mid-30s. So I really look at it on a full-year basis, you know, for the OSS segment. Our full year 2024 gross margin excluding the inventory and contract loss impacts was about 36.4%, and that's compared to 36.5% in 23, so very stable in that mid-30s range that we target.

You know, as we look to... Is it hardware pass-throughs? I mean, you have quite valuable services and products So I'm curious what drives it lower. Is it pass-through revenue that contractors have?

Yeah. So, I mean, we have both. We have some customer-funded NRE that certainly with, you know, the one-time impact impacted gross margins in the fourth quarter. But we also have, you know, a pretty wide variety of products, some of which are higher margin, some of which are lower margin. And in the fourth quarter, we just saw more of those lower margin products shipping. Okay.

Okay. And then it sounds like you, the company, which I'm sure the industry too, is experiencing order delays and you expect that'll persist in the first half of the year, if I heard that right. We've got Doge, we've got the natural budget delays. Maybe talk about how this may or may not have changed your weighted pipeline that you provided last quarter and also what's addressable in 2025.

Yeah, Brian, thanks. So, interestingly enough, I was actually just on the Hill last week with the House and the Senate working on a 2026 budget. And so, kind of really two interesting sides of the coin here. On the technology side, you know, we're seeing even increased momentum and interest in transitioning commercial technologies into the Department of Defense. especially in this area of artificial intelligence sensor products. The opportunity to take high technology readiness level products and move them onto existing platforms to increase capabilities, something that's greatly aligned with the current administration and within the services. So we continue to see a lot of willingness and interest in the kinds of products and capabilities that OSS can deliver. As you did mention, We are seeing as a result, you can see just last Friday, they passed a continuing resolution, not a full budget. You know, that has impact in the way that the department spends and how they place orders. So we're seeing stability in the intent and where the purchases are going to be, but the timing and how that will be executed will be affected by how they work continuing resolution. There's some informal discussion that a defense budget may still be passed in the coming months, even though that they have a full year continuing resolution. So we'll continue to monitor those. And then as a effect of DOGE, We're still seeing our end customers and the DOD procurement offices are moving through. There's a bit of confusion and slowness in there as they're working through their internal requests back through that process. That is causing some delays in awards. But we still have insights. Communication lines are still open. We can still track where things are. We're just having to manage through the process and As Dan noted and I noted, as we're looking at 2025, you know, we'll see a little bit broader pickup in the second half of the year as a result of that. We'll account for anticipated delays here, Q1, Q2, on some of these defense orders.

So do you think the addressable pipeline for 2025 is still around $200 million, which I think you mentioned earlier? total was a billion and addressable was 20% for 2025. Is that still a good picture of where the business is or has some of that 200 million shifted to the right?

At this point, I haven't seen a big shift in anything in our pipeline as a result of what we're seeing. In fact, I'm seeing a little bit of the reverse. With our expanded reach and broadening customer reach, we're seeing more opportunities that we can load into the pipeline that are seeking information or requesting pricing on our opportunities and capabilities. So I feel our pipeline is stable where there's some elements that allow us to adjust for some of that timing. And our pipeline is – I wouldn't take the billion dollars and divide it by five. It builds out over time, as you would expect. As we land early customer-funded development programs, they lead to larger-scale production orders as follow-ons and follow-on years, right? So we see some of that growing out over time. But for the pipeline we're looking to address in 2025 to drive the growth and the revenue we were talking about, we still feel comfortable and our internal assessments are indicating we have the available pipeline to continue to drive those kinds of orders.

Great. One last question for me. As it relates to the server extension box order for $2 million, can you talk about maybe the opportunity for – similar sales to AI infrastructure companies, including that existing customer? What's the market opportunity you see maybe over the next, in the short to medium term?

Yeah, I mean, I mentioned that, you know, that overall broad term of $200 million. Yeah, so there is a set of customers that have requested and responded to multiple customers in terms of those GPU accelerator and expansion boxes. So we're seeing increased interest and demand for that. We also see the end customer applications and OEMs, if you will, in that market, and that has allowed us to be able to reach out directly to them also and engage in broader communications, which is continuing to increase our interest about this field and where we can go and what we can do. We also have presented now the new our devices for this application, this market, at Embedded World last week, and we're at the GTC trade show this week presenting the same technology. And so there's also an emerging set of new higher-end, higher-wattage NVIDIA GPUs and other GPU boards by several vendors inside the commercial market. And our product suite, we are adapting and adjusting to that, so we'll be will be one of the early market adopters of some of the high wattage GPU accelerators.

Great. Thanks so much. Thank you, Brian. Thanks, Brian.

And your next question comes from the line of Max Michaelis with Lake Street Capital Markets.

Please go ahead.

Hey guys, if we look at your order growth for 2025 and maybe if we split that up between the, that's for the OSS segment, if we split that up between the commercial and defense market, maybe help me understand where you're seeing more of the growth coming from or is it pretty stable across the two segments in terms of like size of order expansion?

Yeah, thanks Max for the question. So we see the growth almost equally across commercial defense markets. So the pipeline opportunities we have, the opportunities we're chasing are well balanced between both. And so we highlighted a couple of them here. Data center on the commercial side, the data centers, the medical imaging, commercial aerospace. All our areas that are deep in our pipeline and of interest and we're tracking to opportunities there in 2025. And then on the defense market, you know, we just noted that we had a renewal of long-term contracts we've had with Raytheon and Lockheed Martin. So we've got several existing customers that are expanding their opportunities. They're also creating opportunity for us more broadly within large prime contractors inside of other company divisions. So we're seeing opportunity in defense there to find new platforms to move our capabilities on. And then, as I mentioned, we have an order in the medical field and an order in the defense field. field that we expect to be announcing soon. That'll give you some good insight into the broadening application and the building of the platforms and our strategy where we can stack these long-term capabilities together. So short answer, we're seeing that activity in both sides, commercial and defense, and as expected and tied to our strategy.

I guess if we stay on the commercial segment, is there any areas in that market where you weren't originally forecasting strength going into 2025, but you're seeing an uptick in orders?

You know, I would say we've been pretty broad in our assessment of that market. The one in the medical imaging is coming on probably a little bit faster, a little bit larger than we had first anticipated. But that customer set in some of that medical imaging area is is creating a quicker adoption of artificial intelligence into imaging processing. As I've continued to note, application of AI ML to data sources at sensors is a sweet spot for our company and our hardware. Some of the capabilities built out in the new GPU processing allow some unique advances sensors directly at the point of medical imaging can be processed real time using the likes of our hardware. So we're seeing some acceleration of that that maybe we hadn't anticipated a couple quarters ago.

Awesome. And then just one last one for me. I don't know if I missed it, but your current product programs under your OSS segment, how many are currently in development?

You know, I'd have to find a number for you, but the intent for the company really, as we talk about customer-funded development as we grow, there'll be a percentage of our revenue and our efforts every year that are tied to customer-funded development. This is how we identify early on opportunities to develop a bespoke solution to a customer set that we know will lead to low rates and then full production and sustainment and support. Much like what we've done in our long-running P8 program through Raytheon and the Navy. Started with a small development opportunity over the six or seven years we've been on that program. We've been able to generate double-digit millions of dollars over that program through production, tech refresh, sustainment support, logistics. As we announced, we had another multi-year extension on that program. to continue to support that program. So these customer-funded development programs are what instantiated us on to these long-running opportunities. And so we'll see multiple programs in any given year. As a percentage of revenue, as we grow out and the production elements start to hit, that'll decrease from where we are right now. So we're on the front end of really building those platform legacy positions.

All righty. Thanks, guys. Thanks, Max. Appreciate it.

Thank you. And I'm showing no further questions at this time. This will conclude today's conference call.

Thank you all for joining. You may now disconnect.