Good day and welcome to the One Stop Systems Third Quarter 2024 Conference Call and Webcast. At this time, all participants are in a listen-only mode. Later you will have the opportunity to ask questions during the question-and-answer session. As a reminder, this conference 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 as well as their 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 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 protections of the Safe Harbor for these statements. Please also be advised that actual results could differ materially from those stated or implied by the forward-looking statements due to certain risks and uncertainties including those described in the 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 the 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, Vincent. Good afternoon, everyone, and thank you for joining today's call. The growth strategies we are pursuing to take advantage of large, high-growth and higher-margin market opportunities are taking hold and positive momentum is growing within our OSS segment. Higher OSS segment revenue helped offset continued softness in our Bressner segment, which remained impacted by sluggish economic activity in European market. With year-to-date orders well in excess of revenue in our OSS segment, we believe that we are well positioned for sustainable revenue growth. We remain focused on converting our $1 billion plus pipeline to sales and pursuing a greater number of customer-funded development projects. Highlights for the 2024 third quarter include positive OSS segment orders that have outpaced quarterly revenue in four of the five last quarters. Continued sequential revenue growth on a consolidated basis, expanded customer-funded development revenue, year-over-year OSS segment revenue growth of 17.5%. Gross margin in our OSS segment of 43.2%, excluding the impact of a $6.1 million inventory charge. Operating cash flow of over $900,000 and a return to adjusted EBITDA profitability after backing out the inventory charge. We believe these favorable trends are positioning OSS for continued sequential revenue growth throughout the remainder of 2024 and setting the stage for a transformative 2025. As we discussed in this morning's press release, during the third quarter, we identified 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. As a result, we took a charge of $6.1 million, which reduced reported gross margin, net income and adjusted EBITDA for the three and nine month periods ended September 30th, 2024. This charge had limited impact on our cash position. And during the third…

Thank you. Ladies and gentlemen, we will now begin question-and-answer session. [Operator Instructions] First question comes from the line of Brian Kinstlinger with Alliance Global Partners. Please go ahead.

Great. Congrats on the continued success of bookings, and John if you are there, it has been great working with you. My first question is you had three consecutive quarters of improving bookings and book-to-bill above one in core OSS. What's driving the strengthening trends? And how much of this is government versus commercial?

Yeah, good morning, Brian, and thanks for the question. Yes, we continue to be positive on the growing book-to-bill ratios and the bookings over revenue in the OSS segment over the past few quarters. We're really seeing it driven both defense and commercial markets. Some of the pickup that we're starting to see now has really been the effect of the broadening of the scope of reach of the company since I joined almost 18 months ago when we brought on the new VP of Sales and Business Development, Robert Kalebaugh. So as we extended our reach in the defense markets and started to position our products and solutions and respond to more available request for information or request for proposals, that time frame to move through those acquisition processes is now to the point where prework has turned into responses is turning into the point where now we're able to start receiving orders based on those actions. In addition, we've continued our outreach on the commercial side and in similar fashion just the broader outreach and application. And then I just go to the general underlying trend in the markets today around autonomy, artificial intelligence and machine learning. We've seen just a general pickup in the adoption of those technologies and integration of them and the need for the enterprise compute to deliver on the processing for those capabilities.

And just ballpark, is government as a percentage of the first nine months of bookings, 75%? Is it 50-50? Just ball parking, not giving us exact numbers.

Yes. I would say, ballpark, we're probably around 55%, 60% defense to commercial.

Great. And then are you continuing to see those trends in the fourth quarter? Is there any seasonality? And with the change in administration, is there any impact, positive or negative on business development with the federal government?

Yes. We would expect to see the same kind of themes in our bookings plan as we go through Q4. We're always at the behest of government timing and processing time frames. There are two big holidays in the fourth quarter. So we generally try to push on those actions to move orders in to be not affected by the holidays. Some slight seasonality, more so on the government side throughout the holidays and the beginning of the new year. But we've generally planned for those in our assessment of timing bookings, though at times, we can be surprised at how long processing can sometimes take on contract awards. The interesting thing about the company, if you're talking about the administration change that will be occurring is in general, the markets that we've seen in defense and commercial have generally been a little bit impervious to administrative or even on the OSS segment, some of the economic impacts. And it's in part because of the demand for autonomy, the increase in the market and for AI/ML. So we've been able to weather some storms and be able to find some bookings and continue to drive the performance despite those. But overall, in general, I don't think the administration change will have, should have a big impact. If anything, I would think it might be more on the positive side with potentially a greater focus on defense under the new administration.

I would also add, maybe we won't have CRs if we have a full Republican ticket across the board.

Yes, Brian, and a small point that you bring up. If control of the House and the Senate rolls through, any CR that we wouldn't have or a short CR would clearly have a positive effect on our business because any new starts would be allowed funding and procurement placement faster. So that would help with the timing of bookings and programs, some of which we have bids in the market already. So that would be a positive thing if the current control across the House and Senate and presidency would allow for a shorter CR.

Two more for me. The first one is you quantified $1 billion pipeline a couple of times in the last few quarters. Can you quantify at least roughly what the addressable percentage of that is in 2025? And does it breakdown similar to your bookings, 55% to 60% government?

Yes, I would say, if we took the five-year pipeline in total, it's around that same percentage. We're in that 50-50, plus or minus 5% to 10% in any direction in any given year or a total as we modify it and we continue processing our pipeline. And then it generally breaks out over the years. 2025 will be probably close to a fifth of that maybe in unfactored. So that will have to -- ability to process against that in a factored approach. And the large element of our pipeline is really all addressable to us. As I'd mentioned in earlier calls, the probability weightings we put for the probability that the opportunity will happen and the probability that we win helps us prioritize those elements in the pipeline to assign our resources effectively to drive those bookings and backlog.

Great. One last for me and then I'll get back in the queue. You touched on the gross margin was abnormally high in the OSS segment. You said due to mix and focus on higher margin. However, low-margin customer funded development was abnormally high as well. So can you give us some more detail on this? And based on your bookings, what type of gross margin is reasonable to assume for investors over the next 18 months for just core segment?

Yes. So in the quarter, we generally saw a stronger mix of product development on some higher margins and our server and our storage systems, we saw a product mix that carried a higher gross margin. So that we had a fairly large amount of those orders in the quarter, which is, as you just noted, good for gross margin. On the customer-funded development. Depending on the implementation of that, we can reach a normal company margins. Oftentimes, it's a little bit less as we secure an incumbent position. So over time, a good way to look at those customer development programs is as we build the development into what is almost always a production and then support over the lifetime of that product. If you take that as a business case, the net of that will be eventually overcome by our product deliveries at our normal margins on the production end. And as a business case as a whole, those efforts achieve our gross margin. So the early development, customer funded development that we're seeing now and growing is really setting the stage for the longer run production contracts. So example is our P-8 program. We've been on that program for well over five years, started with some early development and we have been in production support and tech refresh over the last three to four years in that program and are contracted to continue to support that for another five years. So those are the kinds of programs that our early customer funded development is leading up to. Our expectation in the OSS segment is that in the next 18 months or so we should be able to continue to drive up to the 35% or better gross margin area as we start to balance out the products and the customer-funded development as they grow in volume.

Okay. Thank you.

Thanks, Brian.

Next question comes from Scott Searle with ROTH Capital Partners. Please go ahead.

Hey, good morning. Thanks for taking the questions. Hey, Mike, maybe to quickly follow up on the prior gross margin questions. Just wanted to get some clarification. The 43% OSS is net of the customer-funded development, which is running more in the 20% range. Is that correct? Just want to get calibrated on that front.

Yes. Yes. The 43% would include the margin, gross margin on the customer development work we've done to date.

Got you. And then the blended gross margin you're talking about overall is about -- can you get to 35%, depending on mix as we start to get a little bit more, I'll call it, upscale contribution from customer funded and some better contracts like you saw in the current quarter with OSS. Is that correct?

Yes.

Okay. Very good. So maybe to follow-up then on the customer-funded development front, I think you talked about a conversion time line to production of one to two years. Is there a Rule of Thumb to be thinking about the multiplier effect. I think you said about $900,000 in '23 of customer-funded development. As we start to get into '25, what does that really convert into in a fully commercialized setting? Like what's the revenue run rate we should think about that on a dollar-for-dollar basis? Is it $3 per year, $5 per year? Is it a fraction of that? Just trying to get calibrated in terms of how to mathematically extrapolate that.

Scott, you're talking about how to extrapolate the customer-funded development dollars that would be contracted?

Yes, exactly. Once they're into production, what should we be thinking about an annualized contribution basis for each one of those. And I'm sure it's kind of a wide range, but just trying to understand a little bit of what that translates into.

Yes. It really is a wide range. And generally, on average, those product development cycles one to two years, depending on the size, if it's a brand-new start or a large system solution, that's your kind of your year, 1.5 years, 2-year development cycle, usually followed by an LRIP or a low rate initial production period, but usually about a year and then a full rate production period that depending on the quantity could run an additional two to three years. And then you generally look at a tech refresh cycle every two to three years after that and sustainment and support through the whole time. Depending again on the -- that could be shorter time frames on the development, if it's less scope of development. And then really, the back end of production, how much and how long that goes compared to the development is really tied more to the number of platforms that are available. So if it's an aircraft solution, what are the number of aircraft inventory. If it's a vehicle solution, what are the number of vehicles in inventory. And in that case, right, that those amounts can spread out over the years. As a general, general Rule of Thumb, usually development amount is in the order of 10% to 20% of a whole program as it rolls through LRIP and production. And then after that, right, is just additional tech refresh and logistics support oftentimes for a decade or more on the platform.

Got you. Very helpful. And maybe just to dive in on the pipeline. I know it's a big number. It sounds like maybe there's a fifth of that that's addressable then on an annualized basis. What is getting you guys to the table and positioning you for the win? There are a lot of different core capabilities that you guys have and even bringing Coolidge Systems to bear now in these applications, whether it's autonomy, AI, ML, but where are you guys really excelling in terms of what's getting you to the table and what's going to get you across the finish line with a win?

Yes. Great question, Scott. So at the top level, really, what's driving it is a lot of the architectures in commercial and defense applications today where they're trying to run artificial intelligence or autonomy, basically AI algorithms, if I simplify it, are using an embedded technology that's derived in a architecture form factor that is really limited to running one to two AI algorithms in a given volume, say, on a given card or in a given chassis. And what we've seen in the last two to three years though and coming out even stronger is the demand for artificial intelligence, machine learning. And what we're seeing is on platforms, autonomous trucking or autonomous vehicles or in the defense market, sensor aircraft, is that even given a single one or two sensors on a platform, we're finding that using more and more AI algorithms or inferences can pull more information and data out of those sensors, fuse it in a more effective manner and drive implementation to autonomy or sensor and defense applications. What that means is customers are trying to put more AI inferences on the same computing solution inside their platform. And instead of running one to two AI algorithms, they want to run 10 to 12 or 13 to 15 and you can't do that with the current embedded technology today. What we offer through the enterprise class computing for what we're taking out of the data centers is the ability in that same volume and essentially at the same price point is the ability to do 20 to 25 AI algorithms in that same volume and that gives massive potential for growth and capability inside those applications. And then second to that is our ability and how we use our backplane and fabrics that tie together the compute inside of a chassis or a solution is through PCI Express and some other technologies. We're able to perform that generally close to 1,000 times less latency or faster than those current solutions. So generally, what's bringing us to table is the ability at similar prices to give significant performance advantage and AI and autonomy applications to customers. And we're generally competing against the new capability versus old architectures and solutions. And that's what's been our positioning and what has been driving the increased interest in the company and why we're starting to see the early returns on the bookings over revenue.

Great. Very helpful. Thank you. And lastly, if I could, then taking that and shifting the outlook to 2025 Bressner has had some headwinds, I think, just general macroeconomic softness in Europe, but it seems like that OSS pipeline and your book-to-bill this year sounds like it's north of 1.2 over the last three quarters. What does that translate into kind of the range of outcomes in 2025, you're talking about growth, but could you help us frame what you're thinking about in the early going now for 20 to 25 and the swing factors to the upside or the downside? Thanks.

Yes, Scott. No, I appreciate that. And yes, with the last three quarters running kind of on the OSS segment, a book-to-bill ratio of around 1.25. We anticipate that will carry into 2025. So on the OSS side, we're contemplating revenue growth on that order of 25%. We're starting to see slowly, slowly some initial indicators that may be some economic turnaround in Europe and Germany. So on the Bressner segment, that turnaround will take a while to capture if it emerges as we hope or some economists are predicting because the supply chains will have to catch up to it. And the supply chains are in the 6 to 12 week range. So it will likely be more into Q2, Q3 before I think we would start to see that, but we've got some optimistic views on Bressner that we could have that Bressner segment back on the growth scale, maybe in the upper single-digits. So 2025, we're really looking to see that turn. We'll probably see some seasonality maybe early in Q1 as the US defense markets roll out of the holidays that's generally a little bit slow period. And then we've got the Chinese New Year and some others, seasonally a little bit lower quarter for Bressner, but as we back into Q2, Q3 and Q4 is where I think we would start to see the impact of these book-to-bill ratios and the performance here at the end of the year.

Okay, great. Thanks so much. I'll get back in the queue.

Thanks, Scott. Appreciate it.

Next question comes from Eric Martinuzzi with Lake Street. Please go ahead.

I wanted to follow up on the Bressner question, just to ask just to put a finer point on. So the expectation here was that we could potentially anticipate growth in Bressner segment as soon as Q2. Is that correct?

Yes. We're looking at a rebound for Bressner in 2025, likely to see that around the Q2 time frame at the earliest, as some of these factors, if they can continue to hold in the European economy and then that can convert into delivery of supply chain, then we could start to see some stuff potentially as early as Q2.

Okay. All right. And then just on the guide for Q4, you've got an outlook that anticipates a step-up in revenue here given the -- that we were kind of net of the inventory adjustment, we were essentially breakeven for the adjusted EBITDA in Q3. Is it fair to assume that we have a step-up in adjusted EBITDA in Q4? Or are there investment expenses that you're planning on in Q4 that might take the wind out of that?

Yes. No, Eric, no additional investments planned in Q4 that I think would have a negative impact on that.

Okay. All right. And then my last, actually, it's not even a question just a comment. I wanted to wish my best to John in his retirement as well. Enjoyed working with you, John, and best wishes to Daniel in his new role.

Thanks much for that, Eric. Okay. Operator, I think with the end of the questions there, we can bring the call to a close.

Ladies and gentlemen, this concludes today's conference call. Thank you for your participation. You may now disconnect.