ONE STOP SYSTEMS, INC. You should read the following discussion and analysis of our financial condition and operating results together with our financial statements and related notes included elsewhere in this Quarterly Report. This discussion and analysis contains forward-looking statements based upon current beliefs, plans and expectations that involve risks, uncertainties and assumptions. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of various factors, including those set forth under "Risk Factors" or in other parts of this Quarterly Report.
Overview
OSS designs, manufactures and markets custom high speed computing systems for high performance computing (HPC) applications. These applications require ultra-fast processing power and the ability to quickly access and store ever-growing data sets. Systems are built using the latest GPU (graphical processing unit) and solid-state flash (memory) technologies. We are a niche provider of HPC custom servers, compute accelerators, and flash storage arrays. We deliver this technology to customers through sale of equipment and software to customers.
Bressner Technology GmbH , (Bressner) which was acquired onOctober 31, 2018 , provides standard and customized servers, panel PCs, and PCIe expansion systems. Bressner provides manufacturing, test, sales and marketing services for customers throughoutEurope .
Business Developments
OnFebruary 15, 2020 ,Steve Cooper departed as President and CEO ofOne Stop Systems, Inc. , and was replaced byDavid Raun who became the interim President and CEO of the Company. OnApril 24, 2020 , the Company consummated the initial closing of the offering (the "Initial Closing") under the Purchase Agreement and issued a Senior Secured Convertible Promissory Note with an aggregate of$3,000,000 to an institutional investor ("Initial Note"). The investors purchased the Initial Note for an aggregate purchase price of$2,700,000 , at the Initial Closing after a 10% original issue discount. The Initial Note bears no interest rate (except upon event of default) and, unless earlier converted or redeemed, will mature on the date that is the twenty-three (23) month anniversary of the last day from the Initial Closing.
On
On
OnJuly 1, 2020 , three new members were added to the board of directors and as a result the Company now has six independent members and onewho is not independent. The board consists of four male members and three female members consistent with directives for a company inCalifornia
Our Business Model
OSS designs, manufactures and sells specialized high performance computing (HPC)
systems to customers world-wide. We differentiate ourselves from other suppliers
of HPC solutions by utilizing our expertise in custom systems design and PCIe
expansion to build systems with a greater quantity of PCIe add-in slots,
GPU-based compute cards and/or flash cards. Our systems offer industry leading
capabilities that occupy less physical space and power consumption.
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Concept Development, LLC focuses on engineering innovative products and
solutions that enhances success for our clients in their design, manufacturing
and life support cycle, with in-flight entertainment and connectivity of their
processes enabling efficiencies and cost savings.
Bressner Technology GmbH is a leading provider of industrial IT solutions with
long standing international contact to assist in leveraging markets around the
world to our customers benefit and give them early access to innovative new
products. By continuing to forge strategic partnerships, we have significantly
expanded our range of services. With this, we offer consistent product portfolio
at all integration levels, superior product quality, efficient logistics and
excellent support.
Components of Results of Operations
Revenue
OnJanuary 1, 2019 , the Company adopted the new accounting standard update ASC 606, Revenue from Contracts with Customers, which superseded nearly all existing revenue recognition guidance under GAAP, to all contracts using the modified retrospective method. For a more detailed description of our revenue recognition policies see the Company's consolidated financial statements Note 2 - Significant Accounting Policies for the years endedDecember 2019 and 2018 as included in our 2019 Form 10-K.
Cost of revenue
Cost of revenue primarily consists of costs of materials, costs paid to third-party contract manufacturers (which may include the costs of components), and personnel costs associated with manufacturing and support operations. Personnel costs consist of wages, bonuses, benefits, stock-based compensation expenses. Cost of revenue also includes freight, allocated overhead costs and inventory write-offs and changes to our inventory and warranty reserves. Allocated overhead costs consist of certain facilities and utility costs. We expect cost of revenue to increase in absolute dollars, as product revenue increases.
Operating expenses
Our operating expenses consist of general and administrative, sales and marketing and research and development expenses. Salaries and personnel-related costs, benefits, and stock-based compensation expense, are the most significant components of each category of operating expenses. Operating expenses also include allocated overhead costs for facilities and utility costs.
General and Administrative - General and administrative expense consists primarily of employee compensation and related expenses for administrative functions including finance, legal, human resources and fees for third-party professional services, as well as allocated operational costs.
Sales and Marketing - Sales and marketing expense consists primarily of employee compensation and related expenses, sales commissions, marketing programs, travel and entertainment expenses as well as allocated overhead. Marketing programs consist of advertising, tradeshows, events, corporate communications and brand-building activities. Sales and marketing expenses may increase in absolute dollars as we expand our sales force, increase marketing resources, and further develop sales channels. Research and Development - Research and development expense consists primarily of employee compensation and related expenses, prototype expenses, depreciation associated with assets acquired for research and development, third-party engineering and contractor support costs, as well as allocated overhead. Research and development expenses may increase in absolute dollars as we continue to invest in new and existing products.
Other Income (Expense), net
Other income consists of income received for activities outside of our core
business. This includes interest income from investments and finance charges
from customers. Other expense includes expenses for activities outside of our
core business. These expenses consist primarily of loan amortization and
interest expense.
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Provision for Income Taxes
Provision for income taxes consists of estimated income taxes due tothe United States and German governments and to the state tax authorities in jurisdictions in which we conduct business, as well as the change in our deferred income tax assets and liabilities. Results of Operations The following tables set forth our results of operations for the three and six month periods endedJune 30, 2020 and 2019 respectively, presented in dollars and as a percentage of revenue. For the Three Months For the Six Month Period Ended June 30, Ended June 30, 2020 2019 2020 2019
Revenue$ 11,625,327 $ 14,886,236 $ 24,984,964 $ 24,944,135 Cost of revenue 8,300,132 9,473,078 18,264,082 17,119,354 Gross profit 3,325,195 5,413,158 6,720,882 7,824,781 Operating expenses: General and administrative 1,877,358 3,931,478 4,391,423 5,975,413 Marketing and selling 845,098 1,237,003 2,034,449 2,374,936 Research and development 1,008,625 1,225,157 2,212,050 2,487,121 Total operating expenses 3,731,081 6,393,638 8,637,922 10,837,470 Loss from operations (405,886 ) (980,480 ) (1,917,040 ) (3,012,689 ) Other income (expense): Interest income 99,343 10,168 123,980 13,275 Interest expense (150,186 ) (53,013 ) (218,970 ) (59,281 ) Other income (expense), net 3,056 (13,236 ) (4,973 ) (24,507 ) Total other income (expense), net (47,787 ) (56,081 ) (99,963 ) (70,513 ) Loss before income taxes (453,673 ) (1,036,561 ) (2,017,003 ) (3,083,202 ) (Benefit) provision for income taxes (441,511 )
558,072 (908,809 ) (543,839 )
Net loss attributable to common stockholders
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For the Three Months For the Six Month Period
Ended June 30, Ended June 30,
2020 2019 2020 2019
Revenue 100.0% 100.0% 100.0% 100.0%
Cost of revenue 71.4% 63.6% 73.1% 68.6%
Gross profit 28.6% 36.4% 26.9% 31.4%
Operating expenses:
General and administrative 16.1% 26.4% 17.6% 24.0%
Marketing and selling 7.3% 8.3% 8.1% 9.5%
Research and development 8.7% 8.2% 8.9% 10.0%
Total operating expenses 32.1% 42.9% 34.6% 43.4%
Loss from operations -3.5% -6.6% -7.7% -12.1%
Other income (expense):
Interest income 0.9% 0.1% 0.5% 0.1%
Interest expense -1.3% -0.4% -0.9% -0.2%
Other income (expense), net 0.0% -0.1% 0.0% -0.1%
Total other income (expense), net -0.4% -0.4% -0.4% -0.3%
Loss before income taxes -3.9% -7.0% -8.1% -12.4%
(Benefit) provision for income taxes -3.8% 3.7% -3.6% -2.2%
Net loss attributable to common stockholders -0.1% -10.7% -4.4% -10.2%
Comparison of the three and six months ended
Revenue, cost of revenue and gross profit:
For the Three Months Ended June 30, 2020 For the Three Months Ended June 30, 2019
Gross Gross
Cost of Gross Margin Cost of Gross Margin
Entity: Revenue Revenue Profit % Revenue Revenue Profit %
OSS $ 6,918,831 $ (4,583,955 ) $ 2,334,876 33.7%
43.5% 894,562 (717,717 ) 176,845 19.8%
19.0% 3,983,870 (3,043,170 ) 940,700 23.6%
$ 11,625,327 $ (8,300,132 ) $ 3,325,195 28.6% $ 14,886,236 $ (9,473,078 ) $ 5,413,158 36.4%
For the Six Months Ended June 30, 2020 For the Six Months Ended June 30, 2019
Gross Gross
Cost of Gross Margin Cost of Gross Margin
Entity: Revenue Revenue Margin % Revenue Revenue Margin %
OSS $ 14,737,108 $ (10,205,706 ) $ 4,531,402 30.7%
28.9% 1,194,016 (1,063,444 ) 130,572 10.9%
20.5% 8,512,229 (6,614,815 ) 1,897,414 22.3%
$ 24,984,964 $ (18,264,082 ) $ 6,720,882 26.9% $ 24,944,135 $ (17,119,354 ) $ 7,824,781 31.4%
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Revenue
For the three month period endedJune 30, 2020 , total revenue decreased$3,260,909 or 21.9%, as compared to the same period in 2019. The decrease was primarily driven by reduced revenue from OSS' core media and entertainment business and data storage units of$3,088,973 or 20.8 percentage points of the decrease. Bressner contributed an additional$336,155 or 2.3 percentage points increase for the quarter as compared to the prior year and CDI had a reduction in revenue of$508,091 or 3.4 percentage point decrease of the total reduction in revenue. For the six month period endedJune 30, 2020 , total revenue increased$40,829 or less than 1%, as compared to the same period in 2019. During the six months endedJune 30, 2020 , OSS's has experienced a reduction in revenue of approximately$4,100,000 from its two largest customers. These decreases have been offset by new business opportunities associated with the Company's AI on the fly products and as a result OSS experienced a net decrease in revenue for the period of$500,782 or approximately 2.0 percentage points. Bressner contributed$727,210 or an increase of 2.9 percentage points and CDI had a decrease of$185,599 or 0.8 percentage points of the total increase in revenue.
Cost of revenue and gross margin
Cost of revenue decreased$1,172,946 or 12.4%, for the three month period endedJune 30, 2020 as compared to the same period in 2019. The decrease in cost of revenue was primarily driven by cost of revenue from OSS' core business which had a reduction of$1,128,236 or 11.9 percentage points of the decrease as a result of the reduction in media and entertainment sales and sales of data storage units. Bressner contributed an increase of$454,785 or 4.8 percentage points and CDI had a reduction in costs of$499,495 or 5.3 percentage points of the total decrease in cost of revenue. Cost of revenue increased by$1,144,728 or 6.7%, for the six month period endedJune 30, 2020 as compared to the same period in 2019. The increase in cost of revenue was primarily driven by cost of revenue from OSS' lower margin products which contributed$764,611 or 4.5 percentage points of the increase. Bressner contributed$726,181 or 4.2 percentage points on increased revenues. CDI experienced a reduction in costs of$346,064 or 2.0 percentage points as a result of cost reduction measures. The overall gross margin percentage decreased from 36.4% for the three month period endedJune 30, 2019 to 28.6% for the three month period endedJune 30, 2020 , a decrease of 7.8 percentage points. The gross margin for the core OSS business for the three month period endedJune 30, 2020 was 33.7%, which was 9.2 percentage points less in comparison to the prior year period of 42.9% attributable to the lack of sales of data storage units to military end-users. CDI's gross margin improved from 19.8% to 43.5% as a result of significant cost containment efforts in the current quarter. Bressner contributed gross margin at a rate of 19.0% as compared to 23.6% in the same year ago period due to change in product mix. The overall gross margin percentage decreased from 31.4% for the six month period endedJune 30, 2019 to 26.9% for the three month period endedJune 30, 2020 , a decrease of 4.5 percentage points. The gross margin for the core OSS business for the six month period endedJune 30, 2020 was 30.7%, which was 7.3 percentage points less in comparison to the prior year period of 38.0%. The majority of the decline is attributable to the reduction of sales of data storage units (DSU) to military end users in the second quarter as compared to the prior year. Military grade DSUs tend to command higher margins as compared to other products. CDI improved margin from 10.9% to 28.9% as a result of cost reduction efforts. Bressner contributed gross margin at a rate of 20.5% as compared to 22.3% in the same year ago period.
Operating expenses
General and administrative expense
General and administrative expense decreased$2,054,120 or 52.3%, for the three month period endedJune 30, 2020 as compared to same period in 2019. The decrease is primarily driven by an impairment charge of$1,697,394 that was recognized in the prior year due to a write down in goodwill at CDI. In addition, there were costs savings attributable to a cost reduction initiative that took effect inApril 2020 , in which the workforce was reduced and cost containment efforts were implemented. Overall general and administrative expenses decreased as a percentage of revenue to 16.1% during the three month periods endedJune 30, 2020 as compared to 26.4% during the same period in 2019. 30 -------------------------------------------------------------------------------- General and administrative expense decreased$1,583,990 or 26.5 %, for the six month period endedJune 30, 2020 as compared to same period in 2019. The decrease is primarily driven by an impairment charge of$1,697,394 that was recognized in the prior year due to a write down in goodwill at CDI. In addition, there were costs savings attributable to a cost reduction initiative that took effect inApril 2020 , in which the workforce was reduced and cost containment efforts were implemented. These cost savings were more than offset by accruals for severance benefits attributable to the termination of our former president and chief executive officer. Overall general and administrative expenses decreased as a percentage of revenue to 17.6% during the six month periods endedJune 30, 2020 as compared to 24.0% during the same period in 2019.
Marketing and selling expense
Marketing and selling expense decreased$391,905 or 31.7% during the three month periods endedJune 30, 2020 as compared to the same period in 2019. The decreases in marketing and selling expenses is primarily attributable to a cost reduction initiative that took effect inApril 2020 , in which the workforce was reduced and cost containment efforts were implemented. Additionally, as a result of COVID-19 there has been a reduction in travel and tradeshows. Marketing and selling expense decreased as a percentage of revenue to 7.3% during the three month period endedJune 30, 2020 as compared to 8.3% during the same period in 2019. Marketing and selling expense decreased$340,487 or 14.3% during the six month periods endedJune 30, 2020 as compared to the same period in 2019. The decreases in marketing and selling expenses is primarily attributable to a cost reduction initiative that took effect inApril 2020 , in which the workforce was reduced and cost containment efforts were implemented. Additionally, as a result of COVID-19 there has been a reduction in travel and tradeshows. Marketing and selling expense decreased as a percentage of revenue to 8.1% during the six month period endedJune 30, 2020 as compared to 9.5% during the same period in 2019.
Research and development expense
Research and development expense decreased by$216,532 or 17.7% during the three month period endedJune 30, 2020 as compared to same period in 2019. The majority of the decrease is primarily attributable to a cost reduction initiative that took effect inApril 2020 , in which the workforce was reduced and cost containment efforts were implemented. Overall, total research and development expense increased as a percentage of revenue to 8.7% during the three month period endedJune 30, 2020 as compared to 8.2% during the same period in 2019 primarily because of the calculation based upon a smaller revenue number. Research and development expense decreased by$275,071 or 11.0% during the six month period endedJune 30, 2020 as compared to same period in 2019. The majority of the decrease is primarily attributable to a cost reduction initiative that took effect inApril 2020 , in which the workforce was reduced and cost containment efforts were implemented. These reductions were offset by increases at Bressner of$143,364 and CDI of$55,057 attributable to on-going projects. Overall, total research and development expense decreased as a percentage of revenue to 8.9% during the six month period endedJune 30, 2020 as compared to 10.0% during the same period in 2019.
Interest income
Interest income increased$89,175 for the three month period endedJune 30, 2020 as compared to same period in 2019. The increase is attributable to increased finance charges on outstanding accounts receivable balances from our largest customer in the media and entertainment industry. Interest income increased$110,705 for the six month period endedJune 30, 2020 as compared to same period in 2019. The increase is attributable to increased finance charges on outstanding accounts receivable balances from our largest customer in the media and entertainment industry 31
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Interest expense
Interest expense increased$97,173 for the three month period endedJune 30, 2020 as compared to same period in 2019. OnApril 4, 2019 , the Company borrowed$1,500,000 from individuals and related parties at an annual interest rate of 9.5%, additionally, warrants of 10% of the value of the borrowing were also granted. The fair value of the warrants is amortized over the life of the loans and such costs are included as interest expense. Additionally, onApril 24, 2020 , the Company borrowed$3,000,000 through a senior secured convertible debt offering issued with a 10% original issue discount. The interest and the professional fees incurred on securing the debt are being amortized on an effective interest rate basis to interest expense. Interest expense increased$159,689 for the six month period endedJune 30, 2020 as compared to same period in 2019. OnApril 4, 2019 , the Company borrowed$1,500,000 from individuals and related parties at an annual interest rate of 9.5%, additionally, warrants of 10% of the value of the borrowing were also granted. The fair value of the warrants is amortized over the life of the loans and such costs are included as interest expense. Additionally, onApril 24, 2020 , the Company borrowed$3,000,000 through a senior secured convertible debt offering issued with a 10% original issue discount. The interest and the professional fees incurred on securing the debt are being amortized on an effective interest rate basis to interest expense.
Other income (expense), net
Other income (expense), for the three month period endedJune 30, 2020 resulted in a net increase in other income and expense of$16,292 and compared to the same period in 2019, attributable to foreign currency translation re-measurements gains and losses. Other income (expense), for the six month period endedJune 30, 2020 resulted in a net decrease in other income and expense of$19,534 and compared to the same period in 2019, attributable to foreign currency translation re-measurements gains and losses.
Provision for income taxes / Income tax benefits
We have recorded an income tax (benefit) provision of$(441,511) and$558,072 , respectively, for the three month periods endedJune 30, 2020 and 2019, and$(908,809) and$(543,839) , respectively, for the six month periods endedJune 30, 2020 and 2019. The 2020 benefit is attributable to projected annual taxable income for 2020 with a projected tax rate of 33.9% as compared to the prior year of 49.7%. The projected effective tax rate for the six months endedJune 30, 2020 differs from the statutory rate mainly due to permanent non-deductible goodwill amortization forBressner Technology GmbH , income from the Global Intangible Low-Taxed Income inclusion, as well as projecting federal, foreign and state tax liabilities for the year. In determining the periodic income tax expense, GAAP requires the Company to forecast its annual effective income tax rate ("AETR") for the yearsDecember 31, 2020 and 2019. Based on management's projections, the Company expects income tax benefits related to research and development credits and equity compensation benefits to exceed our pretax earnings in 2020 and 2019.
Liquidity and capital resources
Given our recent operating losses, the Company's primary sources of liquidity have been provided by (i) the Company'sFebruary 2018 initial public offering (net proceeds were approximately$16,100,000 ), (ii)March 2019 notes payable from members of the Board of Directors and others of$1,500,000 , (iii) theJune 2019 sale of 1,554,832 shares of the Company's common stock for net cash proceeds of$2,488,148 , (iv) theApril 24, 2020 sale of$3,000,000 of Senior Secured Convertible Promissory Notes issued at a 10% original issue discount and (v) receipt of approximately$1,500,000 onApril 28, 2020 of government loan proceeds under the Payroll Protection Program. As ofJune 30, 2020 , the Company's cash and cash equivalents were$4,654,602 and working capital of$14,381,656 . Cash and cash equivalents held by Bressner totaled$677,715 (USD) atJune 30, 2020 , and Bressner's debt covenants do not permit the use of those funds by its parent company. During the six months endedJune 30, 2020 , the Company experienced an operating loss of$1,917,040 with cash used in operating activities of$2,935,059 . Our largest customerwho is engaged in the media and entertainment industry is having significant financial hardships attributable to the COVID-19 pandemic and as a result has been slow in paying its outstanding 32
-------------------------------------------------------------------------------- accounts receivables. The Company has formulated a plan whereby extended payment terms have been made available, and our customer is presently honoring those terms. The Company's revenue growth, inclusive of two acquisitions made in 2018, has resulted in growth of the Company as a whole, but has been offset by increased spending in all areas of operating expenses: general and administrative, marketing and selling, and research and development. The coronavirus, or COVID-19, which has been declared by theWorld Health Organization to be a "public health emergency of international concern," has spread across the globe and is impacting worldwide economic activity. A public health pandemic, including COVID-19, poses the risk that we or our employees, contractors, suppliers, and other partners may be prevented from conducting business activities for an indefinite period of time, including due to shutdowns that may be requested or mandated by governmental authorities. More generally, COVID-19 raises the possibility of an extended global economic downturn, which could affect demand for our products and services and impact our results and financial condition even after the pandemic is contained and remediation/restriction measures are lifted. For example, we may be unable to collect receivables from customers that are significantly impacted by COVID-19. Also, a decrease in orders in a given period could negatively affect our revenues in future periods. COVID-19 may also have the effect of heightening many of the other risks described in the "Risk Factors" section of our Annual Report on Form 10-K, including risks associated with our customers and supply chain. We will continue to evaluate the nature and extent of the impact of COVID-19 to our business. At present, it is clear the global economy has been negatively impacted by COVID-19, and demand for some of our products and services have been reduced due to uncertainty and the economic impact of COVID-19. For example, customers in certain of the industries most impacted by COVID-19, have requested, and we expect will continue to request, relief to existing contracts or payment obligations, and the impact of those is uncertain. For example, some customers are delaying payments owed to the Company while they address immediate financial crises in their operations due to COVID-19. In particular, in the media and entertainment industry, demand for the use of outdoor media equipment has been impacted due to restrictions on public gatherings. Until such restrictions improve, we expect that demand for certain of our clients' products and services will be limited, and thus, may impact our financial results and operations. Specifically, our business has also begun to be negatively affected by a range of external factors related to COVID-19 that are not within our control. For example, numerous measures have been implemented by governmental authorities across the globe to contain the virus, including travel bans and restrictions, quarantines, shelter-in-place orders, restrictions and limitations of public gatherings, and business limitations and shutdowns. Many of our customers' businesses have been severely impacted by these measures and some have been required to reduce employee headcount as a result. If a significant number of our customers are unable to continue as a going concern, this would have an adverse impact on our business and financial condition. In addition, many of our customers are working remotely, which may delay the timing of new business and implementations of our services. If COVID-19 continues to have a substantial impact on our partners, customers, or suppliers, our results of operations and overall financial performance will be harmed.
Though management has been proactively managing through the current known impacts, if the situation further deteriorates or the outbreak results in further restriction on both supply and demand factors, our cash flows, financial position and operating results for fiscal year 2020 and beyond will be negatively impacted. Neither the length of time nor the magnitude of the negative impacts can be presently determined.
The longer the COVID-19 pandemic persists, the greater the potential for
significant adverse impact to our business operations. Quarantines, travel
restrictions, prohibitions on non-essential gatherings, shelter-in-place orders
and other similar directives and policies intended to reduce the spread of the
disease, may reduce our productivity and that of the third parties on which we
rely and may disrupt and delay many aspects of our business. .
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We have not developed a specific and comprehensive contingency plan designed to
address the challenges and risks presented by the COVID-19 pandemic and, even if
and when we do develop such a plan, there can be no assurance that such plan
will be effective in mitigating the potential adverse effects on our business,
financial condition and results of operations.
Management's plans with respect to the above is to continue its efforts towards
responding to the changing economic landscape attributable to COVID-19, to
restructure the Company with the primary objectives of reducing costs,
conserving cash, strengthening margins, and improving company-wide
execution. Specific actions already implemented by management include a
reduction in force, a freeze on hiring, reduced work week, minimizing overtime,
travel and entertainment, and contractor costs. On April 7, 2020 , the Company
implemented a cost reduction plan which included the termination of certain
employees and elimination of certain costs. Estimated savings from this effort
are expected to be $2.5 to $3.0 million for the year ending 2020.
While management expects these actions to result in prospective cost reductions,
management is also committed to securing debt and/or equity financing to ensure
that liquidity will be sufficient to meet the Company's cash requirements
through at least a period of the next twelve months. Management believes
potential sources of liquidity include at least the following:
? In
has been drawn through December 31, 2019 . As of April 1, 2020 , the
remaining unfunded commits expired.
? In
and Exchange Commission which became effective on June 19, 2019 , and
allows the Company to offer up to $100,000,000 aggregate dollar amount
of shares of its common stock, preferred stock, debt securities,
warrants to purchase its common stock, preferred stock or debtsecurities, subscription rights to purchase its common stock, preferred
stock or debt securities andor units consisting of some or all of these
securities, in any combination, together or separately, in one of more
offerings, in amounts, at prices and on the terms that the Company will
determine at the time of the offering and which will be set forth in a
prospectus supplement and any related free writing prospectus.
? On
offering (the "Initial Closing") under the Purchase Agreement and issued
a Senior Secured Convertible Promissory Note with an aggregate of
purchased the Initial Note for an aggregate purchase price of
discount. The Initial Note bears no interest rate (except upon event of
default) and, unless earlier converted or redeemed, will mature on the
date that is the twenty-three (23) month anniversary of the last dayfrom the Initial Closing in either cash or shares of the Company's
common stock.
? On April 28, 2020 , the Company received a Paycheck Protection Program
(PPP) loan in the amount of $1,499,360 . Management believes that most of
the loan, if not all, will likely be forgiven.
As a result of management's cost reduction plans, the Company's potential
sources of liquidity and management's most recent cash flow forecasts,
management believes that the Company has sufficient liquidity to satisfy its
anticipated cash requirements for at least the next twelve months. However,
there can be no assurance that management's cost reduction efforts will be
effective, the forecasted cash flows will be achieved, or that external sources
of financing, including the issuance of debt and/or equity securities, will be
available at times and on terms acceptable to the Company, or at all.
The following table summarizes our cash flows for the six month periods ended
June 30, 2020 and 2019:
For the Six Months Ended June 30,
Cash flows: 2020 2019
Net cash (used in) provided by operating activities
$ 1,713,884 Net cash used in investing activities$ (414,040 ) $ (1,355,925 ) Net cash provided by financing activities$ 2,817,718 $ 2,323,170 34
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Operating Activities
During the six month period endedJune 30, 2020 , the Company used$2,935,059 in cash from operating activities, a$4,648,943 net change in cash when compared to the cash provided by operating activities of$1,713,884 during the same period in 2019. The increase in cash used in operating activities was primarily a result of reductions in net sources of working capital of$3,759,437 which contributed to the increase in the use of cash. This use of working capital was offset by a reduction in the net loss of$1,431,169 as compared to the same period in the prior year, which improvement was offset by a decrease in the add-back for non-cash items of$2,320,675 . In comparison to the prior year, non-cash adjustments which are added back to the net loss generated during a period decreased to$406,785 for the six month period endedJune 30, 2020 as compared to$2,727,460 for the same period in 2019, a decrease of$2,320,675 . This decrease in non-cash adjustments consists of increases of$426,436 comprised of gain on disposal of property and equipment, depreciation, inventory reserves and debt discount. These increases were offset by$2,747,111 in decreases in non-cash adjustments attributable to deferred benefit for income taxes, unrealized gain of foreign currency transactions, provision for bad debt, impairment of goodwill, warranty reserves, amortization of deferred gain, amortization of intangibles, and stock-based compensation expense. Cash generated by changes in working capital accounts as compared to the prior year decrease overall by$3,759,437 . During the six month period endedJune 30, 2020 cash used for working capital requirements increased$2,233,650 as compared to cash generated from changes in working capital of$1,525,787 in the same year ago period. Our ability to generate cash from operations in future periods will depend in large part on our profitability, the rate and timing of collections of our accounts receivable, our inventory turns and our ability to manage other areas of working capital including accounts payable.
Investing Activities
During the six month period endedJune 30, 2020 , the Company used cash of$414,040 in investing activities as compared to$1,355,925 used during the same period in 2019, a decrease of$941,885 . In the prior reporting period, the Company was expanding and remodeling its facility for increased capacity. Such costs were not incurred in the current period. Additionally, in the prior year, the Company was implementing phase I of its ERP system which included a team of external resources for which the costs were capitalized. Though phase II is currently in process, the implementation team is significantly smaller and as a result we are not incurring comparable costs. We do not anticipate any other significant purchases of equipment beyond that which is anticipated for use in the normal course of our core business activity.
Financing Activities
During the six month period endedJune 30, 2020 , the Company generated net,$2,817,718 in financing activities as compared to the cash generated of$2,323,170 during the same period in 2019. During the six month period endedJune 30, 2020 , in addition to payments on term loans and outstanding lines of credit, the Company received proceeds of$64,467 through the exercise of stock options which was offset by a payment for taxes of$670,599 that were paid on behalf of those that exercised options and RSU's on a net cashless basis. Additionally, during April of 2020, the Company closed on a$3,000,000 , 10% original issue discount, senior secured convertible debt offering which resulted in net proceeds after the payment of discount and professional fees of$2,383,726 . OnApril 28, 2020 , the Company received a two year Paycheck Protection Plan loan in the amount of$1,499,360 . Management believes that most of the loan, if not all, will likely be forgiven. During the six month period endedJune 30, 2019 , the Company raised$1,500,000 from individuals and related parties through the issuance of notes payable that bear interest at an annual rate of 9.5% and are repaid through 24 months monthly installments. Bressner increased borrowing under its lines of credit for the purchase of inventories and also borrowed funds through term loans at interest rates of 2.125% - 2.150% that are repaid through monthly installments of up to 24 months. The Company received proceeds of$21,149 for the exercise of warrants and stock options. 35
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Off balance sheet arrangements
Other than lease commitments incurred in the normal course of business and certain indemnification provisions, we do not have any off-balance sheet financing arrangements or liabilities, guarantee contracts, retained or contingent interests in transferred assets, or any obligation arising out of a material variable interest in an unconsolidated entity.
We do not have any majority-owned subsidiaries that are not consolidated in the financial statements. Additionally, we do not have an interest in, or relationships with, any special purpose entities.
Stockholder transactions
InApril 2019 , certain members of the Company's Board of Directors executed definitive agreements to commit funds of up to$4,000,000 as a credit facility. The Company initially borrowed$1,150,000 from members of the Board of Directors and$350,000 from other shareholders for a two year period at an interest rate of 9.5% which requires the Company to make monthly principal and interest payment of$69,000 per month. In connection with these loans, the Company issued the note holders warrants to purchase shares of the Company's common stock equal to 10% of the original principal at a price per share equal to$2.15 per share. Accordingly, the Company issued to the note holders warrants to purchase 69,766 shares of the Company's common stock. The relative fair value of the warrants issued was$60,158 . The remaining unfunded loan commitments expired as ofApril 1, 2020 .
Critical accounting policies and estimates
In preparing our consolidated financial statements in conformity withU.S. generally accepted accounting principles, management must make a variety of decisions which impact the reported amounts and the related disclosures. These decisions include the selection of the appropriate accounting principles to be applied and the assumptions on which to base accounting estimates. In making these decisions, management applies its judgment based on its understanding and analysis of the relevant circumstances and our historical experience. Our accounting policies and estimates that are most critical to the presentation of our results of operations and financial condition, and which require the greatest use of judgments and estimates by management, are designated as our critical accounting policies. See further discussion of our critical accounting policies under Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations," in our Annual Report on Form 10-K for our year endedDecember 31, 2019 . We periodically re-evaluate and adjust our critical accounting policies as circumstances change. There were no significant changes in our critical accounting policies during the three months endedJune 30, 2020 .
Recently implemented accounting pronouncements
Per the Company's consolidated financial statements Note 2 - Significant Accounting Policies, we have implemented a number of changes, as required by FASB. See Note 2 of the accompanying financial statements for further details.
Recent accounting pronouncements
Per the Company's consolidated financial statements Note 2 - Significant Accounting Policies, we may be implementing a number of changes, as required by FASB. See Note 2 of the accompanying financial statements or further details.
Interest rate risk
Our exposure to interest rate risk is primarily associated with borrowing on revolving lines of credit denominated in bothU.S. dollars and Euros. We are exposed to the impact of interest rate changes primarily through our borrowing activities for our variable rate borrowings. 36
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Concentration of credit risk
Financial instruments that potentially expose us to concentrations of credit risk consist principally of cash, cash equivalents and accounts receivable. We place our cash and cash equivalents with financial institutions with high credit quality. AtJune 30, 2020 andDecember 31, 2019 , we had$4,654,602 and$5,185,321 , respectively, of cash and cash equivalents on deposit or invested with our financial and lending institutions. We provide credit to our customers in the normal course of business. We perform ongoing credit evaluations of our customers' financial condition and limit the amount of credit extended when deemed necessary. Customer Concentration The Company's largest customer is in the media and entertainment industry which has been adversely affected by the COVID pandemic as a result of the guidelines limiting non-essential public gatherings. As a result, sales to this customer have slowed and the collection cycle of accounts receivable has protracted and been limited by their available cash flow. The Company has made arrangement for the payment of receives over an extended period of time.
Foreign currency risk
We operate primarily inthe United States . Foreign sales of products and services are primarily denominated inU.S. dollars. We also conduct business outsidethe United States through our foreign subsidiary inGermany , where business is largely transacted in non-U.S. dollar currencies particularly the Euro, which is subject to fluctuations due to changes in foreign currency exchange rates. Accordingly, we are subject to exposure from changes in the exchange rates of local currencies. Foreign currency transaction gains and losses are recorded in other income (expense), net in the consolidated statements of operations.OSS GmbH operates as an extension of OSS' domestic operations and acquiredBressner Technology GmbH inOctober 2018 . The functional currency ofOSS GmbH is the Euro. Transactions denominated in currencies other than the functional currency are remeasured to the functional currency at the average exchange rate in effect during the period. At the end of each reporting period, monetary assets and liabilities are translated using exchange rates in effect at the balance sheet date. Non-monetary assets and liabilities are remeasured at historical exchange rates. Consequently, changes in the exchange rates of the currencies may impact the translation of the foreign subsidiaries' statements of operations intoU.S. dollars, which may in turn affect our consolidated statement of operations. The resulting foreign currency translation adjustments are recorded as a separate component of accumulated other comprehensive income in the consolidated statement of comprehensive income.
Derivative Financial Instruments
We employ derivatives on a periodic basis to manage certain market risks through the use of foreign exchange forward contracts. We do not use derivatives for trading or speculative purposes. Our derivatives are designated as a hedge of a forecasted transaction or of the variability of cash flows to be received or paid related to a recognized asset or liability (cash flow hedge). We hedge a portion of the exchange risk involved in anticipation of highly probable foreign currency-denominated transactions. In anticipation of these transactions, we may enter into foreign exchange contracts to provide currency at a fixed rate.
Non-GAAP Financial Measures
Adjusted EBITDA
We believe that the use of adjusted earnings before interest, taxes,
depreciation and amortization, or adjusted EBITDA, is helpful for an investor to
assess the performance of the Company. The Company defines adjusted EBITDA as
income (loss) attributable to common stockholders before interest, taxes,
depreciation, amortization, acquisition expenses, impairment of long-lived
assets, financing costs, fair value adjustments from purchase accounting,
stock-based compensation expense and expenses related to discontinued
operations.
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Adjusted EBITDA is not a measurement of financial performance under generally
accepted accounting principles in the United States , or GAAP. Because of varying
available valuation methodologies, subjective assumptions and the variety of
equity instruments that can impact a company's non-cash operating expenses, we
believe that providing a non-GAAP financial measure that excludes non-cash and
non-recurring expenses allows for meaningful comparisons between our core
business operating results and those of other companies, as well as providing us
with an important tool for financial and operational decision making and for
evaluating our own core business operating results over different periods of
time.
Our adjusted EBITDA measure may not provide information that is directly
comparable to that provided by other companies in our industry, as other
companies in our industry may calculate non-GAAP financial results differently,
particularly related to non-recurring, unusual items. Our adjusted EBITDA is not
a measurement of financial performance under GAAP, and should not be considered
as an alternative to operating income or as an indication of operating
performance or any other measure of performance derived in accordance with GAAP.
We do not consider adjusted EBITDA to be a substitute for, or superior to, the
information provided by GAAP financial results.
For The Three Months For The Six Months
Ended June 30, Ended June 30,
2020 2019 2020 2019
Net loss attributable to common stockholders
402,385 422,254 798,210 886,982
Amortization of deferred gain (12,359 ) (16,478 ) (53,838 ) (32,957 )
Impairment of goodwill - 1,697,394 - 1,697,394
Stock-based compensation expense 85,378 157,807 293,139 325,283
Interest income (99,343 ) (10,168 ) (123,980 ) (13,275 )
Interest expense 150,186 53,013 218,970 59,281
Acquisition expense - 100 - 4,075
(Benefit) provision for income taxes (441,511 ) 558,072 (908,809 ) (543,839 )
Adjusted EBITDA $ 72,574 $ 1,267,361 $ (884,502 ) $ (156,419 )
Adjusted EPS
Adjusted EPS excludes the impact of certain items and, therefore, has not been
calculated in accordance with GAAP. We believe that exclusion of certain
selected items assists in providing a more complete understanding of our
underlying results and trends and allows for comparability with our peer company
index and industry. We use this measure along with the corresponding GAAP
financial measures to manage our business and to evaluate our performance
compared to prior periods and the marketplace. The Company defines Non-GAAP
(loss) income attributable to common stockholders as (loss) or income before
amortization, stock-based compensation, expenses related to discontinued
operations, impairment of long-lived assets and non-recurring acquisition
costs. Adjusted EPS expresses adjusted (loss) income on a per share basis using
weighted average diluted shares outstanding.
Adjusted EPS is a non-GAAP financial measure and should not be considered in
isolation or as a substitute for financial information provided in accordance
with GAAP. These non-GAAP financial measures may not be computed in the same
manner as similarly titled measures used by other companies. We expect to
continue to incur expenses similar to the adjusted income from continuing
operations and adjusted EPS financial adjustments described above, and investors
should not infer from our presentation of these non-GAAP financial measures that
these costs are unusual, infrequent or non-recurring.
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The following table sets-forth Non-GAAP net (loss) income attributable to common stockholders and basic and diluted earnings per share:
For The Three Months For The Six Months
Ended June 30, Ended June 30
2020 2019 2020 2019
Net loss attributable to common
stockholders $ (12,162 ) $ (1,594,633 ) $ (1,108,194 ) $ (2,539,363 )
Amortization of intangibles 174,525 269,151 349,051 618,570
Impairment of goodwill - 1,697,394 - 1,697,394
Stock-based compensation expense 85,378 157,807 293,139 325,283
Acquisition expense - 100 - 4,075
Non-GAAP net income (loss) attributable
to common stockholders $ 247,741 $ 529,819 Non-GAAP net income (loss) per share attributable to common stockholders: Basic$ 0.02 $ 0.04 $ (0.03 ) $ 0.01 Diluted$ 0.01 $ 0.04 $ (0.03 ) $ 0.01 Weighted average common shares outstanding: Basic 16,488,325 14,442,291 16,410,660 14,341,560 Diluted 16,867,921 14,916,460 16,410,660 14,815,730 Free Cash Flow Free cash flow, a non-GAAP measure for reporting cash flow, is defined as cash provided by or used in operating activities less capital expenditures for property and equipment, which includes capitalized software development costs for the implementation of the Company's ERP system. We believe free cash flow provides investors with an important perspective on cash available for investments and acquisitions after making capital investments required to support ongoing business operations and long-term value creation. We believe that trends in our free cash flow can be valuable indicators of our operating performance and liquidity. Free cash flow is a non-GAAP financial measure and should not be considered in isolation or as a substitute for financial information provided in accordance with GAAP. This non-GAAP financial measure may not be computed in the same manner as similarly titled measures used by other companies. We expect to continue to incur expenditures similar to the free cash flow adjustments described above, and investors should not infer from our presentation of this non-GAAP financial measure that these expenditures reflect all of our obligations which require cash. The following table reconciles cash provided by or used in operating activities, the most directly comparable GAAP financial measure, to free cash flow: For the Six Months Ended June 30, Change Cash flow: 2020 2019
Net cash (used in) provided by operating
1,713,884
activities$ (4,648,943 ) Capital expenditures (415,582 ) (1,356,975 ) 941,393 Free cash flow$ (3,350,641 ) $ 356,909$ (3,707,550 ) 39
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