UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

 

FORM 10-Q

 

(Mark One)

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2018

OR

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from __________ to ________________

Commission File Number: 001-38371

 

One Stop Systems, Inc.

(Exact Name of Registrant as Specified in its Charter)

 

 

Delaware

33-0885351

( State or other jurisdiction of

incorporation or organization)

(I.R.S. Employer
Identification No.)

 

 

2235 Enterprise Street #110

Escondido, California  92029

(Address of principal executive offices including Zip Code

 

(877) 438-2724

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.     Yes  No 

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes     No  

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer

 

  

Accelerated filer

 

 

 

 

 

Non-accelerated filer

 

  (Do not check if a smaller reporting company)

  

Smaller reporting company

 

 

 

 

 

 

 

 

Emerging growth company

 

 

 

 

 

 

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes      No 

As of April 1, 2018, the registrant had 12,773,289 shares of common stock (par value $0.0001) outstanding.

 

 

 

 

 


Table of Contents

 

PART I. FINANCIAL INFORMATION

 

 

 

 

 

Page

Item 1.

 

Financial Statements

 

4

 

 

Unaudited Condensed Consolidated Balance Sheets

 

4

 

 

Unaudited Condensed Consolidated Statements of Operations

 

5

 

 

Unaudited Condensed Consolidated Statement of Stockholders’ Equity

 

6

 

 

Unaudited Condensed Consolidated Statements of Cash Flows

 

7

 

 

Notes to Unaudited Condensed Consolidated Financial Statements

 

9

Item 2.

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

31

Item 3.

 

Quantitative and Qualitative Disclosures About Market Risk

 

46

Item 4.

 

Controls and Procedures

 

46

 

 

PART II. OTHER INFORMATION

 

 

Item 1.

 

Legal Proceedings

 

48

Item 1A.

 

Risk Factors

 

48

Item 2.

 

Unregistered Sales of Equity Securities and Use of Proceeds

 

48

Item 3.

 

Defaults Upon Senior Securities

 

49

Item 4.

 

Mine Safety Disclosures

 

49

Item 5.

 

Other Information

 

49

Item 6.

 

Exhibits

 

50

 

 

Signatures

 

51

 

 

 

i


 

PART I—FINANCIAL INFORMATION

Item 1. Financial Statements.

ONE STOP SYSTEMS, INC. (OSS)

CONDENSED CONSOLIDATED BALANCE SHEETS

 

 

 

Unaudited

 

 

 

 

 

 

 

March 31,

 

 

December 31,

 

 

 

2018

 

 

2017

 

ASSETS

 

 

 

 

 

 

 

 

Current assets

 

 

 

 

 

 

 

 

Cash  and cash equivalents

 

$

9,126,847

 

 

$

185,717

 

Accounts receivable, net

 

 

5,213,551

 

 

 

5,192,730

 

Inventories, net

 

 

3,339,761

 

 

 

3,696,330

 

Prepaid expenses and other current assets

 

 

418,969

 

 

 

978,428

 

Total current assets

 

 

18,099,128

 

 

 

10,053,205

 

Property and equipment, net

 

 

1,824,422

 

 

 

1,581,814

 

Deposits and other

 

 

31,215

 

 

 

31,215

 

Deferred tax assets, net

 

 

1,102,465

 

 

 

1,318,447

 

Goodwill

 

 

3,324,128

 

 

 

3,324,128

 

Intangible assets, net

 

 

509,745

 

 

 

608,405

 

 

 

$

24,891,103

 

 

$

16,917,214

 

LIABILITIES AND STOCKHOLDERS' EQUITY

 

 

 

 

 

 

 

 

Current liabilities

 

 

 

 

 

 

 

 

Accounts payable

 

$

1,101,298

 

 

$

3,904,613

 

Accrued expenses and other liabilities

 

 

1,460,160

 

 

 

1,933,977

 

Borrowings on bank line of credit

 

 

-

 

 

 

3,334,508

 

Current portion of related-party notes payable, net of debt discount

   of $0 and $13,905, respectively

 

 

-

 

 

 

136,303

 

Current portion of note payable, net of debt discount of $0 and

   $9,932, respectively

 

 

-

 

 

 

640,079

 

Total current liabilities

 

 

2,561,458

 

 

 

9,949,480

 

Related-party notes payable, net of current portion and debt discount

   of $0 and $579, respectively

 

 

-

 

 

 

12,696

 

Note payable, net of current portion and debt discount of $0 and

   $414, respectively

 

 

-

 

 

 

335,267

 

Total liabilities

 

 

2,561,458

 

 

 

10,297,443

 

Commitments and contingencies (Note 9)

 

 

 

 

 

 

 

 

Stockholders’ equity

 

 

 

 

 

 

 

 

Series C preferred stock, no par value, convertible; 2,000,000 shares

   authorized; 0 and 1,087,006 issued and outstanding respectively;

   liquidation preference of $1,630,508 in 2017

 

 

-

 

 

 

1,604,101

 

Series B preferred stock, no par value, convertible; 1,500,000 shares

   authorized; 0 and 1,450,000 issued and outstanding respectively;

   liquidation preference of $725,000 in 2017

 

 

-

 

 

 

697,996

 

Series A preferred stock, no par value, convertible; 500,000 shares

   authorized; 0 and 500,000 issued and outstanding respectively;

   liquidation preference of $125,000 in 2017

 

 

-

 

 

 

114,430

 

Common stock, $0.0001 par value; 50,000,000 shares authorized;12,773,289

   and 5,514,917 shares, respectively issued and outstanding, respectively

 

 

1,277

 

 

 

551

 

Additional paid-in capital

 

 

22,517,107

 

 

 

3,484,428

 

Noncontrolling interest

 

 

324,257

 

 

 

436,842

 

Retained (deficit) earnings

 

 

(512,996

)

 

 

281,423

 

Total stockholders’ equity

 

 

22,329,645

 

 

 

6,619,771

 

 

 

$

24,891,103

 

 

$

16,917,214

 

 

See accompanying notes to condensed consolidated financial statements

4


 

ONE STOP SYSTEMS, INC. (OSS)

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

 

 

 

For The Three Month Periods

ended March 31,

 

 

 

2018

 

 

2017

 

Net revenue

 

$

7,119,712

 

 

$

6,336,338

 

Cost of revenue

 

 

4,906,846

 

 

 

4,279,269

 

Gross margin

 

 

2,212,866

 

 

 

2,057,069

 

Operating expenses:

 

 

 

 

 

 

 

 

General and administrative

 

 

1,073,048

 

 

 

688,730

 

Marketing and selling

 

 

869,015

 

 

 

607,038

 

Research and development

 

 

972,631

 

 

 

587,454

 

Total operating expenses

 

 

2,914,694

 

 

 

1,883,222

 

(Loss) income from operations

 

 

(701,828

)

 

 

173,847

 

Other income (expense):

 

 

 

 

 

 

 

 

Interest expense

 

 

(55,661

)

 

 

(50,001

)

Other, net

 

 

67,609

 

 

 

(67

)

Total other income (expense), net

 

 

11,948

 

 

 

(50,068

)

(Loss)  income before provision for income taxes

 

 

(689,880

)

 

 

123,779

 

Provision for income taxes

 

 

217,124

 

 

 

44,632

 

Net (loss) income

 

$

(907,004

)

 

$

79,147

 

Net loss attributable to noncontrolling interest

 

$

(112,585

)

 

$

-

 

Net (loss) income attributable to common stockholders

 

$

(794,419

)

 

$

79,147

 

Net (loss) income per share attributable to common stockholders:

 

 

 

 

 

 

 

 

Basic

 

$

(0.08

)

 

$

0.01

 

Diluted

 

$

(0.08

)

 

$

0.01

 

Weighted average common shares outstanding:

 

 

 

 

 

 

 

 

Basic

 

 

10,140,459

 

 

 

5,379,141

 

Diluted

 

 

10,140,459

 

 

 

9,757,229

 

 

See accompanying notes to condensed consolidated financial statements

 

 

5


 

ONE STOP SYSTEMS, INC. (OSS)

UNAUDITED CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY

For The Three Month Period Ended March 31, 2018

 

 

 

Series C Preferred

Stock

 

 

Series B Preferred

Stock

 

 

Series A Preferred

Stock

 

 

Common Stock

 

 

Additional

Paid-in

 

 

Noncontrolling

 

 

Retained (Deficit)

 

 

Total

Stockholders'

 

 

 

Shares

 

 

Amount

 

 

Shares

 

 

Amount

 

 

Shares

 

 

Amount

 

 

Shares

 

 

Amount

 

 

Capital

 

 

Interest

 

 

Earnings

 

 

Equity

 

Balance, January 1,

   2018

 

 

1,087,006

 

 

$

1,604,101

 

 

 

1,450,000

 

 

$

697,996

 

 

 

500,000

 

 

$

114,430

 

 

 

5,514,917

 

 

$

551

 

 

$

3,484,428

 

 

$

436,842

 

 

$

281,423

 

 

$

6,619,771

 

Conversion of preferred

   stock to common

   stock upon initial

   public offering

 

 

(1,087,006

)

 

 

(1,604,101

)

 

 

(1,450,000

)

 

 

(697,996

)

 

 

(500,000

)

 

 

(114,430

)

 

 

3,037,006

 

 

 

304

 

 

 

2,416,223

 

 

 

-

 

 

 

-

 

 

 

-

 

Stock-based

   compensation

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

35,318

 

 

 

-

 

 

 

-

 

 

 

35,318

 

Exercise of stock

   options

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

321,366

 

 

 

32

 

 

 

54,543

 

 

 

-

 

 

 

-

 

 

 

54,575

 

Taxes paid on net

   issuance of employee

   stock options

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

(274,663

)

 

 

-

 

 

 

-

 

 

 

(274,663

)

Relative fair value of

   warrants issued to

   Underwriters with

   IPO

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

669,408

 

 

 

-

 

 

 

-

 

 

 

669,408

 

Proceeds from issuance

   of stock, net of

   issuance costs

   of $3,367,760

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

3,900,000

 

 

 

390

 

 

 

16,131,850

 

 

 

-

 

 

 

-

 

 

 

16,132,240

 

Noncontrolling interest

   in consolidated

   subsidiary (Note 1)

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

(112,585

)

 

 

-

 

 

 

(112,585

)

Net loss

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

(794,419

)

 

 

(794,419

)

Balance, March 31,

   2018

 

 

-

 

 

$

-

 

 

 

-

 

 

$

-

 

 

 

-

 

 

$

-

 

 

 

12,773,289

 

 

$

1,277

 

 

$

22,517,107

 

 

$

324,257

 

 

$

(512,996

)

 

$

22,329,645

 

 

See accompanying notes to condensed consolidated financial statements

 

 

6


ONE STOP SYSTEMS, INC. (OSS)

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

 

 

 

For The Three Month Periods

ended March 31,

 

 

 

2018

 

 

2017

 

Cash flows from operating activities:

 

 

 

 

 

 

 

 

Net (loss) income

 

$

(907,004

)

 

$

79,147

 

Less:  Net loss attributable to noncontrolling interest

 

 

(112,585

)

 

 

-

 

Net (loss) income attributable to common stockholders

 

 

(794,419

)

 

 

79,147

 

Adjustments to reconcile net (loss) income to net cash (used) provided in

   operating activities:

 

 

 

 

 

 

 

 

Net loss attributable to noncontrolling interest

 

 

(112,585

)

 

 

-

 

Deferred provision for income taxes

 

 

215,982

 

 

 

-

 

Provision for bad debt

 

 

91,127

 

 

 

-

 

Warranty reserves

 

 

1,326

 

 

 

2,135

 

Amortization of deferred gain

 

 

(28,838

)

 

 

-

 

Depreciation and amortization

 

 

253,758

 

 

 

179,044

 

Inventory reserves

 

 

(457,872

)

 

 

(152,647

)

Amortization of debt discount

 

 

24,830

 

 

 

5,959

 

Stock-based compensation expense

 

 

35,318

 

 

 

24,626

 

Changes in operating assets and liabilities:

 

 

 

 

 

 

 

 

Accounts receivable

 

 

(111,949

)

 

 

1,337,017

 

Inventories

 

 

430,121

 

 

 

(990,200

)

Prepaid expenses and other current assets

 

 

(340,579

)

 

 

(14,623

)

Accounts payable

 

 

(2,803,316

)

 

 

550,505

 

Accrued expenses and other liabilities

 

 

(433,714

)

 

 

178,105

 

Net cash (used) provided in operating activities

 

 

(4,030,810

)

 

 

1,199,068

 

Cash flows from investing activities:

 

 

 

 

 

 

 

 

Purchases of property and equipment, including capitalization of labor

   costs for tooling and test equipment

 

 

(13,387

)

 

 

(51,760

)

Net cash used in investing activities

 

 

(13,387

)

 

 

(51,760

)

Cash flows from financing activities:

 

 

 

 

 

 

 

 

Proceeds from stock options exercised

 

 

54,575

 

 

 

14,415

 

Payment of payroll taxes on net issuance of employee stock options

 

 

(274,663

)

 

 

-

 

Stock issuance costs

 

 

(1,810,902

)

 

 

-

 

Proceeds from issuance of common stock

 

 

19,500,000

 

 

 

-

 

Net repayments on bank line of credit

 

 

(3,334,508

)

 

 

(982,982

)

Payments on related-party notes payable

 

 

(163,483

)

 

 

(32,357

)

Payments on notes payable

 

 

(985,692

)

 

 

(151,897

)

Net cash provided (used) in financing activities

 

 

12,985,327

 

 

 

(1,152,821

)

Net change in cash and cash equivalents

 

 

8,941,130

 

 

 

(5,513

)

Cash and cash equivalents, beginning of period

 

 

185,717

 

 

 

14,197

 

Cash and cash equivalents, end of period

 

$

9,126,847

 

 

$

8,684

 

 

See accompanying notes to condensed consolidated financial statements

7


 

ONE STOP SYSTEMS, INC. (OSS)

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS – CONTINUED

 

 

 

For The Three Month Periods

ended March 31,

 

 

 

2018

 

 

2017

 

Supplemental disclosure of cash flow information:

 

 

 

 

 

 

 

 

Cash paid during the period for interest

 

$

39,351

 

 

$

44,545

 

Cash paid during the period for income taxes

 

$

-

 

 

$

-

 

Supplemental disclosure of non-cash transactions:

 

 

 

 

 

 

 

 

Reclassification of inventory to property and equipment

 

$

384,318

 

 

$

-

 

Relative fair value of warrants issued in connection with initial public

   offering

 

$

669,408

 

 

$

-

 

Reclassification of prepaid IPO expenses to additional paid in capital

 

$

887,450

 

 

$

-

 

 

See accompanying notes to condensed consolidated financial statements

 

 

8


ONE STOP SYSTEMS, INC. (OSS)

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

For Three Month Periods Ended March 31, 2018 and 2017

 

NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Nature of Operations

One Stop Systems, Inc. (“we,” “our,” “OSS,” or the “Company”) was originally incorporated as a California corporation in 1999 after initially being formed as a California limited liability company in 1998. On December 14, 2017, the Company was reincorporated as a Delaware corporation in connection with its initial public offering.  The Company designs, manufactures and markets industrial grade computer systems and components that are based on industry standard computer architectures. The Company markets its products to manufacturers of automated equipment used for telecommunications, industrial and military applications.     

During the year ended December 31, 2015, the Company formed a new wholly-owned subsidiary in Germany (“OSS GmbH”).  During July 2016, the Company acquired Mission Technologies Group, Inc. (“Magma”) and its operations (Note 2).

In April 2017, the Company and a related entity formed a joint venture named SkyScale, LLC in the State of California (“SkyScale”).  In accordance with the Contribution Agreement, each member contributed $750,000 and received a 50% interest in the joint venture.  The purpose of SkyScale, is to engage in the business of providing high performance computing capabilities as cloud services.

In May 2017, the Company entered into a Technology and Software License Agreement with Western Digital (“WDT”) for their Ion flash storage software.  The agreement provides the Company with the Ion source code and rights to develop and market derivative products.  The Company intends to develop and sell Ion flash storage software with its high-density storage arrays, as well as servicing existing WDT software users (Note 2).

Also, in July 2017, the Company entered in to a Service Agreement with WDT to service their existing customer base that utilizes Ion flash storage software.  The Company also purchased certain equipment from WDT and hired selected employees to assist in the servicing of these existing customers.  Management has determined that the activities and assets acquired from WDT comprise a business as defined in ASC 805-10-55-4 through 55.  Consideration paid by the Company to WDT pursuant to the arrangements described above was $67,000.  In addition, the Company is required to pay prospective royalties to WDT of $2,500 or $5,000 for each sale of the Company’s products that include licensed software.  WDT is obligated to pay the Company for services rendered to support existing WDT software users the amount of $1,400,000 in defined declining quarterly amounts over a three year period.  Management does not believe this business acquisition meets the significance definition provided in Regulation S-X, Rune 210.1-02(w).

 

Through March 31, 2018, the Company’s primary sources of liquidity came from existing cash; cash generated from operations, a bank revolving line of credit and related party and third party term notes.  Borrowings under the debt agreements are collateralized by substantially all of the Company’s assets and the personal guarantee of its CEO.  During 2017, the Company experienced growing sales and gross profits, has a strong order backlog, and increased its line of credit facility.  

 

On February 1, 2018, the Company completed its initial public offering through the initial sale of 3,800,000 shares of common stock at a price to the public of $5.00 per share (see Note 8).  Proceeds from the sale were used to retire outstanding debt obligations and provide the Company with requisite working capital.

9


ONE STOP SYSTEMS, INC. (OSS)

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

For The Three Month Periods Ended March 31, 2018 and 2017

 

The combination of the continued revenue growth we have experienced, coupled with an expected improvement in gross margins and cost containment of expenses and funding received from our initial public offering leads management to believe that it is probable that our liquidity will be sufficient to meet our cash requirements for current operations through at least a period of the next twelve months. If necessary, it is probable that external sources of debt and/or equity financing could be obtained based on management’s history of being able to raise capital. As a result of both management’s plans and current favorable business trends, 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 our operations will become profitable 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 us, or at all.  The Company’s management prepares budgets and monitors the financial results of the Company as a tool to align liquidity needs to the recurring business requirements.     

The accompanying unaudited condensed consolidated financial statements have been prepared pursuant to the rules and regulations of the U.S. Securities and Exchange Commission.  Certain information and note disclosures normally included in annual financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to those rules and regulations, although the Company believes that the disclosures made are adequate to make the information not misleading.  It is suggested that these unaudited condensed consolidated financial statements be read in conjunction with the Company’s audited December 31, 2017 consolidated financial statements.

Basis of Presentation

The accompanying financial statements have been prepared on an accrual basis of accounting in accordance with United States Generally Accepted Accounting Principles (“U.S. GAAP”), as set forth in the Financial Accounting Standards Board’s (“FASB”) Accounting Standards Codification (“ASC”).  Certain prior year balances have been reclassified to conform to the current year presentation particularly with the presentation of common stock which is now presented with a par value of $0.0001 per share in accordance with our reincorporation as a Delaware corporation.

Principles of Consolidation

The accompanying unaudited consolidated financial statements include the accounts of OSS, which includes the results from the Magma acquisition and Ion business combination since their respective dates of acquisition, its wholly-owned subsidiary, OSS GmbH, and the accounts of the joint venture, SkyScale LLC (collectively referred to as the “Company”).  Intercompany balances and transactions have been eliminated in consolidation.

On April 6, 2017, the Company and Jacoma Investments, LLC, an entity owned by our board member Jack Harrison, formed a joint venture, SkyScale, LLC (“SkyScale”), to engage in the business of providing high performance computing capabilities as cloud services.  In accordance with the terms of the contribution agreement, Jacoma Investments, LLC agreed to contribute $750,000 in capital and the Company agreed to contribute $750,000 in the form of credits to purchase equipment, personnel or support services from the Company.  Each party received 50% membership interest in the joint venture.  Management determined that SkyScale is a variable interest entity primarily because it is thinly capitalized and may require additional capital to finance its activities.  

10


ONE STOP SYSTEMS, INC. (OSS)

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

For The Three Month Periods Ended March 31, 2018 and 2017

 

Management also determined that the Company is the primary beneficiary of SkyScale based primarily on the related party nature of SkyScale’s decision-makers and daily business operators.  As of March 31, 2018, SkyScale’s significant assets were comprised of cash, cash equivalents and receivables of $170,888 and computer-related equipment and other assets of $759,058, its significant liabilities were comprised of trade accounts payable of $222,395, and its net members’ equity totaled $707,551.  For the three month period ended March 31, 2018, SkyScale’s revenues were $120,539, its operating expenses (primarily personnel costs) aggregated $108,849, and its net loss was $135,290.  SkyScale did not have any operations in the three month period ended March 31, 2017.     The non-controlling interest attributable to SkyScale is shown as a component of equity on the consolidated balance sheets and the share of the profit (loss) attributable to the non-controlling interest is shown as a component of profit (loss) in the consolidated statements of operations.

Use of Estimates

The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and disclosures of contingent assets, liabilities, and expenses at the date of the consolidated financial statements during the reporting period.  

Significant estimates made by management include, among others, the fair value of net assets of Magma acquired in July 2016 and ION in July 2017, the allowance for doubtful accounts, fair value of stock options and warrants, recoverability of inventories and long-lived assets, and realizability of deferred tax assets.  Actual results could differ from those estimates.

Concentration Risks

At times, deposits held with financial institutions may exceed the amount of insurance provided by the Federal Deposit Insurance Corporation (“FDIC”), which provides basic deposit coverage with limits up to $250,000 per owner.  As of March 31, 2018, the Company had $8,766,990 in excess of the insurance limits.  The Company has not experienced any such losses in these accounts.

At March 31, 2018 and December 31, 2017, three  customers accounted for 63% and 69% respectively of net trade accounts receivable.  For the three month periods ended March 31, 2018 and 2017, three customers accounted for 54% and 46% of net revenue.  During the three month periods ended March 31, 2018 and 2017, the Company made purchases from three suppliers which represented approximately 48% and 45% of materials purchased.

Fair Value of Financial Instruments

The Company’s financial instruments consist principally of cash, accounts receivable, accounts payable, accrued expenses and debt instruments. The fair value of the Company’s cash equivalents is determined based on quoted prices in active markets for identical assets or Level 1 inputs.  The Company recognizes transfers between Levels 1 through 3 of the fair value hierarchy at the beginning of the reporting period.  The fair values of the Company’s variable rate debt instruments approximate its carrying values based upon management’s assessment of the current credit markets.  It is not practicable to estimate the fair value of the Company’s fixed rate instruments (including related party notes payable) due to the private nature of those transactions and the lack of an observable market.

Cash and Cash Equivalents

Cash and cash equivalents consist of cash on deposit and money market accounts.  The Company considers all highly liquid temporary cash investments with an initial maturity of three months or less when acquired to be cash equivalents.  Management believes that the carrying amounts of cash equivalents approximate their fair value because of the short maturity period.

 

11


ONE STOP SYSTEMS, INC. (OSS)

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

For The Three Month Periods Ended March 31, 2018 and 2017

 

Accounts Receivable

Accounts receivable are presented net of an allowance for doubtful accounts.  The allowance for doubtful accounts is an estimate to cover the losses resulting from the inability of customers to make payments on their outstanding balances.  In estimating the required allowance, management considers the overall quality and aging of the accounts receivable, specific customer circumstances, current economic trends, and historical experience with collections.  At March 31, 2018 and December 31, 2017, the allowance for doubtful accounts is $93,228 and $2,101, respectively.

Inventories

Inventories are valued at the lower of cost or net realizable value determined on a first-in, first-out basis.  The Company uses the average cost method for purposes of determining cost, which approximates the first-in, first-out method.

The Company establishes reserves on its inventories to write-down the carrying value of its estimated obsolete or excess inventories to estimated net realizable value based upon observations of historical usage and assumptions about future demand and market conditions.  In addition, the Company considers changes in the market value of components in determining the net realizable value of its inventory.  Inventory reserves are considered permanent adjustments to the cost basis of the inventories and are not typically reversed until the specific inventories are sold or otherwise disposed.

Property and Equipment

Property and equipment, other than leasehold improvements, are recorded at cost and depreciated using the straight-line method over the estimated useful lives of the assets, generally from three to five years. Leasehold improvements are recorded at cost and are amortized using the straight-line method over the shorter of the remaining lease term or the estimated useful life of the related asset.  Tooling and test equipment includes capitalized labor costs associated with the development of the related tooling and test equipment.  Costs incurred for maintenance and repairs are expensed as incurred, and expenditures for major replacements and improvements are capitalized. Upon retirement or sale, the cost and related accumulated depreciation and amortization of disposed assets are removed from the accounts and any resulting gain or loss is included in other expense, net.

Goodwill

Goodwill relates to the excess of the purchase price over the fair value of identifiable net assets acquired in a business combination.  Goodwill is not amortized, but instead the Company assesses possible impairment of goodwill on December 31, of each year and when an event occurs that may trigger such a review.  Determining whether a triggering event has occurred involves significant judgment by the Company.  Management assesses goodwill for impairment at the reporting unit level, and has determined that the Company only has one reporting unit.  In assessing qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount, the Company assesses relevant events and circumstances that may impact the fair value and the carrying amount of a reporting unit.  The identification of relevant events and circumstances and how these may impact a reporting unit’s fair value or carrying amount involve significant judgments by management.  These judgments include the consideration of macroeconomic conditions, industry and market considerations, cost factors, overall financial performance and events which are specific to the Company.  Each factor is assessed to determine whether it impacts the impairment test positively or negatively, and the magnitude of any such impact.

After the qualitative assessment, the impairment testing is a two-step process.  In the first step, the fair value of each reporting unit is compared to its carrying value.  If the fair value of the reporting unit exceeds the carrying value of the net assets assigned to that unit, then goodwill is not impaired and no further testing is required.  

12


ONE STOP SYSTEMS, INC. (OSS)

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

For The Three Month Periods Ended March 31, 2018 and 2017

 

If the carrying value of the net assets assigned to the reporting unit exceeds its fair value, then the second step is performed in order to determine the implied fair value of the reporting unit’s goodwill and an impairment loss is recorded for an amount equal to the difference between the implied fair value and the carrying value of the goodwill.  Determining the fair value of a reporting unit and goodwill is judgmental and involves the use of significant estimates and assumptions.

Based upon its impairment testing, management determined that no impairment loss has occurred during the three month periods ended March 31, 2018 and 2017.  There can be no assurance, however, that market conditions will not change or demand for the Company’s products will continue, which could result in an impairment of goodwill in the future.

Impairment of Long-Lived Assets

The Company reviews the recoverability of its other long-lived assets, such as property and equipment and definite lived intangible assets, whenever events or changes in circumstances occur that indicate the carrying value of the asset or asset group may not be recoverable.  The assessment for possible impairment is based on the Company’s ability to recover the carrying value of the asset or asset group from the expected future pre-tax cash flows, undiscounted and without interest charges, from the related operations.

If the aggregate of the net cash flows is less than the carrying value of such assets, an impairment loss is recognized for the difference between estimated fair value and carrying value. The determination and measurement of impairment of long-lived assets requires management to estimate future cash flows and the fair value of long-lived assets.

Management determined that there were no impairment charges to be recognized during the three month periods ended March 31, 2018 and 2017.  There can be no assurance, however, that market conditions will not change or demand for the Company’s products will continue, which could result in an impairment of long-lived assets in the future.

Revenue Recognition

The Company recognizes revenue in accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 605.  Accordingly, revenue from the sale of products is recognized when there is evidence of an arrangement, the selling price is fixed or determinable, title and risk of loss has transferred to the customer, any installation or service obligations have been satisfied, and collection is reasonably assured. Net revenue includes deductions for customer discounts and actual and estimated returns. All amounts billed to customers related to shipping and handling are classified as net sales.

Customer agreements include one vendor managed inventory program.  Pursuant to Staff Accounting Bulletin Topic 13.A.3.a, the Company recognizes revenue under this arrangement when (i) risks of ownership have passed to the customer; (ii) the customer's  commitment to purchase the goods is fixed; (iii) there is a fixed schedule for delivery of the goods that is reasonable and consistent with the customer's  business purpose; (iv) the Company does not have any specific performance obligations such that the earning process is not complete; (v) the ordered goods been segregated from the Company's inventory and are not subject to being used to fill other orders; and (vi) the product is complete and ready for shipment.  Also, such arrangement must be requested by the customer and the customer has explained a substantial business purpose for the arrangement.  Management also considers whether the customer's custodial risks are insured and whether modifications to the Company's normal billing and credit terms were required. During the three month periods ended March 31, 2018 and 2017, the Company recorded revenue from product sales that are held in vendor managed inventory under these agreements of $990,401 and $1,898,510, respectively.  As of March 31, 2018 and December 31, 2017, $721,335 and $996,588, respectively, of products sold through those dates were held by the Company in the vendor management program.

13


ONE STOP SYSTEMS, INC. (OSS)

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

For The Three Month Periods Ended March 31, 2018 and 2017

 

Warranty Reserve

The Company offers product warranties that generally extend for one year from the date of sale. Such warranties require the Company to repair or replace defective product returned to the Company during the warranty period at no cost to the customer. The Company records an estimate for warranty‑related costs at the time of sale based on its historical and estimated future product return rates and expected repair or replacement costs (Note 6).  

While such costs have historically been within management’s expectations and the provisions established, unexpected changes in failure rates could have a material adverse impact on the Company, requiring additional warranty reserves and could adversely affect the Company’s gross profit and gross margins.

Shipping and Handling Costs

The Company's shipping and handling costs are included in cost of goods sold for all periods presented.

Foreign Currency

OSS GmbH operates as an extension of OSS’s domestic operations.  The functional currency of OSS 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 remeasured using exchange rates in effect at the balance sheet date. Non-monetary assets and liabilities are remeasured at historical exchange rates. Foreign currency transaction gains and losses are recorded in other income (expense), net in the consolidated statements of operations.

Stock-Based Compensation

The Company accounts for employee and director share-based compensation in accordance with the provisions of ASC Topic 718 “Compensation – Stock Compensation”.  Under ASC 718, share-based compensation cost is measured at the grant date, based on the calculated fair value of the award, and is recognized as an expense over the employee’s requisite service period (generally the vesting period of the equity grant).

All transactions in which goods or services are the consideration received for the issuance of equity instruments to non-employees are accounted for based on the fair value of the consideration received or the fair value of the equity instrument issued, whichever is more reliably measurable.  The measurement date used to determine the estimated fair value of the equity instrument issued is the earlier of the date on which the third-party performance is complete or the date on which it is probable that performance will occur.

Employee and director stock-based compensation expense recognized during the period is based on the value of the portion of stock-based payment awards that is ultimately expected to vest during the period.  Given that stock-based compensation expense recognized in the accompanying consolidated statements of operations is based on awards ultimately expected to vest, it has been reduced for estimated forfeitures. The Company’s estimated average forfeiture rates are based on historical forfeiture experience and estimated future forfeitures.

The estimated fair value of common stock option awards is calculated using the Black-Scholes option pricing model. The Black-Scholes model requires subjective assumptions regarding future stock price volatility and expected time to exercise, along with assumptions about the risk-free interest rate and expected dividends, all of which affect the estimated fair values of the Company’s common stock option awards.  Given a lack of historical stock option exercises, the expected term of options granted is calculated as the average of the weighted vesting period and the contractual expiration date of the option.  

14


ONE STOP SYSTEMS, INC. (OSS)

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

For The Three Month Periods Ended March 31, 2018 and 2017

 

This calculation is based on the safe harbor method permitted by the Securities and Exchange Commission in instances where the vesting and exercise terms of options granted meet certain conditions and where limited historical exercise data is available.  The expected volatility is based on the historical volatility of the common stock of comparable public companies that operate in similar industries as the Company.

The risk-free rate selected to value any particular grant is based on the U.S. Treasury rate that corresponds to the expected term of the grant effective as of the date of the grant. The expected dividend assumption is based on the Company’s history and management’s expectation regarding dividend payouts. Compensation expense for common stock option awards with graded vesting schedules is recognized on a straight-line basis over the requisite service period for the last separately vesting portion of the award, provided that the accumulated cost recognized as of any date at least equals the value of the vested portion of the award.

If there are any modifications or cancellations of the underlying vested or unvested stock-based awards, the Company may be required to accelerate, increase or cancel any remaining unearned stock-based compensation expense, or record additional expense for vested stock-based awards. Future stock-based compensation expense and unearned stock- based compensation may increase to the extent that the Company grants additional common stock options or other stock-based awards.

 

Debt Discounts

The debt discounts, which originated from the relative fair value of the warrants issued in connection with note payable and related-party notes payable during 2016 and 2015 (Note 7), are recorded against note payable and related-party notes payable in the accompanying consolidated balance sheets. Amortization of the debt discounts are calculated using the straight-line method over the term of the notes which approximates the effective interest method and are recorded in interest expense in the accompanying consolidated statements of operations. All notes with warrants were retired in February of 2018, and the remaining debt discount balance of $24,830 was recognized as interest expense in the current period.  

Advertising Costs

Advertising costs are expensed as incurred and included in marketing and selling expense in the accompanying consolidated statements of operations. Advertising costs for the three month periods ended March 31, 2018 and 2017 were $17,626 and $32,088, respectively.

Research and Development Expenses

Research and development expenditures are expensed in the period incurred.  Research and development expenses primarily consist of salaries, benefits and stock-based compensation, as well as consulting expenses and allocated facilities and other overhead costs. Research and development activities include the development of new technologies, features and functionality in support of the Company’s products and customer needs.

Income Taxes

The Company utilizes the asset and liability method of accounting for income taxes. Under this method, deferred tax assets and liabilities are determined based on the difference between the consolidated financial statement and tax bases of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to affect taxable income. Valuation allowances are established when necessary to reduce deferred tax assets to the amounts expected to be realized.

15


ONE STOP SYSTEMS, INC. (OSS)

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

For The Three Month Periods Ended March 31, 2018 and 2017

 

Under ASC Topic 740, the impact of an uncertain income tax position on the income tax return must be recognized at the largest amount that is more-likely-than-not to be sustained upon audit by the relevant taxing authority.  An uncertain income tax position will not be recognized if it has less than a 50% likelihood of being sustained.  Additionally, ASC Topic 740 provides requirements for derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition.  The Company’s policy is to recognize interest and/or penalties related to income tax matters in income tax expense.  

The Company files income tax returns in the U.S. federal jurisdiction, California and overseas in Germany and has open tax statutes for federal taxes for the years ended December 31, 2014 through 2016.  For California, the open tax statutes are for years December 31, 2013 through 2016 and for Germany the open years include December 31, 2015 and 2016.

On December 22, 2017, the U.S. government enacted comprehensive tax legislation commonly referred to as the Tax Cuts and Jobs Act (the “Tax Act”).  The Tax Act reduces the corporate tax rate to 21%, effective January 1, 2018.  Consequently, the Company has recorded a decrease related to deferred tax assets and deferred tax liabilities as of December 31, 2017.   Except for this adjustment, the Company does not foresee material changes to its gross liability of uncertain tax positions within the next twelve months.

Interest Expense

Interest expense consists primarily of interest associated with the Company’s issued debt including the amortization of debt discounts.  The Company recognizes the amortization of debt discounts and the amortization of interest costs using a straight-line method which approximates the effective interest method.

Net Income (Loss) Per Share

Basic net income (loss) per share is calculated by dividing net income (loss) by the weighted-average common shares outstanding during the period.  Diluted net income (loss) per share is calculated by dividing the net income (loss) by the weighted-average shares and dilutive potential common shares outstanding during the period. Dilutive potential shares consist of dilutive shares issuable and the exercise or vesting of outstanding stock options and warrants, respectively, computed using the treasury stock method. During a period where a net loss is incurred, dilutive potential shares are excluded from the computation of dilutive net loss per share, as inclusion is anti-dilutive.  

On February 1, 2018, in connection with the Company’s initial public offering, the Company’s outstanding Series A, Series B, and Series C, Preferred Stock was automatically converted to common stock, par value $0.0001.

Recent Accounting Pronouncements

In May 2014, the FASB issued Accounting Standards Update (“ASU”) No. 2014-09, Revenue from Contracts with Customers (“ASU 2014-09”). ASU 2014-09 supersedes the revenue recognition requirements in FASB Topic 605, Revenue Recognition. ASU 2014-09 implements a five-step process for customer contract revenue recognition that focuses on transfer of control, as opposed to transfer of risk and rewards. The amendment also requires enhanced disclosures regarding the nature, amount, timing and uncertainty of revenues and cash flows from contracts with customers. Other major provisions include the capitalization and amortization of certain contract costs, ensuring the time value of money is considered in the transaction price, and allowing estimates of variable consideration to be recognized before contingencies are resolved in certain circumstances. Entities can transition to the standard either retrospectively or as a cumulative-effect adjustment as of the date of adoption.  On July 9, 2015, the FASB approved amendments deferring the effective date of the standard by one year. The new standard will be effective for the Company in the first quarter of 2019.  The Company has not yet selected a transition method and is currently assessing the impact the adoption of ASU 2014-09 will have on its consolidated financial statements and disclosures.

16


ONE STOP SYSTEMS, INC. (OSS)

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

For The Three Month Periods Ended March 31, 2018 and 2017

 

In February 2016, the FASB issued ASU No. 2016-02, Leases (“ASU 2016-02”).  Under ASU 2016-02, lessees will be required to recognize the following for all leases (with the exception of short-term leases) at the commencement date: a lease liability, which is a lessee’s obligation to make lease payments arising from a lease, measured on a discounted basis; and a right-of-use asset, which is an asset that represents the lessee’s right to use, or control the use of, a specified asset for the lease term.  ASU 2016-02 is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years.  Early application is permitted.  Lessees must apply a modified retrospective transition approach for leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements.  The modified retrospective approach would not require any transition accounting for leases that expired before the earliest comparative period presented.  Lessees may not apply a full retrospective transition approach.  The Company is currently evaluating the impact of adopting ASU 2016-02 on its consolidated financial statements and disclosures.

In August 2016, the FASB issued ASU No. 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments (“ASU 2016-15”), which is intended to reduce the existing diversity in practice in how certain cash receipts and cash payments are classified in the statement of cash flows. ASU 2016-15 is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years with early adoption permitted, provided that all of the amendments are adopted in the same period. The Company is currently evaluating the impact of adopting ASU 2016-15 on its consolidated financial statements.

In January 2017, the FASB issued ASU No. 2017-01, Business Combinations (Topic 805): Clarifying the Definition of a Business (“ASU 2017-01”). The amendments in this update clarify the definition of a business with the objective of adding guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions or disposals of assets or businesses. ASU 2017-01 will be effective for the Company for the year ending December 31, 2019 and interim reporting periods within that year. Early adoption is permitted for transactions that have not been reported in financial statements that have been issued or made available for issuance. The Company is currently evaluating the effect of the adoption of this guidance on the Company’s consolidated financial statements.

In January 2017, the FASB issued ASU No. 2017-04, Intangibles - Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment (“ASU 2017-04”). ASU 2017-04 simplifies the subsequent measurement of goodwill by eliminating Step 2 from the goodwill impairment testing. An entity will no longer determine goodwill impairment by calculating the implied fair value of goodwill by assigning the fair value of a reporting unit to all of its assets and liabilities as if that reporting unit had been acquired in a business combination. Instead, an entity should perform its annual, or interim, goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount and recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value. The loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. An entity still has the option to perform the qualitative assessment for a reporting unit to determine if the quantitative impairment test is necessary.  ASU 2017-04 will be effective for the Company for the fiscal year ending December 31, 2021 and interim reporting periods within that year. Early adoption is permitted for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017. The Company expects the adoption of this guidance will not have a material effect on the Company’s consolidated financial statements.

In May 2017, the FASB issued ASU No. 2017-09, Compensation - Stock Compensation (Topic 718): Scope of Modification Accounting (“ASU 2017-09”), which provides guidance about which changes to the terms or conditions of a share-based payment award require an entity to apply modification accounting in ASC Topic 718. Under the new guidance, modification accounting is required only if the fair value, the vesting conditions, or the classification of the award (as equity or liability) changes as a result of the change in terms or conditions. ASU 2017-09 will be effective for the Company for the year ending December 31, 2019 and interim reporting periods within that year. Early adoption is permitted. The Company expects the adoption of this guidance will not have a material effect on the Company’s consolidated financial statements.

17


ONE STOP SYSTEMS, INC. (OSS)

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

For The Three Month Periods Ended March 31, 2018 and 2017

 

Recently implemented accounting pronouncements

 

In July 2015, the FASB issued ASU No. 2015-11, Inventory (Topic 330) ("ASU 2015-11"). The amendments in ASU 2015-11 require that an entity measure inventory within the scope of the standard at the lower of cost and net realizable value. Net realizable value is the estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transaction. The amendments in this update more closely align the measurement of inventory in U.S. GAAP with the measurement of inventory in International Financial Reporting Standards. ASU 2015-11 is effective for annual and interim periods beginning on or after December 15, 2017.  The Company adopted ASU No. 2015-11 in the first quarter of 2018, without a material impact to its consolidated financial statements and disclosures.

 

In March 2016, the FASB issued ASU No. 2016-09, Compensation – Stock Compensation (Topic 718) (“ASU 2016-09”), which simplified certain aspects of the accounting for stock-based payment transactions, including income taxes, classification of awards and classification in the statement of cash flows. ASU 2016-09 will be effective for annual reporting periods beginning after December 15, 2017 and interim periods within those annual periods. The Company adopted ASU No. 2016-09 in the first quarter of 2018, with no impact to its consolidated financial statements and disclosures.

 

NOTE 2 – ACQUISITIONS

Magma

On July 15, 2016, the Company acquired 100% of the outstanding common shares of Mission Technology Group, Inc. (“Magma”) from Magma’s former stockholder (“Magma Stockholder”) pursuant to a Merger Agreement and Plan of Reorganization (the “Merger Agreement”).  Magma designs, manufactures, and markets industrial grade computer systems and components and is also located in Southern California. The acquisition is expected to increase the Company’s brand awareness and market share and combines the expertise of OSS in the computer hardware industry with Magma's customer base.  

The Company issued 1,263,749 shares of the Company’s common stock to the Magma Stockholder for 100% of Magma shares. The fair value assigned to the shares of common stock was $1,756,611.  

Management estimated the fair value of the consideration issued to the Magma Stockholder and considered factors including recent third-party valuation reports of the Company’s common stock and estimates of discounts for lack of marketability related to the Company’s common stock to the extent not considered in the third-party valuation report.

This transaction was accounted for using the acquisition method pursuant to ASC Topic 805, Business Combinations. Accordingly, goodwill has been measured as the excess of the total consideration over the amounts assigned to the identifiable assets acquired and liabilities assumed. Goodwill was attributed to management’s assessment of projected increases in overall revenues derived from greater brand awareness and certain economies of scale.

18


ONE STOP SYSTEMS, INC. (OSS)

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

For The Three Month Periods Ended March 31, 2018 and 2017

 

The allocation of the total consideration to the acquired net assets as of the acquisition date for Magma was as follows:

 

Cash

 

$

68,308

 

Accounts receivable

 

 

356,499

 

Prepaid expenses

 

 

93,800

 

Inventories

 

 

1,208,675

 

Property and equipment

 

 

143,705

 

Customer lists and relationships

 

 

398,717

 

Drawings and technology

 

 

760,207

 

Trademarks and URL's

 

 

25,000

 

Other intangibles

 

 

2,759

 

Deposits and other

 

 

17,202

 

Accounts payable

 

 

(842,843

)

Warranty reserve

 

 

(15,000

)

Deferred tax liability

 

 

(266,620

)

Accrued expenses

 

 

(816,249

)

Other accrued liabilities

 

 

(50,000

)

Line of credit

 

 

(517,335

)

Notes payable, current portion

 

 

(157,572

)

Notes payable, long-term

 

 

(200,000

)

Total fair value excluding goodwill

 

 

209,253

 

Goodwill

 

 

1,547,358

 

Total consideration

 

$

1,756,611

 

 

Fair valuation methods used for the identifiable net assets acquired in the acquisition make use of quoted prices in active markets, discounted cash flows for assessing the value of the customer lists and relationships and the relief from royalty method for determination of drawing and technology values, both using a risk adjusted weighted cost of capital. Management estimates that any residual value from the intangible assets listed above will not be significant.  The weighted-average amortization period of each intangible asset identified above is three years.

On the acquisition date, goodwill of $1,547,358 and other intangible assets of $1,186,683 were recorded. The business combination is considered a tax-free reorganization under Section 368(a) under the Internal Revenue Code; therefore, acquired goodwill and intangibles of $2,734,041 is not tax-deductible. However, Magma had tax-deductible goodwill of $496,275 (with an original basis of $1,294,624) that will continue to be amortized for tax purposes after the acquisition.  In accordance with Topic 350, Intangibles––Goodwill and Other, the Company completed its most recent annual impairment test and determined that the goodwill was not impaired at December 31, 2017.

19


ONE STOP SYSTEMS, INC. (OSS)

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

For The Three Month Periods Ended March 31, 2018 and 2017

 

The amount of revenues and net (loss) income of Magma included in the Company’s consolidated statements of operations for the three month period ended March 31, 2017 was $1,564,365 and $11,620, respectively.  Subsequent to December 31, 2017, the results of operations for Magma are no longer identified on a standalone basis as Magma has been fully integrated into the consolidated operations of the Company.

 

Definite lived intangible assets as of March 31, 2018:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Expected Life

 

Average

Remaining

Life

 

Gross

Intangible

Assets

 

 

Accumulated

Amortization

 

 

Net

Intangible

Assets

 

Drawings and technology

 

3 years

 

1.25 years

 

$

760,207

 

 

$

(432,896

)

 

$

327,311

 

Customer lists and relationships

 

3 years

 

1.25 years

 

 

398,717

 

 

 

(227,047

)

 

 

171,670

 

Trademarks,  URLs and other

 

3 years

 

1.25 years

 

 

27,759

 

 

 

(16,995

)

 

 

10,764

 

 

 

 

 

 

 

$

1,186,683

 

 

$

(676,938

)

 

$

509,745

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Definite lived intangible assets as of December 31, 2017:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Expected Life

 

Average

Remaining

Life

 

Gross

Intangible

Assets

 

 

Accumulated

Amortization

 

 

Net

Intangible

Assets

 

Drawings and technology

 

3 years

 

1.5 years

 

$

760,207

 

 

$

(369,545

)

 

$

390,662

 

Customer lists and relationships

 

3 years

 

1.5 years

 

 

398,717

 

 

 

(193,821

)

 

 

204,896

 

Trademarks,  URLs and other

 

3 years

 

1.5 years

 

 

27,759

 

 

 

(14,912

)

 

 

12,847

 

 

 

 

 

 

 

$

1,186,683

 

 

$

(578,278

)

 

$

608,405

 

 

Amortization expense recognized during the three month periods ended March 31, 2018 and 2017 was $98,660 and $99,208, respectively.  The amortization expense of the definite lived intangible assets for the years remaining is as follows:

 

 

 

 

 

 

 

2018

 

 

2019

 

 

Total

 

 

 

 

 

 

 

$

295,981

 

 

$

213,764

 

 

$

509,745

 

 

Ion Software and Services

On May 9, 2017, the Company entered into a Technology and Software Source Code License Agreement with Western Digital (WDT) for its Ion flash storage software.  The agreement provides the Company with the Ion source code and rights to develop and market derivative products with the intended purpose of developing and selling Ion flash storage software with the Company’s high-density storage arrays.  Concurrent with this agreement, the Company purchased certain equipment from Western Digital, has the right to hire selected employees and to forgo certain royalty payments on purchases of solid state drives for a designated customer.  

The Company took receipt of the licensed software and equipment in July 2017 and made payment in September 2017.  As of December 31, 2017, a significant amount of the equipment has not yet been placed in service pending build-out of a facility and evaluation as to what equipment will be retained or sold.

Subsequently, on July 1, 2017, the Company entered into a Service Agreement with WDT to service their existing customer base that utilizes Ion flash storage software.  The Services Agreement grants the rights and obligations to OSS to provide Ion software level 1-4 support services (as defined in the agreement) to existing WDT software users for a three year period based upon fixed quarterly payments.

20


ONE STOP SYSTEMS, INC. (OSS)

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

For The Three Month Periods Ended March 31, 2018 and 2017

 

The “Ion” transaction was accounted for using the acquisition method pursuant to ASC Topic 805, Business Combinations. Accordingly, the excess of the total fair value of identifiable assets value over the consideration paid was recognized as a bargain purchase and the resulting gain is being deferred and recognized over a thirty-six month period pro-rata with the time period and the rendering of WDT customer support services.  Deferred revenue recognized for the three month period ended March 31, 2018 is $28,838 and is included in revenue in the accompanying consolidated statements of operations.  The Company incurred $65,805 in shipping and storage fees related to the acquisition of this equipment. These costs were included in general and administrative expenses in the consolidated statements of operations in the period incurred.

The determination of fair value for the identifiable net assets acquired in the acquisition was determined by management and considered the results of a third-party appraisal of the fair value of equipment purchased. Prior to July 1, 2017, there were no operations or activities associated with this acquisition.

The allocation of the total consideration to the acquired net assets as of the acquisition date for Ion is as follows:

 

Equipment at estimated fair value

 

$

297,700

 

Amount paid

 

 

(67,000

)

Gain on acquisition of equipment to be recognized

   over the three year contract service period

 

$

230,700

 

 

NOTE 3 – ACCOUNTS RECEIVABLE

 

Accounts receivable, net consists of the following:

 

 

 

March 31,

 

 

December 31,

 

 

 

2018

 

 

2017

 

Accounts receivable

 

$

5,306,779

 

 

$

5,194,831

 

Less:  allowance for doubtful accounts

 

 

(93,228

)

 

 

(2,101

)

 

 

$

5,213,551

 

 

$

5,192,730

 

 

NOTE 4 – INVENTORIES

 

Inventories, net consist of the following:

 

 

 

March 31,

 

 

December 31,

 

 

 

2018

 

 

2017

 

Raw materials

 

$

1,790,781

 

 

$

2,079,589

 

Sub-assemblies

 

 

1,891,462

 

 

 

2,417,095

 

 

 

 

3,682,243

 

 

 

4,496,684

 

Less:  reserves for obsolete and slow-moving

   inventories

 

 

(342,482

)

 

 

(800,354

)

 

 

$

3,339,761

 

 

$

3,696,330

 

 

21


ONE STOP SYSTEMS, INC. (OSS)

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

For The Three Month Periods Ended March 31, 2018 and 2017

 

NOTE 5 – PROPERTY AND EQUIPMENT

 

Property and equipment, net consist of the following:

 

 

 

March 31,

 

 

December 31,

 

 

 

2018

 

 

2017

 

Computers and computer equipment

 

$

1,162,948

 

 

$

936,317

 

Furniture and office equipment

 

 

171,586

 

 

 

161,434

 

Manufacturing equipment and engineering tools

 

 

2,190,366

 

 

 

2,041,238

 

Leasehold improvements

 

 

142,982

 

 

 

131,188

 

 

 

 

3,667,882

 

 

 

3,270,177

 

Less:  accumulated depreciation and amortization

 

 

(1,843,460

)

 

 

(1,688,363

)

 

 

$

1,824,422

 

 

$

1,581,814

 

 

During the three month periods ended March 31, 2018 and 2017, the Company incurred $155,097 and $79,835 of depreciation and amortization expense related to property and equipment, respectively.

NOTE 6 – ACCRUED EXPENSES AND OTHER LIABILITIES

Accrued expenses and other liabilities consist of the following:

 

 

 

March 31,

 

 

December 31,

 

 

 

2018

 

 

2017

 

Accrued compensation and related liabilities

 

$

479,055

 

 

$

457,152

 

Deferred revenue and customer deposits

 

 

871,803

 

 

 

1,033,845

 

Warranty reserve

 

 

58,100

 

 

 

56,774

 

Other accrued expenses

 

 

51,202

 

 

 

386,206

 

 

 

$

1,460,160

 

 

$

1,933,977

 

 

NOTE 7 – DEBT

Bank Line of Credit

In May 2015, the Company entered into a credit agreement (“Credit Agreement”) with a financial institution which provides for a revolving line of credit and a term note payable. Borrowings under the Credit Agreement are collateralized by substantially all of the Company's assets and the personal guarantee of the Company’s Chief Executive Officer (“CEO”).  Under the terms of the revolving line of credit, as amended on October 5, 2017, the line of credit was extended through August 31, 2018, and the unrestricted borrowing capacity was increased from $3,000,000 to $3,500,000.

Borrowings under the revolving line of credit bear interest at a LIBOR-based rate, as defined in the Credit Agreement, plus 2.5% (totaling 3.93% at December 31, 2017  ), and interest is payable monthly. On February 5, 2018, the Company paid down the outstanding balance on the line of credit with no balance remaining outstanding.

On March 2, 2018, the Company cancelled its line of credit with the Bank of West and the personal guarantee of the Company’s CEO was released as a result.   

22


ONE STOP SYSTEMS, INC. (OSS)

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

For The Three Month Periods Ended March 31, 2018 and 2017

 

Notes Payable

In May 2015, the Company issued a note payable in connection with the Credit Agreement totaling $1,250,000 (“May 2015 Note”).  Under the terms of the note agreement, interest accrued on the outstanding balance at 3.60% per annum.  The May 2015 Note required the Company to make monthly principal and interest payments totaling $36,750 through the maturity date.

In July 2016, the Company refinanced the Magma note payable (Note 2) and the May 2015 Note into a new $1,600,000 note payable (“Refinanced Note”).  Under the terms of the Refinanced Note, interest accrues on the outstanding balance at 3.80% per annum.  The Refinanced Note requires the Company to make monthly principal and interest payments totaling $47,219 through the maturity date of July 31, 2019.  As of March 31, 2018, the note has been paid in full.

In July 2016, the Company issued a note payable totaling $250,000 (“July 2016 Note”) to a third party.  Under the terms of the note agreement, interest accrues on the outstanding balance at 11% per annum.  The July 2016 Note requires the Company to make monthly principal and interest payments totaling $9,570 with a maturity date on January 15, 2019.  The note is unsecured and guaranteed by the Company’s CEO and is subordinated to borrowings under the Credit Agreement. As of March 31, 2018, the July 2016 Note has been paid in full.  

In connection with July 2016 Note, the Company issued to the noteholder warrants to purchase shares of the Company’s common stock equal to 20% of the original principal at a price per share equal to $1.78 per share.

Accordingly, the Company issued to the noteholder warrants to purchase 28,090 shares of the Company’s common stock at an exercise price of $1.78 per share in July 2016. The relative fair value of the warrants was $24,830.

The relative fair value of warrants was estimated using Black-Scholes with the following weighted-average assumptions: fair value of the Company’s common stock at issuance of $1.78 per share; seven year contractual term; 54% volatility; 0% dividend rate; and a risk-free interest rate of 1.42%.  

Related-Party Notes Payable

In July 2016, the Company issued notes payable totaling $350,000 (“July 2016 Related Party Notes”) to two stockholders.  Under the terms of the note agreements, interest accrues on the outstanding balance at 11% per annum.  The July 2016 Related Party Notes require the Company to make total monthly principal and interest payments of $13,397 with maturity dates on January 15, 2019.  The notes are unsecured and guaranteed by the Company’s CEO and are subordinated to borrowings under the Credit Agreement. As of March 31, 2018, the Related Party Notes have been paid in full.

In connection with July 2016 Related Party Notes, the Company issued to the noteholders warrants to purchase shares of the Company’s common stock equal to 20% of the original principal at a price per share equal to $1.78 per share. Accordingly, the Company issued to the noteholders warrants to purchase 39,326 shares of the Company’s common stock at an exercise price of $1.78 per share in July 2016.

The relative fair value of the warrants was $34,763. The relative fair value of warrants was estimated using Black-Scholes with the following weighted-average assumptions: fair value of the Company’s common stock at issuance of $1.78 per share; seven year contractual term; 54% volatility; 0% dividend rate; and a risk-free interest rate of 1.42%.  

23


ONE STOP SYSTEMS, INC. (OSS)

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

For The Three Month Periods Ended March 31, 2018 and 2017

 

Debt Discount

The relative fair value of the warrants were recorded as debt discounts, decreasing notes payable and related-party notes payable and increasing additional paid-in capital on the accompanying consolidated balance sheets. The debt discounts are being amortized to interest expense over the terms of the corresponding notes payable using the straight-line method which approximates the effective interest method. The debt discount was fully amortized to interest expense when the related notes were paid in full.

For the three month periods ended March 31, 2018 and 2017, total debt discount amortization was $24,830 and $5,959, respectively, and is included in interest expense in the accompanying consolidated statements of operations.

 

NOTE 8 – STOCKHOLDERS’ EQUITY

The Company’s amended and restated certificate of incorporation filed on December 14, 2017, authorizes the Company to issue 10,000,000 shares of preferred stock and 50,000,000 shares of common stock. On February 1, 2018, in connection with the Company’s initial public offering, each share of the Company’s outstanding Series A, Series B, and Series C, Preferred Stock was automatically converted into a share of the Company’s common stock, par value $0.0001 on a one-for-one basis.  

Common Stock

The voting, dividend and liquidation rights of the holders of the common stock are subject to rights of preferred stockholders, if any, as designated by the Board of Directors.  Common stockholders have voting rights at all meetings of stockholders and are entitled to one vote for each share held subject to certain limitations otherwise required by law.  Dividends may be declared and paid on the common stock as and when determined by the Board of Directors subject to any preferential dividend or other rights of preferred stockholders.  The Company does not anticipate declaring any dividends in the foreseeable future.  Upon the dissolution or liquidation of the Company, common stockholders are entitled to receive all assets of the Company, subject to any preferential or other rights of preferred stockholders.

 

Initial Public Offering

On December 18, 2017, the Company announced the commencement of an underwritten public offering of its common stock, par value $0.0001 per share. The offering became effective on January 31, 2018 and trading began on February 1, 2018.  On February 5, 2018, the Company closed the initial public offering selling an aggregate of 3,800,000 shares of common stock at a price to the public of $5.00 for total gross proceeds of $19,000,000, which resulted in net proceeds of $17,485,000, after deducting underwriting discounts and commissions of $1,330,000 and underwriter offering-related transaction costs of $185,000. Additionally, the Company incurred costs associated with the transaction for accounting, legal and other fees and costs of $1,148,352 and a warrant expense of $699,408 for warrants issued to the underwriter pursuant to the underwriter agreement.  Such stock issuance costs have been deducted from the proceeds received from the underwriter and disclosed as net proceeds in the consolidated statement of stockholders’ equity.

On February 9, 2018, the underwriters exercised their over-allotment option to purchase an additional 200,000 shares of common stock at the public offering price of $5.00 per share, of which 100,000 shares of newly issued common stock were purchased from the Company and 100,000 shares were sold by the Company’s CEO’s family trust.  The Company received gross proceeds of $500,000, which resulted in net proceeds to the Company of $465,000, after deducting underwriting discounts and commissions of $35,000.

24


ONE STOP SYSTEMS, INC. (OSS)

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

For The Three Month Periods Ended March 31, 2018 and 2017

 

Warrants

In conjunction with the Company’s initial public offering, on February 1, 2018, the Company issued warrants to the underwriter to purchase 380,000 shares of common stock at a price of $6.00 pursuant to the Underwriting and Warrant Agreements dated February 1, 2018.

The fair value of the warrants was $699,408. The fair value of warrants was estimated using Black-Scholes with the following weighted-average assumptions: fair value of the Company’s common stock at issuance of $5.00 per share; five year contractual term; 42.7% volatility; 0% dividend rate; and a risk-free interest rate of 2.72%.  The warrant expense was treated as a stock issuance cost and was deducted from the gross proceeds received in the offering in the current period.  A corresponding increase in additional paid in capital was recognized in relation to this transaction.

Exercise of Stock Options

During the three month period ended March 31, 2018, the Company issued 321,366 shares of common stock for proceeds of $54,575 in cash related to the exercise of stock options.

Preferred Stock

Preferred Stock may be issued in one or more series, with expressed rights by resolution of the Board of Directors.  As of March 31, 2018, there is no outstanding preferred stock.

On December 14, 2017, the Company was reincorporated in the State of Delaware.  Prior to that date the Company was authorized to issue 5,000,000 shares of preferred stock and 11,000,000 share of common stock.  The authorized preferred stock had been further designated as follows:  500,000 as Series A Preferred Stock; 1,500,000 as Series B Preferred Stock; and 2,000,000 as Series C Preferred Stock.