UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-K

 

(Mark One)

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

For the fiscal year ended December 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)

 

Securities registered pursuant to Section 12(b) of the Act:

Title of each class:

Name of each exchange on which registered:

Common Stock, par value $0.0001 per share

The NASDAQ Stock Market LLC

Securities registered pursuant to Section 12(g) of the Act: None

Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes  No 

Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act. Yes  No 

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 every Interactive Data File required to be submitted 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 such files).Yes  No 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405) is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. 

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

 

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 June 30, 2018, the aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant was $34,236,900, based on the closing price of the registrant’s common stock on The Nasdaq Capital Market of $4.18 per share.  

As of February 28, 2019, the registrant had 14,270,268 shares of common stock (par value $0.0001) outstanding.

 

 

 

 

 


One Stop Systems, Inc.

FORM 10-K

For the Fiscal Year Ended December 31, 2018

Table of Contents

 

 

 

Page

PART I

 

 

Item 1.

Business

3

Item 1A.

Risk Factors

20

Item 1B.

Unresolved Staff Comments

34

Item 2.

Properties

34

Item 3.

Legal Proceedings

34

Item 4.

Mine Safety Disclosures

34

 

 

 

PART II

 

 

Item 5.

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

35

Item 6.

Selected Financial Data

37

Item 7.

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

38

Item 7A.

Quantitative and Qualitative Disclosures About Market Risk

56

Item 8.

Financial Statements and Supplementary Data

56

Item 9.

Changes in and Disagreements With Accountants on Accounting and Financial Disclosure

56

Item 9A.

Controls and Procedures

57

Item 9B.

Other Information

59

 

 

 

PART III

 

 

Item 10.

Directors, Executive Officers and Corporate Governance

60

Item 11.

Executive Compensation

65

Item 12.

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

78

Item 13.

Certain Relationships and Related Transactions, and Director Independence

80

Item 14.

Principal Accounting Fees and Services

82

 

 

 

PART IV

 

 

Item 15.

Exhibits, Financial Statement Schedules

83

 

 

i


CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

This Annual Report on Form 10-K (“Annual Report”) contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. All statements other than statements of historical fact contained in this Annual Report, including statements regarding our future operating results, financial position and cash flows, our business strategy and plans and our objectives for future operations, are forward-looking statements. These statements involve known and unknown risks, uncertainties and other important factors that may cause our actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by the forward-looking statements. This Annual Report also contains estimates and other statistical data made by independent parties and by us relating to market size and growth and other data about our industry. This data involves a number of assumptions and limitations, and you are cautioned not to give undue weight to such estimates. In addition, projections, assumptions and estimates of our future performance and the future performance of the markets in which we operate are necessarily subject to a high degree of uncertainty and risk. In some cases, you can identify forward-looking statements by terms such as “may,” “will,” “would,” “could,” “should,” “expect,” “plan,” “anticipate,” “could,” “intend,” “target,” “project,” “contemplate,” “believe,” “estimate,” “predict,” “potential” or “continue” or the negative of these terms or other similar expressions.  The forward-looking statements in this Annual Report are only predictions. We have based these forward-looking statements largely on our current expectations and projections about future events and financial trends that we believe may affect our financial condition, operating results, business strategy, short-term and long-term business operations and objectives. These forward- looking statements speak only as of the date of this Annual Report and are subject to a number of risks, uncertainties and assumptions, including those described in Part I, Item 1A, “Risk Factors. The events and circumstances reflected in our forward-looking statements may not be achieved or occur and actual results could differ materially from those projected in the forward-looking statements. Moreover, we operate in a very competitive and rapidly changing environment. New risk factors and uncertainties may emerge from time to time, and it is not possible for management to predict all risk factors and uncertainties. Except as required by applicable law, we do not plan to publicly update or revise any forward-looking statements contained herein, whether as a result of any new information, future events, changed circumstances or otherwise.

One Stop Systems, the One Stop Systems logo, and other trademarks or service marks of One Stop Systems appearing in this Annual Report are the property of One Stop Systems, Inc. This Annual Report also includes trademarks, tradenames and service marks that are the property of other organizations. Solely for convenience, trademarks and tradenames referred to in this Annual Report appear without the ® and ™ symbols, but those references are not intended to indicate, in any way, that we will not assert, to the fullest extent under applicable law, our rights, or that the applicable owner will not assert its rights, to these trademarks and tradenames.

WHERE YOU CAN FIND MORE INFORMATION

We file annual, quarterly and current reports, proxy statements and other information required by the Securities and Exchange Act of 1934, as amended (the “Exchange Act”), with the Securities and Exchange Commission (the “SEC”).  You may read and copy any document we file with the SEC at the SEC’s public reference room located at 100 F Street, N.E. Washington D.C. 20549, U.S.A.  Please call the SEC at 1-800-SEC0330 for further information on the public reference room.  Our SEC filings are also available to the public from the SEC’s internet site at http://www.sec.gov.

On our internet website, http://www.onestopsystems.com, we post the following recent filings as soon as reasonably practicable after they are electronically file with or furnish to the SEC: our annual reports on Form 10-K, our quarterly reports on Form 10-Q our current reports on Form 8-K, and any amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act.  The information in or accessible through the SEC and our website are not incorporated into, and are not considered part of, this filing. Further, our references to the URLs for these websites are intended to be inactive textual references only.

 

2


PART I

ITEM 1. BUSINESS.

 

Overview

One Stop Systems (OSS) designs, manufactures and markets specialized high-performance computing modules and systems.  These specialized computers incorporate state-of-the art components and allow our customers to offer high-end computing capabilities (often embedding within their equipment) to their target markets. Our customer applications often require ultra-fast processing power and the ability to quickly access and store ever-growing data sets. We are uniquely positioned as a specialized provider for the high-end of this marketplace providing custom servers, compute accelerators, solid-state storage arrays and system expansion systems. We deliver this high-end technology to our customers through the sale of equipment and embedded software.

The worldwide high-performance computing (HPC) market is expected to grow from $38.4 billion in 2018 to $43.9 billion by 2021, representing a compound annual growth rate (CAGR) of 6.0%. We are establishing a leading position as a provider of specialized servers, compute accelerators and flash storage arrays to the high-end of this growing marketplace. In addition, we are a leading provider of PCIe over cable adapters and expansion systems used worldwide. PCIe is the high performance communication protocol used within servers for Input/Output expansion.  This protocol can also be used between servers and external systems to enable additional expansion at very high performance levels.   OSS systems offer high performance in a physically dense packaging, enabling our customers to build end-user systems that occupy less space and require less power and cooling than conventional systems.

The more GPU compute acceleration and flash-based storage resources available to a server, the faster it can process, store, and retrieve data. In cases where the amount of these resources does not fit within the constraints of a conventional server, PCIe is used to disaggregate the resources into a multi-chassis solution. We have built leading edge expertise in PCIe expansion technology and leveraged it to design and build systems that offer a high quantity and density of GPU compute acceleration, flash storage and other I/O resources.

A key element of our product strategy is technological market leadership. We believe a first-to-market strategy is key to our ability to continue to win significant OEM design wins. As a result, we are continually developing new state-of-the-art products. Our ability to drive the leading edge of technology is enabled by our strong relationships with strategic component manufactures, including NVIDIA (for GPUs), Western Digital (for flash memory) and Broadcom (for PCIe switch components). In each of these cases, OSS has access to product roadmaps and other technical information relating to future technology. Access to this information allows us to begin our design process well before the future components we are designing for even exist. This accelerates our time-to-market and allows us to produce and release state-of-the-art designs well ahead of our competitors.

High-performance computing applications are moving beyond the traditional academic and scientific realms to broad application across the spectrum of vertical markets. These applications include computationally intense areas like artificial intelligence (AI), deep learning, seismic exploration, media and entertainment, test and measurement, medical imaging, genomics, cyber security and defense. We are well positioned to leverage these market trends and capitalize on our unique core competencies in high speed system design. We have a proven track record of delivering first-to-market advanced technologies and have continued to do so recently with high-end GPU accelerators and high-performance flash arrays with light-weight removable high-capacity canisters. These products fit solidly into the emerging markets for specialized high-performance computing.

OSS sells its products worldwide to industry leading customers.  In total, we service over 1,500 customers per year, with major repeat customers including disguise, National Instruments, and Raytheon. We anticipate continued market growth in our target markets and sustaining the ability to increase market share through our leading technology, engineering expertise, supply chain management and go-to-market innovation.

We were originally organized as One Stop Systems, LLC, a California limited liability company in 1998 before converting into One Stop Systems, Inc., a California corporation in 1999. On July 6, 2016, we entered into a Merger Agreement and Plan of Reorganization with Mission Technology Group, Inc. (“Magma”) whereby Magma merged with and into OSS with OSS continuing as the surviving corporation. We reincorporated as a Delaware corporation on December 14, 2017 and began trading as a public company on the Nasdaq Capital Markets on February 1, 2018. On August 31, 2018, we acquired Concept Development Inc., a provider of specialty in-flight entertainment located in Irvine, California.  On October 31, 2018, we acquired Bressner Technology GmbH located near Munich, Germany.  Bressner is a valued-added reseller of high technology hardware.  Our principal executive offices are located at 2235 Enterprise Street, Suite 110, Escondido, California 92029 and our telephone number is (760) 745-9883. Our website address is www.onestopsystems.com. Information contained in, or accessible through, our website is for reference purposes only.

3


Industry Background

High performance computing refers to computing solutions capable of processing large amounts of data and storing and retrieving that data at speeds 10-1,000 times faster than a typical corporate computer. Increasingly, commercial companies, financial entities, governmental agencies, including the Department of Defense (DoD), and academic institutions are turning to high-performance computing solutions to analyze vast amounts of data to obtain meaningful and actionable insights. Two technologies, GPU compute accelerators and flash memory, enable systems to process and store data at significantly higher rates than traditional systems. By harnessing large quantities of these components, companies can receive necessary data analysis much more quickly. Industry experts typically divide the high-performance computing market into the following categories:

 

Servers – This market represents all high-end servers, which is composed of Supercomputers (>$500,000 per unit), Divisional Servers ($250,000-$500,000), Departmental Servers ($100,000-$250,000), and Workgroup Servers (<$100,000 per unit).

 

Storage – This includes both traditional hard disc drives and flash storage devices.

 

Middleware – A broad category encompassing programming environments, schedulers, and other tools outside the operating system.

 

Applications – Specific applications for high performance computing.

 

Services – All services associated with high performance computing.

Intersect360 Research categorizes and projects sales in the total high-performance computing market.

High Performance Computing Market by Product Category — Total Market Forecast by Economic Sectors ($M)

 

 

 

2018

 

 

2019

 

 

2020

 

 

2021

 

 

CAGR

 

Servers

 

 

12,480

 

 

 

13,072

 

 

 

13,370

 

 

 

14,443

 

 

 

6.53

%

Storage

 

 

6,460

 

 

 

6,845

 

 

 

7,272

 

 

 

7,772

 

 

 

8.33

%

Services

 

 

3,939

 

 

 

4,010

 

 

 

4,090

 

 

 

4,174

 

 

 

2.49

%

Software

 

 

9,502

 

 

 

9,852

 

 

 

10,243

 

 

 

10,775

 

 

 

5.45

%

Networks

 

 

2,955

 

 

 

3,066

 

 

 

3,190

 

 

 

3,324

 

 

 

5.20

%

Cloud

 

 

930

 

 

 

1,015

 

 

 

1,108

 

 

 

1,210

 

 

 

12.32

%

Other

 

 

2,134

 

 

 

2,183

 

 

 

2,238

 

 

 

2,296

 

 

 

3.18

%

Total

 

 

38,400

 

 

 

40,042

 

 

 

41,871

 

 

 

43,944

 

 

 

5.97

%

 

Source: HPC Advisory Council Website, Market Report, HPC Market Update, Total HPC Market by Revenue, June 2017, Report by Intersect360 Research, authored by Addison Snell, Christopher Willard, Ph.D., and Laura Segervall. (Accessed on July 23, 2017).

The markets for these products are large, and growing. The industry sectors that are currently or anticipated to require high-performance computing systems include:

 

 

Artificial Intelligence

 

Computer Aided Engineering

 

Test and Measurement

 

Media and Entertainment

 

Economics/Financial

 

Environmental Data Acquisition

 

Geosciences

4


 

Mechanical Design Defense

 

Government Laboratories

 

Medical Imaging

These industry sectors expect to deploy increasingly faster computing systems to meet industry and competitive goals. GPU computer acceleration and high-density flash storage are key subsets of the high-performance computing market.

GPU Compute Acceleration

The capabilities and speed of GPU accelerated computers are beginning to drive significant advances in AI and machine learning. Massive amounts of data are being collected, stored and analyzed by today’s sophisticated algorithms.   AI and machine learning are poised to transform worldwide business, as advances in computing speed and storage come together to enable businesses to solve complex problems.

High Density Solid-State Storage

The market for flash memory based solid-state storage systems is large and growing. According to a study by MarketsandMarkets, the flash storage market is growing at 9.5% per year and is expected to reach $25.3 billion by 2022. The proliferation of larger and larger databases, virtualized servers, virtual desktop servers, analytic application servers and other server configurations are feeding the need for higher capacity and higher performance storage.

Traditionally, companies have used hard disk drives for their primary storage.  Hard drive based systems are being replaced by flash memory based systems which offer higher capacity, performance and ruggedness.  Flash-based storage systems also consume significantly less power.

Flash-based storage systems are especially useful for many high performance computing applications, which deal with large amounts of data and the need for complex calculations to be completed very rapidly. In these applications, speed and efficiency are paramount. Military systems, for example, generate vast amounts of data using sensor systems, radar systems, and a myriad of other applications. This data needs to be collected, stored, analyzed and acted upon in a real-time environment.

Key Components of Our Business

Product Development

Our systems are built using the latest GPU and flash storage technologies and draw upon years of expertise in designing and manufacturing semi-custom systems for OEMs. We have a history of being first to market with many solutions for emerging technologies. When PCIe was introduced in 2005, we were the first company to produce PCIe over cable adapters allowing system-to-system communication at same speed as internal I/O expansion. Today, we are one of the largest providers of PCIe adapters and expansion components used worldwide.

When GPU technology and solid-state flash were first introduced, we began designing systems that maximized the effectiveness of these technologies. We now produce compute systems with large numbers of GPUs and flash memory to allow faster processing and data storage and retrieval. The more GPUs and flash devices available to a server the faster that system can process and store data.

We use leading edge, state-of-the art components from major technology providers to design purpose-built systems that solve customer problems in an efficient, cost-effective manner. We do not design silicon chips, but instead apply the technology provided by Intel, NVIDIA, Western Digital, Broadcom and others to deliver customer driven designs to provide true value to our customers.

5


Worldwide Sales

We provide our products on a worldwide basis and are supported through a network of reseller and distribution partners. Sales in North America and Europe are predominately driven by our direct sales force whereas Asian sales are driven through distributors. In June 2015, we formed our wholly-owned subsidiary One Stop Systems, GmbH (“OSS GmbH”), located within the Bressner GmbH facility in Gröbenzell, Germany.

On October 31, 2018, OSS GmbH acquired 100% of the outstanding stock of Bressner Technology GmbH, (Bressner) a Germany Limited Liability Company.  This acquisition provides a strong European corporate presence with sales, marketing, engineering, manufacturing and support capabilities.

Recent Business Initiatives

On April 6, 2017, OSS formed SkyScale, LLC (“SkyScale”) to provide high-performance computing through the cloud. SkyScale is a 50/50 joint venture between OSS and Jacoma Investments, LLC, an entity affiliated with a member of our board of directors, which allows customers to lease state-of-the-art high performance computing hardware. This business has contributed only a small amount of revenue to the Company, and the Company is in the process of exiting this business area.

On May 9, 2017, OSS entered into an agreement to acquire the source code license to the Ion flash array software from Western Digital. We plan to continue to develop and sell Ion software with our high-density storage arrays, as well as servicing existing Western Digital software users. OSS Ion software works with our all-flash storage systems, and provides a critical point of differentiation with respect to speed and throughput. The OSS Ion software leverages flash storage to accelerate applications and storage-area network performance.   Having the Ion software source code and engineering team on-board allows us to strategically grow our all-flash storage business in the many markets as well as increases our software content over time.

On August 31, 2018, the Company acquired 100% of the outstanding common stock of Concept Development Inc. (“CDI”) from CDI’s former stockholder (“CDI Stockholder”) pursuant to an Agreement and Plan of Merger and Reorganization (the “Merger Agreement”).  CDI specializes in the design and manufacturing of custom high-performance computing systems for airborne in-flight entertainment systems.  CDI is located in Irvine, California. The acquisition is expected to increase the Company’s access to the in-flight entertainment market and gain technical expertise in the design and manufacturing of airborne equipment.  

The Company paid cash of $646,759 and issued 1,266,364 shares of the Company’s common stock to the CDI Stockholder for 100% of CDI outstanding common stock. The fair value assigned to the shares of common stock was $4,194,673 which was based upon the closing price of OSS’s stock on August 31, 2018 of $3.63 less a discount of 8.75% for lack of marketability for a one year period.

On October 31, 2018, OSS GmbH, our wholly owned subsidiary, acquired 100% of the outstanding stock of Bressner Technology GmbH, a Germany limited liability company located near Munich, Germany, from its principal owners for cash consideration of €4,725,000 (US$5,374,582) and stock consideration of 106,463 newly-issued restricted shares of the Company’s common stock. The fair value assigned to the shares of common stock was $220,890 which was based upon the closing price of OSS’s stock on October 31, 2018 of $2.47 less a discount of 13.0% for lack of marketability for a two year period.

What Sets OSS Apart

Several factors differentiate OSS from other suppliers of high-performance computing solutions:

 

Our expertise in PCIe expansion and building custom systems allows us to design reliable systems using this challenging highest performance technology with a greater quantity of GPUs and flash storage devices than other suppliers.

 

We design systems that both attach to existing servers through PCIe over cable leveraging our customer’s existing investments as well as all-in-one systems with the server, GPU computing and flash storage devices all included in a single package.

6


 

We produce the software required to operate high-capacity, low-latency storage systems used by defense systems and commercial applications and expect this will expand into other products in the future.

Our business model generally consists of developing specialized computing solutions that our OEM customers utilize as a major component of the equipment that they sell to end users.

Our niche is to provide reliable purpose-built platforms with the latest high-performance computing technology.

Business Strategy

We have traditionally followed a strategy of being first-to-market in leading edge technologies by designing and developing products that are delivered before our competitors. This market leader strategy is accomplished through what we term a “Catch the Wave” approach to the market. We currently have products spanning the spectrum of high-performance computing including servers, flash storage, GPU acceleration, networking and PCIe expansion. Within these product areas the OSS “Catch the Wave” approach implies that we:

 

anticipate trends in these markets;

 

consistently deploy resources in engineering and sales to bring innovative products to market before our competitors;

 

work closely and leverage strategic vendor relationships to get early access to future products and technologies;

 

seek to procure early design wins; and

 

continually monitoring the market for next generation technologies for which a new “Wave” may be forming.

Growth Strategy

OSS intends to continue its rapid growth through three avenues:

 

Ramp-up of existing OEM and military design-wins

Many of our design wins are in the early stages, and we anticipate significant revenue growth as they move into full production.

 

Winning new OEM and military program designs

Our technology leadership provides the “in” to many potential OEM relationships. As we continue to grow the Company, our capabilities and market recognition also grow rapidly, providing even more opportunities for OEM and military program design-ins.

 

Acquisitions of strategic companies

OSS has an experienced team that has negotiated and managed numerous acquisitions of smaller companies. We have identified a number of firms that we believe have potential to be acquired and could provide significant, accretive value to OSS. Some of the proceeds from our initial public offering have been used in our acquisition activities.

7


OSS is using the following criteria for potential acquisition targets:

 

Target has a presence in our served or desired markets.

 

Target’s products can be easily integrated into our product portfolio and/or product roadmap resulting in an accretive benefit to our existing position.

 

Target should be profitable with positive cash flow at the outset or shortly following the acquisition.

 

Will consider companies that can extend our markets geographically.

 

Will consider companies that have an existing incremental services revenue stream.

Our acquisition strategy has the following benefits for OSS and our stockholders:

 

Immediate acquisition of new customers and products. Acquisition of new engineering, sales, administrative and operations personnel.

 

The increase in size and scale of OSS which can be leveraged to lower overall costs and increase margins/profits.

 

Increased credibility with customers, vendors, and suppliers.

Our Opportunity

The worldwide high-performance computing market is expected to grow from $38.4 billion in 2018 to $43.9 billion by 2021. Within this market, OSS is positioned in the highest performance and fastest growing portions of the market including the server (custom and GPU accelerators), storage (flash arrays) and PCIe expansion sectors. Custom Built Servers

 

GPU Compute Accelerators

 

All Flash Arrays

 

PCIe Expansion and Adaptors

Custom Built Servers

Within the server sector, OSS has secured a niche position of building purpose-built specialty servers, which the major server suppliers choose not to supply as they require custom tuning and special features that major OEMs cannot easily provide. Such flexibility is difficult to maintain for major suppliers because their systems are not designed to reflect specific customer specifications. OSS on the other hand has continued to find efficient ways service this market profitably.  For example, OSS designs and builds a custom server with custom connectors and 16 high definition video media outputs that are used in the entertainment industry to provide multimedia at a live performance.

8


We believe the custom server segment is growing at a greater rate than the standard server segment. Intersect360 Research estimates that the market for high-performance servers is expected to be approximately $14.4 billion by 2021, with corporate market share as follows:

 

Hewlett Packard

 

 

33.0

%

Dell

 

 

26.4

%

Lenovo

 

 

6.9

%

IBM

 

 

6.8

%

Cray

 

 

4.5

%

ATOS/Bull

 

 

2.6

%

Inspur

 

 

2.0

%

Fujitsu

 

 

1.8

%

Penguin

 

 

1.5

%

Huawei

 

 

1.2

%

Others

 

 

13.5

%

 

It is our experience that OSS is increasingly competitive in the “Others” category, where customers require their systems to meet specific operational specifications, power requirements, speed, latency, or other requirements not covered by traditional designs. We estimate that our addressable market for HPC computers is approximately 20% of the “Others” category in the above chart. This translates to an addressable market size of approximately $389 million with our current engineering capability and product set. Our strategy is to remain focused and be the best in this market segment.

GPU Compute Accelerators

GPU computing uses hardware components that are optimized to perform mathematical calculations in a rapid fashion. NVIDIA is the market leader in the design and manufacturing of these components. NVIDA has done extremely well in recent years as this part of the computing market is growing much faster compared to the traditional CPUs from companies like Intel.  OSS works closely with NVIDIA to design and build systems which use multiple GPUs to accelerate the applications being run by the computer.

The unique design of the GPU provides thousands of processing “cores” which act as individual coprocessors to speed up the calculations on large data sets. GPU acceleration is driving many of the newest and fastest growing technology opportunities in this new age of computing. Many of the applications that are gaining notoriety today have only become possible because of the ability of GPUs to optimize computational throughput, perform many tasks at once, and make sense of the massive amounts of data that is available to high performance algorithms.

Markets such as image rendering and processing, self-driving cars, deep learning, molecular modeling and genomics, advanced visualization, machine learning, and image processing, all benefit from the ability to use GPUs to accelerate the application. OSS builds specialized compute accelerators, using the latest GPU technology, to attach to traditional servers used in these emerging growth markets. Because of the relative newness of these markets, little market data exists to precisely define these markets, but we estimate these markets to be very large and growing. While we are beginning from a small base, we expect these markets to be valued in the billions of dollars in the near future. Because our strategy has been to be first-to-market with the fastest and densest compute accelerator appliances, we anticipate our addressable market here to be in the hundreds of millions of dollars.

 

We also have a strong position in the government market which, according to Grandview Research and Intersect360, constitutes 26% of the market that is growing to $46.2 billion by 2021. OSS products can form a basis for companies who wish to participate in the hyper-scale market, which includes deep learning and AI. This is a major technology trend that OSS is addressing through its product roadmap. Intersect360 estimates the deep learning market was worth more than $3.2 billion in 2018 with 41.7% growth projected from 2018 to 2013 resulting in $18.2 billion in 2023 according to MarketsandMarkets.

9


All Flash Arrays

We build flash storage arrays to customer specifications utilizing our unique know-how in packaging, cooling, and PCIe-over-cable. We deliver dense, high-performance systems that provide customers with extreme value and utility in the most demanding, data-intensive operations.

Through a strategic agreement with Western Digital, we have acquired the software engineering team and the appropriate source code license for the Ion flash array software.  This provides OSS flash arrays with a high level of differentiation relating to storage management, latency and throughput. Although we maintain an offering of standard flash array products, our expertise and success has been in providing arrays with specialized packaging for demanding applications that are not suitable for standard offerings.

For example, we provide products to a large military contractor for integration into a military aircraft that required us to provide a completely new ruggedized mil-spec flash array. This new product provides extreme data density with low weight and a high degree of portability and security for the data. We believe our experience and capability in high speed, low-latency, digital signaling via PCIe gives us an edge in providing these custom designs to OEMs, military programs and other special purpose applications.

The overall market for flash arrays is growing rapidly. According to IDC the flash storage market totaled more than $2.1 billion in the first quarter of 2018, up 55% compared to the same year-ago quarter, and is expected to grow to reach $12 billion by 2022. According to Dell’Oro Group about 82% of the total in the first quarter was attributed to traditional large OEMs, like Dell EMC, NetApp, Hewlett Packard Enterprise, Pure Storage and IBM. The remaining 18% is addressed by many smaller flash storage providers, including OSS. We believe that because our products are positively differentiated by speed, density, and management features, our offerings compete favorably in this market and provide a substantial growth opportunity.

OSS participates in the broader market for dense, high-performance flash storage systems that may or may not be deployed into data center environments. Since we develop custom flash storage arrays, we work closely with both OEMs and end users to insure they receive the product they want in the specific configuration, size and weight required for their application. We believe this gives OSS an advantageous position in a market that is growing rapidly and allows us to favorably compete in the market.

PCIe Expansion and Adaptors

PCIe (PCI Express) is a high-speed computer expansion standard. This standard defines the signals and connectors (i.e. slots) that are used for computer add-in cards (such as Ethernet or graphics). PCIe signaling can also be routed over a cable, allowing expansion input/output slots to be physically located in a separate chassis. This provides for the highest performance and lowest latency which is essential in this market.

Being able to route PCIe over a cable facilitates disaggregation of server functionality. That is, with PCIe, certain server functions no longer needed to be contained in the physical server chassis, but could instead be separated and continue to operate at full speed. From a practical perspective, servers could now be connected directly to larger storage arrays or other peripheral devices, with the resulting group of chassis operating as if they were all in the same physical chassis.

We began developing our first PCIe-over-cable adaptor in 2006, and were one of the early providers of PCIe adaptors. We recognized this as prime opportunity to utilize our core strengths, such as:

 

 

High-speed board design and layout

 

Hardware tuning to improve signal integrity

 

Design optimization for low cost

 

Rapid design capability

 

Manufacturing and supply chain management

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This technology has now become a standard within the computer industry, and OSS customers have used our adaptors to connect their custom input/output chassis and achieve performance equivalence as if the input/output was integrated into the server box. This gives designers and integrators a degree of flexibility and utility in architecting computer systems that is unprecedented. For example, one of our customers has utilized PCIe-over-cable to connect its high performance video editing systems to a host computer, providing a system that is optimized for an application using standard servers. We have expanded our PCIe adaptor market in breadth and depth, including making adaptors for many OEM customers. To date, we have shipped more than 100,000 PCIe adaptor cards to customers globally.

With our expertise developed in designing adaptor cards, the logical extension of our capability led us to develop a method for expanding the PCIe bus into an external chassis containing one or many expansion slots. This allowed a customer to install multiple standard PCIe boards into a chassis and expand their system without having to add additional servers. A user could now connect a multiplicity of PCIe devices to a single server, and achieve performance and throughput that was not possible prior to the introduction of PCIe.

We have been a leader in PCIe expansion backplanes and chassis through generations 1, 2 and 3. As PCIe evolves through generations 4 and 5, we are uniquely positioned to continue our leadership role in this market. We currently offer what we believe to be the largest PCIe expansion product line breadth, with chassis and backplanes that offer expansion from one to 64 slots. Due to its greater data throughput and flexibility of design, we believe this is a growing market, and we intend to maintain our leadership role.

Our Technology

We design and manufacture high performance computing systems that increase compute performance while reducing cost and impact to the infrastructure. Our high-density compute accelerators connect directly to a server’s PCIe bus, delivering substantial compute performance. Our flash storage arrays support hundreds of terabytes of high-speed storage that can also be accessed by multiple servers.

Technology Drivers for OSS High-Performance Computing Business

OSS has developed expertise and core competencies in the three fundamental technology drivers of today’s high-performance computing market. Namely, high-speed serial interconnect technology, compute acceleration utilizing GPUs, and low latency flash storage. In combination, these technologies are changing the economics of computing, bringing high-performance computing within the grasp of a wide range of new industries and commercial applications. Simultaneously the emergence of massive data being generated in each of these industries is pushing the requirement for state-of-the-art technology.

The opportunity is not only to provide competitive advantage for corporations, but also address some of the most fundamental challenges in life science, energy and security. OSS is well situated to leverage these major industry forces. By exploiting its unique set of expertise in the underpinning technologies of high-performance computing, OSS will continue to deliver world leading solutions, with the opportunity to capture a growing market share of this rapidly expanding marketplace.

Switched Serial Interconnect

Switched serial interconnects are the data highways connecting many elements of today’s high-performance computing platforms. At ever increasing speeds, these pathways move data between system’s processing units, storage, networking, and peripheral elements. For high performance computing the primary processing, storage and peripheral interconnect is PCIe Gen 3. PCIe Gen 3 has an ability to run up to 16 lanes in parallel, which allows up to 16 gigabytes per second bandwidth between system elements.

Serial switches incorporated in system design allow many system elements to be connected together in a non-blocking interconnect fabric at PCIe Gen 3 speeds. This allows systems to scale internally avoiding bottlenecks. The serial interconnect can be embedded directly in the computer printed circuit boards, across connectors board-to-board, or traverse across copper or optical cables for chassis-to-chassis connection. Due to the extremely high speeds, the design considerations around signal integrity are rigorous and with unforgiving tolerances. PCIe Gen 4 will begin deployment in 2019, doubling the interconnect speed.

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Serial interconnects are also used to interconnect nodes into larger scale networks and clusters. In this case, the primary interconnects are Infiniband and Ethernet. These technologies have the advantage of scaling to very high numbers of network elements over potentially large distances. The tradeoff over PCIe is higher latency (transit time across the interconnect) and protocol complexity requiring processing cycles to manage. Many high-performance computing deployments incorporate these interconnect technologies in order to deliver large scale solutions with optimized technology selections for each system aspect. In summary, PCIe is used at the local level for the ultimate performance/low latency and these other interconnects are used to expand the network.

Compute Acceleration with GPUs.

Over the last several years, GPUs have evolved from graphics display acceleration to becoming general-purpose processing workhorses for high-performance computing systems. Today, the majority of the fastest supercomputers in the world utilize GPUs as their primary compute engines. GPUs are ideal for high-performance computing workloads because of their ability to do massively parallel processing. While traditional CPUs today may have dozens of processing cores, GPUs have thousands of cores that are all able to execute calculations simultaneously.

For many high-performance applications, fundamental pieces of the code can be optimized to run in parallel and therefore experience significant performance enhancements. NVIDIA, a key supplier of GPUs to the market, has done extensive benchmarking showing the ability of single GPU based machines to exceed the performance of dozens or even thousands of traditional CPU-only computers. NVIDIA has worked extensively with the software development community, and hundreds of applications have been tuned and developed to run on GPUs.

The current NVIDIA GPU Applications catalog lists more than 400 such applications across a broad set of market spaces including:

 

 

Computational Finance

 

Climate, Weather and Ocean Modeling

 

Computational Chemistry and Biology

 

Data Science and Analytics

 

Deep Learning and Machine Learning

 

Federal Defense and Intelligence

 

Genomics

 

Manufacturing

 

Media and Entertainment

 

Medical Imaging

 

Oil and Gas

 

Safety and Security

Many of these applications also scale performance based on the number of GPU components utilized. OSS has designed multi-GPU systems including up to 16 GPUs in a single system. Current state-of-the art GPUs provide over 7 teraflops of performance, with future products set to dramatically increase overall processing capabilities in the years to come.

Although GPUs provide tremendous application performance advantages, they pose significant system design challenges due to their high power requirements. High-end GPUs can require as much as 350 watts of power, which generates a tremendous amount of heat. Sophisticated power distribution and cooling designs are required, especially for large scale systems with multiple GPUs per chassis.

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PCI Express Flash Storage – NVMe protocol

The use of flash memory technology for system storage has gained traction over the last several years, as the cost per gigabyte has continued to dropFlash memory is now becoming the ubiquitous storage technology in high-performance systems.

Combined with the move away from traditional rotating hard drive technology has been the trend toward eliminating traditional storage protocols in favor of low latency flash memory protocols. Newer flash memory modules utilize a protocol known as NVNe, which connects the flash memory directly to the system’s PCIe interconnect. This direct connection allows for very high bandwidth between the storage and the other system elements and eliminates the need for protocol translation as data is moved from storage subsystems to and from the compute complex.

Today, flash memory modules with capacities up to 8 terabytes and PCIe Gen 3 interfaces are available. OSS flash storage arrays with hundreds of terabytes of capacity are available, enabling the scaling of high-speed storage to meet the full range of high-performance application requirements.

Core Technical Capabilities

For 20 years, OSS has developed unique expertise and core competency across the fundamental technologies of today’s rapidly expanding specialized high-performance computing marketplace. These valuable assets are embedded in the leading-edge engineering capabilities of our engineers, the proprietary intellectual property residing in our vast library of designs, and our brand equity based on our reputation as a high-quality producer of state-of-the-art custom and standard solutions across a broad array of markets.

High Speed System Interconnect Design

Our electrical engineers are experts in high speed digital signaling design. They have continually designed at the leading edge of the state-of-the-art signaling speeds, as semiconductor technology has driven up the clock rate of digital transmission. We have consistently been among a small handful of companies able to come to market first with the latest technology. In fact, we delivered the industry’s first PCIe over cable solutions for PCIe Gen 1, Gen 2 and Gen 3 and are currently on track to accomplish this again in Gen 4. The expertise required includes circuit design, PCB (printed circuit board) layout and routing optimizations all with a focus on achieving the highest levels of signal integrity. In our current systems, PCIe Gen 3 signals are propagated across multiple PCBs, connectors, and copper cabling while maintaining the ability to recognize digital signal transitions at 8 billion times per second.

In high-performance computing systems the trajectory of ever increasing signaling speeds is continuing.  Next generations of PCIe and nvlink will increase signaling rates to 16 and 20 gigahertz (billions of transitions per second).  An ever-shrinking set of companies have the capability to design robust, highly-reliable systems at these speeds. We believe our core competency in large-scale, high-speed design and layout will allow us to remain on the forefront of this growing industry.

Complex System Design

In addition to low-level signal integrity design expertise, we have amassed expertise and intellectual property in high-performance system architecture design. This expertise allows us to develop extremely sophisticated systems with massive scaling, while meeting customer demands for reliability, cost, and flexibility.

We have developed the deep knowledge for high-capacity input/output systems and operating system adjustments and configuration tuning required. Our engineers are often called upon to co-design with OEM designers to create the perfect fit solution for their customers.

For highly scalable systems, a deep understanding and experience with switching topologies and interconnect fabric design is required. We have worked with serial switching technology starting with the first generation of PCIe and have been an innovator in creating unique and flexible topologies to meet the specific needs of the customers. Creating custom solutions for unique customer solutions is a core competency and relies on this deep knowledge of switch capabilities and limitations.

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For maximum system performance, design for optimizing data transfer speeds is also an important consideration. OSS has developed expertise in system design to leverage peer-to-peer data flows between GPUs and pioneering techniques for optimized data flows between flash storage and GPU compute engines. Our systems optimize switch and GPU configuration topologies to optimize GPU-to-GPU communication without requiring latency-inducing data transfer between host dual processors. Our platforms feature RDMA (remote direct memory access) across compute nodes, which support data transfer without burdening the host CPU.

OSS has pioneered the ability to extend the PCIe bus beyond the confines of a single enclosure, opening the possibility of flexible system expansion options. We believe we are one of the leading designers and suppliers of PCIe host bus adapters that extend PCIe signals from the host motherboard across copper or optical cables to expansion enclosures. OSS adapters provide both ends of the external cable connection. Our expertise in high-speed signal design in printed circuit boards, connectors and cables is essential to successful expansion designs. We also hold expertise in incorporating clustering and rack scale expansion into our system designs, including 100 gigabit Ethernet, 100 gigabit Infiniband, and emerging PCIe top-of-rack switch technology.

Expertise in power, cooling and mechanical design are required to address the requirements of the high-performance computing customers. We have developed leadership design capability in high-power design and distribution within large rack enclosures. High-end GPUs today require 350 watts or above, and in our high-end systems up to 16 of these can reside in a single chassis. Thousands of kilowatts of redundant power are required. Power stability and huge thermal loads are some of the critical design issues that must be addressed.

We have expertise in power distribution, redundant power and complex chassis cooling design, including materials selection, airflow simulation, fan technology and cable routing. We have also developed extensive intellectual property in regulatory compliance of complex high-performance computing system design across emission, shock, vibration, thermal, humidity and other environmental requirements that are required for highly reliable and highly available solutions. OSS engineers are experts in design for regulatory testing for FCC (Federal Communications Commission), CE (European Conformity), UL (Underwriters Laboratories), and Mil-Spec (Military Standard) standards. Additionally, we have expertise in rapid prototyping, design for manufacturability, and design for serviceability.

Storage Management Software

Given our hardware design and integration expertise, we see the next natural step is to add a robust software capability that will allow us to offer more optimized and customized systems. Our Ion software design team provides the expertise to deliver full server and storage solutions that produce the highest performance from today’s leading-edge flash storage devices.

The Ion software allows flash-based modules to be put into a variety of storage and network configurations which can then be accessed by multiple servers. The Ion software can do this cost-effectively, while preserving the low latency that is vital for many business and mission-critical enterprise applications, from database and transaction processing to massive data collection programs. Ion also has a full high-availability option to ensure complete data integrity.

In-house mature and established foundational storage software allows OSS to add new products and capabilities to its product portfolio. Possibilities range from increasing data efficiency with de-duplication and compression, to improving system manageability and adding software-defined storage to our server products.

Benefits of Technology and Core Capabilities to our Customers

Due to our core capabilities, we can provide our high-performance computing customers with platforms possessing high reliability and cost effectiveness. Such performance allows our customers to solve bigger problems faster, and save the cost and time of highly-paid engineers, data scientists, and other human resources. Our technology enhances innovation by allowing more ‘what-if’ analysis in a finite amount of time. Our price/performance leadership enhances our customers’ competitiveness, and lowers capital expense and total cost of ownership.

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Our Products

OSS has developed a complete line of products that have been customized for the benefit of its customers.

GPU Appliances – high-density, fully integrated computer clusters that are purpose-built for user applications. They provide thousands of cores and hundreds of teraflops of computing performance.

GPU Expansion – expansion units can add hundreds or thousands of computing cores with hundreds of teraflops of computing performance to virtually any OEM server.

Flash Storage and Network Appliances – networked storage appliances optimized for the environment and system software of our customers. These offer flexible and powerful turnkey, customer-driven solutions for the HPC market.

Flash Storage Arrays – arrays that provide hundreds of terabytes of storage and millions of input/output operations per second with flash memory. They are flexible, powerful, and configurable for customers in the HPC market.

Servers – OSS designs servers optimized for PCIe-over-cable expansion. Available in various turn-key and custom configurations, they provide simple, reliable and cost-effective server solutions. These servers are optimized to work seamlessly with other OSS systems and appliances.

Desktop Computing Appliances – OSS designs and builds desktop expansion appliances in many configurations that add input/output flexibility to any user’s desktop system. These appliances come pre-configured with many combinations of flash memory, GPUs, and other add-in boards.

PCIe Expansion – PCIe is the standard for high speed connectivity from a server to a PCIe device. It provides vastly faster throughput compared to USB or Ethernet in a simple, cost-effective connection. It requires no special software, which adds no overhead to the system, and improves latency of throughput. OSS provides cables, kits, backplanes, enclosures, switches, and adaptor cards for this market.

Customers

We serve a global clientele consisting of multinational companies, governmental agencies, and leading technology providers. Some of our key customers are set forth below, including case studies illustrating how we provide custom solutions.

Raytheon – OSS is working closely with Raytheon to build a customized flash storage array, with flash drives installed in removable canisters. Raytheon has installed these storage arrays on a current military aircraft equipped with multiple sensors and data capture arrays. These devices are fully compliant with appropriate military specifications, including shock and vibration. Each canister has the capacity to save 50 terabytes of data and weighs only 6.5 pounds. Data is captured onto the OSS flash array canisters, which can be easily removed at the end of the mission for analysis. Our expertise in designing and manufacturing high-density flash arrays in the lightest, most compact package allow military aircraft to realize faster turn-arounds during critical missions. These systems are intended to be incorporated into new aircraft and retrofitted into the existing fleet.

disguise– disguise is the leading provider of hardware and software that allows their customers to produce live events, television broadcasts, theater effects, and special effects for concert tours. OSS has worked with disguise to design purpose-built, custom servers that act as video controllers for special effects at these events. These servers work seamlessly with disguise software applications, providing up to 16 simultaneous video outputs that supports a rich array of special effects. Events like the Super Bowl halftime show and numerous musical concerts rely upon disguise controllers, designed and produced by OSS, to deliver a lasting impression on audiences.

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National Instruments – National Instruments is a market leader and multinational company that produces automated test equipment and virtual instrumentation software. OSS provides several PXI/PXIe/PCIe interface cards that are branded by National Instruments. OSS acts as an extension to National Instruments’ engineering group, allowing National to complete their product roadmap in a timely and cost-effective manner.

Sales and Marketing

Our sales and marketing efforts are focused on promoting sales and brand awareness.

Sales

Our sales efforts entail three main areas:

 

General Sales – OSS maintains a web site and direct sales team that sell directly to end-users. This includes e-commerce sales via typical web store functionality, and direct calling of potential customers to provide unique solutions that fits their needs. The OSS direct sales team typically works in the OSS booth at tradeshows, directly interacting with potential customers and presenting solutions for their high-performance needs.

 

OEM Focused Sales – Our direct sales team also works to identify and develop potential OEM and government program customers. This is the largest and fastest growing part of our business. For typical OEM customers, we design and build customer specified systems that are branded with the OEMs name and label. These companies then resell the products through their own channels. We actively seek this type of relationship, which is leveraged as a sales multiplier, allowing us to grow sales at a faster rate without adding more dedicated sales resources.

 

Channels – We have a dedicated sales resource that manages our worldwide network of resellers and distributors. We typically sell standard products through these channels, which allow us to achieve global customer touch without requiring a physical presence in all geographies. With the recent acquisition of Bressner, we have a greater presents in Europe which will allow greater access to those markets.

Marketing

Our marketing department focuses on building cost effective brand awareness in several ways. We generate interest by utilizing traditional and non-traditional marketing to convey the uniqueness and compelling value of our products and services. The markets we target include machine learning, deep learning, finance, medical equipment, in-flight entertainment, manufacturing automation, defense/government, oil and gas exploration, media and entertainment. Among the many channels utilized are:

 

Social Media – We regularly use Facebook and Twitter to instantly alert the followers of OSS to new events, products, services, and customer stories.

 

Publications – We periodically publish white papers, customer success stories, and other demand generation articles in periodicals and newsletters that include InsideHPC, Storage Newsletter, and HPC wire. We also purchase some print ads in many industry magazines.

 

Trade Shows – OSS participates in many tradeshow and events during the marketing year. Among these are AFCEA/USNI West, Rice University Oil and Gas Conference, National Association of Broadcasters (NAB), GPU Technology Conference (GTC), Gearfest, ISC (high performance computing show), HPC Summit, AI World, Supercomputing, and GTC Tokyo. OSS evaluates the value and costs of each show on an annual basis, and the number and themes of our participation may change from year to year.

As we grow, it is anticipated our marketing efforts will likewise continue to increase in size and diversity.

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Competition

In many cases, our primary competition is actually our potential customer. Our operational model lends itself to understanding technical and physical specifications, completing a rapid design based on our library of over 600 previous designs and prototypes, building a rapid prototype for customer approval, and an efficient design-to-manufacturing process.

Most of our OEM customers have sophisticated design capabilities in-house. They come to OSS for our particular expertise and experience, which allows us to work collaboratively with the customer to produce more advanced systems in a shorter timeframe. In most cases, the primary alternative to engaging OSS is for the customer to design the products themselves. We win when our customers realize that together we can produce better products faster and more cost-effectively than they can themselves. This has proven to be particularly evident when customers require state-of-the-art products that are constructed of parts available commercially. This has resulted in several design wins that demonstrate our flexibility and how we can work closely with large OEM and government customers.

We also compete with established competitors, third party competitive products and new entrants into the markets we serve. Established competitors include IBM, Lenovo, HP and Dell. Each offers a broad range of standard products and services for this market. In many cases, these companies are able to meet their customer needs thought their standard product offerings. In other cases, these companies work with us to help extend their product capabilities to meet customer-specific requirements.

Third party competitive products include cases where the manufacturers of the underlying chip or board-level products decide to also offer system-level products. This is the case with Intel, NVIDIA, Western Digital and others. These offerings tend to be tactical, short-term products that are intended to demonstrate a new technology, rather than long-term forays into the systems business. In addition these “technology demonstration systems” tend to be priced at high levels, making them less competitive once the newness factor wears off.

New market entrants continue to move into the rapidly evolving high-performance computing space. Some, such as Pure Storage, raise significant amounts of capital and endure huge loses in an attempt to establish market share.

Manufacturing and Operations

OSS is certified under ISO 9001-20015 for “design, manufacture, and supply of industrial computers.” This means OSS has demonstrated its ability to consistently provide products that meet both customer requirements and applicable regulatory or statutory requirements. It also indicates that we have programs and processes in place to ensure a high level of customer satisfaction, as well as a continuous improvement program that ensures OSS gets better over time.

We utilize lean principles to drive our manufacturing and assembly process. One of the key aspects of this is our application of just-in-time principles that ensure effective ordering and utilization of inventory, and this helps optimize cash flow throughout the manufacturing cycle. Within the manufacturing process, our operations encompass three categories of “builds:”

 

Standard Builds – These are builds of standard products that are sold with little or no customization or non-standard features. These are products that are ready to be installed or integrated by the customer upon receipt.

 

Custom Builds – Custom builds involve a product built to a customer specification. Upon receipt, the customer has a unique product that performs all the functions and has the physical dimensions that match their specifications.

 

Engineering Project Builds – OSS supports the product development process by building models and prototypes of products. Developed by the OSS engineering group, the prototypes can be of standard or custom products.

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OSS is dedicated to quality and customer satisfaction. Within the manufacturing operations function at OSS, our processes begin with the end goal in mind. This means we start with the customer. All our business processes begin with the idea that the customer is the essence of why we exist. Our continuous improvement efforts require us to review products, services, and processes with the idea that minor changes can lead to greater outcomes for our customers.

While we are cognizant of the additive nature of small improvements, we believe a disciplined approach to improvement sometime leads to extraordinary, large, and positive advances in our products and services. This is extremely important to OSS, as our goal is to bring the most advanced leading-edge technologies to our customers before our competitors can. Our operations strategy supports our overall mission of being first to market with customized, leading-edge products that are best-in-market in terms of speed and overall performance.

Research and Development

Research and development at OSS is centered on the exploitation of key technologies as they evolve in the marketplace. Our product roadmap reflects new component technologies for CPUs, GPUs, flash storage, and advanced PCIe switches. We design first-to-market, custom implementations utilizing these component technologies. Accordingly, our focus lies not in the capital-intensive development of silicon implementations of technologies (i.e., chips, processors, GPUs, or storage devices), but rather in taking leading-edge technologies and building first-to-market products that fully exploit those technologies for solving customer problems.

The OSS research and development strategy can be summarized as follows: OSS drives design wins by utilizing key new technologies to develop products that are leading edge and first to market.

Some examples of OSS developments:

 

GPU compute accelerators with the most GPUs per rack unit.

 

Networking of GPUs.

 

Broad range of solutions, due to specific customer design.

 

Capability to expand existing servers from virtually any OEM.

 

First-to-market products as new GPUs are introduced by NVIDIA, Intel, Western Digital and Broadcom.

 

Complete customization per the needs of our OEM customers.

 

Integration of multiple new technologies (servers, GPUs, flash drives, and PCIe) into optimized products for our OEM customers.

Intellectual Property

The primary intellectual property value of OSS emanates from the more than 600 individual design projects we have undertaken over the decades since our founding. These designs are archived and cataloged, so we rarely begin a new design from scratch.

Over the years, our team has developed and maintained expertise in high-speed signal design and analysis, electronic and mechanical packaging, PCIe-over-cable, fiber optics transmission, high-speed/density flash arrays, and integration and deployment of GPUs in compute accelerators and servers. This extensive expertise positions us to expand and rationalize our product line to meet the growing and ever-changing HPC market.

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Employees

As of December 31, 2018, we had approximately 114 employees or which 112 are full-time and 2 are part-time employees.  Our employees are comprised 90 which are domestic and 24 which are international. Our employees include highly skilled engineers, technicians, assemblers, and support staff. They are housed in multiple facilities, and are led by a management team that is supportive and helpful. We have experienced very little turnover of personnel in the past and endeavor to provide an environment that allows meaningful employee input to all functional areas of the Company. The management team provides transparency to its employees through regular communication meetings designed to update employees on current results and future expectations. None of our employees are covered by a collective bargaining agreement or represented by a labor union. We consider our relationship with our employees to be strong.

Facilities

Our corporate headquarters are in a leased space comprising approximately 24,032 square feet in Escondido, California under a lease that was renewed in August 2018 and now expires in August 2024.  Our headquarters were expanded to accommodate increased manufacturing capacity and to assimilate personnel from a facility on which the Company did not renew its lease. We also lease a 3,208 square foot facility in Salt Lake City, Utah that houses our Ion software development team. CDI is the lessee of approximately 12,000 square feet located in Irvine, California with the lease expiring in June 2021.  Bressner Technology, which was acquired in October 2018, leases space comprising 8,073 square feet which lease expires in December 2019.  

Legal Proceedings

From time to time, we may be a party to legal proceedings and subject to claims incident in the ordinary course of business. Although the results of litigation and claims cannot be predicted with certainty, we believe that the final outcome of such matters will not have a material adverse effect on our financial condition or business. Regardless of outcome, litigation can have an adverse impact on us because of defense and settlement costs, diversion of management resources, and other factors.

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ITEM 1A.  RISK FACTORS

Investing in our common stock involves a high degree of risk. You should carefully consider the risks described below, as well as the other information in this Annual Report, including our financial statements and the related notes and “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” before deciding whether to invest in our common stock. The occurrence of any of the events or developments described below could harm our business, financial condition, operating results, and growth prospects. In such an event, the market price of our common stock could decline, and you may lose all or part of your investment. Additional risks and uncertainties not presently known to us or that we currently deem immaterial also may impair our business operations.

Risks Related to Our Business and Industry

The market for our products is developing and may not develop as we expect.

The market for our high performance computing (“HPC”) products is developing and may not develop as we expect. The market for cutting-edge, high performance computing products is characterized by rapid advances in technologies. We believe our future success will depend in large part on our ability to develop products, new business initiatives and creating innovative and custom designs for our customers. The growth of server clusters, specialized or high performance applications, and hosted software solutions which require fast and efficient data processing, is crucial to our success. It is difficult to predict the development of the demand for high performance computing, supercomputers, and related hardware solutions, the size and growth rate for this market, the entry of competitive products, or the success of existing competitive products. Any expansion in our market depends on several factors, including the demand, cost, performance, and perceived value associated with our products. If our products are not adopted or there is a reduction in demand for our products caused by a lack of customer acceptance, a slowdown in demand for computational power, an overabundance of unused computational power, technological challenges, competing technologies and products, decreases in corporate spending, weakening economic conditions, or otherwise, it could result in reduced customer orders, early order cancellations, the loss of customers, or decreased sales, any of which would adversely affect our business, operating results, and financial condition.

Our operating results may fluctuate significantly, which makes our future operating results difficult to predict and could cause our operating results to fall below expectations or our guidance.

Our quarterly and annual operating results have fluctuated in the past and may fluctuate significantly in the future, which makes it difficult for us to predict our future operating results. The timing and size of sales of our products are variable and difficult to predict and can result in fluctuations in our net sales from period to period. In addition, our budgeted expense levels depend in part on our expectation of future sales. Any substantial adjustment to expenses to account for lower levels of sales is difficult and takes time, thus we may not be able to reduce our costs sufficiently to compensate for a shortfall in net sales, and even a small shortfall in net sales could disproportionately and adversely affect our operating margin and operating results for a given quarter.

Our operating results may also fluctuate due to a variety of other factors, many of which are outside our control, including the changing and volatile local, national, and international economic environments, any of which may cause our stock price to fluctuate. Besides the other risks in this “Risk Factors” section, factors that may affect our operations include:

 

fluctuations in demand for our products and services;

 

the inherent complexity, length, and associated unpredictability of product development windows and product lifecycles;

 

changes in customers’ budgets for technology purchases and delays in their purchasing cycles;

 

changing market conditions;

 

any significant changes in the competitive dynamics of our markets, including new entrants, or further consolidation;

 

our ability to continue to broaden our customer base beyond our traditional customers;

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the timing of product releases or upgrades by us or our competitors; and

 

our ability to develop, introduce, and ship in a timely manner new products and product enhancements and anticipate future market demands that meet our customers’ requirements.

Each of these factors individually, or the cumulative effect of two or more of these factors, could result in large fluctuations in our quarterly and annual operating results. As a result, comparing our operating results on a period-to-period basis may not be meaningful. You should not rely on our past results as an indication of future performance.

Our products are subject to competition, including competition from the customers to whom we sell.

Servers, computer accelerators, flash storage arrays, PCIe expansion products, and other products that we design, manufacture, and sell or license are subject to competition. The computer hardware and technology fields are well established with limited, and in many cases no, intellectual property and technological barriers to entry. The markets in which we operate are competitive and we expect competition to increase in the future from established competitors and new market entrants. The markets are influenced by, among others, brand awareness and reputation, price, strength and scale of sales and marketing efforts, professional services and customer support, product features, reliability and performance, scalability of products, and breadth of product offerings. Due to the nature of our products, competition occurs at the design, performance, and sales stages. A design or sales win by us does not limit further competition and our customers may purchase competitive products from third parties at any time. This competition could result in increased pricing pressure, reduced profit margins, increased sales and marketing expenses and failure to increase, or the loss of, market share, any of which would likely seriously harm our business, operating results or financial condition. From a cost and control perspective, our products are specialized and thus generally cost more than our competitors’ products. If our ability to design specialized solutions is deemed to be on par or of lesser value than competing solutions, we could lose our customers and prospects.

Many of our customers and competitors, often with substantially more resources or larger economies of scale, produce products that are competitive with our products. Many of these third parties mass-produce hardware solutions and have not heavily invested in or allocated resources to the smaller scale specialized products and solutions we design. A decrease in the cost of general mass-produced hardware solutions, which can serve as a substitute for our products, or the entrance of or additional allocation of resources by one of these customers or competitors into the production of specialized systems which compete with our products could create increased pricing pressure, reduced profit margins, increased sales and marketing expenses, or the loss of market share or expected market share, any of which may significantly harm our business, operating results and financial condition.

New entrants and the introduction of other distribution models in our markets may harm our competitive position.

The markets for development, distribution, and sale of our high performance computing solutions are rapidly evolving. New entrants seeking to gain market share by introducing new technology, new products and new server configurations may make it more difficult for us to sell our products and earn design wins which could create increased pricing pressure, reduced profit margins, increased sales and marketing expenses, or the loss of market share or expected market share, any of which may significantly harm our business, operating results and financial condition.

Large computer hardware and equipment manufacturers and suppliers have traditionally designed, produced, and sold general purpose servers, and storage arrays and related products and equipment. Our customers supplement these general purpose systems by purchasing our specialized or customized systems or supplemental products which improve the speed, efficiency, or performance of such systems. If the speed, efficiency, or computational power of such general purpose systems increases such that supplemental or specialized products become unnecessary, or the cost of such general purpose systems declines such that it is more cost effective for prospective customers to add general-purpose equipment rather than specialized or supplemental equipment, we could experience a significant decline in demand for the products which may significantly harm to our business, operating results and financial condition.

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Our products compete with and supplement general purpose servers, storage systems and related equipment. If the producers of general purpose equipment implement proprietary standards, software, interfaces, or other interoperability restrictions, including controls which restrict the equipment’s compatibility with third party systems, we could experience a significant decline in sales because our products would not be interoperable with such systems, resulting in may significantly harm to our business, operating results and financial condition.

In our marketplace, general-purpose equipment is traditionally mass-produced and available to order while specialized equipment and custom bulk-order equipment is subject to a bid-based purchase system. If one or more large manufacturers of general or standard servers storage arrays, or related products and equipment provide specialized, customized, or supplementary equipment on a made-to-order or generally available basis, we could be forced to reduce our prices or change our selling model to remain competitive which would significantly harm to our business, operating results and financial condition.

If we are unable to manage our growth and expand our operations successfully, our business and operating results will be harmed and our reputation may be damaged.

We have expanded our operations significantly since inception and anticipate that further significant expansion will be required to achieve our business objectives. The growth and expansion of our business and product offerings places a continuous and significant strain on our management, operational and financial resources. Any such future growth would also add complexity to and require effective coordination throughout our organization. To manage any future growth effectively, we must continue to improve and expand our information technology and financial infrastructure, our operating and administrative systems and controls, and our ability to manage headcount, capital and processes in an efficient manner. We may not be able to successfully implement improvements to these systems and processes in a timely or efficient manner, which could result in additional operating inefficiencies and could cause our costs to increase more than planned. If we do increase our operating expenses in anticipation of the growth of our business and this growth does not meet our expectations, our operating results may be negatively impacted. If we are unable to manage future expansion, our ability to provide high quality products and services could be harmed, which could damage our reputation and brand and may have a material adverse effect on our business, operating results and financial condition.

A limited number of customers represent a significant portion of our sales. If we were to lose any of these customers, our sales could decrease significantly.

In the fiscal years ended December 31, 2018 and December 31, 2017, two customers, disguise (formerly d3) and Raytheon accounted for approximately 61%, and 43% of net sales of OSS, excluding the revenue of the recent acquisitions of CDI and Bressner, respectively. As of December 31, 2018, three customers accounted for 74% of net trade accounts receivable and, as of December 31, 2017, three customers accounted for 69% of net trade accounts receivables, excluding recent acquisitions.

A significant portion of revenue for CDI is derived from two customers, Thales and Inflight Canada which represents approximately 67% of its revenue earned since CDI’s acquisition on August 31, 2018.  Two customers represented 84% of accounts receivable as of December 31, 2018.

Bressner Technologies GmbH has two customers which represent approximately 47% of the Company’s revenue earned since their acquisition on October 31, 2018.  Two customers represented 61% of accounts receivable as of December 31, 2018.

In addition, a few products comprise a significant amount of our sales, and the discontinuation, modification, or obsolescence of such products may materially and adversely affect our sales and results of operations. Any loss of, or a significant reduction in purchases by, these other significant customers or a decrease in the high performance applications that drive the use of our products, or the modification, discontinuation, or obsolescence of a device which constitutes a significant portion of our sales could have an adverse effect on our financial condition and operating results.

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Some of our contracts allow our customers to have access to the design drawings for products which we have designed and manufacture for them.

Some of our contracts allow our customers to have access to the design drawings for products which we have designed and manufacture for them.  In some cases these drawings are included as a deliverable in conjunction with their non-recurring engineering fee, and in other cases, an additional fee is required to obtain the drawings package.  Since these customers have access to the drawings, there is no guarantee that they will continue to purchase the manufactured products from OSS.  This arrangement applies to our large media and entertainment customer, several of the customers within the recently acquired CDI business and other customers.  Neither our media and entertainment customer, nor our current CDI customers have had any of the OSS-designed products manufactured by anyone other than OSS, but they may have the capability to do so in the future.

We rely on a limited number of parts suppliers to support our manufacturing and design processes.

We rely on a limited number of suppliers to provide us with the necessary devices, parts and systems to allow us to build, design and manufacture our products, and the failure to manage our relationships with these parties successfully could adversely affect our ability to market and sell our products. In the fiscal years ended December 31, 2018 and December 31, 2017, excluding recent acquisitions, three suppliers, Concisys, Inc., Exact Computers and Supermicro, accounted for approximately 45%, and 48%, respectively, of materials purchased.

Although we do believe we could locate additional suppliers to fulfill our needs, any significant change in our relationship with these suppliers could have a material adverse effect on our business, operating results, and financial condition unless and until we are able to find suitable replacements. We make substantially all of our purchases from our contract suppliers on a purchase order basis. Our suppliers are not required to supply our raw materials for any specific period or in any specific quantity or price.

Our future success depends on our ability to develop and successfully introduce new and enhanced products that meet the needs of our customers.

Our sales depend on our ability to anticipate our existing and prospective customers’ needs and develop products that address those needs. Our future success will depend on our ability to design new products, anticipate technological improvements and enhancements, and to develop products that are competitive in the rapidly changing computer hardware and software industry. Introduction of new products and product enhancements will require coordination of our efforts with those of our customers, suppliers, and manufacturers to develop products that offer performance features desired by our customers and performance and functionality superior or more cost effective than solutions offered by our competitors. If we fail to coordinate these efforts, develop product enhancements or introduce new products that meet the needs of our customers as scheduled, our operating results will be materially and adversely affected, and our business and prospects will be harmed. We cannot assure that product introductions will meet our anticipated release schedules or that our products will be competitive in the market. Furthermore, given the rapidly changing nature of the computer equipment market, there can be no assurance our products and technology will not be rendered obsolete by alternative or competing technologies.

Delays in our production cycle could result in outdated equipment or decreased purchases of our products.

The design and manufacture of our products can take several months to several years. The length of such process depends on the complexity and purpose of the system or equipment being designed, and may be affected by factors such as: the development and design of unique or specialized systems, the fabrication, availability, and supply of parts, the customization of parts as applicable, the manufacture and/or assembly of the units, quality control testing, and the development and incorporation of new technologies. If our products are outdated upon completion of this process our sales could materially decline and it may be necessary to sell products at a loss.

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Unsuccessful government programs or OEM contracts could lead to reduced revenues.

We design and manufacture certain products to fit the specifications of government programs or OEM contracts. These programs may take months or years to complete and involve significant investment of our time, money and resources. We generally receive upfront fees for these programs but there is often no or little obligation on the part of our customer to purchase large volumes of products at the time of final product launch. Unsuccessful product launches could lead to reduced revenues, potential returns of products and have a material adverse effect on our financial condition and operating results. We may be forced to sell products at a loss or spend a significant amount of resources to find additional customers for these products if these programs do not fit the future needs of our intended customers.

Our inventory may rapidly become obsolete.

Sales cycles for some of our products can take several months. In addition, it can take time from the bid to the development and manufacture of the equipment. We maintain inventory based in large part on our forecasts of the volume and timing of orders. The varying length of the sales cycles makes accurate forecasting difficult. The delays inherent in our sales cycles raise the risk that the inventory we have on hand will become obsolete or impaired prior to its use or sale. If our forecasted demand does not materialize into purchase orders, we may be required to write off our inventory balances or reduce the value of our inventory, based on a reduced sales price. A write off of the inventory, or a reduction in the inventory value due to a sales price reduction, could have an adverse effect on our financial condition and operating results.

We offer an extended product warranty to cover defective products at no cost to the customer. An unexpected change in failure rates of our products could have a material adverse impact on our business.

We offer product warranties that generally extend for one year from date of sale that requires us to repair or replace defective products returned by the customer during the warranty period at no cost to the customer. Our product warranties are in addition to warranties we receive from our vendors. We record an estimate for anticipated warranty-related costs at the time of sale based on historical and estimated future product return rates and expected repair or replacement costs. While such costs have historically been within management’s expectations and the provisions established and we receive warranty coverage from our vendors, unexpected changes in failure rates could have a material adverse impact on our business requiring additional warranty reserves. These failures could adversely impact our operating results.

If we fail to achieve design wins for our products, our business will be harmed.

Achieving design wins is an important success factor for our business. We work closely with OEM’s and end users to insure the customer gets the product they want in the specific configuration, size and weight required for the application. We have participated in many design wins based upon our ability to interpret technical specifications and proceed rapidly through prototyping, development, and delivery. This approach and expertise is one of the factors driving our growth. Failure to maintain our expertise and ability to deliver custom, specific design systems could harm our business. In order to achieve design wins, we must:

 

anticipate the features and functionality that OEMs, customers and consumers will demand;

 

incorporate those features and functionalities into products that meet the exacting design requirements of our customers; and

 

price our products competitively.

Unanticipated changes in industry standards could render our products incompatible with products developed by major hardware manufacturers and software developers. Further, if our products are not in compliance with prevailing industry standards, our customers may not incorporate our products into their design strategies.

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If we cannot retain, attract and motivate key personnel, we may be unable to effectively implement our business plan.

Our success depends in large part upon our ability to retain, attract and motivate highly skilled management, development, marketing, sales and service personnel. The loss of and failure to replace key technical management and personnel could adversely affect multiple development efforts. Recruitment and retention of senior management and skilled technical, sales and other personnel is very competitive, and we may not be successful in either attracting or retaining such personnel. We have lost key personnel to other high technology companies, and many larger companies with significantly greater resources than us have aggressively recruited, and continue to aggressively recruit, key personnel. As part of our strategy to attract and retain key personnel, we may offer equity compensation through grants of stock options, restricted stock awards or restricted stock units. Potential employees, however, may not perceive our equity incentives as attractive enough. In addition, due to the intense competition for qualified employees, we may be required to, and have had to, increase the level of compensation paid to existing and new employees, which could materially increase our operating expenses.

We have made in the past, and may make in the future, acquisitions which could require significant management attention, disrupt our business, result in dilution to our stockholders, deplete our cash reserves and adversely affect our financial results.

Acquisitions involve numerous risks, including the following:

 

difficulties in successfully integrating the operations, systems, technologies, products, offerings and personnel of the acquired company or companies;

 

insufficient revenue to offset increased expenses associated with acquisitions;

 

diversion of management’s attention from normal daily operations of the business and the challenges of managing larger and more widespread operations resulting from acquisitions;

 

potential difficulties in completing projects associated with in-process research and development intangibles;

 

difficulties in entering markets in which we have no or limited direct prior experience and where competitors in such markets have stronger market positions;

 

initial dependence on unfamiliar supply chains or relatively small supply partners; and

 

the potential loss of key employees, customers, distributors, vendors and other business partners of the companies we acquire following and continuing after announcement of acquisition plans.

Acquisitions may also cause us to:

 

use a substantial portion of our cash reserves or incur debt;

 

issue equity securities or grant equity incentives to acquired employees that would dilute our current stockholders’ percentage ownership;

 

assume liabilities, including potentially unknown liabilities;

 

record goodwill and non-amortizable intangible assets that are subject to impairment testing on a regular basis and potential periodic impairment charges;

 

incur amortization expenses related to certain intangible assets;

 

incur large and immediate write-offs and restructuring and other related expenses; or

 

become subject to intellectual property litigation or other litigation.

Acquisitions of high-technology companies and assets are inherently risky and subject to many factors outside of our control and no assurance can be given that our recently completed or future acquisitions will be successful and will not materially adversely affect our business, operating results, or financial condition. Failure to manage and successfully integrate acquisitions could materially harm our business and operating results.

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The continuing commoditization of HPC hardware and software has resulted in increased pricing pressure and may adversely affect our operating results.

The continuing commoditization of HPC hardware, such as processors, interconnects, flash storage and other infrastructure, and the growing commoditization of software, including plentiful building blocks and more capable open source software, as well as the potential for integration of differentiated technology into already-commoditized components, has resulted in, and may result in increased pricing pressure that may cause us to reduce our pricing in order to remain competitive, which can negatively impact our gross margins and adversely affect our operating results.

Our election to not opt out of the extended accounting transition period under the Jumpstart Our Business Startups Act of 2012, or the JOBS Act, may make our financial statements difficult to compare to other companies.

Under the JOBS Act, as an emerging growth company, we can elect to opt out of the extended transition period for any new or revised accounting standards that may be issued by the Financial Accounting Standards Board (“FASB”) or the U.S. Securities and Exchange Commission (the “SEC”). We have elected not to opt out of such extended transition period. This means that when a standard is issued or revised and it has different application dates for public or private companies, we, as an emerging growth company, are permitted to use any extended transition period for adoption that is provided in the new or revised accounting standard having different application dates for public and private companies. This may make the comparison of our financial statements with any other public company, which is not either an emerging growth company nor an emerging growth company which has opted out of using the extended transition period, difficult or impossible as possible different or revised standards may be used.

If we are unable to maintain effective internal control over financial reporting in the future, the accuracy and timeliness of our financial reporting may be adversely affected. In addition, because of our status as an emerging growth company, you will not be able to depend on any attestation from our independent registered public accounting firm as to our internal control over financial reporting for the foreseeable future.

The Sarbanes-Oxley Act requires, among other things, that we assess disclosure controls and procedures and controls over financial reporting. In particular, we are required to perform system and process evaluations and testing of our internal control over financial reporting to allow management to report on the effectiveness of our internal controls over financial reporting, as required by Section 404 of the Sarbanes-Oxley Act. We are required to furnish a report by management on, among other things, the effectiveness of our internal control over financial reporting beginning with the fiscal year ended December 31, 2018. However, our independent registered public accounting firm will not be required to attest to the effectiveness of our internal control over financial reporting pursuant to Section 404 of the Sarbanes-Oxley Act until the date we are no longer an “emerging growth company” as defined in the JOBS Act. Accordingly, you will not be able to depend on any attestation concerning our internal control over financial reporting from our independent registered public accounting firm for the foreseeable future.

Risks Relating to Intellectual Property

If we are unable to protect our proprietary design and intellectual property rights, our competitive position could be harmed or we could be required to incur significant expenses to enforce our rights.

Our ability to compete effectively is dependent in part upon our ability to protect our proprietary technology. We rely on patents, trademarks, trade secret laws, confidentiality procedures and licensing arrangements to protect our intellectual property rights. There can be no assurance these protections will be available in all cases or will be adequate to prevent our competitors from copying, reverse engineering or otherwise obtaining and using our technology, proprietary rights or products. For example, the laws of certain countries in which our products are manufactured or licensed do not protect our proprietary rights to the same extent as the laws of the United States. In addition, third parties may seek to challenge, invalidate or circumvent our patents, trademarks, copyrights and trade secrets, or applications for any of the foregoing. There can be no assurance that our competitors will not independently develop technologies that are substantially equivalent or superior to our technology or design around our proprietary rights. In each case, our ability to compete could be significantly impaired. To prevent substantial unauthorized use of our intellectual property rights, it may be necessary to prosecute actions for infringement and/or

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misappropriation of our trade secrets and/or proprietary rights against third parties. Any such action could result in significant costs and diversion of our resources and management’s attention, and there can be no assurance we will be successful in such action. Furthermore, many of our current and potential competitors have the ability to dedicate substantially greater resources to enforce their intellectual property rights than we do. Accordingly, despite our efforts, we may not be able to prevent third parties from infringing upon or misappropriating our trade secrets and/or intellectual property.

Many of our proprietary designs are in digital form and the breach of our computer systems could result in these designs being stolen.

If our cybersecurity measures are breached or unauthorized access to private or proprietary data is otherwise obtained, our proprietary designs could be stolen. Because we hold many of these designs in digital form on our servers, there exists an inherent risk that an unauthorized third party could conduct a cybersecurity breach resulting in the theft of our proprietary information. While we have taken cybersecurity steps to protect our proprietary information, because techniques used to obtain unauthorized access or sabotage systems change frequently and generally are not identified until they are launched against a target, we may be unable to anticipate these techniques or to implement adequate preventative measures. Any or all of these issues could negatively impact our competitive edge and our ability to obtain new customers thereby adversely affecting our financial results.

Our proprietary designs are susceptible to reverse engineering by our competitors.

Much of the value of our proprietary rights is derived from our vast library of design specifications. While we consider our design specifications to be protected by various proprietary, trade secret and intellectual property laws, such information is susceptible to reverse engineering by our competitors. We may not be able to prevent our competitors from developing competing design specifications and the cost of enforcing these rights may be significant. If we are unable to adequately protect our proprietary designs our financial condition and operating results could suffer.

If we are unable to protect the confidentiality of our trade secrets, our business and competitive position would be harmed.

We consider trade secrets, including confidential and unpatented know-how and designs important to the maintenance of our competitive position. We protect trade secrets and confidential and unpatented know-how, in part, by customarily entering into non-disclosure and confidentiality agreements with parties who have access to such knowledge, such as our employees, outside technical and commercial collaborators, consultants, advisors and other third parties. We also enter into confidentiality and invention or patent assignment agreements with our employees and consultants that obligate them to maintain confidentiality and assign their inventions to us. Despite these efforts, any of these parties may breach the agreements and disclose our proprietary information, including our trade secrets, and we may not be able to obtain adequate remedies for such breaches.

Claims by others that we infringe their intellectual property or trade secret rights could harm our business.

Our industry is characterized by vigorous protection and pursuit of intellectual property rights, which has resulted in protracted and expensive litigation for many companies. Third parties may in the future assert claims of infringement of intellectual property rights against us or against our customers or channel partners for which we may be liable. As the number of products and competitors in our market increases and overlaps occur, infringement claims may increase.

Intellectual property or trade secret claims against us, and any resulting lawsuits, may result in our incurring significant expenses and could subject us to significant liability for damages and invalidate what we currently believe are our proprietary rights. Our involvement in any patent dispute or other intellectual property dispute or action to protect trade secrets and know-how could have a material adverse effect on our business. Adverse determinations in any litigation could subject us to significant liabilities to third parties, require us to seek licenses from third parties and prevent us from manufacturing and selling our products. Any of these situations could have a material adverse effect on our business. These claims, regardless of their merits or outcome, would likely be time consuming and expensive to resolve and could divert management’s time and attention.

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We are generally obligated to indemnify our channel partners and end-customers for certain expenses and liabilities resulting from intellectual property infringement claims regarding our products, which could force us to incur substantial costs.

We have agreed, and expect to continue to agree, to indemnify our channel partners and end-customers for certain intellectual property infringement claims regarding our products. As a result, in the case of infringement claims against these channel partners and end-customers, we could be required to indemnify them for losses resulting from such claims or to refund amounts they have paid to us. Our channel partners and other end-customers in the future may seek indemnification from us in connection with infringement claims brought.

Risks Related to Our International Operations

Our international sales and operations subject us to additional risks that can adversely affect our operating results and financial condition.

Our international operations subject us to a variety of risks and challenges, including: exposure to fluctuations in foreign currency exchange rates, increased management, travel, infrastructure and legal compliance costs associated with having international operations; reliance on channel partners; increased financial accounting and reporting burdens and complexities; compliance with foreign laws and regulations; compliance with U.S. laws and regulations for foreign operations; and reduced protection for intellectual property rights in some countries and practical difficulties of enforcing rights abroad. Any of these risks could adversely affect our international operations, reduce our international sales or increase our operating costs, adversely affecting our business, operating results and financial condition and growth prospects.

We are subject to governmental export and import controls that could impair our ability to compete in international markets due to licensing requirements and subject us to liability if we are not in compliance with applicable laws.

Our products are subject to export control and import laws and regulations, including the U.S. Export Administration Regulations, U.S. Customs regulations and various economic and trade sanctions regulations administered by the U.S. Treasury Department’s Office of Foreign Assets Controls. Exports of our products must be made in compliance with these laws and regulations. If we violate these laws and regulations, we and certain of our employees could be subject to substantial civil or criminal penalties, including the possible loss of export or import privileges, fines, which may be imposed on us and responsible employees or managers and, in extreme cases, the incarceration of responsible employees or managers. In addition, if our channel partners, agents or consultants fail to obtain appropriate import, export or re-export licenses or authorizations, we may also be adversely affected through reputational harm and penalties. Obtaining the necessary authorizations, including any required license, for a particular sale may be time-consuming, is not guaranteed and may result in the delay or loss of sales opportunities. Changes in our products or changes in applicable export or import laws and regulations may also create delays in the introduction and sale of our products in international markets, prevent our end-customers with international operations from deploying our products or, in some cases, prevent the export or import of our products to certain countries, governments or persons altogether. Any change in export or import laws and regulations, shift in the enforcement or scope of existing laws and regulations, or change in the countries, governments, persons or technologies targeted by such laws and regulations, could also result in decreased use of our products, or in our decreased ability to export or sell our products to existing or potential end-customers with international operations. Any decreased use of our products or limitation on our ability to export or sell our products would likely adversely affect our business, financial condition and operating results.

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New regulations or standards or changes in existing regulations or standards in the United States or internationally related to our suppliers products may result in unanticipated costs or liabilities, which could have a material adverse effect on our business, operating results and future sales, and could place additional burdens on the operations of our business.

Our suppliers’ products are subject to governmental regulations in many jurisdictions. To achieve and maintain market acceptance, our suppliers’ products must continue to comply with these regulations and many industry standards. As these regulations and standards evolve, and if new regulations or standards are implemented, our suppliers may have to modify their products. The failure of their products to comply, or delays in compliance, with the existing and evolving industry regulations and standards could prevent or delay introduction of our products, which could harm our business. Supplier uncertainty regarding future policies may also affect demand for HPC products, including our products. Moreover, channel partners or customers may require us, or we may otherwise deem it necessary or advisable, to alter our products to address actual or anticipated changes in the regulatory environment. Our inability to alter our products to address these requirements and any regulatory changes may have a material adverse effect on our business, operating results and financial condition.

We could be adversely affected by violations of the U.S. Foreign Corrupt Practices Act and similar worldwide anti-bribery laws.

We have international operations. The U.S. Foreign Corrupt Practices Act and similar anti-bribery laws generally prohibit companies and their intermediaries from making improper payments to foreign government officials for the purpose of obtaining or retaining business. Practices in the local business communities of many countries outside the United States have a level of government corruption that is greater than that found in the developed world. Our policies mandate compliance with these anti-bribery laws and we have established policies and procedures designed to monitor compliance with these anti-bribery law requirements; however, we cannot assure that our policies and procedures will protect us from potential reckless or criminal acts committed by individual employees or agents. If we are found to be liable for anti-bribery law violations, we could suffer from criminal or civil penalties or other sanctions that could have a material adverse effect on our business.

Risks Related to Our Common Stock

The price of our common stock may be volatile, and you could lose all or part of your investment.

The trading price of our common stock following our initial public offering may fluctuate substantially and may be higher or lower than the initial public offering price. The trading price of our common stock will depend on several factors, including those described in this “Risk Factors” section, many of which are beyond our control and may not be related to our operating performance. These fluctuations could cause you to lose all or part of your investment in our common stock since you might be unable to sell your shares at or above the price you paid.  Factors that could cause fluctuations in the trading price of our common stock include:

 

price and volume fluctuations in the overall stock market from time to time;

 

volatility in the market prices and trading volumes of technology stocks;

 

changes in operating performance and stock market valuations of other technology companies generally, or those in our industry in particular;

 

sales of shares of our common stock by us or our stockholders;

 

failure of financial analysts to maintain coverage of us, changes in financial estimates by any analysts who follow our company, or our failure to meet these estimates or the expectations of investors;

 

the financial projections we may provide to the public, any changes in those projections or our failure to meet those projections;

 

announcements by us or our competitors of new products or new or terminated significant contracts, commercial relationships or capital commitments;

 

the public’s reaction to our press releases, other public announcements and filings with the SEC;

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rumors and market speculation involving us or other companies in our industry;

 

actual or anticipated changes in our operating results or fluctuations in our operating results;

 

actual or anticipated developments in our business or our competitors’ businesses or the competitive landscape generally;

 

litigation involving us, our industry or both or investigations by regulators into our operations or those of our competitors;

 

developments or disputes concerning our intellectual property or other proprietary rights;

 

announced or completed acquisitions of businesses or technologies by us or our competitors;

 

new laws or regulations or new interpretations of existing laws or regulations applicable to our business;

 

changes in accounting standards, policies, guidelines, interpretations or principles;

 

any major change in our management;

 

general economic conditions and slow or negative growth of our markets; and

 

other events or factors, including those resulting from war, incidents of terrorism or responses to these events.

In addition, the stock market in general, and the market for technology companies in particular, have experienced extreme price and volume fluctuations that have often been unrelated or disproportionate to the operating performance of those companies. Broad market and industry factors, as well as general economic, political and market conditions such as recessions or interest rate changes, may seriously affect the market price of our common stock, regardless of our actual operating performance. These fluctuations may be even more pronounced in the trading market for our stock shortly following our initial public offering. If the market price of our common stock after our initial public offering does not exceed the initial public offering price, you may not realize any return on your investment in us and may lose some or all of your investment.

In the past, following periods of volatility in the overall market and the market prices of particular companies’ securities, securities class action litigations have often been instituted against these companies. Litigation of this type, if instituted against us, could result in substantial costs and a diversion of our management’s attention and resources. Any adverse determination in any such litigation or any amounts paid to settle any such actual or threatened litigation could require that we make significant payments.

Our directors and principal stockholders own a significant percentage of our stock and will be able to exert significant control over matters subject to stockholder approval.

Our directors, executive officers and significant stockholders have substantial control over the Company and could delay or prevent a change in corporate control. Our directors, executive officers and holders of more than 5% of our common stock, together with their affiliates, beneficially own, in the aggregate, 37.8% of our outstanding common stock, based on the number of shares outstanding as of February 28, 2019. As a result, these stockholders, acting together, would have the ability to control the outcome of matters submitted to our stockholders for approval, including the election of directors and any merger, consolidation or sale of all or substantially all of our assets. In addition, these stockholders, acting together, would have the ability to control the management and affairs of our company. Accordingly, this concentration of ownership might adversely affect the market price of our common stock by:

 

delaying, deferring or preventing a change in control of the Company;

 

impeding a merger, consolidation, takeover, or other business combination involving us; or

 

discouraging a potential acquirer from making a tender offer or otherwise attempting to obtain control of the company.

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If securities or industry analysts issue an adverse opinion regarding our stock or do not publish research or reports about our company, our stock price and trading volume could decline.

The trading market for our common stock will depend in part on the research and reports that equity research analysts publish about us and our business. We anticipate having limited analyst coverage and we may continue to have inadequate analyst coverage in the future. Even if we obtain adequate analyst coverage, we would have no control over such analysts or the content and opinions in their reports. Securities analysts may elect not to provide research coverage of our company and such lack of research coverage may adversely affect the market price of our common stock. The price of our common stock could also decline if one or more equity research analysts downgrade our common stock or if those analysts issue other unfavorable commentary or cease publishing reports about us or our business. If one or more equity research analysts cease coverage of our company, we could lose visibility in the market, which in turn could cause our stock price to decline.

Substantial future sales of shares of our common stock could cause the market price of our common stock to decline.

The market price of shares of our common stock could decline as a result of substantial sales of our common stock, particularly sales by our directors, executive officers and significant stockholders, a large number of shares of our common stock becoming available for sale or the perception in the market that holders of a large number of shares intend to sell their shares. As of February 28, 2019, we have 14,270,268 shares of our common stock outstanding. This includes the shares issued in our initial public offering, which may be resold in the public market immediately without restriction.

Moreover, certain holders of our common stock will have rights, subject to some conditions, to require us to file registration statements covering their shares or to include their shares in registration statements that we may file for ourselves or our stockholders. Substantially all of these shares are subject to lock-up agreements restricting their sale for a period of one to two years depending on the terms of the agreement.

Anti-takeover provisions in our charter documents and under Delaware law could make an acquisition of us, which may be beneficial to our stockholders, more difficult and may prevent attempts by our stockholders to replace or remove our current management and limit the market price of our common stock.

Provisions in our certificate of incorporation and amended and restated bylaws may have the effect of delaying or preventing a change of control or changes in our management. Some of these provisions:

 

authorize our board of directors to issue, without further action by the stockholders, up to 10,000,000 shares of undesignated preferred stock and up to 50,000,000 shares of authorized common stock;

 

require that any action to be taken by our stockholders be affected at a duly called annual or special meeting and not by written consent;

 

specify that special meetings of our stockholders can be called only by our board of directors, the chairman of the board of directors, the chief executive officer or the president;

 

establish an advance notice procedure for stockholder approvals to be brought before an annual meeting of our stockholders, including proposed nominations of persons for election to our board of directors;

 

provide that our directors may be removed only for cause; and;

 

provide that vacancies on our board of directors may, except as otherwise required by law, be filled only by a majority of directors then in office, even if less than a quorum.

31


In addition, we are subject to the provisions of Section 203 of the Delaware General Corporation Law, which limits the ability of stockholders owning in excess of 15% of our outstanding voting stock to merge or combine with us. Furthermore, our certificate of incorporation specifies that, unless we consent in writing to the selection of an alternative forum, the Court of Chancery of the State of Delaware will be the sole and exclusive forum for most legal actions involving actions brought against us by stockholders. We believe this provision benefits us by providing increased consistency in the application of Delaware law by chancellors particularly experienced in resolving corporate disputes, efficient administration of cases on a more expedited schedule relative to other forums and protection against the burdens of multi-forum litigation. However, the provision may have the effect of discouraging lawsuits against our directors and officers. The enforceability of similar choice of forum provisions in other companies’ certificates of incorporation has been challenged in legal proceedings, and it is possible that, in connection with any applicable action brought against us, a court could find the choice of forum provisions contained in our certificate of incorporation to be inapplicable or unenforceable in such action.

These anti-takeover provisions and other provisions in our certificate of incorporation and amended and restated bylaws make it more difficult for stockholders or potential acquirers to obtain control of our board of directors or initiate actions that are opposed by the then-current board of directors and could also delay or impede a merger, tender offer or proxy contest involving our company. These provisions could also discourage proxy contests and make it more difficult for you and other stockholders to elect directors of your choosing or cause us to take other corporate actions you desire. Any delay or prevention of a change of control transaction or changes in our board of directors could cause the market price of our common stock to decline.

We have never paid cash dividends on our capital stock, and we do not anticipate paying cash dividends in the foreseeable future.

We have never declared or paid any cash dividends on our common stock and do not intend to pay any cash dividends in the foreseeable future. In addition, our loan and security agreement with Bank of the West restricts our ability to pay cash dividends on our common stock without the prior written consent of Bank of the West, and we may also enter into credit agreements or other borrowing arrangements in the future that will restrict our ability to declare or pay cash dividends on our common stock. We currently intend to retain any future earnings to fund the growth of our business. Any determination to pay dividends in the future will be at the discretion of our board of directors and will depend on our financial condition, operating results, capital requirements, general business conditions and other factors that our board of directors may deem relevant.

If an active, liquid trading market for our common stock does not develop, you may not be able to sell your shares quickly or at or above the initial offering price.

There has not been a public market for our common stock prior to our initial public offering. An active and liquid trading market for our common stock may not develop or be sustained following our initial public offering. Given the small size of our initial public offering, it may take some time for an active market to develop. The lack of an active market may impair your ability to sell your shares at the time you wish to sell them or at a price that you consider reasonable. The lack of an active market may also reduce the fair market value of your shares. An inactive market may also impair our ability to raise capital to continue to fund operations by selling shares and may impair our ability to acquire other companies or technologies by using our shares as consideration. You may not be able to sell your shares quickly or at or above the initial offering price. The initial public offering price was determined by negotiations with the representatives of the underwriters. This price may not be indicative of the price at which our common stock will continue to trade in the future, and our common stock could trade below the initial public offering price.

32


Our inability to raise additional capital on acceptable terms in the future may limit our ability to develop and commercialize new solutions and technologies and expand our operations.

If our available cash balances, net proceeds from our initial public offering and anticipated cash flow from operations are insufficient to satisfy our liquidity requirements, due to lower demand for our products as a result of other risks described in this “Risk Factors” section, we may seek to raise additional capital through equity offerings, debt financings, collaborations or licensing arrangements. We may also consider raising additional capital in the future to expand our business, pursue strategic investments, take advantage of financing opportunities, or other reasons.

Additional funding may not be available to us on acceptable terms, or at all. If we raise funds by issuing equity securities, dilution to our stockholders could result. Any equity securities issued also may provide for rights, preferences or privileges senior to those of holders of our common stock. The terms of debt securities issued or borrowings could impose significant restrictions on our operations. The incurrence of indebtedness or the issuance of certain equity securities could result in increased fixed payment obligations and could also result in restrictive covenants, such as limitations on our ability to incur additional debt or issue additional equity, limitations on our ability to acquire or license intellectual property rights, and other operating restrictions that could adversely affect our ability to conduct our business. In addition, the issuance of additional equity securities by us, or the possibility of such issuance, may cause the market price of our common stock to decline. If we do not have, or are not able to obtain, sufficient funds, we may have to delay development or commercialization of our products or license to third parties the rights to commercialize products or technologies that we would otherwise seek to commercialize. If we raise additional funds through collaboration and licensing arrangements with third parties, it may be necessary to relinquish some rights to our technologies or our products, or to grant licenses on terms that are not favorable to us. If we are unable to raise adequate funds, we may have to liquidate some or all of our assets, or delay, reduce the scope of or eliminate some or all of our development programs. We also may have to reduce marketing, customer support or other resources devoted to our products or cease operations. Any of these actions could harm our business, operating results and financial condition.

We are an “emerging growth company” and we cannot be certain if the reduced disclosure requirements applicable to emerging growth companies will make our common stock less attractive to investors.

We are an “emerging growth company” as defined in the JOBS Act. For as long as we continue to be an emerging growth company, we may choose to take advantage of certain exemptions from various reporting requirements applicable to other public companies but not to emerging growth companies, which includes, among other things:

 

exemption from the auditor attestation requirements under Section 404(b) of the Sarbanes-Oxley Act of 2002;

 

reduced disclosure obligations regarding executive compensation in our periodic reports and proxy statements; and

 

exemption from the requirements of holding non-binding stockholder votes on executive compensation arrangements.

We could be an emerging growth company until the last day of the fiscal year following the fifth anniversary after our initial public offering, or until the earliest of (i) the last day of the fiscal year in which we have annual gross revenue of $1.07 billion or more, (ii) the date on which we have, during the previous three year period, issued more than $1.07 billion in non-convertible debt or (iii) the date on which we are deemed to be a large accelerated filer under the federal securities laws. We will qualify as a large accelerated filer as of the first day of the first fiscal year after we have (i) more than $700 million in outstanding common equity held by our non-affiliates and (ii) been public for at least 12 months. The value of our outstanding common equity will be measured each year on the last day of our second fiscal quarter.

We cannot predict if investors will find our common stock less attractive if we rely on these exemptions. If some investors find our common stock less attractive as a result, there may be a less active trading market for our common stock and our stock price may be more volatile.

33


We will incur significant increased costs as a result of operating as a public company, and our management will be required to devote substantial time to comply with the laws and regulations affecting public companies, particularly after we are no longer an emerging growth company.

We have limited experience operating as a public company. As a public company, particularly after we cease to qualify as an emerging growth company, we will incur significant legal, accounting and other expenses that we did not incur as a private company, including costs associated with public company reporting and corporate governance requirements, to comply with the rules and regulations imposed by the Sarbanes-Oxley Act and the Dodd-Frank Act, as well as rules implemented by the SEC and Nasdaq. Our management and other personnel will need to devote a substantial amount of time to these compliance initiatives and our legal and accounting compliance costs will increase. It is likely that we will need to hire additional staff or devote additional financial and other resources in the areas of investor relations, legal and accounting to operate as a public company. We also expect these new rules and regulations may make it more difficult and expensive for us to obtain director and officer liability insurance, and we may be required to accept reduced policy limits and coverage or incur substantially higher costs to obtain the same or similar coverage. As a result, it may be more difficult for us to attract and retain qualified individuals to serve on our board of directors or as executive officers. We are evaluating and monitoring developments regarding these rules, and we cannot predict or estimate the amount of additional costs we may incur or the timing of such costs.

For example, the Sarbanes-Oxley Act requires, among other things, that we assess the effectiveness of internal controls over financial reporting and disclosure controls and procedures. In particular, as a public company, we will be required to perform system and process evaluations and testing of our internal control over financial reporting to allow management to report on the effectiveness of our internal controls over financial reporting, as required by Section 404 of the Sarbanes-Oxley Act. As described above, as an emerging growth company, we will not need to comply with the auditor attestation provisions of Section 404(b) for several years. Our testing, or the subsequent testing by our independent registered public accounting firm, may reveal deficiencies in our internal control over financial reporting that are deemed to be material weaknesses. Our compliance with Section 404 will require that we incur substantial accounting expense and management time on compliance-related issues. Moreover, if we are not able to comply with the requirements of Section 404 in a timely manner, or if we or our independent registered public accounting firm identify deficiencies in our internal control over financial reporting that are deemed to be material weaknesses, we could lose investor confidence in the accuracy and completeness of our financial reports, which could cause our stock price to decline.

ITEM 1B. UNRESOLVED STAFF COMMENTS.

Not applicable.

ITEM 2. PROPERTIES.

Our corporate headquarters are in a leased space comprising approximately 24,032 square feet in Escondido, California under a lease that was renewed in August 2018 and now expires in August 2024.  We also lease a 3,208 square foot facility in Salt Lake City, Utah that houses our Ion software development team that expires in August 2020. CDI is the lessee of approximately 12,000 square feet located in Irvine, California with the lease expiring in June 2021.  Bressner Technology, which was acquired in October 2018, leases space comprising 8,073 square feet which lease expires in December 2019.  

ITEM 3. LEGAL PROCEEDINGS.

We are subject to litigation, claims, investigations and audits arising from time to time in the ordinary course of our business. However, at this time, we are not aware of any material pending, threatened or unasserted claims.

ITEM 4. MINE SAFETY DISCLOSURES.

Not Applicable.

34


PART II

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.

Market Information

Our common stock par value $0.0001, has been publicly traded on The Nasdaq Capital Market under the symbol “OSS” since our initial public offering on February 1, 2018, which was completed at an offering price to the public of $5.00 per share.  Prior to our initial public offering, there was no public market for our common stock.  Due to the fact that our common stock has only been traded on a public market since February 1, 2018, we have only set forth quarterly information with respect to the high and low sale prices for our common stock for such time period.

 

Year ended December 31, 2019

 

High

 

 

Low

 

First  Quarter (through March 8, 2019)

 

$

2.85

 

 

$

1.87

 

 

 

 

 

 

 

 

 

 

Year ended December 31, 2018

 

High

 

 

Low

 

First Quarter (beginning February 1, 2018)

 

$

6.25

 

 

$

4.40

 

Second Quarter

 

$

5.00

 

 

$

4.10

 

Third Quarter

 

$

4.75

 

 

$

3.20

 

Fourth Quarter

 

$

3.99

 

 

$

1.81

 

 

Holders

As of February 28, 2019, there were 14,270,268 shares of our common stock outstanding held by approximately 64 holders of record of our common stock.  This number was derived from our stockholder records and does not include beneficial holders of our common stock whose shares are held in “street name” with various dealers, clearing agencies, banks, brokers and other fiduciaries.

Dividend Policy

We have never declared or paid cash dividends on our common stock. We currently intend to retain all available funds and any future earnings for use in the operation of our business and do not anticipate paying any cash dividends on our common stock in the foreseeable future.  We may enter into credit agreements or other borrowing arrangements in the future that will restrict our ability to declare or pay cash dividends on our common stock. Any future determination to declare dividends will be made at the discretion of our board of directors and will depend on our financial condition, operating results, capital requirements, general business conditions and other factors that our board of directors may deem relevant.

Equity Compensation Plan Information

See Part III, Item 12, “Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters” for information regarding securities authorized for issuance under equity compensation plans.

Unregistered Sales of Equity Securities

None.

Use of Proceeds

On December 18, 2017, the Company filed a Registration Statement on Form S-1 with the SEC related to a firm commitment underwritten initial public offering of the Company’s common stock, par value $0.0001 per share.

35


On January 31, 2018, our registration statement on Form S-1 (File No. 333-222121) was declared effective by the SEC for our initial public offering. At the closing of the offering on February 5, 2018, we sold 3,800,000 shares of common stock at an initial public offering price of $5.00 per share and received gross proceeds of $19,000,000, which resulted in net proceeds to us of $17,485,000, after deducting underwriting discounts and commissions of $1,330,000 and underwriter offering-related transaction costs of $185,000. None of the expenses associated with the initial public offering were paid to directors, officers, persons owning ten percent (10%) or more of any class of equity securities, or to their associates, or to our affiliates. Roth Capital Partners, LLC, acted as sole book-running managers for the offering and The Benchmark Company, LLC acted as co-manager.

The Company commenced trading on The Nasdaq Capital Market under the symbol “OSS” on February 1, 2018.

On February 1, 2018, in connection with the completion of its initial public offering, the Company filed its amended and restated certificate of incorporation with the Secretary of the State of Delaware whereby it increased its authorized common stock to 50,000,000 shares and authorized preferred stock to 10,000,000 shares.

On February 1, 2018, the Company issued warrants to purchase 380,000 shares of common stock at a price of $6.00 per share to Roth Capital Partners LLC.

On February 5, 2018, the Company paid down the outstanding balance of the line of credit which had an outstanding balance of $2,758,517.

On February 9, 2018, the underwriter partially exercised their over-allotment option to purchase an additional 200,000 shares of common stock of which 100,000 were newly issued by the Company and 100,000 were sold by our CEO Steve Cooper, as selling stockholder, at the public offering price of $5.00 per share. The Company received gross proceeds of $500,000 for its portion of the over-allotment, which resulted in net proceeds to us of $465,000, after deducting underwriting discounts and commissions of $35,000.

On February 15, 2018, the Company paid-off the remaining balances of the related party notes payable in the amount of $152,973.

On February 15, 2018, the Company paid-off the remaining balance of the “July 2016 Note” in the amount of $109,267.

On February 23, 2018, the Company paid-off the remaining balance of the Bank of the West term loan in the amount of $834,103.

On March 2, 2018, the Company cancelled its line of credit with Bank of the West.

On August 31, 2018, the Company acquired Concept Development Inc., and utilized cash of approximately $891,787, inclusive of acquisition and working capital requirements.

On October 31, 2018, the Company acquired Bressner Technology GmbH and utilized cash of approximately $5,794,000, inclusive of acquisition costs.

There has been no material change in the planned use of proceeds from our initial public offering as described in our final prospectus filed with the SEC on February 1, 2018, pursuant to Rule 424(b)(4).

Issuer Repurchases of Equity Securities

None.

36


ITEM 6. SELECTED FINANCIAL DATA.

The following tables set forth a summary of our historical financial data as of, and for the periods ended on, the dates indicated. We have derived the statements of operations and balance sheet data for the years ended December 31, 2018 and 2017 from our audited consolidated financial statements included elsewhere in this Annual Report. The following selected financial data should be read in conjunction with our financial statements and related notes included elsewhere in this Annual Report and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this Annual Report. Our historical results for any prior period are not indicative of our future results.

 

 

 

For The Years Ended December 31,

 

 

 

2018

 

 

2017

 

Net revenue

 

$

37,027,382

 

 

$

27,538,333

 

Cost of revenue

 

 

25,692,658

 

 

 

18,873,797

 

Gross margin

 

 

11,334,724

 

 

 

8,664,536

 

Operating expenses:

 

 

 

 

 

 

 

 

General and administrative

 

 

6,513,298

 

 

 

3,502,998

 

Marketing and selling

 

 

3,995,258

 

 

 

2,924,727

 

Research and development

 

 

4,001,757

 

 

 

2,687,249

 

Total operating expenses

 

 

14,510,313

 

 

 

9,114,974

 

Loss from operations

 

 

(3,175,589

)

 

 

(450,438

)

Other income (expense):

 

 

 

 

 

 

 

 

Interest expense

 

 

(65,693

)

 

 

(199,257

)

Other, net

 

 

271,878

 

 

 

30,440

 

Total other income (expense), net

 

 

206,185

 

 

 

(168,817

)

Loss before benefit from income taxes

 

 

(2,969,404

)

 

 

(619,255

)

Benefit for income taxes

 

 

(1,396,784

)

 

 

(402,717

)

Net loss

 

$

(1,572,620

)

 

$

(216,538

)

Net loss attributable to noncontrolling interest

 

$

(436,342

)

 

$

(313,158

)

Net (loss) income attributable to common stockholders

 

$

(1,136,278

)

 

$

96,620

 

 

Balance Sheet Data:

 

As of December 31,

 

 

 

2018

 

 

2017

 

Cash and cash equivalents

 

$

2,272,256

 

 

$

185,717

 

Other working capital accounts

 

 

8,810,952

 

 

 

(81,992

)

Total working capital

 

$

11,083,208

 

 

$

103,725

 

 

 

 

 

 

 

 

 

 

Long-term debt

 

$

265,038

 

 

$

347,963

 

Preferred stock

 

 

-

 

 

 

2,416,527

 

Common stock

 

 

1,422

 

 

 

551

 

Noncontrolling interest

 

 

500

 

 

 

436,842

 

Additional paid in capital

 

 

27,424,113

 

 

 

3,484,428

 

Retained (deficit) earnings

 

 

(854,855

)

 

 

281,423

 

Total long-term debt and stockholders' equity

 

$

26,836,218

 

 

$

6,967,734

 

 

37


ITEM 7.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

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 Annual 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 Annual 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.  Concept Development Inc., (CDI) which was acquired on August 31, 2018, specializes in the design and manufacture of specialized high-performance in-flight entertainment systems for commercial aircraft.  CDI’s capabilities include electrical, mechanical and software design as well as extensive experience in test and certifications required for airborne systems. Bressner Technology GmbH, (Bressner) which was acquired on October 31, 2018, provides standard and customized servers, panel PCs, and PCIe expansion systems. Bressner provides manufacturing, test, sales and marketing services for customers throughout Europe.

Business Developments

On July 15, 2016, we acquired 100% of the outstanding common shares of Mission Technology Group, Inc. (“Magma”). Magma designs, manufactures, and markets industrial grade computer systems and components and is located in Southern California.

On April 6, 2017, we formed SkyScale, LLC (“SkyScale”), a High-Performance Computing as a Service (HPCaaS) provider to offer customers world-class, ultra-fast, multi-GPU hardware platforms in the cloud.  SkyScale is jointly owned with Jacoma Investments, LLC, an entity controlled by our board member Jack Harrison.  In accordance with the terms of the operating agreement, Jacoma Investments, LLC agreed to contribute $750,000 in capital and we agreed to contribute $750,000 in the form of credits to purchase equipment, personnel or support services. Each of us received a 50% membership interest.

On May 9, 2017, we entered into an agreement to acquire the source code license to the Ion flash array software from Western Digital.  We plan to continue to develop and sell Ion software with our high-density storage arrays, as well as servicing existing Western Digital software users.  OSS Ion software works with our all-flash storage systems, and provides them with a critical point of differentiation with respect to speed and throughput.  The OSS Ion software leverages flash storage and open server hardware to accelerate applications and SAN performance through sharing or clustering high-speed all-flash storage arrays.  The software supports many major OEM servers and provides an intuitive interface for system users to manage its many features.  Having the Ion software source code and engineering team on-board allows us to strategically grow our all-flash storage business in the many Big Data and HPC markets going forward.

On July 1, 2017, we entered in to a Service Agreement with Western Digital to service their existing customer base that utilizes Ion flash storage software.  Additionally, we purchased certain equipment from Western Digital and hired selected employees to assist in the servicing of these existing customers.  

On August 1, 2017, we received a three month extension on our line of credit with no modification in terms.

On October 5, 2017, we received a renewal and modification on our line of credit that extends the line through August 31, 2018, and increases the borrowing capacity limit from $ 3.0 million to $3.5 million.

38


On November 9, 2017, we submitted a confidential draft registration statement on Form S-1 with the SEC in connection with a proposed initial public offering of our common stock.  

On December 14, 2017, the Company was reincorporated as a Delaware corporation in connection with our initial public offering.  

On December 18, 2017, the Company filed a Registration Statement on Form S-1 with the SEC related to a firm commitment underwritten initial public offering of the Company’s common stock, par value $0.0001 per share. The initial public offering was declared effective by the SEC on January 31, 2018.  The Company commenced trading on The Nasdaq Capital Market under the symbol “OSS” 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 to the Company of $19,000,000, after deducting underwriting discounts and commissions of approximately $1,330,000 and underwriter offering-related transaction costs of $185,000, the Company received net proceeds of $17,485,000.

On February 1, 2018, the Company issued warrants to purchase 380,000 shares of common stock at a price of $6.00 to Roth Capital Partners LLC.

On February 2, 2018, in connection with the completion of its initial public offering, the Company filed its amended and restated certificate incorporation with the Secretary of the State of Delaware whereby it increased its authorized common shares to 50,000,000 shares and authorized preferred stock to 10,000,000 shares.

On February 5, 2018, the Company paid down the outstanding balance of the line of credit which had an outstanding balance of $2,758,517.

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 newly issued shares of common stock were purchased directly from the Company and 100,000 shares were sold by our CEO’s family trust as selling stockholder.  The Company received gross proceeds of $500,000, which resulted in net proceeds of $465,000 to the Company, after deducting underwriting discounts and commissions of $35,000.

On February 15, 2018, the Company paid-off the remaining balances of the related party notes payable in the amount of $152,973.

On February 15, 2018, the Company paid-off the remaining balance of the “July 2016 Note” in the amount of $109,267.

On February 23, 2018, the Company paid-off the remaining balance of the Bank of the West term loan in the amount of $834,103.

On March 2, 2018, the Company cancelled its line of credit with Bank of the West.

On August 31, 2018, the Company acquired Concept Development Inc. (CDI) located in Irvine, California for cash of $646,759, and common stock of $4,194,673 (Note 3).  CDI specializes in the design and manufacture of custom high-performance computing systems for airborne in-flight entertainment systems.  The operating results for CDI for the months of September 2018 through December 2018 are included in the accompanying consolidated financial statements.

On October 3, 2018, the Company filed a Form S-8 relating to the 3,432,525 shares of the Company’s common stock, par value $0.0001 per share issuable to the employees, officers, directors, consultants and advisors of the Company under the Company’s 2017 Plan, 2015 Plan, 2011 Plan, and 2000 Plan.

39


On October 31, 2018, the Company’s wholly-owned German subsidiary, OSS GmbH, acquired 100% of the outstanding stock of Bressner Technology GmbH, a Germany limited liability company located near Munich, Germany, from its principal owners for cash consideration of €4,725,000 (US$5,374,582) and stock consideration of 106,463 newly-issued restricted shares of the Company’s common stock.  The operating results for Bressner for the months of November 2018 and December 2018 are included in the accompanying consolidated financial statements.

On December 31, 2018, as a result of changes in the competitive landscape and downward pressure on pricing from large competitors, the members to the joint venture agreement agreed to begin the dissolution of SkyScale.

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.

Components of Results of Operations

Revenue

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 have 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.

 

Revenues on certain fixed-price contracts where we provide engineering services, prototypes and completed products are recognized over the contract term based on the percentage of completion or based upon milestones delivered that are provided during the period and compared to the total estimated development and milestone goals to be provided over the entire contract. These services require that we perform significant, extensive and complex design, development, modification or implementation of our customers’ systems. Performance will often extend over long periods of time, and our right to receive future payment depends on our future performance in accordance with the agreement

 

The percentage-of-completion methodology involves recognizing probable and reasonably estimable revenue using the percentage of services completed, on a current cumulative cost to estimated total cost basis, using a reasonably consistent profit margin over the period. Due to the long-term nature of these projects, developing the estimates of costs often requires significant judgment. Factors that must be considered in estimating the progress of work completed and ultimate cost of the projects include, but are not limited to, the availability of labor and labor productivity, the nature and complexity of the work to be performed and the impact of delayed performance. If changes occur in delivery, productivity or other factors used in developing the estimates of costs or revenues, we revise our cost and revenue estimates, which may result in increases or decreases in revenues and costs, and such revisions are reflected in earnings in the period in which the revision becomes known.

 

40


Products are typically shipped directly to our customers, or in some cases to our international distributors.  These international distributors assist with import regulations, currency conversions and local language, but do not stock our inventory.  Our product revenues vary from period to period based on, among other things, the customer orders received and our ability to produce and deliver the ordered products. Customers often specify requested delivery dates that coincide with their need for our products.

Because these customers may use our products in connection with a variety of projects of different sizes and durations, a customer’s orders for one reporting period generally do not indicate a trend for future orders by that customer. Additionally, order patterns do not necessarily correlate amongst customers and, therefore, we generally cannot identify seasonal trends.  

In 2017, we began offering support services which may involve providing customer phone support, system debug and software upgrades for a period of time. We recognize revenue from support services ratably over the contractual service period.

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 overhead. For 2018, general and administrative expenses include the costs related to the dissolution of SkyScale, LLC.  We expect our general and administrative expense to increase in absolute dollars as we continue to invest in growing the business.

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. We expect sales and marketing expenses to 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. We expect our research and development expenses to 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.  In 2017, this includes rental income received through the sub-leasing of certain facility space.  Other expense includes expenses for activities outside of our core business.  These expenses consist primarily of loan amortization and interest expense.

41


Provision for Income Taxes

Provision for income taxes consists of estimated income taxes due to the 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

Results of operations for the years ended December 31, 2018 and 2017 include Magma, SkyScale, which began operations in April 2017, the purchase of the Ion business from Western Digital on July 1, 2017, Concept Development Inc., which was acquired on August 31, 2018, and Bressner Technology GmbH, which was acquired on October 31, 2018.

Accordingly, the periods presented below are not directly comparable.  After the completion of four quarters, these businesses for both revenue and expense reporting will be treated as organic operating activity for current and comparable historical periods.  The following tables set forth our results of continued operations for the years ended December 31, 2018 and 2017 respectively, presented in dollars and as percentage of net revenue.

The following tables set forth our results of operations for the years ended December 31, 2018 and 2017 respectively, presented in dollars and as a percentage of net revenue.

 

 

 

For The Years Ended December 31,

 

 

 

2018

 

 

2017

 

Net revenue

 

$

37,027,382

 

 

$

27,538,333

 

Cost of revenue

 

 

25,692,658

 

 

 

18,873,797

 

Gross margin

 

 

11,334,724

 

 

 

8,664,536

 

Operating expenses:

 

 

 

 

 

 

 

 

General and administrative

 

 

6,513,298

 

 

 

3,502,998

 

Marketing and selling

 

 

3,995,258

 

 

 

2,924,727

 

Research and development

 

 

4,001,757

 

 

 

2,687,249

 

Total operating expenses

 

 

14,510,313

 

 

 

9,114,974

 

Loss from operations

 

 

(3,175,589

)

 

 

(450,438

)

Other income (expense):

 

 

 

 

 

 

 

 

Interest expense

 

 

(65,693

)

 

 

(199,257

)

Other, net

 

 

271,878

 

 

 

30,440

 

Total other income (expense), net

 

 

206,185

 

 

 

(168,817

)

Loss before benefit from income taxes

 

 

(2,969,404

)

 

 

(619,255

)

Benefit for income taxes

 

 

(1,396,784

)

 

 

(402,717

)

Net loss

 

$

(1,572,620

)

 

$

(216,538

)

Net loss attributable to noncontrolling interest

 

$

(436,342

)

 

$

(313,158

)

Net (loss) income attributable to common stockholders

 

$

(1,136,278

)

 

$

96,620

 

42


 

 

 

For The Years Ended December 31,

 

 

 

2018

 

 

2017

 

Net revenue

 

 

100.0

%

 

 

100.0

%

Cost of revenue

 

 

69.4

%

 

 

68.5

%

Gross margin

 

 

30.6

%

 

 

31.5

%

Operating expenses:

 

 

 

 

 

 

 

 

General and administrative

 

 

17.6

%

 

 

12.7

%

Marketing and selling

 

 

10.8

%

 

 

10.6

%

Research and development

 

 

10.8

%

 

 

9.8

%

Total operating expenses

 

 

39.2

%

 

 

33.1

%

Loss from operations

 

 

-8.6

%

 

 

-1.6

%

Other income (expense):

 

 

 

 

 

 

 

 

Interest expense

 

 

-0.2

%

 

 

-0.7

%

Other, net

 

 

0.7

%

 

 

0.1

%

Total other income (expense), net

 

 

0.6

%

 

 

-0.6

%

Loss before benefit from income taxes

 

 

-8.0

%

 

 

-2.2

%

Benefit for income taxes

 

 

-3.8

%

 

 

-1.5

%

Net loss

 

 

-4.2

%

 

 

-0.8

%

Net loss attributable to noncontrolling interest

 

 

-1.2

%

 

 

-1.1

%

Net (loss) income attributable to common stockholders

 

 

-3.1

%

 

 

0.4

%

 

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 expense, impairment of long-lived assets, financing costs, fair value adjustments from purchase accounting, stock-based compensation expense and expenses related to discontinued operations.

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.

43


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.

 

 

 

December 31,

 

 

 

2018

 

 

2017

 

Net (loss) income attributable to company

 

$

(1,136,278

)

 

$

96,620

 

Depreciation and amortization

 

 

1,350,329

 

 

 

836,274

 

Amortization of debt discount

 

 

24,830

 

 

 

23,837

 

Stock-based compensation expense

 

 

527,335

 

 

 

160,062

 

Interest expense

 

 

65,693

 

 

 

199,257

 

Benefit for income taxes

 

 

(1,396,784

)

 

 

(402,717

)

Costs resulting from dissolution of SkyScale

 

 

705,309

 

 

 

-

 

Acquisition expense (1)

 

 

664,333

 

 

 

65,805

 

Adjusted EBITDA

 

$

804,767

 

 

$

979,138

 

 

(1)

Expenses incurred in the acquisition of CDI and Bressner in 2018 and Ion in 2017, respectively.

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, and 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.

44


The following table reconciles net (loss) income attributable to common stockholders and diluted earnings per share:

 

 

 

For The Year Ended December 31,

 

 

 

2018

 

 

2017

 

Net (loss) income attributable to common stockholders

 

$

(1,136,278

)

 

$

96,620

 

Amortization of intangibles

 

 

636,786

 

 

 

395,644

 

Stock-based compensation expense

 

 

527,335

 

 

 

160,062

 

Costs resulting from dissolution of SkyScale

 

 

705,309

 

 

 

-

 

Acquisition expenses

 

 

664,333

 

 

 

65,805

 

Non-GAAP income attributable to common stockholders

 

$

1,397,485

 

 

$

718,131

 

 

 

 

 

 

 

 

 

 

Non-GAAP income per share attributable to common stockholders:

 

 

 

 

 

 

 

 

Basic

 

$

0.11

 

 

$

0.13

 

Diluted

 

$

0.10

 

 

$

0.07

 

Weighted average common shares outstanding:

 

 

 

 

 

 

 

 

Basic

 

 

12,586,513

 

 

 

5,449,413

 

Diluted

 

 

13,741,343

 

 

 

10,689,047

 

 

Free cash flow, a non-GAAP measure for reporting cash flow, is defined as cash provided by operating activities less capital expenditures for property and equipment, which includes capitalized software development costs. 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 operating activities, the most directly comparable GAAP financial measure, to free cash flow:

 

 

 

As of December 31,

 

 

 

2018

 

 

2017

 

Cash used in operating activities

 

$

(3,909,643

)

 

$

(381,766

)

Capital expenditures

 

 

(623,166

)

 

 

(425,482

)

Free cash flow

 

$

(4,532,809

)

 

$

(807,248

)

 

45


Comparison of the Years Ended December 31, 2018 and 2017

Net revenue

 

 

 

Year Ended December 31,

 

 

Year Ended December 31,

 

Revenues:

 

2018

 

 

2017

 

 

2018

 

 

2017

 

OSS - (organic, inclusive of SkyScale)

 

$

32,487,630

 

 

$

27,538,333

 

 

 

87.7

%

 

 

100.0

%

Concept Development Inc.

 

 

755,259

 

 

 

-

 

 

 

2.0

%

 

 

0.0

%

Bressner Technology GmbH

 

 

3,784,493

 

 

 

-

 

 

 

10.2

%

 

 

0.0

%

 

 

$

37,027,382

 

 

$

27,538,333

 

 

 

100.0

%

 

 

100.0

%

 

For the year ended December 31, 2018, total revenue increased $9,489,049 or 34.5%, as compared to the same period in 2017. The increase in revenue was primarily driven by OSS with an increase of $4,821,671 or 17.5 percentage points of the total increase in revenue.  This increase was attributable mainly to increased sales of flash arrays on our airborne military contract and improvement in sales to our OEM media and entertainment customers. SkyScale contributed $158,514 or 0.5 percentage points which was an increase of $127,627 as compared to the previous year.  CDI which was acquired on August 31, 2018 contributed $755,259 or 2.7 percentage points of the total revenue increase for 2018.  Bressner Technology GmbH (Bressner) which was acquired on October 31, 2018, contributed $3,784,493 or 13.8 percentage points of the total revenue increase for 2018.

Cost of revenue and gross margin

Cost of revenue increased by $6,818,861 or 36.1%, for the year ended December 31, 2018 as compared to the same period in 2017. The increase in cost of revenue was primarily driven by an increase in OSS cost of sales of $2,551,507 or 13.5 percentage points of the total increase.  This increase was attributable mainly to increased sales of flash arrays on our airborne military contract and improvement in sales to our OEM media and entertainment customers and an increase in applied labor and overhead to cost of goods sold of $952,341 based upon an evaluation of labor and overhead costs and allocations.   SkyScale had cost of revenue of $675,058 or 3.6 percentage points as a result of underutilization of resources.  CDI contributed $748,230 in costs or 4.0 percentage points of the annual increase while Bressner contributed $2,844,066 or 15.0 percentage points of the annual increase for 2018.

The overall gross margin percentage decreased from 31.5% for the year ended December 31, 2017 to 30.6% for the year ended December 31, 2018, a decrease of 0.7 percentage points.  OSS gross margin percentage for the year ended December 31, 2018, was 33.7%, which includes a revaluation of labor and overhead cost allocations applied to inventory which eroded the OSS’s gross margin by approximately 2.9 percentage points, this is in comparison to the prior year period of 31.4%.  The improvement in OSS’s margin is attributable to the core business of OSS and the sale of flash array systems.  SkyScale contributed negative margin of $516,545 as a result the underutilization of resources and lack of revenue.  CDI contributed gross margin at a rate of 0.9%, while Bressner contributed gross margin at a rate of 24.8% for the periods in which these new entities were owned.  

46


Operating expenses

General and administrative expense

General and administrative expense increased $3,010,300, or 85.9%, for the year ended December 31, 2018, as compared to same period in 2017.  OSS contributed an additional $2,754,460 or 91.5% of the total annual increase in these expenses.  The increase in general and administrative expense increased primarily due to acquisition fees of $664,333 incurred in the acquisitions of CDI and Bressner.  Additionally, due to the dissolution of SkyScale the Company incurred $776,811 in additional costs.  The Company wrote off receivables of $648,411 for notes, interest receivable, and accounts receivable.  There was also an accrual for additional costs expected to be incurred in the amount of $288,400 related to termination of a service agreement and the settlement for abandonment of the rental space at this co-location facility.  These charges were offset by the receipt of equipment valued at $160,000 and allocated net income of $71,502 from the dissolution of SkyScale.  Additionally, there was increased third party service costs associated with being a public company which includes legal and accounting costs, insurance, listing fees and reporting and compliance costs.  Additionally, there was a minimal increase in salaries.  SkyScale actually saw a reduction of administrative costs of $221,340 (7.3%) as a result of not incurring one-time start-up costs that were incurred in the prior year.  CDI contributed $144,971 or 4.8% of the annual increase while Bressner contributed $332,209 or 11.0 % of the total annual increase.  Overall general and administrative expenses increased as a percentage of revenue to 17.6% during the year ended December 31, 2018 as compared to 12.7 % during the same period in 2017.

Marketing and selling expense

Marketing and selling expense increased $1,070,531 or 36.6% during the year ended December 31, 2018, as compared to the same period in 2017.  OSS had an increase of $693,543 or 64.8% of the total increase.  Major components of the change were an increase in external commissions associated with the sale of flash array systems and increases in employee costs.  SkyScale had an increase of $54,864 or 5.1% of the increase attributable to tradeshow costs.  CDI’s marketing expense for 2018 was negligible at $4,518 and Bressner contributed $317,606 or 31.3% of the total annual increase.  Overall, total marketing and selling expense increased as a percentage of revenue to 10.8% during the year ended December 31, 2018 as compared to 10.6% during the same period in 2017.

Research and development expense

Research and development expense increased by $1,314,508 or 48.9% during the year ended December 31, 2018 as compared to same period in 2017.  These expenses are mainly compromised of salary and related costs and professional consulting services attributable to continued development of new and enhanced product offerings.  OSS saw an increase of $1,059,429 or 80.6%.  The increase for the year was largely driven by increased employee compensation costs of approximately $700,000 which was attributable to new employees being hired in the latter half of 2017 for which the full annualized burden of these additional employees is reflected in 2018.  Additionally, OSS incurred additional expense for outside contractors of approximately $180,000 and depreciation expense of approximately $113,000 associated with test equipment.  CDI contributed $174,522 or 13.3% of the annual increase while Bressner contributed $80,555 of 6.1% of the annual increase for 2018. Overall, total research and development expense increased as a percentage of revenue to 10.8% during the year ended December 31, 2018 as compared to 9.8% during the same period in 2017.

Interest expense

Interest expense decreased $133,564 or (67.0%) for the year ended December 31, 2018, as compared to same period in 2017, as the outstanding debt associated with OSS which was outstanding as of December 31, 2017, was paid down in its entirety with proceeds from its public offering.  Thus, since February 2018, OSS has been free of debt. Interest expense decreased $143,451 as compared to the same time period in the previous year as a result of not carrying any debt after February 2018. CDI contributed a minimal amount of interest expense.  On October 31, 2018, the Company acquired Bressner which has a line of credit and certain term loans outstanding and as a result incurred interest charges of $9,817.  

47


Other income (expense), net

Other income (expense), which increased $241,438 during the year ended December 31, 2018, as compared to the same period in 2017.  Significant components of other income (expenses), includes interest income of $85,710 which was mainly attributable to earned interest on bank deposits which were derived from our public offering, and a net currency translation gain of $16,983, a gain of $56,058 attributable to settlement of outstanding obligations, and a loss on disposal of OSS equipment of $63,142.  Included in other income is also a net gain of $173,105 from SkyScale resulting from disposition of certain of its assets and liabilities and $30,729 from data mining of digital currencies.

Provision for income taxes

We have recorded an income tax benefit of $1,396,784 for the year ended December 31, 2018, as compared to a tax benefit of $402,717 for the same period in 2017.  The increase in benefit is attributable to the increase in pre-tax loss of $2,350,149 when comparing the two periods.  The effective tax rates for the years ended December 31, 2018 and 2017 were 47% and 65%, respectively.  For the year ended December 31, 2018, the reduction in the effective tax rate is attributable to the increased loss for the year and the related tax benefit and an increase in stock compensation expense.

Liquidity and capital resources

During 2018, our primary sources of liquidity came from existing cash, net proceeds from our February IPO, a bank revolving line of credit and related party and third party term notes. Based on our current plans and business conditions, we believe that existing cash and cash generated from operations will be sufficient to satisfy our anticipated cash requirements for at least the next twelve months.  In addition to cash generated from operations, certain members of the Company’s Board of Directors have executed a definitive agreement to commit funds of up to $4,000,000 as a credit facility if called upon.

Our future capital requirements will depend on many factors including our growth rate, the timing and extent of spending to support development efforts, the expansion of our sales and marketing, the timing of new product introductions and the continuing market acceptance of our products and services.

We may be required to seek additional equity or debt financing. In the event that additional financing is required from outside sources, we may not be able to raise monies on terms acceptable to us or at all. If we are unable to raise additional capital when desired, our business, operating results and financial condition would be adversely affected.

The following table summarizes our cash flows for the years ended December 31, 2018 and 2017:

 

 

 

For the years ended December 31,

 

Cash flows:

 

2018

 

 

2017

 

Net cash used in operating activities

 

$

(3,909,643

)

 

$

(381,766

)

Net cash used in investing activities

 

$

(5,909,192

)

 

$

(425,482

)

Net cash provided by financing activities

 

$

11,900,178

 

 

$

978,768

 

 

48


Operating Activities

During the year ended December 31, 2018, we used $3,909,623 in cash from operating activities, an increase in the use of cash of $3,527,857 when compared to the cash used in operating activities of $381,766 during the same period in 2017. The increase in cash used in operating activities was primarily a result of an increase in net loss, and an increase in non-cash adjustments, comprised of the deferred benefit for income taxes, amortization of deferred gain, , inventory reserves, offset by increases in amortization and depreciation,  and stock-based compensation expense.  During the year ended December 31, 2018 and 2017, respectively, net loss adjusted for non-cash expenditures was $595,347 in 2018 as compared to a net income adjusted for non-cash expenditures of $929,438 in 2017, a decrease of $1,524,785. Additionally, working capital requirements increase overall by $2,003,072.  This net increase was attributable to an increase in working capital provided by reductions in inventories and prepaid expenses and other current assets and an increase in accrued expenses and other liabilities of $3,045,031.  These sources of working capital were offset by uses of working capital of $5,048,103 attributable to accounts receivable and accounts payable for the comparable 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 year ended December 31, 2018, we used cash of $5,909,192 in investing activities as compared to $425,483 used during the same period in 2017, an increase of $5,483,710. The net increase is primarily due to purchase of two entities, Concept Development Inc., on August 31, 2018 and Bressner Technology GmbH on October 31, 2018.  Additionally, the Company made investments in test equipment and began the implementation of an ERP system for which the software costs and external consulting costs are being capitalized.  We are in the process of expanding and completing tenant improvements to our facility which are anticipated to be approximately $550,000 and anticipate additional costs in the implementation of our ERP system of approximately $600,000.  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 year ended December 31, 2018, we generated $11,900,178 from financing activities as compared to the cash generated of $978,768 during the same period in 2017.  During the year 2018, we received proceeds from the sale of common stock in our initial public offering of $19,500,000 which was offset by our stock issuance costs for commissions and third party professional services.  We also received $113,168 from the exercise of warrants and stock options.  With the proceeds from our initial public offering we paid off our line of credit and retired all outstanding debt obligations so that the Company is debt free.  Additionally, as part of the acquisition of CDI the Company assumed the obligation of a working capital line loan in the amount of $370,096, which was subsequently paid in full.  We also incurred certain employee costs associated with the exercise of employee stock options, which were consummated on a net exercise basis.

Contractual obligations and commitments

The following table sets forth our non-cancellable contractual obligations as of December 31, 2018.

 

 

 

Total

 

 

Less than 1 year

 

 

1-3 years

 

 

3-5 years

 

 

More than 5 Years

 

Notes payable

 

$

1,421,953

 

 

$

1,156,915

 

 

$

265,038

 

 

$

-

 

 

$

-

 

Operating leases

 

 

2,707,126

 

 

 

867,281

 

 

 

1,316,678

 

 

 

523,167

 

 

 

-

 

Total

 

$

4,129,079

 

 

$

2,024,196

 

 

$

1,581,716

 

 

$

523,167

 

 

$

-

 

 

49


All OSS notes payable were paid-off in February 2018, from proceeds from the Company’s initial public offering.  Subsequently on October 31, 2018, the Company acquired Bressner which had a line of credit and certain term loans outstanding which are reflected in the schedule above.  We have made certain indemnities, under which the Company may be required to make payments to an indemnified party, in relation to certain transactions.  We indemnify our directors, officers, employees and agents to the maximum extent permitted under the laws of the State of Delaware.  In connection with our facilities leases, we indemnify our lessors for certain claims arising from the use of our facilities.  The duration of the indemnities varies, and in many cases is indefinite.  These indemnities do not provide for any limitation of the maximum potential future payments we could be obligated to make.  Historically, we have not been obligated to make any payments for these obligations and no liabilities have been recorded for these indemnities.

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.  Prior to the 2018 pay-off of our outstanding notes payable and line of credit, our CEO provided a personal guarantee on much of our outstanding debt obligations.

Stockholder transactions

Effective August 1, 2016, we entered into a management services agreement with a company owned by the former Chief Executive Officer of Magma.  The agreement calls for payments of $180,000 per year for the first two years paid in monthly installments.  In year three the amount is reduced to $37,500 for the year paid in monthly installments.  Additionally, we granted 30,000 options in conjunction with execution of this agreement.  Payments for the year ended December 31, 2018 were $120,625.

Critical accounting policies and estimates

Our consolidated financial statements are prepared in accordance with U.S. generally accepted accounting principles (GAAP). The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, expenses, and related disclosures. We evaluate our estimates and assumptions on an ongoing basis. Our estimates are based on historical experience and various other assumptions that we believe to be reasonable under the circumstances. Our actual results could differ from these estimates.  The critical accounting estimates, assumptions and judgments that we believe have the most significant impact on our consolidated financial statements are described below.

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.

50


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