One Stop Systems - Q4 2023

Executive Summary

• Q4 2023 revenue of $13.2M decreased 27.9% YoY due primarily to the cessation of a former media customer and timing delays in certain government programs; however, consolidated gross margin expanded 640 bps to 33.7% on mix shift to higher‑margin rugged edge/AI Transportables, with OSS segment gross margin at 45.9%.
• Non‑GAAP turned positive: Q4 non‑GAAP net income was $0.18M ($0.01/share) vs. a non‑GAAP loss in the prior year, while GAAP net loss narrowed to $(0.28)M (EPS $(0.01)) as the 2022 tax DTA write‑down rolled off.
• The five‑year unfactored pipeline increased to $1B+ (from ~$850M four months earlier) on rising AI/ML edge demand and deeper prime contractor engagement; management expects YoY sales growth to resume in 2H24 with improved gross margins as pipeline converts.
• Q1 2024 revenue guidance: ~$12.5M (seasonality and U.S. government continuing resolutions), implying ~5% sequential decline from Q4; management aims to maximize gross profit and may selectively accept low‑margin pass‑through revenue (none in Q4 or Q1 guide) to support cash while transitioning mix.
• Stock reaction catalyst: margin inflection and defense/commercial wins (e.g., Leidos/Dynetics multi‑year AI signal program; FLYHT AFIRS Edge collaboration), plus debut of Gen5 SDS with NVIDIA H100 GPUs—tempered near‑term by softer macro and CR timing risk and a lower Q1 revenue outlook.

What Went Well and What Went Wrong

• What Went Well

  • Margin inflection: consolidated gross margin +640 bps YoY to 33.7% on mix shift away from low‑margin media; OSS segment gross margin 45.9% (+14.5 pts YoY) on rugged edge products.
  • Strategic wins and TAM expansion: multi‑year Leidos/Dynetics AI signal collection award ($2.5–$3.5M over three years; initial $0.5M), FLYHT AFIRS Edge manufacturing collaboration (min. $6M over five years), added scope on Army 360‑degree SA program.
  • Strengthened pipeline and product leadership: five‑year unfactored pipeline >$1B; launched Gen5 short‑depth server with NVIDIA H100 GPUs; won “Best in Show” for liquid‑cooled SDS at a premier Naval event (early 2024).

• What Went Wrong

  • Top‑line pressure: Q4 revenue fell 27.9% YoY to $13.2M on media revenue cessation (~$3.1M impact in Q4), softer commercial demand, and government timing delays; adjusted EBITDA decreased YoY to $0.35M.
  • Operating expense overhang: Q4 OpEx rose 3% to $4.8M on transition costs (~$175k); FY23 OpEx +37% on $5.6M goodwill impairment and $1.7M CEO/board transition costs, though ex‑items OpEx fell 1.5%.
  • Near‑term guide soft: Q1 2024 revenue guided to ~$12.5M (seasonality/CR effects) and management cautioned it may accept some low‑margin pass‑through revenue (none in Q4 or included in Q1 guide) to support cash generation during the transition.

Transcript

Operator (participant)

Good afternoon, and thank you for joining us today to discuss One Stop Systems' financial results for the Q4 and full year ended December 31, 2023. With us today are the company's President and Chief Executive Officer, Mike Knowles, and its Chief Financial Officer, John Morrison. Following their remarks, we will open the call to your questions. Before we conclude this call, I will provide some important information regarding the forward-looking statements made by management during the call. I would like to remind everyone that the call will be recorded and made available for replay in the investors' section of the company's website. Now, I would like to turn the call over to OSS President and CEO, Mike Knowles. Sir, please go ahead.

Mike Knowles (President and CEO)

Thank you, Ina. Good afternoon, everyone, and thank you for joining today's call. This is an exciting time at OSS as we completed this strategic transition away from lower margin media revenue, established a new management team, and refocused our strategic growth priorities on large and rapidly evolving global markets. Throughout 2023, we demonstrated continued progress in our efforts to pursue strategies focused on AI-centered high-performance computing at the edge, where platforms require data center-level compute, storage, and switching solutions. These solutions support AI and machine learning, sensor fusion, sensor processing, and autonomy applications. We coined this market AI Transportables. We will continue these efforts throughout 2024, backed by the strong influence of AI and ML demand in both the commercial and defense markets. Recent wins in both markets, combined with a growing pipeline of opportunities, continue to validate our strategic focus.

We have also continued our efforts to strengthen our executive team and our board of directors, adding skills and experience that will help facilitate our strategy and enable the company to scale for growth. Financially, we were able to further offset revenue from our foreign media customer with higher margin revenue aligned with our strategy.

So with this introduction, I want to provide an update on the growth strategies we are pursuing, our growing pipeline, and recent wins that we believe will create lasting value for OSS and our shareholders. Commercial adoption of artificial intelligence and machine learning, taking advantage of advanced sensor fusion and sensor processing, is dramatically moving to the edge across almost all business segments. Sensor systems and autonomous applications can rival those in modern defense implementations. We believe that our product portfolio and future roadmap position us to uniquely take advantage of this evolving technology environment.

Strategically, we are focusing our efforts to expand the number of customers and platforms in our rugged edge processing portfolio and increasing our multi-year backlog by securing new long-term contracts. These efforts are supported by opportunities in both commercial and defense markets, where strong dynamics and growth are being driven by AI/ML adoption, sensor fusion, sensor processing, and autonomy. The Department of Defense is making significant investments in next-generation capabilities that require edge computing. While the overall defense budgets in the U.S. are expected to remain stable, we expect to see increased spend, especially for autonomy, artificial intelligence, and machine learning. In fact, these represent some of the fastest areas of growth as the military looks to augment existing platforms with new sensors, platforms, and weapon systems to maintain a technical and tactical advantage over our adversaries.

We are continuing to pursue opportunities in both commercial and military segments where we can leverage OSS's differentiated and technologically advanced capabilities by bringing enterprise and data center-class compute, storage, and switching capabilities to the most challenging environments, delivering low latency, high throughput, scalable solutions in real-time environments, delivering configurable off-the-shelf and custom high-performance solutions, and providing high technology readiness level product availability to enable first-to-market AI at the edge. We believe a balanced portfolio of commercial and military customers can serve as a strategic benefit as we focus on creating long-term value for our shareholders. Looking at our pipeline and recent wins in more detail, we made progress throughout the Q4, penetrating defense and commercial markets. We had three major new wins in composable infrastructure, aerospace, and defense that totaled $2.7 million during the quarter.

These wins reflect our continued leadership in high-speed PCIe interconnect technology and scalable AI GPU compute systems. Turning to a major defense win, we announced a multimillion-dollar program with Dynetics, a prime contractor of mission-critical solutions for the U.S. government. Under this multi-year program, we will provide our proprietary transportable compute and storage technology designed to power an emerging specialized mobile AI signal collection application.

The award is the first multi-year win OSS has secured with Dynetics, highlighting the growth, trust, and confidence in OSS and our innovative technology and advanced engineering capabilities. We are also pleased to see the expansion of mission application and platform integration consistent with our growth strategies. Earlier this month, we announced a pilot project to provide a liquid immersion-cooled data storage system for use on a deployable ground station that was also contracted through Dynetics.

This project for a major government intelligence agency expands our market opportunity into the intelligence community. As the pilot progresses over the coming quarters, we expect this program will lead to follow-on production orders. This program also demonstrates our innovative thermal management technologies for cooling rugged high-performance computing solutions. Our cooling solutions enable the highest level of GPU performance, which our customers need to support their AI and ML mission objectives. We anticipate this initial design win will lead to additional deployments with this customer and other customers in the future. During the Q4, we also booked an additional award from the U.S. Army Ground Vehicle Systems Center, increasing our scope in the 360-degree situational awareness program to include the sensor processing for the video data input into the system.

Within our commercial markets, we received an order from Daimler Truck partner Torc Robotics to develop a cooling solution for their existing compute system, expanding our relationship within the autonomous trucking software vendor. We also finalized a multi-year deal with Thales in support of their InFlyt networking system for commercial airlines. With growing interest in AI and ML solutions, we are quickly expanding our outreach efforts. We expect that 2024 will be a year marked by pipeline expansion and conversion as demand increases and we execute on our strategic plan.

Actions underway include submitting a bid to provide a rugged high-performance compute solution for a classified program within the sector that is advancing AI implementation at the edge, establishing a sponsorship and collaborative relationship with Andretti Global and Zapata AI, promoting edge applications for AI/ML in commercial and defense markets, engaging with companies in the composable infrastructure market marked by leveraging our expansion chassis product line and our UBMC software capability for system control and monitoring, and continuing to advance our engagement and reach with large prime organizations such as Booz Allen Hamilton, BAE Systems, Leidos, General Dynamics, Lockheed Martin, and General Atomics. As the Pentagon prioritizes incorporating advanced technologies into their equipment, we expect engagements for our products in the military space covering various autonomy, sensor fusion, and AI/ML applications for aircraft, drones, ships, helicopters, and land vehicles will increase.

Although we are seeing progress, it will continue to take time to pursue, secure, and turn target opportunities into increased bookings and revenue. One way that we've been working to accelerate the opportunities with the U.S. Department of Defense is through lobbying efforts in Washington to advance the innovative solutions offered by OSS. Lastly, we continue attending commercial and defense trade shows to advance the OSS brand in the market and identify new and partner opportunities.

The result of our efforts has enabled us to expand our five-year unfactored pipeline to an excess of $1 billion. This growth reflects the initial success from our new sales infrastructure and talent, as well as the rapid expansion across our commercial and defense markets for AI and ML solutions. We are actively engaged with current and potential customers to execute against these opportunities and convert our growing pipeline into multi-year, multimillion-dollar orders.

Given our expanded engagements and growing pipeline, I am pleased to announce that we have added Craig Powell as business development executive. Craig served as an armored infantry officer in the Royal Canadian Armored Corps and brings 22 years of experience in the high-performance compute, defense, and commercial markets, having held senior positions at Systel, L3Harris, Rheinmetall, Haivision, and Teledyne. We believe his experience will support our efforts to expand sales into the Canadian markets in addition to his primary focus on supporting sales efforts in the U.S. Turning to recent progress on the product and program front, at the beginning of 2024, we shipped our first AI Transportable compute system for the motorsport industry to legendary motorsport champion Andretti Global.

The system includes OSS's 3U SDS GPU accelerated server powering advanced AI race analytics for Andretti, using Zapata AI's industrial generative AI platform for the cloud and edge called Orquestra. The solution represents a new application of OSS technology in our first foray into the $5 billion motorsports industry. This milestone demonstrates our unique capabilities for powering generative AI technology at the edge. Also, at the beginning of this year, we announced the commencement of a multi-year design and manufacturing collaboration for FLYHT Aerospace's automated flight information reporting system, Edge Family, including its new AFIRS Edge+. The expanded relationship ensures that FLYHT has access to OSS's scaled capabilities as it launches the aviation industry's first-to-market 5G-enabled avionics solutions. For OSS, the design and manufacturing agreement with FLYHT is valued at a minimum of $6 million over the initial five-year term.

In Q4, we received $500,000 in revenue from the new FLYHT contract. We have successfully passed the critical design review and are entering the test phase of the program. We expect to complete testing and expect to begin production and shipment of AFIRS Edge+ as early as the Q2 of 2024. This multi-year engagement expands our position in commercial aerospace and further strengthens our technology development and manufacturing platform.

This opportunity also underscores our commitment to aviation safety and delivering mission-critical performance. We've also seen progress on several fronts in the defense industry. The Raytheon P-8 program has funded multiple development initiatives to incorporate hardware and software technology refresh and upgrades that will extend our product position and lifecycle through 2028. As a result, we expect annual revenue of $6 million in 2024 related to this program, which is at a similar level from 2023.

We delivered our first shipments of the new Gen 5 Short Depth Server to Dynetics, a Leidos company, for the C4ISR mobile command centers and to Thales for submarine sonar and AI processing on a European Navy submarine. In addition, we received a contract amendment to add additional capability for time-sensitive networking, or TSN, to our 360-degree situational awareness solution for the Army Ground Vehicle Systems Center. This capability adds the critical timing element required for contested environment operations and is an integrating capability for Joint All-Domain Command and Control, or JADC2, nodes. We continue to focus resources and capital to support our technology roadmap and maintain our strong market differentiation.

As I've noted before, a key capability of ours is the ability to bring the newest and highest performing compute, storage, and switching solutions to the market and facilitate the demanding requirements of AI/ML, sensor fusion, sensor processing, and autonomy. We have seen that a first-to-market strategy is key to our ability to win significant opportunities. As a result, we continue to develop new state-of-the-art products across a range of high-performance compute demand, providing a unique value proposition for our customers in the targeted spaces. In November, we unveiled our latest rugged Gen 5 Short Depth Server at Supercomputing 2023, the international conference for high-performance computing. Powered by NVIDIA H100 Tensor Core GPUs and high-performance NVMe storage, the OSS Gen 5 SDS addresses the growing demand for more powerful and lower latency rugged compute, storage, and networking capability at the edge.

This new OSS Gen 5 SDS server demonstrates our continued leadership in AI computing and high-speed PCIe interconnect technology. We anticipate this hyper-converged data center-class computing server will be highly sought after for demanded rugged edge, real-time AI applications, and is already proving to be the workhorse of the OSS product portfolio. In fact, in February 2024, we showcased our specialized high-performance AI computing solutions at AFCEA West 2024, the premier naval conference and exposition on the West Coast, where we won the Best in Show Award for our liquid-cooled version of the rugged edge short depth server. Since I joined over eight months ago, we have focused on enhancing our management team and board of directors.

Recent efforts include, in the Q3 of 2023, we appointed industry veteran Robert Kalebaugh as VP of Sales, bringing more than 36 years of award-winning achievement in business development, sales, and marketing in the commercial and defense markets. Robert's impact is already being seen in our market outreach, increased opportunities, and growth. In the Q4 of 2023, we appointed retired U.S. Navy three-star Vice Admiral Michael Dumont to the board, bringing background and experience insights into technology and military operations. Mitchell Herbert was also added to our board, bringing extensive strategic and technical experience as a C-suite executive serving technology and defense industries. Finally, we also appointed Joseph Manko to our board, who is affiliated with one of our largest shareholders and brings extensive financial, capital markets, investor, and governance experience to OSS.

All these additions have substantially reprofiled our board and enhanced their impact on supporting strategy, driving growth, and delivering shareholder value. In addition to enhancing our management team and the board, we also have added talent to our growing program management capabilities with the addition of two seasoned professionals who bring over a decade of defense and commercial program management experience. I believe their experience will allow us to pursue even larger programs for development and production in defense and commercial markets. I'm extremely encouraged by the successful ongoing transformation we have completed to our business in 2023. As a result, we enter 2024 with strong momentum supported by a new, highly experienced leadership team, reprofiled board of directors, an enhanced margin profile, and a growing pipeline of significant revenue opportunities that we believe will support our business for many years to come.

I want to thank our team for their continued hard work and dedication as we pursue compelling growth strategies aimed at creating lasting value for our shareholders. With this overview, I'd like to turn the call over to our CFO, John Morrison, to review our Q4 and the full year 2023 financial results in more detail. John, please go ahead.

John Morrison (CFO)

Thank you, Mike. Good afternoon, everyone. I am particularly excited by the level of activity underway, the direction we're headed, and the strategies we are pursuing to create value for our shareholders. We began 2023 with two objectives. The first was to substantially replace $18.5 million of low-margin legacy media revenue with higher-margin AI Transportable product revenue. This was necessitated by our media customer moving away from ruggedized equipment to a less rugged cloud solution.

Total media revenue in 2023 was $4.8 million, representing a difference of $13.7 million from last year. The second objective we had was to grow Bressner annual revenue. Although OSS's strategy was implemented to replace the media business, during the year, we experienced a general hesitation by commercial customers to place orders because of economic conditions.

We also experienced timing delays in some government programs. This all resulted in OSS being unable to fully replace the lost media revenue in 2023. However, I am pleased to report that Bressner met their annual objective by growing annual revenue by 10.1%. Bressner also improved both margins and profitability despite a challenging economy in Germany and throughout Europe. Our company's business is really comprised of two segments: OSS, which is located and operates in the United States, and Bressner, which is in Munich, Germany, and operates throughout Europe.

OSS is primarily focused and involved in the design and manufacture of high-performance ruggedized edge processing, compute, storage, and connectivity systems. Bressner operates as a systems integrator with standard and custom all-in-one hardware systems and components. They also serve as a channel for OSS products to the European and Middle East markets. The following comments are based upon comparison of Q4 2023 results as compared to Q4 2022. For the Q4, we reported consolidated revenue of $13.2 million. Of this, OSS contributed $6.4 million, and Bressner contributed $6.8 million, inclusive of OSS product content of $597,000. Consolidated quarterly revenue reflects a reduction of $5.1 million, or 27.9%.

Of this amount, OSS had a decrease of $4.9 million, or 43.5%, of OSS quarterly revenue, of which approximately $3.1 million of the decrease was attributable to a revenue reduction from the former media customer and from whom we do not expect any further revenue. Bressner had a decrease of $175,000, or 2.5%. Consolidated gross profit in the Q4 decreased $544,000-$4.4 million, with overall gross margins improving and increasing to 33.7% from 27.3% due to decreased media revenue costs and a shift in product mix to our higher-margin rugged edge processing products. The gross margin for OSS business improved 14.5 percentage points to 45.9%, which was attributable to the absence of lower-margin media revenue costs and the higher mix of the rugged edge processing products.

Bressner's gross margin percentage improved 1.6 percentage points to 22.2%, largely due to product mix, the sale of higher-margin OSS products, and having sought-after products readily sold at a premium. Overall, quarterly operating expenses increased 3% to $4.8 million, which was attributable to additional CEO transition and board reprofiling costs. Loss from operations totaled $331,000 compared to income from operations of $353,000 in the same period in 2022.

Net loss on a GAAP basis was $278,000, or $0.01 per share, as compared to a net loss of $3.3 million, or $0.16 per share. Net loss in the Q4 of 2023 included a provision for income taxes of $42,000, as compared to a tax provision of $4.1 million in the fourth quarter of 2022 that included a significant increase in taxes being attributable to a write-down of our deferred tax asset of $3.8 million in 2022.

Now, non-GAAP net income for Q4 2023 was $177,000, or $0.01 per diluted share, compared to non-GAAP net loss in the prior year of $2.7 million, or $0.14 per diluted share. Adjusted EBITDA, a non-GAAP metric, was favorable $353,000, a decrease from the Adjusted EBITDA of $1.6 million in the prior year. The following comments are based upon a comparison of the annual results for 2023 as compared to the annual results for 2022.

Consolidated revenue was down $11.5 million, or 15.9%, from $72.4 million to $60.9 million, predominantly due to a decrease of $13.7 million in media revenue. OSS had revenue of $28.8 million, or 47% of total revenue, and Bressner had a revenue of $32.1 million, or 53% of total consolidated revenue. OSS experienced a decrease of $14.5 million, or 33.4%, with the decrease was offset by an increase by Bressner of $2.9 million, or 10.1%.

During the year 2023, revenues for OSS were fairly evenly balanced between commercial and defense applications. During the year 2023, consolidated gross margins were 29.5% versus the prior year of 28.2% due to less lower-margin media business being offset by an increase in higher-margin AI Transportable products. OSS gross margin was 35.6% as compared to 32.7%, an improvement of 2.9 percentage points. Bressner margin was 24% compared to 21.5%. Excluding the goodwill impairment charge of $5.6 million and CEO transition and board reprofiling costs of $1.7 million, our operating expenses actually decreased 1.5% from the prior year. Other income and expense, excluding a one-time government-funded employee retention credit of $1.7 million, resulted in net other income of $417,000 compared to $626,000.

Net loss was $6.7 million, or a loss of $0.32 per share, compared to $1.7 million, which was inclusive of the $1.7 million employee retention credit, compared to a loss of $2.2 million, or a loss of $0.11 per share in 2022. Non-GAAP net loss was $415,000, or a loss of $0.02 per share as compared to a loss of $175,000, or $0.01, in 2022. Adjusted EBITDA, a non-GAAP metric, was positive $1.1 million as compared to $5.2 million in 2022. Loss before the provision for income taxes on a pro forma basis, which excludes the impairment of the goodwill, the CEO transition and board reprofiling costs, and the benefit of the employee retention credit, results in a pro forma loss before income taxes of $165,000 as compared to income before taxes of $2.2 million in the prior year.

Now, looking at the balance sheet, on December 31, 2023, cash and cash equivalents totaled $4 million, with short-term investments of $7.8 million for a combined total of $11.8 million. Compared to the prior year, this represents a decrease of $1.4 million, which represents cash being deployed in working capital. As the company continues to transition and evolve its business from being largely dependent on media-derived revenue, the company will operationally focus on maximizing gross profit contribution. In the near term, this may include accepting lower-margin business that incrementally contributes to gross profits but may be inconsistent with our long-term objective of increasing our consolidated gross margin percentage. The objective of this effort is to have sustainable cash flow as the company bridges its revenue model.

Looking forward to the Q1 of 2024, influenced by seasonal and U.S. government continuing resolutions, we expect revenue of approximately $12.5 million, which represents an approximate 5% sequential decrease from Q4 2023 and a year-over-year decrease of approximately $4.3 million, or 25%. Of that decrease, $1.5 million of that is expected to decline, which is attributable to the loss of media revenue. This completes our financial review for the quarter. Now, with that, we'd like to turn the call back and open up to your questions. Operator, Ina?

Operator (participant)

Thank you. Ladies and gentlemen, we will now begin the question and answer session. Should you have a question, please press star followed by the 1 on your telephone keypad. And should you wish to cancel your request, please press star followed by the 2. If you're using a speakerphone, please leave the handset before pressing any keys.

One moment, please, for your first question. Your first question comes from the line of Scott Searle from Roth MKM.

Scott Searle (Managing Director and Senior Research Analyst)

Please go ahead. Good afternoon. Thanks for taking my questions. Nice to see the continued progress on the opportunity pipeline as well as the gross margins. Maybe that's a good place to start. On the gross margins for the Q4, John, I'm wondering, are there any one-time benefits that you saw on that? I think you said the number was 45%-46% in the core OSS business. Could you help us understand, from a mixed standpoint, what's going on and how we should think about the progression throughout 2024? You also had some comments in terms of maximizing gross profit contribution. So it seemed to imply that there's going to be some volatility there. Can you kind of walk us through that a little bit?

John Morrison (CFO)

Thank you, Scott.

So in the Q4, it was very heavily weighted towards AI Transportable products, specifically to the defense industry and in the sale of our data storage units, which tend to have a higher margin. So that's what skewed that in the Q4. With respect to ensuring that we maintain our cash position, there is some pass-through revenue that we are going to be accepting on an agent basis that has low margin but provides good cash opportunities for us.

Scott Searle (Managing Director and Senior Research Analyst)

Gotcha. Okay. Thank you. And Mike, in terms of the opportunity pipeline, it seems like it's continuing to build. The message that you're getting out there in terms of AI/ML and sensor fusion continues to seem to get traction. I'm wondering if you could help us frame near-term, when we start to see decisions getting made, how that will start to filter into the results.

It sounds like it's more geared towards 2025. As part of that, I'm wondering if you could couple in the current discussion around the continuing resolution around the budget and how that impacts you guys over the course of 2024.

Mike Knowles (President and CEO)

Yeah. Sure. Thanks, Scott. Yeah. We've continued to grow and expand that pipeline. Really, what it is is really aligning, especially in the defense market, aligning our opportunities up with existing platforms that are going through tech refresh cycles or upgrades so that we're present for those that help develop and determine our timing. Then also on new starts, being part of those with generally the longer runway approaches to those. So we'll use 2024 to build back through the lost DoD revenue, replacing with commercial and defense opportunities.

Expecting the second half of the year, unless the media business, right, we'll start to see the momentum really start to pick up. For us, that whole effort will all be about the pipeline conversion, right? We've got these opportunities out there. Now, we need to convert them and potentially move them to the left. That's why I had spoke, especially in the defense market, where we have opportunity to use our lobbying efforts to help move and make sure programs are funded and move out on time. Then the second part of your question was what again, Scott?

Scott Searle (Managing Director and Senior Research Analyst)

Sorry. Related to the budget resolution.

Mike Knowles (President and CEO)

Oh, the budget resolution. Yeah. Well, a significant amount of our revenue is tied up to government new starts, which can't start under a CR.

We do have a couple of bids currently that we have out that are being held up by continuing resolution. Not a significant number, but still some, nonetheless. I just think I got a note from our lobbyists today that the latest on CR defense budgets, we're going to make it through approval. So that should untie the logjam. Now, we'll have to go through the period that usually follows that, where the money moves, and then the acquisition professionals have to put it on contract. That is not a fast pace either itself. It'll take some weeks and months for that to flow through. But it's positive that that's made it through. And this is something that we'll continue to deal with in quarters and years to come. But it's not uncommon anymore in the defense market. And we have pipeline and opportunities.

We'll plan for that and tend to try to update our forecasts around that also.

Scott Searle (Managing Director and Senior Research Analyst)

Okay. Great. And one last one, if I could. Just in terms of moving the AI strategy along, I'm not sure if you mentioned at all about various software partners and go-to-market strategy on the front. I'm wondering if you could articulate where we stand on that front now and how that's looking throughout the course of 2024. Thanks.

Mike Knowles (President and CEO)

Yeah. Thanks, Scott. So I had mentioned last year, during 2023, we had expanded our outreach to multiple AI software companies, really around two reasons. One, so that we had opportunity where our customers needed it to provide a more integrated solution rather than just a pure compute or storage or switching solution. And we wanted to establish those partnerships to provide some more discriminating capability to our solutions.

In addition, as we started engaging with a lot of these AI software companies, many of them were looking to find ways to standardize on hardware so that they could sell their software directly. So we wanted to open up the pipeline for those discussions where we could become a standard provider to some AI software companies. We have expanded that reach and continue to do so. Over the course of 2024, I think we should see a couple of opportunities where we have aligned with a couple of specific companies and some capture approaches and some collaborations in the market for both commercial and defense that we should start to see the fruits of some of those labors. I noted one in the earnings call that we're doing with Zapata AI through works with Andretti.

There's some cross-correlation to some defense markets and prime contractors who are very interested in a lot of the work that Andretti and Zapata are doing in vehicles and data analytics. And they're all working that off of our compute systems. So similar to that, we've got multiple instances like that across both markets that we think could help build future solutions.

Scott Searle (Managing Director and Senior Research Analyst)

Great. Thanks so much.

John Morrison (CFO)

Thanks, Scott.

Operator (participant)

Thank you. And your next question comes from the line of Brian Kinstlinger from Alliance Global Partners. Please go ahead.

Brian Kinstlinger (Managing Director, Director of Research, and Senior Technology Analyst)

Great. Thanks so much for taking my questions. In the defense market, it's long been characterized as having long sales cycles. And you've talked about delays. Both of those are common. You mentioned you expect a return to growth in the second half of the year.

Maybe if you could talk about how you think about sales cycles for some of your new products and just some of your products in general, and how does that contemplate in expecting a return to growth in the second half of the year?

Mike Knowles (President and CEO)

Sure. Thanks, Brian. So on the commercial side, with our standard product approach in a number of areas, those turns tend to come a little bit quicker. We're seeing some increased activity in that composable market, composable data center market that I was talking about. The contract, the 5-year agreement with FLYHT, was a good move for us. They were advancing a new product line based on projected future growth they see. So that was another one that we'll be developing a product and roll through to them. The defense side, it will continue to leverage our high-technology readiness level products.

That gives us a really good capability where we see a technology refresh cycle or upgrade opportunity on any vehicle or platform for us to be able to readily bid a highly mature and readily available solution. So that gives us some competitive edge in any of those competitions or allows us, if we have a unique discriminating capability, to justify a sole-source acquisition to OSS. So those cycles, again, will prove to be shorter or longer, depending on when the vehicle upgrade cycles are. But we've begun to plot those into the timing, into our pipeline, so we can start to see those.

Now, we're starting to see the picture start to paint on when we'd expect the opportunities to come to market, which is why we're feeling the second half of 2024. We should start to see, you'll start to see, some early bookings wins, and then that'll roll into revenue increases. So as we start to exit Q3 into Q4, we should see consolidated revenues increase over where we have been the last 2 quarters.

Brian Kinstlinger (Managing Director, Director of Research, and Senior Technology Analyst)

Got it. Okay. And then you've been there now for, I don't know, what is it, 5, 6 months? 9 months. 9 months. Wow. So now, that's plenty of time to take a look and evaluate the business of where you need to increase your investments to drive growth, maybe talk about new product opportunities. You already talked about your increased pipeline.

How do you bid on more, so to speak, or capture more of the market? Maybe anywhere you see investment opportunities to capture that.

Mike Knowles (President and CEO)

Yeah, Brian. So as John mentioned, right, and part of the reason to bring in the lower-margin programs was to help to make sure we could facilitate keeping our product line going forward and keep stable cash in the program in the company. So we have a number of product development elements planned for the year that will continue to keep us on the forefront of compute, storage, and switching technology. We did just launch our Gen 5 SDS and our Gen 5 storage products. So those are both new to market. So they'll have a product lifecycle run here for a bit of time. We'll be able to leverage that. And then the second half of your question, again, Brian, was on.

Brian Kinstlinger (Managing Director, Director of Research, and Senior Technology Analyst)

Just on proposals.

Bidding proposal, how are you going to, with that growing market opportunity, go after more business, bid on more work, so to speak?

Mike Knowles (President and CEO)

Yeah. No, I appreciate that. So that's part of the reason why we take our pipeline, and we assess the probabilities as we do so we can determine where to focus our resources on our highest probability of winning. And so that actually has been quite useful for us. We've kind of restructured and reprocessed how we use some of our tools internally to help facilitate getting more proposals out the door more efficiently and more effectively. And then, as I noted, we had the opportunity to add Craig Powell to our sales force. That will significantly increase not only our opportunity growth but more ability of a seasoned veteran in terms of being able to respond to and conduct captures on programs in the defense market.

And then outside of that, other areas in terms of just general product line growth, there's interest in moving to some of the international defense and commercial opportunities. Craig will provide us the opportunity to expand additionally into Canada with an existing sales force with sales capability that we have. So I think we're well situated with the priorities of our resources and a team to be able to tackle it.

Brian Kinstlinger (Managing Director, Director of Research, and Senior Technology Analyst)

Okay. Thank you.

John Morrison (CFO)

Thanks, Brian.

Operator (participant)

Thank you. And your next question comes from the line of David Williams from Benchmark. Please go ahead.

David Williams (Senior Equity Research Analyst)

Hey. Good afternoon. And thanks for letting me ask the question.

Mike Knowles (President and CEO)

Sure.

David Williams (Senior Equity Research Analyst)

So Mike, maybe start off on the funnel. You've got over a billion-dollar pipeline here that you've talked about. Can you help us understand how you're qualifying those programs and how you expect that to maybe materialize over the next several years?

What is that conversion rate? And just maybe what does it take to convert and how you think about that funnel overall?

Mike Knowles (President and CEO)

Yeah. Thanks for your question, David. So what we've done is that and that pipeline number is a five-year view. And so what we do is we identify opportunities. We assess it in two probabilities. The first probability is what we call PGO. And that is the likelihood that an opportunity will emerge and actually go to acquisition or to the market, something that we can't readily control but we can monitor and we can influence, especially on the defense side. As I mentioned, lobbying efforts in Congress, our engagements with senior defense executives can help influence the funding and the timing of those efforts. The second probability we factor the pipeline by is probability to win. That is something we control.

That determines, right, our capabilities, products, and services that we can deliver for solutions that lead us over our competitors. When we multiply those two together, we get what's called a probability of award. And it really sets a level at which we know, above a certain level of percentage, that it's highly likely that we should win, and we increase our efforts there to pull those forward.

And then there's a mid-area where we can determine whether the effort needs to be more on influencing a high-probability-to-win product to emerge or if we have to increase our P to win on a program that will definitely emerge. And we can identify resources, assets, or support to go do that. And then anything below that generally will be something we either have to determine, is it a future roadmap capability we need to develop?

Is it a market we're fully interested in working through? Those tend to be longer-term views of how to move those probabilities of award up and higher in assessment. Because of the way we've got started, part of 2023 and 2024, we're doing a fair amount of positioning into those markets. The near-term ones, as I mentioned, were about getting into the upgrade cycles on defense customers and then finding commercial customers in similar situations who are looking to transition to higher-end processed compute and storage. Then additionally, what it's done in terms of conversion is let us identify future starts that would be in the future for which you want to start early on the capture so you can influence requirements to increase your probability of win. We've now transitioned those into captures and campaigns inside the company.

That'll increase our focus where we go on those. And we'll be looking to capitalize on converting that pipeline to opportunity. And that's really where our measure will be on seeing the bookings converting to revenue and converting that pipeline.

David Williams (Senior Equity Research Analyst)

Great. Thanks for the color there. And then maybe, John, if you could talk about your inventory levels. You talked about cash just now and having the working capital and maybe taking some lower-margin business. But you've got, it looks like, a pretty significant days of inventory. How do you think about working those down and just that working capital that you could return for other investments? Thank you.

John Morrison (CFO)

Thank you.

Obviously, that's always been a concern of ours as we built inventory during the COVID period and later on as companies required us to have sometimes a 52-week lead time and demanded certain minimum order requirements in order to maintain pricing. During that period of time, it was important for us to secure inventory. We made certain non-cancellable, non-returnable commitments for inventory. That inventory still continues to this day to come in. We have still approximately about $3.4 million of inventory that will be coming in the door for which the orders were placed in 2021, 2022. However, we have gone through. We have analyzed all of that inventory. We believe that we will be able to actually free up about $2 million in working capital this year through the current plan that we have. We believe all of the inventory is sellable.

We do not see any of the inventory being designed out. Nor do we see it in a situation of being obsoleted or obsoleted. So yes, we do acknowledge that we have more inventory on the balance sheet than we would like, but we think we'll be able to free up about $2 million of that as we go throughout the year and bring it down to a more manageable level. Thank you.

David Williams (Senior Equity Research Analyst)

Thanks.

Operator (participant)

Thank you. And your next question comes from the line of Eric Martinuzzi from Lake Street. Please go ahead.

Eric Martinuzzi (Head of Research and Managing Director)

Yeah. I wanted to clarify the contribution from your media customer that's no longer with you. For 2022, I had them at $18.8 million. And then in 2023, I had them at $5.1 million. Are those two numbers correct? $18.5 million and $4.8 million. $18.5 million and $4.8 million. Okay. All right. And then go ahead.

John Morrison (CFO)

Yeah. It's $18.504 million and $4.858 million.

Eric Martinuzzi (Head of Research and Managing Director)

Okay. And then the guide for Q1 and I would expect the expectation for 2024, there's nothing in there for that media customer?

John Morrison (CFO)

No, sir. We would not have any ongoing revenue at all.

Eric Martinuzzi (Head of Research and Managing Director)

Okay. And then second question is around the gross margins. It's really good to see that step up not only for the full year at 130 basis points but for Q4, just a big step up with the 640 basis points. How should we be thinking about either address a full-year basis for 2024 or maybe even just Q1? A year ago, you had a 30.2% gross margin in Q1. Should we be expecting something similar, something better? What can you tell us about gross margin?

John Morrison (CFO)

Gross margins will continue to grow just as a consequence of having the lower-margin business from the media customer go away. They were running about 19.7% gross margin.

And we have been replacing that consistently with sales of between 30%-40%. That's pretty much our bottom-line target, is 30%. And it really is different when you're looking at mix. So depending on how much of our data storage product we're selling in any given quarter, that tends to have a higher margin, which is actually what we saw in the Q4. We had nearly $2.5 million of data storage and data storage replacement parts, which are very profitable for us, drive that margin. Long term, we believe that we're going to be more consistent this year with what you saw in 2022 of the 32%-33% margins on a consolidated basis.

Eric Martinuzzi (Head of Research and Managing Director)

Okay. Full year. Got it. And then last question, really more on the product side.

At a high level, Mike, what is the lag time between somebody like NVIDIA kicking off their latest and greatest chip and your customers expecting you to have designed that in and have it available for shipment for them? I'm talking specifically to this week's announcement regarding their new Blackwell chip GPU versus the prior generation, the Hopper. What's the lag time there for your product design?

Mike Knowles (President and CEO)

Yeah. Generally, inside of a year, less than a year, we can go from product availability from NVIDIA to our product or the short-depth server with storage added. We can move to available product inside of a year. Now, we'll also have to work the lead times. There's a lot of major companies out there who are buying up the GPUs. So our customers are aware of that.

Actually, unique to probably OSS in this respect is because of our expertise and engineering capabilities, we're actually able to sit down with the customer and work through two scenarios. If they have a clear demand and desire for the newest and the latest and the greatest and they understand the lead times on that, we can do that. On the defense side, we can use their defense ratings to help accelerate the supply chain on their orders. Alternatively, what we've done in some cases is we've worked with customers on what their exact AI or sensor fusion, sensor processing implementation is. And we'll help them with their compute, storage, and switching needs and performance parameters. In some cases, we've actually been able to recommend alternative NVIDIA GPUs whose lead times might be measured in 6-12 weeks.

We can still implement capability that exceeds their demand. We can offer them a faster lead time to get either initial capability that they could upgrade to later with the higher-end GPUs or if they're happy with that selection, then they can carry on with that configuration.

Eric Martinuzzi (Head of Research and Managing Director)

Got it. Thanks for taking my questions.

Mike Knowles (President and CEO)

Thank you.

John Morrison (CFO)

Thank you, Eric.

Operator (participant)

Thank you. And your last question comes from the line of Joe Gomes from Noble Capital Markets. Please go ahead.

Joe Gomes (Senior Generalist Equity Analyst)

Good evening. Thanks for taking the questions. Hi. I wanted to go back for a second to some of this lower-margin pass-through revenue you've talked about. Did any of that show up in the revenue for the Q4 or is any of it projected for the Q1, $12.5 million guidance?

John Morrison (CFO)

There was nothing in the Q4.

There is nothing right now planned or included in the guidance number in Q1.

Joe Gomes (Senior Generalist Equity Analyst)

Okay. Pardon me. Thanks for that. And then on the...

John Morrison (CFO)

And when we do that, we will disclose it separately. So we're going to be very visible as to what those numbers are.

Joe Gomes (Senior Generalist Equity Analyst)

Great. And on the pilot program for the deployable ground station, you mentioned that you think you can get some future production orders from that. And I was wondering, maybe you could talk a little bit about the timing, do you think, of those production orders and the size that could possibly be there in terms of revenue?

Mike Knowles (President and CEO)

Yes, Joe. So in two cases, right, on kind of the ground station one where we're shipping our compute capability, these initial forays as they get instantiated and used are in the mid-hundreds of thousands range in terms of value.

We would expect that follow-on orders could be double that for a couple of years in that implementation. Then depending on how it grows into other similar-type programs within the company or others, right, that's where we look for the add-on effect. The liquid immersion cooled one, also very similar in terms of application, that would be another one, that first one, $200,000 for the first foray. But we would expect implementations double that, maybe a little bit more than double that after they've gone in and validated their first fielding, if you will, happy and comfortable with the solution, then we would expect to see multiples of those values later this year, 2025, 2026.

Joe Gomes (Senior Generalist Equity Analyst)

Okay. Great. And just one more quick one for me. I know in the last quarter, you talked about you got the site facility clearance.

Just wondering, have you been able to see that clearance turn into any new opportunities for you or anything particular more that you can tell us about that?

Mike Knowles (President and CEO)

Right. It is opening up our opportunity for placement right now. So what it's allowed us to do is on some existing programs where we've just been providing a product to fulfill a compute requirement, we've been able to go in now and have a broader discussion on the operational problem that the platform is trying to solve. And that provides us a greater understanding of what the architecture on the platform is doing.

And then that allows us now to be able to recommend a broader implementation of OSS products that could help facilitate, if you were on a vehicle that was widely a sensor-integrating vehicle, right, the ability to move our processing up to the sensor for rapid processing at the sensor. That data needs to come back and be fused together into a common picture. Again, that's another need for high-end processing. And then if there's any generative learning off of that or autonomy based off that, yet another level of compute. So right now, it's opened that up. In addition, as I mentioned, a couple classified programs we've delivered to, in the past, we would have just delivered to those a set of requirements. Now, we can actually figure out and understand, I said more broadly, what's going on in the program.

And then a couple prime contractors that we've spoken to in the last quarter have opened up access to us into their classified teams that are pursuing programs. So now, we're starting to field initial forays into our capability. And we're able to respond to those now in a classified environment.

Joe Gomes (Senior Generalist Equity Analyst)

Great. Thanks for that. Appreciate it.

Mike Knowles (President and CEO)

Thanks, Joe.

John Morrison (CFO)

Thank you.

Operator (participant)

Thank you. We have no more questions. I'd like to turn the conference back to our speakers for closing remarks.

Mike Knowles (President and CEO)

All right. Thank you, Ena. And we appreciate having enjoyed sharing our latest progress with everybody today. I believe the company's strategy is solid, and the future is bright. OSS management looks forward to speaking with you again in May, if not sooner. In the meantime, as always, feel free to reach out to John or myself at any time.

With that, let's go ahead and wrap up the call, Ena.

Operator (participant)

Thank you. Now, before we conclude today's call, I would like to provide the company's safe harbor statement that includes important cautions regarding forward-looking statements made during today's call. One Stop Systems cautions you that the statements in the presentation that are not a description of historical facts are forward-looking statements. These statements are based on the company's current beliefs and expectations. Such forward-looking statements include, for example, those regarding the company's expectations for revenue growth generated by new products, penetration of the defense and AI Transportable sectors, future changes to its business objectives, design wins, among other things. The inclusion of such forward-looking statements and others should not be regarded as a representation by OSS that any of its plans will be achieved.

Our actual results may differ from those set forth in the presentation due to the risks and uncertainties inherent in our business, including without limitation that the market for our products is developing and may not develop as we expect. Military conflicts, global pandemics, or other disasters, or public health concerns, and economic instability in regions of the world where we have operations, customers, or source material or sell products may affect such markets. Our operating results could be negatively impacted by inflationary pressures, supply chain constraints, increased interest rates, U.S. government continuing resolution, or other economic conditions. Our operating results may fluctuate significantly, which would make our future operating results difficult to predict and could cause operating results to fall below expectations or guidance.

If we are unable to offset loss of revenue in our prior media and entertainment space with other business, our operating financial results may be adversely affected. Our products are subject to competition, including competition from the customers to whom we may sell, and competitive pressure from new and existing companies may harm our business sales, growth rates, and market share. Our future success depends on our abilities to develop and successfully introduce new and enhanced products that meet the needs of our customers.

The likelihood of our design proposals becoming design wins is uncertain, and revenue may never be realized. Our products fulfill specialized needs and functions within the technology industry. And such needs or functions may become unnecessary, or the characteristics of such needs and functions may shift in such a way as to cause our products to no longer fulfill such needs or functions.

New entrants into our market may harm our competitive position. We rely on a limited number of suppliers to support a manufacturer design process. And if we cannot protect our proprietary design rights and intellectual property rights, our competitive position could be harmed, or we could incur significant expenses to enforce our rights. Our international sales and operations subject us to additional risks that can adversely affect our operating results and financial condition.

We may not be able to accurately report our financial results and other risks described in our prior press releases and in our filings with the Securities and Exchange Commission, or SEC, including under the heading risk factors in our annual report on Form 10-K and any subsequent filings with the SEC. You are cautioned not to place a true reliance on these forward-looking statements, which speak only as of the date of the conference call.

We undertake no obligation to revise or update this information to reflect events or circumstances after this day hereof. All forward-looking statements are qualified in their entirety by this cautionary statement, which is made under the safe harbor provision of the Private Securities Litigation Reform Act of 1995. Before we end today's conference, I would like to remind everyone that this call will be available for replay starting later this evening through April 4, 2024. Please refer to today's press release for dial-in and replay instructions available via the company's website at onestopsystems.com. Thank you for joining us today. This concludes our conference. You may disconnect.