ONE STOP SYSTEMS, INC. You should read the following discussion and analysis of our financial condition and operating results together with our financial statements and related notes included elsewhere in this Quarterly Report. This discussion and analysis contain forward-looking statements based upon current beliefs, plans and expectations that involve risks, uncertainties and assumptions. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of various factors, including those set forth under "Risk Factors" or in other parts of this Quarterly Report. In evaluating our business, you should carefully consider the information set forth under the heading "Risk Factors" included in our Annual Report filed on Form 10-K for the year endedDecember 31, 2021 , filed with theSEC onMarch 24, 2022 . Readers are cautioned not to place undue reliance on these forward-looking statements.
Overview
One Stop Systems, Inc. (the "Company") designs, manufactures, and markets specialized high-performance computing modules and systems, which are designed to target edge deployments. These specialized modules and systems consist of computers and storage products that incorporate the latest state-of-the art components with our embedded proprietary software. Such modules and systems allow our customers to offer high-end computing capabilities (often integrated within their equipment) to their target markets and applications. Edge computing is a form of computing that is done on site, near a particular data source or the user (rather than in the cloud), minimizing the need for data to be processed in a remote data center. The global increase in load on the cloud infrastructure and increase in artificial intelligence ("AI") applications are the primary factors driving the growth of the edge computing market. We market our products to manufacturers of automated equipment used for media and entertainment, medical, industrial, and military applications. Our customer applications often require connection to a wide array of data sources and sensors, ultra-fast processing power, and the ability to quickly access and store large and ever-growing data sets at their physical location (rather than in the cloud). This equipment requires datacenter class performance optimized for deployment at the edge in challenging environments. Many of these edge applications have unique requirements, including special and compact form factors ruggedized for harsh conditions, which cannot be accommodated by traditional controlled air-conditioned data centers. We believe that we are uniquely positioned as a specialized provider to address the needs of this market, providing custom servers, data acquisition platforms, compute accelerators, solid-state storage arrays, system I/O expansion systems, as well as edge optimized industrial and panel PCs, tablets, and handheld compute devices. Our systems also offer industry leading capabilities that occupy less physical space and require less power consumption. We deliver this high-end technology to our customers through the sale of equipment and embedded software.One Stop Systems, Inc. was originally incorporated as aCalifornia corporation in 1999, after initially being formed as aCalifornia limited liability company in 1998. OnDecember 14, 2017 , the Company was reincorporated as aDelaware corporation in connection with the initial public offering of its securities.
During the year ended
OnAugust 31, 2018 , the Company acquiredConcept Development Inc. ("CDI") located inIrvine, California . CDI specializes in the design and manufacture of custom high-performance computing systems for airborne in-flight entertainment and networking systems. CDI has been fully integrated into the core operations of OSS as ofJune 1, 2020 . OnOctober 31, 2018 ,OSS GmbH acquired 100% of the outstanding stock ofBressner Technology GmbH , aGermany limited liability company located nearMunich, Germany ("Bressner"). Bressner designs and manufactures standard and customized servers, panel PCs, and PCIe expansion systems. Bressner also provides manufacturing, test, sales, and marketing services for customers throughoutEurope . 28
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Recent Developments
The negative impact of the COVID-19 pandemic and the impact on the global economy and capital markets resulting from the geopolitical instability caused in part by the ongoing military conflict betweenRussia andUkraine , have contributed to global supply chain issues and economic uncertainty, which has affected negatively our operations. For example, the Company's revenue growth during fiscal year 2020 slowed due to the effects of COVID-19 and, although it rebounded in 2021, it has not yet fully recovered, particularly in our media and entertainment business. Currently, we are experiencing increased pricing, longer lead-times, unavailability of product and limited supplies, protracted delivery dates, changes in minimum order quantities to secure product, and/or shortages of certain parts and supplies that are necessary components for the products and services we offer to our customers. As a result, the Company is carrying increased inventory balances to ensure availability of necessary products and to secure pricing. Additionally, products that are in the "work-in-process" stage and our inventory of finished goods have increased due to as the timing and availability of certain componentry necessary to complete our products. These global issues are also impacting some of our customers, who are experiencing downturns or uncertainty in their own business operations and revenue, and as a result, these customers may need to decrease or delay their technology spending, requested pricing concessions or payment extensions, or seek to renegotiate their contracts. As a result of these global issues, it has been difficult to accurately forecast our revenues or financial results, especially given the near and long-term impact of the pandemic and geopolitical issues. In addition, while the potential impact and duration of these issues on the economy and our business may be difficult to assess or predict, these world events have resulted in, and may continue to result in, significant disruption of global financial markets, and may reduce our ability to access additional capital, which could negatively affect our liquidity in the future. Our results of operations could be materially below our forecasts as well, which could adversely affect our results of operations, disappoint analysts and investors, or cause our stock price to decline. Furthermore, a decrease in orders in a given period could negatively affect our revenues in future periods. These global issues and events may also have the effect of heightening many risks associated with our customers and supply chain. We may take further actions that alter our operations as may be required by federal, state, or local authorities from time to time, or which we determine are in our best interests. In addition, we may decide to postpone or abandon planned investments in our business in response to changes in our business, which may impact our ability to attract and retain customers and our rate of innovation, either of which could harm our business.
Management's plans with respect to the above is to continue their efforts towards responding to the changing economic landscape, to continue to control costs, conserve cash, strengthen margins, and improve company-wide execution.
Components of Results of Operations
Revenue
The Company recognizes revenue under accounting standard ASC 606. Revenue is
primarily generated from the sale of computer hardware and engineering services
and to a minimal extent the sale of software, and sales of software maintenance
and support contracts. The Company's performance obligations are satisfied over
time as work is performed or at a point in time. The majority of the Company's
revenue is recognized at a point in time when products ship and control is
transferred to the customer. The Company determines revenue recognition through
the following steps: (1) identification of the contract with a customer; (2)
identification of the performance obligations in the contract; (3) determination
of the transaction price; (4) allocation of the transaction price to the
performance obligations in the contract; and (5) recognition of revenue when, or
as, a performance obligation is satisfied.
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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, and 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 with an improvement in margin, as product revenue increases.
Operating expenses
Our operating expenses consist of general and administrative, marketing and selling, 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. We expect our general and administrative expense to increase in absolute dollars as we continue to invest in growing the business. Marketing and Selling - Marketing and selling 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 marketing and selling 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 miscellaneous income and income received from activities outside of our core business. Other expense includes expenses from activities outside of our core business.
Provision for Income Taxes
Provision for income taxes consists of estimated income taxes due tothe United States and German governments as well as state tax authorities in jurisdictions in which we conduct business, along with the change in our deferred income tax assets and liabilities. 30
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Results of Operations
The following tables set forth our results of operations for the three month periods endedMarch 31, 2022 and 2021, presented in dollars and as a percentage of revenue, respectively. For the Three Months Ended March 31, 2022 2021 Revenue$ 17,052,677 $ 13,315,752 Cost of revenue 11,912,022 8,882,968 Gross profit 5,140,655 4,432,784 Operating expenses: General and administrative 1,774,689 2,157,619 Marketing and selling 1,471,720 1,167,901 Research and development 1,244,115 832,233 Total operating expenses 4,490,524 4,157,753 Income from operations 650,131 275,031 Other income (expense), net: Interest income 51,005 5,300 Interest expense (58,715 ) (149,982 ) Other income (expense), net 102,121 (28,629 ) Total other income (expense), net 94,411 (173,311 ) Income before income taxes 744,542 101,720 Provision for income taxes 165,308 60,522 Net income$ 579,234 $ 41,198 For the Three Months Ended March 31, 2022 2021 Revenue 100.0% 100.0% Cost of revenue 69.9% 66.7% Gross profit 30.1% 33.3% Operating expenses: General and administrative 10.4% 16.2% Marketing and selling 8.6% 8.8% Research and development 7.3% 6.2% Total operating expenses 26.3% 31.2% Income from operations 3.8% 2.1% Other income (expense), net: Interest income 0.3% 0.0% Interest expense -0.3% -1.1% Other income (expense), net 0.6% -0.2% Total other income (expense), net 0.6% -1.3% Income before income taxes 4.4% 0.8% Provision for income taxes 1.0% 0.5% Net income 3.4% 0.3% 31
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Comparison of the three months ended
Revenue, cost of revenue and gross profit:
For the Three Months Ended March 31, 2022 For the Three Months Ended March 31, 2021
Gross Gross
Cost of Gross Margin Cost of Gross Margin
Entity: Revenue Revenue Profit % Revenue Revenue Profit %
OSS $ 10,582,042 $ (6,801,711 ) $ 3,780,331 35.7 %
GmbH 6,470,635 (5,110,311 ) 1,360,324
21.0 % 4,713,781 (3,541,606 ) 1,172,175 24.9 %
$ 17,052,677 $ (11,912,022 ) $ 5,140,655 30.1 %$ 13,315,752 $ (8,882,968 ) $ 4,432,784 33.3 % Revenue For the three month period endedMarch 31, 2022 , total revenue increased$3,736,925 , or 28%, as compared to the same period in 2021. OSS saw an increase in revenue of$1,980,071 , or 23%, as compared to the prior year in 2021. The majority of this increase is attributable to an increase in shipments of product to our media and entertainment customer. Bressner experienced improved revenue of$1,756,854 , or 37.3%, as compared to the prior year in 2021. This increase is mainly due to a general economic improvement inEurope attributable to the diminishing impact of the COVID-19 pandemic in the current business environment.
Cost of revenue and gross profit
Cost of revenue increased$3,029,054 , or 34.1%, for the three month period endedMarch 31, 2022 , as compared to the prior year in 2021. OSS saw an increase in cost of revenue of$1,460,349 , or 27.3%, as compared to the prior year in 2021 The increase in cost of revenue is mainly attributable to our improved sales to our media and entertainment customer. Bressner's cost of revenue increased$1,568,705 , or 44.3%, as compared to the prior year in 2021, which increase is primarily attributable to higher sales and changes in product mix. The overall gross margin percentage decreased from 33.3% for the three month periodMarch 31, 2021 , to 30.1% for the same period endedMarch 31, 2022 , a decrease of 3.2 percentage points. OSS' gross margin percentage for the three months endedMarch 31, 2022 , was 35.7%, a decrease of 2.2 percentage points as compared to the prior year period in 2021 of 37.9%, which the decrease was primarily attributable to a higher concentration of the sales of our media and entertainment product. Bressner contributed gross margin at a rate of 21% as compared to the same prior year period in 2021 of 24.9%, a decrease of 3.9 percentage points which was primarily attributable to an increase in material and transportation costs. Operating expenses
General and administrative expense
General and administrative expense decreased$382,930 , or 17.8%, for the three month period endedMarch 31, 2022 , as compared to the same prior year period in 2021. OSS experienced a decrease of$286,967 , or 17.6% and Bressner had a decrease$95,963 , or 18.1%. The decrease in general and administrative expense is primarily attributable to a reduction in stock compensation expense, which was higher in the prior year due to the acceleration of performance based vesting and legal costs. We have reinstated certain employee benefits, implemented pay increases and reestablished certain services that were suspended during the strict policies implemented during the height of the pandemic. Overall, total general and administrative expense decreased as a percentage of revenue to 10.4% during the three month period endedMarch 31, 2022 , as compared to 16.2% during the same period in 2021. 32
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Selling and marketing expense
Selling and marketing expense increased$303,819 , or 26%, during the three month period endedMarch 31, 2022 , as compared to the same prior year period in 2021. OSS had an increase of$260,224 , or 29.2%, which was mainly attributable to normalized business activities which include trade shows, business travel, and increased marketing activities. Bressner had an increase of$43,595 , or 15.7%, due to new marketing personnel and sales collateral materials. Generally, both OSS and Bressner experienced additional marketing costs as markets are beginning to re-open now that certain restrictions have been lifted that were previously imposed during the height of the COVID-19 pandemic. Overall, total marketing and selling expense decreased as a percentage of revenue to 8.6% during the three month period endedMarch 31, 2022 , as compared to 8.8% during the same period in 2021.
Research and development expense
Research and development expense increased$411,882 , or 49.5%, during the three month period endedMarch 31, 2022 , as compared to the same prior year period in 2021. OSS saw an increase of$403,574 or 55%. This increase was largely driven by the deployment of more engineering resources on internal development projects rather than on customer billable projects for which such costs would have been charged to cost of revenue rather than being charged to research and development expense. Bressner had a modest increase of$8,308 , or 8.4%. Overall, total research and development expense as a percentage of revenue increased as a percentage of revenue to 7.3% during the three month period endedMarch 31, 2022 , as compared to 6.2% during the same period in 2021.
Interest income
Interest income increased$45,705 for the three month period endedMarch 31, 2022 , as compared to the same prior year period in 2021. The increase is attributable to interest on marketable securities that were purchased inApril 2021 . Interest expense Interest expense decreased$91,267 for the three month period endedMarch 31, 2022 , as compared to the same period in 2021. OnApril 24, 2020 , the Company borrowed$3,000,000 through a senior secured convertible debt offering issued with a 10% original issue discount and incurred legal costs associated with this debt offering. Interest and related transaction costs are amortized using the effective interest method for which the periodic amortization costs decreases over the time. The notes issued in the debt offering were scheduled to mature onApril 1, 2022 ; however, onMarch 31, 2022 , these notes converted into shares of common stock of the Company. Other income (expense), net Other income (expense) for the three month period endedMarch 31, 2022 , resulted in net other income of$102,121 , as compared to net other expense of$28,629 in the same prior year period in 2021, for a net increase of$130,750 . The most significant contribution to this increase is the sale of the URL for Magma.com, off-set by foreign currency losses.
Provision (benefit) for income taxes
We have recorded an income tax provision of$165,308 and$60,522 , respectively, for the three month period endedMarch 31, 2022 and 2021, respectively. The effective tax rate for the period endedMarch 31, 2022 and 2021, differs from the statutory rate mainly due to permanent non-deductible goodwill amortization forBressner Technology GmbH , deductions related to expenses of OSS stock options, as well as projecting federal, foreign and state tax liabilities for the year. The annual expect tax rate for 2022 is anticipated to be approximately 20.66%. 33
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Liquidity and capital resources
OnMarch 3, 2021 , we sold and issued 1,497,006 shares of Company common stock to an accredited investor pursuant to a Securities Purchase Agreement through a registered direct offering, resulting in net proceeds of$9,188,673 to us. Historically, our primary sources of liquidity have been provided by public and private offerings of our securities and revenues generated from our business operations. As ofMarch 31, 2022 , we had total cash and cash equivalents of$2,219,800 , with short-term investments of$13,540,410 , and total working capital of$31,447,290 . Cash and cash equivalents held by Bressner totaledUS$979,990 onMarch 31, 2022 . Bressner's debt covenants do not permit the use of those funds by its parent company.
During the year ended
Our sources of liquidity and cash flows are used to fund ongoing operations, fund research and development projects for new products and technologies, and provide ongoing support services for our customers. Over the next year, we anticipate that we will use our liquidity and cash flows from our operations to fund our growth. In addition, as part of our business strategy, we occasionally evaluate potential acquisitions of businesses and products and technologies. Accordingly, a portion of our available cash may be used at any time for the acquisition of complementary products or businesses. Such potential transactions may require substantial capital resources, which may require us to seek additional debt or equity financing. We cannot assure you that we will be able to successfully identify suitable acquisition candidates, complete acquisitions, successfully integrate acquired businesses into our current operations, or expand into new markets. Furthermore, we cannot provide assurances that additional financing will be available to us in any required time frame and on commercially reasonable terms, if at all. Our revenue growth during 2020 slowed due to the effects of COVID-19, and, although it rebounded somewhat in 2021, it has not yet fully recovered, particularly in our media and entertainment business. However, through a reduction in force and strict cost containment, we have been able to mitigate the effects, to some degree, of the reduced revenue. For a further description and risk factors associated with COVID-19, please see Part 1A of our Annual Report filed onMarch 24, 2022 .
Management's plans are to continue its efforts towards responding to the changing economic landscape by continuing to control hiring and costs, conserve cash, strengthen margins, and improve company-wide execution.
While management expects these actions to result in prospective cost containment, and our results of operations for the year endedDecember 31, 2021 , and the three month period endedMarch 31, 2022 , improved partially as a result of such actions, management is also committed to conserving cash and securing debt and/or equity financing, as required, for liquidity to meet our cash requirements through at least a period of the next twelve months. Management believes potential sources of liquidity include at least the following:
? In
333-231513) with the
allows us to offer and sell up to an aggregate of
stock, preferred stock, debt securities, warrants to purchase our common
stock, preferred stock or debt securities, subscription rights to purchase
our common stock, preferred stock or debt securities and/or units consisting
of some or all of these securities, in any combination, together or
separately, in one or more offerings, in amounts, at prices and on the terms
that we will determine at the time of the offering and which will be set
forth in a prospectus supplement and any related free writing
prospectus. The registration statement will automatically terminate
effective
the registration statement.
As a result of management's implementation of our cost reduction plans, our
potential sources of liquidity and management's most recent cash flow forecasts,
management believes that we have sufficient liquidity to satisfy our anticipated
working capital requirements for our ongoing operations and obligations for at
least the next twelve months. However, there can be no assurance that
management's cost reduction efforts will be effective or the forecasted cash
flows will be achieved. Furthermore, we will continue to evaluate our capital
expenditure needs based upon factors including but not limited to, our sales
from operations, growth rate, the timing and extent of
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spending to support development efforts, the expansion of our sales and marketing efforts, the timing of new product introductions, and the continuing market acceptance of our products and services.
If cash generated from operations is insufficient to satisfy our capital requirements, we may open a revolving line of credit with a bank, may have to sell additional equity or debt securities, or may obtain expanded credit facilities to fund our operating expenses, pay our obligations, diversify our geographical reach, and grow the Company. In the event such financing is needed in the future, there can be no assurance that such financing will be available to us, or, if available, that it will be in amounts and on terms acceptable to us. If we cannot raise additional funds when we need or wants them, our operations and prospects could be negatively affected. However, if cash flows from operations become insufficient to continue operations at the current level, and if no additional financing were obtained, then management would consider restructuring the Company in a way to preserve its business while maintaining expenses within operating cash flows. The following table summarizes our cash flows for the three month periods endedMarch 31, 2022 and 2021: For the Three Months Ended March 31, Cash flows: 2022 2021 Net cash (used in) provided by operating activities$ (5,018,398 ) $ 4,291,066 Net cash provided by (used in) investing activities$ 1,028,504 $ (121,759 ) Net cash provided by financing activities$ 1,131,345 $ 9,173,593 Operating Activities During the three month period endedMarch 31, 2022 , we used$5,018,398 in cash from operating activities, a difference of$9,309,464 when compared to the cash provided by operating activities of$4,291,066 during the three month period in year 2021. This significant decrease in operating cash flow is mainly attributable to improved earnings resulting from increased sales, offset by a significant increase in working capital requirements for accounts receivable and inventories. The change is cash used in operating activities during the three month period endedMarch 31, 2022 , as compared to the same period in 2021, is primarily a result of the improvement in profitability from net income of$41,198 in the prior year period to net income of$579,234 in the current year, an improvement of$538,036 . Net negative adjustments for non-cash items of$(324,818) were comprised of$227,691 of favorable non-cash items, offset by$552,509 of negative non-cash items that did not generate operating cash flow. Additionally, there was an increase in the use of operating cash flow for working capital items of$9,522,682 . Net working capital requirements for the three month period endedMarch 31, 2022 , were$6,245,595 , as compared to the prior year period sources of working capital of$3,277,087 , an increase in the use of working capital of$9,522,682 . The source of working capital of$559,024 was attributable to changes in accounts payable for the comparable period. This source was offset by uses of working capital of$10,081,706 being applied to changes in accounts receivables, inventory levels, prepaid and other current assets, accrued expenses, and other liabilities. 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 and accrued expenses
Investing Activities
During the three month period endedMarch 31, 2022 , the Company generated cash of$1,028,504 in investing activities, as compared to$121,759 used during the prior year period in 2021, an improvement of$1,150,263 . The source of investing funds was attributable to the redemption of short-term investments and the sale of the Magma.com URL. Additionally, the Company continues to enhance the capabilities of its ERP system, and purchase test equipment for the engineering department. We do not anticipate any significant investments not normally anticipated in the original course of business. 35
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Financing Activities
Given the current economic, financial, and geopolitical instability, the Company believes it is imperative to maintain opportunities for additional financial resources to ensure financial stability during trying economic times. During the three month period endedMarch 31, 2022 , the Company generated$1,131,345 in cash from borrowing activities for Bressner for working capital to finance inventory purchases, as compared to the cash provided by financing activities of$9,173,593 , during the same three month period year in 2021. The main differences between the comparative periods are new borrowings from our German subsidiary, Bressner for inventories, and the proceeds received in the prior year from a$10,000,000 registered direct offering that was completed inMarch 2021 .
Known trends or uncertainties
Although we have not seen any significant reduction in revenues to date due to consolidations, we have seen some consolidation in our industry during economic downturns. These consolidations have not had a negative effect on our total sales; however, should consolidations and downsizing in the industry continue to occur, those events could adversely impact our revenues and earnings going forward. As discussed in this Quarterly Report on Form 10-Q, the world has been affected due to the COVID-19 pandemic. Until the pandemic has passed, there remains uncertainty as to the effect of COVID-19 on our business in both the short and long-term. We believe that the need for improved productivity in the research and development activities directed toward developing new products and/or software will continue to result in increasing adoption of high-performance computers and interconnect technologies such as those we produce. New product and/or software developments in the specialized compute business segment could result in increased revenues and earnings if they are accepted by our markets; however, there can be no assurances that new products and/or software will result in significant improvements to revenues or earnings. For competitive reasons, we do not disclose all of our new product development activities.
Also, the potential for growth in new markets is uncertain. We will continue to explore these opportunities until such time as we either generate sales or determine that resources would be more efficiently used elsewhere.
Inflation
We have not been affected materially by inflation during the periods presented, but we may experience some effect in the near future due to increased product pricing due to semiconductor product shortages, increased transportation costs due to increases in the cost of energy and general price increases due to inflation in the economy.
Off balance sheet arrangements
We do not have any off-balance sheet financing arrangements or liabilities, guarantee contracts, retained or contingent interests in transferred assets, or any obligation arising out of a material variable interest in an unconsolidated entity.
We do not have any majority-owned subsidiaries that are not consolidated in the financial statements. Additionally, we do not have an interest in, or relationships with, any special purpose entities.
Stockholder transactions
See Note 11 to the accompanying financial statements for a discussion regarding our stockholder transactions for the relevant periods.
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Critical accounting policies and estimates
In preparing our consolidated financial statements in conformity withU.S. generally accepted accounting principles, management must make a variety of decisions which impact the reported amounts and the related disclosures. These decisions include the selection of the appropriate accounting principles to be applied and the assumptions on which to base accounting estimates. In making these decisions, management applies its judgment based on its understanding and analysis of the relevant circumstances and our historical experience. Our accounting policies and estimates that are most critical to the presentation of our results of operations and financial condition, and which require the greatest use of judgments and estimates by management, are designated as our critical accounting policies. See further discussion of our critical accounting policies under Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations," in our Annual Report on Form 10-K for year endedDecember 31, 2021 . We periodically re-evaluate and adjust our critical accounting policies as circumstances change. There were no significant changes to our critical accounting policies during the three month period endedMarch 31, 2022 , except for adoption of ASU No. 2016-02, Leases ("ASU 2016-02").
Leases
OnJanuary 1, 2022 , the Company adopted ASC 842 using the Transition method. The reported results for the three month period endedMarch 31, 2022 , reflect the application of the guidance of ASC 842 while the reported results for the three month period endedMarch 31, 2021 , was prepared under the guidance of ASC 840.
Per the Company's consolidated financial statements Note 2- Significant Accounting Policies, we have adopted "Lease accounting" as required by FASB ASC 842. See Note 2 to the accompanying financial statements for further details.
Recently implemented accounting pronouncements
EffectiveJanuary 1, 2022 , the Company implemented ASU No. 2016-02, Leases ("ASU 2016-02"). Under ASU 2016-02, the Company recognized for all leases a lease liability, which is our obligation to make lease payments arising from a lease, measured on a discounted basis and a right-of-use asset, which is an asset that represents the lessee's right to use, or control the use of, a specified asset for the lease term. The Company elected to use the transition method and reflected the cumulative effect of adoption as an adjustment to beginning retained earnings.
Interest rate risk
Our exposure to interest rate risk is primarily associated with borrowing on revolving lines of credit denominated in bothU.S. dollars and Euros. We are exposed to the impact of interest rate changes primarily through our borrowing activities for our variable rate borrowings.
Concentration of credit risk
Financial instruments that potentially expose us to concentrations of credit risk consist principally of cash, cash equivalents, short-term investments and accounts receivable. We place our cash and cash equivalents with financial institutions with high credit quality. OnMarch 31, 2022 andDecember 31, 2021 , we had$2,219,800 and$5,101,174 , respectively, of cash and cash equivalents on deposit or invested with our financial and lending institutions. We provide credit to our customers in the normal course of business. We perform ongoing credit evaluations of our customers' financial condition and limit the amount of credit extended when deemed necessary. 37
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Foreign currency risk
We operate primarily inthe United States . Foreign sales of products and services are primarily denominated inU.S. dollars. We also conduct business outsidethe United States through our foreign subsidiary inGermany , where business is largely transacted in non-U.S. dollar currencies, particularly the Euro, which is subject to fluctuations due to changes in foreign currency exchange rates. Accordingly, we are subject to exposure from changes in the exchange rates of local currencies. Foreign currency transaction gains and losses are recorded in other income (expense), net in the consolidated statements of operations. OSSGmbH operates as an extension of OSS' domestic operations, and acquired Bressner inOctober 2018 . The functional currency ofOSS GmbH is the Euro. Transactions denominated in currencies other than the functional currency are remeasured to the functional currency at the average exchange rate in effect during the period. At the end of each reporting period, monetary assets and liabilities are translated using exchange rates in effect at the balance sheet date. Non-monetary assets and liabilities are remeasured at historical exchange rates. Consequently, changes in the exchange rates of the currencies may impact the translation of the foreign subsidiaries' statements of operations intoU.S. dollars, which may in turn affect our consolidated statement of operations. The resulting foreign currency translation adjustments are recorded as a separate component of accumulated other comprehensive income in the consolidated statement of comprehensive income.
Derivative Financial Instruments
We employ derivatives on a periodic basis to manage certain market risks through the use of foreign exchange forward contracts. We do not use derivatives for trading or speculative purposes. Our derivatives are designated as a hedge of a forecasted transaction or of the variability of cash flows to be received or paid related to a recognized asset or liability (cash flow hedge). We hedge a portion of the exchange risk involved in anticipation of highly probable foreign currency-denominated transactions. In anticipation of these transactions, we may enter into foreign exchange contracts to provide currency at a fixed rate.
Non-GAAP Financial Measures
Adjusted EBITDA
We believe that the use of adjusted earnings before interest, taxes, depreciation and amortization, or adjusted EBITDA, is helpful for an investor to assess the performance of the Company. The Company defines adjusted EBITDA as income (loss) before interest, taxes, depreciation, amortization, acquisition expenses, impairment of long-lived assets, financing costs, fair value adjustments from purchase accounting, stock-based compensation expense and expenses related to discontinued operations. Adjusted EBITDA is not a measurement of financial performance under generally accepted accounting principles inthe 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. 38 -------------------------------------------------------------------------------- Our adjusted EBITDA measure may not provide information that is directly comparable to that provided by other companies in our industry, as other companies in our industry may calculate non-GAAP financial results differently, particularly related to non-recurring, unusual items. Our adjusted EBITDA is not a measurement of financial performance under GAAP and should not be considered as an alternative to operating income or as an indication of operating performance or any other measure of performance derived in accordance with GAAP. We do not consider adjusted EBITDA to be a substitute for, or superior to, the information provided by GAAP financial results. For the Three Months Ended March 31, 2022 2021 Net income$ 579,234 $ 41,198 Depreciation and amortization 269,791 380,778 Stock-based compensation expense 382,828 438,394 Interest expense 58,715 149,982 Interest income (51,005 ) (5,300 ) Provision for income taxes 165,308 60,522 Adjusted EBITDA$ 1,404,871 $ 1,065,574 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 income (loss) as income or (loss) before amortization, stock-based compensation, expenses related to discontinued operations, impairment of long-lived assets and non-recurring acquisition costs. Adjusted EPS expresses adjusted income (loss) 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. The following table reconciles non-GAAP net income (loss) and basic and diluted earnings per share: For the Three Months Ended March 31, 2022 2021 Net income$ 579,234 $ 41,198 Amortization of intangibles 15,809 163,900 Stock-based compensation expense 382,828
438,394
Non-GAAP net income$ 977,871 $
643,492
Non-GAAP net income per share: Basic $ 0.05 $
0.04
Diluted $ 0.05 $
0.03
Weighted average common shares outstanding:
Basic 18,886,939 17,348,164
Diluted 19,764,069 18,642,061
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Free Cash Flow
Free cash flow, a non-GAAP measure for reporting cash flow, is defined as cash
provided by or used in operating activities, less capital expenditures for
property and equipment, which includes capitalized software development costs
for the implementation of the Company's ERP system. We believe free cash flow
provides investors with an important perspective on cash available for
investments and acquisitions after making capital investments required to
support ongoing business operations and long-term value creation. We believe
that trends in our free cash flow can be valuable indicators of our operating
performance and liquidity.
Free cash flow is a non-GAAP financial measure and should not be considered in
isolation or as a substitute for financial information provided in accordance
with GAAP. This non-GAAP financial measure may not be computed in the same
manner as similarly titled measures used by other companies.
We expect to continue to incur expenditures similar to the free cash flow
adjustments described above, and investors should not infer from our
presentation of this non-GAAP financial measure that these expenditures reflect
all of our obligations which require cash. The following table reconciles cash
provided by or used in operating activities, the most directly comparable GAAP
financial measure, to free cash flow:
For the Three Months Ended
March 31,
Cash flow: 2022 2021
Net cash (used in) provided by operating activities
$ 4,291,066 Capital expenditures (85,841 ) (121,759 ) Free cash flow$ (5,104,239 ) $ 4,169,307 40
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