See accompanying notes to the condensed consolidated financial
statements.
NOTES TO INTERIM CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS
June 30, 2014
(Unaudited)
1. Basis of Presentation and Significant
Accounting Policies
Document Security Systems,
Inc. (the “Company”, or “DSS”), through two of its subsidiaries, Premier Packaging Corporation, which also
does business under the assumed names of DSS Packaging and Printing Group, and Plastic Printing Professionals, Inc., which also
does business under the assumed name of DSS Plastics Group, operates in the security and commercial printing, packaging and plastic
ID markets. The Company develops, markets, manufactures and sells paper and plastic products designed to protect valuable information
from unauthorized scanning, copying, and digital imaging. The Company’s subsidiary, Extradev, Inc., which operates under
the assumed name of DSS Digital Group, develops, markets and sells digital information services, including data hosting, disaster
recovery and data back-up and security services. The Company’s subsidiary, DSS Technology Management, Inc. (“DSS Technology
Management”), acquires intellectual property assets, interests in companies owning intellectual property assets, and assists
others in managing their intellectual property, for the purpose of monetizing intellectual property assets through a variety of
value-enhancing initiatives, including, but not limited to, investments in the development and commercialization of patented technologies,
licensing, strategic partnerships and commercial litigation.
The accompanying unaudited
condensed consolidated financial statements have been prepared in accordance with United States generally accepted accounting principles
(“U.S. GAAP”) for interim financial information and with the instructions to Form 10-Q and Rule 8.03 of Regulation
S-X for smaller reporting companies. Accordingly, these statements do not include all of the information and footnotes required
by U.S. generally accepted accounting principles for complete financial statements. In the opinion of management, the accompanying
balance sheets and related interim statements of operations and comprehensive loss and cash flows include all adjustments, considered
necessary for their fair presentation in accordance with U.S. generally accepted accounting principles (“U.S. GAAP”).
All significant intercompany transactions have been eliminated in consolidation.
Interim results are
not necessarily indicative of results expected for a full year. For further information regarding the Company’s accounting
policies, refer to the audited consolidated financial statements and footnotes thereto included in the Company's Form 10-K for
the fiscal year ended December 31, 2013.
Use of Estimates
-
The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the
financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ
materially from those estimates and assumptions. In preparing these financial statements, the Company has evaluated events and
transactions for potential recognition or disclosure.
Restricted Cash
–As
of June 30, 2014 cash of $245,479 ($500,000 – December 31, 2013) received pursuant to a proceeds rights agreement is restricted
for payments of costs and expenses associated with one of the Company’s monetization programs.
Fair Value of
Financial Instruments
- Fair value is defined as the price that would be received to sell an asset or paid to transfer
a liability in an orderly transaction between market participants at the measurement date. The Fair Value Measurement Topic of
the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) establishes
a three-tier fair value hierarchy which prioritizes the inputs used in measuring fair value. The hierarchy gives the highest
priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest
priority to unobservable inputs (Level 3 measurements). These tiers include:
¨
|
Level 1, defined as observable inputs such as quoted prices for identical instruments in active markets;
|
¨
|
Level 2, defined as inputs other than quoted prices
in active markets that are either directly or indirectly observable such as quoted prices for similar instruments in active markets
or quoted prices for identical or similar instruments in markets that are not active; and
|
¨
|
Level 3, defined as unobservable inputs in which little
or no market data exists, therefore requiring an entity to develop its own assumptions, such as valuations derived from valuation
techniques in which one or more significant inputs or significant value drivers are unobservable.
|
The carrying amounts
reported in the balance sheet of cash, accounts receivable, prepaids, accounts payable and accrued expenses approximate fair value
because of the immediate or short-term maturity of these financial instruments. The fair value of revolving credit lines, notes
payable and long-term debt approximates their carrying value as the stated or discounted rates of the debt reflect recent market
conditions. Derivative instruments, as discussed below, are recorded as assets and liabilities at estimated fair value based on
available market information. The Company’s convertible note payable is recorded at its face amount, net of an unamortized
premium for a beneficial conversion feature and as of June 30, 2014, has an estimated fair value of approximately $356,000 ($539,000
at December 31, 2013) based on the underlying shares the note can be converted into at the trading price on June 30, 2014. Since
the underlying shares the debt could be converted into are trading in and active, observable market, and are considered similar
to the debt itself, the fair value measurement qualifies as a Level 2.
Derivative Instruments
-
The Company maintains an overall interest rate risk management strategy that incorporates the use of interest rate
swap contracts to minimize significant fluctuations in earnings that are caused by interest rate volatility. The Company has two
interest rate swaps that change variable rates into fixed rates on two term loans. These swaps qualify as Level 2 fair value financial
instruments. These swap agreements are not held for trading purposes and the Company does not intend to sell the derivative swap
financial instruments. The Company records the interest swap agreements on the balance sheet at fair value because the agreements
qualify as cash flow hedges under U.S. GAAP
.
Gains and losses on these instruments are recorded
in other comprehensive income (loss) until the underlying transaction is recorded in earnings. When the hedged item is realized,
gains or losses are reclassified from accumulated other comprehensive income (loss) (“AOCI”) to the Consolidated Statement
of Operations on the same line item as the underlying transaction. The valuations of the interest rate swaps have been derived
from proprietary models of Citizens Bank (defined below) based upon recognized financial principles and reasonable estimates about
relevant future market conditions and may reflect certain other financial factors such as anticipated profit or hedging, transactional,
and other costs. The notional amounts of the swaps decrease over the life of the agreements. The Company is exposed to a credit
loss in the event of nonperformance by the counter parties to the interest rate swap agreements. However, the Company does not
anticipate non-performance by the counter parties. The cumulative net loss attributable to these cash flow hedges recorded in accumulated
other comprehensive loss and other liabilities at June 30, 2014 was approximately $53,000 ($28,000 - December 31, 2013), which
is included in other long-term liabilities on the balance sheet.
The Company has notional
amounts of approximately $1,306,000 as of June 30, 2014 on its interest rate swap agreements for its debt with RBS Citizens, N.A.
(“Citizens Bank”) (See Note 5). The Company has two interest rate swaps that change variable rates into fixed rates
on two term loans and the terms of these instruments are as follows:
Notional
|
|
|
Variable
|
|
|
|
|
|
|
Amount
|
|
|
Rate
|
|
|
Fixed Cost
|
|
|
Maturity Date
|
$
|
200,000
|
|
|
|
3.90
|
%
|
|
|
5.70
|
%
|
|
February 1, 2015
|
$
|
1,105,792
|
|
|
|
3.30
|
%
|
|
|
5.87
|
%
|
|
August 30, 2021
|
Earnings Per
Common Share
- The Company presents basic and diluted earnings per share. Basic earnings per share reflect the actual weighted
average of shares issued and outstanding during the period. Diluted earnings per share are computed including the number of additional
shares that would have been outstanding if dilutive potential shares had been issued. In a loss period, the calculation for basic
and diluted earnings per share is considered to be the same, as the impact of potential common shares is anti-dilutive.
As of June 30, 2014
and 2013, there were 16,239,947 and 4,286,534 respectively, of common stock share equivalents potentially issuable under convertible
debt agreements, employment agreements, options, warrants, overallotment options, and restricted stock agreements, including common
shares being held in escrow pursuant to the Company’s merger completed in July 2013, that could potentially dilute basic
earnings per share in the future. These shares were excluded from the calculation of diluted earnings per share because their inclusion
would have been anti-dilutive to the Company’s losses in the respective periods.
Concentration
of Credit Risk
-
The Company maintains its cash in bank deposit accounts, which at times may exceed federally insured
limits. The Company believes it is not exposed to any significant credit risk as a result of any non-performance by the financial
institutions.
During the six months
ended June 30, 2014 and 2013, one customer accounted for 30% and 22%, respectively, of the Company’s consolidated revenue.
As of June 30, 2014 and 2013, this customer accounted for 20% and 20%, respectively, of the Company’s trade accounts receivable
balance. The risk with respect to trade receivables is mitigated by credit evaluations the Company performs on its customers, the
short duration of its payment terms for the significant majority of its customer contracts and by the diversification of its customer
base.
Reclassifications
- Certain prior year amounts have been reclassified to conform to the current year presentation.
New Accounting
Pronouncements Not Yet Adopted
–
In May 2014, the FASB issued new accounting guidance on revenue from contracts with
customers. The new guidance requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer
of promised goods or services to customers. The updated guidance will replace most existing revenue recognition guidance in GAAP
when it becomes effective and permits the use of either a retrospective or cumulative effect transition method. This guidance is
effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2016. We have not yet selected
a transition method and we are currently evaluating the effect that the updated standard will have on our financial statements
and related disclosures.
2. Inventory
Inventory consisted of the following:
|
|
June 30, 2014
|
|
|
December 31,
2013
|
|
|
|
|
|
|
|
|
Finished Goods
|
|
$
|
493,616
|
|
|
$
|
395,767
|
|
Work in process
|
|
|
99,935
|
|
|
|
129,627
|
|
Raw Materials
|
|
|
326,108
|
|
|
|
309,585
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
919,659
|
|
|
$
|
834,979
|
|
3. Investments
Since March 2013, DSS
Technology Management has made a series of investments in VirtualAgility, Inc. (“VirtualAgility”), a developer of programming
platforms that facilitate the creation of business applications without programming or coding. The initial investment consisted
of a $200,000 non-recourse note plus an equity stake of 1/8 of 7% of the outstanding common stock of VirtualAgility, for a total
cash investment of $250,000. Each non-recourse note, when purchased, is eligible for a preferred return of $1,250,000, plus a variable
return of 1.875% based on gross proceeds, if any, derived from VirtualAgility’s patent portfolio. In addition, VirtualAgility
granted DSS Technology Management a total of seven additional options to make additional quarterly investments of $250,000 apiece,
under the same terms as the first investment. If all of such options are exercised, DSS Technology Management will have invested
an aggregate of $2,000,000, consisting of $1,600,000 in non-recourse notes that would be eligible for an aggregate preferred return
of $10,000,000 plus up to 15% of variable returns and, based on the current capitalization of VirtualAgility, DSS Technology Management
would also own approximately 7% of the outstanding common stock of VirtualAgility. In May 2013, DSS Technology Management created
a subsidiary called VirtualAgility Technology Investment, LLC (“VATI”) and transferred its ownership of the VirtualAgility
investment and future investment options to VATI. Also in May 2013, a third-party investor became a 40% member of VATI. In exchange,
the investor contributed $250,000 into VATI which was used to exercise one of the investment options in VirtualAgility per the
terms described above. As of July 1, 2013, DSS Technology Management owned 60% of VATI. In conjunction with its acquisition accounting,
the Company assessed the fair value of the VirtualAgility investment, including the expected exercise of future investment options
as of the acquisition date, at approximately $10,750,000, which became the cost basis of the investment as of July 1, 2013. A relief
from royalty methodology was used to value the potential proceeds to be derived from the patent portfolio and the analysis included
a discounted cash flow which estimated future net cash flows resulting from the licensing and enforcement of the VirtualAgility
patent portfolio based on information as of the date of acquisition, considering assumptions and estimates related to potential
infringers of the patents, applicable industries, usage of the underlying patented technologies, estimated license fee revenues,
contingent legal fee arrangements, other estimated costs, tax implications and other factors. A discount rate consistent with the
risks associated with achieving the estimated net cash flows was used to estimate the present value of estimated net cash flows.
The measurement of the VirtualAgility investment constitutes a Level 3 input. In August 2013, the Company contributed $250,000
into VATI which used the funds to make an additional investment in VirtualAgility per the terms described above. In November 2013,
the other member of VATI contributed $250,000 into VATI which used the funds to make an additional investment in VirtualAgility
per the terms described above. As of December 31, 2013, the investment in VATI was $11,250,000 and DSS Technology Management owned
60% of VATI. As of December 31, 2013, VATI owned 438,401 shares of common stock of VirtualAgility. On February 14, 2014, DSS Technology
Management contributed $250,000 into VATI which used the funds to make an additional investment in VirtualAgility per the terms
described above. In May 2014, the other member of VATI contributed $250,000 into VATI which used the funds to make an additional
investment in VirtualAgility per the terms described above. As of June 30, 2014, VATI owned 657,119 shares of common stock of VirtualAgility.
As of June 30, 2014, investment in VATI was $11,750,000 and DSS Technology Management owned 60% of VATI. VATI did not record any
income or loss during the six months ended June 30, 2014.
In January and February
2014, DSS Technology Management made investments of $100,000 and $400,000, respectively, to purchase an aggregate of 594,530 shares
of common stock of Express Mobile, Inc. (“Express Mobile”), which represented approximately 6% of the outstanding common
stock of Express Mobile at the time of investment. Express Mobile is a developer of custom mobile applications and websites. The
investments were recorded using the cost method.
4. Intangible Assets
On May 23, 2014, the
Company’s subsidiary, DSS Technology Management, purchased 115 patents covering certain methods and processes in the semiconductor
industry for $1,150,000.
Intangible
assets are comprised of the following:
|
|
|
|
June
30, 2014
|
|
|
December
31, 2013
|
|
|
|
Useful
Life
|
|
Gross
Carrying
Amount
|
|
|
Accumulated
Amortizaton
|
|
|
Net
Carrying
Amount
|
|
|
Gross
Carrying
Amount
|
|
|
Accumulated
Amortizaton
|
|
|
Net
Carrying
Amount
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Acquired intangibles- customer lists and non-compete
agreements
|
|
5 -10 years
|
|
$
|
1,997,300
|
|
|
$
|
1,437,971
|
|
|
$
|
559,329
|
|
|
$
|
1,997,300
|
|
|
$
|
1,343,819
|
|
|
$
|
653,481
|
|
Acquired intangibles-patents and patent rights
|
|
Varied (1)
|
|
|
31,506,567
|
|
|
|
4,211,408
|
|
|
|
27,295,159
|
|
|
|
30,356,164
|
|
|
|
2,042,083
|
|
|
|
28,314,081
|
|
Patent application costs
|
|
Varied (2)
|
|
|
1,012,099
|
|
|
|
379,753
|
|
|
|
632,346
|
|
|
|
965,523
|
|
|
|
330,494
|
|
|
|
635,029
|
|
|
|
|
|
$
|
34,515,966
|
|
|
$
|
6,029,132
|
|
|
$
|
28,486,834
|
|
|
$
|
33,318,987
|
|
|
$
|
3,716,396
|
|
|
$
|
29,602,591
|
|
(1) acquired patents and patent
rights are amortized over their expected useful life which is generally the remaining legal life of the patent. As of June 30,
2014, the weighted average remaining useful life of these assets in service was approximately 7.4 years.
(2) patent application costs
are amortized over their expected useful life which is generally the remaining legal life of the patent. As of June 30, 2014, the
weighted average remaining useful life of these assets in service was approximately 8.6 years.
Intangible asset amortization expense for the six
months ended June 30, 2014 amounted to $2,312,737 ($168,252 for the same period in 2013).
Approximate expected intangible asset amortization
for each of the five succeeding fiscal years is as follows:
2015
|
|
$
|
4,602,000
|
|
2016
|
|
$
|
4,402,000
|
|
2017
|
|
$
|
4,383,000
|
|
2018
|
|
$
|
4,247,000
|
|
2019
|
|
$
|
3,975,000
|
|
5. Short-Term and Long-Term Debt
Revolving Credit
Lines -
The Company’s subsidiary Premier Packaging Corporation (“Premier Packaging”) has a revolving
credit line with Citizens Bank of up to $1,000,000 that bears interest at 1 Month LIBOR plus 3.75% (3.90% as of June 30, 2014)
and matures on May 31, 2015. As of June 30, 2014, the revolving line had a balance of $0 ($158,087 as of December 31, 2013).
Long-Term Debt
-
On December 30, 2011, the Company issued a $575,000 convertible note that was due on December 29, 2013, and carries
an interest rate of 10% per annum. Interest is payable quarterly, in arrears. The convertible note can be converted at any time
during the term at lender’s option into a total of 260,180 shares of the Company’s common stock at a conversion price
of $2.21 per share. In conjunction with the issuance of the convertible note, the Company determined a beneficial conversion feature
existed amounting to approximately $88,000, which was recorded as a debt discount to be amortized over the term of the note. On
May 24, 2013, the Company amended the convertible note to extend the maturity date of the note from December 29, 2013 to December
29, 2015. The change in the fair value of the embedded conversion option exceeded 10% of the carrying value of the original debt
and, therefore, the Company accounted for this restructuring as an extinguishment in accordance with FASB ASC 470-50 “Debt
Modifications and Extinguishments” and recognized a loss on extinguishment of $26,252. The note was written up to its fair
value on the date of modification of approximately $650,000 and the premium recorded in excess of its face value will be amortized
over the remaining life of the note. The carrying amount of the note on June 30, 2014 was approximately $619,000 ($633,000 at December
31, 2013).
On May 24, 2013, the
Company entered into a promissory note in the principal sum of $850,000 to purchase three printing presses that were previously
leased by the Company’s wholly-owned subsidiary, Secuprint Inc., and carries an interest rate of 9% per annum. Interest is
payable quarterly, in arrears. The Company also issued the lender as additional consideration a five-year warrant to purchase up
to 60,000 shares of the Company’s common stock at an exercise price of $3.00 per share. The warrant was valued at approximately
$69,000 using the Black-Scholes-Merton option pricing model with a volatility of 60.0%, a risk free rate of return of 0.89% and
zero dividend and forfeiture estimates. In conjunction with the issuance of the warrants, the Company recorded a discount on debt
of approximately $69,000 that was amortized over the original term of the note. The note was set to mature on May 24, 2014, but
its maturity date was extended on May 2, 2014 to May 24, 2015 by the lender. In exchange for the extension, the Company also issued
the lender as additional consideration a five-year warrant to purchase up to 40,000 shares of the Company’s common stock
at an exercise price of $1.50 per share. The warrant was valued at approximately $29,000 using the Black-Scholes-Merton option
pricing model with a volatility of 70.0%, a risk free rate of return of 1.53% and zero dividend and forfeiture estimates. In conjunction
with the issuance of the warrants, the Company recorded expense for modification of debt of approximately $29,000. As of June
30, 2014, the debt was recorded as short-term debt and had a carrying value and outstanding balance of $850,000. As of December
31, 2013, the debt was recorded as short-term debt and had a carrying value of $824,857 with an outstanding balance of $850,000
net of unamortized discount of $25,143.
Term Loan Debt
-
On February 12, 2010, in conjunction with the credit facility agreement with Citizens Bank, Premier Packaging entered
into a term loan with Citizens Bank for $1,500,000. As amended on July 26, 2011, the term loan requires monthly principal
payments of $25,000 plus interest through maturity in February 2015. Interest accrues at 1 Month LIBOR plus 3.75% (3.90% at June
30, 2014). The Company entered into an interest rate swap agreement to lock into a 5.7% effective interest rate over
the remaining life of the amended term loan. As of June 30, 2014, the balance of the term loan was $200,000 ($350,000 at December
31, 2013).
On October 8, 2010,
Premier Packaging amended its credit facility agreement with Citizens Bank to add a standby term loan note pursuant to which Citizens
Bank was to provide Premier Packaging with up to $450,000 towards the funding of eligible equipment purchases for up to one year.
In October 2011, the Company had borrowed $42,594 under the facility which amount was converted into a term note payable in 60
monthly installments of $887 plus interest at 1 Month LIBOR plus 3% (3.15% at June 30, 2014). As of June 30, 2014, the balance
under this term note was $23,959 ($30,171 at December 31, 2013).
On July 19, 2013,
Premier Packaging entered into an equipment loan with People’s Capital and Leasing Corp. (“Peoples Capital”)
for a printing press. The loan was for $1,303,900, repayable over a 60-month period which commenced when the equipment was
placed in service in January 2014. The loan bears interest at 4.84% and is payable in equal monthly installments of $24,511. As
of June 30, 2014, the loan had a balance of $1,187,000 ($1,303,900 at December 31, 2013).
Promissory Notes
-
On August 30, 2011, Premier Packaging purchased the packaging plant
it occupies in Victor, New York, for $1,500,000, which was partially financed with a $1,200,000 promissory note obtained from Citizens
Bank (“Promissory Note”). The Promissory Note calls for monthly payments of principal and interest in the amount of
$7,658, with interest calculated as 1 Month LIBOR plus 3.15% (3.30% at June 30, 2014). Concurrently with the transaction, the Company
entered into an interest rate swap agreement to lock into a 5.865% effective interest rate for the life of the loan. The
Promissory Note matures in August 2021 at which time a balloon payment of the remaining principal balance of $919,677 is due. As
of June 30, 2014, the Promissory Note had a balance of $1,105,792 ($1,132,998 at December 31, 2013).
On December 6, 2013,
Premier Packaging entered into a Construction to Permanent Loan with Citizens Bank for up to $450,000 that was to convert into
a promissory note upon the completion and acceptance of building improvements to the Company’s packaging plant in Victor,
New York. In May 2014, the Company converted the loan into a $450,000 note payable in monthly installments over a 5 year period
of $2,500 plus interest calculated at a variable rate of 1 Month Libor plus 3.15% (3.30% at June 30, 2014), which payments commenced
on July 1, 2014. The note matures in July 2019 at which time a balloon payment of the remaining principal balance of $300,000 is
due. As of June 30, 2014, the note had a balance of $450,000 ($250,464 –at December 31, 2013).
Under the Citizens
Bank credit facilities, the Company’s subsidiary, Premier Packaging, is subject to various covenants including fixed charge
coverage ratio, tangible net worth and current ratio covenants. In March 2014, Premier Packaging was notified that it was not in
compliance with the required fixed charge coverage ratio as of December 31, 2013. In March 2014, the Company received a waiver
as of December 31, 2013 from Citizens Bank, relating to the above-mentioned financial covenant. For the quarters ended June 30,
2014 and March 31, 2014, Premier Packaging was in compliance with the covenants. The Citizens Bank obligations are secured by all
of the assets of Premier Packaging and are also secured through cross guarantees by the Company and its other wholly-owned subsidiaries,
Plastic Printing Professionals and Secuprint.
Promissory
Notes and other long-term liabilities -
On February 13, 2014, the Company’s subsidiary, DSS Technology Management,
entered into an agreement with certain investors pursuant to which the Company contracted to receive a series of advances up to
$4,500,000 from the investors in exchange for promissory notes, fixed return interests and contingent interests collateralized
by certain of the Company’s intellectual property (the “Agreement”). On February 13, 2014, the Company received
the first advance of $2,000,000 in exchange for a promissory note in the amount of $1,791,000 (the “Initial Advance Note”)
fixed return equity interests in the amount of $199,000, and contingent equity interests in the amount of $10,000. On March 27,
2014, upon achieving the First Milestone as defined in the Agreement, the Company issued to the investors a promissory note in
the amount of $900,000 (the “First Milestone Note”) and fixed return equity interests in the amount of $100,000, and
in turn received $1,000,000 (collectively, the “First Milestone Advance”). Upon the Company achieving the Second Milestone
as defined in the Agreement, the Company will issue to the Investors a promissory note in the amount of $1,350,000 (the “Second
Milestone Note”) and fixed return equity interests in the amount of $150,000 (the “Second Milestone Fixed Return Interests”),
and in turn will receive $1,500,000 (collectively, the “Second Milestone Advance”). The Initial Advance Note, the First
Milestone Note, and the Second Milestone Note (collectively, the “Notes”) bear interest at a rate per annum equal to
the Applicable Federal Rate on the unpaid principal amount thereof, which was 1.95% as of June 30, 2014. The Notes are subject
to various covenants and will also be subject to a Make Whole Amount calculation (as defined in the Agreement), which will result
in an effective annual interest rate of approximately 4.23% for the term thereof, assuming no prepayments. At the Company’s
option, it may pay accrued interest when due on the Notes, or elect to capitalize the accrued interest, adding it to the principal
thereof. The maturity date of all the Notes shall be the date four years after issuance (February 13, 2018) of the Initial Advance
Note. As of June 30, 2014, an aggregate of $2,706,000, which includes approximately $15,000 of accrued interest was outstanding
under the promissory notes and is included in long-term debt on the balance sheet and $309,000 was outstanding under the fixed
return equity interest and contingent equity interests which is included in other long-term liabilities on the balance sheet. See
Note 8. Commitments and Contingencies.
6. Stockholders’ Equity
On June 16, 2014, the
Company sold 209,700 shares of common stock at a purchase price of $1.44 per share to an institutional investor for a total purchase
price of approximately $302,000. Additionally, from the date of the closing until 90 days after the closing date, the investor
has a non-transferable overallotment right to purchase up to 209,700 additional shares of common stock at a price per share of
$1.60, for an additional subscription amount of up to an aggregate of approximately $335,500.
Stock Options
- During the six months ended June 30, 2014, the Company issued options to purchase up to an aggregate of 1,138,697 shares of its
common stock to its employees that met certain minimum employment criteria, all with an exercise price of $2.00 per share. The
aggregate fair value of these options amounted to approximately $886,000 as determined by utilizing the Black-Scholes-Merton option
pricing model with a volatility of 70.4%, a risk free rate of return of 1.53% and zero dividend and forfeiture estimates.
Stock
Warrants
- During the six months ended June 30, 2014, the Company issued 8,443 shares of its common stock in exchange for
warrants to purchase 80,645 shares of the Company which were exercisable at a price of $3.10 per share, dated February 13, 2012
and expiring February 12, 2017. In May 2014, the Company issued a warrant to purchase up to 60,000 of the Company’s common
stock at $1.60 per share to a vendor of investor relations services
.
The warrants have a term
of 3 years and will vest pro ratably over 12 monthly periods. The warrant was valued at approximately $34,000 using the Black-Scholes-Merton
option pricing model with a volatility of 71.4%, a risk free rate of return of 1.67% and zero dividend and forfeiture estimates.
Also in May 2014, the Company issued fully vested five-year warrants to purchase 40,000 shares of the Company’s common stock
at $1.50 per share in conjunction with the extension of the Company’s $850,000 term note that was due to expire in May 2014
to May 2015. The estimated fair value of the warrant was recognized as expense on the date of grant. The warrant was valued at
approximately $27,000 using the Black-Scholes-Merton option pricing model with a volatility of 65.5%, a risk free rate of return
of 1.57% and zero dividend and forfeiture estimates.
Stock-Based Payments
and Compensation -
The Company records stock-based payment expense related to options and warrants based on the grant date
fair value in accordance with FASB ASC 718. Stock-based compensation includes expense charges for all stock-based awards to employees,
directors and consultants. Such awards include option grants, warrant grants, and restricted stock awards. During the six months
ended June 30, 2014, the Company had stock compensation expense of approximately $841,000 or $0.02 basic earnings per share ($1,289,000;
$0.06 basic earnings per share for the corresponding six months ended June 30, 2013).
During the six months
of 2014, the Company issued an aggregate of 84,025 shares of the Company’s common stock to certain of its directors in settlement
of approximately $134,000 of board of director fees owed to such directors.
As of June 30, 2014,
there was approximately $1,794,000 of total unrecognized compensation costs related to options, warrants and restricted stock granted
under the Company’s stock option plans that will be recognized over the next 24 months. This amount excludes $536,000 of
potential stock based compensation for stock options that vest upon the occurrence of certain events which the Company does not
believe are likely.
7. Business Combination
On July 1, 2013 (the
“Closing Date”), DSSIP, Inc., a Delaware corporation (“Merger Sub”) and a wholly-owned subsidiary of DSS
merged with and into Lexington Technology Group, Inc. (the “Merger”) pursuant to the terms and conditions of an Agreement
and Plan of Merger, dated as of October 1, 2012 (as amended, the “Merger Agreement”). Effective on July 1, 2013, as
a result of the Merger, Lexington Technology Group, Inc (“Lexington”), which changed its name to DSS Technology Management,
Inc. on August 2, 2013, became a wholly-owned subsidiary of the Company. The Company believes the merger with Lexington was an
opportunity to significantly increase its intellectual property assets and expand its intellectual property development, acquisition
and monetization business. In connection with the Merger, the Company issued on the Closing Date, its securities in exchange for
the capital stock owned by Lexington stockholders, as follows (the “Merger Consideration”): (i) an aggregate of 16,558,387
shares of the Company’s common stock, par value $0.02 per share (the “Common Stock”), which includes 240,559
shares of the Company’s common stock owned by DSS Technology Management prior to the Merger that were exchanged for shares
issuable to Lexington stockholders pursuant to the Merger (the “Exchange Shares”); (ii) 7,100,000 shares of the Company’s
Common Stock to be held in escrow pursuant to an escrow agreement, dated July 1, 2013; (iii) warrants to purchase up to an aggregate
of 4,859,894 shares of the Company’s Common Stock, at an exercise price of $4.80 per share and expiring on July 1, 2018;
and (iv) warrants to purchase up to an aggregate of 3,432,170 shares of the Company’s Common Stock, at an exercise price
of $0.02 per share and expiring on July 1, 2023 (the “$.02 Warrants”), to Lexington’s preferred stockholders
that would beneficially own more than 9.99% of the shares of the Company’s Common Stock as a result of the Merger. In addition,
the Company assumed options to purchase an aggregate of 2,000,000 shares of the Company’s Common Stock at an exercise price
of $3.00 per share, in exchange for 3,600,000 outstanding and unexercised stock options to purchase shares of DSS Technology Management’s
common stock. Pursuant to the escrow agreement, the shares of the Company’s Common Stock deposited in the escrow account
would be released to the holders if and when the closing price per share of the Company’s Common Stock exceeded $5.00 per
share (as adjusted for stock splits, stock dividends and similar events) for 40 trading days within a continuous 90 trading day
period following the closing of the Merger. If within one year following the closing of the Merger, such threshold was not achieved,
the shares of the Company’s Common Stock held in escrow would be cancelled and returned to the treasury of the Company. The
holders of the escrow shares had voting rights with respect to the shares until such shares were either released or retired after
one year. As of July 1, 2014, the vesting criteria for the escrow shares was not met. As a result, the Company received authorization
from holders of an aggregate of 3,038,357 of the escrow shares to retire such shares as of June 29, 2014. The remaining 4,061,643
escrow shares were retired on July 1, 2014. The Company had also issued an aggregate of 786,678 shares of Common Stock to Palladium
Capital as compensation for advisory services performed in connection with the Merger. Of those shares issued to Palladium Capital,
400,000 were being held in escrow pursuant to the same terms and conditions as those set forth in the escrow agreement. Since Paladium
Capital’s escrow shares did not vest, the Company received authorization from Palladium Capital to retire their 400,000 escrow
shares as of June 29, 2014. The Company spent approximately $1,445,000 in legal, accounting, consulting and filing fees related
to the Merger.
Purchase Price Allocation
The Merger was accounted
for in accordance with the acquisition method of accounting under FASB ASC Topic 805, “
Business Combinations”
(“Topic
805”). Under Topic 805, the assets and liabilities of the acquired business, DSS Technology Management, are recorded
at their fair values at the date of acquisition. The excess of the purchase price over the estimated fair values is recorded as
goodwill, if any. If the fair value of the assets acquired exceeds the purchase price and the liabilities assumed then a gain on
acquisition is recorded. The purchase price is based on the fair value of the Company’s common stock, and common stock to
be held in escrow and issued if certain contingencies are met, warrants to purchase the Company’s common stock issued by
the Company to DSS Technology Management stockholders, and replacement options awards related to pre-combination services granted
to certain DSS Technology Management employees pursuant to the Merger Agreement. The Company measured the identifiable assets acquired
and liabilities assumed based on the acquisition date fair value. The fair value of the equity instruments issued to former stockholders
of DSS Technology Management is based on a $1.87 share price of the Company’s common stock which was the closing share price
of the Company’s common stock on the Closing Date of July 1, 2013. For warrants and employee options to purchase DSS common
stock issued or assumed as consideration in the Merger, the Company used the Black Scholes Merton option pricing model to determine
fair values, with terms set at the remaining life of the option or warrant, a volatility of approximately 59%, and a risk free
rate of return of approximately 0.9% with zero forfeitures expected. For the Company common stock to be held in escrow, the Company
used a Monte Carlo simulation model to determine an average expected fair value.
|
|
($ -in
thousands)
|
|
|
|
|
|
Current assets, net of current liabilities
|
|
$
|
6,252
|
|
Deposits and non-current assets
|
|
|
9
|
|
Investments at fair value
|
|
|
10,750
|
|
Other intangible assets- patent and patent rights
|
|
|
27,856
|
|
Goodwill
|
|
|
11,962
|
|
|
|
|
56,829
|
|
Deferred tax liability, net
|
|
|
11,962
|
|
|
|
|
44,867
|
|
Non-controlling interest in subsidiary
|
|
|
(4,300
|
)
|
Total purchase price
|
|
$
|
40,567
|
|
|
|
|
|
|
Consideration issued:
|
|
|
|
|
Fair value of 16,317,828 shares of DSS common stock issued to DSS Technology Management shareholders
|
|
$
|
30,514
|
|
Fair value of 7,100,000 shares of DSS common stock issued to DSS Technology Management shareholders to be held in escrow for up to one year
|
|
|
901
|
|
Fair value of options to purchase 2,000,000 shares DSS common stock for $3.00 per share exchanged for options to purchase DSS Technology Management's common stock that were granted to DSS Technology Management's employees which relate to pre-combination services
|
|
|
141
|
|
Fair value of warrants to purchase up to 4,859,894 shares of DSS common stock for $4.80 per share issued to DSS Technology Management shareholders
|
|
|
2,661
|
|
Fair value of warrants to purchase 3,432,170 shares of DSS common stock for $0.02 per share issued to certain DSS Technology Management shareholders
|
|
|
6,350
|
|
|
|
|
|
|
Total purchase price
|
|
$
|
40,567
|
|
The Company’s
management is responsible for determining the fair value of the tangible and identifiable intangible assets acquired and liabilities
assumed as of the Closing Date. Management considered a number of factors, including reference to an analysis under Topic 805 solely
for the purpose of allocating the purchase price to the assets acquired and liabilities assumed. The Company’s estimates
are based upon assumptions believed to be reasonable, but which are inherently uncertain and unpredictable. These valuations require
the use of management’s assumptions, which would not reflect unanticipated events and circumstances that occur. A relief
from royalty methodology was used to value the patent portfolio and investment and the analysis included a discounted cash flow
which estimated future net cash flows resulting from the licensing and enforcement of the patent portfolio based on information
as of the date of acquisition, considering assumptions and estimates related to potential infringers of the patents, applicable
industries, usage of the underlying patented technologies, estimated license fee revenues, contingent legal fee arrangements, other
estimated costs, tax implications and other factors. A discount rate consistent with the risks associated with achieving the estimated
net cash flows was used to estimate the present value of estimated net cash flows.
Set forth below is
the unaudited pro-forma revenue, operating loss, net loss and loss per share of the Company as if DSS Technology Management had
been acquired by the Company as of January 1, 2013.
|
|
Six Months Ended
June 30, 2013
(unaudited)
|
|
|
|
|
|
Revenue
|
|
$
|
8,078,000
|
|
Operating Loss
|
|
|
(5,545,000
|
)
|
Net loss
|
|
|
(6,463,000
|
)
|
Earnings per share:
|
|
|
|
|
Basic and diluted
|
|
$
|
(0.15
|
)
|
8. Commitments and Contingencies
On October 24, 2011,
the Company initiated a law suit against Coupons.com Incorporated (“Coupons.com”). The suit was filed in the United
States District Court, Western District of New York, located in Rochester, New York. Coupons.com is a Delaware corporation having
its principal place of business located in Mountain View, California. In the Coupons.com complaint, the Company alleged breach
of contract, misappropriation of trade secrets, unfair competition and unjust enrichment, and is seeking money damages from Coupons.com
for those claims. The Company’s breach of contract claim remains intact as of the date of this report.
On October 3, 2012,
DSS Technology Management’s subsidiary, Bascom Research, LLC, commenced legal proceedings against five companies, including
Facebook, Inc. and LinkedIn Corporation, in the United States District Court, Eastern District of Virginia, pursuant to which Bascom
Research, LLC alleges infringement of certain of its patents relating to networking technologies (the “Bascom Litigation”).
Bascom Research, LLC is seeking a judgment for infringement, injunctive relief, compensatory damages, treble damages for willful
infringement, costs and attorneys’ fees. In December 2012, the Bascom Litigation was transferred to the United States District
Court, Northern District of California, and is still in process.
On November 26, 2013,
DSS Technology Management filed suit against Apple, Inc., in the United States District Court for the Eastern District of Texas,
for patent infringement (the “Apple Litigation”). The Apple Litigation relates to certain patents owned by DSS Technology
Management in the wireless peripheral technology space. DSS Technology Management is seeking a judgment for infringement, injunctive
relief, and compensatory damages from Apple, Inc.
On March 10, 2014,
DSS Technology Management filed suit in the United States District Court for the Eastern District of Texas against Taiwan Semiconductor
Manufacturing Company, TSMC North America, TSMC Development, Inc., Samsung Electronics Co., Ltd., Samsung Electronics America,
Inc., Samsung Telecommunications America L.L.C., Samsung Semiconductor, Inc., Samsung Austin Semiconductor LLC, and NEC Corporation
of America, for patent infringement involving one of its semiconductor patents. In this case, DSS Technology Management is seeking
a judgment for infringement, injunctive relief, and money damages from each of the named defendants.
On May 30, 2014, DSS
Technology Management filed suit in the United States District Court for the Eastern District of Texas against Lenovo (United States),
Inc. for patent infringement of a patent owned by DSS Technology Management in the wireless peripheral technology space. DSS Technology
Management is seeking a judgment for infringement, injunctive relief, and compensatory damages from Lenovo (United States), Inc.
In addition to the
foregoing, the Company is subject to other legal proceedings that have arisen in the ordinary course of business and have not been
finally adjudicated. Although there can be no assurance in this regard, in the opinion of management, none of the legal proceedings
to which the Company is a party, whether discussed herein or otherwise, will have a material adverse effect on its results of operations,
cash flows or financial condition.
Contingent
Litigation Payments
–
The Company retains the services of professional
service providers, including law firms that specialize in intellectual property licensing, enforcement and patent law. These service
providers are often retained on an hourly, monthly, project, contingent or a blended fee basis. In contingency fee arrangements,
a portion of the legal fee is based on predetermined milestones or the Company’s actual collection of funds. The Company
accrues contingent fees when it is probable that the milestones will be achieved and the fees can be reasonably estimated. As of
June 30, 2014, the Company has not accrued any contingent legal fees pursuant to these arrangements.
Contingent
Payments
–
The Company is party to certain agreements with funding partners
who have rights to portions of IP monetization proceeds that the Company receives.
Related
Party Consulting Payments
–
The Company has a consulting agreement with Patrick White, its former
CEO. During the six months ended June 30, 2014, the Company paid approximately $75,000 to Mr. White and expects to pay approximately
$105,000 in future monthly payments through the expiration of the agreement in March 2015.
9. Supplemental Cash Flow Information
Supplemental cash flow information for the
six months ended June 30, 2014 and 2013 is approximately as follows:
|
|
2014
|
|
|
2013
|
|
Cash paid for interest
|
|
$
|
151,000
|
|
|
$
|
96,000
|
|
Non-cash investing and financing activities:
|
|
|
|
|
|
|
|
|
(Loss) gain from change in fair value of interest rate swap derivative
|
|
$
|
(25,000
|
)
|
|
$
|
76,000
|
|
Accrued liabilities with related parties
|
|
|
|
|
|
|
|
|
settled with equity
|
|
$
|
134,000
|
|
|
$
|
-
|
|
Financing of building improvements
|
|
$
|
200,000
|
|
|
$
|
-
|
|
Change in non-controlling interest
|
|
$
|
200,000
|
|
|
$
|
-
|
|
Warrants issued with debt
|
|
$
|
-
|
|
|
$
|
69,000
|
|
Accounts payable converted to debt
|
|
$
|
-
|
|
|
$
|
153,000
|
|
Financing of equipment purchase
|
|
$
|
-
|
|
|
$
|
697,000
|
|
Intrinsic value of beneficial conversion feature at
|
|
|
|
|
|
|
|
|
Reaquisition
|
|
$
|
-
|
|
|
$
|
75,000
|
|
10. Segment Information
As
of January 1, 2014, the Company’s businesses are organized, managed and internally reported as four operating segments. Two
of these operating segments, Premier Packaging Corporation, and Plastic Printing Professionals, Inc., dba DSS Plastics Group are
engaged in the printing and production of paper, cardboard and plastic documents with a wide range of features, including the Company’s
patented technologies and trade secrets designed for the protection of documents against unauthorized duplication and altering.
Previously, the Company maintained a separately located operating segment, DSS Printing Group. This operating segment was relocated
to the Company’s packaging facility in Victor, New York in January 2014. For presentation purposes, the 2013 Printing Group
segment and Packaging segment amounts were combined to be consistent with the 2014 segment presentation. The two other operating
segments, ExtraDev, Inc., dba DSS Digital Group, and DSS Technology Management, Inc., are engaged in various aspects of developing,
acquiring, selling and licensing technology assets and are grouped into one reportable segment called Technology.
DSS Technology
Management acquires or internally develops patented technology or intellectual property assets (or interests therein), with the
purpose of monetizing these assets through a variety of value-enhancing initiatives, including, but not limited to, investments
in the development and commercialization of patented technologies, licensing, strategic partnerships and commercial litigation.
DSS Digital Group researches and develops intellectual property, products and services for purposes of creating commercial sales
of products that are based on internally developed intellectual property and intellectual property assets and rights acquired by
DSS Technology Management. DSS
Digital Group also provides IT sales and services
including
remote server and application hosting, cloud computing, secure document systems, back-up and disaster recovery services and custom
program development services.
Approximate information
concerning the Company’s operations by reportable segment for the three and six months ended June 30, 2014 and 2013 is as
follows. The Company relies on intersegment cooperation and management does not represent that these segments, if operated independently,
would report the results contained herein:
Three Months Ended June 30, 2014
|
|
Packaging and
Printing
|
|
|
Plastics
|
|
|
Technology
|
|
|
Corporate
|
|
|
Total
|
|
Revenues from external customers
|
|
$
|
3,503,000
|
|
|
|
899,000
|
|
|
|
481,000
|
|
|
|
-
|
|
|
$
|
4,883,000
|
|
Depreciation and amortization
|
|
|
106,000
|
|
|
|
44,000
|
|
|
|
1,127,000
|
|
|
|
11,000
|
|
|
|
1,288,000
|
|
Stock based compensation
|
|
|
18,000
|
|
|
|
10,000
|
|
|
|
24,000
|
|
|
|
241,000
|
|
|
|
293,000
|
|
Net income (loss)
|
|
|
263,000
|
|
|
|
(13,000
|
)
|
|
|
(1,557,000
|
)
|
|
|
(1,037,000
|
)
|
|
|
(2,344,000
|
)
|
Six Months Ended June 30, 2014
|
|
Packaging and
Printing
|
|
|
Plastics
|
|
|
Technology
|
|
|
Corporate
|
|
|
Total
|
|
Revenues from external customers
|
|
$
|
5,746,000
|
|
|
|
1,820,000
|
|
|
|
945,000
|
|
|
|
-
|
|
|
$
|
8,511,000
|
|
Depreciation and amortization
|
|
|
256,000
|
|
|
|
87,000
|
|
|
|
2,245,000
|
|
|
|
14,000
|
|
|
|
2,602,000
|
|
Stock based compensation
|
|
|
92,000
|
|
|
|
52,000
|
|
|
|
117,000
|
|
|
|
579,000
|
|
|
|
840,000
|
|
Net income (loss)
|
|
|
199,000
|
|
|
|
(22,000
|
)
|
|
|
(3,236,000
|
)
|
|
|
(2,340,000
|
)
|
|
|
(5,399,000
|
)
|
Identifiable assets
|
|
|
9,143,000
|
|
|
|
2,059,000
|
|
|
|
53,786,000
|
|
|
|
1,321,000
|
|
|
|
66,309,000
|
|
Three Months Ended June 30, 2013
|
|
Packaging and
Printing
|
|
|
Plastics
|
|
|
Technology
|
|
|
Corporate
|
|
|
Total
|
|
Revenues from external customers
|
|
$
|
3,048,000
|
|
|
|
977,000
|
|
|
|
254,000
|
|
|
|
-
|
|
|
$
|
4,279,000
|
|
Depreciation and amortization
|
|
|
157,000
|
|
|
|
42,000
|
|
|
|
29,000
|
|
|
|
1,000
|
|
|
|
229,000
|
|
Net income (loss)
|
|
|
46,000
|
|
|
|
63,000
|
|
|
|
(177,000
|
)
|
|
|
(1,857,000
|
)
|
|
|
(1,925,000
|
)
|
Six Months Ended June 30, 2013
|
|
Packaging and
Printing
|
|
|
Plastics
|
|
|
Technology
|
|
|
Corporate
|
|
|
Total
|
|
Revenues from external customers
|
|
$
|
5,743,000
|
|
|
|
1,805,000
|
|
|
|
501,000
|
|
|
|
-
|
|
|
$
|
8,049,000
|
|
Depreciation and amortization
|
|
|
304,000
|
|
|
|
91,000
|
|
|
|
57,000
|
|
|
|
2,000
|
|
|
|
454,000
|
|
Net income (loss)
|
|
|
118,000
|
|
|
|
40,000
|
|
|
|
(395,000
|
)
|
|
|
(2,820,000
|
)
|
|
|
(3,057,000
|
)
|
Identifiable assets
|
|
|
9,600,000
|
|
|
|
2,080,000
|
|
|
|
903,000
|
|
|
|
734,000
|
|
|
|
13,317,000
|
|
11. Subsequent Events
In conjunction with
the Company’s merger with Lexington Technology Group on July 1, 2013 (See Footnote 7 –Business Combination), the Company
issued 7,100,000 shares of the Company’s Common Stock to be held in escrow pursuant to an escrow agreement, dated July 1,
2013. Pursuant to the escrow agreement, the shares of the Company’s Common Stock deposited in the escrow account would be
released to the holders if and when the closing price per share of the Company’s Common Stock exceeded $5.00 per share (as
adjusted for stock splits, stock dividends and similar events) for 40 trading days within a continuous 90 trading day period following
the closing of the Merger. If within one year following the closing of the Merger, such threshold was not achieved, the shares
of the Company’s Common Stock held in escrow would be cancelled and returned to the treasury of the Company. As of July 1,
2014, the vesting criteria for the escrow shares was not met. As a result, the Company received authorization from holders of an
aggregate of 3,038,357 of the escrow shares to retire such shares as of June 29, 2014. The remaining 4,061,643 escrow shares were
retired on July 1, 2014. The Company had also issued an aggregate of 786,678 shares of Common Stock to Palladium Capital as compensation
for advisory services performed in connection with the Merger. Of those shares issued to Palladium Capital, 400,000 were being
held in escrow pursuant to the same terms and conditions as those set forth in the escrow agreement. Since Paladium Capital’s
escrow shares did not vest, the Company received authorization from Palladium Capital to retire their 400,000 escrow shares as
of June 29, 2014.
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
FORWARD-LOOKING STATEMENTS
Certain statements
contained herein constitute “forward-looking statements” within the meaning of the Private Securities Litigation Reform
Act of 1995 (the “1995 Reform Act”). Document Security Systems, Inc. desires to avail itself of certain “safe
harbor” provisions of the 1995 Reform Act and is therefore including this special note to enable us to do so. Except for
the historical information contained herein, this report contains forward-looking statements (identified by the words “estimate”,
“project”, “anticipate”, “plan”, “expect”, “intend”, “believe”,
“hope”, “strategy” and similar expressions), which are based on our current expectations and speak only
as of the date made. These forward-looking statements are subject to various risks, uncertainties and factors, as previously set
forth in the Risk Factors section of our Annual Report on Form 10-K for the year ended December 31, 2013, that could cause actual
results to differ materially from the results anticipated in the forward-looking statements.
Overview
Document Security Systems,
Inc. (referred to in this report as “DSS”, “we”, “us”, “our” or “Company”)
was formed in New York in 1984. We specialize in fraud and counterfeit protection for all forms of printed documents and digital
information. We hold numerous patents for optical deterrent technologies that provide protection of printed information from unauthorized
scanning and copying. We operate two production facilities, a combined security and commercial printing and packaging facility,
and a plastic card facility where we produce secure and non-secure documents for our customers. We license our anti-counterfeiting
technologies to printers and brand-owners. In addition, we have a digital division which provides cloud computing services for
our customers, including disaster recovery, back-up and data security services.
Prior to 2006, our
revenues were derived primarily from the licensing of our proprietary technology. In 2006, we began a series of acquisitions designed
to expand our ability to produce our products for end-user customers. In 2006, we acquired Plastic Printing Professionals, Inc.,
a privately held plastic cards manufacturer located in the San Francisco, California area which became the “DSS Plastics
Group”. In 2008, we acquired substantially all of the assets of DPI of Rochester, LLC, a privately held commercial printer
located in Rochester, New York, which became the “DSS Printing Group”. In 2010, we acquired Premier Packaging Corporation,
a privately held packaging company located in Victor, New York, which became the “DSS Packaging Group”. In May 2011,
we acquired ExtraDev, Inc., a privately held information technology and cloud computing company located in the Rochester, New York
area which became the “DSS Digital Group”, In January 2014, we combined our packaging and printing operations into
our Victor, NY facility.
On July 1, 2013, we
merged with Lexington Technology Group, a private intellectual property monetization company, after which we changed the name to
DSS Technology Management, Inc. DSS Technology Management is focused on extracting the economic benefits of intellectual property
assets through acquiring or internally developing patents or other intellectual property assets (or interests therein) and then
monetizing such assets through a variety of value enhancing initiatives, including, but not limited to:
|
·
|
customized technology solutions (such as applications for medical
electronic health records),
|
|
·
|
strategic partnerships, and
|
On July 8, 2013, DSS
Technology Management, purchased two patents for $500,000 covering certain methods and processes related to wireless peripheral
devices. In conjunction with the patent purchases, DSS Technology Management entered into a proceeds right agreement with certain
investors whereby we initially received $250,000 of a total of $750,000 which it is due to receive thereunder, subject to certain
payment milestones, in exchange for 40% of the proceeds it receives, if any, from the use, sale, litigation or licensing of the
two patents.
On September 27, 2013,
DSS Technology Management purchased ten patents covering certain methods and processes in the semiconductor industry for $2,000,000.
In January and February
2014, DSS Technology Management made investments of $100,000 and $400,000, respectively, to purchase an aggregate of 594,530 shares
of common stock of Express Mobile, Inc. (“Express Mobile”), which represented approximately 6% of the outstanding common
stock of Express Mobile at the time of investment. Express Mobile is a developer of custom mobile applications and websites.
On February 13, 2014,
DSS Technology Management entered into an agreement with investors to receive a series of advances up to $4,500,000 from the investors
in exchange for promissory notes, fixed return interests and contingent interests collateralized by certain of DSS Technology Management’s
intellectual property. On February 13, 2014, the Company received $2,000,000 under the agreement and on March 27, 2014, DSS Technology
Management received $1,000,000 under the agreement.
On May 23, 2014, DSS
Technology Management, purchased 115 patents covering certain methods and processes in the semiconductor industry for $1,150,000.
To date, DSS Technology
Management has initiated patent infringement lawsuits against numerous defendants, including, but not limited to Facebook, Inc.,
Linkedin Corporation, Apple, Inc., Taiwan Semiconductor Manufacturing Company, Inc., Samsung, NEC Corporation of America, and
Lenovo (United States), Inc., seeking money damages and other relief.
We do business in four operating segments
as follows:
DSS Packaging
and Printing Group
— Produces custom paperboard packaging serving clients in the pharmaceutical, beverage,
photo packaging, toy, specialty foods and direct marketing industries, among others. The group also provides secure and commercial
printing services for end-user customers along with technical support for our technology licensees. The division produces a wide
array of printed materials such as security paper, vital records, prescription paper, birth certificates, receipts, manuals, identification
materials, entertainment tickets, secure coupons, parts tracking forms, brochures, direct mailing pieces, catalogs, business cards,
etc. The division also provides the basis of research and development for our security printing technologies.
DSS Plastics
Group
— Manufactures laminated and surface printed cards which can include magnetic stripes, bar codes,
holograms, signature panels, invisible ink, micro fine printing, guilloche patterns, biometric, radio frequency identification
(RFID) and watermarks for printed plastic documents such as ID cards, event badges, and driver’s licenses.
DSS Digital Group
— Provides
data center centric solutions to businesses and governments delivered via the “cloud”. This division developed an iPhone
based application that integrates some of the our traditional optical deterrent technologies into proprietary digital data security
based solutions for brand protection and product diversion prevention.
DSS Technology
Management
— Acquires or internally develops patented technology or intellectual property assets (or interests
therein), with the purpose of monetizing these assets through a variety of value-enhancing initiatives, including, but not limited
to, investments in the development and commercialization of patented technologies, licensing, strategic partnerships and commercial
litigation.
Results
of Operations for the Three and Six Months Ended June 30, 2014 Compared to the Three and Six Months Ended June 30, 2013
This discussion should
be read in conjunction with the financial statements and footnotes contained in this quarterly report and in our Annual Report
on Form 10-K for the year ended December 31, 2013.
Revenue
|
|
Three Months
Ended June 30,
2014
|
|
|
Three Months
Ended June 30,
2013
|
|
|
%
change
|
|
|
Six Months
Ended June
30, 2014
|
|
|
Six Months
Ended June
30, 2013
|
|
|
% change
|
|
Revenue
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Printed products
|
|
$
|
4,407,000
|
|
|
$
|
3,822,000
|
|
|
|
15
|
%
|
|
$
|
7,571,000
|
|
|
$
|
7,101,000
|
|
|
|
7
|
%
|
Technology sales, services and licensing
|
|
|
476,000
|
|
|
|
458,000
|
|
|
|
4
|
%
|
|
|
940,000
|
|
|
$
|
949,000
|
|
|
|
-1
|
%
|
Total revenue
|
|
$
|
4,883,000
|
|
|
$
|
4,280,000
|
|
|
|
14
|
%
|
|
$
|
8,511,000
|
|
|
$
|
8,050,000
|
|
|
|
6
|
%
|
For the three months
ended June 30, 2014, total revenue was approximately $4.9 million, representing an increase of 14% from the corresponding three
months ended June 30, 2013. Revenues from the sale of printed products increased 15%, which reflected a 23% increase in revenues
from packaging and printing, primarily driven by an increase in packaging sales which offset decreases in commercial printing sales
and plastics products. Technology sales, services and licensing revenue increased 4% which reflected a 24% increase in revenues
from the sale of the Company’s digital products offset by a decrease in licensing revenue of 21% for the three months ended
June 30, 2014, as compared to the same period in 2013.
For the six months
ended June 30, 2014, total revenue was approximately $8.5 million, an increase of 6% from the six months ended June 30, 2013. Revenues
from the sale of printed products increased 7%, which reflected an 8% increase in revenues from packaging and printing, primarily
driven by an increase in packaging sales which offset decreases in commercial printing sales and a 1% increase in sales of plastics
products. Technology sales, services and licensing revenue decreased 1% for the six months ended June 30, 2014, as compared to
the same period in 2013, primarily due to lower royalty payments made by our security print technology licensees, which was offset
by a 19% increase in revenues from the sale of the Company’s digital products.
Costs and expenses
|
|
Three Months
Ended June 30,
2014
|
|
|
Three Months
Ended June 30,
2013
|
|
|
% change
|
|
|
Six Months
Ended June
30, 2014
|
|
|
Six Months
Ended June
30, 2013
|
|
|
% change
|
|
Costs and expenses
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of goods sold, exclusive of depreciation and amortization
|
|
$
|
3,197,000
|
|
|
$
|
2,546,000
|
|
|
|
26
|
%
|
|
$
|
5,395,000
|
|
|
$
|
4,749,000
|
|
|
|
14
|
%
|
Sales, general and administrative compensation
|
|
|
1,154,000
|
|
|
|
1,221,000
|
|
|
|
-5
|
%
|
|
|
2,446,000
|
|
|
|
2,356,000
|
|
|
|
4
|
%
|
Depreciation and amortization
|
|
|
1,288,000
|
|
|
|
224,000
|
|
|
|
475
|
%
|
|
|
2,602,000
|
|
|
|
454,000
|
|
|
|
473
|
%
|
Professional fees
|
|
|
502,000
|
|
|
|
602,000
|
|
|
|
-17
|
%
|
|
|
1,042,000
|
|
|
|
1,016,000
|
|
|
|
3
|
%
|
Stock based compensation
|
|
|
294,000
|
|
|
|
949,000
|
|
|
|
-69
|
%
|
|
|
841,000
|
|
|
|
1,289,000
|
|
|
|
-35
|
%
|
Sales and marketing
|
|
|
128,000
|
|
|
|
126,000
|
|
|
|
2
|
%
|
|
|
301,000
|
|
|
|
208,000
|
|
|
|
45
|
%
|
Rent and utilities
|
|
|
181,000
|
|
|
|
154,000
|
|
|
|
18
|
%
|
|
|
366,000
|
|
|
|
311,000
|
|
|
|
18
|
%
|
Other operating expenses
|
|
|
242,000
|
|
|
|
224,000
|
|
|
|
8
|
%
|
|
|
449,000
|
|
|
|
446,000
|
|
|
|
1
|
%
|
Research and development
|
|
|
112,000
|
|
|
|
62,000
|
|
|
|
81
|
%
|
|
|
226,000
|
|
|
|
121,000
|
|
|
|
87
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total costs and expenses
|
|
$
|
7,098,000
|
|
|
$
|
6,108,000
|
|
|
|
16
|
%
|
|
$
|
13,668,000
|
|
|
$
|
10,950,000
|
|
|
|
25
|
%
|
Costs of goods sold,
exclusive of depreciation and amortization
includes all direct cost of printed products revenues, including materials,
direct labor, transportation and manufacturing facility costs. In addition, this category includes all direct costs associated
with technology sales, services and licensing including hardware and software that are resold, third-party fees, and fees paid
to inventors or others as a result of technology licenses or settlements, if any. Costs of goods sold increased 26% and 14% during
the three and six months ended June 30, 2014, respectively, primarily reflecting higher materials costs due to the increase in
packaging sales as a percentage of total sales as compared to the three and six months ended June 30, 2013.
Sales, general and
administrative compensation
costs, excluding stock based compensation, decreased 5% and increased 4% during the three and six
months ended June 30, 2014, respectively, compared to the corresponding 2013 periods, which reflected the addition of employees
from our DSS Technology Management division, which was acquired on July 1, 2013, and which therefore was not a component of the
corresponding 2013 period amounts, offset by a decrease in bonus compensation expense in the 2014 periods and a decrease in the
number of employees at our printed products group following the consolidation of our packaging and printing operations into one
location in January 2014.
Depreciation and
amortization
includes the depreciation of machinery and equipment used for production, depreciation of office equipment and
building and leasehold improvements, amortization of software, and amortization of acquired intangible assets such as customer
lists, trademarks, non-compete agreements and patents, and internally developed patent assets. Depreciation and amortization increased
475% and 473% during the three and six months ended June 30, 2014, respectively, as compared to the corresponding 2013 periods,
due to the additional amortization of patent assets owned by our DSS Technology Management group valued at approximately $27.9
million on the date of acquisition of July 1, 2013, along with approximately $3.7 million of patent assets acquired by the Company
since July 1, 2013 which costs and related amortization were not a component of the pre-July1, 2013 periods.
Professional fees
decreased 17% and increased 3% in the three and six months ended June 30, 2014 compared to the corresponding 2013 periods. The
decrease during the three months ended June 30, 2014 was primarily due to the significant legal costs incurred during the corresponding
2013 periods in connection with the Company’s July 1, 2013 merger, that were not incurred in 2014. For the six months ended
June 30, 2014, the reduction in merger related costs has been offset by a significant increase in legal, consulting and advisory
expenses incurred in connection with the intellectual property monetization business of DSS Technology Management which was not
a component of the corresponding 2013 period amounts.
Stock-based compensation
includes expense charges for all stock-based awards to employees, directors and consultants. Such awards include option grants,
warrant grants, and restricted stock awards. Stock-based compensation for the three and six months ended June 30, 2014 decreased
69% and 35%, respectively, from the corresponding 2013 periods, primarily due to the significant stock based compensation expense
recorded in the second quarter of 2013 in conjunction with the July 1, 2013 merger.
Sales
and marketing
costs, which includes internet and trade publication advertising, travel and entertainment costs, sales-broker
commissions, and trade show participation expenses, increased 2% during the three months ended June 30, 2014, and increased 45%
during the six months ended June 30, 2014, as compared to the corresponding 2013 periods. The increase during the first six months
of 2014 is primarily due to increases in travel costs and marketing study costs associated with the Company’s sales and marketing
efforts for its AuthentiGuard
™
smart phone based products, offset by fluctuations in the timing of those costs.
Rent and utilities
increases during the three and six months ended June 30, 2014, respectively, as compared to the corresponding 2013 periods,
are due to the increased costs of the New York, Texas and Virginia office locations maintained by our DSS Technology Management
group acquired in July, 2013, and which therefore were not a component of the corresponding 2013 amounts.
Other operating
expenses
consist primarily of equipment maintenance and repairs, office supplies, IT support, bad debt expense and insurance
costs.
Other operating expenses increased 8% and 1% for the three months and six months
ended June 30, 2014, respectively, as compared to the corresponding 2013 periods, primarily due to an increase in equipment and
miscellaneous costs associated with the Company’s effort to lower equipment maintenance costs.
Net Loss and Loss per Share
|
|
Three Months
Ended June 30,
2014
|
|
|
Three Months
Ended June 30,
2013
|
|
|
% change
|
|
|
Six Months
Ended June
30, 2014
|
|
|
Six Months
Ended June
30, 2013
|
|
|
% change
|
|
Net loss
|
|
$
|
(2,344,000
|
)
|
|
$
|
(1,925,000
|
)
|
|
|
22
|
%
|
|
$
|
(5,399,000
|
)
|
|
$
|
(3,057,000
|
)
|
|
|
77
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earnings per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic and diluted
|
|
$
|
(0.06
|
)
|
|
$
|
(0.09
|
)
|
|
|
-33
|
%
|
|
$
|
(0.13
|
)
|
|
$
|
(0.14
|
)
|
|
|
-7
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Shares used in computing earnings per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic and diluted
|
|
|
42,040,907
|
|
|
|
21,710,034
|
|
|
|
94
|
%
|
|
|
41,982,770
|
|
|
|
21,711,503
|
|
|
|
93
|
%
|
During the three and
six months ended June 30, 2014, we had a net loss of approximately $2,344,000 and $5,399,000, respectively, representing increases
of 22% and 77%, respectively, in our net losses as compared to the corresponding 2013 periods. The increases in net loss were primarily
the result of the significant increase in amortization costs incurred during the 2014 periods for the carrying value of our patent
assets acquired in connection with our acquisition of DSS Technology Management in July 2013.
LIQUIDITY AND CAPITAL
RESOURCES
We have historically
met our liquidity and capital requirements primarily through the private placement of our equity securities and debt financings.
As of June 30, 2014, we had cash of approximately $1.3 million and restricted cash of approximately $245,000. In addition, we had
$1,000,000 available to our packaging division under a revolving credit line. In addition, our subsidiary, DSS Technology Management
expects to receive a $1.5 million milestone payment in the second half of 2014 which will be available to us to meet our general
operating cash needs.
Operating Cash Flow
– During the first six months of 2014, we used approximately $1,104,000 of cash for operations, representing an 18% increase
from a use of cash for operations during the first six months of 2013.
Investing
Cash Flow
-
During the first six months of 2014, we paid approximately $158,000 for building
improvements that were not financed, $750,000 for investments into VirtualAgility and Express Mobile as part of our IP monetization
strategy, $1,150,000 for 115 patents in the semiconductor field and approximately $47,000 for capitalized patent application and
filing fees for internally developed patents.
Financing Cash Flows
- During the first six months of 2014, we paid a net of approximately $158,000 against our revolving line of credit, paid long-term
debt of approximately $299,000, and received $2,691,000 from a limited-recourse promissory note entered into by our subsidiary,
DSS Technology Management. In addition, the Company sold 209,700 shares of common stock at a purchase price of $1.44 per share
to an institutional investor for a total purchase price of approximately $302,000.
Off-Balance Sheet Arrangements
We do not have any
off-balance sheet arrangements that have, or are reasonably likely to have, an effect on our financial condition, financial statements,
revenues or expenses.
Critical Accounting Policies and Estimates
As of June 30, 2014,
our critical accounting policies and estimates have not changed materially from those set forth in our Annual Report on Form 10-K
for the year ended December 31, 2013.