NOTES
TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
March
31, 2017
(Unaudited)
1.
Basis of Presentation and Significant Accounting Policies
Document
Security Systems, Inc. (the “Company”), through two of its subsidiaries, Premier Packaging Corporation and Plastic
Printing Professionals, Inc., which operates 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, DSS
Digital 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., acquires intellectual property (“IP”) assets and interests in companies owning intellectual property
assets, or assists others in managing their intellectual property monetization efforts, for 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.
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. GAAP 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. GAAP. All significant intercompany transactions have been eliminated in consolidation.
Interim
results are not necessarily indicative of results expected for the 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, 2016.
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 March 31, 2017, cash of $421,671 ($177,609 – December 31, 2016) is restricted for payments of
costs and expenses associated with one of the Company’s IP 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 FASB 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:
●
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Level
1, defined as observable inputs such as quoted prices for identical instruments in active markets;
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●
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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
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●
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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.
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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.
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 a cash flow hedges under accounting principles generally accepted in the United States of America. Gains
and losses on these instruments are recorded in other comprehensive loss until the underlying transaction is recorded in earnings.
When the hedged item is realized, gains or losses are reclassified from accumulated other comprehensive 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 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 this cash flow
hedge recorded in accumulated other comprehensive loss and other liabilities as of March 31, 2017 was approximately $38,000 ($45,000
- December 31, 2016).
As
of March 31, 2017 the Company has an interest rate swap agreement for its debt with RBS Citizens, N.A. (“Citizens
Bank”) (see Note 4) which changes a variable rate into a fixed rate on a term loan as follows:
Notional
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Variable
|
|
|
|
|
Amount
|
|
Rate
|
|
Fixed Cost
|
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Maturity Date
|
$
|
953,256
|
|
|
|
3.94
|
%
|
|
|
5.87
|
%
|
|
August 30, 2021
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Impairment
of Long Lived Assets and Goodwill
- Long-lived and intangible assets and goodwill are assessed for potential impairment
whenever events or changes in circumstances indicate that full recoverability of net asset balances through future cash flows
is in question. Goodwill and indefinite-lived intangible assets are assessed at least annually, but also whenever events or changes
in circumstances indicate the carrying values may not be recoverable. Factors that could trigger an impairment review, include
(a) significant underperformance relative to historical or projected future operating results; (b) significant changes in the
manner of or use of the acquired assets or the strategy for the Company’s overall business; (c) significant negative industry
or economic trends; (d) significant decline in the Company’s stock price for a sustained period; and (e) a decline in the
Company’s market capitalization below net book value.
Contingent
Legal Expenses
-
Contingent legal fees associated with our commercial litigation involving our IP are expensed
in the consolidated statements of operations in the period that the related revenues are recognized. In instances where there
are no recoveries from potential infringers, no contingent legal fees are paid; however, the Company may be liable for certain
out of pocket legal costs incurred pursuant to the underlying legal services agreement that will be paid out from the proceeds
from settlements or licenses that arise pursuant to an enforcement action, which will be expensed as legal fees in the period
in which the payment of such fees is probable. Any unamortized patent acquisition costs will be expensed in the period in which
a conclusion is reached in an enforcement action that does not yield future royalties potential.
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.
On
August 26, 2016, the Company affected a one for four reverse stock split of the Company’s common stock. No fractional shares
of the Company’s common stock were issued as a result of the reverse stock split. Instead, stockholders of record who otherwise
would have been entitled to receive fractional shares were entitled to a rounding up of their fractional share to the nearest
whole share, except in the case of any stockholder that owned less than four shares of the Company’s common stock immediately
preceding the reverse stock split. In such case, such stockholder received cash for such fractional share in an amount equal to
the product obtained by multiplying: (x) the closing sale price of the common stock on August 25, 2016 as reported on the NYSE
MKT, by (y) the amount of the fractional share. As a result, the Company issued 1,166 common shares for shares due as a result
of the rounding up feature and paid $92 to buy-out the fractional shares of holders with less than four shares immediately preceding
the reverse stock split.
As
of March 31, 2017 and 2016, there were 3,668,127 and 2,644,227 (as adjusted to reflect the one-for-four reverse stock split that
took effect on August 26, 2016) respectively, of common stock share equivalents potentially issuable options, warrants, and restricted
stock agreements, that could potentially dilute basic earnings per share in the future. These shares are excluded from the calculation
of diluted earnings per share in periods in which the Company had a net loss because their inclusion would be 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 three months ended March 31, 2017, two customers accounted for 31% and 12%, respectively, of the Company’s consolidated
revenue and accounted for 20% and 12%, respectively, of the Company’s accounts receivable balance as of March 31, 2017.
During the three months ended March 31, 2016 these two customers accounted for 27% and 12%, respectively, of the Company’s
consolidated revenue and accounted for 24% and 4%, respectively, of the Company’s accounts receivable balance as of March
31, 2016. The risk with respect to accounts 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. All common share and
per share figures are presented on a post one for four reverse stock split basis.
Recent
Accounting Pronouncements
–
In May 2014, the FASB issued ASU 2014-9 “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. Subsequently, the FASB has issued the following standards related to ASU 2014-09: ASU
No. 2016-08, “Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations” (“ASU
2016-08”); ASU No. 2016-10, “Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations
and Licensing” (“ASU 2016-10”); and ASU No. 2016-12, “Revenue from Contracts with Customers (Topic 606):
Narrow-Scope Improvements and Practical Expedients” (“ASU 2016-12”). The Company must adopt ASU 2016-08, ASU
2016-10 and ASU 2016-12 with ASU 2014-09 (collectively, the “new revenue standards”). The revenue standards will replace
most existing revenue recognition guidance in U.S. 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, 2017. The Company has not yet selected a transition method and is currently evaluating the effect
that the revenue standards will have on its consolidated financial statements and related disclosures.
In
February 2016, the FASB issued ASU 2016-02, “Leases”, which requires that lease arrangements longer than 12 months
result in an entity recognizing an asset and liability. ASU 2016-02 is effective for interim and annual periods beginning after
December 15, 2018, and early adoption is permitted. The Company has not yet evaluated nor has it determined the effect of the
standard will have on its consolidated financial statements and related disclosures.
In
March 2016, the FASB issued ASU 2016-09, “Compensation — Stock Compensation: Improvements to Employee Share-Based
Payment Accounting.” The standard is intended to simplify several areas of accounting for share-based compensation arrangements,
including the income tax impact, classification on the statement of cash flows and forfeitures. ASU 2016-09 is effective for the
Company on January 1, 2017. Adoption of this new accounting standard resulted in the recognition of an increase in the Company’s
gross deferred tax asset of approximately $350,000 and an offsetting increase in the valuation allowance. There was no impact
to the Company’s retained earnings or other material impact to the financial statements as a result of adopting this new
accounting standard.
In
August 2016, the FASB issued ASU 2016-15, “Classification of Certain Cash Receipts and Cash Payments”, which clarifies
the treatment of several types of cash receipts and payments for which there was diversity in practice. This update is effective
for annual periods beginning after December 15, 2017, and interim periods within those fiscal years, with early adoption permitted,
including adoption in an interim period. We anticipate that the adoption of this guidance will not have a material impact on our
consolidated financial statements.
In
November 2016, the FASB issued ASU 2016-18, “Statement of Cash Flows”, regarding the presentation of restricted cash
on the statement of cash flows. The standards update requires that the reconciliation of the beginning and end of period cash
amounts shown in the statement of cash flows include restricted cash. When restricted cash is presented separately from cash and
cash equivalents on the balance sheet, a reconciliation is required between the amounts presented on the statement of cash flows
and the balance sheet. Also, the new guidance requires the disclosure of information about the nature of the restrictions. The
standards update is effective retrospectively for fiscal years and interim periods beginning after December 15, 2017, with early
adoption permitted. We anticipate that the adoption of this guidance will not have a material impact on our consolidated financial
statements.
2.
Inventory
Inventory
consisted of the following:
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March 31, 2017
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December 31, 2016
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Finished Goods
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$
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941,819
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$
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736,987
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Work in process
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114,329
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|
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314,353
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Raw Materials
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147,375
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155,037
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|
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|
|
|
|
|
|
|
|
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$
|
1,203,523
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|
|
$
|
1,206,377
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3.
Intangible Assets
Intangible
assets are comprised of the following:
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March 31, 2017
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December 31, 2016
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Useful Life
|
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Gross Carrying Amount
|
|
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Accumulated Amortizaton
|
|
|
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Net Carrying Amount
|
|
|
|
Gross Carrying Amount
|
|
|
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Accumulated Amortizaton
|
|
|
|
Net Carrying Amount
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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Acquired intangibles- customer lists and non-compete agreements
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5 -10 years
|
|
|
1,997,300
|
|
|
|
1,742,883
|
|
|
|
254,417
|
|
|
|
1,997,300
|
|
|
|
1,721,357
|
|
|
|
275,943
|
|
Acquired intangibles-patents and patent rights
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|
Varied
|
(1)
|
|
3,155,000
|
|
|
|
2,220,561
|
|
|
|
934,439
|
|
|
|
3,155,000
|
|
|
|
2,092,767
|
|
|
|
1,062,233
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|
Patent application costs
|
|
Varied
|
(2)
|
|
1,141,415
|
|
|
|
599,323
|
|
|
|
542,092
|
|
|
|
1,136,465
|
|
|
|
578,623
|
|
|
|
557,842
|
|
|
|
|
|
$
|
6,293,715
|
|
|
$
|
4,562,767
|
|
|
$
|
1,730,948
|
|
|
$
|
6,288,765
|
|
|
$
|
4,392,747
|
|
|
$
|
1,896,018
|
|
|
(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 March 31, 2017, the weighted average remaining useful life of these assets in service was approximately 1.8
years.
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|
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(2)
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Patent
application costs are amortized over their expected useful life which is generally the remaining legal life of the patent.
As of March 31, 2017, the weighted average remaining useful life of these assets in service was approximately 6.7 years.
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Intangible
asset amortization expense for the three months ended March 31, 2017 amounted to $170,019 ($190,377 - March 31, 2016).
4.
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 $800,000 that bears interest at 1 Month LIBOR plus 3.75% (4.64% as of March 31, 2017)
and matures on May 31, 2017. As of March 31, 2017 and December 31, 2016, the revolving line had a balance of $0. The Company expects
to renew the revolving credit line prior to its maturity.
Long-Term
Debt
- On December 30, 2011, the Company issued a $575,000 convertible note that was initially due on December 29, 2013,
and carries an interest rate of 10% per annum. The note is secured by the assets of Company’s wholly-owned subsidiary, Secuprint
Inc. Interest is payable quarterly, in arrears. 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”. 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 was amortized over the remaining life
of the note. On February 23, 2015, the Company entered into Convertible Promissory Note Amendment No. 2 to extend the maturity
date to December 30, 2016, eliminate the conversion feature, and to institute principal payments in the amount of $15,000 per
month plus interest through the extended maturity date, and a balloon payment of $230,000 due on the extended maturity date. On
April 12, 2016, the Company entered into Convertible Promissory Note Amendment No. 3 to extend the maturity date to May 31, 2017
and change the balloon payment to $155,000 due on the extended maturity date. The Company expects to extend the maturity date
of the note. As of March 31, 2017, the balance of the term loan was $185,000 ($230,000 at December 31, 2016).
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. The note is secured by the assets of Company’s wholly-owned subsidiary, Secuprint Inc. 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. On February 23,
2015, the Company entered into Promissory Note Amendment No. 2 to extend the maturity date to May 31, 2016 and to institute principal
payments in the amount of $15,000 per month plus interest through the extended maturity date, and a balloon payment of $610,000
due on the extended maturity date. On April 12, 2016, the Company entered into Promissory Note Amendment No. 3 to extend the maturity
date to May 31, 2017 and change the balloon payment to $430,000 due on the extended maturity date. The Company expects to extend
the maturity date of the note. As of March 31, 2017, the balance of the term loan was $460,000 ($505,000 at December 31, 2016).
Term
Loan Debt
- On July 19, 2013, Premier Packaging entered into an equipment loan with People’s Capital and Leasing
Corp. (“People’s Capital”) for a printing press. The loan is secured by the 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 March 31, 2017, the loan had a balance
of $492,578 ($559,609 at December 31, 2016).
On
April 28, 2015, Premier Packaging entered into a term note with Citizens for $525,000, repayable over a 60-month period. The loan
bears interest at 3.61% and is payable in equal monthly installments of $9,591 until April 28, 2020. Premier Packaging used the
proceeds of the term note to acquire a HP Indigo 7800 Digital press. The loan is secured by the printing press. As of December
31, 2016, the loan had a balance of $335,024 ($360,611 at December 31, 2016).
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% (3.94% at March 31, 2017). Concurrently with the transaction, the Company entered into an interest rate swap
agreement to lock into a 5.87% 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 will be due. As of March 31, 2017, the Promissory Note had a balance
of $953,256 ($966,786 at December 31, 2016).
On
December 6, 2013, Premier Packaging entered into a Construction to Permanent Loan with Citizens Bank for up to $450,000 that was
converted 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% (3.93% at March 31, 2017), 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 March 31, 2017, the note had a balance of $367,500 ($375,000 – December 31, 2016).
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. For the quarter ended March 31, 2017 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.
Other
Debt
- On February 13, 2014, the Company’s subsidiary, DSS Technology Management, Inc. (“DSSTM”), entered
into an Investment Agreement (the “Agreement”) dated February 13, 2014 (the “Effective Date”) with Fortress
Credit Co LLC, as collateral agent (the “Collateral Agent” or “Fortress”), and certain investors (the
“Investors”), pursuant to which DSSTM contracted to receive a series of advances up to $4,500,000 (collectively, the
“Advances”). Under the terms of the Agreement, on the Effective Date, DSSTM issued and sold a promissory note in the
amount of $1,791,000, fixed return equity interests in the amount of $199,000, and contingent equity interests in the amount of
$10,000, to each of the Investors, and in return received $2,000,000 in proceeds. To secure the Advances, DSSTM placed a lien
in favor of the Investors on ten semi-conductor patents (the “Patents”) and assigned to the Investors certain funds
recoverable from successful patent litigation involving these Patents, including settlement payments, license fees and royalties
on the Patents. DSSTM is a plaintiff in various ongoing patent infringement lawsuits involving certain of the Patents.
On
March 27, 2014, DSSTM received an additional $1,000,000 under the Agreement comprised of a promissory note for $900,000 and fixed
and contingent equity interests of $100,000. On September 5, 2014, DSSTM received the remaining $1,500,000 under the Agreement
comprised of a promissory note for $1,350,000 and fixed and contingent return interests of $150,000. On May 23, 2016, DSSTM remitted
$495,000 in proceeds received from the sale of patent assets (Note 5) to Fortress under the terms of the Agreement. On September
20, 2016, DSSTM remitted $125,250 in proceeds received from a settlement to Fortress as repayment of the note principal balance
under the terms of the Agreement.
The
Agreement defines certain events as Events of Default, one of which is the failure by DSSTM, on or before the second anniversary
of the Effective Date, to make payments to the Investors equal to the outstanding Advances. On February 13, 2016, being the second
anniversary date of the Effective Date, DSSTM had failed to make these payments and was therefore in default of the Agreement.
On December 2, 2016, the parties entered into a First Amendment to Investment Agreement and Certain Other Documents (the “Amendment”).
The purpose of the Amendment was to vacate DSSTM’s ongoing non-payment default under the Agreement, and to amend certain
provisions of the Agreement.
The
Agreement was amended to add expenses in the amount of $150,000 to DSSTM’s payment obligation, payable on the Maturity Date.
This amount was recorded as debt issuance costs and is being amortized on a straight line basis through the amended maturity date
of February 13, 2018. The Amendment added a provision whereby DSSTM is required to deposit $300,000 on or before March 2, 2017
and (ii) a further sum of $300,000 on or before March 2, 2018, into a deposit account (collectively, the “Deposit”).
The March 2, 2017 deposit was made in a timely manner. The Deposit funds will be restricted to pay certain expenses, consisting
of out-of-pocket expenses incurred in connection with certain existing patent litigation matters and other patent litigation matters
which may occur after the Amendment Effective Date (the “Qualified Expenses”). In the Event of Default, the Investors
may apply the then remaining Deposit to the then outstanding Obligations, if any.
Additionally
per the Amendment, DSSTM agrees to pay to the Investors an amount equal to 25% of any amounts received by DSSTM for any and all
types of monetization activities related to certain of its patents covering systems and methods of using low power wireless peripheral
devices (collectively, “BlueTooth Patents”), but only until the Investors have received payments under the Agreement
totaling the sum of (i) the Capitalized Expenses plus (ii) payments of principal and interest on the Notes totaling the sum of
(x) $4,500,000 (consisting of the previously made Advances) plus (y) additional amounts, if any, advanced by the Investors pursuant
to the Agreement. In addition to the monetization interest granted the Investors in the BlueTooth Patents, DSSTM also granted
the Collateral Agent and the Investors a security interest in certain of DSSTM’s unencumbered semiconductor patents to further
collateralize the amounts owed under the Agreement.
As
of March 31, 2017, DSSTM has made aggregate principal payments of $770,250 on the notes. As of March 31, 2017, $3,538,129 is recorded
as a short-term debt under the arrangement, which includes $227,500 of accrued interest, less unamortized debt issuance costs
of $139,943. In addition, as of March 31, 2017, $459,000 of fixed and contingent equity interests are recorded in other short-term
liabilities. The Company will reduce the liability upon payment to the Investor from available proceeds from litigation, or if
none by the maturity date of February 13, 2018, then such amounts will be settled by the Company by the transfer and assignment
of certain of the Company’s patent assets.
5.
Other Liabilities
On
November 14, 2016, the Company entered into a Proceeds Investment Agreement (the “Agreement”) with Brickell Key Investments
LP (“BKI”). Pursuant to the Agreement, BKI financed an aggregate of $13,500,000 in a patent purchase and monetization
program to be implemented and managed by the Company (the “Financing”). Pursuant to Agreement, $3,000,000 of the Financing
was used to cover the Company’s purchase of a portfolio of U.S. and foreign LED patents and a license from Intellectual
Discovery Co., Ltd., a Korean company (collectively, the “LED Patent Portfolio”), resulting in a basis in these assets
of $0. A total of $6,000,000 of the Financing was directed by BKI to attorneys to cover anticipated attorneys’ fees and
out-of-pocket expenses for legal proceedings that may transpire relating to enforcement of the LED Patent Portfolio. This amount
is not included in the Company’s financial statements as the Company has no control over these funds, which are segregated
and escrowed in the attorneys’ trust account.
In
addition, the Company received $4,500,000 of the Financing, which is required to be used by the Company to pay for the defense
of
Inter Partes Review
or other similar proceedings that may be filed from time to time by defendants with the U.S. Patent
& Trademark Office relating to the LED Patent Portfolio, with excess amounts available for general working capital needs.
The Company has allocated $2,500,000 of the amount received for the payment of estimated future
Inter Partes Review
costs.
As of March 31, 2017, an aggregate of approximately $4,067,000 was recorded as other liabilities by the Company, of which approximately
$2,982,000 is classified as short-term. The Company will reduce the liability as it pays legal and other expenses related to the
Inter Partes Review
matters involving the LED Patent Portfolio as incurred. For the remaining $1,709,000 in other liabilities
allocated to working capital, the Company is amortizing this amount on a pro-rata basis over the expected life of the monetization
period of the LED Patent Portfolio which the Company estimates at 36 months, ending November 31, 2019. For this amount, the Company
reduces the liability with an offset to selling, general and administrative costs of $47,500 each month. During the three months
ended March 31, 2017, there were no
Inter Partes Review
costs and approximately $142,500 was recoded as a reduction of
the liability.
On
July 8, 2013, the Company’s subsidiary, DSS Technology Management, purchased two patents for $500,000 covering certain methods
and processes related to Bluetooth devices. In conjunction with the patent purchases, DSS Technology Management entered into a
Proceed Right Agreement with certain investors pursuant to which DSS Technology Management initially received $250,000 of a total
of $750,000 which it will ultimately receive thereunder, subject to certain payment milestones, in exchange for 40% of the proceeds
which it receives, if any, from the use, sale or licensing of the two patents. As of March 31, 2017, the Company had received
an aggregate of $650,000 from the investors pursuant to the agreement of which approximately $453,000 was in other liabilities
in the consolidated balance sheets ($467,000 as December 31, 2016). The Company will reduce the liability as it pays legal and
other expenses related to its litigation involving the Bluetooth patents, for which the amount is available to be used for 50%
of all such expenses.
As
described in Note 4, On February 13, 2014, the Company’s subsidiary, DSSTM entered into an Investment Agreement with Fortress
pursuant to which DSSTM contracted to receive a series of advances up to $4,500,000. Under the terms of the Agreement, on the
Effective Date, DSSTM issued and sold a promissory note in the amount of $1,791,000, fixed return equity interests in the amount
of $199,000, and contingent equity interests in the amount of $10,000. On March 27, 2014, DSSTM received an additional $1,000,000
under the Agreement comprised of a promissory note for $900,000 and fixed and contingent equity interests of $100,000. On September
5, 2014, DSSTM received the remaining $1,500,000 under the Agreement comprised of a promissory note for $1,350,000 and fixed and
contingent return interests of $150,000. The $459,000 of aggregate fixed and contingent equity interests received are recorded
in other liabilities. The Company will reduce the liability upon payment to the Investor from available proceeds from litigation,
or if none by the maturity date of February 13, 2018, then such amounts will be reversed from other liabilities and recorded as
other income as of the maturity date.
6.
Commitments and Contingencies
On
November 26, 2013, DSS Technology Management filed suit against Apple, Inc. (“Apple”) in the United States District
Court for the Eastern District of Texas, for patent infringement (the “Apple Litigation”). The complaint alleges infringement
by Apple of DSS Technology Management’s patents that relate to systems and methods of using low power wireless peripheral
devices DSS Technology Management is seeking a judgment for infringement, injunctive relief, and compensatory damages from Apple.
On October 28, 2014, the case was stayed by the District Court pending a determination of Apple’s motion to transfer the
case to the Northern District of California. On November 7, 2014, Apple’s motion to transfer the case to the Northern District
of California was granted. On December 30, 2014, Apple filed two
Inter Partes Review
(“IPR”) petitions with
the Patent Trial and Appeal Board (“PTAB”) for review of the patents at issue in the case. The PTAB instituted the
IPRs on June 25, 2015. The California District Court then stayed the case pending the outcome of those IPR proceedings. Oral arguments
of the IPRs took place on March 15, 2016, and on June 17, 2016, PTAB ruled in favor of Apple on both IPR petitions. DSS Technology
Management has filed an appeal with the U.S. Court of Appeals for the Federal Circuit (the “Federal Circuit”) seeking
reversal of the PTAB decisions. The appeal is still pending as of the date of this Report. The patent assets underlying this matter
had no carrying value as of the date of the PTAB decision and therefore, there were no impairment considerations as a result of
the decision.
On
February 16, 2015, DSS Technology Management filed suit in the United States District Court, Eastern District of Texas, against
defendants Intel Corporation, Dell, Inc., GameStop Corp., Conn’s Inc., Conn Appliances, Inc., NEC Corporation of America,
Wal-Mart Stores, Inc., Wal-Mart Stores Texas, LLC, and AT&T, Inc. The complaint alleges patent infringement and seeks judgment
for infringement of two of DSSTM’s patents, injunctive relief and money damages. On December 9, 2015, Intel filed IPR petitions
with PTAB for review of the patents at issue in the case. Intel’s IPRs were instituted by PTAB on June 8, 2016. The Intel
litigation has been stayed by the District Court pending final determination of the IPR proceedings.
On
July 16, 2015, DSS Technology Management filed three separate lawsuits in the United States District Court for the Eastern District
of Texas alleging infringement of certain of its semiconductor patents. The defendants are SK Hynix
et al.,
Samsung Electronics
et al.,
and Qualcomm Incorporated. Each respective complaint alleges patent infringement and seeks judgment for infringement,
injunctive relief and money damages. On November 12, 2015, SK Hynix filed an IPR petition with PTAB for review of the patent at
issue in their case. SK Hynix’s IPR was instituted by the PTAB on May 11, 2016. On August 16, 2016, DSS Technology Management
and SK Hynix entered into a confidential settlement agreement ending the litigation between them. The pending SK Hynix IPR was
then terminated by mutual agreement of the parties on August 31, 2016. On March 18, 2016, Samsung also filed an IPR petition.
On September 23, 2016, Samsung’s IPR was instituted by PTAB. Qualcomm then filed its IPR proceeding on July 1, 2016, which
was then later joined with Intel’s IPRs in August 2016 by PTAB. As of the date of this Report, PTAB has not yet issued a
decision on any of the pending IPR proceedings.
In
addition to the foregoing, we may become subject to other legal proceedings that arise in the ordinary course of business and
have not been finally adjudicated. Adverse decisions in any of the foregoing may have a material adverse effect on our results
of operations, cash flows or our financial condition. The Company accrues for potential litigation losses when a loss is probable
and estimable.
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 March 31, 2017, 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 intellectual
property monetization proceeds that the Company receives. As of March 31, 2017 and December 31, 2016, there are no contingent
payments due.
7.
Stockholders’ Equity
On
August 26, 2016, the Company affected a one-for-four reverse stock split of the Company’s common stock. All references in
this report to the number of shares of our common stock and to related per-share prices (including references to periods prior
to the effective date of the reverse stock split) reflect this reverse stock split.
Restricted
Stock
- On January 12, 2017, the Company issued an aggregate of 200,000 shares of restricted stock to members of the Company’s
management of which 150,000 will vest on May 17, 2017 and had an aggregated grant date fair value of approximately $126,000, and
50,000 will vest if the Company achieves adjusted EBITDA of at least $500,000 and a stock trading price of at least $1.00 per
share by the close of the fourth quarter of 2017. In addition, during 2016 the Company issued an aggregate of 224,750 shares of
restricted stock to members of the Company’s management which will vest on May 17, 2017 and had an aggregated grant date
fair value of approximately $124,000.
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 three months ended March 31, 2017, the Company had stock compensation expense of approximately $132,000 or less than $0.01
basic and diluted earnings per share ($74,000; less than $0.01 basic and diluted earnings per share for the corresponding three
months ended March 31, 2016).
8.
Supplemental Cash Flow Information
Supplemental
cash flow information for the three months ended March 31, 2017 and 2016 is approximately as follows:
|
|
2017
|
|
2016
|
|
|
|
|
|
Cash paid for interest
|
|
$
|
44,000
|
|
|
$
|
58,000
|
|
|
|
|
|
|
|
|
|
|
Non-cash investing and financing activities:
|
|
|
|
|
|
|
|
|
Gain (loss) from change in fair value of interest rate swap derivatives
|
|
$
|
7,000
|
|
|
$
|
(26,000
|
)
|
9.
Segment Information
The
Company’s businesses are organized, managed and internally reported as four operating segments. Two of these operating segments,
Packaging and Printing, and Plastics 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. The two other operating segments, DSS Digital Group and DSS Technology
Management, are engaged in various aspects of developing, acquiring, selling and licensing technology assets and are grouped into
one reportable segment called Technology.
Approximate
information concerning the Company’s operations by reportable segment for the three months ended March 31, 2017 and 2016
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 March 31, 2017
|
|
Packaging and Printing
|
|
Plastics
|
|
Technology
|
|
Corporate
|
|
Total
|
Revenues from external customers
|
|
$
|
3,246,000
|
|
|
|
1,157,000
|
|
|
|
368,000
|
|
|
|
—
|
|
|
$
|
4,771,000
|
|
Depreciation and amortization
|
|
|
159,000
|
|
|
|
30,000
|
|
|
|
153,000
|
|
|
|
1,000
|
|
|
|
343,000
|
|
Stock based compensation
|
|
|
—
|
|
|
|
—
|
|
|
|
24,000
|
|
|
|
110,000
|
|
|
|
134,000
|
|
Loss before income taxes
|
|
|
392,000
|
|
|
|
163,000
|
|
|
|
(310,000
|
)
|
|
|
(424,000
|
)
|
|
|
(179,000
|
)
|
Identifiable assets
|
|
|
9,331,000
|
|
|
|
2,339,000
|
|
|
|
1,998,000
|
|
|
|
3,923,000
|
|
|
|
17,591,000
|
|
Three Months Ended March 31, 2016
|
|
Packaging and Printing
|
|
Plastics
|
|
Technology
|
|
Corporate
|
|
Total
|
Revenues from external customers
|
|
$
|
2,927,000
|
|
|
|
1,048,000
|
|
|
|
364,000
|
|
|
|
—
|
|
|
$
|
4,339,000
|
|
Depreciation and amortization
|
|
|
153,000
|
|
|
|
29,000
|
|
|
|
178,000
|
|
|
|
1,000
|
|
|
|
361,000
|
|
Stock based compensation
|
|
|
17,000
|
|
|
|
10,000
|
|
|
|
13,000
|
|
|
|
34,000
|
|
|
|
74,000
|
|
Loss before income taxes
|
|
|
244,000
|
|
|
|
111,000
|
|
|
|
(565,000
|
)
|
|
|
(409,000
|
)
|
|
|
(619,000
|
)
|
Identifiable assets
|
|
|
9,345,000
|
|
|
|
2,178,000
|
|
|
|
2,767,000
|
|
|
|
661,000
|
|
|
|
14,951,000
|
|