NOTES
TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
June
30, 2018
(Unaudited)
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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 product authentication
solutions and digital information services. The Company and its subsidiary, DSS Technology Management, Inc., also acquires intellectual
property (“IP”) assets 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. In addition, in January 2018, the Company commenced international operations with its
wholly owned subsidiary, DSS International Inc., in its Hong Kong office.
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 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, 2017.
Principles
of Consolidation -
The consolidated financial statements include the accounts of Document Security Systems and its subsidiaries.
All intercompany balances and transactions have been eliminated in consolidation.
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, 2018, cash of $141,351 ($256,005 – December 31, 2017) is restricted by a third-party
co-investor to payments of costs and expenses associated with one of the Company’s IP monetization programs. For purposes
of the statement of cash flow, cash and restricted cash are combined. The break out of these amounts by period are as follows:
|
|
June 30, 2018
|
|
|
December 31, 2017
|
|
|
June 30, 2017
|
|
|
December 31, 2016
|
|
Cash
|
|
$
|
3,051,593
|
|
|
$
|
4,188,623
|
|
|
$
|
4,068,745
|
|
|
$
|
5,871,738
|
|
Restricted Cash
|
|
|
141,351
|
|
|
|
256,005
|
|
|
|
402,827
|
|
|
|
177,609
|
|
Total
|
|
$
|
3,192,944
|
|
|
$
|
4,444,628
|
|
|
$
|
4,471,572
|
|
|
$
|
6,049,347
|
|
Investment
– In accordance with ASC 325-20, the Company records its investment in common stock of Singapore eDevelopment Limited
at cost as the fair market value of the investment is not readily determinable. The Company evaluates investment for indications
of impairment at least annually.
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:
●
|
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
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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.
|
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, promissory notes 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 an interest rate swap that changes variable rates into fixed rates on one Citizens Bank term loan relating to the Company’s
subsidiary, Premier Packaging. This swap qualifies as a Level 2 fair value financial instrument. This swap agreement is not held
for trading purposes and the Company does not intend to sell this derivative swap financial instrument. The Company records the
interest swap agreement on the balance sheet at fair value because the agreement qualifies as a cash flow hedge 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, N.A. 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 June 30, 2018 was approximately $1,000 ($23,000 - December 31, 2017).
As
of June 30, 2018, the Company has an interest rate swap agreement for its debt with RBS Citizens, N.A. (“Citizens Bank”)
(see Note 6) which changes a variable rate into a fixed rate on a term loan as follows:
Notional
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|
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Variable
|
|
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Fixed
|
|
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Maturity
|
Amount
|
|
|
Amount
|
|
|
Cost
|
|
|
Date
|
$
|
891,608
|
|
|
|
5.15
|
%
|
|
|
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 and is calculated utilizing
the treasury stock method. In a loss period, the calculation for basic and diluted earnings per share is the same, as the impact
of potential common shares is anti-dilutive.
As
of June 30, 2018 and 2017, there were 3,376,527 and 3,278,127 respectively, of common stock share equivalents potentially issuable
by the Company pursuant to existing options, warrants, and restricted stock agreements, that could potentially dilute basic earnings
per share in the future. For the six-months ended June 30, 2018, based on the average market price of the Company’s common
stock during that period of $1.41, 283,123 common stock equivalents were added to the basic shares outstanding to calculate dilutive
earnings per share. For the three-months ended June 30, 2018, based on the average market price of the Company’s common
stock during that period of $1.33, 242,877 common stock equivalents were added to the basic shares outstanding to calculate dilutive
earnings per share. Common stock equivalents were excluded from the calculation of diluted earnings per share for 2017 periods
presented in which the Company had a net loss, since their inclusion would have been anti-dilutive.
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, 2018, two customers accounted for 24% and 14%, respectively, of the Company’s consolidated
revenue and accounted for 25% and 5%, respectively, of the Company’s accounts receivable balance as of June 30, 2018. During
the six months ended June 30, 2017, these two customers accounted for 23% and 14%, respectively, of the Company’s consolidated
revenue and accounted for 0% and 16%, respectively, of the Company’s accounts receivable balance as of June 30, 2017. 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 most of its customer contracts and by the diversification of its customer base.
Income
Taxes
- The Company has approximately $42.3M in federal net operating loss carryforwards (“NOLs”) available
to reduce future taxable income, which will expire at various dates from 2022 through 2036. As these NOL’s were generated
prior to the enactment of H.R. 1 (“Tax Cuts and Jobs Act” or “TCJA”) they are eligible to fully offset
taxable income. While the company generated taxable income due to the extinguishment of certain liabilities, it is not expected
to reoccur. Therefore, due to the uncertainty as to the Company’s ability to generate sufficient taxable income in the future
and utilize the NOLs before they expire, the Company has maintained a full valuation allowance against its deferred tax assets
accordingly.
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.
Recently
Adopted Accounting Pronouncements
–
In May 2014, the Financial Accounting Standards Board (“FASB”) issued
Accounting Standards Update (“ASU”) No. 2014-09 (Topic 606) “Revenue from Contracts with Customer” related
to revenue from contracts with customers. Under this standard, revenue is recognized when promised goods or services are transferred
to customers in an amount that reflects the consideration that is expected to be received for those goods or services. The updated
standard will replace most existing revenue recognition guidance under GAAP and permits the use of either the retrospective or
cumulative effect transition method. Topic 606 is effective for annual reporting periods beginning after December 15, 2017, including
interim periods within that reporting period. The Company adopted Topic 606 effective January 1, 2018. Topic 606 did not have
a material impact on the Company’s Consolidated Financial Statements
.
In
January 2016, the FASB issued ASU No. 2016-01, “Recognition and Measurement of Financial Assets and Financial Liabilities.”
ASU 2016-01 requires that most equity investments be measured at fair value, with subsequent changes in fair value recognized
in net income. Entities will no longer be able to use the cost method of accounting for equity securities. However, for equity
investments without readily determinable fair values, entities may elect a measurement alternative that will allow those investments
to be recorded at cost, less impairment, and adjusted for subsequent observable price changes. Upon adoption, entities must record
a cumulative-effect adjustment to the balance sheet as of the beginning of the first reporting period in which the standard is
adopted. The guidance on equity securities without readily determinable fair values will be applied prospectively to all equity
investments that exist as of the date of the adoption of the standard. The pronouncement also impacts financial liabilities under
the fair value option and the presentation and disclosure requirements for financial instruments. This pronouncement is effective
for fiscal years, and interim periods within those years, beginning after December 15, 2017, and early adoption is not permitted.
The Company adopted this new accounting standard during the three months ended March 31,
2018. ASU 2016-01 did not have a material impact on the Company’s Consolidated Financial Statements.
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. The Company adopted this standard during the three months ended March 31, 2018. The adoption
did not have a material impact on the Company’s 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
Company adopted the standard as of January 1, 2018 on a retrospective basis, wherein the statement of cash flow of each period
presented was adjusted to reflect the effects of applying the new guidance.
In
May 2017, the FASB issued ASU 2017-09, “Compensation – Stock Compensation (Topic 718) – Scope of Modification
Accounting”, which provides guidance about which changes to the terms or conditions of a share-based payment award require
an entity to apply modification accounting in Topic 718. ASU 2017-09 is effective for fiscal years beginning after December 15,
2017 and interim periods within those fiscal years, and early adoption is permitted, including in an interim period. ASU 2017-09
is to be applied on a prospective basis to an award modified on or after the adoption date. The Company adopted this standard
during the quarter ended March 31, 2018. The new accounting standard did not have a material impact on the Company’s Consolidated
Financial Statements.
Recent
Accounting Pronouncements
–
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 elected not to adopt this standard in advance of its required
effective date. The Company is currently assessing the impact that adopting this new accounting standard will have on its Consolidated
Financial Statements.
In
January 2017, the FASB issued ASU 2017-04, “Intangibles – Goodwill and Other (Topic 350) – Simplifying the Test
for Goodwill Impairment”, which eliminates the two-step process that required identification of potential impairment and
a separate measure of the actual impairment. The annual assessment of goodwill impairment will be determined by using the difference
between the carrying amount and the fair value of the reporting unit. The standards update are effective for goodwill impairment
tests in fiscal years beginning after December 15, 2019. The Company is currently assessing the impact that adopting this new
accounting standard will have on its Consolidated Financial Statements.
In
February 2018, the FASB issued ASU 2018-03, “Technical Corrections and Improvements to Financial Instruments (Subtopic 825-10)
– Recognition and Measurement of Financial Assets and Financial Liabilities”. This update was issued to clarify certain
narrow aspects of guidance concerning the recognition of financial assets and liabilities established in ASU No. 2016-01, “Financial
Instruments—Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities”.
This includes an amendment to clarify that an entity measuring an equity security using the measurement alternative may change
its measurement approach to a fair valuation method in accordance with Topic 820, Fair Value Measurement, through an irrevocable
election that would apply to that security and all identical or similar investments of the same issued. The update is effective
for fiscal years beginning after December 15, 2017 and interim periods within those fiscal years beginning after June 15, 2018.
The Company is currently assessing the impact that adopting this new accounting standard will have on its Consolidated Financial
Statements. The adoption of this standard is not expected to have a material impact on the Company’s Consolidated Financial
Statements.
2.
Revenue
Effective
January 1, 2018, the Company adopted Topic 606 using the modified retrospective approach and applied the guidance to those contracts
which were not completed as of January 1, 2018. Adoption of Topic 606 did not impact the timing of revenue recognition in the
Company’s Consolidated Financial Statements for the current or prior interim or annual periods. Accordingly, no adjustments
have been made to opening retained earnings or prior period amounts.
Revenue
Recognition
The
Company sells printed products including packaging printing and fabrication, commercial and security printing and plastic cards
and badges, including cards and badges integrated with technology such as RFID and smart chips. The Company also provides information
technology services and digital authentication products and services to its customers. The Company recognizes its products and
services revenue based on when the title passes to the customer or when the service is completed and accepted by the customer.
Revenue is measured as the amount of consideration the Company expects to receive in exchange for shipped product or service provided.
Sales and other taxes billed and collected from customers are excluded from revenue. Customers, including distributors, do not
have a general right of return. The Company also derives revenue from royalties from third parties which are typically based on
licensees’ net sales of products that utilize the Company’s technology, or on a per item usage of the technology on
the customers’ printed products. The Company recognizes license revenue at the time it is reported by the licensee. From
time to time, the Company generates license revenues through litigation settlements. For these, the Company recognizes revenue
upon the execution of the agreement, when collectability is reasonably assured, or upon receipt of the minimum upfront fee for
term agreement renewals, and when all other revenue recognition criteria have been met.
As
of June 30, 2018, the Company had no unsatisfied performance obligations for contracts with an original expected duration of greater
than one year. Pursuant to Topic 606, the Company has applied the practical expedient with respect to disclosure of the deferral
and future expected timing of revenue recognition for transaction price allocated to remaining performance obligations. The Company
elected the practical expedient allowing it to not recognize as a contract asset the commission paid to its salesforce on the
sale of its products as an incremental cost of obtaining a contract with a customer but rather recognize such commission as expense
when incurred as the amortization period of the asset that the Company would have otherwise recognized is one year or less.
Accounts
Receivable
The
Company extends credit to its customers in the normal course of business. The Company performs ongoing credit evaluations and
generally do not require collateral. Payment terms are generally 30 days but up to net 60 for certain customers. Trade accounts
receivable are recorded at their invoiced amounts, net of allowance for doubtful accounts. The Company evaluates the adequacy
of its allowance for doubtful accounts quarterly. Accounts outstanding for longer than contractual payment terms are considered
past due and are reviewed for collectability. Receivable balances are written off when collection is deemed unlikely.
Sales
Commissions
Sales
commissions are expensed as incurred for contracts with an expected duration of one year or less. There were no sales commissions
capitalized as of June 30, 2018.
Shipping
and Handling Costs
Costs
incurred by the Company related to shipping and handling are included in cost of products sold. Amounts charged to customers pertaining
to these costs are reflected as revenue.
See
Note 11 for disaggregated revenue information.
3.
Inventory
Inventory
consisted of the following:
|
|
Inventory
|
|
|
|
June 30, 2018
|
|
|
December 31, 2017
|
|
|
|
|
|
|
|
|
Finished Goods
|
|
$
|
1,075,963
|
|
|
$
|
965,757
|
|
WIP
|
|
|
142,997
|
|
|
|
383,270
|
|
Raw Materials
|
|
|
142,773
|
|
|
|
302,219
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
1,361,733
|
|
|
$
|
1,651,246
|
|
4.
Related Party Investment
On
September 12, 2017, the Company and Hengfai Business Development Pte Ltd. (“HBD”) entered into a
Securities Exchange Agreement whereby the Company agreed to issue and sell to HBD 683,000 shares of its common stock, which
had a market value on that date of $484,930, in exchange for 21,196,552 ordinary shares which was 1.92% of the total
outstanding common stock of SED as of December 31, 2017, and an existing three-year warrant to purchase up to 105,982,759
of ordinary shares at an exercise price of SGD$0.040 (US$0.0298) per share of Singapore eDevelopment Limited
(“SED”), a company incorporated in Singapore and publicly-listed on the Singapore Exchange Limited. The SED
shares and warrants were owned by HBD. One of the directors of the Company, Mr. Heng Fai Ambrose Chan, who also serves as the
Chief Executive Officer of the Company’s subsidiary, DSS International Inc., is a related party to each of HBD and SED.
The shares and warrants are restricted for two years after the agreement date. At the time of the investment, the cost of the
investment was determined to be the fair value of the Company’s common stock issued in the transaction, which was
determined to have the most readily determinable fair value. As of December 31, 2017, the Company performed its annual
assessment of impairment for the SED shares and warrant. In making this assessment, the Company determined, that the SED
shares, which trade on the Singapore Stock Exchange, had a market value of $900,112 and the warrant had an aggregate
intrinsic value of approximately $1,343,000 based on a share price of SGD $0.057 (US$ 0.042) as of December 31, 2017.
However, the Company determined that these values did not represent a readily determinable fair value due to a potential lack
of liquidity of the SED shares and warrants due to a low average trading volume of the SED shares and the effect of the time
restriction on the ability of the Company to sell the shares until September 17, 2019. In 2018, the Company adopted ASU No.
2016-01, “Recognition and Measurement of Financial Assets and Financial Liabilities.” In accordance with ASU No.
2016-01, the Company noted that the SED share price had changed but such change, evaluated under the practicability election
of ASU 2016-01, did not affect the Company’s determination that this observable price change would cause the Company to
change its determination that the investment cost was the most readily determinable fair value or that such price change was
an indicator of impairment. As of June 30, 2018, the SED shares had a market value of $762,319 and the warrant had an
aggregate intrinsic value of approximately $700,122 based on a share price of SGD $0.049 (US$ 0.036).
5.
Intangible Assets
Intangible
assets are comprised of the following:
|
|
|
|
June 30, 2018
|
|
|
December 31, 2017
|
|
|
|
Useful Life
|
|
Gross Carrying Amount
|
|
|
Accumulated Amortization
|
|
|
Net Carrying Amount
|
|
|
Gross Carrying Amount
|
|
|
Accumulated Amortization
|
|
|
Net Carrying Amount
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Acquired intangibles - customer lists and non-compete agreements
|
|
5-10 years
|
|
|
1,997,300
|
|
|
|
1,853,800
|
|
|
|
143,500
|
|
|
|
1,997,300
|
|
|
|
1,810,750
|
|
|
|
186,550
|
|
Acquired intangibles - patents and patent rights
|
|
|
|
|
500,000
|
|
|
|
500,000
|
|
|
|
-
|
|
|
|
3,155,000
|
|
|
|
2,603,942
|
|
|
|
551,058
|
|
Patent application costs
|
|
Varied (1)
|
|
|
1,168,155
|
|
|
|
705,899
|
|
|
|
462,256
|
|
|
|
1,148,017
|
|
|
|
664,873
|
|
|
|
483,144
|
|
|
|
|
|
$
|
3,665,455
|
|
|
$
|
3,059,699
|
|
|
$
|
605,756
|
|
|
$
|
6,300,317
|
|
|
$
|
5,079,565
|
|
|
$
|
1,220,752
|
|
(1)
|
Patent
application costs are amortized over their expected useful life which is generally the remaining legal life of the patent.
As of June 30, 2018, the weighted average remaining useful life of these assets in service was approximately 7.2 years.
|
Intangible
asset amortization expense for the six months ended June 30, 2018 amounted to $339,663 ($344,238- June 30, 2017).
On
June 26, 2018, the Company entered into an agreement with Fortress Credit Co LLC (“Fortress”), which among other things
transferred to Fortress all of the remaining economic rights to certain of the Company’s semi-conductor related patents
(See Note 6). As a result, the Company wrote-off these patents which had an aggregated gross cost of $2,655,000 and a net unamortized
carrying amount of $295,470 on the agreement date.
6.
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 (“Citizens”) of up to $800,000 that bears interest at 1 Month LIBOR plus 3.75% (5.81%
as of June 30, 2018) and expired on July 26, 2018. As of June 30, 2018, and December 31, 2017, the revolving line had a
balance of $0.
On
July 26, 2017, Premier Packaging entered into a Loan Agreement and accompanying Term Note Non-Revolving Line of Credit Agreement
with Citizens pursuant to which Citizens agreed to lend up to $1,200,000 to permit Premier Packaging to purchase equipment from
time to time that it may need for use in its business. As of June 30, 2018, and December 31, 2017, the revolving line had a balance
of $0.
On
December 1, 2017, the Company’s subsidiary Plastic Printing Professionals entered into a Loan Agreement and accompanying
Term Note Non-Revolving Line of Credit Agreement with Citizens pursuant to which Citizens agreed to lend up to $800,000 to enable
Plastic Printing Professionals to purchase equipment from time to time that it may need for use in its business. Advances may
be made under this Equipment Acquisition Line of Credit, from time to time, from December 1, 2017 until December 1, 2018. The
aggregate principal balance outstanding under the Equipment Acquisition Line of Credit bears interest at 2% above the LIBOR Advantage
Rate (as defined in the agreement) (4.00% at June 30, 2018) until converted. Effective on conversion, the interest rate payable
on the aggregate principal balance outstanding shall be adjusted to a fixed rate equal to 2% above Citizens’ cost of funds
as determined by Citizens. Prior to conversion, interest on the outstanding principal is payable in arrears monthly. After conversion,
the aggregate principal balance may be repaid in (i) up to 84 installments comprised of principal and interest for new equipment
or (ii) up to 60 installments comprised of principal and interest for used equipment. An initial advance was made under the Equipment
Acquisition Line of Credit on December 1, 2017, in the amount of $522,000, to fund the purchase of a used 6-color commercial press.
As of June 30, 2018, the balance of the equipment line was $522,000 ($522,000 at December 31, 2017). As of the date of this report,
the Company had not yet converted the $522,000 into a term note.
Long-Term
Debt
- 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. On May
31, 2017, the Company entered into Convertible Promissory Note Amendment No. 4 to extend the maturity date to December 31, 2018
at which point the note is scheduled to be paid in full. In exchange for the extension, the Company issued the lender as additional
consideration 18,000 shares of the Company’s common stock which had a fair value of $17,640. As of June 30, 2018, the balance
of the term loan was $195,000 ($325,000 at December 31, 2017).
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 June 30, 2018, the loan had a balance of
$145,010 ($286,560 at December 31, 2017).
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 3.62% 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 June 30,
2018, the loan had a balance of $203,755 ($257,007 at December 31, 2017).
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% (5.15% at June 30, 2018). 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 (see Note 1. “Derivative Instruments”). The
Promissory Note matures in August 2021 at which time a balloon payment of the remaining principal balance will be due. As of June
30, 2018, the Promissory Note had a balance of $891,608 ($915,107 at December 31, 2017).
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% (5.15% at June 30, 2018), 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, 2018, the note had a balance of $330,000 ($345,000 – December 31, 2017).
The
Citizens credit facilities to each of the Company’s subsidiaries, Premier Packaging and Plastic Printing Professionals,
contain various covenants including fixed charge coverage ratio, tangible net worth and current ratio covenants which are tested
annually at December 31. For the year ended December 31, 2017, both Premier Packaging and Plastic Printing Professionals were
in compliance with the annual covenants.
Other
Debt
- On February 13, 2014, the Company’s subsidiary, DSS Technology Management, Inc. (“DSS Technology Management”
or “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 also 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 was being amortized on a straight-line basis through the amended maturity
date of February 13, 2018. The Amendment added a provision whereby DSSTM was 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 and March 2, 2018 deposits were made in a timely manner. The Deposit funds were 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 would 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 February 13, 2018, DSSTM had made aggregate principal payments of $794,283 on the notes. On February 13, 2018, the Maturity
Date, DSS Technology Management defaulted by failing to pay the investors an amount equal to (x) two times the aggregate amount
of all advances made by the investors as of such date plus (y) the Capitalized Expenses. The sole recourse available to the investors
under the Agreement, as amended, was the establishment of a special purpose entity controlled by the investors which would take
ownership of the collateral consisting of the patents covered under the amended Agreement. Each of the investors and the collateral
agent had contractually agreed that they would not, individually or collectively, seek to enforce any monetary judgment with respect
to or against any assets of the Company other than the patents and the monetization payments and the remaining deposit. On June
26, 2018, the parties agreed that the amounts due under the Agreement having an aggregate remaining balance of $3,714,129 as of
the Maturity Date, are discharged, without the assignment to the Investors of any of the collateral that secured the repayment
under the Agreement. In addition, the Company confirmed its obligation to pay the Investors $345,000 that remained from an aggregate
of $600,000 that had been deposited and restricted to cover expenses related to the IP monetization activities. Furthermore, the
parties agreed that in the event there are any future recoveries by DSSTM with respect to monetization activities relating to
the collateralized patents or applicable proceed rights set forth in the Agreement, the contractual payment provisions of the
original Agreement will apply and the Investors will be entitled to receive payment of such proceeds. As a result of this agreement,
the Company paid $345,000 from restricted cash and recorded a gain of extinguishment of liabilities of $3,372,129 to reflect the
discharge of the notes, wrote off contingent equity interests of $459,000 eliminated by the agreement, and wrote-off the underlying
patents which had an aggregated gross cost of $2,655,000 and an net unamortized carrying amount of $295,470 on the agreement date,
all of which resulted in the a net gain on the extinguishment of liabilities of $3,532,659 recorded in the three months ending
June 30, 2018.
7.
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 the 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, on November 14, 2016, the Company received $4,500,000 of the Financing, which was 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. As of June 30, 2018, an aggregate of approximately $2,873,000 is recorded as other liabilities by the Company,
of which approximately $2,089,000 is classified as short-term. Of this amount, the Company allocated $2,500,000 which it subsequently
adjusted to $1,500,000 for the payment of estimated future Inter Partes Review costs. The Company will reduce this liability as
it pays legal and other expenses related to the Inter Partes Review matters involving the LED Patent Portfolio as incurred. The
remaining $1,476,000 in other liabilities is allocated to working capital, which the Company is amortizing on a pro-rata basis
over the expected remaining life of the monetization period of the LED Patent Portfolio through November 30, 2019. For this amount,
the Company reduced the liability with an offset to selling, general and administrative costs by $47,500 per month from January
2017 through July 2017, $80,000 per month for the remainder of 2017 through March 2018, and $86,500 per month for the remainder
of 2018. During the six months ended June 30, 2018, there was $74,000 of Inter Partes Review costs and an aggregate of $501,000
was recorded as a reduction of the liability allocated to working capital.
On
July 8, 2013, the Company’s subsidiary, DSSTM , purchased two patents for $500,000 covering certain methods and processes
related to Bluetooth devices. In conjunction with the patent purchases, DSSTM entered into a Proceed Right Agreement with certain
investors pursuant to which DSSTM 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 June 30, 2018, the Company had received an aggregate of $650,000 ($650,000 in 2017) from the investors
pursuant to the agreement of which approximately $407,000 was in current liabilities in the consolidated balance sheets ($432,000
as of December 31, 2017). The Company reduces 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 6, on February 13, 2014, DSSTM entered into an Investment Agreement with Fortress. Pursuant to this agreement,
an aggregate of $459,000 of fixed and contingent equity interests received are recorded in current liabilities. The liabilities
under the agreement matured on February 13, 2018. Per the agreement, the Investors have the right to take ownership of the patents
as settlement of the liabilities upon maturity. On June 26, 2018, the parties entered into an agreement (see Note 6 “Other
Debt”) which among other things eliminated the Company’s obligation for the fixed and contingent equity interests
under the agreement.
8.
Commitments and Contingencies
On
November 26, 2013, DSSTM 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
DSSTM’s patents that relate to systems and methods of using low power wireless peripheral devices. DSSTM 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. DSSTM then filed an appeal with the U.S. Court of Appeals for the Federal
Circuit (the “Federal Circuit”) seeking reversal of the PTAB decisions. Oral arguments for the appeal were held on
August 9, 2017. On March 23, 2018, the Federal Circuit reversed the PTAB, finding that the PTAB erred when it found the claims
of U.S. Patent No. 6,128,290 to be unpatentable. The Federal Circuit affirmed its decision on July 12, 2018, when it denied Apple’s
petition for panel rehearing of the Federal Circuit’s Opinion and Judgment issued on March 23, 2018. On July 27, 2018, the
District Court judge lifted the Stay resuming the litigation. 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 because of that earlier PTAB decision.
On
February 16, 2015, DSSTM 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. On June 1, 2017, the PTAB ruled
in favor of Intel for all the challenged claims. On July 28, 2017, DSSTM filed a notice of appeal of the PTAB’s decision
relating to U.S. Patent 6,784,552 with the Federal Circuit. The Intel litigation has been stayed by the District Court pending
final determination of the IPR proceedings.
On
July 16, 2015, DSSTM 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, DSSTM 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, which was instituted by the PTAB. On September
20, 2017, PTAB ruled in favor of Samsung for all the challenged claims relating to U.S. Patent 6,784,552. DSSTM then appealed
this PTAB ruling to the Federal Circuit on November 17, 2017. The Federal Circuit joined this appeal with the Intel appeal effective
on December 7, 2017. The appeal is still pending as of the date of this Report. Qualcomm filed its IPR proceeding on July 1, 2016,
which was then later joined with Intel’s IPRs in August 2016 by PTAB. On June 1, 2017, the PTAB ruled in favor of Intel/Qualcomm
for all the challenged claims. On July 28, 2017, DSSTM filed a notice of appeal of the PTAB’s decision relating to U.S.
Patent 6,784,552 with the Federal Circuit. As indicated above, this joint appeal is still pending as of the date of this Report.
On
April 13, 2017, the Company filed a patent infringement lawsuit against Seoul Semiconductor Co., Ltd. and Seoul Semiconductor,
Inc. (collectively, “Seoul Semiconductor”) in the United States District Court for the Eastern District of Texas,
alleging infringement of certain of the Company’s Light-Emitting Diode (“LED”) patents. The Company is seeking
a judgement for infringement of the patents along with other relief including, but not limited to, money damages, costs and disbursements.
On June 7, 2017, the Company refiled its patent infringement complaint against Seoul Semiconductor in the United States District
Court for the Central District of California, Southern Division. The case is currently pending. On December 3, 2017, Seoul Semiconductor
filed an IPR challenging the validity of certain claims of U.S. Patent No. 6,949,771. This IPR was instituted by the PTAB on June
7, 2018. On December 21, 2017, Seoul Semiconductor filed an IPR challenging the validity of certain claims of U.S. Patent No.
7,256,486. This IPR was instituted by the PTAB on June 21, 2018. On January 25, 2018, Seoul Semiconductor filed an IPR challenging
the validity of certain claims of U.S. Patent No. 7,524,087. This IPR was instituted by the PTAB on July 27, 2018. These challenged
patents are the patents that are the subject matter of the infringement lawsuit which is still pending as of the date of this
Report.
On
April 13, 2017, the Company filed a patent infringement lawsuit against Everlight Electronics Co., Ltd. and Everlight Americas,
Inc. (collectively, “Everlight”) in the United States District Court for the Eastern District of Texas, alleging infringement
of certain of the Company’s LED patents. The Company is seeking a judgement for infringement of the patents along with other
relief including, but not limited to, money damages, costs and disbursements. On June 8, 2017, the Company refiled its patent
infringement complaint against Everlight in the United States District Court for the Central District of California. The case
is currently pending as of the date of this Report. On June 8, 2018, Everlight filed IPR petitions challenging the validity of
claims under U.S. Patent Nos. 7256486 and 7524087. On June 12, 2018, Everlight filed an IPR petition challenging the validity
of claims under U.S. Patent No. 6949771, and on June 15, 2018, filed an IPR petition challenging the validity of claims under
U.S. Patent No 7919787. These challenged patents are the patents that are the subject matter of the infringement lawsuit.
On
April 13, 2017, the Company filed a patent infringement lawsuit against Cree, Inc. (“Cree”) in the United States District
Court for the Eastern District of Texas, alleging infringement of certain of the Company’s LED patents. The Company is seeking
a judgement for infringement of the patents along with other relief including, but not limited to, money damages, costs and disbursements.
On June 8, 2017, the Company refiled its patent infringement complaint against Cree in the United States District Court for the
Central District of California, and thereafter filed a first amended complaint for patent infringement against Cree in that same
court on July 14, 2017. The case is currently pending as of the date of this Report. On June 6, 2018, Cree filed an IPR petition
challenging the validity of claims under U.S. Patent No. 7256486. On June 7, 2018, Cree filed IPR petitions challenging the validity
of claims under U.S. Patent Nos. 7524087 and 6949771. These challenged patents are the patents that are the subject matter of
the infringement lawsuit.
On
July 13, 2017, the Company filed a patent infringement lawsuit against Osram GMBH, Osram OPTO Semiconductors GMBH & Co., and
Osram Sylvania Inc. (collectively, “Osram”) in the United States District Court for the Central District of California,
alleging infringement of certain of the Company’s LED patents. DSS is seeking a judgment for infringement of the patents
along with other relief including, but not limited to, money damages, costs and disbursements. On February 21, 2018, the Company
and Osram executed a confidential settlement agreement ending the litigation between them.
On
August 15, 2017, the Company filed a patent infringement lawsuit against Lite-On, Inc., and Lite-On Technology Corporation (collectively,
“Lite-On”) in the United States District Court for the Central District of California, alleging infringement of certain
of the Company’s LED patents. The Company is seeking a judgement for infringement of the patents along with other relief
including, but not limited to, money damages, costs and disbursements. The case is currently pending as of the date of this Report.
On
December 7, 2017, the Company filed a patent infringement lawsuit against Nichia Corporation and Nichia America Corporation (collectively,
“Nichia”) in the United States District Court for the Central District of California, alleging infringement of certain
of the Company’s LED patents. The Company is seeking a judgement for infringement of the patents along with other relief
including, but not limited to, money damages, costs and disbursements. The case is currently pending as of the date of this Report.
On May 10, 2018, Nichia filed an IPR petition challenging the validity of claims under U.S. Patent No. 7919787. On May 11, 2018,
Nichia filed an IPR petition challenging the validity of claims under U.S. Patent No. 7652297. On May 25, 2018, Nichia filed an
IPR petition challenging the validity of claims under U.S. Patent No. 7524087. On May 29, 2018, Nichia filed an IPR petition challenging
the validity of claims under U.S. Patent No. 6949771. On May 30, 2018, Nichia filed an IPR petition challenging the validity of
claims under U.S. Patent No. 7256486. These challenged patents are the patents that are the subject matter of the infringement
lawsuit.
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 June 30, 2018, and December 31, 2017, the Company
had 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 June 30, 2018, and December 31, 2017, there are no contingent
payments due.
On
July 31, 2018, the Company and Robert Bzdick entered into a Non-Compete Letter Agreement (the “Agreement”) whereby
the parties mutually agreed that Mr. Bzdick’s employment as President of the Company and Chief Executive Officer of Premier
Packaging Corporation, a wholly-owned subsidiary of the Company, terminated effective on August 1, 2018. The Agreement voids and
replaces Mr. Bzdick’s existing Employment Agreement with the Company, originally dated February 12, 2010, and amended on
October 1, 2012, except for the non-competition and non-solicitation covenants contained therein, which have been carried forward
in their entirety to the new Agreement. Pursuant to the terms of the Agreement, Mr. Bzdick will receive his regular wages and
contractual bonus sum accrued through the separation date, and will also receive the sum of $16,000 per month, for a period of
19 months, as consideration for the two-year non-competition and non-solicitation restrictive covenants contained in the Agreement,
which are identical to the restrictive covenants contained in Mr. Bzdick’s previous employment agreement, which are now
incorporated by reference into the Agreement. In addition, the Company will continue to pay the cost of Mr. Bzdick’s health,
dental and vision insurance coverage for a period of 19 months or until he is eligible for such benefits from another employer,
whichever is shorter.
9.
Stockholders’ Equity
Stock
Options
-
During the six months ended June 30, 2016, the Company issued an aggregate of 265,000 options to purchase
the Company’s common stock at $1.30 per share with a term of five years to employees at its technology divisions and to
independent board members. The options vest pro-ratably as follows: 1/3 on the grant date, 1/3 on the first anniversary of the
grant date and 1/3 on the second anniversary of the grant date as long as the employee is employed or direct is active on such
dates. The options had an aggregate estimated fair value on the grant date $217,300 using the Black-Scholes-Merton option pricing
model with a volatility of 98.1%, a risk free rate of return of 2.67% and zero dividend and forfeiture estimates.
Sales
of Equity
-
On August 30, 2017, the Company sold 1,200,000 shares of unregistered common stock and five-year warrants
to purchase up to an aggregate of 240,000 additional shares of the Company’s common stock at an exercise price of $1.00
to a total of two related party accredited investors for an aggregate purchase price of $900,000, of which $300,000 was recorded
as a subscription receivable as of December 31, 2017 in the stockholders equity section. On March 29, 2018, the Company received
the payment of the $300,000 subscription receivable from the investor, which is presented net of $12,000 of financing costs.
On
July 3, 2018, the Company sold 214,286 shares of its common stock, par value $0.02 per share, to a related party accredited investor,
Heng Fai Holdings Limited. The purchase price was $1.40 per share, for total proceeds of $300,000.
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 six months ended June 30, 2018, the Company had stock compensation expense of approximately $86,000 or less than $0.01 basic
and diluted earnings per share ($191,000; less than $0.01 basic and diluted earnings per share for the corresponding six months
ended June 30, 2017).
10.
Supplemental Cash Flow Information
The
following table summarizes supplemental cash flows for the six-month periods ended June 30, 2018 and 2017:
Supplemental Cash Information
|
|
|
|
|
|
|
|
|
2018
|
|
|
2017
|
|
|
|
|
|
|
|
|
Cash paid for interest
|
|
$
|
71,000
|
|
|
$
|
85,500
|
|
|
|
|
|
|
|
|
|
|
Non-cash investing and financing activities:
|
|
|
|
|
|
|
|
|
Gain from change in fair value of interest rate swap derivatives
|
|
$
|
22,000
|
|
|
$
|
5,000
|
|
|
|
|
|
|
|
|
|
|
Eliminiation of contingent liabilities through agreement
|
|
$
|
459,000
|
|
|
$
|
-
|
|
11.
Segment Information
The
Company’s businesses are organized, managed and internally reported as five 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 three other operating segments, DSS Digital Group, DSS Technology
Management, and DSS International, which was added in 2018, 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 and six months ended June 30, 2018 and
2017 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, 2018
|
|
Packaging and Printing
|
|
|
Plastics
|
|
|
Technology
|
|
|
Corporate
|
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue
|
|
$
|
2,829,000
|
|
|
$
|
896,000
|
|
|
$
|
362,000
|
|
|
$
|
-
|
|
|
$
|
4,087,000
|
|
Depreciation and amortization
|
|
|
168,000
|
|
|
|
29,000
|
|
|
|
150,000
|
|
|
|
-
|
|
|
|
347,000
|
|
Interest expense
|
|
|
(23,000
|
)
|
|
|
(5,000
|
)
|
|
|
-
|
|
|
|
(6,000
|
)
|
|
|
(34,000
|
)
|
Stock based compensation
|
|
|
-
|
|
|
|
-
|
|
|
|
66,000
|
|
|
|
19,000
|
|
|
|
85,000
|
|
Net Income (loss)
|
|
|
35,000
|
|
|
|
(87,000
|
)
|
|
|
3,016,000
|
|
|
|
(287,000
|
)
|
|
|
2,677,000
|
|
Three Months Ended June 30, 2017
|
|
Packaging and Printing
|
|
|
Plastics
|
|
|
Technology
|
|
|
Corporate
|
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue
|
|
$
|
2,157,000
|
|
|
$
|
1,226,000
|
|
|
$
|
477,000
|
|
|
$
|
-
|
|
|
$
|
3,860,000
|
|
Depreciation and amortization
|
|
|
159,000
|
|
|
|
30,000
|
|
|
|
157,000
|
|
|
|
1,000
|
|
|
|
347,000
|
|
Interest expense
|
|
|
(27,000
|
)
|
|
|
-
|
|
|
|
(14,000
|
)
|
|
|
(14,000
|
)
|
|
|
(55,000
|
)
|
Stock based compensation
|
|
|
-
|
|
|
|
-
|
|
|
|
14,000
|
|
|
|
44,000
|
|
|
|
58,000
|
|
Net Income (loss)
|
|
|
116,000
|
|
|
|
155,000
|
|
|
|
(260,000
|
)
|
|
|
(276,000
|
)
|
|
|
(265,000
|
)
|
Six Months Ended June 30, 2018
|
|
Packaging and Printing
|
|
|
Plastics
|
|
|
Technology
|
|
|
Corporate
|
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue
|
|
$
|
5,747,000
|
|
|
$
|
1,901,000
|
|
|
$
|
817,000
|
|
|
$
|
-
|
|
|
$
|
8,465,000
|
|
Depreciation and amortization
|
|
|
334,000
|
|
|
|
59,000
|
|
|
|
299,000
|
|
|
|
-
|
|
|
|
692,000
|
|
Interest expense
|
|
|
(46,000
|
)
|
|
|
(11,000
|
)
|
|
|
(12,000
|
)
|
|
|
(14,000
|
)
|
|
|
(83,000
|
)
|
Stock based compensation
|
|
|
-
|
|
|
|
-
|
|
|
|
67,000
|
|
|
|
19,000
|
|
|
|
86,000
|
|
Net Income (loss)
|
|
|
281,000
|
|
|
|
(9,000
|
)
|
|
|
2,523,000
|
|
|
|
(524,000
|
)
|
|
|
2,271,000
|
|
Identifiable assets
|
|
|
9,048,000
|
|
|
|
2,947,000
|
|
|
|
1,113,000
|
|
|
|
2,034,000
|
|
|
|
15,142,000
|
|
Six Months Ended June 30, 2017
|
|
Packaging and Printing
|
|
|
Plastics
|
|
|
Technology
|
|
|
Corporate
|
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue
|
|
$
|
5,403,000
|
|
|
$
|
2,383,000
|
|
|
$
|
845,000
|
|
|
$
|
-
|
|
|
$
|
8,631,000
|
|
Depreciation and amortization
|
|
|
319,000
|
|
|
|
60,000
|
|
|
|
310,000
|
|
|
|
1,000
|
|
|
|
690,000
|
|
Interest Expense
|
|
|
(55,000
|
)
|
|
|
-
|
|
|
|
(27,000
|
)
|
|
|
(30,000
|
)
|
|
|
(112,000
|
)
|
Stock based compensation
|
|
|
-
|
|
|
|
-
|
|
|
|
37,000
|
|
|
|
154,000
|
|
|
|
191,000
|
|
Net Income (loss)
|
|
|
508,000
|
|
|
|
318,000
|
|
|
|
(571,000
|
)
|
|
|
(704,000
|
)
|
|
|
(449,000
|
)
|
Identifiable assets
|
|
|
9,185,000
|
|
|
|
2,395,000
|
|
|
|
1,897,000
|
|
|
|
3,341,000
|
|
|
|
16,818,000
|
|
The
following tables disaggregate our business segment revenues by major source.
Printed
Products Revenue Information:
Printed Products Revenue Information
|
|
|
|
|
|
Total
|
|
Three months ended June 30, 2018
|
|
|
|
|
Packaging Printing and Fabrication
|
|
$
|
2,491,000
|
|
Commercial and Security Printing
|
|
|
338,000
|
|
Technology Integrated Plastic Cards and Badges
|
|
|
253,000
|
|
Plastic Cards, Badges and Accessories
|
|
|
643,000
|
|
Total Printed Products
|
|
$
|
3,725,000
|
|
|
|
|
|
|
Three months ended June 30, 2017
|
|
|
|
|
Packaging Printing and Fabrication
|
|
$
|
1,931,000
|
|
Commercial and Security Printing
|
|
|
223,000
|
|
Technology Integrated Plastic Cards and Badges
|
|
|
611,000
|
|
Plastic Cards, Badges and Accessories
|
|
|
618,000
|
|
Total Printed Products
|
|
$
|
3,383,000
|
|
|
|
|
|
|
Six months ended June 30, 2018
|
|
|
|
|
Packaging Printing and Fabrication
|
|
$
|
5,110,000
|
|
Commercial and Security Printing
|
|
|
638,000
|
|
Technology Integrated Plastic Cards and Badges
|
|
|
505,000
|
|
Plastic Cards, Badges and Accessories
|
|
|
1,395,000
|
|
Total Printed Products
|
|
$
|
7,648,000
|
|
|
|
|
|
|
Six months ended June 30, 2017
|
|
|
|
|
Packaging Printing and Fabrication
|
|
$
|
4,865,000
|
|
Commercial and Security Printing
|
|
|
540,000
|
|
Technology Integrated Plastic Cards and Badges
|
|
|
893,000
|
|
Plastic Cards, Badges and Accessories
|
|
|
1,488,000
|
|
Total Printed Products
|
|
$
|
7,786,000
|
|
Technology
Sales, Services and Licensing Revenue Information:
|
|
Total
|
|
Three months ended June 30, 2018
|
|
|
|
Information Technology Sales and Services
|
|
$
|
78,000
|
|
Digital Authentication Products and Services
|
|
|
174,000
|
|
Royalties from Licensees
|
|
|
110,000
|
|
Total Technology Sales, Services and Licensing
|
|
$
|
362,000
|
|
|
|
|
|
|
Three months ended June 30, 2017
|
|
|
|
|
Information Technology Sales and Services
|
|
$
|
120,000
|
|
Digital Authentication Products and Services
|
|
|
189,000
|
|
Royalties from Licensees
|
|
|
169,000
|
|
Total Technology Sales, Services and Licensing
|
|
$
|
478,000
|
|
|
|
|
|
|
Six months ended June 30, 2018
|
|
|
|
|
Information Technology Sales and Services
|
|
$
|
208,000
|
|
Digital Authentication Products and Services
|
|
|
351,000
|
|
Royalties from Licensees
|
|
|
257,000
|
|
Total Technology Sales, Services and Licensing
|
|
$
|
816,000
|
|
|
|
|
|
|
Six months ended June 30, 2017
|
|
|
|
|
Information Technology Sales and Services
|
|
$
|
251,000
|
|
Digital Authentication Products and Services
|
|
|
254,000
|
|
Royalties from Licensees
|
|
|
340,000
|
|
Total Technology Sales, Services and Licensing
|
|
$
|
845,000
|
|