DSS, Inc. — Q2 2018 Form 10-Q
Reporting period: Three and six months ended June 30, 2018. DSS operates in security and commercial printing, packaging, plastic cards, digital authentication and services, and intellectual-property monetization. Figures below are unaudited.
Financial results and liquidity
| Metric | Q2 2018 | Q2 2017 | First half 2018 | First half 2017 |
|---|---|---|---|---|
| Revenue | $4.087 million | $3.860 million | $8.465 million | $8.631 million |
| Operating loss | $(818,000) | $(168,000) | $(1.151) million | $(254,000) |
| Net income (loss) | $2.677 million | $(265,000) | $2.271 million | $(449,000) |
| Operating cash flow | Not stated separately for the quarter | $(450,000) | $(800,000) |
- Q2 revenue rose 6%; printed-products revenue increased 10%, while technology sales, services and licensing declined 24%. First-half revenue fell 2%, with printed products down 2% and technology revenue down 3%.
- Gross margin, calculated as revenue less cost of revenue before depreciation and amortization, was approximately 32.6% in Q2 versus 43.2% a year earlier, and 36.9% for the first half versus 42.3%. Higher direct costs, including outside packaging services and materials, weighed on margins.
- Net income reflects a one-time $3.533 million net gain on extinguishment of liabilities. Excluding that gain, the company had an operating loss and other net expenses; the filing does not present an adjusted net-income measure.
- At June 30, cash was $3.052 million and restricted cash was $141,000, compared with cash of $4.189 million and restricted cash of $256,000 at year-end. Total current assets were $6.751 million and current liabilities $5.139 million, implying working capital of about $1.611 million and a current ratio of about 1.31.
- Balance-sheet debt was approximately $2.265 million, consisting of $624,000 current and $1.641 million long-term debt; this compares with approximately $6.346 million at December 31, 2017. The company used $758,000 for debt principal payments in the first half, including a $345,000 payment related to the Fortress settlement.
- Investing cash outflow was $332,000, mainly for equipment. Financing cash outflow was $470,000, partly offset by $288,000 collected on a subscription receivable. Cash and restricted cash decreased by $1.252 million in the first half.
Material changes and unusual items
- On June 26, DSS reached an agreement with Fortress and related investors discharging approximately $3.714 million of debt obligations without transferring the collateral patents. DSS paid $345,000 of restricted funds, eliminated $459,000 of contingent equity interests, and wrote off patents with a $295,000 net carrying amount. These items resulted in the reported $3.533 million net gain.
- Intangible assets fell to $606,000 from $1.221 million, reflecting amortization and the write-off of the semiconductor-related patents transferred or otherwise covered by the Fortress agreement.
- Other liabilities included approximately $2.873 million related to the LED patent monetization program, including amounts for anticipated legal proceedings and working capital. The filing reports no contingent payments currently due to funding partners, but future patent monetization proceeds may be subject to contractual sharing.
- A related-party investor purchased $300,000 of DSS shares after quarter-end, on July 3, 2018. DSS also disclosed that its president and Premier Packaging CEO’s employment ended effective August 1; the agreement provides $16,000 per month for 19 months, plus continued insurance subject to stated terms.
Outlook, risks and management commentary
- Management stated that available cash should be sufficient for at least 12 months from the filing date and said equity or debt financing could be available if needed. No specific revenue, earnings or margin guidance was provided.
- Management attributed increased operating losses to higher direct costs as a percentage of printed-products sales, increased professional fees and costs associated with the Hong Kong office opened in January 2018. Professional fees increased 80% in Q2 and 63% in the first half, primarily due to consulting and patent litigation costs.
- Patent litigation remains a significant uncertainty. The Federal Circuit reversed the PTAB’s adverse ruling on a DSS patent in the Apple matter; the district court lifted its stay in July 2018. Other infringement cases remain pending, while multiple defendants have challenged DSS LED patents through inter partes review proceedings. Adverse outcomes could materially affect results, cash flows or financial condition.
- Two customers represented 24% and 14% of first-half 2018 revenue, respectively, creating customer concentration risk. DSS also reported that disclosure controls and procedures remained ineffective at June 30 because of a previously disclosed material weakness. Management planned to continue monitoring and evaluating remediation options.
- Management cautioned that interim results may not indicate full-year performance. The filing reports no material change to the risk factors previously disclosed in the 2017 Form 10-K.
Most important facts for investors to verify
- Whether core operations can improve margins and reduce operating losses without relying on debt extinguishments or other nonrecurring gains.
- Cash burn, debt repayment requirements, covenant compliance and the availability of financing; management’s liquidity statement is an expectation, not a guarantee.
- The status and potential cost or proceeds of the Apple, LED and other patent cases, including IPR outcomes and contractual claims on any recoveries.
- The composition, timing and ultimate cash requirements of the $2.873 million in other liabilities tied to the LED monetization program.
- Progress in remediating the material weakness and the effect of customer concentration on revenue and collections.