DSS, Inc. — Q2 2011 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2011. DSS operates security and commercial printing, plastic cards, packaging, licensing and digital solutions businesses. It acquired IT and cloud-services provider ExtraDev in May and reorganized reporting into four segments.
Financial performance
| Metric | Q2 2011 | Q2 2010 | Six months 2011 | Six months 2010 |
|---|---|---|---|---|
| Revenue | $2.876 million | $3.325 million | $5.561 million | $6.100 million |
| Gross profit | $808,000 | $878,000 | $1.742 million | $1.724 million |
| Gross margin | 28% | 26% | 31% | 28% |
| Operating loss | $1.049 million | $847,000 | $1.753 million | $1.948 million |
| Net loss | $1.112 million | $997,000 | $1.510 million | $2.117 million |
| Loss per share, basic and diluted | $0.06 | $0.06 | $0.08 | $0.12 |
Q2 revenue fell 14%, mainly from lower printing and packaging sales; first-half revenue fell 9%. First-half printing revenue decreased 38%, while packaging rose 7%, plastics rose 6%, and licensing and digital solutions rose 47%. Q2 operating expenses rose 8%; first-half expenses fell 5%, in part as intangible amortization declined. The first-half net loss included a $361,000 noncash gain from revaluing and eliminating a derivative liability tied to amended investor warrants.
Cash, debt and liquidity
- Cash was $1.512 million at June 30, down from $4.087 million at December 31, 2010. First-half operating cash use was $1.892 million, compared with $329,000 in the prior-year period; investing provided $33,000 and financing used $715,000.
- Working capital was $1.126 million and the current ratio was 1.38 at June 30. Total debt and capital leases, as presented by the company, were approximately $3.014 million.
- The company reported $730,000 available under revolving credit facilities and $397,000 under an equipment line. It said available resources should fund operations and obligations for at least 12 months, assuming expected second-half sales and cash generation; additional financing may be needed if those expectations are not met.
- A new $650,000 commercial term note in June repaid the related-party revolving facility. In July, the packaging subsidiary refinanced its Citizens Bank facilities: the term loan maturity was extended to February 2015, its $625,000 balloon payment was eliminated, and the revolving facility was restated at up to $1 million, with stated termination in May 2012 unless extended.
Material developments, outlook and risks
- ExtraDev was acquired for stated consideration of approximately $274,000 in restricted shares; the transaction added about $70,000 of goodwill. ExtraDev contributed approximately $96,000 of revenue and a $23,000 loss after acquisition through June 30. DSS said the deal expands digital security and cloud-computing capabilities.
- Management attributed printing weakness to the loss of a large commercial-print customer and a deliberate reduction of low-margin work. It expected packaging orders delayed from Q2 to arrive in the third and fourth quarters, helping convert inventory into sales and cash. No quantified earnings or revenue guidance was provided.
- One customer represented 16% of first-half revenue and 20% of June 30 trade receivables, creating customer-concentration exposure.
- The long-running European Central Bank patent litigation had adverse patent-validity rulings in multiple countries; the patent remained valid in Spain, subject to appeal. The filing disclosed potential court costs, including a €93,752 ECB request relating to Luxembourg, whose amount had not yet been assessed. Litigation outcomes and related recoveries remain uncertain.
- Management concluded disclosure controls were ineffective due to a material weakness involving limited qualified accounting staff and inadequate segregation of duties. A staff accountant was hired in June; remediation was planned but not yet demonstrated as effective.
- Other unusual items include approximately $75,000 of one-time rebranding expenses in Q2 and a $110,000 reversal of estimated payroll costs that reduced Q2 compensation expense.
Important facts for investors to verify
- Whether expected second-half packaging orders materialize and improve operating cash flow, and whether DSS maintains adequate liquidity without new financing.
- Current borrowing availability, covenants, and compliance under the amended Citizens facilities, including the revolving line’s stated May 2012 termination.
- Progress in remediating the financial-reporting material weakness and whether controls become effective.
- Developments in the ECB patent disputes, remaining potential legal costs, and any effect on the value or commercial prospects of DSS’s intellectual property.
- ExtraDev’s subsequent revenue, profitability, and contribution to the digital business, as well as the ongoing impact of printing customer losses and customer concentration.