DSS, Inc. (Document Security Systems) — Q3 2016 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2016; comparisons are with the corresponding 2015 periods. The company operates in security and commercial printing, packaging, plastic cards, digital services, and intellectual-property (IP) monetization.
Financial performance
- Revenue: Q3 revenue was $4.98 million, up 13% year over year. Printed-products revenue rose 12%; technology sales, services and licensing rose 19%, including a $150,000 IP license settlement. Nine-month revenue was $13.39 million, up 11%; printed products increased 14%, while technology revenue declined 9%, mainly due to lower digital hardware and software resales.
- Profitability: Q3 gross profit was approximately $2.10 million (about 42% margin), versus $1.86 million (42%) a year earlier. Operating income was $46,000 versus an operating loss of $767,000; net loss narrowed to $27,000 from $860,000. For nine months, gross profit was $5.58 million (about 42% margin); operating loss was $737,000 versus $3.41 million, and net loss was $969,000 versus $3.55 million. Nine-month loss per share was $0.07 versus $0.31. Margins are approximate calculations from reported revenue and cost of revenue.
- Cash flow: Nine-month operating cash flow was positive $384,000, compared with cash use of $1.17 million in 2015. Investing cash flow was positive $229,000, including $495,000 from patent-asset sales; financing cash flow was negative $1.23 million, primarily from debt repayments. Cash declined $617,000 to $823,000.
- Liquidity and debt: At September 30, cash was $823,000 and restricted cash was $188,000; up to $800,000 was available on a packaging subsidiary revolver, with no balance drawn. Current assets of $4.61 million compared with current liabilities of $8.91 million, leaving negative working capital of approximately $4.30 million. Reported short-term debt was $3.44 million, current long-term debt $1.29 million, and long-term debt $1.90 million. Debt carrying values are net of issuance costs.
- Other metrics: Total assets were $13.86 million, down from $15.60 million at year-end 2015; stockholders’ equity was $2.78 million, down from $3.69 million. One customer accounted for 25% of nine-month revenue. The company completed a one-for-four reverse stock split in August 2016; share figures in the filing reflect the split.
Changes and notable items
- Revenue growth and lower SG&A, professional fees, depreciation and stock compensation sharply reduced losses. Professional fees fell 54% for the nine-month period, largely reflecting lower IP litigation costs and dismissal of a shareholder derivative suit.
- Packaging and plastic printing generated nine-month segment income, while Technology and Corporate reported losses. Technology revenue and its reported segment loss were lower than in 2015.
- The company received $495,000 from a patent-asset sale and remitted it to its Fortress funding provider; it also remitted $125,250 from a settlement. A $150,000 license settlement contributed to Q3 technology revenue.
Outlook, risks and contingencies
- Outlook: No specific revenue or earnings guidance was provided. Management said available cash and credit resources should fund operations and obligations for at least 12 months if the company increases digital-product sales, reduces IP-related legal and professional costs, and maintains operating profits in packaging and plastic printing. If these conditions are not met, management estimated it may need $500,000–$1 million to fund operations through September 30, 2017; additional financing or debt-maturity extensions are not assured.
- Debt default: DSS Technology Management failed to make required payments by February 13, 2016 under its Fortress agreement. Approximately $3.46 million was classified as short-term debt. The agreement limits recourse principally to specified patents and related proceeds, but discussions to amend or remedy the default had no assured outcome.
- Litigation: PTAB ruled for Apple in June 2016 on patent reviews, and DSS appealed. Other patent matters include an Intel litigation stayed pending IPR proceedings and Samsung IPR proceedings; the company reported confidential settlements with TSMC and SK Hynix. Management warned that adverse legal costs or awards could materially affect results, cash flows, or financial condition.
- Controls and other risks: Management concluded disclosure controls were ineffective at quarter-end because a previously reported material weakness remained; remediation efforts were planned. The company continued to report losses in prior years, substantial negative working capital, customer concentration, and dependence on future operating performance and financing. Premier Packaging was in compliance with Citizens Bank covenants for the first three quarters of 2016.
Important facts for investors to verify
- Whether the Fortress default is amended or otherwise resolved, and the timing and cash impact of the approximately $3.46 million classified as short-term debt.
- Whether operating cash generation continues and whether management’s sales, expense-reduction, and profitability assumptions are achieved.
- Availability and terms of any required capital raise or debt-maturity extensions, given negative working capital and limited unrestricted cash.
- Developments in patent reviews, appeals, litigation settlements, and the proceeds available to DSS after obligations to funding partners.
- Progress in remediating the material weakness and restoring effective disclosure controls.