DSS, Inc. — Second-Quarter 2014 Form 10-Q
Business context and period: This report covers the quarter and six months ended June 30, 2014. DSS operates packaging and printing, plastics, digital services, and intellectual-property (IP) monetization businesses. The 2014 results include DSS Technology Management, acquired July 1, 2013, so year-over-year comparisons are not fully like-for-like. DSS combined its printing and packaging operations in January 2014.
Financial performance and position
| Metric | Three months ended June 30 | Six months ended June 30 |
|---|---|---|
| Revenue | $4.88 million, up 14% from 2013 | $8.51 million, up 6% |
| Net loss | $2.34 million, versus $1.93 million loss | $5.40 million, versus $3.06 million loss |
| Operating loss | $2.22 million, versus $1.83 million loss | $5.16 million, versus $2.90 million loss |
| Basic and diluted loss per share | $0.06, versus $0.09 | $0.13, versus $0.14 |
- Second-quarter printed-products revenue rose 15%; six-month printed-products revenue rose 7%. Technology sales, services and licensing increased 4% for the quarter but declined 1% for the half year, as lower royalties offset growth in digital products.
- Cost of goods sold rose faster than revenue: 26% in the quarter and 14% for the half year. Approximate gross margin before depreciation and amortization was 34.5% for Q2 2014, versus 40.6% in Q2 2013; for the first half it was 36.6%, versus 41.0%.
- Depreciation and amortization increased substantially, to $1.29 million for Q2 and $2.60 million for the half year, mainly from amortization of acquired patent assets. Management identified this as the primary reason net losses increased.
- Six-month operating cash use was $1.10 million, compared with $0.94 million in 2013. Investing used $2.10 million, including patent purchases and investments; financing provided $2.54 million, mainly from $2.69 million of borrowing, partly offset by debt payments.
- At June 30, cash was $1.30 million and restricted cash was $245,000. Current assets were $5.02 million and current liabilities $4.24 million, implying working capital of about $777,000. The company also had $1.0 million available under its revolving credit line, which had no balance outstanding.
- Reported borrowings totaled approximately $7.14 million: $850,000 short-term debt, $522,000 current long-term debt, and $5.77 million long-term debt. This excludes $309,000 of fixed-return and contingent interests classified in other long-term liabilities. Borrowings increased from year-end, principally following the IP-backed financing.
Material changes, outlook, and risks
- DSS acquired 115 semiconductor-industry patents for $1.15 million in May and made investments in VirtualAgility and Express Mobile. Its $11.75 million VATI investment in VirtualAgility was carried at cost/fair value basis described in the filing; VATI recorded no income or loss in the first half.
- An IP-collateralized financing agreement allows advances of up to $4.5 million. DSS had received $3.0 million by June 30; a further $1.5 million was expected in the second half of 2014 upon achievement of a milestone. The notes have a stated AFR-based rate plus a make-whole feature, resulting in an estimated effective annual rate of about 4.23% if not prepaid.
- Management said the expected $1.5 million milestone payment would be available for general operating cash needs. The filing provides no earnings or revenue guidance.
- Premier Packaging received a waiver for noncompliance with its fixed-charge coverage covenant at December 31, 2013; it reported compliance for the March and June 2014 quarters. Debt is secured by Premier Packaging assets and supported by cross-guarantees. The IP financing is also collateralized by certain IP.
- DSS reported patent litigation involving Coupons.com, Facebook and LinkedIn, Apple, semiconductor defendants including TSMC and Samsung, and Lenovo. Management stated it did not expect the legal proceedings to have a material adverse effect, but outcomes and monetization proceeds are uncertain. No contingent legal fees had been accrued at June 30.
- One customer represented 30% of first-half revenue, up from 22% in the prior-year period, and 20% of receivables. DSS also noted risks in forward-looking statements and uncertainty in estimates used to value IP assets.
- The company said disclosure controls were effective, while noting that a prior material weakness involving accounting staffing and segregation of duties was being remediated. Management said remediation would not be considered complete until controls had operated and been tested for a sufficient period.
- Shares held in escrow under the 2013 merger did not meet their release condition and were retired in late June and July 2014. The filing reports 42,213,737 common shares outstanding as of August 12, 2014.
Important facts for investors to verify
- Whether the additional $1.5 million financing milestone was achieved and received, and the cash runway given ongoing operating cash use.
- Progress on covenant compliance, debt service, balloon maturities, and the terms and collateral of IP-backed financing.
- Revenue and margins by business line, especially packaging growth, lower licensing royalties, and the high customer concentration.
- Recoverability and monetization prospects for patent and investment assets, including litigation costs and outcomes.
- Completion and testing of the internal-control remediation, and the effect of retired escrow shares and outstanding potential share equivalents on dilution.