DSS, Inc. — Form 10-Q Summary
Reporting period: Three and nine months ended September 30, 2013. Filed November 13, 2013. The July 1 merger with DSS Technology Management materially changed the company’s business and financial profile; its results are included from the merger date.
Business context and merger
DSS combines packaging, commercial and security printing, plastic cards, digital services, and intellectual-property acquisition and monetization. The merger added a patent-focused licensing and litigation business. DSS accounted for the transaction as an acquisition, with an estimated purchase price of $40.6 million, including $27.9 million of acquired patents and $12.2 million of goodwill. The allocation was preliminary.
Merger consideration included 16.6 million common shares issued, 7.1 million shares held in escrow, warrants covering up to approximately 8.3 million shares, and assumed options. Former DSS Technology Management holders owned about 51% of the combined company at closing. The escrow shares are subject to a $5 share-price condition; if it is not met within one year, those shares are cancelled. DSS had 49.2 million common shares outstanding as of November 12, 2013.
Financial performance
| Metric | Q3 2013 | Q3 2012 | Nine months 2013 | Nine months 2012 |
|---|---|---|---|---|
| Revenue | $4.25 million | $4.16 million | $12.30 million | $11.67 million |
| Gross profit / margin | $1.61 million / 38% | $1.52 million / 37% | $4.70 million / 38% | $4.11 million / 35% |
| Operating loss | $2.66 million | $1.03 million | $5.56 million | $2.73 million |
| Net income (loss) | $6.46 million | ($1.10 million) | $3.40 million | ($3.16 million) |
| Basic and diluted EPS | $0.15 | ($0.05) | $0.12 | ($0.15) |
- Revenue rose 2% in Q3 and 5% for the nine-month period. Technology sales, services and licensing grew 14% in both comparisons, primarily reflecting licensing and litigation-settlement revenue, including the acquired business. DSS reported declines in legacy digital hardware and cloud services.
- Gross margin improved year over year, but operating expenses rose 67% in Q3 and 50% for the nine months. Higher amortization from acquired patents, merger-related stock compensation, professional fees and a $517,000 intangible-asset impairment contributed to the increase.
- Reported net income depended on a non-cash deferred tax benefit of approximately $9.2 million related to the merger and release of part of the deferred-tax-asset valuation allowance. Before income taxes, DSS lost $2.74 million in Q3 and $5.79 million in the nine months.
Cash flow, liquidity and debt
- At September 30, cash was $3.24 million, current assets were $6.51 million and current liabilities were $4.32 million, implying working capital of approximately $2.19 million. Total assets were $64.82 million and stockholders’ equity was $54.38 million.
- For the first nine months, operating cash flow was negative $1.92 million, investing cash flow was positive $3.43 million, and financing cash flow was negative $0.16 million. Ending cash increased by $1.35 million. Investing cash flow included approximately $6.6 million of cash acquired in the merger; DSS also spent approximately $2.75 million after the merger on patents and a VirtualAgility investment.
- Reported debt carrying amounts totaled approximately $4.32 million across revolving credit, short-term debt and current and long-term debt. Significant obligations include an $850,000 note due May 2014, a $640,000 convertible note due December 2015, bank debt, and equipment financing. A $1.009 million demand note for a printing press was outstanding while the equipment had not yet been placed in service. Certain debt is secured, and bank facilities include financial covenants and cross-guarantees.
Outlook, risks and unusual items
- DSS gave no specific revenue or earnings guidance. Management stated that available resources were expected to fund planned operations into the fourth quarter of 2014, but anticipated needing additional equity financing then; weaker revenue or higher expenses could require funding sooner. Any equity raise could dilute existing holders.
- Bascom Research’s patent litigation is a potentially significant but uncertain source of licensing or settlement revenue. As of September 30, the company reported settlements with three defendants, with terms confidential; cases against other defendants, including Facebook and LinkedIn, remained pending. DSS estimated approximately $2 million in legal costs to pursue the case to trial. The company’s share of recoveries is subject to contractual splits and costs.
- Other legal exposures include approximately $356,000 accrued for certain European Central Bank litigation costs and a further approximately $127,000 requested but not yet assessed. DSS also seeks more than $10 million in a Coupons.com lawsuit; the filing does not establish a likely recovery.
- DSS impaired approximately $517,000 of ExtraDev-related goodwill and intangible assets, citing customer losses and competition, including from Microsoft. It also changed its policy effective July 1 to expense patent-defense costs as incurred; management stated there was no retrospective impact on the periods presented.
- Management concluded disclosure controls were ineffective. Two previously identified material weaknesses remained, including inadequate accounting staffing and segregation of duties and insufficient controls for complex or non-routine transactions. Management planned remediation, including using additional resources from the acquired subsidiary.
- Key risks include integration and execution of the merger, dependence on patent litigation and licensing outcomes, possible impairment of acquired patents and goodwill, financing needs, debt and covenant obligations, dilution from shares and warrants, and the company’s history of operating losses.
Most important facts for investors to verify
- How much of reported earnings reflects the one-time $9.2 million tax benefit, and whether the combined business can improve operating results without it.
- Cash burn, remaining financing capacity, the timing and terms of any required capital raise, and compliance with debt covenants.
- Progress, costs, contractual recovery splits and outcomes of Bascom and other patent matters; settlement terms are not disclosed.
- Whether acquired patents and goodwill support their recorded values, given the preliminary purchase accounting and the existing impairment.
- Whether management remediates the material weaknesses and improves financial-reporting controls.
- The potential dilution and ownership effects of escrow shares, merger warrants, options and other share equivalents.