DSS, Inc. — Q1 2013 Form 10-Q
Reporting period: Three months ended March 31, 2013; comparisons are with the three months ended March 31, 2012 unless otherwise stated. DSS operates printing, plastics/cards, packaging, and licensing/digital businesses.
Financial performance
| Metric | Q1 2013 | Q1 2012 | Change |
|---|---|---|---|
| Revenue | $3.77 million | $3.84 million | Down 2% |
| Gross profit | $1.46 million | $1.25 million | Up 16% |
| Gross margin | 38.6% | 32.5% | Up about 6.1 percentage points |
| Operating loss | $1.07 million | $0.77 million | Loss widened |
| Net loss | $1.13 million | $1.07 million | Loss widened 5% |
| Net loss per share | $0.05 | $0.05 | No change |
| Operating cash flow | Used $347,000 | Used $495,000 | Use decreased 30% |
Revenue by business: printing $899,000, up 34%; packaging $1.55 million, down 26%; plastic IDs and cards $828,000, up 22%; licensing and digital solutions $491,000, up 23%. DSS attributed the packaging decline chiefly to a major customer’s order timing; it expected that customer to return to normal order levels during the rest of 2013. Printing benefited from secure-coupon and commercial orders, plastics from RFID-card and event-badge projects, and licensing/digital from higher royalties.
Gross profit improved mainly on printing’s favorable sales mix and higher plastics and licensing/digital profit, partly offset by lower packaging profit. Operating expenses rose 25% to $2.53 million, including higher professional fees related to the proposed merger, increased stock-based compensation, and higher compensation costs. Stock-based compensation was approximately $341,000 versus $98,000 a year earlier. The company reported interest expense of $44,000 and income tax expense of $4,737.
Cash, liquidity, and debt
- Cash was $1.20 million at March 31, down from $1.89 million at December 31, 2012. Current assets were $4.26 million and current liabilities $3.62 million.
- Operating activities used $347,000; investing activities used $18,000, mainly for equipment; financing activities used $326,000, including repayment of $238,000 on revolving credit and scheduled debt payments.
- Long-term debt, net of discount, was $1.41 million, with a further $909,000 reported as current long-term debt. The company also had a $575,000 convertible note bearing 10% interest and maturing December 2013.
- The packaging revolving credit facility had no balance at quarter-end and provided up to $1 million of availability. It bore interest at 3.95% and matured May 31, 2013.
- Management said cash and credit availability, together with at least $6.25 million expected from Lexington if the merger closed, were expected to fund operations and obligations for at least 12 months. It cautioned that a delayed or failed merger, or insufficient operating cash generation, could require additional financing, which may not be available.
Material developments, outlook, and risks
- Proposed Lexington merger: The transaction remained subject to approval by both companies’ shareholders. DSS said it expected completion in the second quarter of 2013 and elsewhere estimated closing on or about July 1, 2013. The filing described substantial potential share, warrant, and option issuance; former Lexington shareholders were expected to own about 51% of the combined company’s common stock, excluding specified existing holdings. The exchange ratio and final securities issuance remained subject to determination. DSS warned that failure to complete the merger could adversely affect its business and share and warrant prices.
- Operating outlook: Management anticipated normalizing packaging orders from its largest customer during the remainder of 2013. No quantified revenue or earnings guidance was provided.
- Legal and contingent matters: The company disclosed ongoing patent-related disputes with the European Central Bank (ECB), accrued approximately $428,000 for German and Dutch legal costs, and noted an additional ECB request for approximately $120,000 in Luxembourg fees that had not yet been assessed. A Spanish patent appeal decision was expected in Q2 2013. DSS’s Coupons.com lawsuit continued on a breach-of-contract claim; other claims had been dismissed, and DSS sought more than $10 million. Management stated it did not believe the disclosed or other legal proceedings would materially adversely affect results, cash flows, or financial condition.
- Merger termination exposure: The merger agreement included a potential $5 million fee payable by Lexington in specified circumstances and potential payments by DSS to Lexington, including $3 million plus 5% of certain superior-proposal consideration under specified circumstances.
- Financial reporting controls: Management concluded disclosure controls were ineffective and identified material weaknesses involving insufficient qualified accounting staff, segregation of duties, and review of financial reporting. Remediation plans included evaluating additional resources; management expected merger-related resources could help if the transaction closed.
- Other risks: DSS cited risks involving its limited operating history with its business model, intellectual-property protection and disputes, product acceptance, technology change, competition, and execution of its acquisition and growth strategy. One customer represented 16% of Q1 revenue, versus 33% a year earlier.
Important facts for investors to verify
- Whether the Lexington merger received the required approvals and closed, and the final consideration, dilution, and accounting treatment.
- Whether the packaging customer’s orders normalized and whether the company’s improved gross margin translated into better operating results.
- Post-quarter liquidity, renewal or replacement of the revolving facility due May 31, 2013, and the company’s ability to meet debt obligations without merger proceeds.
- Developments in the ECB and Coupons.com litigation, related legal costs, and any resulting payments or recoveries.
- Progress in remediating the material weaknesses in internal control over financial reporting.