DSS, Inc. — FY 2013 Form 10-K
Reporting period: Fiscal year ended December 31, 2013; comparison is with fiscal 2012. DSS combines secure printing, packaging, plastic cards and digital services with a new intellectual-property (IP) monetization business acquired in the July 2013 merger with DSS Technology Management.
Financial performance and condition
| Metric | FY 2013 | FY 2012 |
|---|---|---|
| Revenue | $17.45 million | $17.12 million |
| Operating loss | $(8.15) million | $(3.77) million |
| Loss before income taxes | $(8.36) million | $(4.26) million |
| Net income (loss) | $2.59 million | $(4.28) million |
| Cash used in operations | $(3.15) million | $(3.16) million |
- Revenue increased 2%. Printed-product revenue rose about 1%; technology sales, services and licensing rose 11%.
- Costs of revenue, excluding depreciation and amortization, were $10.46 million, implying a roughly 40% gross margin on that basis. Operating expenses rose 23% to $25.61 million; depreciation and amortization increased to $2.97 million, largely from acquired patents.
- Reported net income was driven by a $10.95 million deferred tax benefit related to the merger. Excluding that benefit, DSS reported a pre-tax loss of $8.36 million; the filing does not present an adjusted net-income figure excluding the benefit.
- Year-end cash was $2.48 million; current assets were $6.09 million and current liabilities $4.47 million. About $942,000 was available under revolving credit lines, subject to limitations.
- Balance-sheet debt included $158,000 of revolving credit, $825,000 of short-term debt, $613,000 of current long-term debt and $3.09 million of long-term debt, all net of applicable discounts.
- Total assets were $67.34 million, including $29.60 million of net intangible assets and $15.05 million of goodwill. Stockholders’ equity was $58.39 million.
Material changes and significant events
- The July 1 merger was accounted for as a business combination, with estimated purchase consideration of $40.57 million. Former DSS Technology Management holders owned approximately 51% of the combined company at closing. The transaction included substantial stock, warrants and options; 7.1 million shares were placed in escrow and could be cancelled if the specified share-price condition was not met within one year.
- The acquired business contributed about $566,000 of revenue and incurred a loss of about $2.75 million after acquisition. DSS acquired patents valued at approximately $27.86 million and recorded approximately $11.96 million of goodwill.
- Printed-product trends were mixed: plastics ID and card sales increased 23% and security paper-related sales increased 31%, while packaging sales declined 4% and commercial printing declined 15%.
- DSS recorded a $517,000 impairment charge for ExtraDev-related goodwill and intangible assets. Management cited customer losses in legacy hosting and programming services amid competition and a shift in focus.
- Two customers represented 35% of 2013 revenue and 30% of year-end trade receivables, versus one customer representing 29% of 2012 revenue.
Outlook, risks and contingencies
- Management stated that available resources were expected to fund planned operations into Q4 2014, but anticipated needing additional funding then; weaker revenue or higher expenses could bring the need forward. The filing gives no quantified revenue or earnings guidance.
- After year-end, DSS received a $2.0 million advance under an IP-collateralized financing arrangement, with up to a further $2.5 million available upon milestones. Patent monetization proceeds are subject to a payment waterfall benefiting the financing investors and other participants.
- Premier Packaging breached a fixed-charge-coverage covenant at December 31, 2013; Citizens Bank granted a waiver in March 2014. Certain obligations are secured and cross-guaranteed. A $850,000 secured note was due May 24, 2014.
- Bascom Research’s patent cases, including actions involving Facebook and LinkedIn, remained pending against some defendants; DSS reported settlements with two defendants but could not disclose details. Management estimated approximately $2 million of legal fees to pursue the case to trial. DSS also sued Apple over Bluetooth-related patents. Outcomes, recoveries and timing are uncertain.
- DSS continued a Coupons.com lawsuit seeking more than $10 million; its breach-of-contract claim remained intact. The concluded European Central Bank litigation resulted in about $241,000 of accrued fees, with an additional requested amount of about $127,000 subject to assessment.
- Management identified a material weakness in internal control over financial reporting due to inadequate segregation of duties and insufficient qualified accounting resources. It estimated remediation costs of $200,000–$400,000. Disclosure controls were deemed ineffective; the auditor did not attest to internal control effectiveness.
- Other key risks include recurring operating losses before the one-time tax benefit, uncertain patent-litigation monetization, dilution from merger securities and potential financing, patent validity and enforcement risks, and exposure to rising paper and paperboard costs.
Investor verification priorities
- Assess operating cash burn and the timing, terms and adequacy of post-year-end financing, including collateral and the patent-proceeds waterfall.
- Reconcile reported net income to the large merger-related deferred tax benefit and evaluate the sustainability of future profitability.
- Track debt maturities, covenant compliance and the effects of secured and cross-guaranteed borrowing.
- Review patent-case status, expected legal spending, settlement economics and the assumptions supporting patent and VirtualAgility valuations.
- Evaluate customer concentration, segment-level performance and whether newer digital and security products are gaining commercial acceptance.
- Monitor remediation of the material weakness and potential dilution from escrow shares, warrants, options and future equity financing.