DSS, Inc. — Form 10-Q Summary
Reporting period: Three and six months ended June 30, 2013. DSS operated printing, plastics, packaging, and digital/licensing businesses. The July 1, 2013 Lexington merger occurred after the quarter and is not reflected in June 30 balance-sheet figures.
Financial performance and position
- Revenue: Second-quarter revenue was $4.28 million, up 17% year over year; first-half revenue was $8.05 million, up 7%. Q2 packaging rose 38% and plastic IDs/cards rose 22%, while printing fell 21%. First-half growth was led by plastics (+22%) and licensing/digital (+14%).
- Profitability: Gross profit was $1.63 million in Q2 and $3.08 million for the first half, up 22% and 19%, respectively. Gross margin was approximately 38% in Q2 versus 36% a year earlier, and 38% for the first half versus 34%.
- Losses: Net loss widened to $1.93 million in Q2 from $995,000, and to $3.06 million for the first half from $2.07 million. Basic and diluted loss per share was $0.09 for Q2 and $0.14 for the first half. Management attributed the increase principally to merger-related professional fees and stock compensation; excluding merger-related costs, management estimated losses of about $723,000 for Q2 and $1.75 million for the first half.
- Cash flow: First-half operating cash use was $938,000, compared with $1.43 million in 2012. Investing used $135,000 and financing used $255,000. Cash declined by $1.33 million to $559,000 at June 30.
- Liquidity: Current assets were $3.82 million and current liabilities $4.05 million, leaving a current ratio below 1.0. DSS reported approximately $930,000 available under its packaging revolving facility. Cash was $559,000, versus $1.89 million at year-end 2012.
- Debt: Reported debt carrying amounts totaled approximately $3.20 million, including revolving credit, short-term debt, current long-term debt, and long-term debt. The company also reported secured borrowing and covenant obligations; its Citizens Bank facilities include fixed-charge coverage, tangible-net-worth, and current-ratio covenants.
- Other: Stock-based compensation was $1.29 million in the first half, versus $332,000 in 2012. One customer represented 22% of first-half revenue and 20% of June 30 receivables.
Material changes and significant events
- Revenue and gross profit improved, but operating expenses rose 40% in the first half, mainly reflecting higher professional fees and stock-based compensation associated with the merger process.
- On July 1, DSS completed its merger with Lexington Technology Group. DSS issued 16.56 million common shares, with another 7.1 million shares placed in escrow subject to a share-price condition; it also issued warrants and assumed options. Lexington shareholders held approximately 51% of the combined company at closing. DSS reported receiving approximately $6.5 million from the merger, net of transaction fees.
- The merger accounting was incomplete when the filing was issued. Lexington was expected to expand DSS’s intellectual-property portfolio and monetization activities, but its patent litigation and licensing strategy was unproven.
- After quarter-end, Premier Packaging entered into financing arrangements for printing equipment: a $1.304 million, 60-month equipment loan and a $1.35 million demand note intended to fund progress payments, with amounts under the demand note to be transferred to the equipment facility up to the stated loan amount when the equipment is placed in service and accepted.
Outlook, risks, and contingencies
- Management stated that June 30 cash, merger proceeds, and available credit were expected to fund operations and obligations for at least 12 months. Separately, the filing said combined-company resources were expected to support planned operations into Q4 2014 and anticipated a need to raise additional funds around then; weaker revenue or higher costs could bring that need forward. Any equity financing could dilute shareholders.
- Management cited approximately $1 million in expected merger integration costs. Lexington’s patent monetization effort was expected to incur about $2 million in legal fees over the next 12 months; litigation outcomes, timing, costs, and recoveries are uncertain.
- Lexington’s Bascom patent litigation included claims against five companies, including Facebook and LinkedIn; the filing reported settlements with two defendants but did not disclose terms. The filing cautions that patents could be invalidated, found not infringed, or prove difficult or costly to monetize.
- DSS disclosed material weaknesses in financial reporting controls, including insufficient accounting personnel and segregation of duties, and inadequate controls for complex and non-routine transactions. Management concluded disclosure controls were not effective. Remediation costs were estimated at $200,000–$400,000, and management expected Lexington resources to help.
- Other disclosed matters include foreign judgments and requested legal fees related to the concluded ECB litigation, and DSS’s Coupons.com lawsuit seeking more than $10 million. Management said it did not believe the legal proceedings would materially adversely affect DSS, but outcomes remain uncertain.
Most important facts to verify
- Whether merger proceeds and available credit were sufficient to fund operations, and the timing and terms of any subsequent financing.
- The final purchase accounting for Lexington, including recognized assets, liabilities, goodwill, and any additional merger-related costs.
- The combined company’s fully diluted share count, escrow-share release or cancellation conditions, and the potential dilution from merger warrants and options.
- Progress, legal spending, settlements, and potential recoveries in Lexington’s patent cases, as well as the status and exposure of DSS’s other litigation.
- Whether DSS remediated its material weaknesses and maintained compliance with debt covenants.
- Whether customer concentration and the sustainability of packaging and plastics growth affected subsequent revenue and cash flow.