DSS, Inc. — Form 10-Q Summary
Reporting period: Three and nine months ended September 30, 2012. DSS develops and sells secure printing, plastic card, packaging, licensing and digital solutions. The interim financial statements are unaudited.
Financial performance
| Metric | Q3 2012 | Q3 2011 | Nine months 2012 | Nine months 2011 |
|---|---|---|---|---|
| Revenue | $4.164 million | $3.616 million | $11.666 million | $9.177 million |
| Gross profit | $1.523 million | $1.271 million | $4.109 million | $3.013 million |
| Gross margin | About 37% | About 35% | About 35% | About 33% |
| Operating loss | $(1.029) million | $(0.861) million | $(2.725) million | $(2.613) million |
| Net loss | $(1.096) million | $(0.757) million | $(3.165) million | $(2.267) million |
| Basic and diluted loss per share | $(0.05) | $(0.04) | $(0.15) | $(0.12) |
- Q3 revenue rose 15%; nine-month revenue rose 27%. Packaging was the largest growth driver, up 39% in Q3 and 54% year to date. Nine-month licensing and digital revenue increased 41%, partly reflecting the 2011 ExtraDev acquisition. Printing revenue declined 17% in Q3 and 5% year to date.
- Gross profit increased 20% in Q3 and 36% year to date. Management attributed improvement to printing’s better product mix and cost structure, packaging growth, and higher plastics and digital gross profit.
- Operating expenses rose 20% in Q3 and 21% year to date. Q3 professional fees included about $461,000 for the proposed Lexington merger. Research and development expense also increased substantially, partly due to ipCapital-related costs.
- Management said Q3 net loss excluding merger-related costs would have been approximately $635,000, a 16% improvement year over year. For the nine-month comparison, management cited $216,000 of debt-discount amortization, a $361,000 prior-year derivative gain, and $461,000 of merger costs as major differences; excluding these items, it said the loss would have declined about 7%.
Cash, liquidity and debt
- At September 30, cash was $1.023 million, versus $718,000 at December 31, 2011. Current assets were $4.191 million and current liabilities $3.882 million, implying working capital of about $310,000.
- Nine-month operating cash use was $2.078 million, compared with $2.017 million in 2011. Investing cash use was $213,000; financing provided $2.596 million. Cash increased by $305,000 over the period.
- Balance-sheet revolving credit lines totaled $543,000; current and long-term debt totaled approximately $2.465 million, excluding leases. The related-party short-term loan was repaid in March. Debt balances declined during the period, while the company also raised equity and received proceeds from warrant exercises.
- In February, DSS sold $3.0 million of units in a private placement. In October, after quarter-end, it completed another private placement for gross proceeds of about $2.751 million; Lexington participated. Management said existing cash, working capital and credit availability should fund operations and obligations for at least 12 months, but warned additional financing could be needed if revenues or operating cash generation fall short. The filing gives differing figures for remaining credit availability, so the precise available amount is unclear.
Outlook, material events and risks
- No quantified operating guidance is provided. Management expected research and development spending to increase significantly over the next 12–18 months, with the aim of supporting security products, licensing sales and the patent portfolio.
- On October 1, 2012, DSS agreed to acquire Lexington Technology Group in a stock-based merger, subject to both companies’ shareholder approvals and other conditions. DSS estimated closing in the first half of 2013. Lexington was identified as the accounting acquirer. The merger could substantially change ownership and governance: Lexington holders were expected to own about 55% on a fully diluted basis including escrow shares; the filing describes a different ownership split if escrow shares are cancelled. Merger termination fees may reach $5 million in specified circumstances, and DSS could owe a fee tied to a superior proposal.
- Lexington subsidiary Bascom Research filed patent infringement suits against five companies, including Facebook and LinkedIn, on October 3, 2012. These claims are contingent and no outcome or recovery is assured.
- DSS’s Coupons.com lawsuit seeks more than $10 million; the court dismissed unfair competition and unjust enrichment claims in August 2012, while breach-of-contract and trade-secret claims remained. In European Central Bank patent litigation, the patent had been invalidated in several countries; a Spanish decision remained under appeal. DSS recorded approximately $395,000 for certain German and Netherlands legal fees and disclosed a further ECB fee request of about $121,000 whose assessment had not begun.
- Premier had received waivers for specified financial covenant breaches as of December 31, 2011 and March 31, 2012, and was reported in compliance at September 30, 2012.
- One customer represented 26% of nine-month 2012 revenue and 22% of receivables at September 30, 2012. Other stated risks include competition, technology changes, intellectual-property claims, market acceptance and the ability to finance growth.
- Management concluded disclosure controls were ineffective because of material weaknesses, including insufficient qualified accounting staff, inadequate segregation of duties and ineffective review of financial reporting. Management planned to monitor controls and evaluate cost-effective remediation.
Investor facts to verify
- Merger approval status, final transaction terms, dilution, escrow-share conditions, termination-fee exposure and Lexington’s accounting-acquirer treatment.
- Quarterly cash burn, remaining credit availability, covenant compliance and whether DSS can sustain liquidity without further financing.
- Whether packaging growth and improved gross margins continue, and how rising operating, merger and R&D expenses affect losses.
- Progress and potential costs or recoveries in the Coupons.com, ECB and Bascom patent matters.
- Remediation of the reported material weaknesses and the effectiveness of financial-reporting controls.