After our last writing about Document Security Systems, Inc (DSS) in late December, the stock dropped to new lows at $2. Considering the shift of the patent case to California, it isn't too surprising that the stock has limped along. The previous documented success of VirnetX Holding Corp (VHC) and Vringo Inc. (VRNG) only occurred after those stocks had initial progress in their patent cases.
DSS is a leading developer and integrator of cloud computing data security, Radio Frequency Identification (RFID) systems and security printing technologies that prevent counterfeiting and brand fraud.
The last article, How Does Document Security Systems Compare To Other Patent Stocks?, offered a detailed analysis of how VirnetX and Vringo performed prior to and after particular milestones in the applicable patent cases. As mentioned previously, a big key for DSS will be the execution of the plans highlighted in Important Dates For Document Security Systems. The delays in the merger and the litigation have naturally hurt the stock short-term, but for patient investors this might be setting up for an ideal entry point.
While the stock rebounded a little last week, the stock still sits near 52-week lows and significantly below the LTG merger and private placements levels from last year. The positive news from the setting of the Markman Hearing in October should buoy the stock over the summer. So far it doesn't appear that Document Security Systems has strayed much from the path of VirnetX or Vringo.
Moving Forward In California
As the company announced last week, the case is finally moving forward in California. As investors will remember, DSS reported back in January that the federal judge in the Eastern District of Virginia ruled that the case would be transferred to the Northern District of California. The company had hoped that the lawsuits against Facebook, Inc (FB), LinkedIn Corp. (LNKD), Novell Inc. (NOVL), Jive Software Inc. (JIVE) and BroadVision, Inc. (BVSN) would proceed in the 'rocket docket' court of the Eastern District of Virginia.
The movement of the case to California should have no bearing on the outcome of the lawsuits and is now set to kickoff on October 2nd with the Markman hearing. Anybody reading the previous research on VirnetX and Vringo will note that this applicable hearing for both companies is what moved their stocks higher. It wasn't the initial claims or filing of lawsuits that moved the stocks outside of temporary jumps. The sustainable moves came as the Markman hearing kicked off either leading up to anticipation in the case of Vringo or after a positive ruling for VirnetX. Clearly investors that think positively on the outcome of the DSS patent case will want to look at October 2nd as the date to be positioned in the stock. Prior discovery work could possibly lead to settlements or licenses by IPNav, hence the potential for investors owning shares prior to the all-important ruling on October 2nd.
The merger is on track for a close in the spring of 2013. Having the merger finalized will be a big step for the stock price. Remember that investors in DSS now technically don't own the patents owned by the LTG division of Bascom Research. The potential blockbuster case against Facebook and others will only benefit DSS shareholders assuming the merger is finalized.
No reason exists to doubt the merger won't be concluded eventually. The updated schedule for a close in the second quarter of 2013 will provide for plenty of time to complete the merger prior to the Markman hearing satisfying any concerns by investors.
Naturally until the merger is finalized the stock could remain under pressure. Even though investors currently can obtain an exceptional price, the vast majority won't rush in until the deal is complete and the hearing gets closer to fruition.
The recent investment in VirtualAgility is an encouraging sign as LTG moves forward on the goal to have a broad portfolio of IP assets and patents. VirtualAgility is a developer of user-friendly programming platforms that facilitate the creation of sophisticated business applications without programming or coding.
While LTG only purchased a minority stake, the position can be increased in the future and VirtualAgility is already involved in pending patent litigation against Salesforce.com (CRM) in the Eastern District of Texas. The company owns five patents with several additional patents pending.
Presumably VirtualAgility will be able to lean on some of the patent expertise of the management team at LTG to move this case forward in a favorable manner.
Another bonus will be the ability of DSS to utilize some of the technology created by VirtualAgility in the authentication and anti-counterfeit solutions in the AuthentiGuard product line.
For any potential investor, the key takeaway is that the management team is moving forward with the plan of building a diversified IP platform where the success of the company and hence stock isn't dependent on one case or patent. By delivering on this promise with the interesting VirtualAgility stake the company and the management team becomes more investable.
Q4 2012 Results Show Improvements
One difference between DSS and the majority of the patent stocks is that the company is making progress on developing the operations side and not solely focused on patent and intellectual property enforcement. The company actually has some interesting technology around document security and digital printing that could be a catalyst for the stock.
The Q4 results showed significant progress and more importantly the company is close to EBITDA break-even that will ensure the operational side of DSS doesn't bleed cash impacting the amount available to pursue the Bascom Research lawsuits.
The company reported the following highlights for Q4 2012:
- Revenues for fourth quarter of 2012 were $5.4 million, a 30% increase over the fourth quarter of 2011.
- Revenues for the full year of 2012 were $17.1 million, a 28% increase from 2011.
- Gross profit for the fourth quarter of 2012 was $1.6 million, a 40% increase over the fourth quarter of 2011.
- Adjusted EBITDA for the fourth quarter of 2012 was a loss of $280,000, or a 49% improvement over the adjusted EBITDA loss of $545,000 for the fourth quarter of 2011.
DSS is seeing great progress in the Packaging & Licensing and Digital Solutions divisions, which grew by 59% and 26%, respectively. With adjusted EBITDA at only a $280,000 loss, the company is approaching breakeven.
As mentioned in detail in the previous articles, DSS has several major catalysts that could push the stock up starting with the Bascom Research patent case through to the merger. Other potential catalysts include the Coupons.com trademark lawsuit and the IPNav license program.
Clearly the major catalyst remains the Bascom Research litigation against Facebook, LinkedIn, and the others. Considering that trial isn't likely to have a significant start prior to when the merger with LTG will be finalized, the completion of the merger might be the first major catalyst. Having those patents finally under the official wings of DSS will undoubtedly remove one layer of risk.
Of course the movement to California pushed the original timeline back by an approximate nine months. Not to mention that some of the trial stuff will take even longer outside the fast courts of Virginia.
Below are some key dates for DSS going forward:
- April/May 2013 - SEC approval on LTG merger
- May/June 2013 - Shareholder vote on LTG merger.
- End of Q2 2013- Closing of LTG merger.
- October 2, 2013 - Markman Hearing on Bascom Research case.
- 2013 hearings - Unannounced Coupons.com trial dates.
- 2014 - Bascom Research trial dates.
The merger dates are general assumptions based on closing the merger by the end of the second quarter.
The stock hit new 52-week lows in March, as the original timeline were not met. As the below chart shows, the stock has been very weak since announcing the merger and patent monetization plans in early October.
1-Year Chart - Document Security Systems
As noted in the original articles, the lack of a bounce off the $2.50 level signaled the stock might be unable to hold support at that level. The inability of the stock to maintain a position above the 20ema suggested the market was concerned about the transfer to California leading to a delay in the case.
The stock remains a huge risk/reward situation even with the negative outcome in the transfer motion hearing back in December. The movement to the Northern District of California probably left the stock off the radar for a while, but the recent announcement of the Markman date should reinvigorate the investment community.
The past histories of both VirnetX and Vringo suggest that the original weakness was an ideal time to purchase the stocks. In both situations the stocks had long periods of limited gains after the initial lawsuits were filed. The patient investor that stuck with the story tended to make out very well.
All three firms will own significant and interesting patent portfolios that are in the process of being monetized. Even a patent expert would have a difficult time forecasting the eventual judgments so a wise investor might want to trade the extremes. Buy as investors dismiss the potential lawsuits ability to win and sell as the stock soars on any positive verdicts or speculation of unmitigated success on those lawsuits.
With the stock trading near lows and significantly below where institutional-grade investors bought back in 2012, new investors could reap significant rewards from the investors that lost faith during the last few months. After all, only a short six months exists between now and the Markman date. Based on past examples, investors will want to be positioned in this stock as the merger is finalized and prior to the all important date in October.
Additional disclosure: The information contained herein is for informational purposes only. Nothing in this article should be taken as a solicitation to purchase or sell securities. Before buying or selling any stock you should do your own research and reach your own conclusion or consult a financial advisor. Investing includes risks, including loss of principal.