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Document Security Systems, Inc. (NYSEMKT:DSS)

Q1 2013 Earnings Conference Call

May 15, 2013 4:30 PM ET

Executives

Peter Salkowski - Managing Director - Blueshirt Group

Robert Bzdick - President and Chief Executive Officer

Philip Jones - Chief Financial Officer

Jeff Ronaldi - Chief Executive Officer, Lexington Technology Group

Analysts

Thomas Pfister - RedChip Companies, Inc.

Operator

Greetings, and welcome to the Document Security Systems First Quarter Financial Results Conference Call. At this time all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation (Operator Instructions). As a reminder this conference is being recorded.

I would now like to introduce your host for today, Peter Salkowski, Investor Relations for Document Security Systems. Thank you, Mr. Salkowski. Please begin.

Peter Salkowski

Thank you, Doug. Good afternoon. I'd like to thank everyone for joining us today for the Document Security's first quarter 2013 earnings conference call.

Joining me on today's call from Document Security Systems are CEO, Robert Bzdick and CFO, Phil Jones. Also on today's call from Lexington Technology Group are CEO, Jeff Ronaldi; and COO, Peter Hardigan. Following management's prepared remarks we will open the call for your questions.

This afternoon Document Security Systems issued a press release announcing its first quarter 2013 financial results. That press release is available on the company's website at www.dsssecure.com.

Before management begins I'll review the company's Safe Harbor statement. On today's call management will discuss certain factors that are likely to improve the business going forward. Any factors discussed today that are not historical facts, particularly comments regarding the company's long term prospects and market opportunities should be considered forward-looking statements.

These forward-looking statements may include comments about the company's plans and expectations of future performance. Forward-looking statements are subject to a number of risks and uncertainties which could cause actual results to differ materially. Management encourages all listeners to review the company's SEC filings, including the most recent 10-K and the company's other SEC filings for a more complete description of these risks.

Statements on this call are made as of today, May 15, 2013 and the company undertakes no obligation to revise or update publicly any of the forward-looking statements contained herein, whether as a result of new information, future events, changes in expectations or otherwise for any reason.

During the call today management will discuss adjusted EBITDA, in the company's press release issued today and in the company's filing with the SEC, each of which are posted the company's website you will find additional disclosures regarding this non-GAAP financial measure and reconciliations of net loss to adjusted EBITDA.

I would now like to turn the call over to Robert Bzdick, CEO of Document Security Systems. Robert?

Robert Bzdick

Thank you, Peter. We are very pleased with the company's first quarter performance as we continue to make progress in growing our sales pace and moving towards profitability. Positive sales improvements in printing, licensing and plastics offset the negative impact of an order (signing) difference in the packaging division.

In the first quarter of 2013 the packaging division experienced a $726,000 decline of revenue from a large prime packaging customer. This very large customer was responsible for $846,000 increase in revenue for this division during the fourth quarter of 2012. If we look at the six month comparison the result is a $120,000 increase in revenues from this customer. We continue to make progress in our efforts to monetize AuthentiGuard, through developments that allow brand owners to use this technology for both brand protection and direct-to-consumer marketing opportunities. The added value of direct-to-consumer marketing significantly increases the return of investments potential for brand owners. We continue to expect AuthentiGuard will positively impact the company's revenues during 2013.

I am extremely pleased that we have announced a special meeting of stock owners has been scheduled for June 20, 2013. The purpose of this meeting is to vote on matters relating to the proposed business combination of Documents Security Systems and Lexington Technology Group. DSS stock holders of record as of the close of business on this coming, Friday, May 17 2013 are entitled to vote at the special meeting. If approved by the Document Security Systems' stockholders the combination is expected to close on or about July 1, 2013.

The merger approval process, while time consuming, has provided many positive reinforcements to the benefit of synergies we believe will result from the merger. Working through the process with Jeff Ronaldi and Peter Hardigan has been constructive and I believe we will have a very effective and successful team going forward.

I would like to now turn the call over to Phil Jones who will take you through the first quarter results of DSS.

Philip Jones

Thank you, Bob. Today, we announced our first quarter financial results which are summarized in the earnings press release that was issued after market close today. To begin, revenue reached $3.8 million in the first quarter, which was down 2% over quarter one of 2012. However, while revenue decreased overall, the quarter was actually quite strong in several areas as printing sales increased 34%, licensing and digital sales increased 23%, and plastics sales increased 22%. While these increases were offset by the decrease in packaging revenue, which was due to the timing of orders from that division's largest customer as Bob has described earlier, we are very pleased with the revenue strength of these other four groups.

During the quarter, printing sales were positively impacted by a strong quarter of security sales, especially secure coupons. Licensing sales also increased significantly due to higher royalty submissions from our two largest licensees during the quarter, and plastics sales were positively impacted by event badge sales including an increase in event badges that incorporate our RFID technology. In addition, the plastics group received a high volume order from a new customer which also contributed to that division's sales increase and every indication is that this will be a recurring quarterly order for the plastics group.

Total gross profit for the first quarter of 2013 was $1.5 million, a 16% increase over the first quarter of 2012, resulting in a total gross profit margin of 38.6%. A significant contributing factor to the approximately 600 basis points year-over-year increase in our gross profit margin was the improvement in the printing division's gross profit margins of 40.6%, up from 24.3% in the first quarter of 2012.

As was the case for most of 2012, the company remained focused on increasing sales of higher margin products. In the first quarter of 2013, this included secure coupon sales in the printing division and RFID card sales in the plastics division. In addition, the licensing group revenue growth had an immediate impact on the company’s gross profit margins.

During the quarter, operating expenses increased for two reasons. First, the company continued to incur higher than normal professional fees due to their direct merger related costs, which were approximately $108,000 during the quarter as well as an increase in investor relations costs during this quarter. As the merger nears its completion, we expect to see professional fees return to their traditional levels.

Second, stock based compensation charges rose significantly during the first quarter of 2013 as compared to the first quarter of 2012, primarily due to equity grants that vest upon the merger. Once again after the merger, these charges will decrease. Absent these two items, operating expenses were essentially flat.

Adjusted EBITDA, defined as earnings before interest, taxes, depreciation, amortization, stock-based competition, and other non-recurring items including the merger-related professional fees was a loss of $398,000 for the first quarter of 2013, a 17% improvement over the first quarter of 2012. Once again, adjusted EBITDA is a non-GAAP measure of performance. Please refer to the table included in our earnings release from today for a reconciliation of our GAAP net loss to the adjusted EBITDA loss I just reported. Net loss for the first quarter was approximately $1.1 million or $0.05 per share, essentially flat when compared to a $1.1 million loss or $0.05 per share in the first quarter of 2012.

Moving to the balance sheet, at March 31, 2013 we had approximately $1.2 million in cash and a working capital surplus of approximately $640,000. In addition, the company had a zero balance on its revolving credit line held at its packaging division, which had used its strong cash flows during the quarter to pay down [the line] (ph) and continue to pay down its long term debt obligations.

To summarize, we believe our first quarter performance is summarized as follows: The first quarter 2013 was very strong for our printing, licensing and digital and plastics division. As a group, these three divisions posted a 26% year-over-year revenue increase. The growth in gross profit illustrates our focus on growing our higher margin businesses and the slight increase in total non-merger related operating costs illustrates our continued steps in containing our core operating cost. While these trends were somewhat overshadowed by the high degree of costs the company had incurred during the pending merger with Lexington Technology we are excited by the results.

With that, I would turn the call over to Jeff Ronaldi, CEO of Lexington Technology Group.

Jeff Ronaldi

Thank you, Phil. First, I am very pleased with the progress we've made with DSS management team in relation to the merger. We have laid the ground work for a strong, successful company and I believe our combined resources will lead to future success. Recently, Lexington announced that our wholly owned subsidiary Bascom Research reached a settlement in its ongoing litigation in the Northern District of California. As a result Lexington will realize revenues beginning in the second quarter of fiscal year 2013.

The term of the patent license are confidential but include a royalty rate of approximately 4% for use of the four Bascom patents currently in the litigation. In addition, Bascom Research yesterday announced another settlement that includes a royalty rate of approximately 5% in relation to the same patent group. With cases still pending against the other defendants including Facebook and LinkedIn Lexington in the Northern District of California and a Markman hearing for the case is scheduled to be heard on October 2, 2013. These settlements demonstrate the strength of the Bascom Research portfolio and we look forward to contributing these strengths to the combined company.

With that I will pass the call back to Robert Bzdick.

Robert Bzdick

Thank you, gentlemen. I guess the opportunity to update everyone will come over the next couple of weeks of May as we look at our presentations at the B Riley Investor Conference and the Markman Investor Conference on May 22nd, and May 30th respectively. We plan to publish the appropriate detail including webcast links at least several days prior to attending these conferences. We will now open the call to questions, operator?

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from the line of Thomas Pfister with Red Chip Companies. Please proceed with your question.

Thomas Pfister - RedChip Companies, Inc.

Hey thanks. Congratulations on the good quarter shown here. My first question, I have a question as it relates to AuthentiGuard. Has there been any increases in the amount of companies that are currently using your new technology in beta testing?

Robert Bzdick

We have been presenting our AuthentiGuard product for the last, approximately , four months. We currently have a couple of dozen folks that we are in the third stage or what we consider the third stage of implementation as far as the establishment of interest and going to two or three levels of management including the brand protection folks, the legal people , and the operations managers. Each of these brand owners has a whole different set of approval processes and beta testing requirements. Of those 25 to 30 opportunities, approximately 10 of them or half are in the phase where we are identifying a beta program to go forward with.

In addition to that, as I mentioned in our call, in my comments earlier, there are several folks that are interested in combining the uses for (inaudible) protection in the direct-to-consumer marketing process, and what we are finding there is that the brand protection department’s budget is nowhere near near what the marketing folks are, and they are able to to help them justify the cost of both the brand protection and the marketing use for a consumer -- direct-to-consumer. So, we are making some good strides there. (Inaudible) these are long term investments to the brand owners and they take them very seriously, so it's a long -- as we have talked about in the past, it's a very long sales cycle, but again I am very pleased with our progress at this point.

Thomas Pfister - RedChip Companies, Inc.

Right great, good to see the progress there. I have another question here, this is directed towards Lexington, and could you give us, potentially is there any additional progress or insight that you can give into either the litigation as it relates to VirtualAgility's patents or the litigation against Coupons.com

Jeff Ronaldi

I will speak to the VirtualAgility question. It's currently on track for a scheduling hearing where the Judge decides on whether the case will be moved from (inaudible) ,and again it's just on schedule that as all cases are.

Thomas Pfister - RedChip Companies, Inc.

Okay.

Jeff Ronaldi

As far as Coupons, did you have a specific question?

Thomas Pfister - RedChip Companies, Inc.

Just last I saw, it looks like I guess this is related to the patents with DSS. As there is some litigation there, I was wondering if there is any progress made on that case?

Robert Bzdick

That process is currently in the discovery phase, and we have just settled that phase just recently.

Thomas Pfister - RedChip Companies, Inc.

Okay, and then just one final question from me here, and I will jump back into the queue. As far as Lexington's current pipeline of potential acquisitions goes on, I guess it's kind of a general question, but has there been maybe narrowing down of maybe what you -- what kind of patent portfolios you guys are looking to bring to the fold here.

Robert Bzdick

We continue to work through our pipeline, which is very healthy, looking for operating companies that have strong -- that are supported by strong IP rights. It's a long process, and we like the pipeline as it is and it grows every day. There is nothing I can talk about on any specific pending deals.

Thomas Pfister - RedChip Companies, Inc.

Okay, understood and good to hear and congratulations on the good quarter everyone. I look forward to seeing the continued progress and the completion of the merger here between the two companies.

Robert Bzdick

Thank you.

Operator

Thank you. (Operator Instructions). Our next question comes from the line of Neil Teppard, who is a private investor. Please proceed with your question

Unidentified Analyst

Yeah, I have been an investor for five years with this company, and every quarter it's the same $1 million loss, $1 million loss, and listened to the EBITDA nonsense, bottom line is you lost a $1 million, and all your gross profits and all your improvements in your margins, in your percentages, bottom line you lost $1 million this quarter, you lost $1 million last quarter, you lost $1 million a quarter before that. Now we have two great companies trying to merge, one losing money and the other losing money, so what do we have here?

You can't tell us anything, you never tell us anything. You settled on two claims with potential companies on this lawsuit, and you are giving us percentages, you are giving us a 4% and 5%. 4% of what and 5% of what? A 100% of zero is still zero. So, this means nothing to any investor, and we are sitting and waiting and waiting, we know nothing. Okay, all we know is every quarter this company loses $1 million dollars, and you get people calling up on these conference calls with congratulatory comments about great quarter, great quarter, and great quarter.

How is anybody going to interpret the results of this company's operation as a great quarter? Can anyone of you tell me that? Phil Jones, you are a CPA, you know what I am a CPA too. Tell me how it's a great quarter, tell me how last quarter was a great quarter or the year before was a great year or quarter, tell me that. What makes it a great quarter? Your manipulation of the percentages and your EBITDA nonsense, what don't you take out everything from the expenses and then just show a profit, we’ll have a special EBITDA for DSS, which is basically all expenses removed and just gross profit. Why are we listening to this nonsense?

Robert Bzdick

Thank you for your interest in DSS. Obviously, you along with many of our stockholders have been frustrated. Since I have joined the company just three years ago we have made a lot of efforts again regarding investments whether it is in developing our IP, whether it was in this process with the going forward plan to merge with Lexington to position this company to make a (inaudible) for the stockholders that I think that you have been looking for, and we certainly have been looking for it. I think we've put ourselves in a position now where we are on the launching pad going forward.

We certainly and I have never been as confident in our position regarding our products and the fact that we can digitally deliver our product, and I have never been more excited about the future from our management standpoint as it relates to the folks coming from Lexington as well as the folks that we have here.

I am very proud of the work that they have done regarding running the business in the last few quarters and also preparing all of the things that needs to be prepared for the merger, and quite frankly, I feel like it was between the technologies that we have that we are out there positioning. We are going to see a significant increase in licensing fees and other successes as it relates to the IP and business model that Lexington bring with it. So Jeff, do you have any other comments to make regarding Neil’s comment regarding the the percentages versus (inaudible)?

Jeff Ronaldi

Sure, pursuant to our (inaudible) agreement, those amounts are confidential, and we will not be breaching that confidentiality agreement. Thus the royalty rates are against effective revenue, and that's the most we can actually comment on that.

Robert Bzdick

Thanks Jeff. Next question

Operator

(Operator Instructions). Our next question comes from the line of Barbara Blaze. She is also private investor.

Unidentified Analyst

As a long investor in DSS, I have been excited about the possibilities of the merger with Lexington Technology. However I have been rather discouraged with the share prices of DSS, since the merger plan. I would have thought it would have been just the opposite of the downward prices, it would have gone up. And as we come to a vote I am hearing June I was wondering why it would be in my best interest to vote in favor of the merger.

Robert Bzdick

Thank you. We appreciate your questions obviously the Board of Governors of DSS put a lot of thought in to our strategy going forward. We feel very comfortable and confident that this is the path forward that will result in significant opportunity for us to improve the share value to our stockholders. And over the course of this merger process there's been lot of speculation as to whether the merger would happen or not. And obviously a lot of people have been passive because of that. We also have seen as we step though the meeting date and the record date and prior to (remove) it recently. And ultimately the proof is going to be in the pudding of execution and we certainly intend as everybody that is involved believes, and everybody at Lexington and certainly DSS is eager and anxious to begin and start that process of adding value to the stock and to the stockholders.

Unidentified Analyst

Okay.

Operator

Thank you. There are no further questions at this time. I would like to turn the floor back over to Robert Bzdick for closing comments.

Robert Bzdick

I want to thank everyone who has joined the call and their interest in DSS. As I have stated we are very anxious to go forward. We see a very bright combination for the DSS in combination with Lexington Group. We realize there is other things we have said in the past, that somewhere along shareholders have been very patient with us. Some obviously are running out of patience. However that said I think that there is a -- we are at a point now where we can start executing on our business plans and our new business plans and start seeing some results from that. So again I appreciate everybody's interest and look forward to talking to you in the future.

Operator

Thank you. This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.

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