Document Security Systems' CEO Discusses Q2 2013 Results - Earnings Call Transcript

| About: Document Security (DSS)

Document Security Systems, Inc. (NYSEMKT:DSS)

Q2 2013 Earnings Call

August 13, 2013 4:30 p.m. ET


Peter Salkowski – Managing Director – Blueshirt Group

Robert Fagenson – Chairman

Jeff Ronaldi – CEO

Peter Hardigan – COO

Bob Bzdick – President

Phil Jones – CFO


Yun Kim – Janney Capital Markets

Mark Argento – Lake Street Capital


Greetings, and welcome to the Document Security Systems 2013 second 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. You may now begin.

Peter Salkowski

Good afternoon. I'd like thank everyone for joining us today for the Document Security Systems’ second quarter 2013 earnings conference call. Joining me on today's call are Chairman Robert Fagenson, CEO Jeff Ronaldi, COO Peter Hardigan, President Bob Bzdick, and CFO Phil Jones.

Following management’s prepared remarks, we will open the call for your questions. This afternoon, Document Security systems issued release announcing its second quarter 2013 financial results. That press release is available on the company's website at

Before management begins, I'll review the company's Safe Harbor statement. Forward-looking statements on this call, including, without limitation, statements related to the company’s plans, strategies, objectives, expectations, potential value, intentions and adequacy of resources, are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act and contain words such as “believes”, “anticipates”, “expects”, “plans”, “intends” and similar words and phrases. These forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from the results projected in any forward-looking statement.

In addition to the factors specifically noted in the forward-looking statements, other important factors, risks and uncertainties that could result in those differences include, but are not limited to, those risks in the “Risk Factors” section of the company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2013, filed with the Securities and Exchange Commission on August 13, 2013. Forward-looking statements made as part of this call are being made as of today August 13, 2013, and the company assumes no obligation to update the forward-looking statements, or to update the reasons why actual results could differ from those projected in the forward-looking statements.

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

I would now like to turn the call over to Robert Fagenson, Chairman of the Board for Document Security Systems. Robert?

Robert Fagenson

Thank you, Peter. Hello and welcome everyone to the conference call. A lot has gone since our last call. As you recall, in July 1, Document Security at long last entered at a new chapter when we closed the merger with Lexington Technology Group. Prior to the close of the merger, management worked quiet and long to close this merger and all the complexities that went along with it while still managing to improve the operations of the company. The company's second quarter financial results, which you’ve seen and which Phil will discuss with you shortly, shows the management team’s effort to improve the business is gaining momentum. Unfortunately an almost constant backdrop through the positive operational progress, we've continued to witness unprecedented trading volume in the shares since the merger closed and the concomitant selling pressure has caused a decline in our share value which we believe is not reflective of the company's future long-term prospects.

As the Chairman of our Board and a major shareholder, I continue to be deeply concerned and disappointed with the amount of trading and effect it has had on our stock price and our long-term shareholders. When the transaction was negotiated, the entire Document Security Systems’ board, myself included, believed there were sufficient incentives in the structure to encourage a longer term focus by our merger partners who would become major shareholders.

Incentives included nearly 5 million warrants with an exercise price of $4.80 and 7.1 million escrow shares to be delivered to the LTG shareholders only if certain conditions were met, including a sustained share price above $5. [This was] put in place to focus shareholders on longer term prospects of DSS and we felt all parties to the merger shared. We believe trading since the close of the merger has been originating in large part from investors who we partnered with originally, but who are now capitalizing on their own short term opportunities in the market, while ignoring what we believe, and continue to believe they saw together with us a significant longer term benefits of the merged company.

We can't do anything about shareholders exercising their legitimate legal rights to sell their own shares. But we don't want to ignore that what we did receive on this merger – excuse me -- was a new management team (inaudible) with the expertise in development licensing and management of intellectual property . Nothing about that has changed. Additionally, we received a strong pipeline of IP assets in the Bascom Research and VirtualAgility portfolios which (inaudible) considerable strengthening to our company's balance sheet.

I want to separate the two things in all of our minds, which is one, the short-term stock price and pressure that we've been experiencing and the existence and effectiveness of a solid management team dedicated to improving Document Security Systems overall operations and continue to focus on positioning the business for future growth. The financial partnering model which Jeff will explain in greater detail is going to allow our team to put leverage our management and their expertise while expanding the universe of opportunities that the company can participate in and allowing us to conserve our cash for other uses.

As DSS continues to report improved operating results, we believe the company's stock price hopefully will more accurately reflect these positive efforts resulting in an increased shareholder value for our long-term and our short-term shareholders.

Despite what all this may feel and disappointment with the certain parties and with the short-term stock price, it does not in any way diminish the effectiveness and creativity of our management team, those that are joined and those have been a part of running our legacy businesses, excuse me, and cannot ignore the complementary nature of our operating divisions, our management team and the addition of Jeff and Peter and the additional breadth and knowledge base that they bring to where we believe the company is going to be moving.

And with that, I'd like to turn the call over to our Chief Financial Officer, Phil Jones for a recap of the company's improving second quarter financial results. Phil, over to you.

Phil Jones

Thank you, Robert. Today we announced the second quarter financial results for Document Security Systems, which are summarized in the press release issued today after market closed. As a reminder, our second quarter earnings and 10-Q reflect the results of the pre- merger DSS on a standalone basis through June 30, 2013.

In the second quarter, DSS continued to benefit from the trends established over the last several quarters. The company experienced strong growth in revenues and gross profit as a result of management's efforts to optimize product sales mix to control costs.

Second quarter revenue was $4.3 million, a year-over-year increase of 17%. Total revenue was driven by growth in the packaging and plastics business segments. Packaging revenue strongly increased 38% year-over-year to $2.2 million while revenue for the plastics group increased 22% year-over-year to nearly $1 million. Plastics group sales continued to benefit from the n increase in sales of the RFID badge products while the packaging group saw an increase in orders from its largest customer. Revenue for the licensing and digital solutions groups increased 6% year-over-year to just under $0.5 million. Printing revenues decreased 21% year-over-year to approximately $700,000.

Total gross profit for the second quarter of 2013 was $1.6 million, a 22% increase over the second quarter of 2012, resulting in a total gross profit margin of 38%. The significant factor for the approximately $300,000 year-over-year increase in the company's second quarter total gross profit was the nearly $200,000 increase in gross profit for the company's packaging business.

In addition, the printing segment contributed $67,000 to the year-over-year increase in gross profits. Once again gross profit growth outpaced revenue growth, but these divisions continued to focus on improving their sales mix while also reducing production costs.

In the second quarter, total operating expenses increased 53% year-over-year to nearly $3.5 million. Two factors contributed to the increase in operating expenses. First, operating expenses increased due to the higher than normal professional fees as a result of the merger, including legal, accounting and filing fees. The merger-related professional fees totaled approximately $479,000 in the quarter. With the merger closed, we expect professional fees to return to their traditional levels.

Second, stock-based compensation charges rose significantly during the second quarter 2013, primarily due to equity grants invested on the merger. Absent the merger-related items just described, operating expenses remained essentially flat compared to the same quarter of last year.

Adjusted EBITDA defined as earnings before interest, taxes, depreciation, amortization, stock-based compensation and other non-recurring items, including the merger-related professional fees and stock-based compensation was a loss of $171,000 for the second quarter, a 65% improvement over the second quarter of 2012. Once again adjusted EBITDA is a non-GAAP measure of performance and please refer to the table included in our earnings release for today for a reconciliation of our GAAP net loss to adjusting EBITDA.

Net loss for the second quarter was approximately $1.9 million or $0.09 per share which compared to a net loss of $1 million or $0.05 per share in the second quarter of 2012. We ended the second quarter 2013 with approximately 22 million shares outstanding and as of August 10 the number of shares outstanding is approximately 49 million, which includes 7.1 million shares being held in escrow as Robert described earlier.

Moving to the balance sheet, as of June 30, 2013 we had approximately $600,000 in cash. With the close of the merger on July 1, we added approximately 6.2 million to our balance sheet. As a result, the company has a healthy net cash position that will allow management to continue to meet its operating needs and to make selective investments to ensure the future growth of the overall business.

As a reminder, starting with the third quarter of 2013, DSS will have a very different balance sheet. We're finalizing the accounting treatment of the merger and we will file an 8-K with the pro forma post- merger financial information no later than September 13, 2013.

The second quarter of 2013 can be summarized as follows: Packaging and plastics division each posted strong second quarter revenue results. Combined these two divisions posted a 33% year-over-year revenue increase. Second, management’s efforts to improve sales mix and control costs leveraged a 17% year-over-year increase in total company revenue into a 22% year-over-year -over-year increase in gross profit. And finally, we completed the merger with the Lexington Technology management thereby increasing the company's intellectual property capabilities while adding senior management and strengthening the company's balance sheet.

With that, I will turn the call over to Rob Bzdick for few comments. Bob?

Bob Bzdick

Thank you, Phil. During the second quarter as CEO I was very pleased with the company's performance with high-teens sales growth translating into gross profit improvement and (inaudible). As a reminder, the company's reported structure will be different in the third quarter. The company will continue to report DSS printing, packaging and plastics as we have been but the digital and licensing group will be split. Digital will become DSS Digital and licensing will be combined with Lexington Technology Group.

Effective August 2, 2013, the Lexington Technology Group changed its name to DSS Technology Management. Therefore DSS Technology Management is the company's fifth reported segment. This segment will assume the ongoing management of the litigation as well as DSS intellectual property portfolio. This business unit will be responsible for evaluating new investment opportunities in the IP monetization and licensing space.

Our new structure better positions DSS to capture the financial potential associated with IP monetization while limiting company’s downside through continued growth of its legacy business operations. As President of the company in charge of DSS, printing , packaging, plastics and digital divisions and a focus on providing reliable stream of revenues from operations, while continuing to improve the overall profitability of these divisions. Our efforts to monetize our AuthentiGuard are fast progressing and we continue to expect AuthentiGuard revenues in 2013. As previously stated, we have competed further developments that allow brand owners to use AuthentiGuard technology for both brand protection and direct-to-consumer marketing opportunities.

Regarding our efforts to improve profitability, and you have seen the recent 8-K filings (inaudible) printing press. The strong performance of our packaging division as well as our stronger post-merger balance sheet contribute to the company receiving very favorable financing terms. The press provided the ability to print a wider range of materials and will result significant productivity improvements by reducing sales tax. The press is part of a larger (inaudible) to combining the print packaging divisions into one facility. We expect this process to be completed by the end of this calendar year and when completed we expect both significant cost savings and operational efficiencies.

I am very (inaudible) Document Security Systems (inaudible) amount of opportunities for the company and believe that the new structure [crosses] a strong and unique company geared toward system profitability.

I would now like to turn the call over to Jeff Ronaldi to discuss the company on a going forward basis.

Jeff Ronaldi

Thank you, Bob. First, congratulations on the progress that was made in the second quarter. You created an excellent platform from which we'll continue to grow Document Security Systems.

Before making a few remarks about our ongoing business, I would like to remind everyone of the strategic priorities I mentioned in early July. Number one, focus on profits by continuing to grow revenues and by diligently controlling costs. In other words, build up the momentum that Bob and Phil referred to. Number two, monetize AuthentiGuard , as Bob reiterated a moment ago, we expect revenue from AuthentiGuard in 2013.

Number three, manage the Bascom litigation against the remaining defendants. Four, develop our IP portfolio by leveraging the company's expertise to evaluate investments with significant potential and make investments in companies that meet our criteria. Number five, increase the company’s IP strength by adding managers and partners capable of working complex IP investments. Speaking to point four and five, management has considered partnering with outside teams capable of providing capital to partially or fully finance certain IP investments.

Management has had conversation with professionals who have a strong understanding of intellectual property, appreciate the illiquid nature of those investments and therefore recognize the need to be patient. In such a partnership scenario, DSS manages the IP investment and in return receives a portion of the outcome. It's important to note that these outside groups usually do not partake in equity transactions. Rather their confidence in the management and the financial upside with the IP investment is so strong that they only seek to invest in the asset itself.

We feel that DSS's ability to attract outside capital speaks to the strength of our relationship and the expertise of the IP management team. The management is dedicated to attracting long term institutional equity investors to Document Security Systems stock. One way to accomplish this is by transparent communication with the investment community. To this end, DSS management has [looked at] four key milestones that we intend to update on a quarterly basis. The milestones are: revenue from AuthentiGuard, improve profitability of legacy DSS business, a total investment of 5 to 7 in the IP portfolio by year end, including Bascom Research, VirtualAgility and and finally progress in reaching positive cash flow. We believe that these milestones accurately portray positive growth in our business and allow Investors to gauge the company's progress in meeting our goals.

As previously discussed for many reasons, DSS is not able to provide guidance. In addition, management is limited in disposing certain information for contractual and competitive reasons, we usually do not release customer names, the terms of license agreements or the terms of settlement agreements. Disclosing our IP valuations could ultimately hinder the company's ability to monetize these investments.

That said, as a publicly traded company, we do have SEC reporting requirements to uphold. Most notably ,we are required to report any information that is deemed to be material for the company's operations in a Form 8-K. Stockholders can expect that management will provide update on court filings, developments such as Markman hearings and settlements and other important issues when possible. In fact, we are pleased to report that the Markman hearing for the VirtualAgility case has been scheduled for April 2014.

As part of its IP portfolio, DSS Technology Management has a minority investment in VirtualAgility with an option to increase its investment. Given the data some eight months delay, it is important to mention that this Markman data is sensitive. We will continue to update investor community as we receive more information regarding the schedule.

We have laid the groundwork for an exciting time for Document Security Systems. For the legacy DSS operations, it is about expanding the business while transitioning the business to higher margin to achieve profitability. We plan to leverage cash generated by legacy DSS operations to fund the higher growth areas of DSS digital and DSS technology management, presenting what we believe is significant upside for investors.

Although we still have a lot of work ahead, DSS is well positioned to achieve its long stated objectives as evidenced by the solid second quarter results that we reported today. We look forward to continued progress in 2013 and beyond and I want to thank you for your ongoing support. I will now open the call up for questions.

Question-and-Answer Session


(Operator Instructions) Our first question comes from the line of Yun Kim from Janney Capital Markets.

Yun Kim – Janney Capital Markets

Congratulations on a solid operating results for the quarter. Obviously a lot of stuff going on, on the litigation front, first, the case against Novell and the Bascom case that is -- Bascom case got dismissed. I believe there was a settlement in the case. Can you provide us with any color around the settlement such as royalty rates, I am not sure if you can disclose that and any revenue contribution you would expect from that settlement?

Jeff Ronaldi

Yeah unfortunately we are not able to comment on the Novell dismissal from that case. I can say we continue to manage this thing and work towards the positive results that we all want to see.

Yun Kim – Janney Capital Markets

But do you expect any revenue contribution from that settlement at all?

Jeff Ronaldi

Again unfortunately by contract I am unable to discuss it.

Yun Kim – Janney Capital Markets

And then also the case against got dismissed voluntarily. What was the reason or strategic rationale behind the dismissal?

Jeff Ronaldi

It’s just an overall evaluation of the portfolio and trying to identify the best way to move it forward against the proper defendants. We constantly evaluate our portfolio to see if there is other ways to monetize it, we felt at this time it was best to remove Salesforce from the defendant list.

Yun Kim – Janney Capital Markets

And then last question on the litigation front, why was there a change in the law firm on the case against Facebook and LinkedIn, and does that have any effect on the Markman case?

Jeff Ronaldi

It does not have an effect on the Markman case. We were looking for a law firm that was better aligned with our long-term interest to maximize the value of the portfolio.

Yun Kim – Janney Capital Markets

And then just talking about the operation side of the business, notice that you borrowed some money to buy a fairly expensive printing press in the quarter. Does this investment reflect a change in your strategy for that business or do you still plan to focus on margin improvement in that business like you showed this past quarter?

Bob Bzdick

It's a little bit of both. This is Bob Bzdick. It's a little bit of both. That piece of equipment as I stated in my remarks better fits the combination of printing, security of printing which is lighter weight sacks and also our packaging which is heavy weight sacks, currently we have to outsource some of our packaging printing due to the fact that the printer that we are currently using is limited in that regard. So obviously we are going to continue to improve our sales, which is to emphasize security when the margins are higher and again continue to look for value added products that we can use that fast forward.

Yun Kim – Janney Capital Markets

And then on the packaging side of the business obviously that showed very strong growth. Was that driven primarily by new customer adds or was there any couple of large deals contributing to the growth?

Bob Bzdick

Again in that case it is a little bit of both, we have actually had further penetration into some of our larger customers. The good news in that regard is it's not, we are getting into other areas of that large customer and so they’re just total packaging, actually those packaging regarding the pharmaceutical efforts. So it’s almost like having a second customer within a customer. And the other areas we have found some good success in medical device packaging and the design of, that kind of packaging. So that's been a new area for us and so we've seen some growth in that area.

Yun Kim – Janney Capital Markets

And then just a last question, is there -- can you just update us on what your current thinking is with regards to cash flow? Do you have any particular goal in mind in terms of when you can expect to turn positive cash flow?

Phil Jones

Hi, this is Phil Jones. I can answer that. Ultimately as we described, the model is geared towards having the legacy businesses, the traditional DSS businesses continue to pave their way towards cash flow positive results. And as we mentioned we were very close to that when you take out the merger costs. So, on top of that are the efforts that will now ongoing from the DSS Technology Management Group. So, we are continuing to drive that path forward and we feel we are getting very close to that milestone.

Bob Bzdick

And again this is Bob Bzdick. As it relates to combining the printing and packaging facility and as I indicated before that will be concluded by the end of calendar year. So we expect to see significant savings and efficiencies there obviously that will manifest themselves in 2014.


Our next question comes from Mark Argento from Lake Street Capital.

Mark Argento – Lake Street Capital

Question on VirtualAgility now that you have a little bit better color on timing in terms of some of the core calendar, can you remind us what -- you have the ability, I believe, to put more capital to work there, if you so choose. And then kind of dovetailing to my second question, or I guess I should ask, is that something that you are thinking about doing and what are some of the gaiting factors? And then kind of dovetailing to my second question about capital and your thoughts about alternative mechanisms in terms of funding some of your projects from deploying your capital versus maybe a third-party capital and if you can talk about that a little bit as well? Thank you.

Jeff Ronaldi

Sure. As far as VirtualAgility, they had a scheduled hearing August 8 in Marshville, Texas where the Judge set up a Markman hearing for April 2013 and a jury selection in November of 2014, so all indications point towards that schedule. Having said that, we think they have a tendency to move, so we will keep a close eye on that.

To answer the question about our ability to fund this or desire to fund this, the answer is yes, our intent and desire is to continue to exercise our options in this investment. This was done for several reasons, one of the reasons was to help manage risks, the further you get down the path of these litigations, you can understand the case better and by allowing us to spread out the investment over time we get more exposure into how the case is progressing. And to answer the question I think you asked is progressing well, our intention is to continue to exercise as our options come up.

Second part of your question was about capital sourcing, and what we're doing here is kind of just leveraging our skill set and our network to have a third-party come in to provide either a 100% or partial investment in -- these IP investments and allowing DSS technology management to earn basically an advisory fee on someone else's money. We are doing this now, we want to move forward with our strategic plan but we also need to conserve cash especially while the stock prices go up.

Peter Hardigan

And I guess just one to thing to add. This is Peter. The investors or the partners that we're working with are long-term focused, understanding asset class. It is patient capital and they will lack liquidity. They're tied to the outcome of what we're doing. So they are in it, they only make money when we make money which is I think a different prospect than, with some of what Robert was saying at the front of this call. These are people who know us and believe in us and know that we're making money.

Mark Argento – Lake Street Capital

When you talk to these third-party providers, their capital sources and when you think about your business model, what kind of return profile are you guys targeting, is it about 3 to 5x recurring over certain period of time? Are you willing to take, turn the money quicker or maybe take a lesser return, but more quickly, just talk a little bit about how you guys think about returns on capital?

Jeff Ronaldi

Sure. In in the IP space, it’s high risk high return money and our job as manager of these assets is to manage that risk and try to remove it along the way. But even evaluate something to move forward with it, you better see a 5 to 10 return on the investment at minimum, but as you go through the path of monetization you have to constantly evaluate where you are. Sometimes that dictate you take settlements. And by taking settlements you reduce risk. So each one is unique, but so far we've had a pretty good track record of performing on these investments.

Peter Hardigan

I guess maybe for I think a comparable that people talk about a lot is the IP space and bio tech. And I think that the risk return profile is similar. There are very significant milestones that happen in investments where things change. There is a process of going through litigation. It is not too dissimilar from the process that a company goes through in dealing with the FDA and the entire regulatory process. It's a critical process but if you know what you are doing and you are investing wisely when these payoff, they pay-off the way the biotech does.

Mark Argento – Lake Street Capital

And then last question. In regards to various verticals in which -- in terms of IP acquisition or management, clearly you have a pretty robust platform now in the Document Security space with the DSS business, legacy DSS business and when you evaluate the different portfolios, are you trying to cluster what's the segment strategy if there is one?

Jeff Ronaldi

It's the evaluation of the IP as a standalone and how it can be combined into our businesses. As you might have seen in both the VirtualAgility and the Bascom portfolio, those are both products that we will use within our AuthentiGuard products. And so it's an evaluation of what we can use internally, but also looking at the strength of the IP in and of itself, so if there was an opportunity to acquire and build a product line around it, we would consider doing that as well.

Mark Argento – Lake Street Capital

Yeah it's very helpful

Robert Fagenson

And one other thing -- when we evaluate investments where we have existing technical competency, we are going to be more confident in our assessment. So I think that's probably our ability to make wise investments within the technology verticals we have, is going to be an advantage, especially because we have a lot of very smart people many of whom who have invented industry leading technologies, who we can speak to about issues, about the IP value of our competitiveness, about importance of a portfolio as we're looking at. So, I think definitely where we have an operating footprint, we are going to have an advantage over other buyers who are paying for that services or outsourcing and are doing other things. So, this is where our total capabilities as a technology development company give us a significant advantage in assessing the portfolio and also of course give us the ability to make money by making a product, commercializing a technology that can be industry-leading, have a lot of upside.

Mark Argento – Lake Street Capital

How would you characterize your -- deal pipeline in your portfolio, maybe evaluating some of new opportunities is that, has it leaned a little bit in the summer months and there has been more noise in the popular press, probably at White House and the legislators getting up for the IP space a little bit, how would you characterize kind of where you see your pipeline today relative to three, six and 12 months ago?

Jeff Ronaldi

I would say it’s stronger than before. One of our differentiators is, we're an operating company and there is a lot of concern out there with the pending legislation about patents, NPEs and other sourcing companies. And we're an operating company and that's how we differentiate ourselves. So I would say that our pipeline is probably a little bit too robust right now.


Okay. Thank you. At this time I will turn the floor back over to Peter Salkowski for closing comments.

Peter Salkowski

Great. I want to thank everybody for joining us today on the earnings call for Document Security Systems. Look forward to updating you again in the next call and everyone have a great day. Thank you very much.


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

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