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Introduction

Document Security Systems, Inc. (NYSEMKT:DSS) is a US-based company that specializes in anti-counterfeit, authentication, and mass-serialization technologies. It works with corporations, governments, and financial institutions around the world to provide custom security solutions aimed at combating theft, counterfeiting, product diversion, and other costly problems. DSS operates a number of segments - DSS Printing, DSS Packaging, DSS Plastics, DSS Digital, DSS Technology Management - all in support of its larger vision, "to be the comprehensive powerhouse in brand protection." It has spent over 10 years researching, developing and refining its suite of technologies, resources, and manufacturing capabilities. DSS owns and operates its own secure manufacturing facilities in New York and California. The company appeared on the Technology Fast 500 from 2008-2011 - an annual list published by Deloitte LLP that recognizes the fastest growing technology companies in the U.S based on percentage of fiscal year revenue growth. Clients include Fortune 500 companies, U.S. Homeland Security, U.S. Customs and Border Patrol, the U.S. Air Force, and others. You can learn more about DSS here.

I'll concentrate this article in three segments:

1. I'll start with a look at the core business area of DSS (the printed products segments).

2. Next I'll look at DSS Digital Group, which includes its cloud computing and web/digital security businesses, as well as recent efforts in the mobile security market, including a look at the basic fundamentals of the company's stock price/financials.

3. In the final segment, I'll look at DSS's technology management group, where the good news continues to pour in, and the decisions by management look to be leading this segment down a road to profitability and success. This includes a look at all the recent news regarding its pending lawsuits against the likes of Apple (NASDAQ:AAPL), Facebook (NASDAQ:FB), LinkedIn (NYSE:LNKD), BroadVision (NASDAQ:BVSN), Jive Software (NASDAQ:JIVE), SalesForce.com (NYSE:CRM) and Novell (NASDAQ:NOVL) - thanks in large part to the merger with Lexington Technology Group in which it acquired its patent-weilding subsidiary, Bascom Research.

1. DSS Printing, Packaging, and Plastics Groups

These three segments of DSS make up the bulk of its business - manufacturing and sale of physical products.

DSS Printing produces things like currency, coupons, voter ballots, event tickets, documents, etc. DSS even produces and sells its own line of paper products that organizations can purchase to increase security among their documents. It offers a variety of watermarks, hidden text messages, and other anti-copying technologies to suit a wide variety customers needs. This presumably is a great way to lead customers into its own printing capabilities - a way to upsell. DSS's printing facility offers clients complete security while delivering total customization and controls throughout the process. DSS serves legal firms, real estate offices, governments, the academic world, pharmaceutical companies... basically any organization that would place an added importance on document security.

DSS Packaging serves customers who are looking to design and manufacture packaging for their products in a secure environment. It combines numerous security and anti-counterfeiting features into sleek and attractive packages for the world's top brands. Again, all in a secure facility where customers track and remain active throughout the entire process.

DSS Plastics produces things like drivers licenses and other ID cards, employee access cards, customer loyalty cards, gift cards, and various RFID and "smart" cards - cards with computer chip-like functions that offer enhanced security features.

Overall, you can see that DSS has placed great emphasis on being able to meet any type of security need. It incorporates all kinds of technology into these three businesses to combat fraud, theft, and counterfeiting that could possibly be achieved by fake IDs, illegal copying, picture-taking, etc. Across all industries one could expect to see an increased effort to utilize the capabilities of companies like DSS when it comes to their printing, packaging, or plastics needs.

2. DSS Digital Group

Cloud Computing, Digital/Web/Email Security:

This segment of DSS specializes in online security, including antivirus/antimalware software for businesses. It mainly concentrates on securing information such as emails, digital documents (images, spreadsheets, labels, word, etc.), and business transactions from accidental loss, corruption, damage, or infection due to hardware failure or environmental hazards via secure online backup servers. DSS has developed proprietary software to catalog and organize this data, that customers can then use to keep track of all their stored digital data. It also offers cloud solutions and connectivity for data exchange and processing.

Mobile Security Technology:

On November 26th, DSS announced it had entered into a sales and IP licensing agreement with Express Mobile, a developer on enterprise mobility solutions. This gives DSS a great avenue into the world of mobile anti-fraud and counterfeit detection, and comes on the heels of its integrating of the AuthentiGuard suite into an iPhone application. Many businesses are currently using reader devices to scan product barcodes, RFIDs and packaging labels that can cost upwards of $1500/unit and require significant operator training. Should DSS be successful in integrating its AuthentiGuard software suite into a program that uses the simpler and cheaper iPhone to scan items, and marketing this capability properly to pharmaceutical and logistic companies, substantial new revenues would result. I believe the agreement with Express Mobile shows that DSS management is serious when it comes to expanding its business to include monetizing the ever-growing mobile market.

DSS Stock Fundamentals:

  • 2012 showed a 27.6% increase in revenue year-over-year across these 3 businesses. So far in 2013 DSS looks to be headed to another YOY increase, only a fair bit smaller at 10.5%.
  • Most recent 3Q earnings showed 2.2% increase over previous year's 3Q.
  • Every year for the past five years DSS has seen revenues increase, with an average of 24.5% YOY. I look for DSS to, at a minimum, continue this trend into the foreseeable future as royalties from settlements bring more capital into the business, portions of which can be invested into improving and marketing these core segments.
  • Revenue from the other two segments (Digital/Technology Groups) was up almost 14% YOY
  • Current ratio stands at about 1.5 while Total Debt/Equity stands at 0.45, reflecting the company has been cautious about taking on debt to finance its growth.
  • Gross margin is 35.58%, average yearly improvement of 9%
  • Operating and Net margins are both around -25%, and have been at those levels for a while, indicating why the price of DSS had been on a downward trend for some time
  • Price/sales is currently around 4x - sales are projected to grow at 7% for the next three years
  • Price/book is currently 1.2x
  • As of 3QFY13, cash per share was $0.07
  • Sources: Reuters Global/Yahoo! Finance

3. DSS Technology Management Group

Effective July 1, 2013, Lexington Technology Group, Inc. became a wholly-owned subsidiary of DSS. This is now known as DSS Technology Management Group - "DSS TM" - and provides strategy for DSS's IP portfolio, as well as legal expertise and investment capital for pioneering inventions. Along with Lexington Technology Group came $7 million in cash and Bascom Research, with its strong IP portfolio. However, the true hidden gem in this deal may have been current CEO Jeffrey Ronaldi - a guru in the patent monetization world. With LTG Inc., Ronaldi was vital in securing successful patent verdicts against companies like Microsoft (NASDAQ:MSFT) and Citrix Systems (NASDAQ:CTXS). He turned $12 million in patent investments into $160 million in gains during his nearly 20 year tenure there. Also of note in this segment is DSS's investment in VirtualAgility, Inc. - an enterprise software company that currently has filed a patent infringement lawsuit against 9 defendants, most notably Salesforce.com (it would seem that DSS is going at CRM with two separate lawsuits - one from Bascom's patent portfolio and the other via VirtualAgility's patent portfolio).

From the dozen or so lawsuits that were filed by Bascom Research (owned by DSS) as well as VirtualAgility, Inc., three have already been settled and dismissed - BroadVision (4%), Jive Software (5%), and Novell (unknown %). Links to these settlements can be found here, here, and here, respectively. DSS quickly followed suit by taking action against Facebook, LinkedIn, Salesforce.com, and most recently Apple. Apple's lawsuit is being headed up by one of the most successful IP litigation firms in the country: Buether, Joe and Carpenter, LLC. The goal here is obviously to settle, which may be difficult with the remaining larger companies. One look at a case like Vringo vs. Google will show you that when a large company with loads of cash would rather let a lawsuit go to court, it will. This would be a negative for DSS, as it would surely draw out the lawsuits into years-long litigation, adding to its legal expenses. In the end, however, one could speculate by looking at the three recent settlements that future settlements are to be expected, as well as expected to be substantial. One should assume that if the lawyers from Jive, Broadvision, or Novell were not willing to let matters get to court that the Bascom patents are valid and infringement is legit.

I'm by no means an expert in patent law, so I recommend reading up further on the potential outcomes of these lawsuits via other recent DSS articles on SA, and monitoring future developments closely. One fellow SA contributor "conservatively" calculates here that similar settlements (4-5% or revenues) from Facebook and LinkedIn would amount to between $145-$182 million annually, after legal percentages and portions paid to the patents' inventor. Remember, market cap is currently at about $105 million. Also remember, the Bascom patents don't expire until 2022, so you're looking at the possibility of 7-8 years worth of income streams. It's obvious that the market has not priced in the full potential of these possible winnings.

Currently the Markman hearing date for the lawsuit against Facebook and LinkedIn is set for February 26, 2014, while the Markman hearing date for the lawsuit against Salesforce.com is set for April 2, 2014. The link for those announcements is here. In summary, when you look at the management's past successes in this arena, as well as the recent settlements, it bodes well for DSS's future in the patent and IP monetization world. I think the main driving force behind DSS's venture into this world is obviously to find a new and sustainable source for revenues that it can invest back into its core businesses, further enabling its success and leading to increasing shareholder value. In that light I think that shows again how devoted management is to becoming the major player in all things related to document security.

Conclusion

As you can see, Document Security Systems, Inc. looks to be well on the way to achieving its goal of becoming "the comprehensive powerhouse in brand protection." Every effort of management and every segment of the company is devoted to providing security and protection against the ever-increasing threat of fraud, theft, and counterfeiting that businesses find themselves fighting daily. Counterfeiting alone costs the global economy an estimated $1 trillion each year. If you consider that dollar amount a potential market for companies like DSS, you're looking at what could amount to a huge future revenue stream for its core segments alone. Combine that with the potential cash flows that current and future lawsuits could add to its bottom line thanks to the new technology management segment, and you're looking at what I believe to be a solid investment with a potential for massive upsides. Every favorable court ruling or news of a settlement will send this stock soaring, producing a substantial gain for the investors who get in early.

DSS's cash position is currently solid and projected to hold steady for the foreseeable future. As noted in the 3QFY13 earnings call, the company is sitting on around $3.2 million, which it expects to remain at that level through the next 3-4 quarters - enough to cover its potential legal expenses (estimated at $2 million/year with all current lawsuits) for at least 2014, allowing for plenty of time to cover any further delays in proceedings. CEO Ronaldi also pointed out that "the royalty revenues will probably start in later fourth quarter or first quarter (of 2014)..." so we can expect the cash position to strengthen. In summary, this means that shareholders are likely safe from additional stock offerings to raise more capital in the near future, providing further support to share prices at current levels.

As one of the oldest adages of investing goes... "follow the money." And that money has been pouring into DSS recently, including heavy insider buying as of mid-September in the $1.28-$1.33 range. I currently recommend adding to positions or buying DSS in the low $2 range, which is where I think we'll see strong support in the coming months heading into February's hearing and March's earnings release. Dawson James (the only analyst I could find covering DSS at this time) recently placed a $4/share price target on DSS and has it rated at "outperform" - assigning a $1.65 value to its underlying business model and $2.35 to future potential royalty revenue. The current share price of around $2.15 means the market has assigned a measly value of only about $.50/share to the possible patent monetization. The current share price represents only about a 15-20% downside looking at the value of DSS's underlying business assets, and a potentially huge upside when you begin to factor in settlements and patent monetization.

Risks

There is inherent risk when it comes to investing in a stock like DSS - it is a small-cap company and you must consider that a lot of the recent lawsuit news is already factored into the current share price. DSS has failed to make any significant profit recently. Any sort of bad news that breaks could potentially drop the share price significantly. Please do your own research and due diligence before making any investment decisions regarding this or any company.

Disclosure: I am long DSS. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Source: Document Security Systems: This Fast-Growing Small Cap Set To Double In 2014