Document Security Systems' CEO Discusses Q4 2013 Results - Earnings Call Transcript

Mar.26.14 | About: Document Security (DSS)

Document Security Systems, Inc. (NYSEMKT:DSS)

Q4 2013 Earnings Conference Call

March 26, 2014 04:30 PM ET

Executives

Peter Salkowski - IR

Jeff Ronaldi - CEO

Phil Jones - CFO

Analysts

Mark Argento - Lake Street Capital Markets

Bob Wasserman - Dawson James

Operator

Greetings, and welcome to the Document Security Systems’ 2013 Fourth Quarter and Year End Financial Results Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. (Operator Instructions) As a reminder, this conference is being recorded.

I would like to now turn conference over to your host Peter Salkowski, Investor Relations for DDS. Thank you. You may now begin.

Peter Salkowski

Good afternoon. And I’d like thank everyone for joining us today for the Document Security Systems’ fourth quarter and full year 2013 earnings conference call. Joining me on today’s call are CEO, Jeff Ronaldi, and CFO, Phil Jones.

Following Phil and Jeff’s prepared remarks, we will open the call for your questions. This afternoon, Document Security systems issued a press release announcing its fourth quarter and full year 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. Forward-looking statements on this call, including, without limitation, statements related to the company’s plans, strategies, objectives, expectations, potential value, intentions and the 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 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 Annual Report on Form 10-Q for the year ended December 31, 2013, to be filed with the Securities and Exchange Commission. Forward-looking statements made as part of this call are being made as of today March 26, 2014, 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, you will find additional disclosures regarding the non-GAAP financial measure and reconciliations of net loss to adjusted EBITDA.

I would like to now turn the call over to Phil Jones, Chief Financial Officer of Document Security Systems. Phil?

Phil Jones

Thank you, Peter. Today, we announced fourth quarter financial results, which are summarized in the press release we published after market closed today and detailed in the Form 10-K filed with SEC today as well. We have now reported twice into our merger with Lexington Technology Group or Lexington in July 2013. To review printed products revenue consists of the results from our packaging, plastics, and printing business units. Technology, sales, services, and licensing revenue consist of results from our DSS Digital and DSS Technology Management Business units. These units are engaged in the various aspects of developing, acquiring, selling, and licensing technology assets.

For the fourth quarter, total revenue was $5.2 million down 5% year-over-year marked by 3% increase in technology revenue offset by 6% decline in printed products revenue. Year-over-year increase in technology revenue primarily reflects the digital revenue generated by our DSS Technology Management Division. Two factors mainly contributed to the year-over-year decline in total fourth quarter revenue. First was our efforts to focus on higher profit margin printing and packaging customers, this resulted in the loss of some less profitable business. Second, we are up against a very difficult comparison in which the fourth quarter of 2012 total revenue was up 30% due to the timing of sales to our largest customer, this revenue was offset by lower first quarter of 2013 sales to that same customer.

In the fourth quarter of 2013, we saw that customer return towards more normal ordering pattern. Fourth quarter, cost and expenses increase 19% from 2012 which once again will [pace by] [ph] the significant growth in noncash based patent amortization expense, which was driven by a substantial increase from the value of our intangible assets on our balance sheet as a result of the Lexington merger. Cash based expenses increased only 3% during the quarter, reflecting a 14% decrease in direct cost of revenues offset by increases in compensation costs and professional fees. These increases were primarily the result of our new technology management division as a result of the Lexington merger.

Net loss of the fourth quarter was approximately $800,000 or loss of $0.02 per basic and diluted share. This compares to a net loss of $1.1 million or $0.05 per basic and diluted share in fourth quarter of 2012. Improvement in net loss was mainly due to a deferred income tax benefit of approximately $1.8 million recorded in the fourth quarter of 2013. The noncash tax benefit is related to the Lexington merger and reversal of deferred tax valuation allowances that have been carried by DSS.

As in the past we believe adjusted EBITDA is a good measure of the company’s performance. Adjusted EBITDA is defined as earnings before interest, taxes, depreciation, amortization, stock-based compensation and other non-recurring items, including merger-related professional fees. Adjusted EBITDA for the printed products group increased 95% in the fourth quarter of 2013 to a positive $597,000 from $306,000 in the fourth quarter of 2012. The increase was driven by our efforts to focus on our more profitable customers as well as an improved overall product mix, with particular strength in our plastics group’s RFID related ID card sales. The adjusted EBITDA loss for our technology group increased to $602,000 from a $130,000 loss year-over-year. Higher loss reflects costs associated with non-merger professional fees related to our ongoing monetization and due diligence activities associated with the evaluation and acquisition of additional IP assets.

Once again adjusted EBITDA is a non-GAAP measure of performance. Please refer to the table in our earnings release from today for reconciliation of GAAP net income and loss through adjusted EBITDA.

To summarize the full year, we were able to grow revenue by 2% [paced] [ph] by an 11% increase in our technology revenue line and decreased direct cost of revenues by 5%, therefore improving the core profitability of our operating businesses. While cost and expenses increased 23%, the majority of this increase was due to non-cash based expense categories, depreciation, amortization and stock-based compensation. Cash-based expenses increased only 5% for the year despite the addition of a significant new line of business [at the company] [ph].

Moving to the balance sheet as of December 31, 2013, the company had a cash balance of approximately $2.5 million. Furthermore, as was detailed in an 8-K filed by the company on February 18 of 2014, we secured a third party IP funding commitment of up to $4.5 million of which the company received $2 million on that date. Otherwise our balance sheet when compared to where we were at the end of 2012 reflects a significant change in our business as a result of the merger with Lexington along with equipment additions. We expect these equipment investments to contribute to the continued profitability of our Printed Products group.

In regards to the Lexington merger as many of you may recall, there are 7.5 million shares being held in escrow that will only be released if DSS stock trades above $5, with 40 out of 90 trading days before June 30, 2014. If this condition is not met which appears likely at this point then the escrow shares are returned to the company to become treasury shares, thus reducing our outstanding share count to approximately 42 million.

With that I’ll turn the call over to CEO, Jeff Ronaldi. Jeff?

Jeff Ronaldi

Thank you, Phil. I’d like to thank everyone for your continued support of Document Security Systems. DSS has always been a technology operating company that engages in IP licensing and enforcement. Management has focused on continuing to improve the profitability of our printed products and growing the technology sales, services and licensing group. Since mid-2013, management has performed well against our strategic objective. We’ve improved the performance of our printed products group as demonstrated by the group’s strong adjusted EBITDA growth for both the fourth quarter and full year of 2013.

In the fourth quarter we generated revenue from Authentiguard by way of a contract with MedTech Wristbands. We accomplished our goal of investing in five to seven IP portfolios and closed the year with a total of six patent portfolios which includes the additions of the semiconductor and Bluetooth patents. Adding to this, we adjusted the company’s incentive structure to better align DSS employee interest with shareholder interest. On this last point we granted stock options as part of a total compensation to DSS employees who’ve worked for the company for at least a year. While we believe we’re driving the company in the right direction, we realized there is a lot of heavy lifting ahead. For the printed products operation we’re targeting a level of the same profitability. For the technology business we are carefully evaluating and investing in multiple IP opportunities so as to be less dependent on a single case outcome.

With many cases lasting two to three years this can be an arduous and timely process. However, we expect the end results of these efforts to generate positive cash flow on a consistent basis.

I’ll now review some of the events that occurred for DSS in the fourth quarter of 2013, including positive development with our Authentiguard products, ongoing improvement with the printed products group and the growth of our technology group.

Regarding our AuthentiSuite product, recent events such as the sale of fake Super Bowl tickets in New York City this past January and the use of stolen passwords on Malaysia Airlines Flight 370 have increased awareness to the severity of counterfeiting and the advantages our authentication products such as Authentiguard provides. In fact we’re encouraged by Authentiguard’s path of adoption and see the sports merchandize and the entertainment market as a natural extension of the success we’ve experienced with MedTech Wristbands. Specifically, we believe our technologies are well suited to help major sports league, amateur leagues and entertainment venues, fight the proliferation of counterfeit merchandize and tickets that is not only costing these industry millions of dollars but damaging their brand’s integrity with consumers. On that note I’m pleased to announce DSS has recently signed an agreement with former NFL player Pat McInally to represent our anti-counterfeiting authentication technologies in the sports merchandize and entertainment markets. As a former Cincinnati Bengals player, top rated syndicated sports columnist and creator of a line of action figures, Mr. McInally has personal exposure to the issues of counterfeit branded merchandize. He’ll apply this knowledge to introduce and position DSS’ technologies and solutions to these industries. We expect Pat to play a large part in developing the sports and entertainment market for DSS and look forward to building our market share along with him.

Moving to printed products, in the fourth quarter we combined our printing and packaging to a single facility to better align an improved profitability of these operations. We expect to see cost savings as a result of this initiative beginning in the first quarter of 2014. We remain focused on aligning these business operations to generate a reliable stream of profitable revenues.

Moving to the technology group, in the fourth quarter, we announced several positive developments. First we announced the sales and IP licensing partnership with Express Mobile. Express Mobile also known as XMO is a developer of enterprise mobility solutions. The partnership grants DSS rights as exclusive channel partner for XMO’s mobile enterprise application platform in the anti-counterfeit and fraud detection market. The partnership will enable us to integrate XMO’s technology into our AuthentiSuite product line.

We also received a license to XMO’s pioneering patent portfolio which relates to the development of custom applications and websites. As part of this agreement, DSS Technology Management will provide advisory services to assist XMO in monetizing their IP portfolio. Second, since our last update in November we filed a patent infringement lawsuit against Apple in the U.S. District Court for the Eastern District of Texas. At issue are patents that relate to the use of wireless peripheral devices that we acquired during the third quarter of 2013.

We made several additional announcements since the close of the fourth quarter. In January we announced the stay of Bascom Research Markman hearing in light of the expected Supreme Court ruling in June or July covering the patentability of software. Also in January, we announced that Eastern District of Texas had denied the defendant’s motion to stay the VirtualAgility case. However, the Markman has since been temporarily stayed pending a decision by the federal circuit. By waiving additional update the coupons.com case continues progression towards a trial. A list of DSS Technology Management’s current cases and their respective docket numbers are now available under the investor FAQs on our website.

The IP environment is one of constant change. The DSS management team has a broad range of experience and a proven track record of success in this space. We’re confident in our position as an operating company and in our ability to navigate this changing landscape in the future. Notwithstanding the delays with Bascom and VirtualAgility, this March we announced the filing of a patent infringement lawsuits against Samsung, Taiwanese Semiconductor Company and NEC in the U.S. District Court for the Eastern District of Texas Tyler division. Our complaint alleges infringement of patents related to semiconductor manufacturing.

Lastly, in the first quarter the company received $4 million in external commitments from co-investors. These co-investments are consistent with the strategy [regarding with] [ph] outside investors in a manner that is non-dilutive to DSS shareholders. These outside investors have a dual interest in IP investments and clearly demonstrate confidence in DSS’ ability to manage and monetize the acquired assets.

In closing, in 2014, we will build on the momentum we have generated since July 2013. For the digital operations we plan on leveraging partnerships, establishing 2013 as well as our recent partnership with former NFL player Pat McInally to seek new revenue opportunities. In addition, we’ll focus on managing the printed products group for further consolidation of profitability, cash from this group will be used to fund the higher growth areas of our business. And DSS Technology Management will continue to manage the coupons.com, Bascom, VirtualAgility, Bluetooth and semiconductor cases.

We plan to increase the number of patent portfolios from six to at least 10 by the end of 2014. We’re proud of what the company has accomplished in such a short period of time and look forward to providing further updates.

I will now open the call up for questions.

Question-and-Answer Session

Operator

Thank you. We’ll now be conducting a question-and-answer session. (Operator Instructions) Our first question comes from Mark Argento from Lake Street Capital Markets.

Mark Argento - Lake Street Capital Markets

Just two quick questions, one, could you remind us typically when you do the co-investments with additional investor how the basic economics of those relationships work. And then secondly as you look to expand your IP portfolio, if you could talk a little bit about what areas generally from a technology perspective you’d be focusing on? I know there has been, you’ve run in a few roadblocks in terms of some of the technology areas given some of the different activities in the court systems but you’ll stay focused on - in and around software and/or security or would you look to branch out outside of that area?

Jeff Ronaldi

The co-investments are typically made - each one is different, so it’s hard to characterize them all together, some of them are actually co-investments worth dollar-for-dollar equal where we are just going split profit. This last one was a bigger deal where they provided a certain amount of funding and for that they get priority return. All that is spelled out in our filings but what it does is allow us to expand and reduce our risk by getting a bigger portfolio which is critical for this. As we have stated, we need a broader portfolio to reduce the risk on a single outcome. The answer to your second question about expanding in areas we are going to look for, it’s - we are an operating company and what we are doing is looking for patents that protect our various products and allow us to sell a product that doesn’t infringe on other peoples IP, if it happens, if this, the IP we acquire has monetization capability we will go ahead and pursue that, so to answer your question it’s been in support of our operating divisions.

And one last piece on the pending Supreme Court decision, for now we are shying away from software patents until the Supreme Court can clarify what’s patentable.

Mark Argento - Lake Street Capital Markets

In terms of other business development strategies, are there opportunity to acquire other complementary operating businesses that also have similar characteristics in terms of their dependence on technology IP or you looking prominently just at the IP assets?

Jeff Ronaldi

We are looking at undervalued assets and so that happen to the operating divisions, we would be glad to look at that as well. So, it’s not just exclusively looking for IP, if it comes along with the business that’s even better.

Mark Argento - Lake Street Capital Markets

And last question for me, what’s the total headcount today and could you compare that to historically the various levels of headcount within the organization?

Jeff Ronaldi

Phil, you have been here longer than I have.

Phil Jones

Yes, right now we are right around 105, and that’s fairly consistent. We’ve seen turnover from some of our manufacturing headcount but we’re placing those with the developer and the technology related headcount. So, we have been pretty consistent here for the last three years around 105.

Mark Argento - Lake Street Capital Markets

And what percentage roughly are engineers?

Phil Jones

About 15% are in the technology and the development group, software engineers, IT professionals, so 15%.

Operator

Thank you. Our next question comes from Bob Wasserman from Dawson James.

Bob Wasserman - Dawson James

Hi guys. Congratulations on the good year. Wonder if you could comment little bit about your cash needs for this year without borrowing the receipt of any type of litigation settlement, maybe split that up a little bit between what’s your CapEx is for the printed business and also what’s your operating cash flow will be for the technology group business. I know you’ve got some leeway left in your financing but maybe if you could comment a little bit about your cash needs for this year.

Phil Jones

Okay, this is Phil. As we said, we do have, considered to be a healthy cash balance as of year-end plus the additional funding that we spoke about that we received in February 2014. So, the business model is geared towards generating our cash and profitable cash flow from the operating groups, the printed products group, and they certainly were able to do that in 2013. That group also had a fairly significant equipment upgrade that we are able to finance. So, the idea is any equipment in that group can be financed through traditional, either bank debt or equipment finance. Beyond that as Jeff could speak too as well, it’s basically evaluating investment opportunities and determining best way to go about financing those opportunities, third-party funding, profit sharing, existing cash et cetera. So, Jeff I don’t know if you have anything to add to that.

Jeff Ronaldi

Sure, thanks Phil. As far as evaluation of new opportunities, the opportunity based funding, we have enough cash for operations but if we see an opportunity that’s larger than that and there is a third-party funder that’s willing to come in and help support that, we will evaluate it. Having a strong cash position allows us to be much stronger at the settlement table when dealing with these losses. So, I like where we are right now.

Bob Wasserman - Dawson James

Okay, thanks, I know that was a broad question but thanks for answering that.

Jeff Ronaldi

Any additional questions?

Operator

Thank you. I will now turn the floor back over to Peter Salkowski for closing comments.

Peter Salkowski

Great. I’d like to thank everyone for being on the DSS shareholders earnings call. Much appreciate your interest in the company, and we look forward to updating you guys in the future. Have a good day. Take care.

Operator

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

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!