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Document Security Systems, Inc. (NYSEMKT:DSS)

Q1 2014 Earnings Conference Call

May 13, 2014 4:30 PM ET

Executives

Peter Salkowski – Investor Relations-The Blueshirt Group

Philip Jones – Chief Financial Officer

Jeff Ronaldi – Chief Executive Officer

Analysts

James P. McIlree – Chardan Capital Markets LLC

Operator

Greetings, and welcome to the Document Security Systems’ 2014 First Quarter Results. 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. 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’ first quarter 2014 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, DSS issued a press release announcing its first quarter 2014 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 disclosed in the “Risk Factors” section of the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2013, previously filed with the Securities and Exchange Commission.

Forward-looking statements made as part of this call are made as of today May 13, 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 you will find additional disclosures regarding the non-GAAP financial measure and reconciliations of net loss to adjusted EBITDA.

I would like to remind everyone that this call will be recorded and made available for replay via a link available in the Investor Relation section of the Company’s Web site at www.dsssercure.com.

Also, for those listening to today’s call via webcast who would like to submit question for the management, please click the “Ask a Question” link located in the Web site window, the webcast window. If we are unable to address all your questions on today’s call, please contact Investor Relations and we’ll be happy to answer them.

I will now turn the call over to Phil Jones, Chief Financial Officer of DSS. Phil?

Philip Jones

Thank you, Peter. Today, we announced first quarter financial results, which are summarized in the press release we published after market closed today and detailed in the Form 10-Q, which was filed with the SEC as well today.

For the first quarter, total revenue was $3.6 million, a year-over-year decline of $142,000. Printed Product revenue declined $115,000 to $3.2 million in the first quarter with technology revenues down $27,000 to $464,000.

Our first quarter Printed Products results were impacted primarily by the timing of several packaging orders that slipped from March into April, which in fact have reported to strong than normal April sales for the Printed Products group. Therefore, our expectations for this group in 2014 remain in tact.

First quarter cost and expenses increased 35.7% year-over-year, $6.6 million driven primarily by significant increase in non-cash based patents, amortization and stock-based compensation expense. The higher deprecation and amortization expenses driven by the substantial increase in intangible assets on the balance sheet resulting from our merger with Lexington Technology Group to close at the beginning of the third quarter of 2013.

And these costs were not a component of the first quarter 2013 results.

Cash-based expenses were up 10.1% versus the first quarter of 2013, which primarily reflect increases in compensation cost, professional fees and sales and marketing costs. The increases in compensation cost and professional fees will primarily the result of our new technology management division created as a result of the Lexington merger.

Professional fees include cost for lawyers and consultants utilized by our DSS Technology Management division for its IP monetization efforts. While substantial during the quarter, these costs were geared towards our efforts to add to and further strengthen our IP portfolio during the quarter.

Net loss for the first quarter was approximately $3.1 million or loss of $0.07 per basic and diluted share, which compares to a net loss of $1.1 million were flat and per basic and diluted share in the first quarter of 2013. Once again 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 such as an including merger related professional fees.

For the first quarter, the company had a consolidated adjusted EBITDA loss of $1.1 million, an increase of 172% from the year ago period. From a product adjusted EBITDA was $283,000, a year-over-year decline of $35,000. And looking at the year-over-year comparison for the print products growth, it’s important to note that certain licensing revenue that was contained in the 2013 results for the group was re-classified to the Technology group to reset our post merger structure in 2014.

If this licensing and that was included in the 2014 amount, the printed products would have shown an approximately $150,000 increase in adjusted EBITDA profit. Once again our printed products grew, which incorporates all of our printing, packaging and plastic operations is well positioned to continue to deliver reliable financial performance in surge of the solid financial base for our other higher growth ventures. The first quarter adjusted EBITDA loss for our technology group was $468,000, down from a loss of $188,000 in the prior year period.

However, prior year periods did not include any of the DSS technology management operations. The first quarter showed a 22% improvement from the adjusted EBITDA loss of $602,000 reported a pull back growth in the fourth quarter of 2013, which is a more comparable period. Once again adjusted EBITDA is a non-GAAP measurable performance. Please refer to the table included in our earnings release from today for a reconciliation of our GAAP net loss to adjusted EBITDA.

Moving to the balance sheet, as of March 31, 2014 the company had a cash balance of approximately $3.4 million of which $500,000 loss was passed by the restricted cash. This compares to a combined cash balance on December 31, 2013 of approximately $2.5 million. The quarter’s increase in cash was due primarily to the receipt of $3.0 million was up to $4.5 million in commitments we received from a third-party IP funding source.

As discussed in our previous calls, one component of our IP strategy is to work with specialized investors who wish to participate directly in the IP monetization asset class.

We are very pleased to have accomplished the second funding on favorable terms during the quarter, which was a limited recourse now classified as long-term debt. The funding strengthened our balance sheet, while also allowing us to make additional investments during the quarter of $750,000 that’s further added to our growing IP portfolio. Finally, as many of you know there are 7.5 million of our common shares currently being held in escrow related to the Lexington merger.

As of the date of this call, the criteria investing of these shares were not met and the shares will be retired on July 1, 2014, which will reduce our shares outstanding by 14% to 42 million.

With that I will turn the call over to our CEO Jeff Ronaldi. Jeff?

Peter Salkowski

Operator, is Jeff on line?

Jeff Ronaldi

Thank you Phil. I would like to thank everyone for your continued support of DSS. While the company began the year slower than anticipated, we are still optimistic regarding our prospects in 2014 for several reasons. This quarter, as Phil pointed out, the price of timing of several packaging orders that’s booked from March and April, the Printed Products group posted positive adjusted EBITDA. This is evidence of the hard work and important decisions management have made.

During the first quarter, we finished combining our printing and packaging business with single facility to better align and improve profitability of these operations. We expect to see cost savings in 2014 as a result of our efforts. We’re managing this area of the business for cash flow and expect to invest the majority of the cash generated from our printing and packaging operations into the higher growth areas of our business.

One of the high growth areas is our AuthentiGuard line of products. During the first quarter, we filmed the successful media appearance on Fox and Friends where I had the opportunity to give a live demo of our product. If you hadn’t already seen it, the demo is available on the landing page of our AuthentiGuard website.

As we announced on our last earnings call, we’ve recently invited former NFL player, Pat McInally, on board to represent our anti-counterfeiting and authentication technologies in the sports merchandize and entertainment markets. As a result of both of these efforts, we’re getting very visibility in the pipeline and added our second AuthentiGuard customer.

Moving to an update for our technology group, up to this point we’ve invested and diversified portfolio comprised of various technology patterns, including those related to wireless peripherals and semiconductors. Using this IP as a foundation of our portfolio, we filed patent infringement claims against Facebook, LinkedIn, Apple, Samsung, TSMC and others.

The most recent developments for our IP portfolio include the announcement that Eastern just reflected, had denied the defendant’s motion to stay the VirtualAgility case. However, the Markman continues to be temporarily stayed pending a decision by the federal circuit. We also announced the stay of Bascom Research Markman hearing in January in light of the expected Supreme Court ruling on the Alice or CLS Bank case in June or July this year.

As we understand it, the Alice case covers the question of whether the computer automation of a bookkeeping process can be patented. Our interpretation of the case is that while some of the questions of case appear broad, we believe it’s likely the case will be interpreted narrowly, that is we believe the court will issue a decision as to the specific technology of the Alice case, but not necessarily rule on the overall patentability of software. Several prominent industry analysts also support our view. Ben Strauss of the University in the Barry School of Law writes a quote, there are some potential that the decision will be rather small and that this result would essentially care the results of those (indiscernible) and potentially add nothing of substance to the wall and quote.

In addition, other type top IP (indiscernible) appoint this pattern in the Alice’s state will be invalidated. In other words, we’re trying to follow, but the rules governing software patentability will not change. With that said, we wait for ruling by the court on the Alice case.

Now to an exciting one on the IT front. As we post in our press release today, I’m pleased to announce that we recently contracted purchase in other strategic and robust portfolio patterns. In addition to the sequentially expanding our hardware pattern portfolio, this acquisition will provide us additional freedom for further development AuthentiGuard.

And keeping with our previously discussed IT strategy we look for multiple ways to monetize this IT and in fact see the company’s investment opening a door to potential new products through R&D. It’s important to mention that as IT litigation continues to evolve, we believe we structure the company to withstand any changes brought by the legislation on the horizon. The legislation under considerations includes including building parties and interest and includes our pay outcomes. While this legislation may affect other companies in the state, we do not see for legislation having a strong impact on DSS for its operations.

Further, we have carefully invested in a range of important patent assets that support our AuthentiGuard product thereby successfully linking much of our IT, the DSS’ current operation. It is important to note that in order to make strategic IT investments to grow our technology group we have received funding from outside forces. Today, we have growth of $6 million in project funding.

In addition to strengthening our balance sheet in the first quarter, we made progress in multiple areas including consolidating printing and packaging, adding our AuthentiGuard customer and investing in new IT.

We continue to focus on growing our company and look forward to seeing the rewards of our efforts as we move forward.

With that I’d like to open the call for questions. Operator?

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from James McIlree with Chardan Capital. Please proceed with your question.

James P. McIlree – Chardan Capital Markets LLC

Thanks and good afternoon. You mentioned in your remarks a couple of times about announcing that investment, and I’m wondering if that investment applies to the entire IP portfolio or just some sub segments of it.

Philip Jones

Thanks James. It’s a good question because that has been asked several times. When we are getting investment it’s typically just geared to that specific set of patents that are used to get the outside funding. So the funding that we received this year, the $3 million is only based on the proceeds based from those nine patents we acquired from Cypress Semiconductor. We do not have anything to carryover into any of the other portfolios.

James P. McIlree – Chardan Capital Markets LLC

And does it have any contingent obligation from the investor to help fund potential litigation or the cost of IP monetization for those nine patents?

Philip Jones

Yes, that’s what the funding was for us to acquire and to occur and for that they received a certain pieces of proceeds from those specific patents.

James P. McIlree – Chardan Capital Markets LLC

So let me ask it differently then, is there any other obligation that the investor has in addition to the $3 million that’s already been received.

Jeff Ronaldi

We have another $1.5 million to be received.

James P. McIlree – Chardan Capital Markets LLC

Okay great. And then just one other thing if I might going forward the SG&A expense is that to be about this $3 million or is it higher or lower going forward.

Jeff Ronaldi

Phil?

Philip Jones

Yes, if you look at our SG&A for the fourth quarter of 2013 which is more comparable period because that includes post merger operations. You will note that our SG&A was fairly consistent, with a variability most likely in the professional fees area depending on different stages of various assertion activities. So you will note that we actually had a decline in our SG&A compensation from the fourth quarter so those numbers are stabilizing.

James P. McIlree – Chardan Capital Markets LLC

Okay, great thank you.

Peter Salkowski

Jeff, are there any questions from the webcast.

Jeff Ronaldi

I don’t see any further questions through the webcast.

Operator

Okay. (Operator Instructions). Okay, there are no further questions at this time, if you’d like to do your closing remarks.

Jeff Ronaldi

I’d just like to thank everybody for being on today’s call and your interest in Document Security Systems, and I wish everybody a good day. Take care. Thank you.

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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