DSS, Inc. (DSS) Q2 2012 Earnings Report, Transcript and Summary

Greetings and welcome to the Document Security Systems second quarter 2012 financial results call. [Operator Instructions] A brief question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host Patrick White, CEO of Document Security Systems. Thank you Mr. White, you may now begin.

Thank you. Good morning and welcome the conference call. Phil Jones our CFO is with me as well as Michael Roy, President of DSS Digital Division, Rob Bzdick, the Chief Operating Officer and our Chairman of the Board Mr. Robert Fagenson. The objectives of this call are to review and discus second quarter financial results, talk about significant business developments and market conditions and provide an update on our strategy and operations. The webcast will be archived in the investor relations section of our website. Please note that during the course of this call we'll be making certain forward looking statements including those regarding revenue recognition matters, results of operations, investments, initiatives and growth strategies. These statements are subject to many assumptions, risks, uncertainties and changes in circumstances. Any assumptions we offer about future performance represent a single point in time estimate. Actual results may vary materially from those expressed or implied by such statements. We expressly disclaim any obligation to revise or update any assumptions, projections or other forward-looking statements reflecting events or circumstances that may arise after the day of this conference call. For more information about risk factors that may cause actual results to defer from expectations, please see the company's filings with the SEC. Phil will begin by reviewing our financial results. I will then discuss our outlook and execution of strategy and then Robert Fagenson will add some closing remarks. Phil, would you like to begin?

Thank you Pat. Today we announced our second quarter 2012 financial results and flied our Form 10-Q with the SEC which includes the detail of the results that I will summarize to you now. I encourage all interested investors to read to the 10-Q for a broader understanding of our financial results and financial position as of June 30, 2012. To begin, revenue continues the momentum from the first quarter as revenues grew 27% over Q2 of 2011. Driving the revenue growth was consistent growth in both our packaging division which increased 33% and our plastics division which increased 25%. In addition, our printing group regained a positive trend with an 8% increase. Licensing in digital sales were up 65% as well. So we're very, very pleased to be able to follow our first quarter which we increased 43% with a 27% increase in the second quarter. Year to date, for the first 6 months of 2012, revenues have increased 35%. And just as exciting as the revenue growth was the gross profit performance. Gross profit for Q2 of 2012 was 1.3 million, a 65% increase over Q2, 2011. Once again, as was the case from the first quarter, our efforts to streamline operating loss and focus our sales efforts on a higher margin opportunity is paying off. Each of our divisions performed strongly during the quarter especially printing which is really turned the corner from the challenges in 2010 and 2011. The strength in gross profits from these divisions is the core financial strength of our company. Our total operating expenses increased 22% which was driven by significant increase in research and development costs including research and development cost paid by equity. As we discussed in the first quarter, we managed strategic decision to focus on our development of our intellectual property portfolio in 2012 which Pat will discuss in his comments. A portion of the compensation we are paying IP capital, our primary R&D consultant, is in the form of warrants. We feels these warrants have allowed us to gain access to this great resource with IP capital in a way that aligns them to the long term success of the company. Without any significant increase in stock based compensation and other research and development cost, operating expenses would have increased by only 12% for the second quarter. This lines up very well against a 65% increase in gross profits the company was able to generate. Net loss for Q2, 2012 was $995,000 compared to a loss of $1,112,000 in the second quarter of 2011. That is an 11% improvement. Perhaps a better indicator of performance is adjusted EBITDA which is defined as earnings before interest, taxes, depreciation, amortization, stock based compensation and other non-recurring items. The second quarter of 2012 was a loss of 494,000 which represents a 37% decrease from the same measurement of the second quarter of 2011. Thus despite a significant increase in cash based research and development cost, we have in full this measurement significantly. I'll remind everyone that adjusted EBITDA is a non-GAAP measure of performance and I encourage everyone to refer to the table we included in our earnings release from today to a reconciliation of our GAAP net loss to the adjusted EBITDA loss I just referred to. Moving to the balance sheet. Our balance sheet as of June 30, 2012, continues to reflect the improvement in our financial condition that we realized in the first quarter of 2012. As we have been able to reduce our near and long term liabilities while maintaining a healthy cash balance at an overall current asset level. So to summarize, our second quarter of 2012 was a very strong quarter based on 2 very important measurements, revenue growth and gross profit growth. Our increase in gross profit allowed us to absorb a significant portion of the increase in research and development cost that the company has targeted. We strongly believe that these costs will generate long term benefits to the company. Furthermore we expect our sales and gross profit strengths to continue in the second half of the year which has traditionally been our busiest time. With that, I'll turn the call over to Pat.

Thank you Phil. To begin the crime of counterfeiting continuous as a major threat worldwide. Most of the instances of the most serious problems occur mainly in the third world. However, unfortunately the USA is now being penetrated in that risk as evidence by expensive counterfeit cancer drugs that enter the US supply chain and the recent significant counterfeit coupon bust in Arizona. In that Arizona bust, a couple out of their home were reselling coupons on the internet that they purchased from overseas counterfeiters. Their Arizona home contained over $25 million worth of counterfeit coupons. In this published story $600 million estimated will be the amount of the cost to the brand owners for this type of crime and we're talking every major brand owner that you can imagine, American companies. The good news for DSS is there were received many, multiple inquiries from brand owners and landed several new clients for coupons ever since this story became public information. As I noted in our last call, 2012 plan was to markedly enhance and build our intellectual property portfolio with the help and guidance from our IP Capital Group which is headed by one of board members John Cronin. This strategy and process continues in the second quarter and are expected to continue for the rest of 2012. This process has DSS developing, what we believe is cutting edge technology mainly in the digital area. For a marketing test, or sales team has presented several of these new product concepts to a select clientele. Initial reactions are positive and we have strong interest in several Fortune 500 companies from these test markets. Based on the positive reactions we are receiving from clients, we are all excited about our IP development. DSS is working on solutions and products that uniquely combine authentication, cloud computing, data security and mass serialization using a variety of data capture methods and our in-house cloud computing capability. DSS believes digital security represents the future and as such, is developing technology which should position us favorably in this rapidly growing market. Right now, DSS's very proposition is its growing value of intellectual property portfolio. And as we continue to bring new and exciting security products to the marketplace, we feel that this portfolio will form the foundation for larger revenue generating opportunities. I, along with our sales team recently presented at the headquarters of a large Fortune 500 company. After presenting in our new technology offerings, I was excited by the client's response. Immediately following the presentation at the client's request, the next meeting was scheduled to discuss implementation of our technologies into their packaging and processes. That is a type of fast track we actually want. If response to our technology is this good, then my opinion guys who are sale order will be much quicker and impactful. Turning now to our coupons.com litigation. There is a motions hearing scheduled this week at Thursday August 16, 2012 in the federal district court located here in Rochester, New York. Once the motion's hearing is complete and decided, we hope and expect that the discovery stage of litigation process will move along expeditiously thereafter. In regards to our financial performance, we anticipate that our licensing revenue will increase in the fourth quarter of 2012. As you may be aware, DSS has recently announced several licensing deals and we continue to build momentum in this area. Just recently we announced our license with a company who supplies transaction security for our large international firm with 19,000 locations worldwide where the transactions occur. Also on late 2011, one of our licensees was awarded a government projects which we expect to start generating revenue in the fourth quarter as the previous old inventory should then be exploited. In addition, we expect expansion in licensing revenue from one of our largest licensees as they have seen to have completed testing and are now beginning to apply our technologies, significantly more printed products requiring security features. As Phil reported, all 4 of operating divisions reported increased sales and gross profits. To begin with, the packaging division continues to be the largest percentage of our revenue as they have been winning business from new customers and expanding sales from current clients. Forward-looking, the packaging division has several new opportunities with large brand owners in the works, and hopefully will have decisions made on this opportunities in the near future. By the way if you are in the Chicago area in late October this year, DSS will have a booth at the largest packaging trade show of the year called the PACK Expo Show. If you attend it will be held in the McCormic Place from October 28 to October 31st. and you'll be able to see some of our new digital products as well as we meet and speak with DSS people regarding our product offerings. Turning now to our plastics division. They are growing and operating profitably as they continue to post wins in foreign drivers' licenses, RFID projects and entertainment credentialing. Looking forward, this division has 2 important revenue opportunities in the works. The first of which is the development of a clinical trial RFID application for a client that, once completed, will have strong revenue potential on a going forward basis. The second opportunity revolves around a recent report by Acuity Market Intelligence which states that by 2015 85% of all credentials issued annually will be plastics smartcards called EIDs which will replace paper. The report goes on to say that countries issuing EID will exceed those still using traditional paper IDs by 4 to 1. This conversion from paper to plastic smartcard ID issue presents a nice opportunity for our plastics division and a smartcard department. DSS plans on exploiting this trend as we have several strategic initiatives on the work regarding this opportunity. Our DSS digital division has been very busy writing software and intellectual property claims. Unfortunately these are mandatory steps prior to actual filling the application in the workplace. Without this time consuming and expensive process you have risk having comparably duplicating your intellectual property without recourse. On the sale side however, the digital division has been traveling internationally at the request of some international government to address multiple government cloud computing security opportunities. Also on the sales side the digital division has several exciting internet based security opportunities and is working on for some ecommerce clients. We look forward to sharing some of their wins in the very near future. Information we have made a strategic decision to increase our research and development projects. We expect this investment to lead to substantial growth both in our patent portfolio as well as sales and profits. As you will see in the weeks and months to come, intellectual property will take center stage which should be followed up by increasing licensing and product revenues. What I am most pleased about is our growing pipeline of security sales opportunities that individually could be very significant and literally change the financial future of the company overnight. We believe that all of this adds up to a growing and thriving DSS for 2012 and beyond. Thank you and that concludes my comments. Robert, would you like to add something at this time?

Sure, thank you Pat. Thank you all for being with us today. When we made the decision to invest and when our expenses go higher level in our intellectual property and broaden our base, it was a conscious decision as that we had derived that based on how we sell market moving and how we could strengthen not only our position but our ability to really compete and to penetrate the customers that we were already working with and customers that had been approaching us. With the 3 legs in the stool with print, plastic and packaging being one, that security, planning, licensing and cloud being another, where we protect our IP as we're dealing in the coupons.com litigation was an area where seen opportunities to basically expand not only our portfolio but to seek other opportunities as well and we have been working diligently exploring some possibilities for the company that we hope between now and the next quarterly call or have more to report on. But in short, it's working. We do not regret for a minute the higher level expenses and making a tradeoff between the closing net GAAP to our EBITDA finally turned into the positive and actually investing in the future of the company was not something we took lightly but is something that we absolutely have followed with tremendous enthusiasm and we believe that we're definitely on the right track. It is leading us down a path, where I think we are all going to be happy that we saw the divisions of operating. I mean finally it appears that everything that we have including the printing division which has been a while, after hard work and attention from management team will move forward now operating in a way that I think positions us for a tremendous success in the near future. So I personally have never felt better about customer interaction, the quality of customer, the size of orders and growth that we're seeing in our sales base and the breadth of where those sales are coming from. The progress that our team has made in terms of additional patent flings and when we put the cloud together with it and look where we are getting the greatest excitement, the mobile app delivery of our technology is enabling people to receive and transmit data securely. It's clearly the hotspot around the globe today and we are very far ahead of the curve in terms of having a product that everyone seems to want. So I have never been more optimistic, the company is performing well and I think the management team has had an excellent quarter moving us in all strategic directions that the board has wanted to go. And I leave it there and turn it back to Pat or are we ready for questions?

[Operator Instructions] Our first question is coming from David Wolfson from Wm. Smith.

And my first question is just related to your cash level. Given your current higher R&D expenses, how long do you envision you can really last on $1.5 million?

Let me address that simply by saying that we have recently had a warrant exercised that was $500,000 in to a company, post the reporting and we have in place plans for additional capital to enter the company in the near future. While the check has not been signed, the expectations is that that will not be a problem for us as it has been in the past.

Okay. So in terms of just looking forward in terms of revenue, what internally do you think it will take in order to reach a breakeven level? Have you set a goal internally?

A lot has to do with the product mix and the margin mix but if we were to cut back on our R&D, and the trends were continuing and I agree with we would see that that would be something that we would be able to achieve in the coming year. This is the time when you have to make a tough decision, do you put that off and continue to invest more heavily or do you try and squeeze the grape and break into the black but sacrifice some longer term opportunities. And we've wrestled with that every quarter and we think we're on the right track and we hope to see some greater clarity for that between now and the next conference call.

Yes and another thing just on what Robert said as we get in more into the licensing and digital solutions, the margins are much higher and that makes it our breakeven much lower and I do see a shift occurring that begin in the fourth quarter as we get into more of this going forward.

Okay, well I have just one last question, just in terms of R&D going forward over the next couple of quarters. Is this current level of expense something that you'll replicate?

Yes. I think that will run about quarter of a million per quarter on average but that seems to be the track.

[Operator Instructions] Our next question is coming from Sandy Wyman with Gilford Securities.

Couple of things, actually one of my questions was just answered. Could you bring us up to speed a little bit what's going on with Kodak? Could you bring us up to speed a little bit what's going on with Standard Register? Are they starting to pay their bills? And Robert, I noticed a little bit better tone in your voice from the last conference call where you sounded pretty down and out. May be you can elaborate a little bit on what your better feeling is?

I'm never down and out Sandy but I get impatient. As a million plus shareholder, I want to higher stock price and I want to see get to our goal standard. You catch me on a bad afternoon, maybe more of that reflects on my optimism about the company, if that really is unwavering.

And regarding to your first part of your question, this Kodak relationship as you know is quite complicated particularly with their financial situation. They have this brand protection division that they are steam rolling ahead with. It seems business as usual. They have several orders in house for us right now and several quotes that we're working on for projects both for themselves that they want to use to market technology as well as products for clients that are in the international arena. That's where it stands right now. We're trying to walk carefully until we see what their financial condition ends up happening. They are quite positive and they do talk about it they think they are going to be a year from now, they are going to be singing songs and we're following that track at this point, but we just want to walk slowly regards to that, until a little more information comes out. RR Donnelly, honestly this is the year that they finally, I think the Arizona bugs they must have got their ears ringing from all the screaming clients out there that want security for their coupons and other financial instruments. So they came to us like a bull herd trying to get the technology up and running and much more type of printing opportunities worth rather than just a check industry where they were mainly using us. But now we seem them printing and actually into some coupons and so we see some major stuff because they are a very large company doing very large products for a lot of brand owners. So I think they will start ramping up there in the near future.

Maybe you could elaborate Robert a little bit when you are talking about the $500,000 coming in on warrant exercise but you mentioned something else, a new potential source of capital. Are you at liberty to discuss that at all?

No, because we're a bit more involved than I want to get into on the call. We'd have to make all sorts of forward-looking disclosures in the broader sense we have taken a look at the next stage of capital expenditures and capital needs and made a provision to deal with that. So it should not be a concern as we sit here today. Obviously an uncle used to say, until our conversation from a checklist, so I think that's the best way to put it but we believe that we've laid the ground work to be able to not have that become an issue for us.

Thank you. That does conclude our question and answer session. I would turn the floor back over to management for closing comments.

I will simply say that it was a good quarter. We had moved forward in all the directions that we wanted to and that we are very, very pleased with the results we're seeing in terms of the R&D expenditures in filling out our IP portfolio. We are working on a number of fronts to broaden the company's penetration and to broaden the company's scope in terms of what we do in our various divisions and as I said, the 3 areas of focus that we have laid out for the company's future and I am feeling very good about how things are going and I want to thank the management team again for good quarter and good work and all of you our shareholders for staying with us and hopefully, as I've said in the past, but I am feeling better now than ever before, the time will be short when we start to see those results. Pat, management anyone else would like to wrap up?

Again, I echo your sentiments to our shareholders and investors and Robert, I would like to thank you also for all of you support and I think we're at the point of where we always wanted to be. So this is good news. Thank you.

In that case, thank you all and good evening.

Thank you. This does conclude today's teleconference. You can disconnect your lines at the time and have a wonderful day. We thank you for participating in the call today.