DSS Inc (DSS) 2010 Q3 法說會逐字稿

Good afternoon, and welcome to the Document Security Systems conference call. (Operator Instructions). Please note that today's event is being recorded.

At this time, I would like to turn the conference call over to Jody Janson. Ma'am, please go ahead.

Thank you, Jamie. Good afternoon, everyone. This is Jody Janson, Director of Investor Relations for Document Security Systems, and I want to thank you for joining us for the third-quarter 2010 conference call and webcast.

Joining us today from management are Chairman Robert Fagenson, Chief Executive Officer Patrick White, CFO Philip Jones, and COO Bob Bzdick.

This conference call is also being webcast and will be archived on our website, which is www.documentsecurity.com.

Before returning the call over to management, I'll read the Safe Harbor statement. Document Security Systems has included in today's press release and conference forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, including all statements considering future or expected events or results. Please note that during the course of this call we will be making forward-looking statements regarding management's opinion and expectations about Document Security Systems' business, its markets, and financial performance.

These statements are subject to risks, assumptions, uncertainties, and changes in circumstances. Actual results may vary materially from those expressed or implied in such statements.

For more detailed information about Document Security Systems' risk factors that may cause actual results to differ from expectations, please see the Company's filings within the SEC website at www.SEC.gov, including our Form 10-Q that we filed yesterday and is posted on our website.

Part of the Company's presentation today includes non-GAAP numbers that management considers to be useful, such as adjusted EBITDA, which is earnings before interest, taxes, depreciation, and amortization, stock-based compensation, and nonrecurring items. These non-GAAP measures should be considered in supplemental to its corresponding GAAP numbers, and we encourage you to review the differences between these measures as described in today's press release.

With that, I'd like to turn the call over to Philip Jones, Chief Financial Officer, Document Security Systems. Philip?

Thank you, Jody. Today, we announced our third-quarter 2010 financial results, of which a full analysis of results is available in the Company's Form 10-Q, which is available on our website at www.documentsecurity.com, or visit in the Securities and Exchange Commission website at www.SEC.gov.

As we highlighted on the press release, revenue increased 23% from the third quarter of 2009. Consistent with our last quarter, our revenue increase reflects the addition of our -- of $1.4 million in revenue derived during the quarter from our Premier Packaging division, which we acquired in February of this year.

This more than offset declines in our commercial print business and reduction in technology licensing payments. In addition, we no longer have sales of legal products associated with our LegalStore.com division, which we sold in October of 2009.

Specifically, commercial printing declined $500,000 -- approximately $500,000 from the third quarter of last year. Our commercial print business continues to face challenges, as we had discussed in the last quarter, and we have seen a significant decline in business from one major customer.

We had hoped to see an uptick in business from this customer in the second half of this year, as the customer was revamping its marketing initiatives after a merger. However, thus far, this client has chosen to concentrate its marketing efforts on lower-value letters and forms in which we are not competitive. So, we have continued to be negatively affected by this situation.

First, we do believe we are very well positioned to get their business, if and when they decide to return to the higher quality marketing materials which we excel in. Secondly, we are continuously developing new commercial printing relationships that we are very excited about and hope will lessen our reliance on this customer in the future.

In regards to security printing, we have seen -- continue to see consistent growth in that area. Security printing increased 107% from the third quarter of 2009 and 14% from the second quarter of 2010. So this is a trend that we are most pleased with.

Gross profits were negatively affected by the challenges in commercial printing, due to the fairly high degree of fixed equipment and facility costs associated with the operations of our printing facility. In addition, the 2010 quarter -- third quarter, we do not have any gross profits from our former legalstore.com division.

Otherwise, gross profits reflect the favorable impact of the addition of our packaging division and the increase in security printing.

Operating expenses decreased 13% from the third quarter of 2009 and have decreased 8% sequentially from the second quarter of this year. Our continued focus on cost controls has allowed us to actually lower operating costs -- lower our operating costs despite the addition of a major new division, Premier Packaging. And our lower operating costs have helped mitigate the impact of the lower-than-expected commercial printing sales.

Net loss decreased 8% from the third quarter of 2009 and decreased 11% sequentially from the second quarter of 2010. Our net loss is obviously not where we want it to be, and continues to reflect the challenges in our print markets, along with the large impact of non-cash charges such as amortization of intangibles and stock-based compensation.

In regards to that issue, we use adjusted EBITDA as a measurement of our performance. Once again, I remind you this is a non-GAAP measurement, as Jody pointed out earlier. Adjusted EBITDA loss for the quarter was $270,000, a 31% improvement over the loss for the third quarter of 2009. We continue to strive for this number to be consistently positive, and are encouraged by this trend.

Regarding the balance sheet, we entered into the fourth quarter with our strongest working capital position of the year. For those that have had a chance to review our 10-Q, you will have noted that we had a significant increase in accounts receivable and inventory levels. The increase in inventory levels are primarily due to the seasonal build-up at Premier Packaging for its seasonally heavy fourth quarter.

In addition, you will note that we have classified a dividend payable with an offsetting current asset called investment for the dividend of the IMS shares that we declared on September 23, 2010.

Regarding the dividend, all of our shareholders of record as of October 8, 2010, should have received their share dividend by now either electronically or via certified mail. If you have not received your shares as of yet, please contact our IR director, Jody Janson, at IR -- e-mail him at IR@documentsecurity.com. His contact info is listed at the bottom of our press releases, if you didn't have a chance to write that down.

With that, I will be open to answer questions during the Q&A, but I'd like to turn it over to Bob Bzdick, our Chief Operating Officer.

Thank you, Phil, and good afternoon.

During our third quarter, we continued our emphasis on integrating security technology into our three operating entities. This process included training of sales and manufacturing personnel alike, as well as the development of a tighter quality control procedures.

We increased security printing by 89.4% quarter over quarter at our commercial printer, DPI Secuprint. We recently brought all security coupon printing in-house, resulting in significant quality improvements and customer satisfaction.

We added many notable new clients during the quarter. Coupon printing for P&G, Pfizer, Pepsi, Quaker, Lorillard, Reynolds, and Unilever were printed during the quarter. These are repeating orders which also provide additional entrees for our other capabilities.

At P3, we continue to be on the cutting edge of security and card technology. We recently announced agreements with Populous and CardLogix, which will utilize our investments in RFID card production equipment and increase our value-added opportunities.

Recently, Wrigley's selected a package design provided by our Premier Packaging subsidiary for a significant promotional project slated for 2011. A marketing test production run is currently underway.

Several security packaging presentations occurred during the quarter, with very encouraging reactions. During one of those presentations to an international beer company, the potential use of some of our technologies for promotional purposes were uncovered in additional opportunities.

Lastly, I am pleased to announce the newest member of our management team, Jason Grady, has joined DSS as Director of Sales and Marketing. Jason possesses backgrounds in graphic design, printing, and packaging. He has had significant experience in developing and executing sales and marketing plans.

The development of a coordinated and focused marketing plan is essential and of the highest priority for DSS in order to harvest the value of our technologies. I look forward to supporting him in his efforts, which have already resulted in our securing of that Wrigley's package design.

Thank you for your interest in DSS, and I'll now turn the call over to Pat White, our CEO.

Thank you, Bob, and good afternoon, everyone.

My current view on the state of Document Security Systems is that the Company has never been better positioned to capitalize on larger opportunities and relationships.

During the past few weeks, DSS made announcements concerning our entry into generation-two RFID, with the cutting-edge company Bob referred to as Populous. We also had a partnership with a California smartcard company announced, called CardLogix, for electronic passports. These two deals will generate revenues in 2011, and in fact, we have recently signed a contract to have some of our people at the 2011 Super Bowl in Dallas to work with Populous on the RFID product rollout for that major sporting event venue.

DSS will also be working with CardLogix and a well-known, soon-to-be-named partner for a high-profile government immigration card project, which is in final negotiations. The card will contain a smart chip from CardLogix, some visible security features from the third party, as well as our patented optical deterrent features.

I am also happy to report that DSS is also involved in a very large foreign government bid for secured documents requiring our technologies. This particular project is so large that we are coordinating with our licensee, RR Donnelley, for capacity reasons.

Originally, 41 companies were in the running on this bid. I was informed today that we made the short list of the remaining five companies.

In my opinion, we made the short list due to a combination of our design skills and technology offerings. No other company possesses the full gamut of paper, packaging, labels, digital, and plastic cards, skill sets like we have developed here at Document Security Systems.

In fact, we now have competitors coming to us for help on their opportunities. That didn't happen a year ago.

There is much more. Soon you will hear about our entry into the secure Internet-produced documents from a cloud computing partner. These secure documents contain our technology for a Fortune 500 consumer product company we all know very, very well.

DSS was paid for this test, and I can tell you that the test is currently live, successful, and being accessed right now, as we speak, by the general public on the Internet. Once the test results are completed and accepted, a complete rollout of our solution is anticipated, which will produce royalties based on schedules which have been established between DSS and our new, well-known consumer product company client.

Taking this project one step further, once successful this product will be suitable for all consumer product companies, and we will work with our partners in making this a 2011 Level I priority revenue opportunity.

Now I would like to briefly provide you an update on some of the Company's ongoing strategic initiatives. To begin, by now all of our shareholders should have received their share certificates in Internet Media Services. This was a stock dividend which was the result of our spin-off of a non-core business called LegalStore.com.

Currently, we have been inundated with two questions by our shareholders concerning this. The first question is, "When will Internet Media Services begin trading?" and the second question is, "What will the share price be?"

I spoke to Mr. Raymond Meyers, who is the Internet Media Services CEO, and he informed me that he is working closely with a market maker and he expects their stock to begin trading on the OTC bulletin board in approximately six weeks or sooner. As to the price, there is no control or setting process. Therefore, the price will be determined by the market once the stock begins the normal trading process.

Mr. Meyers did inform me that he has processed their very first 10-Q SEC report, and it is now -- and now can be accessed at www.SEC.gov if you'd like further information concerning their company.

In regards to the Euro infringement initiative, the current status is that we are awaiting the outcome of an appeal which was heard earlier this year on our patent validity in the Netherlands, where we won an earlier decision. The decision was scheduled to be announced on October 27, but we were told that due to a heavy caseload, the appeal decision has been postponed by two months. We therefore anticipate the Netherlands court to make an announcement on the ECB's appeal towards the end of this year or early January.

If the court decides in our favor, then we are scheduled to begin the infringement suit against the European Central Bank on January 21, 2011, in the Netherlands. If the appeal is lost, then the pursuit of our lost royalties is essentially over.

We have several things to report on our digital information security initiative known as AuthentiGuard DX. First of all, we are pleased to announce we have successfully installed our software on our local computing company partner servers. We are declaring this a beta system since it is very new, and we are carefully monitoring its performance in a few different settings, as well as testing functions in some stress modes.

In addition, we have begun work on a new, more dynamic digital viewing system, and we've completed a key software enhancement that allows our product to operate fully on the new Windows 7 and Server 2008 platforms.

Our cloud computing partner has just begun introducing a product to their various clients. The response has all been very, very favorable. We are working with one particular accounting firm client whom I would describe as a highly computer-sophisticated client, as they securely store tax returns for their clients through a cloud portal.

This particular firm has offices on both coasts, so it's a perfect test for us. They are using this relationship to build the product to the client specifications, which we feel will increase the product's capabilities tenfold as it will teach us how flexible and user-friendly our software needs to be for a broad array of clients in the dynamic business environments they all work in.

One thing of note is that this client is currently using a boring, outdated redaction system, and they have informed us they are looking forward to converting to our product's upgraded capabilities once we have coded and embedded their specific specified enhancements.

During the quarter, we have had intense negotiations and meetings with several Fortune 500 companies who are developing their own brand protection divisions to serve their clients. The companies saw a licensing deal and a reseller agreement with DSS where they will privately-brand our technology portfolio.

These negotiations have gone so well that I feel safe in saying that you can anticipate announcements in the very near future as we partner up with some very large, well-known companies who are using our technology portfolio to help them combat fraud, grand theft around the world.

I think you may also find it interesting to know that we are involved in a very large bid project. In fact, we are involved with a 30 million-document project for a very well-known U.S. company that we will know probably within the next 60 days.

We are also in the running for a foreign government lottery ticket security application, and during the fourth quarter we made presentations to three extremely large pharmaceutical companies, all of which have established next steps for us to follow up and have scheduled further face-to-face discussions.

Finally, the dangerous environment we all live in has not changed. I am sure you have heard about toner cartridges that contain explosive materials and were placed on planes in Yemen which were bound for the United States and other parts of the world. Due to this event, DSS was quickly contacted by several well-known toner manufacturing companies who now had a reason to discuss our solutions for their packaging security. Both of these companies have scheduled formal meetings with us at their facilities to begin discussions and incorporate our technologies into their toner packaging.

I think you can see from this example that word is finally getting out there as we are meeting with some of the biggest companies in the world who have finally discovered that we have the power to mitigate their risks.

Yes, it's a long sales cycle. But even if nothing else happens and just one of these toner application opportunities alone was to hit, our financial picture changes literally overnight. That's the point of how big and quick a change could come to our Company's prospectus.

To summarize, opportunities continue to be very brisk and much larger in size. As always, we will share our successes with you as they transpire.

I now would like to turn it over to our Chairman of the Board, Mr. Robert Fagenson, who would like to add some comments.

Thank you, Pat. Good afternoon, everyone.

As you can hear, there's still an awful lot going on at Document Security, and while we are certainly continuing to move in the right direction, as nonexecutive chairman I'm clearly not satisfied by our performance in the third quarter.

The problem that held us back came from a direction I would never have expected. We moved steadily forward in our security products, couponing, packaging, plastic cards, but the stable business of printing, that I thought would remain extremely reliable, proved to be a drag this quarter.

It would certainly be convenient to simply blame this on the economy, and clearly that had a significant impact on all our businesses. But we had a division management problem that led us to be chasing lower-margin work that we should never have pursued.

The good news is that with Bob Bzdick and Phil Jones, we have an active management engaged in righting the ship at DPI, and I believe that we've made the necessary changes and they've put us back on track in October and for the periods going forward.

Last month, I accompanied our management team on a major product demonstration trip to California. I must tell you, I came away more enthusiastic than ever that we are in the right place at the right time with the right technology, and the missing element seems finally to be falling into place, and that is we are finally gaining the recognition we deserve in the marketplace with customers coming to us.

I have to tell you that seeing our products in action, and watching the reaction of a Fortune 100 company as they were introduced to our security products and particularly to our ADX digital technology that is now complete and being installed, was an extremely exhilarating experience for me. I'm actually very pleased that I went.

While health issues have sidelined me in recent weeks, I believe that that is now resolved and behind me, so if I appear a little bit more reserved than usual, I apologize, but I hope I'll be able to make up for it on our call at the end of the fourth quarter.

Sales are up, losses are down. Adjusted EBITDA continues to move in the right direction. And I hope the time will soon be upon us when the numbers are not just getting better, but getting a lot better.

As I think you well know, I'm an optimist by nature, but I'm also a realist. We clearly lost a year to the recession, but now I hope that we're ready to make up for lost time and I thank our management team for really doing so. I saw it in the visit, I see it in the marketplace, so all I can say to all of you, and myself as a major shareholder, is now is the time to stay tuned.

And with that, I'll turn it back to our operator for questions and answers.

(Operator Instructions). Chris Wittenborn from Wm Smith & Co..

Good afternoon and thanks for the call. A quick question, is there any way to quantify the approximate dollar impact if the large commercial printing customer permanently decides to shift their mix away from the commercial printing capabilities that you guys have?

Hi, Chris, it's Phil Jones. I would think -- it's difficult to quantify. I can tell you by order of magnitude what we've lost in commercial printing from the last -- third quarter of 2009, which was $500,000.

So, you certainly cannot quantify exactly what their exact demands are going to be, but I would say that's an approximate kind of order of magnitude of what we're talking about.

Okay, so the $500,000 could be a good run rate?

Yes. Well, that's for one quarter.

Right, right. And what percent of capacity is the Rochester facility currently operating?

This is Bob Bzdick. For commercial printing, we are probably running at approximately 65%.

We've actually developed a strategy by which we have infused more of the packaging company's printing into the commercial printing outfit, and what we've done is actually established three weekend shifts to accomplish that without incurring any overtime.

So we've increased our bandwidth there in the hopes of helping cover some of the overhead.

And are there any significant capital expenditures needed? I mean, is the useful life, both on an accounting and an actual perspective for your equipment in that facility -- I mean, do you still have enough time on that equipment or are you seeing any large capital outlays at any point in the near future?

The main six-color printing press is a recent model, and most of the capital requirements for that would be ongoing maintenance. The capital requirements that I see in the future would be primarily in opportunity purchases for increased capabilities or [actual] customer needs.

Okay. And then, turning to the security printing side, has most of the growth within the coupons resulted in the addition of new customers or growth amongst existing accounts? And then a follow-up to that, which of those two, in your opinion, presents the largest opportunity?

I would say about half of the customers that I listed were new customers for this quarter, which is showing the success of the coupons that we already have out there.

We are going to be pushing a lot more, obviously, with the coming onboard of Jason Grady for more of that work. We are restructuring our sales force to do that. And the incremental opportunities, obviously, are the various other printing and packaging that that entree affords us.

Great. And then, last question, what percent, if any, of your packaging business currently has security features bundled into it?

That's probably been one of our disappointments. Right now, it's a very low percentage, less than 5%, because of the client base that we currently had, although National was mostly for consumer products, non-consumables.

What I've found, as opposed to the coupons and the technology that we use for that, the technologies that would apply to packaging have a longer lifecycle, because they touch many more areas of the organization. Therefore, they need to really develop an internal plan as to how they're going to monitor the security packages, how they are going to integrate them in the total package.

And because of that, it seems like the life cycle -- the sales cycle is just extremely elongated. However, that said, if -- I walk away from every one of our presentations feeling like the customer is going to integrate our technologies into their system, but they want to design the entire system before they pull the trigger on the packaging.

All right, well, thank you all for your time.

Sandy Wyman, Gilford Securities.

Yes, good evening. Just a couple of quickies. I sense from the conversation about the buildup in inventories and so forth that either anticipated business or by now, I guess, October/November, we can tell whether the business has actually picked up on at least the packaging side. (Multiple speakers)

Excuse me, go ahead.

No, the second question sort of is I guess somewhat unrelated, but I know, Robert, historically you've signed a lot of agreements in particular with, like, RR Donnelley in the past and you've felt like they weren't necessarily, how do you say it nicely -- that they hadn't been really fulfilling their part of the bargain, and you had hoped by the second half of the year that you would start to see that kicking in. So I guess the second question is, are they holding up to their part of the bargain, or do you have to audit them, or what exactly is going on on that respect?

Well, I will handle the first question in regards to the activity at Premier Packaging. Historically, the ramping up toward Christmas season for photo packaging is very significant. Historically, we see probably a $1 million swing in receivables and inventory from the period of July to November as all the stores ramp up to have their inventory in place.

So we'll see that slide back down and turn into cash during the December/January period.

I guess -- are you actually seeing orders for that, or is this just anticipated orders and consequently ramping up the inventory?

All -- Premier is a job shop, so all inventory and so forth is committed to by purchase orders of the customers.

Okay, so then it is somewhat of a cyclical business, at least that end of it?

That's correct.

Okay, thanks.

On the other piece, Sandy, the determination about whether to conduct an audit to see whether or not we're getting all of our royalties is something that's ongoing actually at this moment. So we will have more on that next quarter.

In terms of getting the most out of our licensees, there is a lot more activity going on now than there was the last time we spoke, a lot more out for bid, and a lot more customer-generated interest that's causing our licensees to come to us for updated technologies and additional assistance in gearing up additional plants, so that they're ready and able to produce. We have to fine-tune their presses and we have to familiarize their staffs in the remote plants. So I do see a definite trend in there picking up.

The decision about whether or not (multiple speakers) any of our licensees at a given time is one where you want to pick just the right time and make sure that you're getting the bang for the buck because it's not without cost. But be assured that we are monitoring that closely, and we're probably going to make a decision on that particular issue in the next 60 days.

Okay, good. I'm sorry to hear about your health, but quite frankly, as opposed to after the first quarter where you more or less put a shot across the bow where you had indicated that you'd put all the pieces in place here, and management and the Board was put on notice and so forth that they better get the act together before the end of the year, or you almost threatened to sell the Company. But it certainly seems to me, regardless of your health, a much stronger and better kind of outlook and attitude, and I thank you.

Yes, I think there is no question that you are reading that right, Sandy. I think -- and the recessionary pressure may have taken some of the froth off the glass that we had hoped would be shining through last quarter, but it also allowed us to propel ourselves forward in a lot more areas.

And I am not the least bit -- I am disappointed, clearly, by the timing, but not in the least bit daunted by the prospects. I really was very much reinvigorated by what I've seen in the marketplace, and going out in the field with these guys was a very, very positive thing.

Good. Thank you.

(Operator Instructions). [Tom Felker], [T & T Asset Management].

Mr. Felker, you are currently in the queue. Is it possible your phone is on mute?

Tom, did we lull you to sleep?

He must have gone offline, Operator. Do you have someone else in queue?

(Operator Instructions). (Multiple speakers)

We hear you, Tom. Go ahead.

Okay, thank you. Pat, this is for you. When do you anticipate receiving significant revenue from your Internet technology?

We were paid for a test for the Internet document we're producing right now for a major Fortune 500 consumer brand -- consumer product company. The test is absolutely being used right now by the general public. It's a valuable document, and we think that testing should be done in about 45 to 60 days, max.

This company is hinged on gathering information and data on everything before they make a full-blown distribution mode for this.

I would be anticipating rolling it out to this one client, making an announcement about that, and working with the marketing firm who has potentially numerous clients that would utilize the system as well after that. So, it is being used right now.

Tom, it's probably second quarter before you start seeing some meaningful sales.

Thank you, Robert. Thank you, Pat.

And at this time, the Q&A session has ended. I'd like to turn the conference call back over to management for any closing remarks.

Pat, anything you want to follow up with?

Well, I just -- once again, I just appreciate the support we have been receiving from all of our employees and clients and vendors, and I can tell you, it's so busy right now, one game changer could hit the fan and this Company will have a completely different look to everyone in the world. So I'm telling you, it's very close, and that's about all I can say without crossing the line.

So, let's all make that our New Year's resolution. Thank you all for being present. Thank you, management, for the hard work and to our shareholders for your patience, but we are moving forward, and I anticipate we'll have more to report the next time we all meet, and hopefully we'll all be pleased.

So with that, Operator, we'll sign off.

That concludes today's conference call. We thank you for attending. You may now disconnect your telephone lines.