DSS Inc (DSS) 2012 Q2 法說會逐字稿

Greetings and welcome to the Document Security Systems second quarter 2012 financial results call. At this time, all participants are in a listen-only mode. 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 afternoon, everyone, and welcome to the conference call. Phil Jones, our CFO, is with me; as well as Mike Roy, President of the DSS Digital Division, Bob Bzdick, Chief Operating Officer; and our Chairman of the Board, Mr. Robert Fagenson. The objectives of this call are to review and discuss 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 will 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 to reflect events or circumstances that may arise after the date of this conference call. For more information about risk factors that may cause actual results to differ 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 have some closing remarks. Phil, would you like to begin?

Thank you, Pat. Today we announced our second-quarter 2012 financial results and filed our Form 10-Q with the SEC, which includes the details of the results that I will summarize to you now. I encourage all interested investors to read the 10-Q for a broader understanding of our financial results and financial position as of June 30, 2012.

To begin, revenues continued the momentum from the first quarter as revenues grew 27% over Q2 of 2011. Driving 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 and digital sales were up 65% as well.

So we are 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 six months of 2012, revenues have increased 35%.

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 of 2011. Once again, as was the case in the first quarter, our efforts to streamline operating cost and focus our sales efforts on our higher-margin opportunities is paying off. Each of our divisions performed strongly during the quarter, especially Printing, which has really turned the corner from the challenges it faced in 2010 and 2011. The strength in gross profits from these divisions is a core financial strength of our Company.

Our total operating expenses increased 22%, which was driven by a significant increase in research and development costs, including research and development costs paid by equity. As we discussed in the first quarter, we made a 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 ipCapital, our primary R&D consultant, is in the form of warrants. We feel these warrants have allowed us to gain access to this great resource with ipCapital in a way that aligns them to the long-term success of the Company.

Without this significant increase in stock compensation and other research and development costs, operating expenses would have increased by only 12% for the second quarter. This lines up very well against a 65% increase in gross profit 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 nonrecurring items, which for 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 improved this measurement significantly. I 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 for 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 and an overall current asset level.

So, to summarize, our second quarter of 2012 was a very strong quarter based on two very important measurements -- revenue growth and gross profit growth. Our increase in gross profits allowed us to absorb a significant portion of the increase in research and development costs 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 strength 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 continues to be 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 and at risk, as evidenced by expensive counterfeit cancer drugs that entered the US supply chain and the recent significant counterfeit coupon bus in Arizona. In that Arizona bus, 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. And in this published story, $600 million was estimated to be the amount of 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 that we 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, our 2012 plan was to markedly enhance and build our intellectual property portfolio with the help and guidance from ipCapital group, which is headed by one of our Board members, John Cronin. This strategy and process continued 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, our sales team has presented several of these new product concepts to a select clientele. Initial reactions are positive and we have strong interest from 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 value proposition is its growing and valuable intellectual property portfolio. 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 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 the type of fast-track reaction we want. If response to our new technology is this good, then in my opinion sizable sales orders will be much quicker and impactful.

Turning now to our Coupons.com litigation, there is a motions hearing scheduled this week on Thursday, August 16, 2012 in the Federal District Court located here in Rochester, New York. Once the motions hearing is complete and decided, we hope and expect that the discovery stage of the 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 a license with a company who supplies transaction security for a large international firm with 19,000 locations worldwide where the transactions occur.

Also in late 2011, one of our licensees was awarded a government project, which we expect to start generating revenue in the fourth quarter, as the previous old inventory should then be expired. In addition, we expect expansion of licensing revenue from one of our largest licensees, as they seem to have completed testing and are now beginning to apply our technologies to significantly more printer products requiring security features.

As Phil reported, all four of our 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 these 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 PAC EXPO show. If you attend, it will be held at the McCormick Place from October 28 through October 31, and you will be able to see some of our new digital products as well as 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 two 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 plastic smartcards called EIDs, which will replace paper. The report goes on to say that countries issuing EIDs will exceed those still using traditional paper IDs by 4 to 1. This conversion from paper to plastic smartcards IDs should present a nice opportunity for our Plastics division and its smartcard partners. DSS plans on exploiting this trend, as we have several strategic initiatives in the works regarding this opportunity.

Our DSS Digital division has been very busy writing software and intellectual property claims. Unfortunately, these are mandatory steps prior to actually selling the applications in the workplace. Without this time-consuming and expensive process, you have risks of having competitors duplicating your intellectual property without recourse.

On the sales side, however, Digital division has been traveling internationally at the request of some international governments to address multiple government cloud computing security opportunities. Also on the sales side, Digital division has several exciting unit based security print opportunities that it is working on for some e-commerce clients. We look forward to sharing some of their wins in the very near future.

In summation, we have made a strategic decision to increase our research and development budget. We expect this investment to lead to substantial growth both in our patent portfolio as well as our sales and profits. As you'll see in the weeks and months to come, intellectual property will take center stage, which should be followed up by increasing licensing and product revenue.

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 run our expenses to a higher level in our intellectual property and broaden our base, it was a conscious decision that we arrived at based on how we saw the 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 have been approaching us. With three legs of the stool -- with Print, Packaging and Printing being one; and security printing, licensing and the cloud being another -- where we protect our IP, as we are doing in the Coupons.com litigation, was an area we are seeing 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, we will have more to report on.

But, in short, it's working. We do not forget for a minute the higher level of expenses and making the trade-off between closing that gap to where EBITDA finally turned into a 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 the path that I think we're all going to be happy that we started.

So the divisions are operating. Finally, it appears that everything that we have, including the Printing division, which had been a laggard, after hard work and attention from the management team, have moved forward and move forward, now operating it in a way that I think positions us for tremendous success in the near future. So I personally have never felt better about customer interaction, the quality of customer, the size of orders, the growth that we are 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 filings. 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 in enabling people to receive and transmit data securely is clearly the hot spot 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've never been more optimistic. The Company is performing well. And I think the management team has an excellent quarter, moving us in all strategic directions that the Board has wanted us to go. And I will leave it there and turn it back to Pat, or are we ready for questions?

Yes, Kevin, you can begin the questions at this point.

David Wolfson, William Smith.

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 we have recently had a warrant exercise that brought $500,000 into the Company, post the reporting, and we have in place plans for additional capital to going to the Company in the near future. While the check has not been signed, the expectation is that that will not be a problem for us, as it hasn't 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 R&D and the trends we're continuing, I think we would see that that would be something that we would be able to achieve in the coming year. This is a time when you have to make the tough decisions -- 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 wrestle with that every quarter, and we think we are on the right track. And we hope to see some better clarity for that between now and next conference call.

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

Okay, just one last question just in terms of R&D going forward over the next couple of quarters. Is this current level of spend something that you will replicate?

Yes. But if we're running about $250,000 per quarter on average, but this seems to be the track.

Okay, thank you.

(Operator instructions) Sandy Wyman, Gilford Securities.

A couple of things -- actually, one of my questions was just answered. Can 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? Excuse me -- R.R. Donnelly? And Robert, I noticed a little bit better tone in your voice from the last conference call, where you sounded pretty down and out. Maybe 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 1-million-plus shareholder I want a higher stock price and I want us to get to our goals faster. So if you catch me on a bad afternoon, maybe more of that reflects on my optimism about the Company. But that really is unwavering.

In regards to the first part of your question, the Eastman 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 are working on for projects, both for themselves that they want to use to market technology and as well as products for clients that are in the international arena.

That's where it stands right now. We are trying to walk carefully until we see what their financial condition ends up -- happening here. They're quite positive when they do talk about it. They think a year from now, they are going to be singing songs. So we're following the track at this point, but we just want to walk slowly in regards to that until a little more information comes out.

R.R. Donnelly -- honestly, this is the year that they finally -- I think the Arizona bust -- 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 for us rather than just the check industry, where they were mainly using us. So now we see them printing it into some coupons. And so we see some major stuff because they are a very large company doing very large projects for a lot of the brand owners. So I think that will start ramping up here in the near future.

Okay, thank you. And one last one -- maybe you can elaborate, Robert, a little bit. When you were 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 it's a bit more involved than I want to get into on the call because we would have to make all sorts of forward-looking disclosures. But in the broadest sense, we have taken look at the next stage of capital expenditures and capital needs and made a provision to deal with that. So it should not be of concern as we sit here today. Obviously, I had an uncle who used to say, it's all conversation until the check clears. So I think that's the best way to put it. But we believe that we've laid the groundwork to be able to not have that become an issue for us.

I understand. Okay, thank you.

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

Well, I'll simply say that it was a good quarter. We moved forward in all the directions that we wanted to. And we are very, very pleased with the results we are seeing in terms of the R&D expenditures and 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 three areas of focus that we have laid out for the Company's future. And I'm feeling very good about how things are going and I want to thank the management team again for a good quarter and good work and all of you, our shareholders, for staying with us. And hopefully, as I said in the past, but I'm feeling better now than ever before, the time will be short when we will start to see those results.

Pat, management, anyone else who would like to wrap up?

Again, I echo your sentiment to our shareholders and investors. And, Robert, I'd like to thank you also for all of your support. And I think we are at that point where we always wanted to be. So this is good news. Thank you.

Okay, in that case, thank you all and good evening.

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