DOCUMENT SECURITY SYSTEMS INC
10-Ks and 10-Qs
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UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
Washington,
D.C. 20549
Form
10-K
x
Annual Report under
Section 13 or 15(d) of the Securities
Exchange
Act of 1934
For
the fiscal year ended December 31, 2009
or
¨
Transitional Report
under Section 13 or 15(d) of the
Securities
Exchange Act of 1934
1-32146
Commission
file number
DOCUMENT
SECURITY SYSTEMS, INC.
(Exact
name of Registrant as specified in its charter)
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New York
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16-1229730
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(State
of incorporation)
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(IRS
Employer Identification
Number)
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First
Federal Plaza
28
East Main Street, Suite 1525
Rochester,
New York 14614
(Address
of principal executive office)
(585)
325-3610
(Registrant’s
telephone number)
Securities
registered under Section 12(b) of the Act:
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Title of each class
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Name of each exchange on which
registered
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Common
Stock (Par Value - $0.02)
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NYSE
Amex Equities
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Securities
registered under to Section 12(g) of the Act:
Indicate
by check mark if the registrant is a well-known seasoned issuer as defined in
Rule 405 of the Securities Act
YES
¨
NO
x
Indicate
by check mark if the registrant is not required to file reports pursuant to
Section 13 or 15(d) of the Exchange Act.
YES
¨
NO
x
Indicate
by check mark whether the registrant:
(1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports) and (2) has been subject to such
filing requirements for the past 90 days. YES
x
NO
¨
Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K (
§
229.405 of this
chapter) is not contained herein, and will not be contained, to the best of
registrant’s knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K.
¨
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer.
Large
Accelerated Filer
¨
Accelerated
Filer
¨
Non-Accelerated
Filer
¨
Smaller
Reporting Company
x
Indicate by check mark whether the
registrant is a shell company (as defined by Rule 12b-2 of the Act).
Yes
¨
No
x
The
aggregate market value of the stock held by non-affiliates (11,030,754 shares)
computed by reference to the closing price of such stock ($1.90), as of June 30,
2009, was $20,958,000.
As of
March 19, 2010, there were 17,760,324
shares of Common Stock
of Document Security Systems, Inc. issued.
DOCUMENTS
INCORPORATED BY REFERENCE
The
definitive proxy statement relating to the registrant’s Annual Meeting of
Stockholders, to be held on May 18, 2010, is incorporated by reference into Part
III of this Form 10-K to the extent described therein.
DOCUMENT
SECURITY SYSTEMS, INC. & SUBSIDIARIES
Table
of Contents
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ITEM
1.
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BUSINESS
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3
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ITEM
1A.
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RISK
FACTORS
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11
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ITEM
2.
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PROPERTIES
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17
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ITEM
3.
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LEGAL
PROCEEDINGS
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18
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ITEM
4.
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SUBMISSION
OF MATTERS TO A VOTE OF SECURITY HOLDERS
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19
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PART
II
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ITEM
5.
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MARKET
FOR THE REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS
AND ISSUER PURCHASES OF EQUITY SECURITIES
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20
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ITEM
7.
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MANAGEMENT’S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
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21
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ITEM
8.
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FINANCIAL
STATEMENTS AND SUPPLEMENTARY DATA
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33
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ITEM
9.
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CHANGES
IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
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33
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CONTROLS
AND PROCEDURES
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33
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PART
III
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ITEM
10.
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DIRECTORS,
EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
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35
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ITEM
11.
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EXECUTIVE
COMPENSATION
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35
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ITEM
12.
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SECURITY
OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS
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35
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ITEM
13.
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CERTAIN
RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR
INDEPENDENCE
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35
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ITEM
14.
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PRINCIPAL
ACCOUNTANT FEES AND SERVICES
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35
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ITEM
15.
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EXHIBITS
AND FINANCIAL STATEMENT SCHEDULES
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35
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SIGNATURES
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40
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2
Overview
Document
Security Systems, Inc. (referred to in this report as “Document Security,”
“DSS,” “we,” “us,” “our” or “Company”) develops, markets,
manufactures and sells paper and plastic products designed to protect valuable
information from unauthorized scanning, copying, and digital
imaging. We have developed security technologies that are applied
during the normal printing process and by all printing methods including
traditional offset, gravure, flexo, digital or via the internet on paper,
plastic, or packaging. Our technologies and products are used by
federal, state and local governments, law enforcement agencies and are also
applied to a broad variety of industries as well, including financial
institutions, high technology and consumer goods, entertainment and gaming,
healthcare/pharmaceutical, defense and genuine parts industries.
Our customers use our
technologies where there is a need for enhanced security for protecting and
verification of critical financial instruments and vital records, or where there
are concerns of counterfeiting, fraud, identity theft, brand protection and
liability.
We were
organized as a New York corporation in 1984, and in 2002, chose to strategically
focus on becoming a developer and marketer of secure technologies for all forms
of print media. To accomplish this, we acquired Lester Levin, Inc, an
operator of a small printing company called Patrick Printing and an
Internet-based business called Legalstore.com, and Thomas M. Wicker Enterprises,
Inc. and Document Security Consultants, Inc., two privately owned companies
engaged in the document security technology business with rights to certain
patents developed by certain members of the Wicker Family. As a
result of these acquisitions, we compiled the basis of our document security
business by combining basic print capabilities necessary for research and
development with the knowledge and expertise of our team of printing
professionals and a foundation of patented technologies and trade secrets from
which to launch our product offerings. Since this early stage, we
have focused our efforts on developing and in some cases patenting new
technologies and products, building our corporate, operational, marketing and
sales staff to accommodate our expected growth, and developing and implementing
our patent and intellectual property protection
strategy. In September 2007, we sold certain assets and
the operations of Patrick Printing to a private company, as this operation no
longer supported our core industry focus. In October 2009, we
sold the assets and liabilities associated with our Legalstore.com business in
exchange for common stock of Internet Media Services, Inc., in order to
concentrate our efforts on the security and printing segments of our
Company.
In
December 2004, the Company entered into an agreement with the Wicker Family in
which Document Security Systems obtained the legal ownership of technology
(including patent ownership rights) previously held by the Wicker
Family. At that time, the agreement with the Wicker Family provided
that the Company would retain 70% of the future economic benefit derived from
settlements, licenses or subsequent business arrangements from any infringer of
the Wicker patents that Document Security Systems chooses to
pursue. The Wicker Family was to receive the remaining 30% of such
economic benefit. In February 2005, the Company further consolidated
its ownership of the Wicker Family based patents and its rights to the economic
benefit of infringement settlements when the Company purchased economic
interests and legal ownership from approximately 45 persons and entities that
had purchased various rights in Wicker Family technologies over several decades.
In August
2005, the Company commenced a suit against the European Central Bank (“ECB”)
alleging patent infringement by the ECB and claimed unspecified damages. We
brought the suit in the European Court of First Instance in
Luxembourg. We alleged that all Euro banknotes in circulation
infringe the Company European Patent 0 455 750B1 (the “Patent”), which covers a
method of incorporating an anti-counterfeiting feature into banknotes or similar
security documents to protect against forgeries by digital scanning and copying
devices. Commencing in March 2006, the ECB countersued in eight
national courts that the Patent was invalid. To date, the most
significant events in the case since it was filed have been the challenges of
patent validity by the ECB. To date, there have been four adverse rulings and
two positive rulings in regard to the patent’s
validity. Through August 2008, the Company spent approximately
$4.2 million dollars on legal, expert and consulting fees for its
case. In August 2008, the Company decided to
reduce its cost burden from the case and entered into an agreement with
Trebuchet Capital Partners, LLC (“Trebuchet”) under which Trebuchet
agreed to pay substantially all of the litigation costs associated with pending
validity proceedings and future validity and future patent infringement suits
filed against the ECB and certain other alleged infringers of the Patent in
exchange for 50% of any future proceeds or settlements associated with the
litigation.
In
addition to its patent defense efforts, since 2002, the Company has also worked
to develop and expand its patent and product portfolio. As of
March 22, 2010, we have 14 patents and have 57 patent applications in process,
including provisional and PCT patent applications and applications that have
entered the National Phase in various countries including the United States,
Canada, Europe, Japan, Brazil, Israel, Mexico, Indonesia and South Africa. These
applications cover our technologies, including our AuthentiGuard
®
On-Demand, AuthentiGuard
®
Prism™,
AuthentiGuard
®
Phantom™, AuthentiGuard
®
ObscuraScan™, AuthentiGuard
®
Survivor
21™, AuthentiGuard
®
VeriGlow™ products, and several other anti-counterfeiting and authentication
technologies in development. The Company believes that its
commitment to research and development is critical to its position as a leading
provider of anti-counterfeiting solutions to our customers.
3
Prior
to 2006, the Company’s primary revenue source in its document security division
was derived from the licensing of its technology. The Company had
limited production capabilities. In 2006, the
Company began to expand its ability to be a provider of anti-counterfeiting
products that utilize the Company’s anti-counterfeiting
technologies. In 2006, we acquired San Francisco-based Plastic
Printing Professionals, Inc. (“P3”), a privately held plastic cards manufacturer
located in the San Francisco, CA area. P3’s primary focus is
manufacturing long-life composite, laminated and surface printed cards which can
include magnetic stripes, bar codes, holograms, signature panels, invisible ink,
micro fine printing, guilloche patterns, Biometric, RFID and a patent-pending
watermark technology. P3’s products are marketed through an extensive broker
network that covers much of North America, Europe and South America and by
manufacturing for various industry integrators.
In
December 2008, we acquired substantially all of the assets of DPI of Rochester,
LLC, (“DPI”)a privately held commercial printer located in Rochester,
NY. We formed a new subsidiary called DPI Secuprint to incorporate
this new company which significantly improved our ability to produce our
security paper products as well as improving our competitiveness in the market
for custom security printing, especially in the areas of vital records, secure
coupons, transcripts, and prescription paper along with the ability
to offer our customers a wider range of commercial printing
offerings.
In 2009,
we generated revenue of $9.9 million in 2009, a 49% increase compared to
2008. The increase was primarily due to the acquisition of DPI in
December of 2008. The increase caused by the acquisition of DPI more
than offset decreases experienced by the Company’s other divisions, Document
Security Systems and P3, and the loss of revenue as a result of the Company’s
divestiture of its legal products division in October of
2009. All of the Company’s divisions experienced sales
declines which the Company believes were the direct result of the widespread
global economic recession that occurred during the first six months of 2009, and
the lingering effects of the deep recession during the last half of
2009. During 2009, the Company experienced a net loss of
$4.0 million, a 52% decrease from a net loss of $8.3 million in
2008. During 2009, the Company was able to offset the effects of less
than forecasted revenues with significant cost reductions that will allow the
Company to reach cash flow and net income breakeven at sales levels consistent
with the historical demand at each of its divisions, which the Company believes
will occur as general global economic levels recover from the
recession.
On
February 12, 2010, the Company acquired Premier Packaging Corporation, a
privately held packaging company located in the Rochester NY
area. Premier Packaging Corporation is an ISO 9001:2008 registered
manufacturer of custom paperboard packaging serving clients in the
pharmaceutical, beverage, photo packaging, toy, specialty foods and direct
marketing industries, among others. The Company expects the
acquisition will allow it to introduce anti-counterfeiting products to the
packaging market that further expands the usage of its
technologies. The Company believes that the ability to deter and
prevent counterfeiting of brand packaging will provide major benefits to
companies around the globe who are affected by product
counterfeiting.
Our
Core Products, Technology and Services
Our core business is counterfeit
prevention, brand protection and validation of authentic print media, including
government-issued documents, aerospace industry spare parts documents,
packaging, ID Cards, licenses and more. We are a leader in the
research and development of optical deterrent technologies and have
commercialized these technologies with a suite of products that offer our
customers an array of document security solutions. We provide
document security technology to security printers, corporations, consumer
product companies and governments worldwide and for currency, identifications,
certifications, travel documents, prescription and medical forms, consumer
product and pharmaceutical packaging, and school transcripts.
Our
products can be delivered on paper, plastic, or digitally via our
AuthentiGuard
®
DX™
product suite. We believe that our continued efforts in the field of
digital security and technology greatly expands the reach and potential market
for our AuthentiGuard
®
DX™
digital products and enterprise solutions. We believe that our
AuthentiGuard
®
DX™
solution significantly changes the economics of document security for many
customers as it eliminates the requirement to utilize pre-printed forms while
allowing customers to leverage existing investments in their information
technology infrastructure.
4
Technologies
We have developed or acquired over 30
technologies that provide to our customers a wide spectrum of
solutions.
According
to a March 2010 report by the MDB Capital Group LLC, an institutional research
and investment banking firm, located in Santa Monica, California that focuses
exclusively on companies that possess market changing, disruptive intellectual
property, has DSS ranked among the top companies in intellectual property
leadership based on several proprietary intellectual property
indexes.
DSS ranks
in the 90th percentile from over 4,000 companies for IP leadership as defined by
a high patent citation (Companies citing the Company’s Patents in their patent
applications) number of 2.12 which is two times higher than its peer
group. The Company also has a 40.38 PV Ratio which indicates that the
Company’s stock market value is lower than its patent value according to the
MDB’s PatentVest evaluation methodology.
The
company’s primary anti-counterfeiting products and technologies are marketed
under the following trade names:
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AuthentiGuard™ DX™
is a
networked appliance that allows the author of any Microsoft Office
document (Outlook, Word, Excel, or PowerPoint) to secure nearly any of its
alphanumeric content when it is printed or digitally stored.
AuthentiGuard® DX prints selected content using the company’s patented
technology so that it cannot be read by the naked eye. Reading the hidden
content, or authenticating the document is performed with a proprietary
viewing device or software.
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Like
AuthentiGuard® DX™
,
AuthentiGuard® On -Demand™
is a customized software or a web-based
application that incorporates the verification feature of AuthentiGuard
®
Prism™
and the anti-copy anti-scan features of AuthentiGuard
®
Pantograph 4000™ in a manner that makes those technologies printable from
desktop printers and digital presses worldwide. On-Demand™ provides
the ability to produce highly secure documents virtually “any-time, anywhere”,
and is highly effective in variable data applications.
|
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·
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AuthentiGuard
®
Laser Moiré™,
a
counterfeit
deterrent
technology,
prevents counterfeit reproductions by creating gross distortions and
unmistakable moiré interference patterns throughout the
image. Verification of original documents or images is fast and
easy with The Authenticator – our proprietary lens that reveals the moiré
pattern. The technology is embedded into an image that requires
protection from duplication and theft, such as photographs, portraits,
currency, driver’s licenses, postage stamps, tickets, labels, brand
packaging, or documents.
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·
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AuthentiGuard
®
Prism™,
a
verification technology, embeds hidden words, images, or logos using
2-color or 4-color processes that are only visible using a special,
non-public proprietary Prism™ lens that reveals hidden
Prism™
images. We believe that the hidden words, images or logos
embedding with the Prism™ technology cannot be reproduced with even the
most sophisticated digital copiers or scanners. As a result,
the absence of the hidden words, images or logos alerts the end-user that
the document is counterfeit. The AuthentiGuard® Prism
technology protects verification forms such as spare parts, packing slips,
checks, currency, licenses, travelers’ checks, postage stamps, legal
documents, tickets, labels, and brand
packaging.
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·
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AuthentiGuard
®
Pantograph 4000™
,
a
counterfeit
deterrent
technology,
provides what we believe is the most powerful, patented pantograph
technology ever created. Hidden words such as “VOID” or “COPY”,
company logos, or designs appear when a document utilizing the technology
is photocopied or scanned, preventing unauthorized
duplication. Although there are other versions of this
technology being sold by competitors, we believe that no version other
than our Pantograph 4000™ defeats high and low resolution scanners and
produces crisp clear and readable warning words. We believe
that virtually any printable surface can utilize the technology, including
paper, Teslin, PVC, Tyvek and cardboard packaging. This
technology has been used for gift certificates, school transcripts,
coupons, tickets, checks, packing slips, receipts, schematic drawings,
plans, music, scripts, training manuals, business plans, internal memos,
letterhead, legal forms and prescription
pads.
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·
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AuthentiGuard
®
Phantom™,
a
verification technology, uses “tilt-to-reveal” hidden images or words that
can be easily viewed without special equipment. Viewed straight
on, the hidden images are virtually invisible to the naked eye, but when
the package or document is viewed at an angle, the hidden images are
clearly revealed. For added security, we believe that our patented
AuthentiGuard® Phantom™ technology cannot be reproduced with even
the best copiers or scanners. We also feel that this technology is much
more effective and eye catching then color shifting
ink.
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5
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·
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AuthentiGuard
®
VeriGlow™,
a verification technology, is a two-tiered, customized document
security systems that utilizes unique photosensitive inks and incorporates
embedded hidden messages or images that are only viewable with a special
light source and our special non-public proprietary Veri-Glow reading
device. This patent pending technology can be applied during
the printing process or it can be applied to pre-printed items and is
useful in the protection of vital records such as passports, documents,
brand protection, packaging and
currency.
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·
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AuthentiGuard
®
Survivor 21®,
a
counterfeit
deterrent
technology,
protects printed checks from duplication via digital copiers and scanners
while providing a patent-pending security feature that survives the
background dropout that results from bank’s archival
scan. Survivor 21™ was created to meet new government banking
regulations that require documents to be archive-scan friendly, without
compromising security.
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·
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AuthentiGuard
®
Block-Out™
, a
counterfeit
deterrent
technology, also
called the “anti-color reproduction system”, makes it very difficult to
reproduce protected documents on digital color copiers. Certain
copiers recognize Block-Out’s embedded graphics on the original document,
and print out solid black sheets or highly distorted
images. AuthentiGuard® Block-Out™ is our own unique proprietary
graphic design that is recognized and triggers a mechanism developed by
Omron Corporation in some copiers. We developed it to prevent color
copiers and photo processors from replicating any image or document that
contains our custom Block-Out™ graphics. This technology can be
integrated into highly sensitive government documents such as currency,
car titles, passports and licenses as well as checks, travelers’ checks,
postage stamps, photographs, original art and brand
packaging.
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·
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AuthentiGuard
®
MicroPerf™,
a
verification technology
,
creates a verifier mark that is invisible to the naked eye when
viewed under normal circumstances and unnoticeable to the touch, but can
be viewed by simply holding the document up to a normal light for fast and
easy authentication. MicroPerf™ uses a laser to insert fine
perforations into the document, and can be placed on vital records,
documents, packaging or currency and is a micro-sized perforation in the
shape of a word or image that cannot be removed or altered in any
way.
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Products
and Services
Generic Security
Paper
: Our primary product for the retail end-user market is
AuthentiGuard
®
Security
Paper. AuthentiGuard
®
Security
Paper is blank paper that contains our Pantograph 4000
TM
technology. The paper reveals hidden warning words, logos or images
using The Authenticator- our proprietary viewing lens – or when the paper is
faxed, copied or scanned. The hidden words appear on the duplicate or
the computer digital file and essentially prevent documents, including forms,
coupons and tickets, from being counterfeited. We market and sell our
AuthentiGuard
®
Security
Paper primarily through several major paper distributors such as Boise Cascade
and Blanks USA. Since 2005, Boise has marketed our AuthentiGuard
®
Security
Paper under its Boise Beware brand name in North America, primarily through its
commercial paper sales group. Blanks USA sells and manufactures the technology
under the “Kant Kopy” brand name. The company also sells its security
paper on the internet utilizing a ecommerce website, www.protectedpaper.com. We
retain the rights to sell the AuthentiGuard
®
Security
Paper directly to end-users anywhere in the world. The company
also had a version of its security paper tested and certified for use on Hewlett
Packard (“HP”) Indigo Digital presses by the Rochester Institute of Technology’s
Printing Applications Laboratory. This certification allows the
Company’s security paper to be marketed to HP Indigo users
worldwide.
Security and non-security
printing
: Our technology portfolio allows us to create unique
custom secure paper, plastic, packaging and Internet-based and software
enterprise solutions. We market and sell to end-users that require
anti-counterfeiting and authentication features in a wide range of printed
materials such as documents, vital records, prescription paper, driver’s
licenses, birth certificates, receipts, manuals, identification materials,
entertainment tickets, secure coupons, parts tracking forms, as well as product
packaging including pharmaceutical and a wide range of consumer
goods. In addition, we provide a full range of digital and large
offset commercial printing capabilities to our customers.
Since our
inception, we have primarily outsourced the production of the majority of our
custom security print orders to strategic printing vendors. In
December 2008, we acquired a commercial printer with long-run offset and short
run digital printing capabilities that will allow us to produce the majority of
our security print orders in-house. We produce our
plastic printed documents such as ID cards, event badges, and driver licenses at
our manufacturing facility in Brisbane, California under the name Plastic
Printing Professionals. In late 2007, we moved our P3 manufacturing facility to
a 25,000 square foot facility in order to increase our plastic manufacturing
capacity, and during 2008, we upgraded their production capabilities by adding
equipment that will improve its productivity, along with equipment for high
speed data encoding and equipment that for productions of high-volume precision
RFID cards.
6
Digital Security
Solutions:
Using software that we have developed, we can electronically render several of
our technologies digitally to extend the use of optical security to the end-user
of sensitive information. With our AuthentiGuard
® DX™
we market a
networked appliance that allows the author of any Microsoft Office document
(Outlook, Word, Excel, or PowerPoint) to secure nearly any of its alphanumeric
content when it is printed or digitally stored. AuthentiGuard® DX prints
selected content using DMC’S patented technology so that it cannot be read by
the naked eye. Reading the hidden content, or authenticating the document
is performed with a proprietary viewing device or software.
The
company has developed an internet delivered technology called AuthentiGuard® –
On Demand™ where information is hidden and then verified utilizing a inexpensive
viewing glass. This technology is currently being utilized by a
Central American country for travel visas.
The
company has also developed digital versions of its AuthentiGuard® –
Prism™ and AuthentiGuard® – Pantograph 4000™ technologies
which are produced on HP Indigo Presses, Canon Color Copiers, Ricoh Color
Copiers and Konica Desktop Printers. The company sells the digital
products directly through its internal sales force and it has also entered a
contract to sell its digital solutions through a third party who specializes in
hardware software engineering solutions.
Technology
Licensing:
We license our anti-counterfeiting technology and
trade secrets to security printers through licensing arrangements. We
seek licensees that have a broad customer base that can benefit from our
technologies or have unique and strategic capabilities that expand the
capabilities that we can offer our potential customers Licenses can be for a
single technology or for a package of technologies. We offer
licensees a variety of pricing models, including:
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·
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Pay
us one price per year;
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·
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Pay
us a percentage of gross sales price of the product containing the
technology during the term; or
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·
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Joint
venture or profit sharing
arrangement
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·
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Pay
Per Finished Piece
|
Legal Products
: We
also owned and operated Legalstore.com, an Internet company which sells legal
supplies and documents, including security paper and products for the users of
legal documents and supplies in the legal, medical and educational
fields. On October 8, 2009 we sold the assets and liabilities
associated with our Legalstore.com business in exchange for 7,500,000 shares of
common stock of Internet Media Services, Inc., representing approximately 37% of
the outstanding shares of the newly formed company.
Intellectual
Property
Patents
Our
ability to compete effectively depends in part on our ability to maintain the
proprietary nature of our technology, products and manufacturing processes. We
principally rely upon patent, trademark, trade secrets and contract law to
establish and protect our proprietary rights. During our development, we have
expended a significant percentage of our resources on the research and
development to ensure that we are a market leader the ability to provide our
customers effective solutions against a never changing array of counterfeit
risks.
Based
largely on these efforts, we currently fourteen patents and have 57 patent
applications in process, including provisional and PCT patent applications and
applications that have entered the National Phase in various countries including
the United States, Canada, Europe, Japan, Brazil, Israel, Mexico, Indonesia and
South Africa. These applications cover our technologies, including our
AuthentiGuard
®
On-Demand, AuthentiGuard
®
Prism™,
AuthentiGuard
®
Phantom™, AuthentiGuard
®
ObscuraScan™, AuthentiGuard
®
Survivor
21™, AuthentiGuard
®
VeriGlow™ products, and several other anti-counterfeiting and authentication
technologies in development.
We also
jointly have the rights to Patent No. 5,707,083 with R.R. Donnelly. Under the
terms of our agreement with R.R. Donnelly, it has no rights in any revenue
generated by us through the technology represented by the patent. R.R. Donnelly
may license the technology but is required to split any revenue with us after
costs associated with any licensing.
7
In
addition to our current patent activities, we own several patents that we
acquired in 2002 when we acquired companies owned by various members of the
Wicker Family and The Estate of Ralph Wicker, including US Patents 5,018,767,
European Patent 0455750, Canadian Patent 2,045,580, and a 50% ownership of US
Patent No 5,735,547 (collectively, the “Wicker Patents”). However,
due to previous contractual agreements associated with the Wicker Patents, we
did not obtain certain economic rights to these patents, including certain
economic rights to benefits derived from settlements, licenses or other
subsequent business arrangements from any person or entity that had been proven
to infringe these patents. Therefore, to consolidate our ownership
and economic rights to the Wicker Patents, we entered into the following
transactions.
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|
·
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In
2004, we entered into an agreement with The Estate of Ralph Wicker and its
assigns to purchase from them the right to 70% of the future economic
benefit derived from settlements, licenses or subsequent business
arrangements from any infringer of the Wicker Patents
that we choose to
pursue, with The Estate of Ralph Wicker receiving the remaining 30% of
such economic benefit.
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·
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In
February 2005, we further consolidated our ownership of the Wicker Patents
by purchasing the economic interests and ownership from 45 persons and
entities that had purchased various rights in Wicker Family technologies,
including the Wicker Patents. As a result of this transaction,
we increased our ownership of US Patent 5,735,547 to 100%, and increased
to our right to future economic benefits to the Wicker Patents to
approximately 86% of all settlements or license royalties derived from,
among other things, infringement suits related to the foreign Wicker
Patents, including European Patent 0455750. Pursuant to these
transactions, we issued an aggregate of 541,460 shares to of our Common
Stock, valued at approximately $3.9
million.
|
On August
20, 2008, the Company entered into an agreement with Trebuchet Capital Partners,
LLC (“Trebuchet”) under which Trebuchet has agreed to pay substantially all of
the litigation costs associated with pending validity proceedings initiated by
the European Central Bank (“ECB”) in eight European countries relating to the
Company’s European Patent 0 455 750B1 that the Company has claimed the ECB
infringed in printing of the Euro currency (the “Patent”). Trebuchet also agreed
to pay substantially all of the litigation costs associated with future validity
challenges filed by the ECB or other parties, provided that Trebuchet elects to
assume the defense of any such challenges, in its sole discretion, and patent
infringement suits filed against the ECB and certain other alleged infringers of
the Patent, all of which suits may be brought at the sole discretion of
Trebuchet and may be in the name of the Company, Trebuchet or both. The Company
provided Trebuchet with the sole and exclusive right to manage infringement
litigation relating to the Patent in Europe, including the right to initiate
litigation in the name of the Company, Trebuchet or both and to choose whom and
where to sue, subject to certain limitations set forth in the agreement. Under
the terms of the Agreement, the Company and Trebuchet have agreed to equally
share all proceeds generated from litigation relating to the Patent, including
judgments and licenses or other arrangements entered into in settlement of any
such litigation. Trebuchet is also entitled to recoup any litigation expenses
specifically awarded to the Company in such actions.
By
aggressively defending our intellectual property rights, we believe that we may
be able to secure a potentially significant amount of additional and ongoing
revenue by securing proceeds from lawsuits, settlements, or licensing agreements
with those persons, companies or governments that we believe are infringing our
patents. We intend to use the appropriate legal means that are
economically feasible to protect our ownership of these technologies. We cannot
be assured, however, that our efforts to prevent the misappropriation of the
intellectual property used in our business will be successful, or that we will
be successful in obtaining monetary proceeds from entities that we believe are
infringing our patents. Further, we cannot be assured that any
patents will be issued for our U.S. or foreign applications or that, if issued,
they will provide protection against competitive technologies or will be held
valid and enforceable if challenged. We also cannot be assured that
competitors would not be able to design around any such proprietary right or
obtain rights that we would need to license or design around in order to
practice under these patents.
Trademarks
We have
registered our “AuthentiGuard” mark, as well as our “Survivor 21” electronic
check icon with the U.S. Patent and Trademark Office. A trademark
application is pending in Canada for
“AuthentiGuard.” AuthentiGuard
®
is
registered in several European countries including the United
Kingdom.
Research
and Development
Our research and development
costs
consist primarily of compensation costs for research personnel and
direct costs for the use of third-party printers’ facilities to test and develop
our technologies on equipment that we do not have access to
internally. We focus our research efforts on creating
anti-counterfeiting solutions and products for current and anticipated customer
needs. Furthermore, we often seek patent or trademark protection on
our developments.
8
Major
Customers
During
2009, two customers accounted for 19% and 12% of the Company’s total revenue,
respectively. As of December 31, 2009, two customer account
receivable balances accounted for 21% and 17% of the Company’s trade accounts
receivable balance, respectively. During 2008, two customers
accounted for 11% and 10% of the Company’s total revenue from continuing
operations, respectively. As of December 31, 2008, one customer
account receivable balance that was acquired as part of the Company’s
acquisition of the assets of a commercial printer in December 2008, accounted
for 42% of the Company’s trade accounts receivable balance.
Websites
We
maintain the website, www.documentsecurity.com, which describes our patented
document security solutions, our targeted vertical markets, company history, and
offers our security consulting services. We also maintain
www.plasticprintingprofessionals.com, which describes our ID card and other
plastic and vinyl printing services. In addition, we maintain the website
www.protectedpaper.com, an e-commerce site that markets and sells our patented
security papers hand-held security verifiers and custom security documents to
end users worldwide. We also utilize www.authenticate-360.com, a
website which is hosted and owned by our licensee, The Ergonomic Group; this
website is a source for counterfeiting information and promotion of our
On-Demand™ products. In addition, we market digital and large offset commercial
printing at our subsidiaries website:
www.dpirochester.com
. In
February 2010, we acquired Premier Packaing Corp, which maintains the website
www.premiercustompkg.com. In addition to the active
websites, the company owns over 40 domain names for future use or for strategic
competitive reasons.
Competition
Currently,
the security print market is comprised of a few very large companies and an
increasing number of small companies with specific technology
niches. The expansion of this market is the result of increasing
requirements for national security, as well as the proliferation of brand and
identity theft. Counterfeiting has expanded significantly as
advancing technologies in digital duplication and scanning combined with
increasingly sophisticated design software has enabled easier reproduction of
originals.
Our
industry is highly fragmented and characterized by rapid technological change
and product innovations and evolving standards. We feel a
consolidation of the industry may transpire in the near future as larger, well
financed companies acquire smaller technology companies to position themselves
in the industry and access their intellectual property and access to client
lists. Many of our current competitors have longer operating
histories, more established products, greater name recognition, larger customer
bases, and greater financial, technical and marketing resources. As a
result, our competitors may be able to adapt more quickly to new or emerging
technologies and changes in customer requirements, and devote greater resources
to the promotion and sale of their products. Competition may also
force us to decrease the price of our products and services. There is
no assurance that we will be successful in developing and introducing new
technology on a timely basis, new products with enhanced features, or that these
products, if introduced, will enable us to establish selling prices and gross
margins at profitable levels.
Although
our technology is effective primarily on analog and digital copiers and
scanners, our competition covers a wide array of document security and
anti-counterfeiting solutions. We conduct research and development to
improve our technology, including the development of new patents and trade
secrets. We will rely primarily upon our patents and trade secrets to attempt to
thwart competition, although there can be no assurance that we will be
successful.
Our
competitors include Standard Register Company, which specializes in printing
security technologies for the check and forms and medical industries; De La Rue
Plc, that specializes in printing secure currency, tickets, labels, lottery
tickets and vital records for governments and Fortune 500 companies; Xerox, an
industry leader in copying and scanning that has made recent entries into the
anti-counterfeiting business and has a competing Safety Paper product called “X
Void.” Our P3 ID card manufacturing operation competes with LaserCard
Corporation which supplies advanced ID technology to the U.S. federal government
and other government programs worldwide, with a range of products and solutions
that includes secure ID technologies.
In
addition, other competing hidden word technologies are being marketed by
competitors such as NoCopi Technologies which sells and markets secure paper
products, and Graphic Security Systems Corporation, which markets scrambled
indicia.
9
Digital
watermarks, RFID and biometric technologies are also being introduced into the
marketplace by Digimarc Corporation, IBM and L-1 Identity
Solutions. These digital protection systems require software and
hardware such as scanners and computers to implement and utilize the technology
and, consequently, this technology must be utilized in a controlled environment
with the necessary equipment to create the verification
process. Therefore, versions of our optical security technologies do
not require hardware and software to operate and therefore, provide a power
outage fail-safe when combined or layered with RFID, digital watermarks or
biometric systems.
Large Office Equipment Manufacturers,
called OEMs, such as Sharp, Canon, Ricoh, Hewlett Packard and Eastman Kodak are
developing “smart copier” technology that recognizes particular graphical images
and produces warning words or distorted copies. Some of the OEMs are
also developing user assigned and variable pantograph “hidden word” technologies
in which users can assign a particular hidden work in copy, such as “void” that
is displayed when copy of such document is made.
Optical Deterrent features such as ours
are utilized mainly by the large worldwide security printers for the protection
of currency. Many of these features such as micro-printing were
developed pre-1980 as they were designed to be effective on the imaging devices
of the day which were mainly photography mechanisms. With the advent
of modern day scanners, digital copiers, digital cameras and easy to use imaging
software such as Adobe Photoshop many of the pre-1980 optical deterrents such as
micro-printing are no longer or much less effective in the prevention of
counterfeiting.
Unlike some of our competitors, our
technologies are developed to defeat today’s modern imaging
systems. Almost all of our products and processes are built to thwart
scanners and digital copiers and we believe that our products are the most
effective in doing so in the market today. In addition, our
technologies do not require expensive hardware or software add-ons to
authenticate a document, but instead require simple, inexpensive hand-held
readers which can be calibrated to particular hidden design
features. Our technologies are literally ink on paper that is printed
with a particular method to hide selected things from a scanner’s “eye” or
distort what a scanner “sees.” These attributes make our
anti-scanning technologies very cost effective versus other current offerings on
the market since our technologies are imbedded during the normal printing
process, thereby significantly reducing the costs to implement the
technologies.
The
commercial printing industry in the US includes around 35,000 companies with $90
billion of annual revenue. (Source:
http://www.firstresearch.com/industryanalysis/commercialprinting.html
). Several
giants like RR Donnelley and Canadian printer Quebecor World have multibillion
revenues, but most printers considered "large" have annual revenues under
$1 billion. The majority of commercial printers are small or midsized businesses
that operate one production plant, employ fewer than 20 people, and have
annual revenue under $5 million. Despite continuing consolidation, the
industry is highly fragmented; the largest 50 companies hold only about 30
percent of the market.
We
compete primarily with locally-based printing companies in the Rochester and
Western New York markets. Most of our competitors in these markets
are privately-held, single location operations.
In the
packaging industry, we compete with a significant number of national, regional
and local companies, many of which are independent and privately-held. The
largest competitors in this market are primarily focused on the long-run print
order market. They include large integrated paper companies such as Rock-Tenn
Company, Caraustar Industries, Inc., Graphic Packaging Holding Company and Mead
Westvaco.
In
general, changes in prevailing U.S. economic conditions significantly impact the
general commercial printing industry. To the extent weakness in the
U.S. economy causes local and national corporations to reduce their spending on
advertising and marketing materials, the demand for commercial printing services
may be adversely affected.
Segment
Information
We
operate through two segments:
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·
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Security and
commercial printing
. This segment
consists of the
license, manufacture and sale of
document security technologies, including digital security print solutions
and secure printed products at Document Security Systems and P3 divisions,
along with commercial printing provided by P3 and DPI
Secuprint.
|
|
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·
|
Legal
Supplies
.
Sale of specialty legal supplies,
primarily to lawyers and law firms located throughout the United States as
Legalstore.com.
During the fourth quarter of
2009, the Company sold its legal products business. The Company
continues to report the results as continued operations because the
operations and cash flows of the component have not been eliminated and
given the Company’s continued involvement after the sale
.
|
10
Financial
information regarding these segments is provided in Note 15 to our consolidated
financial statements included in this Annual Report on
Form 10-K.
Employees
As of
December 31, 2009, we had 80 full and part-time employees. In
February 2010, we added 32 employees as the result of our acquisition of Premier
Packaging Corp. It is important that we continue to retain and
attract qualified management and technical personnel. Our employees
are not covered by any collective bargaining agreement, and we believe that our
relations with our employees are good.
Government
Regulation
In light
of the events of September 11, 2001 and the subsequent war on terrorism,
governments, private entities and individuals have become more aware of, and
concerned with, the problems related with counterfeit documents. Homeland
Security remains a high priority in the United States. This new heightened
awareness may result in new laws or regulations which could impact our business.
We believe, however, that any such laws or regulations would be aimed at
requiring or promoting anti-counterfeiting, and therefore would likely have a
positive impact on our business plans.
Document
Security Systems plays an active role with the Document Security Alliance group,
as it sits on various committees and has been involved in design recommendations
for important U.S. documents. This group of security industry
specialists was formed by the U.S. Secret Service to evaluate and recommend
security solutions to the Federal government for the protection of credentials
and vital records.
As
counterfeiting continues to increase worldwide, various new laws and mandates
are occurring to address the growing security problem which we believe will
increase our ability to generate revenue. For example, in 2007
Federal legislation was enacted that required hospitals, physicians and
pharmacies to use tamperproof paper to fill all Medicaid
prescriptions. Initially, the requirement, which was part 7002(b) of
the “U.S. Troop Readiness, Veterans’ Care, Katrina Recovery and Iraq
Accountability Appropriations Act of 2007”, was effective April 1,
2008.
An
investment in our securities is subject to numerous risks, including the Risk
Factors described below. Our business, operating results or financial condition
could be materially adversely affected by any of the following
risks. The risks described below are not the only ones we face.
Additional risks we are not presently aware of or that we currently believe are
immaterial may also materially affect our business. The trading price of our
Common Stock could decline due to any of these risks. In assessing these risks,
you should also refer to the other information contained or incorporated by
reference in this Form 10-K, including our financial statements and related
notes, competition and intellectual property.
We have a history of losses and we may experience losses in the foreseeable
future.
We have
not achieved profitability and we may incur losses for the foreseeable future.
In fiscal 2009, 2008, and 2007, we incurred losses of approximately $4.0
million, $8.3 million, and $7.0 million, respectively. As of
December 31, 2009, our accumulated deficit was $36.5 million, which
represents our net losses since inception. We will need to achieve
incremental revenue growth and manage our costs to achieve profitability. Even
if we do achieve profitability, we may be unable to sustain profitability on a
quarterly or annual basis thereafter. It is possible that our revenue will grow
at a slower rate than we anticipate or that operating expenses will increase
beyond our current run rate. The current global economic slowdown could slow
customer orders, as well as anticipated revenue growth, and could further delay
our prospects for operating profitability.
Due
to our low cash balance and negative cash flow, we may have to further reduce
our costs by curtailing future operations to continue as a
business.
We have
incurred significant net losses in previous years. Our ability to
fund our capital requirements out of our available cash and cash generated from
our operations depends on a number of factors. Some of these factors include our
ability to (i) increase security and commercial printing and plastic card sales
and (ii) increase sales of our digital products. We have approximately $417,000
of cash available to us under a credit facility as of December 31, 2009, that we
recently extended the expiration date to January 2012, we will likely need
additional funds in the future in order to fund our working capital needs
including equity capital. In addition, as the result of our
acquisition of Premier Packaging Corp. in February 2010, we have access to a
$1,000,000 revolving line of credit, although such funds can only be accessed by
the Premier Packaging division. If we are not successful in
generating needed funds from operations or in capital raising transactions, we
may need to reduce our costs which measures could include selling or
consolidating certain operations or assets, and delaying, canceling or scaling
back product development and marketing programs. These measures could materially
and adversely affect our ability to operate profitably.
11
We
have a significant amount of relatively short term indebtedness and may be
unable to satisfy our obligations to pay interest and principal thereon when
due.
As of
December 31, 2009, we have the following approximate amounts of outstanding
indebtedness:
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(i)
|
$450,000
Convertible Note bearing interest at 8% per annum due June 23, 2012,
convertible into up to 260,116 shares of Document Security Systems Common
Stock, and is secured by the accounts receivable of the Company, excluding
the accounts receivable of the Company’s wholly owned subsidiaries,
Plastic Printing Professionals and DPI Secuprint,
respectively.
|
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(ii)
|
$350,000
Convertible Note bearing interest at 10% per annum due November 24, 2012,
convertible into up to 218,750 shares of Document Security Systems Common
Stock and is secured by the assets of the Company’s wholly owned
subsidiary DPI Secuprint.
|
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(iii)
|
$575,000
Promissory Note bearing interest at 10% per annum due November 24, 2012
and accrues interest at 10% and is secured by the assets of the Company’s
wholly owned subsidiary DPI
Secuprint.
|
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(iv)
|
$735,000,
inclusive of accrued interest of approximately $152,000, due under a
Credit Facility under which the Company can borrow up to $1,000,000
bearing interest at LIBOR plus 2% per annum due January 4,
2012.
|
Furthermore,
in February 2010, the Company entered into new debt agreements in conjunction
with its acquisition of Premier Packaging Corp as follows:
|
(v)
|
A
$1,500,000 Term Loan which matures March 1, 2013 and is payable in 35
monthly payments of $25,000 plus interest commencing March 1, 2010 and a
payment of $625,000 on the 36 month. Interest accrues at 1
Month LIBOR plus 3.75% and is secured by all of the assets of the
Company’s subsidiary, Premier Packaging Corporation, which the Company
acquired on February 12, 2010. The Company subsequently entered
into a credit swap agreement to lock into a 5.66% effective interest over
the life of the term loan. The Loan has also been guaranteed by
Document Security Systems, and its subsidiaries Plastic Printing
Professionals and DPI
Secuprint.
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(vi)
|
Up
to $1,000,000 in a revolving line of credit available for use
by Premier Packaging, subject to certain limitations which matures on
February 12, 2011 and is payable in monthly installments of interest only
beginning on March 1, 2010. Interest accrues at 1 Month LIBOR plus
3.75%. $735,000. As of March 19, 2010, approximately
$300,000 is outstanding on the line. The revolving line of credit
has also been guaranteed by Document Security System, and its subsidiaries
Plastic Printing Professionals and DPI
Secuprint.
|
Absent
a new financing or series of financings, our current operations may not generate
sufficient cash to pay the interest and principal on these obligations when they
become due. Accordingly, we may default in these obligations in the
future.
Our
limited cash resources may not be sufficient to fund continuing losses from
operations and the expenses of the current patent validity and patent
infringement litigations.
The cost
to defend current and future litigation may be significant. We cannot
assure you that the ultimate cost of current known or future unknown litigation
and claims will not exceed our current expectations and/or our ability to pay
such costs and it is possible that such litigation costs could have a material
adverse effect on our business, financial condition and operating
results. In addition, litigation is time consuming and could divert
management attention and resources away from our business, which could adversely
affect our business, financial condition and operating results.
12
If
we lose our current litigation, we may lose certain of our technology rights,
which may affect our business plan.
We are
subject to litigation and threatened litigation, including without limitation
our litigation with the European Central Bank, in which parties allege, among
other things, that certain of our patents are invalid. If the ECB or
other parties are successful in invalidating any or all of our patents, it may
materially affect us, our financial condition, and our ability to market and
sell certain of our products based on any patent that is
invalidated. Furthermore, we have granted nearly all control
over our ECB Litigation to a third party, Trebuchet Capital Partners, LLC., who
may or may not have the resources or capabilities to successfully defend our
patent rights.
If
we are unable to adequately protect our intellectual property, our competitive
advantage may disappear.
Our
success will be determined in part by our ability to obtain United States and
foreign patent protection for our technology and to preserve our trade secrets.
Because of the substantial length of time and expense associated with developing
new document security technology, we place considerable importance on patent and
trade secret protection. We intend to continue to rely primarily on a
combination of patent protection, trade secrets, technical measures, copyright
protection and nondisclosure agreements with our employees and customers to
establish and protect the ideas, concepts and documentation of software and
trade secrets developed by us. Our ability to compete and the ability
of our business to grow could suffer if these intellectual property rights are
not adequately protected. There can be no assurance that our patent
applications will result in patents being issued or that current or additional
patents will afford protection against competitors. We rely on a
combination of patents, copyrights, trademarks and trade secret protection and
contractual rights to establish and protect our intellectual
property. Failure of our patents, copyrights, trademarks and trade
secret protection, non-disclosure agreements and other measures to provide
protection of our technology and our intellectual property rights could enable
our competitors to more effectively compete with us and have an adverse effect
on our business, financial condition and results of operations. In
addition, our trade secrets and proprietary know-how may otherwise become known
or be independently discovered by others. No guarantee can be given that others
will not independently develop substantially equivalent proprietary information
or techniques, or otherwise gain access to our proprietary
technology.
In
addition, we may be required to litigate in the future to enforce our
intellectual property rights, to protect our trade secrets, to determine the
validity and scope of the proprietary rights of others, or to defend against
claims of infringement or invalidity. Any such litigation could result in
substantial costs and diversion of resources and could have a material adverse
effect on our business, financial condition or results of operations, and there
can be no assurances of the success of any such litigation.
We
may face intellectual property infringement or other claims against us, our
customers or our intellectual property that could be costly to defend and result
in our loss of significant rights.
Although
we have received patents with respect to certain technologies of ours, there can
be no assurance that these patents will afford us any meaningful
protection. Although we believe that our use of the technology and
products we developed and other trade secrets used in our operations do not
infringe upon the rights of others, our use of the technology and trade secrets
we developed may infringe upon the patents or intellectual property rights of
others. In the event of infringement, we could, under certain circumstances, be
required to obtain a license or modify aspects of the technology and trade
secrets we developed or refrain from using same. We may not have the
necessary financial resources to defend an infringement claim made against us or
be able to successfully terminate any infringement in a timely manner, upon
acceptable terms and conditions or at all. Failure to do any of the foregoing
could have a material adverse effect on us and our financial
condition. Moreover, if the patents, technology or trade secrets we
developed or use in our business are deemed to infringe upon the rights of
others, we could, under certain circumstances, become liable for damages, which
could have a material adverse effect on us and our financial
condition. As we continue to market our products, we could encounter
patent barriers that are not known today. A patent search will not disclose
applications that are currently pending in the United States Patent Office, and
there may be one or more such pending applications that would take precedence
over any or all of our applications.
Furthermore,
third parties may assert that our intellectual property rights are invalid,
which could result in significant expenditures by us to refute such
assertions. If we become involved in litigation, we could lose our
proprietary rights, be subject to damages and incur substantial unexpected
operating expenses. Intellectual property litigation is expensive and
time-consuming, even if the claims are subsequently proven unfounded, and could
divert management’s attention from our business. If there is a successful claim
of infringement, we may not be able to develop non-infringing technology or
enter into royalty or license agreements on acceptable terms, if at
all. If we are unsuccessful in defending claims that our intellectual
property rights are invalid, we may not be able to enter into royalty or license
agreements on acceptable terms, if at all. This could prohibit us
from providing our products and services to customers, which could have a
material adverse effect on us and our financial condition.
13
The
value of our intangible assets may not be equal to their carrying
values.
As of December 31, 2009, we had $2.9 million of intangible assets. We
are required to evaluate the carrying value of such intangibles. including
goodwill. Whenever events or changes in circumstances indicate that
the carrying value of an intangible asset, including goodwill, may not be
recoverable, we determine whether there has been impairment by comparing the
anticipated undiscounted cash flows (discounted cash flows for goodwill) from
the operation and eventual disposition of the product line with its carrying
value. If any of our intangible assets are deemed to be impaired then it will
result in a significant reduction of the operating results in such
period.
If
our products and services do not achieve market acceptance, we may not achieve
our revenue and net income goals in the time prescribed or at all.
We are at
the early stage of introducing our document security technology and products to
the market. If we are unable to operate our business as contemplated by our
business model or if the assumptions underlying our business model prove to be
unfounded, we could fail to achieve our revenue and net income goals within the
time we have projected, or at all, which could have a material adverse effect on
our business. As a result, the value of your investment could be significantly
reduced or completely lost.
We cannot
assure you that a sufficient number of such companies will demand our products
or services or other document security products. In addition, we cannot predict
the rate of market’s acceptance of our document security solutions. Failure to
maintain a significant customer base may have a material adverse effect on our
business.
Certain
of our recently developed products are not yet commercially accepted and there
can be no assurance that those products will be accepted, which would adversely
affect our financial results.
Over the
past several years, we have spent significant funds and time to create new
products by applying our technologies onto media other than paper, including
plastic and cardboard packaging, and delivered our technologies
digitally. We have had limited success in selling our products that
are on cardboard packaging and those that are delivered
digitally. Our business plan for 2010 and beyond includes plans to
incur significant marketing and sales costs for these newer products,
particularly the digitally delivered products. If we are not able to
sell these new products, our financial results will be adversely
affected.
The
results of our research and development efforts are uncertain and there can be
no assurance of the commercial success of our products.
We
believe that we will need to continue to incur research and development
expenditures to remain competitive. The products we currently are developing or
may develop in the future may not be technologically successful. In addition,
the length of our product development cycle may be greater than we originally
expect and we may experience delays in future product development. If our
resulting products are not technologically successful, they may not achieve
market acceptance or compete effectively with our competitors’
products.
Changes
in document security technology and standards could render our applications and
services obsolete.
The
market for document security products, applications, and services is fast moving
and evolving. Identification and authentication technology is constantly
changing as we and our competitors introduce new products, applications, and
services, and retire old ones as customer requirements quickly develop and
change. In addition, the standards for document security are continuing to
evolve. If any segments of our market adopt technologies or standards that are
inconsistent with our applications and technology, sales to those market
segments could decline, which could have a material adverse effect on us and our
financial condition.
14
The
market in which we operate is highly competitive, and we may not be able to
compete effectively, especially against established industry competitors with
greater market presence and financial resources.
Our
market is highly competitive and characterized by rapid technological change and
product innovations. Our competitors may have advantages over us because of
their longer operating histories, more established products, greater name
recognition, larger customer bases, and greater financial, technical and
marketing resources. As a result, they may be able to adapt more quickly to new
or emerging technologies and changes in customer requirements, and devote
greater resources to the promotion and sale of their products. Competition may
also force us to decrease the price of our products and services. We cannot
assure you that we will be successful in developing and introducing new
technology on a timely basis, new products with enhanced features, or that these
products, if introduced, will enable us to establish selling prices and gross
margins at profitable levels.
Our
growth strategy depends, in part, on our acquiring complementary businesses and
assets and expanding our existing operations to include manufacturing
capabilities, which we may be unable to do.
Our
growth strategy is based, in part, on our ability to acquire businesses and
assets that are complementary to our existing operations and expanding our
operations to include manufacturing capabilities. We may also seek to acquire
other businesses. The success of this acquisition strategy will depend, in part,
on our ability to accomplish the following:
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·
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identify
suitable businesses or assets to
buy;
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·
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complete
the purchase of those businesses on terms acceptable to
us;
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·
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complete
the acquisition in the time frame we expect;
and
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·
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improve
the results of operations of the businesses that we buy and successfully
integrate their operations into our
own.
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Although
we were able to acquire our Plastic Printing Professionals, Inc. subsidiary in
February 2006 and our DPI Secuprint subsidiary in December 2008, and Premier
Packaging in February 2010, there can be no assurance that we will be successful
in pursuing any or all of these steps on future transactions. Our failure to
implement our acquisition strategy could have an adverse effect on other aspects
of our business strategy and our business in general. We may not be able to find
appropriate acquisition candidates, acquire those candidates that we find or
integrate acquired businesses effectively or profitably.
Our
acquisition program and strategy may lead us to contemplate acquisitions of
companies in bankruptcy, which entail additional risks and uncertainties. Such
risks and uncertainties include, without limitation, that, before assets may be
acquired, customers may leave in search of more stable providers and vendors may
terminate key relationships. Also, assets are generally acquired on an “as is”
basis, with no recourse to the seller if the assets are not as valuable as may
be represented. Finally, while bankrupt companies may be acquired for
comparatively little money, the cost of continuing the operations may
significantly exceed expectations.
We have
in the past used, and may continue to use, our Common Stock as payment for all
or a portion of the purchase price for acquisitions. If we issue significant
amounts of our Common Stock for such acquisitions, this could result in
substantial dilution of the equity interests of our stockholders.
We
may not realize the anticipated benefits of our recent
acquisitions.
Our
expectations regarding the earnings, operating cash flow, capital expenditures
and liabilities resulting from our recent acquisition Premier Packaging Corp in
February 2010 are based on information currently available to us and may prove
to be incorrect. In addition, we may not realize any anticipated benefits of
either of this acquisition and may not be successful in integrating the acquired
assets into our existing business.
If
we fail to retain our key personnel and attract and retain additional qualified
personnel, we might not be able to pursue our growth strategy.
Our
future success depends upon the continued service of our executive officers and
other key sales and research personnel who possess longstanding industry
relationships and technical knowledge of our products and operations. The loss
of any of our key employees could negatively impact our ability to pursue our
growth strategy and conduct operations. Although we believe that our
relationship with these individuals is positive, there can be no assurance that
the services of these individuals will continue to be available to us in the
future. There can be no assurance that these persons will continue to agree to
be employed by us after such dates.
15
If
we do not successfully expand our sales force, we may be unable to increase our
revenues.
We must
expand the size of our marketing activities and sales force to increase
revenues. We continue to evaluate various methods of expanding our marketing
activities, including the use of outside marketing consultants and
representatives and expanding our in-house marketing
capabilities. If we are unable to hire or retain qualified
sales personnel, if newly hired personnel fail to develop the necessary skills
to be productive, or if they reach productivity more slowly than anticipated,
our ability to increase our revenues and grow could be compromised. The
challenge of attracting, training and retaining qualified candidates may make it
difficult to meet our sales growth targets. Further, we may not generate
sufficient sales to offset the increased expense resulting from expanding our
sales force or we may be unable to manage a larger sales force.
Future
growth in our business could make it difficult to manage our
resources.
Our
anticipated business expansion could place a significant strain on our
management, administrative and financial resources. Significant growth in our
business may require us to implement additional operating, product development
and financial controls, improve coordination among marketing, product
development and finance functions, increase capital expenditures and hire
additional personnel. There can be no assurance that we will be able to
successfully manage any substantial expansion of our business, including
attracting and retaining qualified personnel. Any failure to properly manage our
future growth could negatively impact our business and operating
results.
We
cannot predict our future capital needs and we may not be able to secure
additional financing.
We may need to raise additional funds
in the future to fund our working capital needs, to fund more aggressive
expansion of our business, to complete development, testing and marketing of our
products, or to make strategic acquisitions or investments. We may require
additional equity or debt financings, collaborative arrangements with corporate
partners or funds from other sources for these purposes. No assurance can be
given that necessary funds will be available for us to finance our development
on acceptable terms, if at all. Furthermore, such additional
financings may involve substantial dilution of our stockholders or may require
that we relinquish rights to certain of our technologies or products. In
addition, we may experience operational difficulties and delays due to working
capital restrictions. If adequate funds are not available from operations or
additional sources of financing, we may have to delay or scale back our growth
plans.
Risks
Related to Our Stock
Provisions
of our certificate of incorporation and agreements could delay or prevent a
change in control of our company.
Certain
provisions of our certificate of incorporation may discourage, delay, or prevent
a merger or acquisition that a stockholder may consider favorable. These
provisions include:
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·
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the
authority of the Board of Directors to issue preferred stock;
and
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·
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a
prohibition on cumulative voting in the election of
directors.
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We
have a large number of authorized but unissued shares of common stock, which our
management may issue without further stockholder approval, thereby causing
dilution of your holdings of our common stock.
As of December 31, 2009, there were
approximately 184 million
authorized but unissued
shares of our common stock. Our management continues to have broad discretion to
issue shares of our common stock in a range of transactions, including
capital-raising transactions, mergers, acquisitions, for anti-takeover purposes,
and in other transactions, without obtaining stockholder approval, unless
stockholder approval is required for a particular transaction under the rules of
the NYSE Amex, New York law, or other applicable laws. If our
Board of Directors determines to issue additional shares of our common stock
from the large pool of authorized but unissued shares for any purpose in the
future without obtaining stockholder approval, your ownership position would be
diluted without your further ability to vote on such
transaction.
16
The
exercise of our outstanding options and warrants and vesting of restricted stock
awards may depress our stock price.
As of
December 31, 2009, we had (i) outstanding stock options and warrants to purchase
an aggregate of 2,089,020 shares of our Common Stock at exercise prices ranging
from $1.60 to $12.65 per share; (ii). 85,000 restricted shares of our
common stock that are subject to various vesting terms, and (iii) convertible
notes that convert to up to 478,866 shares of our common
stock. To the extent that these securities are converted into
common stock, dilution to our stockholders will
occur, Moreover, the terms upon which we will be able to obtain
additional equity capital may be adversely affected, since the holders of these
securities can be expected to exercise or convert them at a time when we would,
in all likelihood, be able to obtain any needed capital on terms more favorable
to us than the exercise and conversion terms provided by those
securities.
Sales of
these shares in the public market, or the perception that future sales of these
shares could occur, could have the effect of lowering the market price of our
common stock below current levels and make it more difficult for us and our
stockholders to sell our equity securities in the future.
Sale or
the availability for sale of shares of common stock by stockholders could cause
the market price of our common stock to decline and could impair our ability to
raise capital through an offering of additional equity securities.
We
do not intend to pay cash dividends.
We do not
intend to declare or pay cash dividends on our common stock in the foreseeable
future. We anticipate that we will retain any earnings and other cash resources
for investment in our business. The payment of dividends on our common stock is
subject to the discretion of our Board of Directors and will depend on our
operations, financial position, financial requirements, general business
conditions, restrictions imposed by financing arrangements, if any, legal
restrictions on the payment of dividends and other factors that our Board of
Directors deems relevant.
We
may not meet the continued listing standards of the NYSE AMEX
We
received notice from the NYSE Amex (formerly NYSE Alternext US) on December 2,
2008 that based on a review of our Form 10-Q for the period ended September 30,
2008, that we did not meet certain of the Exchange’s continued listing standards
related to stockholders’ equity as set forth in Part 10 of the NYSE
Amex Company Guide. We were afforded the opportunity to submit a
plan of compliance to the Exchange and on January 9, 2009 presented our plan to
the Exchange. On January 29, 2009, the Exchange notified us that it accepted our
plan of compliance and granted to us an extension until June 2, 2010 to regain
compliance with the continued listing standards and that our listing is being
continued pursuant to this extension. We are subject to periodic
review by Exchange Staff during the extension period. Failure to make progress
consistent with the plan or to regain compliance with the continued listing
standards by the end of the extension period could result in the Company being
delisted from the Exchange. There is no guarantee that we will
be able to regain compliance to the listing standards and therefore, our common
shares may no longer be able to be traded, which could cause the market price of
our common stock to decline and could impair our ability to raise capital
through an offering of additional equity securities.
Our
administrative offices are approximately 4,700 square feet and are located in
the First Federal Plaza Building, 28 East Main Street, Rochester, New York 14614
which we occupy under a lease that will expire in 2011. Our
plastic printing division leases approximately 25,000 square feet in Brisbane,
CA in a lease that will expire in July 2014. DPI Secuprint, our
commercial printing group leases an approximately 20,000 square foot facility in
Rochester, NY under a lease expiring in 2013. On February 12,
2010, in conjunction with the acquisition of Premier Packaging, the Company
entered into a lease for approximately 40,000 square feet of production and
warehouse space located in Victor, NY, a suburb of Rochester. The
lease is with Bzdick Properties, LLC, an entity owned by the former owner of
Premier Packaging and the Company’s new President and COO, and will expire on
February 12, 2020. We believe that our facilities are adequate for
our current operations. The Company also believes that it can negotiate renewals
or similar lease arrangements on acceptable terms when our current leases
expire.
17
On August
1, 2005, the Company commenced a suit against the European Central Bank (“ECB”)
alleging patent infringement by the ECB and claimed unspecified damages. We
brought the suit in the European Court of First Instance in
Luxembourg. We alleged that all Euro banknotes in circulation
infringe the Company European Patent 0 455 750B1 (the “Patent”), which covers a
method of incorporating an anti-counterfeiting feature into banknotes or similar
security documents to protect against forgeries by digital scanning and copying
devices. The Court of First Instance ruled on September 5, 2007 that
it does not have jurisdiction to rule on the patent infringement claim, and also
ruled that we will be required to pay attorneys and court fees of the
ECB. The ECB formally requested the Company to pay attorneys and
court fees in the amount of Euro 93,752 which, unless the amount is settled will
be subject to an assessment procedure that will not likely be concluded until
late 2010, which the Company will accrue as soon as the assessed amount, if any,
is reasonably estimatable.
On
March 24, 2006, the Company received notice that the ECB had filed a separate
claim in the United Kingdom and Luxembourg courts seeking the invalidation
of the Patent. Proceedings were commenced before the national courts
seeking revocation and declarations of invalidity of the Patent in each of the
Netherlands, Belgium, Italy, France, Spain, Germany and Austria. On
March 26, 2007, the High Court of Justice, Chancery Division, Patents Court in
London, England (the “English Court”) ruled that the Patent was deemed invalid
in the United Kingdom, and on March 19, 2008 this decision was upheld on
appeal. The English Court rejected the ECB’s allegations of
invalidity based on lack of novelty, lack of inventive step and insufficiency,
but held that the patent was invalid for added subject matter. The English
Court’s decision does not affect the validity of the Patent in other European
countries. As a result of these decisions, the Company was notified
of the final assessment of the reimbursable ECB costs for both court cases was
₤356,490, of which the Company has paid ₤332,000 through December 31,
2009 and owes approximately ₤25,000 (approximately $40,000 as of December 31,
2009), which amount was included in accrued expenses as of December 31,
2009.
On March
27, 2007 the Bundespatentgericht of the Federal Republic of Germany ruled that
the German part of the Patent was valid, having considered the English Court’s
decision. As a result of this ruling, the Company expects to be
awarded reimbursements for its costs associated with the German validity case,
which is Euro 44,692 ($65,000 at December 31, 2009), which the Company will
record when the amount, if any, is received. The ECB has filed an
appeal against that decision, which is not expected to be decided before July
2010. On January 9, 2008 the French Court held that the Patent was
invalid in France for the same reasons given by the English
Court. The Company is required to pay de minimus attorneys’ fees of
the ECB as a result of the French decision. The Company filed an
appeal against the French decision on May 7, 2008. The French appeal was heard
on December 7, 2009. On March 20, 2010, the Company
was informed that the decision was upheld in the French appeal. On
March 12, 2008 the Dutch Court, having considered the English, German and French
decisions, ruled that the Patent is valid in the Netherlands. The ECB
filed an appeal against the Dutch decision on March 27, 2008. The Dutch
appeal will be heard in the Hague on June 2010. On November 3, 2009, the Belgium
Court held that the Patent was invalid in Belgium for the same reasons given by
the English and French courts as were similarly informed by the Austrian court
on November 17, 2009. Costs reimbursements, if any, associated with
the Belgium and Austrian validity case are covered under the Trebuchet Agreement
as described below. A trial was also held in Madrid, Spain on June 3
and 5, 2008 and oral and written closing submissions were made on July 19, 2008.
On
March 24, 2010 the Spanish Court ruled that the Patent was valid
. In
Italy the validity case is to be heard again by a newly appointed judge during
2010 and a hearing in Luxembourg is expected in 2010.
On August
20, 2008, the Company entered into an agreement with Trebuchet Capital Partners,
LLC (“Trebuchet”) under which Trebuchet has agreed to pay substantially all
of the litigation costs associated with pending validity proceedings initiated
by the European Central Bank (“ECB”) in eight European countries relating to the
Company’s European Patent 0 455 750B1 that the Company has claimed
the ECB infringed in printing of the Euro currency (the “Patent”). Trebuchet
also agreed to pay substantially all of the litigation costs associated with
future validity challenges filed by the ECB or other parties, provided that
Trebuchet elects to assume the defense of any such challenges, in its sole
discretion, and patent infringement suits filed against the ECB and certain
other alleged infringers of the Patent, all of which suits may be brought at the
sole discretion of Trebuchet and may be in the name of the Company, Trebuchet or
both. The Company provided Trebuchet with the sole and exclusive right to manage
infringement litigation relating to the Patent in Europe, including the right to
initiate litigation in the name of the Company, Trebuchet or both and to choose
whom and where to sue, subject to certain limitations set forth in the agreement
under the terms of the Agreement, and in consideration for Trebuchet's funding
obligations, the Company assigned and transferred a 49% interest of the
Company's rights, title and interest in the Patent to Trebuchet which allows
Trebuchet to have a separate and distinct interest in and share of the Patent,
along with the right to sue and recover in litigation, settlement or otherwise
to collect royalties or other payments under or on account of the Patent. In
addition, the Company and Trebuchet have agreed to equally share all proceeds
generated from litigation relating to the Patent, including judgments and
licenses or other arrangements entered into in settlement of any such
litigation. Trebuchet is also entitled to recoup any litigation expenses
specifically awarded to the Company in such actions.
The
Patent has thus been confirmed to be valid and enforceable in three
jurisdictions (Germany, the Netherlands and Spain) that use the Euro as its
national currency allowing the Company or Trebuchet Capital Partners, on the
Company’s behalf, to proceed with infringement cases in these countries if we
choose to do so. On February 18, 2010, Trebuchet, on behalf of
Document Security Systems, filed an infringement suit in the Netherlands.
The suit is being lodged against the ECB and two security printing entities with
manufacturing operations in the Netherlands, Joh. Enschede Banknotes B.V.; and
Koninklijke Joh. Enschede B.V. The ECB's and the security
printers have been notified and the court hearing date is tentatively scheduled
for January 21, 2011.
18
On
January 31, 2003, the Company commenced an action, unrelated to the above ECB
litigation, entitled New Sky Communications, Inc., As Successor-In-Interest To
Thomas M. Wicker, Thomas M.Wicker Enterprises, Inc. and Document Security
Consultants V. Adler Technologies, Inc. N/K/A Adlertech International, Inc. and
Andrew McTaggert (United States District Court, Western District Of New York
Case No.03-Cv-6044t(F)) regarding certain intellectual property in which the
Company has an interest. On December 7, 2009, the Company reached an
agreement to terminate all litigation in association with this
suit. In conjunction with that agreement, the Company issued to the
opposing parties an aggregate of 40,000 shares of common stock valued at
approximately $85,000 and 50,000 of common stock warrants for the purchase of
common shares at $3.00 per share valued at approximately $30,000 utilizing the
Black Scholes pricing model. The Company recorded an expense related
to the estimated grant date fair value of the shares and warrants issued of
approximately $115,000. In addition, both parties agreed not to compete with
certain of the other party’s customers for 7 years. The Company does
not believe that the competition agreement will have a material impact on its
business.
In
addition to the foregoing, we are subject to other legal proceedings that have
arisen in the ordinary course of business and have not been finally adjudicated.
Although there can be no assurance in this regard, in the opinion of management,
none of the legal proceedings to which we are a party, whether discussed herein
or otherwise, will have a material adverse effect on our results of operations,
cash flows or our financial condition.
There
were no matters submitted to a vote of security holders in the fourth quarter of
2009.
19
Our
Common Stock is listed on the NYSE Amex, where it trades under the symbol
“DMC.”
The
following table sets forth the high and low closing prices for the shares of our
Common Stock, for the periods indicated.
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QUARTER
ENDING
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HIGH
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LOW
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||||||
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March
31, 2009
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$ | 1.92 | $ | 1.59 | ||||
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June
30, 2009
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2.24 | 1.63 | ||||||
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September
30, 2009
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2.45 | 1.86 | ||||||
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December
31, 2009
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3.14 | 1.95 | ||||||
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QUARTER
ENDING
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HIGH
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LOW
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||||||
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March
31, 2008
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$ | 6.85 | $ | 4.20 | ||||
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June
30, 2008
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6.87 | 4.68 | ||||||
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September
30, 2008
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5.25 | 4.83 | ||||||
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December
31, 2008
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4.40 | 1.40 | ||||||
From
January 1, 2010 through March 19, 2010, our Common Stock had a high
closing price of $4.41 and a low closing price of $2.44 and a closing price on
March 19, 2010 of $4.15.
Issued
and Outstanding
Our
certificate of incorporation authorizes 200,000,000 shares of Common Stock, par
value $0.02. As of March 19, 2010, we had 17,760,324 shares of Common
Stock, issued and outstanding.
Recent
Issuances of Unregistered Securities
On
February 12, 2010, the Company acquired all of the outstanding common stock of
Premier Packaging Corporation from Robert B. and Joan T. Bzdick for
$2,000,000 in cash and 735,437 shares of the Company's common stock. The
shares of common stock have not been registered under the Securities Act of
1933, as amended (the “Securities Act”), and were issued and sold in reliance
upon the exemption from registration contained in Section 4(2) of the Securities
Act and Rule 506 of Regulation D promulgated
thereunder.
On
February 17, 2010, the Company completed the sale of 20 investment units in a
private placement pursuant to subscription agreements with six accredited
investors. Each investment unit was comprised of 5,000 shares of the
Company’s common stock and five year warrants to purchase 1,000 shares of common
stock at an exercise price of $3.50 per share. In the transaction, the Company
sold 20 investment units for $15,000 per unit for gross cash proceeds of
$300,000, consisting of 100,000 shares of common stock and warrants to purchase
an aggregate of 20,000 shares of common stock. In connection with
these sales EKN Financial Services Inc., a registered broker-dealer, acted as
non-exclusive placement agent. EKN Financial Services, Inc. received
a cash fee in the aggregate of $30,000 as commission for these sales. On
February 17, 2010, the Company also sold 20 investment units for gross cash
proceeds of $270,000, consisting of 100,000 shares of common stock and warrants
to purchase an aggregate of 20,000 shares of common stock.
No placement agent fees
were paid on these sales. The shares of common stock have not been
registered under the Securities Act of 1933, as amended (the “Securities Act”),
and were issued and sold in reliance upon the exemption from registration
contained in Section 4(2) of the Securities Act and Rule 506 of Regulation D
promulgated thereunder.
On
January 21, 2010, the Company issued 29,400 shares to its former investor
relations firm for payment of services. On February 23, 2010, the
Company issued 304,000 common stock pursuant to the exercise of warrants in
which the Company received proceeds of $608,000. The shares of
common stock have not been registered under the Securities Act of 1933, as
amended (the “Securities Act”), and were issued and sold in reliance upon the
exemption from registration contained in Section 4(2) of the Securities Act and
Rule 506 of Regulation D promulgated thereunder.
20
Stockholders
As of March 19, 2010, we had
approximately 902 record holders of our Common Stock. This number does not
include the number of persons whose shares are in nominee or in “street name”
accounts through brokers.
Dividends
We did
not pay dividends during 2009 or 2008. We presently intend to retain
our cash for use in the operation and expansion of our business and, therefore,
do not anticipate paying any cash dividends in the foreseeable
future.
Stock
Transfer Agent and Warrant Agent
Our stock
transfer agent is American Stock Transfer & Trust Co., 6201 15th Avenue,
Brooklyn, NY 11219. We act as our own warrant agent for our outstanding
warrants.
Share
Repurchased by the Registrant
We did
not purchase or repurchase any of our securities in the fiscal year ended
December 31, 2009, including the fourth quarter.
The
information required by Item 201(d) of Regulation S-K will be contained in
our Proxy Statement for our Annual Stockholders Meeting, which we will file with
the Securities and Exchange Commission within 120 days after December 31,
2009, and which is incorporated by reference herein.
Forward-Looking
Statements
This
Annual Report contains forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933 and Section 21E of the
Securities Exchange Act of 1934, including statements that contain the words
“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 any forward-looking statement. 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 discussed under Part I, Item 1A “Risk Factors” in this
Annual Report. The forward-looking statements are made as of the date of this
Annual Report, and we assume 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. Investors should consult all of the
information set forth in this report and the other information set forth from
time to time in our reports filed with the Securities and Exchange Commission
pursuant to the Securities Exchange Act of 1934, including our reports on
Forms 10-Q and 8-K.
The
following discussion should be read in conjunction with the Consolidated
Financial Statements and Notes thereto included in Item 8 of this Annual
Report.
Overview
Document
Security Systems, Inc., markets and sells products designed to protect valuable
information from unauthorized scanning, copying, and digital
imaging. We have developed security technologies that are applied
during the normal printing process and by all printing methods including
traditional offset, gravure, flexo, digital or via the internet on paper,
plastic, or packaging. As of March 22, 2010, we hold 14 patents that
protect our technology and have approximately 57 patent applications in
process. Our technologies and products are used by federal, state and
local governments, law enforcement agencies and are also applied to a broad
variety of industries as well, including financial institutions, high technology
and consumer goods, entertainment and gaming, healthcare/pharmaceutical, defense
and genuine parts industries.
Our customers use our
technologies where there is a need for enhanced security for protecting and
verification of critical financial instruments and vital records, or where there
are concerns of counterfeiting, fraud, identity theft, brand protection and
liability.
21
We have
developed or acquired over 30 technologies that provide to our customers a wide
spectrum of solutions. We sell our products under the
AuthentiGuard
®
name
generally in the following ways: (a) as generic products, including safety paper
and plastic cards geared for the end user market for printed security products;
(b) as custom printed products; (c) as technology licenses; or (d) as customized
digital implementations.
In 2006,
we acquired San Francisco-based Plastic Printing Professionals, Inc. (“P3”), a
privately held security printer specializing in plastic cards containing state
of the art multiple or singular security technologies. P3’s primary
focus is manufacturing long-life composite, laminated and surface printed cards
which can include magnetic stripes, bar codes, holograms, signature panels,
invisible ink, micro fine printing, guilloche patterns, Biometric, RFID and a
patent-pending watermark technology. P3’s products are marketed through an
extensive broker network that covers much of North America, Europe and South
America. P3’s product and client list includes the Grammy Awards, the
Country Music Association awards, sporting event media cards, ID cards for major
airports and Latin American and African driver’s licenses. Our
acquisition of P3 marked the initial execution of our strategy to expand our
manufacturing capabilities through acquisitions in order to expand our custom
security printing business. During 2007, we moved P3’s operation to a
25,000 square foot facility and upgraded some of its equipment, most notably
with a significant investment in a new state of the art
laminator. These actions were taken in order to significantly
increase the capacity and efficiency of the operation to meet expected future
demand requirements. During 2008, we placed approximately
$600,000 of leased equipment into service at our plastic printing division to
significantly increase the production capability and expand its services in the
variable data card and RFID markets. These leases were accounted for
as operating leases.
On August
20, 2008, we entered into an agreement with Trebuchet Capital Partners, LLC in
which Trebuchet agreed to pay substantially all of the litigation costs
associated with pending litigation proceedings initiated by the European Central
Bank in eight European countries relating to the Company’s European Patent 0 455
750B1 that the Company has claimed the ECB infringed in printing of the Euros
currency in exchange for a 50% share of any proceeds generated from the
litigation. Under the terms of the agreement, and in consideration
for Trebuchet’s funding obligations, the Company assigned and transferred a 49%
interest of the Company’s rights, title and interest in the Patent to Trebuchet
which allows Trebuchet to have as a separate and exclusive interest including a
separate and distinct right to exploit the Patent.
In
December 2008, we acquired substantially all of the assets of DPI of Rochester,
LLC, a million privately held commercial printer with approximately $7.6 million
in sales in 2007 located in Rochester, NY. We formed a new
subsidiary called DPI Secuprint to house this new company. As a
result of this acquisition, we have significantly improved our ability to meet
our current and expected future demand of our security paper products as well as
improving our competitiveness in the market for custom security printing,
especially in the areas of vital records, coupons, transcripts, and prescription
paper. In addition, as a result of the acquisition, we believe
we can offer our customers a wider range of commercial printing
offerings.
In the
past few years, we have divested two operations so that we could focus our
efforts on security and commercial printing. During 2007, we sold the
assets of our retail printing and copying division, called Patrick
Printing. In October 2009, we sold the assets and liabilities
associated with our Legalstore.Com business in exchange for common stock of
Internet Media Services, Inc., representing approximately 37% of the outstanding
shares of the newly formed company.
On
February 12, 2010, the Company acquired all of the outstanding common stock of
Premier Packaging Corporation from Robert B. and Joan T. Bzdick for
$2,000,000 in cash and 735,437 shares of the Company's common stock. In
conjunction with the transaction, the Company entered into a Credit Facility
Agreement with RBS Citizens, N.A. (“Citizens Bank”) pursuant to which Citizens
Bank provided Premier Packaging Corporation with a term loan of $1,500,000,
and a revolving line of $1,000,000. The Credit Facility Agreement
contains customary representations and warranties, affirmative and negative
covenants, and events of default and is secured by all of the assets of Premier
Packaging Corporation. The credit facilities are also secured by
cross guarantees by Document Security Systems, Inc., and its other wholly owned
subsidiaries, Plastic Printing Professionals, Inc. and Secuprint, Inc.
The $1,500,000 term loan
matures March 1, 2013 and is payable in 35 monthly payments of $25,000 plus
interest commencing March 1, 2010 and a payment of $625,000 on the 36
month. Interest accrues at 1 Month LIBOR plus
3.75%. The proceeds of the term loan were used as partial
payment of the purchase of all of the outstanding common stock of Premier
Packaging Corporation. The $1,000,000 revolving line of
credit matures on February 12, 2011 and is payable in monthly installments of
interest only beginning on March 1, 2010. Interest accrues at 1 Month LIBOR plus
3.75%. The Company subsequently entered into a credit swap agreement
to lock into a 5.66% effective interest over the life of the term
loan.
22
RESULTS
OF OPERATIONS FOR THE FISCAL YEARS ENDED DECEMBER 31, 2009 AND 2008
The
following discussion and analysis provides information that our management
believes is relevant to an assessment and understanding of our results of
operations and financial condition. In December 2008, we acquired substantially
all of the assets of DPI of Rochester, LLC, a $7.6 million privately held
commercial printer located in Rochester, NY with approximately $7.6 million in
sales in 2007. We formed a new subsidiary called DPI Secuprint
to house this new company. DPI Secuprint’s results for the period
from December 19, 2008 to December 31, 2008 are included in 2008
amounts. In October 2009, the Company sold its Legalstore.com
division. In accordance with ASC 205-20-45, the Company reported the
results of Legalstore.com as continued operations because the operations and
cash flows of the component have not been eliminated and given the Company’s
continued involvement after the sale. The discussion should be read
in conjunction with the financial statements and footnotes that appear elsewhere
in this report.
Revenue
|
Year Ended
December 31,
2009
|
Year Ended
December 31,
2008
|
% change
|
||||||||||
|
Revenue
|
||||||||||||
|
Security
and commercial printing
|
$ | 8,773,000 | $ | 4,386,000 | 100 | % | ||||||
|
Technology
license royalties and digital solutions
|
783,000 | 1,647,000 | -52 | % | ||||||||
|
Legal
products
|
355,000 | 610,000 | -42 | % | ||||||||
|
Total
Revenue
|
9,911,000 | 6,643,000 | 49 | % | ||||||||
Revenue - 2009 vs
2008
:
Revenue in
2009 increased 49% from 2008. Security and commercial print
sales increased 100% which reflects the impact of the Company’s acquisition of
DPI Secuprint, a commercial printer, in December, 2008. This increase
was offset by a decrease in royalty revenue of 52% which primarily reflects the
impact of a non-recurring royalty of $542,000 recorded in the second quarter of
2008. Furthermore, the Company experienced a 42% decline of revenue
at its Legalstore.com division due to the sale of the division in October of
2009, as well as a decline in revenue prior to the sale caused by the
global recession. In accordance with ASC 205-20-45, the Company
reported the results of Legalstore.com as continued operations because the
operations and cash flows of the component have not been eliminated and given
the Company’s continued involvement after the sale.
During
2009, all of the Company’s divisions were adversely affected by significant
delays or reductions in orders by core customers that reflected the rapid
decline in the U.S. and global economies during the latter half of 2008 and the
first half of 2009. The Company began to see demand in
each of divisions to return to more traditional levels in the third quarter of
2009 and expects this trend to continue as the U.S. and global economies
stabilize.
23
Gross
profit
|
Year Ended
December 31,
2009
|
Year Ended
December 31,
2008
|
% change
|
||||||||||
|
Costs
of revenue
|
||||||||||||
|
Security
and commercial printing
|
$ | 6,063,000 | $ | 2,663,000 | 128 | % | ||||||
|
Technology
license royalties and digital solutions
|
14,000 | 14,000 | 0 | % | ||||||||
|
Legal
products
|
179,000 | 352,000 | -49 | % | ||||||||
|
Total
cost of revenue
|
6,256,000 | 3,029,000 | 107 | % | ||||||||
|
Gross
profit
|
||||||||||||
|
Security
and commercial printing
|
2,710,000 | 1,723,000 | 57 | % | ||||||||
|
Technology
license royalties and digital solutions
|
769,000 | 1,633,000 | -53 | % | ||||||||
|
Legal
products
|
176,000 | 258,000 | -32 | % | ||||||||
|
Total
gross profit
|
3,655,000 | 3,614,000 | 1 | % | ||||||||
|
Year Ended
December 31,
2009
|
Year Ended
December 31,
2008
|
% change
|
||||||||||
|
Gross
profit percentage:
|
37 | % | 54 | % | -32 | % | ||||||
Gross Profit
-
2009 vs 2008
Gross
profit in 2009 was flat as compared to 2008. While sales increased in
2009, the mix of sales was significantly different from 2008 due to the increase
of commercial printing by the Company as a result of the Company’s acquisition
of DPI Secuprint in December 2008. Commercial printing
typically carries lower margins than the Company’s security printing
projects. In addition, the Company increased the fixed cost component
of its cost of sales as a result of investments in equipment at the Company’s
plastic printing facility which while significantly increasing that division’s
production capacity and capabilities, caused margins in that division to decline
as sales gains did not fully offset the increase in costs. Finally,
gross margins were favorably impacted by a one-time non-recurring deferred
revenue item in 2008 that carried a 100% gross margin. Without this
one-time item, 2009 gross margins would have increased 18% over
2008.
24
Operating
Expenses
|
Year Ended
December 31,
2009
|
Year Ended
December 31,
2008
|
% change
|
||||||||||
|
Operating
Expenses
|
||||||||||||
|
Sales,
general and administrative compensation
|
$ | 3,638,000 | $ | 2,966,000 | 23 | % | ||||||
|
Professional
Fees
|
539,000 | 896,000 | -40 | % | ||||||||
|
Sales
and marketing
|
154,000 | 340,000 | -55 | % | ||||||||
|
Research
and development
|
292,000 | 432,000 | -32 | % | ||||||||
|
Rent
and utilities
|
477,000 | 509,000 | -6 | % | ||||||||
|
Other
|
710,000 | 807,000 | -12 | % | ||||||||
| $ | 5,810,000 | $ | 5,950,000 | -2 | % | |||||||
|
Other
Operating Expenses
|
||||||||||||
|
Depreciation
and amortization
|
148,000 | 167,000 | -11 | % | ||||||||
|
Stock
based payments
|
68,000 | 1,747,000 | -96 | % | ||||||||
|
Impairment
of patent defense costs and other intangible assets
|
- | 797,000 | ||||||||||
|
Amortization
of intangibles
|
1,342,000 | 1,972,000 | -32 | % | ||||||||
| 1,558,000 | 4,683,000 | -67 | % | |||||||||
|
Total
Operating Expenses
|
7,368,000 | 10,633,000 | -31 | % | ||||||||
Selling,
General and Administrative – 2009 vs 2008
Sales, general and
administrative compensation
costs were 23% higher in 2009, compared to
2008, due to sales and administrative staff additions as the result of the
Company’s acquisition of its commercial printing business in December
2008. Otherwise, SG&A compensation costs at the Company’s
remaining divisions would have decreased 52% during 2009 compared to 2008, as
the result of significant staff reductions in sales, marketing and
administration that the Company initiated in the middle of 2008 and during the
first quarter of 2009.
Professional fees
decreased 40% in 2009 from 2008 primarily as a result of a significant
decrease in consulting fees which was offset by a significant increase in legal
fees incurred by the Company as a result of increase of usage of external legal
counsel after the Company’s legal counsel left the Company in March of 2009,
including an increase in legal costs associated with non-ECB related litigation
matters. The Company has evaluated its use of external legal counsel
and expects legal costs to decline in 2010.
Sales and marketing
expenses decreased significantly in 2009 as compared to 2008 as the Company
changed its primary sales and marketing strategy resulting in a reduction in its
non-direct marketing costs, its international sales cost, and an overall
reduction in sales related travel. The Company focused its efforts in
2009 on direct sales techniques that utilize telephone and web-conferencing
communication with current and prospective customers, along with increasing its
internet presence focused on the Company’s primary e-commerce website
www.protectedpaper.com.
Research and development
costs
consist primarily of compensation costs for research personnel and
direct costs for the use of third-party printers’ facilities to test our
technologies on equipment that we do not have access to
internally. Research and development costs decreased during
2009 compared to 2008 as the result of lower external research costs and
reduction in compensation cost as the Company reduced the department by two
persons.
Rent and utilities
increased in 2009 as a result of the Company’s acquisition of its commercial
printing business in December 2008, which operates a 20,000 square foot facility
in Rochester, NY. These increases were offset by a reduction in
utility costs at the Company’s plastic printing facility, along with rental cost
offsets from a sublease for approximately 7,500 feet at the Company’s plastic
printing facility.
25
Other operating
expenses are primarily equipment maintenance and repairs, office supplies, IT
support, bad debt expense and insurance costs. On a consolidated
basis, these costs decreased by 12% in 2009 as compared to 2008, despite the
addition of other expenses associated with the Company’s acquisition of DPI
Secuprint in December 2008, as the Company reduced insurance costs and office
and miscellaneous costs
Stock-based
compensation
includes expense charges for all stock-based awards to
employees, directors and consultants. Such awards include option
grants, warrant grants, and restricted stock
awards. Stock-based compensation 2009 as compared to 2008, as
current-period stock based compensation expense was offset by reversals of
previously recorded stock-based compensation expense for stock options and
restricted shares issued to the Company’s employees which terminated unvested
due to employee terminations that occurred during
2009. Furthermore, the Company’s compensation costs
for option awards granted in 2009 are lower than past awards as the Company has
typically granted out-the-money options due to the Company’s lower than average
stock price during the year.
Impairment of patent defense
costs and other intangible assets:
On March 19, 2008, the
Company received notification that its appeal of the invalidation of its
European Patent 455750B1 in the UK was not successful. As result of
the adverse court decision, the Company recognized an impairment loss of
$292,000 associated with costs directly related to the U.K appeal as of March
31, 2008. The impairment loss includes a judgment for reimbursement
of estimated counterpart legal fees. In January, 2009, the Company
received a formal request for fee reimbursement from the ECB for a total of
$420,000 inclusive of amounts already paid by the Company. The
Company hired an independent firm to assist the Company in reducing or
eliminating the ECB’s fees request, however, the Company recorded
$145,000 as additional accrued expenses as of December 31,
2008. On July 31, 2009, the UK Court made the final assessment
of costs for the UK patent validity case due from the Company to the ECB of
₤356,490 of which the Company has paid ₤332,000 through December 31, 2009 and
owes approximately ₤25,000 ($40,000 as of December 31, 2009) as of December
31, 2009, which amount was included in accrued expenses as of December 31,
2009. In addition, the Company recorded an impairment of
$361,000 for a license agreement the Company had acquired in 2006 for RSS
Barcodes for which the Company assessed that the probable future cash flows
derived from the license did not support the net carrying value of the license
as of December 31, 2008.
No such
expense was incurred in 2009.
Amortization of
intangibles
expense decreased 32% in 2009, as compared to 2008 as a
result of the reduction in the Company’s net capitalized patent acquisition and
defense costs asset since the Company transferred and assigned 49% of
its interest in the patent to a third-party in August 2008, which resulted in a
reduction in the asset of approximately $1.7 million. As a result,
the Company’s amortizable base reduced significantly.
Other Income and
expenses
|
Year Ended
December 31,
2009
|
Year Ended
December 31,
2008
|
% change
|
||||||||||
|
Other
income (expense):
|
||||||||||||
|
Gain/(Loss)
on foreign currency adjustments
|
15,000 | (59,000 | ) | -125 | % | |||||||
|
Interest
Income
|
18,000 | - | ||||||||||
|
Interest
expense
|
(259,000 | ) | (136,000 | ) | 90 | % | ||||||
|
Amortizaton
of note discount
|
(250,000 | ) | (8,000 | ) | 3025 | % | ||||||
|
Loss
on sale of patent assets
|
- | (1,170,000 | ) | |||||||||
|
Gain
on deconsolidation of Legalstore.com division
|
26,000 | - | ||||||||||
|
Litigation
settlements
|
(115,000 | ) | 126,000 | -191 | % | |||||||
|
Registration
rights penalties
|
(109,000 | ) | - | |||||||||
|
Other
income
|
416,000 | - | ||||||||||
|
Other
income (expense), net
|
(258,000 | ) | (1,247,000 | ) | -79 | % | ||||||
Interest expense:
During 2009, the Company had significant increases in interest expense
over 2008 as a result of the Company’s borrowings it made during 2008 against
its various credit facilities and for interest associated with a $900,000
Secured Promissory Note which the Company used to acquire its commercial
printing business in December of 2008 which carried an annual interest rate of
12%.
26
Amortization of note
discount:
During 2009, the Company also recognized the amortization of
note discount expense of approximately $247,000 for warrants that were issued in
conjunction with the secured promissory note which had a fair value of
approximately $256,000.
Loss on sale of
patents
: In 2008 the Company entered into an agreement with
Trebuchet Capital Partners, LLC Pursuant to the Agreement, Trebuchet has agreed
to pay substantially all of the litigation costs associated with pending
validity proceedings initiated by the European Central Bank in eight European
countries relating to the Company’s European Patent 0 455 750B1 that the Company
has claimed the ECB infringed in printing of the Euros
currency. Under the terms of the Agreement, and in consideration for
Trebuchet’s funding obligations, the Company assigned and transferred a 49%
interest of the Company’s rights, title and interest in the Patent to Trebuchet
which allows Trebuchet to have as a separate and exclusive interest including a
separate and distinct right to exploit the Patent. Pursuant to this transaction,
the Company recognized a loss on the sale of patent assets for its assignment
and transfer of 49% of its ownership rights in the patent, which had a net book
value of approximately $1,670,000, for $500,000, As a result,
the Company recognized a loss on sale of patent assets of
$1,170,000.
Gain on deconsolidation of
Legalstore.com division
:
In October 2009
,
the Company sold its
Legalstore.com division for a non-controlling interest (37% ownership interest)
in Internet Media Services. The Company recognized a gain on
the transaction of approximately $26,000 as the estimated fair value of
consideration received in exchange for the assets and liabilities sold exceeded
the Company’s book value of the assets and liabilities.
The
Company accounted for the deconsolidation of the business by recognizing a gain
in net income, measured as the difference between: the fair value of the
consideration received, which in the Company’s case is a 37% equity interest in
Internet Media Services, Inc. over the book value of the assets and liabilities
transferred. The Company determined that the consideration received
was not readily measurable because there was no activity in Internet Media
Services, Inc. prior to the transaction. Therefore, the Company
determined the value of the “business transferred” was more readily measurable
and determined the fair value utilizing a discounted cash flow
model.
Litigation settlements:
On December 7, 2009, the Company reached an agreement to issue 40,000
shares of common stock valued at approximately $86,000 and 50,000 of common
stock warrants valued at approximately $30,000 utilizing the Black Scholes
option pricing model, for the purchase of common shares at $3.00 per share in
connection with the settlement of certain litigation between the Company and the
recipients. The shares and common stock warrants were recorded at the
aggregate estimated fair value of $115,000. In 2008, the Company was
awarded a judgment of approximately $126,000 pursuant to a counterclaim by the
Company in the connection with certain litigation the Company won in June
2006.
Registration Rights
Penalties:
The Company recorded expense of approximately $110,000 for the
fair value of 40,000 warrants to purchase the shares of the Company’s common
stock at $2.00 issuable to Printer’s LLC as a result of the Company’s failure to
file a registration statement under the terms of the $450,000 Convertible Note
the Company entered into in December 2009.
Other Income:
The Company received
$416,000 for New York State Qualified Emerging Technology Company (“QETC”)
refundable tax credit for the tax years ended 2005, 2006, and 2007
which the Company received in December, 2009.
Net
loss and loss per share
|
Year Ended
December 31,
2009
|
Year Ended
December 31,
2008
|
% change
|
||||||||||
|
Net
loss
|
$ | (3,990,000 | ) | $ | (8,285,000 | ) | -52 | % | ||||
|
Net
loss per share, basic and diluted
|
$ | (0.27 | ) | $ | (0.59 | ) | -54 | % | ||||
|
Weighted
average common shares outstanding, basic and diluted
|
14,700,453 | 14,002,034 | 5 | % | ||||||||
27
Net
loss and loss per share - 2009 vs 2008
During
2009, the Company experienced a net loss of $4.0 million, a 52% decrease from
the net loss of 2008. The decrease in reflects the significant
decrease in other operating costs, along with the absence of a non-recurring
loss on sale of patent which the Company incurred in
2008. These decreases more than offset increases in interest
expense and amortization of note discount associated with the increase in debt
incurred by the Company in the latter half of 2008 and during the first nine
months of 2009.
Liquidity
and Capital Resources
The
Company’s cash flows and other key indicators of liquidity are summarized as
follows:
|
As
Of And For The Period Ended:
|
||||||||||||
|
December 31,
2009
|
December 31,
2008
|
% change vs.
2008
|
||||||||||
|
Cash
flows from:
|
||||||||||||
|
Operating
activities
|
$ | (1,595,000 | ) | $ | (2,391,000 | ) | 33 | % | ||||
|
Investing
activities
|
(108,000 | ) | (2,266,000 | ) | 95 | % | ||||||
|
Financing
activities
|
2,064,000 | 4,002,000 | 48 | % | ||||||||
|
Working
capital
|
(818,000 | ) | (1,481,000 | ) | -45 | % | ||||||
|
Current
ratio
|
0.70 | x | 0.58 | x | 21 | % | ||||||
|
Cash
and cash equivalents
|
$ | 449,000 | $ | 88,000 | 410 | % | ||||||
|
Funds
Available from Open Credit Facilities
|
$ | 417,000 | $ | 1,317,000 | -68 | % | ||||||
|
Debt
(excluding unamortized debt discount)
|
$ | 1,958,000 | $ | 3,183,000 | -38 | % | ||||||
As of
December 31, 2009, we had cash and cash equivalents of $449,000, representing an
410% increase over our December 31, 2008 cash position. As discussed below, the
increase in the Company’s cash position was primarily due to funds received from
the issuance of equity offset by use of cash from operations.
Operating Cash Flow
–
During 2009, the Company used approximately $1.6 million of cash for operations,
a 33% decrease in its use of cash for operations compared to 2008, which
generally reflected the Company’s increase in sales and the significant decrease
in operating costs that the Company achieved during the year. Specifically, the
Company realized the benefits of significant cost reductions that it initiated
in 2008 and early 2009. In addition, during the fourth quarter of 2009, the
Company received $412,000 from a New York State Qualified Emerging Technology
Company tax refund that significantly improved the Company’s 2009 operating cash
flow. The Company used a portion of its cash to improve its working capital
position to negative $818,000 from negative $1,481,000 at December 31,
2008.
Investing Cash Flow
-
During 2009, the Company
used approximately $108,000 for investing activities. Specifically, the Company
used $63,000 for capital equipment at its commercial printing plant and plastic
printing plants, respectively, along with approximately $176,000 for payments
for patent application fees. These expenditures were offset by the release of
$131,000 from restricted cash. The Company does not have any material
commitments for capital expenditures as of December 31, 2009, other than
operating leases for certain equipment for its newly acquired commercial
printing operation.
Financing Cash Flows
– During 2009, the Company significantly improved its financial position by
refinancing $1,350,000 of its shorter –term debt into longer term debt, raising
$1.4 million in equity through the private placement of its common shares, and
converting $2,000,000 in debt to equity. As of December 31, 2009, the Company
had debt of $1,958,000, all of which is due on various date in
2012.
28
Future Capital
Needs
–
The Company
expects to use its existing cash to support its operations and its efforts to
achieve consistent positive cash flow from operations. On February
12, 2010, the Company obtained $1,500,000 in secured debt and a $1,000,000
revolving line of credit in conjunction with its acquisition of Premier
Packaging Corp. This acquisition, while adding to the Company’s debt
levels, is expected to improve the Company’s operating cash flow in 2010 and
beyond by adding a business that has historically generated positive cash flows,
as well as by creating opportunities by integrating that business with existing
product lines. During 2009, the Company raised approximately
$1.4 million in net proceeds from the issuance of its Common Stock in private
placements to accredited investors. Furthermore, as of December
31, 2009, the Company has approximately $449,000 in cash, $417,000 available to
it under one credit facility and up to $1,000,000 available under a credit line
at its Premier Packaging subsidiary acquired in 2010.
In
February 2010, the Company raised approximately $1.1 million through the
exercise of warrants and sale of shares of common stock through private
placements. The Company used approximately $600,000 of these funds
towards the acquisition of Premier Packaging Corp. The remainder is available
for working capital requirements.
At its current revenue levels and
with the impact of the Company’s acquisition of Premier Packaging in February
2010, the Company expects its use of cash for operations to reduce during 2010
from the 2009 levels, and is striving to reach and maintain positive operating
cash flows on a consistent basis in 2010, although there is no guarantee the
Company will be able to do so. The Company’s ability to fund
its capital requirements out of its available cash and cash generated from its
operations depends on a number of factors. Some of these factors include the
Company’s ability to (i) increase commercial and security printing and plastic
card sales; (ii) increase sales of the Company’s digital products; and (iii)
integrate its new acquisition of Premier Packaging with its existing product
lines. If the Company cannot generate sufficient cash from its
operations, the Company may need to raise additional funds in the future in
order to fund its working capital needs.
Key
Indicators of Future Results
We
believe that cash flow from operations is a significant key indicator for the
Company. Our ability to reduce our use of cash will depend on our
ability to grow revenue to a level sufficient to meet our operating expense
requirements. To grow revenue, we may merge with or acquire
manufacturing or related companies. Our ability to successfully
complete these transactions on favorable terms will be a significant key
indicator of our future results. These acquisitions may require
additional funds that the Company does not currently have. To obtain
additional investments in the future may require us to issue shares of our
Common Stock. Our ability to sell our Common Stock on favorable
terms will also be a significant key indicator of our future
results. In addition, we believe that our ability to successfully
enforce our patent rights, including our current litigation against the European
Central Bank, is a significant key indicator for the Company.
Off-Balance
Sheet Arrangements
We do not
have any off-balance sheet arrangements that have, or are reasonably likely to
have, an effect on our financial condition, financial statements, revenues or
expenses.
Inflation
Although
our operations are influenced by general economic conditions, we do not believe
that inflation had a material effect on our results of operations during 2009 or
2008 as we are generally able to pass the increase in our material and labor
costs to our customers, or absorb them as we improve the efficiency of our
operations.
Critical
Accounting Policies
The
preparation of financial statements and related disclosures in conformity with
accounting principles generally accepted in the United States requires
management to make judgments, assumptions and estimates that affect the amounts
reported in our consolidated financial statements and accompanying
notes. The consolidated financial statements for the fiscal year
ended December 31, 2009 describe the significant accounting policies and methods
used in the preparation of the consolidated financial
statements. Estimates are used for, but not limited to, the
accounting for the allowance for doubtful accounts and sales returns, goodwill
impairments, inventory allowances, revenue recognition, stock based compensation
valuations, the valuation of intangible assets, and allocation of assets in
business combinations. Actual results could differ from these
estimates. The following critical accounting policies are impacted
significantly by judgments, assumptions and estimates used in the preparation of
our consolidated financial statements:
29
Long
Lived Assets
The
Company reviews long-lived assets and certain identifiable intangibles for
impairment whenever events or changes in circumstances indicate that the
carrying amount of an asset may not be recoverable. Recoverability of
assets to be held and used is measured by a comparison of the carrying amount of
an asset to future net undiscounted cash flows expected to be generated by the
asset. If such assets are considered to be impaired, the impairment
to be recognized is measured by the amount by which the carrying amount of the
assets exceeds the fair value of the assets. Fair value is determined
based on discounted cash flows or appraised values, depending on the nature of
the assets.
Fixed
assets are carried at cost. Depreciation is computed over the estimated useful
life of five to seven years using the straight-line depreciation method.
Leasehold improvements are amortized over the shorter of their useful life or
the lease term. Intangible assets consist primarily of royalty rights,
contractual rights, customer list, and patent acquisition, application and
defense costs. Amortization is computed over the estimated useful life of five
to twenty years using the straight-line depreciation
method. For patent related assets, the remaining legal life of
the patent is used as the estimate useful life unless circumstances determine
that the useful life will be less than the legal life. Long-lived
assets to be held and used by the Company are reviewed for impairment whenever
events or changes in circumstances indicate that the carrying amount of an asset
may not be recoverable. We periodically evaluate the recoverability of our
long-lived assets based on estimated future cash flows from and the estimated
fair value of such long-lived assets, and provide for impairment if such
undiscounted cash flows are insufficient to recover the carrying amount of the
long-lived asset.
Goodwill
Goodwill
is the excess of cost of an acquired entity over the fair value of amounts
assigned to assets acquired and liabilities assumed in a business
combination. Goodwill is not amortized, rather it is tested for
impairment annually, and will be tested for impairment between annual tests if
an event occurs or circumstances change that would indicate the carrying amount
may be impaired. Impairment testing for goodwill is done at a
reporting unit level. Reporting units are one level below the
business segment level, but are combined when reporting units within the same
segment have similar economic characteristics. The Company has three reporting
units based on the current structure. An impairment loss generally
would be recognized when the carrying amount of the reporting unit’s net assets
exceeds the estimated fair value of the reporting unit. The Company
completed its assessment of any potential impairment upon adoption of this
standard and performs annual assessments.
Goodwill
and indefinite-lived intangible assets are tested for impairment on an annual
basis or sooner if an indicator of impairment occurs. To determine whether
goodwill is impaired, we determine the fair values of each of our reportable
business unit using a discounted cash flow methodology and then compare the fair
values to the carrying values of each reportable business unit.
The
current Carrying value of goodwill of Document Security Systems is $631,000 with
estimated discounted cash flow of $12,930,000
which
includes projected cash flows from operations and estimated cash flow from
successful results in infringement suits
. The current carrying value of
goodwill of Plastic Printing Professionals is $685,000 with an estimated
discounted cash flow of $1,160,000 based on projected cash flows from
operations.
As of December 31, 2009, the 2009 annual testing date, the
Company’s market capitalization was approximately $40 million compared to
stockholders’ equity of $2.2 million. We have determined that a 10% decrease in
the fair value of any one of our reporting units as of December 31, 2009 would
have no impact on the carrying value of our goodwill. Though we believe our
estimates are reasonable, these fair values require the use of management’s
assumptions, which would not reflect unanticipated events and circumstances that
may occur.
Other Intangible
Assets and Patent Defense Costs
Other
intangible assets consists of costs associated with the application, acquisition
and defense of the Company’s patents, contractual rights to patents and trade
secrets associated with the Company’s technologies, a non-exclusive licensing
agreement, and customer lists obtained as a result of acquisitions. The
Company’s patents and trade secrets are for document anti-counterfeiting and
anti-scanning technologies and processes that form the basis of the Company’s
document security business. Patent application costs are capitalized
and amortized over the estimated useful life of the patent, which generally
approximates its legal life. External legal costs incurred to defend
the Company’s patents are capitalized to the extent of an evident increase in
the value of the patents and an expected successful outcome, in accordance to
guidance provided by FASB Concept Statement No. 6 and related guidance in AICPA
Technical Questions and Answers, Section 2260, Other Assets, paragraph .03,
“Legal Expenses Incurred to Defend Patent Infringement Suit”.
Patent defense costs are
expensed at the point when it is determined that the outcome is expected to be
unsuccessful. The Company capitalizes the cost of an appeal
until it is determined that the appeal will be
unsuccessful. The Company’s capitalized patent
defense costs expenses are analyzed for impairment based on the expected
eventual outcome of the legal action and recoverability of proceeds or added
economic value of the patent in excess of the
costs. Legal actions related to the same patent defense
case are unified into one asset group for the purposes on the impairment
analysis. The Company amortizes its other intangible assets
over their estimated useful lives. Patents are amortized over the
remaining legal life, up to 20 years. Intangible asset amortization
expense is generally classified as an operating expense. The Company
believes that the decision to incur patent costs is discretionary as the
associated products or services can be sold prior to or during the application
process. The Company accounts for other intangible amortization
as an operating expense, unless the underlying asset is directly associated with
the production or delivery of a product. To date, the amount of
related amortization expense for other intangible assets directly attributable
to revenue recognized is not material.
In
December 2008, the Company recorded an impairment $361,000 for this license
agreement the Company had acquired in 2006 for RSS Barcodes for which the
Company assessed that the probable future cash flows derived from the license
did not support the net carrying value of the license as of December 31,
2008.
30
On March
19, 2008, the Company received notification that its appeal of the invalidation
of its European Paten 455750B1 in the UK was not successful. As a result of the
adverse court decision, the Company recognized an impairment loss of $292,000
associated with the costs directly related to the UK appeal. The impairment loss
includes a judgment for reimbursement of estimated counterpart legal fees. In
January 2009, the Company received a formal request for the fee reimbursement
from the ECB of $420,000 in addition to the amounts already paid by the Company.
The Company hired an independent firm to assist the Company in reducing or
eliminating the ECB’s fees request, however, the Company recorded $145,000 as
additional accrued expenses and an impairment loss as of December 31, 2008. On
July 31, 2009, the UK court made the final assessment of costs for the UK patent
validity case due from the Company to the ECB of ₤356,490, of which the Company
has paid ₤332,000 pounds through December 31, 2009 and owes approximately
₤25,000 ($40,000 as of December 31, 2009), which amount was included in accrued
expenses as of December 31, 2009.
On August
20, 2008, the Company entered into an agreement with Trebuchet Capital Partners,
LLC (“Trebuchet”) under which Trebuchet has agreed to pay substantially all of
the litigation costs associated with pending validity proceedings initiated by
the European Central Bank (“ECB”) in eight European countries relating to the
Company’s European Patent 0 455 750B1 that the Company has claimed the ECB
infringed in printing of the Euro currency (the “Patent”). Trebuchet also agreed
to pay substantially all of the litigation costs associated with future validity
challenges filed by the ECB or other parties, provided that Trebuchet elects to
assume the defense of any such challenges, in its sole discretion, and patent
infringement suits filed against the ECB and certain other alleged infringers of
the Patent, all of which suits may be brought at the sole discretion of
Trebuchet and may be in the name of the Company, Trebuchet or both. The Company
provided Trebuchet with the sole and exclusive right to manage infringement
litigation relating to the Patent in Europe, including the right to initiate
litigation in the name of the Company, Trebuchet or both and to choose whom and
where to sue, subject to certain limitations set forth in the agreement. Under
the terms of the Agreement, the Company and Trebuchet have agreed to equally
share all proceeds generated from litigation relating to the Patent, including
judgments and licenses or other arrangements entered into in settlement of any
such litigation. Trebuchet is also entitled to recoup any litigation expenses
specifically awarded to the Company in such actions. Under the terms of the
Agreement, and in consideration for Trebuchet’s funding obligations, the Company
assigned and transferred a 49% interest of the Company’s rights, title and
interest in the Patent to Trebuchet which allows Trebuchet to have a separate
and distinct interest in and share of the Patent, along with the right to sue
and recover in litigation, settlement or otherwise to collect royalties or other
payments under or on account of the Patent. Pursuant to this transaction, the
Company recognized a loss on the sale of patent assets for its assignment and
transfer of 49% of its ownership rights in the patent, which had a net book
value of approximately $1,670,000, for proceeds of $500,000, As a result, the
Company recognized a loss on sale of patent assets of $1,170,000.
As of
December 31, 2009, the Company had a net carrying value of
approximately $1,589,000 of other intangible assets and patent defense
costs of which $134,000 was acquired intangibles, $851,000 was patent
acquisition and defense costs and $604,000 was patent application costs.
The
estimated cash flow that support the carrying values of these assets are derived
at the reporting unit level, except for patent defense costs which are only
supported by the estimated cash flow from successful results in infringement
suits, if any.
When the
convertible feature of the conventional convertible debt provides for a rate of
conversion that is below market value, this feature is characterized as a
beneficial conversion feature (BCF"). Prior to the determination of the BCF, the
proceeds from the debt instrument were first allocated between the convertible
debt and any embedded or detachable free standing instruments that are included,
such as common stock warrants. We record a BCF as a debt discount pursuant to
ASC Topic 470-20, formerly EITF Issue No. 98-5 (EITF 98-05"), Accounting for
Convertible Securities with Beneficial Conversion Features or Contingency
Adjustable Conversion Ratio," and EITF Issue No. 00-27, Application of EITF
Issue No. 98-5 to Certain Convertible Instrument(s) ." In those circumstances,
the convertible debt will be recorded net of the discount related to the BCF. We
amortize the discount to interest expense over the life of the debt using the
effective interest method.
Revenue
Recognition
Sales of
security and other printing products, and legal products are recognized when a
product or service is delivered, shipped or provided to the customer and all
material conditions relating to the sale have been substantially
performed.
For
digital solutions sales, revenue is recognized in accordance with the American
Institute of Certified Public Accountant's Statement of Position (SOP) No. 97-2,
"Software Revenue Recognition," as modified by SOP No. 98-9, "Modification of
SOP No. 97-2, Software Revenue Recognition with Respect to Certain Transactions"
and Staff Accounting Bulletin (SAB) No. 104, "Revenue Recognition." Accordingly,
revenue is recognized when all of the following conditions are satisfied: (1)
there is persuasive evidence of an arrangement; (2) the service or product has
been provided to the customer; (3) the amount of fees to be paid by the customer
is fixed or determinable (4) the collection of our fees is reasonably
assured.
The
Company recognizes revenue from technology licenses once all the following
criteria for revenue recognition have been met: (1) persuasive evidence of an
agreement exists; (2) the right and ability to use the product or technology has
been rendered; (3) the fee is fixed and determinable and not subject to refund
or adjustment; and (4) collection of the amounts due is reasonably
assured.
31
Share-Based
Payments
We
measure compensation cost for stock awards at fair value and recognize
compensation expense over the service period for which awards are expected to
vest. The Company uses the Black-Scholes option pricing model for determining
the estimated fair value for stock-based awards. The Black-Scholes model
requires the use of subjective assumptions which determine the fair value of
stock-based awards, including the option’s expected term and the price
volatility of the underlying stock. For equity instruments issued to consultants
and vendors in exchange for goods and services the Company determines the
measurement date for the fair value of the equity instruments issued at the
earlier of (i) the date at which a commitment for performance by the consultant
or vendor is reached or (ii) the date at which the consultant or vendor’s
performance is complete. In the case of equity instruments issued to
consultants, the fair value of the equity instrument is recognized over the term
of the consulting agreement
The fair
value of each option award is estimated on the date of grant utilizing the Black
Scholes Option Pricing Model that uses the assumptions noted in the following
table.
|
2009
|
2008
|
|||||||
|
Volatility
|
54.7 | % | 53.6 | % | ||||
|
Expected
option term
|
3.9
|
years |
3.3
|
years | ||||
|
Risk-free
interest rate
|
2.30 | % | 3.09 | % | ||||
|
Expected
forfeiture rate
|
0.0 | % | 0.0 | % | ||||
|
Expected
dividend yield
|
0.0 | % | 0.0 | % | ||||
Income
Taxes
Deferred tax assets and liabilities are
determined based on temporary differences between income and expenses reported
for financial reporting and tax reporting. FASB ASC 740 (formerly Statement of
Financial Accounting Standards (“SFAS”) No. 109, “Accounting for Income Taxes”)
requires that a valuation allowance be established when management determines
that it is more likely than not that all or a portion of a deferred tax asset
will not be realized. The Company evaluates the realizability of its net
deferred tax assets on an annual basis an valuation allowances are provided or
released, as necessary. Since the Company has had cumulative losses in recent
years, the accounting guidance suggest that we should not look to future
earnings to support the realizability of the net deferred tax asset. As a
result, as of the years ended December 31, 2009 and 2008, the Company has
elected to record a valuation allowance to reduce net deferred tax assets to
zero.
The Company believes that the
accounting estimates related to deferred tax valuation allowances are “critical
accounting estimates” because: (1) the need for valuation allowance is highly
susceptible to change from period to period due to changes in deferred tax asset
and deferred tax liability balances, (2) the need for valuation allowance is
susceptible to actual operating results and (3) changes in the tax valuation
allowance can have a material impact on the tax provisions/benefit in the
consolidated statements of operations and on deferred income taxes in the
consolidated balance sheets.
Investment
Valuation and Deconsolidation
On
October 8, 2009, the Company entered into an Asset Purchase Agreement with
Internet Media Services, Inc. whereby the Company sold the assets and
liabilities of Legalstore.com, a division of the Company, in exchange for
7,500,000 shares of common stock of the Internet Media Services, Inc. The
Company recorded its investment in Internet Media Services as an equity method
investment at the fair market value of the business sold. Management determined
that the transaction did not qualify as a non-monetary exchange due to the
exception noted in ASC 845-10 ( [ A transfer of assets to an entity in exchange
for an equity interest in that entity). Management determined that the
transaction qualified as a derecoginition of a subsidiary under ASC 810-10-40.
Therefore, the Company accounted for the deconsolidation of a subsidiary (“the
business”) by recording the consideration received at fair market value and
recognizing a gain in net income measured as the difference between: the fair
value of the consideration received (7,500,000 shares of common stock of
Internet Media Services, Inc. or a 37% interest) and the carrying value of the
assets and liabilities sold. Given that the consideration received is not
readily measurable because of the lack of activity in Internet Media Services,
Inc. prior to the transaction, the Company determined that the value of the
“business transferred” is more readily measurable. The Company determined the
fair market value of the business transferred based on a discounted cash flow
model. The Company is recording the equity method investment at fair value.
Under the equity method investment the Company is required to account for the
difference between the cost of an investment and the amount of the underlying
equity in net assets of an investee as if the investee were a consolidated
subsidiary. If the investor is unable to relate the difference to specific
accounts of the investee (
e.g.
, property and
equipment), the difference should be considered to be the same as goodwill.
Investors shall not amortize goodwill associated with equity method investments
after the date ASC 350/Statement No. 142,
Goodwill and Other Intangible
Assets
, is initially applied by the entity in its entirety. The Company
has determined that given the lack of activity in Internet Media Services, Inc.
prior to the transaction, the difference between the cost of the investment
(fair market value) and the underlying equity interest is attributable to
goodwill. The Company is continuing to report the activity in operating loss and
not breaking out and reporting it as discontinued operations because the
operations and cash flows of the component have not been eliminated from the
ongoing operations of the entity as a result of the equity method investment and
because the Company will have significant continuing involvement in the
operations of Internet Media Services, Inc. after the disposal transaction
because of the ownership percentage and the board representation.
32
Our
audited financial statements for the fiscal years ended December 31, 2009 and
2008 follow Item 14, beginning at page F-1.
None
Evaluation
of Disclosure Controls and Procedures
Management is responsible for
establishing and maintaining effective disclosure controls and procedures. As of
December 31, 2009, our Chief Executive Officer and Chief Financial Officer
participated with our management in evaluating the effectiveness of our
disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e)
under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)). Our
disclosure controls and procedures are designed to ensure that information
required to be disclosed in the Securities and Exchange Commission (“SEC”)
reports we file or submit under the Exchange Act is recorded, processed,
summarized and reported within the time period specified by the SEC’s rules and
forms and that such information is accumulated and communicated to management,
including our Chief Executive Officer and Chief Financial Officer, to allow
timely decisions regarding required disclosure. In light of the discussion of
material weaknesses set forth below, these officers have concluded that our
disclosure controls and procedures were not effective as of December 31, 2009.
To the best of their knowledge, management believes that the financial
statements included in this Annual Report on Form 10-K fairly present, in all
material respects, our financial condition, results of operations and cash flows
for the periods presented in conformity with accounting principles generally
accepted in the United States of America (US GAAP).
Management’s
Annual Report on Internal Control Over Financial Reporting
A
company’s internal control over financial reporting is a process designed by, or
under the supervision of, a public company’s principal executive and principal
financial officers, or persons performing similar functions, and effected by the
board of directors, management and other personnel, to provide reasonable
assurance regarding the reliability of financial reporting and the preparation
of financial statements for external purposes in accordance with generally
accepted accounting principles (“GAAP”) including those policies and procedures
that: (i) pertain to the maintenance of records that in reasonable detail
accurately and fairly reflect the transactions and dispositions of the assets of
the company, (ii) provide reasonable assurance that transactions are recorded as
necessary to permit preparation of financial statements in accordance with GAAP,
and that receipts and expenditures are being made only in accordance with
authorizations of management and directors of the company, and (iii) provide
reasonable assurance regarding prevention or timely detection of unauthorized
acquisition, use or disposition of the company’s assets that could have a
material effect on the financial statements.
Management
is responsible for establishing and maintaining adequate internal control over
financial reporting. Our management, with the participation of our Chief
Executive Officer and Chief Financial Officer, has assessed the effectiveness of
our internal control over financial reporting as of December 31, 2009. In making
this assessment, our management used the criteria established in
Internal Control—Integrated
Framework
issued by the Committee of Sponsoring Organizations of the
Treadway Commission (COSO).
33
A
material weakness is a control deficiency, or combination of control
deficiencies, such that there is a reasonable possibility that a material
misstatement of the annual or interim financial statements will not be prevented
or detected on a timely basis. In connection with management’s assessment of our
internal control over financial reporting described above, management has
identified the following material weaknesses in the Company’s internal control
over financial reporting as of December 31, 2009:
We did
not maintain a sufficient complement of qualified accounting personnel and
controls associated with segregation of duties were ineffective. During 2009 we
had one person on staff that performs nearly all aspects of our external
financial reporting process, including but not limited to access to the
underlying accounting records and systems, the ability to post and record
journal entries and responsibility for the preparation of the external financial
statements. This creates certain incompatible duties and a lack of review over
the financial reporting process that would likely fail to detect errors in
spreadsheets, calculations, or assumptions used to compile the financial
statements and related disclosures as filed with the SEC. Specifically, we
determined that our controls over the preparation, review and monitoring of the
financial statements were ineffective to provide reasonable assurance that
financial disclosures agreed to appropriate supporting detail, calculations or
other documentation. In addition, during the preparation of our annual
consolidated financial statements, we determined that certain key assumptions
and calculations used in the future cash flow analysis supporting our asset
impairment tests required editing after submission to our auditors. These edits
did not result in audit adjustments to our December 31, 2009 consolidated
financial statements. These control deficiencies could result in a material
misstatement to our interim or annual consolidated financial statements that
would not be prevented or detected.
Controls
associated with identifying and accounting for complex and non-routine
transactions in accordance with U.S. generally accepted accounting principles
were ineffective. Specifically, during the course of the quarterly interim
reviews and the annual audit, audit adjustments were made to correct the
recorded amounts for certain deconsolidation, and debt and equity based
transactions, including the resulting impact on out income tax provision, as
well as required disclosures based on the misapplication of GAAP by the Company
that would have resulted in a material misstatement of our financial
statements.
As a
result of the material weaknesses described above, our management concluded that
as of December 31, 2009, we did not maintain effective internal control over
financial reporting based on the criteria established in
Internal Control—Integrated
Framework
issued by the COSO.
This
annual report does not include an attestation report of the Company’s registered
public accounting firm regarding internal control over financial reporting.
Management’s report was not subject to attestation by the Company’s registered
public accounting firm pursuant to temporary rules of the Securities and
Exchange Commission that permit the Company to provide only Management’s report
in this annual report.
Plan
for Remediation of Material Weaknesses
In
response to the identified material weaknesses, management, with oversight from
the Company’s audit committee, plans to review our control environment and to
evaluate whether cost effective solutions are available to remedy the identified
material weaknesses by expanding the resources available to the financial
reporting process.
Notwithstanding
the material weaknesses discussed above, management believes that the financial
statements included in this report present fairly, in all material respects, our
financial position, results of operations, and cash flows for the periods
presented in accordance with U.S. generally accepted accounting
principles.
Changes
in Internal Control over Financial Reporting
There
have been a number of changes made to our internal control over financial
reporting (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the
Securities Exchange Act) during 2009. Specifically, the Company added one
divisional controller as the result of the Company’s acquisition of a commercial
printing. The Company began implement a new accounting and estimating system at
its printing division in order to improve the efficiency and effectiveness of
reporting and workflow at that operation. After which, the Company expects to
utilize the financial resources that become available after the system
implementation to improve its areas of deficiency in the financial reporting
process.
34
The
information required by this Item will be contained in the Company’s Proxy
Statement for its Annual Stockholders Meeting, which will be filed with the
Securities and Exchange Commission within 120 days after December 31, 2009, and
which is incorporated by reference herein.
We make
available free of charge through the investor relations page of our Web site
(www.documentsecurity.com) our annual reports on Form 10-K, quarterly reports on
Form 10-Q, current reports on Form 8-K and all amendments to those reports, and
all beneficial ownership reports on Forms 3, 4 and 5 filed by directors,
officers and beneficial owners of more than 10% of our equity, as soon as
reasonably practicable after such reports are electronically filed with the
Securities and Exchange Commission. We have adopted codes of business conduct
and ethics for all of our employees, including our principal executive officer,
principal financial officer and principal accounting officer. Copies of the
codes of business conduct and ethics are available on our Web site.
Our Web
sites and the information contained therein or incorporated therein are not
intended to be incorporated into this Annual Report on Form 10-K or our other
filings with the SEC.
The
information required by this Item will be contained in the Company’s Proxy
Statement for its Annual Stockholders Meeting, which will be filed with the
Securities and Exchange Commission within 120 days after December 31, 2009, and
which is incorporated by reference herein.
The
information required by this Item will be contained in the Company’s Proxy
Statement for its Annual Stockholders Meeting, which will be filed with the
Securities and Exchange Commission within 120 days after December 31, 2009, and
which is incorporated by reference herein.
The
information required by this Item will be contained in the Company’s Proxy
Statement for its Annual Stockholders Meeting, which will be filed with the
Securities and Exchange Commission within 120 days after December 31, 2009, and
which is incorporated by reference herein.
The
information required by this Item will be contained in the Company’s Proxy
Statement for its Annual Stockholders Meeting, which will be filed with the
Securities and Exchange Commission within 120 days after December 31, 2009, and
which is incorporated by reference herein.
(a)
Exhibits
The
Exhibits listed below designated by an * are incorporated by reference to the
filings by Document Security Systems, Inc. under the Securities Act of 1933 or
the Securities and Exchange Act of 1934, as indicated. All other exhibits are
filed herewith.
|
3.1
|
Articles
of Organization, as amended (incorporated by reference to exhibit 3.1 to
the Company’s Registration Statements No. 2-98684-NY on Form
S-18).*
|
|
3.2
|
By-laws,
as amended (incorporation by reference to exhibit 3.2 to the Company’s
Registration Statement No. 2-98684-NY on Form S-18).*
|
|
10.1
|
Agreement
dated November 7, 1996 with Charles M. LaLoggia (incorporated by reference
from Company’s Form 10-Q for March 31, 1997).*
|
|
10.2
|
Agreement
dated July 2, 1996 with Frank LaLoggia (incorporated by reference from
Company’s Form 10-Q for June 30, 1996).*
|
|
10.3
|
Agreement
dated July 31, 2002 between New Sky Communications, Inc. and Patrick White
(incorporated by reference from Company’s Form 8-K filed on August 8,
2002).*
|
35
|
10.4
|
Agreement
dated July 31, 2002 between New Sky Communications, Inc. and Thomas M.
Wicker (incorporated by reference from Company’s Form 8-K filed on August
8, 2002).*
|
|
10.5
|
Agreement
dated November 1, 2002 between New Sky Communications, Inc. and David
Thomas M. Wicker, Christine Wicker, Kenneth Wicker and Michael Caton
(incorporated by reference to the Registrant’s Form 10-KSB for the fiscal
year ended December 31, 2002). *
|
|
10.6
|
Employment
Agreement dated November 1, 2002 between New Sky Communications, Inc. and
David Wicker (incorporated by reference to the Registrant’s Form 10-KSB
for the fiscal year ended December 31, 2002). *
|
|
10.7
|
Form
of Warrant Agreement between the Registrant and Fordham Financial
Management, Inc.(incorporated by reference on Company’s registration
statement on Form S-3 filed on January 20, 2004).*
|
|
10.8
|
Form
of Warrant Agreement between the Registrant and W.A.B. Capital
(incorporated by reference on Company’s registration statement on Form S-3
filed on January 20, 2004).*
|
|
10.9
|
Form
of Warrant Agreement between the Registrant and Howard Safir (incorporated
by reference on Company’s registration statement on Form S-3 filed on
January 20, 2004).*
|
|
10.10
|
Form
of Series A Warrant Agreement issued by the Registrant to participants in
its private placement offering completed on December 29, 2003.
(incorporated by reference on Company’s registration statement on Form S-3
filed on January 20, 2004).*
|
|
10.11
|
Form
of Registration Rights Agreement issued by the Registrant to participants
in its private placement offering completed on December 29, 2003.
(incorporated by reference on Company’s registration statement on Form S-3
filed on January 20, 2004)*
|
|
10.12
|
Form
of Warrant issued to IDT Venture Capital Corporation dated October 31,
2003.(incorporated by reference on Schedule 13D filed by IDT Venture
Capital Corporation dated December 2, 2003)*
|
|
10.13
|
Form
of Securities Purchase Agreement between Registrant and IDT Venture
Capital Corporation dated as of October 31, 2003. (incorporated by
reference on Schedule 13D filed by IDT Venture Capital Corporation dated
December 2, 2003).*
|
|
10.14
|
Form
of Licensing and Marketing Agreement between Registrant and Boise White
Paper LLC dated January 19, 2005. (redacted version)
|
|
10.15
|
Form
of Surrender and Assignment Agreement dated as of February 25, 2005
between Registrant and the Net Interest Holders. (filed as Exhibit 10.1 to
form 8-K dated February 25, 2005)*
|
|
10.16
|
Form
of Surrender and Assignment Agreement dated as of February 25, 2005
between Registrant and the Gross Interest Holders (filed as Exhibit 10.2
to Form 8-K dated February 25, 2005)*
|
|
10.17
|
Agreement
of Sublease dated May 2004 for the Premises Located at 28 E. Main Street,
Rochester, New York (filed as Exhibit 10.1 to Form 10-QSB for the Quarter
ended June 30, 2004)*
|
|
10.18
|
Form
of Employment Agreement dated as of June 10, 2004 between Registrant and
Patrick White (filed as Exhibit 10.2 to Form 10-QSB for the Quarter ended
June 30, 2005)*
|
|
10.19
|
Form
of Employment Agreement dated as of June 11, 2004 between Registrant and
Thomas Wicker (filed as Exhibit 10.26 of 10-KSB for the fiscal year ended
December 31, 2004)*
|
|
10.20
|
Form
of 2004 Employee Stock Option Plan (filed as Appendix D to Proxy Statement
for the Meeting of Stockholders held on December 17,
2004)*
|
|
10.21
|
Form
of Non Executive Director Stock Option Plan (filed as Appendix E to Proxy
Statement for the Meeting of Stockholders held on December 17,
2004)*
|
|
10.22
|
Asset
Purchase Agreement, dated February 7, 2006 by and between the Registrant
and Plastic Printing Professionals, Inc. . (filed as exhibit 10.30 to Form
10-KSB for the fiscal year ended December 31, 2005)*
|
|
10.23
|
Stock
Option Agreement pursuant to the Registrant’s 2004 Employee Stock Option
Plan (filed as exhibit 10.31 to Form S-8 filed May 12,
2006)*
|
|
10.24
|
Warrant
and Amendment to Warrant dated June 16, 2006, granted to International
Barcode Corporation (filed as exhibit 10.33 and 10.34 respectively to Form
10-Q for the quarter ended June 30, 2007)*
|
|
10.25
|
License
and Distribution Agreement dated November 8, 2006 by and between the
Registrant and PT Sekur Grafika (filed as exhibit 10.30 to Form 10-Q for
the quarter ended June 30, 2007)*
|
|
10.26
|
Form
of Subscription Agreement by and between the Registrant and investors in a
Private Placement (filed as Exhibit 10.1 to Form 8-K/A dated December 27,
2006)*
|
|
10.27
|
Registration
Rights Agreement dated December 12, 2006 between the Registrant and
Perrin, Holden &Davenport Capital Corp. as agent for those investing
in a Private Placement (filed as Exhibit 10.2 to Form 8-K/A dated December
27, 2006)*
|
|
10.28
|
Form
of Common Stock Purchase Warrant granted pursuant to a Private Placement
(filed as Exhibit 4.1 to Form 8-K/A dated December 27,
2006)*
|
|
10.29
|
Limited
Exclusive Patent License Agreement dated December 29, 2006 between the
Registrant and Ergonomic Group, Inc. (filed as exhibit 10.31 to Form 10-Q
for the quarter ended June 30,
2007)*
|
36
|
10.30
|
Letter
Agreement dated June 11, 2007 between the Registrant and International
Barcode Corporation (BTI) (filed as exhibit 10.35 to Form 10-Q for the
quarter ended June 30, 2007)*
|
|
10.31
|
License
and Distribution Agreement dated June 27, 2007 by and between the
Registrant and Cultura Interactiva S.A. de C.V. (filed as exhibit 10.32 to
Form 10-Q for the quarter ended June 30, 2007)*
|
|
10.32
|
Credit
Facility Agreement, dated January 4, 2008, between the Registrant and
Fagenson & Co., Inc., as Agent
|
|
10.33
|
Security
Agreement, dated January 4, 2008, between the Registrant and Fagenson
& Co., Inc., as Agent
|
|
10.34
|
Form
of Secured Promissory Note between the Registrant and Fagenson & Co.,
Inc., as Agent
|
|
10.35
|
Credit
Facility Agreement, dated January 4, 2008, between the Registrant and
Patrick White
|
|
10.36
|
Security
Agreement, dated January 4, 2008, between the Registrant and Patrick
White
|
|
10.37
|
Form
of Secured Promissory Note between the Registrant and Patrick
White
|
|
10.38
|
Agreement,
dated April 11, 2008, between the Registrant and Ergonomic Group (filed as
exhibit 10.1 to Form 8-K dated April 11, 2008)*
|
|
10.39
|
Credit
Facility Note, dated May 7, 2008, between the Registrant and Taiko III
Corp. (filed as exhibit 10.1 to Form 8-K dated May 7,
2008)*
|
|
10.40
|
Confidential
Separation Agreement and General Release, dated May 10, 2008, between
Peter Ettinger and the Company (filed as exhibit 10.1 to Form 8-K dated
May 10, 2008)*
|
|
10.41
|
Consulting
Agreement, dated May 12, 2008, between Peter Ettinger and the Company
(filed as exhibit 10.2 to Form 8-K dated May 10, 2008)*
|
|
10.42
|
Share
Purchase Agreement, dated as of June 25, 2008, between the Registrant and
Walton Invesco Inc. (filed as exhibit 10.1 to Form 10-Q for the quarter
ended June 30, 2008)*
|
|
10.43
|
Share
Purchase Agreement, dated as of June 25, 2008, between the Registrant and
Walton Invesco Inc. (filed as exhibit 10.2 to Form 10-Q for the quarter
ended June 30, 2008)*
|
|
10.44
|
Asset
Purchase Agreement, dated as of November 6, 2008, among Secuprint Inc.,
DPI of Rochester, LLC, James Stanley and Matthew Kellman (filed as exhibit
10.1 to Form 8-K dated November 6, 2008)*
|
|
10.45
|
Agreement,
dated August 20, 2008, between Document Security Systems, Inc. and
Trebuchet Capital Partners, LLC (filed as exhibit 10.1 to Form 10-Q for
the quarter ending September 30, 2008)*
|
|
10.46
|
Warrant,
dated December 18, 2008, of Document Security Systems, Inc. issued to Baum
Capital Investments Inc. (filed as exhibit 4.1 to Form 8-K dated December
22, 2008)*
|
|
10.47
|
Secured
Promissory Note, dated December 18, 2008, between Document Security
Systems, Inc. , Secuprint Inc. and Baum Capital Investments Inc. (filed as
exhibit 10.2 to Form 8-K dated December 22, 2008)*
|
|
10.48
|
Security
Agreement, dated December 18, 2008, between Secuprint Inc. and Baum
Capital Investments Inc. (filed as exhibit 10.3 to Form 8-K dated December
22, 2008)*
|
|
10.49
|
Form
of Registration Rights Agreement dated as of May 29, 2009 executed and
delivered by Document Security Systems, Inc. and the holders listed
therein. (filed as exhibit 10.2 to Form 8-K dated May 29,
2009)*
|
|
10.50
|
Form
of Warrant to Purchase Common Stock of Document Security Systems, Inc.
dated May 29, 2009.
|
|
(filed
as exhibit 4.1 to Form 8-K dated May 29, 2009)*
|
|
|
10.51
|
Form
of Subscription Agreement dated as of May 29, 2009 between Document
Security Systems, Inc. and the Subscribers. (filed as exhibit 10.1 to Form
8-K dated May 29, 2009)*
|
|
10.52
|
Asset
Purchase Agreement between Lester Levin Inc. and Internet Media Services,
Inc. dated October 8, 2009. (filed as exhibit 10.1 to Form 8-K dated
October 8, 2009)*
|
|
10.53
|
Stock
Pledge and Escrow Agreement between Lester Levin Inc., Document Security
Systems, Inc., Internet Media Services, Inc., Michael Buechler and
Manufacturers and Traders Trust Company dated October 8, 2009. (filed as
exhibit 10.3 to Form 8-K dated October 8, 2009)*
|
|
10.54
|
Stock
Pledge and Escrow Agreement between Lester Levin Inc., Document Security
Systems, Inc., Internet Media Services, Inc., Raymond Meyers and
Manufacturers and Traders Trust Company dated October 8, 2009. (filed as
exhibit 10.2 to Form 8-K dated October 8, 2009)*
|
|
10.55
|
Voting
Agreement between Document Security Systems, Inc., Internet Media
Services, Inc., Raymond Meyers and Michael Buechler dated October 8, 2009.
(filed as exhibit 10.4 to Form 8-K dated October 8,
2009)*
|
|
10.55
|
$350,000
Convertible Promissory Note dated November 24, 2009. (filed as exhibit
10.1 to Form 8-K dated December 15, 2009)*
|
|
10.56
|
$575,000
Promissory Note dated November 24, 2009. (filed as exhibit 10.2 to Form
8-K dated December 15, 2009)*
|
|
10.57
|
Form
of Letter Agreement dated December 11, 2009. (filed as exhibit 10.3 to
Form 8-K dated December 15, 2009)*
|
|
10.58
|
Form
of Letter Agreement dated December 11, 2009
|
|
10.59
|
Form
of $450,000 Convertible Promissory Note. (filed as exhibit 10.1 to Form
8-K dated December 30,
2009)*
|
37
|
21
|
Subsidiaries
of Registrant
|
|
23.1
|
Consent
of Freed Maxick & Battaglia, CPAs, PC
|
|
31.1
|
Certification
of Chief Executive Officer Pursuant to 18 USC 1350 Section
302
|
|
31.2
|
Certification
Principal Accounting Officer Pursuant to 18 USC 1350 Section
302
|
|
32.1
|
Certification
of Chief Executive Officer Pursuant to 18 USC 1350 Section
906
|
|
32.2
|
Certification
Principal Accounting Officer Pursuant to 18 USC 1350 Section
906
|
(1) This
exhibit contains a redacted copy of the agreement. We have filed a
confidentiality request with the Commission with respect to certain portions of
the agreement.
38
DOCUMENT
SECURITY SYSTEMS, INC. AND SUBSIDIARIES
CONTENTS
|
Page
|
||
|
Report
of Independent Registered Public Accounting Firm
|
F-1
|
|
|
Consolidated
Financial Statements:
|
||
|
Balance
Sheets
|
F-2
|
|
|
Statements
of Operations
|
F-3
|
|
|
Statements
of Cash Flows
|
F-4
|
|
|
Statements
of Changes in Stockholders’ Equity
|
F-5
|
|
|
Notes
to the Consolidated Financial Statements
|
F6
- F30
|
39
REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the
Board of Directors and Stockholders
Document
Security Systems, Inc. and Subsidiaries
We have
audited the accompanying consolidated balance sheets of Document Security
Systems, Inc. and Subsidiaries as of December 31, 2009 and 2008, and the related
consolidated statements of operations, stockholders’ equity, and cash flows for
the years then ended. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. The Company is not required to
have, nor have we been engaged to perform, an audit of its internal control over
financial reporting. Our audits included consideration of internal control over
financial reporting as a basis for designing audit procedures that are
appropriate in the circumstances, but not for the purpose of expressing an
opinion on the effectiveness of the Company’s internal control over financial
reporting. Accordingly we express no such opinion. An audit includes examining,
on a test basis, evidence supporting the amounts and disclosures in the
financial statements. An audit also includes assessing the accounting principles
used and significant estimates made by management, as well as evaluating the
overall financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our
opinion, the consolidated financial statements referred to above present fairly,
in all material respects, the financial position of Document Security Systems,
Inc. and Subsidiaries as of December 31, 2009 and 2008, and the results of its
operations and its cash flows for the years then ended, in conformity with U.S.
generally accepted accounting principles.
FREED
MAXICK & BATTAGLIA, CPAs, PC
/s/ FREED
MAXICK & BATTAGLIA, CPAs, PC
Buffalo,
New York
March 24,
2010
F-1
DOCUMENT
SECURITY SYSTEMS, INC. AND SUBSIDIARIES
As
of December 31,
|
2009
|
2008
|
|||||||
|
ASSETS
|
||||||||
|
Current
assets:
|
||||||||
|
Cash
and cash equivalents
|
$ | 448,895 | $ | 87,820 | ||||
|
Restricted
cash
|
- | 131,004 | ||||||
|
Accounts
receivable, net of allowance of $66,000 ($50,000- 2008)
|
1,143,939 | 1,284,208 | ||||||
|
Inventory
|
184,174 | 359,034 | ||||||
|
Loans
to employees
|
- | 67,781 | ||||||
|
Prepaid
expenses and other current assets
|
91,310 | 75,066 | ||||||
|
Total
current assets
|
1,868,318 | 2,004,913 | ||||||
|
Fixed
assets, net
|
1,286,226 | 1,517,357 | ||||||
|
Other
assets
|
305,507 | 264,529 | ||||||
|
Investment
|
350,000 | - | ||||||
|
Goodwill
|
1,315,721 | 1,396,734 | ||||||
|
Other
intangible assets, net
|
1,588,969 | 2,873,789 | ||||||
|
Total
assets
|
$ | 6,714,741 | $ | 8,057,322 | ||||
|
LIABILITIES
AND STOCKHOLDERS' EQUITY
|
||||||||
|
Current
liabilities:
|
||||||||
|
Accounts
payable
|
$ | 1,673,901 | $ | 1,411,942 | ||||
|
Accrued
expenses & other current liabilities
|
909,432 | 1,312,745 | ||||||
|
Deferred
revenue & customer deposits
|
25,163 | 30,193 | ||||||
|
Short-term
debt, net of unamortized discount of $247,000 -2008
|
- | 652,511 | ||||||
|
Current
portion of capital lease obligations
|
78,167 | 78,367 | ||||||
|
Total
current liabilities
|
2,686,663 | 3,485,758 | ||||||
|
Revolving
notes from related parties
|
583,000 | 2,283,000 | ||||||
|
Long
term debt, net of unamortized discount of $420,000 ($0
-2008)
|
954,616 | - | ||||||
|
Capital
lease obligations
|
182,424 | 210,365 | ||||||
|
Deferred
tax liability
|
70,830 | 51,878 | ||||||
|
Commitments
and contingencies (see Note 13)
|
||||||||
|
Stockholders'
equity
|
||||||||
|
Common
stock, $.02 par value;
200,000,000
shares authorized,
16,397,887
shares issued and outstanding (14,369,764 in 2008) (325,000 subscribed in
2008)
|
327,957 | 287,395 | ||||||
|
Additional
paid-in capital
|
38,399,033 | 35,538,695 | ||||||
|
Common
stock subscriptions receivable
|
- | (1,300,000 | ) | |||||
|
Accumulated
deficit
|
(36,489,782 | ) | (32,499,769 | ) | ||||
|
Total
stockholders' equity
|
2,237,208 | 2,026,321 | ||||||
|
Total
liabilities and stockholders' equity
|
$ | 6,714,741 | $ | 8,057,322 | ||||
See
accompanying notes.
F-2
DOCUMENT
SECURITY SYSTEMS, INC. AND SUBSIDIARIES
For the
Years Ended December 31,
|
2009
|
2008
|
|||||||
|
Revenue
|
||||||||
|
Security
and commercial printing
|
$ | 8,773,131 | $ | 4,386,552 | ||||
|
Technology
license royalties and digital solutions
|
783,453 | 1,646,648 | ||||||
|
Legal
products
|
355,107 | 609,807 | ||||||
|
Total
Revenue
|
9,911,691 | 6,643,007 | ||||||
|
Costs
of revenue
|
||||||||
|
Security
and commercial printing
|
6,063,479 | 2,663,309 | ||||||
|
Technology
license royalties and digital solutions
|
14,028 | 14,028 | ||||||
|
Legal
products
|
178,892 | 351,769 | ||||||
|
Total
costs of revenue
|
6,256,399 | 3,029,106 | ||||||
|
Gross
profit
|
3,655,292 | 3,613,901 | ||||||
|
Operating
expenses:
|
||||||||
|
Selling,
general and administrative
|
5,733,908 | 7,431,313 | ||||||
|
Research
and development
|
291,538 | 432,550 | ||||||
|
Impairment
of patent defense costs and other intangible assets
|
- | 797,143 | ||||||
|
Amortization
of intangibles
|
1,342,105 | 1,972,233 | ||||||
|
Operating
expenses
|
7,367,551 | 10,633,239 | ||||||
|
Operating
loss
|
(3,712,259 | ) | (7,019,338 | ) | ||||
|
Other
income (expense):
|
||||||||
|
Interest
income
|
18,140 | 658 | ||||||
|
Gain
(loss) on foreign currency transactions
|
15,050 | (59,094 | ) | |||||
|
Interest
expense
|
(258,918 | ) | (136,306 | ) | ||||
|
Amortizaton
of note discount
|
(250,102 | ) | (8,227 | ) | ||||
|
Loss
on sale of patent assets
|
- | (1,169,947 | ) | |||||
|
Gain
on deconsolidation of Legalstore.com division
|
25,755 | - | ||||||
|
Litigation
settlements
|
(115,101 | ) | 126,073 | |||||
|
Registration
rights penalties
|
(109,464 | ) | - | |||||
|
Other
income
|
415,838 | - | ||||||
|
Loss
before income taxes
|
(3,971,061 | ) | (8,266,181 | ) | ||||
|
Income
tax expense
|
18,952 | 18,961 | ||||||
|
Net
loss
|
$ | (3,990,013 | ) | $ | (8,285,142 | ) | ||
|
Net
loss per share -basic and diluted:
|
$ | (0.27 | ) | $ | (0.59 | ) | ||
|
Weighted
average common shares outstanding, basic and diluted
|
14,700,453 | 14,002,034 | ||||||
See
accompanying notes.
F-3
DOCUMENT
SECURITY SYSTEMS, INC. AND SUBSIDIARIES
For
the Years Ended December 31,
|
2009
|
2008
|
|||||||
|
Cash
flows from operating activities:
|
||||||||
|
Net
loss
|
$ | (3,990,013 | ) | $ | (8,285,142 | ) | ||
|
Adjustments
to reconcile net loss to net cash used by operating
activities:
|
||||||||
|
Depreciation
and amortization
|
1,661,522 | 2,288,061 | ||||||
|
Stock
based compensation
|
67,709 | 1,747,368 | ||||||
|
Stock
based payments for legal settlements
|
115,101 | - | ||||||
|
Warrants
issuable for registration rights penalty
|
109,464 | - | ||||||
|
Impairment
of patent defense costs and other intangible assets
|
- | 797,143 | ||||||
|
Amortization
of note discount
|
250,102 | 8,227 | ||||||
|
Gain
on deconsolidation of division
|
(25,755 | ) | ||||||
|
Loss
of sale of patent assets
|
- | 1,169,947 | ||||||
|
Decrease
in restricted cash for foreign currency loss
|
- | 46,341 | ||||||
|
(Increase)
decrease in assets:
|
||||||||
|
Accounts
receivable
|
109,108 | 209,399 | ||||||
|
Inventory
|
73,849 | (32,342 | ) | |||||
|
Prepaid
expenses and other assets
|
(81,547 | ) | (36,653 | ) | ||||
|
Increase
(decrease) in liabilities:
|
||||||||
|
Accounts
payable
|
276,070 | 31,096 | ||||||
|
Accrued
expenses and other liabilities
|
(155,681 | ) | 383,884 | |||||
|
Deferred
revenue and customer deposits
|
(5,030 | ) | (718,100 | ) | ||||
|
Net
cash used by operating activities
|
(1,595,101 | ) | (2,390,771 | ) | ||||
|
Cash
flows from investing activities:
|
||||||||
|
Purchase
of fixed assets
|
(62,522 | ) | (334,800 | ) | ||||
|
Decrease
in restricted cash
|
131,004 | - | ||||||
|
Acquisition
of business
|
- | (1,082,537 | ) | |||||
|
Proceeds
from the sale of patent assets
|
- | 500,000 | ||||||
|
Purchase
of other intangible assets
|
(176,083 | ) | (1,348,666 | ) | ||||
|
Net
cash used by investing activities
|
(107,601 | ) | (2,266,003 | ) | ||||
|
Cash
flows from financing activities:
|
||||||||
|
Borrowing
on revolving note- related parties
|
1,030,000 | 1,983,000 | ||||||
|
Repayment
on revolving note- related parties
|
(730,000 | ) | - | |||||
|
Borrowings
on short-term credit facility
|
- | 500,000 | ||||||
|
Repayment
on short-term credit facility
|
- | (500,000 | ) | |||||
|
Borrowings
on short- term debt
|
- | 900,000 | ||||||
|
Payments
on short-term debt
|
(900,000 | ) | - | |||||
|
Borrowings
on long-term debt
|
575,000 | - | ||||||
|
Borrowings
on long-term convertible notes
|
800,000 | - | ||||||
|
Payments
of capital lease obligations
|
(86,124 | ) | (86,037 | ) | ||||
|
Issuance
of common stock, net
|
1,374,901 | 1,205,163 | ||||||
|
Net
cash provided by financing activities
|
2,063,777 | 4,002,126 | ||||||
|
Net
increase (decrease) in cash and cash equivalents
|
361,075 | (654,648 | ) | |||||
|
Cash
and cash equivalents beginning of period
|
87,820 | 742,468 | ||||||
|
Cash
and cash equivalents end of period
|
$ | 448,895 | $ | 87,820 | ||||
See
accompanying notes.
F-4
DOCUMENT
SECURITY SYSTEMS, INC. AND SUBSIDIARIES
Consolidated
Statements of Changes in Stockholders' Equity
For
the Years Ended December 31, 2009 and 2008
|
Common Stock
|
Additional Paid-
|
Subscriptions
|
Accumulated
|
|||||||||||||||||||||
|
Shares
|
Amount
|
in Capital
|
Receivable
|
Deficit
|
Total
|
|||||||||||||||||||
|
Balance,
December 31, 2007
|
13,654,364 | $ | 273,087 | $ | 31,298,571 | $ | - | $ | (24,214,627 | ) | $ | 7,357,031 | ||||||||||||
|
Shares
issued upon the exercise of warrants and options
|
50,000 | 1,000 | 99,000 | - | - | 100,000 | ||||||||||||||||||
|
Stock
based payments
|
65,400 | 1,308 | 1,497,407 | - | - | 1,498,715 | ||||||||||||||||||
|
Warrants
issued with debt
|
- | - | 255,717 | - | - | 255,717 | ||||||||||||||||||
|
Issuance
of common stock, net
|
600,000 | 12,000 | 2,388,000 | (1,300,000 | ) | - | 1,100,000 | |||||||||||||||||
|
Net
Loss
|
- | - | - | - | (8,285,142 | ) | (8,285,142 | ) | ||||||||||||||||
|
Balance,
December 31, 2008
|
14,369,764 | $ | 287,395 | $ | 35,538,695 | $ | (1,300,000 | ) | $ | (32,499,769 | ) | $ | 2,026,321 | |||||||||||
|
Issuance
of common stock, net
|
1,010,000 | 20,200 | 1,354,702 | - | - | 1,374,902 | ||||||||||||||||||
|
Conversion
of debt to equity
|
1,250,000 | 25,000 | 1,975,000 | - | 2,000,000 | |||||||||||||||||||
|
Discount
on debt and beneficial conversion features
|
422,997 | - | 422,997 | |||||||||||||||||||||
|
Stock
based payments
|
93,123 | 1,862 | 401,139 | - | - | 403,001 | ||||||||||||||||||
|
Cancellation
of subscribed shares
|
(325,000 | ) | (6,500 | ) | (1,293,500 | ) | 1,300,000 | - | ||||||||||||||||
|
Net
Loss
|
- | (3,990,013 | ) | (3,990,013 | ) | |||||||||||||||||||
|
Balance,
December 31, 2009
|
16,397,887 | $ | 327,957 | $ | 38,399,033 | $ | - | $ | (36,489,782 | ) | $ | 2,237,208 | ||||||||||||
See
accompanying notes.
F-5
DOCUMENT
SECURITY SYSTEMS, INC. AND SUBSIDIARIES
NOTES
TO THE CONSOLIDATED FINANCIAL STATEMENTS
Document
Security Systems, Inc. (the “Company”), a New York corporation, and its
subsidiaries, primarily operates in the security and commercial printing
markets. The Company develops, patents, markets produces and licenses technology
that prevents documents from unauthorized copying, scanning and counterfeiting.
The Company also provides commercial print services for high quality documents
produced on offset and digital presses, along with plastic documents and ID’s
that include embedded electronics, such as RFID (Radio Frequency Identification)
and variable data magnetic strips. The Company’s customers include governments,
law enforcement agencies, security printers, check and forms printers and
corporations.
Principles of
Consolidation
- The consolidated financial statements include the
accounts of Document Security Systems, Inc. and its subsidiaries. All
intercompany balances and transactions have been eliminated in
consolidation.
Use of
Estimates
- The preparation of consolidated financial statements in
conformity with accounting principles generally accepted in the United States
requires us to make estimates and assumptions that affect the amounts reported
and disclosed in the financial statements and the accompanying notes. Actual
results could differ materially from these estimates. On an ongoing basis, we
evaluate our estimates, including those related to the accounts receivable, fair
values of intangible assets and goodwill, useful lives of intangible assets and
property and equipment, fair values of options and warrants to purchase our
common stock, deferred revenue and income taxes, among others. We base our
estimates on historical experience and on various other assumptions that are
believed to be reasonable, the results of which form the basis for making
judgments about the carrying values of assets and liabilities. We engage
third-party valuation consultants to assist management in the allocation of the
purchase price of significant acquisitions.
Reclassifications
- Certain prior year amounts have been reclassified to conform to the current
year presentation.
Cash and Cash
Equivalents
– The Company maintains its cash in bank deposit accounts
and, from time to time, short term Certificates of Deposits with original
maturities of three months or less. For financial statement presentation
purposes, the Company considers those short-term, highly liquid investments with
original maturities of three months or less to be cash or cash
equivalents.
Restricted
Cash
-
In July 2007, the Company established a restricted cash balance of 87,500
British pounds, as collateral for a deed of guarantee that was required by the
English Court of Appeals in order for the Company to pursue an appeal in that
court. On March 19, 2008, the Company was notified that its appeal was denied
and that the Company owed the European Central Bank, the successful party in the
appeal, the 87,500 British pounds. Final assessment by the Court was made on
July 31, 2009 and in August 2009, the funds were used to pay a portion of the
appeal costs owed by the Company.
Accounts
Receivable
- The Company carries its trade accounts receivable at invoice
amount less an allowance for doubtful accounts. On a periodic basis, the Company
evaluates its accounts receivable and establishes an allowance for doubtful
accounts based upon management’s estimates that include a review of the history
of past write-offs and collections and an analysis of current credit conditions.
At December 31, 2009 the Company established a reserve for doubtful accounts of
approximately $66,000 ($50,000 – 2008). The Company does not accrue interest on
past due accounts receivable.
Inventory
- Inventories consist primarily of paper, plastic materials and cards,
pre-printed security paper, and legal supplies held for resale and are stated at
the lower of cost or market on the first-in, first-out (“FIFO”)
method.
Fixed
Assets
-
Fixed
assets are recorded at cost. Depreciation is computed using the straight-line
method over the estimated useful lives or lease period of the assets whichever
is shorter. Expenditures for renewals and betterments are capitalized.
Expenditures for minor items, repairs and maintenance are charged to operations
as incurred. Any gain or loss upon sale or retirement due to obsolescence is
reflected in the operating results in the period the event takes place.
Depreciation expense in 2009 was approximately $319,000 ($316,000-
2008).
F-6
Investment
- On October 8, 2009, the
Company entered into an Asset Purchase Agreement with Internet Media Services,
Inc. whereby the Company sold the assets and liabilities of Legalstore.com, a
division of the Company, in exchange for 7,500,000 shares of common stock of the
Internet Media Services, Inc. The Company recorded its investment in Internet
Media Services as an equity method investment at the fair market value of the
business sold. Management determined that the transaction qualified as a
derecoginition of a subsidiary under ASC 810-10-40. Therefore, the Company
accounted for the deconsolidation of a subsidiary (“the business”) by recording
the consideration received at fair market value and recognizing a gain in net
income measured as the difference between: the fair value of the consideration
received (7,500,000 shares of common stock of Internet Media Services, Inc. or a
37% interest) and the carrying value of the assets and liabilities sold. Given
that the consideration received is not readily measurable because of the lack of
activity in Internet Media Services, Inc. prior to the transaction, the Company
determined that the value of the “business transferred” is more readily
measurable. The Company determined the fair market value of the business
transferred based on a discounted cash flow model. Under the equity method
investment the Company is required to account for the difference between the
cost of an investment and the amount of the underlying equity in net assets of
an investee as if the investee were a consolidated subsidiary. If the investor
is unable to relate the difference to specific accounts of the investee (
e.g.
, property and
equipment), the difference should be considered to be the same as goodwill.
Investors shall not amortize goodwill associated with equity method investments
after the date ASC 350/Statement No. 142,
Goodwill and Other Intangible
Assets
, is initially applied by the entity in its entirety. The Company
has determined that given the lack of activity in Internet Media Services, Inc.
prior to the transaction, the difference between the cost of the investment
(fair market value) and the underlying equity interest is attributable to
goodwill which difference amounted to approximately $243,000 at December 31,
2009. For the period from October 9, 2009 through December 31, 2009, the
Company’s equity in the earnings of Internet Media Services was di minimus and
not recorded by the Company. The total assets and liabilities of Internet Media
Services, Inc. as of December 31, 2009 amounted to approximately $350,000 and
$60,000, respectively. (See Note 8)
Goodwill
-
Goodwill is the excess of cost of an acquired entity over the fair value of
amounts assigned to assets acquired and liabilities assumed in a business
combination. Goodwill is not amortized, rather it is tested for impairment
annually, and will be tested for impairment between annual tests if an event
occurs or circumstances change that would indicate the carrying amount may be
impaired. Impairment testing for goodwill is done at a reporting unit level.
Reporting units are one level below the business segment level, but are combined
when reporting units within the same segment have similar economic
characteristics. The Company has three reporting units based on the current
structure. An impairment loss generally would be recognized when the carrying
amount of the reporting unit’s net assets exceeds the estimated fair value of
the reporting unit. The Company performs annual assessments and has determined
that no impairment is necessary
Other Intangible
Assets, Patent Defense Costs and
Patent
Application Costs
–
Other intangible assets consists of costs associated with the
application, acquisition and defense of the Company’s patents, contractual
rights to patents and trade secrets associated with the Company’s technologies
and a customer list obtained as a result of acquisitions. The Company’s patents
and trade secrets are for document anti-counterfeiting and anti-scanning
technologies and processes that form the basis of the Company’s document
security business. Patent application costs are capitalized and amortized over
the estimated useful life of the patent, which generally approximates its legal
life. External legal costs incurred to defend the Company’s patents are
capitalized to the extent of an evident increase in the value of the patents and
an expected successful outcome, in accordance to guidance provided by FASB
Concept Statement No. 6 and related guidance in AICPA Technical Questions and
Answers, Section 2260, Other Assets, paragraph .03, “Legal Expenses Incurred to
Defend Patent Infringement Suit”.
Patent defense costs are expensed at the point when it is determined that
the outcome is expected to be unsuccessful. The Company capitalizes the cost of
an appeal until it is determined that the appeal will be unsuccessful. The
Company’s capitalized patent defense costs expenses are analyzed for impairment
based on the expected eventual outcome of the legal action and recoverability of
proceeds or added economic value of the patent in excess of the costs. Legal
actions related to the same patent defense case are unified into one asset group
for the purposes on the impairment analysis. Intangible asset amortization
expense is classified as an operating expense. The Company believes that the
decision to incur patent costs is discretionary as the associated products or
services can be sold prior to or during the application process. The Company
accounts for other intangible amortization as an operating expense, unless the
underlying asset is directly associated with the production or delivery of a
product. To date, the amount of related amortization expense for other
intangible assets directly attributable to revenue recognized is not
material.
Impairment of
Long-Lived Assets -
The Company accounts for long-lived assets and certain identifiable
intangibles for impairment whenever events or changes in circumstances indicate
that the carrying amount of an asset may not be recoverable. Recoverability of
assets to be held and used is measured by a comparison of the carrying amount of
an asset to future net undiscounted cash flows expected to be generated by the
asset including its ultimate disposition. If such assets are considered to be
impaired, the impairment to be recognized is measured by the amount by which the
carrying amount of the assets exceeds the fair value of the assets. Fair value
is determined based on discounted cash flows or appraised values, depending on
the nature of the assets. In December 2008, the Company recorded an impairment
$361,000 for a license agreement the Company had acquired in 2006 for which the
Company assessed that the probable future cash flows expected to be derived from
the license did not support the net carrying value of the license as of December
31, 2008. (See Note 5)
F-7
Fair Value of
Financial Instruments
- Fair value estimates discussed herein are based
upon certain market assumptions and pertinent information available to
management as of December 31, 2009. The carrying amounts reported in the balance
sheet as of December 31, 2009 of cash and cash equivalents, accounts receivable,
accounts payable and accrued expenses approximate fair value because of the
immediate or short-term maturity of these financial instruments. The fair value
of notes payable and long-term debt approximates their carrying value as the
stated or discounted rates of the debt reflect recent market conditions.
Conventional
Convertible Debt
-
When the convertible feature of the conventional convertible debt
provides for a rate of conversion that is below market value, this feature is
characterized as a beneficial conversion feature (“BCF"). Prior to the
determination of the BCF, the proceeds from the debt instrument were first
allocated between the convertible debt and any detachable free standing
instruments that are included, such as common stock warrants. We record a BCF as
a debt discount pursuant to ASC Topic 470-20, formerly EITF Issue No. 98-5 (EITF
98-05"), Accounting for Convertible Securities with Beneficial Conversion
Features or Contingency Adjustable Conversion Ratio," and EITF Issue No. 00-27,
“Application of EITF Issue No. 98-5 to Certain Convertible Instrument(s)". In
those circumstances, the convertible debt will be recorded net of the discount
related to the BCF. We amortize the discount to interest expense over the life
of the debt using the effective interest method.
Share-Based
Payments
- Compensation cost for stock awards are measured at fair value
and recognize compensation expense over the service period for which awards are
expected to vest. The Company uses the Black-Scholes option pricing model for
determining the estimated fair value for stock-based awards. The Black-Scholes
model requires the use of subjective assumptions which determine the fair value
of stock-based awards, including the option’s expected term and the price
volatility of the underlying stock. For equity instruments issued to consultants
and vendors in exchange for goods and services follows the Company determines
the measurement date for the fair value of the equity instruments issued at the
earlier of (i) the date at which a commitment for performance by the consultant
or vendor is reached or (ii) the date at which the consultant or vendor’s
performance is complete. In the case of equity instruments issued to
consultants, the fair value of the equity instrument is recognized over the term
of the consulting agreement.
Revenue
Recognition
-
Sales of
security and commercial printing products, and legal products are recognized
when a product or service is delivered, shipped or provided to the customer and
all material conditions relating to the sale have been substantially
performed.
For
digital solutions sales, revenue is recognized in accordance with authoritative
guidance on software revenue recognition.
Accordingly, revenue is
recognized when all of the following conditions are satisfied: (1) there is
persuasive evidence of an arrangement; (2) the service or product has been
provided to the customer; (3) the amount of fees to be paid by the customer is
fixed or determinable (4) the collection of our fees is reasonably
assured.
The
Company recognizes revenue from technology licenses once all the following
criteria for revenue recognition have been met: (1) persuasive evidence of an
agreement exists; (2) the right and ability to use the product or technology has
been rendered; (3) the fee is fixed and determinable and not subject to refund
or adjustment; and (4) collection of the amounts due is reasonably
assured.
Advertising
Costs
– Generally consist of online, keyword advertising with Google with
additional amounts spent on certain print media in targeted industry
publications
.
Advertising costs were $23,000 in 2009 ($42,000 – 2008).
Research and
Development
– Research and development costs are expensed as
incurred.
Foreign
Currency-
. Net gains and losses resulting from transactions denominated
in foreign currency are recorded as other income or loss.
Income
Taxes
- The Company recognizes estimated income taxes payable or
refundable on income tax returns for the current year and for the estimated
future tax effect attributable to temporary differences and carry-forwards.
Measurement of deferred income items is based on enacted tax laws including tax
rates, with the measurement of deferred income tax assets being reduced by
available tax benefits not expected to be realized. We recognize penalties and
accrued interest related to unrecognized tax benefits in income tax
expense.
F-8
Earnings Per
Common Share
- The Company presents basic and diluted earnings per share.
Basic earnings per share reflects the actual weighted average of shares issued
and outstanding during the period. Diluted earnings per share are computed
including the number of additional shares that would have been outstanding if
dilutive potential shares had been issued. In a loss year, the calculation for
basic and diluted earnings per share is considered to be the same, as the impact
of potential common shares is anti-dilutive.
For the
years ended December 31, 2009 and 2008, there were up to 2,652,886 and
1,868,063, respectively, of shares potentially issuable under convertible debt
agreements, options, warrants and restricted stock agreements that could
potentially dilute basic earnings per share in the future were excluded from the
calculation of diluted earnings per share because their inclusion would have
been anti-dilutive to the Company’s losses in the respective years. From January
1, 2010 to March 19, 2010 , the Company issued a total of 1,277,437 shares of
common stock that will dilute future earnings of the Company, consisting of
735,437 shares that were issued in conjunction with the acquisition of Premier
Packaging (See Note 16), 304,000 share issued for the exercise of warrants,
200,000 shares issued for private placements, and 38,000 shares issued for
payments. In addition, the Company issued 150,000 options to employees during
this period that could potentially dilute basic earnings per share in the
future.
Concentration of
Credit Risk
- The Company maintains its cash and cash equivalents in bank
deposit accounts, which at times may exceed federally insured limits. The
Company believes it is not exposed to any significant credit risk as a result of
any non-performance by the financial institutions.
During
2009, two customers accounted for 19% and 12% of the Company’s total revenue
from continuing operations, respectively. As of December 31, 2009, two
customers’ account receivable balance accounted for 21% and 17% of the Company’s
trade accounts receivable balance, respectively. During 2008, two customers
accounted for 11% and 10% of the Company’s total revenue from continuing
operations, respectively. As of December 31, 2008, one customer account
receivable balance that was acquired as part of the Company’s acquisition of the
assets of a commercial printer in December 2008, accounted for 42% of the
Company’s trade accounts receivable balance. The risk with respect to trade
receivables is mitigated by credit evaluations we perform on our customers, the
short duration of our payment terms for the significant majority of our customer
contracts and by the diversification of our customer base.
Continuing
Operations -
The
Company has incurred significant net losses in previous years. The Company’s
ability to fund its capital requirements out of its available cash and cash
generated from its operations depends on a number of factors. Some of these
factors include the Company’s ability to (i) increase commercial and security
printing and plastic card sales; (ii) increase sales of the Company’s digital
products; and (iii) integrate its new acquisition of Premier Packaging with
its existing product lines. If the Company cannot generate sufficient cash from
its operations as of December 31, 2009, the Company has approximately $449,000
in cash and $417,000 available to it under one credit facility. In
February 2010, the Company raised approximately $1.1 million through the
exercise of warrants and sale of shares of common stock through private
placements. The Company used approximately $600,000 of these funds
towards the acquisition of Premier Packaging Corp. The remainder is available
for working capital requirements together with up to $1,000,000 available
under a credit line at its Premier Packaging, subsidiary acquired in 2010. (See
Note 16).
Further, the
Company may need to raise additional funds in the future in order to fund its
working capital needs
and
pursue its growth strategy, which although there can be no assurances,
management feels that sources for these additional funds will be available
through either current or future investors.
Recent Accounting
Pronouncements
In
December 2007, the Financial Accounting Standards Board (“FASB”) issued SFAS
141(r),
Business
Combinations
, now Accounting Standards Codification (“ASC”) 805, which
addresses the accounting and disclosure for identifiable assets acquired,
liabilities assumed, and noncontrolling interests in a business combination. In
April 2009, the FASB issued FASB Staff Position No. FAS 141(r)-1,
Accounting for Assets Acquired and
Liabilities Assumed in a Business Combination That Arise from
Contingencies
(FSP FAS 141(r)-1), which amended certain provisions of
SFAS 141(r) related to the recognition, measurement, and disclosure of assets
acquired and liabilities assumed in a business combination that arise from
contingencies. SFAS 141(r) and FSP FAS 141(r)-1 became effective in the first
quarter of 2009, and did not have a material impact on the consolidated
financial statements.
In June
2008, the EITF reached a consensus in Issue No. 07-5, “Determining Whether an
Instrument (or Embedded Feature) Is Indexed to an Entity’s Own Stock” (“EITF
07-5”), now ASC 815. This Issue addresses the determination of whether an
instrument (or an embedded feature) is indexed to an entity’s own stock, which
is the first part of the scope exception in paragraph 11(a) of SFAS 133. EITF
07-5 is effective for fiscal years beginning after December 15, 2008, and
interim periods within those fiscal years. Early application is not permitted.
The adoption of EITF 07-5 during the first quarter of 2009 did not have a
material impact on the consolidated financial statements.
F-9
In May
2009, the FASB issued SFAS No. 165, “Subsequent Events” (“SFAS No. 165”), now
ASC 855, to incorporate accounting guidance that originated as auditing
standards into the body of authoritative literature issued by the FASB. SFAS No.
165 requires the evaluation of subsequent events through the date the financial
statements are issued and the disclosure of the date through which subsequent
events were evaluated and the basis for that date. This statement is effective
for interim and annual financial periods ending after June 15, 2009. The Company
adopted the requirements of SFAS No. 165 for the period ending June 30, 2009.
The adoption of SFAS No. 165 did not have a significant impact on our
consolidated financial position, results of operations or cash flows. (See Note
16).
FASB Codification.
In July
2009, the FASB issued SFAS No. 168, “The FASB Accounting Standards Codification
and the Hierarchy of Generally Accepted Accounting Principles (“GAAP”) (as
amended)” (“SFAS No. 168”), now ASC 105, making the FASB Accounting Standards
Codification the single source of authoritative nongovernmental U.S. GAAP. The
Codification is not intended to change GAAP, however, it will represent a
significant change in researching issues and referencing U.S. GAAP in financial
statements and accounting policies. This statement is effective for financial
statements issued for interim and annual periods ending after September 15,
2009. The Company has adopted the new codification standards.
ASU No.
2010-06, Fair Value Measurements and Disclosures (Topic 820) – Improving
Disclosures about Fair Value Measurements This ASU affects all entities that are
required to make disclosures about recurring and nonrecurring fair value
measurements under FASB ASC Topic 820, originally issued as FASB Statement No.
157, Fair Value Measurements. The ASU requires certain new disclosures and
clarifies two existing disclosure requirements. The new disclosures and
clarifications of existing disclosures are effective for interim and annual
reporting periods beginning after December 15, 2009, except for the disclosures
about purchases, sales, issuances, and settlements in the roll forward of
activity in Level 3 fair value measurements. Those disclosures are effective for
fiscal years beginning after December 15, 2010, and for interim periods within
those fiscal years. The Company is currently evaluating the potential impact of
the adoption on the consolidated financial position, results of operations and
cash flows.
Inventory
consisted of the following:
|
December 31,
|
December 31,
|
|||||||
|
2009
|
2008
|
|||||||
|
Finished
Goods
|
$ | 38,093 | $ | 137,972 | ||||
|
Work
in process
|
58,493 | 120,713 | ||||||
|
Raw
Materials
|
87,588 | 100,349 | ||||||
| $ | 184,174 | $ | 359,034 | |||||
F-10
Fixed
assets consisted of the following at December 31:
|
2009
|
2008
|
|||||||||||||||||
|
Estimated
Useful Life
|
Purchased
|
Under Capital
Leases
|
Purchased
|
Under
Capital
Leases
|
||||||||||||||
|
Machinery
& equipment
|
5-7
years
|
$ | 752,387 | $ | 547,936 | $ | 770,672 | $ | 484,936 | |||||||||
|
Leasehold
improvements
|
up
to 13 years (1)
|
735,434 | - | 727,339 | - | |||||||||||||
|
Furniture
& fixtures
|
7
years
|
70,209 | 0 | 90,952 | - | |||||||||||||
|
Software
& websites
|
3
years
|
270,725 | - | 258,744 | - | |||||||||||||
|
Total
cost
|
$ | 1,828,755 | $ | 547,936 | $ | 1,847,707 | $ | 484,936 | ||||||||||
|
Less
accumulated depreciation
|
809,082 | 281,383 | 610,267 | 205,019 | ||||||||||||||
|
Net
|
$ | 1,019,673 | $ | 266,553 | $ | 1,237,440 | $ | 279,917 | ||||||||||
(1)
Expiration of lease term
Goodwill
-
The Company performs an annual fair value test of its recorded goodwill for its
reporting units using a discounted cash flow and capitalization of earnings
approach. As of December 31, 2009, the Company had goodwill of approximately
$1,316,000 attributable to the document security products and printing segment.
There was no goodwill recorded by the Company as a result of the acquisition of
substantially all of the assets of DPI of Rochester, LLC in December 2008. In
October 2009, we sold the assets and liabilities associated with our
Legalstore.com business in exchange for common stock of Internet Media Services,
Inc.. The sale included goodwill with a net book value of approximately
$81,000.
Other Intangible
Assets
- Other intangible assets are comprised of the following at
December 31:
|
2009
|
2008
|
|||||||||||||||||||||||||
|
Useful Life
|
Gross Carrying
Amount
|
Accumulated
Amortizaton
|
Net Carrying
Amount
|
Gross
Carrying
Amount
|
Accumulated
Amortizaton
|
Net Carrying
Amount
|
||||||||||||||||||||
|
Royalty
rights
|
5
years
|
$ | 90,000 | $ | 90,000 | $ | - | $ | 90,000 | $ | 90,000 | $ | - | |||||||||||||
|
Acquired
intangibles
|
5
years
|
666,300 | 532,285 | 134,015 | 666,300 | 405,424 | 260,876 | |||||||||||||||||||
|
Patent
acquisition and defense costs
|
Varied
(1)
|
4,729,889 | 3,879,341 | 850,548 | 4,729,889 | 2,732,422 | 1,997,467 | |||||||||||||||||||
|
Patent
application costs
|
Varied
(2)
|
776,159 | 171,753 | 604,406 | 718,875 | 103,429 | 615,446 | |||||||||||||||||||
| $ | 6,262,348 | $ | 4,673,379 | $ | 1,588,969 | $ | 6,205,064 | $ | 3,331,275 | $ | 2,873,789 | |||||||||||||||
(1)-
patent rights are amortized over their expected useful life which is generally
the legal life of the patent. As of December 31, 2009 the weighted average
remaining useful life of these assets in service was 1.1 years.
(2)-
patent rights are amortized over their expected useful life which is generally
the legal life of the patent. As of December 31, 2009 the weighted average
remaining useful life of these assets in service was 13.6 years.
Actual
amortization for 2009 and 2008 and expected amortization for each of the next
five years is as follows:
F-11
|
2008
Actual
|
$ | 1,972,000 | ||||
|
2009
Actual
|
$ | 1,342,000 | ||||
|
Expected
|
2010
|
$ | 641,185 | |||
|
2011
|
426,781 | |||||
|
2012
|
39,845 | |||||
|
2013
|
39,845 | |||||
|
2014
|
39,845 | |||||
|
Thereafter
|
401,468 | |||||
| $ | 1,588,969 |
Acquired
Intangible Assets -
In February 2006, the Company acquired intangible
assets associated with its acquisitions of the assets of Plastic Printing
Professional. These intangible assets were valued at $625,000 by an independent
valuation firm and consist of customer lists, trade name and brand, and a
non-compete agreement.
In June
2007, the Company entered into an agreement with International Barcode
Technologies, also known as BTI, to extend the expiration date of warrants to
purchase 500,000 shares of common stock of the Company at a purchase price of
$10.00 per share from June 16, 2007 to December 31, 2007. In exchange, BTI
agreed to provide the Company with a five year non-exclusive license to market
and produce BTI’s advanced barcode technologies in the United States. The value
of the extension of the warrant was determined to be approximately $521,000
using the Black-Scholes option pricing model. This amount was recorded as an
other intangible asset and was being amortized over the expected useful life of
the license agreement of five years. In December 2008, the Company recorded an
impairment of $361,000 when the Company assessed that the probable future cash
flows expected to be derived from the license did not support the net carrying
value of the license as of December 31, 2008.
Patent
Acquisition and Defense Costs
-
Included
in the Company’s capitalized patent defense costs are costs associated with the
acquisition of certain rights associated with patents that the Company is
defending. In December 2004, the Company entered into an agreement with the
Wicker Family in which Document Security Systems obtained the legal ownership of
technology (including patent ownership rights) previously held by the Wicker
Family. At that time, the agreement with the Wicker Family provided that the
Company would retain 70% of the future economic benefit derived from
settlements, licenses or subsequent business arrangements from any infringer of
the Wicker patents that Document Security Systems chooses to pursue. The Wicker
Family was to receive the remaining 30% of such economic benefit. In February
2005, the Company further consolidated its ownership of the Wicker Family based
patents and its rights to the economic benefit of infringement settlements when
the Company purchased economic interests and legal ownership from approximately
45 persons and entities that had purchased various rights in Wicker Family
technologies over several decades. The Company issued an aggregate of 541,460
shares of its Common Stock for the rights of the interest holders and secured
100% ownership of a US Patent and approximately 16% of additional economic
rights to settlements with infringers of the Wicker Family’s foreign patents.
The value of the shares of Common Stock was determined based upon the closing
price of the shares of the Company’s Common Stock on the American Stock Exchange
on February 15, 2005 of $7.25 per share was, $ 3,905,672 net of expenses. As of
December 31, 2009, the net unamortized balance of acquired patent assets was
$757,000.
Patent
defense costs are comprised of legal cost associated with our patent
infringement suit against the European Central Bank (“ECB Litigation”). We based
our decision to defer the costs associated with this case on the principal that
successful patent defense costs are capitalizable. First, the Company’s case is
based on the relationship of the inventor of the Company’s patent with various
representatives of European currency printers, consultants, and other
participants during the late 1990’s in regard to the industry’s attempts to
defeat new advanced levels of copier and scanning technologies that were then
emerging in the marketplace. The inventor of the DSS’s patent had a proven
history of success in anti-counterfeiting technology, and was seen as a source
for these industry participants to help solve these challenges. The Company
believes that it can establish a direct link between these communications and
the use of the technology by these industry participants in the design and
production of the Euro, which was designed in the late 1990’s and was initially
released for circulation in 2002. In addition, prior to filing the ECB
litigation, the Company consulted extensively with legal counsel and performed
extensive due diligence with our legal counsel for approximately one year to
analyze the merits of our patent infringement case, and only after these efforts
did we take our legal counsel’s recommendation to proceed with the European
Central Bank (ECB) Litigation.
Based on the cumulative evidence available to the Company at the time of
filing the suit, the Company has believed from the outset of the case that it
will be able to prove in court that the ECB infringed the Company’s patent on
its Euro notes by using the Company’s technology in the design of the notes for
the specific purpose of making the notes difficult to copy, and therefore the
Company’s infringement case would be successful. Since the case was filed, the
Company has not seen any evidence from the ECB which specifically addresses the
Company’s infringement assertions.
F-12
The most
significant events in the case since it was filed have been the challenges of
patent validity by the ECB. The Company believes that the ECB’s
challenge of patent validity represents the biggest hurdle to a successful
outcome. To date, there have been four adverse rulings and two
positive rulings in regard to the patent’s validity. The
Company believes that the European court system for patent disputes is unique
since it separates jurisdiction to its member states despite having a unified
patent application and approval system. As a case in point, on March
26, 2007, the Company’s patent was deemed invalid in the United Kingdom and then
on the immediately following day, on March 27, 2007, the Company’s patent was
ruled as valid in Germany. In addition, on January 9, 2008 the
French Court held that the patent was invalid in France for the same reasons
given by the English Court. On March 12, 2008 the Dutch Court, having
considered the English, German and French decisions, ruled that the Patent is
valid in the Netherlands. On November 3, 2009, the Belgium
Court held that the Patent was invalid in Belgium for the same reasons given by
the English and French Courts.
When we
assess the impact of these decisions, the Company understands that the adverse
rulings on validity mean that the Company will not be able to file infringement
lawsuits in those jurisdictions, and assesses these material changes in its
analysis of the potential proceeds of its case. The win in Germany,
which has the largest volume of circulation of the European banknotes, had a
significant positive impact on the Company’s probability analysis of cash flows
associated with the case. Furthermore, the Company understands that a
successful infringement ruling in any one of the jurisdictions of the European
Union will have a similar impact as if the Company was successful in all of the
jurisdictions of the case, since the ECB would have to either remove the
technology from its banknotes, produce different banknotes depending on the
jurisdiction in which the banknote is circulated, or pay a licensing fee to
continue to use the Company’s patented technology. The Company
believes that the ECB would address the going-forward use of the Company’s
technology in its banknotes, either through a license or settlement, regardless
if the Company wins in one jurisdiction or all
nine. Furthermore, regardless of the ECB’s decision on how to
address a going-forward usage of the Company’s technology, if the Company is
successful in its litigation against the ECB, it is expected that a court would
impose damages on the ECB for prior, unauthorized usage of the Company’s
patent.
The
Company will seek a lump-sum payment for all past uses of the infringed patented
technology, and then will seek an on-going license fee for the continued use of
the patented technology. The Company expects that the ECB will choose
to pay the ongoing license fees rather than redesign the Euro bank notes to not
include the patented technology. The Company’s basis for
this expectation is based on its understanding of the security printing
business. The Company has a long history of licensing its other
patented technology to commercial security printers for use in commercial and
governmental documents in the same manner (% of sales) that it expects the ECB
to pay, either via court decision or a license fee settlement.
In its
analysis of the recoverability of its capitalized patent defense costs, the
Company uses the potential proceeds from its ECB Litigation as the primary
source of future cash flows. In addition, the Company believes that
there are additional infringers of the technology that it may pursue in the
future, depending on the outcomes of its suit with the
ECB. Specifically, the Company uses assumptions of
banknote production volumes during the alleged infringement period and estimated
banknote production costs from third party sources to determine the estimated
total costs of the production of the Euro banknotes in each year of
infringement. The Company then applies a royalty rate that the
Company generally charges international licensees and that the Company believes
is consistent with industry standards to determine the amount that would be due
to the Company if the ECB had licensed the technology from the Company on the
Company’s standard licensing terms. The Company uses this
amount as an estimate of the gross proceeds it could receive from a successful
outcome of the litigation in all jurisdictions. The Company then
allocates these potential proceeds by the percent of circulation of each
jurisdiction in which the Company has ongoing litigation to determine the
potential proceeds of a successful outcome in the jurisdictions where the patent
has been held as valid or where the patent validity has not yet been
determined. Finally, the Company uses a probability factor in its
analysis that discounts these potential future proceeds that takes into account
the different status levels of each jurisdiction. Thus, the
Company determines a probability based cash flow which is compared to the net
patent defense costs balance to determine whether an impairment of these costs
has occurred.
If a
patent is determined to be invalid in a jurisdiction, as has occurred in the
United Kingdom, France, Belgium and Austria, then all appeal costs and other
costs associated with the loss such as court and opposition fees awarded are
expensed as incurred in the period in which the amount is
determined.
F-13
On March
19, 2008, the Company received notification that its appeal of the invalidation
of its European Paten 455750B1 in the UK was not successful. As a
result of the adverse court decision, the Company recognized an impairment loss
of $292,000 during 2008 associated with the costs directly related to the UK
appeal. The impairment loss includes a judgment for reimbursement of
estimated counterpart legal fees. In January 2009, the Company
received a formal request for the fee reimbursement from the ECB of $420,000 in
addition to the amounts already paid by the Company. The
Company hired an independent firm to assist the Company in reducing or
eliminating the ECB’s fees request, however, the Company recorded $145,000 as
additional accrued expenses and an impairment loss as of December 31,
2008. On July 31, 2009, the UK court made the final assessment
of costs for the UK patent validity case due from the Company to the ECB of
₤356,490, of which the Company has paid ₤332,000 through December 31, 2009 and
owes approximately ₤25,000 ($40,000 as of December 31, 2009), which amount was
included in accrued expenses as of December 31, 2009.
On August
20, 2008, the Company entered into an agreement with Trebuchet Capital Partners,
LLC (“Trebuchet”) under which Trebuchet has agreed to pay
substantially all of the litigation costs associated with pending validity
proceedings initiated by the European Central Bank (“ECB”) in eight European
countries relating to the Company’s European Patent 0 455 750B1 that the
Company has claimed the ECB infringed in printing of the Euro
currency (the “Patent”). Trebuchet also agreed to pay substantially all of the
litigation costs associated with future validity challenges filed by the ECB or
other parties, provided that Trebuchet elects to assume the defense of any such
challenges, in its sole discretion, and patent infringement suits filed against
the ECB and certain other alleged infringers of the Patent, all of which suits
may be brought at the sole discretion of Trebuchet and may be in the name of the
Company, Trebuchet or both. The Company provided Trebuchet with the sole and
exclusive right to manage infringement litigation relating to the Patent in
Europe, including the right to initiate litigation in the name of the Company,
Trebuchet or both and to choose whom and where to sue, subject to certain
limitations set forth in the agreement. Under the terms of the Agreement, the
Company and Trebuchet have agreed to equally share all proceeds generated from
litigation relating to the Patent, including judgments and licenses or other
arrangements entered into in settlement of any such litigation. Trebuchet is
also entitled to recoup any litigation expenses specifically awarded to the
Company in such actions. Under the terms of the Agreement, and in consideration
for Trebuchet’s funding obligations, the Company assigned and transferred a 49%
interest of the Company’s rights, title and interest in the Patent to Trebuchet
which allows Trebuchet to have a separate and distinct interest in and share of
the Patent, along with the right to sue and recover in litigation, settlement or
otherwise to collect royalties or other payments under or on account of the
Patent. Trebuchet will receive 50% of all proceeds from any
judgments, settlements, licenses or other forms of payment received as a result
of any litigation. Pursuant to this transaction, the Company
recognized a loss on the sale of patent assets for its assignment and transfer
of 49% of its ownership rights in the patent, which had a net book value of
approximately $1,670,000, for proceeds of $500,000, As a
result, the Company recognized a loss on sale of patent assets of approximately
$1,170,000 as of December 31, 2008.
As of
December 31, 2009, the net unamortized balance of the Company’s capitalized
patent defense costs was approximately $93,000.
Patent
Application Costs
-
On an
ongoing basis, the Company submits formal and provisional patent applications
with the United States, Canada and countries included in the Patent Cooperation
Treaty (PCT). The Company capitalizes these costs and amortizes
them over the patents’ estimated useful life.
Long Term Revolving Notes- Related
Parties
-
On
January 4, 2008, the Company entered into a Credit Facility Agreement with
Fagenson and Co., Inc., as agent, a related party to Robert B. Fagenson, the
Chairman of the Company's Board of Directors. Under the Fagenson Credit
Agreement, the Company could borrow up to a maximum of $3,000,000 from time to
time up to and until January 4, 2010. Any amount borrowed by the
Company pursuant to the Fagenson Credit Agreement has annual interest rate of 2%
above LIBOR and is secured by the Common Stock of Plastic Printing
Professionals, Inc., (“P3”) the Company's wholly owned
subsidiary. Interest is payable quarterly in arrears and the
principal is payable in full at the end of the term under the Fagenson Credit
Agreement. On December 11, 2009, the Company entered into a Letter
Agreement with the lenders for the conversion of $2,000,000 of debt owed under
the Credit Facility into 1,250,000 shares of Document Security Systems Common
Stock. In addition, the parties amended the Credit Facility to
allow for a maximum borrowing of up to $1,000,000 and extended the due date to
January 4, 2012. As of December 31, 2009, the Company had outstanding
$583,000 under the Fagenson Credit Agreement. Under the
terms of the agreement the Company is required to comply with various
covenants. As of December 31, 2009, the Company was in default of the
agreement due to a failure to pay interest when due. Fagenson and Co.
has waived the defaults through January 1, 2011.
On January 4, 2008, the Company also
entered into a Credit Facility Agreement with Patrick White, the Company's Chief
Executive Officer and a member of the Board of Directors. Under the
White Credit Agreement, the Company could borrow up to $600,000 from time to
time up to and until January 4, 2010. Any amount borrowed by the
Company pursuant to the White Credit Agreement will have an annual interest rate
of 2% above LIBOR.
On December 30,
2009, the Company used the proceeds
from a $450,000 Convertible Note to pay in full the $450,000 due under the White
Credit Agreement
.
F-14
Interest
expense for the two revolving notes for the years ended December 31, 2009 and
2008 was $106,000 and $82,000, respectively, of which $152,000 for the Fagenson
and Company Note is included in accrued expenses as of December 31, 2009
($54,000 -2008).
Notes Payable-
On May 7, 2008
the Company entered into a $500,000 unsecured credit facility with Taiko III
Corp to fund the Company’s ongoing patent infringement and related lawsuits
against the European Central Bank. Interest accrued on the unpaid
principal amount at a 6% annual rate. On August 20, 2008, the
Company entered into an agreement with Trebuchet Capital Partners, LLC, which,
among other things, called for Trebuchet to pay the Company $500,000, which the
Company used to pay in full the Company’s existing obligation owed to Taiko III
Corp.
On
December 18, 2008, the Company’s wholly owned subsidiary, Secuprint, Inc. (dba
DPI Secuprint, Inc.) entered a Secured Promissory Note with Baum
Capital Investments Inc. in the principal amount of up to $900,000 to pay for
most of the cash portion of the purchase price of the Company’s acquisition of
substantially all of the assets of DPI of Rochester, LLC. The Secured
Promissory Note had a one-year term, and was secured by all of the assets of DPI
Secuprint with an annual interest rate of 15% that was reduced to 12% after
certain conditions were met. In conjunction with the Note, the
Company issued warrants to purchase up to a total of 250,000 shares of the
Company’s common stock at an average price of $2.00 per
share. The warrants are exercisable on February 16, 2009
and expire on December 17, 2013. The fair value of the warrants of approximately
$256,000 was determined using the Black Scholes option pricing model, and was
recorded as discount on debt and will be amortized over the term of the
Note.
On
December 9, 2009, the Company used the proceeds from a $350,000 Convertible Note
and a $575,000 Promissory Note, respectively, to pay in full the $900,000 Baum
Note. The $350,000 Convertible Note matures November 24, 2012,
accrues interest at 10%, payable quarterly, and is convertible into up to
218,750 shares of Document Security Systems Common Stock. The
$575,000 Promissory Note matures November 24, 2012 and accrues interest at 10%,
payable quarterly. Both Notes are secured with equal rights by
the assets of the Company’s wholly owned subsidiary, DPI Secuprint. In
conjunction with the convertible note, the Company determined a beneficial
conversion feature existed amounting to approximately $94,000 which was recorded
as discount on debt and will be amortized over the term of the
Note.
On
December 30, 2009, the Company used the proceeds from a $450,000 Convertible
Note to pay in full $450,000 due under White Credit
Facility. The $450,000 Convertible Note matures June 23, 2012,
accrues interest at 8%, payable quarterly, is convertible into up to 260,116
shares of Document Security Systems Common Stock, and is secured by the accounts
receivable of the Company, excluding the accounts receivable of the Company’s
wholly owned subsidiaries, Plastic Printing Professionals and DPI
Secuprint. In conjunction with the Note, the Company issued to
the holders of the Note warrants to purchase up to 65,000 shares of the
Company’s common stock within five years at $2.00 per share. The
estimated fair market value of these warrants was determined using the Black
Scholes option pricing model at approximately $72,000, which was recorded as
discount on debt and will be amortized over the term of the
Note. Furthermore, in conjunction with this convertible note, the
Company determined a beneficial conversion feature existed amounting to
approximately $257,000, which was recorded as discount on debt and will be
amortized over the term of the Note. In addition, the Company
recorded expense of approximately $110,000 for the fair value of 40,000 warrants
to purchase the shares of the Company’s common stock at $2.00 issuable to the
holder of the Convertible Note as a result of the Company’s failure to file a
registration statement under the terms of the Note.
All of
the obligations outstanding as of December 31, 2009 mature during
2012.
Stock Issued in
Private Placements
-In June, 2008 the Company entered into two
Share Purchase Agreements pursuant to which the Company agreed to sell a total
of 500,000 shares of the Company’s common stock for an aggregate purchase price
of $2,000,000. Pursuant to the terms of the first Agreement, the Company sold
150,000 shares of Common Stock to the Purchaser for $600,000 payable on June 25,
2008. Pursuant to the terms of the first Agreement, the Purchaser could not sell
the 150,000 shares of Common Stock purchased thereunder earlier than June 25,
2009. Pursuant to the terms of the second Agreement, the Company sold
350,000 shares of Common Stock for $1,400,000, with $100,000 payable on June 25,
2008 and the remaining $1,300,000 payable in six-month installments over a
two-year period. On June 3, 2009, the Company and the purchaser
executed a letter agreement terminating the parties' Share Purchase Agreement
dated June 25, 2008 and any obligations outstanding thereunder. The first
installment of $100,000 was paid. A second payment installment in the
amount of $300,000 was due on December 25, 2008, but was not paid. As
a result, the parties agreed to terminate the Share Purchase Agreement which
resulted in the cancellation of 325,000 of the Company’s shares as of June 3,
2009.
F-15
On August
20, 2008, the Company entered into an agreement with Trebuchet Capital Partners,
LLC who agreed to pay substantially all of the litigation costs associated with
pending validity proceedings initiated by the ECB in eight European countries
relating to the Company’s European Patent 0 455 750B1 that the Company has
claimed the ECB infringed in printing of the Euro
currency. Trebuchet has also purchased 100,000 shares of the
Company’s common stock for an aggregate purchase price of $400,000, the
proceeds of which were used by the Company to pay existing litigation
cost.
Between
May 29, 2009 and June 22, 2009, the Company sold 56 investment units in a
private placement at a price of $10,000 per unit for aggregate proceeds of
$560,000 less $44,000 in expenses, consisting of 400,000 shares of common
stock and warrants to purchase an aggregate of 80,000 shares of common
stock. The estimated fair market value of these warrants was
determined using the Black Scholes option pricing model at approximately
$80,000. On July 15, 2009, the Company sold 24.5 investment units for
$10,000 per unit for gross cash proceeds of $245,000, consisting of 175,000
shares of Common Stock and Warrants to purchase an aggregate of 35,000 shares of
Common Stock. The estimated fair market value of these warrants was determined
using the Black Scholes option pricing model at approximately
$34,000. On August 24, 2009, the Company completed the sale of 7
investment units in a private placement pursuant to subscription agreements with
one accredited investor dated the same date. In the transaction, the
Company sold 7 investment units for $10,000 per unit for gross cash proceeds of
$70,000, consisting of 50,000 shares of common stock and warrants to purchase an
aggregate of 10,000 shares of common stock. The estimated fair market
value of these warrants was determined using the Black Scholes option pricing
model at approximately $10,000. Each investment unit consisted of
7,142 shares of its common stock and five-year warrants to purchase up to an
aggregate of 1,427 shares of its common stock at an exercise price of $2.00 per
share.
On
September 4, 2009, the Company completed the sale of 44 investment units in a
private placement pursuant to subscription agreements with three accredited
investors dated the same date. Each investment unit is comprised of 6,250 shares
of the Company’s common stock and five year warrants to purchase 1,250 shares of
common stock at an exercise price of $2.00 per share. In the transaction, the
Company sold 44 investment units for $10,000 per unit for gross cash proceeds of
$440,000, less expenses of $52,000, consisting of 275,000 shares of common stock
and warrants to purchase an aggregate of 55,000 shares of common stock. The
estimated fair market value of these warrants was determined using the Black
Scholes option pricing model at approximately $54,000.
On
October 19, 2009, the Company completed the sale of 17.6 investment units in a
private placement pursuant to subscription agreements with three accredited
investors dated the same date. Each investment unit is comprised of 6,250 shares
of the Company’s common stock and five year warrants to purchase 1,250 shares of
common stock at an exercise price of $2.00 per share. In the transaction, the
Company sold 17.6 investment units for $10,000 per unit for gross cash proceeds
of $176,000, less expenses of $17,600, consisting of 110,000 shares of common
stock and warrants to purchase an aggregate of 22,000 shares of common stock.
The estimated fair market value of these warrants was determined using the Black
Scholes option pricing model at approximately $38,000.
Stock
Warrants
- During 2009, in conjunction with the private placements
described above, the Company issued an aggregate of 202,000 warrants to purchase
the Company’s shares of Common Stock at an exercise price of $2.00, as described
above. In addition, during 2009, the Company issued to the holders of
a Convertible Note warrants to purchase up to 65,000 shares of the Company’s
common stock within five years at $2.00 per share.
On
October 21, 2009, the Company entered into a consulting agreement with
Vertical Innovations and agreed to issue the consultant five year warrants to
purchase 50,000 shares of the Company's common stock at $3.00, 100,000 shares of
common stock at $3.50 and 50,000 shares of common stock at $4.00. The
Company estimated the value of these warrants at approximately
$258,000 as of December 31, 2009 using the Black-Scholes option pricing model
which the Company expects to record the measurement date fair value as expense
over a two year period.
On
November 19, 2009, the Company entered into an agreement with Baum Capital for
which Baum Capital would execute up to an aggregate amount of $275,000 of
Letters of Credit on behalf of the Company’s subsidiary, DPI Secuprint, for the
extension of credit from certain of DPI Secuprint’s paper
vendors. The Letters of Credit will have a term of twelve months and
are secured by the accounts receivable of DPI Secuprint. In exchange,
the Company issued to Baum Capital warrants to purchase 50,000 shares of the
Company's common stock at $2.00. The Company valued these warrants at
approximately $56,000 using the Black-Scholes option pricing model which the
Company expects to record as expense over a one year period.
On
December 7, 2009, the Company reached an agreement to issue 40,000 shares of
common stock and 50,000 of common stock warrants for the purchase of common
shares at $3.00 per share for a period of three years from November 23, 2009, in
connection with the settlement of certain litigation between the Company and the
recipients. The value of the stock amounted to $85,000 based on the
closing price the day the agreement was reached. The fair value of
the warrants of approximately $29,500 was determined utilizing the Black Scholes
pricing model. The aggregate cost of approximately $115,000 is
recognized in the statement of operations under Litigation
Settlements,
F-16
During
year ended December 31, 2008, the Company received $100,000 in proceeds from the
exercise of warrants to purchase 50,000 shares of its common
stock. The Company received no proceeds from the exercise of warrants
during 2009.
On
December 18, 2008, the Company issued warrants to purchase up to a total of
250,000 shares of the Company’s common stock at an average price of $2.00 per
share in conjunction with a secured promissory note. (See Note 6- Short Term and
Long-Term Debt) The warrants are exercisable on February 16, 2009
and expire on December 17, 2013. The fair value of the warrants of
approximately $256,000 was determined using the Black Scholes option pricing
model, and was recorded as discount on debt and will be amortized over the term
of the note.
The
following is a summary with respect to warrants outstanding and exercisable at
December 31, 2009 and 2008 and activity during the years then
ended:
|
2009
|
2008
|
|||||||||||||||
|
Weighted
|
Weighted
|
|||||||||||||||
|
Average
|
Average
|
|||||||||||||||
|
Exercise
|
Exercise
|
|||||||||||||||
|
Warrants
|
Price
|
Warrants
|
Price
|
|||||||||||||
|
Outstanding
January 1
|
761,032 | $ | 8.73 | 591,093 | $ | 10.82 | ||||||||||
|
Granted
during the year
|
556,988 | $ | 2.63 | 250,000 | $ | 2.00 | ||||||||||
|
Exercised
|
- | $ | - | (50,000 | ) | $ | (2.00 | ) | ||||||||
|
Lapsed
|
- | $ | - | (30,061 | ) | $ | (5.00 | ) | ||||||||
|
Outstanding
at December 31
|
1,318,020 | $ | 6.15 | 761,032 | $ | 8.73 | ||||||||||
|
Exercisable at
December 31
|
1,118,020 | $ | 6.63 | 761,032 | $ | 8.73 | ||||||||||
|
|
||||||||||||||||
| Weighted average months remaining | 43.0 | 44.7 | ||||||||||||||
Stock Options
- The Company has two stock-based compensation plans. The 2004
Employees’ Stock Option Plan (the “2004 Plan”) provides for the issuance of up
to a total of 1,700,000 shares of common stock authorized to be issued for
grants of options, restricted stock and other forms of equity to employees and
consultants. Under the terms of the 2004 Plan, options granted
thereunder may be designated as options which qualify for incentive stock option
treatment (“ISOs”) under Section 422A of the Internal Revenue Code, or options
which do not qualify (“NQSOs”). The exercise price for options
granted under the Director Plan is 100% of the fair market value of the Common
Stock on the date of grant. The Non-Executive Director Stock Option Plan (the
“Director Plan”) provides for the issuance of up to a total of 200,000 shares of
common stock authorized to be issued for options grants for non-executive
directors and advisors. Under the terms of the Director Plan, an
option to purchase (a) 5,000 shares of our common stock shall be granted to each
non-executive director upon joining the Board of Directors and (b) 5,000 shares
of our common stock plus an additional 1,000 shares of our common stock for each
year that the applicable director has served on the Board of Directors, up to a
maximum of 10,000 shares per year shall be granted to each non-executive
director thereafter on January 2nd of each year; provided that any non-executive
director who has not served as a director for the entire year immediately prior
to January 2nd shall receive a pro rata number of options based on the time the
director has served in such capacity during the previous year. Both
Plans were adopted by the Company’s shareholders.
F-17
The
following is a summary with respect to options outstanding at December 31,
2009 and 2008 and activity during the years then ended:
|
2004 Employee Plan
|
Non-Executive Director Plan
|
|||||||||||||||||||||||
|
Number of
Options
|
Weighted
Average
Exercise Price
|
Weighted
Average
Life
Remaining
|
Number of
Options
|
Weighted
Average
Exercise Price
|
Weighted
Average Life
Remaining
|
|||||||||||||||||||
|
(in
years)
|
(in
years)
|
|||||||||||||||||||||||
|
Outstanding
at December 31, 2007
|
617,500 | 9.70 | 78,750 | $ | 8.78 | |||||||||||||||||||
|
Granted
|
83,000 | 5.01 | 37,000 | 6.31 | ||||||||||||||||||||
|
Exercised
|
- | - | - | - | ||||||||||||||||||||
|
Forfeited
|
(37,000 | ) | (8.87 | ) | - | - | ||||||||||||||||||
|
Outstanding
at December 31, 2008:
|
663,500 | 7.27 | 115,750 | 7.99 | ||||||||||||||||||||
|
Granted
|
274,000 | 4.00 | 40,000 | 1.86 | ||||||||||||||||||||
|
Exercised
|
- | - | ||||||||||||||||||||||
|
Forfeited
|
(298,500 | ) | (6.37 | ) | (23,750 | ) | (4.59 | ) | ||||||||||||||||
|
Outstanding
at December 31, 2009:
|
639,000 | 6.29 | 2.8 | 132,000 | 6.74 | 2.5 | ||||||||||||||||||
|
Exercisable
at December 31, 2009:
|
336,833 | 8.16 | 1.4 | 92,000 | 8.86 | 1.9 | ||||||||||||||||||
|
Aggregate
Intrinsic Value of outstanding options at December 31,
2009
|
$ | - | $ | 23,600 | ||||||||||||||||||||
|
Aggregate
Intrinsic Value of exercisable options at December 31,
2009
|
$ | - | $ | - | ||||||||||||||||||||
The
weighted-average grant date fair value of options granted during the year ended
December 31, 2009 was $0.53 ($2.03 -2008). There were no options exercised
during the year ended December 31, 2009 or 2008.
The fair
value of each option award is estimated on the date of grant utilizing the Black
Scholes Option Pricing Model that uses the assumptions noted in the following
table.
|
2009
|
2008
|
|||||||
|
Volatility
|
54.7 | % | 53.6 | % | ||||
|
Expected
option term
|
3.9
|
years |
3.3
|
years | ||||
|
Risk-free
interest rate
|
2.30 | % | 3.09 | % | ||||
|
Expected
forfeiture rate
|
0.0 | % | 0.0 | % | ||||
|
Expected
dividend yield
|
0.0 | % | 0.0 | % | ||||
Restricted Stock
Issued to Employees
– Restricted common stock is issued under the 2004
Plan for services to be rendered and may not be sold, transferred or pledged for
such period as determined by our Compensation Committee. Restricted
stock compensation cost is measured as the stock’s fair value based on the
quoted market price at the date of grant. The restricted shares
issued reduce the amount available under the employee stock option
plans. Compensation cost is recognized only on restricted
shares that will ultimately vest. The Company estimates the number of
shares that will ultimately vest at each grant date based on historical
experience and adjust compensation cost and the carrying amount of unearned
compensation based on changes in those estimates over
time. Restricted stock compensation cost is recognized ratably
over the requisite service period which approximates the vesting
period. An employee may not sell or otherwise transfer unvested
shares and, in the event that employment is terminated prior to the end of the
vesting period, any unvested shares are surrendered to us. We have no
obligation to repurchase any restricted stock.
F-18
The
following is a summary of activity of restricted stock during the years ended at
December 31, 2009 and 2008:
|
Shares
|
Weighted- average
Grant Date Fair
Value
|
|||||||
|
Restricted
shares outstanding, December 31, 2007
|
513,323 | $ | 12.35 | |||||
|
Restricted
shares granted
|
110,592 | 2.31 | ||||||
|
Restricted
shares vested
|
(46,134 | ) | (10.49 | ) | ||||
|
Restricted
shares forfeited
|
(250,000 | ) | (12.50 | ) | ||||
|
Restricted
shares outstanding, December 31, 2008
|
327,781 | $ | 9.05 | |||||
|
Restricted
shares granted
|
- | - | ||||||
|
Restricted
shares vested
|
(30,281 | ) | (6.77 | ) | ||||
|
Restricted
shares forfeited
|
(212,500 | ) | (10.05 | ) | ||||
|
Restricted
shares outstanding, December 31, 2009
|
85,000 | $ | 7.61 | |||||
As of
December 31, 2009, there are 40,000 unvested restricted shares granted to an
employee that vests proratably through December 2013 and 45,000 restricted
shares that will vest only upon the occurrence of certain through December 2014
which include, among other things a change of control of the Company or other
merger or acquisition of the Company, the achievement of certain financial
goals, including among other things a successful result of the Company’s patent
infringement lawsuit against the European Central Bank. These
45,000 shares, if vested, would result in the recording of stock based
compensation expense of approximately $562,500, the grant date fair value, over
the period beginning when any of the contingent vesting events is deemed to be
probable over the expected requisite service period. As of December
31, 2009, vesting is not considered probable and no compensation expense has
been recognized related to the performance grants.
On May
10, 2008, the Company accelerated the vesting of 33,333 restricted shares and
retired 250,000 of unvested restricted stock as the result of a separation
agreement with the Company’s former President. The 33,333
shares of restricted stock, formerly set to vest pro-ratably through June 2009,
were accelerated to vest pro-ratably on a monthly basis over a ten-month vesting
period ending in March 2009. As a result of the acceleration of the
33,333 shares of restricted stock, the Company recognized approximately $194,000
of stock based compensation during the year ended December 31,
2008. (See Note 13) On December 18, 2008, the Company
issued under the 2004 Plan 50,000 restricted shares of the Company’s common
stock each to two former employees of DPI of Rochester, LLC, which the Company
acquired substantially all of the assets of on that date. The
restricted shares had an aggregated grant date fair value of $210,000 and will
vest proratably over five years.
Stock-Based
Compensation
–
Stock-based compensation
includes expense charges for all stock-based awards to employees, directors and
consultants. Such awards include option grants, warrant grants, and restricted
stock awards. During the year ended December 31, 2009, the
Company had stock compensation expense of approximately $292,000 or $0.02 per
share ($1,747,000- 2008; $0.12 per share).
As of December 31, 2009,
there was approximately $550,000 of total unrecognized compensation costs
(excluding the $563,000 that vest upon the occurrence of certain events) related
to non-vested options and restricted stock granted under the Company’s stock
option plans which the Company expects to vest over a period of not to exceed
five years.
On August
13, 2008, the Company cancelled 330,500 employee stock options with exercise
prices ranging from $6.24 to $12.50, and replaced the cancelled options with
330,500 employee stock options with an exercise price of $6.00. No
other terms of the options were modified. On the date of grant, the
fair market value of the Company’s Common Stock was $5.15. The
repricing was treated as a modification under FAS123R, and resulted in an
additional aggregate fair value expense determined using the Black- Scholes
option pricing model of approximately $225,000, of which approximately $170,000
was expensed as of the grant date for fully vested options. The
remaining fair value of the modified options is being expensed proratably during
the expected vesting period of the options thru 2010.
F-19
In
conjunction with the Asset Purchase Agreement, the Company and Internet Media
Services made the followg agreements:
Within
180 days of closing, IMS will file a registration statement on Form S-1 with
respect to the IMS Common Stock pursuant to the terms of the Asset Purchase
Agreement and Registration Rights Agreement (the “Registration Rights
Agreement”) executed by IMS and the Company concurrently with the Asset Purchase
Agreement. Pursuant to the terms of the Asset Purchase Agreement, Registration
Rights Agreement, and the Stock Pledge and Escrow Agreements executed by IMS’
principal shareholders, IMS, Lester Levin, Inc. and the Company (the
“Pledge Agreements”), if IMS fails to secure registration of at least 20% of the
IMS Common Stock within 360 days of closing, and to meet certain working capital
thresholds contained in the Asset Purchase Agreement, then IMS will be in
default. In the event of a default by IMS with respect to the registration of
the IMS Common Stock, if IMS has failed to satisfy the working capital
requirements provided for in the Asset Purchase Agreement, the Company may take
back the collateral, consisting of 12,500,000 shares (an additional 61% of the
IMS shares outstanding) of IMS Common Stock owned by the IMS shareholders
identified in the Pledge Agreements. If IMS is in default with
respect to the registration of IMS Common Stock, and IMS has satisfied the
working capital requirements contained in the Asset Purchase Agreement, the
Company may take back the collateral, consisting of 5,250,000 shares (an
additional 26% of IMS shares outstanding) of IMS Common Stock owned by the IMS
shareholders identified in the Pledge Agreements. In addition to the
Asset Purchase Agreement, the Registration Rights Agreement, and the Pledge
Agreements, IMS’ principal shareholders, IMS and the Company entered into a
voting agreement (the “Voting Agreement”) whereby the principal shareholders of
IMS agreed to vote all IMS Common Stock held by them so as to elect two nominees
designated by Lester Levin, Inc. or the Company as members of the IMS
Board of Directors.
On
December 18, 2008, the Company” through its wholly owned subsidiary,
Secuprint, Inc. (dba DPI Secuprint, Inc.) acquired substantially all of the
assets of DPI of Rochester, LLC (“DPI”) for approximately $938,000 in cash and
$145,000 of expenses, the right to assume certain leases, including the lease on
its building, and a contingent payment of up to $50,000 within five years of the
acquisition. The acquisition has been accounted for as a business
combination. Under business combination accounting (formerly SFAS141), the total
purchase price was allocated to DPI’s net tangible and identifiable intangible
assets, if any, based on their estimated fair values as of December 18,
2008 as determined by management. No goodwill was recorded as a
result of the business combination. The contingent payment of up to
$50,000 was considered remote, therefore, future payments made, if any, will be
considered additional purchase price when paid.
F-20
The
allocation of the purchase price and the estimated useful lives associated with
the acquired assets is as follows:
|
Estimated
|
|||||
|
Amount
|
Useful Life
|
||||
|
Accounts
receivable
|
$ | 876,287 | |||
|
Inventory
and work in process
|
67,250 | ||||
|
Machinery
and equipment
|
139,000 |
5
years
|
|||
|
Total
assets acquired
|
1,082,537 | ||||
|
Liabilities
assumed
|
— | ||||
|
Total
preliminary purchase price
|
$ | 1,082,537 | |||
Set
forth below is the unaudited pro forma revenue, operating loss, net loss and
loss per share of the Company as if DPI had been acquired by the Company as of
January 1, 2008:
|
Year Ended December 31,
|
||||
|
(unaudited)
|
||||
|
2008
|
||||
|
Revenue
|
$ | 14,119,500 | ||
|
Gross
profit
|
5,886,063 | |||
|
Net
Loss
|
(8,717,790 | ) | ||
|
Basic
and diluted loss per share
|
(0.62 | ) | ||
The
Company received approximately $416,000 in 2009 for New York State Qualified
Emerging Technology Company (“QETC”) refundable tax credits for the tax years
ended 2005, 2006, and 2007 which the Company received in December,
2009.
In May
2008, the Company was awarded a judgment of approximately $126,000 pursuant to a
positive judgement for the Company in its counterclaim the matter “Frank
LaLoggia v. Document Security Systems, Inc”, which the Company won in June
2006. The Company expects to collect the full amount of the
judgment.
F-21
Following
is a summary of the components giving rise to the income tax provision (benefit)
for the years ended December 31:
The
provision (benefit) for income taxes consists of the following:
|
2009
|
2008
|
|||||||
|
Currently
payable:
|
||||||||
|
Federal
|
$ | - | $ | - | ||||
|
State
|
- | - | ||||||
|
Total
currently payable
|
- | - | ||||||
|
Deferred:
|
||||||||
|
Federal
|
(1,113,695 | ) | (2,583,341 | ) | ||||
|
State
|
(265,310 | ) | (616,339 | ) | ||||
|
Total
deferred
|
(1,379,005 | ) | (3,199,680 | ) | ||||
|
Less
increase in allowance
|
1,397,957 | 3,218,641 | ||||||
|
Net
deferred
|
18,952 | 18,961 | ||||||
|
Total
income tax provision
|
$ | 18,952 | $ | 18,961 | ||||
|
Individual
components of deferred taxes are as follows:
|
||||||||
|
|
2009
|
2008
|
||||||
| Deferred tax assets: | ||||||||
|
Net
operating loss carry forwards
|
$ | 10,330,310 | $ | 9,321,843 | ||||
|
Depreciation
and amortization
|
||||||||
|
Equity
issued for services
|
1,006,186 | 1,010,084 | ||||||
|
Other
|
425,619 | 104,299 | ||||||
|
Total
|
11,762,115 | 10,436,226 | ||||||
|
Less
valuation allowance
|
(11,600,983 | ) | (10,342,023 | ) | ||||
|
Gross
deferred tax assets
|
$ | 161,132 | $ | 94,203 | ||||
|
Deferred
tax liabilities:
|
||||||||
|
Goodwill
|
$ | 69,665 | $ | 51,878 | ||||
|
Modification
of equity awards for licensing agreeement
|
- | - | ||||||
|
Depreciation
and amortization
|
162,297 | 94,203 | ||||||
|
Gross
deferred tax liabilities
|
$ | 231,962 | $ | 146,081 | ||||
|
Net
deferred tax liabilities
|
$ | (70,830 | ) | $ | (51,878 | ) | ||
The
Company has approximately $28,034,000 in net operating loss carryforwards
(“NOL’s”) available to reduce future taxable income, of which approximately
$1,412,000 is subject to change of control limitations that generally
restricts the utilization of the NOL per year and $2,400,000 of the NOL will be
allocated to contributed capital when subsequently realized. Due to
the uncertainty as to the Company’s ability to generate sufficient taxable
income in the future and utilize the NOL’s before they expire, the Company has
recorded a valuation allowance accordingly a portion of the net operating
loss carryforward, amounting to approximately $990,000, relates to tax
deductions for stock awards, options and warrants exercised subsequent to the
implementation of SFAS 123(R), which are not included in the determination
of the deferred tax asset above and will be recognized in accordance with
SFAS 123(R) and FIN48, when realized for tax purposes. These
carryforwards expire at various dates from 2022 through
2028. In addition, a portion of the valuation allowance
amounting to approximately $318,000 will be recorded as a reduction to
additional paid in capital in the event that it is determined that a valuation
allowance is no longer considered necessary.
F-22
The
differences between the United States statutory federal income tax rate and the
effective income tax rate in the accompanying consolidated statements of
operations are as follows:
|
2009
|
2008
|
|||||||
|
Statutory
United States federal rate
|
34 | % | 34 | % | ||||
|
State
income taxes net of federal benefit
|
4.4 | 5 | ||||||
|
Permanent
differences
|
(3.8 | ) | (0.3 | ) | ||||
|
Change
in valuation reserves
|
(35.1 | ) | (38.9 | ) | ||||
|
Effective
tax rate
|
(0.5 | )% | (0.2 | )% | ||||
In July
2006, the FASB released Interpretation No. 48, “Accounting for Uncertainty in
Income Taxes – an Interpretation of FASB Statement 109” (“FIN48”). Effective for
fiscal years beginning after December 15, 2006, FIN48 provides guidance on the
financial statement recognition and measurement for income tax positions that we
have taken or expect to take in our income tax returns. It also provides related
guidance on derecognition, classification, interest and penalties, accounting in
interim periods, disclosure and transition. We adopted the provisions of FIN48
on January 1, 2007. The adoption did not have a material impact on the Company’s
consolidated results of operations and financial position, and therefore, the
Company did not have any adjustment to the January 1, 2007 beginning balance of
retained earnings.
A
reconciliation of the beginning and ending amount of unrecognized tax benefits
is as follows:
|
Unrecognized
tax benefits balance at January 1, 2008
|
$ | — | ||
|
Gross
increase for tax positions of prior years
|
446,000 | |||
|
Unrecognized
tax benefits balance at January 1, 2009
|
$ | 446,000 | ||
|
Unrecognized
tax benefits balance at December 31, 2009
|
$ | 446,000 |
At
December 31, 2009, the total unrecognized tax benefits of $446,000 have
been netted against the related deferred tax assets.
The
Company recognizes interest accrued and penalties related to unrecognized tax
benefits in tax expense. During the years ended December 31, 2009 and 2008 the
Company recognized no interest and penalties.
The
Company files income tax returns in the U.S. federal jurisdiction and various
states. The tax years 2006-2008 generally remain open to examination by major
taxing jurisdictions to which the Company is subject.
The
Company established an Employee savings plan (the “401(k) Plan”) in 2006 which
qualifies as a deferred salary arrangement under Section 401(k) of the Internal
Revenue Code. Employees become eligible to participate in the Plan at
the beginning of the following quarter after the employee’s hire
date. Employees may contribute up to 20% of their pay to the Plan,
subject to the limitations of the Internal Revenue
Code. Company matching contributions are
discretionary. Pursuant to the 401(k) Plan, employees may elect to defer a
portion of their salary on a pre-tax basis. During the years ended
December 31, 2009 and 2008, the Company did not make any matching
contributions.
Facilities
- The Company leases a total of approximately 55,000 square feet of office space
for its administrative offices and its printing facilities at a monthly rental
aggregating approximately $36,000. The leases expire through July 2014, although
renewal options exist to extend lease agreements for up to an additional 60
months.
Equipment
Leases
- The Company leases digital and offset presses, laminating
and finishing equipment for its various printing operations. The leases may be
capital leases or operating leases and are generally for a term of 36 to 60
months. The leases expire through March 2016.
F-23
A summary
of lease commitments at December 31, 2009 are as follows:
|
Operating Leases
|
||||||||||||||||
|
Capital Leases
|
Equipment
|
Facilities
|
Total
|
|||||||||||||
|
Payments
made in 2009
|
$ | 123,878 | $ | 471,326 | $ | 440,575 | $ | 911,901 | ||||||||
|
Future
minimum lease commitments:
|
||||||||||||||||
|
2010
|
107,052 | 662,071 | 434,782 | 1,096,853 | ||||||||||||
|
2011
|
107,052 | 625,218 | 467,639 | 1,092,857 | ||||||||||||
|
2012
|
94,453 | 439,912 | 355,540 | 795,452 | ||||||||||||
|
2013
|
5,665 | 296,284 | 365,366 | 661,650 | ||||||||||||
|
2014
|
- | 245,100 | 153,898 | 398,998 | ||||||||||||
|
Thereafter
|
- | 282,750 | - | 282,750 | ||||||||||||
|
Total
future minimum lease commitments
|
$ | 314,222 | $ | 2,551,335 | $ | 1,777,225 | $ | 4,328,560 | ||||||||
|
Less
amount representing interest
|
(53,631 | ) | ||||||||||||||
|
Present
value of future minimum lease commitments
|
260,591 | |||||||||||||||
|
Less
current portion
|
(78,167 | ) | ||||||||||||||
|
Long
term portion
|
$ | 182,424 | ||||||||||||||
Employment
agreements -
The Company
has employment agreements having terms in excess of one year with four members
of its management team with terms ranging from three to five years through
December 2013. The agreements provide for severance payments of between 12 and
18 months of salary in the event of termination for certain
causes.
As of
December 31, 2009, the minimum annual severance payments under these
employment agreements are,
in aggregate, approximately $743,000.
In May
2008, the Company entered into a Separation Agreement with its former President
that, among other things, accelerated the vesting of 33,333 shares of restricted
common stock of the Company that were previously awarded to the former President
pursuant to the Company’s 2004 Employee Stock Option Plan so that such shares
vested in equal monthly installments during the immediately following ten
months. The Separation Agreement further provided that if the former
President did not realize at least $212,000 in gross proceeds from the sale of
such 33,333 shares of restricted stock upon their vesting, then the Company
would pay the former President the amount that such proceeds is less than
$212,000 in cash or additional shares of common stock of the
Company. As of June 30, 2009, all 33,333 shares had vested generating
gross proceeds of approximately $99,000. The Company has agreed to
issue up to 30,000 shares of stock to pay the remaining amount due of
$113,000. As of December 31, 2009, $74,000 remains due under the
agreement and is recorded in accrued expenses as of December 31,
2009. Any remaining amounts due under the agreement after the shares
are issued, if any, can be paid in cash or additional shares.
Contingent
Litigation Payment –
In May 2005, the Company made an agreement with its
legal counsel in charge of the Company’s litigation with the European Central
Bank which capped the fees for all matters associated with that litigation at
$500,000 plus expenses, and a $150,000 contingent payment upon a successful
ruling or settlement on the Company’s behalf in that litigation. The
Company will record the $150,000 in the period in which the Company has
determined that a successful ruling or settlement is probable.
In addition, pursuant to an agreement
made in December 2004, the Company is required to share the economic benefit
derived from settlements, licenses or subsequent business arrangements that the
Company obtains from any infringer of patents formerly owned by the Wicker
Family. For infringement matters involving certain U.S. patents, the
Company will be required to disburse 30% of the settlement
proceeds. For infringement matters involving certain foreign patents,
the Company will be required to disburse 14% of the settlement
proceeds. These payments do not apply to licenses or royalties to
patents that the Company has developed or obtained from persons other than the
Wicker Family. As of December 31, 2009, there have been no settlement
amounts related to these agreements.
F-24
Legal
Proceedings
On August 1, 2005, the Company commenced a suit against the
European Central Bank (“ECB”) alleging patent infringement by the ECB and
claimed unspecified damages. We brought the suit in the European Court of First
Instance in Luxembourg. We alleged that all Euro banknotes in
circulation infringe the Company European Patent 0 455 750B1 (the “Patent”),
which covers a method of incorporating an anti-counterfeiting feature into
banknotes or similar security documents to protect against forgeries by digital
scanning and copying devices. The Court of First Instance ruled on
September 5, 2007 that it does not have jurisdiction to rule on the patent
infringement claim, and also ruled that we will be required to pay attorneys and
court fees of the ECB. The ECB formally requested the Company to pay
attorneys and court fees in the amount of Euro 93,752 which, unless the amount
is settled will be subject to an assessment procedure that will not likely be
concluded until late 2010, which the Company will accrue as soon as the assessed
amount, if any, is reasonably estimatable.
On
March 24, 2006, the Company received notice that the ECB had filed a separate
claim in the United Kingdom and Luxembourg courts seeking the invalidation
of the Patent. Proceedings were commenced before the national courts
seeking revocation and declarations of invalidity of the Patent in each of the
Netherlands, Belgium, Italy, France, Spain, Germany and Austria. On
March 26, 2007, the High Court of Justice, Chancery Division, Patents Court in
London, England (the “English Court”) ruled that the Patent was deemed invalid
in the United Kingdom, and on March 19, 2008 this decision was upheld on
appeal. The English Court rejected the ECB’s allegations of
invalidity based on lack of novelty, lack of inventive step and insufficiency,
but held that the patent was invalid for added subject matter. The English
Court’s decision does not affect the validity of the Patent in other European
countries. As a result of these decisions, the Company was notified
of the final assessment of the reimbursable ECB costs for both court cases was
₤356,490, of which the Company has paid ₤332,000 through December 31,
2009 and owes approximately ₤25,000 (approximately $40,000 as of December 31,
2009), which amount was included in accrued expenses as of December 31,
2009.
On March
27, 2007 the Bundespatentgericht of the Federal Republic of Germany ruled that
the German part of the Patent was valid, having considered the English Court’s
decision. As a result of this ruling, the Company expects to be
awarded reimbursements for its costs associated with the German validity case,
which is Euro 44,692 ($65,000 at December 31, 2009), which the Company will
record when the amount, if any, is received. The ECB has filed an
appeal against that decision, which is not expected to be decided before July
2010. On January 9, 2008 the French Court held that the Patent was
invalid in France for the same reasons given by the English
Court. The Company is required to pay de minimus attorneys’ fees of
the ECB as a result of the French decision. The Company filed an
appeal against the French decision on May 7, 2008. The French appeal was heard
on December 7, 2009. On March 20, 2010, the Company
was informed that the decision was upheld in the French appeal. On
March 12, 2008 the Dutch Court, having considered the English, German and French
decisions, ruled that the Patent is valid in the Netherlands. The ECB
filed an appeal against the Dutch decision on March 27, 2008. The Dutch
appeal will be heard in the Hague on June 2010. On November 3, 2009, the Belgium
Court held that the Patent was invalid in Belgium for the same reasons given by
the English and French courts as were similarly informed by the Austrian court
on November 17, 2009. Costs reimbursements, if any, associated with
the Belgium and Austrian validity case are covered under the Trebuchet Agreement
as described below. A trial was also held in Madrid, Spain on June 3
and 5, 2008 and oral and written closing submissions were made on July 19,
2008. On March 24, 2010 the Spanish Court ruled that the Patent was
valid. In Italy the validity case is to be heard again by a newly
appointed judge during 2010 and a hearing in Luxembourg is expected in
2010.
On August
20, 2008, the Company entered into an agreement with Trebuchet Capital Partners,
LLC (“Trebuchet”) under which Trebuchet has agreed to pay substantially all
of the litigation costs associated with pending validity proceedings initiated
by the European Central Bank (“ECB”) in eight European countries relating to the
Company’s European Patent 0 455 750B1 that the Company has claimed
the ECB infringed in printing of the Euro currency (the “Patent”). Trebuchet
also agreed to pay substantially all of the litigation costs associated with
future validity challenges filed by the ECB or other parties, provided that
Trebuchet elects to assume the defense of any such challenges, in its sole
discretion, and patent infringement suits filed against the ECB and certain
other alleged infringers of the Patent, all of which suits may be brought at the
sole discretion of Trebuchet and may be in the name of the Company, Trebuchet or
both. The Company provided Trebuchet with the sole and exclusive right to manage
infringement litigation relating to the Patent in Europe, including the right to
initiate litigation in the name of the Company, Trebuchet or both and to choose
whom and where to sue, subject to certain limitations set forth in the agreement
under the terms of the Agreement, and in consideration for Trebuchet's funding
obligations, the Company assigned and transferred a 49% interest of the
Company's rights, title and interest in the Patent to Trebuchet which allows
Trebuchet to have a separate and distinct interest in and share of the Patent,
along with the right to sue and recover in litigation, settlement or otherwise
to collect royalties or other payments under or on account of the Patent. In
addition, the Company and Trebuchet have agreed to equally share all proceeds
generated from litigation relating to the Patent, including judgments and
licenses or other arrangements entered into in settlement of any such
litigation. Trebuchet is also entitled to recoup any litigation expenses
specifically awarded to the Company in such actions.
F-25
The
Patent has thus been confirmed to be valid and enforceable in three
jurisdictions (Germany, the Netherlands and Spain) that use the Euro as its
national currency allowing the Company or Trebuchet Capital Partners, on the
Company’s behalf, to proceed with infringement cases in these countries if we
choose to do so. On February 18, 2010, Trebuchet, on behalf of
Document Security Systems, filed an infringement suit in the Netherlands.
The suit is being lodged against the ECB and two security printing entities with
manufacturing operations in the Netherlands, Joh. Enschede Banknotes B.V.; and
Koninklijke Joh. Enschede B.V. The ECB's and the security
printers have been notified and the court hearing date is tentatively scheduled
for January 21, 2011.
On
January 31, 2003, the Company commenced an action, unrelated to the above ECB
litigation, entitled New Sky Communications, Inc., As Successor-In-Interest To
Thomas M. Wicker, Thomas M.Wicker Enterprises, Inc. and Document Security
Consultants V. Adler Technologies, Inc. N/K/A Adlertech International, Inc. and
Andrew McTaggert (United States District Court, Western District Of New York
Case No.03-Cv-6044t(F)) regarding certain intellectual property in which the
Company has an interest. On December 7, 2009, the Company reached an
agreement to terminate all litigation in association with this
suit. In conjunction with that agreement, the Company issued to the
opposing parties an aggregate of 40,000 shares of common stock valued at
approximately $85,000 and 50,000 of common stock warrants for the purchase of
common shares at $3.00 per share valued at approximately $30,000 utilizing the
Black Scholes pricing model. The Company recorded an expense related
to the estimated grant date fair value of the shares and warrants issued of
approximately $115,000. In addition, both parties agreed not to
compete with certain of the other party’s customers for 7 years. The
Company does not believe that the competition agreement will have a material
impact on its business.
In
addition to the foregoing, we are subject to other legal proceedings that have
arisen in the ordinary course of business and have not been finally adjudicated.
Although there can be no assurance in this regard, in the opinion of management,
none of the legal proceedings to which we are a party, whether discussed herein
or otherwise, will have a material adverse effect on our results of operations,
cash flows or our financial condition.
|
Cash
paid for interest
|
$ | 157,000 | $ | 69,000 | ||||
|
Non-cash
investing and financing activities:
|
||||||||
|
Conversion
of debt to equity
|
2,000,000 | - | ||||||
|
Equity
issued for severance agreements
|
55,000 | 129,000 | ||||||
|
Equity
issued for prepaid services
|
56,000 | - | ||||||
|
Equity
issued for to satisfy an obligation
|
- | 94,000 | ||||||
|
Equipment
purchased via capital lease
|
63,000 | - | ||||||
|
Deferred
tax liability offsetting additional paid in capital
|
- | (156,000 | ) | |||||
|
Warrants
issued with debt
|
72,000 | 256,000 | ||||||
|
Beneficial
conversion features of convertible debt
|
351,000 | - | ||||||
|
Equity
method investment received in exchange for the assets and liabilities of
Legalstore.com
|
350,000 | - |
The
Company's businesses are organized, managed and internally reported as four
operating segments. Each of these operating segments, Document
Security Systems, Plastic Printing Professionals, and DPI Secuprint, are engaged
in various aspects of developing and applying printing technologies and
procedures to produce, or allow others to produce, documents with a wide range
of features, including the Company’s patented technologies and trade
secrets. For the purposes of providing segment information, these
three operating segments have been aggregated into one reportable
segment. A summary of the two segments is as follows:
|
Security
and
Commercial
Printing
|
License,
manufacture and sale of patented document security technologies, including
digital security print solutions, and general commercial printing,
primarily on paper and plastic. Comprises the operations of
Document Security Systems, Plastic Printing Professionals, and DPI
Secuprint, which the Company acquired on December 18,
2008.
|
|
|
Legal
Supplies
|
|
Sale
of specialty legal supplies, primarily to lawyers and law firms located
throughout the United States as Legalstore.com. During the fourth
quarter of 2009, the Company sold its legal products
business.
|
F-26
Approximate
information concerning the Company’s operations by reportable segment as of and
for the year ended December 31, 2009 and 2008 is as follows. The Company
relies on intersegment cooperation and management does not represent that these
segments, if operated independently, would report the results contained
herein:
|
Security
and
|
||||||||||||||||
|
Legal
|
Commercial
|
|||||||||||||||
|
2009
|
Supplies
|
Printing
|
Corporate
|
Total
|
||||||||||||
|
Revenues
from external customers
|
$ | 355,000 | $ | 9,556,000 | $ | - | $ | 9,911,000 | ||||||||
|
Interest
Expense and amortization of note discount
|
- | 363,000 | 146,000 | 509,000 | ||||||||||||
|
Stock
based payments
|
- | - | 292,000 | 292,000 | ||||||||||||
|
Depreciation
and amortization
|
16,000 | 1,644,000 | 2,000 | 1,662,000 | ||||||||||||
|
Operating
(loss) profit
|
40,000 | (2,353,000 | ) | (1,400,000 | ) | (3,713,000 | ) | |||||||||
|
Capital
Expenditures
|
- | 302,000 | - | 302,000 | ||||||||||||
|
Identifiable
assets
|
- | 6,276,000 | 439,000 | 6,715,000 | ||||||||||||
|
2008
|
||||||||||||||||
|
Revenues
from external customers
|
$ | 610,000 | $ | 6,033,000 | $ | - | $ | 6,643,000 | ||||||||
|
Interest
Expense and amortization of note discount
|
- | - | 145,000 | 145,000 | ||||||||||||
|
Stock
based payments
|
- | 1,148,000 | 599,000 | 1,747,000 | ||||||||||||
|
Depreciation
and amortization
|
15,000 | 2,269,000 | 4,000 | 2,288,000 | ||||||||||||
|
Impairment
of patent defense costs and other
|
||||||||||||||||
|
intangible
assets
|
- | 797,000 | - | 797,000 | ||||||||||||
|
Loss
on sale of patent
|
- | (1,170,000 | ) | - | (1,170,000 | ) | ||||||||||
|
Operating
(loss) profit
|
(6,000 | ) | (4,709,000 | ) | (2,304,000 | ) | (7,019,000 | ) | ||||||||
|
Capital
Expenditures
|
12,000 | 1,669,000 | 3,000 | 1,684,000 | ||||||||||||
|
Identifiable
assets
|
252,000 | 7,705,000 | 100,000 | 8,057,000 | ||||||||||||
International
revenue, which consists of sales to customers with operations in Western Europe,
Latin America, Africa, Mddle East and Asia comprised 3% of total revenue for
2009, (4%- 2008). Revenue is allocated to individual countries by
customer based on where the product is shipped to, location of services
performed or the location of equipment that is under an annual maintenance
agreement. The Company had no long-lived assets in any country other
than the United States for any period presented.
Major
Customers
–
During
2009, two customers in the security and commercial printing segment accounted
for 19% and 12% of the Company’s total revenue, respectively. As of
December 31, 2009, two customer account receivable balances accounted for 21%
and 17% of the Company’s trade accounts receivable balance,
respectively. During 2008, two customers in the security and
commercial printing segment accounted for 11% and 10% of the Company’s total
revenue from continuing operations, respectively. As of December 31,
2008, one customer account receivable balance that was acquired as part of the
Company’s acquisition of the assets of a commercial printer in December 2008,
accounted for 42% of the Company’s trade accounts receivable balance.
Business
Combination
On
February 12, 2010, the Company acquired all of the outstanding common stock of
Premier Packaging Corporation from Robert B. and Joan T. Bzdick for
$2,000,000 in cash and 735,437 shares of the Company's common stock. The
cash payment was subject to a working capital adjustment which was not required
as the working capital was within the target range. In
addition, the purchase price is subject to increase if the capital gains tax
rate that was in effect as of February 12, 2010 is retroactively increased by
legislation or otherwise whereas the seller’s tax on its gain
increases. Any increase in taxes will be payable by the Company
in either cash or stock. The Company believe this contingent payment
is remote. In addition, the seller has registration rights for its
shares to which the Company is subject to registration penalties of up to $5,000
per month after 120 days.
F-27
In
connection with the transaction, the Company incurred secured bank debt in the
principal amount of $1,500,000 which was used to partially satisfy the purchase
price of the Premier common stock. In conjunction with the transaction, the
Company entered into a Credit Facility Agreement with RBS Citizens, N.A.
(“Citizens Bank”) pursuant to which Citizens Bank provided Premier Packaging
Corporation with a term loan of $1,500,000, and a revolving line of up to
$1,000,000. The Credit Facility Agreement contains customary
representations and warranties, affirmative and negative covenants,
including financial covenants (minimum coverage ratio, debt to EBITDA
ratio, and current ratio requirements) and events of default and is secured by
all of the assets of Premier Packaging Corporation. The credit
facilities are also secured by cross guarantees by Document Security Systems,
Inc., and its other wholly owned subsidiaries, Plastic Printing Professionals,
Inc. and Secuprint, Inc.
The $1,500,000 term loan
matures March 1, 2013 and is payable in 35 monthly payments of $25,000 plus
interest commencing March 1, 2010 and a payment of $625,000 on the 36
month. Interest accrues at 1 Month LIBOR plus
3.75%. The proceeds of the term loan were used as partial
payment of the purchase of all of the outstanding common stock of Premier
Packaging Corporation. The revolving line of credit up to
$1,000,000 is accessible by the Premier Packaging division subject to
certain terms matures on February 12, 2011 and is payable in monthly
installments of interest only beginning on March 1, 2010. Interest accrues at 1
Month LIBOR plus 3.75%. The Company subsequently entered into a
credit swap agreement to lock into a 5.66% effective interest over the life of
the term loan.
The
Company has engaged a valuation expert to assist management in determining the
fair value of the assets acquired. The preliminary estimate of the
fair value of assets and liabilities acquired as a result of this business
combination were as follows:
|
Fair
value of the consideration transferred
|
$ | 4,566,675 | ||
|
Cash
|
5,290 | |||
|
Accounts
receivable
|
1,284,227 | |||
|
Inventory
and work in process
|
504,162 | |||
|
Machinery
and equipment
|
1,557,500 | |||
|
Goodwill
and other intangible assets
|
1,999,360 | |||
|
Total
Assets
|
5,350,539 | |||
|
Liabilities
assumed
|
||||
|
Accounts
payable
|
448,128 | |||
|
Short-term
cash overdraft
|
277,645 | |||
|
Accrued
Liabilities
|
58,091 | |||
|
Total
Liabilities
|
783,864 | |||
|
Total
preliminary purchase price
|
$ | 4,566,675 |
Set forth
below is the unaudited pro forma condensed balance sheet and profit and loss
statements of the Company as if Premier Packaging had been acquired by the
Company as of January 1, 2009, adjusted for intercompany sales, intercompany tax
benefits, and contractual cost reductions as a result of the purchase agreement
and employment contract.
F-28
Pro-
Forma Profit & Loss Statement For the Twelve Months Ended December 31,
2009
|
Document
Security Systems
|
Premier
Packaging
Corp.
|
Pro-Forma
Adjustments
|
Consolidated
|
|||||||||||||
|
(Unaudited)
|
(Unaudited)
|
(Unaudited)
|
||||||||||||||
|
Total
Revenue
|
9,911,691 | 6,938,000 | (194,000 | )a | 16,655,691 | |||||||||||
|
Total
costs of revenue
|
6,256,399 | 4,973,000 | (194,000 | ) a | 11,035,399 | |||||||||||
|
Gross
profit
|
3,655,292 | 1,965,000 | - | 5,620,292 | ||||||||||||
|
Operating
expenses
|
7,367,551 | 1,434,000 | (170,000 | ) b | 8,631,551 | |||||||||||
|
Operating
(loss) profit
|
(3,712,259 | ) | 531,000 | 170,000 | (3,011,259 | ) | ||||||||||
|
Other
income (expense):
|
||||||||||||||||
|
Interest
income
|
18,140 | - | 18,140 | |||||||||||||
|
Interest
expense
|
(509,020 | ) | (1,000 | ) | (75,000 | )c | (585,020 | ) | ||||||||
|
Other
Income
|
232,078 | (1,000 | ) | 231,078 | ||||||||||||
|
Other
income (expense)
|
(258,802 | ) | (2,000 | ) | (75,000 | ) | (335,802 | ) | ||||||||
|
Income
(loss) before income taxes
|
(3,971,061 | ) | 529,000 | 95,000 | (3,347,061 | ) | ||||||||||
|
Income
Tax Expense
|
18,952 | 1,000 | - | 19,952 | ||||||||||||
|
Net
(loss) income
|
$ | (3,990,013 | ) | $ | 528,000 | $ | 95,000 | $ | (3,367,013 | ) | ||||||
|
Net
loss per share - basic and diluted:
|
(0.27 | ) | (0.22 | ) | ||||||||||||
|
Weighted
average common shares outstanding, basic and diluted
|
14,700,453 | 735,437 | 15,435,890 | |||||||||||||
a-
Elimination of intercompany sales and offsetting cost of sales
b-
Contractual reductions of rent and officer compensation expense
c-
Interest expense on Term Note used to finance a portion of the purchase
price
F-29
Pro-
Forma Condensed Consolidated Balance Sheets
As
of December 31, 2009
|
Document
Security
Systems
|
Premier
Packaging
Corp
|
Pro-forma
adjustments
|
Consolidated | ||||||||||||||
|
ASSETS
|
(Unaudited)
|
(Unaudited)
|
(Unaudited)
|
||||||||||||||
|
Current
assets:
|
|||||||||||||||||
|
Cash and cash
equivalents
|
$ | 448,895 | $ | 37,069 | $ | (500,000 | ) | b | $ | 485,964 | |||||||
| 500,000 | c | ||||||||||||||||
|
Accounts receivable net of
allowance
|
1,143,939 | 898,513 | (66,506 | ) | a | 1,975,946 | |||||||||||
|
Inventory
|
184,174 | 637,061 | - | 821,235 | |||||||||||||
|
Prepaid expenses and other
current assets
|
91,310 | - | - | 91,310 | |||||||||||||
|
Total
current assets
|
1,868,318 | 1,572,643 | (66,506 | ) | 3,374,455 | ||||||||||||
|
Fixed assets,
net
|
1,286,226 | - | 1,557,500 | b | 2,843,726 | ||||||||||||
|
Other
assets
|
305,507 | - | - | 305,507 | |||||||||||||
|
Investment
|
350,000 | - | - | 350,000 | |||||||||||||
|
Goodwill
|
1,315,721 | - | 959,500 | b | 2,275,221 | ||||||||||||
|
Other intangible assets,
net
|
1,588,969 | - | 1,000,000 | b | 2,588,969 | ||||||||||||
|
Total
assets
|
$ | 6,714,741 | $ | 1,572,643 | $ | 3,450,494 | $ | 11,737,878 | |||||||||
|
LIABILITIES AND STOCKHOLDERS'
EQUITY
|
|||||||||||||||||
|
Current
liabilities:
|
|||||||||||||||||
|
Accounts
payable
|
$ | 1,673,901 | $ | 472,994 | $ | (66,506 | ) | a | $ | 2,080,389 | |||||||
|
Accrued expenses &
other current liabilities
|
934,595 | 22,481 | - | 957,076 | |||||||||||||
|
Short-term
debt
|
- | - | 300,000 | b | 300,000 | ||||||||||||
|
Current portion of capital
lease obligations
|
78,167 | - | - | 78,167 | |||||||||||||
|
Total
current liabilities
|
2,686,663 | 495,475 | 233,494 | 3,415,632 | |||||||||||||
|
Revolving notes from related
parties
|
583,000 | - | - | 583,000 | |||||||||||||
|
Long term debt, net of unamortized
discount of $420,000
|
954,616 | - | 1,200,000 | b | 2,154,616 | ||||||||||||
|
Capital lease
obligations
|
182,424 | - | - | 182,424 | |||||||||||||
|
Deferred tax
liability
|
70,830 | - | - | 70,830 | |||||||||||||
|
Stockholders'
equity
|
2,237,208 | 1,077,168 | 1,517,000 | b | 5,331,376 | ||||||||||||
| 500,000 | c | ||||||||||||||||
|
Total liabilities and
stockholders' equity
|
$ | 6,714,741 | $ | 1,572,643 | $ | 3,450,494 | $ | 11,737,878 | |||||||||
|
a- Pro-forma adjustments for
accounts receivable and accounts payable in each company for
pre-acquisition billings owed/collectible
to each party that will be
eliminated in consolidation post
acquistion.
|
|
|
b- Adjustment to reflect
consideration paid and assets acquired
|
|
|
c- Pro-forma adjustment to remove
Premier Packaging shareholder
distributions
|
Private
Placement and Warrants Exercised
On
February 17, 2010, the Company completed the sale of 20 investment units in a
private placement pursuant to subscription agreements with six accredited
investors. Each investment unit was comprised of 5,000 shares of the
Company’s common stock and five year warrants to purchase 1,000 shares of common
stock at an exercise price of $3.50 per share. In the transaction, the Company
sold 20 investment units for $15,000 per unit for gross cash proceeds of
$300,000, consisting of 100,000 shares of common stock and warrants to purchase
an aggregate of 20,000 shares of common stock. In connection with
these sales EKN Financial Services Inc., a registered broker-dealer, acted as
non-exclusive placement agent. EKN Financial Services, Inc. received
a cash fee in the aggregate of $30,000 as commission for these sales. On
February 17, 2010, the Company also sold 20 investment units for gross cash
proceeds of $270,000, consisting of 100,000 shares of common stock and warrants
to purchase an aggregate of 20,000 shares of common stock.
No placement agent fees
were paid on these sales.
On
February 23, 2010, the Company issued 304,000 shares of common stock pursuant to
the exercise of warrants in which the Company received proceeds of
$608,000.
F-30
SIGNATURES
In
accordance with Section 13 or 15(d) of the Exchange Act of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
DOCUMENT
SECURITY SYSTEMS, INC.
|
March
24, 2010
|
By:
|
/s/ Patrick White |
|
Patrick
White
Chief
Executive
Officer
|
In
accordance with Section 13 or 15(d) of the Exchange Act of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
|
March
24, 2010
|
By:
|
/s/ Robert Fagenson |
|
Robert
Fagenson
Director
|
||
|
March
24, 2010
|
By:
|
/s/ Patrick White |
|
Patrick
White
Chief
Executive Officer and Director
(Principal
Executive Officer)
|
||
|
March
24, 2010
|
By:
|
/s/ David Wicker |
|
David
Wicker
Vice
President and Director
|
||
|
March
24, 2010
|
By:
|
/s/ Timothy Ashman |
|
Timothy
Ashman
Director
|
||
|
March
24, 2010
|
By:
|
/s/ Alan E. Harrison |
|
Alan
E. Harrison
Director
|
||
|
March
24, 2010
|
By:
|
/s/ Ira A. Greenstein |
|
Ira
A. Greenstein
Director
|
||
|
March
24, 2010
|
By:
|
/s/ Philip Jones |
|
Philip
Jones
Chief
Financial
Officer
|
40
TABLE OF CONTENTS
Part IItem 1. Business 3Item 1A. Risk Factors 11Item 2. Properties 17Item 3. Legal Proceedings 18Item 4. Submission Of Matters To A Vote Of Security Holders 19Part IIItem 5. Market For The Registrant S Common Equity, Related Stockholder Matters and Issuer Purchases Of Equity Securities 20Item 7. Management S Discussion and Analysis Of Financial Condition and Results Of Operations 21Item 8. Financial Statements and Supplementary Data 33Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 33Item 9a(t). Controls and Procedures 33Item 9a(t)Part IIIItem 10. Directors, Executive Officers and Corporate Governance 35Item 11. Executive Compensation 35Item 12. Security Ownership Of Certain Beneficial Owners and Management and Related Stockholder Matters 35Item 13. Certain Relationships and Related Transactions, and Director Independence 35Item 14. Principal Accountant Fees and Services 35Item 15. Exhibits and Financial Statement Schedules 35Item 1 - BusinessItem 1A Risk FactorsItem 2 - PropertiesItem 3 - Legal ProceedingsItem 4 - Submission Of Matters To A Vote Of Security HoldersItem 5 - Market For Registrant S Common Equity, Related Stockholder Matters and Issuer Purchases Of Equity SecuritiesItem 7 - Management S Discussion and Analysis Of Financial Condition and Results Of OperationsItem 8 - Financial Statements and Supplementary DataItem 9 - Changes in and Disagreements with Accountants on Accounting and Financial DisclosureItem 9a(t) - Controls and ProceduresItem 10 - Directors, Executive Officers, Corporate GovernanceItem 11 - Executive CompensationItem 12 - Security Ownership Of Certain Beneficial Owners and Management and Related Stockholder MattersItem 13 - Certain Relationships and Related Transactions, and Director IndependenceItem 14 - Principal Accounting Fees and ServicesItem 15 - Exhibits and Financial Statement SchedulesNote 1. - Description Of BusinessNote 2. - Summary Of Significant Accounting PoliciesNote 3. InventoryNote 4. - Fixed AssetsNote 5. - Intangible AssetsNote 6. Short Term and Long Term DebtNote 7. - Stockholders EquityNote 8. Deconsolidation Of Legalstore.com DivisionNote 9. Business Combinations-Note 10. Other IncomeNote 11. - Income TaxesNote 12. - Defined Contribution Pension PlanNote 13. Commitments and ContingenciesNote 14. - Supplemental Cash Flow InformationNote 15. - Segment InformationNote 16. Subsequent Events