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-Q
QUARTERLY
REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended
June 30,
2010
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1-32146
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Commission file number
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DOCUMENT SECURITY SYSTEMS,
INC.
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(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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28
Main Street East, Suite 1525
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Rochester,
NY
14614
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(Address of principal executive office)
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(585) 325-3610
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(Registrant's telephone number)
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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 whether the registrant has submitted electronically and posted on
its corporate Web site, if any, every Interactive Date File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding
12 months (or for such shorter period that the registrant was required to submit
and post such files)*
Yes
¨
No
¨
* The
issuer has not yet been phased into the interactive data
requirements
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting
company. See definition of “large accelerated filer”, “accelerated
filer” and “smaller reporting company” in Rule 12b-2 of the Exchange
Act. (Check one):
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 in Rule
12b-2 of the Exchange Act)
Yes
¨
No
x
Applicable
only to corporate issuers
As of
August 12, 2010 (the most recent practicable date), there were 18,188,071 shares
of the issuer's Common Stock, $0.02 par value per share, issued.
FORM
10-Q
TABLE
OF CONTENTS
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PART
I
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FINANCIAL
INFORMATION
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|||
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Item
1
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Financial
Statements
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|||
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Consolidated
Balance Sheets
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3
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|||
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Consolidated
Statements of Operations
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4
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|||
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Consolidated
Statements of Cash Flows
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5
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|||
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Notes
to Interim Consolidated Financial Statements
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6
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|||
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Item
2
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Management's
Discussion and Analysis of Financial Condition and Results of
Operations
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15
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||
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Item
4T
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Controls
and Procedures
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22
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PART
II
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OTHER
INFORMATION
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|||
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Item
1
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Legal
Proceedings
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22
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Item
1A
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Risk
Factors
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24
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Item
2
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Unregistered Sales
of Equity Securities and Use of Proceeds
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29
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Item
3
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Defaults
upon Senior Securities
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29
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Item
4
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Submission
of Matters to a Vote of Security Holders
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29
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Item
5
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Other
Information
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30
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Item
6
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Exhibits
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30
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SIGNATURES
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31 | |||
2
DOCUMENT
SECURITY SYSTEMS, INC. AND SUBSIDIARIES
As
of
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December 31,
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||||||||
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June 30, 2010
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2009
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|||||||
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(Unaudited)
|
||||||||
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ASSETS
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||||||||
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Current
assets:
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||||||||
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Cash
and cash equivalents
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$ | 308,973 | $ | 448,895 | ||||
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Accounts
receivable, net of allowance of $66,000 ($66,000- 2009)
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1,538,555 | 1,143,939 | ||||||
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Inventory,
net
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487,326 | 184,174 | ||||||
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Prepaid
expenses and other current assets
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55,407 | 91,310 | ||||||
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Total
current assets
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2,390,261 | 1,868,318 | ||||||
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Fixed
assets, net
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2,717,778 | 1,286,226 | ||||||
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Other
assets
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325,953 | 305,507 | ||||||
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Investment
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278,321 | 350,000 | ||||||
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Goodwill
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1,943,081 | 1,315,721 | ||||||
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Other
intangible assets, net
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2,586,565 | 1,588,969 | ||||||
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Total
assets
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$ | 10,241,959 | $ | 6,714,741 | ||||
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LIABILITIES
AND STOCKHOLDERS' EQUITY
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||||||||
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Current
liabilities:
|
||||||||
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Accounts
payable
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$ | 1,558,461 | $ | 1,673,901 | ||||
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Accrued
expenses & other current liabilities
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1,246,283 | 934,595 | ||||||
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Current
portion of long-term debt
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300,000 | - | ||||||
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Current
portion of capital lease obligations
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83,300 | 78,167 | ||||||
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Total
current liabilities
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3,188,044 | 2,686,663 | ||||||
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Revolving
notes from related party
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683,000 | 583,000 | ||||||
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Long-term
debt, net of unamortized discount of $339,000 ($420,000 -
2009)
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2,136,080 | 954,616 | ||||||
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Capital
lease obligations
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132,947 | 182,424 | ||||||
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Deferred
tax liability
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80,305 | 70,830 | ||||||
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Commitments
and contingencies (see Note 8)
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||||||||
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Stockholders'
equity
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||||||||
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Common
stock, $.02 par value; 200,000,000 shares authorized,
|
||||||||
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17,686,284
shares issued and outstanding (16,397,887 in 2009)
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353,725 | 327,957 | ||||||
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Additional
paid-in capital
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42,300,699 | 38,399,033 | ||||||
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Accumulated
other comprehensive loss
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(25,834 | ) | - | |||||
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Accumulated
deficit
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(38,607,007 | ) | (36,489,782 | ) | ||||
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Total
stockholders' equity
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4,021,583 | 2,237,208 | ||||||
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Total
liabilities and stockholders' equity
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$ | 10,241,959 | $ | 6,714,741 | ||||
See
accompanying notes
3
DOCUMENT
SECURITY SYSTEMS, INC. AND SUBSIDIARIES
(Unaudited)
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Three Months Ended June 30,
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Six Months Ended June 30,
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|||||||||||||||
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2010
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2009
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2010
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2009
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|||||||||||||
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Revenue
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||||||||||||||||
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Security
and commercial printing
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$ | 1,828,001 | $ | 1,941,818 | $ | 3,686,776 | $ | 4,358,509 | ||||||||
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Packaging
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1,329,955 | - | 2,070,580 | - | ||||||||||||
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Technology
license royalties and digital solutions
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167,516 | 191,334 | 342,846 | 414,574 | ||||||||||||
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Legal
products
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- | 114,871 | - | 253,496 | ||||||||||||
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Total
Revenue
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3,325,472 | 2,248,023 | 6,100,202 | 5,026,579 | ||||||||||||
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Costs
of revenue
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||||||||||||||||
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Security
and commercial printing
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1,389,464 | 1,496,256 | 2,753,586 | 3,030,324 | ||||||||||||
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Packaging
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1,058,072 | - | 1,617,181 | - | ||||||||||||
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Technology
license royalties and digital solutions
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- | 3,507 | 5,476 | 7,014 | ||||||||||||
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Legal
products
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- | 59,757 | - | 122,819 | ||||||||||||
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Total
costs of revenue
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2,447,536 | 1,559,520 | 4,376,243 | 3,160,157 | ||||||||||||
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Gross
profit
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877,936 | 688,503 | 1,723,959 | 1,866,422 | ||||||||||||
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Operating
expenses:
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||||||||||||||||
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Selling,
general and administrative
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1,474,113 | 1,139,831 | 3,109,564 | 2,703,218 | ||||||||||||
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Research
and development
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66,688 | 74,676 | 132,355 | 162,092 | ||||||||||||
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Amortization
of intangibles
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183,801 | 323,675 | 430,200 | 647,132 | ||||||||||||
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Operating
expenses
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1,724,602 | 1,538,182 | 3,672,119 | 3,512,442 | ||||||||||||
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Operating
loss
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(846,666 | ) | (849,679 | ) | (1,948,160 | ) | (1,646,020 | ) | ||||||||
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Other
income (expense):
|
||||||||||||||||
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Loss
in equity investment
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(20,000 | ) | - | (71,679 | ) | - | ||||||||||
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Interest
expense
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(84,407 | ) | (68,420 | ) | (149,510 | ) | (149,174 | ) | ||||||||
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Amortizaton
of note discount
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(40,732 | ) | (63,756 | ) | (81,464 | ) | (125,455 | ) | ||||||||
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Gain
on foreign currency transactions
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- | 11,782 | - | 11,782 | ||||||||||||
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Other
income
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- | - | 143,063 | - | ||||||||||||
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Loss
before income taxes
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(991,805 | ) | (970,073 | ) | (2,107,750 | ) | (1,908,867 | ) | ||||||||
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Income
tax expense
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4,737 | 4,738 | 9,475 | 9,476 | ||||||||||||
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Net
loss
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$ | (996,542 | ) | $ | (974,811 | ) | $ | (2,117,225 | ) | $ | (1,918,343 | ) | ||||
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Other
comprehensive loss:
|
||||||||||||||||
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Interest
rate swap loss
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(9,559 | ) | - | (25,834 | ) | - | ||||||||||
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Comprehensive
Loss
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$ | (1,006,101 | ) | $ | (974,811 | ) | $ | (2,143,059 | ) | $ | (1,918,343 | ) | ||||
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Net
loss per share -basic and diluted:
|
$ | (0.06 | ) | $ | (0.07 | ) | $ | (0.12 | ) | $ | (0.13 | ) | ||||
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Weighted
average common shares outstanding, basic and diluted
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17,769,726 | 14,417,699 | 17,390,570 | 14,397,942 | ||||||||||||
See
accompanying notes
4
For
the Six Months Ended June 30,
(Unaudited)
|
2010
|
2009
|
|||||||
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Cash
flows from operating activities:
|
||||||||
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Net
loss
|
$ | (2,117,225 | ) | $ | (1,918,343 | ) | ||
|
Adjustments
to reconcile net loss to net cash used by operating
activities:
|
||||||||
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Depreciation
and amortization
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641,548 | 819,852 | ||||||
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Stock
based compensation expense
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204,961 | (116,756 | ) | |||||
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Amortization
of note discount
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81,464 | 125,455 | ||||||
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Loss
in equity investment
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71,679 | - | ||||||
|
Provision
for inventory reserve
|
10,000 | - | ||||||
|
(Increase)
decrease in assets:
|
||||||||
|
Accounts
receivable
|
889,660 | 103,817 | ||||||
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Inventory
|
191,010 | 32,320 | ||||||
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Prepaid
expenses and other assets
|
(17,923 | ) | (38,039 | ) | ||||
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Increase
(decrease) in liabilities:
|
||||||||
|
Accounts
payable
|
(424,409 | ) | 205,781 | |||||
|
Accrued
expenses and other current liabilities
|
140,594 | (21,553 | ) | |||||
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Net
cash used by operating activities
|
(328,641 | ) | (807,466 | ) | ||||
|
Cash
flows from investing activities:
|
||||||||
|
Decrease
in restricted cash
|
- | 93,026 | ||||||
|
Purchase
of fixed assets
|
(85,400 | ) | (18,255 | ) | ||||
|
Purchase
of other intangible assets
|
(43,137 | ) | (37,280 | ) | ||||
|
Acquisition
of business
|
(2,272,405 | ) | - | |||||
|
Net
cash (used) provided by investing activities
|
(2,400,942 | ) | 37,491 | |||||
|
Cash
flows from financing activities:
|
||||||||
|
Borrowing
on revolving note- related parties
|
100,000 | 930,000 | ||||||
|
Borrowings
on long-term debt
|
1,500,000 | - | ||||||
|
Payments
of long-term debt
|
(100,000 | ) | ||||||
|
Payments
of capital lease obligations
|
(44,344 | ) | (46,023 | ) | ||||
|
Issuance
of common stock, net
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1,134,005 | 516,000 | ||||||
|
Net
cash provided by financing activities
|
2,589,661 | 1,399,977 | ||||||
|
Net
increase (decrease) in cash and cash equivalents
|
(139,922 | ) | 630,002 | |||||
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Cash
and cash equivalents beginning of period
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448,895 | 87,820 | ||||||
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Cash
and cash equivalents end of period
|
$ | 308,973 | $ | 717,822 | ||||
See accompanying
notes.
5
NOTES
TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
June
30, 2010
(Unaudited)
1.
Basis of Presentation and Significant Accounting Policies
The
accompanying unaudited condensed consolidated financial statements have been
prepared in accordance with U.S. generally accepted accounting principles for
interim financial information and with the instructions to Form 10-Q and Rule
8.03 of Regulation S-X for smaller reporting companies. Accordingly, these
statements do not include all of the information and footnotes required by U.S.
generally accepted accounting principles for complete financial statements. In
the opinion of management, the accompanying balance sheets and related interim
statements of operations and cash flows include all adjustments, consisting only
of normal recurring items, necessary for their fair presentation in accordance
with U.S. generally accepted accounting principles. All significant intercompany
transactions have been eliminated.
Interim
results are not necessarily indicative of results expected for a full year. For
further information regarding Document Security Systems, Inc (the “Company”)
accounting policies, refer to the audited consolidated financial statements and
footnotes thereto included in the Company's Form 10-K for the fiscal year ended
December 31, 2009.
The
preparation of financial statements in conformity with accounting principles
generally accepted in the United States requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ materially from those estimates
and assumptions. In preparing these financial statements, the Company has
evaluated events and transactions for potential recognition or
disclosure.
Reclassifications
-
Certain prior period amounts in the accompanying consolidated financial
statements and notes thereto have been reclassified to current period
presentation. These classifications had no effect on the results of
operations for the period presented. These reclassifications include
the combination of deferred revenue and customer deposits into accrued
expenses.
Fair Value of
Financial Instruments
-
Fair value estimates discussed herein are based upon certain market
assumptions and pertinent information available to management as of June 30,
2010. The carrying amounts reported in the balance sheet as of June 30, 2010 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 revolving credit lines, notes
payable and long-term debt approximates their carrying value as the stated or
discounted rates of the debt reflect recent market conditions.
Derivative
instruments are recorded as assets and liabilities at estimated fair value based
on available market information. The Company's derivative instrument is an
interest rate swap that changes a variable rate into a fixed rate on the term
loan and qualifies as a cash flow hedge and is included in accrued expenses on
the accompanying Consolidated Balance Sheet as of June 30,
2010. Gains and losses on these instruments are recorded in
other comprehensive income (loss) until the underlying transaction is recorded
in earnings. When the hedged item is realized, gains or losses are reclassified
from accumulated other comprehensive income (loss) (AOCI) to the Consolidated
Statement of Operations on the same line item as the underlying
transaction. The cumulative net loss attributable to this cash
flow hedge recorded in AOCl at June 30, 2010, was approximately
$26,000.
6
Investment
- On October 8, 2009,
the Company entered into an Asset Purchase Agreement with Internet Media
Services, Inc. (“IMS”) 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 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 loss during the year ending December 31, 2009 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 was 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” was 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
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.
During
the six months ended June 30, 2010, the Company recognized a loss on its
investment in IMS of approximately $72,000 using the equity method of accounting
for the investment.
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
six months ended June 30, 2010 and 2009, there were up to 2,522,946 and
1,656,532, respectively, of shares potentially issuable under convertible debt
agreements, options, warrants and restricted stock agreements that could 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 periods.
Concentration
of Credit Risk -
The
Company acquired Premier Packaging Corporation in February
2010.
During the year
ended December 31, 2009, 72% of Premier Packaging’s sales were to two customers,
which comprised 81% of Premier Packaging’s accounts receivable balance as of
December 31, 2009. During the six month period ended June 30, 2010,
these two customers accounted for 23% of the Company’s consolidated
revenue. As of June 30, 2010 one of the customers,
which accounted for 18% of the Company’s consolidated sales for the first six
months of 2010, has a contract with the Company that is currently set to expire
in July 2011, and comprised 22% of the Company’s consolidated accounts
receivable as of June 30, 2010
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. As of
June 30, 2010, the Company has approximately $309,000 in cash and $317,000
available to it under one credit facility, along with up to $1,000,000 available
under a credit line at its Premier Packaging subsidiary. To address
its working capital needs, on July 21, 2010 and July 22, 2010, the Company
raised a aggregate of $1,080,000, net of fees, from the sale of common stock
. However, 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 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.
7
Recent Accounting
Pronouncements
In
January 2010, the FASB issued ASU 2010-6, “
Improving Disclosures About Fair
Value Measurements”
(“ASU 2010-6”), which requires reporting entities to
make new disclosures about recurring or nonrecurring fair-value measurements
including significant transfers into and out of Level 1 and Level 2 fair-value
measurements and information on purchases, sales, issuances, and settlements on
a gross basis in the reconciliation of Level 3 fair- value measurements. ASU
2010-6 is effective for interim and annual reporting periods beginning after
December 15, 2009, except for Level 3 reconciliation disclosures which are
effective for interim and annual periods beginning after December 15, 2010.
The Company adopted the requirements within ASU 2010-6 as of January 1,
2010. The adoption did not have an impact on our financial
statements.
2.
Inventory
Inventory
approximately consisted of the following:
|
|
June 30,
|
December 31,
|
||||||
|
|
2010
|
2009
|
||||||
|
Finished
Goods
|
$ | 283,490 | $ | 38,093 | ||||
|
Work
in process
|
61,271 | 58,493 | ||||||
|
Raw
Materials
|
152,565 | 87,588 | ||||||
| 497,326 | 184,174 | |||||||
|
Less
inventory reserve
|
(10,000 | ) | - | |||||
| $ | 487,326 | $ | 184,174 | |||||
3. Other
Intangible
Assets
Other
intangible assets are comprised of the following:
|
June 30, 2010 (unaudited)
|
December 31, 2009
|
|||||||||||||||||||||||||
|
Useful
Life
|
Gross
Carrying
Amount
|
Accumulated
Amortizaton
|
Net
Carrying
Amount
|
Gross
Carrying
Amount
|
Accumulated
Amortizaton
|
Net
Carrying
Amount
|
||||||||||||||||||||
|
Acquired
intangibles
|
5
years
|
$ | 2,038,300 | $ | 658,467 | $ | 1,379,833 | $ | 756,300 | $ | 622,285 | $ | 134,015 | |||||||||||||
|
Patent
acquisition and defense costs
|
Varied
(1)
|
4,729,889 | 4,162,737 | 567,152 | 4,729,889 | 3,879,341 | 850,548 | |||||||||||||||||||
|
Patent
application costs
|
Varied
(2)
|
831,961 | 192,381 | 639,580 | 776,159 | 171,753 | 604,406 | |||||||||||||||||||
| $ | 7,600,150 | $ | 5,013,585 | $ | 2,586,565 | $ | 6,262,348 | $ | 4,673,379 | $ | 1,588,969 | |||||||||||||||
(1)-
patent rights are amortized over their expected useful life which is generally
the legal life of the patent. As of June 30, 2010 the weighted
average remaining useful life of these assets in service was 1.28
years.
(2)-
patent rights are amortized over their expected useful life which is generally
the legal life of the patent. As of June 30, 2010 the weighted
average remaining useful life of these assets in service was 14.6
years.
4.
Debt
Revolving Note -
Related Party-
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 June 30, 2010, the Company had
outstanding $683,000 ($583,000 – December 31, 2009) under the Fagenson Credit
Agreement. Under the terms of the agreement the Company
is required to comply with various covenants. As of June 30, 2010,
the Company was in default of the Fagenson Credit Agreement due to a failure to
pay interest when due. Fagenson and Co. has waived the defaults
through January 1, 2012.
8
Interest
expense for revolving notes from related parties for the six months ended June
30, 2010 was approximately $10,000 ($58,000 – 2009) of which approximately
$162,000 is included in accrued expenses as of June 30, 2010 ($152,000 –December
31, 2009).
Notes
Payable -
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 a $900,000 Term 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 is being
amortized over the term of the Note. Under the terms of the
agreements the Company is required to comply with various covenants, which the
Company was in compliance with as of June 30, 2010.
On
December 30, 2009, the Company used the proceeds from a $450,000 Convertible
Note to pay in full $450,000 due under a 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 is being
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 is being 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. Under the terms of the agreements the Company is required to
comply with various covenants, which the Company was in compliance as
of June 30, 2010.
On
February 12, 2010, the Company acquired all of the outstanding common stock of
Premier Packaging Corporation (“Premier”) from Robert B. and Joan T. Bzdick
for $2,000,000 in cash and 735,437 shares of the Company's common
stock. 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 credit 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 (“DPI Secuprint”). 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 an
interest rate swap agreement to lock into a 5.6% effective interest over the
life of the term loan.
9
5.
Stockholders’ Equity
Restricted Stock
–
As of June 30, 2010, there are 40,000 unvested restricted shares
granted to an employee that vests proratably through December
2013. The unvested shares are valued at $84,000. In
addition, there are 45,000 restricted shares that will vest only upon the
occurrence of certain events prior to May 3, 2012, 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 $563,000, 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 June 30, 2010, vesting is not considered probable
and no compensation expense has been recognized related to the performance
grants.
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 which was
valued at $2,547,675.
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.
Stock
Options
– During the six months ended June 30, 2010, the Company issued
options to purchase 40,000 of its common shares at an exercise price of $2.45
per share to non-employee directors pursuant to the 2004 Non-Employee Officer
Director Stock Option Plan that vest at the end of one year of service on the
Company’s Board of Directors. The fair value of these options
amounted to approximately $38,000 determined by utilizing the Black Scholes
option pricing model. In addition, the Company issued options to
purchase 170,000 of its common shares at an exercise prices between $3.23 and
$4.00 per share under the Company’s 2004 Employees’ Stock Option Plan to certain
employees. The fair value of these options amounted to approximately
$235,000 determined by utilizing the Black Scholes option pricing
model. The Company records stock-based payment expense related to
these options based on the grant date fair value in accordance with ASC
718.
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 six months ended June
30, 2010, the Company had stock compensation expense of approximately $205,000
($0.01 per share) (negative stock compensation expense of $117,000- 2009; $0.01
per share).
As of
June 30, 2010, there was approximately $630,000 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.
6.
Business Combination
On
February 12, 2010, the Company acquired all of the outstanding common stock of
Premier Packaging Corporation (“Premier”) from Robert B. and Joan T. Bzdick
for $2,000,000 in cash and 735,437 shares of the Company's common stock with a
value of $2,566,675 at February 12, 2010. 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
believes 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.
The
acquisition has been accounted for as a business combination, whereby the
Company measured the identifiable assets acquired and liabilities assumed based
on the acquisition date fair value. The Company incurred
approximately $30,000 of acquisition related legal and professional fees that
were expensed in the period in which they were incurred. The
Company is required to recognize and measure any related goodwill acquired in
the business combination or a gain from a bargain purchase. Based on
management’s preliminary assumptions, the fair value of the assets acquired and
liabilities assumed was less than the purchase price resulting in the recording
of goodwill. The goodwill recorded with the transaction is not
deductible for income taxes.
10
The
Company has engaged a valuation expert, The Financial Valuation Group, to assist
management in determining the fair value of the assets acquired. The
allocation of the purchase price and the estimated useful lives associated with
the acquired assets and liabilities is as follows:
|
Fair
value of the consideration transferred
|
$ | 4,566,675 |
Estimated Useful
Lives
|
|||
|
Fair
value of assets acquired and liabilities assumed:
|
||||||
|
Cash
|
$ | 5,290 | ||||
|
Accounts
receivable
|
1,284,227 | |||||
|
Inventories
|
504,162 | |||||
|
Machinery
and equipment
|
1,557,500 |
3
to 7 years
|
||||
|
Other
intangible assets
|
1,372,000 |
5
to 10 years
|
||||
|
Goodwill
|
627,360 | |||||
|
Total
Assets
|
$ | 5,350,539 | ||||
|
Liabilities
assumed:
|
||||||
|
Accounts
payable
|
$ | 448,128 | ||||
|
Revolving
credit lines
|
277,645 | |||||
|
Accrued
Liabilities
|
58,091 | |||||
|
Total
Liabilities
|
$ | 783,864 | ||||
|
Total
prelimary purchase price
|
$ |
4,566,675
|
Set forth
below is the unaudited proforma revenue, operating loss, net loss and loss per
share of the Company as if Premier Packaging Corporation had been acquired by
the Company as of January 1, 2009.
|
Three Months Ended June 30,
|
Six Months Ended June 30,
|
|||||||||||||||
|
(unaudited)
|
2010
|
2009
|
2010
|
2009
|
||||||||||||
|
Revenue
|
3,325,472 | 3,624,326 | 6,984,570 | 7,964,276 | ||||||||||||
|
Operating
Loss
|
(846,666 | ) | (753,617 | ) | (2,014,016 | ) | (1,529,036 | ) | ||||||||
|
Net
Loss
|
(996,542 | ) | (878,749 | ) | (2,184,892 | ) | (1,801,359 | ) | ||||||||
|
Basic
and diluted loss per share
|
(0.06 | ) | (0.06 | ) | (0.13 | ) | (0.12 | ) | ||||||||
7.
Other Income
In March,
2010, the Company received notification that it was due approximately $143,000
for New York State Qualified Emerging Technology Company (“QETC”) refundable tax
credits for the tax year ended 2008 which the Company received in April,
2010.
8.
Commitments and Contingencies
Legal
Matters
-
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.
11
In 2006,
the Company received notices that the ECB had filed separate claims in each of
the United Kingdom, The Netherlands, Belgium, Italy, France, Spain, Germany,
Austria 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. On March 26, 2007, the High Court of
Justice, Chancery Division, Patents Court in London, England ruled that the
Patent was deemed invalid in the United Kingdom, and on March 19, 2008 this
decision was upheld on appeal. 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 ₤327,000 through June 30, 2010
and owes approximately ₤51,000 (approximately $76,000 as of June 30, 2010),
which includes approximately ₤22,000 of interest on unpaid fees, which amount is
included in accrued expenses as of June 30, 2010. In April 2010, the Company was
notified that a suit was filed by the ECB in the State of New York seeking
summary judgment for the unpaid fees reimbursement of ₤39,000 and interest of
₤22,000, of which a ₤10,000 payment was made during the secong quarter of 2010.
The suit is scheduled to be heard during the third quarter of 2010.
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. On July 6, 2010, the Company was notified that the German Court has
ruled that the Patent, that was awarded to the Company by the European Patent
Office and upheld as valid in a previous hearing in the German Court of First
Instance, has now been deemed invalid in Germany due to added matter. 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 filed an appeal against the
French decision on May 7, 2008. On March 20, 2010, the Company was informed that
the decision was upheld in the French appeal. On March 12, 2008 the Dutch Court
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 was heard in June
2010, with a decision expected in October 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. Cost reimbursement, if any, associated with the Belgium,
Austrian and French validity cases as well as the appeals in Germany and
France are covered under the Trebuchet agreement 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 agreed to pay substantially all of the
litigation costs associated validity proceedings in eight European countries
relating to the Patent. Trebuchet also agreed to pay substantially all of the
litigation costs associated with any 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 two jurisdictions
(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 and the security printers have been notified and the court hearing date
is tentatively scheduled for January 21, 2011.
12
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 June 30, 2010, there has been no settlement
amounts related to these agreements.
Contingent
Purchase Price
-In December, 2008, the Company acquired substantially all
of the assets of DPI of Rochester, LLC (“DPI”) in which the Company guaranteed
up to $50,000 to certain parties depending on whether certain conditions
occurred within five years of the acquisition. As of June 30, 2010,
the Company considers the likelihood that the payment will be required as
remote.
Employment
agreements -
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 June 30, 2010, approximately $20,000 remains
due under the agreement and is recorded in accrued expenses. Any
remaining amounts due under the agreement after the shares are issued, if any,
can be paid in cash or additional shares.
Operating
leases
with a related
party
- In conjunction with it acquisition of Premier Packaging in
February 2010, the Company entered into a ten-year lease for a production
facility in Victor, NY with Robert Bzdick, the former owner of Premier
Packaging, and the Company’s Chief Operating Officer and President
of Premier Packaging. The minimum future lease
payments subsequent to June 30, 2010 under this lease are as
follows:
|
2010
|
80,000 | |||
|
2011
|
160,000 | |||
|
2012
|
160,000 | |||
|
2013
|
160,000 | |||
|
2014
|
160,000 | |||
|
2015
|
178,333 | |||
|
Thereafter
|
735,000 |
9.
Supplemental Cash Flow Information
During the six months ended June 30,
2010, the Company issued 735,437 shares valued at $2,566,675 as a partial
payment of an acquisition. In addition, the Company satisfied
approximately $54,000 of accrued expenses by issuing common stock of the Company
and had a non-cash other comprehensive loss item for interest rate swap loss of
approximately $26,000. Cash paid for interest during the six months
ended June 30, 2010, was approximately $112,000 ($17,000 - 2009)
.
13
10.
Segment Information
The
Company's businesses are organized, managed and internally reported as four
operating segments. Three 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,
along with traditional commercial printing on paper and
plastic. For the purposes of providing segment
information, these three operating segments have been aggregated into one
reportable segment in accordance with ASC 280. The fourth business is
engaged in the production of packaging products and is classified as a separate
segment. A summary of the three segments
follows:
|
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.
|
|
|
Packaging
|
The
Company acquired Premier Packaging in February 12, 2010 which produces
packaging products such as boxes, mailers, and point of sale displays for
various end-users.
|
|
|
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.
|
Approximate
information concerning the Company’s operations by reportable segment for the
three and six months ended June 30, 2010 and 2009 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:
|
3 months ended June 30,
2010:
|
Legal
Supplies
|
Security and
Commercial Printing
|
Packaging
|
Corporate
|
Total
|
|||||||||||||||
|
Revenues
from external customers
|
$ | - | $ | 1,995,000 | 1,330,000 | $ | - | $ | 3,325,000 | |||||||||||
|
Depreciation
and amortization
|
- | 210,000 | 99,000 | 1,000 | 310,000 | |||||||||||||||
|
Segment
profit (loss)
|
- | (563,000 | ) | (92,000 | ) | (342,000 | ) | (997,000 | ) | |||||||||||
| Identifiable assets | - | 5,382,000 | 4,602,000 | 258,000 | 10,242,000 | |||||||||||||||
|
3
months ended June 30, 2009:
|
||||||||||||||||||||
|
Revenues
from external customers
|
$ | 115,000 | $ | 2,133,000 | - | $ | - | $ | 2,248,000 | |||||||||||
|
Depreciation
and amortization
|
5,000 | 404,000 | - | 1,000 | 410,000 | |||||||||||||||
|
Segment
profit (loss)
|
9,000 | (769,000 | ) | - | (215,000 | ) | (975,000 | ) | ||||||||||||
| Identifiable assets | 252,000 | 6,870,000 | - | 707,000 | 7,828,000 | |||||||||||||||
|
6 months ended June 30, 2010:
|
Legal
Supplies
|
Security and
Commercial Printing
|
Packaging
|
Corporate
|
Total
|
|||||||||||||||
|
Revenues
from external customers
|
$ | - | $ | 4,029,000 | 2,071,000 | $ | - | $ | 6,100,000 | |||||||||||
|
Depreciation
and amortization
|
- | 515,000 | 126,000 | 1,000 | 642,000 | |||||||||||||||
|
Segment
profit (loss)
|
- | (1,284,000 | ) | (75,000 | ) | (758,000 | ) | (2,117,000 | ) | |||||||||||
|
6
months ended June 30, 2009:
|
||||||||||||||||||||
|
Revenues
from external customers
|
$ | 253,000 | $ | 4,774,000 | - | $ | - | $ | 5,027,000 | |||||||||||
|
Depreciation
and amortization
|
10,000 | 808,000 | - | 2,000 | 820,000 | |||||||||||||||
|
Segment
profit (loss)
|
27,000 | (1,105,000 | ) | - | (840,000 | ) | (1,918,000 | ) | ||||||||||||
11.
Subsequent Events
On July 21, 2010 and July 22, 2010,
Document Security Systems entered into subscription agreements with each of
twenty two (22) accredited investors. Under these subscription
agreements the Company issued an aggregate of 413,787 shares of common stock and
five-year warrants to purchase 82,753 shares of common stock, in consideration
of an aggregate of $1,200,000. The warrants are exercisable at $3.75
per share.
The
Company paid Aegis Capital Corp., for its services as placement agent, a 7%
commission, and a 3% non-accountable expense allowance, in the aggregate amount
of $120,000. In addition, we issued the placement agent five year
warrants to purchase 41,379 shares of common stock, exercisable at $3.75 per
share.
14
FORWARD-LOOKING
STATEMENTS
Certain
statements contained herein constitute “forward-looking statements” within the
meaning of the Private Securities Litigation Reform Act of 1995 (the “1995
Reform Act”). Document Security Systems, Inc. desires to avail
itself of certain “safe harbor” provisions of the 1995 Reform Act and is
therefore including this special note to enable us to do so. Except
for the historical information contained herein, this report contains
forward-looking statements (identified by the words "estimate," "project,"
"anticipate," "plan," "expect," "intend," "believe," "hope," "strategy" and
similar expressions), which are based on our current expectations and speak only
as of the date made. These forward-looking statements are subject to various
risks, uncertainties and factors that could cause actual results to differ
materially from the results anticipated in the forward-looking statements,
including, without limitation, those contained in our Form 10-K for the year
ended December 31, 2009, and those described herein that could cause actual
results to differ materially from the results anticipated in the forward-looking
statements, and the following:
|
|
·
|
Our
limited operating history with our business
model
|
|
|
·
|
Our
low cash balance and limited financing currently available to us, we may
in the near future have a number of obligations that we will be unable to
meet without generating additional income or raising additional
capital.
|
|
|
·
|
The
risk of insolvency or bankruptcy if we cannot generate additional income
or raise additional capital in the near
future
|
|
|
·
|
Further
cost reductions or curtailment in future operations due to our low cash
balance and negative cash flow
|
|
|
·
|
Our
ability to effect a financing transaction to fund our operations could
adversely affect the value of your
stock.
|
|
|
·
|
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
loss in current litigation in which we may lose certain of our technology
rights, which may affect our business
plan.
|
|
|
·
|
The
inability to adequately protect our intellectual
property
|
|
|
·
|
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.
|
|
|
·
|
The
failure of our products and services to achieve market
acceptance
|
|
|
·
|
Changes
in document security technology and standards could render our
applications and services obsolete.
|
|
|
·
|
The
inability to compete in our market, especially against established
industry competitors with greater market presence and financial
resources.
|
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. In addition, our technologies can be applied
to product 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.
15
Our core
business is counterfeit prevention, brand protection and validation of authentic
print media, including government-issued documents, currency, private corporate
record and, securities. We believe we are a world leader in the
research and development of optical deterrent technologies and have
commercialized these technologies with a broad suite of products that offer our
customers a wide array of document security solutions to satisfy their specific
anti-counterfeiting requirements. Our technology can be used in
securing sensitive and critical documents such as currency, automobile titles,
spare parts forms for the aerospace industry, gift certificates, permits,
checks, licenses, receipts, prescription and medical forms, engineering
schematics, ID cards, labels, original music, coupons, homeland security
manuals, consumer product and pharmaceutical packaging, tickets, and school
transcripts. In addition, we have developed a digital product to
implement our technologies in Internet-based environments utilizing standard
desktop printers. We believe that our digital technology greatly
expands the reach and potential market for our technologies and
solutions. In February 2010, we acquired Premier Packaging, a
privately held commercial packaging company located in Victor, NY with
approximately $7.3 million in sales in 2009. As a result of
this acquisition, we have entered the packaging market with the intent to
introduce our security technologies to a new audience geared toward the
protection of brand counterfeiting. We believe that the use of our
technologies on product packaging presents a significant
opportunity. In addition, this acquisition will allow us to
strengthen our competitive position in the traditional commercial printing and
packaging markets as we will be able to offer a very price effective combination
of services.
Technologies
We have developed or acquired over 30
technologies that provide our customers a wide spectrum of
solutions. Our primary anti-counterfeiting products and technologies
are marketed under the AuthentiGuard trade names.
Products
and Services
Security and
C
ommercial
P
rinting
: Our
technology portfolio allows us to create unique custom secure paper, plastic,
packaging and Internet-based and software enterprise solutions. We
market and sell under the name Document Security Systems 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, coupons, parts tracking forms.
Our
primary product for the retail end-user market is AuthentiGuard® Security
Paper. AuthentiGuard® Security Paper is blank paper that contains our
Pantograph 4000™ technology. The paper reveals
hidden warning words, logos or images using “The Authenticator”- our proprietary
viewing lens –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 one major paper distributor: Boise. 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.
We retain the rights to sell the AuthentiGuard® Security Paper directly to
end-users anywhere in the world.
We
produce secure and non-secure printing at our 20,000 square foot printing
facility in Rochester, NY. Our printing division has a
high speed 6 color press along with two digital presses along with a full range
of die cutting, packing, and folding capabilities.
We
produce our secure and non-secure plastic printed documents such as ID cards,
event badges, and driver licenses at our 25,000 square foot facility in
Brisbane, California under the name Plastic Printing
Professionals. Our plastic division has the capabilities for high
speed data encoding and production of high-volume precision RFID
cards.
Packaging:
We produce our
secure and non-secure packaging products such as boxes, mailers, point of sale
displays, utilizing a CAD/CAM design system that allows for early stage
prototyping at our manufacturing facility in Victor, New York. Our
packaging division offers automated die cutting, high speed folding, gluing,
window and paper patching, automated in-line inserting, pick and place and
tip-on systems.
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 our 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 an
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.
16
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:
|
|
·
|
Pay
us one price per year;
|
|
|
·
|
Pay
us a percentage of gross sales price of the product containing the
technology during the term; or
|
|
|
·
|
Joint
venture or profit sharing
arrangement
|
|
|
·
|
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.
Results of
Operations for the Three and Six Months Ended
June 30, 2010
Compared to the Three and Six Months ended June 30, 2009
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. During the third quarter of
2009, the Company’s Board of Directors finalized an agreement to sell its legal
products business. In accordance with ASC 205-20-45, the
Company reported the results of Legalstore.com as continued operations because
the operations and cash flow 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 in this quarterly report and in our annual report on Form 10-K for the
year ended December 31, 2009.
Revenue
|
Three Months
Ended June 30,
2010
|
Three Months
Ended June 30,
2009
|
% change
|
Six Months
Ended June
30,
2010
|
Six Months Ended
June 30, 2009
|
% change
|
|||||||||||||||||||
|
Revenue
|
||||||||||||||||||||||||
|
Security
and commercial printing
|
$ | 1,828,000 | $ | 1,942,000 | -6 | % | $ | 3,687,000 | $ | 4,359,000 | -15 | % | ||||||||||||
|
Packaging
|
1,330,000 | - | 2,070,000 | - | ||||||||||||||||||||
|
Technology
license royalties and digital solutions
|
167,000 | 191,000 | -13 | % | 343,000 | 415,000 | -17 | % | ||||||||||||||||
|
Legal
products
|
- | 115,000 | -100 | % | - | 253,000 | -100 | % | ||||||||||||||||
|
Total
Revenue
|
3,325,000 | 2,248,000 | 48 | % | 6,100,000 | 5,027,000 | 21 | % | ||||||||||||||||
For the
three months ended June 30, 2010, revenue was $3.3 million compared to $2.2
million for the three months ended June 30, 2009, an increase of
48%. In February 2010, the Company acquired Premier Packaging
Corp, which had sales of $1,330,000. The addition of Premier
Packaging sales offset a 6% decline in security and commercial print revenue and
a decrease of 13% of technology license royalties and digital solutions, and the
absence of legal products revenue in 2010 as the division was sold in the fourth
quarter of 2009.
For the
six months ended June 30, 2010, revenue was $6.1 million compared to $5.0
million for the six months ended June 30, 2009, an increase of
21%. The addition of Premier Packaging sales offset a 15% decline in
security and commercial print revenue and a decrease of 17% of technology
license royalties and digital solutions, and the absence of legal products
revenue in 2010 as the division was sold in the fourth quarter of
2009.
17
Cost
of Sales and Gross Profit
|
Three Months
Ended June 30,
2010
|
Three Months
Ended June 30,
2009
|
%
change
|
Six Months Ended
June 30, 2010
|
Six Months Ended
June 30, 2009
|
% change
|
|||||||||||||||||||
|
Costs
of revenue
|
||||||||||||||||||||||||
|
Security
and commercial printing
|
$ | 1,389,000 | $ | 1,496,000 | -7 | % | $ | 2,754,000 | $ | 3,031,000 | -9 | % | ||||||||||||
|
Packaging
|
1,058,000 | $ | - | 1,617,000 | - | |||||||||||||||||||
|
Technology
license royalties and digital solutions
|
- | 4,000 | -100 | % | 5,000 | 7,000 | -29 | % | ||||||||||||||||
|
Legal
products
|
- | 60,000 | -100 | % | - | 123,000 | -100 | % | ||||||||||||||||
|
Total
cost of revenue
|
2,447,000 | 1,560,000 | 57 | % | 4,376,000 | 3,161,000 | 38 | % | ||||||||||||||||
|
Gross
profit
|
||||||||||||||||||||||||
|
Security
and commercial printing
|
439,000 | 446,000 | -2 | % | 933,000 | 1,328,000 | -30 | % | ||||||||||||||||
|
Packaging
|
272,000 | - | 453,000 | - | ||||||||||||||||||||
|
Technology
license royalties and digital solutions
|
167,000 | 187,000 | -11 | % | 338,000 | 408,000 | -17 | % | ||||||||||||||||
|
Legal
products
|
- | 55,000 | -100 | % | - | 130,000 | -100 | % | ||||||||||||||||
|
Total
gross profit
|
878,000 | 688,000 | 28 | % | 1,724,000 | 1,866,000 | -8 | % | ||||||||||||||||
|
Three Months
Ended June 30,
2010
|
Three Months
Ended June 30,
2009
|
% change
|
Six Months
Ended
June 30,
2010
|
Six Months Ended
June 30, 2009
|
% change
|
|||||||||||||||||||
|
Gross
profit percentage:
|
26 | % | 31 | % | -16 | % | 28 | % | 37 | % | -24 | % | ||||||||||||
Gross
profit increased 28% to $878,000 in the second quarter of 2010 as compared to
the second quarter of 2009. The increase was primarily due to the
addition of gross profits from the Company’s packaging division acquired in
February 2010 which was offset by decreases in security and commercial print
margins and technology licensing margins. In addition, the Company
did not have any gross profits from legal product sales as the division was sold
in the fourth quarter of 2009. Gross profit for the six months ended
June 30, 2010 decreased 8%, which reflect a significant decrease in security and
commercial print profits that the Company experienced in the first quarter of
2010 due to the lack of large commercial print orders in 2010 that the Company
had in 2009. The Company expects that the impact of the
Company’s acquisition of it packaging division will be to decrease overall gross
profit margins for at least the near future, especially as the number of
non-security packaging projects out-number the security packaging projects,
which the Company expect will be at higher profit margins.
Operating
Expenses
|
Three Months
Ended June 30,
2010
|
Three Months
Ended June 30,
2009
|
% change
|
Six Months Ended
June 30, 2010
|
Six Months Ended
June 30, 2009
|
% change
|
|||||||||||||||||||
|
Operating
Expenses
|
||||||||||||||||||||||||
|
Sales,
general and administrative compensation
|
$ | 859,000 | $ | 835,000 | 3 | % | $ | 1,691,000 | $ | 1,858,000 | -9 | % | ||||||||||||
|
Professional
Fees
|
133,000 | 40,000 | 233 | % | 345,000 | 287,000 | 20 | % | ||||||||||||||||
|
Sales
and marketing
|
57,000 | 11,000 | 418 | % | 126,000 | 71,000 | 77 | % | ||||||||||||||||
|
Research
and development
|
67,000 | 75,000 | -11 | % | 133,000 | 162,000 | -18 | % | ||||||||||||||||
|
Rent
and utilities
|
166,000 | 115,000 | 44 | % | 308,000 | 270,000 | 14 | % | ||||||||||||||||
|
Other
|
163,000 | 70,000 | 133 | % | 372,000 | 255,000 | 46 | % | ||||||||||||||||
| $ | 1,445,000 | $ | 1,146,000 | 26 | % | $ | 2,975,000 | $ | 2,903,000 | 2 | % | |||||||||||||
|
Other
Operating Expenses
|
||||||||||||||||||||||||
|
Depreciation
and amortization
|
31,000 | 40,000 | -23 | % | 62,000 | 80,000 | -23 | % | ||||||||||||||||
|
Stock
based compensation
|
65,000 | 28,000 | 132 | % | 205,000 | (117,000 | ) | 275 | % | |||||||||||||||
|
Amortization
of intangibles
|
184,000 | 324,000 | -43 | % | 430,000 | 647,000 | -34 | % | ||||||||||||||||
| 280,000 | 392,000 | -29 | % | 697,000 | 610,000 | 14 | % | |||||||||||||||||
|
Total
Operating Expenses
|
1,725,000 | 1,538,000 | 12 | % | 3,672,000 | 3,513,000 | 5 | % | ||||||||||||||||
18
Selling, General and
Administrative
Sales, general and
administrative compensation
costs were 3% higher in the three months
ending June, 30, 2010 as compared to the three months ended June 30, 2009, which
reflects the impact of the addition of approximately $149,000 of SG&A
compensation expense from the packaging division the Company acquired in
February 2010. Otherwise, SG&A compensation costs would have
decreased 15% during the three months ended June 30, 2010, as compared to the
three months ended June 30, 2009 as the result of staff reductions that the
Company made throughout 2009 and in early 2010.
For the
six months ended June 30, 2010, SG&A compensation costs decreased 9% despite
the addition of the packaging division, which added $219,000 of SG&A
compensation expense. Otherwise, SG&A compensation expense has
decreased 21% during the first six months of 2010 as compared to the first six
months of 2009, which reflect the staff reductions that the Company made
throughout 2009 and in early 2010.
Professional fees
in
the three months ended June 30, 2010 were $133,000 due to costs associated with
corporate legal and accounting costs, along with approximately $43,000 of costs
of the Company’s annual report mailing and shareholder’s meeting. In
addition, the Company increased is consulting costs during the second quarter of
2010 for business development efforts. Professional fees for the
second quarter of 2009 were offset by a one-time reduction of expense due to the
reversal of previously accrued consulting costs that were never incurred and
never billed by consultant. Without this one time item, professional
fees during the second quarter of 2009 would have been approximately
$100,000.
For the
six months ended 2010, professional fees have increased 20% from the first six
months of 2009, primarily due to the above-mentioned one-term expense reduction
item in second quarter of 2009, offset by increases in consulting expense during
2010 for a business development consultant, and due to approximately $30,000 of
legal and financial fees associated with the Company’s acquisition of Premier
Packaging in February 2010.
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 due to a
reduction in compensation cost.
Rent and utilities
increased as a result of the acquisition of Premier Packaging in February
2010.
Other
operating
expenses are primarily equipment maintenance and repairs, office supplies, IT
support, bad debt expense and insurance costs. For the three months
ended June 30, 2010, these costs increased by $93,000 or 133%, from the three
months ended June 30, 2009, primarily the result of one-time reversals of rent
expense and bad debt expense recorded by the Company in the 2009
period. Otherwise, other operating expenses for the three and
six month periods ended June 30, 2010 were generally consistent with the 2009
periods.
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 in the second quarter of 2010 was $65,000 as compared to
$28,000 in the second quarter of 2009 which reflected the impact of options
granted to employees at Premier Packaging when the Company acquired it in
February 2010, and to certain senior management, along with stock based
compensation expense related to warrants issued to third parties for
consulting.
Stock
based compensation in the first six months of 2010 was $205,000 as compared to a
negative $117,000 stock based compensation expense for the first six months of
2009 which reflected the effect of 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 the first quarter
of 2009.
Amortization of
intangibles
expense decreases in the three and six month periods ended
June 30, 2010, as compared to the 2009 periods were a result of the reduction in
the Company’s net capitalized patent acquisition and defense costs asset, offset
by increases in amortization of other intangible expense of new other
intangibles acquired.
19
Other
Income and expenses
|
Three Months
Ended June
30,
2010
|
Three Months
Ended June 30,
2009
|
%
change
|
Six Months
Ended June 30,
2010
|
Six Months
Ended
June 30,
2009
|
%
change
|
|||||||||||||||||||
|
Other
income (expense):
|
||||||||||||||||||||||||
|
Interest
expense
|
(84,000 | ) | (68,000 | ) | 24 | % | (150,000 | ) | (149,000 | ) | 1 | % | ||||||||||||
|
Amortizaton
of note discount
|
(41,000 | ) | (64,000 | ) | -36 | % | (81,000 | ) | (125,000 | ) | -35 | % | ||||||||||||
|
Loss
in equity investment
|
(20,000 | ) | - | (72,000 | ) | - | ||||||||||||||||||
|
Gain
on foreign currency transactions
|
- | 12,000 | -100 | % | - | 12,000 | -100 | % | ||||||||||||||||
|
Other
income
|
- | - | 143,000 | - | ||||||||||||||||||||
|
Other
income (expense), net
|
(145,000 | ) | (120,000 | ) | 21 | % | (160,000 | ) | (262,000 | ) | -39 | % | ||||||||||||
Loss in equity investment:
The Company recognizes gains or losses on its investment in Internet
Media Services, the entity that purchased Legalstore.com business from the
Company in October 2009 under the equity method of accounting for
investments.
Other income:
In March, 2010,
the Company received notification that it was due approximately $143,000 for New
York State Qualified Emerging Technology Company (“QETC”) refundable tax credits
for the tax year ended 2008 which the Company received in April,
2010.
Net
Loss and Loss Per Share
|
Three Months
Ended June
30,
2010
|
Three Months
Ended June
30,
2009
|
%
change
|
Six Months
Ended June
30,
2010
|
Six Months
Ended
June 30,
2009
|
%
change
|
|||||||||||||||||||
|
Net
loss
|
$ | (997,000 | ) | $ | (975,000 | ) | 2 | % | $ | (2,117,000 | ) | $ | (1,918,000 | ) | 10 | % | ||||||||
|
Net
loss per share, basic and diluted
|
$ | (0.06 | ) | $ | (0.07 | ) | -14 | % | $ | (0.12 | ) | $ | (0.13 | ) | -8 | % | ||||||||
|
Weighted
average common shares outstanding, basic and diluted
|
17,769,726 | 14,417,699 | 23 | % | 17,390,570 | 14,397,942 | 21 | % | ||||||||||||||||
During
the three months ended June 30, 2010, the Company experienced a net loss of
$997,000, a 2% increase from the net loss during the three months ended June 30,
2009. The increase in net loss during the quarter was due to several
factors, including a increases in legal fees, consulting fees, rent and
utilities and other operating expense, and stock based compensation that more
than offset an increase in gross profit and decreases in amortization expense
and note discount amortization.
During
the six months ended June 30, 2010, the Company has experienced a net loss of
$2,117,000, a 10% increase from the net loss during the six months ended June
30, 2009. The increase in net loss during this period was due to
several factors, including a increases in legal fees, consulting fees, rent and
utilities and other operating expense, and stock based compensation that more
than offset an increase in gross profit and decreases in amortization expense
and note discount amortization.
20
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:
|
||||||||||||
|
June 30,
2010
|
June 30,
2009
|
% change
vs.
2009
|
||||||||||
|
Cash
flows from:
|
||||||||||||
|
Operating
activities
|
$ | (329,000 | ) | $ | (807,000 | ) | 63 | % | ||||
|
Investing
activities
|
(2,401,000 | ) | 37,000 | 6589 | % | |||||||
|
Financing
activities
|
2,590,000 | 1,400,000 | -83 | % | ||||||||
|
Working
capital
|
(798,000 | ) | (4,553,000 | ) | -82 | % | ||||||
|
Current
ratio
|
0.75 | x | 0.35 | x | 115 | % | ||||||
|
Cash
and cash equivalents
|
$ | 309,000 | $ | 718,000 | -57 | % | ||||||
|
Funds
Available from Open Credit Facilities
|
$ | 1,317,000 | $ | 387,000 | 240 | % | ||||||
|
Debt
(excluding unamortized debt discount)
|
$ | 3,674,000 | $ | 4,329,000 | -15 | % | ||||||
As of
June 30, 2010, our cash balance was approximately $309,000, down from $449,000
at December 31, 2009. During the first six months of 2010, the
Company used $295,000 of cash for operations, a 63% improvement over the use of
cash for the first six months of 2009, which reflects the positive effect of
cost cuts at every division that allows the Company to use less cash to support
its operations. On February 12, 2010, the Company
acquired Premier Packaging Corp for $2,000,000 in cash, which was funded by
proceeds from a $1,500,000 Term Note and the proceeds from the exercise of
warrants by certain warrant holders that the Company received during the
quarter.
Future
Capital Needs
As of June
30, 2010, the Company has approximately $309,000 in cash and $317,000
available to it under one credit facility, along with up to $1,000,000 available
under a credit line at its Premier Packaging subsidiary. While the
Company’s working capital position has significantly improved since December 31,
2009, the Company continued to incur operating losses during the first six
months of 2010. In July of 2010, the Company was able to raise a
gross of $1,200,000 from the private sales of its common stock to meet much of
it near term funding requirements. However, if the Company cannot
generate sufficient cash from its operations in the future, the Company may need
to raise additional funds 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 continue to be available through
either current or future investors.
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.
Critical
Accounting Policies and Estimates
As of
June 30, 2010, our critical accounting policies and estimates have not changed
materially from those set forth in our Annual Report on Form 10-K for the year
ended December 31, 2009.
21
Evaluation
of Disclosure Controls and Procedures
Management is responsible for
establishing and maintaining effective disclosure controls and
procedures. 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”)) as
of the end of the period covered by this report to provide reasonable assurance
that information we are required to disclose in reports that we file or submit
under the Exchange Act is recorded, processed, summarized and reported within
the time periods specified in SEC rules and forms and that such information is
accumulated and communicated to management, including the CEO and the CFO, as
appropriate, to allow timely decisions regarding required
disclosure.
Based on this evaluation, and in light
of the material weaknesses in our internal control over financial reporting that
are discussed in our Annual Report on Form 10-K for the fiscal year ended
December 31, 2009 these officers have concluded that our disclosure controls and
procedures were not effective. The material weaknesses consist of an
insufficient complement of qualified accounting personnel and controls
associated with segregation of duties and ineffective controls associated with
identifying and accounting for complex and non-routine transactions in
accordance with U.S. generally accepted accounting principles. To
address the material weaknesses we performed additional analyses and other
post-closing procedures to ensure our consolidated financial statements were
prepared in accordance with accounting principles generally accepted in the
United States of America (U.S. GAAP). Notwithstanding these material weaknesses,
management believes that the financial statements included in this Quarterly
Report on Form 10-Q fairly present, in all material respects, our financial
condition, result of operations and cash flows for the periods
presented.
There
can be no assurance, however, that our disclosure controls and procedures will
detect or uncover all failures of persons within the Company and its
consolidated subsidiaries to disclose material information otherwise required to
be set forth in our periodic reports. There are inherent limitations to the
effectiveness of any system of disclosure controls and procedures, including the
possibility of human error and the circumvention or overriding of the controls
and procedures. Accordingly, even effective disclosure controls and procedures
can only provide reasonable, not absolute, assurance of achieving their control
objectives.
Changes
in Internal Control Over Financial Reporting
During
the first six months of 2010, the Company added the accounting staff from its
acquisition of a packaging company in February 2010, and will incorporate these
individuals into its financial reporting process. The Company
will evaluate the effect of its changes in internal controls during its annual
assessment of its internal controls as of December 31,
2010. Additionally, as described above under "Controls And
Procedures - Evaluation of Disclosure Controls and Procedures," we also began
implementing additional procedures to address the material weaknesses identified
in our internal controls over financial reporting.
An
evaluation was performed under the supervision of the Company’s management,
including the CEO and CFO, as required under Exchange Act Rule 13a-15(d) and
15d-15(d), of whether any change in the Company’s internal control over
financial reporting occurred during the fiscal quarter ended June 30,
2010. Based on that evaluation, the Company’s management, including
the CEO and CFO, concluded that, other than the changes discussed above, no
other changes in our internal control over financial reporting occurred during
the second three months of 2010 that have materially affected, or are reasonably
likely to materially affect, our internal control over financial
reporting.
OTHER
INFORMATION
Information
concerning pending legal proceedings is incorporated herein by reference to Note
8 to the Consolidated Financial Statements (Unaudited) in Part I of this Form
10-Q.
22
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.
In
2006, the Company received notices that the ECB had filed separate claims in
each of the United Kingdom, The Netherlands, Belgium, Italy, France, Spain,
Germany, Austria 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. On March 26,
2007, the High Court of Justice, Chancery Division, Patents Court in London,
England ruled that the Patent was deemed invalid in the United
Kingdom, and on March 19, 2008 this decision was upheld on appeal.
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 ₤327,000 through June 30, 2010 and owes
approximately ₤51,000 (approximately $76,000 as of June 30, 2010), which
includes approximately ₤22,000 of interest on unpaid fees, which amount is
included in accrued expenses as of June 30, 2010. In April
2010, the Company was notified that a suit was filed by the ECB in the State of
New York seeking summary judgment for the unpaid fees reimbursement of ₤29,000
and interest of ₤22,000 which is scheduled to be heard during the third quarter
of 2010.
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. On July 6, 2010, the Company was notified that the German
Court has ruled that the Patent, that was awarded to the Company by the European
Patent Office and upheld as valid in a previous hearing in the German Court of
First Instance, has now been deemed invalid in Germany due to added
matter. 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 filed an appeal against the French decision on May 7,
2008. On March 20, 2010, the Company was informed that the decision was
upheld in the French appeal. On March 12, 2008 the Dutch
Court 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 was heard in June 2010, with a decision
expected in October 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. Cost reimbursement, if any, associated with the Belgium,
Austrian and French validity cases as well as the appeals in Germany and
France are covered under the Trebuchet agreement 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 agreed to pay substantially all of
the litigation costs associated validity proceedings in eight European countries
relating to the Patent. Trebuchet also agreed to pay substantially
all of the litigation costs associated with any 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 two
jurisdictions (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 and the security printers have been
notified and the court hearing date is tentatively scheduled for January 21,
2011.
23
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 these legal proceedings to which we are a party will have a material
adverse effect on our results of operations, cash flows or our financial
condition.
We face many significant risks in
our business, some of which are unknown to us and not presently foreseen. These
risks could have a material adverse impact on our business, financial condition
and results of operations in the future. We have disclosed a number of material
risks under Item 1A of our annual report on Form 10-K for the year ended
December 31, 2009, which we filed with the Securities and Exchange
Commission on March 25, 2010. The following discussion is of material
changes to risk factors disclosed in that report.
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.
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. As of June 30, 2010, the Company has approximately
$309,000 in cash and $317,000 available to it under one credit facility,
along with up to $1,000,000 available under a credit line available to its
Premier Packaging subsidiary. To address its working capital needs, on
July 21, 2010 and July 22, 2010, the Company raised an aggregate of
$1,080,000, net of fees, from the sale of common stock
. However, 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 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. 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.
We
have a significant amount of indebtedness and may be unable to satisfy our
obligations to pay interest and principal thereon when due.
As of
June 30, 2010, we have the following approximate amounts of outstanding
indebtedness:
|
(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.
|
|
(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.
|
|
(iii)
|
$575,000 Promissory Note bearing
interest at 10% per annum due November 24, 2012 and is secured by the
assets of the Company’s wholly owned subsidiary DPI
Secuprint.
|
|
(iv)
|
$683,000
due under a Credit Facility to a related party 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:
24
|
(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 interest rate swap agreement to lock into a 5.6% 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.
|
|
(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%.
As of June 30, 2010, there was $0 outstanding on the
line.
|
We have not made interest payments on
the Credit Facility to a related party and have had to obtain
a
default waiver from
the holder
in the past
, including one as of June 30,
2010.
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
and there is no guarantee that we will
be able to obtain default waivers from the holders in the
future.
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 or meet its financial obligations. If Trebuchet
is unable to meet its financial obligations, then we may be obligated to pay for
certain court mandated legal costs to the ECB or other parties, which may
materially affect our financial condition.
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.
25
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.
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.
26
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:
|
|
·
|
identify
suitable businesses or assets to
buy;
|
|
|
·
|
complete
the purchase of those businesses on terms acceptable to
us;
|
|
|
·
|
complete
the acquisition in the time frame we expect;
and
|
|
|
·
|
improve
the results of operations of the businesses that we buy and successfully
integrate their operations into our
own.
|
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. 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. In particular, 72% of Premier Packaging’s
sales for the year ended December 31, 2009 were with two customers and which
comprised 81% of Premier Packaging’s accounts receivable balance as of December
31, 2009. During the six month period ended June 30, 2010, these two
customers accounted for 23% of the Company’s consolidated
revenue. One of the customers, which accounted for 18% of the
Company’s consolidated sales, has a contract with the Company that ends in July
2011, and comprised 22% of the Company’s consolidated accounts receivable as of
June 30, 2010
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.
27
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.
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:
|
|
·
|
the
authority of the Board of Directors to issue preferred stock;
and
|
|
|
·
|
a prohibition on cumulative
voting in the election of
directors
.
|
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 June 30, 2010, there were
approximately 182 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.
28
The
exercise of our outstanding options and warrants and vesting of restricted stock
awards may depress our stock price.
As of
June 30, 2010, we had (i) outstanding stock options and warrants to purchase an
aggregate of 1,959,080 shares of our Common Stock at exercise prices ranging
from $1.86 to $12.65 per share; (ii) 85,000 unvested 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
In
December 2008, we received a letter from the NYSE Amex stating that, based on
the NYSE Amex’s review of publicly available information, we were considered to
be below the NYSE Amex’s continued listing standards. After
submitting a plan of compliance to the NYSE Amex and additional evaluation by
the Exchange, we were informed in March 2010 that we had resolved the continued
listing deficiencies. We cannot assure you that we will not receive
additional deficiency letters in the future, or that we will continue to satisfy
the continued listing standards in order to remain listed on the
Exchange.
On July 21, 2010 and July 22, 2010,
Document Security Systems entered into subscription agreements with each of
twenty two (22) accredited investors. Under these subscription
agreements the Company issued an aggregate of 413,787 shares of common stock and
five-year warrants to purchase 82,753 shares of common stock, in consideration
of an aggregate of $1,200,000. The warrants are exercisable at $3.75
per share.
The
Company paid Aegis Capital Corp., for its services as placement agent, a 7%
commission, and a 3% non-accountable expense allowance, in the aggregate amount
of $120,000. In addition, we issued the placement agent five year
warrants to purchase 41,379 shares of common stock, exercisable at $3.75 per
share.
The
Company has 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 Credit Agreement,as amended, the Company can borrow up to a
maximum of $1,000,000 from time to time up to and until January 4,
2012. As of June 30, 2010, the Company was in default of the
agreement due to a failure to pay interest when due. The holder has
waived the default through January 1, 2012.
The
shareholders of the Company voted on two items at the Annual Meeting of
Shareholders held on June 10, 2010:
29
1. Election
of seven Directors to serve for a term of one year until the 2011 Annual Meeting
of Stockholders, or until their successors are duly elected and
qualified.
2. Ratification
of the appointment of Freed Maxick & Battaglia, CPAs, PC, as the Company’s
independent registered public accounting firm for the fiscal year ending
December 31, 2010.
The
nominees for director were elected based on the following vote:
|
Nominees for Director
|
For
|
Withheld
|
||||||
|
Patrick
White
|
7,671,521 | 251,040 | ||||||
|
David
Wicker
|
7,899,604 | 22,957 | ||||||
|
Robert
Bzdick
|
7,898,526 | 24,035 | ||||||
|
Timothy
Ashman
|
7,339,412 | 583,149 | ||||||
|
Robert
B. Fagenson
|
7,540,359 | 382,202 | ||||||
|
Ira
A. Greenstein
|
7,540,437 | 382,124 | ||||||
|
Alan
E. Harrison
|
7,339,787 | 582,774 | ||||||
There
were 4,933,560 broker held non-voted shares represented at the Meeting with
respect to this matter.
The
proposal to ratify the appointment of Freed Maxick & Battaglia, CPAs, PC, as
the Company’s independent registered public accounting firm for the fiscal year
ending December 31, 2010 was adopted and received the following
votes:
|
For
|
Against
|
Abstain
|
||||
|
12,713,454
|
24,948 | 117,819 |
None
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.
Exhibits
|
Item
3.1
|
Certificate
of Incorporation of the Registrant, as amended (incorporated by reference
to
|
|
|
Exhibit
3.1 to the Company’s Registration Statement No. 2-98684-NY on Form
S-18).
|
|
Item
3.2
|
By-Laws
of the Registrant, as amended (incorporated by reference to Exhibit
3.2
|
|
|
to
the Company’s Registration Statement No. 2-98684-NY on Form
S-18).
|
|
Item
31.1
|
Certification
of Chief Executive Officer as required by Rule 13a-14 or 15d-14 of the
Securities
|
|
|
Exchange
Act of 1934, as adopted pursuant to Section 302 of the Sarbanes Oxley Act
of 2002.
|
|
Item
31.2
|
Certification
of Chief Financial Officer as required by Rule 13a-14 or 15d-14
of
|
|
|
the
Securities Exchange Act of 1934, as adopted pursuant to Section 302 of
the
|
|
|
Sarbanes
Oxley Act of 2002.
|
|
Item
32.1
|
Certification
of Chief Executive Officer as required by 18 U.S.C. Section 1350,
as
|
|
|
adopted
pursuant to Section 906 of the Sarbanes Oxley Act of
2002.
|
|
Item
32.2
|
Certification
of Chief Financial Officer as required by 18 U.S.C. Section
1350,
|
|
|
as
adopted pursuant to Section 906 of the Sarbanes Oxley Act of
2002.
|
30
SIGNATURES
In
accordance with the requirements of the Exchange Act, the registrant caused this
report on Form 10-Q to be signed on its behalf by the undersigned, thereunto
duly authorized.
|
DOCUMENT
SECURITY SYSTEMS, INC.
|
||||
|
August
12, 2010
|
By:
|
/s/
Patrick White
|
||
|
Patrick
White
Chief
Executive Officer
|
||||
|
August
12, 2010
|
By:
|
/s/
Philip Jones
|
||
|
Philip
Jones
Chief
Financial Officer
|
31
Exhibit
Index
Item
3.1 Certificate of Incorporation
of the Registrant, as amended (incorporated by reference to Exhibit 3.1 to the
Company’s Registration Statement No. 2-98684-NY on Form S-18).
Item
3.2 By-Laws of the Registrant, as
amended (incorporated by reference to Exhibit 3.2 to the Company’s Registration
Statement No. 2-98684-NY on Form S-18).
Item
31.1 Certification of Chief Executive Officer
as required by Rule 13a-14 or 15d-14 of the Securities Exchange Act of 1934, as
adopted pursuant to Section 302 of the Sarbanes Oxley Act of 2002.
Item
31.2 Certification of Chief Financial Officer
as required by Rule 13a-14 or 15d-14 of the Securities Exchange Act of 1934, as
adopted pursuant to Section 302 of the Sarbanes Oxley Act of 2002.
Item
32.1 Certification of Chief Executive Officer
as required by 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the
Sarbanes Oxley Act of 2002.
Item
32.2 Certification of Chief Financial Officer
as required by 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the
Sarbanes Oxley Act of 2002.
32
TABLE OF CONTENTS
Part IItem 1 - Financial StatementsItem 2 - Management's Discussion and Analysis Of Financial Condition and Results Of OperationsItem 4T - Controls and ProceduresPart IIItem 1 - Legal ProceedingsItem 1A Risk FactorsItem 2 - Unregistered Sales Of Equity Securities and Use Of ProceedsItem 3 - Defaults Upon Senior SecuritiesItem 4 - Submission Of Matters To A Vote Of Security HoldersItem 5 - Other InformationItem 6 - ExhibitsItem 3. 1 Certificate Of Incorporation Of The Registrant, As Amended (incorporated By Reference ToItem 3. 2 By-laws Of The Registrant, As Amended (incorporated By Reference To Exhibit 3. 2Item 31. 1 Certification Of Chief Executive Officer As Required By Rule 13a-14 Or 15d-14 Of The SecuritiesItem 31. 2 Certification Of Chief Financial Officer As Required By Rule 13a-14 Or 15d-14 OfItem 32. 1 Certification Of Chief Executive Officer As Required By 18 U.s.c. Section 1350, AsItem 32. 2 Certification Of Chief Financial Officer As Required By 18 U.s.c. Section 1350,