1-32146
|
Commission file number
|
DOCUMENT SECURITY SYSTEMS, INC.
|
(Exact name of registrant as specified in its charter)
|
New York
|
16-1229730
|
|
(State or other Jurisdiction of incorporation- or Organization)
|
(IRS Employer Identification No.)
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28 Main Street East, Suite 1525
|
Rochester, NY 14614
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(Address of principal executive offices)
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(585) 325-3610
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(Registrant's telephone number, including area code)
|
FORM 10-Q
TABLE OF CONTENTS
|
|||||
PART I
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FINANCIAL INFORMATION
|
||||
Item 1
|
Financial Statements
|
||||
Consolidated Balance Sheets as of September 30, 2011 (Unaudited) and December 31, 2010 (Audited)
|
3 | ||||
Consolidated Statements of Operations for the three and nine months ended September 30, 2011 and 2010 (Unaudited)
|
4 | ||||
Consolidated Statements of Cash Flows for the nine months ended September 30, 2011 and 2010 (Unaudited)
|
5 | ||||
Notes to Interim Consolidated Financial Statements (Unaudited)
|
6 | ||||
Item 2
|
Management's Discussion and Analysis of Financial Condition and Results of Operations
|
20 | |||
Item 4
|
Controls and Procedures
|
28 | |||
PART II
|
OTHER INFORMATION
|
||||
Item 1
|
Legal Proceedings
|
29 | |||
Item 2
|
Unregistered Sales of Equity Securities and Use of Proceeds
|
29 | |||
Item 3
|
Defaults upon Senior Securities
|
30 | |||
Item 4
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Other Information
|
30 | |||
Item 5
|
Exhibits
|
30 |
September 30, 2011
|
December 31, 2010
|
|||||||
ASSETS
|
(Unaudited)
|
(Restated)
|
||||||
Current assets:
|
||||||||
Cash
|
$ | 1,070,510 | $ | 4,086,574 | ||||
Accounts receivable, net of allowance
|
||||||||
of $66,000 ($66,000- 2010) | 1,805,735 | 2,227,877 | ||||||
Inventory
|
1,043,780 | 601,359 | ||||||
Prepaid expenses and other current assets
|
98,102 | 231,190 | ||||||
Total current assets
|
4,018,127 | 7,147,000 | ||||||
Property, plant and equipment, net
|
4,147,327 | 2,543,494 | ||||||
Other assets
|
244,356 | 325,953 | ||||||
Goodwill
|
3,322,799 | 3,084,121 | ||||||
Other intangible assets, net
|
2,076,508 | 1,847,859 | ||||||
Total assets
|
$ | 13,809,117 | $ | 14,948,427 | ||||
LIABILITIES AND STOCKHOLDERS' EQUITY
|
||||||||
Current liabilities:
|
||||||||
Accounts payable
|
$ | 1,595,952 | $ | 1,828,138 | ||||
Accrued expenses and other current liabilities
|
1,181,767 | 1,312,363 | ||||||
Revolving lines of credit
|
842,109 | 614,833 | ||||||
Short-term loan from related party
|
150,000 | - | ||||||
Current portion of long-term debt
|
447,645 | 300,000 | ||||||
Current portion of capital lease obligations
|
97,683 | 88,776 | ||||||
Total current liabilities
|
4,315,156 | 4,144,110 | ||||||
Revolving note from related party
|
- | 583,000 | ||||||
Long-term debt
|
3,035,414 | 1,578,242 | ||||||
Capital lease obligations
|
16,698 | 98,532 | ||||||
Deferred tax liability
|
103,990 | 89,779 | ||||||
Derivative liabilities
|
- | 3,866,836 | ||||||
Commitments and contingencies (see Note 7)
|
||||||||
Stockholders' equity
|
||||||||
Common stock, $.02 par value; 200,000,000 shares authorized, 19,503,132 shares issued and outstanding
|
||||||||
(19,391,319 in 2010)
|
390,062 | 387,825 | ||||||
Additional paid-in capital
|
48,189,936 | 44,178,569 | ||||||
Accumulated other comprehensive loss
|
(22,156 | ) | (25,834 | ) | ||||
Accumulated deficit
|
(42,219,983 | ) | (39,952,632 | ) | ||||
Total stockholders' equity
|
6,337,859 | 4,587,928 | ||||||
Total liabilities and stockholders' equity
|
$ | 13,809,117 | $ | 14,948,427 |
For the Three Months Ended September 30,
|
For the Nine Months Ended September 30,
|
|||||||||||||||
2011
|
2010
|
2011
|
2010
|
|||||||||||||
Revenue
|
(Restated)
|
|||||||||||||||
Printing
|
$ | 831,468 | $ | 1,056,167 | $ | 2,342,463 | $ | 3,488,351 | ||||||||
Packaging
|
1,575,948 | 1,381,526 | 3,795,599 | 3,452,106 | ||||||||||||
Plastic IDs and cards
|
757,489 | 564,037 | 2,087,196 | 1,821,630 | ||||||||||||
Licensing and digital solutions
|
451,254 | 149,206 | 951,669 | 489,051 | ||||||||||||
Total revenue
|
3,616,159 | 3,150,936 | 9,176,927 | 9,251,138 | ||||||||||||
Costs of revenue
|
||||||||||||||||
Printing
|
698,715 | 864,517 | 2,082,810 | 2,820,452 | ||||||||||||
Packaging
|
1,124,973 | 1,056,274 | 2,762,941 | 2,673,455 | ||||||||||||
Plastic IDs and cards
|
453,932 | 345,492 | 1,231,079 | 1,143,143 | ||||||||||||
Licensing and digital solutions
|
67,778 | - | 86,877 | 5,476 | ||||||||||||
Total costs of revenue
|
2,345,398 | 2,266,283 | 6,163,707 | 6,642,526 | ||||||||||||
Gross profit
|
1,270,761 | 884,653 | 3,013,220 | 2,608,612 | ||||||||||||
Operating expenses:
|
||||||||||||||||
Selling, general and administrative
|
1,976,913 | 1,332,229 | 5,212,788 | 4,441,793 | ||||||||||||
Research and development
|
83,387 | 71,731 | 208,498 | 204,086 | ||||||||||||
Amortization of intangibles
|
71,376 | 189,467 | 205,416 | 619,667 | ||||||||||||
Operating expenses
|
2,131,676 | 1,593,427 | 5,626,702 | 5,265,546 | ||||||||||||
Operating loss
|
(860,915 | ) | (708,774 | ) | (2,613,482 | ) | (2,656,934 | ) | ||||||||
Other income (expense):
|
||||||||||||||||
Change in fair value of derivative liability
|
- | - | 360,922 | - | ||||||||||||
Interest expense
|
(60,531 | ) | (78,572 | ) | (169,711 | ) | (228,082 | ) | ||||||||
Loss on equity investment
|
- | (49,714 | ) | - | (121,393 | ) | ||||||||||
Amortizaton of note discount
|
- | (40,732 | ) | - | (122,196 | ) | ||||||||||
Other income
|
- | - | - | 143,063 | ||||||||||||
Loss before income taxes
|
(921,446 | ) | (877,792 | ) | (2,422,271 | ) | (2,985,542 | ) | ||||||||
Income tax (benefit) expense
|
(164,394 | ) | 4,737 | (154,920 | ) | (1,126,828 | ) | |||||||||
Net loss
|
$ | (757,052 | ) | $ | (882,529 | ) | $ | (2,267,351 | ) | $ | (1,858,714 | ) | ||||
Other comprehensive income (loss):
|
||||||||||||||||
Interest rate swap income (loss)
|
- | (6,000 | ) | 3,678 | (31,834 | ) | ||||||||||
Comprehensive Loss
|
$ | (757,052 | ) | $ | (888,529 | ) | $ | (2,263,673 | ) | $ | (1,890,548 | ) | ||||
Net loss per share -basic and diluted:
|
$ | (0.04 | ) | $ | (0.05 | ) | $ | (0.12 | ) | $ | (0.11 | ) | ||||
Dividend per share
|
$ | - | $ | 0.01 | $ | - | $ | 0.01 | ||||||||
Weighted average common shares outstanding, basic and diluted
|
19,474,173 | 18,008,012 | 19,435,930 | 17,599,410 |
2011 |
2010
|
|||||||
Cash flows from operating activities:
|
(Restated)
|
|||||||
Net loss
|
$ | (2,267,351 | ) | $ | (1,858,714 | ) | ||
Adjustments to reconcile net loss to net cash used by operating activities:
|
||||||||
Depreciation and amortization
|
534,292 | 949,683 | ||||||
Stock based compensation
|
319,106 | 336,111 | ||||||
Amortization of note discount
|
- | 122,196 | ||||||
Loss on equity investment
|
- | 121,393 | ||||||
Change in fair value of derivative liability
|
(360,922 | ) | - | |||||
Deferred tax benefit
|
(169,131 | ) | (1,141,040 | ) | ||||
(Increase) decrease in assets:
|
||||||||
Accounts receivable
|
491,497 | 593,122 | ||||||
Inventory
|
(442,421 | ) | (125,381 | ) | ||||
Prepaid expenses and other assets
|
110,208 | (59,881 | ) | |||||
Increase (decrease) in liabilities:
|
||||||||
Accounts payable
|
(300,291 | ) | (406,598 | ) | ||||
Accrued expenses and other current liabilities
|
67,820 | 207,614 | ||||||
Net cash used by operating activities
|
(2,017,193 | ) | (1,261,495 | ) | ||||
Cash flows from investing activities:
|
||||||||
Purchase of Property, plant and equipment
|
(497,709 | ) | (138,640 | ) | ||||
Purchase of other intangible assets
|
(26,313 | ) | (118,999 | ) | ||||
Acquisition of business
|
61,995 | (2,272,405 | ) | |||||
Net cash used by investing activities
|
(462,027 | ) | (2,530,044 | ) | ||||
Cash flows from financing activities:
|
||||||||
Net (payments) borrowings on revolving lines of credit
|
(11,883 | ) | 285,705 | |||||
Borrowings on long-term debt
|
- | 1,500,000 | ||||||
Payments of long-term debt
|
(245,183 | ) | (175,000 | ) | ||||
Payments of capital lease obligations
|
(72,927 | ) | (69,424 | ) | ||||
Issuance of common stock, net of issuance costs
|
(206,851 | ) | 2,209,445 | |||||
Net cash (used) provided by financing activities
|
(536,844 | ) | 3,750,726 | |||||
Net decrease in cash
|
(3,016,064 | ) | (40,813 | ) | ||||
Cash beginning of period
|
4,086,574 | 448,895 | ||||||
Cash end of period
|
$ | 1,070,510 | $ | 408,082 |
|
Level 1, defined as observable inputs such as quoted prices for identical instruments in active markets;
|
|
Level 2, defined as inputs other than quoted prices in active markets that are either directly or indirectly observable such as quoted prices for similar instruments in active markets or quoted prices for identical or similar instruments in markets that are not active; and
|
|
Level 3, defined as unobservable inputs in which little or no market data exists, therefore requiring an entity to develop its own assumptions, such as valuations derived from valuation techniques in which one or more significant inputs or significant value drivers are unobservable.
|
September 30,
|
December 31,
|
|||||||
2011
|
2010
|
|||||||
Finished Goods
|
$
|
696,162
|
$
|
193,346
|
||||
Work in process
|
114,575
|
86,776
|
||||||
Raw Materials
|
233,043
|
321,237
|
||||||
$
|
1,043,780
|
$
|
601,359
|
September 30, 2011
|
December 31, 2010
|
||||||||||||||||||||||||
Useful Life
|
Gross Carrying Amount
|
Accumulated Amortizaton
|
Net Carrying Amount
|
Gross Carrying Amount
|
Accumulated Amortizaton
|
Net Carrying Amount
|
|||||||||||||||||||
Acquired intangibles
|
5 -10 years
|
$ | 2,446,300 | $ | 983,042 | $ | 1,463,258 | $ | 2,038,300 | $ | 815,177 | $ | 1,223,123 | ||||||||||||
Patent application costs
|
Varied (1)
|
867,334 | 254,084 | 613,250 | 843,693 | 218,957 | 624,736 | ||||||||||||||||||
$ | 3,313,634 | $ | 1,237,126 | $ | 2,076,508 | $ | 2,881,993 | $ | 1,034,134 | $ | 1,847,859 |
Derivative
Liability
|
||||
Balance, January 1, 2011
|
$
|
3,866,836
|
||
Fair
|
||||
Change in fair value
|
(360,922)
|
|||
Reclass to equity on date of amendment that eliminated derivative liabilities to net proceeds
|
(3,505,914)
|
|||
Balance, September 30, 2011
|
$
|
-
|
Estimated Useful Lives
|
|||||
Fair value of consideration transferred
|
$ | 274,232 | |||
Fair value of assets acquired and liabilities assumed:
|
|||||
Cash
|
$ | 61,995 | |||
Accounts receivable
|
69,355 | ||||
Prepaid expenses
|
10,050 | ||||
Computer equipment
|
85,000 |
3 to 7 years
|
|||
Other intangible assets
|
408,000 |
5 to 10 years
|
|||
Goodwill
|
238,678 | ||||
Fair value of assets acquired
|
$ | 873,078 | |||
Liabilities assumed:
|
|||||
Accounts payable
|
$ | 68,353 | |||
Outstanding credit card balances
|
90,207 | ||||
Revolving credit lines
|
148,952 | ||||
Accrued liabilities and deferred revenue
|
122,203 | ||||
Deferred tax liability
|
169,131 | ||||
Fair value of liabilities
|
$ | 598,846 | |||
Total Purchase Price
|
$ | 274,232 |
For the Three Months Ended September 30,
|
For the Nine Months Ended September 30,
|
|||||||||||||||
2011
|
2010
|
2011
|
2010
|
|||||||||||||
Revenue
|
3,616,159 | 3,355,642 | 9,527,685 | 9,925,329 | ||||||||||||
Net Loss
|
(757,052 | ) | (867,039 | ) | (2,249,448 | ) | (1,780,573 | ) | ||||||||
Basic and diluted loss per share
|
(0.04 | ) | (0.05 | ) | (0.12 | ) | (0.10 | ) |
For the Nine Months Ended September 30, 2011
|
For the Nine Months Ended September 30, 2010
|
|||||||
Cash paid for interest
|
$ | 333,000 | $ | 185,000 | ||||
Non-cash investing and financing activities:
|
||||||||
Equity issued for severance agreements
|
- | 74,000 | ||||||
Equity issued for acqusition
|
274,000 | 2,567,000 | ||||||
Non-monetary dividend
|
- | 229,000 | ||||||
Retirement of derivative liability instruments
|
3,506,000 | - | ||||||
Refinance of related party revolving line of credit and accrued interest
|
650,000 | - | ||||||
Property and Plant acquired with debt
|
1,350,000 | - |
Licenses security printing technologies and manufactures and sells secure documents such as vital records, transcripts, safety paper, secure coupons, voter ballots, event tickets, among others. In addition, sells general commercial printing services utilizing digital and offset printing capabilities.
|
|
DSS Plastics
|
Manufactures and sells secure and non-secure plastic printed products such as ID cards, event badges and passes, and loyalty and gift cards, among others. Plastic cards include RFID chips, magnetic strips with variable data, high quality graphics with overt and covert security features.
|
DSS Packaging
|
Manufactures and sells secure and non-secure custom paperboard packaging serving clients in the pharmaceutical, beverage, photo packaging, toy, specialty foods and direct marketing industries, among others.
|
DSS Digital
|
Develops, installs, hosts and services IT services including remote server and application hosting, cloud computing, secure document systems, back-up and disaster recovery services and customer program development services.
|
Three months ended September 30, 2011
|
DSS Printing
|
DSS Plastics
|
DSS Packaging
|
DSS Digital
|
Corporate
|
Total | ||||||||||||||||||
Revenues from external customers
|
$ | 986,000 | $ | 757,000 | 1,576,000 | 297,000 | $ | - | $ | 3,616,000 | ||||||||||||||
Depreciation and amortization
|
39,000 | 44,000 | 90,000 | 9,000 | 1,000 | 183,000 | ||||||||||||||||||
Net (loss) income
|
(448,000 | ) | (33,000 | ) | 120,000 | 19,000 | (415,000 | ) | (757,000 | ) | ||||||||||||||
Three months ended September 30, 2010
|
||||||||||||||||||||||||
Revenues from external customers
|
$ | 1,205,000 | $ | 564,000 | 1,382,000 | - | $ | - | $ | 3,151,000 | ||||||||||||||
Depreciation and amortization
|
146,000 | 75,000 | 86,000 | - | 1,000 | 308,000 | ||||||||||||||||||
Net loss
|
(553,000 | ) | (104,000 | ) | (27,000 | ) | - | (199,000 | ) | (883,000 | ) | |||||||||||||
Nine months ended September 30, 2011
|
||||||||||||||||||||||||
Revenues from external customers
|
$ | 2,901,000 | $ | 2,087,000 | 3,796,000 | 393,000 | $ | - | $ | 9,177,000 | ||||||||||||||
Depreciation and amortization
|
113,000 | 142,000 | 263,000 | 14,000 | 2,000 | 534,000 | ||||||||||||||||||
Net (loss) income
|
(1,312,000 | ) | (12,000 | ) | (51,000 | ) | (4,000 | ) | (888,000 | ) | (2,267,000 | ) | ||||||||||||
Identifiable assets
|
2,237,000 | 2,233,000 | 7,609,000 | 713,000 | 1,017,000 | 13,809,000 | ||||||||||||||||||
Nine months ended September 30, 2010 (As Restated) | ||||||||||||||||||||||||
Revenues from external customers
|
$ | 3,977,000 | $ | 1,822,000 | 3,452,000 | - | $ | - | $ | 9,251,000 | ||||||||||||||
Depreciation and amortization
|
512,000 | 224,000 | 212,000 | - | 2,000 | 950,000 | ||||||||||||||||||
Net (loss) income
|
(1,679,000 | ) | (262,000 | ) | (102,000 | ) | - | 184,000 | (1,859,000 | ) | ||||||||||||||
Identifiable assets at December 31, 2010
|
2,294,000 | 2,063,000 | 6,465,000 | - | 4,126,000 | 14,948,000 |
As Originally Reported
|
As Adjusted
|
Effect of Change
|
||||||||||
Current assets
|
7,147,000 | 7,147,000 | - | |||||||||
Goodwill
|
1,943,081 | 3,084,121 | 1,141,040 | |||||||||
Total assets
|
13,807,387 | 14,948,427 | 1,141,040 | |||||||||
Total current liabilities
|
4,144,110 | 4,144,110 | - | |||||||||
Total liabilities
|
10,360,499 | 10,360,499 | - | |||||||||
Accumulated deficit
|
(41,093,672 | ) | (39,952,632 | ) | 1,141,040 | |||||||
Total stockholders' equity
|
3,446,888 | 4,587,928 | 1,141,040 | |||||||||
Total liabilities and stockholders' equity
|
13,807,387 | 14,948,427 | 1,141,040 |
Originally Reported
|
As Adjusted
|
Effect of Change
|
||||||||||
Revenue
|
9,251,138 | 9,251,138 | - | |||||||||
Cost of revenue
|
6,642,526 | 6,642,526 | - | |||||||||
Gross profit
|
2,608,612 | 2,608,612 | - | |||||||||
Operating expense
|
5,265,546 | 5,265,546 | - | |||||||||
Operating loss
|
(2,656,934 | ) | (2,656,934 | ) | - | |||||||
Other expense
|
(328,608 | ) | (328,608 | ) | - | |||||||
Loss before income taxes
|
(2,985,542 | ) | (2,985,542 | ) | - | |||||||
Income tax expense (benefit)
|
14,212 | (1,126,828 | ) | (1,141,040 | ) | |||||||
Net Loss
|
(2,999,754 | ) | (1,858,714 | ) | 1,141,040 | |||||||
Comprehensive loss
|
(3,031,588 | ) | (1,890,548 | ) | 1,141,040 | |||||||
Net Loss per share -basic and diluted
|
(0.17 | ) | (0.11 | ) | 0.06 |
Originally Reported
|
As Adjusted
|
Effect of Change
|
||||||||||
Net Loss
|
(2,999,754 | ) | (1,858,714 | ) | 1,141,040 | |||||||
Adjustments to reconcile net loss to net cash used by operating activities:
|
||||||||||||
Deferred tax benefit
|
- | 1,141,040 | 1,141,040 | |||||||||
Net cash used by operating activities
|
(1,261,495 | ) | (1,261,495 | ) | - | |||||||
Net cash used by investing activities
|
(2,530,044 | ) | (2,530,044 | ) | - | |||||||
Net cash provided by financing activities
|
3,750,726 | 3,750,726 | - | |||||||||
Net decrease in cash
|
(40,813 | ) | (40,813 | ) | - |
·
|
Our limited operating history with our business model.
|
·
|
Our ability to effect a financing transaction to fund our operations could adversely affect the value of your stock.
|
·
|
A potential 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.
|
·
|
The inability to meet our growth strategy of acquiring complementary businesses and assets and expanding our existing operations to include manufacturing capabilities.
|
·
|
AuthentiGuard™ DX™
|
·
|
AuthentiGuard® Laser Moiré™
|
·
|
AuthentiGuard® Prism™
|
·
|
AuthentiGuard® Pantograph 4000™
|
·
|
AuthentiGuard® Phantom™
|
·
|
AuthentiGuard® VeriGlow™
|
·
|
AuthentiGuard® Survivor 21®
|
·
|
AuthentiGuard® Block-Out™
|
·
|
AuthentiGuard® MicroPerf™
|
Three Months Ended September 30, 2011
|
Three Months Ended September 30, 2010
|
% change
|
Nine Months Ended September 30, 2011
|
Nine Months Ended September 30, 2010
|
% change
|
|||||||||||||||||||
Revenue
|
||||||||||||||||||||||||
Printing
|
$ | 832,000 | $ | 1,056,000 | -21 | % | $ | 2,342,000 | $ | 3,488,000 | -33 | % | ||||||||||||
Packaging
|
1,576,000 | 1,382,000 | 14 | % | 3,796,000 | 3,452,000 | 10 | % | ||||||||||||||||
Plastic IDs and cards
|
757,000 | 564,000 | 34 | % | 2,087,000 | 1,822,000 | 15 | % | ||||||||||||||||
Licensing and digital solutions
|
451,000 | 149,000 | 203 | % | 952,000 | 489,000 | 95 | % | ||||||||||||||||
Total Revenue
|
$ | 3,616,000 | $ | 3,151,000 | 15 | % | $ | 9,177,000 | $ | 9,251,000 | -1 | % |
Three Months Ended September 30, 2011
|
Three Months Ended September 30, 2010
|
% change
|
Nine Months Ended September 30, 2011
|
Nine Months Ended September 30, 2010
|
% change
|
|||||||||||||||||||
Costs of revenue
|
||||||||||||||||||||||||
Printing
|
$ | 699,000 | $ | 865,000 | -19 | % | $ | 2,083,000 | $ | 2,821,000 | -26 | % | ||||||||||||
Packaging
|
1,125,000 | 1,056,000 | 7 | % | 2,763,000 | 2,673,000 | 3 | % | ||||||||||||||||
Plastic IDs and cards
|
453,000 | 345,000 | 31 | % | 1,231,000 | 1,143,000 | 8 | % | ||||||||||||||||
Licensing and digital solutions
|
68,000 | - | 100 | % | 87,000 | 5,000 | 1640 | % | ||||||||||||||||
Total cost of revenue
|
2,345,000 | 2,266,000 | 3 | % | 6,164,000 | 6,642,000 | -7 | % | ||||||||||||||||
Gross profit
|
||||||||||||||||||||||||
Printing
|
133,000 | 191,000 | -30 | % | 259,000 | 667,000 | -61 | % | ||||||||||||||||
Packaging
|
451,000 | 326,000 | 38 | % | 1,033,000 | 779,000 | 33 | % | ||||||||||||||||
Plastic IDs and cards
|
304,000 | 219,000 | 39 | % | 856,000 | 679,000 | 26 | % | ||||||||||||||||
Licensing and digital solutions
|
383,000 | 149,000 | 157 | % | 865,000 | 484,000 | 78 | % | ||||||||||||||||
Total gross profit
|
$ | 1,271,000 | $ | 885,000 | 44 | % | $ | 3,013,000 | $ | 2,609,000 | 15 | % |
Three Months Ended September 30, 2011
|
Three Months Ended September 30, 2010
|
% change
|
Nine Months Ended September 30, 2011
|
Nine Months Ended September 30, 2010
|
% change
|
|||||||||||||||||||
Gross profit percentage: | 35 | % | 28 | % | 25 | % | 33 | % | 28 | % | 18 | % |
Three Months
|
Three Months
|
Nine Months
|
Nine Months
|
|||||||||||||||||||||
Ended September
|
Ended September
|
Ended September
|
Ended September
|
%
|
||||||||||||||||||||
30, 2011 | 30, 2010 |
% change
|
30, 2011 | 30, 2010 |
change
|
|||||||||||||||||||
Operating Expenses
|
||||||||||||||||||||||||
Sales, general and administrative compensation
|
$ | 1,080,000 | $ | 870,000 | 24 | % | $ | 2,684,000 | $ | 2,561,000 | 5 | % | ||||||||||||
Professional Fees
|
219,000 | 92,000 | 138 | % | 582,000 | 437,000 | 33 | % | ||||||||||||||||
Sales and marketing
|
127,000 | 46,000 | 176 | % | 413,000 | 172,000 | 140 | % | ||||||||||||||||
Research and development
|
83,000 | 72,000 | 15 | % | 208,000 | 205,000 | 1 | % | ||||||||||||||||
Rent and utilities
|
195,000 | 170,000 | 15 | % | 547,000 | 478,000 | 14 | % | ||||||||||||||||
Other
|
212,000 | (10,000 | ) | 2220 | % | 575,000 | 361,000 | 59 | % | |||||||||||||||
1,916,000 | 1,240,000 | 55 | % | 5,009,000 | 4,214,000 | 19 | % | |||||||||||||||||
Other Operating Expenses
|
||||||||||||||||||||||||
Depreciation and software amortization
|
31,000 | 34,000 | -9 | % | 94,000 | 96,000 | -2 | % | ||||||||||||||||
Stock based compensation
|
114,000 | 130,000 | -12 | % | 319,000 | 336,000 | -5 | % | ||||||||||||||||
Amortization of intangibles
|
71,000 | 189,000 | -62 | % | 205,000 | 620,000 | -67 | % | ||||||||||||||||
216,000 | 353,000 | -39 | % | 618,000 | 1,052,000 | -41 | % | |||||||||||||||||
Total Operating
|
||||||||||||||||||||||||
Expenses
|
$ | 2,132,000 | $ | 1,593,000 | 34 | % | $ | 5,627,000 | $ | 5,266,000 | 7 | % |
Three Months
|
Three Months
|
Nine Months
|
Nine Months
|
|||||||||||||||||||||
Ended September
|
Ended September
|
Ended September
|
Ended September
|
%
|
||||||||||||||||||||
30, 2011 | 30, 2010 |
% change
|
30, 2011 | 30, 2010 |
change
|
|||||||||||||||||||
Other income (expense):
|
||||||||||||||||||||||||
Change in fair value of derivative liability
|
$ | - | $ | - | 0 | % | $ | 361,000 | $ | - | 0 | % | ||||||||||||
Interest expense
|
(61,000 | ) | (79,000 | ) | -23 | % | (170,000 | ) | (228,000 | ) | -25 | % | ||||||||||||
Amortizaton of note discount
|
- | (41,000 | ) | -100 | % | - | (122,000 | ) | -100 | % | ||||||||||||||
Loss in equity investment
|
- | (50,000 | ) | -100 | % | - | (121,000 | ) | -100 | % | ||||||||||||||
Other income | - | - | 0 | % | - | 143,000 | -100 | % | ||||||||||||||||
Other income (expense), net
|
$ | (61,000 | ) | $ | (170,000 | ) | -64 | % | $ | (191,000 | ) | $ | (328,000 | ) | -42 | % |
Three Months
|
Three Months
|
Nine Months
|
Nine Months
|
|||||||||||||||||||||
Ended
|
Ended
|
Ended |
Ended
|
|||||||||||||||||||||
September 30, 2011 | September 30, 2010 |
% change
|
September 30, 2011
|
September 30, 2010 (Restated)
|
% change
|
|||||||||||||||||||
Income taxes
|
(165,000 | ) | 5,000 | -3400 | % | (156,000 | ) | (1,127,000 | ) | -86 | % |
Three Months
|
Three Months
|
Nine Months
|
Ended September
|
|||||||||||||||||||||
Ended September
|
Ended September
|
Ended September
|
30, 2010 |
%
|
||||||||||||||||||||
30, 2011 | 30, 2010 |
% change
|
30, 2011 |
(Restated)
|
change
|
|||||||||||||||||||
Net loss
|
$ | (757,000 | ) | $ | (883,000 | ) | -14 | % | $ | (2,267,000 | ) | $ | (1,859,000 | ) | 22 | % | ||||||||
|
||||||||||||||||||||||||
Net loss per share, basic and diluted
|
$ | (0.04 | ) | $ | (0.05 | ) | -20 | % | $ | (0.12 | ) | $ | (0.11 | ) | 9 | % | ||||||||
Weighted average common
|
||||||||||||||||||||||||
shares outstanding, basic and diluted
|
19,474,173 | 18,008,012 | 8 | % | 19,435,930 | 17,599,410 | 10 | % |
As Of And For The Period Ended:
|
||||||||||||
September 30, 2011
|
September 30, 2010
|
% change vs. 2010 | ||||||||||
Cash flows from:
|
||||||||||||
Operating activities
|
$ | (2,017,000 | ) | $ | (1,261,000 | ) | -60 | % | ||||
Investing activities
|
(462,000 | ) | (2,530,000 | ) | 82 | % | ||||||
Financing activities
|
(537,000 | ) | 3,751,000 | -114 | % | |||||||
Working capital
|
(297,000 | ) | (329,000 | ) | 17 | % | ||||||
Current ratio
|
.93 | .91 | 3 | % | ||||||||
Cash
|
$ | 1,071,000 | $ | 408,000 | 163 | % | ||||||
Funds Available from Open Credit Facilities
|
$ | 310,000 | $ | 1,131,000 | -73 | % | ||||||
Debt (excluding unamortized debt discount and capitalized Leases)
|
$ | 4,475,000 | $ | 3,569,000 | 24 | % |
|
•
|
develop and implement additional procedures to increase the level of review, evaluation and validation of the Company’s valuation of deferred tax assets; and
|
•
|
increase the level of knowledge among Company employees in the area of accounting for income taxes.
|
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.
|
101 ** | The following materials from our Quarterly Report on Form 10-Q for the quarter ended September 30, 2011 formatted in XBRL (eXtensible Business Reporting Language): (i) Consolidated Balance Sheets, (ii) Consolidated Statements of Operations, (iii) Consolidated Statements of Cash Flows, and (iv) related notes to these financial statements, tagged as blocks of text. |
DOCUMENT SECURITY SYSTEMS, INC. | |||||
November 14, 2011
|
By:
|
/s/ Patrick White
|
|||
Patrick White
Chief Executive Officer
|
|||||
November 14, 2011
|
By:
|
/s/ Philip Jones
|
|||
Philip Jones
Chief Financial Officer
|
/s/ Patrick White
|
|
|||
Patrick White
|
|
|||
Chief Executive Officer
|
|
/s/ Philip Jones
|
|
|||
Philip Jones
|
|
|||
Chief Financial Officer
|
|
(1)
|
The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and
|
(2)
|
The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.
|
/s/ Patrick White
|
|
|||
Patrick White
|
|
|||
Chief Executive Officer
|
|
(1)
|
The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and
|
(2)
|
The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.
|
/s/ Philip Jones
|
|
|||
Philip Jones
|
|
|||
Chief Financial Officer
|
|
Consolidated Balance Sheets (Parenthetical) (USD $) | Sep. 30, 2011 | Dec. 31, 2010 |
---|---|---|
Accounts receivable, allowance | $ 66,000 | $ 66,000 |
Common stock, par value | $ 0.02 | $ 0.02 |
Common stock, shares authorized | 200,000,000 | 200,000,000 |
Common stock, shares issued | 19,503,132 | 19,391,319 |
Common stock, shares outstanding | 19,503,132 | 19,391,319 |
Consolidated Statements of Operations (USD $) | 3 Months Ended | 9 Months Ended | ||
---|---|---|---|---|
Sep. 30, 2011 | Sep. 30, 2010 | Sep. 30, 2011 | Sep. 30, 2010 | |
Revenue | ||||
Printing | $ 831,468 | $ 1,056,167 | $ 2,342,463 | $ 3,488,351 |
Packaging | 1,575,948 | 1,381,526 | 3,795,599 | 3,452,106 |
Plastic IDs and cards | 757,489 | 564,037 | 2,087,196 | 1,821,630 |
Licensing and digital solutions | 451,254 | 149,206 | 951,669 | 489,051 |
Total revenue | 3,616,159 | 3,150,936 | 9,176,927 | 9,251,138 |
Costs of revenue | ||||
Printing | 698,715 | 864,517 | 2,082,810 | 2,820,452 |
Packaging | 1,124,973 | 1,056,274 | 2,762,941 | 2,673,455 |
Plastic IDs and cards | 453,932 | 345,492 | 1,231,079 | 1,143,143 |
Licensing and digital solutions | 67,778 | 86,877 | 5,476 | |
Total costs of revenue | 2,345,398 | 2,266,283 | 6,163,707 | 6,642,526 |
Gross profit | 1,270,761 | 884,653 | 3,013,220 | 2,608,612 |
Operating expenses: | ||||
Selling, general and administrative | 1,976,913 | 1,332,229 | 5,212,788 | 4,441,793 |
Research and development | 83,387 | 71,731 | 208,498 | 204,086 |
Amortization of intangibles | 71,376 | 189,467 | 205,416 | 619,667 |
Operating expenses | 2,131,676 | 1,593,427 | 5,626,702 | 5,265,546 |
Operating loss | (860,915) | (708,774) | (2,613,482) | (2,656,934) |
Other income (expense): | ||||
Change in fair value of derivative liability | 360,922 | |||
Interest expense | (60,531) | (78,572) | (169,711) | (228,082) |
Loss on equity investment | (49,714) | (121,393) | ||
Amortizaton of note discount | (40,732) | (122,196) | ||
Other income | 143,063 | |||
Loss before income taxes | (921,446) | (877,792) | (2,422,271) | (2,985,542) |
Income tax (benefit) expense | (164,394) | 4,737 | (154,920) | (1,126,828) |
Net loss | (757,052) | (882,529) | (2,267,351) | (1,858,714) |
Other comprehensive income (loss): | ||||
Interest rate swap income (loss) | (6,000) | 3,678 | (31,834) | |
Comprehensive Loss | $ (757,052) | $ (888,529) | $ (2,263,673) | $ (1,890,548) |
Net loss per share -basic and diluted: | $ (0.04) | $ (0.05) | $ (0.12) | $ (0.11) |
Dividend per share | $ 0.01 | $ 0.01 | ||
Weighted average common shares outstanding, basic and diluted | 19,474,173 | 18,008,012 | 19,435,930 | 17,599,410 |
Document and Entity Information | 9 Months Ended | |
---|---|---|
Sep. 30, 2011 | Nov. 12, 2011 | |
Document Information [Line Items] | ||
Document Type | 10-Q | |
Amendment Flag | false | |
Document Period End Date | Sep. 30, 2011 | |
Document Fiscal Year Focus | 2011 | |
Document Fiscal Period Focus | Q3 | |
Trading Symbol | DSS | |
Entity Registrant Name | DOCUMENT SECURITY SYSTEMS INC | |
Entity Central Index Key | 0000771999 | |
Current Fiscal Year End Date | --12-31 | |
Entity Filer Category | Smaller Reporting Company | |
Entity Common Stock, Shares Outstanding | 19,548,132 |
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Commitments and Contingencies | 9 Months Ended |
---|---|
Sep. 30, 2011 | |
Commitments and Contingencies |
7. Commitments and
Contingencies
Legal Matters - On August 1, 2005,
the Company commenced a suit in the European Court of First
Instance in Luxembourg against the ECB alleging patent infringement
by the ECB and claimed unspecified damages (the
“ECB Litigation”). 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 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. 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 each of the
national courts seeking revocation and declarations of invalidity
of the Patent. 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 with validity
proceedings in eight European countries relating to the
Patent. 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 Trebuchet Agreement. In
consideration for Trebuchet's funding obligations, the Company
assigned and transferred a 49% interest in 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 and to collect royalties or other payments
under or on account of the Patent. In addition, the Company and
Trebuchet 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. On July 7, 2011, Trebuchet and
the Company entered into a series of agreements wherein
Trebuchet effectively ended its ongoing participation in
the ECB litigation, except for continuing involvement in the final
settlement of fees that may become payable as a result of the
infringement case in the Netherlands described
below. The original agreement with Trebuchet will
remain in effect until Trebuchet makes any and all final payments
that may become due in the Netherland infringement
case.
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 paid the ECB costs for both court cases in
the amount of ₤356,490. 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. However, on July 6,
2010, the Company was notified that the German Court had reversed
the ruling on appeal and the Patent was deemed invalid in
Germany. The Court of First Instance in
Luxembourg ruled on September 5, 2007 that it does not have
jurisdiction to rule on the patent infringement
claim. On January 9, 2008 the French Court held
that the Patent was invalid in France and on March 10, 2010, this
decision was upheld on appeal. On March 12, 2008
the Dutch Court ruled that the Patent was valid in the
Netherlands. However, on December 21, 2010 the Dutch
Court reversed the ruling on appeal and the Patent was deemed
invalid in the Netherlands. On November 3, 2009,
the Belgium Court held that the Patent was invalid in
Belgium. On November 17, 2009, the Austrian Court held
that the Patent was invalid in Austria. On March
24, 2010 the Spanish Court ruled that the Patent was
valid. The decision is being appealed by the
ECB. In July 2010, the Company was notified that
the Italian Court deemed the patent invalid. The
decision was not appealed.
In
certain jurisdictions in the ECB Litigation, the losing party is
responsible for the other party’s legal fees, subject to
court approval. The Company paid a total of
₤356,490 to the ECB for the United Kingdom
case. Trebuchet paid for the costs reimbursements
due, if any, for all of the other jurisdictions involved, except
for approximately €156,000 for the Germany case and
approximately €175,000 for the Netherlands case,
which were still due as of September 30,
2010. In July 2011, Trebuchet transferred funds to
the Company for disbursement of these amounts, which the Company
has recorded as accrued liabilities. In addition, the
ECB formally requested the Company to pay attorneys and court fees
for the Court of First Instance case in Luxembourg in the amount of
€93,752 which, unless the amount is settled will be subject
to an assessment procedure that has not been initiated. The Company
will accrue the assessed amount, if any, as soon as it is
reasonably estimable.
On
February 18, 2010, Trebuchet, on behalf of the Company, filed an
infringement suit in the Netherlands 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. Upon determination on December 21, 2010, that
the patent was invalid in the Netherlands, the infringement case
was terminated by Trebuchet. Trebuchet will be
responsible for costs reimbursement associated with the case, if
any, when determined by the Dutch Court.
There
are no other material pending legal proceedings to which the
Company or any of its subsidiaries is a party or of which any of
its property is subject, other than ordinary routine litigation
incidental to the Company’s business.
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 September 30, 2011, 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
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 September 30, 2011, the
Company considers the likelihood that the payment will be required
as remote.
|
Other Intangible Assets | 9 Months Ended | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Sep. 30, 2011 | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Other Intangible Assets |
3. Other Intangible
Assets
Other
intangible assets are comprised of the following:
(1)-
patent rights are amortized over their expected useful
life which is generally the legal life of the patent. As
of September 30, 2011 the weighted average remaining useful life of
these assets in service was approximately 13 years.
|
Segment Information | 9 Months Ended | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
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Segment Information |
9. Segment Information
The
Company's businesses are organized, managed and internally reported
as four operating segments. In the second quarter of
2011, the Company acquired ExtraDev for its DSS Digital Group and
the Company launched a new corporate identity and logo, along with
a new website that grouped the Company under four distinct
divisions. In conjunction with this, the Company
determined that an expansion of its segment reporting to align with
the new internal structure was appropriate. A summary of
the four reportable segments follows:
Approximate information concerning the Company’s operations
by reportable segment for the three and nine months ended September
30, 2011 and 2010 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:
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Restatement |
10. Restatement
The
Company identified an error in the Company’s accounting
treatment relating to the deferred tax liability created as a
result of an acquisition in the first quarter of
2010, On February 12, 2010, the Company purchased
all of the outstanding stock of Premier Packaging Corporation for
$2,000,000 in cash and 735,437 shares of the Company’s common
stock with a value of $2,566,675 plus the assumption of liabilities
at February 12, 2010. Among the various assets and
liabilities acquired, the Company allocated $1,557,500 to machinery
and equipment and $1,372,000 to other intangible
assets. The tax basis for the machinery and equipment
and other intangible assets as of the date of acquisition was zero,
resulting in a deferred tax liability of $1,141,040 as a result of
the acquisition. As part of the business combination
accounting, the Company properly recorded the deferred tax
liability that was caused by the acquisition, but erroneously
reduced a deferred tax asset valuation allowance. The
Company has determined that the deferred tax liability should have
been included in the business combination accounting, resulting in
an additional $1,141,040 of goodwill. Also, the Company
in a separate entry should have recorded a deferred tax benefit
along with a reversal of the deferred tax asset valuation
allowance. As a result of this determination, the
Company recorded an additional deferred tax benefit and additional
goodwill in the amount of $1,141,040 as of the March 31, 2010 and
subsequent periods. The correction of this error had no
impact on previously disclosed revenue, cost of sales, gross
profit, operating expenses and other income and
expense. Additionally, this error had no
impact on net loss for the interim periods ended June 30, 2011 and
March 31, 2011.
The
following table represents the impact of the restatement
adjustments on the Company's Condensed Consolidated Balance
Sheet as of December 31, 2010
The
following table represents the impact of the restatement
adjustments on the Company's Condensed Consolidated Statement
of Operations for the nine months ended September 30, 2010. There
was no effect on the three months ended September 30, 2010
Consolidated Statement of Operations.
The
following table represents the impact of the restatement
adjustments on the Company's Condensed Consolidated Statement
of Cash Flows for the nine months ended September 30,
2010
|
Supplemental Cash Flow Information | 9 Months Ended | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
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Supplemental Cash Flow Information |
8. Supplemental Cash Flow
Information
|
Basis of Presentation and Significant Accounting Policies | 9 Months Ended | ||||||
---|---|---|---|---|---|---|---|
Sep. 30, 2011 | |||||||
Basis of Presentation and Significant Accounting Policies |
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 in
consolidation.
Interim
results are not necessarily indicative of results expected for a
full year. For further information regarding Document Security
Systems, Inc.’s (the “Company”) accounting
policies, refer to the audited consolidated financial statements
and footnotes thereto included in the Company's Form 10-K and Form
10-K/A for the fiscal year ended December 31,
2010.
The
preparation of financial statements in conformity with accounting
principles generally accepted in the United States (U.S. GAAP)
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.
Fair Value of Financial Instruments -The
Company accounts for financial instruments measured at fair value
on a recurring basis and on a non-recurring basis. The accounting
guidance defines fair value, establishes a framework for measuring
fair value in accordance with U.S. GAAP and expands disclosures
about fair value measurements.
Fair
value is defined as the price that would be received to sell an
asset or paid to transfer a liability in an orderly transaction
between market participants at the measurement date. The Fair Value
Measurement Topic of the FASB Accounting Standards Coded
(“ASC “) establishes a three-tier fair value hierarchy
which prioritizes the inputs used in measuring fair value. The
hierarchy gives the highest priority to unadjusted quoted prices in
active markets for identical assets or liabilities (Level 1
measurements) and the lowest priority to unobservable inputs (Level
3 measurements). These tiers include:
The
carrying amounts reported in the balance sheet of cash, 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. One of the Company's derivative instruments is an
interest rate swap that changes a variable rate into a fixed rate
on the term loan and mortgage and qualifies as a cash flow
hedge and is included in accrued expenses on the accompanying
Consolidated Balance Sheet as of September 30, 2011 and December
31, 2010. Gains and losses on this instrument 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 September 30, 2011, was
approximately $22,000 ($26,000 at December 31, 2010).
The
Company accounts for warrants and other rights to acquire capital
stock with exercise price reset features, or
“down-round” provisions, as derivative liabilities.
Similarly, down-round provisions for issuances of common stock are
also accounted for as derivative liabilities. These derivative
liabilities are measured at fair value with the changes in fair
value at the end of each period reflected in current period income
or loss. The fair value of derivative liabilities is estimated
using a binomial model or Monte Carlo simulation to model the
financial characteristics, depending on the complexity of the
derivative being measured. A Monte Carlo simulation
provides a more accurate valuation than standard option valuation
methodologies such as the Black-Scholes or binomial option models
when derivatives include changing exercise prices or different
alternatives depending on average future price targets. In
computing the fair value of the derivatives, the Company uses
significant judgments, which, if incorrect, could have a
significant negative impact to the Company’s consolidated
financial statements. The input values for determining
the fair value of the derivatives include observable market indices
such as interest rates, and equity indices as well as unobservable
model-specific input values such as certain volatility
parameters. Future changes in the fair value of the
derivatives liabilities, if any, will be recorded in the statement
of operations as gains or losses from derivative
liabilities.
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 IMS. The Company recorded its investment in IMS 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. The Company
recognized gains or losses on its investment under the equity
method of accounting for investments. During the
nine months ended September 30, 2010, the Company recorded a
cumulative loss on its investment of approximately
$121,000. On September 23, 2010, the
Company’s Board of Directors declared a dividend whereas the
Company distributed to its stockholders of record on October 8,
2010 on a pro-rata basis its 7,500,000 shares of stock of
IMS. There was no loss on investment in IMS during the
nine months ended September 30, 2011 as the Company no longer owned
shares in IMS as of September 23, 2010.
Business Combinations -
Business
combinations and non-controlling interests are recorded in
accordance with the Business Combination Topic of the FASB
ASC. Under the guidance, the assets and liabilities of
the acquired business are recorded at their fair values at the date
of acquisition. The excess of the purchase price over the estimated
fair values is recorded as goodwill. If the fair value
of the assets acquired exceeds the purchase price and the
liabilities assumed then a gain on acquisition is
recorded. Under the guidance, all acquisition costs are
expensed as incurred and in-process research and development costs
are recorded at fair value as an indefinite-lived intangible asset.
The application of business combination and impairment accounting
requires the use of significant estimates and
assumptions.
Earnings Per Common Share - The Company presents
basic and diluted earnings per share. Basic earnings per
share reflect 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.
As
of September 30, 2011 and 2010, there were up to
3,271,853 and 2,580,699, respectively, of shares potentially
issuable under convertible debt agreements, options, warrants,
restricted stock agreements and employment agreements that could
potentially dilute basic earnings per share in the future. These
shares 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
maintains its cash in bank deposit accounts, which at times may
exceed federally insured limits. The Company believes it is
not exposed to any significant credit risk as a result of any
non-performance by the financial
institutions. During the nine months ended
September 30, 2011 and 2010, one customer accounted for 15% and
25%, respectively, of the Company’s consolidated
revenue. As of September 30, 2011 and 2010, this
customer accounted for 20% and 26%, respectively, of the
Company’s trade accounts receivable balance. The
risk with respect to trade receivables is mitigated by credit
evaluations we perform on our customers, the short duration of our
payment terms for the significant majority of our customer
contracts and by the diversification of our customer
base.
Recent Accounting Pronouncements- In May 2011, the FASB
issued Accounting Standards Update No. 2011-04, Fair Value
Measurement (Topic 820): Amendments to Achieve Common Fair Value
Measurement and Disclosure Requirements in U.S. GAAP and
IFRS. This update results in common principles and
requirements for measuring fair value and for disclosing
information about fair value measurements in accordance with U.S.
GAAP and IFRS. ASU 2011-04 is required to be applied
prospectively in interim and annual periods beginning after
December 15, 2011. Early application is not
permitted. The Company is currently evaluating the
impact that the adoption of ASU 2011-04 will have and does not
believe the adoption will have a material impact on the
consolidated financial statements.
In
June 2011 the Financial Accounting Standards Board issued
Accounting Standards Update No. 2011-05, Presentation of
Comprehensive Income. This standard eliminates the option to report
other comprehensive income and its components in the statement of
changes in equity. The Company may elect to present items of net
income and other comprehensive income in one continuous statement
or in two consecutive statements. Each component of net income and
each component of other comprehensive income, together with totals
for comprehensive income and its two parts – net income and
other comprehensive income – would need to be displayed under
either alternative, and the statements would need to be presented
with equal prominence as the other primary financial statements.
This standard does not change 1) the items that constitute net
income and other comprehensive income, 2) when an item of other
comprehensive income must be reclassified to net income, or 3) the
computation for earnings per share - which will continue to be
based on net income. This standard is effective for fiscal years
beginning after December 15, 2011, and the Company has not yet
determined which method it will elect upon adoption.
In
September 2011 the Financial Accounting Standards Board issued
Accounting Standards Update No. 2011-08, Intangibles –
Goodwill and Other (Topic 350), Testing Goodwill for Impairment.
The revised standard is intended to reduce the cost and complexity
of the annual goodwill impairment test by providing the option of
performing a “qualitative” assessment to determine
whether further impairment testing is necessary. Under this
standard, the Company has the option to first assess qualitative
factors to determine whether the existence of events or
circumstances leads to a determination that it is more likely than
not that the fair value of a reporting unit is less than its
carrying amount. If, after assessing the totality of events or
circumstances, the Company determines that it is not more likely
than not that the fair value of a reporting unit is less than its
carrying amount, performing the two-step impairment test under
Topic 350 is unnecessary. However, if the Company concludes
otherwise, it is required to perform the first step of the two-step
impairment test, as described in Topic 350. If the carrying amount
of a reporting unit exceeds its fair value under the first step,
the Company is required to perform the second step of the goodwill
impairment test to measure the amount of the impairment loss, if
any. The Company also has the option to bypass the qualitative
assessment for any reporting unit in any period and to proceed
directly to performing the first step of the two-step goodwill
impairment test. The Company may resume performing the qualitative
assessment in any subsequent period. This standard is effective for
annual and interim goodwill impairment tests performed for fiscal
years beginning after December 15, 2011, and early adoption is
permitted. The Company believes that the adoption of this standard
will not have a material impact on the Company’s financial
statements.
|
Debt | 9 Months Ended |
---|---|
Sep. 30, 2011 | |
Debt |
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 (the “Fagenson Credit Agreement” or
“Credit Facility”). Under the Fagenson Credit
Agreement, as amended on December 11, 2009, the Company could
borrow up to a maximum of $1,000,000 from time to time up until
January 4, 2012. Any amount borrowed by the Company
pursuant to the Fagenson Credit Agreement had annual interest rate
of 2% above LIBOR and was secured by the Common Stock of P3, the
Company's wholly owned subsidiary. Interest was payable
quarterly in arrears and the principal was payable in full at the
end of the term under the Fagenson Credit
Agreement. On June 29, 2011, the Credit
Facility, along with accrued interest, was paid in full
from the proceeds of a Commercial Term Note as described below
under Long-Term Debt, along with approximately $119,000 of payments
by the Company to the lenders.
Revolving Credit Lines- On February 12, 2010, the Company
entered into a Credit Facility Agreement with RBS Citizens, N.A.
(“Citizens Bank”) in connection with the
Company’s acquisition of Premier Packaging
(“Premier”) pursuant to which Citizens Bank provided
Premier with a revolving credit line of up to
$1,000,000. The revolving line of credit
is accessible by the Premier Packaging division subject to
certain terms, scheduled to mature on July 13, 2011 and is payable
in monthly installments of interest only beginning on March 1,
2010. Interest accrued at 1 Month LIBOR plus 3.75% (3.97% at
September 30, 2011). On July 26, 2011, the
Company entered into a Second Amended and Restated Credit Facility
Agreement with Citizens (collectively the “Second Credit
Facility Agreement”) for the purpose of amending the Amended
and Restated Credit Facility Agreement dated as of October 8, 2010,
as amended on February 24, 2011 (the “Original Credit
Facility Agreement”). The Second Credit Facility Agreement
provides for a revolving line of credit up to $1,000,000 and a loan
of $1,075,000 to Premier. The effect of the Second
Credit Facility Agreement was the elimination of the
“borrowing base” component of the Original Revolving
Note and the extension of the maturity date to May 31,
2012. As of September 30, 2011, the revolving line had a
balance of $690,474.
On
May 12, 2011, in conjunction with the Company’s acquisition
of ExtraDev, Inc. (“ExtraDev”) the Company assumed
revolving credit lines and open credit card accounts totaling
approximately $239,000, comprising of a $100,000 revolving line of
credit with a bank at 4.5% with an outstanding balance of $63,000,
a $100,000 revolving line of credit with a bank at 8.09% with an
outstanding balance of $86,000, and various credits cards with an
aggregate outstanding balance of approximately $90,000. All of the
credit lines are secured by personal guarantees of the former
ExtraDev owners. In accordance with the purchase
agreement with ExtraDev, the Company committed to paying these
balances within 90 days of acquisition. In August,
the Company reached an informal agreement with the former owners of
ExtraDev whereas the Company would make monthly payments against
the balances of these accounts of at least $25,000 in order to
pay-down these liabilities. As of September 30, 2011,
the aggregate balance of the ExtraDev credit lines was
approximately $152,000.
Short-Term Loan from Related
Party - The DSS Note issued to
Bzdick Properties, totaling $150,000, matures on March 31, 2012,
and accrues interest at an annualized rate of 9.5% per annum.
Prepayment of principal may be made without penalty. The DSS Note
calls for interest only payments during its term with a balloon
payment due at maturity, and will be secured by a guaranty
agreement between Premier abd Bzdick Properties. The DSS
Note is subordinated to the Citizens loan documents. One
of the members of Bzdick Properties is Robert Bzdick, who also
serves as a director and chief operating officer of DSS, and as
such is a related party to both DSS and Premier. The outstanding
balance of the term loan at September 30, 2011 was
$150,000.
Long-Term Debt - On December 9, 2009, the Company entered
into a $575,000 promissory note with an accredited investor
(“Note”) which matures November 24, 2012 and accrues
interest at 10% annually, payable quarterly. The
Note is secured by the assets of the Company’s wholly owned
subsidiary, Secuprint Inc. (a/k/a DSS Printing
Group). Under the terms of the Note, the Company
is required to comply with various covenants. As
of September 30, 2011, the Note had a balance of $575,000 ($575,000
at December 31, 2010) and the Company was in compliance with the
debt covenants.
On
February 12, 2010, in conjunction with the Credit Facility
Agreement, the Company entered into a term loan with Citizens Bank
for $1,500,000. The proceeds of the term loan were used
to partially satisfy the purchase price of Premier. 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. The $1,500,000 term loan was
scheduled to mature on March 1, 2013 and was 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 was
accruing at 1 Month LIBOR plus 3.75% (3.97% at September 30,
2011). 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. On July 26, 2011, the Company
entered into the Second Credit Facility Agreement for the purpose
of amending the Original Credit Facility Agreement. The Second
Credit Facility Agreement provides for a revolving line of credit
up to $1,000,000 and a loan of $1,075,000 to
Premier. The effect of the Second Credit Facility
Agreement was the extension of the payment term of the Original
Note to February 1, 2015 and the elimination of the $625,000
balloon payment originally due on July 1, 2013 under the Original
Note. The outstanding balance of the term loan at September 30,
2011 was $1,025,000.
On
June 29, 2011, the Company and Plastic Printing Professionals, Inc.
(“P3”), a wholly owned subsidiary of the Company
entered into a Commercial Term Note (the “Note”) with
Neil Neuman (”Neuman”) whereby the Company borrowed
$650,000 from Neuman. The applicable interest rate under the Note
is 6.5% per annum, and the term is forty-eight months (the
“Term”). Commencing on August 1, 2011, the Company will
pay monthly installments of $13,585 for the Term of the Note, and a
final balloon payment of $100,000 on August 1, 2015. Any reasonable
expense incurred by Neuman (including reasonable attorneys’
fees and disbursements) in connection with the administration or
enforcement of the Note shall be paid by the Company and, if not
timely paid, shall earn interest at the same rate as the
principal. The Company may prepay all or a portion of
the outstanding principal balance prior to maturity at any time,
without penalty. The Note is collateralized by all
of the machinery and equipment of P3. Neuman is neither
an affiliate of, nor a related party to, the Company or
P3. The proceeds from the Note were used to pay in full
all sums owed by the Company under a Credit Agreement executed
between the Company and Fagenson & Co., Inc., as agent for
certain lenders, including Neuman, dated January 4, 2008. Upon such
payment the Credit Agreement between the Company and Fagenson &
Co., Inc. was terminated in its entirety. As of
September 30, 2011, the Note had a balance of
$629,817.
Promissory Note- On August 30,
2011, the Company’s wholly owned subsidiary
Premier entered into a Purchase and Sale Agreement (the
“Purchase Agreement”) with Bzdick Properties, LLC, a
New York limited liability company (“Bzdick
Properties”), to purchase the
packaging plant at 6 Framark Drive, Victor,
NY, (the “Real Estate”). The Real Estate transaction
closed simultaneously with the execution of the Purchase
Agreement.
The purchase price for the Real Estate was $1,500,000. The purchase
price consisted of a $150,000 cash down payment, a $150,000
subordinated promissory note (the “DSS Note”) from DSS
to Bzdick Properties, and a $1,200,000 loan obtained by Premier
from Citizens Bank. The Citizens loan documents for the
Real Estate transaction consisted of a Promissory Note (the
“Citizens Promissory Note”), an Amended and Restated
Promissory Note (the “Citizens Amended and Restated
Note”), a Mortgage and Security Agreement (the
“Citizens Mortgage”), a Consolidation, Modification and
Extension Agreement (the “Citizens Consolidation”), a
Guaranty Agreement (the “Citizens Guaranty”) and an
Indemnity Agreement (the “Citizens Indemnity”), each
executed on August 30, 2011. Monthly payments of
principal and interest in the amount of $7,658 and interest of 1
month LIBOR plus 3.15% (3.37% at September 30, 2011) are due under
the Citizens Amended and Restated Note. Concurrently
with the transaction, the Company entered into an interest rate
swap agreement to lock into a 5.865% effective interest rate for
the life of the loan. The Citizens Promissory Note matures in
10 years at which time a balloon payment of the remaining principal
balance of $919,677 is due. As of September 30, 2011,
the Citizens Promissory Note had a balance of
$1,200,000.
The Real Estate is currently occupied solely by Premier and prior
to this Real Estate transaction, Premier was leasing the
Real Estate from Bzdick Properties under a lease which was set to
expire in January 2020 at a rental rate of $13,333 per
month. The Real Estate transaction resulted from the
exercise of a purchase option under the existing lease, and the
lease was terminated on August 30, 2011.
Short-Term Loan from Related Party - The DSS Note issued to
Bzdick Properties, totaling $150,000, matures on March 31, 2012,
and accrues interest at an annualized rate of 9.5% per annum.
Prepayment of principal may be made without penalty. The DSS Note
calls for interest only payments during its term with a balloon
payment due at maturity, and will be secured by a guaranty
agreement between Premier abd Bzdick Properties. The DSS
Note is subordinated to the Citizens loan documents. One
of the members of Bzdick Properties is Robert Bzdick, who also
serves as a director and chief operating officer of DSS, and as
such is a related party to both DSS and Premier. The outstanding
balance of the term loan at September 30, 2011 was
$150,000.
Stand-By Term Note - On October 8, 2010, the Company amended
the Credit Facility Agreement with Citizens Bank to add a Standby
Term Loan Note pursuant to which Citizens Bank will provide Premier
with up to $450,000 towards the funding of eligible equipment
purchases. The Company has 12 months to draw upon
this line of credit, after which the balance of funds advanced from
the line is converted into a 5 year term loan. Interest
accrues at 1 month LIBOR plus 3.00% (3.22% at September 30,
2011). As of September 30, 2011, the Company has drawn
approximately $53,000 ($53,000 at December 31, 2010) from the
Standby line for the purchase of equipment.
All of the Citizen’s
Credit Facilities are secured by all the assets of Premier
Packaging and are also cross guarentee by Document Security System,
Inc. and the Company’s
other wholly owned subsidiaries, P3 and Secuprint. In addition, the
citizen credit facilities are subject to various financial ratio
covenents. The Company was in compliance with the covenents at
September 30, 2011.
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Stockholders' Equity |
5. Stockholders’ Equity
On
February 18, 2011, the Company entered into an Amended and Restated
Agreement (“Amended Agreement”) with Fletcher
International, Ltd. (“Fletcher”) for the purpose of
modifying the terms of an agreement (“Original
Agreement”) previously entered into between the Company and
Fletcher on December 31, 2010.
Under
the Original Agreement, Fletcher purchased $4,000,000 of the
Company’s common stock (756,287 shares) at a price of
approximately $5.29 per share on December 31, 2010 (the
“Initial Investment”). In conjunction with the Initial
Investment, Fletcher received a warrant (the “Initial
Warrant”) to purchase up to $4,000,000 of the Company’s
common stock at a price of approximately $5.29 per share at any
time until December 31, 2019, subject to adjustment as set forth in
the Initial Warrant. Under the Original Agreement,
Fletcher also received the right to make additional equity
investments of up to $4,000,000 in total (the “Later
Investments”) by May 2, 2011 at the average of the daily
volume-weighted price of the Company’s common stock in the
calendar month preceding each Later Investment notice date at
prices no lower than approximately $4.76 per share and no greater
than approximately $6.35 per share, subject to adjustment as set
forth in the Original Agreement. The
warrants issued to Fletcher had down-round and anti-dilution
provisions as of December 31, 2010, and were considered derivative
liabilities recorded at fair value. The down-round provisions
result in the number of shares to be issued determined on a
variable that is not an input to the fair value of a
“fixed-for-fixed” option. Under the Original
Agreement, Fletcher also received a second warrant (the
“Second Warrant”) to purchase shares of the
Company’s common stock with an aggregate purchase price of up
to the total dollar amount of the Later Investments at a per-share
exercise price of 120% of the per-share price paid in the final
Later Investment to occur, subject to adjustment as set forth in
the Second Warrant. The Initial Warrant and the
Second Warrant each also had a cashless exercise
provision.
Under
the Amended Agreement, the purchase price for the Initial
Investment made on December 31, 2010 was increased to $5.38 per
share, increasing the aggregate purchase price paid by Fletcher for
the Initial Investment from $4,000,000 to $4,068,825. The Initial
Warrant received by Fletcher was amended and reissued (the
“Amended Initial Warrant”) entitling Fletcher to
purchase newly-issued shares of common stock at $5.38 per share
(the “Warrant Price”) at any time until February 18,
2020 (the “Warrant Term”), up to an aggregate purchase
price of $4,300,000 (the “Warrant Amount”). Under the
Amended Agreement, Fletcher also received the right to make
additional equity investments (“Later Investments”) of
up to $4,068,000 (the “Aggregate Later Investment
Amount”) provided notice was given to the Company prior to
July 2, 2011 of Fletcher’s intention to make the Later
Investment. The Second Warrant received by
Fletcher was amended (the “Amended Second Warrant”, and
together with the Amended Initial Warrant, the
“Warrants”) to fix the Warrant Price at $5.38 per
share. The Second Warrant entitled Fletcher to purchase
newly-issued shares of common stock up to the aggregate purchase
price of the Later Investments. The Amended Initial Warrant and the
Amended Second Warrant each had a cashless exercise
provision. Fletcher did not make the Later
Investment.
In
connection with the Amended Agreement, the Company filed a
registration statement with the Securities and Exchange Commission
(“SEC”) covering the Initial Investment of 756,287
shares and 799,256 shares underlying the Initial
Warrant. The registration statement was declared
effective on April 13, 2011.
On
March 14, 2011, the Company and Fletcher executed further
amendments to the Amended and Restated Agreement and Warrants
addressing stockholder approval and pricing provisions relating to
Change of Control (as defined therein). The March 14, 2011
amendments were executed by the Company and Fletcher in response to
an NYSE Amex inquiry, and were required to solidify NYSE Amex
approval of the Company’s additional listing applications,
which approval was received from NYSE Amex on March 15,
2011.
Certain
events, such as dividends, stock splits, and other events specified
in the Amended Agreement and in the Warrants could have resulted in
additional shares of Common Stock being issued to Fletcher,
adjustments being made to the terms of the Later Investments, the
Initial Warrant or the Second Warrant, or other results, in each
case as set forth in the Amended Agreement, the Amended Initial
Warrant and the Amended Second Warrant. The terms
of the Amended Agreement granted Fletcher certain participation
rights in certain later equity issuances by the
Company (except for certain exclusions) and certain
other rights upon a change of control, in each case as set forth in
the Amended Agreement, the Amended Initial Warrant and the Amended
Second Warrant.
Proceeds
from the transaction were used primarily for sales and marketing,
product development, and working capital. The Company paid WM Smith
& Co., as placement agent, a cash placement fee of 6% of all
cash investments received under the Amended Agreement, or in the
case of the cashless exercise of the Warrants, common stock equal
to 6% of the shares issued to Fletcher in conjunction with the
cashless exercise. During the first quarter
of 2011, the Company paid $240,000 in accrued placement
agent fees.
Derivative Liability -The financial instruments issued
to Fletcher had down-round and anti-dilution provisions as of
December 31, 2010, which are considered a derivative liability
recorded at fair value. The down-round provisions result in the
number of shares to be issued determined on a variable that is not
an input to the fair value of a “fixed-for-fixed”
option. The Company recognized the derivative liability at the fair
value at inception. The derivative liability was
considered a Level 3 liability on the fair value hierarchy as the
determination of fair value includes various assumptions about the
Company’s future activities and the Company’s stock
prices and historical volatility as inputs. To determine the fair
value of the various components of the Fletcher investments, the
Company selected the binomial option model and the Monte Carlo
Simulation to model the financial characteristics of the various
components. The derivative liability was initially
recorded in the consolidated balance sheet upon issuance as of
December 31, 2010 at a fair value of
$3,866,836. On February 18, 2011 the Company
entered into certain amendments with Fletcher for the purpose of
modifying the terms of the previous agreement entered into between
the Company and Fletcher on December 31, 2010. As a
result of the amendments, the down-round and anti-dilution
provisions were eliminated; therefore, the Company determined that
the derivative liability that existed under the terms of the
original agreement no longer existed. As a result, the
Company determined the fair value of the derivative liability
instrument as of the modification date of February 18, 2011 and
recorded the change in fair value of the derivative liability since
December 31, 2010 amounting to $360,922 which is reflected in the
statement of operations. With the elimination of
the derivative liability provision, the Company re-classed the fair
value of the financial instruments amounting to $3,505,914 from
derivative liability to additional paid in capital.
The
table below provides a reconciliation of the beginning and ending
balances for the derivative liability measured at fair value using
significant unobservable inputs (Level 3). There were no assets as
of or during the period ended September 30, 2011 measured using
significant unobservable inputs.
Fair
Value Measurements Using Significant Unobservable Inputs (Level
3):
Restricted Stock –
In May 2011, the Company issued an aggregate of 82,352 restricted
shares of the Company’s common stock, pursuant to the
Company’s 2004 Employee Stock Option Plan, as amended, valued
at $3.33 per share to the owners of ExtraDev, which the Company
acquired. Such restricted stock vests in equal
installments annually over four years. The
restricted stock granted to the owners of ExtraDev was classified
as consideration for the acquisition of ExtraDev at a fair value of
approximately $274,000, which upon termination any unvested
restricted stock shall immediately vest. In addition, as
of September 30, 2011, 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 September 30,
2011, vesting is not considered probable and no compensation
expense has been recognized related to the performance
grants.
Stock Options – The Company records stock-based
payment expense related to these options based on the grant date
fair value in accordance with FASB ASC
718. During the nine months ended
September 30, 2011, the Company issued an aggregate of 262,648
options to purchase its common shares at an exercise price ranging
from $3.33 to $5.52 per share to employees and non-employee
directors. The fair value of these options
amounted to approximately $402,000 determined by utilizing the
Black Scholes option pricing model. Included in the options issued
during the nine months ended September 30, 2011 are five-year
options to purchase an aggregate of 77,648 shares of the
Company’s common stock, pursuant to the Company’s 2004
Employee Stock Option Plan, as amended, at an exercise price of
$3.33 per share, to the owners of ExtraDev. Such
options vest in equal installments annually over four
years. The fair value of these options amounted to
approximately $121,000 determined by utilizing the Black Scholes
option pricing model. Additionally, pursuant to the employment
agreements with the previous owners of ExtraDev, the Company
awarded earn-out options to purchase an aggregate of 450,000 shares
of common stock at an exercise price of $4.50 per share that will
be granted if the Company’s Digital division achieves certain
annual revenue targets by the end of fiscal year 2016. If the
annual revenue targets are met or are deemed probable to occur,
then the Company will record stock based compensation expense at
the then current fair value. As of September 30, 2011 vesting is
considered remote. All options granted to the owners of ExtraDev
were classified as compensation for post combination services since
the vesting of each grant is based on length of employment, with
all unvested options forfeiting upon termination of employment,
therefore, the fair value of these equity instruments was not
considered a component of the purchase price of the
acquisition.
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 nine months ended September 30,
2011, the Company had stock compensation expense of approximately
$319,000 ($0.02 per share) ($336,000- 2010; $0.02 per
share).
As
of September 30, 2011, there was approximately $451,000 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.
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Business Combination |
6. Business Combination
On
May 12, 2011, the Company entered into an agreement
(“Agreement”) to purchase all the issued and
outstanding common stock of ExtraDev pursuant to which the Company
purchased 10,000 shares of ExtraDev common stock, par value $.01
per share, from each of ExtraDev’s two owners, representing
all of ExtraDev’s issued and outstanding common
stock.
The
Agreement provided that as consideration for the purchase of the
ExtraDev common stock, the Company would acquire all of
the assets of ExtraDev in exchange for the assumption of all the
liabilities of Extradev, employment agreements with the two owners
of Extradev, and an aggregate of 94,336 restricted shares of the
Company’s common stock valued at $3.33 per share and
five-year options to purchase an aggregate of 65,664 shares of the
Company’s common stock, at an exercise price of $3.33 per
share, were granted to the owners of ExtraDev pursuant to the
Company’s 2004 Employee Stock Option Plan, as
amended. Such restricted stock and options vest in
equal installments annually over four years and are subject to
adjustment based upon ExtraDev’s working capital deficit as
set forth in its final financial statements, which were provided
within 30 days of closing. A subsequent contractual
adjustment resulted in a reduction in the aggregate number of
restricted shares issued to the two ExtraDev owners to
82,352 and an increase in the aggregate number of options issued to
the ExtraDev owners to 77,648. The fair value of the restricted
shares was approximately $274,000 and shall vest immediately upon
termination. Therefore, restricted shares were recorded as
consideration transferred. The options were valued using the
Black-Scholes Option Pricing Model at approximately $121,000. The
options granted are based on the length of employment with all
unvested options forfeiting upon termination of employment.
Therefore they are being recorded as post combination compensation
expense and not a component of the purchase price of the
acquisition. The fair value of these instruments will be expensed
pro-ratably over the 4-year vesting period.
The
acquisition was 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 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 assumptions, the fair value of the assets
acquired, which included customer lists of $258,000 and non-compete
agreements of $150,000, and the liabilities assumed was less than
the purchase price resulting in the recording of goodwill. The
goodwill recorded with this transaction has been recorded in the
Company’s Digital division and is not deductible for income
taxes.
The
preliminary allocation of the purchase price and the fair values of
the assets acquired and their associated useful lives and
liabilities were estimated by management as follows:
Set
forth below is the unaudited proforma revenue, operating loss, net
loss and loss per share of the Company as if ExtraDev had been
acquired by the Company as of January 1, 2010.
In
conjunction with the acquisition of ExtraDev completed on May 12,
2011, ExtraDev’s two owners entered into five-year employment
agreements (with an option to renew for three years on mutually
agreed upon terms) with the Company (the “Employment
Agreements”), pursuant to which Michael Roy (former ExtraDev
owner) will serve as the President and Timothy Trueblood (former
ExtraDev owner) will serve as the Chief Technology Officer of the
Company’s newly-formed Digital Division
(“Digital”), each at an annual base salary of $100,000.
Under the Employment Agreements, each of the former ExtraDev
shareholders will be eligible for an annual (i) earn-out bonus
based upon Digital’s earnings, before interest, taxes
depreciation and amortization for the prior year as described in
the Employment Agreements payable within days of the end of the
year and (ii) earn-out options to purchase common stock of the
Company at an exercise price of $4.50 per share under the
Company’s Option Plan that vest if Digital achieves certain
annual revenue targets by the end of fiscal year 2016. Both the
earn-out bonus and earn-out options will be recorded as post
combination compensation expense, if earned, since both are based
on length of employment and forfeit upon termination. In addition,
the former ExtraDev shareholders are eligible for a one-time grant
of options to purchase common stock of the Company, at an exercise
price of $4.50 per share in the amounts and in accordance with the
conditions set forth in the Employment Agreements. The Employment
Agreements also provide for health care insurance for each former
ExtraDev shareholder and his family. The Company may terminate the
Employment Agreements at any time upon 30 days notice, in which
event, any vested earn-out options will be exercisable for 90 days
and the former ExtraDev shareholders will be entitled to receive an
annualized salary of $50,000 and continued health insurance
coverage for the remainder of the term of the Employment
Agreement.
ExtraDev
was a privately owned company founded in 1998 and headquartered in
Rochester, NY. ExtraDev provides data center centric
solutions to businesses and governments. The acquisition of
ExtraDev is expected to enhance the Company’s digital
security solutions capabilities, including the ability of the
Company to offer its digital security products in a “cloud
computing” format. ExtraDev had approximately
$837,000 in revenue for the year ended December 31, 2010 and lost
$10,000 on a tax basis. The acquisition did not
create a significant subsidiary in accordance with the Securities
and Exchange Commission Regulation S-X 210.1-2(w). Since
the date of the acquisition, ExtraDev has generated approximately
$392,000 of revenue and experienced net loss of approximately
$4,000.
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Inventory |
2. Inventory
Inventory
consisted of the following:
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