TABLE OF CONTENTS
Table of Contents
| | | | Page
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Report of Independent Registered Public Accounting Firm | | F-1 |
| PART III | | |
| | | | |
Consolidated Financial Statements:ITEM 10. | DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE | 3 |
| ITEM 11. | EXECUTIVE COMPENSATION | 9 |
| ITEM 12. | SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS | 11 |
| ITEM 13. | CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE | 12 |
| ITEM 14. | PRINCIPAL ACCOUNTING FEES AND SERVICES | 13 |
| | | |
| PART IV | | |
| | | | |
| ITEM 15. | Balance SheetsEXHIBITS, FINANCIAL STATEMENT SCHEDULES | 13 |
| | F-2 |
| SIGNATURES | 14 |
PART III
ITEM 10 - DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
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The Company’s By-laws, as amended, currently specify that the number of directors shall be at least three and no more than eight persons, unless otherwise determined by a vote of the majority of the Board of Directors. Former Board members Alan Harrison and Timothy Ashman were not nominated for election at the Company’s 2012 Annual Meeting, and their directorships terminated effective on June 14, 2012. Patrick White resigned from the Board effective on December 1, 2012. Each director of the Company serves for a one-year term or until such director’s successor is duly elected and qualified or until such director’s earlier resignation or removal.
Biographical and certain other information concerning the Company’s directors is set forth below. There are no familial relationships among any of our directors. Except as indicated below, none of our directors is a director in any other reporting companies. None of our directors has been affiliated with any company that has filed for bankruptcy within the last ten years. We are not aware of any proceedings to which any of our directors, or any associate of any such director is a party adverse to us or any of our subsidiaries or has a material interest adverse to us or any of our subsidiaries.
BOARD MEMBERS
| Name | | Age | | Positions |
| | | | |
| Statements of Operations | | F-3 |
| | | |
| Statements of Cash FlowsRobert B. Fagenson | | F-4 |
| 64 | | | Chairman of the Board of Directors |
| Statements of Changes in Stockholders’ EquityDavid Wicker | | F-5 |
| 53 | | | Vice President of Research & Development and Director |
| Robert B. Bzdick | | | |
Notes to the Consolidated Financial Statements58 | | F6 - F29Chief Executive Officer and Director |
| Roger O’Brien | | 64 | | Director |
| Ira A. Greenstein | | 53 | | Director |
| David Klein | | 49 | | Director |
| John Cronin | | 58 | | Director |
REPORTThe principal occupation and business experience for each of the Company’s directors, for at least the past five years, is as follows:
Robert B. Fagenson spent the majority of his career at the New York Stock Exchange, where he was Managing Partner of one of the largest specialist firms operating on the exchange trading floor. Having sold his firm and subsequently retired from that business in 2007, he has since been the Chief Executive Officer of Fagenson & Co., Inc., a 50 year old broker dealer that is engaged in institutional brokerage as well as investment banking and money management. On March 1, 2012, Fagenson & Co., Inc. transferred its brokerage operations, accounts and personnel to National Securities Corporation and now operates as a branch office of that firm. On April 4, 2012, Mr. Fagenson was elected Chairman of the Board of National Holdings Corporation which is the parent of National Securities Corporation, a full line broker dealer with offices around the United States.
During his career as a member of the New York Stock Exchange beginning in 1973, Mr. Fagenson has served as a Governor on the trading floor and was elected to the NYSE Board of Directors in 1993, where he served for six years, eventually becoming Vice Chairman of the Board in 1998 and 1999. He returned to the NYSE Board in 2003 and served as a director until the Board was reconstituted with only non-industry directors in 2004.
Mr. Fagenson has previously served on the boards of a number of public companies and is presently the Non-Executive Chairman of the Board of Directors of DSS. He has served as a director for the Company since 2004, and as the Board’s Non-Executive Chairman since 2008. He is also a member of the Board of Directors of Cash Technologies Corp., and is also a Director of the National Organization of Investment Professionals (NOIP).
In addition to his business related activities, Mr. Fagenson serves as Vice President and a director of New York Services for the Handicapped, Treasurer and director of the Centurion Foundation, Director of the Federal Law Enforcement Officers Association Foundation, Treasurer and director of the New York City Police Museum and as a member of the Board of the Sports and Arts in Schools Foundation. He is a member of the alumni boards of both the Whitman School of Business and the Athletic Department at Syracuse University. He also serves in a voluntary capacity on the boards and committees of many civic, social and community organizations. Mr. Fagenson received his B.S. degree in Transportation Sciences & Finance from Syracuse University in 1970.
David Wicker joined our Company as Vice President of Operations in August 2002 and has served as director for the Company since December 2007. Mr. Wicker currently serves as Vice President of Research & Development for the Company, directing the technical operations behind our patented document security technologies. Mr. Wicker has authored and co-authored several patents and patent applications in the anti-counterfeiting field. Mr. Wicker is an active member of the Document Security Alliance, Center for Identity Management and Information Protection, the Association of Certified Fraud Examiners, and the U.S. Chamber of Commerce CACP Counterfeiting Coalition. Prior to joining the Company, Mr. Wicker consulted for banknote and security printers and developed several security technologies in use worldwide today.
With his 32 years of printing experience, including 22 years specializing in security printing, Mr. Wicker has established himself as an industry expert in the field of anti-counterfeiting. In addition to his active membership in various anti-counterfeiting organizations and standard setting boards, Mr. Wicker leads a research team that holds several US and international patents that form the basis of several of the Company’s products. Mr. Wicker is integral to business development efforts, especially in regards to licensing and custom security products and projects, and has relationships with leading security printers.
Robert B. Bzdick joined the Company on February 17, 2010 as Chief Operating Officer after the Company’s acquisition of its wholly-owned subsidiary, Premier Packaging Corporation, for which Mr. Bzdick was the owner and Chief Executive Officer. Mr. Bzdick became a director of the Company in March 2010, and Chief Executive Officer in December 2012. Prior to founding Premier Packaging Corporation in 1989, Mr. Bzdick held positions of Controller, Sales Manager, and General Sales Manager at the Rochester, New York division of Boise Cascade, LLC (later Georgia Pacific Corporation). Mr. Bzdick has over 29 years of experience in manufacturing and operations management in the printing and packaging industry.
Ira A. Greenstein is President of IDT Corporation (NYSE: IDT), a provider of wholesale and retail telecommunications services. Prior to joining IDT in January 2000, Mr. Greenstein was a partner in the law firm of Morrison & Foerster LLP from February 1997 to November 1999, where he served as the chairman of the firm’s New York Business Department. Concurrent to his tenure at Morrison & Foerster, Mr. Greenstein served as General Counsel and Secretary of Net2Phone, Inc. from January 1999 to November 1999. Prior to 1997, Mr. Greenstein was an associate in the New York and Toronto offices of Skadden, Arps, Meagher & Flom LLP. Mr. Greenstein also served on the Securities Advisory Committee to the Ontario Securities Commission from 1992 through 1996. From 1991 to 1992, Mr. Greenstein served as counsel to the Ontario Securities Commission. Mr. Greenstein currently serves on the Board of Advisors of the Columbia Law School Center on Corporate Governance. Mr. Greenstein received a B.S. from Cornell University and a J.D. from Columbia University Law School. Mr. Greenstein was appointed to our Board of Directors in September 2004.
Mr. Greenstein provides the Company with significant public company management experience, particularly in regards to legal and corporate governance matters, mergers and acquisitions, and strategic planning. In addition, Mr. Greenstein’s extensive legal experience has provided the Company insights and guidance throughout the Company’s patent litigation initiatives.
John Cronin was appointed to our Board of Directors in February 2012. Mr. Cronin is Managing Director and Chairman of ipCapital Group, Inc., a Delaware corporation, and has served in that capacity since 1998. Prior thereto, Mr. Cronin spent 17 years at IBM with over 100 patents and 150 patent publications. Mr. Cronin created and ran the IBM Patent Factory and was part of the team that contributed to the start of and success of IBM’s licensing program. Mr. Cronin serves as a member of the Boards of Directors of GraphOn Corporation, ImageWare Systems, Inc., and Primal Fusion, Inc., and is also a member of the advisory boards for InnoPad, Inc., VirnetX Holding Corporation, and Parker Vision, Inc. Mr. Cronin holds a BSEE, an MSEE, and a BA in Psychology from the University of Vermont.
Roger O’Brienwas elected to the Board of Directors of the Company on June 14, 2012. Mr. O’Brien is President of O’Brien Associates, LLC, a general management consulting firm providing advisory and implementation services to managements in a variety of competitive industries, with special focus on interim general management, technology commercialization, marketing and strategy development. The firm was founded in 1999 and has offices in Rochester, New York and Santa Fe, New Mexico. Mr. O’Brien’s background includes serving as Chief Operating Officer of Ultralife Batteries, Inc. a publicly-held manufacturer of advanced battery power sources, and as an officer of Sun Microsystems, Inc. during a period in the late 1980’s when the company grew from $500 million to $2 billion in sales over a 24-month period. Mr. O’Brien is a member of the Board of Directors of Odyssey Software, Inc. and Bristol ID Technologies, Inc. He also serves as an adjunct professor for the Human Resources Development graduate school program at Rochester Institute of Technology. Mr. O’Brien holds a Bachelor of Science degree in Nuclear Engineering from New York University and a MBA from The Wharton School, University of Pennsylvania.
David Kleinwas elected to the Board of Directors of the Company on June 14, 2012. Mr. Klein has served as Senior Vice President, Treasurer of Constellation Brands, Inc., a Delaware corporation, since March 2009. From September 2004 until March 2009, Mr. Klein served in the capacities of Vice President, Business Development and Chief Financial Officer of Constellation Europe, for Constellation Brands. In his current role, Mr. Klein is responsible for the quantitative management of risk, improving company-wide cash flow generation and the management of capital structure. Mr. Klein’s previous contributions at Constellation Brands include lead roles in several international acquisitions and divestitures, as well as conceptualizing and executing Constellation’s United Kingdom distribution joint venture. Preceding his tenure at Constellation Brands, Mr. Klein was Chief Financial Officer at Montana Mills Bread Co., Inc., a Delaware corporation where he was involved with the transformation from private to public company and the subsequent sale of Montana Mills Bread Co., Inc. to Krispy Kreme Doughnuts Inc. Mr. Klein holds a Bachelor’s Degree in Economics from SUNY Geneseo and a MBA from SUNY Buffalo.
There are no legal proceedings that have occurred within the past ten years concerning our directors which involved a criminal conviction, a criminal proceeding, an administrative or civil proceeding limiting one's participation in the securities or banking industries, or a finding of securities or commodities law violations.
Each of our Board members have been selected for the breadth of experience they offer the Company in the areas of strategic marketing, fiscal planning and oversight, and corporate governance, and for their proven track record of success in developing and executing complex and effective corporate strategies during their respective professional careers.
INFORMATION CONCERNING BOARD OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
ToDIRECTORSCompensation of Directors
Each independent director (as defined under Section 803 of the NYSE MKT LLC Company Guide) is entitled to receive $12,000 per year in compensation soon after the end of each fiscal year, so long as the director attended at least 75% of the Board of Director meetings during such fiscal year, as well as reimbursement for travel expenses. Non-independent members of the Board of Directors do not receive cash compensation in any form, except for reimbursement of travel expenses. In order to attract and retain qualified persons to our Board, the Company maintains a non-executive director stock option plan (the “Director Plan”) which provides for the grant of five-year options to purchase our common stock at 100% of fair market value at the date of grant. Under the Director Plan, each non-executive director receives an option to purchase 5,000 shares of the Company’s common stock upon becoming a Board member and 5,000 shares at the beginning of each year thereafter while serving as a director plus an additional option to purchase 1,000 shares for each year (or portion thereof, on a pro rata basis) of service on the Board, up to a maximum of 10,000 shares annually.
Director Compensation
The following table sets forth cash compensation and the value of stock options awards granted to the Company’s non-employee independent directors for their service in 2012:
| Name | | Fees Earned or
Paid in Cash | | | Stock
Awards | | | Option Awards(1) | | | Total | |
| | | ($) | | | ($) | | | ($) | | | ($) | |
| Robert B. Fagenson | | | 36,000 | | | | — | | | | 9,900 | | | | 45,900 | |
| Ira A. Greenstein | | | 12,000 | | | | — | | | | 57,500 | | | | 69,500 | |
| David Klein(2) | | | 7,000 | | | | — | | | | 55,650 | | | | 62,650 | |
| John Cronin(3) | | | 10,000 | | | | — | | | | 8,050 | | | | 18,050 | |
| Roger O’Brien(4) | | | 7,000 | | | | — | | | | 27,450 | | | | 34,450 | |
| Alan Harrison(5) | | | — | | | | — | | | | 9,900 | | | | 9,900 | |
| Timothy Ashman(6) | | | — | | | | — | | | | 9,900 | | | | 9,900 | |
| (1) | Represents the total grant date fair value of option awards computed in accordance with FASB ASC 718. Our policy and assumptions made in the valuation of share-based payments are contained in Note 7 to our financial statements for the year ended December 31, 2012. |
| (2) | Mr. Klein was elected as a director of the Company on June 14, 2012. |
| (3) | Mr. Cronin was appointed as a director of the Company on February 21, 2012. |
| (4) | Mr. O’Brien was elected as a director of the Company on June 14, 2012. |
| (5) | Mr. Harrison’s service as a director of the Company terminated on June 14, 2012. |
| (6) | Mr. Ashman’s service as a director of the Company terminated on June 14, 2012. |
Board of Directors and Committees
The Company has determined that each of the following directors, Messrs. O’Brien, Fagenson, Greenstein, Cronin and Klein, qualify as independent directors (as defined under Section 803 of the NYSE MKT LLC Company Guide).
In fiscal 2012, each of the Company’s directors attended or participated in 75% or more of the aggregate of (i) the total number of meetings of the Board of Directors held during the period in which each such director served as a director and (ii) the total number of meetings held by all committees of the Board of Directors during the period in which each such director served on such committee. During the fiscal year ended December 31, 2012, the Board held five meetings and acted by written consent on nine occasions. The Board’s independent directors met in executive session on one occasion outside the presence of the non-independent directors and management.
Audit Committee
The Company has separately designated an Audit Committee established in accordance with Section 3(a)(58)(A) of the Securities Exchange Act of 1934. The Audit Committee held four meetings in 2012. The Audit Committee is responsible for, among other things, the appointment, compensation, removal and oversight of the work of the Company’s independent registered public accounting firm, overseeing the accounting and financial reporting process of the Company, and reviewing related person transactions. During his most recent term as a member of the Company’s Board of Directors, which term expired on June 14, 2012, Timothy Ashman served as Chairman of the Audit Committee of the Board and qualified as a “financial expert” as defined in Item 407 under Regulation S-K of the Securities Act of 1933.The Audit Committee is currently comprised of David Klein, its Chairman, Robert Fagenson and John Cronin. David Klein is qualified as a “financial expert” as defined in Item 407 under Regulation S-K of the Securities Act of 1933. Each of the members of the Audit Committee is an independent director (as defined under Section 803 of the NYSE MKT LLC Company Guide). The Audit Committee operates under a written charter adopted by the Board of Directors, which can be found in the Corporate Governance section of our web site, www.dsssecure.com.
Compensation and Management Resources Committee
The purpose of the Compensation and Management Resources Committee is to assist the Board in discharging its responsibilities relating to executive compensation, succession planning for the Company's executive team, and to review and make recommendations to the Board regarding employee benefit policies and programs, incentive compensation plans and equity-based plans. The Compensation and Management Resources Committee held one meeting in 2012.
The Compensation and Management Resources Committee is responsible for, among other things, (a) reviewing all compensation arrangements for the executive officers of the Company and (b) administering the Company’s stock option plans. During his most recent term as a member of the Company’s Board of Directors, which expired on June 14, 2012, Alan Harrison served as Chairman of the Compensation and Management Resources Committee of the Board. The Compensation and Management Resources Committee currently consists of Roger O’Brien, its Chairman, Robert Fagenson, John Cronin and Ira Greenstein. Each of the members of the Compensation and Management Resources Committee is an independent director (as defined under Section 803 of the NYSE MKT LLC Company Guide). The Compensation and Management Resource Committee operates under a written charter adopted by the Board of Directors, which can be found in the Corporate Governance section of our web site, www.dsssecure.com.
The duties and responsibilities of the Compensation and Management Resources Committee in accordance with its charter are to review and discuss with management and the Board the objectives, philosophy, structure, cost and administration of the Company's executive compensation and employee benefit policies and programs; no less than annually, review and approve, with respect to the Chief Executive Officer and the other executive officers (a) all elements of compensation, (b) incentive targets, (c) any employment agreements, severance agreements and change in control agreements or provisions, in each case as, when and if appropriate, and (d) any special or supplemental benefits; make recommendations to the Board with respect to the Company's major long-term incentive plans, applicable to directors, executives and/or non-executive employees of the Company and approve (a) individual annual or periodic equity-based awards for the Chief Executive Officer and other executive officers and (b) an annual pool of awards for other employees with guidelines for the administration and allocation of such awards; recommend to the Board for its approval a succession plan for the Chief Executive Officer, addressing the policies and principles for selecting a successor to the Chief Executive Officer, both in an emergency situation and in the ordinary course of business; review programs created and maintained by management for the development and succession of other executive officers and any other individuals identified by management or the Compensation and Management Resources Committee; review the establishment, amendment and termination of employee benefits plans, review employee benefit plan operations and administration; and any other duties or responsibilities expressly delegated to the Compensation and Management Resources Committee by the Board from time to time relating to the Committee's purpose.
The Compensation and Management Resources Committee may request any officer or employee of the Company or the Company's outside counsel to attend a meeting of the Compensation and Management Resources Committee or to meet with any members of, or consultants to, the Compensation and Management Resources Committee. The Company's Chief Executive Officer does not attend any portion of a meeting where the Chief Executive Officer's performance or compensation is discussed, unless specifically invited by the Compensation and Management Resources Committee.
The Compensation and Management Resources Committee has the sole authority to retain and terminate any compensation consultant to be used to assist in the evaluation of director, Chief Executive Officer or other executive officer compensation or employee benefit plans, and shall have sole authority to approve the consultant's fees and other retention terms. The Compensation and Management Resources Committee also has the authority to obtain advice and assistance from internal or external legal, accounting or other experts, advisors and consultants to assist in carrying out its duties and responsibilities, and has the authority to retain and approve the fees and other retention terms for any external experts, advisors or consultants.
Nominating and Corporate Governance Committee
The Nominating and Corporate Governance Committee is responsible for overseeing the appropriate and effective governance of the Company, including, among other things, (a) nominations to the Board of Directors and Stockholders
making recommendations regarding the size and composition of the Board of Directors and (b) the development and recommendation of appropriate corporate governance principles. During his most recent term as a member of the Company’s Board of Directors, which term expired on June 14, 2012, Alan Harrison served as the Board’s Nominating and Corporate Governance Committee chairman. The Nominating and Corporate Governance Committee currently consists of Ira Greenstein, its Chairman, Roger O’Brien and David Klein, all of whom are independent directors (as defined under Section 803 of the NYSE MKT LLC Company Guide). The Nominating and Corporate Governance Committee held one meeting in 2012. The Nominating and Corporate Governance Committee operates under a written charter adopted by the Board of Directors, which can be found in the Corporate Governance section of our web site, www.dsssecure.com. The Nominating and Corporate Governance Committee does not have a formal policy that requires it to consider any director candidates that might be recommended by stockholders, but adheres to the Company’s By-Laws provisions and Securities and Exchange Commission rules relating to proposals by shareholders. The Nominating and Corporate Governance Committee of the Board of Directors is responsible for identifying and selecting qualified candidates for election to the Board of Directors prior to each annual meeting of the Company’s stockholders. In identifying and evaluating nominees for director, the Committee considers each candidate’s qualities, experience, background and skills, as well as other factors, such as the individual’s ethics, integrity and values which the candidate may bring to the Board of Directors. Code of Ethics
The Company has adopted a code of Ethics that establishes the standards of ethical conduct applicable to all directors, officers and employees of the Company. A copy of the Code of Ethics covering all of our employees, directors and officers, is available in the Corporate Governance section of our web site,www.dsssecure.com.
Leadership Structure and Risk Oversight
Currently, the positions of Chief Executive Officer and Chairman of the Board are held by two different individuals. Robert Fagenson currently serves as Chairman of the Board and Robert Bzdick currently serves as Chief Executive Officer of the Company and as a member of the Board. Although no formal policy currently exists, the Board determined that the separation of these positions would allow our Chief Executive Officer to devote his time to the daily execution of the Company’s business strategies and Board Chairman to devote his time to the long-term strategic direction of the Company. Our senior management manages the risks facing the Company under the oversight and supervision of the Board. While the full Board is ultimately responsible for risk oversight at our Company, two of our Board committees assist the Board in fulfilling its oversight function in certain areas of risk. The Audit Committee assists the Board in fulfilling its oversight responsibilities with respect to risk in the areas of financial reporting and internal controls. The Nominating and Corporate Governance Committee assists the Board in fulfilling its oversight responsibilities with respect to risk in the area of corporate governance. Other general business risks such as economic and regulatory risks are monitored by the full Board. While the Board oversees the Company’s risk management, management is responsible for day-to-day oversight of risk management processes.
Compensation Risk Assessment
Our Board considered whether our compensation program encouraged excessive risk taking by employees at the expense of long-term Company value. Based upon its assessment, the Board does not believe that our compensation program encourages excessive or inappropriate risk-taking. The Board believes that the design of our compensation program does not motivate imprudent risk-taking.
COMMUNICATION WITH DIRECTORS
The Company has established procedures for stockholders or other interested parties to communicate directly with the Board of Directors. Such parties can contact the Board of Directors by mail at: Document Security Systems, Inc. and Subsidiaries
, Board of Directors, Attention: Robert Fagenson, Chairman of the Board, 28 East Main Street, Suite 1525, Rochester, New York 14614. All communications made by this means will be received by the Chairman of the Board.AUDIT COMMITTEE REPORT
The following Audit Committee Report shall not be deemed to be “soliciting material,” “filed” with the SEC, or subject to the liabilities of Section 18 of the Exchange Act. Notwithstanding anything to the contrary set forth in any of the Company’s previous filings under the Securities Act of 1933, as amended, or the Exchange Act, that might incorporate by reference future filings, in whole or in part, the following Audit Committee Report shall not be incorporated by reference into any such filings.
The Audit Committee is comprised of three independent directors (as defined under Section 803 of the NYSE MKT LLC Company Guide). The Audit Committee operates under a written charter adopted by the Board of Directors, which can be found in the Corporate Governance section of our web site, www.dsssecure.com.
We have reviewed and discussed with management the Company’s audited the accompanying consolidated balance sheets of Document Security Systems, Inc. and Subsidiariesfinancial statements as of and for the fiscal year ended December 31, 20102012, as well as the quarterly unaudited financial statements.
We have reviewed and 2009,discussed with management and the related consolidated statements of operations, stockholders’ equity,independent registered public accounting firm the quality and cash flows for the years then ended. These financial statements are the responsibilityacceptability of the Company's management. Our responsibility is to express an opinion on theseCompany’s financial statements based on our audits.
reporting and internal controls.We conducted our audits in accordancehave discussed with the independent registered public accounting firm the overall scope and plans for their audit as well as the results of their examinations, their evaluations of the Company’s internal controls, and the overall quality of the Company’s financial reporting.
We have discussed with management and the independent registered public accounting firm such other matters as required to be discussed with the Audit Committee under Professional Standards, the corporate governance standards of the NYSE MKT LLC Exchange and the Audit Committee’s Charter.
We have received and reviewed the written disclosures and the letter from the independent registered public accounting firm required by the Statement on Auditing Standards as adopted by the Public Company Accounting Oversight Board, (United States). Those standards require that we plan and performhave discussed with the auditindependent registered public accounting firm their independence from management and the Company, including the impact of permitted non-audit related services approved by the Committee to obtain reasonable assurance about whetherbe performed by the financial statements are free of material misstatement. The Company is not required to have, nor have we been engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinionindependent registered public accounting firm.
Based on the effectivenessreviews and discussions referred to above, we recommended to the Board of the Company’s internal control over financial reporting. Accordingly we express no such opinion. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believeDirectors that our audits provide a reasonable basis for our opinion.
In our opinion, the
consolidated financial statements referred to above
present fairly,be included in
all material respects, the
financial position of Document Security Systems, Inc. and Subsidiaries as ofCompany’s Annual Report on Form 10-K for the fiscal year ended December 31,
2010 and 2009, and2012, filed with the
results of its operations and its cash flowsSEC on March 6, 2013. | David Klein, Audit Committee Chairman |
| Robert Fagenson |
| John Cronin |
EXECUTIVE OFFICERS
The biography for Robert Bzdick, 58, our Chief Executive Officer, is contained herein in the years then ended, in conformity with U.S. generally accepted accounting principles.
As discussed in Note 17information disclosures relating to the consolidated financial statements,Company’s directors. Mr. Bzdick has served as the 2010 consolidated financial statements have been restatedCompany’s Chief Executive Officer since December 1, 2012. Prior to correct an error inthat, Mr. Bzdick served as the accounting for the business combination.
/s/ FREED MAXICK & BATTAGLIA, CPAs, PC
Buffalo, New York
March 31, 2011, except for the effects of the restatement described in Note 17 to the consolidated financial statements, as to which the date is November 14, 2011.
DOCUMENT SECURITY SYSTEMS, INC. AND SUBSIDIARIES |
Consolidated Balance Sheets |
As of December 31, |
| | | 2010 | | 2009 |
| | | (Restated) | | |
| ASSETS | | | | | | | | |
| | | | | | | | | |
| Current assets: | | | | | | | | |
| Cash and cash equivalents | | $ | 4,086,574 | | | $ | 448,895 | |
| Accounts receivable, net of allowance | | | | | | | | |
| of $66,000 ($66,000- 2009) | | | 2,227,877 | | | | 1,143,939 | |
| Inventory | | | 601,359 | | | | 184,174 | |
| Prepaid expenses and other current assets | | | 231,190 | | | | 91,310 | |
| Total current assets | | | 7,147,000 | | | | 1,868,318 | |
| | | | | | | | | |
| Equipment and leasehold improvements, net | | | 2,543,494 | | | | 1,286,226 | |
| Other assets | | | 325,953 | | | | 305,507 | |
| Goodwill | | | 3,084,121 | | | | 1,315,721 | |
| Other intangible assets, net | | | 1,847,859 | | | | 1,588,969 | |
| Investment | | | - | | | | 350,000 | |
| Total assets | | $ | 14,948,427 | | | $ | 6,714,741 | |
| | | | | | | | | |
| LIABILITIES AND STOCKHOLDERS' EQUITY | | | | | |
| | | | | | | | | |
| Current liabilities: | | | | | | | | |
| Accounts payable | | $ | 1,828,138 | | | $ | 1,673,901 | |
| Accrued expenses and other current liabilities | | | 1,312,363 | | | | 934,595 | |
| Revolving line of credit | | | 614,833 | | | | - | |
| Current portion of long-term debt | | | 300,000 | | | | - | |
| Current portion of capital lease obligations | | | 88,776 | | | | 78,167 | |
| Total current liabilities | | | 4,144,110 | | | | 2,686,663 | |
| | | | | | | | | |
| Revolving notes from related party | | | 583,000 | | | | 583,000 | |
| Long-term debt, net of unamortized discount of $0 in 2010 ($420,000 -2009) | | | 1,578,242 | | | | 954,616 | |
| Capital lease obligations | | | 98,532 | | | | 182,424 | |
| Deferred tax liability | | | 89,779 | | | | 70,830 | |
| Derivative liabilities | | | 3,866,836 | | | | - | |
| Commitments and contingencies (see Note 13) | | | | | | | | |
| | | | | | | | | |
| Stockholders' equity | | | | | | | | |
| Common stock, $.02 par value; 200,000,000 shares authorized, | | | | | | | | |
| 19,391,319 shares issued and outstanding (16,397,887 in 2009) | | | 387,825 | | | | 327,957 | |
| Additional paid-in capital | | | 44,178,569 | | | | 38,399,033 | |
| Accumulated other comprehensive loss | | | (25,834 | ) | | | - | |
| Accumulated deficit | | | (39,952,632 | ) | | | (36,489,782 | ) |
| | | | | | | | | |
| Total stockholders' equity | | | 4,587,928 | | | | 2,237,208 | |
| | | | | | | | | |
| Total liabilities and stockholders' equity | | $ | 14,948,427 | | | $ | 6,714,741 | |
See accompanying notes.
DOCUMENT SECURITY SYSTEMS, INC. AND SUBSIDIARIES
Consolidated Statements of Operations
For the Years Ended December 31,
| | | 2010 | | 2009 |
| | | (Reatated) | | |
| Revenue | | | | | | | | |
| Security and commercial printing | | $ | 6,987,930 | | | $ | 8,773,131 | |
| Packaging | | | 5,752,601 | | | | - | |
| Technology license royalties and digital solutions | | | 641,050 | | | | 783,453 | |
| Legal products | | | - | | | | 355,107 | |
| Total Revenue | | | 13,381,581 | | | | 9,911,691 | |
| | | | | | | | | |
| Costs of revenue | | | | | | | | |
| Security and commercial printing | | | 5,303,952 | | | | 6,063,479 | |
| Packaging | | | 4,386,829 | | | | - | |
| Technology license royalties and digital solutions | | | 5,476 | | | | 14,028 | |
| Legal products | | | - | | | | 178,892 | |
| Total costs of revenue | | | 9,696,257 | | | | 6,256,399 | |
| | | | | | | | | |
| Gross profit | | | 3,685,324 | | | | 3,655,292 | |
| | | | | | | | | |
| Operating expenses: | | | | | | | | |
| Selling, general and administrative | | | 6,136,152 | | | | 5,733,908 | |
| Research and development | | | 265,360 | | | | 291,538 | |
| Impairment of intangible assets | | | 376,481 | | | | - | |
| Amortization of intangibles | | | 803,468 | | | | 1,342,105 | |
| | | | | | | | | |
| Operating expenses | | | 7,581,461 | | | | 7,367,551 | |
| | | | | | | | | |
| Operating loss | | | (3,896,137 | ) | | | (3,712,259 | ) |
| | | | | | | | | |
| Other income (expense): | | | | | | | | |
| Interest income | | | - | | | | 18,140 | |
| Loss on equity investment | | | (121,393 | ) | | | - | |
| Interest expense | | | (290,087 | ) | | | (258,918 | ) |
| Amortizaton of note discount | | | (420,385 | ) | | | (250,102 | ) |
| Gain on deconsolidation of Legalstore.com division | | | - | | | | 25,755 | |
| Litigation settlements | | | - | | | | (115,101 | ) |
| Registration rights penalties | | | - | | | | (109,464 | ) |
| Gain on foreign currency transactions | | | - | | | | 15,050 | |
| Other income | | | 143,061 | | | | 415,838 | |
| | | | | | | | | |
| Loss before income taxes | | | (4,584,941 | ) | | | (3,971,061 | ) |
| | | | | | | | | |
| Income tax (benefit) expense | | | (1,122,091 | ) | | | 18,952 | |
| | | | | | | | | |
| Net loss | | $ | (3,462,850 | ) | | $ | (3,990,013 | ) |
| | | | | | | | | |
| Other comprehensive loss: | | | | | | | | |
| Interest rate swap loss | | | (25,834 | ) | | | - | |
| | | | | | | | | |
| Comprehensive Loss | | $ | (3,488,684 | ) | | $ | (3,990,013 | ) |
| | | | | | | | | |
| Divedend per share | | $ | 0.01 | | | $ | - | |
| | | | | | | | | |
| Net loss per share -basic and diluted: | | $ | (0.20 | ) | | $ | (0.27 | ) |
| | | | | | | | | |
| Weighted average common shares outstanding, basic and diluted | | | 17,755,141 | | | | 14,700,453 | |
DOCUMENT SECURITY SYSTEMS, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
For the Years Ended December 31,
| | | | 2010 (Restated) | | | | 2009 | |
| Cash flows from operating activities: | | | | | | | | |
| Net loss | | $ | (3,462,850 | ) | | $ | (3,990,013 | ) |
| Adjustments to reconcile net loss to net cash and cash equivalents used by operating activities: | | | | | | | | |
| Depreciation and amortization | | | 1,261,122 | | | | 1,661,522 | |
| Stock based compensation | | | 423,471 | | | | 67,709 | |
| Stock based payments for legal settlements | | | - | | | | 115,101 | |
| Warrants issuable for registration rights penalty | | | - | | | | 109,464 | |
| Amortization of note discount | | | 420,385 | | | | 250,102 | |
| Gain on deconsolidation of division | | | - | | | | (25,755 | ) |
| Deferred tax benefit | | | (1,141,040 | ) | | | - | |
| Loss on equity investment | | | 121,393 | | | | - | |
| Intangible asset impairment | | | 376,481 | | | | - | |
| (Increase) decrease in assets: | | | | | | | | |
| Accounts receivable | | | 200,339 | | | | 109,108 | |
| Inventory | | | 86,977 | | | | 73,849 | |
| Prepaid expenses and other assets | | | (101,465 | ) | | | (81,547 | ) |
| Increase (decrease) in liabilities: | | | | | | | | |
| Accounts payable | | | (209,516 | ) | | | 276,070 | |
| Accrued expenses and other current liabilities | | | 265,450 | | | | (160,711 | ) |
| Net cash used by operating activities | | | (1,759,253 | ) | | | (1,595,101 | ) |
| | | | | | | | | |
| Cash flows from investing activities: | | | | | | | | |
| Decrease in restricted cash | | | - | | | | 131,004 | |
| Purchase of equipment and leashold improvements | | | (157,422 | ) | | | (62,522 | ) |
| Purchase of other intangible assets | | | (269,729 | ) | | | (176,083 | ) |
| Acquisition of business | | | (2,000,000 | ) | | | - | |
| Net used by investing activities | | | (2,427,151 | ) | | | (107,601 | ) |
| | | | | | | | | |
| Cash flows from financing activities: | | | | | | | | |
| Net borrowing on revolving note- related parties | | | - | | | | 300,000 | |
| Net borrowings on revolving line of credit | | | 342,428 | | | | - | |
| Payments on short-term debt | | | - | | | | (900,000 | ) |
| Borrowings on long-term debt | | | 1,553,242 | | | | 575,000 | |
| Payments of long-term debt | | | (250,000 | ) | | | - | |
| Borrowings on long-term convertible notes | | | - | | | | 800,000 | |
| Payments of capital lease obligations | | | (73,283 | ) | | | (86,124 | ) |
| Issuance of common stock, net | | | 6,251,696 | | | | 1,374,901 | |
| Net cash provided by financing activities | | | 7,824,083 | | | | 2,063,777 | |
| | | | | | | | | |
| Net increase in cash and cash equivalents | | | 3,637,679 | | | | 361,075 | |
| Cash and cash equivalents beginning of year | | | 448,895 | | | | 87,820 | |
| | | | | | | | | |
| Cash and cash equivalents end of year | | $ | 4,086,574 | | | $ | 448,895 | |
See accompanying notes.
Consolidated Statements of Changes in Stockholders' Equity
For the Years Ended December 31, 2010 and 2009
| | | Common Stock | | | | | | | | | Accumulated | | | | | | | |
| | | Shares | | | Amount | | | Additional Paid-in Capital | | | Subscriptions Receivable | | | Other Comprehensive Income | | | Accumulated Deficit | | | Total | |
| | | | | | | | | | | | | | | | | | | | | | |
| Balance, December 31, 2008 | | | 14,369,764 | | | $ | 287,395 | | | $ | 35,538,695 | | | $ | (1,300,000 | ) | | $ | - | | | $ | (32,499,769 | ) | | $ | 2,026,321 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Issuance of common stock, net | | | 1,010,000 | | | | 20,200 | | | | 1,354,702 | | | | - | | | | - | | | | - | | | | 1,374,902 | |
| Conversion of debt to equity | | | 1,250,000 | | | | 25,000 | | | | 1,975,000 | | | | - | | | | - | | | | - | | | | 2,000,000 | |
| Discount on debt | | | - | | | | - | | | | 72,126 | | | | - | | | | - | | | | - | | | | 72,126 | |
| Fair value of beneficial conversion features | | | - | | | | - | | | | 350,871 | | | | - | | | | - | | | | - | | | | 350,871 | |
| Stock based payments, net of tax effect | | | 93,123 | | | | 1,862 | | | | 401,139 | | | | - | | | | - | | | | - | | | | 403,001 | |
| Cancellation of subscribed shares | | | (325,000 | ) | | | (6,500 | ) | | | (1,293,500 | ) | | | 1,300,000 | | | | - | | | | - | | | | - | |
| Net Loss | | | | | | | | | | | | | | | - | | | | - | | | | (3,990,013 | ) | | | (3,990,013 | ) |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Balance, December 31, 2009 | | | 16,397,887 | | | $ | 327,957 | | | $ | 38,399,033 | | | $ | - | | | $ | - | | | $ | (36,489,782 | ) | | $ | 2,237,208 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Issuance of common stock, net | | | 1,729,129 | | | | 34,583 | | | | 5,977,113 | | | | - | | | | - | | | | - | | | | 6,011,696 | |
| Acquisition of Premier Packaging | | | 735,437 | | | | 14,709 | | | | 2,551,966 | | | | - | | | | - | | | | - | | | | 2,566,675 | |
| Stock based payments, net of tax effect | | | 50,000 | | | | 1,000 | | | | 555,476 | | | | - | | | | - | | | | - | | | | 556,476 | |
| Property dividend | | | | | | | | | | | (228,607 | ) | | | - | | | | - | | | | - | | | | (228,607 | ) |
| Conversion of debt | | | 478,866 | | | | 9,576 | | | | 790,424 | | | | - | | | | - | | | | - | | | | 800,000 | |
| Other comprehensive loss | | | - | | | | - | | | | - | | | | - | | | | (25,834 | ) | | | - | | | | (25,834 | ) |
| Derivative liabilities | | | - | | | | - | | | | (3,866,836 | ) | | | - | | | | - | | | | - | | | | (3,866,836 | ) |
| Net Loss (as Restated) | | | - | | | | - | | | | - | | | | - | | | | - | | | | (3,462,850 | ) | | | (3,462,850 | ) |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Balance, December 31, 2010 (as restated) | | | 19,391,319 | | | $ | 387,825 | | | $ | 44,178,569 | | | $ | - | | | $ | (25,834 | ) | | $ | (39,952,632 | ) | | $ | 4,587,928 | |
See accompanying notes.
DOCUMENT SECURITY SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. - DESCRIPTION OF BUSINESS
The Company develops, markets, manufactures and sells paper and plastic products designed to protect valuable information from unauthorized scanning, copying, and digital imaging. We have developed security technologies that are applied during the normal printing process and by all printing methods including traditional offset, gravure, flexo, digital or via the internet on paper, plastic, or packaging. Our technologies and products are used by federal, state and local governments, law enforcement agencies and are also applied to a broad variety of industries as well, including financial institutions, high technology and consumer goods, entertainment and gaming, healthcare/pharmaceutical, defense and genuine parts industries. Our customers useCompany’s Chief Operating Officer since February 2010.Philip Jones, 44, our technologies where there is a need for enhanced security for protection and verification of critical financial instruments and vital records, or where there are concerns of counterfeiting, fraud, identity theft, brand protection and liability.
NOTE 2. - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation - The consolidated financial statements include the accounts of Document Security System and its subsidiaries. All intercompany balances and transactions have been eliminated in consolidation.
Use of Estimates - The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States requires us to make estimates and assumptions that affect the amounts reported and disclosed in the financial statements and the accompanying notes. Actual results could differ materially from these estimates. On an ongoing basis, we evaluate our estimates, including those related to the accounts receivable, fair values of intangible assets and goodwill, useful lives of intangible assets and property and equipment, fair values of options and warrants to purchase our common stock, valuation of derivative liabilities arising from issuances of common stock and associated warrants and other rights to acquire common stock in the future, deferred revenue and income taxes, among others. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable, the results of which form the basis for making judgments about the carrying values of assets and liabilities. We engage third-party valuation consultants to assist management in the allocation of the purchase price of significant acquisitions and the determination of the fair value of derivative liabilities.
Reclassifications - Certain prior year amounts have been reclassified to conform to the current year presentation.
Cash and Cash Equivalents – The Company maintains its cash in bank deposit accounts and, from time to time, short term Certificates of Deposits with original maturities of three months or less. For financial statement presentation purposes, the Company considers those short-term, highly liquid investments with original maturities of three months or less to be cash or cash equivalents.
Accounts Receivable - The Company carries its trade accounts receivable at invoice amount less an allowance for doubtful accounts. On a periodic basis, the Company evaluates its accounts receivable and establishes an allowance for doubtful accounts based upon management’s estimates that include a review of the history of past write-offs and collections and an analysis of current credit conditions. At December 31, 2010, the Company established a reserve for doubtful accounts of approximately $66,000 ($66,000 – 2009). The Company does not accrue interest on past due accounts receivable.
Inventory - Inventories consist primarily of paper, plastic materials and cards, pre-printed security paper, paperboard and fully-prepared packaging which and are stated at the lower of cost or market on the first-in, first-out (“FIFO”) method.Packaging Work-in-process and finished goods included the cost of materials, direct labor and overhead.
Equipment and Leasehold Improvements - Equipment and leasehold improvements are recorded at cost. Depreciation is computed using the straight-line method over the estimated useful lives or lease period of the assets whichever is shorter. Expenditures for renewals and betterments are capitalized. Expenditures for minor items, repairs and maintenance are charged to operations as incurred. Any gain or loss upon sale or retirement due to obsolescence is reflected in the operating results in the period the event takes place. Depreciation expense in 2010 was approximately $458,000 ($319,000- 2009).
Investment - On October 8, 2009, the Company entered into an Asset Purchase Agreement with Internet Media Services whereby the Company sold the assets and liabilities of Legalstore, a division ofChief Financial Officer, joined the Company in exchange2005 as Controller and Principal Accounting Officer and has served as the Company’s Chief Financial Officer since May 2009. Mr. Jones also serves as the Company's Treasurer. Prior to joining the Company, Mr. Jones held financial management positions at Zapata Corporaton, a public holding company, and American Fiber Systems, a private telecom company. In addition, Mr. Jones was a CPA at PriceWaterhouseCoopers and Arthur Andersen. Mr. Jones holds a Bachelor’s Degree in Economics from SUNY Geneseo and a MBA from the Rochester Institute of Technology.There are no familial relationships among any of our executive officers and our directors. None of our executive officers has been affiliated with any company that has filed for 7,500,000 sharesbankruptcy within the last ten years. We are not aware of common stockany proceedings to which any of our executive officers or any associate of any such officer is a party adverse to us or any of our subsidiaries or has a material interest adverse to us or any of our subsidiaries.
Each executive officer serves at the pleasure of the Internet Media Services. board of directors.
There are no legal proceedings that have occurred within the past ten years concerning our executive officers which involved a criminal conviction, a criminal proceeding, an administrative or civil proceeding limiting one's participation in the securities or banking industries, or a finding of securities or commodities law violations.
ITEM 11 - EXECUTIVE COMPENSATION
EXECUTIVE COMPENSATION
Summary Compensation Table
The Company recordedfollowing table sets forth the compensation earned by persons serving as the Company’s Chief Executive Officer during 2012 and 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 derecognition of a subsidiary under FASB ASC 810-10-40. Therefore,two other most highly compensated executive officers who served the Company accounted for the deconsolidation of a subsidiary (“the business”) by recording the consideration received at fair market value and recognizing a gain in net income measured2012, referred to herein collectively as the difference between: the fair value of the consideration received (7,500,000 shares of common stock of Internet Media Services“named executive officers”, or a 37% interest) and the carrying value of the assets and liabilities sold. Given that the consideration received is not readily measurable because of the lack of activity in Internet Media Services shares priorNEOs, for services rendered to the transaction, the Company determined that the value of the “business transferred” is more readily measurable by determining the fair market value of the business transferred based on a discounted cash flow model. The Company recorded the equity method investment at fair value. Under the equity method investment the Company is required to accountus 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 FASB ASC 350 is initially applied by the entity in its entirety. The Company determined that given the lack of activity in Internet Media Services shares prior to the transaction, the difference between the cost of the investment (fair market value) and the underlying equity interest is attributable to goodwill which difference amounted to approximately $243,000 at December 31, 2009. For the period from October 9, 2009 through December 31, 2009, the Company’s equity in the earnings of Internet Media Services was di minimus and not recorded by the Company. The total assets and liabilities of Internet Media Services as of December 31, 2009 amounted to approximately $350,000 and $60,000, respectively.
The Company recognized gains or losses on its investment under the equity method of accounting for investments. During 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 Internet Media Services. As a result, the Company has recorded a dividend of approximately $229,000 which was the book value of the investment as of September 23, 2010.
Business Combinations -The Company adopted new FASB guidance on business combinations and non-controlling interests. The new guidance on business combinations retains the underlying concepts of the previously issued standard in that the acquirer of a business is required to account for the business combination at fair value. As under previous 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. The new pronouncement results in some changes to the method of applying the acquisition method of accounting for business combinations in a number of significant aspects. Under the new 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.
Goodwill - Goodwill is the excess of cost of an acquired entity over the fair value of amounts assigned to assets acquired and liabilities assumed in a business combination. Goodwill is not amortized, rather it is tested for impairment annually, and will be tested for impairment between annual tests if an event occurs or circumstances change that would indicate the carrying amount may be impaired. Impairment testing for goodwill is done at a reporting unit level. Reporting units are one level below the business segment level, but are combined when reporting units within the same segment have similar economic characteristics. The Company has three reporting units based on the current structure. An impairment loss generally would be recognized when the carrying amount of the reporting unit’s net assets exceeds the estimated fair value of the reporting unit. The Company performs annual assessments and has determined that no impairment is necessary during the years ended December 31, 20102012 and 2009.
Other Intangible Assets, Patent Defense Costs2011:| Name and Principal Position | | Year | | | Salary | | | Bonus | | | Stock
Awards | | | Option
Awards (1) | | | All Other
Compensation (2) | | Total | |
| | | | | | ($) | | | ($) | | | ($) | | | ($) | | | ($) | | ($) | |
| Robert B. Bzdick | | | 2012 | | | | 240,000 | | | | 97,458 | | | | — | | | | 412,398 | | | 21,505 | | | 771,361 | |
| Chief Executive Officer(4) | | | 2011 | | | | 240,000 | | | | 33,270 | | | | — | | | | — | | | 19,324 | | | 292,594 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Philip Jones | | | 2012 | | | | 120,000 | | | | — | | | | — | | | | 143,741 | | | — | | | 263,741 | |
| Chief Financial Officer | | | 2011 | | | | 120,000 | | | | 30,000 | | | | — | | | | — | | | — | | | 150,000 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Patrick A. White, | | | 2012 | | | | 183,333 | | | | — | | | | — | | | | 102,393 | | | 16,080 | | | 301,806 | |
| Former Chief Executive Officer(3) | | | 2011 | | | | 198,450 | | | | 12,000 | | | | — | | | | 39,000 | | | 14,688 | | | 264,138 | |
| (1) | Represents the total grant date fair value of option awards computed in accordance with FASB ASC 718. DSS’s policy and assumptions made in the valuation of share-based payments are contained in Note 7 to DSS’s financial statements for the year ended December 31, 2012. |
| (2) | Includes health insurance premiums and automobile expenses paid by DSS. |
| (3) | Effective December 1, 2012, Mr. White’s employment with DSS was terminated and he will continue to serve as a consultant of DSS. |
| (4) | Effective December 1, 2012, Mr. Bzdick was appointed as Chief Executive Officer of the Company. He had previously served as the Company’s Chief Operating Officer since February 2010. |
Employment and
Patent Application Costs– Other intangible assets consists of costs associated Severance AgreementsOn November 15, 2012, Patrick White (“White”) and the Company executed a letter (the “Employment Termination Letter”) terminating White’s existing employment agreement and his employment with the application, acquisitionCompany, effective on December 1, 2012, and defensefurther providing that White would also resign as a director of the Company’s patents, contractual rights to patents and trade secrets associated with the Company’s technologies and a customer list obtained as a result of acquisitions. The Company’s patents and trade secrets are for document anti-counterfeiting and anti-scanning technologies and processes that form the basis of the Company’s document security business. Patent application costs are capitalized and amortized over the estimated useful life of the patent, which generally approximates its legal life. External legal costs incurred to defend the Company’s patents are capitalized to the extent of an evident increase in the value of the patents and an expected successful outcome. Patent defense costs are expensed at the point when it is determined that the outcome is expected to be unsuccessful. The Company, capitalizes the cost of an appeal until it is determined that the appeal will be unsuccessful. The Company’s capitalized patent defense costs expenses are analyzed for impairment basedeffective on the expected eventual outcome of the legal action and recoverability of proceeds or added economic value of the patent in excess of the costs. Legal actions related to the same patent defense case are unified into one asset group for the purposes on the impairment analysis. Intangible asset amortization expense is classified as an operating expense. The Company believes that the decision to incur patent costs is discretionary as the associated products or services can be sold prior to or during the application process. The Company accounts for other intangible amortization as an operating expense, unless the underlying asset is directly associated with the production or delivery of a product. Costs incurred to renew or extend the term of recognized intangible assets, including patent annuities and fees, are expensed as incurred. To date, the amount of related amortization expense for other intangible assets directly attributable to revenue recognized is not material.
Impairment of Long-Lived Assets - The Company accounts for long-lived assets and certain identifiable intangibles for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future net undiscounted cash flows expected to be generated by the asset including its ultimate disposition. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets. Fair value is determined based on discounted cash flows or appraised values, depending on the nature of the assets.
Fair Value of Financial Instruments - Effective JanuaryDecember 1, 2008, the Company adopted the new accounting guidance relating to fair value measurements as required by the Fair Value Measurement Topic of the FASB ASC for financial instruments measured at fair value on a recurring basis and effective January 1, 2009 on a non-recurring basis. The new 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 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:
· | 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. |
The carrying amounts reported in the balance sheet 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. 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 qualifies as a cash flow hedge and is included in accrued expenses on the accompanying Consolidated Balance Sheet as of December 31, 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 December 31, 2010, was approximately $26,000.
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.
Conventional Convertible Debt -When the convertible feature of the conventional convertible debt provides for a rate of conversion that is below market value, this feature is characterized as a beneficial conversion feature (“BCF"). Prior to the determination of the BCF, the proceeds from the debt instrument were first allocated between the convertible debt and any detachable free standing instruments that are included, such as common stock warrants. We record a BCF as a debt discount pursuant to FASB ASC Topic 470-20. In those circumstances, the convertible debt will be recorded net of the discount related to the BCF. We amortize the discount to interest expense over the life of the debt using the effective interest method. During 2010, the holders of both of the Company’s convertible notes totaling $800,000 exercised the conversion features of the respective convertible notes for an aggregate of 478,866 shares of the Company’s common stock, which retired the debt in full.2012. In conjunction with the conversions,Employment Termination Letter, the Company recognized approximately $263,000and White entered into an Amended Consulting Agreement (the “White Amended Consulting Agreement”) and a Confidentiality, Non-Competition, Non-Solicitation and Intellectual Property Agreement (the “White Confidentiality Agreement”), both having an effective date of unamortized note discount expense.
Share-Based Payments - Compensation cost for stock awards are measured at fair valueDecember 1, 2012. The White Amended Consulting Agreement replaced the consulting agreement previously entered into between the Company and recognize compensation expense over the service period for which awards are expected to vest. The Company uses the Black-Scholes option pricing model for determining the estimated fair value for stock-based awards. The Black-Scholes model requires the use of subjective assumptions which determine the fair value of stock-based awards, including the option’s expected term and the price volatilityWhite on October 1, 2012, in contemplation of the underlying stock. For equity instruments issued to consultants and vendors in exchange for goods and services followseventual consummation of the proposed merger of the Company, determines the measurement date for the fair valueDSSIP, Inc. and Lexington Technology Group, Inc. (the “Merger”) pursuant to that certain Agreement and Plan of the equity instruments issued at the earlier of (i) the date at which a commitment for performance by the consultant or vendor is reached or (ii) the date at which the consultant or vendor’s performance is complete. In the case of equity instruments issued to consultants, the fair value of the equity instrument is recognized over theMerger executed on October 1, 2012. The term of the consulting agreement.
Revenue Recognition- Sales of security and commercial printing products, and legal products are recognized when a product or service is delivered, shipped or providedWhite Amended Consulting Agreement will run from December 1, 2012 until March 1, 2015. Pursuant to the customer and all material conditions relatingWhite Amended Consulting Agreement, White will provide consulting services to the sale have been substantially performed.
For digital solutions sales, revenue is recognized in accordance with FASB ASC 985-605. Accordingly, revenue is recognized when allCompany as requested by the Company, up to a maximum of 60 hours per month. As consideration for the performance of the following conditions are satisfied: (1) there is persuasive evidenceconsulting services, White will be paid the sum of an arrangement; (2)$14,167 per month for the service or product has been provided15 month period dating from December 1, 2012 through February 28, 2014 and, thereafter, White will be paid the sum of $11,667 per month for the remaining 12 months of the consulting term. In addition to the customer; (3) the amountabove-described consulting compensation, White was paid a bonus of fees$40,000 in December 2012. In November 2012, White was also granted options to be paid by the customer is fixed or determinable (4) the collection of our fees is reasonably assured.
For technology licenses revenue is recognized once all the following criteria for revenue recognition have been met: (1) persuasive evidence of an agreement exists; (2) the right and ability to use the product or technology has been rendered; (3) the fee is fixed and determinable and not subject to refund or adjustment; and (4) collection of the amounts due is reasonably assured.
Advertising Costs– Generally consist of online, keyword advertising with Google with additional amounts spent on certain print media in targeted industry publications. Advertising costs were $32,000 in 2010 ($23,000 – 2009).
Research and Development– Research and development costs are expensed as incurred.
Foreign Currency- Net gains and losses resulting from transactions denominated in foreign currency are recorded as other income or loss.
Income Taxes - The Company recognizes estimated income taxes payable or refundable on income tax returns for the current year and for the estimated future tax effect attributable to temporary differences and carry-forwards. Measurement of deferred income items is based on enacted tax laws including tax rates, with the measurement of deferred income tax assets being reduced by available tax benefits not expected to be realized. We recognize penalties and accrued interest related to unrecognized tax benefits in income tax expense.
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.
For the years ended December 31, 2010 and 2009, there werepurchase up to 2,767,131 and 2,652,886, respectively, of shares potentially issuable under convertible debt agreements, options, warrants and restricted stock agreements that could potentially dilute basic earnings per share in the future were excluded from the calculation of diluted earnings per share because their inclusion would have been anti-dilutive to the Company’s losses in the respective years. This amount includes the warrants issued to Fletcher on December 31, 2010 (as amended on February18, 2011 and March 14, 2011). These amounts do not include potentially issuable shares under Fletcher’s Later Investment rights which provide Fletcher the right to acquire up to 756,38750,000 shares of the Company’s common stock at aan exercise price of $3.00 per share of $5.38 anytime prior to July 2, 2011. For each share purchased by Fletcher pursuant to the Later Investment, Fletcher would receive a warrant to purchase an additional shareexercisable until September 21, 2017. The options will fully vest one year after closing of the Company’s commons stock at $5.38 for up to nine years. If Fletcher exercises all of its Later Investment Rights, then an additional 756,387 warrants would be issued. (See Note 7).
Concentration of Credit Risk - The Company maintains its cash and cash equivalents in bank deposit accounts, which at times may exceed federally insured limits. The Company believes it is not exposed to any significant credit risk as a result of any non-performance by the financial institutions.
DuringMerger.On February 12, 2010, two customers accounted for 25% and 10% of the Company’s total revenue from continuing operations, respectively. As of December 31, 2010, these customers accounted for 37% and 7% of the Company’s trade accounts receivable balance, respectively. During 2009, two customers accounted for 19% and 12% of the Company’s total revenue from continuing operations, respectively. As of December 31, 2009, two customers’ account receivable balance accounted for 21% and 17% of the Company’s trade accounts receivable balance, respectively. 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 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 partially adopted the requirements within ASU 2010-6 as of January 1, 2010. The adoption did not have an impact on our financial statements.
In December 2010, the FASB issued ASU 2010-29, Business Combinations (Topic 805): Disclosure of Supplementary Pro Forma Information for Business Combinations. This ASU specifies that when comparative financial statements are presented, the revenue and earnings of the combined entity should be disclosed as though the business combination that occurred during the current year had occurred as of the beginning of the comparable prior annual reporting period only. ASU 2010-29 is effective for business combinations with acquisition dates on or after the beginning of the first annual reporting period beginning on or after December 15, 2010; early adoption is permitted. Management is currently evaluating the impact that the adoption of ASU 2010-29 will have and does not believe the adoption will have a material impact on our consolidated financial statements.
NOTE 3. – INVENTORY
Inventory consisted of the following at December 31,:
| | | 2010 | | | 2009 | |
| | | | | | | |
| | | | | | | |
| Finished Goods | | $ | 193,346 | | | $ | 38,093 | |
| Work in process | | | 86,776 | | | | 58,493 | |
| Raw Materials | | | 321,237 | | | | 87,588 | |
| | | | | | | | | |
| | | $ | 601,359 | | | $ | 184,174 | |
NOTE 4. - EQUIPMENT AND LEASEHOLD IMPROVEMENTS
Equipment and leasehold improvements consisted of the following at December 31:
| | | | 2010 | | | 2009 | |
| | Estimated Useful Life | | Purchased | | | Under Capital Leases | | | Purchased | | | Under Capital Leases | |
| | | | | | | | | | | | | | |
| Machinery & equipment | 5-7 years | | $ | 2,514,045 | | | $ | 369,114 | | | $ | 752,387 | | | $ | 547,936 | |
| Leasehold improvements | up to 13 years (1) | | | 741,919 | | | | - | | | | 735,434 | | | | - | |
| Furniture & fixtures | 7 years | | | 104,709 | | | | - | | | | 70,209 | | | | - | |
| Software & websites | 3 years | | | 356,125 | | | | - | | | | 270,725 | | | | - | |
| | | | | | | | | | | | | | | | | | |
| Total cost | | | $ | 3,716,798 | | | $ | 369,114 | | | $ | 1,828,755 | | | $ | 547,936 | |
| Less accumulated depreciation | | | | 1,391,693 | | | | 150,725 | | | | 809,082 | | | | 281,383 | |
| | | | | | | | | | | | | | | | | | |
| Net | | | $ | 2,325,105 | | | $ | 218,389 | | | $ | 1,019,673 | | | $ | 266,553 | |
(1) Expiration of lease term
NOTE 5. - INTANGIBLE ASSETS (as Restated)
Goodwill - The Company performs an annual fair value test of its recorded goodwill for its reporting units using a discounted cash flow and capitalization of earnings approach. As of December 31, 2010, the Company had goodwill of approximately $3,084,000 ($1,316,000- December 31, 2009) attributable to the commercial and security printing segment ($1,316,000) and the packaging segment ($1,768,000) which was recorded in 2010 as a result of our acquisition of Premier Packaging (See Note 9). In October 2009, we sold the assets and liabilities associated with Legalstore in exchange for common stock of Internet Media Services. The sale included goodwill with a net book value of approximately $81,000.
Other Intangible Assets - Other intangible assets are comprised of the following at December 31:
| | | | 2010 | | | 2009 | |
| | Useful Life | | Gross Carrying A mount | | Accumulated Amortizaton | | Net Carrying Amount | | Gross Carrying Amount | | Accumulated Amortizaton | | Net Carrying Amount | |
| Acquired intangibles | 5 -10 years | | $ | 2,038,300 | | | $ | 815,177 | | | $ | 1,223,123 | | | $ | 666,300 | | | $ | 532,285 | | | $ | 134,015 | |
| Patent acquisition and defense costs | Varied | | | 4,729,889 | | | | 4,729,889 | | | | - | | | | 4,729,889 | | | | 3,879,341 | | | | 850,548 | |
| Patent application costs | Varied (1) | | | 843,693 | | | | 218,957 | | | | 624,736 | | | | 776,159 | | | | 171,753 | | | | 604,406 | |
| | | | $ | 7,611,882 | | | $ | 5,764,023 | | | $ | 1,847,859 | | | $ | 6,172,348 | | | $ | 4,583,379 | | | $ | 1,588,969 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| (1)- patent rights are amortized over their expected useful life which is generally the legal life of the patent. As of December 31, 2010 the weighted average remaining useful life of these assets in service was 14.8 years. | |
Actual amortization for 2010 and 2009 and expected amortization for each of the next five years is as follows:
| 2009 Actual | | $ | 1,342,000 | |
| 2010 Actual | | $ | 803,000 | |
| | | | | | |
| Expected | 2011 | | $ | 242,253 | |
| | 2012 | | | 232,365 | |
| | 2013 | | | 232,365 | |
| | 2014 | | | 232,365 | |
| | 2015 | | | 147,198 | |
| | Thereafter | | | 761,313 | |
| | | | $ | 1,847,859 | |
Acquired Intangible Assets - In February 2010, the Company acquired intangible assets associated with its acquisition of Premier Packaging as described in Note 9. These intangible assets were valued at $1,372,000 by an independent valuation firm and consist of customer lists, amortized over the expected life of 10 years, and a non-compete agreement, amortized over the expected life of 5 years.
In February 2006, the Company acquired intangible assets associated with its acquisition of the assets of P3. These intangible assets were valued at $625,300 by an independent valuation firm and consist of customer lists, trade name and brand, and a non-compete agreement, which will be fully amortized as of February 2011.
Patent Acquisition and Defense Costs- Included in the Company’s capitalized patent defense costs are costs associated with the acquisition of certain rights associated with patents that the Company is defending. In December 2004, the Company entered into an agreement with the Wicker Family in which Document Security Systems obtained the legal ownership of technology (including patent ownership rights) previously held by the Wicker Family. At that time, the agreement with the Wicker Family provided that the Company would retain 70% of the future economic benefit derived from settlements, licenses or subsequent business arrangements from any infringer of the Wicker patents that Document Security Systems chooses to pursue. The Wicker Family was to receive the remaining 30% of such economic benefit. In February 2005, the Company further consolidated its ownership of the Wicker Family based patents and its rights to the economic benefit of infringement settlements when the Company purchased economic interests and legal ownership from approximately 45 persons and entities that had purchased various rights in Wicker Family technologies over several decades. The Company issued an aggregate of 541,460 shares of its common stock for the rights of the interest holders and secured 100% ownership of a US Patent and approximately 16% of additional economic rights to settlements with infringers of the Wicker Family’s foreign patents. The value of the shares of common stock was determined based upon the closing price of the shares of the Company’s common stock on the American Stock Exchange on February 15, 2005 of $7.25 per share was, $ 3,905,672 net of expenses. The Company amortized these costs over the weighted average expected life of the patents underlying the acquired rights, which was 6.75 years as of the date of acquisition. As of December 31, 2010, the net unamortized balance of acquired patent assets was $377,000, which was recorded in the corporate segment. As a result of the losses in the appeal of two court decisions in the fourth quarter of 2010 related to the Company’s infringement case against the ECB (as described in Note 13- Legal Proceedings), the Company’s management determined that an impairment of this asset occurred as it is more likely than not that the Company would not receive proceeds from infringement litigation in these non-European jurisdictions, and the remaining balance was considered impaired.
Patent defense costs are comprised of legal cost associated with our patent infringement suit against the ECB which the Company commenced in 2005. The Company bases it decision to defer the costs associated with this case on the principal that successful patent defense costs are capitalizable. First, the Company’s infringement case is based on the relationship of the inventor of the Company’s patent with various representatives of European currency printers, consultants, and other participants during the late 1990’s in regard to the industry’s attempts to defeat new advanced levels of copier and scanning technologies that were then emerging in the marketplace. The inventor of the patent had a proven history of success in anti-counterfeiting technology, and was seen as a source by these industry participants for help solve these challenges. The Company believed that it could establish a direct link between these communications and the use of the technology by these industry participants in the design and production of the Euro, which was designed in the late 1990’s and was initially released for circulation in 2002. In addition, prior to filing the ECB litigation, the Company consulted extensively with legal counsel and performed extensive due diligence with our legal counsel for approximately one year to analyze the merits of our patent infringement case, and only after these efforts did we take our legal counsel’s recommendation to proceed with the ECB litigation. Based on the cumulative evidence available to the Company at the time of filing the suit, the Company believed from the outset of the case that it will be able to prove in court that the ECB infringed the Company’s patent on its Euro notes by using the Company’s technology in the design of the notes for the specific purpose of making the notes difficult to copy, and therefore the Company’s infringement case would be successful.
During the course of the ECB litigation, the most significant events in the case were challenges of patent validity by the ECB in nine jurisdictions in Europe as a core component of its defense. The Company believed that the ECB’s challenge of patent validity represented the biggest hurdle to a successful outcome of the overall infringement case. During the course of the ECB litigation, the Company spent approximately $4,247,000 on legal and related court cost associated with defending the patent in these jurisdictions. The Company amortized these costs over the expected life of the patent which expired as of January 2010. During the course of the ECB litigation, the Company analyzed the recoverability of its capitalized patent defense costs. The Company used the potential proceeds from its ECB Litigation as the primary source of future cash flows. Specifically, the Company used assumptions of banknote production volumes during the alleged infringement period and estimated banknote production costs from third party sources to determine the estimated total costs of the production of the Euro banknotes in each year of infringement. The Company then applied a royalty rate that the Company generally charges international licensees and that the Company believes is consistent with industry standards to determine the amount that would be due to the Company if the ECB had licensed the technology from the Company on the Company’s standard licensing terms. The Company uses this amount as an estimate of the gross proceeds it could receive from a successful outcome of the litigation in all jurisdictions. The Company then allocated these potential proceeds by the percent of circulation of each jurisdiction in which the Company has ongoing litigation to determine the potential proceeds of a successful outcome in the jurisdictions where the patent has been held as valid or where the patent validity has not yet been determined. Finally, the Company uses a probability factor in its analysis that discounts these potential future proceeds that takes into account the different status levels of each jurisdiction. Thus, the Company determined a probability based cash flow which is compared to the net patent defense costs balance to determine whether an impairment of these costs has occurred. In 2008, as a result of an adverse decision regarding patent validity in one of the jurisdictions, the United Kingdom, the Company recognized an impairment of approximately $281,000. All other patent defense costs were amortized over the expected life of the patent and were fully amortized as of January 2010. As of December 31, 2010, there were no longer any unamortized patent defense costs or patent acquisition costs reflected on the Company’s balance sheet.
In August 2008, the Company entered into an agreement with Trebuchet under which Trebuchet agreed to pay substantially all of the litigation costs associated with pending validity proceedings and infringement suits, if any, subsequent to that point. 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. Trebuchet will receive 50% of all proceeds from any judgments, settlements, licenses or other forms of payment received as a result of any litigation. Pursuant to this transaction, the Company recognized a loss on the sale of patent assets for its assignment and transfer of 49% of its ownership rights in the patent, which had a net book value of approximately $1,670,000, for proceeds of $500,000.
Patent Application Costs - On an ongoing basis, the Company submits formal and provisional patent applications with the United States, Canada and countries included in the Patent Cooperation Treaty (PCT). The Company capitalizes these costs and amortizes them over the patents’ estimated useful life.
NOTE 6. – SHORT TERM AND LONG TERM DEBT
Revolving Note - Related Party- On January 4, 2008, the Company entered into a Credit Facility Agreementfive-year employment agreement with Fagenson and Co., Inc.,Robert Bzdick to serve as agent, a related party to Robert B. Fagenson, the ChairmanChief Operating Officer of the Company's Board of DirectorsCompany (the “Fagenson Credit“Bzdick Employment Agreement” or “Credit Facility”). Under the Fagenson CreditThe Bzdick Employment Agreement the Company could borrow up toautomatically renews for a maximum of $3,000,000 from time to time up to and until January 4, 2010. Any amount borrowed by the Company pursuantsuccessive five-year term unless either party gives notice to the Fagenson Credit Agreement has annual interest rate of 2% above LIBOR and is secured byother at least 90 days prior to the Common Stock of P3, the Company's wholly owned subsidiary. Interest is payable quarterly in arrears and the principal is payable in full at the endexpiration of the initial term underof its desire to terminate the Fagenson Credit Agreement. On December 11, 2009, the Company entered into a Letter Agreement with the lender for the conversion of $2,000,000 of debt owed under the Credit Facility into 1,250,000 shares of Document Security Systems common stock. In addition, the parties amended the Credit Facility to allow for a maximum borrowing of up to $1,000,000 and extended the due date to January 4, 2012. As of December 31, 2010, the Company had outstanding $583,000 ($583,000 – December 31, 2009) under the Fagenson CreditBzdick Employment Agreement. Under the termsBzdick Employment Agreement, Mr. Bzdick is entitled to an annual base salary of $240,000 and an annual bonus of 10% of the Credit Facility the Company is required to comply with various covenants, in which the Company was in violation of one covenant for the lack of payment of interest. While the Company had not received a notice of default from the lender, the Company did receive a waiver from the lender for the violation as of December 31, 2010.
Interest expense for revolving notes from related parties for the year ended December 31, 2010 was approximately $20,000 ($108,000 – 2009) of which approximately $172,000 is included in accrued expenses as of December 31, 2010 ($152,000 –December 31, 2009).
Notes Payable and Revolving Credit Line - On December 9, 2009, the Company used the proceeds from a $350,000 Convertible Note and a $575,000 Promissory Note (collectively, the “Notes”), respectively, to pay in full a $900,000 Term Note. The $350,000 Convertible Note was set to mature on November 24, 2012, accrued interest at 10% and was convertible into up to 218,750 shares of Document Security Systems common stock. The $575,000 Promissory Note matures on November 24, 2012 accrues interest at 10%, payable quarterly. Both Notes are secured with equal rights by the assetsadjusted net income of the Company’s wholly owned subsidiary, DPI. In conjunction with the convertible note,packaging division. If the Company determined a beneficial conversion feature existed amountingelects not to approximately $94,000renew the term for an additional five years for any reason except for cause, the Company will be obligated to pay Mr. Bzdick $100,000 per year and health insurance premiums for Mr. Bzdick and his family for five years. The Bzdick Employment Agreement also provides for non-competition covenants by Mr. Bzdick in favor of the Company for the longer of (i) one year after the term of employment, or (ii) any period during which was recorded as discountMr. Bzdick receives severance payments.On October 1, 2012, the Company and Robert Bzdick entered into Amendment No. 1 to the Bzdick Employment Agreement (the “Bzdick Amendment”) which amended certain terms and provisions of the Bzdick Employment Agreement. The Bzdick Amendment will become effective on debt and was being amortized overthe date of closing of the Merger. As such, the Bzdick Employment Agreement is still in effect until that time. Pursuant to the Bzdick Amendment, among other things, (i) the term of the Note. On November 29, 2010,Bzdick Employment Agreement is reduced from February 12, 2015 to December 31, 2014, and such term will be renewed automatically for a succeeding period of five years on the holder exercisedsame terms and conditions as set forth in the conversion featureBzdick Amendment, unless either party, at least 90 days prior to expiration of the $350,000 Convertible Note for 218,750 sharesterm, provides written notice to the other party of Document Security Systems common stock, par value $0.02 which retiredits intention not to renew the debt in full. In conjunction with the conversion,term, (ii) if the Company recognized approximately $63,000 of note discount expense.
On December 30, 2009,elects not to renew the term, the Company
usedwill pay Mr. Bzdick $300,000, which shall be payable as follows: $100,000 on the
proceeds from a $450,000 Convertible Note (“Note”) to pay in full $450,000 due under a previous Credit Facility due to the Company’s CEO. The $450,000 Note was set to maturefirst anniversary of such non-renewal, and $50,000 on
June 23, 2012, accrued interest at 8%, and was convertible into up to 260,116 shares of Document Security Systems common stock, and was secured by the accounts receivableeach of the
Company, excludingsecond through fifth anniversaries after such non-renewal, and (iii) Mr. Bzdick’s salary will be decreased from $240,000 annually to $200,000 annually upon the
accounts receivableeffective date of the
Company’s wholly owned subsidiaries, P3 and DPI. In conjunction withBzdick Amendment. Upon consummation of the
Note,Merger, the Company
issuedwill pay Mr. Bzdick a bonus equal to
$50,000. In November 2012, the
holders of the Note warrantsCompany granted Mr. Bzdick options 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 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 the150,000 shares of the Company’s common stock at
$2.00 issuable under the termsan exercise price of $3.00 per share exercisable until September 21, 2017. These options will vest in full upon closing of the
Note as a resultMerger, which is currently pending. In November 2012, the Company also granted Mr. Bzdick options to purchase up to 100,000 shares of the Company’s
failure to timely file a registration statement for the shares issuable upon conversioncommons stock at an exercise price of
the Note and underlying the warrants, respectively,$3.00 per share, exercisable until September 21, 2017. These options will vest ratably over 12 calendar quarters, commencing on December 31, 2012.The Company’s CFO, Philip Jones, is currently an at will employee. On December 24, 2010, the holder of the Note exercised the conversion feature of the Note for 260,116 shares of Document Security Systems common stock, par value $0.02 which retired the debt in full. In conjunction with the conversion, the Company recognized approximately $200,000 of note discount expense.
On February 12, 2010, the Company acquired all of the outstanding common stock of Premier Packaging. In conjunction with the transaction,October 1, 2012, the Company entered into a Credit Facility Agreementletter agreement with RBS Citizens, N.A. (“Citizens Bank”Philip Jones (the “Jones Letter Agreement”) pursuant to which Citizens Bank provided Premier Packaging with a term loanwill become effective on the date of $1,500,000, and a revolving credit line of up to $1,000,000, which provides for the ability to get letters of credits based on available revolving credit balances. The Citizens Bank 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 allconsummation of the assetsMerger, which is currently pending. Under the Jones Letter Agreement, upon termination of Premier Packaging. The $1,500,000 term loan matures March 1, 2013 and isMr. Jones’ employment for any reason by the Company, the Company will pay Mr. Jones severance in the amount of his current base salary, payable in 35 monthly paymentsbi-weekly installments in accordance with the Company’s regular payroll practices, for a period of $25,000 plus interest commencing March 1, 2010 and a payment of $625,000 on the 36th month. Interest accrues at 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. The revolving line of credit up to $1,000,000 is accessible by the Premier Packaging division subject to certain terms matures on May 13, 2011, as amended, 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. The amount of the swap liability was $26,000 at December 31, 2010 and is included in accrued expenses in the accompanying balance sheet. As of December 31, 2010, the remaining principal balance due on the Note was $1,250,000 and there was approximately $615,000 outstanding on the revolving credit line.
Standby Term Loan Note - On October 8, 2010,12 months. In November 2012, the Company amended the Credit Facility Agreement to add a Standby Term Loan Note pursuant to which Citizens Bank will provide Premier Packaging 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 LIBOR plus 3.00%. As of December 31, 2010, the Company has drawn approximately $53,000 from the Standby line for the purchase of equipment.
All of the Citizen’s credit facilities are secured by all of the assets of Premier Packaging and are also secured through cross guarantees by Document Security Systems and the Company’s other wholly owned subsidiaries, P3 and DPI.
A summary of scheduled principal payments of revolving notes related party and notes payable at December 31, 2010 are as follows:
| 2011 | | $ | 300,000 | |
| 2012 | | | 1,458,000 | |
| 2013 | | | 650,000 | |
| | | | | |
| | | $ | 2,408,000 | |
NOTE 7. - STOCKHOLDERS’ EQUITY
Stock Issued in Private Placements -Between May 29, 2009 and June 22, 2009, the Company sold 56 investment units in a private placement at a price of $10,000 per unit for aggregate proceeds of $560,000 less $44,000 in expenses, consisting of 400,000 shares of common stock and warrants to purchase an aggregate of 80,000 shares of common stock. The estimated fair market value of these warrants was determined using the Black Scholes option pricing model at approximately $80,000. On July 15, 2009, the Company sold 24.5 investment units for $10,000 per unit for gross cash proceeds of $245,000, consisting of 175,000 shares of common stock and warrants to purchase an aggregate of 35,000 shares of common stock. The estimated fair market value of these warrants was determined using the Black Scholes option pricing model at approximately $34,000. On August 24, 2009, the Company completed the sale of 7 investment units in a private placement pursuant to subscription agreements with one accredited investor dated the same date. In the transaction, the Company sold 7 investment units for $10,000 per unit for gross cash proceeds of $70,000, consisting of 50,000 shares of common stock and warrants to purchase an aggregate of 10,000 shares of common stock. The estimated fair market value of these warrants was determined using the Black Scholes option pricing model at approximately $10,000. Each investment unit consisted of 7,142 shares of its common stock and five-year warrantsgranted Mr. Jones options to purchase up to an aggregate of 1,427100,000 shares of itsthe Company’s common stock at an exercise price of $2.00$3.00 per share.
Onshare, exercisable until September
4, 2009,21, 2017. These options will vest ratably over 12 calendar quarters commencing on December 31, 2012. Outstanding Equity Awards at Fiscal Year-End
The following table summarizes the Company completedequity awards we have made to our Named Executive Officers, which are outstanding as of December 31, 2012:
| Name | | Number of
Securities
Underlying
Unexercised
Options | | | Number of
Securities
Underlying
Unexercised
Options | | | Number
of Shares
of
Stock
That Have
Not
Vested | | | Market
Value
of Shares
of
Stock
That Have
Not
Vested | | | Option
Exercise
Price | | | Option Expiration
Date |
| | | (#) | | | (#) | | | (#) | | | ($) | | | ($) | | | |
| | | Exercisable | | | Un-exercisable | | | | | | | | | | | | |
| Philip Jones | | | 50,000 | | | | | | | | — | | | | — | | | | 4.00 | | | 2/11/2014 |
| | | | 33,333 | | | | 16,667 | (1) | | | — | | | | — | | | | 3.29 | | | 1/28/2015 |
| | | | 33,333 | | | | 16,667 | (1) | | | — | | | | — | | | | 4.00 | | | 1/28/2015 |
| | | | 13,333 | | | | 6,667 | (2) | | | — | | | | — | | | | 3.23 | | | 6/10/2015 |
| | | | 8,333 | | | | 91,667 | (3) | | | — | | | | — | | | | 3.00 | | | 11/19/2017 |
| Robert B. Bzdick | | | 8,333 | | | | 91,667 | (3) | | | — | | | | — | | | | 3.00 | | | 11/19/2017 |
| | | | — | | | | 150,000 | (4) | | | — | | | | — | | | | 3.00 | | | 11/19/2007 |
| (1) | Vests as to one-third of the shares subject to the option in equal installments on each of 1/28/2011, 1/28/2012, and 1/28/2013. |
| (2) | Vests as to one-third of the shares subject to the option in equal installments on each of 6/10/2011, 6/10/2012, and 6/10/2013. |
| (3) | Vests as to one-twelfth of the shares subject to the option in equal quarterly installments commencing on 12/31/2012. |
| (4) | Vests upon consummation of the Merger, which is currently pending. |
ITEM 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth information as of April 24, 2013, regarding the salebeneficial ownership of 44 investment units in a private placement pursuant to subscription agreements with three accredited investors dated the same date. Each investment unit is comprised of 6,250 shares of the Company’sDSS common stock and five year warrantsby (i) each person known to purchase 1,250 shares of common stock at an exercise price of $2.00 per share. In the transaction, the Company sold 44 investment units for $10,000 per unit for gross cash proceeds of $440,000, less expenses of $52,000, consisting of 275,000 shares of common stock and warrants to purchase an aggregate of 55,000 shares of common stock. The estimated fair market value of these warrants was determined using the Black Scholes option pricing model at approximately $54,000.
On October 19, 2009, the Company completed the sale of 17.6 investment units in a private placement pursuant to subscription agreements with three accredited investors dated the same date. Each investment unit is comprised of 6,250 shares of the Company’s common stock and five year warrants to purchase 1,250 shares of common stock at an exercise price of $2.00 per share. In the transaction, the Company sold 17.6 investment units for $10,000 per unit for gross cash proceeds of $176,000, less expenses of $17,600, consisting of 110,000 shares of common stock and warrants to purchase an aggregate of 22,000 shares of common stock. The estimated fair market value of these warrants was determined using the Black Scholes option pricing model at approximately $38,000.
On February 12, 2010, the Company acquired allown beneficially 5% or more of the outstanding
shares of DSS common stock,
(ii) each director of
Premier Packaging from Robert B.DSS, (iii) each named executive officer, and
Joan T. Bzdick for $2,000,000(iv) all of DSS’s directors and executive officers as a group. Information with respect to beneficial ownership is based solely on a review of DSS’s capital stock transfer records and on publicly available filings made with the SEC by or on behalf of the stockholders listed below.Percentage of beneficial ownership is calculated in cash and 735,437relation to the 21,709,488 shares of DSS Common Stock that were outstanding as of April 24, 2013. Beneficial ownership is determined in accordance with the Company's common stockrules of the SEC, which was valued at $2,566,675.
On February 17, 2010, the Company completed the salegenerally attribute beneficial ownership of 20securities to persons who possess sole or shared voting or investment units in a private placement pursuantpower with respect to subscription agreements with six accredited investors. Each investment unit was comprised of 5,000those securities, and includes 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 an aggregate 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 stockDSS Common Stock issuable pursuant to the exercise of warrants in which the Company received proceeds of $608,000.
On July 21, 2010 and July 22, 2010, Document Security Systems enteredstock options or other securities that are exercisable or convertible into subscription agreements with twenty two accredited investors. Under these subscription agreements the Company issued an aggregate of 413,787 shares of common stock and five-year warrantsDSS Common Stock within 60 days of April 24, 2013. Options to purchase up to 82,753 shares of common stock, in consideration of an aggregate of $1,200,000. The warrantsDSS Common Stock that 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, inwithin 60 days of April 24, 2013 are considered beneficially owned by 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.
On February 18, 2011, the Company entered into an Amended and Restated Agreement (“Amended Agreement”) with Fletcherperson holding such options for the purpose of
modifyingcomputing ownership of such person, but are not treated as outstanding for the
termspurpose of
computing the beneficial ownership of any other person. Unless otherwise indicated, to DSS’s knowledge, the persons or entities identified in the table below have sole voting and investment power with respect to all shares shown as beneficially owned by them.| Name and Address of Beneficial Owner(1) | | Number of Shares of Common
Stock Beneficially Owned | | | Percentage of Common
Stock(2) | |
| Five percent or more beneficial owners: | | | | | | | | |
| None | | | | | | | | |
| Named Executive Officers and Directors | | | | | | | | |
| Robert B. Bzdick, CEO & Director | | | 682,104 | (3) | | | 3.12 | % |
| David Wicker, VP Research & Operations and Director | | | 229,834 | (4) | �� | | 1.05 | % |
| Philip Jones, CFO | | | 186,667 | (5) | | | * | |
| David Klein, Director | | | 11,667 | (6) | | | * | |
| Robert B. Fagenson, Director | | | 1,049,500 | (7) | | | 4.83 | % |
| Ira A. Greenstein, Director | | | 46,667 | (8) | | | * | |
| Roger O’Brien, Director | | | 27,500 | (9) | | | * | |
| John Cronin, Director | | | 5,000 | (10) | | | * | |
| All executive officers and directors as a group (8 persons) | | | 2,238,939 | (11) | | | 10.04 | % |
| (1) | The business address of the individuals is c/o Document Security Systems, Inc., 28 East Main Street, Suite 1525, Rochester, New York 14614. |
| (2) | Based upon 21,709,488 shares of DSS Common Stock issued and outstanding on April 24, 2013. |
| (3) | Includes 166,667 shares of Common stock issuable upon the exercise of stock options exercisable within 60 days of April 24, 2013. |
| (4) | Includes 105,000 shares of DSS Common Stock issuable upon the exercise of stock options exercisable within 60 days of April 24, 2013. |
| (5) | Includes 186,667 shares of DSS Common Stock issuable upon the exercise of stock options exercisable within 60 days April 24, 2013. |
| (6) | Includes 11,667 shares of DSS Common Stock issuable upon the exercise of stock options exercisable within 60 days of April 24, 2013. |
| (7) | Includes 40,000 shares of DSS Common Stock issuable upon the exercise of currently exercisable stock options, 100,000 shares of DSS Common Stock held by Mr. Fagenson’s wife and an aggregate of 100,000 shares of DSS Common Stock held in trusts for Mr. Fagenson’s two adult children, of which Mr. Fagenson is trustee. Mr. Fagenson disclaims beneficial ownership of the 100,000 shares of DSS Common Stock held by his wife and the 100,000 shares of DSS Common Stock held in trusts for Mr. Fagenson’s two adult children. |
| (8) | Includes 46,667 shares of DSS Common Stock issuable upon the exercise of stock options exercisable within 60 days of April 24, 2013. |
| (9) | Includes 27,500 shares of DSS Common Stock issuable upon the exercise of stock options exercisable within 60 days of April 24, 2013. |
| (10) | Includes 5,000 shares of Common stock issuable upon the exercise of stock options exercisable within 60 days of April 24, 2013. |
| (11) | Includes an aggregate of 589,168 shares of Common Stock subject to options currently exercisable or exercisable within 60 days of April 24, 2013. |
SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE AND RELATED PERSON TRANSACTIONS
Section 16(a) Beneficial Ownership Reporting Compliance
Section 16(a) of the Exchange Act requires our executive officers and directors, and persons who beneficially own more than ten percent of our equity securities (“Reporting Persons”) to file reports of ownership and changes in ownership with the Securities and Exchange Commission. Based solely on our review of copies of such reports and representations from the Reporting Persons, we believe that during the fiscal year ended December 31, 2012, all Reporting Persons were in compliance with the applicable requirements of Section 16(a) of the Exchange Act.
ITEM 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
Transactions with Related Persons
On June 29, 2011, the Company used proceeds received from a commercial term note entered into with lender Neil Neuman to pay in full all sums owed under a credit agreement (“Original Agreement”) previously entered intodated January 4, 2008, between the Company and FletcherFagenson & Co., Inc. (“Fagenson & Co.”), as agent for certain lenders. The Fagenson & Co. credit agreement was terminated in its entirety 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,June 29, 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 have down-round and anti-dilution provisions as of December 31, 2010, and are 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 haveCompany has no further obligations thereunder. Director Robert Fagenson was 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 sharesprincipal 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 is given to the Company prior to July 2, 2011 of Fletcher’s intention to make Later Investments. 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 entitles 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 have a cashless exercise provision.
In connection with the Amended Agreement, the Company was required to file a registration statement with the SEC covering the Initial Investment of 756,287 shares and 799,256 shares underlying the Initial Warrant, and to have such registration statement declared effective no later than April 15, 2011. The Company filed Amendment No. 1 to S-3 Registration Statement with the SEC on March 7, 2011 in accordance with the requirements of the Amended Agreement. If Fletcher makes any Later Investment purchases of the Company’s Common Stock, the Company would have similar registration requirements. In the event that any registration statement is not timely filed or declared effective, or is not kept effective and available in accordance with the Amended Agreement, the Company will be obligated to pay certain amounts to Fletcher as set forth in the Amended Agreement.
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. The Company filed Amendment No. 2 to S-3 Registration Statement with the SEC on March 25, 2011.
Certain events, such as dividends, stock splits, and other events specified in the Amended Agreement and in the Warrants may result 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 will be used primarily for sales and marketing, product development, and working capital. The Company will pay WM SmithFagenson & 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. As of December 31, 2010, the Company accrued $240,000 for placement agent fees paid in January 2011.
Derivative Liabilities
The warrants issued to Fletcher have down-round and anti-dilution provisions as of December 31, 2010, and are 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. The Company recognizes the derivative liabilities at their respective fair values at inception and on each reporting date. The derivative liabilities are considered Level 3 liabilities on the fair value hierarchy as the determination of fair value includes various assumptions about our 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 liabilities were initially recorded in the consolidated balance sheet upon issuance as of December 31, 2010 at a fair value of $3,866,836. 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.
The components of the derivative liability, measured at fair value, are summarized as follows at December 31:
| | | 2010 | |
| | | | | |
| Initial Warrant | | $ | 3,482,486 | |
| Later Investment Rights | | | 384,350 | |
| | | $ | 3,866,836 | |
The table below provides a reconciliation of the beginning and ending balances for the liabilities measured at fair value using significant unobservable inputs (Level 3). There were no assets as of or during the year ended December 31, 2010 measured using significant unobservable inputs.
Fair Value Measurements Using Significant Unobservable Inputs (Level 3):
| | | Derivative Liabilities | |
| | | | |
| Balance, January 1, 2010 | | $ | - | |
| Fair Value upon issuance: | | | | |
| Expensed at issuance | | | - | |
| Allocated to net proceeds | | | 3,866,836 | |
| Balance, December 31, 2010 | | $ | 3,866,836 | |
Stock Warrants - During 2010, in conjunction with the private placements described above, the Company issued an aggregate of 922,009 warrants to purchase the Company’s shares of common stock at exercise prices ranging from $3.50 to $5.38, as described above. In addition, in connection with the Fletcher Investment (as described above), the Company issued a contingent warrant for the purchase of up to the amount of the Later Investment of the Company’s common stock at a price contingent on the purchse price of the Later Investment, but not less than $5.71 per share. In addition, during 2010, the Company issued to the holders of a Convertible Note warrants to purchase up to 40,000 shares of the Company’s common stock within five years at $2.00 per share as compensation for a registration rights penalty.
During 2009, in conjunction with the private placements described above, the Company issued an aggregate of 202,000 warrants to purchase the Company’s shares of common stock at an exercise price of $2.00, as described above. In addition, during 2009, the Company issued to the holders of a Convertible Note warrants to purchase up to 65,000 shares of the Company’s common stock within five years at $2.00 per share. On October 21, 2009,August 22, 2011, the Company entered into a consulting agreement with Vertical Innovations and agreed to issue the consultant five year warrants to purchase 50,000 sharesAlan Harrison, a member of the Company's common stock at $3.00, 100,000 sharesCompany’s Board of common stock at $3.50 and 50,000 sharesDirectors, for consulting services with respect to Secuprint Inc., a wholly-owned subsidiary of common stock at $4.00. The Company estimated the valueCompany. Mr. Harrison received a consulting fee of these warrants at approximately $258,000 as$9,000 per month during the term of the agreement which expired on December 31, 2009 using the Black-Scholes option pricing model which the Company expects to record the measurement date fair value as expense over2011.
On August 30, 2011, Premier Packaging Corporation (“PPC”), a two year period. On November 19, 2009,wholly-owned subsidiary of the Company, entered into ana purchase and sale agreement with Baum CapitalBzdick Properties, LLC, a New York limited liability company (“Bzdick Properties”), to purchase commercial real property in Victor, New York, for which Baum Capital would execute up to an aggregate amount of $275,000 of Letters of Credit on behalf of the Company’s subsidiary, DPI, for the extension of credit$1.5 million. The purchase price included a $150,000 subordinated promissory note from certain of DPI’s paper vendors. In exchange, the Company issued to Baum Capital warrantsBzdick Properties. Prior to purchase 50,000 shares of the Company's common stock at $2.00. The Company valued these warrants at approximately $56,000 using the Black-Scholes option pricing model which the Company expects to record as expense over a one year period. On December 7, 2009, the Company reached an agreement to issue 40,000 shares of common stock and 50,000 of common stock warrants for the purchase, and since February 2010, PPC leased the property from Bzdick Properties under a lease at a rate of common shares$13,333 per month. The promissory note to Bzdick Properties accrued interest at $3.00a rate of 9.5% per share forannum and matured on March 31, 2012, at which time the promissory note was paid-off in full, and Bzdick Properties was paid $150,000. Robert Bzdick, who serves as both a perioddirector of three years from November 23, 2009, in connection with the settlement of certain litigation between the Company and the recipients. The valueas our Chief Operating Officer, is a member of the stock amounted to $85,000 based on the closing price the day the agreement was reached. The fair value of the warrants of approximately $29,500 was determined utilizing the Black Scholes pricing model. The aggregate cost of approximately $115,000 is recognized in the statement of operations under Litigation Settlements. During 2009, Bzdick Properties, LLC.
On February 20, 2012, the Company recorded expense of approximately $110,000and ipCapital Group, Inc., a Delaware corporation (“ipCapital”), entered into an engagement letter (the “ipCapital Agreement”) for the fair valueprovision of 40,000 warrants to purchase the shares of the Company’s common stock at $2.00 issuable to Printer’s LLC as a result of the Company’s failure to file a registration statement under the terms of the $450,000 Convertible Note the Company entered into in December 2009.
The following is a summary with respect to warrants outstanding and exercisable at December 31, 2010 and 2009 and activity during the years then ended:
| | | | 2010 | | | | 2009 | |
| | | | Warrants | | | | Price | | | | Warrants | | | | Price | |
| Outstanding January 1 | | | 1,318,020 | | | $ | 6.15 | | | | 761,032 | | | $ | 8.73 | |
| Granted during the year | | | 962,009 | | | | 5.02 | | | | 556,988 | | | | 2.63 | |
| Exercised | | | (363,398 | ) | | | (2.16 | ) | | | - | | | | - | |
| Lapsed | | | (25,000 | ) | | | (12.59 | ) | | | - | | | | - | |
| | | | | | | | | | | | | | | | | |
| Outstanding at December 31 | | | 1,891,631 | | | $ | 6.26 | | | | 1,318,020 | | | $ | 6.15 | |
| Exercisable at December 31 | | | 1,891,631 | | | $ | 6.26 | | | | 1,118,020 | | | $ | 6.63 | |
| Weighted average months remaining | | | | | | | | | | | | | | | | |
| | | | | | | | 44.2 | | | | | | | | 43.0 | |
Stock Options - The Company has two stock-based compensation plans. The 2004 Employees’ Stock Option Plan (the “2004 Plan”) provides for the issuance of up to a total of 1,700,000 shares of common stock authorized to be issued for grants of options, restricted stock and other forms of equity to employees and consultants.certain IP strategic consulting services by ipCapital. Under the terms of the 2004 Plan, options granted thereunder may be designated as options which qualifyipCapital Agreement, fees payable for incentive stock option treatment (“ISOs”)consulting services would range from $240,000 to $365,000 for the 2012 calendar year. In 2012, actual fees paid to ipCapital under Section 422Athe ipCapital Agreement totaled $325,000. In addition to cash fees, the Company issued ipCapital a five-year warrant to purchase up to 100,000 shares of the Internal Revenue Code, or options which do not qualify (“NQSOs”). TheCompany’s Common Stock at an exercise price of $4.62 per share. Also, on February 20, 2012, the Company entered into a three-year consulting arrangement with ipCapital for options granted understrategic advice on the Director Plan is 100%development of the fair market valueCompany’s digital group infrastructure and cloud computing business strategy and issued ipCapital a five-year warrant to purchase up to 200,000 shares of the Company’s Common Stock at an exercise price of $4.50 per share in consideration therefor. The warrants vest and become exercisable as to one-third of the shares subject to the warrants on the first, second and third anniversary of the date of grant. The Non-Executive Director Stock Option Plan (the “Director Plan”) provides for the issuance of up toissuance. John Cronin, a total of 200,000 shares of common stock authorized to be issued for options grants for non-executive directors and advisors. Under the termsdirector of the Company, is Chairman, Managing Director Plan, an option to purchase (a) 5,000 sharesand a 42% owner of our common stock shall be granted to each non-executive director upon joiningipCapital.Effective on December 1, 2012, the Board of Directors and (b) 5,000 shares of our common stock plus an additional 1,000 shares of our common stock for each year thatCompany entered into a consulting agreement with Patrick White, the applicable director has served onCompany’s former CEO. White will provide consulting services as requested by the Board of Directors,Company, up to a maximum of 10,000 shares60 hours per year shallmonth. Under the consulting agreement, White will be granted to each non-executive directorpaid the sum of $14,167 per month from December 1, 2012 through February 28, 2014 and, thereafter, on January 2ndwill be paid the sum of each year; provided that any non-executive director who has not served as a director$11,667 per month for the entire year immediately prior to January 2nd shall receive a pro rata numberremaining 12 months of options basedthe consulting agreement term.
Director Independence
The Company has determined that each of the following directors, Messrs. O’Brien, Fagenson, Greenstein, Cronin and Klein, qualify as independent directors (as defined under Section 803 of the NYSE MKT LLC Company Guide). Each of Timothy Ashman and Alan Harrison, whose directorship terms expired on June 14, 2012, were also independent directors (as defined under Section 803 of the timeNYSE MKT LLC Company Guide).
ITEM 14 - PRINCIPAL ACCOUNTING FEES AND SERVICES
Audit Fees
Audit fees consist of fees for professional services rendered for the director has servedaudit of the Company’s consolidated financial statements included in such capacity during the previous year. Both Plans were adoptedCompany’s Annual Report on Form 10-K, the review of financial statements included in the Company’s Quarterly Reports on Form 10-Q, and for services that are normally provided by the Company’s shareholders.
auditor in connection with statutory and regulatory filings or engagements. The
following is a summary with respect to options outstanding ataggregate fees billed for professional services rendered by our principal accountant, Freed Maxick CPAs, P.C., for audit and review services for the fiscal years ended December 31,
20102012 and
20092011 were $148,850 and
activity during$155,000, respectively. Audit Related Fees
The aggregate fees billed for other related services by our principal accountant, Freed Maxick CPAs, P.C., pertaining to registration statements and consultation on financial accounting or reporting standards for the years then ended:
| | | 2004 Employee Plan | | | Non-Executive Director Plan | |
| | | | | | | | | | | | | | | | | | | |
| | | Number of Options | | | Weighted Average Exercise Price | | | Weighted Average Life Remaining | | | Number of Options | | | Weighted Average Exercise Price | | | Weighted Average Life Remaining | |
| | | | | | | | | (in years) | | | | | | | | | (in years) | |
| Outstanding at December 31, 2008 | | | 663,500 | | | | 7.27 | | | | | | | 115,750 | | | $ | 7.99 | | | | |
| Granted | | | 274,000 | | | | 4.00 | | | | | | | 40,000 | | | | 1.86 | | | | |
| Exercised | | | - | | | | - | | | | | | | - | | | | - | | | | |
| Forfeited | | | (298,500 | ) | | | (6.37 | ) | | | | | | (23,750 | ) | | | (4.59 | ) | | | |
| Outstanding at December 31, 2009: | | | 639,000 | | | | 6.29 | | | | | | | 132,000 | | | | 6.74 | | | | |
| Granted | | | 185,000 | | | | 3.40 | | | | | | | 40,000 | | | | 2.45 | | | | |
| Exercised | | | - | | | | - | | | | | | | - | | | | - | | | | |
| Forfeited | | | (150,500 | ) | | | 5.54 | | | | | | | (15,000 | ) | | | (7.14 | ) | | | |
| Outstanding at December 31, 2010: | | | 673,500 | | | | 5.66 | | | | 2.6 | | | | 157,000 | | | | 5.61 | | | | 2.4 | |
| Exercisable at December 31, 2010: | | | 329,850 | | | | 7.64 | | | | 1.4 | | | | 117,000 | | | | 6.69 | | | | 1.8 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Aggregate Intrinsic Value of outstanding options at December 31, 2010 | | $ | 631,225 | | | | | | | | | | | $ | 258,800 | | | | | | | | | |
| Aggregate Intrinsic Value of exercisable options at December 31, 2010 | | $ | 116,969 | | | | | | | | | | | $ | 141,200 | | | | | | | | | |
ended December 31, 2012 and 2011 were $58,925 and $22,000, respectively.Tax Fees
The weighted-average grant date fair value of options grantedaggregate fees billed for professional services rendered by our principal accountant, Freed Maxick CPAs, P.C., for tax compliance, tax advice and tax planning during the year ended December 31, 20102012 was $1.38 ($0.53 -2009). The aggregate grant date fair value of options that vested during the year was approximately $128,000.$14,500. There were no options exercisedfees billed for professional services rendered by our principal accountant, Freed Maxick CPAs, P.C., for tax compliance, tax advice and tax planning during the year ended December 31, 2010 or 2009.
The fair value of each option award is estimated on the date of grant utilizing the Black Scholes Option Pricing Model that uses the assumptions noted in the following table.
| | 2010 | 2009 |
| | | |
| Volatility | 54.3 | % | 54.7 | % |
| Expected option term | 3.8 | years | 3.9 | years |
| Risk-free interest rate | 2.5 | % | 2.3 | % |
| Expected forfeiture rate | 0.0 | % | 0.0 | % |
| Expected dividend yield | 0.0 | % | 0.0 | % |
Restricted Stock Issued to Employees – Restricted common stock is issued under the 2004 Plan2011.All Other Fees
There were no fees billed for professional services to be rendered and may not be sold, transferred or pledged for such period as determined by our Compensation Committee. Restricted stock compensation cost is measured as the stock’s fair value based on the quoted market price at the date of grant. The restricted shares issued reduce the amount available under the employee stock option plans. Compensation cost is recognized only on restricted shares that will ultimately vest. The Company estimates the number of shares that will ultimately vest at each grant date based on historical experience and adjust compensation cost and the carrying amount of unearned compensation based on changes in those estimates over time. Restricted stock compensation cost is recognized ratably over the requisite service period which approximates the vesting period. An employee may not sell or otherwise transfer unvested shares and, in the event that employment is terminated prior to the end of the vesting period, any unvested shares are surrendered to us. We have no obligation to repurchase any restricted stock.
The following is a summary of activity of restricted stockprincipal accountant, Freed Maxick CPAs, P.C., for other related services during the years ended at December 31, 2010 and 2009:
| | | | Shares | | | | Weighted-average Grant Date Fair Value | |
| Restricted shares outstanding, December 31, 2008 | | | 327,781 | | | $ | 9.05 | |
| Restricted shares granted | | | - | | | | - | |
| Restricted shares vested | | | (30,281 | ) | | | (6.77 | ) |
| Restricted shares forfeited | | | (212,500 | ) | | | (10.05 | ) |
| Restricted shares outstanding, December 31, 2009 | | | 85,000 | | | $ | 7.61 | |
| Restricted shares granted | | | - | | | | - | |
| Restricted shares vested | | | - | | | | - | |
| Restricted shares forfeited | | | (40,000 | ) | | | (2.10 | ) |
| Restricted shares outstanding, December 31, 2010 | | | 45,000 | | | $ | 12.50 | |
As of December 31, 2010, there are 45,000 restricted shares that will vest only upon the occurrence of certain through May 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 $562,500, the grant date fair value, over the period beginning when any of the contingent vesting events is deemed to be probable over the expected requisite service period. As of December 31, 2010, vesting is not considered probable and no compensation expense has been recognized related to the performance grants.
Stock-Based Compensation –Stock-based compensation includes expense charges for all stock-based awards to employees, directors and consultants. Such awards include option grants, warrant grants, and restricted stock awards. During the year ended December 31, 2010, the Company had stock compensation expense of approximately $423,000 or $0.02 per share ($292,000- 2009; $0.02 per share). As of December 31, 2010, there was approximately $368,000 of total unrecognized compensation costs (excluding the $562,500 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.
NOTE 8. –DECONSOLIDATION OF LEGALSTORE DIVISION
On October 8, 2009, the Company entered into an Asset Purchase Agreement with Internet Media Services whereby the Company sold the assets and liabilities of Legalstore, a division of the Company with assets of approximately $252,000 and liabilities of $13,000, in exchange for 7,500,000 shares of common stock of Internet Media Services. The Company recorded its investment in Internet Media Services as an equity method investment at the fair market value of the business sold. Management determined that the transaction did not qualify as a non-monetary exchange due to the exception noted in FASB ASC 845-10 ( [ A transfer of assets to an entity in exchange for an equity interest in that entity). Management determined that the transaction qualified as a derecoginition of a subsidiary under FASB ASC 810-10-40. Therefore, the Company accounted for the deconsolidation of a subsidiary (“the business”) by recording the consideration received at fair market value and recognizing a gain in net income measured as the difference between: the fair value of the consideration received (7,500,000 shares of common stock of Internet Media Services or a 37% interest) and the carrying value of the assets and liabilities sold. Given that the consideration received is not readily measurable because of the lack of activity in Internet Media Services shares prior to the transaction, the Company determined that the value of the “business transferred” is more readily measurable by determining the fair market value of the business transferred based on a discounted cash flow model amounted to $350,000, which resulted in a gain of approximately $26,000 which is included in the consolidated statement of operations. The Company recorded the equity method investment at fair value. Under the equity method investment the Company was 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 FASB ASC 350 is initially applied by the entity in its entirety. The Company determined that given the lack of activity in Internet Media Services shares prior to the transaction, the difference between the cost of the investment (fair market value) and the underlying equity interest is attributable to goodwill. The Company is continuing to report the activity in operating loss and not breaking out and reporting it as discontinued operations because the operations and cash flows of the component have not been eliminated from the ongoing operations of the entity as a result of the equity method investment and because the Company had significant continuing involvement in the operations of Internet Media Services after the disposal transaction because of the ownership percentage and board representation. The Company recognized gains or losses on its investment under the equity method of accounting for investments. During 2010, the Company recorded a cumulative loss in its investment of $121,000. On September 23, 2010, the Company’s Board of Directors declared a dividend whereas the Company would distribute to its stockholders of record on October 8, 2010 on a pro-rata basis its shares of stock in Internet Media Services. As a result, the Company has recorded a dividend of approximately $229,000 which was the book value of the investment as of September 23, 2010.NOTE 9. –BUSINESS COMBINATIONS (as Restated)
On February 12, 2010, the Company acquired all of the outstanding common stock of Premier Packaging 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. In addition, the purchase price was 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, which did not occur. In addition, the seller had registration rights for its shares to which the Company was subject to registration penalties of up to $5,000 per month after 120 days, which the sellers waived
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. Management determined that the fair value of the assets acquired and liabilities assumed was less than the purchase price resulting in the recording of goodwill. Goodwill totaling approximately $1,768,000 represents the excess of the purchase price over the fair value of tangible and identifiable intangible assets acquired, which included $861,000 for customer relationships and $511,000 for non-compete agreement, and is due primarily to expected increased market penetration from future products in the secure packaging market s and synergies expected from combining packaging capabilities of Premier Packaging with the printing capabilities of the Company’s DPI division. The Company recognized an approximate $1,141,000 deferred tax liability along with additional goodwill as a result of the acquisition, due to the temporary differences between the book fair value and the net tax basis relating to the equipment and other intangibles acquired. The goodwill recorded with the transaction is not deductible for income taxes.
The Company 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 | | | 1,768,400 | | |
| Total Assets | | $ | 6,491,579 | | |
| | | | | | |
| Liabilities assumed: | | | | | |
| Accounts payable | | $ | 448,128 | | |
| Revolving credit lines | | | 277,645 | | |
| Deferred tax liability | | | 1,141,040 | | |
| Accrued Liabilities | | | 58,091 | | |
| Total Liabilities | | $ | 1,924,904 | | |
| | | | | | |
| 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 had been acquired by the Company as of January 1, 2009.| | | Year Ended December 31, | |
| | | | |
| (unaudited) | | 2010 | | | 2009 | |
| | | (As Restated) | | | | |
| | | | | | | |
| Revenue | | | 14,265,949 | | | | 17,011,427 | |
| Operating Loss | | | (3,961,963 | ) | | | (3,170,288 | ) |
| Net Loss | | | (3,530,487 | ) | | | (3,526,173 | ) |
| Basic and diluted loss per share | | | (0.20 | ) | | | (0.24 | ) |
Since the acquisition, Premier Packaging had sales of $5,753,000 and profit of $54,000.
NOTE 10. – OTHER INCOME
The Company received $143,000 during 2010 and $416,000 during 2009 for New York State Qualified Emerging Technology Company (“QETC”) refundable tax credits for the tax years ended 2008, 2007, 2006, and 2005.
NOTE 11. - INCOME TAXES (As Restated)
Following is a summary of the components giving rise to the income tax provision (benefit) for the years ended December 31:
| The provision (benefit) for income taxes consists of the following: | | | | |
| | | | | | | |
| | | 2010 | | | 2009 | |
| | | (As Restated) | | | | |
| Currently payable: | | | | | | |
| Federal | | $ | - | | | $ | - | |
| State | | | - | | | | - | |
| Total currently payable | | | - | | | | - | |
| Deferred: | | | | | | | | |
| Federal | | | (1,150,430 | ) | | | (1,113,695 | ) |
| State | | | (274,396 | ) | | | (265,310 | ) |
| Total deferred | | | (1,424,826 | ) | | | (1,379,005 | ) |
| Less increase in allowance | | | 302,735 | | | | 1,397,957 | |
| Net deferred | | | (1,122,091 | ) | | | 18,952 | |
| Total income tax provision (benefit) | | $ | (1,122,091 | ) | | $ | 18,952 | |
| Individual components of deferred taxes are as follows: | | | | | | | | |
| | | | | | | | | |
| Deferred tax assets: | | | 2010 | | | | 2009 | |
| Net operating loss carry forwards | | $ | 11,909,891 | | | $ | 10,330,310 | |
| Equity issued for services | | | 801,204 | | | | 1,006,186 | |
| Other | | | 138,291 | | | | 425,619 | |
| Total | | | 12,849,386 | | | | 11,762,115 | |
| Less valuation allowance | | | (11,903,718 | ) | | | (11,600,983 | ) |
| Gross deferred tax assets | | $ | 945,668 | | | $ | 161,132 | |
| | | | | | | | | |
| Deferred tax liabilities: | | | | | | | | |
| Goodwill | | $ | 87,452 | | | $ | 69,665 | |
| Depreciation and amortization | | | 947,995 | | | | 162,297 | |
| Gross deferred tax liabilities | | $ | 1,035,447 | | | $ | 231,962 | |
| | | | | | | | | |
| Net deferred tax liabilities | | $ | (89,779 | ) | | $ | (70,830 | ) |
During 2010, the Company acquired the stock of Premier Packaging. As part of the business combination, various intangible assets and equipment with fair market values of $1, 372,000 and $1,557,500, respectively, were recorded along with a deferred tax liability of approximately $1,141,000, since none of the values assigned to the equipment and other intangible assets, in excess of their tax values at the data of the acquisition, will be deductible for income tax purposes.
The Company has approximately $32,114,000 in net operating loss carryforwards (“NOL’s”) available to reduce future taxable income, of which approximately $1,412,000 is subject to change of control limitations that generally restricts the utilization of the NOL per year and $1,855,000 of the NOL will be allocated to contributed capital when subsequently realized. Due to the uncertainty as to the Company’s ability to generate sufficient taxable income in the future and utilize the NOL’s before they expire, the Company has recorded a valuation allowance accordingly. The excess tax benefits associated with stock option exercises are recorded directly to stockholders’ equity only when realized. As a result, the excess tax benefits included in net operating loss carryforwards but not reflected in deferred tax assets was approximately $1,019,000. These carryforwards expire at various dates from 2022 through 2030. In addition, a portion of the valuation allowance amounting to approximately $318,000 will be recorded as a reduction to additional paid in capital in the event that it is determined that a valuation allowance is no longer considered necessary.
The differences between the United States statutory federal income tax rate and the effective income tax rate in the accompanying consolidated statements of operations are as follows:
| | | | 2010 | | | | 2009 | |
| | | | | | | | | |
| Statutory United States federal rate | | | 34 | % | | | 34 | % |
| State income taxes net of federal benefit | | | 4.0 | | | | 4.4 | |
| Permanent differences | | | (6.5 | ) | | | (3.8 | ) |
| Change in valuation reserves | | | (7.1 | ) | | | (35.1 | ) |
| | | | | | | | | |
| | | | | | | | | |
| Effective tax rate | | | 24.4 | % | | | (0.5 | )% |
At December 31, 2010 and 2009, the total unrecognized tax benefits of $446,000 have been netted against the related deferred tax assets.
The Company recognizes interest accrued and penalties related to unrecognized tax benefits in tax expense. During the years ended December 31,
20102012 and
20092011.Administration of the Company recognized no interestEngagement; Pre-Approval of Audit and penalties.
Permissible Non-Audit ServicesThe Company files incomeCompany's Audit Committee Charter requires that the Audit Committee establish policies and procedures for pre-approval of all audit or permissible non-audit services provided by the Company’s independent auditors. Our Audit Committee, approved, in advance, all work performed by our principal accountant, Freed Maxick CPAs, P.C. These services may include audit services, audit-related services, tax returnsservices and other services. The Audit Committee may establish, either on an ongoing or case-by-case basis, pre-approval policies and procedures providing for delegated authority to approve the engagement of the independent registered public accounting firm, provided that the policies and procedures are detailed as to the particular services to be provided, the Audit Committee is informed about each service, and the policies and procedures do not result in the U.S. federal jurisdiction and various states. The tax years 2007-2010 generally remain open to examination by major taxing jurisdictions to which the Company is subject.
NOTE 12. - DEFINED CONTRIBUTION PENSION PLAN
The Company has an Employee savings plan (the “401(k) Plan”) which qualifies as a deferred salary arrangement under Section 401(k)delegation of the Internal Revenue Code which covers its employees at its Document Security Systems, P3 and DPI subsidiaries. Employees become eligibleAudit Committee's authority to participate inmanagement. In accordance with these procedures, the Plan at the beginningAudit Committee pre-approved all services performed by Freed Maxick CPAs, P.C. The percentage of the following quarter after the employee’s hire date. Employees may contribute uphours expended on Freed Maxick CPAs, P.C.’s engagement to 20% of their pay to the Plan, subject to the limitations of the Internal Revenue Code. Company matching contributions are discretionary. Pursuant to the 401(k) Plan, employees may elect to defer a portion of their salary on a pre-tax basis. During the years ended December 31, 2010 and 2009, the Company did not make any matching contributions. In addition, the Company’s subsidiary, Premier Packaging, which the Company acquired in February 2010, has a 401(k) Plan which allows for employee salary deferrals with Premier Packaging matching benefits of up to 3% of the employee’s salary. The matching contribution for 2010 was approximately $25,000.
NOTE 13. – COMMITMENTS AND CONTINGENCIES
Facilities - The Company leases a total of approximately 95,000 square feet of office space for its administrative offices and its printing facilities at a monthly rental aggregating approximately $49,000. The leases expire at various dates through February 2020, although renewal options exist to extend lease agreements for up to an additional 60 months. The Company’s lease for its Premier Packaging facility is with the Company’s COO Bob Bzdick, a related party. The total rent expenseaudit our financial statements for the facility lease with Mr. Bzdick during themost recent fiscal year ended December 31, 2010 amounted to approximately $147,000. Future minimum lease commitments under the facility lease with Mr. Bzdick subsequent to December 31, 2010 are approximately $160,000 per year for the next five years and $735,000 thereafter.
Equipment Leases - The Company leases digital and offset presses, laminating and finishing equipment for its various printing operations. The leases may be capital leases or operating leases and are generally for a term of 36 to 60 months. The leases expire through March 2016.
A summary of lease commitments, including related party lease to Mr. Bzdick, at December 31, 2010 are as follows:
| | | | | | Operating Leases | |
| | | Capital Leases | | | Equipment | | | Facilities | | | Total | |
| | | | | | | | | | | | | |
| Payments made in 2010 | | $ | 107,052 | | | $ | 662,701 | | | $ | 568,115 | | | $ | 1,230,816 | |
| Future minimum lease commitments: | | | | | | | | | | | | | | | | |
| 2011 | | | 107,052 | | | | 625,218 | | | | 627,639 | | | | 1,252,857 | |
| 2012 | | | 94,453 | | | | 439,912 | | | | 515,540 | | | | 955,452 | |
| 2013 | | | 5,665 | | | | 296,284 | | | | 525,366 | | | | 821,650 | |
| 2014 | | | - | | | | 245,100 | | | | 313,898 | | | | 558,998 | |
| 2015 | | | - | | | | 228,300 | | | | 178,333 | | | | 406,633 | |
| Thereafter | | | - | | | | 54,450 | | | | 735,000 | | | | 789,450 | |
| Total future minimum lease commitments | | $ | 207,170 | | | $ | 1,889,264 | | | $ | 2,895,776 | | | $ | 4,785,040 | |
| | | | | | | | | | | | | | | | | |
| Less amount representing interest | | | (19,862 | ) | | | | | | | | | | | | |
| Present value of future minimum lease | | | | | | | | | | | | | | | | |
| commitments | | | 187,308 | | | | | | | | | | | | | |
| Less current portion | | | (88,776 | ) | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | |
| Long term portion | | $ | 98,532 | | | | | | | | | | | | | |
Employment agreements - The Company has employment agreements with four members of its management team with terms ranging from one to 10 years through February 2020. The agreements provide for severance payments in the event of termination for certain causes.As of December 31, 2010, the minimum annual severance payments under these employment agreements are, in aggregate, approximately $1,098,000.
In May 2008, the Company entered into a Separation Agreement with its former President that, among other things, accelerated the vesting of 33,333 shares of restricted common stock of the Company that were previously awardedattributed 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 December 31, 2010, there is no remaining amount due under the agreement. ($74,000 -2009)
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 ownedwork performed by the Wicker Family. For infringement matters involving certain U.S. patents, the Company will be required to disburse 30% of the settlement proceeds. For infringement matters involving certain foreign patents, the Company will be required to disburse 14% of the settlement proceeds. These payments do not apply to licenses or royalties to patents that the Company has developed or obtained from persons other than the Wicker Family. As of December 31, 2010, there have been no settlement amounts related to these agreements.
Legal Proceedings -On August 1, 2005, the Company commenced a suit against the 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 has not been initiated, the Company will accrue as soon as the assessed amount, if any, is reasonably estimable.
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 Patentprincipal accountant's full-time, permanent employees 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 all was paid as of December 31, 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, and the Company was notified on December 21, 2010 that the patent was deemed invalid upon appeal. 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. 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 expected during 2011 and a hearing in Luxembourg thereafter.
On August 20, 2008, the Company entered into an agreement with 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 one jurisdiction (Spain) that uses the Euro as its national currency allowing the Company or Trebuchet, on the Company’s behalf, to proceed with infringement cases in this country if we choose to do so. On February 18, 2010, Trebuchet, on behalf of the Company, filed an infringement suit in the Netherlands. The suit was 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. and was cancelled upon determination on Dcember 21, 2010, that the patent was invalid in the Netherlands.
On January 31, 2003, the Company commenced an action, unrelated to the above ECB litigation, entitled New Sky Communications, Inc., As Successor-In-Interest To Thomas M. Wicker, Thomas M.Wicker Enterprises, Inc. and Document Security Consultants V. Adler Technologies, Inc. N/K/A Adlertech International, Inc. and Andrew McTaggert (United States District Court, Western District Of New York Case No.03-Cv-6044t(F)) regarding certain intellectual property in which the Company has an interest. On December 7, 2009, the Company reached an agreement to terminate all litigation in association with this suit. In conjunction with that agreement, the Company issued to the opposing parties an aggregate of 40,000 shares of common stock valued at approximately $85,000 and 50,000 of common stock warrants for the purchase of common shares at $3.00 per share valued at approximately $30,000 utilizing the Black Scholes pricing model. The Company recorded an expense related to the estimated grant date fair value of the shares and warrants issued of approximately $115,000. In addition, both parties agreed not to compete with certain of the other party’s customers for 7 years. The Company does not believe that the competition agreement will have a material impact on its business.
In addition to the foregoing, we are subject to other legal proceedings that have arisen in the ordinary course of business and have not been finally adjudicated. Although there can be no assurance in this regard, in the opinion of management, none of the legal proceedings to which we are a party, whether discussed herein or otherwise, will have a material adverse effect on our results of operations, cash flows or our financial condition.
NOTE 14. - SUPPLEMENTAL CASH FLOW INFORMATION
| | | 2010 | | | 2009 | |
| | | | | | | |
| Cash paid for interest | | $ | 302,000 | | | $ | 157,000 | |
| | | | | | | | | |
| Non-cash investing and financing activities: | | | | | | | | |
| Conversion of debt to equity | | | 800,000 | | | | 2,000,000 | |
| Equity issued for severance agreements | | | 74,000 | | | | 55,000 | |
| Non-monetary dividend | | | 229,000 | | | | - | |
| Equity issued for acqusition | | | 2,567,000 | | | | - | |
| Equity issued for prepaid services | | | 115,000 | | | | 56,000 | |
| Accrued placement agent fees | | | 240,000 | | | | - | |
| Issuance of derivative liability instruments | | | 3,867,000 | | | | - | |
| Interest rate swap loss | | | 26,000 | | | | - | |
| Equipment purchased via capital lease | | | - | | | | 63,000 | |
| Warrants issued with debt | | | - | | | | 72,000 | |
| Beneficial conversion features of convertible debt | | | - | | | | 351,000 | |
| Equity method investment received in exchange for the assets and liabilities of Legalstore.com | | | - | | | | 350,000 | |
NOTE 15. - SEGMENT INFORMATION (as Restated)
The Company's businesses are organized, managed and internally reported as four operating segments. Three of these operating segments, Document Security Systems, P3 and DPI, 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 FASB ASC 280. The fourth operating segment is engaged in the production of packaging products and is classified as a separate segment. A summary of the three segments follows:
0%.
PART IV
ITEM 15 – EXHIBITS, FINANCIAL STATEMENT SCHEDULES
Exhibits:
Security and Commercial Printing31.1 | | License, manufacture and saleRule 13a-14(a)/15d-14(a) Certification of patented document security technologies, including digital security print solutions, and general commercial printing, primarily on paper and plastic,comprisesChief Executive Officer.* |
| 31.2 | | Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer.* |
| 32.1 | | Certification of Chief Executive Officer pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the operationsSarbanes-Oxley Act of Document Security Systems, P3 and DPI.2002.* |
| 32.2 | | Certification of Chief Financial Officer pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.* |
| | | |
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. During the fourth quarter of 2009, the Company sold its legal products business to Internet Media Services in exchange for Internet Media Services common stock. |
Approximate information concerning the Company’s operations by reportable segment as of and for the years ended December 31, 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:
| 2010 (as Restated) | | Legal Supplies | | | Security and Commercial Printing | | | Packaging Division | | | Corporate | | | Total | |
| | | | | | | | | | | | | | | | |
| Revenues from external customers | | $ | - | | | $ | 7,629,000 | | | $ | 5,753,000 | | | $ | - | | | $ | 13,382,000 | |
| Interest Expense and amortization of note discount | | | - | | | | 34,000 | | | | 78,000 | | | | 598,000 | | | | 710,000 | |
| Stock based payments | | | - | | | | - | | | | - | | | | 115,000 | | | | 115,000 | |
| Impairment of patent acquisition costs and other intangible assets | | | - | | | | 377,000 | | | | - | | | | - | | | | 377,000 | |
| Depreciation and amortization | | | - | | | | 955,000 | | | | 299,000 | | | | 7,000 | | | | 1,261,000 | |
| Net (loss) profit | | | - | | | | (2,633,000 | ) | | | 54,000 | | | | (884,000 | ) | | | (3,463,000 | ) |
| Capital Expenditures | | | - | | | | 59,000 | | | | 98,000 | | | | - | | | | 157,000 | |
| Identifiable assets | | | - | | | | 4,357,000 | | | | 6,465,000 | | | | 4,126,000 | | | | 14,948,000 | |
| Revenues from transactions with other operating segments of the Company. | | | - | | | | 326,000 | | | | 110,000 | | | | - | | | | 436,000 | |
| Other income, net | | | - | | | | - | | | | - | | | | 143,000 | | | | 143,000 | |
| Loss on equity investment | | | - | | | | - | | | | - | | | | (121,000 | ) | | | (121,000 | ) |
| Income tax expense (benefit) | | | - | | | | - | | | | - | | | | (1,122,000 | ) | | | (1,122,000 | ) |
| Stock based compensation | | | - | | | | 224,000 | | | | 18,000 | | | | 181,000 | | | | 423,000 | |
| | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | |
| 2009 | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | |
| Revenues from external customers | | $ | 355,000 | | | $ | 9,556,000 | | | $ | - | | | $ | - | | | $ | 9,911,000 | |
| Interest Expense and amortization of note discount | | | - | | | | 363,000 | | | | - | | | | 146,000 | | | | 509,000 | |
| Stock based payments | | | - | | | | - | | | | - | | | | 292,000 | | | | 292,000 | |
| Depreciation and amortization | | | 16,000 | | | | 1,644,000 | | | | - | | | | 2,000 | | | | 1,662,000 | |
| Net (loss) profit | | | 40,000 | | | | (2,353,000 | ) | | | - | | | | (1,400,000 | ) | | | (3,713,000 | ) |
| Capital Expenditures | | | - | | | | 302,000 | | | | - | | | | - | | | | 302,000 | |
| Identifiable assets | | | - | | | | 6,276,000 | | | | - | | | | 439,000 | | | | 6,715,000 | |
| Other income, net | | | - | | | | - | | | | - | | | | 232,000 | | | | 232,000 | |
| Income tax expense (benefit) | | | - | | | | - | | | | - | | | | 19,000 | | | | 19,000 | |
| Stock based compensation | | | - | | | | 73,000 | | | | - | | | | (5,000 | ) | | | 68,000 | |
| | | | | | | | | | | | | | | | | | | | | |
International revenue, which consists of sales to customers with operations in Western Europe, Latin America, Africa, Mddle East and Asia comprised 2% of total revenue for 2010, (3%- 2009). Revenue is allocated to individual countries by customer based on where the product is shipped to, location of services performed or the location of equipment that is under an annual maintenance agreement. The Company had no long-lived assets in any country other than the United States for any period presented.
Major Customers –
During 2010, two customers accounted for 25% and 10% of the Company’s total revenue from continuing operations, respectively. As of December 31, 2010, these customers accounted for 37% and 7% of the Company’s trade accounts receivable balance, respectively. During 2009, two customers accounted for 19% and 12% of the Company’s total revenue from continuing operations, respectively. As of December 31, 2009, two customers’ account receivable balance accounted for 21% and 17% of the Company’s trade accounts receivable balance, respectively. 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.
NOTE 16. – SUBSEQUENT EVENTS
As discussed in Note 7, on February 18, 2011, and subsequently on March 14, 2011, the Company entered into certain amendments with Fletcher for the purpose of modifying the terms of an agreement previously 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 liabilities that existed under the terms of the original agreement no longer exist. As a result, the Company will revalue these derivative liability instruments as of the modification date with the change in fair value reported in the statement of operations. The Company will then reclass the derivative liability to equity. Furthermore, 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.NOTE 17. – RESTATEMENT
The Company has restated the 2010 consolidated financial statements.
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.
The results of the above are summarized in the tables below.
The following table represents the impact of the restatement adjustments on the Company's Condensed Consolidated Balance Sheet as of December 31, 2010
| | | 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 | |
The following table represents the impact of the restatement adjustments on the Company's Condensed Consolidated Statement of Operations for the year ended December 30, 2010
| | | Originally Reported | | | As Adjusted | | | Effect of Change | |
| | | | | | | | | | | | | |
| Revenue | | $ | 13,381,581 | | | $ | 13,381,581 | | | $ | - | |
| Cost of revenue | | $ | 9,696,257 | | | $ | 9,696,257 | | | $ | - | |
| Gross profit | | $ | 3,685,324 | | | $ | 3,685,324 | | | $ | - | |
| Operating expense | | $ | 7,581,461 | | | $ | 7,581,461 | | | $ | - | |
| Operating loss | | $ | (3,896,137 | ) | | $ | (3,896,137 | ) | | $ | - | |
| Other expense | | $ | (688,804 | ) | | $ | (688,804 | ) | | $ | - | |
| Loss before income taxes | | $ | (4,584,941 | ) | | $ | (4,584,941 | ) | | $ | - | |
| Income tax expense (benefit) | | $ | 18,949 | | | $ | (1,122,091 | ) | | $ | (1,141,040 | ) |
| Net Loss | | $ | (4,603,890 | ) | | $ | (3,462,850 | ) | | $ | 1,141,040 | |
| Comprehensive loss | | $ | (4,629,724 | ) | | $ | 3,488,684 | ) | | $ | 1,141,040 | |
| Net Loss per share -basic and diluted | | $ | (0.26 | ) | | $ | (0.20 | ) | | $ | 0.06 | |
The following table represents the impact of the restatement adjustments on the Company's Condensed Consolidated Statement of Cash Flows for the year ended December 30, 2010
| | | Originally Reported | | | As Adjusted | | | Effect of Change | |
| | | | | | | | | | | | | |
| Net Loss | | $ | (4,603,890 | ) | | $ | (3,462,850 | ) | | $ | 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 | | $ | (1,759,253 | ) | | $ | (1,759,253 | ) | | $ | - | |
| Net cash used by investing activities | | $ | (2,427,151 | ) | | $ | (2,427,151 | ) | | $ | - | |
| Net cash provided by financing activities | | $ | 7,824,083 | | | $ | 7,824,083 | | | $ | - | |
| Net decrease in cash | | $ | 3,637,679 | | | $ | 3,637,679 | | | $ | - | |
In addition to the financial statement restatements above, the Company also restated Notes 5, 9, 11 and 15.
