UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

[X]QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended SeptemberJune 30, 20172018

 

[  ]TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from _____________ to _____________.from_______________________ to______________________ .

 

001-32146

 

Commission file number

 

 

 

DOCUMENT SECURITY SYSTEMS, INC.

(Exact name of registrant as specified in its charter)

DOCUMENT SECURITY SYSTEMS, INC.
(Exact name of registrant as specified in its charter)

 

New York 16-1229730

(State or other Jurisdiction of

incorporation- or Organization)

 

(IRS Employer

incorporation- or Organization)

Identification No.)

 

200 Canal View Boulevard, Suite 300
Rochester, NY 14623
(Address of principal executive offices)

 

(585) 325-3610
(Registrant’s telephone number, including area code)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [  ]

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Date File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files) Yes [X] No [  ]

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See definitions of “large accelerated filer”, “accelerated filer”, “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer [  ]   Accelerated filer [  ]    Non-accelerated filer (Do not check if a smaller reporting company) [  ]

Smaller reporting company [X]     emergingEmerging growth company [  ]

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. [  ]

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act)
Yes [  ] No [X]

 

As of NovemberAugust 14, 2017,2018, there were 16,439,32716,813,613 shares of the registrant’s common stock, $0.02 par value, outstanding.

 

 

 

   

 

DOCUMENT SECURITY SYSTEMS, INC.

FORM 10-Q

TABLE OF CONTENTS

 

PART IFINANCIAL INFORMATION2
Item 1Financial Statements32
 Condensed Consolidated Balance Sheets as of SeptemberJune 30, 20172018 (Unaudited) and December 31, 2016201732
 Condensed Consolidated Statements of Operations and Comprehensive LossIncome (Loss) for the three and ninesix months ended SeptemberJune 30, 2018 and 2017 and 2016 (Unaudited)43
 Condensed Consolidated Statements of Cash Flows for the ninesix months ended SeptemberJune 30, 2018 and 2017 and 2016 (Unaudited)54
 Notes to Interim Condensed Consolidated Financial Statements (Unaudited)65
Item 2Management’s Discussion and Analysis of Financial Condition and Results of Operations1720
Item 4Controls and Procedures2225
  
PART IIOTHER INFORMATION2226

Item 1

Legal Proceedings2226
Item 1ARisk Factors2226
Item 2Unregistered Sales of Equity Securities and Use of Proceeds2226
Item 3Defaults upon Senior Securities2326
Item 4Mine Safety Disclosures2326
Item 5Other Information2326
Item 6Exhibits2326
Signatures 2426

2

PART I – FINANCIAL INFORMATION

ITEM 1 - FINANCIAL STATEMENTS

 

DOCUMENT SECURITY SYSTEMS, INC. AND SUBSIDIARIES

Consolidated Balance Sheets

As of

 

  September 30, 2017  December 31, 2016 
  (Unaudited)     
ASSETS        
Current assets:        
Cash $4,223,005  $5,871,738 
Restricted cash  336,172   177,609 
Accounts receivable, net of $50,000 allowance for uncollectible accounts  1,799,005   1,890,981 
Inventory  1,913,111   1,206,377 
Prepaid expenses and other current assets  308,223   350,289 
         
Total current assets  8,579,516   9,496,994 
         
Property, plant and equipment, net  4,484,284   4,573,841 
Investment  484,930   - 
Other assets  45,821   45,821 
Goodwill  2,453,597   2,453,349 
Other intangible assets, net  1,387,039   1,896,018 
         
Total assets $17,435,187  $18,466,023 
         
LIABILITIES AND STOCKHOLDERS’ EQUITY        
         
Current liabilities:        
Accounts payable $1,706,607  $2,212,653 
Accrued expenses and deferred revenue  1,012,719   1,290,593 
Other current liabilities  2,957,033   2,996,310 
Short-term debt  3,611,560   - 
Current portion of long-term debt, net  752,180   1,202,335 
         
Total current liabilities  10,040,099   7,701,891 
         
Long-term debt, net  1,607,752   5,249,569 
Other long-term liabilities  1,624,500   2,184,843 
Deferred tax liability, net  59,830   45,619 
         
Commitments and contingencies (Note 7)        
         
Stockholders’ equity        
Common stock, $.02 par value; 200,000,000 shares authorized, 15,939,327 shares issued and outstanding (13,502,653 on December 31, 2016)  318,787   270,053 
Additional paid-in capital  106,123,997   104,338,002 
Subscriptions receivable from related party  (300,000)  - 
Accumulated other comprehensive loss  (35,551)  (45,343)
Accumulated deficit  (102,004,227)  (101,278,611)
Total stockholders’ equity  4,103,006   3,284,101 
         
Total liabilities and stockholders’ equity $17,435,187  $18,466,023 

See accompanying notes to the condensed consolidated financial statements.

DOCUMENT SECURITY SYSTEMS, INC. AND SUBSIDIARIES

  June 30, 2018  December 31, 2017 
  (unaudited)    
ASSETS        
         
Current assets:        
Cash $3,051,593  $4,188,623 
Restricted cash  141,351   256,005 
Accounts receivable, net of $50,000 allowance for doubtful accounts  1,906,793   2,025,284 
Inventory  1,361,733   1,651,246 
Prepaid expenses and other current assets  289,095   261,324 
         
Total current assets  6,750,565   8,382,482 
         
Property, plant and equipment, net  4,764,223   4,805,640 
Investment  484,930   484,930 
Other assets  83,376   83,376 
Goodwill  2,453,597   2,453,597 
Other intangible assets, net  605,756   1,220,752 
         
Total assets $15,142,447  $17,430,777 
         
LIABILITIES AND STOCKHOLDERS’ EQUITY        
         
Current liabilities:        
Accounts payable $1,032,559  $728,652 
Accrued expenses and deferred revenue  986,486   1,105,718 
Other current liabilities  2,495,967   2,953,629 
Short-term debt  -   3,645,760 
Current portion of long-term debt, net  624,281   966,506 
         
Total current liabilities  5,139,293   9,400,265 
         
Long-term debt, net  1,640,621   1,734,171 
Other long-term liabilities  783,300   1,384,500 
Deferred tax liability, net  125,982   125,982 
         
Commitments and contingencies (Note 8)        
         
Stockholders’ equity        
Common stock, $.02 par value; 200,000,000 shares authorized, 16,599,327 shares issued and outstanding (16,599,327 on December 31, 2017)  331,987   331,987 
Additional paid-in capital  106,707,881   106,633,708 
Subscription receivable, net  -   (300,000)
Accumulated other comprehensive loss  (1,217)  (23,069)
Accumulated deficit  (99,585,400)  (101,856,767)
Total stockholders’ equity  7,453,251   4,785,859 
         
Total liabilities and stockholders’ equity $15,142,447  $17,430,777 

Consolidated Statements of Operations and Comprehensive Loss

(Unaudited)

  For the Three Months Ended September 30,  For the Nine Months Ended September 30, 
  2017  2016  2017  2016 
             
Revenue:                
Printed products $3,767,334  $4,448,509  $11,552,955  $12,147,796 
Technology sales, services and licensing  431,356   530,979   1,276,489   1,243,158 
                 
Total revenue  4,198,690   4,979,488   12,829,444   13,390,954 
                 
Costs and expenses:                
Cost of revenue, exclusive of depreciation and amortization  2,400,883   2,874,508   7,380,134   7,815,658 
Selling, general and administrative (including stock based compensation)  1,619,066   1,710,099   4,835,079   5,262,618 
Depreciation and amortization  352,040   349,143   1,041,789   1,049,387 
                 
Total costs and expenses  4,371,989   4,933,750   13,257,002   14,127,663 
                 
Operating (loss) income  (173,299)  45,738   (427,558)  (736,709)
                 
Other expense:                
Interest expense  (58,164)  (67,739)  (170,565)  (217,665)
Amortized debt discount  (40,854)      (113,286)    
Loss before income taxes  (272,317)  (22,001)  (711,409)  (954,374)
                 
Income tax expense  4,734   4,737   14,208   14,211 
                 
Net loss $(277,051) $(26,738) $(725,617) $(968,585)
                 
Other comprehensive loss:                
Interest rate swap gain (loss)  3,943   11,843   9,792   (22,451)
                 
Comprehensive loss: $(273,108) $(14,895) $(715,825) $(991,036)
                 
Loss per common share:                
Basic and diluted $(0.02) $(0.00) $(0.05) $(0.07)
                 
Shares used in computing loss per common share:                
Basic and diluted  14,087,849   12,977,903   13,793,946   12,975,053 

See accompanying notes to condensed consolidated financial statements.

DOCUMENT SECURITY SYSTEMS, INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows

For the Nine Months Ended September 30:

(Unaudited)

  2017  2016 
Cash flows from operating activities:        
Net loss $(725,617) $(968,585)
Adjustments to reconcile net loss to net cash from (used by) operating activities:        
Depreciation and amortization  1,041,789   1,049,387 
Stock based compensation  203,111   87,738 
Paid in-kind interest  54,000   58,000 
Change in deferred tax provision  14,211   14,211 
Amortization of deferred financing costs  113,286   15,863 
Decrease (increase) in assets:        
Accounts receivable  91,976   19,501 
Inventory  (706,735)  (250,529)
Prepaid expenses and other current assets  70,838   (24,683)
Restricted cash  (158,563)  105,316 
Increase (decrease) in liabilities:        
Accounts payable  (506,749)  169,394 
Accrued expenses and other liabilities  (867,702)  108,138 
Net cash (used) provided by operating activities  (1,376,155)  383,751 
         
Cash flows from investing activities:        
Purchase of property, plant and equipment  (438,350)  (192,614)
Proceeds from sale of intangibles  -   495,000 
Purchase of intangible assets  (4,903)  (72,953)
Net cash (used) provided by investing activities  (443,253)  229,433 
         
Cash flows from financing activities:        
Payments of long-term debt  (612,419)  (1,229,902)
Issuances of common stock, net of issuance costs  783,094   (92)
Net cash provided (used) by financing activities  170,675   (1,229,994)
         
Net decrease in cash  (1,648,733)  (616,810)
Cash at beginning of period  5,871,738   1,440,256 
         
Cash at end of period $4,223,005  $823,446 

 

See accompanying notes to the condensed consolidated financial statements.

 

52

DOCUMENT SECURITY SYSTEMS, INC. AND SUBSIDIARIES

Consolidated Statements of Operations and Comprehensive Income (Loss)

(unaudited)

  For the Three Months Ended
June 30,
  For the Six Months Ended
June 30,
 
  2018  2017  2018  2017 
             
Revenue:                
Printed products $3,724,980  $3,382,563  $7,648,259  $7,785,621 
Technology sales, services and licensing  362,081   477,600   816,356   845,133 
                 
Total revenue  4,087,061   3,860,163   8,464,615   8,630,754 
                 
Costs and expenses:                
Cost of revenue, exclusive of depreciation and amortization  2,756,447   2,190,901   5,338,062   4,979,251 
Selling, general and administrative (including stock based compensation)  1,802,096   1,490,132   3,584,664   3,216,013 
Depreciation and amortization  346,816   346,975   692,483   689,749 
                 
Total costs and expenses  4,905,359   4,028,008   9,615,209   8,885,013 
                 
Operating loss  (818,298)  (167,845)  (1,150,594)  (254,259)
                 
Other income (expense):                
Interest income  3,033   -   6,107   - 
Interest expense  (33,768)  (54,801)  (82,906)  (112,401)
Amortized debt discount  (6,168)  (37,144)  (33,899)  (72,432)
Gain on extinguishment of liabilities, net  3,532,659   -   3,532,659   - 
Income (loss) before income taxes  2,677,458   (259,790)  2,271,367   (439,092)
                 
Income tax expense  -   4,737   -   9,474 
                 
Net income (loss) $2,677,458  $(264,527) $2,271,367  $(448,566)
                 
Other comprehensive income (loss):                
Interest rate swap gain (loss)  6,963   (1,050)  21,852   5,849 
                 
Comprehensive income (loss): $2,684,421  $(265,577) $2,293,219  $(442,717)
                 
Income (loss) per common share:                
Basic $0.16  $(0.02) $0.14  $(0.03)
Diluted $0.16  $(0.02) $0.13  $(0.03)
                 
Shares used in computing income (loss) per common share:                
Basic  16,599,327   13,644,503   16,599,327   13,644,559 
Diluted  16,842,204   13,644,503   16,882,450   13,644,559 

See accompanying notes to condensed consolidated financial statements.

 3

DOCUMENT SECURITY SYSTEMS, INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows

For the Six Months Ended June 30,

(unaudited)

  2018  2017 
       
Cash flows from operating activities:        
Net income (loss) $2,271,367  $(448,566)
Adjustments to reconcile net income (loss) to net cash used by operating activities:        
Depreciation and amortization  692,483   689,749 
Stock based compensation  86,173   191,360 
Paid in-kind interest  12,000   36,000 
Change in deferred tax provision  -   9,474 
Amortization of deferred financing costs  33,899   72,432 
Gain on extinguishment of liabilities, net  (3,532,659)  - 
Decrease (increase) in assets:        
Accounts receivable  118,491   16,615 
Inventory  289,513   (317,502)
Prepaid expenses and other current assets  (27,771)  52,496 
Increase (decrease) in liabilities:        
Accounts payable  303,907   (445,590)
Accrued expenses  (90,318)  (262,191)
Other liabilities  (606,928)  (393,842)
Net cash used by operating activities  (449,843)  (799,565)
         
Cash flows from investing activities:        
Purchase of property, plant and equipment  (311,402)  (365,659)
Purchase of intangible assets  (20,137)  (4,903)
Net cash used by investing activities  (331,539)  (370,562)
         
Cash flows from financing activities:        
Payments of long-term debt  (758,302)  (407,648)
Subscription receivable, net  288,000   - 
Net cash used by financing activities  (470,302)  (407,648)
         
Net decrease in cash  (1,251,684)  (1,577,775)
Cash and restricted cash at beginning of period  4,444,628   6,049,347 
         
Cash and restricted cash at end of period $3,192,944  $4,471,572 

See accompanying notes to the condensed consolidated financial statements.

4

 

DOCUMENT SECURITY SYSTEMS, INC. AND SUBSIDIARIES


NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

SeptemberJune 30, 20172018

(Unaudited)

 

1. Basis of Presentation and Significant Accounting Policies

1.Basis of Presentation and Significant Accounting Policies

 

Document Security Systems, Inc. (the “Company”), through two of its subsidiaries, Premier Packaging Corporation and Plastic Printing Professionals, Inc., which operates under the assumed name of DSS Plastics Group, operates in the security and commercial printing, packaging and plastic ID markets. The Company develops, markets, manufactures and sells paper and plastic products designed to protect valuable information from unauthorized scanning, copying, and digital imaging. The Company’s subsidiary, DSS Digital Inc., which operates under the assumed name of DSS Digital Group, develops, markets and sells digital information services, including data hosting, disaster recoveryproduct authentication solutions and data back-up and securitydigital information services. The Company’sCompany and its subsidiary, DSS Technology Management, Inc., also acquires intellectual property (“IP”) assets and interests in companies owning intellectual property assets, or assists others in managing their intellectual property monetization efforts, for the purpose of monetizing these assets through a variety of value-enhancing initiatives, including, but not limited to, investments in the development and commercialization of patented technologies, licensing, strategic partnerships and commercial litigation. In addition, in January 2018, the Company commenced international operations with its wholly owned subsidiary, DSS International Inc., in its Hong Kong office.

 

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with United States generally accepted accounting principles (“U.S. GAAP”) for interim financial information and with the instructions to Form 10-Q and Rule 8.03 of Regulation S-X for smaller reporting companies. Accordingly, these statements do not include all of the information and footnotes required by U.S. GAAP for complete financial statements. In the opinion of management, the accompanying balance sheets and related interim statements of operations and comprehensive loss and cash flows include all adjustments considered necessary for their fair presentation in accordance with U.S. GAAP. All significant intercompany transactions have been eliminated in consolidation.

 

Interim results are not necessarily indicative of results expected for the full year. For further information regarding the Company’s accounting policies, refer to the audited consolidated financial statements and footnotes thereto included in the Company’s Form 10-K for the fiscal year ended December 31, 2016.2017.

 

Principles of Consolidation - - The consolidated financial statements include the accounts of Document Security Systems and its subsidiaries. All intercompany balances and transactions have been eliminated in consolidation.

Use of Estimates -The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ materially from those estimates and assumptions. In preparing these financial statements, the Company has evaluated events and transactions for potential recognition or disclosure.

Restricted Cash – As of SeptemberJune 30, 2017,2018, cash of $336,712$141,351 ($177,609256,005 – December 31, 2016)2017) is restricted forby a third-party co-investor to payments of costs and expenses associated with one of the Company’s IP monetization programs. For purposes of the statement of cash flow, cash and restricted cash are combined. The break out of these amounts by period are as follows:

 June 30, 2018  December 31, 2017  June 30, 2017  December 31, 2016 
Cash $3,051,593  $4,188,623  $4,068,745  $5,871,738 
Restricted Cash  141,351   256,005   402,827   177,609 
Total $3,192,944  $4,444,628  $4,471,572  $6,049,347 

 

Investment– In accordance with ASC 325-20, the Company records its investment in common stock of Singapore eDevelopment Limited at cost as the fair market value of the investment is not readily determinable. The Company evaluates investment for indications of impairment at least annually.

5

 

Fair Value of Financial Instruments - 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, accounts receivable, prepaids, 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, promissory 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, as discussed below, are recorded as assets and liabilities at estimated fair value based on available market information.

 

Derivative Instruments -The Company maintains an overall interest rate risk management strategy that incorporates the use of interest rate swap contracts to minimize significant fluctuations in earnings that are caused by interest rate volatility. The Company has twoan interest rate swapsswap that changechanges variable rates into fixed rates on twoone Citizens Bank term loans. These swaps qualifyloan relating to the Company’s subsidiary, Premier Packaging. This swap qualifies as a Level 2 fair value financial instruments. Theseinstrument. This swap agreements areagreement is not held for trading purposes and the Company does not intend to sell thethis derivative swap financial instruments.instrument. The Company records the interest swap agreementsagreement on the balance sheet at fair value because the agreements qualifyagreement qualifies as a cash flow hedgeshedge under accounting principles generally accepted in the United States of America. Gains and losses on these instruments are recorded in other comprehensive loss until the underlying transaction is recorded in earnings. When the hedged item is realized, gains or losses are reclassified from accumulated other comprehensive loss (“AOCI”) to the consolidated statement of operations on the same line item as the underlying transaction. The valuations of the interest rate swaps have been derived from proprietary models of Citizens Bank, N.A. based upon recognized financial principles and reasonable estimates about relevant future market conditions and may reflect certain other financial factors such as anticipated profit or hedging, transactional, and other costs. The notional amounts of the swaps decrease over the life of the agreements. The Company is exposed to a credit loss in the event of nonperformance by the counter parties to the interest rate swap agreements.agreements. However, the Company does not anticipate non-performance by the counter parties. The cumulative net loss attributable to this cash flow hedge recorded in accumulated other comprehensive loss and other liabilities as of SeptemberJune 30, 20172018 was approximately $36,000$1,000 ($45,00023,000 - December 31, 2016)2017).

 

As of SeptemberJune 30, 20172018, the Company has an interest rate swap agreement for its debt with RBS Citizens, N.A. (“Citizens Bank”) (see Note 4)6) which changes a variable rate into a fixed rate on a term loan as follows:

 

Notional  Variable      
Amount  Rate  Fixed Cost  Maturity Date
$927,753   4.38%  5.87% August 30, 2021

Notional  Variable  Fixed  Maturity
Amount  Amount  Cost  Date
$891,608   5.15%  5.87% August 30, 2021

 

Impairment of Long Lived Assets and Goodwill- Long-lived and intangible assets and goodwill are assessed for potential impairment whenever events or changes in circumstances indicate that full recoverability of net asset balances through future cash flows is in question. Goodwill and indefinite-lived intangible assets are assessed at least annually, but also whenever events or changes in circumstances indicate the carrying values may not be recoverable. Factors that could trigger an impairment review, include (a) significant underperformance relative to historical or projected future operating results; (b) significant changes in the manner of or use of the acquired assets or the strategy for the Company’s overall business; (c) significant negative industry or economic trends; (d) significant decline in the Company’s stock price for a sustained period; and (e) a decline in the Company’s market capitalization below net book value.

6

 

Contingent Legal Expenses -Contingent legal fees associated with our commercial litigation involving our IP are expensed in the consolidated statements of operations in the period that the related revenues are recognized. In instances where there are no recoveries from potential infringers, no contingent legal fees are paid; however, the Company may be liable for certain out of pocket legal costs incurred pursuant to the underlying legal services agreement that will be paid out from the proceeds from settlements or licenses that arise pursuant to an enforcement action, which will be expensed as legal fees in the period in which the payment of such fees is probable. Any unamortized patent acquisition costs will be expensed in the period in which a conclusion is reached in an enforcement action that does not yield future royalties potential.

 

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.issued and is calculated utilizing the treasury stock method. In a loss period, 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.

 

On August 26, 2016, the Company affected a one-for-four reverse stock split of the Company’s common stock. No fractional shares of the Company’s common stock were issued as a result of the reverse stock split. Instead, stockholders of record who otherwise would have been entitled to receive fractional shares were entitled to a rounding up of their fractional share to the nearest whole share, except in the case of any stockholder that owned less than four shares of the Company’s common stock immediately preceding the reverse stock split. In such case, such stockholder received cash for such fractional share in an amount equal to the product obtained by multiplying: (x) the closing sale price of the common stock on August 25, 2016 as reported on the NYSE MKT, by (y) the amount of the fractional share. As a result, the Company issued 1,166 common shares for shares due as a result of the rounding up feature and paid $92 to buy-out the fractional shares of holders with less than four shares immediately preceding the reverse stock split.

As of SeptemberJune 30, 20172018 and 2016,2017, there were 3,297,7593,376,527 and 2,498,1283,278,127 respectively, of common stock share equivalents potentially issuable by the Company pursuant to existing options, warrants, and restricted stock agreements, that could potentially dilute basic earnings per share in the future. TheseFor the six-months ended June 30, 2018, based on the average market price of the Company’s common stock during that period of $1.41, 283,123 common stock equivalents were added to the basic shares areoutstanding to calculate dilutive earnings per share. For the three-months ended June 30, 2018, based on the average market price of the Company’s common stock during that period of $1.33, 242,877 common stock equivalents were added to the basic shares outstanding to calculate dilutive earnings per share. Common stock equivalents were excluded from the calculation of diluted earnings per share infor 2017 periods presented in which the Company had a net loss, becausesince their inclusion would be anti-dilutive to the Company’s losses in the respective periods.have been anti-dilutive.

 

Concentration of Credit Risk- The Company maintains its cash in bank deposit accounts, which at times may exceed federally insured limits. The Company believes it is not exposed to any significant credit risk as a result of any non-performance by the financial institutions.

 

During the ninesix months ended SeptemberJune 30, 2017,2018, two customers accounted for 25%24% and 15%14%, respectively, of the Company’s consolidated revenue and accounted for 17%25% and 11%5%, respectively, of the Company’s accounts receivable balance as of SeptemberJune 30, 2017.2018. During the ninesix months ended SeptemberJune 30, 2016, one customer2017, these two customers accounted for 25%23% and 14%, respectively, of the Company’s consolidated revenue and accounted for 7%0% and 16%, respectively, of the Company’s accounts receivable balance as of SeptemberJune 30, 2016.2017. The risk with respect to accounts receivables is mitigated by credit evaluations the Company performs on its customers, the short duration of its payment terms for the significant majoritymost of its customer contracts and by the diversification of its customer base.

Income Taxes - The Company has approximately $42.3M in federal net operating loss carryforwards (“NOLs”) available to reduce future taxable income, which will expire at various dates from 2022 through 2036. As these NOL’s were generated prior to the enactment of H.R. 1 (“Tax Cuts and Jobs Act” or “TCJA”) they are eligible to fully offset taxable income. While the company generated taxable income due to the extinguishment of certain liabilities, it is not expected to reoccur. Therefore, due to the uncertainty as to the Company’s ability to generate sufficient taxable income in the future and utilize the NOLs before they expire, the Company has maintained a full valuation allowance against its deferred tax assets accordingly.

 

Reclassifications- Certain prior year amounts have been reclassified to conform to the current year presentation. All common share and per share figures are presented on a post one for fourone-for-four reverse stock split basis.

 

RecentRecently Adopted Accounting Pronouncements In May 2014, the Financial Accounting Standards Board (FASB)(“FASB”) issued Accounting StandardStandards Update (ASU) 2014-9(“ASU”) No. 2014-09 (Topic 606) “Revenue from Contracts with Customers”. The new guidance requires an entityCustomer” related to recognize the amount of revenue to which it expects to be entitled for the transfer offrom contracts with customers. Under this standard, revenue is recognized when promised goods or services are transferred to customers. Subsequently,customers in an amount that reflects the FASB has issued the following standards relatedconsideration that is expected to ASU 2014-09: ASU No. 2016-08, “Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations” (“ASU 2016-08”); ASU No. 2016-10, “Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing” (“ASU 2016-10”); and ASU No. 2016-12, “Revenue from Contracts with Customers (Topic 606): Narrow-Scope Improvements and Practical Expedients” (“ASU 2016-12”).be received for those goods or services. The Company must adopt ASU 2016-08, ASU 2016-10 and ASU 2016-12 with ASU 2014-09 (collectively, the “new revenue standards”). The revenue standardsupdated standard will replace most existing revenue recognition guidance in U.S.under GAAP when it becomes effective and permits the use of either athe retrospective or cumulative effect transition method. This guidanceTopic 606 is effective for fiscal years, and interimannual reporting periods within those fiscal years, beginning after December 15, 2017.2017, including interim periods within that reporting period. The Company hasadopted Topic 606 effective January 1, 2018. Topic 606 did not yet selectedhave a transition method and is currently evaluatingmaterial impact on the effect that the revenue standards will have on its consolidated financial statements and related disclosures.Company’s Consolidated Financial Statements.

 

In January 2016, the FASB issued ASU No. 2016-01, “Recognition and Measurement of Financial Assets and Financial Liabilities.” ASU 2016-01 requires that most equity investments be measured at fair value, with subsequent changes in fair value recognized in net income. Entities will no longer be able to use the cost method of accounting for equity securities. However, for equity investments without readily determinable fair values, entities may elect a measurement alternative that will allow those investments to be recorded at cost, less impairment, and adjusted for subsequent observable price changes. Upon adoption, entities must record a cumulative-effect adjustment to the balance sheet as of the beginning of the first reporting period in which the standard is adopted. The guidance on equity securities without readily determinable fair values will be applied prospectively to all equity investments that exist as of the date of the adoption of the standand.standard. The pronouncement also impacts financial liabilities under the fair value option and the presentation and disclosure requirements for financial instruments. This pronouncement is effective for fiscal years, and interim periods within those years, beginning after December 15, 2017, and early adoption is not permitted.The Company has not yet evaluated nor has it determinedadopted this new accounting standard during the effect the standard will have on its consolidated financial statements and related disclosures.

In February 2016, the FASB issuedthree months ended March 31, 2018. ASU 2016-02, “Leases”, which requires that lease arrangements longer than 12 months result in an entity recognizing an asset and liability. ASU 2016-02 is effective for interim and annual periods beginning after December 15, 2018, and early adoption is permitted. The Company has not yet evaluated nor has it determined the effect the standard will have on its consolidated financial statements and related disclosures.

In March 2016, the FASB issued ASU 2016-09, “Compensation — Stock Compensation: Improvements to Employee Share-Based Payment Accounting.” The standard is intended to simplify several areas of accounting for share-based compensation arrangements, including the income tax impact, classification on the statement of cash flows and forfeitures. ASU 2016-09 was effective for the Company on January 1, 2017. The adoption of this standard2016-01 did not have a material impact on our consolidated financial statements.the Company’s Consolidated Financial Statements.

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In August 2016, the FASB issued ASU 2016-15, “Classification of Certain Cash Receipts and Cash Payments”, which clarifies the treatment of several types of cash receipts and payments for which there was diversity in practice. This update is effective for annual periods beginning after December 15, 2017, and interim periods within those fiscal years, with early adoption permitted, including adoption in an interim period. We anticipate thatThe Company adopted this standard during the three months ended March 31, 2018. The adoption of this guidance willdid not have a material impact on our consolidated financial statements.the Company’s Consolidated Financial Statements.

 

In November 2016, the FASB issued ASU 2016-18, “Statement of Cash Flows”, regarding the presentation of restricted cash on the statement of cash flows. The standards update requires that the reconciliation of the beginning and end of period cash amounts shown in the statement of cash flows include restricted cash. When restricted cash is presented separately from cash and cash equivalents on the balance sheet, a reconciliation is required between the amounts presented on the statement of cash flows and the balance sheet. Also, the new guidance requires the disclosure of information about the nature of the restrictions. The standards updateCompany adopted the standard as of January 1, 2018 on a retrospective basis, wherein the statement of cash flow of each period presented was adjusted to reflect the effects of applying the new guidance.

In May 2017, the FASB issued ASU 2017-09, “Compensation – Stock Compensation (Topic 718) – Scope of Modification Accounting”, which provides guidance about which changes to the terms or conditions of a share-based payment award require an entity to apply modification accounting in Topic 718. ASU 2017-09 is effective retrospectively for fiscal years and interim periods beginning after December 15, 2017 withand interim periods within those fiscal years, and early adoption permitted. We anticipate thatis permitted, including in an interim period. ASU 2017-09 is to be applied on a prospective basis to an award modified on or after the adoption ofdate. The Company adopted this guidance willstandard during the quarter ended March 31, 2018. The new accounting standard did not have a material impact on our consolidated financial statements.the Company’s Consolidated Financial Statements.

 

Recent Accounting Pronouncements

In February 2016, the FASB issued ASU 2016-02, “Leases”, which requires that lease arrangements longer than 12 months result in an entity recognizing an asset and liability. ASU 2016-02 is effective for interim and annual periods beginning after December 15, 2018, and early adoption is permitted. The Company has elected not to adopt this standard in advance of its required effective date. The Company is currently assessing the impact that adopting this new accounting standard will have on its Consolidated Financial Statements.

In January 2017, the FASB issued ASU 2017-04, “Intangibles – Goodwill and Other (Topic 350) – Simplifying the Test for Goodwill Impairment”, which eliminates the two-step process that required identification of potential impairment and a separate measure of the actual impairment. The annual assessment of goodwill impairment will be determined by using the difference between the carrying amount and the fair value of the reporting unit. The standards update are effective for goodwill impairment tests in fiscal years beginning after December 15, 2019. The Company is currently assessing the impact that adopting this new accounting standard will have on its Consolidated Financial Statements.

In February 2018, the FASB issued ASU 2018-03, “Technical Corrections and Improvements to Financial Instruments (Subtopic 825-10) – Recognition and Measurement of Financial Assets and Financial Liabilities”. This update was issued to clarify certain narrow aspects of guidance concerning the recognition of financial assets and liabilities established in ASU No. 2016-01, “Financial Instruments—Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities”. This includes an amendment to clarify that an entity measuring an equity security using the measurement alternative may change its measurement approach to a fair valuation method in accordance with Topic 820, Fair Value Measurement, through an irrevocable election that would apply to that security and all identical or similar investments of the same issued. The update is effective for fiscal years beginning after December 15, 2017 and interim periods within those fiscal years beginning after June 15, 2018. The Company is currently assessing the impact that adopting this new accounting standard will have on its Consolidated Financial Statements. The adoption of this standard is not expected to have a material impact on the Company’s Consolidated Financial Statements.

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2.Revenue

Effective January 1, 2018, the Company adopted Topic 606 using the modified retrospective approach and applied the guidance to those contracts which were not completed as of January 1, 2018. Adoption of Topic 606 did not impact the timing of revenue recognition in the Company’s Consolidated Financial Statements for the current or prior interim or annual periods. Accordingly, no adjustments have been made to opening retained earnings or prior period amounts.

Revenue Recognition

The Company sells printed products including packaging printing and fabrication, commercial and security printing and plastic cards and badges, including cards and badges integrated with technology such as RFID and smart chips. The Company also provides information technology services and digital authentication products and services to its customers. The Company recognizes its products and services revenue based on when the title passes to the customer or when the service is completed and accepted by the customer. Revenue is measured as the amount of consideration the Company expects to receive in exchange for shipped product or service provided. Sales and other taxes billed and collected from customers are excluded from revenue. Customers, including distributors, do not have a general right of return. The Company also derives revenue from royalties from third parties which are typically based on licensees’ net sales of products that utilize the Company’s technology, or on a per item usage of the technology on the customers’ printed products. The Company recognizes license revenue at the time it is reported by the licensee. From time to time, the Company generates license revenues through litigation settlements. For these, the Company recognizes revenue upon the execution of the agreement, when collectability is reasonably assured, or upon receipt of the minimum upfront fee for term agreement renewals, and when all other revenue recognition criteria have been met.

As of June 30, 2018, the Company had no unsatisfied performance obligations for contracts with an original expected duration of greater than one year. Pursuant to Topic 606, the Company has applied the practical expedient with respect to disclosure of the deferral and future expected timing of revenue recognition for transaction price allocated to remaining performance obligations. The Company elected the practical expedient allowing it to not recognize as a contract asset the commission paid to its salesforce on the sale of its products as an incremental cost of obtaining a contract with a customer but rather recognize such commission as expense when incurred as the amortization period of the asset that the Company would have otherwise recognized is one year or less.

Accounts Receivable

The Company extends credit to its customers in the normal course of business. The Company performs ongoing credit evaluations and generally do not require collateral. Payment terms are generally 30 days but up to net 60 for certain customers. Trade accounts receivable are recorded at their invoiced amounts, net of allowance for doubtful accounts. The Company evaluates the adequacy of its allowance for doubtful accounts quarterly. Accounts outstanding for longer than contractual payment terms are considered past due and are reviewed for collectability. Receivable balances are written off when collection is deemed unlikely.

Sales Commissions

Sales commissions are expensed as incurred for contracts with an expected duration of one year or less. There were no sales commissions capitalized as of June 30, 2018.

Shipping and Handling Costs

Costs incurred by the Company related to shipping and handling are included in cost of products sold. Amounts charged to customers pertaining to these costs are reflected as revenue.

See Note 11 for disaggregated revenue information.

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3. Inventory

 

Inventory consisted of the following:

 

  September 30, 2017  December 31, 2016 
       
Finished Goods $1,315,421  $736,987 
WIP  385,998   314,353 
Raw Materials  211,692   155,037 
         
  $1,913,111  $1,206,377 

  Inventory 
  June 30, 2018  December 31, 2017 
       
Finished Goods $1,075,963  $965,757 
WIP  142,997   383,270 
Raw Materials  142,773   302,219 
         
  $1,361,733  $1,651,246 

 

3.4. Related Party Investment

 

On September 12, 2017, the Company and Hengfai Business Development Pte Ltd. (“HBD”) entered into a Securities Exchange Agreement whereby the Company agreed to issue and sell to HBD 683,000 shares of its common stock, which had a market value on that date of $484,930, in exchange for 21,196,552 ordinary shares which was 1.92% of the total outstanding common stock of SED as of December 31, 2017, and an existing three-year warrant to purchase up to 105,982,759 of commonordinary shares at an exercise price of SGD$0.040 (US$0.0298) per share of Singapore eDevelopment Limited (“SED”), a company incorporated in Singapore and publicly-listed on the Singapore Exchange Limited. The SED shares and warrants were owned by HBD. One of the directors of the Company, Mr. Heng Fai Ambrose Chan, who also serves as the Chief Executive Officer of the Company’s subsidiary, DSS International Inc., is a related party to each of HBD and SED. The shares and warrants are restricted for two years after the agreement date. At the time of the investment, the cost of the investment was determined to be the fair value of the Company’s common stock issued in the transaction, which was determined to have the most readily determinable fair value. As of September 30,December 31, 2017, the investment is carried at costCompany performed its annual assessment of impairment for the SED shares and warrant. In making this assessment, the Company determined, that the SED shares, which trade on the Singapore Stock Exchange, had a market value of $900,112 and the warrant had an aggregate intrinsic value of approximately $485,000.$1,343,000 based on a share price of SGD $0.057 (US$ 0.042) as of December 31, 2017. However, the Company determined that these values did not represent a readily determinable fair value due to a potential lack of liquidity of the SED shares and warrants due to a low average trading volume of the SED shares and the effect of the time restriction on the ability of the Company to sell the shares until September 17, 2019. In 2018, the Company adopted ASU No. 2016-01, “Recognition and Measurement of Financial Assets and Financial Liabilities.” In accordance with ASU No. 2016-01, the Company noted that the SED share price had changed but such change, evaluated under the practicability election of ASU 2016-01, did not affect the Company’s determination that this observable price change would cause the Company to change its determination that the investment cost was the most readily determinable fair value or that such price change was an indicator of impairment. As of June 30, 2018, the SED shares had a market value of $762,319 and the warrant had an aggregate intrinsic value of approximately $700,122 based on a share price of SGD $0.049 (US$ 0.036).

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4.5. Intangible Assets

 

Intangible assets are comprised of the following:

 

  September 30, 2017  December 31, 2016 
  Useful Life  Gross Carrying Amount   Accumulated Amortization   Net Carrying Amount   Gross Carrying Amount   Accumulated Amortization   Net Carrying Amount 
                           
Acquired intangibles - customer lists and non-compete agreements 5-10 years  1,997,300   1,785,932   211,368   1,997,300   1,721,357   275,943 
Acquired intangibles - patents and patent rights Varied (1)  3,155,000   2,476,149   678,851   3,155,000   2,092,767   1,062,233 
Patent application costs Varied (2)  1,141,368   644,548   496,820   1,136,465   578,623   557,842 
    $6,293,668  $4,906,629  $1,387,039  $6,288,765  $4,392,747  $1,896,018 

    June 30, 2018  December 31, 2017 
  Useful Life Gross Carrying Amount  Accumulated Amortization  Net Carrying Amount  Gross Carrying Amount  Accumulated Amortization  Net Carrying Amount 
                     
Acquired intangibles - customer lists and non-compete agreements 5-10 years  1,997,300   1,853,800   143,500   1,997,300   1,810,750   186,550 
Acquired intangibles - patents and patent rights    500,000   500,000   -   3,155,000   2,603,942   551,058 
Patent application costs Varied (1)  1,168,155   705,899   462,256   1,148,017   664,873   483,144 
    $3,665,455  $3,059,699  $605,756  $6,300,317  $5,079,565  $1,220,752 

 

(1)Acquired patents and patent rights are amortized over their expected useful life which is generally the remaining legal life of the patent. As of September 30, 2017, the weighted average remaining useful life of these assets in service was approximately 1.84 years.
(2)Patent application costs are amortized over their expected useful life which is generally the remaining legal life of the patent. As of SeptemberJune 30, 2017,2018, the weighted average remaining useful life of these assets in service was approximately 6.37.2 years.

 

Intangible asset amortization expense for the ninesix months ended SeptemberJune 30, 20172018 amounted to $513,881$339,663 ($530,015 - September344,238- June 30, 2016)2017).

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On June 26, 2018, the Company entered into an agreement with Fortress Credit Co LLC (“Fortress”), which among other things transferred to Fortress all of the remaining economic rights to certain of the Company’s semi-conductor related patents (See Note 6). As a result, the Company wrote-off these patents which had an aggregated gross cost of $2,655,000 and a net unamortized carrying amount of $295,470 on the agreement date.

 

5.6. Short-Term and Long-Term Debt

 

Revolving Credit Lines- The Company’s subsidiary Premier Packaging Corporation (“Premier Packaging”) has a revolving credit line with Citizens Bank (“Citizens”) of up to $800,000 that bears interest at 1 Month LIBOR plus 3.75% (4.98%(5.81% as of SeptemberJune 30, 2017)2018) and expiresexpired on July 26, 2018. As of SeptemberJune 30, 20172018, and December 31, 2016,2017, the revolving line had a balance of $0.

 

On July 26, 2017, Premier Packaging entered into a Loan Agreement and accompanying Term Note Non-Revolving Line of Credit Agreement with Citizens Bank pursuant to which Citizens agreesagreed to lend up to $1,200,000 for the purpose of enablingto permit Premier Packaging to purchase equipment from time to time that it may need for use in its business. As of the date of this report,June 30, 2018, and December 31, 2017, the revolving line had a balance of $0.

 

On December 1, 2017, the Company’s subsidiary Plastic Printing Professionals entered into a Loan Agreement and accompanying Term Note Non-Revolving Line of Credit Agreement with Citizens pursuant to which Citizens agreed to lend up to $800,000 to enable Plastic Printing Professionals to purchase equipment from time to time that it may need for use in its business. Advances may be made under this Equipment Acquisition Line of Credit, from time to time, from December 1, 2017 until December 1, 2018. The aggregate principal balance outstanding under the Equipment Acquisition Line of Credit bears interest at 2% above the LIBOR Advantage Rate (as defined in the agreement) (4.00% at June 30, 2018) until converted. Effective on conversion, the interest rate payable on the aggregate principal balance outstanding shall be adjusted to a fixed rate equal to 2% above Citizens’ cost of funds as determined by Citizens. Prior to conversion, interest on the outstanding principal is payable in arrears monthly. After conversion, the aggregate principal balance may be repaid in (i) up to 84 installments comprised of principal and interest for new equipment or (ii) up to 60 installments comprised of principal and interest for used equipment. An initial advance was made under the Equipment Acquisition Line of Credit on December 1, 2017, in the amount of $522,000, to fund the purchase of a used 6-color commercial press. As of June 30, 2018, the balance of the equipment line was $522,000 ($522,000 at December 31, 2017). As of the date of this report, the Company had not yet converted the $522,000 into a term note.

Long-Term Debt- On December 30, 2011, the Company issued a $575,000 convertible note that was initially due on December 29, 2013, and carries an interest rate of 10% per annum. The note is secured by the assets of Company’s wholly-owned subsidiary, Secuprint Inc. Interest is payable quarterly, in arrears. In conjunction with the issuance of the convertible note, the Company determined a beneficial conversion feature existed amounting to approximately $88,000, which was recorded as a debt discount to be amortized over the term of the note. On May 24, 2013, the Company amended the convertible note to extend the maturity date of the note from December 29, 2013 to December 29, 2015. The change in the fair value of the embedded conversion option exceeded 10% of the carrying value of the original debt and, therefore, the Company accounted for this restructuring as an extinguishment in accordance with FASB ASC 470-50 “Debt Modifications and Extinguishments”. The note was written up to its fair value on the date of modification of approximately $650,000 and the premium recorded in excess of its face value was amortized over the remaining life of the note. On February 23, 2015, the Company entered into Convertible Promissory Note Amendment No. 2 to extend the maturity date to December 30, 2016, eliminate the conversion feature, and to institute principal payments in the amount of $15,000 per month plus interest through the extended maturity date, and a balloon payment of $230,000 due on the extended maturity date. On April 12, 2016, the Company entered into Convertible Promissory Note Amendment No. 3 to extend the maturity date to May 31, 2017 and change the balloon payment to $155,000 due on the extended maturity date. On May 31, 2017, the Company entered into Convertible Promissory Note Amendment No. 4 to extend the maturity date to April 30, 2018 at which point the note is scheduled to be paid in full. In exchange for the extension, the Company also issued the lender as additional consideration 18,000 shares of the Company’s common stock which had a fair value of $17,640. As of September 30, 2017, the balance of the term loan was $95,000 ($230,000 at December 31, 2016).

On May 24, 2013, the Company entered into a promissory note in the principal sum of $850,000 to purchase three printing presses that were previously leased by the Company’s wholly-owned subsidiary, Secuprint Inc., and carries an interest rate of 9% per annum. The note is secured by the assets of Company’s wholly-owned subsidiary, Secuprint Inc. Interest is payable quarterly, in arrears. The Company also issued the lender as additional consideration a five-year warrant to purchase up to 60,000 shares of the Company’s common stock at an exercise price of $3.00 per share. The warrant was valued at approximately $69,000 using the Black-Scholes-Merton option pricing model with a volatility of 60.0%, a risk freerisk-free rate of return of 0.89% and zero dividend and forfeiture estimates. In conjunction with the issuance of the warrants, the Company recorded a discount on debt of approximately $69,000 that was amortized over the original term of the note. The note was set to mature on May 24, 2014, but its maturity date was extended on May 2, 2014 to May 24, 2015 by the lender. In exchange for the extension, the Company also issued the lender as additional consideration a five-year warrant to purchase up to 40,000 shares of the Company’s common stock at an exercise price of $1.50 per share. The warrant was valued at approximately $29,000 using the Black-Scholes-Merton option pricing model with a volatility of 70.0%, a risk freerisk-free rate of return of 1.53% and zero dividend and forfeiture estimates. In conjunction with the issuance of the warrants, the Company recorded expense for modification of debt of approximately $29,000. On February 23, 2015, the Company entered into Promissory Note Amendment No. 2 to extend the maturity date to May 31, 2016 and to institute principal payments in the amount of $15,000 per month plus interest through the extended maturity date, and a balloon payment of $610,000 due on the extended maturity date. On April 12, 2016, the Company entered into Promissory Note Amendment No. 3 to extend the maturity date to May 31, 2017 and change the balloon payment to $430,000 due on the extended maturity date. . On May 31, 2017, the Company entered into Convertible Promissory Note Amendment No. 4 to extend the maturity date to December 31, 2018 at which point the note is scheduled to be paid in full. In exchange for the extension, the Company also issued the lender as additional consideration 18,000 shares of the Company’s common stock which had a fair value of $17,640. As of SeptemberJune 30, 2017,2018, the balance of the term loan was $370,000$195,000 ($505,000325,000 at December 31, 2016)2017).

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Term Loan Debt- On July 19, 2013, Premier Packaging entered into an equipment loan with People’s Capital and Leasing Corp. (“People’s Capital”) for a printing press. The loan is secured by the printing press. The loan was for $1,303,900, repayable over a 60-month period which commenced when the equipment was placed in service in January 2014. The loan bears interest at 4.84% and is payable in equal monthly installments of $24,511. As of SeptemberJune 30, 2017,2018, the loan had a balance of $356,064$145,010 ($559,609286,560 at December 31, 2016)2017).

 

On April 28, 2015, Premier Packaging entered into a term note with Citizens for $525,000, repayable over a 60-month period. The loan bears interest at 3.61%3.62% and is payable in equal monthly installments of $9,591 until April 28, 2020. Premier Packaging used the proceeds of the term note to acquire a HP Indigo 7800 Digital press. The loan is secured by the printing press. As of SeptemberJune 30, 2017,2018, the loan had a balance of $283,271$203,755 ($360,611257,007 at December 31, 2016)2017).

 

Promissory Notes - On August 30, 2011, Premier Packaging purchased the packaging plant it occupies in Victor, New York, for $1,500,000, which was partially financed with a $1,200,000 promissory note obtained from Citizens Bank (“Promissory Note”). The Promissory Note calls for monthly payments of principal and interest in the amount of $7,658, with interest calculated as 1 Month LIBOR plus 3.15% (4.38%(5.15% at SeptemberJune 30, 2017)2018). Concurrently with the transaction, the Company entered into an interest rate swap agreement to lock into a 5.87% effective interest rate for the life of the loan.loan (see Note 1. “Derivative Instruments”). The Promissory Note matures in August 2021 at which time a balloon payment of the remaining principal balance will be due. As of SeptemberJune 30, 2017,2018, the Promissory Note had a balance of $927,753$891,608 ($966,786915,107 at December 31, 2016)2017).

 

On December 6, 2013, Premier Packaging entered into a Construction to Permanent Loan with Citizens Bank for up to $450,000 that was converted into a promissory note upon the completion and acceptance of building improvements to the Company’s packaging plant in Victor, New York. In May 2014, the Company converted the loan into a $450,000 note payable in monthly installments over a 5 year5-year period of $2,500 plus interest calculated at a variable rate of 1 Month LIBOR plus 3.15% (4.38%(5.15% at SeptemberJune 30, 2017)2018), which payments commenced on July 1, 2014. The note matures in July 2019 at which time a balloon payment of the remaining principal balance of $300,000 is due. As of SeptemberJune 30, 2017,2018, the note had a balance of $352,500$330,000 ($375,000345,000 – December 31, 2016)2017).

 

Under theThe Citizens Bank credit facilities to each of the Company’s subsidiary,subsidiaries, Premier Packaging is subject toand Plastic Printing Professionals, contain various covenants including fixed charge coverage ratio, tangible net worth and current ratio covenants.covenants which are tested annually at December 31. For the quartersyear ended MarchDecember 31, June 30, 2017, and September 30, 2017,both Premier Packaging wasand Plastic Printing Professionals were in compliance with the annual covenants. The Citizens Bank obligations are secured by all of the assets of Premier Packaging and are also secured through cross guarantees by the Company and its other wholly-owned subsidiaries, Plastic Printing Professionals and Secuprint.

Other Debt - On February 13, 2014, the Company’s subsidiary, DSS Technology Management, Inc. (“DSSTM”DSS Technology Management” or “DSSTM”), entered into an Investment Agreement (the “Agreement”) dated February 13, 2014 (the “Effective Date”) with Fortress Credit Co LLC, as collateral agent (the “Collateral Agent” or “Fortress”), and certain investors (the “Investors”), pursuant to which DSSTM contracted to receive a series of advances up to $4,500,000 (collectively, the “Advances”). Under the terms of the Agreement, on the Effective Date, DSSTM issued and sold a promissory note in the amount of $1,791,000, fixed return equity interests in the amount of $199,000, and contingent equity interests in the amount of $10,000, to each of the Investors, and in return received $2,000,000 in proceeds. To secure the Advances, DSSTM placed a lien in favor of the Investors on ten semi-conductor patents (the “Patents”) and assigned to the Investors certain funds recoverable from successful patent litigation involving these Patents, including settlement payments, license fees and royalties on the Patents. DSSTM is a plaintiff in various ongoing patent infringement lawsuits involving certain of the Patents.

 

On March 27, 2014, DSSTM received an additional $1,000,000 under the Agreement comprised of a promissory note for $900,000 and fixed and contingent equity interests of $100,000. On September 5, 2014, DSSTM received the remaining $1,500,000 under the Agreement comprised of a promissory note for $1,350,000 and fixed and contingent return interests of $150,000. On May 23, 2016, DSSTM remitted $495,000 in proceeds received from the sale of patent assets (Note 5) to Fortress under the terms of the Agreement. On September 20, 2016, DSSTM remitted $125,250 in proceeds received from a settlement to Fortress as repayment of the note principal balance under the terms of the Agreement.

 

The Agreement defines certain events as Events of Default, one of which is the failure by DSSTM, on or before the second anniversary of the Effective Date, to make payments to the Investors equal to the outstanding Advances. On February 13, 2016, being the second anniversary date of the Effective Date, DSSTM had failed to make these payments and was therefore in default of the Agreement. On December 2, 2016, the parties entered into a First Amendment to Investment Agreement and Certain Other Documents (the “Amendment”). The purpose of the Amendment was to vacate DSSTM’s ongoing non-payment default under the Agreement, and to amend certain provisions of the Agreement.

 

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The Agreement also was amended to add expenses in the amount of $150,000 to DSSTM’s payment obligation, payable on the Maturity Date. This amount was recorded as debt issuance costs and iswas being amortized on a straight linestraight-line basis through the amended maturity date of February 13, 2018. The Amendment added a provision whereby DSSTM iswas required to deposit $300,000 on or before March 2, 2017 and (ii) a further sum of $300,000 on or before March 2, 2018, into a deposit account (collectively, the “Deposit”). The March 2, 2017 deposit wasand March 2, 2018 deposits were made in a timely manner. The Deposit funds will bewere restricted to pay certain expenses, consisting of out-of-pocket expenses incurred in connection with certain existing patent litigation matters and other patent litigation matters which may occur after the Amendment Effective Date (the “Qualified Expenses”). In the Event of Default, the Investors maywould apply the then remaining Deposit to the then outstanding Obligations, if any.

 

Additionally per the Amendment, DSSTM agrees to pay to the Investors an amount equal to 25% of any amounts received by DSSTM for any and all types of monetization activities related to certain of its patents covering systems and methods of using low power wireless peripheral devices (collectively, “BlueTooth Patents”), but only until the Investors have received payments under the Agreement totaling the sum of (i) the Capitalized Expenses plus (ii) payments of principal and interest on the Notes totaling the sum of (x) $4,500,000 (consisting of the previously made Advances) plus (y) additional amounts, if any, advanced by the Investors pursuant to the Agreement. In addition to the monetization interest granted the Investors in the BlueTooth Patents, DSSTM also granted the Collateral Agent and the Investors a security interest in certain of DSSTM’s unencumbered semiconductor patents to further collateralize the amounts owed under the Agreement.

 

As of September 30, 2017,February 13, 2018, DSSTM hashad made aggregate principal payments of $752,180$794,283 on the notes. AsOn February 13, 2018, the Maturity Date, DSS Technology Management defaulted by failing to pay the investors an amount equal to (x) two times the aggregate amount of September 30, 2017, $3,611,560 is recordedall advances made by the investors as a short-term debtof such date plus (y) the Capitalized Expenses. The sole recourse available to the investors under the arrangement,Agreement, as amended, was the establishment of a special purpose entity controlled by the investors which includes $263,500would take ownership of accrued interest, less unamortized debt issuance coststhe collateral consisting of $77,856.the patents covered under the amended Agreement. Each of the investors and the collateral agent had contractually agreed that they would not, individually or collectively, seek to enforce any monetary judgment with respect to or against any assets of the Company other than the patents and the monetization payments and the remaining deposit. On June 26, 2018, the parties agreed that the amounts due under the Agreement having an aggregate remaining balance of $3,714,129 as of the Maturity Date, are discharged, without the assignment to the Investors of any of the collateral that secured the repayment under the Agreement. In addition, asthe Company confirmed its obligation to pay the Investors $345,000 that remained from an aggregate of September 30, 2017, $459,000$600,000 that had been deposited and restricted to cover expenses related to the IP monetization activities. Furthermore, the parties agreed that in the event there are any future recoveries by DSSTM with respect to monetization activities relating to the collateralized patents or applicable proceed rights set forth in the Agreement, the contractual payment provisions of fixedthe original Agreement will apply and the Investors will be entitled to receive payment of such proceeds. As a result of this agreement, the Company paid $345,000 from restricted cash and recorded a gain of extinguishment of liabilities of $3,372,129 to reflect the discharge of the notes, wrote off contingent equity interests isof $459,000 eliminated by the agreement, and wrote-off the underlying patents which had an aggregated gross cost of $2,655,000 and an net unamortized carrying amount of $295,470 on the agreement date, all of which resulted in the a net gain on the extinguishment of liabilities of $3,532,659 recorded in other short-term liabilities. The Company will reduce the liability upon payment to the Investor from available proceeds from litigation, or if none by the maturity date of February 13, 2018, then such amounts will be settled by the Company by the transfer and assignment of certain of the Company’s patent assets.three months ending June 30, 2018.

 

6.7. Other Liabilities

 

On November 14, 2016, the Company entered into a Proceeds Investment Agreement (the “Agreement”) with Brickell Key Investments LP (“BKI”). Pursuant to the Agreement, BKI financed an aggregate of $13,500,000 in a patent purchase and monetization program to be implemented and managed by the Company (the “Financing”). Pursuant to Agreement,the Agreement. $3,000,000 of the Financing was used to cover the Company’s purchase of a portfolio of U.S. and foreign LED patents and a license from Intellectual Discovery Co., Ltd., a Korean company (collectively, the “LED Patent Portfolio”), resulting in a basis in these assets of $0. A total of $6,000,000 of the Financing was directed by BKI to attorneys to cover anticipated attorneys’ fees and out-of-pocket expenses for legal proceedings that may transpire relating to enforcement of the LED Patent Portfolio. This amount is not included in the Company’s financial statements as the Company has no control over these funds, which are segregated and escrowed in the attorneys’ trust account.

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In addition, on November 14, 2106,2016, the Company received $4,500,000 of the Financing, which was required to be used by the Company to pay for the defense ofInter Partes Review or other similar proceedings that may be filed from time to time by defendants with the U.S. Patent & Trademark Office relating to the LED Patent Portfolio, with excess amounts available for general working capital needs. As of SeptemberJune 30, 2017,2018, an aggregate of approximately $3,687,000$2,873,000 is recorded as other liabilities by the Company, of which approximately $2,062,500$2,089,000 is classified as short-term. Of this amount, the Company allocated $2,500,000 which it subsequently adjusted to $1,500,000 for the payment of estimated futureInter Partes Review costs. The Company will reduce this liability as it pays legal and other expenses related to theInter Partes Review matters involving the LED Patent Portfolio as incurred. The remaining $2,217,000$1,476,000 in other liabilities is allocated to working capital, which the Company is amortizing this amount on a pro-rata basis over the expected remaining life of the monetization period of the LED Patent Portfolio through November 31,30, 2019. For this amount, the Company reduced the liability with an offset to selling, general and administrative costs by $47,500 per month from January 2017 through July 2017, and $80,000 per month in Augustfor the remainder of 2017 through March 2018, and September$86,500 per month for the remainder of 2017.2018. During the ninesix months ended SeptemberJune 30, 2017,2018, there was $30,000$74,000 ofInter Partes Review costs and an aggregate of $492,500$501,000 was recorded as a reduction of the liability allocated to working capital.

 

On July 8, 2013, the Company’s subsidiary, DSS Technology Management,DSSTM , purchased two patents for $500,000 covering certain methods and processes related to Bluetooth devices. In conjunction with the patent purchases, DSS Technology ManagementDSSTM entered into a Proceed Right Agreement with certain investors pursuant to which DSS Technology ManagementDSSTM initially received $250,000 of a total of $750,000 which it will ultimately receive thereunder, subject to certain payment milestones, in exchange for 40% of the proceeds which it receives, if any, from the use, sale or licensing of the two patents. As of SeptemberJune 30, 2017,2018, the Company had received an aggregate of $650,000 ($650,000 in 2017) from the investors pursuant to the agreement of which approximately $435,000$407,000 was in current liabilities in the consolidated balance sheets ($467,000432,000 as of December 31, 2016)2017). The Company will reducereduces the liability as it pays legal and other expenses related to its litigation involving the Bluetooth patents, for which the amount is available to be used for 50% of all such expenses.

 

As described in Note 5, On6, on February 13, 2014, the Company’s subsidiary, DSSTM entered into an Investment Agreement with Fortress pursuantFortress. Pursuant to which DSSTM contracted to receive a seriesthis agreement, an aggregate of advances up to $4,500,000. Under the terms of the Agreement, on the Effective Date, DSSTM issued and sold a promissory note in the amount of $1,791,000, fixed return equity interests in the amount of $199,000, and contingent equity interests in the amount of $10,000. On March 27, 2014, DSSTM received an additional $1,000,000 under the Agreement comprised of a promissory note for $900,000 and fixed and contingent equity interests of $100,000. On September 5, 2014, DSSTM received the remaining $1,500,000 under the Agreement comprised of a promissory note for $1,350,000 and fixed and contingent return interests of $150,000. The $459,000 of aggregate fixed and contingent equity interests received are recorded in current liabilities. The Company will reduceliabilities under the liability upon payment to the Investor from available proceeds from litigation, or if none by the maturity date ofagreement matured on February 13, 2018, then such amounts will be reversed from other current liabilities and recorded as other income as2018. Per the agreement, the Investors have the right to take ownership of the maturity date.patents as settlement of the liabilities upon maturity. On June 26, 2018, the parties entered into an agreement (see Note 6 “Other Debt”) which among other things eliminated the Company’s obligation for the fixed and contingent equity interests under the agreement.

 

7.8. Commitments and Contingencies

 

On November 26, 2013, DSS Technology ManagementDSSTM filed suit against Apple, Inc. (“Apple”) in the United States District Court for the Eastern District of Texas, for patent infringement (the “Apple Litigation”). The complaint alleges infringement by Apple of DSS Technology Management’sDSSTM’s patents that relate to systems and methods of using low power wireless peripheral devices DSS Technology Managementdevices. DSSTM is seeking a judgment for infringement, injunctive relief, and compensatory damages from Apple. On October 28, 2014, the case was stayed by the District Court pending a determination of Apple’s motion to transfer the case to the Northern District of California. On November 7, 2014, Apple’s motion to transfer the case to the Northern District of California was granted. On December 30, 2014, Apple filed twoInter Partes Review(“IPR”) petitions with the Patent Trial and Appeal Board (“PTAB”) for review of the patents at issue in the case. The PTAB instituted the IPRs on June 25, 2015. The California District Court then stayed the case pending the outcome of those IPR proceedings. Oral arguments of the IPRs took place on March 15, 2016, and on June 17, 2016, PTAB ruled in favor of Apple on both IPR petitions. DSS Technology Management hasDSSTM then filed an appeal with the U.S. Court of Appeals for the Federal Circuit (the “Federal Circuit”) seeking reversal of the PTAB decisions. Oral arguments for the appeal were held on August 9, 2017, and2017. On March 23, 2018, the appeal is still pending asFederal Circuit reversed the PTAB, finding that the PTAB erred when it found the claims of U.S. Patent No. 6,128,290 to be unpatentable. The Federal Circuit affirmed its decision on July 12, 2018, when it denied Apple’s petition for panel rehearing of the date of this Report.Federal Circuit’s Opinion and Judgment issued on March 23, 2018. On July 27, 2018, the District Court judge lifted the Stay resuming the litigation. The patent assets underlying this matter had no carrying value as of the date of the PTAB decision and therefore, there were no impairment considerations as a resultbecause of thethat earlier PTAB decision.

On February 16, 2015, DSS Technology ManagementDSSTM filed suit in the United States District Court, Eastern District of Texas, against defendants Intel Corporation, Dell, Inc., GameStop Corp., Conn’s Inc., Conn Appliances, Inc., NEC Corporation of America, Wal-Mart Stores, Inc., Wal-Mart Stores Texas, LLC, and AT&T, Inc. The complaint alleges patent infringement and seeks judgment for infringement of two of DSSTM’s patents, injunctive relief and money damages. On December 9, 2015, Intel filed IPR petitions with PTAB for review of the patents at issue in the case. Intel’s IPRs were instituted by PTAB on June 8, 2016. On June 1, 2017, the PTAB ruled in favor of Intel for all the challenged claims. On July 28, 2017, DSS Technology ManagementDSSTM filed a notice of appeal of the PTAB’s decision relating to U.S. Patent 6,784,552 with the Federal Circuit. The Intel litigation has been stayed by the District Court pending final determination of the IPR proceedings.

 

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On July 16, 2015, DSS Technology ManagementDSSTM filed three separate lawsuits in the United States District Court for the Eastern District of Texas alleging infringement of certain of its semiconductor patents. The defendants are SK Hynixet al.,Samsung Electronicset al.,and Qualcomm Incorporated. Each respective complaint alleges patent infringement and seeks judgment for infringement, injunctive relief and money damages. On November 12, 2015, SK Hynix filed an IPR petition with PTAB for review of the patent at issue in their case. SK Hynix’s IPR was instituted by the PTAB on May 11, 2016. On August 16, 2016, DSS Technology ManagementDSSTM and SK Hynix entered into a confidential settlement agreement ending the litigation between them. The pending SK Hynix IPR was then terminated by mutual agreement of the parties on August 31, 2016. On March 18, 2016, Samsung also filed an IPR petition, which was instituted by the PTAB. On September 20, 2017, PTAB ruled in favor of Samsung for all the challenged claims relating to U.S. Patent 6,784,552. DSS Technology Management intends to appealDSSTM then appealed this PTAB ruling to the Federal Circuit on November 17, 2017. The Federal Circuit joined this appeal with the Intel appeal effective on December 7, 2017. The appeal is still pending as of the date of this Report. Qualcomm filed its IPR proceeding on July 1, 2016, which was then later joined with Intel’s IPRs in August 2016 by PTAB. On June 1, 2017, the PTAB ruled in favor of Intel/Qualcomm for all the challenged claims. On July 28, 2017, DSS Technology ManagementDSSTM filed a notice of appeal of the PTAB’s decision relating to U.S. Patent 6,784,552 with the Federal Circuit. TheAs indicated above, this joint appeal is still pending as of the date of this Report.

 

On April 13, 2017, Document Security Systems, Inc. (“DSS”)the Company filed a patent infringement lawsuit against Seoul Semiconductor Co., Ltd. and Seoul Semiconductor, Inc. (collectively, “Seoul Semiconductor”) in the United States District Court for the Eastern District of Texas, Marshall Division, alleging infringement of certain of DSS’sthe Company’s Light-Emitting Diode (“LED”) patents. DSSThe Company is seeking a judgement for infringement of the patents along with other relief including, but not limited to, money damages, costs and disbursements. On June 7, 2017, DSSthe Company refiled its patent infringement complaint against Seoul Semiconductor in the United States District Court for the Central District of California, Southern Division. The case is currently pending. On December 3, 2017, Seoul Semiconductor filed an IPR challenging the validity of certain claims of U.S. Patent No. 6,949,771. This IPR was instituted by the PTAB on June 7, 2018. On December 21, 2017, Seoul Semiconductor filed an IPR challenging the validity of certain claims of U.S. Patent No. 7,256,486. This IPR was instituted by the PTAB on June 21, 2018. On January 25, 2018, Seoul Semiconductor filed an IPR challenging the validity of certain claims of U.S. Patent No. 7,524,087. This IPR was instituted by the PTAB on July 27, 2018. These challenged patents are the patents that are the subject matter of the infringement lawsuit which is still pending as of the date of this Report.

 

On April 13, 2017, DSSthe Company filed a patent infringement lawsuit against Everlight Electronics Co., Ltd. and Everlight Americas, Inc. (collectively, “Everlight”) in the United States District Court for the Eastern District of Texas, Marshall Division, alleging infringement of certain of DSS’sthe Company’s LED patents. DSSThe Company is seeking a judgement for infringement of the patents along with other relief including, but not limited to, money damages, costs and disbursements. On June 8, 2017, DSSthe Company refiled its patent infringement complaint against Everlight in the United States District Court for the Central District of California. The case is currently pending.pending as of the date of this Report. On June 8, 2018, Everlight filed IPR petitions challenging the validity of claims under U.S. Patent Nos. 7256486 and 7524087. On June 12, 2018, Everlight filed an IPR petition challenging the validity of claims under U.S. Patent No. 6949771, and on June 15, 2018, filed an IPR petition challenging the validity of claims under U.S. Patent No 7919787. These challenged patents are the patents that are the subject matter of the infringement lawsuit.

 

On April 13, 2017, DSSthe Company filed a patent infringement lawsuit against Cree, Inc. (“Cree”) in the United States District Court for the Eastern District of Texas, Marshall Division, alleging infringement of certain of DSS’sthe Company’s LED patents. DSSThe Company is seeking a judgement for infringement of the patents along with other relief including, but not limited to, money damages, costs and disbursements. On June 8, 2017, DSSthe Company refiled its patent infringement complaint against Cree in the United States District Court for the Central District of California, and thereafter filed a first amended complaint for patent infringement against Cree in that same court on July 14, 2017. The case is currently pending.pending as of the date of this Report. On June 6, 2018, Cree filed an IPR petition challenging the validity of claims under U.S. Patent No. 7256486. On June 7, 2018, Cree filed IPR petitions challenging the validity of claims under U.S. Patent Nos. 7524087 and 6949771. These challenged patents are the patents that are the subject matter of the infringement lawsuit.

 

On July 13, 2017, DSSthe Company filed a patent infringement lawsuit against Osram GMBH, Osram OPTO Semiconductors GMBH & Co., and Osram Sylvania Inc. (collectively, “Osram”) in the United States District Court for the Central District of California, alleging infringement of certain of DSS’sthe Company’s LED patents. DSS is seeking a judgment for infringement of the patents along with other relief including, but not limited to, money damages, costs and disbursements. The case is currently pending.On February 21, 2018, the Company and Osram executed a confidential settlement agreement ending the litigation between them.

 

On August 15, 2017, DSSthe Company filed a patent infringement lawsuit against Lite-On, Inc., and Lite-On Technology Corporation (collectively, “Lite-On”) in the United States District Court for the Central District of California, alleging infringement of certain of DSS’sthe Company’s LED patents. DSSThe Company is seeking a judgement for infringement of the patents along with other relief including, but not limited to, money damages, costs and disbursements. The case is currently pending.pending as of the date of this Report.

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On December 7, 2017, the Company filed a patent infringement lawsuit against Nichia Corporation and Nichia America Corporation (collectively, “Nichia”) in the United States District Court for the Central District of California, alleging infringement of certain of the Company’s LED patents. The Company is seeking a judgement for infringement of the patents along with other relief including, but not limited to, money damages, costs and disbursements. The case is currently pending as of the date of this Report. On May 10, 2018, Nichia filed an IPR petition challenging the validity of claims under U.S. Patent No. 7919787. On May 11, 2018, Nichia filed an IPR petition challenging the validity of claims under U.S. Patent No. 7652297. On May 25, 2018, Nichia filed an IPR petition challenging the validity of claims under U.S. Patent No. 7524087. On May 29, 2018, Nichia filed an IPR petition challenging the validity of claims under U.S. Patent No. 6949771. On May 30, 2018, Nichia filed an IPR petition challenging the validity of claims under U.S. Patent No. 7256486. These challenged patents are the patents that are the subject matter of the infringement lawsuit.

 

In addition to the foregoing, we may become subject to other legal proceedings that arise in the ordinary course of business and have not been finally adjudicated. Adverse decisions in any of the foregoing may have a material adverse effect on our results of operations, cash flows or our financial condition. The Company accrues for potential litigation losses when a loss is probable and estimable.

Contingent Litigation Payments – The Company retains the services of professional service providers, including law firms that specialize in intellectual property licensing, enforcement and patent law. These service providers are often retained on an hourly, monthly, project, contingent or a blended fee basis. In contingency fee arrangements, a portion of the legal fee is based on predetermined milestones or the Company’s actual collection of funds. The Company accrues contingent fees when it is probable that the milestones will be achieved and the fees can be reasonably estimated. As of SeptemberJune 30, 2017,2018, and December 31, 2016,2017, the Company had not accrued any contingent legal fees pursuant to these arrangements.

Contingent Payments – The Company is party to certain agreements with funding partners who have rights to portions of intellectual property monetization proceeds that the Company receives. As of SeptemberJune 30, 20172018, and December 31, 2016,2017, there are no contingent payments due.

 

On July 31, 2018, the Company and Robert Bzdick entered into a Non-Compete Letter Agreement (the “Agreement”) whereby the parties mutually agreed that Mr. Bzdick’s employment as President of the Company and Chief Executive Officer of Premier Packaging Corporation, a wholly-owned subsidiary of the Company, terminated effective on August 1, 2018. The Agreement voids and replaces Mr. Bzdick’s existing Employment Agreement with the Company, originally dated February 12, 2010, and amended on October 1, 2012, except for the non-competition and non-solicitation covenants contained therein, which have been carried forward in their entirety to the new Agreement. Pursuant to the terms of the Agreement, Mr. Bzdick will receive his regular wages and contractual bonus sum accrued through the separation date, and will also receive the sum of $16,000 per month, for a period of 19 months, as consideration for the two-year non-competition and non-solicitation restrictive covenants contained in the Agreement, which are identical to the restrictive covenants contained in Mr. Bzdick’s previous employment agreement, which are now incorporated by reference into the Agreement. In addition, the Company will continue to pay the cost of Mr. Bzdick’s health, dental and vision insurance coverage for a period of 19 months or until he is eligible for such benefits from another employer, whichever is shorter.

8. Shareholders’9. Stockholders’ Equity

 

On August 26,Stock Options - During the six months ended June 30, 2016, the Company affected a one-for-four reverse stock splitissued an aggregate of 265,000 options to purchase the Company’s common stock. All references in this reportstock at $1.30 per share with a term of five years to the number of shares of our common stockemployees at its technology divisions and to related per-share prices (including references to periods prior toindependent board members. The options vest pro-ratably as follows: 1/3 on the effectivegrant date, 1/3 on the first anniversary of the reverse stock split) reflect this reverse stock split.grant date and 1/3 on the second anniversary of the grant date as long as the employee is employed or direct is active on such dates. The options had an aggregate estimated fair value on the grant date $217,300 using the Black-Scholes-Merton option pricing model with a volatility of 98.1%, a risk free rate of return of 2.67% and zero dividend and forfeiture estimates.

 

Sales of Equity -On August 30, 2017, the Company sold 1,200,000 shares of unregistered common stock and five-year warrants to purchase up to an aggregate of 240,000 additional shares of the Company’s common stock at an exercise price of $1.00 to a total of two related party accredited investors for an aggregate purchase price of $900,000, of which $300,000 was recorded as a subscription receivable as of September 30, 2017.December 31, 2017 in the stockholders equity section. On September 7, 2017,March 29, 2018, the Company sold 133,333 shares of unregistered common stock and five-year warrants to purchase up to an aggregate of 26,667 additional sharesreceived the payment of the Company’s common stock at an exercise price$300,000 subscription receivable from the investor, which is presented net of $1.00 to two related party accredited investors for an aggregate purchase price$12,000 of $100,000. In conjunction with these transactions, the Company recorded $62,000 in related costs for placement agent fees and stock listing fees. The warrants had an estimated aggregate fair value of approximately $112,000 which was determined by utilizing the Black-Scholes-Merton option pricing model with a volatility of 89.3%, a risk free rate of return of 1.7% and zero dividend and forfeiture estimates.financing costs.

 

On September 12, 2017,July 3, 2018, the Company and Hengfai Business Development Pte Ltd. (“HBD”) entered into a Securities Exchange Agreement whereby the Company agreed to issue and sell to HBD 683,000sold 214,286 shares of its common stock, which had a marketpar value on that date of $484,930, in exchange for 21,196,552 ordinary shares and an existing three-year warrant to purchase up to 105,982,759 of common shares at an exercise price of SGD$0.040$0.02 per share, of Singapore eDevelopment Limited (“SED”),to a company incorporated in Singapore and publicly-listed on the Singapore Exchangerelated party accredited investor, Heng Fai Holdings Limited. The SED shares and warrants were owned by HBD. The costpurchase price was $1.40 per share, for total proceeds of the investment was the fair value of the Company’s common stock issued in the transaction which was determined to have the most readily determinable fair value. In conjunction with these transactions, the Company recorded $13,660 in stock listing fees. As of September 30, 2017, and the investment is carried at cost of approximately $485,000.$300,000.

 

During September of 2017, the Company received an aggregate of approximately $176,000 in proceeds from the exercise of warrants for 234,091 shares of the Company’s common stock.

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Restricted Stock - On January 12, 2017, the Company issued an aggregate of 200,000 shares of restricted stock to members of the Company’s management team of which 150,000 vested on May 17, 2017 and had an aggregated grant date fair value of approximately $126,000. The remaining 50,000 will vest if the Company achieves adjusted earnings before interest, taxes, depreciation and amortization (EBITDA) of at least $500,000 and a stock trading price of at least $1.00 per share by the close of the fourth quarter of 2017. In addition, during 2016 the Company issued an aggregate of 224,750 shares of restricted stock to members of the Company’s management team which vested on May 17, 2017 and had an aggregated grant date fair value of approximately $124,000.

 

Stock-Based Payments and Compensation - The Company records stock-based payment expense related to options and warrants based on the grant date fair value in accordance with FASB ASC 718. 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 ninesix months ended SeptemberJune 30, 2017,2018, the Company had stock compensation expense of approximately $203,000$86,000 or less than $0.01 basic and diluted earnings per share ($88,000;191,000; less than $0.01 basic and diluted earnings per share for the corresponding ninesix months ended SeptemberJune 30, 2016)2017).

9.10. Supplemental Cash Flow Information

 

SupplementalThe following table summarizes supplemental cash flow informationflows for the nine monthssix-month periods ended SeptemberJune 30, 20172018 and 2016 is approximately as follows:2017:

 

  2017  2016 
Cash paid for interest $127,000  $163,000 
Non-cash investing and financing activities:        
Gain (loss) from change in fair value of interest rate swap derivatives  10,000  $(22,000)
Common Stock issued for investment  485,000  $- 

Supplemental Cash Information      
  2018  2017 
       
Cash paid for interest $71,000  $85,500 
         
Non-cash investing and financing activities:        
Gain from change in fair value of interest rate swap derivatives $22,000  $5,000 
         
Eliminiation of contingent liabilities through agreement $459,000  $- 

 

10.11. Segment Information

 

The Company’s businesses are organized, managed and internally reported as fourfive operating segments. Two of these operating segments, Packaging and Printing, and Plastics are engaged in the printing and production of paper, cardboard and plastic documents with a wide range of features, including the Company’s patented technologies and trade secrets designed for the protection of documents against unauthorized duplication and altering. The twothree other operating segments, DSS Digital Group, and DSS Technology Management, and DSS International, which was added in 2018, are engaged in various aspects of developing, acquiring, selling and licensing technology assets and are grouped into one reportable segment called Technology.Technology.

 

Approximate information concerning the Company’s operations by reportable segment for the three and ninesix months ended SeptemberJune 30, 20172018 and 20162017 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.

 

Three Months Ended September 30, 2017 Packaging and Printing  Plastics  Technology  Corporate  Total 
Revenue $2,719,000  $1,049,000  $431,000  $-  $4,199,000 
Depreciation and amortization  169,000   30,000   152,000   1,000   352,000 
Stock based compensation  -   -   1,000   11,000   12,000 
Net Income (loss) to common shareholders  304,000   53,000   (397,000)  (237,000)  (277,000)

Three Months Ended June 30, 2018 Packaging and Printing  Plastics  Technology  Corporate  Total 
                
Revenue $2,829,000  $896,000  $362,000  $-  $4,087,000 
Depreciation and amortization  168,000   29,000   150,000   -   347,000 
Interest expense  (23,000)  (5,000)  -   (6,000)  (34,000)
Stock based compensation  -   -   66,000   19,000   85,000 
Net Income (loss)  35,000   (87,000)  3,016,000   (287,000)  2,677,000 

 

Three Months Ended September 30, 2016 Packaging and Printing  Plastics  Technology  Corporate  Total 
Revenue $3,287,000  $1,162,000  $531,000  $-  $4,980,000 
Depreciation and amortization  163,000   29,000   157,000   1,000   350,000 
Stock based compensation  -   -   -   1,000 �� 1,000 
Net Income (loss) to common shareholders  415,000   134,000   (182,000)  (394,000)  (27,000)

Three Months Ended June 30, 2017 Packaging and Printing  Plastics  Technology  Corporate  Total 
                
Revenue $2,157,000  $1,226,000  $477,000  $-  $3,860,000 
Depreciation and amortization  159,000   30,000   157,000   1,000   347,000 
Interest expense  (27,000)  -   (14,000)  (14,000)  (55,000)
Stock based compensation  -   -   14,000   44,000   58,000 
Net Income (loss)  116,000   155,000   (260,000)  (276,000)  (265,000)

 

Nine Months Ended September 30, 2017 Packaging and Printing  Plastics  Technology  Corporate  Total 
Revenue $8,122,000  $3,431,000  $1,276,000  $-  $12,829,000 
Depreciation and amortization  487,000   91,000   462,000   2,000   1,042,000 
Stock based compensation  -   -   38,000   165,000   203,000 
Net Income (loss) to common shareholders  812,000   372,000   (967,000)  (943,000)  (726,000)
Identifiable assets  9,143,000   2,450,000   1,642,000   4,200,000   17,435,000 

Six Months Ended June 30, 2018 Packaging and Printing  Plastics  Technology  Corporate  Total 
                
Revenue $5,747,000  $1,901,000  $817,000  $-  $8,465,000 
Depreciation and amortization  334,000   59,000   299,000   -   692,000 
Interest expense  (46,000)  (11,000)  (12,000)  (14,000)  (83,000)
Stock based compensation  -   -   67,000   19,000   86,000 
Net Income (loss)  281,000   (9,000)  2,523,000   (524,000)  2,271,000 
Identifiable assets  9,048,000   2,947,000   1,113,000   2,034,000   15,142,000 

 

Nine Months Ended September 30, 2016 Packaging and Printing  Plastics  Technology  Corporate  Total 
Revenue $8,871,000  $3,277,000  $1,243,000  $-  $13,391,000 
Depreciation and amortization  469,000   86,000   492,000   2,000   1,049,000 
Stock based compensation  17,000   11,000   19,000   41,000   88,000 
Net Income (loss) to common shareholders  947,000   388,000   (1,242,000)  (1,062,000)  (969,000)
Identifiable assets  9,032,000   2,167,000   2,450,000   207,000   13,856,000 

Six Months Ended June 30, 2017 Packaging and Printing  Plastics  Technology  Corporate  Total 
                
Revenue $5,403,000  $2,383,000  $845,000  $-  $8,631,000 
Depreciation and amortization  319,000   60,000   310,000   1,000   690,000 
Interest Expense  (55,000)  -   (27,000)  (30,000)  (112,000)
Stock based compensation  -   -   37,000   154,000   191,000 
Net Income (loss)  508,000   318,000   (571,000)  (704,000)  (449,000)
Identifiable assets  9,185,000   2,395,000   1,897,000   3,341,000   16,818,000 

17

 

The following tables disaggregate our business segment revenues by major source.

11. Subsequent EventsPrinted Products Revenue Information:

 

On November 1, 2017, the Company issued 500,000 shares of its common stock,

Printed Products Revenue Information   
  Total 
Three months ended June 30, 2018    
Packaging Printing and Fabrication $2,491,000 
Commercial and Security Printing  338,000 
Technology Integrated Plastic Cards and Badges  253,000 
Plastic Cards, Badges and Accessories  643,000 
Total Printed Products $3,725,000 
     
Three months ended June 30, 2017    
Packaging Printing and Fabrication $1,931,000 
Commercial and Security Printing  223,000 
Technology Integrated Plastic Cards and Badges  611,000 
Plastic Cards, Badges and Accessories  618,000 
Total Printed Products $3,383,000 
     
Six months ended June 30, 2018    
Packaging Printing and Fabrication $5,110,000 
Commercial and Security Printing  638,000 
Technology Integrated Plastic Cards and Badges  505,000 
Plastic Cards, Badges and Accessories  1,395,000 
Total Printed Products $7,648,000 
     
Six months ended June 30, 2017    
Packaging Printing and Fabrication $4,865,000 
Commercial and Security Printing  540,000 
Technology Integrated Plastic Cards and Badges  893,000 
Plastic Cards, Badges and Accessories  1,488,000 
Total Printed Products $7,786,000 

18

Technology Sales, Services and a three-year warrant to purchase up to 125,000 additional shares of the Company’s common stock at an exercise price of $1.00 per share, along with a cash payment of $125,000, to Nix, Patterson & Roach LLP (“NPR”), a law firm, for the purpose of settling all accrued and outstanding billed and unbilled invoices for expenses owed by the Company to NPR in connection with various litigation matters handled by NPR on behalf of the Company. The total amount owed to NPR for litigation related expenses was approximately $714,000.Licensing Revenue Information:

  Total 
Three months ended June 30, 2018   
Information Technology Sales and Services $78,000 
Digital Authentication Products and Services  174,000 
Royalties from Licensees  110,000 
Total Technology Sales, Services and Licensing $362,000 
     
Three months ended June 30, 2017    
Information Technology Sales and Services $120,000 
Digital Authentication Products and Services  189,000 
Royalties from Licensees  169,000 
Total Technology Sales, Services and Licensing $478,000 
     
Six months ended June 30, 2018    
Information Technology Sales and Services $208,000 
Digital Authentication Products and Services  351,000 
Royalties from Licensees  257,000 
Total Technology Sales, Services and Licensing $816,000 
     
Six months ended June 30, 2017    
Information Technology Sales and Services $251,000 
Digital Authentication Products and Services  254,000 
Royalties from Licensees  340,000 
Total Technology Sales, Services and Licensing $845,000 

19

ITEM 2 - MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

FORWARD-LOOKING STATEMENTS

 

Certain statements contained herein constitute “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995 (the “1995 Reform Act”). Document Security Systems, Inc. desires to avail itself of certain “safe harbor” provisions of the 1995 Reform Act and is therefore including this special note to enable us to do so. Except for the historical information contained herein, this report contains forward-looking statements (identified by the words “estimate”, “project”, “anticipate”, “plan”, “expect”, “intend”, “believe”, “hope”, “strategy” and similar expressions), which are based on our current expectations and speak only as of the date made. These forward-looking statements are subject to various risks, uncertainties and factors, as previously set forth in the Risk Factors section of our Annual Report on Form 10-K for the year ended December 31, 20162017, that could cause actual results to differ materially from the results anticipated in the forward-looking statements.

 

Overview

 

Document Security Systems, Inc. (referred to in this report as “Document Security Systems”, “DSS”, “we”, “us”, “our” or “Company”) has strategically focused its core business efforts on developing and selling anti-counterfeiting technologies and solutions. We emphasize fraud and counterfeit prevention for all forms of printed documents and digital information. The Company holds numerous patents for optical deterrent technologies that provide protection of printed information from unauthorized scanning and copying. We operate two production facilities, consisting of a combined security printing and packaging facility and a plastic card facility where we produce secure and non-secure documents for our customers. We license our anti-counterfeiting technologies to printers and brand-owners. In addition, we have a digital division which provides cloud computing services for our customers, including disaster recovery, back-up and data security services. In 2013, the Company expanded its business focus by merging with DSS Technology Management, Inc., formerly known as Lexington Technology Group, Inc., which acquires intellectual property assets and interests in companies owning intellectual property assets for the purpose of monetizing these assets through a variety of value-enhancing initiatives, including, but not limited to, investments in the development and commercialization of patented technologies, licensing, strategic partnerships and commercial litigation.

 

20

We do business in fourfive operating segments as follows:

 

DSS Packaging and Printing Group - Produces custom paperboard packaging serving clients in the pharmaceutical, beverage, photo packaging, toy, specialty foods and direct marketing industries, among others. The group also provides secure and commercial printing services for end-user customers along with technical support for our technology licensees. The division produces a wide array of printed materials such as security paper, vital records, prescription paper, birth certificates, receipts, manuals, identification materials, entertainment tickets, secure coupons, parts tracking forms, brochures, direct mailing pieces, catalogs, business cards, etc. The division also provides resources and production equipment resources for our ongoing research and development of security printing and related technologies.

 

DSS Plastics Group - Manufactures laminated and surface printed cards which can include magnetic stripes, bar codes, holograms, signature panels, invisible ink, micro fine printing, guilloche patterns, biometric, radio frequency identification (RFID) and watermarks for printed plastic documents such as ID cards, event badges, and driver’s licenses.

 

DSS Digital Group - Provides data center centric solutions to businesses and governments delivered via the “cloud”. This division developedDevelops and markets digital authentication solutions, including AuthentiGuard, an iPhonea smartphone based application system that integrates traditional printed optical deterrent technologies with proprietary digital data security based solutions for brand protection and product diversion prevention.

 

DSS and DSS Technology Management - Acquires or internally develops patented technology or intellectual property assets (or interests therein), with the purpose of monetizing these assets through a variety of value-enhancing initiatives, including, but not limited to, investments in the development and commercialization of patented technologies, licensing, strategic partnerships and commercial litigation. Since 2013,As previously reported by the Company, both the Company and its wholly-owned subsidiary, DSS Technology Management, has been involved in several patent litigation lawsuits, and as of the date of this filing, hascurrently maintain active litigation against several companies, as summarized below.

On November 26, 2013, DSS Technology Management filed suit against Apple, Inc. (“Apple”) in the United States District Court for the Eastern District of Texas, for patent infringement (the “Apple Litigation”). The complaint alleges infringement by Apple of DSS Technology Management’s patents that relate to systems and methods of using low power wireless peripheral devices DSS Technology Management is seeking a judgment for infringement, injunctive relief, and compensatory damages from Apple. On October 28, 2014, the case was stayed by the District Court pending a determination of Apple’s motion to transfer the case to the Northern District of California. On November 7, 2014, Apple’s motion to transfer the case to the Northern District of California was granted. On December 30, 2014, Apple filed twoInter Partes Review(“IPR”) petitions with the Patent Trial and Appeal Board (“PTAB”) for review of the patents at issue in the case. The PTAB instituted the IPRs on June 25, 2015. The California District Court then stayed the case pending the outcome of those IPR proceedings. Oral arguments of the IPRs took place on March 15, 2016, and on June 17, 2016, PTAB ruled in favor of Apple on both IPR petitions. DSS Technology Management has filed an appeal with the U.S. Court of Appeals for the Federal Circuit (the “Federal Circuit”) seeking reversal of the PTAB decisions. Oral arguments for the appeal were held on August 9, 2017, and the appeal is still pending as of the date of this Report. The patent assets underlying this matter had no carrying value as of the date of the PTAB decision and therefore, there were no impairment considerations as a result of the decision.

On February 16, 2015, DSS Technology Management filed suit in the United States District Court, Eastern District of Texas, against defendants Intel Corporation, Dell, Inc., GameStop Corp., Conn’s Inc., Conn Appliances, Inc., NEC Corporation of America, Wal-Mart Stores, Inc., Wal-Mart Stores Texas, LLC, and AT&T, Inc. The complaint alleges patent infringement and seeks judgment for infringement of two of DSSTM’s patents, injunctive relief and money damages. On December 9, 2015, Intel filed IPR petitions with PTAB for review of the patents at issue in the case. Intel’s IPRs were instituted by PTAB on June 8, 2016. On June 1, 2017, the PTAB ruled in favor of Intel for all the challenged claims. On July 28, 2017, DSS Technology Management filed a notice of appeal of the PTAB’s decision relating to U.S. Patent 6,784,552 with the Federal Circuit. The Intel litigation has been stayed by the District Court pending final determination of the IPR proceedings.

On July 16, 2015, DSS Technology Management filed three separate lawsuits in the United States District Court for the Eastern District of Texas alleging infringement of certain of its semiconductor patents. The defendants are SK Hynixet al.,Samsung Electronicset al.,and Qualcomm Incorporated. Each respective complaint alleges patent infringement and seeks judgment for infringement, injunctive relief and money damages. On November 12, 2015, SK Hynix filed an IPR petition with PTAB for review of the patent at issue in their case. SK Hynix’s IPR was instituted by the PTAB on May 11, 2016. On August 16, 2016, DSS Technology Management and SK Hynix entered into a confidential settlement agreement ending the litigation between them. The pending SK Hynix IPR was then terminated by mutual agreement of the parties on August 31, 2016. On March 18, 2016, Samsung also filed an IPR petition, which was instituted by the PTAB. On September 20, 2017, PTAB ruled in favor of Samsung for all the challenged claims relating to U.S. Patent 6,784,552. DSS Technology Management intends to appeal this PTAB ruling to the Federal Circuit. Qualcomm filed its IPR proceeding on July 1, 2016, which was then later joined with Intel’s IPRs in August 2016 by PTAB. On June 1, 2017, the PTAB ruled in favor of Intel/Qualcomm for all the challenged claims. On July 28, 2017, DSS Technology Management filed a notice of appeal of the PTAB’s decision relating to U.S. Patent 6,784,552 with the Federal Circuit. The appeal is still pending as of the date of this Report.

In April and July of 2017, Document Security Systems filed patent infringement lawsuits against variousnumerous defendants, relatingincluding, but not limited to, DSS’s Light-Emitting Diode patents. Those cases were previously disclosedagainst Apple, Inc., Seoul Semiconductor Co., Ltd.et. al., Everlight Electronics Co., Ltd.et. al., Cree, Inc., Lite-On, Inc.et. al. and Nichia Corporationet. al.

DSS International - Assists in development and marketing of the Company’s digital authentication products in the Company’s second quarter Report on Form 10-Q In August of 2017, Document Security Systems filed another patent infringement suit relating to its Light-Emitting Diode patents, the specifics of which are disclosed in this Report in Part II, Item 1 Legal Proceedings.Hong Kong market.

 

Results of Operations for the Three and NineSix Months Ended SeptemberJune 30, 20172018 as compared to the Three and NineSix Months Ended SeptemberJune 30, 20162017

This discussion should be read in conjunction with the financial statements and footnotes contained in this quarterly reportQuarterly Report and in our Annual Report on Form 10-K for the year ended December 31, 2016.2017.

Revenue

 

 Three Months Ended September 30, 2017 Three Months Ended September 30, 2016 % change Nine Months Ended September 30, 2017 Nine Months Ended September 30, 2016 % change  Three Months Ended June 30, 2018 Three Months Ended June 30, 2017 %
change
 Six Months Ended June 30, 2018 Six Months Ended June 30, 2017 %
change
 
Revenue                                     
Printed products $3,767,000  $4,449,000   -15% $11,553,000  $12,148,000   -5% $3,725,000  $3,382,000   10% $7,648,000  $7,786,000   -2%
Technology sales, services and licensing  432,000   531,000   -19%  1,276,000   1,243,000   3%  362,000   478,000   -24%  817,000   845,000   -3%
                        
Total revenue $4,199,000  $4,980,000   -16% $12,829,000  $13,391,000   -4% $4,087,000  $3,860,000   6% $8,465,000  $8,631,000   -2%

 

For the three months ended SeptemberJune 30, 2017,2018, total revenue was approximately $4.2$4.1 million, a decreasean increase of 16%6% from the corresponding three months ended SeptemberJune 30, 2016.2017. Revenues from the sale of printed products decreased 15%increased 10% during the three months ended SeptemberJune 30, 2017,2018, as compared to the same period in 2016,2017, primarily due to a decreaseincreases in orders fromsales for packaging, printing, and fabrication, and security printing for the Company’s largest packaging customer.Printed Products group. Technology sales, services and licensing revenue decreased 19%24% during the three months ended SeptemberJune 30, 20172018 as compared to the same period in 2016, which primarily reflected the impact of a $150,000 one-time license the Company realized in the 2016 period that did not occur in the 2017, period. Absent this item, this revenue category would have increased approximately 13% during the three months ended September 30, 2107 primarily due to an increasedeclines in revenue generated bylicensing royalties and general IT services. Revenues for the Company’s AuthentiGuard product line.

For the ninesix months ended SeptemberJune 30, 2017, total revenue was approximately $12.82018 decreased from $8.6 million to $8.5, representing a decreasedecline of 4% from2%. Printed products revenues for the corresponding ninesix months ended SeptemberJune 30, 2016. Revenues from the sale of printed products decreased 5% during the nine months ended September 30, 2017,2018 were down by 2% as compared to the same period in 2016,2017, primarily due to a decreasedecline in orders from the Company’s largest packaging customer.sales for commercial and security printing and technology integrated plastic cards and badges, while Technology sales, services and licensing revenue increaseddecreased by 3% during the nine months ended September 30, 2017 as compared to the same period, primarily resulting from a decline in 2016, which primarily reflected an increase in revenue generated by the Company’s AuthentiGuard product line.general IT services and royalty licensing revenues.

21

 

Costs and expenses

 

  Three Months
Ended September 30, 2017
  Three Months
Ended September 30, 2016
  % change  Nine Months Ended
September 30, 2017
  Nine Months Ended
September 30, 2016
  % change 
Costs and expenses                        
Costs of goods sold, exclusive of depreciation and amortization $2,401,000  $2,875,000   -16% $7,380,000  $7,816,000   -6%
Sales, general and administrative compensation  920,000   1,081,000   -15%  2,761,000   3,082,000   -10%
Depreciation and amortization  352,000   349,000   1%  1,042,000   1,049,000   -1%
Professional fees  198,000   162,000   22%  556,000   704,000   -21%
Stock based compensation  12,000   2,000   500%  203,000   88,000   131%
Sales and marketing  117,000   79,000   48%  292,000   245,000   19%
Rent and utilities  167,000   164,000   2%  462,000   449,000   3%
Other operating expenses  205,000   222,000   -8%  561,000   695,000   -19%
                         
Total costs and expenses $4,372,000  $4,934,000   -11% $13,257,000  $14,128,000   -6%

  Three Months Ended June 30, 2018  Three Months Ended June 30, 2017  % change  Six Months Ended June 30, 2018  Six Months Ended June 30, 2017  % change 
Costs and expenses                        
Costs of goods sold, exclusive of depreciation and amortization $2,756,000  $2,191,000   26% $5,338,000  $4,979,000   7%
Sales, general and administrative compensation  855,000   842,000   2%  1,822,000   1,740,000   5%
Depreciation and amortization  347,000   348,000   0%  692,000   690,000   0%
Professional fees  352,000   196,000   80%  585,000   358,000   63%
Stock based compensation  85,000   58,000   47%  86,000   191,000   -55%
Sales and marketing  121,000   81,000   49%  214,000   176,000   22%
Rent and utilities  161,000   144,000   12%  316,000   295,000   7%
Other operating expenses  222,000   126,000   76%  457,000   354,000   29%
Research and development  6,000   42,000   -86%  105,000   102,000   3%
                         
Total costs and expenses $4,905,000  $4,028,000   22% $9,615,000  $8,885,000   8%

 

Costs of goods sold, exclusive of depreciation and amortization includes all direct costs of printed products revenues, including materials, direct labor, transportation and manufacturing facility costs. In addition, this category includes all direct costs associated with technology sales, services and licensing including hardware and software that are resold, and fees paid to inventors or others as a result of technology licenses or settlements, if any. Costs of goods sold decreasedincreased by 16%26% during the three months ended SeptemberJune 30, 20172018 as compared to the same period in 2016. The decrease on2017, primarily due to an increase in outside services used by our packaging division, and a general increase in material costs as a percentage basis was offset by a 16% decrease in revenues overof the same period.printed products groups’ total direct costs. For the ninesix months ended SeptemberJune 30, 2017,2018, costs of goods sold decreasedincreased by 6%, which was greater than the decrease in revenue on a percentage basis, for7% as compared to the same period which reflected the improving gross margin of the Company’s sales mix as it sees a higher percentage of its sales derived from technology based products.in 2017.

Sales, general and administrative compensation costs, excluding stock-based compensation, decreased 15%increased 2% and 10%5%, respectively, during the three and ninesix months ended SeptemberJune 30, 2017,2018, as compared to the same periods in 2016,2017, primarily due to the impactaddition of $207,500payroll and consulting costs for the Company’s office in Hong Kong, and increases in salaries for sales personnel and to certain members of compensation cost sharing amounts received by the CompanyCompany’s senior management team.

Depreciation and amortization includes the depreciation of machinery and equipment used for production, depreciation of office equipment and building and leasehold improvements, amortization of software, and amortization of acquired intangible assets such as customer lists, trademarks, non-compete agreements and patents, and internally developed patent assets. For the three and six months ended June 30, 2018, depreciation and amortization expense was relatively flat as compared to the same periods in conjunction with an intellectual property monetization program management arrangement the Company entered into in November of 2016 for which the Company received funds to offset certain of its compensation expenses associated with the monetization program.2017.

 

Professional fees increased 22%80% and 63%, respectively, during the three and six months ended SeptemberJune 30, 2017,2018, as compared to the same periodperiods in 2016. The increase is primarily due to the addition of investor relations and sales and marketing consultants. For the nine months ended September 30, 2017, professional fees decreased by 21% as compared to the same period in 2016 as a result of a significant reductionincreases in consulting services for the Technology group, new consulting services for DSS International, and increases in legal fees incurred by the Company.services for patent litigation.

 

Stock-based compensation includes expense charges for all stock-based awards to employees, directors and consultants. Such awards include option grants, warrant grants, and restricted stock awards. Stock-based compensation increased 500% and 131%, respectively,47% during the three and nine months ended SeptemberJune 30, 2017,2018, as compared to the same periodsperiod in 2016,2017, due to the costs of restricted stock grantsgranted to various employees during the second quarter of 2018. For the six months ended June 30, 2018, stock-based compensation decreased by 55%, as compared to the same period in 2017, due to a decline in restricted stock granted to certain management membersmember during the fourth quarter of 2016 and the first quarter of 2017 that have vested during 2017.2018.

22

 

Sales and marketing costs, which includesinclude internet and trade publication advertising, travel and entertainment costs, sales-broker commissions, and trade show participation expenses increased 48%49% and 19%22%, respectively, during the three and ninesix months ended SeptemberJune 30, 20172018 as compared to the three and ninesix months ended SeptemberJune 30, 2016, primarily due to increased travel and entertainment2017, resulting from an increase in marketing costs related tofor the Company’s 2017 shareholders’ meeting.Company.

 

Rent and utilities increased by 2%12% and 3%7%, respectively, during the three and ninesix months ended SeptemberJune 30, 2017,2018, as compared to the same periods in 2016,2017, primarily due to increasesan increase in rentstorage space rental costs forat the Company.Company’s packaging division.

Other operating expenses consist primarily of equipment maintenance and repairs, office supplies, IT support, bad debt expense and insurance costs. Other operating expenses decreasedincreased by 7%76% and 19%29%, respectively, during the three and ninesix months ended SeptemberJune 30, 2017,2018, as compared to the same periods in 2016,2017, primarily as the result of increases in equipment maintenance and repairs and software expenses.

Research and development costs consist primarily of compensation costs for research personnel, third-party research costs, and consulting costs. During the three months ended June 30, 2018, Research and development costs decreased 86% as compared to the same period in 2017 due to a decreasedecline in insuranceresearch and development salaries for the Technology group. For the six months ended June 30, 2018, research and development costs office expenses andincreased 3% primarily due to development costs related to the write-offdevelopment of previously expensed customer related fees.proprietary block chain solutions for DSS International.

 

Other Income and Expense

 

  Three Months
Ended September 30, 2017
  Three Months
Ended September 30, 2016
  % change  Nine Months
Ended September 30, 2017
  Nine Months
Ended September 30, 2016
  % change 
                   
Other expenses                        
Interest expense $(58,000) $(68,000)  -15% $(171,000) $(218,000)  -22%
Amortized debt discount  (41,000)  -   100%  (113,000)  -   100%
Other expense $(99,000) $(68,000)  46% $(284,000) $(218,000)  30%

  Three Months Ended June 30, 2018  Three Months Ended June 30, 2017  % change  Six Months Ended June 30, 2018  Six Months Ended June 30, 2017  % change 
                   
Other income and expense                        
Interest income $3,000  $-   NA  $6,000  $-   NA 
Interest expense  (34,000)  (55,000)  -38%  (83,000)  (112,000)  -26%
Amortized debt discount  (6,000)  (37,000)  -84%  (34,000)  (72,000)  -53%
Gain on extinguishment of liabilities, net  3,533,000   -   NA   3,533,000   -   NA 
Total other income and expense $3,496,000  $(92,000)  -3900% $3,422,000  $(184,000)  -1960%

The company recognized interest income on the money market account, in the amount of $3,000 during the six months ended June 30, 2018.

 

Interest expense decreased 15%38% and 22%26%, respectively, during the three and ninesix months ended SeptemberJune 30, 2017,2018, as compared to the same periods in 2016,2017, due to a decrease in the total debt carried by the Company in 20172018 as compared to 2016. 2017.

Amortized debt discount amounts decreased 84% and 53%, respectively, during the three and six months ended June 30, 2018, as compared to the same period in 2017, are due to a decrease in the commencement oftotal debt discount amortization related to a funding agreement entered intocarried by the Company duringin 2018 as compared to 2017.

Gain on extinguishment of liabilities, net -On June 26, 2018, the fourth quarterCompany reached an agreement with one of 2016.its third-party IP monetization co-investors that, among other things, discharged the amounts recorded as liabilities by the Company under an agreement executed in 2014. As a result this agreement, the Company recorded a gain of extinguishment of liabilities of $3,714,129 to reflect the discharge of the notes, a write down of other current labilities of $114,000 to reflect the elimination the contingent equity interests of $459,000 offset by the repayment of the $345,000 restricted cash, and the Company wrote-off the value of the underlying patents which had a net book value of $295,470, all of which resulted in the a net gain on the extinguishment of liabilities of $3,532,659 recorded in the period ended June 30, 2018.

23

Net Loss

 

  Three Months Ended September 30, 2017  Three Months Ended September 30, 2016  % change  Nine Months Ended September 30, 2017  Nine Months Ended September 30, 2016  % change 
                   
Net loss $(277,000) $(27,000)  926% $(726,000) $(969,000)  -25%
                         
Loss per common share:                        
Basic and diluted $(0.02) $(0.00)  100% $(0.05) $(0.07)  -29%
  Three Months Ended June 30, 2018  Three Months Ended June 30, 2017  % change  Six Months Ended June 30, 2018  Six Months Ended June 30, 2017  % change 
                   
Net income (loss) $2,677,000  $(265,000)  -1110% $2,271,000  $(449,000)  -606%
                         
Income (loss) per common share:                        
Basic $0.16  $(0.02)  -900% $0.14  $(0.03)  -567%
Diluted $0.16  $(0.02)  -900% $0.13  $(0.03)  -533%
                         
Shares used in computing income (loss) per common share:                        
Basic  16,599,327   13,664,503   21%  16,599,327   13,644,559   22%
Diluted  16,842,204   13,664,503   23%  16,882,450   13,644,559   24%

 

For the three and six months ended SeptemberJune 30, 2017,2018, the Company recorded net loss wasincome of approximately $277,000, a 926% increase from$2.7 million and $2.3 million, respectively, as compared to a net loss of $27,000$265,000 and $449,000, respectively, during the three and six months ended SeptemberJune 30, 2016. The increase in2017. This net lossgain is primarily due to the impact of significant decreasesnet gain from extinguishment of liabilities of approximately $3.5 million which occurred during the second quarter of 2018, offset by operating losses incurred during the respective periods. The increases in packaging sales. Foroperating losses incurred during the ninethree and six months ended SeptemberJune 30, 2018 as compared to the same periods ended June 30, 2017 net loss was approximately $726,000,primarily reflect an increase in direct costs as a decreasepercentage of 25% from a net loss of $969,000sales at the Company’s printed products divisions, an increase in professional fees and an increase in costs associated with the nine months ended September 30, 2016. The decreaseCompany’s expansion into Asia by opening an office in net loss is primarily due to the combined impact of increases in technology card sales and AuthentiGuard sales, in addition to an overall reduction in operating costs.Hong Kong on January 1, 2018

 

LIQUIDITY AND CAPITAL RESOURCES

 

As of SeptemberJune 30, 2017,2018, the Company had cash of approximately $4,223,000$3,051,593 and restricted cash of approximately $336,000. In addition, the Company had $800,000 available to its packaging division under a revolving credit line. While the Company has a negative net working capital of approximately $1.5 million as of September 30, 2017, approximately $3,612,000 of short-term debt and $450,000 of short term other liabilities which are due in February 2018 can be settled by the Company by the transfer and assignment of certain of the Company’s patent assets and therefore, will not require the use of the Company’s cash or other current assets to settle.$141,351. As of SeptemberJune 30, 2017,2018, the Company believes that it has sufficient cash to meet its cash requirements for at least the next 12 months from the filing date of this Report.quarterly report. In addition, the Company believes that it will have access, if needed, to sources of capital from the sale of its equity securities and debt financings.

 

Operating Cash Flow – During the first ninesix months of 2017,ended June 30, 2018, the Company used approximately $1.4 million$450,000 of cash for operations as compared to the generationuse of $800,000 in cash by operationfor operations during the first ninesix months of 2016 of approximately $384,000.ended June 30, 2017. The significant increasedecrease in operating cash use in 2017 was primarily due to the use of cash to pay-down accounts payablefor operations generally reflects decreases in inventory and accrued expenses, an increase in net restricted cash of approximately $159,000 during 2017, and the build-up of inventoryaccount payables carried by the Company’s packaging division in anticipationCompany for the first six months of sales in2018 as compared to the fourth quarterfirst six months of 2017.

 

Investing Cash Flow – During the first ninesix months of 2017,ended June 30, 2018, the Company expended approximately $438,000$311,000 on equipment for its packaging and plastic card operations and approximately $5,000$20,000 for the prosecution of several patent applications. During the first nine months of 2016, the Company expended approximately $193,000 on equipment for its packaging and plastic card operations and approximately $73,000 for the prosecution of several patent applications. The Company also received $495,000 for the sale of certain of its patent assets in conjunction with a settlement with a former litigant in one of the Company’s patent infringement suits.

 

Financing Cash Flows - During the first ninesix months of 2017,ended June 30, 2018, the Company made aggregate principal payments for long-term debt of approximately $612,000,$758,000, which included a one-time payment of $345,000 as part of a final settlement of one debt agreement, and received proceeds of approximately $783,000$288,000 from the salecollection of the Company’s common stock.subscription receivable.

 

Off-Balance Sheet Arrangements

 

We do not have any off-balance sheet arrangements that have, or are reasonably likely to have, an effect on our financial condition, financial statements, revenues or expenses.

 

Critical Accounting Policies and Estimates

 

As of SeptemberJune 30, 2017,2018, our critical accounting policies and estimates have not changed materially from those set forth in our Annual Report on Form 10-K for the year ended December 31, 2016.2017. Refer to Note 2 of the Notes to Consolidated Condensed Financial Statements included in this report for the Company’s Critical accounting policies with respect to revenue recognition. For a complete discussion of the Company’s other critical accounting policies, refer to the Company’s Annual Report on Form 10-K for the year ended December 31, 2017.

 

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ITEM 4 - CONTROLS AND PROCEDURES

 

Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of our disclosure controls and procedures for the quarter ended June 30, 2017,2018, pursuant to Rule 13a-15(e) and Rule 15d-15(e) promulgated under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Based on this evaluation and on the material weakness disclosed in our Annual Report on Form 10-K for the year ended December 31, 20162017 which remained as of SeptemberJune 30, 2017,2018, our principal executive officer and principal financial officer concluded that as of SeptemberJune 30, 2017,2018, our disclosure controls and procedures were not effective to ensure that information required to be disclosed by us in reports filed or submitted under the Securities Exchange Act is being recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, and that our disclosure controls are not effectively designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Securities Exchange Act is being accumulated and communicated to management, including our principal executive officer and principal financial officer, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.

 

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation.

 

Plan for Remediation of Material Weaknesses

 

In response to the identified material weaknesses identified above, management, with oversight from the Company’s audit committee, plans to continue to monitor and review our control environment and to evaluate whether cost effective solutions are available to remedy the identified material weaknesses by expanding the resources available to the financial reporting process.

 

Changes in Internal Control over Financial Reporting

 

There have been no changes to our internal controls over financial reporting as defined in Rule 13a-15(f) and Rule 15d-15(f) of the Exchange Act during the second quarter of 20172018 that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.

 

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PART II

OTHER INFORMATION

 

ITEM 1 - LEGAL PROCEEDINGS

 

On August 15, 2017, Document Security Systems,March 23, 2018, in connection with the pending patent infringement litigation matter between the Company’s wholly-owned subsidiary, DSS Technology Management, Inc. (“DSS”DSSTM”) filed a patent infringement lawsuit against Lite-On,and defendant Apple, Inc., and Lite-On Technology Corporation (“Apple”) in the United StatesU.S. District Court for the CentralNorthern District of California alleging infringement(the “District Court”), the U.S. Court of Appeals for the Federal Circuit (the “Federal Circuit”) entered judgment in favor of DSSTM reversing a previous ruling made by the Patent Trial and Appeal Board (the “PTAB”), which was favorable to defendant Apple, finding that PTAB erred when it found certain claims of DSS’s LED patents. DSS is seeking a judgementDSSTM’s U.S. Patent No. 6,128,290 to be unpatentable. The Federal Circuit affirmed its decision on July 12, 2018, when it denied Apple’s petition for infringementpanel rehearing of the patents along with other relief including, but not limited to, money damages, costsFederal Circuit’s Opinion and disbursements. The case is currently pending as ofJudgement issued on March 23, 2018. On July 27, 2018, the date of this Report.District Court judge lifted the Stay resuming the litigation.

 

ITEM 1A - RISK FACTORS

 

There have been no material changes to the discussion of risk factors previously disclosed in our most recently filed Annual Report on Form 10-K.10-K for the year ended December 31, 2017.

 

ITEM 2 - UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

 

On November 1, 2017,July 3, 2018, the Company issued 500,000closed the sale of 214,286 shares of its common stock, par value $0.02 per share, (the “Common Stock”) andto a three-year warrant torelated party accredited investor, Heng Fai Holdings Limited. The purchase up to 125,000 additional shares of the Company’s Common Stock at an exercise price of $1.00was $1.40 per share, (the “Warrant”), and also made a cash paymentfor total proceeds of $125,000, to Nix, Patterson & Roach LLP (“NPR”), a law firm, for the purpose of settling all accrued and outstanding billed and unbilled invoices for expenses owed by the Company to NPR$300,000. The common stock sold in connection with various litigation matters handled by NPR on behalf of the Company. The total amount owed to NPR for litigation related expenses was approximately $714,000. The Warrant doesthis transaction has not provide for a cashless exercise feature.

Neither the Common Stock, the Warrant, nor the Common Stock issuable upon exercise of the Warrant (collectively, the “Securities”) have been registered under the Securities Act of 1933, as amended (the “Securities Act”), and were issuedwas sold in reliance upon the exemption from registration contained in Section 4(2)4(a)(2) of the Securities Act. These Securities may not be offered or sold by the recipient in the United States in the absence of an effective registration statement or an applicable exemption from registration requirements.

 

ITEM 3 - DEFAULTS UPON SENIOR SECURITIES

 

None.

 

ITEM 4 – MINE SAFETY DISCLOSURES

 

None.

 

ITEM 5 - OTHER INFORMATION

 

None.

 

ITEM 6 – EXHIBITS

 

Exhibit Number Exhibit Description
31.1 Rule 13a-14(a)/15d-14(a) Certification of Chief 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 Sarbanes Oxley Act of 2002.*
32.2 Certification of Chief Financial Officer as required by 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes Oxley Act of 2002.*

 

101.INSXBRL Instance Document*
101.SCHXBRL Taxonomy Extension Schema Document*
101.CALXBRL Taxonomy Extension Calculation Linkbase Document*
101.DEFXBRL Taxonomy Extension Definition Linkbase Document*
101.LABXBRL Taxonomy Extension Label Linkbase Document*
101.PREXBRL Taxonomy Extension Presentation Linkbase Document*

 

*Filed herewith.

 

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SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

 DOCUMENT SECURITY SYSTEMS, INC.
     
November  August 14, 20172018By:/s/ Jeffrey Ronaldi
    

Jeffrey Ronaldi

Chief Executive Officer (Principal Executive Officer)

     
November  August 14, 20172018By:/s/ Philip Jones
    

Philip Jones

Chief Financial Officer (Principal Financial and Accounting Officer)

 

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