(Exact
name of registrant as specified in Its charter)
Delaware
35-2208007
(State
or other jurisdiction of
(IRS
Employer
incorporation
or organization)
Identification
Number)
9478
West Olympic Blvd
90212
(Address
of principal executive offices)
(Zip
Code)
(310)
203-9855
(Registrant’s
telephone number, including area code)
Securities
registered pursuant to Section 12(b) of the Act:
(None)
Securities
registered pursuant to Section 12(g) of the Act:
Common
Stock, par value $0.001
(Title
of
Class)
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 o
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of “accelerated
filer and large accelerated filer” in Rule 12b-2 of the Exchange
Act).
Large accelerated filer o
Accelerated filer o
Non-accelerated filer x
Indicate
by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act).
Yes
o
No x
Indicate
the number of shares outstanding of each of the issuer’s classes of common stock
as of the latest practicable date:
Series
B convertible preferred stock, $1.00 par value, 3,400
shares designated, 3,400 shares issued and
outstanding with a liquidation preference of $3,400
2,967
2,967
Series
D convertible preferred stock, $1.00 par value, 2,000 shares designated,
2,000 shares issued and outstanding
with a liquidation preference of $2,000
1,931
1,931
Series
E convertible preferred stock, $1.00 par value, 2,500 shares designated,
2,500 shares issued and outstanding
with a liquidation preference of $2,500
2,488
2,488
Common
stock, $0.001 par value, 20,000 shares authorized; 4,808 and 4,808
shares
issued and outstanding as of December 31, 2006 and June 30, 2006,
respectively
5
5
Additional
paid in capital
8,787
8,788
Accumulated
deficit
(19,433
)
(17,004
)
Total
stockholders’ deficit
(3,255
)
(825
)
Total
liabilities and stockholders’ deficit
$
8,324
$
19,794
See
accompanying notes to unaudited interim financial
statements
Unaudited
Interim Financial Information.
The
accompanying unaudited interim financial statements have been prepared in
accordance with the rules and regulations of the Securities and Exchange
Commission for the presentation of interim financial information, but do not
include all the information and footnotes required by accounting principles
generally accepted in the United States of America. The balance sheet as of
June30, 2006 has been derived from the audited financial statements of Superior
Galleries, Inc. (“Superior” or the “Company”) at that date.
In
the
opinion of management, all adjustments considered necessary for a fair
presentation have been included. Operating results for the six month and
three-month period ended December 31, 2006 are not necessarily indicative of
the
results that may be expected for the year ending June 30, 2007. For further
information, refer to the financial statements for the year ended June 30,2006
contained in Superior’s financial statements included in its Annual Report on
Form 10-K filed on September 28, 2006.
Cash
and Cash Equivalents
The
Company considers all highly liquid investments with original maturities of
three months or less when purchased to be cash equivalents. The Company places
its cash with high credit quality institutions. The Federal Deposit Insurance
Corporation (“FDIC”) insures cash accounts at each institution for up to
$100,000. From time to time, the Company maintains cash in excess of the FDIC
limit.
Accounts
Receivable
The
Company evaluates specific accounts receivable balances when it becomes aware
of
a situation where a client may not be able to meet its financial obligations
to
the Company, as indicated by delinquent payments. The amount of the required
allowance is based on the facts available to the Company and is reevaluated
and
adjusted as additional information is available, including its right to offset
debts with accounts payable balances and the proceeds from consigned inventory
sales. Allowances are also established for probable loss inherent in the
remainder of the accounts receivable based on a factor of 0.1% of total gross
sales. As of December 31, 2006, the Company had an allowance of
$821,000.
Inventories
Inventories
consisting of rare coins, bullion and second-hand jewelry are stated (on a
specific identification basis) at the lower of cost or fair market value. As
of
December 31, 2006, the Company’s inventory had a fair market value reserve of
$490,000, set primarily against graded coins.
Property
and Equipment
Property
and equipment are stated at cost and are depreciated or amortized (as
applicable) using the straight-line method over the estimated useful lives
of
the related assets, ranging from two to seven years. Maintenance and repairs
are
charged to expense as incurred. Significant renewals and betterments are
capitalized. At the time of retirement or other disposition of property and
equipment, the cost and accumulated depreciation and amortization are removed
from the accounts and any resulting gain or loss is reflected in
operations.
1.Basis
of Presentation and Accounting Policies (continued)
Property
and Equipment (continued)
The
Company assesses the recoverability of property and equipment by determining
whether the depreciation and amortization of property and equipment over its
remaining life can be recovered through projected un-discounted future cash
flows. The amount of property and equipment impairment, if any, is measured
based on fair value and is charged to operations in the period in which property
and equipment impairment is determined by management. At December 31, 2006
and
June 30, 2006, management of the Company has not identified any impaired
assets.
Use
of Estimates
The
preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America 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 reported periods. Actual results could materially differ from those
estimates. Areas where significant estimation is involved include, but are
not
limited to, the evaluation of the collectibility of accounts receivable, auction
and customer advances, the realizability and valuation of inventories, and
valuation of stock-based compensation.
Revenue
Recognition
The
Company generates revenue from wholesale and retail sales of rare coins,
precious metals bullion and second-hand jewelry. The recognition of revenue
varies for wholesale and retail transactions and is, in large part, dependent
on
the type of payment arrangements made between the parties. We recognize sales
on
an F.O.B. shipping point basis.
The
Company sells rare coins to other wholesalers/dealers within its industry on
credit, generally for terms of 14 to 60 days, but in no event greater than
one
year. The Company grants credit to new dealers based on extensive credit
evaluations and for existing dealers based on established business relationships
and payment histories. The Company generally does not obtain collateral with
which to secure its accounts receivable when the sale is made to a dealer.
The
Company maintains reserves for potential credit losses based on an evaluation
of
specific receivables and the Company’s historical experience related to credit
losses. As of December 31, 2006 and June 30, 2006, management has
established an accounts receivable reserve of $821,000 and $363,000,
respectively.
Revenues
for monetary transactions (i.e., cash and receivables) with dealers are
recognized when the merchandise is shipped to the related dealer.
The
Company also sells rare coins to retail customers on credit, generally for
terms
of 30 to 60 days, but in no event greater than one year. The Company grants
credit to retail customers based on extensive credit evaluations and for
existing retail customers based on established business relationships and
payment histories. When a retail customer is granted credit, the Company
generally collects a payment of 25% of the sales price, establishes a payment
schedule for the remaining balance and holds the merchandise as collateral
as
security against the customer’s receivable until all amounts due under the
credit arrangement are paid in full. If the customer defaults in the payment
of
any amount when due, the Company may declare the customer’s obligation in
default, liquidate the collateral in a commercially reasonable manner using
such
proceeds to extinguish the remaining balance and disburse any amount in excess
of the remaining balance to the customer.
1.Basis
of Presentation and Accounting Policies (continued)
Revenue
Recognition (continued)
Under
this retail arrangement, revenues are recognized when the customer agrees to
the
terms of the credit and makes the initial payment. The Company has a
limited-in-duration money back guaranty policy (as discussed
below).
In
limited circumstances, the Company exchanges merchandise for similar merchandise
and/or monetary consideration with both dealers and retail customers, for which
the Company recognizes revenue in accordance with APB No. 29, “Accounting for
Non-monetary Transactions.” When the Company exchanges merchandise for similar
merchandise and there is no monetary component to the exchange, the Company
does
not recognize any revenue. Instead, the basis of the merchandise relinquished
becomes the basis of the merchandise received, less any indicated impairment
of
value of the merchandise relinquished. When the Company exchanges merchandise
for similar merchandise and there is a monetary component to the exchange,
the
Company recognizes revenue to the extent of monetary assets received and
determines the cost of sale based on the ratio of monetary assets received
to
monetary and non-monetary assets received multiplied by the cost of the assets
surrendered.
The
Company has a return policy (money-back guarantee). The policy covers retail
transactions involving graded rare coins only. Customers may return graded
rare
coins purchased within 7 days of the receipt of the rare coins for a full refund
as long as the rare coins are returned in exactly the same condition as they
were delivered. In the case of rare coin sales on account, customers may cancel
the sale within 7 days of making a commitment to purchase the rare coins. The
receipt of a deposit and a signed purchase order evidences the commitment.
Any
customer may return a coin if they can demonstrate that the coin is not
authentic, or there was an error in the description of a graded
coin.
Revenues
from the sale of consigned goods are recognized as commission income on such
sale if the Company is acting as an agent for the consignor. If in the process
of selling consigned goods, the Company makes an irrevocable payment to a
consignor for the full amount due on the consignment and the corresponding
receivable from the buyer(s) has not been collected by the Company at that
payment date, the Company records that payment as a purchase and the sale of
the
consigned good(s) to the buyer as revenue as the Company has assumed all
collection risk.
The
Company’s auction businesses generate revenue in the form of commissions charged
to buyers and sellers of auction lots. Auction commissions include buyers’
commissions, sellers’ commissions, and buyback commissions, each of which is
calculated based on a percentage of the hammer price.
1.Basis
of Presentation and Accounting Policies (continued)
Revenue
Recognition (continued)
Buyers’
and sellers’ commissions are recognized upon the confirmation of the
identification of the winning bidders. Funds charged to winning bidders include
the hammer price plus the commission. Only the commission portion of the funds
received by winning bidders is recorded as revenue.
Buyback
commissions represent an agreed upon rate charged by the Company for goods
entered in the auction and not sold. Goods remain unsold when an auction lot
does not meet the consignor reserve, which is the minimum sales price as
determined prior to auction, and when items sold at auction are returned
subsequent to the winning bidder taking possession. Buyback commission is
recognized along with sellers’ commission or at the time an item is returned.
Returns from winning bidders are very limited and primarily occur when a rare
coin sold at auction has an error in its description in which the winner bidder
relied upon to purchase the item.
Stock
Based Compensation
The
Company has a stock based compensation plan (“2003 Omnibus Stock Option Plan” or
“2003 Plan”) for the benefit of its employees, directors and outside
consultants. The 2003 Plan was shareholder approved and permits the granting
of
up to 1,200,000 options to purchase the Company’s common stock.
Effective
with the Company’s fiscal year that began on July 1, 2005, the Company adopted
the accounting and disclosure provisions of Statement of Financial Accounting
Standards (“SFAS”) No. 123(R), “Share-Based
Payments.” SFAS
No.123(R) requires that the cost of share-based payment transactions (including
those with employees and non-employees) be recognized in the financial
statements. SFAS No. 123(R) applies to all share-based payment transactions
in
which an entity acquires goods or services by issuing (or offering to issue)
its
shares, share options, or other equity instruments (except for those held by
an
ESOP) or by incurring liabilities (1) in amounts based (even in part) on the
price of the entity’s shares or other equity instruments, or (2) that require
(or may require) settlement by the issuance of an entity’s shares or other
equity instruments.
Currently
the Company uses the Black-Scholes option pricing model to estimate the fair
value of stock options granted to employees for its adoption of SFAS No.
123(R).
The fair
value of stock options was estimated at the date of grant using a Black-Scholes
option pricing model with the following range of assumptions for 2007 and 2006.
No options have been granted during the first six months of fiscal 2007.
1.Basis
of Presentation and Accounting Policies (continued)
Segment
Reporting
The
Company adopted SFAS No. 131 (“SFAS 131”), “Disclosures about Segments of an
Enterprise and Related Information,” during fiscal 1999. SFAS 131 establishes
standards for the way that public companies report information about operating
segments and related disclosures about products and services, geographic areas
and major customers in annual financial statements. The Company views its
operations and manages its business as one segment, collectibles.
Comprehensive
Income
Effective
January 1, 1998, the Company adopted Statement of Financial Accounting Standards
No. 130, “Reporting Comprehensive Income” (“SFAS 130”). SFAS 130 established new
rules for the reporting and display of comprehensive income and its components
in a full set of general-purpose financial statements. The adoption of SFAS
130
had no effect on the accompanying financial statements, because the Company
had
and continues to have no other components of comprehensive income.
2.Description
of Business
Superior
is primarily a wholesaler, retailer and auctioneer of rare coins, bullion and
second-hand jewelry. The Company is based in Beverly Hills, California.
3.Inventories
Inventory
totaling $160,000 and $1,327,000 of owned coins was on consignment with third
parties at December 31, 2006 and June 30, 2006, respectively. The balance of
inventory was located in the Company’s vault, at trade shows or at grading
services. As of December 31, 2006, management reserved $490,000 against the
gross inventory cost to reflect its analysis of the fair market of each
inventory item. The coins were valued by us using our combined experience buying
and selling in the wholesale and retail market places. The valuations are
supported by current market prices quoted in the “Certified Coin Dealer
Newsletter” by the Bluesheet and Greysheet services. All coins were priced
according to eye appeal and demand for specific series of mint dates. Any
average or poor-looking coins were valued less than popular coins with a great
look. Coins with problems, such as damaged, cleaned or repaired surfaces were
valued less, accordingly.
The
Company, from time to time, enters into informal partnerships with third parties
who are either vendors or customers for the purchase and sale of specific rare
coins. These arrangements include joint ownership of the rare coin and equal
participation in profit or loss on specific transactions adjusted for agreed
upon expenses and interest costs. When the rare coins are purchased the Company
records its proportional ownership as inventory and upon the sale of the rare
coins, the Company records its proportional sale and profit or loss. In most
instances, the Company elects to buy-out the partnership interest in rare coins
prior to its sale and the recording of a proportional sale and profit or loss
are no longer applicable. At any given time, the Company may be involved in
a
few of these agreements. The following table provides information regarding
the
Company’s lower of cost or market reserve for inventory as of the dates
indicated:
Superior
has established two short-term lending programs consisting of (i) advancing
consignment customers cash based on consigned inventory acquired for upcoming
auctions, and, (ii) advancing customers cash based on the customer’s assigning
specific rare coins in their inventory to Superior as collateral. Superior
can
advance a customer up to 70% of consigned, or assigned, rare coin(s)’ wholesale
value. For auction advances, Superior will advance cash to a customer and take
control of the inventory to be held on consignment for auction. The customer
will sign a note receivable for the funds advanced to be secured by the
consigned inventory. As consigned inventory is sold, the proceeds will be
collected, repaying Superior for the auction advance and any auction fees,
with
the remaining amount due to the consignor. For customer inventory advances,
Superior will advance cash to a customer and take control of the assigned
inventory. The customer will sign a promissory note for the funds advanced
to be
secured by the assigned inventory. Auction and customer advances bear interest
at rates between prime plus 6% and 14% based primarily on the customer’s
creditworthiness and the loan size. The average term of the loan is
approximately three months and no individual loan will exceed one year.
Customers may require minimum prices for their consigned coins, and if the
coin
has not sold by the loan maturity date, the customer must refinance the loan,
repay the loan, or permit Superior to liquidate the coin. Superior will retain
control of the assigned inventory until the customer repays the advance. Auction
and customer advances consist of the following:
On
October 13, 2003, we executed a Commercial Loan and Security Agreement
(“Commercial LOC”) with Stanford Financial Group Company (“SFG”), an affiliate
of our principal stockholder, Stanford International Bank Limited (“SIBL” or
“Stanford”), to provide us with a $7,500,000 line of credit for purposes of
financing our inventory, auction advances and inventory loans to other rare
coin
dealers and collectors. A portion of this indebtedness was assigned to SIBL,
and
on March 31, 2005, pursuant to SIBL’s purchase of $2,500,000 of our Series E
Preferred Stock, SIBL assumed, converted and cancelled $2,500,000 of this
indebtedness under the Commercial LOC. The remaining indebtedness was
subsequently assigned to SIBL, and further amended the Commercial LOC increasing
the line of credit to $10,000,000. Effective July 21, 2005 the Commercial LOC
was renewed through October 1, 2006. On May 2, 2006, SIBL further amended the
Commercial LOC increasing the line of credit to $10,850,000 to reflect an
additional advance made March 30, 2006, to partially fund the repayment of
a
private line of credit. On September 5, 2006, the Commercial LOC was renewed
through October 1, 2007.
On
November 21,
2006,
the Company entered into an agreement with SIBL pursuant to which the
outstanding balance on the Commercial LOC would be reduced by up to $2,408,481
through the transfer of rare coins to SIBL. As of December 29, 2006 the final
amount of the transfer of coins was determined to be $2,117,012. The Commercial
LOC bears interest at the prime-lending rate (8.25% at December 31, 2006) and
is
secured by substantially all of Superior’s assets. As of December 31, 2006, the
outstanding balance was $8,732,987 and there was no accrued interest payable.
We
are currently in compliance with all of the financial covenants contained in
our
existing Commercial LOC agreements or have waivers in place through December31,2006 that cover variances and the over-advances on collateral.
In
connection with the DGSE Merger, the Company expects to execute an Amended
and
Restated Commercial Loan and Security Agreement with SIBL to provide us with
a
$19,892,340 line of credit expiring January 2011 that bears interest at the
prime-lending rate (8.25% at December 31, 2006). Of the note amount, $8,392,340
is immediately convertible at the closing of the merger to common stock under
a
Note Exchange Agreement. The remaining $11,500,000 will be made available to
the
Company under two revolving loans: $5,500,000 for the acquisition of inventory
subject to a monthly borrowing base calculation and $6,000,000 that is not
subject to any collateral limitation and that may be used for any purpose.
Until
the Merger is closed, the Company entered into a Forbearance Agreement with
SIBL, waiving certain defaults and enabling draw downs under the existing
$10,850,000 Commercial LOC despite the Company’s negative stockholders' equity.
The Forbearance Agreement is effective until six months after the date DGSE
files a registration statement on Form S-4 with the SEC related to the merger,
or upon the earlier notice by SIBL of the occurrence of a new event of default
under the credit facility.
See
Note
11, “Subsequent Events,” below.
6.Note
Payable to a Related Party
On
April10, 2002 we executed a subordinated note payable for $1,000,000 to our CEO,
Silvano DiGenova, bearing interest at 9% per annum with quarterly installment
payments of $150,000 plus interest. No principal payments had been made through
February 2003. On February 14, 2003, the terms of the note were modified to
provide for repayment of principal in the amount of $50,000 per quarter
commencing on September 30, 2003 and for interest to be paid monthly. Effective
January 1, 2006 the interest rate was changed to 12%. During the six month
period ended December 31, 2006, there was a principal payment of $100,000.
At
December 31, 2006, the balance due was $400,000 and there was no accrued
interest payable.
6.Note
Payable to a Related Party (continued)
On
January 6, 2007, the Company; DGSE Companies, Inc., a Nevada corporation
("DGSE") and SIBL, as shareholder agent, entered into an Amended and Restated
Agreement and Plan of Merger and Reorganization (the "Merger Agreement") which
changed some of the terms and conditions of the original Agreement and Plan
of
Reorganization and Merger dated July 12, 2006. The revised Merger
Agreement allowed for the replacement of the Company’s management team and three
of its Directors with persons provided by DGSE which was documented by
a Management
Agreement by and between DGSE and the Company. In accordance with the
Merger Agreement,
the Company repaid in full its
outstanding indebtedness of $400,000 owed to its former Chief Executive Officer
Silvano DiGenova and the note evidencing that indebtedness was
terminated.
The
Company’s 2003 Omnibus Stock Option Plan (“2003 Plan”) is shareholder approved
and permits the granting of up to 1,200,000 options to purchase the Company’s
common stock to its employees, directors and outside consultants. Stock option
awards are granted with an exercise price that is equal to or greater than
the
market price of the Company’s common stock on the date of the grant. The options
vest generally over a range of one to five years and expire five years after
the
final vesting date. As of December 31, 2006, 55,000 stock options had been
exercised. Stock options under the 2003 Plan provide for accelerated vesting
if
there is a change in control (as defined by the 2003 Plan).
The
fair
value of each stock option granted is estimated on the date of the grant using
the Black-Scholes option pricing model and factors in an estimated forfeiture
based on management assessment of historical employee termination experience.
The Black-Scholes option pricing model has assumptions for risk free interest
rates, dividends, stock volatility and expected life of an option grant. The
risk free interest rate is based the U.S. Treasury Bill rate with a maturity
based on the expected life of the options and on the closest day to an
individual stock option grant. Dividend rates are based on the Company’s
dividend history. The stock volatility factor is based on the past three years
of market prices of the Company’s common stock. The expected life of an option
grant is based on its vesting period. The fair value of each option grant is
recognized as compensation expense over the expected life of the option on
a
straight line basis.
During
the six-month period ended December 31, 2006, the Company did not grant to
employees and directors any stock options to purchase common shares. During
this
period, 12,500 options vested, 1,250 expired and 208,100 were forfeited.
The
weighted average remaining contractual lives of the options outstanding and
options exercisable at December 31, 2006, were 6.2 years and 5.3 years
respectively.
During
the six months ended December 31, 2006, the company determined that certain
stock options, related to terminated employees, were not cancelled in the
previous period. As a result, the share-based expense was overstated in the
previous period. The Company in the current period adjusted its share-based
compensation expense reflecting the expense related to cancelled stock options.
The Company determined that the impact of this adjustment on the previous
financial statements was not material. At December 31, 2006 there was a total
of
$537,000 of unrecognized compensation costs related to non-vested share-based
compensation arrangements under the 2003 Plan. The cost is expected to be
recognized over a weighted average period of 2.5 years. The total fair value
of
12,500 shares vested during the six-month period ended December 31, 2006 was
approximately $19,800.
The
Company provides a two-way market or Guaranteed Buy/Sell Spread (the Guarantee”)
to its retail rare coin customers. Retail rare coin sales amounted to $2,379,000
and $6,632,000 for the six months ended December 31, 2006 and 2005,
respectively. The policy grants the customer the opportunity to sell their
coins
back to the Company at the prevailing market “bid” price (below the current
wholesale price in most cases). The Company determines the “bid” price based on
the prevailing market price at which the Company believes it could readily
liquidate the coin. The “bid” price may be substantially below what the customer
originally paid for the coin.
The
values of the rare coins sold to retail customers continually fluctuate.
Furthermore, retail customers continually resell or trade coins purchased from
the Company with third parties. Once retail customers resell the rare coins
to
third parties, the Guarantee is void. Lastly, the Company has had minimal
historical experience with customers exercising the Guarantee. As a result,
it
is not possible for the Company to determine the potential repurchase obligation
pursuant to the Guarantee that it may be subject to as a result of previous
sales of retail rare coins.
Legal
Proceedings
On
June6, 2006the Company was sued in the U.S. District Court for Central California
by Elaine and Dean Sanders in connection with a loan made to them against 32
coins placed on consignment on June 26, 2004. Fourteen of the coins were sold,
and the proceeds from this sale of approximately $186,750 were insufficient
to
repay the remaining loan balance of $359,471 that the Company made to the
Sanders. The plaintiffs subsequently paid an additional $155,000 in December
2005 with respect to the loan, but now allege that the Company violated its
agreement with them relating to the sale of the coins. The Company strongly
denies that it violated the agreement or that it acted improperly in any way.
The complaint seeks undefined dollar amounts, accrued interest and reimbursement
of plaintiffs’ legal costs.
In
April
2004 the Company sued its former Chief Financial Officer, Malingham Shrinivas,
in Los Angeles Superior Court for breach of contract, fraud and conspiracy.
In
that lawsuit, the Company alleged that he fraudulently arranged to receive
more
salary than he was entitled to, to pay personal expenses using Company funds,
and to pay third party vendors with Company funds for services which were not
rendered. In July 2004 Mr. Shrinivas filed a counterclaim in this litigation,
claiming that he was terminated without just cause and was therefore entitled
to
$58,250 in severance pay. Although the case had been scheduled for trial in
August 2006, prior to that time the case was stayed by order of the Superior
Court because the Court had been advised that criminal charges against Mr.
Shrinivas related to this matter were imminent. Those criminal charges were
subsequently filed, and therefore further proceedings in connection with
the
civil
case continue to be stayed. The Company believes that Mr. Shrinivas was
terminated with cause and that he is therefore not entitled to any severance
pay. If and when the stay of our civil case is terminated, the Company intends
to vigorously pursue its claims and defend Mr. Shrinivas’ claims for severance
pay.
On
September 26, 2006the Company was sued in the California Superior Court by
a
former customer, Michael Iatesta, for breach of contract and intentional and
negligent misrepresentation. The suit relates to the Company’s sale of the
plaintiff’s coins at an auction in September 2005. The plaintiff claims that the
Company made errors in connection with the marketing and sale of his coins,
and
that as a result his coins were sold for approximately $123,000 instead of
their
alleged full value of from $225,000 to $250,000. The Company sold the
plaintiff’s coins at or above any minimum prices set by the plaintiff. The
Company believes that the plaintiff’s allegations are without merit and intends
to vigorously defend this suit.
On
November 7, 2006 we were sued in the United States District Court for the
Northern District of Texas by a competitor, Heritage Numismatic Auctions, Inc.
(“Heritage”). In its complaint, Heritage alleges that we violated Heritage’s
copyright rights by copying Heritage’s catalog descriptions of certain coins and
currency offered for sale by Heritage. Heritage claims that these alleged
actions also violate the California Unfair Competition Act. Heritage seeks
an
injunction ordering us to cease the alleged acts of infringement and to destroy
the infringing items and damages in unspecified amounts. We deny that we have
infringed any of Heritage’s legal rights and intend to vigorously defend this
suit. We have reserved for our own legal costs, estimated to be $50,000.
The
Company may from time to time be involved in various claims, lawsuits, disputes
with third parties, actions involving allegations of discrimination, or breach
of contract actions incidental to the operation of its business. Except as
set
forth above, the Company is not currently involved in any such litigation which
it believes could have a material adverse effect on its financial condition
or
results of operations, liquidity or cash flows.
State
Sales and Use Taxes
The
Company does not collect sales and use taxes for interstate sales. Management
believes that the Company’s sales to interstate customers are generally
tax-exempt due to varying state exemptions relative to the definitions of being
engaged in business in particular states and the lack of current internet
taxation. We do collect sales taxes on retail sales made, if any, while at
conventions and auctions held out of state and file related state tax returns.
While the Company has not been contacted by any state authorities seeking to
enforce sales or use tax regulations, there is no assurance that the Company
will not be contacted by authorities in the future with inquiries relative
to
compliance with current statutes, nor is there any assurance that future
statutes will not be enacted that affect the sales and use aspects of the
Company’s business.
9.Merger
Expenses
On
July12, 2006, the Company entered into a Merger Agreement with DGSE which was
subsequently superseded by the Amended
and Restated Agreement and Plan of Merger and Reorganization dated January6, 2007. If the merger contemplated by this agreement is consummated (the
“Merger”), DGSE Merger Corp., a newly-formed Delaware corporation and
wholly-owned subsidiary of DGSE, will merge with and into the Company. The
Company would survive the Merger as a wholly-owned subsidiary of DGSE, and
therefore would cease to be an independent publicly traded company at that
time.
The closing of the Merger is subject to certain conditions, however, and if
these conditions are not satisfied the Merger may not be consummated. The
Company has incurred
costs of approximately $490,000 in connection with the Merger during the due
diligence and closing process through December 31, 2006.
In
September 2006, the Financial Accounting Standards Board (FASB) issued Statement
of Financial Accounting Issues No. 157, "Fair Value Measurements" ("SFAS 157"),
which defines the fair value, establishes a framework for measuring fair value
and expands disclosures about fair value measurements. This statement is
effective for financial statements issued for fiscal years beginning after
November 15, 2007, and interim periods within those fiscal years. Early adoption
is encouraged, provided that the Company has not yet issued financial statements
for that fiscal year, including any financial statements for an interim period
within that fiscal year. The Company is currently evaluating the impact SFAS
157
may have on its results of operations and financial condition.
SFAS
No. 158
In
September 2006, the FASB issued SFAS No. 158, "Employer's accounting for Defined
Benefit Pension and Other Post Retirement Plans". SFAS No. 158 requires
employers to recognize in its statement of financial position an asset or
liability based on the retirement plan's over or under funded status. SFAS
No.
158 is effective for fiscal years ending after December 15, 2006. The Company
is
currently evaluating the effect that the application of SFAS No. 158 will have
on its results of operations and financial condition.
SAB
No. 108
In
September 2006, the United States Securities and Exchange Commission (SEC)
issued Staff Accounting Bulletin No. 108, "Considering the Effects of Prior
Year
Misstatements when Quantifying Misstatements in Current Year Financial
Statements" ("SAB 108"). This SAB provides guidance on the consideration of
the
effects of prior year misstatements in quantifying current year misstatements
for the purpose of a materiality assessment. SAB 108 establishes an approach
that requires quantification of financial statement errors based on the effects
on each of the company's balance sheets, statements of operations and related
financial statement disclosures. The SAB permits existing public companies
to
record the cumulative effect of initially applying this approach in the first
year ending after November 15, 2006 by recording the necessary correcting
adjustments to the carrying values of assets and liabilities as of the beginning
of that year with the offsetting adjustment recorded to the opening balance
of
retained earnings. Additionally, the use of the cumulative effect transition
method requires detailed disclosure of the nature and amount of each individual
error being corrected through the cumulative adjustment and how and when it
arose. The Company is currently evaluating the impact SAB 108 may have on its
results of operations and financial condition.
On
January 6, 2007, the Company; DGSE and SIBL, as stockholder agent, entered
into
an Amended and Restated Agreement and Plan of Merger and Reorganization (the
"Merger Agreement"). The Merger Agreement contemplates that DGSE Merger Corp.,
a
wholly-owned subsidiary of DGSE, will merge with and into the Company would
survive the merger as a wholly-owned subsidiary of DGSE, and each share of
the
Company’s common stock would be exchanged for 0.2731 shares of DGSE common
stock.
Pursuant
to the Merger Agreement, fifteen percent (15%) of the number of shares of DGSE
common stock to be issued at the closing of the Merger, less 33,648 shares
to
which DGSE is entitled under the Merger Agreement due to the fact that our
actual December 31, 2006 stockholders’ equity was $ 89,840 less than our
estimated December 31, 2006 stockholders’ equity used for purposes of
determining the amount of debt to be converted by SIBL, will be deposited in
an
escrow account as security for the payment of indemnification claims made under
the Merger Agreement in the event the Company’s representations and warranties
concerning its capitalization are inaccurate. The escrow will expire one year
after the consummation of the Merger. The stockholder agent, which will
initially be SIBL, will have the exclusive right to defend the escrow against
claims made by DGSE or its related parties on behalf of the Company’s
stockholders.
Consummation
of the Merger is subject to certain closing conditions, including, among others,
stockholder approval of the Merger Agreement; DGSE stockholder approval of
an
increase in the number of authorized shares of common stock of DGSE; absence
of
governmental restraints; and effectiveness of a Form S-4 registration statement
registering the shares of DGSE common stock to be issued as merger
consideration. The Merger Agreement allows DGSE and the Company to terminate
the
Merger Agreement upon the occurrence (or non-occurrence) of certain events.
DGSE
and the Company expect the acquisition to close late in March 2007, subject
to
the satisfaction or waiver of the various closing conditions in the Merger
Agreement and depending in part on the length of regulatory review of this
transaction..
The
Company has entered into a Support Agreement with DGSE and certain stockholders
of the Company whereby such stockholders have agreed to vote their shares in
favor of the Merger. Such stockholders of the Company hold sufficient voting
power to approve the Merger. Similarly, the Company has entered into a Support
Agreement with DGSE and Dr. L.S. Smith, the chairman and chief executive officer
of DGSE, whereby Dr. Smith has agreed to vote his shares, which constitutes
approximately 46% of the outstanding DGSE shares, in favor of the
Merger.
As
a
condition to the closing of the Merger, the Company expects to enter into a
Note
Exchange Agreement with SIBL. Pursuant to the Note Exchange Agreement, SIBL
would convert $8,392,340 in debt into 4,936,671 shares of common stock of the
Company. This conversion would occur immediately prior to the consummation
of
the Merger. A Commercial Line of Credit in the amount of $11,500,000 is provided
in the related Amended
and Restated Commercial Loan and Security Agreement with SIBL.
Related
to the Merger Agreement, on January 6, 2007, the Company entered into a
Management Agreement with DGSE Merger Corp., a wholly-owned subsidiary of DGSE.
Pursuant to the Management Agreement, DGSE Merger Corp. will provide two to
three senior executives to serve as the senior management of the Company.
The
initial individuals are (i) William Oyster, who has been appointed interim
chief
executive officer, (ii) John Benson, who has been appointed interim chief
financial officer and vice president, finance, and (iii) Scott Williamson,
who
has been appointed interim chief operating officer. Mr. Oyster, age 53, has
served as a director and president of DGSE since 1990. Mr. Benson, age 60,
has
served as Chief Financial Officer of DGSE since 1992. Mr. Williamson, age 48,
has served as Executive Vice President - Consumer Finance of DGSE and President
of American Pay Day Centers, Inc., a DGSE subsidiary, since May 2004. Between
2003 and 2004, Mr. Williamson was president of Texas State Credit Co., a finance
company with 63 locations. From 2001 to 2003, Mr. Williamson was the Chief
Financial Officer for Westgate Fabrics, LLC, a distributor of decorative
fabrics. These individuals do not have an employment agreement with, and are
not
being paid any compensation by, the Company.
However, the Company pays a management fee of $ 50,000 per month to DGSE for
the
management services provided under this agreement, as well as certain hourly
fees and expense reimbursements. Upon termination of the Management Agreement,
these individuals are expected to resign their offices with the
Company.
Related
to the Merger Agreement described above, on January 6, 2007 Silvano DiGenova
entered into a Termination and Release Agreement with the Company,
whereby
he resigned as a director, chief executive officer, president, interim chief
financial officer and chairman effective January 6, 2007. Pursuant to this
agreement, Mr. DiGenova and the Company
released
each other from claims either might have against the other related to his
relationship with the Company
as a
stockholder, officer, employee, director or otherwise, subject to specified
exceptions. The Company
then
entered into a consulting agreement with Mr. DiGenova, whereby he will continue
to provide services to the Company
in the
Wholesale Coin Division. On January 6, 2007 Mr. DiGenova was paid the
outstanding balance of his $400,000 Note from the Company.
MANAGEMENT’S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
Cautionary
Statements
This
Quarterly Report on Form 10-Q contains certain forward-looking statements within
the meaning of Section 27A of the Securities Act of 1933 and Section 21E of
the
Securities Exchange Act of 1934. We intend that such forward-looking statements
be subject to the safe harbors created by such statutes. The forward-looking
statements included herein are based on current expectations that involve a
number of risks and uncertainties. Accordingly, to the extent that this
Quarterly Report contains forward-looking statements regarding our financial
condition, operating results, business prospects or any other information or
aspect of our company, you are advised that our actual financial condition,
operating results and business performance may differ materially from that
projected or estimated by us in forward-looking statements. The differences
may
be caused by a variety of factors, including but not limited to:
·
those
identified under “Risk Factors”
below,
·
adverse
economic conditions,
·
unexpected
costs and operating deficits,
·
lower
sales and revenues than forecast,
·
loss
of customers,
·
litigation
and administrative proceedings involving our
company,
·
the
possible acquisition of new businesses that result in operating losses
or
that do not perform as anticipated, resulting in unanticipated losses,
·
adverse
publicity and news coverage,
·
inability
to carry out our marketing and sales
plans,
·
changes
in interest rates and inflationary factors,
and
·
other
specific risks that may be referred to in this Quarterly Report or
in
other reports that we have issued.
In
addition, our business and operations are subject to substantial risks that
increase the uncertainty inherent in the forward-looking statements. The
inclusion of forward-looking statements in this Quarterly Report should not
be
regarded as a representation by us or any other person that we will achieve
our
objectives or plans.
The
following discussion should be read in conjunction with, and is qualified in
its
entirety by, our Financial Statements and related notes thereto included
elsewhere in this Quarterly Report. Historical results of operations, percentage
margin fluctuations and any trends that may be inferred from the discussion
below are not necessarily indicative of the operating results for any future
period.
COMPANY
OVERVIEW
Our
principal line of business is the sale of rare coins, bullion and second-hand
jewelry on a wholesale, retail and auction basis. Our wholesale and retail
operations are conducted in virtually every state in the United States and
in
several foreign countries. We also provide auction services for customers
seeking to sell their own rare coins. We market our services nationwide through
broadcasting and print media and independent sales agents, as well as on the
Internet through third party websites such as eBay and through our own website
at SGBH.com. Our headquarters are in Beverly Hills, California.
We
were
originally organized as a Nevada corporation in 1995. On June 30, 2003, our
stockholders approved and we completed a reincorporation of our company in
the
State of Delaware and changed our corporate name from Tangible Asset Galleries,
Inc. to the Superior Galleries, Inc.. These changes were effective at the close
of business on June 30, 2003.
Page
21
TRENDS
AND UNCERTAINTIES
As
a
dealer and auctioneer of rare coins, our revenue and profitability can be
materially affected by economic factors such as interest rates, inflation,
stock
market performance, the price of gold and other precious metals and world
political stability. The demand for and therefore the price of rare coins tends
to increase with the price of gold. During times of unstable stock market
performance and low interest rates rare coins may become more attractive as
an
investment as compared to the stock market or interest bearing securities.
In
times of strong stock market returns and high interest rates, rare coins may
be
viewed as a less favorable investment. Political instability may also increase
the demand for rare coins as individuals may perceive the security and
portability of rare coins more favorably as compared to other financial assets
such as stocks, bonds or cash. Future changes in the economy such as rapid
increases in interest rates, a decrease in the price of gold or strong growth
in
the stock market could materially reduce our revenue, margins and profitability
and affect our liquidity as inventory turns would diminish.
Furthermore,
certain types of rare coins, as is the case with other collectibles, may become
more or less popular based on market trends that we cannot predict. Although
we
carry a diverse range of categories of rare coins, a decrease in popularity
in a
particular category could result in diminished liquidity as inventory turns
decrease for the affected category.
Within
the rare coin industry many of our customers and suppliers are other dealers.
We
may be materially affected by both external and internal factors that could
affect the financial stability and liquidity of other dealers with whom we
conduct business. Our revenues and profitability could significantly decrease
if
several dealers faced financial difficulties that curtailed their ability to
sell or purchase rare coins either directly or at our auctions.
Over
the
past five years, except for the year ended June 30, 2004, we incurred
substantial losses that severely diminished our capital base and our liquidity.
As a result, we have negative shareholders’ equity and working capital. In
addition, most of our debt is short-term and bears a variable interest rate.
Any
significant unfavorable change in the economic environment or in our industry
could quickly result in declining revenue and operating losses. Our challenge
is
to both raise additional permanent equity capital and restructure our debt
to
include a larger long-term portion, which may be accomplished through the
intended Merger with DGSE Companies, Inc. described below. Although we cannot
assure you that we will be able to accomplish these objectives either with
or
without the Merger, it is our hope that if we are able to restructure our debt
and raise additional equity, we will mitigate some of the impact of a future
negative economic environment and conversely will benefit more sharply from
a
positive environment.
Uncertainties
Resulting from Planned Merger with DGSE
On
July12, 2006, we entered into an Agreement and Plan of Merger and Reorganization
with DGSE. On
January 6, 2007, the Company, DGSE and SIBL, as stockholder agent, entered
into
the Amended and Restated Agreement and Plan of Merger and Reorganization (the
"Merger Agreement"). If
the
Merger is consummated, DGSE Merger Corp., a newly-formed Delaware corporation
and wholly-owned subsidiary of DGSE, will merge with and into the Company.
The
Company.
would
survive the Merger as a wholly-owned subsidiary of DGSE, and therefore would
cease to be an independent publicly traded company at that time. The closing
of
the Merger is subject to certain conditions, however, and if these conditions
are not satisfied the Merger may not be consummated. We have incurred costs
of
approximately $490,000 in connection with the Merger during the due diligence
and closing process through December 31, 2006. We expect to incur additional
costs related to the Merger during fiscal 2007, including substantial legal
and
accounting costs, but we are presently unable to quantify these costs. In
addition, we have entered into an agreement with DGSE under which we will pay
one-half of the total costs and expenses incurred in connection with the Merger
by both us and DGSE, if the Merger is not consummated. These expenses would
include, among others, legal fees, accounting fees and investment banking fees.
Under this arrangement, if the Merger is not consummated our share of the total
expenses may be substantially more than the amount of expenses we have incurred
ourselves.
Page
22
CRITICAL
ACCOUNTING POLICIES
Our
Financial Statements are based on the selection and application of significant
accounting policies, which require our management to make estimates and
assumptions that affect the amounts reported in the Balance Sheets and the
Statements of Operations. We believe that the following are the most critical
areas that may affect our financial condition and results of
operations.
Revenue
Recognition. We
generate revenue from wholesale and retail sales of rare coins, precious metals
bullion and second-hand jewelry and artifacts. The recognition of revenue varies
for wholesale and retail transactions and is, in large part, dependent on the
type of payment arrangements made between the parties.
We
sell
rare coins to other wholesalers/dealers within our industry on credit, generally
for terms of 15 to 60 days, but in no event greater than one year. We grant
credit to new dealers based on extensive credit evaluations and for existing
dealers based on established business relationships and payment histories.
We
generally do not obtain collateral with which to secure our accounts receivable
when the sale is made to a dealer. We recognize revenue for monetary
transactions (i.e., cash and receivables) with dealers when the merchandise
is
shipped to a dealer.
We
also
sell rare coins to retail customers on credit, generally for terms of 30 to
60
days, but in no event greater than one year. We grant credit to retail customers
based on credit evaluations and for existing retail customers based on
established business relationships and payment histories. When a retail customer
is granted credit, we generally collect a payment of 25% of the sales price,
establish a payment schedule for the remaining balance and hold the merchandise
as collateral as security against the customer’s receivable until all amounts
due under the credit arrangement are paid in full. If the customer defaults
in
the payment of any amount when due, we may declare the customer’s obligation in
default, liquidate the collateral in a commercially reasonable manner using
such
proceeds to extinguish the remaining balance and disburse any amount in excess
of the remaining balance to the customer. Under this retail arrangement, we
recognize revenue when our customer agrees to the terms of the credit and makes
the initial payment. We have limited-in-duration money back guaranty policies
for our retail customers only, as discussed below.
In
limited circumstances, we exchange merchandise for similar merchandise and/or
monetary consideration with both dealers and retail customers, for which we
recognize revenue in accordance with APB No. 29, “Accounting for Non-monetary
Transactions.” When we exchange merchandise for similar merchandise and there is
no monetary component to the exchange, we do not recognize any revenue. Instead,
the basis of the merchandise relinquished becomes the basis of the merchandise
received, less any indicated impairment of value of the merchandise
relinquished. When we exchange merchandise for similar merchandise and there
is
a monetary component to the exchange, we recognize revenue to the extent of
monetary assets received and determine the cost of sale based on the ratio
of
monetary assets received to monetary and non-monetary assets received multiplied
by the cost of the assets surrendered.
We
have a
return policy (money-back guarantee). The policy covers retail transactions
involving graded rare coins only. Our customers may return graded rare coins
purchased within 7 days of the receipt of the rare coins for a full refund
as
long as the rare coins are returned in exactly the same condition as they were
delivered. In the case of rare coin sales on account, our customers may cancel
the sale within 7 days of making a commitment to purchase the rare coins. The
receipt of a deposit and a signed purchase order evidences the
commitment.
Revenues
from the sale of consigned goods are recognized as commission income on such
sale if we are acting as an agent for the consignor. If in the process of
selling consigned goods, we make an irrevocable payment to a consignor for
the
full amount due on the consignment and the corresponding receivable from the
buyer(s) has not been collected by us at that payment date, then we record
that
payment as a purchase and the sale of the consigned good(s) to the buyer as
revenue as we have assumed all collection risk.
Page
23
Our
auction business generates revenue in the form of commissions charged to buyers
and sellers of auction lots. Auction commissions include buyers’ commissions,
sellers’ commissions, and buyback commissions, each of which is calculated based
on a percentage of the hammer price. Buyers’ and sellers’ commissions are
recognized upon the confirmation of the identification of the winning bidders.
Funds charged to winning bidders include the hammer price plus the commission.
Only the commission portion of the funds received by winning bidders is recorded
as revenue. Buyback commissions represent an agreed upon rate charged by us
for
goods entered in the auction and not sold. Goods remain unsold when an auction
lot does not meet the consignor reserve, which is the minimum sales price as
determined prior to auction, and when items sold at auction are returned
subsequent to the winning bidder taking possession. Buyback commission is
recognized along with sellers’ commission or at the time an item is returned.
Returns from winning bidders are very limited and primarily occur when a rare
coin sold auction has an error in its description which the winning bidder
relied upon to purchase the item.
Accounts
Receivable. We
are
required to estimate the collectibility of our accounts receivables. A
considerable amount of judgment is required in assessing the collectibility
of
these receivables, including judgments about the current creditworthiness and
financial condition of each client and related aging of past due balances.
We
evaluate specific accounts receivable balances when we become aware of a
situation where a client may not be able to meets its financial obligations
to
us. The amount of the required allowance is based on the facts available to
us
and is reevaluated and adjusted as additional information is available,
including our right to offset debts with accounts payable balances and the
proceeds from consigned inventory sales. Allowances are also established for
probable loss inherent in the remainder of the accounts receivable based on
a
factor of 0.1% of annualized total gross sales. As a result of the expansion
of
our rare coin auction business, we may attract new customers that may adversely
affect our estimates of accounts receivable collectibility, and the
creditworthiness of our clients may deteriorate. These factors would require
the
reassessment of our estimates and additional allowances resulting in a reduction
of our operating results.
Auction
and Customer Advances. We
are
required to estimate the collectibility of our auction and dealer customer
advances. All of our advances are secured by rare coins. Although we make our
decision to advance funds based on customers’ creditworthiness, business
history, and collateral valuation; the collectibility of advances is primarily
based on our estimate of sale prices for customers’ rare coin collateral on a
wholesale liquidation basis. We evaluate specific advance balances when we
become aware of situations where a client may not be able to meet its financial
obligations to us or the value of collateral securing the advance is impaired.
During fiscal 2007, advances for auction consignments and dealer purchases
have
been made from operating cash flows as there was no availability under our
line
of credit from Stanford International Bank. We have not had any significant
history of losses on this type of asset. It is difficult to assess future
performance of the rare coin market. A rapid adverse change in the rare coin
market could diminish the value of the collateral and the creditworthiness
of
our clients may deteriorate. These factors would require the reassessment of
our
estimates and any additional allowances would result in a reduction of our
operating results.
Inventory
Valuation.
We
value our inventory at the lower of cost or market in accordance with generally
accepted accounting principles related to the fair market valuation of assets.
On a periodic basis our numismatic staff will review market data from recognized
industry sources, published auction results in the Bluesheets and Greysheets
and
offers made by customers on specific items to determine whether or not the
cost
of our inventory is above or below market price. If the market value of a coin
is significantly less than its cost to us, we will establish a reserve against
inventory to reflect that the market value of our rare coin inventory in the
aggregate is below cost, which results in reflecting the value of our inventory
at the lower of cost or market.
Stock-Based
Compensation.Our
2003
Omnibus Stock Option Plan (“2003 Plan”) is shareholder approved and permits the
granting of up to 1,200,000 options to purchase our common stock to our
employees, directors and outside consultants. Stock option awards are granted
with an exercise price that is equal to or greater than the market price of
our
common stock on the date of the grant. The options vest generally over a range
of one to five years and expire five years after the final vesting date. Stock
options under the 2003 Plan provide for accelerated vesting if there is a change
in control (as defined by the 2003 Plan).
Page
24
The
fair
value of each stock option granted is estimated on the date of the grant using
the Black-Scholes option pricing model and factors in an estimated forfeiture
based on management assessment of historical employee termination experience.
The Black-Scholes option pricing model has assumptions for risk free interest
rates, dividends, stock volatility and expected life of an option grant. The
risk free interest rate is based the U.S. Treasury Bill rate with a maturity
based on the expected life of the options and on the closest day to an
individual stock option grant. Dividend rates are based on our dividend history.
The stock volatility factor is based on the past three years of market prices
of
our common stock. The expected life of an option grant is based on its vesting
period. The fair value of each option grant is recognized as compensation
expense over the expected life of the option on a straight line
basis.
The
following table sets forth the percentage of net revenue represented by each
item in our statement of operations for the periods presented and the net
changes and percentage of change for each item in our statement of operations
between the periods indicated:
Six
Months Ended (in thousands)
December
31,
December
31,
%
2006
%
2005
%
Change
Change
Net
Sales
$
12,863
90
%
$
20,433
96
%
$
(7,570
)
-37
%
Commission
Income
1,503
10
%
846
4
%
658
78
%
Total
revenue
14,366
100
%
21,279
100
%
(6,912
)
-32
%
Cost
of revenue
11,663
81
%
17,782
84
%
(6,119
)
-34
%
Gross
profit
2,703
19
%
3,497
16
%
(793
)
-23
%
Selling,
general & administrative expenses
4,766
33
%
4,467
21
%
299
7
%
Loss
from operations
(2,063
)
-14
%
(970
)
-5
%
(1,093
)
113
%
Other
income (expense)
(366
)
-3
%
(252
)
-1
%
(114
)
45
%
Loss
before provision for taxes
(2,429
)
-17
%
(1,222
)
-6
%
(1,207
)
99
%
Income
tax provision
1
0
%
1
0
%
-
0
%
Net
loss
$
(2,430
)
-17
%
$
(1,223
)
-6
%
$
(1,207
)
99
%
Our
net
loss for the six months ended December 31, 2006 was $2,430,000 or $0.51 per
share on both a basic and diluted basis as compared to a net loss of $1,223,000
or $0.25 per share on both a basic and diluted basis for the six months ended
December 31, 2005. The 99% decline in our operating results was primarily due
to
32% lower sales revenues available to cover operating costs, allowances for
uncollectible accounts receivable, inventory adjustments, higher net interest
expenses, and costs incurred in connection with the proposed Merger with
DGSE.
Revenues
The
table
below sets forth our primary sources of revenue for the periods
indicated:
Six
Months Ended (in thousands)
December
31,
December
31,
%
2006
%
2005
%
Change
Change
Net
Sales
Rare
Coin - Wholesale
$
10,484
73
%
$
13,801
65
%
$
(3,317
)
-24
%
Rare
Coin - Retail
2,379
17
%
6,632
31
%
(4,253
)
-64
%
Total
Net Sales
12,863
90
%
20,433
96
%
(7,570
)
-37
%
Commission
Income
1,503
10
%
846
4
%
658
78
%
Total
Revenue
$
14,366
100
%
$
21,279
100
%
$
(6,913
)
-32
%
Total
revenue for the six months ended December 31, 2006 decreased $6,913,000 or
32%
to $14,366,000 from $21,279,000 for the six months ended December 31, 2005.
This
decrease in revenues is primarily due to the decrease in retail sales of rare
coins. Retail rare coin sales for the six months ended December 31, 2006
decreased $4,253,000 or 64% from the comparable period in 2005. Wholesale rare
coin sales for the six months ended December 31, 2006 also decreased $3,317,000
or 24% over the comparable period in 2005. Due to the transfer of $2,117,000
of
coins to Stanford International Bank to reduce the balance on the Company’s
commercial line of credit, those coins were not available for sale to other
wholesale customers. On a combined basis, sales of rare coins decreased
$7,570,000 or 37% from the comparable period in 2005.
Page
26
This
decrease in rare coin sales was primarily due to a refocusing of the Company’s
marketing efforts away from the direct wholesale and retail customers and toward
the auction market for consigned collector coins held in private portfolios.
This change was made to mitigate a perceived weakened market demand for quantity
purchases which was caused by a recent decrease in the price of gold, rising
interest rates and new record highs set in the stock market. It also was
necessitated by our lower levels of owned inventory available for sale, which
resulted from the lack of availability of operating cash flow to purchase that
inventory and the need to repay debt in-kind with coins.
Auction
sales (hammer prices realized) were $16,757,000 for the six months ended
December 31, 2006 as compared to $18,726,000 for the six months ended December31, 2005 reflecting a decrease of 11%; however the commission income for these
auction sales increased due to a higher sell through rate. During the six months
ended December 31, 2006 the buybacks were 21% of auction sales as compared
to
51% of auction sales for the comparable period in 2005. Commissions on concluded
sales are approximately 15% of the hammer price and for buybacks they are
approximately 5% of the reserved price. Commission income for the six months
ended December 31, 2006 was $1,504,000, an increase of $658,000, or 78% over
the
comparable period in 2005 due to the refocus of our business strategy.
Our
revenue and profitability during the year is subject to seasonality. Our first
and third fiscal quarters have traditionally been our strongest because two
well-attended auctions are normally scheduled during each of these quarters
and
during these quarters there are more frequent and better-attended trade shows.
The second fiscal quarter has traditionally been our weakest, because we conduct
only one auction event and there are fewer, less popular trade
shows.
To
expand
our wholesale sales efforts, in October 2005 we entered into an informal
preferred supplier arrangement with Stanford Coins and Bullion, Inc.
(“Stanford C&B”), a rare coin retailer and affiliate of our principal
stockholder, Stanford International Bank Limited (“SIBL” or “Stanford”). This
arrangement replaced a Primary Supplier Agreement that terminated upon the
completion of the parties’ obligations in September 2005. In addition to
providing us a preferred status as a supplier, Stanford C&B will exclusively
refer their customers wishing to sell rare coins via auctions to our auction
division. We expect that this arrangement will continue after the Merger. We
believe that it will likely result in increased coins sales by us, but we are
unable to predict the magnitude of that increase.
Our
growth strategy for wholesale type distribution channels changed as of January6, 2007 under the Merger Agreement. In addition to growing the wholesale
business through the hiring of additional numismatic traders, acquiring small
rare coin dealers and supplying rare coins to other retailers; the Company
has
created a new profit center with Silvano DiGenova, the former chief executive
officer of the Company, serving as Managing Director-Numismatics which will
along with other activities, provide services to wholesale customers.
To
expand
our retail distribution channel, following the Merger we plan to remodel the
gallery space located in Beverly Hills. The product mix will be diversified
to
include new high-end jewelry and watches in addition to second-hand jewelry.
We
are in the process of obtaining a pawnbroker license to make loans against
jewelry and other artifacts. The retail business will be supported by local
advertising in print, radio and television media.
To
expand
our auction distribution channels, we plan to find more consigners of rare
coins
for our Auction Events through new functions available on our internet website
(www.SGBH.com) and to integrate that website with DGSE’s websites: www.DGSE.com,
www.USBullionExchange.com, www.FairchildWatches.com (Fairchild International),
and www.CGDEInc.com (Charleston Gold & Diamond Exchange). We do not hold an
internet-only auction during the week that we hold a live auction as our live
auctions are simultaneously broadcast over our website to take bids over the
internet. We plan to hold seven “Elite” live auction events in the fiscal year
ending June 30, 2007. We currently have a strategic relationship with e-Bay.com
for the daily sale of rare coins and jewelry. We pay e-Bay.com a commission
of
5% on sales it makes, and when we sell goods in this manner we increase the
charge to our customer by 5%, to offset the commission paid to e-Bay.com. Under
this relationship, we have agreed that when we conduct internet-only auctions
through e-Bay.com, we will not simultaneously offer the auctioned items through
any other internet-based auction.
Page
27
The
implementation of these strategies may not result in increased revenues. We
will
seek to determine whether the expected benefits from these strategies, measured
principally in terms of increased revenue, justifies the costs of implementing
them. If we determine that any of these strategies is not cost-effective, we
will terminate or amend the strategy. We cannot assure you that our growth
plans
will generate enough revenue to cover the additional operating costs associated
with these growth plans.
Our
ability to expand our revenue is significantly contingent on the availability
of
additional permanent equity and debt financing. As indicated in “Other Liquidity
Plans” below we have plans to raise additional equity and debt, but there is no
assurance that we will be successful in doing so on terms and conditions that
are acceptable to us.
Cost
of Revenue
Cost
of
revenue is primarily comprised of the acquisition price we pay for coins, and
is
dependent on our skill in identifying coins that may be offered for sale at
advantageous prices, as well as the supply and demand factors at the time that
we are purchasing coins. Commission income has minimal cost of revenue
associated with it.
Cost
of
revenue for the six months ended December 31, 2006 decreased $6,119,000 or
34%
to $11,663,000 or 81% of total revenue, from $17,782,000 or 84% of total revenue
for the six months ended December 31, 2005. The decrease in aggregate dollar
cost of revenue in the current period over the comparable period in 2005 was
primarily due to the decrease in wholesale and retail rare coin sales as
discussed in “Total Revenue” above. The cost of revenue as a percentage of total
revenue in the current period varied from 81% to 84% in the comparable period
of
the previous year; but as auction commission income has negligible cost of
revenue, the true comparison is 91% of net rare coin sales in the six months
ended December 31, 2006 to 87% of net rare coin sales in the six months ended
December 31, 2005.
However,
in the six months ended December 31, 2006, mark to market reserves and
adjustments to inventory values totaled $545,000 as compared to $125,000
reserved during the six months ended December 31, 2005. Excluding the effect
of
the mark to market inventory reserve of $490,000, the $245,000 inventory
adjustment for the physical count taken, cost of goods actually sold for the
six
months ended December 31, 2006 would have been 76%. Management’s mark to market
reserve was focused on the fair market valuation of the coins and the other
items in our inventory, on an item-by-item basis, and a reserve was recorded
if
the fair market value was determined to be less than our cost.
Gross
Profit
Gross
profit for the six months ended December 31, 2006 decreased $794,000 to
$2,703,000 or 19% of total revenue from $3,497,000 or 16% of total revenue
for
the six months ended December 31, 2005. The decrease in gross profit dollars
in
the current period over the comparable period in 2005 was primarily due the
reduced level of sales as discussed in “Total Revenue” above. Excluding the
effects of the mark to market inventory reserve and the inventory adjustments
in
cost of goods sold, the gross profit margin for the six months ended December31, 2006 would have been 23.9% The gross profit as a percentage of revenue
will
vary from period to period due to variations in the factors discussed in “Cost
of Revenue” above.
Page
28
Selling,
General and Administrative Expenses
Selling,
general and administrative expenses for the six months ended December 31, 2006
increased $299,000 to $4,766,000 or 33% of total revenue from $4,467,000 or
21%
of total revenue for the six months ended December 31, 2005. The net $299,000
increase in the dollar amount of expenses was primarily due to additional
spending of approximately $929,000 comprised of (i) merger related legal, audit
and consulting fees of $413,000 related to the proposed Merger with DGSE; (ii)
office rent increases of $18,000; (iii) insurance premiums of $29,000 to cover
higher levels of consigned coins in our possession; (iv) additional bad debt
expense of $394,000 and (v) lesser miscellaneous operational expenses of
$75,000.
Net
cost
reductions of $630,000 offset some of the additional expenditures for the six
months ended December 31, 2006. Cost reductions were comprised of:
(i) $207,000 decrease in expenditures for marketing operations and auction
operations expenses associated with the logistics of attending trade shows,
advertising and having coins graded by professional associations; (ii) reduced
employee compensation costs of $282,000 which resulted from decreased
commissions paid to salespersons on our lower level of sales and reversal of
over-stated stock option expenses; (iii) $12,000 decrease in freight and postage
due to a change in vendors; (iv) $74,000 saved by the cancellation of a public
relations service contract; (v) $36,000 decrease in travel and entertainment
expense and (vi) $19,000 resulting from lesser changes in all other selling,
general and administrative expense categories.
Other
Income and Expenses
Other
expenses for the six months ended December 31, 2006 increased $114,000 to
$366,000 from $252,000 for the six months ended December 31, 2005. This increase
was primarily due to increased interest expense, resulting from the combination
of the increased use of our SIBL line of credit to finance our own receivables
and inventory and increases in the rate of interest charged on our SIBL line
of
credit and on Notes from other private lenders for the six months ended December31, 2006 as compared to the six months ended December 31, 2005.
Provision
for Income Taxes
Although
we reported a net loss for the six months ended December 31, 2006, we incurred
income taxes for state franchise and other minimum taxes totaling $600.
Similarly, although we reported a net loss the six months ended December 31,2005, we incurred income taxes for state franchise and other minimum taxes
totaling $800.
The
following table sets forth the percentage of net revenue represented by each
item in our statement of operations for the periods presented and the net
changes and percentage of change for each item in our statement of operations
between the periods indicated:
Three
Months Ended (in thousands)
December
31,
December
31,
%
2006
%
2005
%
Change
Change
Net
sales
$
5,388
93
%
$
9,485
99
%
$
(4,097
)
-43
%
Commission
income
417
7
%
141
1
%
276
196
%
Total
revenue
5,805
100
%
9,626
100
%
(3,821
)
-40
%
Cost
of revenue
4,609
79
%
8,440
88
%
(3,831
)
-45
%
Gross
profit
1,196
21
%
1,186
12
%
10
1
%
Selling,
general and administrative expenses
2,505
43
%
2,166
23
%
339
16
%
Income
(loss) from operations
(1,309
)
-23
%
(980
)
-11
%
(329
)
34
%
Other
income (expense)
(182
)
-3
%
(137
)
-1
%
(45
)
33
%
Loss
before provision for taxes
(1,491
)
-26
%
(1,117
)
-12
%
(374
)
33
%
Income
tax provision
1
0
%
—
0
%
1
0
%
Net
income (loss)
$
(1,492
)
-26
%
$
(1,117
)
-12
%
$
(375
)
33
%
Our
net
loss for the three months ended December 31, 2006 was $1,492,000 or $0.31 per
share on both a basic and diluted basis as compared to a net loss of $1,117,000
or $0.23 per share on both a basic and diluted basis for the three months ended
December 31, 2005. The 16% decline in our operating results was primarily due
to
40% lower sales revenues available to cover operating costs, allowances for
uncollectible accounts receivable, inventory adjustments, lower interest income
on auction advances and costs incurred in connection with the proposed Merger
with DGSE.
Revenues
The
table
below sets forth our primary sources of revenue for the periods
indicated:
Total
revenue for the three months ended December 31, 2006 decreased $3,821,000 or
40%
to $5,805,000 from $9,626,000 for the three months ended December 31, 2005.
This
decrease in revenues is primarily due to the decrease in sales of rare coins
to
both wholesale and retail customers. Wholesale rare coin sales for the three
months ended December 31, 2006 decreased $2,635,000 or 36% from the comparable
period in 2005. Due to the transfer of $2,117,000 of coins to SIBL to reduce
the
balance on the Company’s commercial line of credit, those coins were not
available for sale to other wholesale customers. Retail rare coin sales for
the
three months ended December 31, 2006 decreased $1,462,000 or 66% over the
comparable period in 2005. On a combined basis, sales of rare coins decreased
$4,097,000 or 43% over the comparable period in 2005.
Page
30
This
decrease in rare coin sales was primarily due to a refocusing of the Company’s
marketing efforts away from the direct wholesale and retail customers and toward
the auction market for consigned collector coins held in private portfolios.
This change was made to mitigate a perceived weakened market demand for quantity
purchases which was caused by a recent decrease in the price of gold, rising
interest rates and new record highs set in the stock market. It also was
necessitated by our lower levels of owned inventory available for sale, which
resulted from the lack of availability of operating cash flow to purchase that
inventory and the need to repay debt in-kind with coins.
Commission
income for the three months ended December 31, 2006 was $417,000, an increase
of
$276,000 or 196% over the comparable period in 2005. This
increase was primarily due to our efforts to attract higher quality consignments
with higher average commission rates. Auction
sales (hammer prices realized) were $3,695,000 for the three months ended
December 31, 2006 as compared to $1,862,000 for the three months ended December31, 2005, reflecting an increase of 98% in volume and a 12% decrease in the
buy
back/return rate for the auctions completed during the three months ended
December 31, 2006.
Our
revenue and profitability during the year is subject to seasonality. Our first,
third and fourth fiscal quarters have traditionally been our strongest because
two well-attended Elite live auctions are normally scheduled during each of
these quarters and during these quarters there are more frequent and
better-attended trade shows. Our second fiscal quarter has traditionally been
our weakest because we conduct only one auction event and there are fewer,
less
popular trade shows.
Cost
of Revenue
Cost
of
revenue is primarily comprised of the acquisition price we pay for coins, and
is
dependent on our skill in identifying coins that may be offered for sale at
advantageous prices, as well as the supply and demand factors at the time that
we are purchasing coins. Commission income has minimal cost of revenue
associated with it. Cost
of
revenue for the three months ended December 31, 2006 decreased $3,831,000 or
45%
to $4,609,000 or 79% of total revenue, from $8,440,000 or 88% of total revenue
for the three months ended December 31, 2005. The decrease in aggregate dollar
cost of revenue in the current period over the comparable period in 2005 was
primarily due to the decrease in wholesale and retail rare coin sales as
discussed in “Total Revenue” above.
The
cost
of revenue as a percentage of total revenue in the current period varied 9%
from
79% to 88% in the comparable period of the previous year; but as auction
commission income has negligible cost of revenue, the true comparison is 86%
of
net rare coin sales in the three months ended December 31, 2006 to 89% of net
rare coin sales in the three months ended December 31, 2005. The cost of goods
sold as a percent of net rare coin sales decreased by 7% because fewer Wholesale
Rare Coins were sold with unfavorable margins during the three months ended
December 31, 2006 than during the comparable period of the previous year.
However,
in the three months ended December 31, 2006, mark to market reserves and
adjustments to inventory values totaled $735,000 as compared to $125,000
reserved during the three months ended December 31, 2005. Excluding the effect
of the mark to market inventory reserve of $490,000, the $245,000 inventory
adjustment for the physical count taken, cost of goods sold for the three months
ended December 31, 2006 would have been 72%. Management’s mark to market reserve
was focused on the fair market valuation of the coins and the other items in
our
inventory, on an item-by-item basis, and a reserve was recorded if the fair
market value was determined to be less than our cost.
Although
the cost of revenue as a percentage of total revenue in the current period
may
be similar to that in the comparable period of the previous year, this may
result from a coincidental combination of factors that are not always
consistent. These factors, which we cannot predict from period to period,
include our success in buying coins that generate substantial margin, the supply
of coins that our customers wish to purchase, and the level of auction sales
and
the percentage of commission on these sales that we earn.
Page
31
Gross
Profit
Gross
profit for the three months ended December 31, 2006 increased $10,000 to
$1,196,000 or 21% of total revenue from $1,186,000 or 12% of total revenue
for
the three months ended December 31, 2005. Our gross profit margin increased
1%
because (i) fewer Wholesale Rare Coins were sold with unfavorable margins during
the three months ended December 31, 2006 than during the comparable period
of
the previous year and (ii) the $276,000 increase in auction commissions during
the three months ended December 31, 2006 had a minimal cost of revenue
associated with the consigned coins sold. Excluding the effects of the mark
to
market inventory reserve and the inventory adjustments in cost of goods sold,
the gross profit margin for the three months ended December 31, 2006 would
have
been 33%. The gross profit as a percentage of revenue will vary from period
to
period due to variations in the factors discussed in “Cost of Revenue”
above.
Selling,
General and Administrative Expenses
Selling,
general and administrative (“SGA”) expenses for the three months ended December31, 2006 increased $339,000 or 16% to $2,505,000 from $2,166,000 for the three
months ended December 31, 2005. These expenses represent 43% of total revenue
for the three months ended December 31, 2006 as compared to 23% of total revenue
for the three months ended December 31, 2005. The higher percentage that SGA
expenses for the three months ended December 31, 2006 is a function of there
being 40% less total revenue for that fiscal period and because there was
additional expenses incurred in the three months ended December 31, 2006 than
during the comparable period of the previous year.
The
net
increase in the dollar amount of expenses was primarily due to additional
spending of approximately $832,000 comprised of (i) legal, audit and consulting
fees of $335,000 related to the proposed Merger with DGSE; (ii) internet web
hosting fee increases of $12,000; (iii) additional bad debt expense of $448,000
and (iv) other miscellaneous operational expenses of $37,000.
Net
cost
reductions of $493,000 offset some of the additional expenditures for the three
months ended December 31, 2006. Cost reductions were comprised of:
(i) $96,000 decrease in expenditures for marketing operations and auction
operations expenses associated with the logistics of attending trade shows,
advertising and having coins graded by professional associations; (ii) reduced
employee compensation costs of $262,000 which resulted from decreased
commissions paid to salespersons on our lower level of rare coin sales and
a
one-time reversal of over-stated stock option expenses; (iii) $22,000 decrease
in dues and subscriptions to professional organizations; (iv) $39,000 saved
by
the cancellation of a public relations service contract; (v) $31,000 decrease
in
travel and entertainment expense; (vi) $13,000 decrease in the purchase of
office supplies and (vii) $30,000 resulting from lesser changes in all other
selling, general and administrative expense categories.
Other
Income and Expenses
Other
expenses for the three months ended December 31, 2006 increased $45,000 or
33%
to $182,000 from $137,000 for the three months ended December 31, 2005. This
increase was primarily due to $45,000 less interest earned on auction advances
and dealer loans because outstanding loan balances were reduced to $1,646,000
for the three months ended December 31, 2006 from $3,155,000 for the three
months ended December 31, 2005. Interest expense to finance our own receivables
and inventory remained the same for the three months ended December 31, 2006
as
compared to the three months ended December 31, 2005.
Page
32
Provision
for Income Taxes
Although
we reported a net loss for the three months ended December 31, 2006, we incurred
income taxes for state franchise and other minimum taxes totaling $800. Although
we reported a net loss the three months ended December 31, 2005, we incurred
no
income taxes for state franchise and other minimum taxes during that
period.
LIQUIDITY
AND CAPITAL RESOURCES
At
December 31, 2006, we had negative working capital of $3,369,000 and a current
ratio of 0.68:1.00. We recorded net losses of $2,430,000. Given our December31,2006 cash balance of $1,615,000 and our projected operating cash requirements,
we anticipate that our existing capital resources will probably be adequate
to
satisfy our cash flow requirements through the close of the merger with DGSE.
Until the Merger is closed, we entered into a Forbearance Agreement with SIBL,
waiving certain defaults and enabling draw downs under the existing $10,850,000
commercial line of credit facility despite our negative stockholders' equity.
The Forbearance Agreement is effective until six months after the date DGSE
files a registration statement on Form S-4 with the SEC related to the merger,
or upon the earlier notice by SIBL of the occurrence of a new event of default
under the credit facility. Our cash flow estimates are based upon achieving
certain levels of sales and reductions in operating expenses. Should sales
be
less than forecast or expenses become higher than forecast, then we may require
additional financing through debt and/or equity, and we may not have adequate
resources to fund operations. We expect future fixed obligations through the
close of the Merger to be paid solely by cash generated from operating
activities. However, if we are unable to do so, we intend to satisfy fixed
obligations from: (i) additional debt/equity financings; (ii) extending vendor
payments; and (iii) liquidation of inventory. No assurance can be given that
we
will be able to pay or satisfy our fixed obligations from these sources.
Although we anticipate being able to satisfy our fixed obligations, if we are
unable to satisfy our fixed obligations as they become due, our creditors will
be entitled to take legal action against us. If they do, our business could
be
materially harmed.
Net
cash
used in operating activities totaled $158,000. Cash used in our operating
activities totaled $9,022,000 resulting primarily from our net loss of
$2,240,000; decreases in our accounts payable of $6,173,000; non-cash decrease
in our inventory reserves of $350,000 due to the sale of revalued coins;
decreases in our prepaid expenses of $60,000 and non-cash net reversals of
stock
option expense of $10,000. Cash provided by operations totaled $8,864,000
resulting from decreases in inventories of $6,085,000; pay downs of accounts
receivable of $2,029,000; increases in non-cash allowances for accounts
receivable of $458,000; increases in auction and customer advances of $183,000;
non-cash depreciation expense of $100,000 and non-cash fair value of common
stock grants of $10,000.
To
generate cash to be used for operations, in the six months ended December 31,2006, we made fewer advances against consigned coins and sold off inventory.
Cost cutting measures were implemented for all expenses related to trade shows,
the marketing of the inventory and delivery of goods. We will continue to strive
to gain operating efficiencies by turning our inventory more quickly and
monitoring the amount of inventory that we carry, although there is no assurance
we will achieve these efficiencies.
Investing
Activities
Cash
used
in investing activities for the three months ended December 31, 2006 was
$130,000 consisting of purchases of property and equipment.
Page
33
Financing
Activities
Until
the
quarter ending March 31, 2004, we had incurred losses since July 1999 and have
financed these losses through short-term and long-term borrowings, by issuing
shares in various private placement transactions and by liquidating assets.
Losses in fiscal 2007 and 2006 have been financed primarily through the
restructuring of debt and conversion of revolving debt to equity by SIBL. Net
cash used by financing activities totaled $2,867,000 for the six months ended
December 31, 2006, resulting from the transactions described below.
Financing
Activities - Debt
On
April10, 2002 we executed a subordinated note payable to our then CEO, Silvano
DiGenova, bearing interest at 9% per annum with quarterly installment payments
of $150,000 plus interest. No principal payments had been made through February
2003. On February 10, 2003, the terms of the note were modified to provide
for
repayment of principal in the amount of $50,000 per quarter commencing on
September 30, 2003 and for interest to be paid monthly. We were in arrears
of
$150,000 of principal payments that were due on December 31, 2004, March 31,2005 and June 30, 2005 of $50,000 each. However, the former CEO agreed to delay
these principal repayments to September 30, 2005 when $50,000 was paid. During
the year ended June 30, 2006, the note was reduced by $250,000 and the interest
rate was increased to 12%. During the six month period ended December 31, 2006,
there was a principal repayment of $100,000. At December 31, 2006, the balance
due was $400,000 and there was no accrued interest payable.
On
October 13, 2003, we executed a Commercial Loan and Security Agreement
(“Commercial LOC”) with SFG, an affiliate of our principal stockholder, SIBL, to
provide us with a $7,500,000 line of credit for purposes of financing our
inventory, auction advances and inventory loans to other rare coin dealers
and
collectors. A portion of this indebtedness was assigned to SIBL, and on March31, 2005, as described below, pursuant to SIBL’s purchase of $2,500,000 of our
Series E Preferred Stock, SIBL assumed, converted and cancelled $2,500,000
of
this indebtedness under the Commercial LOC. In addition, SFG further amended
the
Commercial LOC increasing the line of credit to $10,000,000, and subsequently
assigned the indebtedness to SIBL. Effective July 21, 2005, the Commercial
LOC
was renewed through October 1, 2006. On May 2, 2006, the Commercial LOC was
further amended and to increase the line of credit to $10,850,000 to reflect
an
additional advance made March 30, 2006, to partially fund the repayment of
the
Private Line of Credit described in the next paragraph. On September 5, 2006,
the Commercial LOC was renewed through October 1, 2007. On November 21, 2006,
the Company entered into an agreement with SIBL pursuant to which the
outstanding balance on the Commercial LOC would be reduced by up to $2,408,481
through the transfer of rare coins to SIBL. As of December 29, 2006 the final
amount of the transfer of coins was determined to be $2,117,012. As of December31, 2006, the outstanding balance was $8,732,987 and there was no accrued
interest payable. The Commercial LOC bears interest at the prime-lending rate
(8.25% at December 31, 2006) and is secured by substantially all of the
Company’s assets. We are currently in compliance with all of the financial
covenants or we have waivers in effect with respect to any covenants with which
we are not in compliance. If we default in the performance of our obligations
under this loan the lender could foreclose its security interest, which could
lead to a termination of our business or require us to file a bankruptcy
petition.
During
October 2004 the Company executed three demand notes payable with a private
lender totaling $650,000 bearing interest at 10% per annum secured by specific
inventory. Interest was payable monthly. As of January 1, 2006, the interest
rate increased to 12% per annum. During the six months ended December 31, 2006,
the entire outstanding balance of $650,000 was repaid.
Anticipated
Equity Transactions
As
documented in the Merger Agreement,
one
hundred percent (100%) of the issued and outstanding shares of our capital
stock
will be converted into the right to receive shares of Common Stock of (DGSE).
The conversion is made in accordance with the General Corporation Law of the
State of Delaware (the "DGCL"), Chapters 78 and 92A of Title 7 of the Nevada
Revised Statutes (the "NPCA") and the approvals of our and DGSE’s respective
Boards of Directors. In supporting documents, the Company entered into
Conversion Agreements with each of SIBL and Silvano DiGenova, our former
chairman, chief executive officer and interim chief financial officer.
Page
34
Pursuant
to the Conversion Agreement with SIBL on January 6, 2007, SIBL converted and
exchanged all of its shares of preferred stock, which included (i) 3,000,000
shares of the Series B $1.00 Convertible Preferred Stock; (ii) 2,000,000 shares
of the Series D $1.00 Convertible Preferred Stock; and (iii) 2,500,000 shares
of
the Series E $1.00 Convertible Preferred Stock, into an aggregate of 3,600,806
shares of our common stock. In addition, in connection with the closing of
the
Merger, we anticipate that SIBL will convert $8,392,340 in debt owed under
its
Commercial Line of Credit into 4,936,671 shares of our common stock at a
conversion ratio of $1.70 per share. This conversion of the amount outstanding
under the existing Commercial LOC at December 31, 2006 replaces the original
terms of the July 12, 2006 Merger Agreement wherein SIBL was going to convert
debt to the extent that the Company’s stockholders’ equity is less than
$5,751,000 at $2.00 per share. At December 31, 2006 our shareholders’ equity is
($3,255,000), so the conversion amount under the original Merger Agreement
would
have been $8,523,912 into 4,261,956 shares of common stock.
Pursuant
to the Merger Agreement, fifteen percent (15%) of the number of shares of DGSE
common stock to be issued at the closing of the Merger, less 33,648 shares
to
which DGSE is entitled under the Merger Agreement due to the fact that our
actual December 31, 2006 stockholders’ equity was $ 89,840 less than our
estimated December 31, 2006 stockholders’ equity used for purposes of
determining the amount of debt to be converted by SIBL, will be deposited in
an
escrow account as security for the payment of indemnification claims made under
the Merger Agreement in the event the Company’s representations and warranties
concerning its capitalization are inaccurate. The escrow will expire one year
after the consummation of the Merger. The stockholder agent, which will
initially be SIBL will have the exclusive right to defend the escrow against
claims made by DGSE or its related parties on behalf of the Company’s
stockholders.
Pursuant
to the Conversion Agreement with Silvano DiGenova, our former chairman, chief
executive officer and interim chief financial officer, Mr. DiGenova converted
his 400,000 shares of Series B $1.00 Convertible Preferred Stock into 202,330
shares of our common stock.
Other
Liquidity Plans
As
a
condition to the closing of the DGSE Merger, we expect to enter into a Note
Exchange Agreement with SIBL. Pursuant to the Note Exchange Agreement, SIBL
would convert $8,392,340 in debt into 4,936,671 shares of our common stock..
This conversion would occur immediately prior to the consummation of the Merger.
SFG would provide a secured Commercial Line of Credit in the amount of
$11,500,000 to replace the existing facility, which new facility will be
available to both us and our post-Merger corporate parent, DGSE. These
transactions are subject to satisfaction of all of the other conditions to
closing of the Merger, and if the Merger is not consummated, these transactions
will not occur.
Although
we will seek to secure additional financing and/or to raise additional capital
if the Merger is not closed as presently anticipated, we cannot assure you
that
we will be successful in completing these critical tasks. If we are unable
to
successfully obtain such financing, we may be forced to significantly and
materially reduce our operations and/or liquidate inventory at amounts below
current carrying value to generate the necessary working capital to fund any
ongoing operations.
Page
35
Capital
Expenditures
The
Company did not incur any material capital expenditures for property and
equipment during the three months ended December 31, 2006 and does not presently
have any plans to make material capital expenditures through the current fiscal
year ending June 30, 2007.
Additional
Information and Where to Find It
DGSE
will
file a Registration Statement on Form S-4, Superior Galleries will file a
proxy
statement (as part of the Registration Statement on Form S-4) and both companies
will file other relevant documents concerning the proposed Merger with the
Securities and Exchange Commission (the “SEC”). INVESTORS ARE URGED TO READ THE
FORM S-4 AND PROXY STATEMENT WHEN THEY BECOME AVAILABLE AND ANY OTHER RELEVANT
DOCUMENTS FILED WITH THE SEC BECAUSE THEY WILL CONTAIN IMPORTANT INFORMATION.
You will be able to obtain the documents free of charge at the website
maintained by the SEC at www.sec.gov. In addition, you may obtain documents
filed with the SEC by Superior Galleries free of charge by contacting
William
H.
Oyster, Interim Chief Executive Officer of Superior, by telephone at (800)
421-0754,
or by mail at 9478 West Olympic Boulevard, Beverly Hills, CA90212.
Participants
in the Solicitation
Superior
Galleries, DGSE and their respective directors and executive officers may
be
deemed to be participants in the solicitation of proxies from Superior Galleries
shareholders in connection with the Merger. Information about the directors
and
executive officers of Superior Galleries and their ownership of Superior
Galleries stock will be set forth Registration Statement on Form S-4 and
the
included proxy statement of Superior Galleries relating to the Merger. Likewise,
information about the directors and executive officers of DGSE and their
ownership of DGSE stock will be set forth Registration Statement on Form
S-4 and
the included proxy statement of DGSE relating to the Merger.
Investors
should read the Form S-4 and proxy statement carefully when they become
available before making any voting or investment decisions.
ITEM
3.
QUANTITATIVE
AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK
Market
risk represents the risk of loss that may impact our financial position, results
of operations or cash flows due to adverse changes in financial market prices,
including interest rate risk, foreign currency exchange rare risk, commodity
price risk and other relevant market rate or price risks.
We
are
exposed to a degree of market risk through changes in short-term interest rates.
At December 31, 2006, we had a line of credit from a related party with a
balance payable of $8,733,000. This line of credit bears an interest rate that
is tied to the bank prime rate. We are exposed to the risk of increasing
short-term interest rates, but we do not consider this risk to be
material.
We
have
no activities that would expose us to foreign currency exchange rate risk or
commodity price risks.
ITEM
4.
CONTROLS
AND PROCEDURES
Evaluation
of Disclosure Controls and Procedures
Our
Interim Chief Financial Officer carried out an evaluation of the effectiveness
of the Company’s “disclosure controls and procedures” (as defined in the
Securities Exchange Act of 1934 Rules 13a-15(e) or 15d-15(e)) as of December31,2006, as required by paragraph (b) of Exchange Act Rules 13a-15 or 15d-15.
While
we will continually seek to evaluate and improve our disclosure controls,
management does not expect that our disclosure controls or its internal controls
over financial reporting will prevent all possible errors and fraud. A control
system, no matter how well designed and operated, can provide only reasonable,
not absolute, assurance that the control system’s objectives would be met.
Our
Interim Chief Financial Officer has concluded, based on his evaluation as of
December 31, 2006 (“Evaluation Date”), that the design and operation of our
“disclosure controls and procedures” (as defined under the Exchange Act), are
effective to ensure that information required to be disclosed by us in reports
filed or submitted by us under the Exchange Act is accumulated, recorded,
processed, summarized and reported to our management, including our Board of
Directors, as appropriate to allow timely decisions regarding whether or not
disclosure is required. There were no significant changes in our internal
controls or in other factors that could significantly affect our internal
controls subsequent to the Evaluation Date.
Changes
in Internal Controls
During
te
quarter ended December 31, 206, we did no make any material changes to our
internal controls,
In
consideration of the pending Merger with DGSE, we delayed the start date for
implementation of documentation and testing of internal controls required under
Section 404 of the Sarbanes Oxley Act (“SOX”). Assuming the Merger is
consummated as currently planed, the SOX project for the combined companies
will
be conducted under the direction of DGSE. Since we are not an “accelerated
filer,” as defined bt SEC rules, we are not required to comply with Section 404
of SOX until fiscal 2008.
Departure
of Principal Officer and Directors
Page
36
Related
to the Amended and Restated Agreement
and Plan of Merger and Reorganization
dated
January 6, 2007, Silvano DiGenova entered into a Termination and Release
Agreement with the Company, whereby he resigned as a director, chief executive
officer, president, interim chief financial officer and chairman effective
January 6, 2007. Pursuant to this agreement, Mr. DiGenova and the Company
released each other from claims either might have against the other related
to
his relationship with the Company as a stockholder, officer, employee, director
or otherwise, subject to specified exceptions. The Company then entered into
a
consulting agreement with Mr. DiGenova, whereby he will continue to provide
services to the Company.
Related
to the Management Agreement dated January 6, 2007, the board of directors of
the
Company appointed a special committee, consisting of Mitchell Stolz and David
Rector, which is authorized and empowered, with the full power of the full
Board, to review, approve and act upon any issue or action: (1) related to
the
merger prior to closing of the merger, or (2) which in any way relates to any
transaction or other matter in which DGSE has an interest.
Pursuant
to the Management Agreement dated January 6, 2007, Lee Ittner, Anthony Friscia
and Paul Biberkraut also resigned as directors effective January 6, 2007.
Messrs. Friscia and Ittner served on the Superior Galleries audit and
compensation committees, and Mr. Friscia was chair of the audit
committee.
To
replace the resigned directors, pursuant to the Management Agreement, Scott
Williamson, William H. Oyster and John Benson were appointed as replacement
directors by the remaining members of the board of directors effective January6, 2007. Paul Biberkraut entered into a consulting agreement with the Company,
which has a term of three months and which can be renewed by the Company,
pursuant to which the Company will pay him $4,000 per month for consulting
services leading up to the merger.
Copies
of
the Termination and Release Agreement are incorporated by reference to the
Form
8-K filed on January 9, 2007. The foregoing descriptions of those agreements
are
qualified in their respective entirety by reference to the full text of the
agreements.
PART
II - OTHER INFORMATION
ITEM
1.
LEGAL
PROCEEDINGS
On
June6, 2006the Company was sued in the U.S. District Court for Central California
by Elaine and Dean Sanders in connection with a loan made to them against 32
coins placed on consignment on June 26, 2004. Fourteen of the coins were sold,
and the proceeds from this sale of approximately $186,750 were insufficient
to
repay the remaining loan balance of $359,471 that the Company made to the
Sanders. The plaintiffs subsequently paid an additional $155,000 in December
2005 with respect to the loan, but now allege that the Company violated its
agreement with them relating to the sale of the coins. The Company strongly
denies that it violated the agreement or that it acted improperly in any way.
The complaint seeks undefined dollar amounts, accrued interest and reimbursement
of plaintiffs’ legal costs.
In
April
2004 the Company sued its former Chief Financial Officer, Malingham Shrinivas,
in Los Angeles Superior Court for breach of contract, fraud and conspiracy.
In
that lawsuit, the Company alleged that he fraudulently arranged to receive
more
salary than he was entitled to, to pay personal expenses using Company funds,
and to pay third party vendors with Company funds for services which were not
rendered. In July 2004 Mr. Shrinivas filed a counterclaim in this litigation,
claiming that he was terminated without just cause and was therefore entitled
to
$58,250 in severance pay. Although the case had been scheduled for trial in
August 2006, prior to that time the case was stayed by order of the Superior
Court because the Court had been advised that criminal charges against Mr.
Shrinivas related to this matter were imminent. Those criminal charges were
subsequently filed, and therefore further proceedings in connection with the
civil case continue to be stayed. The Company believes that Mr. Shrinivas was
terminated with cause and that he is therefore not entitled to any severance
pay. If and when the stay of our civil case is terminated, the Company intends
to vigorously pursue its claims and defend Mr. Shrinivas’ claims for severance
pay.
Page
37
On
September 26, 2006 we were sued in the California Superior Court by a former
customer, Michael Iatesta, for breach of contract and intentional and negligent
misrepresentation. The suit relates to our sale of the plaintiff’s coins at an
auction in September 2005. The plaintiff claims that we made errors in
connection with the marketing and sale of his coins, and that as a result his
coins were sold for approximately $123,000 instead of their alleged full value
of from $225,000 to $250,000. We sold the plaintiff’s coins at or above the
minimum price set by the plaintiff. We believe that his allegations are without
merit and intend to vigorously defend this suit.
On
November 7, 2006 we were sued in the United States District Court for the
Northern District of Texas by a competitor, Heritage Numismatic Auctions, Inc.
(“Heritage”). In its complaint, Heritage alleges that we violated Heritage’s
copyright rights by copying Heritage’s catalog descriptions of certain coins and
currency offered for sale by Heritage. Heritage claims that these alleged
actions also violate the California Unfair Competition Act. Heritage seeks
an
injunction ordering us to cease the alleged acts of infringement and to destroy
the infringing items and damages in unspecified amounts. We deny that we have
infringed any of Heritage’s legal rights and intend to vigorously defend this
suit. We have reserved for our own legal costs, estimated to be $50,000.
We
may
from time to time be involved in various claims, lawsuits or disputes with
third
parties, actions involving allegations of discrimination, or breach of contract
actions incidental to the operation of its business. We are not currently
involved in any litigation which we believe could have a materially adverse
effect on our financial condition or results of operations.
ITEM
1A.
RISK
FACTORS
There
were no material changes in our risk factors as compared to those previously
disclosed in our Annual Report on Form 10-K for the year ended
June 30, 2006.
ITEM
2.
UNREGISTERED
SALES OF EQUITY SECURITIES AND USE OF
PROCEEDS
None.
ITEM
3.
DEFAULTS
UPON SENIOR SECURITIES
None.
ITEM
4.
SUBMISSION
OF MATTERS TO A VOTE OF SECURITY
HOLDERS
None.
ITEM
5.
OTHER
INFORMATION
None.
Page
38
ITEM
6.
EXHIBITS
Exhibit
No
Description
2.1
Amended
and Restated Agreement and Plan of Merger and Reorganization dated
as of
January 6, 2007, by and among DGSE Companies, Inc., DGSE Merger Corp.,
Superior Galleries, Inc. and Stanford International Bank, Ltd,.,
as
Stockholder Agent (incorporated herein this by reference to Exhibit
2.1 to
the registrant’s Current Report on Form 8-K filed January 9,2007).
2.2
Form
of Escrow Agreement (incorporated herein by this reference to Exhibit
2.2
to the registrant’s Current Report on Form 8-K filed January 9,2007)
2.3
Form
of Amended and Restated Commercial Loan and Security Agreement
(incorporated herein by this reference to Exhibit 2.3 to the registrant’s
Current Report on Form 8-K filed January 9, 2007)
2.4
Form
of Warrant (incorporated herein by this reference to Exhibit 2.4
to the
registrant’s Current Report on Form 8-K filed January 9,2007)
2.5
Form of
Note
Exchange Agreement (incorporated herein by this reference to Exhibit
2.5
to the registrant’s Current Report on Form 8-K filed January 9,2007)
2.6
Form of
Termination
and Release Agreement (incorporated herein by this reference to Exhibit
2.6 to the registrant’s Current Report on Form 8-K filed January 9,2007)
31.1
Certification
of CEO
pursuant to Securities Exchange Act Rules13a-14 and 15d-14 as adopted
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2
Certification
of CFO
pursuant to Securities Exchange Act Rules13a-14 and 15d-14 as adopted
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1
Certification
of CEO
pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906
of
the Sarbanes-Oxley Act of 2002.
32.2
Certification
of CFO
pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906
of
the Sarbanes-Oxley Act of 2002.
Page
39
SIGNATURES
In
accordance with 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.
