UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
(Mark One)
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 For the quarterly period ended September 30, 2006 or
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 For the transition period from ___ to ___
Commission File Number 1-11048
DGSE Companies, Inc.
(Exact name of registrant as specified in its charter)
Nevada 88-0097334
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
2817 Forest Lane
Dallas, Texas 75234
(972) 848-3662
(Address, including zip code, and telephone
number, including area code, of registrant's
principal executive offices)
NONE
(Former name, former address and former
fiscal year, if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
YES |X| NO |_|
Indicate by check mark whether the registrant 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 |_| Accelerated filer |_| 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 |_| NO |X|
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of October 27, 2006:
Class Outstanding
- -------------------------------------- --------------------------------------
Common stock, $.01 par value per share 4,913,290
TABLE OF CONTENTS
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PART I. FINANCIAL INFORMATION Page No.
--------------------- --------
Item 1. Consolidated Financial Statements.
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Consolidated Balance Sheets as of September 30, 2006 and
December 31, 2005 1
Consolidated Statements of Operations for the three months 2
ended September 30, 2006 and 2005
Consolidated Statements of Operations for the nine months 3
ended September 30, 2006 and 2005
Consolidated Statements of Cash Flows for the nine months 4
ended September 30, 2006 and 2005
Notes to Consolidated Financial Statements 5
Item 2. Management's Discussion and Analysis of Financial Condition 9
- ------
and Results of Operations.
Item 3. Quantitative and Qualitative Disclosures About Market Risk. 11
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Item 4. Controls and Procedures. 12
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PART II. OTHER INFORMATION
-----------------
Item 3. Legal Proceedings. 12
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Item 5. Other Information. 12
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Item 6. Exhibits. 12
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SIGNATURES
i
DGSE Companies, Inc. and Subsidiaries
PART I. FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements.
CONSOLIDATED BALANCE SHEETS
September 30, December 31,
2006 2005
------------- -------------
Unaudited
ASSETS
Current Assets:
Cash and cash equivalents .............................................. $ 217,282 $ 1,042,834
Trade receivables ...................................................... 947,897 688,810
Inventories ............................................................ 8,451,224 7,570,120
Prepaid expenses ....................................................... 208,356 215,560
------------- -------------
Total current assets ....................................... 9,824,759 9,517,324
Marketable securities - available for sale ................................. 74,929 65,444
Property and equipment, net ................................................ 1,026,838 1,121,662
Deferred income taxes ...................................................... -- 779
Goodwill ................................................................... 837,117 837,117
Other assets ............................................................... 632,662 287,790
------------- -------------
$ 12,396,305 $ 11,830,116
============= =============
LIABILITIES
Current Liabilities:
Notes payable .......................................................... $ 194,183 $ 594,183
Current maturities of long-term debt ................................... 259,273 259,152
Accounts payable - trade ............................................... 326,834 789,724
Accrued expenses ....................................................... 419,757 580,823
Customer deposits ...................................................... 382,346 206,320
Federal income taxes payable ........................................... 210,584 13,920
------------- -------------
Total current liablilites ................................. 1,792,977 2,444,122
Long-term debt, less current maturities .................................... 3,996,128 3,314,886
Deferred income taxes ...................................................... 2,446 --
------------- -------------
5,791,551 5,759,008
STOCKHOLDERS' EQUITY
Common stock, $.01 par value; 10,000,000 shares authorized; 4,913,290 shares
issued and outstanding at the end of each
period in 2006 and 2005 ................................................. 49,133 49,133
Additional paid-in capital ................................................. 5,708,760 5,708,760
Accumulated other comprehensive loss........................................ (120,992) (127,252)
Retained earnings .......................................................... 967,853 440,467
------------- -------------
6,604,754 6,071,108
------------- -------------
$ 12,396,305 $ 11,830,116
============= =============
The accompanying notes are an integral part of
these consolidated financial statements
1
DGSE Companies, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF OPERATIONS
Three months ended September 30,
--------------------------------
2006 2005
-------------- --------------
Unaudited
Revenue
Sales ..................................... $ 9,497,528 $ 7,129,321
Consumer loan service charges ............. 111,422 85,536
-------------- --------------
9,608,950 7,214,857
Costs and expenses
Cost of goods sold ......................... 8,085,866 5,837,846
Selling, general and administrative expenses 1,251,108 1,124,435
Depreciation and amortization .............. 29,548 46,219
-------------- --------------
9,366,522 7,008,500
Operating income ....................... 242,428 206,357
-------------- --------------
Other (income) expense
Other income ............................... -- (3,895)
Interest expense ........................... 78,646 71,533
-------------- --------------
Earnings before income taxes ........... 163,782 138,719
Income tax expense ............................. 55,686 47,165
-------------- --------------
Net earnings ........................... $ 108,096 $ 91,554
============== ==============
Earnings per common share - basic and diluted .. $ 0.02 $ 0.02
============== ==============
Weighted average number of common shares:
Basic ..................................... 4,913,290 4,913,290
Diluted ................................... 5,056,133 5,040,148
The accompanying notes are an integral part of
these consolidated financial statements
2
DGSE Companies, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF OPERATIONS
Nine months ended September 30,
-------------------------------
2006 2005
-------------- --------------
Unaudited
Revenue
Sales ..................................... $ 31,570,446 $ 20,475,598
Consumer loan service charges ............. 305,554 257,481
-------------- --------------
31,876,000 20,733,079
Costs and expenses
Cost of goods sold ......................... 27,014,402 16,608,461
Selling, general and administrative expenses 3,724,797 3,288,686
Depreciation and amortization .............. 108,563 138,090
-------------- --------------
30,847,762 20,035,237
Operating income ....................... 1,028,238 697,842
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Other (income) expense
Other income ............................... -- (3,895)
Interest expense ........................... 229,227 214,696
-------------- --------------
Earnings before income taxes ........... 799,011 487,041
Income tax expense ............................. 271,664 165,594
-------------- --------------
Net earnings ........................... $ 527,347 $ 321,447
============== ==============
Earnings per common share - basic and diluted .. $ 0.11 $ 0.06
============== ==============
Weighted average number of common shares:
Basic ..................................... 4,913,290 4,913,290
Diluted ................................... 4,989,065 5,059,709
The accompanying notes are an integral part of
these consolidated financial statements
3
DGSE COMPANIES, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF CASH FLOWS
Nine months ended September 30,
-------------------------------
2006 2005
------------- -------------
Unaudited
Cash flows from operating activities
Net earnings ................................................. $ 527,347 $ 321,447
Adjustments to reconcile net earnings to net cash provided
by operating activities
Depreciation and amortization ........................... 108,563 138,090
Realized gain on sale of marketable securities .......... -- (3,895)
(Increase) decrease in operating assets and liabilities
Trade receivables ....................................... (197,173) 52,935
Inventories ............................................. (881,104) (594,535)
Prepaid expenses and other current assets ............... 7,204 (133,001)
Accounts payable and accrued expenses ................... (623,956) (575,112)
Customer deposits ....................................... 176,026 105,548
Federal income taxes payable ............................ 196,664 (66,258)
Other assets ............................................ (344,872) 27,111
------------- -------------
Net cash used in operating activities ................. (1,031,301) (727,670)
Cash flows from investing activities
Pawn loans made ......................................... (387,966) (469,839)
Pawn loans repaid ....................................... 319,203 338,069
Recovery of pawn loan principal through sale of forfeited
collateral ............................................. 67,503 220,356
Pay day loans made ...................................... (207,428) (100,871)
Pay day loans repaid .................................... 146,813 64,270
Purchase of property and equipment ...................... (13,739) (210,709)
Proceeds from sale of marketable securities ............. -- 4,277
------------- -------------
Net cash used in investing activities ................. (75,614) (154,447)
Cash flows from financing activities
Proceeds from notes issued ................................. 840,000 3,481,365
Repayments of notes payable ................................ (558,637) (2,603,519)
------------- -------------
Net cash provided by financing activities ......... 281,363 877,846
NET DECREASE IN CASH AND CASH EQUIVALENTS ............. (825,552) (4,271)
Cash and cash equivalents at beginning of period .............. 1,042,834 314,897
------------- -------------
Cash and cash equivalents at end of period .................... $ 217,282 $ 310,626
============= =============
Supplemental disclosures:
Interest paid for the nine months ended September 30, 2006 and 2005 was $229,227
and $214,696, respectively. Income taxes paid for the nine months ended
September 30, 2006 and 2005 was $75,000 and $225,000, respectively. Pawn loans
forfeited and transferred to inventory amounted to $67,503 and $220,356,
respectively, for the nine months ended September 30, 2006 and 2005.
The accompanying notes are an integral part of
these consolidated financial statements.
4
DGSE COMPANIES, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) Basis of Presentation.
The accompanying unaudited condensed consolidated financial statements of
DGSE Companies, Inc. and Subsidiaries include the financial statements of
DGSE Companies, Inc. and its wholly-owned subsidiaries, DGSE Corporation,
National Jewelry Exchange, Inc., Charleston Gold and Diamond Exchange, Inc.
and American Pay Day Centers, Inc. In the opinion of management, all
adjustments consisting of normal recurring accruals considered necessary
for a fair presentation have been included.
The interim financial statements of DGSE Companies, Inc. included herein
have been prepared by us pursuant to the rules and regulations of the
Securities and Exchange Commission. Certain information and footnote
disclosures normally included in financial statements prepared in
accordance with accounting principles generally accepted in the United
States of America have been condensed or omitted pursuant to the
Commission's rules and regulations, although we believe that the
disclosures are adequate to make the information presented not misleading.
We suggest that these financial statements be read in conjunction with the
financial statements and notes included in our Annual Report on Form 10-K
for the year ended December 31, 2005, and our Quarterly report on Form 10-Q
for the three months ended March 31, 2006 and our Quarterly report on Form
10-Q for the six months ended June 30, 2006. In our opinion, the
accompanying unaudited interim financial statements contain all
adjustments, consisting only of those of a normal recurring nature,
necessary to present fairly its results of operations and cash flows for
the periods presented. The results of operations for the periods presented
are not necessarily indicative of the results to be expected for the full
year. Certain reclassifications were made to the prior year's consolidated
financial statements to conform to the current year presentation.
(2) Trade Receivables
Pawn loans receivable in the amount of $112,042 and $142,611 as of
September 30, 2006 and 2005, respectively, are included in the Consolidated
Balance Sheets caption trade receivables. The related pawn service charges
receivable in the amount of $37,509 and $50,433 as of September 30, 2006
and 2005, respectively, are also included in the Consolidated Balance
Sheets caption trade receivables. Pay day loans receivable in the amount of
$77,273 as of September 30, 2006 and $27,614 as of September 30, 2005,
respectively, are also included in the Consolidated Balance Sheets caption
trade receivables.
(3) Earnings per share.
A reconciliation of the income and shares of the basic earnings per common
share and diluted earnings per common share for the periods ended September
30, 2006 and 2005 is as follows:
2006 2005
Nine months ended September 30, Nine months ended September 30,
Net Earnings Shares Per share Net Earnings Shares Per share
------------ ------------ ------------ ------------ ------------ ------------
Basic earnings per common share..... $ 527,347 4,913,290 $ 0.11 321,447 4,913,290 $ 0.06
Effect of dilutive stock options.... -- 75,775 -- -- 146,419 --
------------ ------------ ------------ ------------ ------------ ------------
Diluted earnings per common share... $ 527,347 4,989,065 $ 0.11 321,447 5,059,709 $ 0.06
============ ============ ============ ============ ============ ============
2006 2005
Three months ended September 30, Three months ended September 30,
Net Earnings Shares Per share Net Earnings Shares Per share
------------ ------------ ------------ ------------ ------------ ------------
Basic earnings per common share..... 108,096 4,913,290 $ 0.02 91,554 4,913,290 $ 0.02
Effect of dilutive stock options.... -- 142,843 -- -- 126,858 --
------------ ------------ ------------ ------------ ------------ ------------
Diluted earnings per common share... 108,096 5,056,133 $ 0.02 91,554 5,040,148 $ 0.02
============ ============ ============ ============ ============ ============
5
DGSE COMPANIES, Inc. and Subsidiaries
(4) Business segment information.
Management identifies reportable segments by product or service offered.
Each segment is managed separately. Corporate and other includes certain
general and administrative expenses not allocated to segments and pawn
operations. Our operations by segment for the nine months ended September
30 were as follows:
(In thousands) Retail Wholesale Rare Corporate
Jewelry Jewelry Bullion Coins and Other Consolidated
------------ ------------ ------------ ------------ ------------ ------------
Revenues
2006 $ 10,885 $ 3,775 $ 13,117 $ 3,659 $ 440 $ 31,876
2005 9,790 2,962 5,536 1,895 550 20,733
Net income (loss)
2006 171 113 181 204 (142) 527
2005 204 144 27 145 (199) 321
Identifiable assets
2006 9,102 1,987 300 266 741 12,396
2005 8,041 1,742 236 145 810 10,974
Capital Expenditures
2006 137 -- -- -- -- 137
2005 169 -- -- -- 42 211
Depreciation and amortization
2006 67 -- -- -- 42 109
2005 85 16 -- -- 37 138
Our operations by segment for the three months ended September 30 were as
follows:
(In thousands) Retail Wholesale Rare Corporate
Jewelry Jewelry Bullion Coins and Other Consolidated
------------ ------------ ------------ ------------ ------------ ------------
Revenues
2006 $ 3,325 $ 1,472 $ 3,526 $ 1,141 $ 145 $ 9,609
2005 3,362 1,015 1,964 732 142 7,215
Net income (loss)
2006 18 56 31 38 (35) 108
2005 44 45 12 58 (68) 91
Identifiable assets
2006 8,633 1,944 172 372 694 11,815
2005 8,041 1,742 236 145 810 10,974
Capital Expenditures
2006 132 -- -- -- -- 132
2005 18 -- -- -- 26 44
Depreciation and amortization
2006 19 -- -- -- 11 30
2005 29 5 -- -- 12 46
6
DGSE COMPANIES, Inc. and Subsidiaries
(5) Other Comprehensive income.
Other comprehensive income is as follows:
Before Tax Tax (Expense) Net-of-Tax
Amount Benefit Amount
------------- ------------- -------------
Other comprehensive loss at
December 31, 2005 .................... $ (162,071) $ 34,819 $ (127,252)
Unrealized gains during the period ended
March 31, 2006 ....................... 4,385 (1,491) 2,894
------------- ------------- -------------
Other comprehensive loss at
March 31, 2006 ...................... (157,686) 33,328 (124,358)
Unrealized gains during the period ended
June 30, and September 30, 2006 ..... 5,100 (1,734) 3,366
------------- ------------- -------------
Other comprehensive loss at
September 30, 2006 ................... $ (152,586) $ 31,594 $ (120,992)
============= ============= =============
(6) Stock-based Compensation.
Prior to January 1, 2006, we elected to follow Accounting Principles Board
Opinion (APB) NO.25, Accounting for Stock Issued to Employees, and related
interpretations to account for our employee and director stock options, as
permitted by Statement of Financial Accounting Standards (SFAS) No. 123,
Accounting for Stock-Based Compensation. Effective January 1, 2006, we
adopted the fair value recognition provision of SFAS No. 123 (revised
2004), Share-Based Payments, (SFAS No. 123(R) for all share-based payment
awards to employees and directors including employee stock options. In
addition, we have applied the provisions of Staff Accounting Bulletin No.
107 (SAB No. 107), issued by the Securities and Exchange Commission, in our
adoption of SFAS No. 123(R).
We adopted SFAS No. 123(R) using the modified-prospective-transition
method. Under this transition method, stock-based compensation expense
recognized after the effective date includes: (1) compensation cost for all
share-based payments granted prior to, but not yet vested as of January 1,
2006, based on the grant date fair value estimate in accordance with the
original provisions of SFAS No. 123, and (2) compensation cost for all
share-based payments granted subsequent to January 1, 2006, based on the
grant-date fair value estimate in accordance with the provision of SFAS No.
123. Results from prior periods have not been restated and do not include
the impact of SFAS No. 123(R). Stock-based compensation expense under SFAS
No. 123(R) for the first nine months of 2006 was $0, relating to employee
and director stock options and our employee stock purchase plan.
Stock-based compensation expense under the provision of APB No. 25 for the
nine months of 2006 was insignificant.
Stock-based compensation expense recognized each period is based on the
value of the portion of share-based payment awards that is ultimately
expected to vest during the period. SFAS No. 123(R) requires forfeitures to
be estimated at the time of grant and revised, if necessary, in subsequent
periods if actual forfeitures differ from those estimates. In our pro forma
disclosures required under SFAS No. 123 for periods prior to 2006, we
accounted for forfeitures as they occurred.
Upon adoption of SFAS No. 123(R), we elected to use the
Black-Scholes-Merton option-pricing formula to value share-based payments
granted to employees subsequent to January 1, 2006 and elected to attribute
the value of stock-based compensation to expense using the straight-line
single option method. These methods were previously used for our pro forma
information required under SFAS No. 123.
On November 10, 2005, the Financial Accounting Standards Board (FASB)
issued FASB Staff Position No. FAS 123(R)-3, "Transition Election Related
to Accounting for Tax Effects of Share-Based Payment Awards", which
detailed an alternative transition method for calculating the tax effects
of stock-based compensation pursuant to SFAS No. 123(R). This alternative
transition method included simplified methods to establish the beginning
balance of the additional paid-in capital pool (APIC pool) related to the
tax effects of employee stock-based compensation and to determine the
subsequent impact on the APIC pool and Consolidated Statement of Cash Flows
of the tax effects of employee stock-based compensation awards that are
outstanding upon adoption of SFAS No. 123(R). As all options outstanding
have vested prior to December 31, 2005, we have not recorded the tax
effects of employee stock-based compensation and have made no adjustments
to the APIC pool.
7
DGSE COMPANIES, Inc. and Subsidiaries
Prior to the adoption of SFAS No. 123(R) tax benefits of deductions
resulting from the exercise of stock options were required to be presented
as operating cash flows in the Consolidated Statement of Cash Flows. SFAS
No. 123(R) requires the cash flows resulting from the tax benefits
resulting from tax deductions in excess of the compensation cost recognized
for those options (excess tax benefits) to be classified as financing cash
flows. As there have been no stock options exercised, we have not reported
these excess tax benefits as of September 30, 2006.
Effective January 1, 2006, we adopted the fair value recognition provisions
of SFAS No. 123(R) for all share based payment awards to employees and
directors including employee stock options granted under our employee stock
option plan. As all options outstanding have vested prior to December 31,
2005, no stock based compensation expense has been recorded as of September
30, 2006.
The following table presents the effect on net income and net income per
share compared with pro forma information as if we had adopted SFAS No. 123
for the periods ended September 30,
Three Months Ended September 30,
2006 2005
-------------- --------------
Net earnings as reported .................................. $ 108,096 $ 91,554
Less stock-based compensation under the fair value method . -- --
-------------- --------------
Pro forma net earnings .................................... $ 108,096 $ 91,554
Earnings per share:
Basic and diluted earnings per common share, as reported $ 0.02 $ 0.02
Basic and diluted earnings per common share, pro forma . $ 0.02 $ 0.02
Nine Months Ended September 30,
2006 2005
-------------- --------------
Net earnings as reported .................................. $ 527,347 $ 321,447
Less stock-based compensation under the fair value method . -- --
-------------- --------------
Pro forma net earnings .................................... $ 527,347 $ 321,447
Earnings per share:
Basic and diluted earnings per common share, as reported $ 0.11 $ 0.06
Basic and diluted earnings per common share, pro forma . $ 0.11 $ 0.06
(7) New Accounting Pronouncements
On July 13, 2006, the FASB issued FASB Interpretation 48, Accounting for
Uncertainty in Income Taxes: an interpretation of FASB Statement No. 109
(FIN 48). FIN 48 clarifies Statement 109, Accounting for Income Taxes, to
indicate the criteria that an individual tax position would have to meet
for some or all of the benefit of that position to be recognized in an
entity's financial statements. FIN 48 is effective for fiscal years
beginning after December 15, 2006. The Company is currently evaluating the
requirements under FIN 48 and the effect, if any, that the adoption of FIN
48 will have on our consolidated financial statements, statement of cash
flows or earnings per share.
In September 2006, the FASB issued SFAS 157 Fair Value Measurements, which
defines fair value, establishes a framework for measuring fair value, and
expands disclosures about fair value measurements. The provisions of SFAS
157 are effective as of the beginning of our 2008 fiscal year. We are
currently evaluating the impact of adopting SFAS 157 on our financial
statements.
(8) Recent Developments
On July 17, 2006, we announced that we had executed a definitive agreement
to acquire all of the issued and outstanding stock of Superior Galleries,
Inc. in a transaction valued at $ 14,000,000. For additional information
regarding this transaction reference is made to our Form 8-K filed on July
17, 2006. As of September 30, 2006 we have incurred $265,000 in legal and
other cost related to this acquisition. This cost is included in the
balance sheet caption "Other assets". In the event this transaction does
not close, this and any additional cost incurred related to this
transaction will be expensed and charged against operating results during
the period in which the transaction is terminated.
8
DGSE COMPANIES, Inc. and Subsidiaries
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations.
Forward-Looking Statements
The statements, other than statements of historical facts, included in this
report are forward-looking statements. Forward-looking statements generally can
be identified by the use of forward-looking terminology such as "may," "will,"
"would," "expect," "intend," "could," "estimate," "should," "anticipate" or
"believe." We believe that the expectations reflected in such forward-looking
statements are accurate. However, we cannot assure you that these expectations
will occur. Our actual future performance could differ materially from such
statements. Factors that could cause or contribute to these differences include,
but are not limited to:
o uncertainties regarding price fluctuations in the price of gold and other
precious metals;
o our ability to manage inventory fluctuations and sales;
o changes in governmental rules and regulations applicable to the specialty
financial services industry;
o the results of any unfavorable litigation;
o interest rates;
o economic pressures affecting the disposable income available to our
customers;
o our ability to maintain an effective system of internal controls;
o the other risks detailed from time to time in our SEC reports.
Additional important factors that could cause our actual results to differ
materially from our expectations are discussed under "Risk Factors" in our
Annual Report on Form 10-K for our fiscal year ended December 31, 2005. You
should not unduly rely on these forward-looking statements, which speak only as
of the date of this report. Except as required by law, we are not obligated to
publicly release any revisions to these forward-looking statements to reflect
events or circumstances occurring after the date of this report or to reflect
the occurrence of unanticipated events.
Our Business
We sell jewelry, bullion products and rare coins to both retail and wholesale
customers throughout the United States and makes collateralized loans to
individuals. Our products are marketed through our facilities in Dallas and
Carrollton, Texas and Mt. Pleasant, South Carolina and through our internet web
sites dgse.com; USBullionExchange.com; and, FairchildWatches.com.
We operate three internet sites on the World Wide Web. Through dgse.com we
operate a virtual store and a real-time auction of our jewelry products. We and
our customers buy and sell items of jewelry and are free to set their own prices
in an interactive market. We also offer customers the key unlimited trading
power to buy and sell precious metal assets. Customers have access to our
competitive two-way markets in all of the most popularly traded precious metal
products as well as current quotations for precious metals prices on our
internet site USBullionExchange.com. FairchildWatches.com provides wholesale
customers a virtual catalog of our fine watch inventory. Over 7,500 items are
available for sale on our internet sites including $10,000,000 in diamonds.
Our wholly-owned subsidiary, National Jewelry Exchange, Inc. ("NJE") operates a
pawn shop in Carrollton, Texas. We have focused the operations of NJE on sales
and pawn loans of jewelry products.
In January 2005 we began offering unsecured payday loans through our wholly
owned subsidiary American Pay Day Centers, Inc. which operates three locations
in New Mexico.
Recent Developments
On July 17, 2006, we announced that we had executed a definitive agreement to
acquire all of the issued and outstanding stock of Superior Galleries, Inc. in a
transaction valued at $ 14,000,000. For additional information regarding this
transaction reference is made to our Form 8-K filed on July 17, 2006. As of
September 30, 2006 we have incurred $265,000 in legal and other cost related to
this acquisition. This cost is included in the balance sheet caption "Other
assets". In the event this transaction does not close, this and any additional
cost incurred related to this transaction will be expensed and charged against
operating results during the period in which the transaction is terminated.
9
DGSE COMPANIES, Inc. and Subsidiaries
Significant Accounting Policies
Inventory. Jewelry and other inventory is valued at lower-of-cost-or-market
(specific identification). Bullion inventory is valued at
lower-of-cost-or-market (average cost).
Accounts Receivable. We record trade receivables when revenue is recognized. No
product has been consigned to customers. Our allowance for doubtful accounts is
primarily determined by review of specific trade receivables. Those accounts
that are doubtful of collection are included in the allowance. These provisions
are reviewed to determine the adequacy of the allowance for doubtful accounts.
Trade receivables are charged off when there is certainty as to their being
uncollectible. Trade receivables are considered delinquent when payment has not
been made within contract terms.
Revenue Recognition. Sales revenue consists of direct sales to customers for
jewelry, rare coins and bullion. Sales are recognized when title and risk of
loss have passed to the customer, which is generally at the point-of-sale.
Provisions for discounts and rebates to customers and returns, bad debts, and
other adjustments are provided in the period the related sales are recorded.
Pawn loans ("loans") are made with the collateral of tangible personal property
for one month with an automatic 60-day extension period. Pawn service charges
are recorded at the time of redemption at the greater of $15 or the actual
interest accrued to date. If the loan is not repaid, the principal amount loaned
plus accrued interest (or the fair value of the collateral, if lower) becomes
the carrying value of the forfeited collateral ("inventories") which is
recovered through sales to customers.
Results of Operations
Nine Months Ended September 30, 2006 compared to Nine Months Ended September 30,
2005
Sales increased by $11,094,848, or 54.2%, during the nine months ended September
30, 2006 as compared to 2005. This increase was primarily the result of a
$7,581,000, or 136.9%, increase in bullion sales, a $1,095,000, or 11.2%,
increase in retail jewelry sales, a $813,000, or 27.4%, increase in wholesale
jewelry sales and a $1,764,000, or 93.1%, increase in the sale of rare coin
products. The increase in both retail and wholesale jewelry sales were due to
higher gold prices and improved activity from our customers. The increase in
rare coin and bullion sales were the result of an increase in gold prices,
increased volatility in the bullion market and the Company's increased focus on
these segments of our business. Consumer loan service fees increased $48,073, or
18.7%, in 2006 due to an increase in pay day loans outstanding during the
period. Cost of goods as a percentage of sales increased from 81.1% in 2005 to
85.6 % in 2006. This increase was due to the increase in rare coin and bullion
revenue as a percentage of total sales.
Selling, general and administrative expenses increased by $436,111, or 13.3%,
during the nine months ended September 30, 2006 as compared to 2005. This
increase was primarily due to an increase in staff and payroll related cost of
$256,000, higher advertising cost of $105,000 and $75,000 in cost related to the
new pay day loan stores. The increase in staff was necessary to maintain a high
level of customer service as sales increased and the opening of three pay day
loan stores. The increase in advertising was necessary in order to attract new
customers in our local markets. Depreciation and amortization decreased by
$29,527, or 21.4%, during 2006 due to certain assets becoming fully depreciated.
Income taxes are provided at the corporate rate of 34% for both 2006 and 2005.
Three Months Ended September 30, 2006 compared to Three Months Ended September
30, 2005
Sales increased by $2,368,207, or 33.2%, during the three months ended September
30, 2006 as compared to 2005. This increase was primarily the result of a
$1,563,000, or 79.5%, increase in bullion sales, a $457,000, or 45.0%, increase
in wholesale jewelry sales and a $409,000, or 55.9%, increase in the sale of
rare coin products during the three months ended September 30, 2006 as compared
to 2005. The overall increase in jewelry sales was due to higher gold prices and
improved activity from our customers. The increase in rare coin and bullion
sales were the result of an increase in gold prices, increased volatility in the
bullion market and the Company's increased focus on these segments of our
business. Consumer loan service fees increased $25,886, or 30.3%, in 2006 due to
an increase in pay day loans outstanding during the period. Cost of goods as a
percentage of sales increased from 81.9% in 2005 to 85.1% in 2006. This increase
was due to the increase in rare coin and bullion revenue as a percentage of
total sales.
Selling, general and administrative expenses increased by $126,673, or 11.3%,
during the three months ended September 30, 2006 as compared to 2005. This
increase was primarily due to an increase in staff and payroll related cost of
$42,000, higher advertising cost of $42,000 and $13,000 in cost related to the
new pay day loan stores. The increase in staff was necessary to maintain a high
level of customer service as sales increased and the opening of three pay day
loan stores. The increase in advertising was necessary in order to attract new
10
DGSE COMPANIES, Inc. and Subsidiaries
customers in our local markets. Depreciation and amortization decreased by
$16,671, or 36.1%, during the three months ended September 30, 2006 as compared
to 2005, due to certain assets becoming fully depreciated.
Income taxes are provided at the corporate rate of 34% for both 2006 and 2005.
Historically, changes in the market prices of precious metals have had a
significant impact on both revenues and cost of sales in the rare coin and
precious metals segments in which we operate. It is expected that due to the
commodity nature of these products, future price changes for precious metals
will continue to be indicative of our performance in these business segments.
Changes in sales and cost of sales in the retail and wholesale jewelry segments
are primarily influenced by the national economic environment. It is expected
that this trend will continue in the future due to the nature of these product.
Liquidity and Capital Resources
We expect capital expenditures to total approximately $100,000 during the next
twelve months. It is anticipated that these expenditures will be funded from
working capital and its credit facility. As of September 30, 2006 there were no
commitments outstanding for capital expenditures.
In the event of significant growth in retail and or wholesale jewelry sales, the
demand for additional working capital will expand due to a related need to stock
additional jewelry inventory and increases in wholesale accounts receivable.
Historically, vendors have offered us extended payment terms to finance the need
for jewelry inventory growth and our management believes that we will continue
to do so in the future. Any significant increase in wholesale accounts
receivable will be financed under our bank credit facility.
Our ability to finance our operations and working capital needs are dependent
upon management's ability to negotiate extended terms or refinance its debt. We
have historically renewed, extended or replaced short-term debt as it matures
and management believes that we will be able to continue to do so in the near
future.
From time to time, we have adjusted our inventory levels to meet seasonal demand
or in order to meet working capital requirements. Management is of the opinion
that if additional working capital is required, additional loans can be obtained
from individuals or from commercial banks. If necessary, inventory levels may be
adjusted or a portion of our investments in marketable securities may be
liquidated in order to meet unforeseen working capital requirements.
On July 17, 2006 we announced that we had executed a definitive agreement to
acquire all of the issued and outstanding stock of Superior Galleries, Inc. in a
transaction valued at $ 14,000,000. As of September 30, 2006 we have incurred
$265,000 in legal and other costs related to this acquisition. We expect to
incur an additional $150,000 in legal and other costs related to this
transaction before closing. For additional information on liquidity see our Form
8-K filed on July 17, 2006.
Payments due by period
Contractual Cash Obligations Total 2006 2007 - 2008 2009 - 2010 Thereafter
- ---------------------------- ----------- ----------- ----------- ----------- -----------
Notes payable ................... $ 194,183 $ 194,183 $ -- $ -- $ --
Long-term debt and capital leases 4,255,401 74,037 3,845,922 145,257 190,185
Federal income taxes ............ 210,584 210,584 -- -- --
Operating Leases ................ 354,259 42,648 238,412 73,199 --
----------- ----------- ----------- ----------- -----------
Total ........................... $ 5,014,427 $ 521,452 $ 4,084,334 $ 218,456 $ 190,185
In addition, we estimate that we will pay approximately $320,000 in interest
during the next twelve months.
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
The following discussion about our market risk disclosures involves
forward-looking statements. Actual results could differ materially from those
projected in the forward-looking statements. We are exposed to market risk
related to changes in interest rates and gold values. We are also exposed to
regulatory risk in relation to its payday loans. We do not use derivative
financial instruments.
11
DGSE COMPANIES, Inc. and Subsidiaries
Our earnings and financial position may be affected by changes in gold values
and the resulting impact on pawn lending and jewelry sales. The proceeds of
scrap sales and our ability to liquidate excess jewelry inventory at an
acceptable margin are dependent upon gold values. The impact on our financial
position and results of operations of a hypothetical change in gold values
cannot be reasonably estimated.
Item 4. Controls and Procedures.
Evaluation of disclosure controls and procedures. An evaluation was performed
under the supervision and with the participation of our management, including
our Chief Executive Officer and Chief Financial Officer, of the effectiveness of
the design and operation of our disclosure controls and procedures (as defined
in Rule 13a-15(e) under the Securities Exchange Act of 1934) as of the end of
the period covered by this quarterly report. Our disclosure controls and
procedures are designed to ensure that information required to be disclosed by
us in the reports we file or submit under the Securities Exchange Act of 1934,
as amended, is (1) recorded, processed, summarized and reported within the time
periods specified in the Securities and Exchange Commission's rules and forms
and (2) accumulated and communicated to our management, including our Chief
Executive Officer, to allow timely decisions regarding required disclosure.
Based on that evaluation, our management, including our Chief Executive Officer
and our Chief Financial Officer, concluded that our disclosure controls and
procedures were effective.
Changes in internal controls. For the quarter ended September 30, 2006, there
have been no changes in our internal control over financial reporting (as
defined in Rule 13a-15(f) under the Securities Exchange Act of 1934) that have
materially affected, or are reasonably likely to materially affect, our internal
control over financial reporting.
PART II- OTHER INFORMATION
Item 3. Legal Proceedings
We are not a party to any material pending legal proceedings which are expected
to have a material adverse effect on us and none of our property is the subject
of any material pending legal proceedings.
Item 5. Other Information.
On July 17, 2006, we announced that we executed a definitive agreement to
acquire all of the issued and outstanding stock of Superior Galleries, Inc. in a
transaction valued at $ 14,000,000. For additional information regarding this
transaction reference is made in our Form 8-K filed on July 17, 2006.
Item 6. Exhibits and Reports on Form 8-K.
Exhibits:
31.1 Certificate of L.S. Smith pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002, Chief Executive Officer.
31.2 Certificate of John Benson pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002, Chief Financial Officer .
32.1 Certificate of L.S. Smith pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002, Chief Executive Officer.
32.2 Certificate of John Benson pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002, Chief Financial Officer.
Reports on Form 8-K :
None
12
SIGNATURES
In accordance with Section 13 and 15(d) of the Exchange Act, the Registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
DGSE Companies, Inc.
By: /s/ L. S. Smith Dated: October 27, 2006
-------------------------
L. S. Smith
Chairman of the Board,
Chief Executive Officer and
Secretary
In accordance with the Exchange Act, this report has been signed below by
the following persons on behalf of the Registrant and in the capacities and on
the date indicated.
By:/s/ L. S. Smith Dated: October 27, 2006
-------------------------
L. S. Smith
Chairman of the Board,
Chief Executive Officer and
Secretary
By:/s/ W. H. Oyster Dated: October 27, 2006
-------------------------
W. H. Oyster
Director, President and
Chief Operating Officer
By:/s/ John Benson Dated: October 27, 2006
-------------------------
John Benson
Chief Financial Officer
(Principal Accounting Officer)