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, 2005
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _________ to _________
Commission File No. 0-27121
SUPERIOR GALLERIES, INC.
(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 [ ]
Indicate by check mark whether the registrant is an accelerated filer
(as defined in Rule 12b-2 of the Exchange Act).
Yes [ ] No [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 the latest practicable date:
Title of each class of Common Stock Outstanding as of October 14, 2005
- ----------------------------------- ----------------------------------
Common Stock, $0.001 par value 4,819,942
TABLE OF CONTENTS
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Page
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PART I - FINANCIAL INFORMATION
Item 1. Financial Statements..................................................3
Balance Sheets at September 30, 2005 (Unaudited) and June 30, 2005....3
Statements of Income and Operations (Unaudited) for the three
months ended September 30, 2005 and 2004..............................5
Statements of Cash Flows (Unaudited) for the three months ended
September 30, 2005 and 2004...........................................6
Notes to Interim Financial Statements (Unaudited) at
September 30, 2005....................................................7
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations................................................17
Item 3. Quantitative and Qualitative Disclosures about Market Risk...........30
Item 4. Controls and Procedures..............................................31
PART II - OTHER INFORMATION
Item 1. Legal Proceedings....................................................31
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds..........32
Item 3. Defaults Upon Senior Securities......................................32
Item 4. Submission of Matters to a Vote of Security Holders..................32
Item 5. Other Information....................................................32
Item 6. Exhibits and Reports on Form 8-K.....................................35
Page 2
PART I - FINANCIAL INFORMATION
ITEM 1 - FINANCIAL STATEMENTS
SUPERIOR GALLERIES, INC.
BALANCE SHEETS
(IN THOUSANDS)
September June 30,
30, 2005 2005
(Unaudited)
-------- --------
ASSETS
CURRENT ASSETS
Cash $ 695 $ 417
Accounts receivable, net of allowance for uncollectible
accounts of $154 (Sep. 2005) and $122 (Jun. 2005) 6,906 4,969
Auction and customer advances 3,176 4,950
Inventories 9,226 8,713
Prepaid expense and other 372 346
-------- --------
Total current assets 20,375 19,395
-------- --------
LONG-TERM ASSETS
Property and equipment, net 197 220
-------- --------
Total long-term assets 197 220
-------- --------
TOTAL ASSETS $20,572 $19,615
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Line of credit - related party $ 8,000 $ 9,250
Line of credit 2,200 2,200
Accounts payable and accrued expenses 7,483 5,154
Notes payable to a related party 350 350
Notes payable 650 650
Series A stock redemption payable 206 275
-------- --------
Total current liabilities 18,889 17,879
-------- --------
LONG-TERM LIABILITIES
Notes payable to a related party, net of current portion 350 400
-------- --------
Total long-term liabilities 350 400
-------- --------
TOTAL LIABILITIES 19,239 18,279
-------- --------
COMMITMENTS AND CONTINGENCIES
See accompanying notes to unaudited interim financial statements
Page 3
SUPERIOR GALLERIES, INC.
BALANCE SHEETS (CONTINUED)
(IN THOUSANDS)
September June 30,
30, 2005 2005
(Unaudited)
--------- ---------
STOCKHOLDERS' EQUITY (DEFICIT)
Preferred stock, 693 shares undesignated,
none outstanding
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; 4,820 shares
issued and outstanding as of September 30, 2005 and June 30, 2005 5 5
Additional paid in capital 8,562 8,459
Accumulated deficit (14,620) (14,514)
--------- ---------
Total stockholders' equity (deficit) 1,333 1,336
--------- ---------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) $ 20,572 $ 19,615
========= =========
See accompanying notes to unaudited interim financial statements
Page 4
SUPERIOR GALLERIES, INC.
STATEMENTS OF INCOME AND OPERATIONS
(UNAUDITED)
(In thousands, except per share data)
Three Months Ended
------------------------
September September
30, 2005 30, 2004
--------- ---------
Net sales $ 10,948 $ 8,513
Commission income 705 757
--------- ---------
TOTAL REVENUE 11,653 9,270
COST OF REVENUE 9,342 7,216
--------- ---------
GROSS PROFIT 2,311 2,054
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES 2,301 1,854
--------- ---------
Income from operations 10 200
--------- ---------
OTHER INCOME (EXPENSE)
Interest income 113 101
Interest expense (227) (175)
Other expense, net -- --
--------- ---------
Total other income (expense) (114) (74)
--------- ---------
INCOME (LOSS) BEFORE PROVISION FOR TAXES (104) 126
INCOME TAX PROVISION 1 1
--------- ---------
NET INCOME (LOSS) $ (105) $ 125
========= =========
NET INCOME (LOSS) PER SHARE
basic $ (0.02) $ 0.03
========= =========
fully diluted $ (0.02) $ 0.02
========= =========
WEIGHTED AVERAGE NUMBER OF COMMON SHARES OUTSTANDING
basic 4,820 4,497
========= =========
fully diluted 4,820 8,170
========= =========
See accompanying notes to unaudited interim financial statements
Page 5
SUPERIOR GALLERIES, INC.
STATEMENTS OF CASH FLOWS
(UNAUDITED)
(In thousands)
Three Months Ended
------------------------
September September
30, 2005 30, 2004
-------- --------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss) $ (105) $ 125
Adjustments to reconcile net income (loss) to net cash
provided by (used) in operating activities:
Depreciation and amortization 28 16
Fair value of common stock options granted 102 23
Fair value of common stock issued for services -- 30
Increase (decrease) in cash from changes in assets and liabilities:
Accounts receivable (1,938) 340
Auction and customer advances, net 1,775 1,381
Inventories (513) (1,324)
Prepaid expenses and other (25) (55)
Other assets -- 11
Accounts payable and accrued expenses 2,328 (1,820)
-------- --------
Net cash provided by (used in) operating activities 1,652 (1,273)
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of property and equipment (5) (10)
-------- --------
Net cash used in investing activities (5) (10)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES
Borrowings under related party line of credit 3,000 1,400
Repayments under related party line of credit (4,250) (500)
Repayments under related party debt (50) --
Payments under Series A preferred stock redemption (69) --
-------- --------
Net cash (used in) provided by financing activities (1,369) 900
-------- --------
Net increase (decrease) in cash and equivalents 278 (383)
Cash and cash equivalents, beginning of period 417 447
-------- --------
Cash and cash equivalents, end of period $ 695 $ 64
======== ========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash paid during the period for:
Interest $ 227 $ 174
======== ========
Income taxes $ 1 $ 1
======== ========
See accompanying notes to unaudited interim financial statements
Page 6
SUPERIOR GALLERIES, INC.
NOTES TO INTERIM FINANCIAL STATEMENTS
SEPTEMBER 30, 2005
(UNAUDITED)
1. BASIS OF PRESENTATION AND ACCOUNTING POLICIES
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 June 30, 2005 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
three-month period ended September 30, 2005 are not necessarily
indicative of the results that may be expected for the year ending June
30, 2006. For further information, refer to the financial statements
for the year ended June 30, 2005 contained in Superior's financial
statements included in its Annual Report on Form 10-K filed on August
11, 2005.
INVENTORIES
Inventories consisting of rare coins are stated at the lower of cost
(on a specific identification basis) or market.
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 and precious metals bullion. 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 15 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 September 30, 2005 and June 30, 2005, management has
established an accounts receivable reserve of $154,000 and $122,000,
respectively.
Page 7
SUPERIOR GALLERIES, INC.
NOTES TO INTERIM FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 2005
(UNAUDITED)
1. BASIS OF PRESENTATION AND ACCOUNTING POLICIES (CONTINUED)
REVENUE RECOGNITION (CONTINUED)
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 Revenue
Recognition (continued)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.
Under this retail arrangement, revenues are recognized when the
customer agrees to the terms of the credit and makes the initial
payment. Less than 5% of the Company's sales are retail credit sales.
The Company has limited-in-duration money back guaranty policies (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.
Page 8
SUPERIOR GALLERIES, INC.
NOTES TO INTERIM FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 2005
(UNAUDITED)
1. BASIS OF PRESENTATION AND ACCOUNTING POLICIES (CONTINUED)
REVENUE RECOGNITION (CONTINUED)
Historically, the Company's retail customers have not exercised their
rights to money-back guarantees and as such, the Company's management
has not provided a reserve for sales returns in the accompanying
financial statements. 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 are calculated based on a percentage
of the hammer price.
Buyers' and sellers' commissions are recognized upon the confirmation
of the identification of the Revenue Recognition (continued)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
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 800,000 options to purchase
the Company's common stock. Effective with the Company's current fiscal
year that began on July 1, 2005, the Company has adopted the accounting
and disclosure provisions of Statement of Financial Accounting
Standards ("SFAS") No. 123(R), "SHARE-BASED PAYMENTS" using the
modified prospective application transition method.
As part of adopting the modified prospective approach during the
transitional period, the Company has implemented the modified
prospective application for SFAS No. 123(R) that includes the
determination of a one-time cumulative effect adjustment for the
portion of stock options granted after December 15, 1994 that had not
vested by June 30, 2005. No cumulative effect adjustment was required
as the Company accounted for the 2003 Plan under Accounting Principles
Board Opinion No. 25, "ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES"
instead of SFAS No. 123, "ACCOUNTING FOR STOCK-BASED COMPENSATION,"
prior to July 1, 2005.
Page 9
SUPERIOR GALLERIES, INC.
NOTES TO INTERIM FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 2005
(UNAUDITED)
1. BASIS OF PRESENTATION AND ACCOUNTING POLICIES (CONTINUED)
STOCK BASED COMPENSATION (CONTINUED)
For fiscal years prior to July 1, 2005, the Company accounted for the
2003 Plan under the recognition and measurement principles of
Accounting Principles Board Opinion No, 25, "ACCOUNTING FOR STOCK
ISSUED TO EMPLOYEES," and related interpretations. The Company had
adopted the disclosure provisions of Statement of Financial Accounting
Standards ("SFAS") No. 123, "ACCOUNTING FOR STOCK-BASED COMPENSATION,"
as amended by SFAS No. 148, "ACCOUNTING FOR STOCK-BASED COMPENSATION -
TRANSITION AND DISCLOSURE," an amendment of FASB Statement No. 123. The
following table illustrates the effect on net income (loss) and income
(loss) per share if the Company had applied the fair value recognition
provisions of SFAS No. 123 to stock-based employee compensation for the
three months ended September 30, 2004:
2004
------------
Net income (loss) applicable to common shares, as reported $ 125
Add: Stock-based employee compensation included reported net
income (loss)
Less: Total stock-based employee compensation expense
determined under Black-Scholes option pricing model,
net of tax effects 60
------------
Pro forma net income (loss) $ 65
============
Earnings (loss) per share - as reported:
Basic $ 0.03
Diluted $ 0.02
Earnings (loss) per share - pro forma:
Basic $ 0.01
Diluted $ 0.01
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.
Page 10
SUPERIOR GALLERIES, INC.
NOTES TO INTERIM FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 2005
(UNAUDITED)
2. DESCRIPTION OF BUSINESS
Superior is primarily a wholesaler, retailer and auctioneer of rare
coins. The Company is based in Beverly Hills, California.
3. INVENTORIES
The Company's inventories consist of rare coins. 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
one to two of these agreements. As of September 30, 2005 and June 30,
2005, inventory totals reflected the Company's total proportional
ownership and does not include any minority interest claims in regard
to such partnership arrangements.
4. AUCTION AND CUSTOMER ADVANCES
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 6% and 12% 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
either 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:
September 30, 2005 June 30, 2005
------------------ -------------
(in thousands)
Auction advances $ 1,917 $ 3,358
Customer inventory advances 1,259 1,592
---------------- ---------------
$ 3,176 $ 4,950
================ ===============
Page 11
SUPERIOR GALLERIES, INC.
NOTES TO INTERIM FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 2005
(UNAUDITED)
5. LINE OF CREDIT - RELATED PARTY
On October 13, 2003, Superior executed a Commercial Loan and Security
Agreement ("LOC"`) with Stanford Financial Group Company ("Stanford
Financial"), an affiliate of a principal stockholder, Stanford
International Bank Limited ("SIBL" or "Stanford"), to provide the
Company with a $7.5 million line of credit for purposes of financing
inventory, auction advances and inventory loans to other rare coin
dealers and collectors. On March 31, 2005, Stanford Financial Group
Company's affiliate, SIBL, pursuant to its purchase of $2.5 million of
the Company's Series E stock assumed, converted and cancelled $2.5
million of the Company's indebtedness under the Commercial LOC. In
addition, Stanford Financial further amended the Commercial LOC
increasing the line of credit to $10 million. The Commercial LOC bears
interest at the prime-lending rate (6.75% at September 30, 2005) and is
secured by substantially all of Superior's assets. Effective July 21,
2005 the Commercial LOC was renewed through October 1, 2006. As of
September 30, 2005 the outstanding balance was $8,000,000 and there was
no accrued interest payable.
6. LINE OF CREDIT
On July 9, 2002 and July 26, 2002 the Company entered into temporary
working capital loan agreements with a private Lender ("Lender") in the
amounts of $1,500,000 and $1,000,000 respectively. These loans bore
interest at the prime lending rate plus 7% per annum, were secured by
the inventory of the Company and a personal guarantee of the Company's
CEO, and, were due to be repaid in 60 days. On August 8, 2002 the
Company converted the two loans from the Lender into a Line of Credit
with the Lender by executing a Secured Revolving Line of Credit
Agreement ("Line of Credit"). The Line of Credit bore interest at the
prime lending rate plus 7% per annum, was due on September 9, 2002, was
secured by substantially all the assets of the Company and a personal
guarantee of the Company's CEO. The Line of Credit provides for
interest payments to made in cash, inventory or restricted common
shares of the Company at the sole discretion of the Lender. On
September 16, 2002 the Line of Credit was amended to extend the due
date to October 15, 2002. In November 2002 the Lender became deceased
and the aforementioned Line of Credit became an asset of the Estate of
the Lender ("Lender Estate"). On September 30, 2003 the Company and the
executor of the Lender Estate executed a Renewal and Modification
Agreement that amended the Line of Credit. In exchange for a payment of
$230,000 representing interest in arrears through September 30, 2003,
the Lender Estate agreed to reduce the interest rate to 6% effective
October 1, 2003, release its first priority lien position on all
accounts receivable of Company and to consider the default cured at
that time. The amendment also requires monthly interest payments
beginning on November 1, 2003. On December 15, 2004, the Company and
the executor of the Lender Estate executed an amendment to the Renewal
and Modification Agreement described above that provides for principal
payments of $100,000 per month for three months starting January 31,
2005 with the remaining principal balance of $2,200,000 to be repaid on
January 31, 2006. Effective July 31, 2005 the Renewal and Modification
Agreement was further amended to provide for principal payments in the
aggregate amount of $500,000, payable in minimum monthly payments of
$50,000 beginning October 1, 2005, with the remaining principal balance
of $1,700,000 to be paid on September 1, 2006. As of September 30, 2005
the outstanding Line of Credit balance was $2,200,000 and there was no
accrued interest payable.
Page 12
SUPERIOR GALLERIES, INC.
NOTES TO INTERIM FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 2005
(UNAUDITED)
7. NOTE PAYABLE TO A RELATED PARTY
On April 10, 2002 the Company executed a subordinated note payable in
the amount of $1,000,000 to the Company's Chief Executive Officer and a
principal stockholder ("CEO") bearing interest at 9% per annum with
quarterly installment payments of $150,000 plus interest. As the CEO
did not enforce the repayment obligation, the amount had been
classified as long term. 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. The Company is in arrears of $150,000 of principal
payments. However, the CEO verbally agreed to delay these principal
repayments until no later than December 31, 2005. As of the September
30, 2005, the outstanding balance was $700,000 and there was no accrued
interest payable.
8. NOTES PAYABLE
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 is payable monthly. As of
September 30, 2005, the outstanding balance was $650,000 and there was
no accrued interest payable.
9. EQUITY
AUTHORIZED CAPITAL CHANGES
On August 19, 2005 a majority of the Company's stockholders approved by
written consent an amendment to the Company's articles of incorporation
to increase the authorized number of common shares from 12,500,000 to
20,000,000. The amendment became effective on September 20, 2005.
STOCK OPTIONS
The Company's 2003 Omnibus Stock Option Plan ("2003 Plan") is
shareholder approved and permits the granting of up to 800,000 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. Stock options under the 2003 Plan provide for
accelerated vesting if there is a change in control (as defined by the
2003 Plan).
Page 13
SUPERIOR GALLERIES, INC.
NOTES TO INTERIM FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 2005
(UNAUDITED)
9. EQUITY (CONTINUED)
STOCK OPTIONS (CONTINUED)
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 three month period ended September 30, 2005, the Company
granted to employees and directors 50,000 stock options to purchase
common shares with exercise prices ranging from $2.75 to $3.02. The
Company has estimated, based on historical data, that all stock options
issued during the three months ended September 30, 2005 will vest. The
options vest in one year and expire five years after vesting. During
the three month period ended September 30, 2005, the Company canceled
76,667 stock options to purchase common shares that were forfeited by
former employees. The Company records expenses on a straight line basis
over the vesting term of the stock options based on fair value using
the Black-Scholes option pricing model. For stock options issued during
the three month period ended September 30, 2005 the fair value was
estimated at the date of grant using the Black-Scholes option pricing
model with the following range of assumptions:
Risk free interest rate 3.50%
Dividends -
Volatility factor 250%
Expected life 1 year
Annual forfeiture rate 0%
The following table summarizes information about stock option
transactions for the period shown:
THREE MONTH PERIOD
ENDED
ALL OPTIONS SEPTEMBER 30, 2005
-----------------------
WEIGHTED
AVERAGE
EXERCISE
PRICE
------------
Outstanding at beginning of period 636,000 $ 2.41
Options granted 50,000 2.80
Options forfeited (76,667) 1.90
Options expired - -
Options exercised - -
-------- ------------
Outstanding at end of period 609,333 $ 2.51
======== ============
Exercisable at end of period 205,333 $ 2.65
======== ============
Page 14
SUPERIOR GALLERIES, INC.
NOTES TO INTERIM FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 2005
(UNAUDITED)
9. EQUITY (CONTINUED)
STOCK OPTIONS (CONTINUED)
THREE MONTH PERIOD
ENDED
NON-VESTED OPTIONS SEPTEMBER 30, 2005
----------------------
WEIGHTED
AVERAGE
EXERCISE
PRICE
------------
Non-vested at beginning of period 464,000 $ 2.28
Options granted 50,000 2.80
Options forfeited (76,667) 1.90
Options expired - -
Options vested (33,333) 2.00
--------- ------------
Non-vested at end of period 404,000 $ 2.44
========= ============
The weighted average grant-date fair value of options granted during
the three month period ended September 30, 2005 was $2.17 per share.
The weighted average remaining contractual lives of the options
outstanding and options exercisable at September 30, 2005, were 6.6
years and 4.6 years respectively.
The Company recorded $102,000 of compensation expense for employee
stock options during the three month period ending September 30, 2005.
At September 30, 2005 there was total of $808,000 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 2.9 years. The total fair value of
shares vested during the three month period ended September 30, 2005
was approximately $66,000.
No comparable information is presented for the three month period ended
September 30, 2004 as the Company adopted the disclosure requirements
for SFAS No. 123(R) using a modified prospective approach effective
with periods commencing on July 1, 2005.
10. CONTINGENCIES
GUARANTEED LIQUIDITY AND BUY BACK
The Company provides a Guaranteed Liquidity and Buy Back at Grade
warranty (the "Guarantee") to its retail rare coin customers. Retail
rare coin sales amounted to $4,413,000 and $1,947,000 for the three
months ended September 30, 2005 and 2004 respectively. The policy
grants the customer the opportunity to sell their coins back to the
Company at the prevailing market "bid" (below the current wholesale
price). 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.
Page 15
SUPERIOR GALLERIES, INC.
NOTES TO INTERIM FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 2005
(UNAUDITED)
10. CONTINGENCIES (CONTINUED)
GUARANTEED LIQUIDITY AND BUY BACK (CONTINUED)
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
The Company has been sued by Heritage Capital Corporation ("Heritage"),
a competitor, in connection with the Company's employment of Larry
Abbott, a former employee of Heritage. This case is pending in the
Dallas County District Court in Texas, pursuant to a petition filed
June 3, 2005. The parties to this case include Heritage, Superior
Galleries, Inc. and Mr. Abbott. In this case, Heritage has sued Mr.
Abbott for breach of his employment agreement with that company,
following his resignation in May 2005. Heritage further alleges that
Mr. Abbott has misappropriated Heritage's trade secrets and that in
hiring Mr. Abbott the Company has wrongfully interfered with Mr.
Abbott's employment contract and employment relationship with Heritage.
Heritage seeks actual and exemplary damages, attorneys' fees and costs
in unspecified amounts and an order from the court concerning the
enforceability and scope of the arbitration provisions of his
employment contract. The Company intends to vigorously defend the
claims against it in this matter.
The Company may from time to time be involved in various other 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. 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.
Page 16
ITEM 2. 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:
o those identified under "Risk Factors" below,
o adverse economic conditions,
o unexpected costs and operating deficits,
o lower sales and revenues than forecast,
o loss of customers,
o litigation and administrative proceedings involving our
company,
o the possible acquisition of new businesses that result in
operating losses or that do not perform as anticipated,
resulting in unanticipated losses,
o adverse publicity and news coverage,
o inability to carry out our marketing and sales plans,
o changes in interest rates and inflationary factors, and
o 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 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 Superior Galleries, Inc. These changes were effective
at the close of business on June 30, 2003.
Page 17
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. While we are currently experiencing economic
conditions that have increased the demand for rare coins, resulting in higher
revenue and profitability for us, 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.
Prior to the year ended June 30, 2004, we incurred substantial losses
that severely diminished our capital base and our liquidity. Although we have
significantly reduced the levels of our losses and have incurred recent periods
of profitability, we have limited shareholders' equity and working capital and
most our debt is short-term. Any significant unfavorable change in the economic
environment or in our industry could quickly result in declining revenue and a
return to operating losses. Our challenge is to both raise additional permanent
equity capital and restructure our debt to include a larger long-term portion.
Although we cannot assure you that we will be able to accomplish these
objectives, we believe that the achievement of these goals would permit us to
increase the levels of inventory that we have available for sale and increase
the funds available to loan to our consignment customers, thus enhancing our
revenues. Accordingly, 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.
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.
ACCOUNTS RECEIVABLE. We are required to estimate the collectibility of
our accounts receivable. 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
Page 18
information is available. Allowances are also established for probable loss
inherent in the remainder of the accounts receivable based on our historical bad
debt loss information. As a result of 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 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 of
customers' rare coin collateral on a whole 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. Due to the availability of a line of credit
from Stanford Financial Group Company, an affiliate of our principal
shareholder, Stanford Venture Capital Holdings, Inc. ("Stanford"), we have
recently and significantly expanded our auction and customer advance activities
and we do not have historical data to estimate probable loss nor have we had any
significant history of losses. It is difficult to assess the 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
additional allowances resulting in a reduction of our operating results.
REVENUE RECOGNITION. We generate revenue from wholesale and retail
sales of rare coins and precious metals bullion. 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 maintain reserves for
potential credit losses based on an evaluation of specific receivables and the
Company's historical experience related to credit losses. 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. Less than 5% of
our sales are retail credit sales. 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.
Page 19
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.
Historically, our retail customers have not exercised their rights to
money-back guarantees and as such, we have not provided a reserve for sales
returns in the accompanying financial statements. 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.
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 are 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.
INVENTORY VALUATION. We value our inventory at the lower of cost or
market. On a periodic basis our numismatic staff will review market data 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 800,000 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).
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.
Page 20
RESULTS OF OPERATIONS
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)
-------------------------------------
SEPTEMBER SEPTEMBER %
30, 2005 % 30, 2004 % CHANGE CHANGE
----------- ----- ------------ ----- ---------- ------
Net Sales $ 10,948 94% $ 8,513 92% $ 2,435 29%
Commission Income 705 6% 757 8% (52) -7%
----------- ----- ------------ ----- ---------- ------
Total revenue 11,653 100% 9,270 100% 2,383 26%
Cost of revenue 9,342 80% 7,216 78% 2,126 29%
----------- ----- ------------ ----- ---------- ------
Gross profit 2,311 20% 2,054 22% 257 13%
Selling, general & administrative
expenses 2,301 20% 1,854 20% 447 24%
----------- ----- ------------ ----- ---------- ------
Income (loss) from operations 10 0% 200 2% (190) -95%
Other income (expense) (114) -1% (74) -1% (40) 54%
----------- ----- ------------ ----- ---------- ------
Income (loss) before provision for
taxes (104) -1% 126 1% (230) -183%
Income tax provision 1 0% 1 0% - 0%
----------- ----- ------------ ----- ---------- ------
Net Income (loss) $ (105) -1% $ 125 1% $ (230) -184%
=========== ===== ============ ===== ========== ======
FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2005 AND 2004
Our net loss for the three months ended September 30, 2005 was $105,000
or $0.02 and $0.02 per share on a basic and diluted basis respectively as
compared to a net income of $126,000 or $0.03 and $0.02 per share on a basic and
diluted basis respectively for the three months ended September 30, 2004.
Although we achieved higher revenue as compared to same quarter last year, the
unfavorable mix of revenue and higher operating costs diminished our
profitability.
REVENUES
The table below sets forth our primary sources of revenue for the
periods indicated:
THREE MONTHS ENDED (IN THOUSANDS)
----------------------------------------------------
SEPTEMBER SEPTEMBER %
30, 2005 % 30, 2004 % CHANGE CHANGE
------------- ------- ------------- ------- ---------- ----------
Net Sales
Rare Coin - Wholesale $ 6,534 56% $ 6,565 71% $ (31) 0%
Rare Coin - Retail 4,414 38% 1,948 21% 2,466 127%
------------- ------- ------------- ------- ---------- ----------
Total Net Sales 10,948 94% 8,513 92% 2,435 29%
Commission Income 705 6% 757 8% (52) -7%
------------- ------- ------------- ------- ---------- ----------
Total Revenue $ 11,653 100% $ 9,270 100% $2,383 26%
============= ======= ============= ======= ========== ==========
Total revenue for the three months ended September 30, 2005 increased
$2,383,000 or 26% to $11,653,000 from $9,270,000 for the three months ended
September 30, 2004. This increase in revenues is primarily due to the increase
in sales of rare coins. Wholesale rare coin sales for the three months ended
Page 21
September 30, 2005 decreased $31,000 or 0% over the comparable period in 2004.
Retail rare coin sales for the three months ended September 30, 2005 increased
$2,466,000 or 127% over the comparable period in 2004. On a combined basis,
sales of rare coins increased $2,435,000 or 29% over the comparable period in
2004. This increase was primarily due to continued strong market demand which
was caused, we believe, by an increase in the price of gold, low interest rates
and uncertainty in the stock market and due to our higher levels of inventory
available for sale, which resulted from the availability to us of increased
financing to purchase that inventory. Commission income for the three months
ended September 30, 2005 was $705,000, a decrease of $52,000, or 7% over the
comparable period in 2004. This decrease was primarily due to the continued
pressure on commission rates caused by the aggressive pricing of our
competitors; this pricing pressure precluded us from increasing our market
share. Auction sales (hammer prices realized) were $7,841,000 for the three
months ended September 30, 2005 as compared to $7,363,000 for the three months
ended September 30, 2004 reflecting an increase of 6%.
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. Our second fiscal quarter has traditionally been
our weakest because we conduct only one auction event and there are fewer, less
popular trade shows.
We believe that for our revenue to continue to grow in the future we
must continue to expand and diversify our distribution channels. We are
continually considering, testing and implementing several growth strategies.
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. While we anticipate that this arrangement will likely result in
increased coins sales by us, we are unable to predict the magnitude of that
increase.
In January 2005, we began to supply internet retailer Amazon.com with
rare coins on a test basis. Our current relationship with Amazon.com is simply
to provide that company, on a nonexclusive basis, with coins to be offered for
sale on its website. We pay Amazon.com a commission, which is presently 15%, on
any sales it makes through this relationship. We have yet to determine the
length of the test period with Amazon.com. Over the medium and long-term our
growth strategy for wholesale type distribution channels includes hiring of
additional numismatic traders, acquiring small rare coin dealers and supplying
rare coins to other retailers. We have yet to determine the associated costs of
our medium and long-term growth strategies in the areas discussed above. We may
extend or terminate any of these arrangements at any time.
To expand our retail and auction distribution channels, we are
continuing to upgrade our web-site. These upgrades include software tools to
integrate our web-site with our operational, customer relationship management
and financial software, increase traffic to our web-site, improve and automate
communication with existing and potential customers, and further enhance our
on-line auction capabilities. The estimated costs to be incurred for this
upgrade are approximately $100,000. We may consider further upgrades to our
website during this year, but we have yet to determine the costs associated with
these potential upgrades. We are continuing in our efforts to list rare coins on
multiple Internet venues including our own web-site, and eBay and Overstock.com
both in their regular listing formats and on their auction platforms. Other
growth plans include the expansion of frequency of our on-line auction
activities.
Page 22
Our ability to expand our wholesale, retail and auction operations is
dependent in part upon the success of the strategies described above, which we
have not yet evaluated. 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.
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
September 30, 2005 increased $2,126,000 or 29% to $9,342,000 or 80% of total
revenue, from $7,216,000 or 78% of total revenue for the three months ended
September 30, 2004. The increase in aggregate cost of revenue in the current
period over the comparable period in 2004 was primarily due to the increase in
rare coin sales as discussed in "Total Revenue" above, rather than factors that
might influence the cost of any particular item of inventory. Our cost of
revenue as a percentage of total revenue increased over the comparable period in
2004 as a result of the decrease in our commission income both in the aggregate
and as a percentage of total revenue. In the current period we had comparable
success as we had in the previous period in purchasing coins at advantageous
prices. 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.
GROSS PROFIT
Gross profit for the three months ended September 30, 2005 increased
$257,000 to $2,311,000 or 20% of total revenue from $2,054,000 or 22% of total
revenue for the three months ended September 30, 2004. The increase in gross
profit in the current period over the comparable period in 2004 was primarily
due to the increase in rare coin sales. 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 expenses for the three months ended
September 30, 2005 increased $447,000 or 23% to $2,301,000 from $1,854,000 for
the three months ended September 30, 2004. These expenses represent 20% of total
revenue for the three months ended September 30, 2005 as compared to 20% of
total revenue for the three months ended September 30, 2004. The increase in
these expenses was primarily due to the following factors: the hiring of new
employees to enhance our operational infrastructure as we anticipated continued
growth in our revenue causing additional employee compensation of $150,000,
which included commissions that resulted from our higher level of sales;
expanded investor and public relations efforts with a cost of $66,000;
additional legal costs of $46,000 primarily related to the defense of a lawsuit
by a competitor; higher auction operating costs of $57,000; and the effect of
adopting an accounting policy to expense the fair value of our employee stock
option grants of $80,000.
OTHER INCOME AND EXPENSES
Other expenses for the three months ended September 30, 2005 increased
$40,000 to $114,000 from $74,000 for the three months ended September 30, 2004.
This increase was primarily due to increased interest expense, resulting from
the combination of the increased use of our lines of credit to finance our own
inventory and increases in the rate of interest charged on our line of credit
with Stanford Financial for the three months ended September 30, 2005 as
compared to the three months ended September 30, 2004.
Page 23
PROVISION FOR INCOME TAXES
Although we reported a net loss the three months ended September 30,
2005, we incurred income taxes for state franchise and other minimum taxes
totaling $1,000. Although we reported a net income the three months ended
September 30, 2004, we have loss carry forwards that negate any income tax
expense during the current period with the exception of taxes due for state
franchise and other minimum taxes totaling $1,000.
LIQUIDITY AND CAPITAL RESOURCES
At September 30, 2005, we had working capital of $1,486,000. We
recorded a net loss of $105,000 and had cash flow from operating activities of
$1,652,000 for the three month period ended September 30, 2005. Given our
September 30, 2005 cash balance of $695,000 and our projected operating cash
requirements, we anticipate that our existing capital resources will be adequate
to satisfy our cash flow requirements through June 30, 2006. However, we may
require additional funding. 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 be 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 June
30, 2006 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. 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.
OPERATING ACTIVITIES
Cash increased $278,000 for the three months ended September 30, 2005
to $695,000 from $417,000 at June 30, 2005.
Cash provided by our operating activities totaled $1,652,000 resulting
primarily from repayments of auction and customer advances of $1,775,000 and
increases in accounts payable of $2,328,000 and offset by increases in accounts
receivable of $1,938,000 and inventories of $513,000.
We will continue to strive to gain operating efficiencies by turning
our coin inventory more quickly, through competitive pricing, although there is
no assurance we will achieve these efficiencies.
INVESTING ACTIVITIES
Cash used in investing activities for the three months ended September
30, 2005 was $5,000 consisting of purchases of property and equipment.
FINANCING ACTIVITIES
Until the quarter ended March 31, 2004, we incurred losses since July
1999 and financed these losses through short-term and long-term borrowings, by
issuing shares in various private placement transactions and by liquidating
assets. Cash used in financing activities totaled $1,369,000 for three months
ended September 30, 2005 reflected by the following transactions:
FINANCING ACTIVITIES - DEBT
On April 10, 2002 we executed a subordinated note payable to our CEO
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,
Page 24
2003 and for interest to be paid monthly. As of the September 30, 2005 the
outstanding balance was $700,000 and all interest payments were paid to date and
continue to be paid current on a monthly basis. The principal repayments that
were due on September 30, 2005, June 30, 2005 and March 31, 2005 were not paid
when due, but our CEO has agreed to further extend the due dates for these
payments to December 31, 2005. During the three month period ended September 30,
2005, the note was reduced by $50,000. If we desire to obtain a further
extension of the deferred portion of this loan in December 2005, but our CEO is
unwilling to provide such an extension, we will be required to liquidate
sufficient inventory to make this payment.
On July 9, 2002 and July 26, 2002 we entered into temporary working
capital loan agreements with a private Lender ("Lender") in the amounts of
$1,500,000 and $1,000,000 respectively. These loans bore interest at the prime
lending rate plus 7% per annum, were secured by our inventory and a personal
guarantee of our CEO and were due to be repaid in 60 days. On August 8, 2002 we
converted the two loans from the Lender into a Line of Credit with the Lender by
executing a Secured Revolving Line of Credit Agreement ("Line of Credit"). The
Line of Credit bore interest at the prime lending rate plus 7% per annum, was
due on September 9, 2002, and was secured by substantially all the assets of the
Company and a personal guarantee of our CEO. The Line of Credit provides for
interest payments to be made in cash, inventory or restricted common shares of
the Company at the sole discretion of the Lender. On September 16, 2002 the Line
of Credit was amended to extend the due date to October 15, 2002. In November
2002 the Lender died and the Line of Credit became an asset of the Estate of the
Lender ("Lender Estate"). On September 30, 2003, we executed a Renewal and
Modification Agreement that amended the Line of Credit. In exchange for payment
of $230,000 representing interest in arrears through September 30, 2003, the
Lender Estate agreed to reduce the interest rate to 6% effective October 1,
2003, release its priority lien position on all of our accounts receivable and
to consider the default cured at that time. The amendment also required monthly
interest payments that began on November 1, 2003. On December 15, 2004, the
Company and the executor of the Lender Estate executed an amendment to the
Renewal and Modification Agreement described above that provided for principal
payments of $100,000 per month for three months starting January 31, 2005 with
the remaining principal balance of $2,200,000 to be repaid on January 31, 2006.
Effective July 31, 2005 the Renewal and Modification Agreement was further
amended to provide for principal payments in the aggregate amount of $500,000,
with minimum monthly payments of $50,000 beginning October 1, 2005, with the
remaining principal balance of $1,700,000 to be paid on September 1, 2006. As of
September 30, 2005 the outstanding Private Line of Credit balance was
$2,200,000, not including accrued interest. During the three month period ended
September 30, 2005 we made no payments to reduce the balance of the Private Line
of Credit.
On October 13, 2003, we executed a Commercial Loan and Security
Agreement ("Commercial LOC") with Stanford Financial Group Company, 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, 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, Stanford
Financial Group Company further amended the Commercial LOC increasing the line
of credit to $10,000,000. The Commercial LOC bears interest at the prime-lending
rate (6.75% at September 30, 2005) and is secured by substantially all of our
assets. As of September 30, 2005 the outstanding Commercial LOC balance was
$8,000,000. Effective July 21, 2005, the Commercial LOC was renewed through
October 1, 2006. The net amount of repayments against the Commercial LOC for the
three month period ended September 30, 2005 was $1,250,000.
In April 2005, we began to make payments on account of our obligations
under our Series A Preferred Stock redemption payable. Upon the commencement of
this redemption provision in March 31, 2004 the total amount of the redemption
payable was $688,000. During the three month period ended September 30, 2005 we
made redemption payments totaling $69,000. We are currently in compliance with
these redemption provisions. As of September 30, 2005 the outstanding balance of
the Series A Preferred Stock redemption payable was $206,000.
Page 25
Since the Line of Credit and the Commercial LOC are secured by
substantially all of our assets, if we default in the performance of our
obligations under any of these loans the lender could foreclose its security
interest, which could lead to a termination of our business or require us to
file a bankruptcy petition.
We are currently in compliance with all of the financial covenants
contained in our credit agreements.
OTHER LIQUIDITY PLANS
We have plans to secure additional financing and/or to raise additional
capital, but there are no assurances that we will be successful in completing
these critical tasks. If we are unable to successfully complete these critical
tasks, 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.
CAPITAL EXPENDITURES
The Company did not incur any material capital expenditures for
property and equipment during the three months ended September 30, 2005 and does
not presently have any plans to make material capital expenditures through the
current fiscal year ending June 30, 2006.
RISK FACTORS
WE HAVE A RECENT HISTORY OF LOSSES AND MAY INCUR FUTURE LOSSES.
We may not be able to sustain profitability or significantly increase
our revenues. Although we recorded net income of $552,000 for the year ended
June 30, 2004, we incurred a net loss of $105,000 for the three months ended
September 30, 2005, a net loss of $616,000 for the year ended June 30, 2005 and
a net loss of $3,491,000 for the year ended June 30, 2003, and have incurred
losses in prior fiscal years since July 1999. We cannot assure you that we will
be profitable in the future.
BECAUSE WE HAVE LIMITED WORKING CAPITAL, IT MAY BE DIFFICULT TO MAINTAIN OR
EXPAND OUR OPERATIONS.
Our working capital at September 30, 2005 was $1,486,000. There can be
no assurance that our revenue or results of operations will not decline in the
future, that we will not have losses in the future, or that we will be able to
continue funding such losses if they occur. Our limited capital could adversely
affect our ability to continue our operations.
IF WE ARE UNABLE TO COMPETE SUCCESSFULLY, OUR REVENUE AND PROFITABILITY
WILL DECREASE.
The business of selling coins and other collectibles is highly
competitive. We compete with a number of comparably sized and smaller firms, as
well as a number of larger firms throughout the United States. Our primary
competitors are Heritage Rare Coins, a large scale coin dealer and auctioneer,
the Spectrum Numismatic unit of Escala Group, a large scale coin dealer and
auctioneer, National Gold Exchange, a large scale coin dealer and American
Numismatic Rarities, a comparably-sized coin auctioneer. Many of our competitors
have the ability to attract customers as a result of their reputation and the
quality collectibles they obtain through their industry connections.
Additionally, other reputable companies that sell or auction rare coins and
other collectibles may decide to enter our markets to compete with us. These
companies have greater name recognition and have greater financial and marketing
resources than we do. If these auction companies are successful in entering the
specialized market for premium collectibles in which we participate or if
dealers and sellers participate less in our auctions, we may attract fewer
buyers and our revenue could decrease.
Page 26
THE VOTING POWER OF SUPERIOR GALLERIES, INC. IS SUBSTANTIALLY CONTROLLED BY
STANFORD INTERNATIONAL BANK LIMITED. THIS CONCENTRATION OF VOTING POWER
MAY, AMONG OTHER THINGS, DELAY OR FRUSTRATE THE REMOVAL OF INCUMBENT
DIRECTORS OR A TAKEOVER ATTEMPT, EVEN IF SUCH EVENTS MAY BE BENEFICIAL TO
OUR SHAREHOLDERS.
Stanford International Bank Limited, or "Stanford," holds 51% of our
voting securities. Consequently, Stanford has sufficient voting power to control
the outcome of virtually all corporate matters submitted to the vote of our
common shareholders. Those matters could include the election of directors,
changes in the size and composition of the board of directors, and mergers and
other business combinations involving Superior. In addition, through this
control of the board of directors and voting power, Stanford is able to control
certain decisions, including decisions regarding the qualification and
appointment of officers, dividend policy, access to capital (including borrowing
from third-party lenders and the issuance of additional equity securities), and
our acquisition or disposition of assets. Also, the concentration of voting
power in the hands of Stanford could have the effect of delaying or preventing a
change in control of our company, even if the change in control would benefit
our shareholders, and may adversely affect the market price of our common stock.
THE HIGH LEVEL OF OUR DEBT MAY LIMIT OUR ABILITY TO IMPLEMENT BUSINESS
STRATEGIES TO GROW OUR REVENUE AND IMPROVE OUR PROFITABILITY.
At September 30, 2005, we had total indebtedness of $11,756,000, of
which $11,406,000 was short-term debt. Our high level of debt limits the amount
of additional funds we can borrow, which in turn limits our ability to increase
inventory or make additional customer advances, thus restricting our ability to
grow our revenues. We do not have sufficient cash flow from operations to
rapidly repay this debt, and therefore if this debt was not renewed we would
have to seek new debt or equity financing to refinance our existing debt, or
liquidate inventory, possibly on unfavorable terms. In the past, we have
renegotiated or renewed the terms of our indebtedness on various occasions, but
we cannot assure you that we will be able to do so in the future or that new
debt or equity financing will be available for this purpose. This could result
in losses from operations, or could even require us to seek protection under the
bankruptcy laws.
IF WE ARE UNABLE TO PAY OUR SECURED DEBT ON A TIMELY BASIS, THE LENDERS
COULD REQUIRE THAT OUR ASSETS BE SOLD IN A FORECLOSURE SALE, WHICH COULD
RESULT IN OUR BANKRUPTCY.
We have borrowed funds from a Stanford affiliate and another private
party, each of which has been granted a security interest in substantially all
of our assets. If we default in the repayment of these debts, these lenders
could, among other things, foreclose on their security interests, which could
result in the sale of substantially all of our assets, the proceeds of which
would be applied to repay our debts to them. If this were to occur, we could be
forced to file a bankruptcy petition, or could go out of business.
DECREASED DEMAND FOR RARE COINS COULD REDUCE OUR REVENUE AND PROFITABILITY.
We derive substantially all of our revenues from commissions paid to us
on the sale of rare coins in our auctions and sales of rare coins from our own
inventory. Sales of rare coins depend on discretionary consumer spending and are
affected by general market conditions, including perceived scarcity, subjective
value, general consumer trends, changes in the prices of precious metals,
government regulation of rare coin transactions, interest rates and other
general economic conditions. Many factors affect discretionary consumer
spending, including the unemployment rate, business conditions, interest rates,
inflation and tax rates. Spending on the types of luxury items that we typically
sell and auction are impacted by these factors more than sales of consumer
products in general.
Some of the market conditions that could cause the dollar volume spent
in our auctions to decrease include the following:
Page 27
o fewer rare coins offered for sale;
o a decline in the prices buyers are willing to pay; and
o shifts in consumer trends.
As buyers' tastes change and economic conditions fluctuate, the supply,
demand and dollar volume of rare coins sales could decrease, which could reduce
our revenues and profits, or cause us to incur losses.
WE COULD BE SUBJECT TO SALES TAXES, INTEREST AND PENALTIES ON INTERSTATE
SALES FOR WHICH WE HAVE NOT COLLECTED TAXES.
We do not collect California sales tax on mail-order sales to
out-of-state customers, nor do we collect use tax on our interstate mail order
sales. We believe that our 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. While we have not been contacted by any state authorities seeking to
enforce sales or use tax regulations, we cannot assure you that we will not be
contacted by authorities in the future with inquiries concerning our compliance
with current statutes, nor can we assure you that future statutes will not be
enacted that affect the sales and use tax aspects of our business.
THE LOSS OF THE SERVICES OF OUR CHIEF EXECUTIVE OFFICER COULD SIGNIFICANTLY
REDUCE OUR REVENUE AND PROFITABILITY.
Our success and future performance depends on the continued services of
our Chief Executive Officer, Silvano DiGenova, on whom we rely heavily for his
expertise and reputation in the rare coin market. Specifically, Mr. DiGenova is
a substantial buyer, appraiser and seller of rare coins on our behalf as well as
a substantial draw to potential auction consigners. Mr. DiGenova's services
would be difficult to replace and the loss of these services could cause
significant harm to our business. While we previously had an employment
agreement with Mr. DiGenova that expired on March 31, 2005, this agreement has
not yet been renewed, and in any event such an employment agreement may not
provide us with meaningful assurance that we will continue to have his services
available to us in the future.
OUR QUARTERLY OPERATING RESULTS MAY VARY, WHICH MAY CAUSE VOLATILITY OR A
DECLINE IN THE PRICE OF OUR COMMON STOCK.
Our revenue, expenses and operating results may vary significantly from
quarter to quarter due to a number of factors, some of which are beyond our
control. These factors include the following:
o potential unfavorable supply of or demand for rare coins;
o quarter-to-quarter variations due to the timing of coin
auctions;
o potential changes in consumer trends negatively affecting the
popularity of rare coins that we auction and sell from time to
time;
o unfavorable fluctuations in the prices of precious metals;
o costs associated with unanticipated personnel changes;
o our inability to maintain customer satisfaction;
o quarter-to-quarter variations due to the size and timing of
capital expenditures and other costs associated with the
expansion of our business and infrastructure;
o our inability to resell our inventory of rare coins in a
timely manner;
o unexpected or severe price competition;
o our inability to maintain gross margins; and
o our inability to expand our sales and distribution channels.
Additional factors that may negatively affect our quarterly operating
results generally include technical difficulties or network downtime and general
economic conditions and economic conditions specific to our industries.
Page 28
IF WE ARE UNABLE TO OBTAIN ADDITIONAL CAPITAL, OUR ABILITY TO INCREASE
REVENUE AND PROFITABILITY WILL BE LIMITED.
Since our business involves the financing of inventory, receivables,
and auction and customer advances, we may require substantial amounts of capital
in order to achieve and accomplish our future business plans. However, to the
extent we are in need of any additional financing, we cannot assure you that any
such additional financing will be available to us on acceptable terms, or at
all. If we raise additional funds through the issuance of equity securities,
further dilution to our existing shareholders may result.
THE COSTS ASSOCIATED WITH OUR GROWTH PLANS MAY RESULT IN REDUCED
PROFITABILITY.
We have experienced significant periods of growth and increased
personnel, marketing and other operational costs, and we anticipate that further
expansion will be required to address potential growth in our customer base and
market opportunities. This expansion has placed, and we expect it will continue
to place, a significant strain on our management and our operational and
financial resources. To manage this growth we must do the following:
o establish and continue to develop operational, financial and
management systems;
o train, manage and motivate our employee base;
o hire additional technology and operations personnel; and
o hire additional rare coin specialists and appraisers.
We expect to incur significant costs in connection with these efforts.
If we underestimate the costs of these efforts or overestimate our anticipated
growth in revenue, we will incur reduced profitability or even losses.
WE MAY INCUR LOSSES AS A RESULT OF ACCUMULATING INVENTORY.
In addition to auctioning rare coins on consignment, a substantial
portion of the rare coins that we sell are from our own inventory. We purchase
these rare coins from dealers and collectors and assume the inventory and price
risks of these items until they are sold. If we are unable to resell the rare
coins that we purchase when we want or need to, or at prices sufficient to
generate a profit from their resale, or if the market value of our inventory of
purchased rare coins were to decline, our revenue would likely decline.
IF WE ARE UNABLE TO OBTAIN A SUFFICIENT SUPPLY OF RARE COINS FOR RESALE AND
FOR SALE AT AUCTIONS, WE WILL BE UNABLE TO SUSTAIN OR INCREASE OUR
REVENUES.
Our business depends substantially on our ability to obtain rare coins
for appraisal, sale and auction. We depend on the availability of rare coins
through dealers and collectors, and we cannot assure you that rare coins will
continue to be available as before. Although we deal with numerous dealers and
collectors from whom we are able to obtain rare coins for resale and for our
auctions, only a limited number of dealers exist with the capacity to supply
rare coins for resale and auction on a regular basis. A change in our
relationships with suppliers or dealers could negatively affect our ability to
obtain, resell or auction rare coins in the quantities and at the times we
desire. A shortage in the supply of rare coins could impair our ability to
attract customers, which would harm our business, operating results and
financial condition.
IF WE ARE UNABLE TO ATTRACT SUFFICIENT CONSIGNMENT MERCHANDISE FOR SALE AT
OUR AUCTIONS, OUR AUCTION OPERATIONS MAY INCUR A LOSS.
We incur certain fixed costs in connection with each auction. Our
auction operations generate commission revenue based on the successful sale of
consigned merchandise. If the volume of sales at our auctions does not generate
sufficient commission revenue to cover fixed costs, our auction operations will
generate a loss.
Page 29
IF WE EXPERIENCE AN INCREASE IN THE RESCISSION OF SALES, OUR REVENUE AND
PROFITABILITY COULD DECREASE.
Our operating results could suffer if we experience a significant
increase in the number of sales that are rescinded due to questions about title,
provenance or authenticity of an item. We warrant the title, provenance and
authenticity of each item that we sell, including items sold at auction. If a
buyer believes that any of these characteristics is in doubt, he or she must
notify us in writing within a certain number of days after the date of sale of
the property. If we cannot substantiate the questioned characteristics, the
buyer may rescind his or her purchase and we will refund the price paid at
auction to the buyer. When a purchase is rescinded, the seller is required to
refund the item's sale price less sellers' commissions and other sellers' fees.
OUR PLANNED EXPANSION AND ENHANCEMENT OF OUR WEBSITE AND INTERNET
OPERATIONS MAY NOT RESULT IN INCREASED PROFITABILITY.
The satisfactory performance, reliability and availability of our
website and network infrastructure are and will be critical to our reputation
and our ability to attract and retain customers and technical personnel and to
maintain adequate customer service levels. Any system interruptions or reduced
performance of our website could materially adversely affect our reputation and
our ability to attract new customers and technical personnel. We are in the
process of development and/or enhancement of several portions of our website
that will offer content and auctions for rare coins that may have a lower
average selling price than many of the rare coins in the markets we currently
serve. Continued development of our website will require significant resources
and expense. If the planned expansion of our website does not result in
increased revenue, we may experience decreased profitability.
OUR WEBSITE MAY BE VULNERABLE TO SECURITY BREACHES AND SIMILAR THREATS
WHICH COULD RESULT IN OUR LIABILITY FOR DAMAGES AND HARM TO OUR REPUTATION.
Despite the implementation of network security measures, our website is
vulnerable to computer viruses, break-ins and similar disruptive problems caused
by Internet users. These occurrences could result in our liability for damages,
and our reputation could suffer. The circumvention of our security measures may
result in the misappropriation of proprietary information. Any such security
breach could lead to interruptions and delays and the cessation of service to
our customers and could result in a decline in revenue and income.
DUE TO ALL OF THE FOREGOING FACTORS, IT IS POSSIBLE THAT IN SOME FUTURE
QUARTER, OUR OPERATING RESULTS MAY BE BELOW THE EXPECTATIONS OF THE PUBLIC
MARKET, ANALYSTS AND INVESTORS. IN SUCH EVENT, OUR COMMON STOCK WOULD
LIKELY BE MATERIALLY ADVERSELY AFFECTED.
ITEM 3 - QUANTATIVE 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 September 30, 2005, we had a line of credit from a related
party with a balance payable of $8,000,000. 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.
Page 30
ITEM 4 - CONTROLS AND PROCEDURES
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES
Our Chief Executive Officer and 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 September 30, 2005, 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 Chief Executive Officer and Chief Financial Officer (our principal
executive officer and principal financial officer, respectively) have concluded,
based on their evaluation as of September 30, 2005 ("Evaluation Date"), that the
design and operation of our "disclosure controls and procedures" (as defined in
Rules 13a-14(c) and 15d-14(c) under 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 Chief Executive Officer and Chief
Financial Officer, 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
There has been no change in our internal controls over financial
reporting during our most recent fiscal year and quarter that has materially
affected, or is reasonably likely to materially affect, our internal controls
over financial reporting.
We have not begun the detailed planning and implementation of our
project to document and test our internal control procedures in order to satisfy
the requirements of Section 404 of the Sarbanes-Oxley Act. We anticipate
commencing the project in our first quarter of fiscal 2007 and will consider
engaging a third party consulting firm to assist us in this effort. Our public
float is less than $75,000,000 and as a result we will not need to comply with
Section 404 until the end of fiscal 2008.
PART II - OTHER INFORMATION
ITEM 1 - LEGAL PROCEEDINGS
We have been sued by Heritage Capital Corporation ("Heritage"), a
competitor of ours, in connection with our employment of Larry Abbott, a former
employee of Heritage. This case is pending in the Dallas County District Court
in Texas, pursuant to a petition filed June 3, 2005. The parties to this case
include Heritage, Superior Galleries, Inc. and Mr. Abbott. In this case,
Heritage has sued Mr. Abbott for breach of his employment agreement with that
company, following his resignation in May 2005. Heritage further alleges that
Mr. Abbott has misappropriated Heritage's trade secrets and that in hiring Mr.
Abbott we have wrongfully interfered with Mr. Abbott's employment contract and
employment relationship with Heritage. Heritage seeks actual and exemplary
damages, attorneys' fees and costs in unspecified amounts and an order from the
court concerning the enforceability and scope of the arbitration provisions of
his employment contract. We intend to vigorously defend the claims against us in
this matter.
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.
Page 31
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
On August 19, 2005, stockholders holding 6,259,070 shares of our voting
stock, or 72.60% of our voting capital stock at that date, approved the
following actions of our Board of Directors by written consent:
o the amendment to our articles of incorporation to increase our number
of authorized common shares from 12,500,000 to 20,000,000.
o the amendment to our Bylaws to increase the authorized number of
directors from 5 to a number between 5 and 9, inclusive, to be set by
our Board of Directors.
No shareholder meeting was held with respect to these matters, and
therefore proxies were not solicited.
ITEM 5 - OTHER INFORMATION
None.
ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K
(A) EXHIBITS
EXHIBIT NO. DESCRIPTION
3.1 Amendment to Bylaws.
10.1 Indemnification Agreement dated July 7,
2005 between Superior Galleries, Inc. and Anthony Friscia
(incorporated herein by this reference to Exhibit 10.1 to the
registrant's Current Report on Form 8-K, filed July 8, 2005).
31.1 Certification of CEO pursuant to Securities Exchange Act Rules
13a-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 Rules
13a-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.
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(B) REPORTS ON FORM 8-K
On July 8, 2005, we filed a Current Report on Form 8-K, reporting our
execution of a material definitive agreement, consisting of an indemnification
agreement with a new director, Anthony Friscia. This filing also reported the
resignation of a director, James Gollihugh, and the election of Mr. Friscia as a
director of the Company.
On August 2, 2005, we filed a Current Report on Form 8-K dated July 31,
2005, reporting the extension of our due date on our Line of Credit - related
party, and the modification of payment terms and the extension of our due date
on our Line of Credit.
On August 12, 2005, we filed a Current Report on Form 8-K, providing
the transcript of a conference call with investors and other interested parties,
and a related press release.
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SIGNATURES
In accordance with the requirement 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.
Dated: October 24, 2005 SUPERIOR GALLERIES, INC.
By /s/ Silvano A. DiGenova
----------------------------------
Silvano A. DiGenova
President and Chief Executive Officer
Dated: October 24, 2005 SUPERIOR GALLERIES, INC.
By /s/ Paul Biberkraut
----------------------------------
Paul Biberkraut, Chief Financial Officer
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EXHIBITS FILED WITH THIS REPORT ON FORM 10-Q
Exhibit 3.1 Amendment to Bylaws.
Exhibit 10.1 Indemnification Agreement dated July 7, 2005 between
Superior Galleries, Inc. and Anthony Friscia
(incorporated herein by this reference to Exhibit
10.1 to the registrant's Current Report on Form 8-K,
filed July 8, 2005).
Exhibit 31.1 Certification of CEO pursuant to Securities Exchange Act
Rules 13a-14 and 15d-14 as adopted pursuant to Section 302
of the Sarbanes-Oxley Act of 2002.
Exhibit 31.2 Certification of CFO pursuant to Securities Exchange Act
Rules 13a-14 and 15d-14 as adopted
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
Exhibit 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.
Exhibit 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.
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