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 March 31, 2006
[_] 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 May 2, 2006
----------------------------------- -----------------------------
Common Stock, $0.001 par value 4,808,280
TABLE OF CONTENTS
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Page
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PART I - FINANCIAL INFORMATION
Item 1. Financial Statements..........................................................................3
Balance Sheets at March 31, 2006 (Unaudited) and June 30, 2005................................3
Statements of Operations (Unaudited) for the nine months ended and three
months ended March 31, 2006 and 2005..........................................................5
Statements of Cash Flows (Unaudited) for the nine months ended
March 31, 2006 and 2005.......................................................................6
Notes to Interim Financial Statements (Unaudited) at March 31, 2006...........................7
Item 2. Management's discussion and Analysis of Financial Condition and Results of Operations........18
Item 3. Quantative and Qualitative Disclosures About Market Risk.....................................33
Item 4. Controls and Procedures......................................................................34
PART II - OTHER INFORMATION
Item 1. Legal Proceedings............................................................................34
Item 1A. Risk Factors.................................................................................35
Item 2. Unregistered Sales Of Equity Securities and Use of Proceeds..................................35
Item 3. Defaults Upon Senior Securities..............................................................35
Item 4. Submission of Matters to a Vote of Security Holders..........................................35
Item 5. Other Information............................................................................35
Item 6. Exhibits and Reports on Form 8-K.............................................................35
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
SUPERIOR GALLERIES, INC.
BALANCE SHEETS
(IN THOUSANDS)
March 31, June 30,
2006 2005
(Unaudited)
------------ ------------
ASSETS
CURRENT ASSETS
Cash $ 471 $ 417
Accounts receivable, net of allowance for uncollectible
accounts of $148 (March 2006) and $122 (Jun. 2005) 5,208 4,969
Auction and customer advances 1,842 4,950
Inventories 9,425 8,713
Prepaid expense and other 328 346
------------ ------------
Total current assets 17,274 19,395
------------ ------------
LONG-TERM ASSETS
Property and equipment, net 409 220
------------ ------------
Total long-term assets 409 220
------------ ------------
TOTAL ASSETS $ 17,683 $ 19,615
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Line of credit - related party $ 10,850 $ 9,250
Line of credit -- 2,200
Accounts payable and accrued expenses 4,394 5,154
Notes payable to a related party 200 350
Notes payable 1,150 650
Series A stock redemption payable -- 275
------------ ------------
Total current liabilities 16,594 17,879
------------ ------------
LONG-TERM LIABILITIES
Notes payable to a related party, net of current portion 300 400
------------ ------------
Total long-term liabilities 300 400
------------ ------------
TOTAL LIABILITIES 16,894 18,279
============ ============
COMMITMENTS AND CONTINGENCIES
See accompanying notes to unaudited interim financial statements
Page 3
SUPERIOR GALLERIES, INC.
BALANCE SHEETS (CONTINUED)
(IN THOUSANDS)
March 31, June 30,
2006 2005
(Unaudited)
------------ ------------
STOCKHOLDERS' EQUITY
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; 4,808 and
4,820 shares issued and outstanding as of March 31, 2006 and June
30, 2005, respectively 5 5
Additional paid in capital 8,685 8,459
Accumulated deficit (15,287) (14,514)
------------ ------------
Total stockholders' equity 789 1,336
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 17,683 $ 19,615
============ ============
See accompanying notes to unaudited interim financial statements
Page 4
SUPERIOR GALLERIES, INC.
STATEMENTS OF OPERATIONS
(UNAUDITED)
(In thousands, except per share data)
Nine Months Ended Three Months Ended
---------------------------- ----------------------------
March 31, March 31, March 31, March 31
2006 2005 2006 2005
------------ ------------ ------------ ------------
Net sales $ 34,302 $ 27,700 $ 13,870 $ 10,933
Commission income 2,043 1,630 1,197 725
------------ ------------ ------------ ------------
TOTAL REVENUE 36,345 29,330 15,067 11,658
COST OF REVENUE 29,866 23,663 12,085 9,661
------------ ------------ ------------ ------------
GROSS PROFIT 6,479 5,667 2,982 1,997
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES 6,872 5,594 2,404 2,098
------------ ------------ ------------ ------------
Income (loss) from operations (393) 73 578 (101)
------------ ------------ ------------ ------------
OTHER INCOME (EXPENSE)
Interest income 313 298 99 95
Interest expense (741) (575) (276) (196)
Other expense, net -- (3) -- (1)
------------ ------------ ------------ ------------
Total other income (expense) (428) (280) (177) (102)
------------ ------------ ------------ ------------
INCOME (LOSS) BEFORE PROVISION FOR INCOME TAXES
AND EXTRAORDINARY ITEM (821) (207) 401 (203)
PROVISIONS FOR INCOME TAXES 1 1 -- --
------------ ------------ ------------ ------------
INCOME (LOSS) BEFORE EXTRAORDINARY ITEM (822) (208) 451 (203)
------------ ------------ ------------ ------------
EXTRAORDINARY GAIN FROM EXTINGUISHMENT OF DEBT,
NET OF APPLICABLE TAXES (NOTES 6 AND 11) 50 -- 50 --
============ ============ ============ ============
NET INCOME (LOSS) $ (772) $ (208) $ 451 $ (203)
============ ============ ============ ============
NET INCOME (LOSS) PER SHARE
Basic:
Income (loss) before extraordinary item (0.17) (0.05) 0.08 (0.04)
Extraordinary income net of applicable taxes 0.01 -- 0.01 --
------------ ------------ ------------ ------------
Net Income (loss) $ (0.16) $ (0.05) $ 0.09 $ (0.04)
============ ============ ============ ============
Fully diluted
Income (loss) before extraordinary item (0.17) (0.05) 0.04 (0.04)
Extraordinary income net of applicable taxes 0.01 -- 0.01 --
------------ ------------ ------------ ------------
Net Income (loss) $ (0.16) $ (0.05) $ 0.05 $ (0.04)
============ ============ ============ ============
WEIGHTED AVERAGE NUMBER OF COMMON
SHARES OUTSTANDING
Basic 4,820 4,563 4,820 4,685
============ ============ ============ ============
Fully diluted 4,820 4,563 8,977 4,685
============ ============ ============ ============
See accompanying notes to unaudited interim financial statements
Page 5
SUPERIOR GALLERIES, INC.
STATEMENTS OF CASH FLOWS
(UNAUDITED)
(In thousands)
Nine Months Ended
----------------------------
March 31, March 31,
2006 2005
------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net (loss) $ (772) $ (208)
Adjustments to reconcile net (loss) to net cash
provided by (used) in operating activities:
Depreciation and amortization 97 51
Extraordinary gain from extinquishment of debt (50) --
Loss on retirement of property and equipment -- 3
Fair value of common stock options granted 312 68
Fair value of common stock issued for services 30 300
Increase (decrease) in cash from changes in assets and liabilities:
Accounts receivable (240) 121
Auction and customer advances, net 3,108 2,915
Inventories (712) (3,227)
Prepaid expenses and other 19 (354)
Other assets -- 11
Accounts payable and accrued expenses (877) (567)
------------ ------------
Net cash provided by (used in) operating activities 915 (887)
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of property and equipment (286) (117)
------------ ------------
Net cash used in investing activities (286) (117)
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES
Borrowings under related party line of credit 10,600 3,150
Repayments under related party line of credit (9,000) (4,750)
Borrowings under lines of credit -- 0
Repayments under line of credit (2,150) (300)
Repayments under related party debt (250) (50)
Borrowings under notes payable 500 650
Issuance of Series E Preferred Stock, net of offering cost -- 2,498
Issuance of Common Stock -- 3
Payments under Series A preferred stock redemption (275) --
------------ ------------
Net cash provided by (used in) financing activities (575) 1,201
------------ ------------
Net increase in cash and equivalents 54 197
Cash and cash equivalents, beginning of period 417 447
------------ ------------
Cash and cash equivalents, end of period $ 471 $ 644
============ ============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash paid during the period for:
Interest $ 741 $ 574
============ ============
Income taxes $ 1 $ 1
============ ============
See accompanying notes to unaudited interim financial statements
Page 6
SUPERIOR GALLERIES, INC.
NOTES TO INTERIM FINANCIAL STATEMENTS
MARCH 31, 2006
(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 nine-month
and three-month periods ended March 31, 2006 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 March 31,
2006 and June 30, 2005, management has established an accounts receivable
reserve of $148,000 and $122,000, respectively.
Page 7
SUPERIOR GALLERIES, INC.
NOTES TO INTERIM FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 2006
(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 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)
MARCH 31, 2006
(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 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 1,200,000 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)
MARCH 31, 2006
(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 loss and loss per share if the Company had
applied the fair value recognition provisions of SFAS No. 123 to
stock-based employee compensation for the nine months ended March 31, 2005:
2005
----------
Net loss applicable to common shares, as reported $ (208)
Add: Stock-based employee compensation included reported net
loss --
Less: Total stock-based employee compensation expense
determined under Black-Scholes option pricing model,
net of tax effects 174
----------
Pro forma net income (loss) $ (382)
==========
Loss per share - as reported:
Basic $ (0.04)
Diluted $ (0.04)
Loss per share - pro forma:
Basic $ (0.08)
Diluted $ (0.08)
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)
MARCH 31, 2006
(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
March 31, 2006 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:
March 31, 2006 June 30, 2005
-------------- -------------
(in thousands)
Auction advances $ 974 $ 3,358
Customer inventory advances 868 1,592
------------ ------------
$ 1,842 $ 4,950
============ ============
Page 11
SUPERIOR GALLERIES, INC.
NOTES TO INTERIM FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 2006
(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. On May 2, 2006 Stanford Financial further amended the
Commercial LOC increasing the line of credit to $10,850,000 to reflect an
additional advance made March 30, 2006. The Commercial LOC bears interest
at the prime-lending rate (7.75% at March 31, 2006) 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 March 31, 2006
the outstanding balance was $10,850,000 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 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 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 the 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.
On March 31, 2006, the Company repaid the balance of the line of credit of
$1,900,000 by applying the accounts receivable from the sale of $1,000,000
of rare coins to the lender, a payment of $850,000 in cash and the
application of a $50,000 discount for early payment. The $50,000 discount
was classified as an extraordinary gain on the Statement of Operations.
Page 12
SUPERIOR GALLERIES, INC.
NOTES TO INTERIM FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 2006
(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 was in arrears of $200,000 of principal payments at December 31,
2005. However, the CEO verbally agreed to delay these principal repayments
until no later than March 31, 2006. On March 9, 2006, the principal in
arrears of $200,000 was paid to the CEO. On March 31, 2006 the CEO verbally
agreed to delay further principal payments until September 30, 2006. As of
March 31, 2006, the outstanding balance was $500,000 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 January 1, 2006
the interest rate will increase to 12% per annum. As of March 31, 2006, the
outstanding balance was $650,000 and there was no accrued interest payable.
On February 6, 2006 the Company executed a demand note payable with a
private lender in the amount of $500,000 bearing interest at 12% per annum
secured by specific inventory. Interest is payable monthly in advance. The
note was due on March 23, 2006. The private lender verbally agreed to
extend the note due date to April 26, 2006. As of March 31, 2006, the
outstanding balance was $500,000 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.
COMMON STOCK
On March 27, 2006, the Company issued 15,000 common shares to a director in
exchange for services. The services were valued at $15,750 and were based
on the closing price of the Company's common stock as listed on NASDAQ's
Over-the-counter Bulletin Board on the day the shares were issued.
Page 13
SUPERIOR GALLERIES, INC.
NOTES TO INTERIM FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 2006
(UNAUDITED)
9. EQUITY (CONTINUED)
COMMON STOCK (CONTINUED)
On March 31, 2006, the Company cancelled 26,662 common shares previously
granted to an investor relations firm in exchange for services. The
services associated with the cancelled shares were previously valued at
$40,000 and were based on the closing price of the Company's common stock
as listed on NASDAQ's Over-the-Counter Bulletin Board on the day the shares
were issued.
STOCK OPTIONS
The Company's 2003 Omnibus Stock Option Plan ("2003 Plan") is shareholder
approved and permits the granting of up to 1,200,000 options to purchase
the Company's common stock to its employees, directors and outside
consultants. Stock option awards are granted with an exercise price that is
equal to or greater than the market price of the Company's common stock on
the date of the grant. The options vest generally over a range of one to
five years and expire five years after the final vesting date. Stock
options under the 2003 Plan provide for accelerated vesting if there is a
change in control (as defined by the 2003 Plan).
The fair value of each stock option granted is estimated on the date of the
grant using the Black-Scholes option pricing model and factors in an
estimated forfeiture based on management assessment of historical employee
termination experience. The Black-Scholes option pricing model has
assumptions for risk free interest rates, dividends, stock volatility and
expected life of an option grant. The risk free interest rate is based the
U.S. Treasury Bill rate with a maturity based on the expected life of the
options and on the closest day to an individual stock option grant.
Dividend rates are based on the Company's dividend history. The stock
volatility factor is based on the past three years of market prices of the
Company's common stock. The expected life of an option grant is based on
its vesting period. The fair value of each option grant is recognized as
compensation expense over the expected life of the option on a straight
line basis.
During the nine-month period ended March 31, 2006, the Company granted to
employees and directors 65,000 stock options to purchase common shares with
exercise prices ranging from $1.20 to $3.02. The Company has estimated,
based on historical data, that all stock options issued during the nine
months ended March 31, 2006 will vest. The options vest in one year and
expire five years after vesting. During the nine-month period ended March
31, 2006, 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 nine-month period ended March 31, 2006
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% to 4.30%
Dividends --
Volatility factor 246% to 255%
Expected life 1 year
Annual forfeiture rate 0%
Page 14
SUPERIOR GALLERIES, INC.
NOTES TO INTERIM FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 2006
(UNAUDITED)
9. EQUITY (CONTINUED)
STOCK OPTIONS (CONTINUED)
The following table summarizes information about stock option transactions
for the period shown:
NINE MONTH PERIOD
ENDED
ALL OPTIONS MARCH 31, 2006
----------------------------
WEIGHTED
AVERAGE
EXERCISE
PRICE
------------
Outstanding at beginning of period 636,000 $ 2.41
Options granted 65,000 2.50
Options forfeited (76,667) 1.90
Options expired -- --
Options exercised -- --
------------ ------------
Outstanding at end of period 624,333 $ 2.49
============ ============
Exercisable at end of period 221,083 $ 2.56
============ ============
NINE MONTH PERIOD
ENDED
NON-VESTED OPTIONS MARCH 31, 2006
----------------------------
WEIGHTED
AVERAGE
EXERCISE
PRICE
------------
Non-vested at beginning of period 464,000 $ 2.28
Options granted 65,000 2.50
Options forfeited (76,667) 1.90
Options expired -- --
Options vested (49,083) 1.83
------------ ------------
Non-vested at end of period 403,250 $ 2.44
============ ============
The weighted average grant-date fair value of options granted during the
nine-month period ended March 31, 2006 was $1.94 per share.
The weighted average remaining contractual lives of the options outstanding
and options exercisable at March 31, 2006, were 6.1 years and 4.2 years
respectively.
The Company recorded $312,000 of compensation expense for employee stock
options during the nine-month period ending March 31, 2006. At March 31,
2006 there was a total of $619,000 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 2.7 years. The total fair value of shares vested during the nine-month
period ended March 31, 2006 was approximately $90,000.
Page 15
SUPERIOR GALLERIES, INC.
NOTES TO INTERIM FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 2006
(UNAUDITED)
9. EQUITY (CONTINUED)
STOCK OPTIONS (CONTINUED)
No comparable information is presented for the nine-month period ended
March 31, 2005 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 $11,107,000 and $8,743,000 for the nine months ended March 31,
2006 and 2005, respectively. The policy grants the customer the opportunity
to sell their coins back to the Company at the prevailing market "bid"
(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.
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
In June 2005, the Company was sued by Heritage Capital Corporation
("Heritage"), a competitor, in connection with the Company's employment of
Larry Abbott, a former employee of Heritage. The parties to this case
included Heritage, Superior Galleries, Inc. and Mr. Abbott. In this case,
Heritage sued Mr. Abbott for breach of his employment agreement with that
company, following his resignation in May 2005. This lawsuit has been
completely settled in accordance with a settlement agreement dated March
27, 2006 at no cost to the Company, other than its own legal costs,
estimated to be $50,000.
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.
Page 16
SUPERIOR GALLERIES, INC.
NOTES TO INTERIM FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 2006
(UNAUDITED)
10. CONTINGENCIES (CONTINUED)
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.
11. EXTRAORDINARY GAIN
On March 31, 2006, the Company repaid the balance of the line of credit of
$1,900,000 by applying the accounts receivable from the sale of $1,000,000
of rare coins to the lender, a payment of $850,000 in cash and the
application of a $50,000 discount for early payment. The $50,000 discount
was classified as an extraordinary gain on the Statement of Operations.
Page 17
SUPERIOR GALLERIES, INC.
NOTES TO INTERIM FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 2006
(UNAUDITED)
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 18
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 periods of
profitability, we have limited shareholders' equity and working capital and most
of our debt is short-term. Any significant unfavorable change in the economic
environment or in our industry could quickly result in declining revenue and
increasing 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
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
Page 19
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 20
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 1,200,000 options to
purchase our common stock to our employees, directors and outside consultants.
Stock option awards are granted with an exercise price that is equal to or
greater than the market price of our common stock on the date of the grant. The
options vest generally over a range of one to five years and expire five years
after the final vesting date. Stock options under the 2003 Plan provide for
accelerated vesting if there is a change in control (as defined by the 2003
Plan).
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 21
RESULTS OF OPERATIONS
FOR THE NINE MONTHS ENDED MARCH 31, 2006 AND 2005
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:
NINE MONTHS ENDED (IN THOUSANDS)
--------------------------------
MARCH 31, MARCH 31, %
2006 % 2005 % CHANGE CHANGE
-------- -------- -------- -------- -------- --------
Net sales $ 34,302 94% $ 27,700 94% $ 6,602 24%
Commission income 2,043 6% 1,630 6% 413 25%
-------- -------- -------- -------- -------- --------
Total revenue 36,345 100% 29,330 100% 7,015 24%
Cost of revenue 29,866 82% 23,663 81% 6,203 26%
-------- -------- -------- -------- -------- --------
Gross profit 6,479 18% 5,667 19% 812 14%
Selling, general and administrative
expenses 6,872 19% 5,594 19% 1,278 23%
-------- -------- -------- -------- -------- --------
Income (loss) from operations (393) -1% 73 0% (466) -638%
Other income (expense) (428) -1% (280) -1% (148) 53%
-------- -------- -------- -------- -------- --------
Income (loss) before provision for
taxes and extraordinary item (821) -2% (207) -1% (614) 297%
Income tax provision 1 0% 1 0% -- 0%
-------- -------- -------- -------- -------- --------
Income (loss) before extraordinary item (822) -2% (208) -1% (614) 295%
Extraordinary item, net of income taxes 50 0% -- 0% 50 n/a
-------- -------- -------- -------- -------- --------
Net income (loss) $ (772) -2% $ (208) -1% $ (564) 271%
======== ======== ======== ======== ======== ========
Our net loss for the nine months ended March 31, 2006 was $772,000 or $0.16
per share on both a basic and diluted basis as compared to a net loss of
$208,000 or $0.05 per share on both a basic and diluted basis for the nine
months ended March 31, 2005. Although we achieved higher revenue as compared to
the same period last year, we had reduced profitability (increased losses) due
to a shift in revenue towards the sale of less profitable rare coins and higher
operating costs.
REVENUES
The table below sets forth our primary sources of revenue for the periods
indicated:
NINE MONTHS ENDED (IN THOUSANDS)
--------------------------------
MARCH 31, MARCH 31, %
2006 % 2005 % CHANGE CHANGE
-------- -------- -------- -------- -------- --------
Net Sales
Rare Coin - Wholesale $ 23,195 64% $ 18,957 64% $ 4,238 22%
Rare Coin - Retail 11,107 31% 8,743 30% 2,364 27%
-------- -------- -------- -------- -------- --------
Total Net Sales 34,302 95% 27,700 94% 6,602 24%
Commission Income 2,043 5% 1,630 6% 413 25%
-------- -------- -------- -------- -------- --------
Total Revenue $ 36,345 100% $ 29,330 100% $ 7,015 24%
======== ======== ======== ======== ======== ========
Total revenue for the nine months ended March 31, 2006 increased $7,015,000
or 24% to $36,345,000 from $29,330,000 for the nine months ended March 31, 2005.
This increase in revenues is primarily due to the increase in sales of rare
coins. Wholesale rare coin sales for the nine months ended March 31, 2006
increased $4,238,000 or 22% over the comparable period in 2005. Retail rare coin
sales for the nine months ended March 31, 2006 increased $2,364,000 or 27% over
the comparable period in 2005. On a combined basis, sales of rare coins
increased $6,602,000 or 24% over the comparable period in 2005. This increase
Page 22
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 nine months ended March 31,
2006 was $2,043,000, an increase of $413,000 or 25% over the comparable period
in 2005. This increase was primarily due to the timing of one auction that
usually occurs at the beginning of our fourth fiscal quarter that instead
occurred this year at the end of our third fiscal quarter, and the effects of
our efforts to attract higher quality consignments with higher average
commission rates. Auction sales (hammer prices realized) were $19,267,000 for
the nine months ended March 31, 2006 as compared to $17,759,000 for the nine
months ended March 31, 2005 reflecting an increase of 8%.
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.
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 costs incurred during the nine months ended March 31, 2006 for
these upgrades were approximately $206,000. We are undertaking further upgrades
to our website during the balance of this year and estimate the costs associated
with these upgrades to be $50,000. 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. We are continuing 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. Other growth plans include the expansion of
frequency of our on-line auction activities.
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
Page 23
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 nine months ended March 31, 2006
increased $6,203,000 or 26% to $29,866,000 or 82% of total revenue, from
$23,663,000 or 81% of total revenue for the nine months ended March 31, 2005.
The increase in aggregate cost of revenue in the current period over the
comparable period in 2005 was primarily due to the increase in rare coin sales
as discussed in "Total Revenue" above. Additionally, in the current period we
had less success than we had in the comparable period last year in purchasing
coins at advantageous prices and the gross margin in the mix of coins sold was
less favorable. 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 nine months ended March 31, 2006 increased $812,000 to
$6,479,000 or 18% of total revenue from $5,667,000 or 19% of total revenue for
the nine months ended March 31, 2005. The increase in gross profit in the
current period over the comparable period in 2005 was primarily due to our
higher level of sales and an improvement in auction commissions. 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 nine months ended
March 31, 2006 increased $1,278,000 or 23% to $6,872,000 from $5,594,000 for the
nine months ended March 31, 2005. These expenses represent 19% of total revenue
for the nine months ended March 31, 2006 as compared to 19% of total revenue for
the nine months ended March 31, 2005. 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, resulting in additional employee compensation of $603,000, which
included commissions that resulted from our higher level of sales; expanded
investor and public relations efforts with an additional cost of $32,000;
additional legal costs of $47,000 primarily related to the defense of a lawsuit
by a competitor; higher advertising costs of $77,000 primarily focused on the
retail market; increased travel and related expense of an additional $80,000 due
to the higher sales volume; higher consulting fees as part of our investment in
enhancing our e-commerce capabilities of $11,000; and the effect of adopting an
accounting policy to expense the fair value of our employee stock option grants
of $259,000 more than the prior period.
OTHER INCOME AND EXPENSES
Other expenses for the nine months ended March 31, 2006 increased $148,000
to $428,000 from $280,000 for the nine months ended March 31, 2005. This
increase was primarily due to increased interest expense of $166,000, 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 nine months ended March 31, 2006 as
compared to the nine months ended March 31, 2005.
Page 24
PROVISION FOR INCOME TAXES
Although we reported a net loss for the nine months ended March 31, 2006,
we incurred income taxes for state franchise and other minimum taxes totaling
$1,000. Similarly, although we reported a net loss the nine months ended March
31, 2005, we incurred income taxes for state franchise and other minimum taxes
totaling $1,000.
FOR THE THREE MONTHS ENDED MARCH 31, 2006 AND 2005
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)
---------------------------------
MARCH 31, MARCH 31, %
2006 % 2005 % CHANGE CHANGE
-------- -------- -------- -------- -------- --------
Net sales $ 13,870 92% $ 10,933 94% $ 2,937 27%
Commission income 1,197 8% 725 6% 472 65%
-------- -------- -------- -------- -------- --------
Total revenue 15,067 100% 11,658 100% 3,409 29%
Cost of revenue 12,085 80% 9,661 83% 2,424 25%
-------- -------- -------- -------- -------- --------
Gross profit 2,982 20% 1,997 17% 985 49%
Selling, general and administrative
expenses 2,404 16% 2,098 18% 306 15%
-------- -------- -------- -------- -------- --------
Income (loss) from operations 578 4% (101) -1% 679 -672%
Other income (expense) (177) -1% (102) -1% (75) 74%
-------- -------- -------- -------- -------- --------
Income (loss) before provision for taxes
and extraordinary 401 3% (203) -2% 604 -298%
Income tax provision -- 0% -- 0% -- 0%
-------- -------- -------- -------- -------- --------
Income (loss) before extraordinary item 401 3% (203) -2% 604 -298%
Extraordinary item, net of income taxes 50 0% -- 0% 50 n/a
-------- -------- -------- -------- -------- --------
Net income (loss) $ 451 3% $ (203) -2% $ 654 -322%
======== ======== ======== ======== ======== ========
Our net income for the three months ended March 31, 2006 was $451,000 or
$0.09 per share basic and $0.05 per share diluted as compared to a net loss of
$203,000 or $0.04 per share on both a basic and diluted basis for the three
months ended March 31, 2005. Our increased profitability was primarily due to
our increased revenue from both sales and auction activities.
REVENUES
The table below sets forth our primary sources of revenue for the periods
indicated:
THREE MONTHS ENDED (IN THOUSANDS)
---------------------------------
MARCH 31, MARCH 31, %
2006 % 2005 % CHANGE CHANGE
-------- -------- -------- -------- -------- --------
Net Sales
Rare Coin - Wholesale $ 9,395 62% $ 7,157 61% $ 2,238 31%
Rare Coin - Retail 4,475 30% 3,776 32% 699 19%
-------- -------- -------- -------- -------- --------
Total Net Sales 13,870 92% 10,933 94% 2,937 27%
Commission Income 1,197 8% 725 6% 472 65%
-------- -------- -------- -------- -------- --------
Total Revenue $ 15,067 100% $ 11,658 100% $ 3,409 29%
======== ======== ======== ======== ======== ========
Page 25
Total revenue for the three months ended March 31, 2006 increased
$3,409,000 or 29% to $15,067,000 from $11,658,000 for the three months ended
March 31, 2005. This increase in revenues is primarily due to the increase in
sales of rare coins. Wholesale rare coin sales for the three months ended March
31, 2006 increased $2,238,000 or 31% over the comparable period in 2005. Retail
rare coin sales for the three months ended March 31, 2006 increased $699,000 or
19% over the comparable period in 2005. On a combined basis, sales of rare coins
increased $2,937,000 or 27% over the comparable period in 2005. 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 March 31,
2006 was $1,197,000, an increase of $472,000 or 65% over the comparable period
in 2005. This increase was primarily due to the timing of one auction that
usually occurs at the beginning of our fourth fiscal quarter that instead
occurred this year at the end of our third fiscal quarter, and the effects of
our efforts to attract higher quality consignments with higher average
commission rates. Auction sales (hammer prices realized) were $10,078,000 for
the three months ended March 31, 2006 as compared to $8,142,000 for the three
months ended March 31, 2005 reflecting an increase of 24%.
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 March 31, 2006
increased $2,424,000 or 25% to $12,085,000 or 80% of total revenue, from
$9,661,000 or 83% of total revenue for the three months ended March 31, 2005.
The increase in aggregate cost of revenue in the current period over the
comparable period in 2005 was due to the increase in rare coin sales as
discussed in "Total Revenue" above. 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 March 31, 2006 increased $985,000
to $2,982,000 or 20% of total revenue from $1,997,000 or 17% of total revenue
for the three months ended March 31, 2005. The increase in gross profit in the
current period over the comparable period in 2005 was primarily due to our
higher level of sales and increased auction commissions, as discussed above. 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
March 31, 2006 increased $306,000 or 15% to $2,404,000 from $2,098,000 for the
three months ended March 31, 2005. These expenses represent 16% of total revenue
for the three months ended March 31, 2006 as compared to 18% of total revenue
for the three months ended March 31, 2005. 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, resulting in additional employee compensation of $238,000, which
included commissions that resulted from our higher level of sales; expanded
investor and public relations efforts with a cost of $81,000; higher travel and
related costs of $52,000 due to increased sales volume; increased internet fees
and commissions due to the expansion of our on-line presence of $33,000; higher
consulting fees as part of our investment in enhancing our e-commerce
capabilities of $22,000; and the effect of adopting an accounting policy to
expense the fair value of our employee stock option grants of $89,000.
Page 26
OTHER INCOME AND EXPENSES
Other expenses for the three months ended March 31, 2006 increased $75,000
to $177,000 from $102,000 for the three months ended March 31, 2005. 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 March 31, 2006 as compared to
the three months ended March 31, 2005.
PROVISION FOR INCOME TAXES
Although we reported net income for the three-month period ended March 31,
2006, our losses from earlier periods in this fiscal year exceeded our third
quarter income and we therefore incurred no income taxes. We reported net losses
for the three months ended March 31, 2005 and we therefore incurred no state
franchise and other minimum taxes for that period.
LIQUIDITY AND CAPITAL RESOURCES
At March 31, 2006, we had working capital of $680,000. We recorded a net
loss of $772,000 and had cash flow from operating activities of $915,000 for the
nine-month period ended March 31, 2006. Given our March 31, 2006 cash balance of
$471,000 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 $54,000 for the nine months ended March 31, 2006 to $471,000
from $417,000 at June 30, 2005.
Cash provided by our operating activities totaled $915,000 resulting
primarily from repayments of auction and customer advances of $3,108,000 and
offset by a decreases in accounts payable of $877,000, increases in inventories
of $712,000 and our net loss of $772,000.
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 nine months ended March 31, 2006
was $286,000 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 $575,000 for the nine months
ended March 31, 2006 reflected by the following transactions:
Page 27
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,
2003 and for interest to be paid monthly. As of the March 31, 2006 the
outstanding balance was $500,000 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 December 31, 2005, September 30, 2005, June 30, 2005 and March 31,
2005 were paid on March 9, 2006. During the nine-month period ended March 31,
2006, note repayments totaled $250,000.
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. On
March 31, 2006 the outstanding Private Line of Credit was paid in full. During
the nine-month period ended March 31, 2006, the Private Line of Credit was
reduced by $2,200,000.
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 (7.75% at March 31, 2006) and is secured by substantially all of our
assets. As of March 31, 2006, the outstanding Commercial LOC balance was
$10,850,000. On May 2, 2006, Stanford Financial further amended the Commercial
LOC, increasing the line up to $10,850,000 to reflect an additional advance made
March 30, 2006.
On February 6, 2006, we executed a demand note payable to a private lender
in the amount of $500,000 bearing interest at 12% per annum secured by specific
inventory. Interest is payable monthly in advance. The note was due on March 23,
2006. The private lender verbally agreed to extend the note due date to April
26, 2006. As of March 31, 2006, the outstanding balance was $500,000 and there
was no accrued interest payable.
Page 28
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 nine-month period ended March 31, 2006 we made
redemption payments totaling $274,000, which completed the redemption.
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 nine months ended March 31, 2006 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 $772,000 for the nine months ended March 31,
2006, 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 March 31, 2006 was $680,000. 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
Page 29
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.
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 March 31, 2006, we had total indebtedness of $12,500,000, of which
$12,200,000 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.
Page 30
Some of the market conditions that could cause the dollar volume spent in
our auctions to decrease include the following:
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.
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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.
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.
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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.
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.
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We are exposed to a degree of market risk through changes in short-term
interest rates. At March 31, 2006, we had a line of credit from a related party
with a balance payable of $10,850,000. This line of credit bears an interest
rate that is tied to the bank prime rate. We are exposed to the risk of
increasing short-term interest rates, but we do not consider this risk to be
material.
We have no activities that would expose us to foreign currency exchange
rate risk or commodity price risks.
ITEM 4. CONTROLS AND PROCEDURES
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES
Our 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 March 31, 2006, as required by paragraph (b) of Exchange Act
Rules 13a-15 or 15d-15. While we will continually seek to evaluate and improve
our disclosure controls, management does not expect that our disclosure controls
or its internal controls over financial reporting will prevent all possible
errors and fraud. A control system, no matter how well designed and operated,
can provide only reasonable, not absolute, assurance that the control system's
objectives would be met.
Our Chief Executive Officer and Chief Financial Officer (our principal
executive officer and principal financial officer, respectively) have concluded,
based on their evaluation as of March 31, 2006 ("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
In June 2005, we were sued by Heritage Capital Corporation ("Heritage"), a
competitor of ours, in connection with our employment of Larry Abbott, a former
employee of Heritage. The parties to this case included 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. This lawsuit has been completely settled in accordance with a
settlement agreement dated March 27, 2006 at no cost to us other than our legal
expenses, estimated to be $50,000.
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We may from time to time be involved in various claims, lawsuits or
disputes with third parties, actions involving allegations of discrimination, or
breach of contract actions incidental to the operation of its business. We are
not currently involved in any litigation which we believe could have a
materially adverse effect on our financial condition or results of operations.
ITEM 1A. RISK FACTORS
There were no material changes in our risk factors as compared to those
previously disclosed in our Annual Report on Form 10-K for the year ended June
30, 2005.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
On March 27, 2006, we issued 15,000 shares of Common Stock to Mr. Paul
Biberkraut, one of our directors, for services performed for the Company. There
was no underwriter for this issuance. Mr. Biberkraut is an accredited investor,
there was no general solicitation in connection with this transaction, and this
issuance was exempt from registration under the Securities Act of 1933 under
Section 4(2) of that Act.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 5. OTHER INFORMATION
(a) On February 21, 2006, we borrowed $500,000 from Kevin Lipton Rare
Coins, Inc. ("Lender") and in connection with that loan we executed a Promissory
Note (the "Note") in the principal amount of $500,000. The Note is secured by
certain coins from our rare coin inventory. The entire principal amount was
originally payable on March 23, 2006. The Lender verbally extended the maturity
date to April 26, 2006. As of March 31, 2006 the outstanding balance was
$500,000 and there was no accrued interest payable.
(b) Not applicable.
ITEM 6. EXHIBITS
EXHIBIT NO. DESCRIPTION
10.1 Promissory Note dated February 21, 2006 by Superior Galleries,
Inc. to Kevin Lipton Rare Coins, Inc. (filed herewith).
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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SIGNATURES
In accordance with the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
Dated: May 12, 2006 SUPERIOR GALLERIES, INC.
By /s/ Silvano A. DiGenova
-------------------------------------------
Silvano A. DiGenova
President and Chief Executive Officer
Dated: May 12, 2006 SUPERIOR GALLERIES, INC.
By /s/ Silvano A. DiGenova
-------------------------------------------
Silvano A. DiGenova, Acting Chief Financial
Officer
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EXHIBITS FILED WITH THIS REPORT ON FORM 10-Q
Exhibit 10.1 Promissory Note dated February 21, 2006 by Superior
Galleries, Inc. to Kevin Lipton Rare Coins, Inc. (filed
herewith).
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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