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DGSE > SEC Filings for DGSE > Form 10-Q on 13-Nov-2012All Recent SEC Filings

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Form 10-Q for DGSE COMPANIES INC


13-Nov-2012

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.

Unless the context indicates otherwise, references to "we," "us," "our," the Company" and "DGSE" refer to the consolidated business operations of DGSE Companies, Inc., the parent, and all of its direct and indirect subsidiaries.

Forward-Looking Statements

This Quarterly Report on Form 10-Q for the quarter ended September 30, 2012 (this "Form 10-Q"), including but not limited to: (i) the section of this Form 10-Q entitled "Management's Discussion and Analysis of Financial Condition and Results of Operations," (ii) information concerning our business prospects or future financial performance, anticipated revenues, expenses, profitability or other financial items, including the outcome of the SEC investigation described elsewhere in this Form 10-Q or pending litigation, and (iii) our strategies, plans and objectives, together with other statements that are not historical facts, includes "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended (the "Securities Act"), and Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). Forward-looking statements generally can be identified by the use of forward-looking terminology, such as "may," "will," "would," "expect," "intend," "could," "estimate," "should," "anticipate" or "believe." We intend that all forward-looking statements be subject to the safe harbors created by these laws. All statements other than statements of historical information provided herein are forward-looking statements are based on current expectations regarding important risk factors. Many of these risks and uncertainties are beyond our ability to control, and, in many cases, we cannot predict all of the risks and uncertainties that could cause our actual results to differ materially from those expressed in the forward-looking statements. Actual results could differ materially from those expressed in the forward-looking statements, and readers should not regard those statements as a representation by us or any other person that the results expressed in the statements will be achieved. Important risk factors that could cause results or events to differ from current expectations are described under the section of this Form 10-Q entitled "Risk Factors" and elsewhere in this Form 10-Q as well as under the section entitled "Risk Factors" in our Annual Report on Form 10-K for the fiscal year ended December 31, 2011 (the "Fiscal 2011 10-K"). These factors are not intended to be an all-encompassing list of risks and uncertainties that may affect the operations, performance, development and results of our business. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof. We undertake no obligation to-release publicly the results of any revisions to these forward-looking statements, which may be made to reflect events or circumstances after the date thereon, including without limitation, changes in our business strategy or planned capital expenditures, store growth plans, or to reflect the occurrence of unanticipated events.

Results of Operations

Three Months Ended September 30, 2012 compared to Three Months Ended September 30, 2011

Sales. Sales decreased by $15,039,586, or 34%, during the three months ended September 30, 2012 to $28,975,063, as compared to $44,014,649 during the same period in 2011. The decrease was primarily driven by a decrease in sales of bullion, with moderate decreases also across other segments. In addition, revenue from discontinued operations for Superior Galleries, Inc. ("Superior Galleries") were excluded in the amount of $59 and $3,513,557 for the periods ended September 30, 2012 and 2011, respectively. These decreases were partially offset by the acquisition of SBT, Inc. ("SBT") in September 2011, which added revenues of $7,824,759 during the three months ended September 30, 2012, an increase of $4,537,538 over the same period in 2011.

Cost of Sales. For the three months ended September 30, 2012, cost of sales decreased by $17,007,853, or 43% to $22,787,722, as compared to $39,795,575 during the same period in 2011, driven by lower sales. Cost of sales as a percentage of revenue decreased from 90.4% in 2011 to 78.6% in 2012 primarily due to the higher margins on the newly-acquired SBT business, as well as reduced sales of bullion which carry significantly lower margins than other categories.

Selling, General and Administrative Expense. For the three months ended September 30, 2012, Selling, General and Administrative ("SG&A") expenses increased by $3,330,190, or 107% to $6,431,750, as compared to $3,101,560 during the same period in 2011. $1,549,948 of this increase is due to the addition of the SBT stores. The opening of four new non-SBT stores added $870,014 in the current period, due to increased advertising costs, salaries, payroll taxes, building rent and other costs. In addition, the Company incurred $1,443,799 in professional fees associated with the restatement of our financial statements, and the related SEC investigation.

Depreciation and Amortization. For the three months ended September 30, 2012, the depreciation and amortization expense was $152,337 compared to $5,899 for the same period in 2011, an increase of $146,438. The current period increase in depreciation and amortization over the same period in 2011 is related to the amortization of intangibles acquired as part of the acquisition of SBT in September 2011 (See note 9 under Item 1 for details on the acquisition).

Loss on settlement of debt with related party. For the three months ended September 30, 2012, loss on settlement of debt with related party decreased by $1,720,000 to $0 compared to $1,720,000 during the same period in 2011. The decrease is primarily related to the loss incurred with the settlement of debt with a related party in the previous year in which we issued 400,000 shares of our common stock to NTR Metals, LLC, our majority stockholder ("NTR"), in exchange for $2,000,000 in debt forgiveness, and incurred a $1,720,000 non-cash loss.

Other income, net. For the three months ended September 30, 2012, other income, net was $41,200 compared to $0 during the same period in 2011. Other income in the current period is driven by gains on available for sale securities.

Interest Expense. For the three months ended September 30, 2012, interest expense was $72,677, a decrease of $101,619 compared to $174,296 during the same period in 2011. This decrease is primarily due to the early pay-off of two credit agreements in the fourth quarter of 2011 and conversion of a portion of the Company's convertible debt instruments, which reduced quarterly interest payments.

Loss from Discontinued Operations. The results for the three months ended September 30, 2012 are a net loss of $107,669 related to operations of Superior Galleries. This loss included an operating loss of $6,552, and other expense of $101,116 consisting of the write off of the deferred rent liability, net of rent expense.

Nine Months Ended September 30, 2012 compared to Nine Months Ended September 30, 2011

Sales. Sales decreased by $7,253,309, or 7.4%, to $90,374,423 during the nine months ended September 30, 2012, as compared to $97,627,732 during the same period in 2011. This decrease was primarily due to the decrease in sales of scrap, bullion and rare coins, offset by the revenues from the acquisition of SBT. Overall, SBT added revenue of $22,247,355 for the nine months ended September 30, 2012 compared to $3,287,222 in the same period of the prior year.

Cost of Sales. For the nine months ended September 30, 2012, cost of sales decreased by $14,293,272, or 16.3%, to $73,447,142, as compared to $87,740,414 during the same period in 2011. Cost of sales as a percentage of revenue decreased from 89.9% in 2011 to 81.2% in 2012 primarily due to the higher margins on the newly acquired SBT business, as well as reduced sales of bullion, which carry significantly lower margins than other categories.

Selling, General and Administrative Expense. For the nine months ended September 30, 2012, SG&A expenses increased by $10,318,440, or 134%, to $18,030,768, as compared to $7,712,328 during the same period in 2011. $5,355,274 of this increase is due to the addition of the SBT stores. The opening of four new non-SBT stores added $2,206,614 in the current period, due to increased advertising costs, salaries, payroll taxes, building rent and other costs. In addition, the Company incurred $2,740,263 in professional fees associated with the restatement of our financial statements, and the related SEC investigation.

Depreciation and Amortization. For the nine months ended September 30, 2012, depreciation and amortization expense was $448,260 compared to $165,993 during the same period in 2011, an increase of $282,267. The current period increase in depreciation and amortization over the same period relates to the amortization of intangible assets acquired as part of the acquisition of SBT in September 2011 (See note 9 under Item 1 for details on the acquisition).

Loss on settlement of debt with related party. For the nine months ended September 30, 2012, loss on settlement of debt with related party decreased by $1,720,000 to $0 compared to $1,720,000 during the same period in 2011. The decrease is primarily related to the loss incurred with the settlement of debt with a related party in the previous year in which we issued 400,000 shares of our common stock to NTR in exchange for $2,000,000 in debt forgiveness, and incurred a $1,720,000 non-cash loss.

Other income, net. For the nine months ended September 30, 2012, other income, net increased to $127,596 compared to $1,745 during the same period in 2011, an increase of $125,851. Other income in the current period is driven by gains on available for sale securities.

Interest Expense. For the nine months ended September 30, 2012, interest expense was $253,796, a decrease of $184,093 from $437,889 during the same period in 2011. This decrease is primarily due to the early pay-off of two credit agreements in the fourth quarter of 2011, and conversion of a portion of the Company's convertible debt instruments, which reduced quarterly interest payments.

Loss from Discontinued Operations. The results for the nine month period ended September 30, 2012 are a net loss of $768,225 related to operations of Superior Galleries. This loss included an operating loss of $342,474, and other expense of $420,389, which consists of the write off of the deferred rent liability, and a $158,094 expense related to a litigation settlement paid in October 2012, which was accrued for as of March 31, 2012.

Liquidity and Capital Resources

During the nine months ended September 30, 2012 and 2011, cash flows (used in) provided by operating activities totaled ($2,672,017) and $6,715,986, respectively. Cash flows used for the nine months ended September 30, 2012 were primarily a result of the $2,446,172 net loss, a $974,998 increase in inventory and a decrease in accounts payables of $1,115,383. This decrease in accounts payable was due to payment of $1,608,028 related to the November 2011 settlement with FASNAP Corporation. Cash flow used in operating activities was partially offset by a $618,745 increase in customer deposits and other liabilities and a $139,498 decrease in accounts receivable. During the same period in 2011, there was a decrease in trade receivables of $351,414, an increase in accounts payable and accrued expenses of $1,650,169, increase in prepaid expense of $160,336 and a decrease in inventory of $2,425,929.

During the nine months ended September 30, 2012 and 2011, cash flows (used in) provided by investing activities totaled ($823,447) and $224,250, respectively. The use of cash during both periods was primarily driven by purchases of property and equipment related to new store openings. In the prior year period, cash used in investing activities was offset by $456,015 in cash acquired in the acquisition of SBT. The 2012 period also includes $95,000 in purchases of available for sale investments and $154,313 in proceeds from the settlement of the available for sale investments.

During the nine months ended September 30, 2012 and 2011, cash flows used in financing activities totaled $334,240 and $344,407, respectively. The use of cash during both periods was the result of repayment of notes payable, including repayment of the TCB line of credit in July of 2012. Cash from financing activities also includes proceeds of $3,583,358 from a new line of credit with NTR in July 2012, and payments on capital lease obligations.

During the nine months ended September 30, 2012 and 2011, cash flows provided by (used in) discontinued operations totaled $628,738 and ($1,636,917), respectively.

We expect capital expenditures to total approximately $1,000,000 during the next twelve months. These expenditures will be largely driven by new store openings. It is anticipated that these expenditures will be funded from working capital. As of September 30, 2012, there were no commitments outstanding for capital expenditures.

In the event of significant growth in retail and or wholesale jewelry sales, our demand for additional working capital will increase due to a related need to stock additional jewelry inventory and increases in wholesale accounts receivable. Historically, vendors have offered us extended payment terms to finance the need for jewelry inventory growth and our management believes that we will continue to do so in the future. Any significant increase in wholesale accounts receivable will be financed under a new bank credit facility or from short-term loans from individuals.

Our ability to finance our operations and working capital needs are dependent upon management's ability to negotiate extended terms or refinance its debt. We have historically renewed, extended or replaced short-term debt as it matures and management believes that we will be able to continue to do so in the near future.

From time to time, we have adjusted our inventory levels to meet seasonal demand or in order to meet working capital requirements. We are of the opinion that if additional working capital is required, additional loans can be obtained from individuals or from commercial banks. If necessary, inventory levels may be adjusted in order to meet unforeseen working capital requirements.

On November 2, 2011, we announced that Texas Capital Bank agreed to renew our then-current credit facility Under that certain loan Agreement, dated as of December 22, 2005, between Texas Capital Bank and us (the "TCB Facility"). The TCB facility was composed of a $3.5 million revolving note and a $1.0 million term loan. The renewal was finalized on November 2, 2011. The TCB facility matured in June 2012.

On June 21, 2012, we entered into an agreement with TCB to extend the maturity date of the credit facility to July 22, 2012. On July 19, 2012, we entered into a Loan Agreement with NTR pursuant to which NTR agreed to provide to us a guidance line of revolving credit in an amount up to $7,500,000. The Loan Agreement will terminate-and all amounts outstanding thereunder will be due and payable (such amounts, the "Obligations")-upon the earlier of: (i) August 1, 2014; (ii) the date that is twelve months after the we receive notice from NTR demanding the repayment of the Obligations; (iii) the date the Obligations are accelerated in accordance with the terms of the Loan Agreement; or (iv) the date on which the commitment terminates under the Loan Agreement. In connection with the Loan Agreement, we granted a security interest in the respective personal property of each of our subsidiaries. The loan carries an interest rate of two percent (2%) per annum for all funds borrowed pursuant to the Loan Agreement. Proceeds received by us pursuant to the terms of the Loan Agreement were used for repayment of all outstanding financial obligations incurred in connection with the TCB Facility, and additional proceeds are expected to be used as working capital in the ordinary course of business. We incurred debt issuance costs associated with the Loan Agreement totaling $56,150. The debt issuance costs are included in other assets in the accompanying consolidated balance sheet and will be amortized to interest expense on a straight-line basis over two years. As of September 30, 2012 we had an outstanding balance of $3,583,358 drawn on the NTR credit facility.

Off-Balance Sheet Arrangements.

We have no off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that is material to stockholders.

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