CLCT Collectors Universe Inc

Forward-Looking Statements

The discussion in this Item 2 of this Quarterly Report on Form 10-Q (this “Report”) includes “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended (the “1933 Act”) and Section 21E of the Securities Exchange Act of 1934, as amended (the “1934 Act”). Those Sections of the 1933 Act and 1934 Act provide a “safe harbor” for forward-looking statements to encourage companies to provide prospective information about their expected future financial performance so long as they provide cautionary statements identifying important factors that could cause their actual results to differ from projected or anticipated results. Other than statements of historical fact, all statements in this Report and, in particular, any projections of or statements as to our expectations or beliefs concerning our future financial performance or financial condition or as to trends in our business or in our markets, are forward-looking statements. Forward-looking statements often include the words "believe," "expect," "anticipate," "intend," "plan," "estimate," "project," or words of similar meaning, or future or conditional verbs such as "will," "would," "should," "could," or "may." Our actual financial performance in future periods may differ significantly from the currently expected financial performance set forth in the forward-looking statements contained in this Report due to the risks to which our business is subject and other circumstances or occurrences which are not presently predictable and over which we do not have control. Consequently, the forward-looking statements and information contained in this Report are qualified in their entirety by, and readers of this Report are urged to read the risk factors that are described in Item 1A of Part I of our Annual Report on Form 10-K for the fiscal year ended June 30, 2016 (the “Fiscal 2016 10-K”), which we filed with the Securities and Exchange Commission (the “SEC”) on August 30, 2016, and the section, entitled “Factors that Can affect our Results of Operations or Financial Position,” below in this Item 2.

Due to these and other possible uncertainties and risks, readers are cautioned not to place undue reliance on the forward-looking statements that are contained or recent trends that we describe in this Report, which speak only as of the date of this Report, or to make predictions about our future financial performance based solely on our historical financial performance. We also disclaim any obligation to update or revise any forward-looking statements contained in this Report or in our Fiscal 2016 10-K or any of our other prior filings with the SEC, except as may be required by applicable law or applicable NASDAQ rules.

Our Business

Collectors Universe, Inc. (“we”, “us”, “our”, or the “Company”) provides authentication and grading services to dealers and collectors of high-value coins, trading cards, event tickets, autographs, sports and historical memorabilia. We believe that our authentication and grading services add value to these collectibles by providing dealers and collectors with a high level of assurance as to the authenticity and quality of the collectible they seek to buy or sell; thereby enhancing their marketability and providing increased liquidity to the dealers, collectors and consumers that own, buy and sell such collectibles.

We principally generate revenues from the fees paid for our authentication and grading services. To a lesser extent, we generate revenues from other related services which consist of: (i) revenues from sales of advertising placed and commissions earned on our websites; (ii) sales of printed publications and collectibles price guides and sales of advertising in our publications; (iii) sales of membership subscriptions in our Collectors Club, which is designed primarily to attract interest in high-value collectibles among new collectors; (iv) sales of subscriptions to our CCE dealer-to-dealer Internet bid-ask market for coins that have been authenticated and graded (or “certified”) and (v) the management and operation of collectibles trade shows and conventions. We also generate revenues from sales of our collectibles inventory, which is comprised primarily of collectible coins that we have purchased under our coin grading warranty program; however, such product sales are neither the focus nor an integral part of our on-going revenue generating activities.

Grading authentication and related service revenues increased to a quarterly record of $17.9 million and a first-half record of $33.6 million in the three and six months ended December 31, 2016, respectively, as compared to $12.6 million and $27.3 million in the three and six months ended December 31, 2015. These increases in services revenues, of $5.2 million, or 41%, in the second quarter and $6.4 million, or 23%, in the first six months of this fiscal year were attributable to coin increases of $4.7 million or 57% in the second quarter and $5.4 million or 30% in the first six months, respectively, and card and autograph increases $0.5 million or 15% in the second quarter and $1.0 million or 13% in the first six months. Contributing to the coin revenue increases were increased China revenues of $3.1 million or 547% and $3.5 million or 317% in the second quarter and first half of the current year, respectively. See Net Revenues below.

Operating income increased to a quarterly record of $4.5 million and a first half record of $7.3 million in the three and six months ended December 31, 2016, respectively, as compared to $1.7 million and $4.9 million in the three and six months ended December 31, 2015. The increase in operating income primarily reflects the increased revenues generated in this year’s second quarter.

These, as well as other factors affecting our operating results in the three and six months ended December 31, 2016, are described in more detail below. See “Factors that Can Affect our operating Results and Financial Position” and “Results of Operations for the Three and Six Months Ended December 31, 2016, as compared to the Three and Six Months Ended December 31, 2015”, below.

Factors That Can Affect our Operating Results and Financial Position

Factors That Can Affect our Revenues and Gross Profit Margins . Authentication and grading fees accounted for approximately 91% and 89% of our service revenues in the three and six months ended December 31, 2016, respectively. The amount of those fees and our gross profit margins are primarily driven by the volume and mix of coin and collectibles sales and purchase transactions by collectibles dealers and collectors, because our authentication and grading services generally facilitate sales and purchases of coins and other high value collectibles by providing dealers and collectors with a high level of assurance as to the authenticity and quality of the collectibles they seek to sell or buy. Consequently, dealers and collectors most often submit coins and other collectibles to us for authentication and grading at those times when they are in the market to sell or buy coins and the other high-value collectibles, that we authenticate and grade.

In addition, our coin authentication and grading and revenues are impacted by the volume of modern coin submissions, which can be volatile, primarily depending on the timing and size of modern coin marketing programs by the United States Mint and by customers or dealers who specialize in sales of such coins. Furthermore, we have experienced a significant increase in world coin authentication and grading revenues, primarily in China, in the first half of fiscal 2017. That increase in China is primarily attributed to the previously announced Guojin contract (a multi-year services agreement for the provision of coin grading services to Guojin in China). The levels of future revenues that we will generate from this contract are dependent upon the success of Guojin’s coin marketing programs in the banking channels in China. Therefore, there may be volatility in the level of world coin revenues on a quarterly basis depending upon the level of submissions from Guojin and specifically in our third fiscal quarter due to the Chinese New Year holidays that occur in that quarter.  

Our authentication and grading revenues and gross profit margins are affected by (i) the volume and mix of authentication and grading submissions among coins and trading cards; (ii) in the case of coins and trading cards, the turnaround times requested by our customers, because we charge higher fees for faster service times; and (iii) the mix of authentication and grading submissions between vintage or “classic” coins and trading cards, on the one hand, and modern coins and trading cards, on the other hand, because dealers generally request faster turnaround times for vintage or classic coins and trading cards than they do for modern submissions, as vintage or classic collectibles generally are of significantly higher value than modern coins and trading cards; and (iv) as discussed above, the volume and timing of marketing programs for modern coins. Furthermore, because a significant proportion of our costs of revenues are relatively fixed in nature in the short term, our gross profit margin is also affected by the overall volume of collectibles that we authenticate and grade in any period.

Our revenues and gross profit margin are also affected by the number of coin authentication and grading submissions we receive at collectibles trade shows where we provide on-site authentication and grading services to show attendees, because show attendees typically request higher priced same-day turnaround for the coins they submit to us for authentication and grading at those shows. The number of trade show submissions varies from period to period depending upon a number of factors, including the number and the timing of the shows in each period and the volume of collectible coins that are bought and sold at those shows by dealers and collectors. In addition, the number of such submissions and, therefore, the revenues and gross profit margin we generate from the authentication and grading of coins at trade shows can be impacted by dealer and collectors sentiment arising from short-term changes in the prices of gold that may occur around the time of shows, because short-term changes in gold prices can affect the willingness of dealers and collectors to sell and purchase coins at the shows.

One of our coin authentication and grading customers accounted, in the aggregate, for approximately 18% and 11% of our total net revenues in the three and six months ended December 31, 2016, respectively. In addition, our top five customers accounted, in the aggregate, for approximately 30% and 22% of our total revenues in the three and six months ended December 31, 2016, respectively. As a result, the loss of any of those customers, or a significant decrease in the volume of grading submissions from any of them to us, could cause our net revenues to decline and, therefore, could adversely affect our results of operations.

The following tables provide information regarding the respective numbers of coins, trading cards and autographs that we authenticated and graded in the three and six months ended December 31, 2016 and 2015, and their estimated values, which are the amounts at which those coins and trading cards were declared for insurance purposes by the dealers and collectors who submitted them to us for grading and authentication:

⁽¹⁾      Consists of trading card units authenticated and graded by our PSA trading card authentication and grading business and autographs certified by our PSA/DNA autograph authentication and grading business.

Impact of Economic Conditions on our Financial Performance. As discussed above, our operating results are affected by the number of collectibles transactions by collectibles dealers and collectors which, in turn, is primarily affected by (i) the cash flows generated by collectibles dealers and their confidence about future economic conditions, which affect their willingness and the ability of such dealers to purchase collectibles for resale; (ii) the availability and cost of borrowings because collectibles dealers often rely on borrowings to fund their purchases of collectibles, (iii) the disposable income available to collectors and their confidence about future economic conditions, because high-value collectibles are generally purchased with disposable income; (iv) prevailing and anticipated rates of inflation and the strength or weakness of the U.S. dollar, and uncertainties regarding the strength of the economy in the United States, Western Europe and China, because conditions and uncertainties of this nature often lead investors and consumers to purchase or invest in gold and silver coins as a hedge against inflation or reductions in the purchasing power of the U.S. currency; as well as an alternative to investments in government bonds and other treasury instruments; and (v) the performance and volatility of the gold and other precious metals markets, which can affect the level of purchases and sales of collectible coins, because investors and consumers will often increase their purchases of gold coins, as well as other hard assets if they believe that the market prices of those assets will increase. As a result, the volume of collectibles transactions and, therefore, the demand for our authentication and grading services, generally increase during periods characterized by increases in disposable income and the availability of lower cost borrowings, on the one hand, or increases in inflation or in gold prices, economic uncertainties and declines in business and consumer confidence or a weakening of the U.S. dollar on the other hand. By contrast, collectibles transactions and, therefore, the demand for our services generally decline during periods characterized by economic downturns or recessions, declines in consumer and business confidence, an absence of inflationary pressures, or periods of stagnation or a downward trend in the market prices of gold. However, these conditions can sometimes counteract each other as it is not uncommon, for example, for investors to shift funds from gold to other investments during periods of economic growth and growing consumer and business confidence and from stocks and other investments to gold during periods of economic uncertainties and decreases in disposable income and consumer and business confidence.

Fact ors That Can Affect our Liquidity and Financial Position . A substantial number of our authentication and grading customers pay our authentication and grading fees when they submit their collectibles to us for authentication and grading or prior to the shipment of the collectible back to them. As a result, historically, we have been able to rely on internally generated cash and have never incurred borrowings to fund our continuing operations.

In addition to the operating performances of our businesses, and in particular our coin authentication and grading business, our overall financial position can also be affected by the dividend policy adopted by the Board of Directors from time to time, the Company’s decisions to invest in and to fund the acquisition of established and/or early stage businesses and any capital raising activities or stock repurchases. In addition, our financial position is impacted by the Company’s tax position. As previously disclosed, the Company has fully utilized all of its federal net operating loss carry forwards and other tax attributes, and therefore we pay federal income taxes at a rate of approximately 35% of taxable income on an annual basis. The Company continues to have net operating losses and other tax credits available for state income tax purposes in California, which should allow us to pay taxes at minimum levels in California for the foreseeable future.

As discussed, in note 11 to the condensed consolidated financial statements included elsewhere in this Quarterly Report, in January 2017 the Company obtained a $10 million three year unsecured revolving credit line from a commercial bank. The Company is entitled to draw down borrowings under the credit line at such times and in such amounts as it may request, provided that the maximum principal amount of the borrowings that may be outstanding at any one time under the Credit Line may not exceed $10 million and there must be a period of 30 consecutive days each year during which no borrowings may be outstanding. The Company also may, at any time or from time to time and at its option, repay outstanding borrowings, in whole or in part, and may reborrow amounts so repaid at such times and in such amounts as it deems appropriate. We intend to use borrowing under the credit line for working capital and other general corporate purposes. Based on the Company’s financial performance for the last 4 quarters ended December 31, 2016, the Company is entitled to borrow $10 million under the credit line. See “Liquidity and Capital Resources— Future Sources of Cash ” below for additional information regarding the credit line.

We currently expect that internally generated cash flows, current cash and cash equivalent balances and borrowings available under the credit line will be sufficient to fund our continuing operations at least through the end of fiscal 2017.

Critical Accounting Policies and Estimates

During the six months ended December 31, 2016 there were no changes in our critical accounting policies or estimates which are described in Item 7 of our Annual Report on Form 10-K, filed with the SEC, for the fiscal year ended June 30, 2016. Readers of this report are urged to read that Section of the Annual Report for a more complete understanding and detailed discussion of our critical accounting policies and estimates.

Goodwill

We test the carrying value of goodwill and other indefinite-lived intangible assets at least annually on their respective acquisition anniversary dates, or more frequently if indicators of impairment are determined to exist. When testing for impairment, in accordance with Accounting Standards Update No. 2011-08, we consider qualitative factors, and where determined necessary, we proceed to the two-step goodwill impairment test. When applying the two-step impairment test, we apply a discounted cash flow model or an income approach in determining a fair value that is used to estimate the fair value of the reporting unit on a total basis, which is then compared to the carrying value of the reporting unit. If the fair value of the reporting unit exceeds the carrying value of the reporting unit, no impairment of goodwill exists as of the measurement date. However, if the fair value is less than the carrying value, then there is the possibility of goodwill impairment and further testing and re-measurement of goodwill is required.

During the first quarter ended September 30, 2016, we completed the annual goodwill impairment assessment with respect to the goodwill acquired in our fiscal year 2006 purchases of CCE and CoinFacts. We assessed qualitative factors, including the significant excess of their fair values over carrying value in prior years, and any material changes in the estimated cash flows of the reporting units, and determined that it was more likely than not that the fair values of CCE and CoinFacts were greater than their respective carrying values, including goodwill, and therefore, it was not necessary to proceed to the two-step impairment test.

Stock-Based Compensation

We recognize stock-based compensation attributable to service-based equity grants over the service period based on the grant date fair value. For performance-based equity grants with financial performance goals, we begin recognizing compensation expense based on the grant date fair value when it becomes probable that we will achieve the financial performance goals.

Restricted Stock Awards  

As previously disclosed, in fiscal 2013, the Compensation Committee of the Board of Directors adopted a Long-Term Incentive Plan (“LTIP”) for the Company’s Chief Executive Officer and Chief Financial Officer, as well as for other selected key management employees (collectively, “Participants”) and currently there are approximately 411,000 unvested restricted shares outstanding under that LTIP. At the time of the adoption of the LTIP, the Compensation Committee established a threshold annual financial performance goal, and four increasingly higher financial performance goals and made the vesting of the LTIP shares conditioned on the Company’s achievement of one or more of those annual financial performance goals prior to the expiration of the LTIP on June 30, 2018. Through fiscal 2015, the Company had achieved the threshold and the first of the other financial performance goals, resulting in the vesting of 25% of the restricted shares that had been granted under the LTIP.  

The Company did not achieve any additional financial performance goals in fiscal 2016 and, therefore, no additional restricted shares became vested in fiscal 2016. However, a determination was made that it had become probable the Company would achieve at least the next higher financial performance goal prior to the expiration of the LTIP in fiscal 2018. Therefore, we are accruing the remaining stock-based compensation expense for that goal on a prospective basis, through the expected later vesting date.

At this time, it is considered too early to determine if it is probable that the Company will achieve any additional financial performance goals under the LTIP in fiscal 2017 or 2018. We will continue to reassess at each reporting date whether it has become probable that any additional performance goals will be achieved. If it does become probable, then the Company would recognize additional stock-based compensation expense in respect of the shares that will become vested as a result of the achievement of the additional financial performance goal or goals based on the expected vesting dates of those shares and, consistent with prior periods, there would be a catch-up expense required to be recognized for prior services from the grant date of those shares to the date such vesting becomes probable.

Stock-based compensation for the three and six months ended December 31, 2016 was $108,000 and $210,000 as compared to $140,000 and $291,000 for the three and six months ended December 31, 2015. The reductions of $32,000 and $81,000, primarily related to lower stock-based compensation expense recognized for service grants that became fully vested as of June 30, 2016.

Results of Operations for the Three and Six Months Ended December 31, 2016 as compared to the Three and Six Months Ended December 31, 2015

Net Revenues

Net revenues consist primarily of fees that we generate from the authentication and grading of high-value collectibles, including coins, trading cards and autographs, and related special inserts, if applicable. To a lesser extent, we generate collectibles related service revenues (which we refer to as “other related revenues”) from advertising and commissions earned on our websites and in printed publications and collectibles price guides; subscription/membership revenues related to our CCE (dealer-to-dealer Internet bid-ask market for certified coins), CoinFacts and Collectors Club; and fees earned from promoting, managing and operating collectibles trade shows. Net revenues also include, to a significantly lesser extent, revenues from the sales of products, which consist primarily of coins that we have purchased under our coin authentication and grading warranty policy. We do not consider such product sales to be the focus or an integral part of our ongoing revenue generating activities.

The following table sets forth the information regarding our net revenues for the three and six months ended December 31, 2016 and 2015 (in thousands):

The following tables set forth certain information regarding the increases (decreases) in net revenues in our larger markets (which are inclusive of revenues from our other related services) and in the number of units authenticated and graded in the three and six months ended December 31, 2016 and 2015 (in thousands):

For the three months ended December 31, 2016, our total service revenues increased by $5,226,000, or 41.4%, to a quarterly record of $17,862,000. That increase was attributable to a $5,327,000, or 48.7%, increase in authentication and grading fees partially offset by a decrease of $101,000, or 5.9%, in other related services. The increase in authentication and grading fees was attributable to a $4,833,000, or 62.8%, increase in coin fees and a $494,000, or 15.2%, increase in cards and autograph fees.

For the six months ended December 31, 2016, our total service revenues increased by $6,356,000 or 23.3%, to a first half record of $33,610,000. That increase was attributable to a $6,590,000, or 28.3%, increase in authentication and grading fees, partially offset by a decrease of $234,000, or 5.9%, in other related services. The increase in authentication and grading fees was attributable to a $5,712,000, or 34.9% increase in coin fees and an $878,000, or 12.7%, increase in cards and autograph fees.

The reductions in other related services in the three and six month ended December 31, 2016 reflects the previously disclosed decision to eliminate, effective January 2016, the subscription fee previously charged for access to our CoinFacts website.

The increases in coin authentication and grading fees in the second quarter and six months ended December 31, 2016 led to record coin fees for both those periods and reflected (i) higher world coin fees of $3,127,000 or 227.7% in the second quarter and $3,814,000 or 150.9% in the six months, primarily attributable to higher fees generated in China from the previously announced Guojin multi-year contract (ii) higher modern fees of $915,000 or 51.3% in the second quarter and $801,000 or 19.7% in the six months (iii) higher vintage coin fees of $664,000 or 22.5% in the second quarter and $775,000 or 12.7% in the six months, and (iv) increased coin trade show revenues of $128,000 or 8.1% in the second quarter and $322,000 or 8.7% in the six months. The increases in modern, vintage and trade shows reflected generally higher U.S. submissions, primarily in the second quarter.

Due to the increase in our coin authentication and grading revenues in the first half of the year, our coin business represented approximately 68% of total service revenues in the first half of the current year, as compared to 65% of total service revenues for the same period of the prior year, and reflects the continued importance of our coin authentication and grading business to our overall financial performance.

As discussed above under “Factors That Can Affect our Revenues and Gross Profit Margin”, and “Impact of Economic Conditions on our Financial Performance”, the level of coin revenues can be volatile.

Revenues from our trading cards and autographs business continued to show consistent growth. Those revenues increased by 14.6% in the second quarter, and 12.7% in the first half of the year and represented record second quarter and first half revenues for that business. Moreover, our card and autographs business has achieved quarter-over-quarter revenue growth in 25 of the last 26 quarters.

As previously disclosed, our third fiscal quarter is typically our seasonally strongest quarter of the year, due to the release of Gold and Silver Eagles by the US Mint in that quarter. To stimulate increased demand for our services, effective January 1, 2016, the Company implemented more competitive programs for our modern coin business, which we expect will continue to drive submissions in calendar 2017. In addition, as discussed above, there was a significant increase in revenues generated in China in this year’s second quarter attributable to the Guojin contract. Therefore, our third quarter revenues will be impacted by the level of revenues generated from that contract, which in turn are dependent on the success of Guojin’s marketing programs in the banking channels in China and the impact of Chinese New Year holidays that occur in the third quarter. However, it is too early to determine the impact of these programs and other market conditions on the level of revenues that we will generate in the third quarter and the second half of fiscal 2017.

Gross Profit

Gross profit is calculated by subtracting the cost of revenues from net revenues. Gross profit margin is gross profit stated as a percent of net revenues. The costs of authentication and grading revenues consist primarily of labor to authenticate and grade collectibles, production costs, credit card fees, warranty expense and occupancy, security and insurance costs that directly relate to providing authentication and grading services. Cost of revenues also includes printing, other direct costs of the revenues generated by our other non-grading related services and the costs of product revenues, which represent the carrying value of the inventory of products (primarily collectible coins) that we sold and any inventory related reserves, considered necessary.

Set forth below is information regarding our gross profit in the three and six months ended December 31, 2016 and 2015 (in thousands):

As indicated in the above table, our services gross profit margin was 63.7% and 62.5% for the three and six months ended December 31, 2016, respectively, as compared to 60.4% and 62.8% for the three and six months ended December 31, 2015. The higher gross profit margin that arose in this year’s second quarter was related to our coins and card and autograph businesses. The higher coin gross profit margin reflects the mix of coin revenues and the higher overall level of coin revenues in the quarter, due to certain of our direct cost being relatively fixed in nature. In addition, due to the significantly higher revenues earned in China in the second quarter, the gross profit margin for our China operations improved and reflects, we believe, a more normalized coin gross profit margin for that business. The higher gross profit margin for our cards and autographs business reflects improving average service fees earned in that business. As discussed in prior filings, there can be variability in the services gross profit margin due to the mix of revenue in any quarter and the seasonality of our business that can impact the level of revenues generated in any given quarter. During the three years ended June 30, 2016, our quarterly services gross profit varied between 59% and 65%.

Selling and Marketing Expenses

Selling and marketing expenses include advertising and promotions costs (including costs associated with Collectors.com), trade-show related expenses, customer service personnel costs, business development incentives, depreciation and outside services. Set forth below is information regarding our selling and marketing expenses in the three and six months ended December 31, 2016 and 2015 (in thousands):

As indicated in the above table, selling and marketing expenses declined to 13.0% and 14.1% of net revenues in the three and six months ended December 31, 2016, respectively, as compared to 16.2% and 15.4% in the same respective periods of the prior year. In absolute dollars, selling and marketing expenses increased by $287,000 and $539,000 in the three and six months ended December 31, 2016, respectively, as compared to the same respective periods of the prior year and was primarily due to (i) increased marketing and business development payroll and incentive costs, of $319,000 and $457,000, respectively, attributable to the growth of our China and Hong Kong coin operations and in the U.S., in support of our U.S. general marketing activities and (ii) increased trade show and travel costs of $137,000 and $262,000, respectively in support of trade show grading activities and the growth of our business in China and Hong Kong. These increases were partially offset by a reduction in promotional costs for Collectors.com in the second quarter and six months ended December 31, 2016.

General and Administrative Expenses

General and administrative (“G&A”) expenses are comprised primarily of compensation paid to general and administrative personnel, including executive management, finance and accounting and information technology personnel, non-cash stock-based compensation, facilities management costs, depreciation, amortization and other miscellaneous expenses, and G&A expenses of Collectors.com. Set forth below is information regarding our G&A expenses in the three and six months ended December 31, 2016 and 2015, (in thousands):

As indicated in the above tables, G&A expenses declined to 25.4% and 26.7% of revenues in the three and six months ended December 31, 2016, respectively, as compared to 30.8% and 29.4% in the same respective period of the prior year. In absolute dollars, G&A expenses increased by $652,000 and $959,000 in the three and six months ended December 31, 2016, respectively, as compared to the same periods of fiscal 2016 and primarily reflected (i) higher G&A bonuses and incentives of $562,000 and $547,000, respectively, primarily based on the improved operating performance of our businesses in the second quarter (ii) higher on-going legal and litigation related expenses of $115,000 and $234,000, respectively, and (iii) higher depreciation and amortization costs of $48,000 and $136,000, respectively, related to Collectors.com and IT infrastructure equipment.

Stock-Based Compensation

As discussed in Note 1, Stock-Based Compensation Expense to the Company’s condensed consolidated financial statements, included elsewhere in this report, the Company recognized stock-based compensation expense (in thousands), as follows: