The accompanying notes are an integral part
of these consolidated financial statements.
The accompanying notes are an integral part
of these consolidated financial statements.
The accompanying notes are an integral part
of these consolidated financial statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) Basis of Presentation
The consolidated interim financial
statements of DGSE Companies, Inc. included herein have been prepared by the Company pursuant to the rules and regulations of the
Securities and Exchange Commission (the “SEC”). Certain information and footnote disclosures normally included in financial
statements prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”)
have been condensed or omitted pursuant to the Commission’s rules and regulations, although the Company believes that the
disclosures are adequate to make the information presented not misleading. The Company suggests that these financial statements
be read in conjunction with the financial statements and notes included in the Company’s Annual Report on Form 10-K for the
fiscal year ended December 31, 2013 (such fiscal year, “Fiscal 2013” and such annual Report on Form 10-K, the “Fiscal
2013 10-K”). In the opinion of the management of the Company, the accompanying unaudited interim financial statements contain
all adjustments, consisting only of those of a normal recurring nature, necessary to present fairly its results of operations and
cash flows for the periods presented. The results of operations for the periods presented are not necessarily indicative of the
results to be expected for the full year. Certain reclassifications were made to the prior year's consolidated financial statements
to conform to the current year presentation.
(2)
Principles of Consolidation and Nature of Operations
DGSE Companies,
Inc., a Nevada corporation, and its subsidiaries (the “Company” or “DGSE”), buy and sell jewelry and bullion
products to both retail and wholesale customers throughout the United States through its facilities in Illinois, South Carolina,
and Texas, and through its various internet sites. Until recently, the Company also operated retail locations in Alabama, Florida,
Georgia, and Tennessee.
The interim consolidated financial
statements have been prepared in accordance with U.S. GAAP and include the accounts of the Company and its subsidiaries. All
material intercompany transactions and balances have been eliminated.
(3) Critical Accounting Policies and
Estimates
Income Taxes
The Company accounts for its
position in tax uncertainties in accordance with Accounting Standards Codification (“ASC”) 740,
Income Taxes
.
The guidance establishes standards for accounting for uncertainty in income taxes. The guidance provides several clarifications
related to uncertain tax positions. Most notably, a “more likely-than-not” standard for initial recognition of tax
positions, a presumption of audit detection and a measurement of recognized tax benefits based on the largest amount that has a
greater than 50 percent likelihood of realization. The guidance applies a two-step process to determine the amount of tax benefit
to be recognized in the financial statements. First, the Company must determine whether any amount of the tax benefit may be recognized.
Second, the Company determines how much of the tax benefit should be recognized (this would only apply to tax positions that qualify
for recognition). The Company has not taken a tax position that, if challenged, would have a material effect on the financial statements
or the effective tax rate during the periods ended March 31, 2014 and 2013, respectively.
Financial Instruments
The carrying amounts reported
in the consolidated balance sheets for cash equivalents, accounts receivable, accounts payable and accrued expenses approximate
fair value because of the immediate or short-term maturity of these financial instruments. The line of credit, related
party does not bear a market rate of interest. Management believes that, based on the Company’s situation at the time the
line was negotiated, it could not have obtained comparable financing, and as such cannot estimate the fair value of the line of
credit, related party. The carrying amounts reported for the Company’s long-term debt, and capital leases approximate fair
value because substantially all of the underlying instruments have variable interest rates, which adjust frequently, or the interest
rates approximate current market rates. None of these instruments are held for trading purposes.
Earnings Per Share
Basic earnings per common share
is computed by dividing net earnings available to holders of the Company’s common stock by the weighted average number of
common shares outstanding for the reporting period. Diluted earnings per share reflect the potential dilution that could occur
if securities or other contracts to issue common stock were exercised or converted into common stock. For the calculation of diluted
earnings per share, the basic weighted average number of shares is increased by the dilutive effect of stock options outstanding
determined using the treasury stock method.
(4) Inventories
A summary of inventories is
as follows:
|
|
March 31,
|
|
|
December 31,
|
|
|
|
2014
|
|
|
2013
|
|
|
|
|
|
|
|
|
Jewelry
|
|
$
|
9,419,397
|
|
|
$
|
9,448,793
|
|
Scrap gold
|
|
|
929,537
|
|
|
|
1,190,490
|
|
Bullion
|
|
|
1,032,793
|
|
|
|
1,199,373
|
|
Rare coins and Other
|
|
|
840,712
|
|
|
|
1,083,201
|
|
|
|
$
|
12,222,439
|
|
|
$
|
12,921,857
|
|
(5) Basic and Diluted Average Shares
A reconciliation
of basic and diluted average common shares for the three months ended March 31, 2014 and 2013 is as follows:
|
|
For the Three Months Ended
March 31,
|
|
|
|
2014
|
|
|
2013
|
|
|
|
|
|
|
|
|
Basic weighted average shares
|
|
|
12,193,940
|
|
|
|
12,175,584
|
|
Effect of potential dilutive securities:
|
|
|
|
|
|
|
|
|
Stock options
|
|
|
-
|
|
|
|
137,464
|
|
Diluted weighted average shares
|
|
|
12,193,940
|
|
|
|
12,313,048
|
|
For the
three months ended March 31, 2014 and 2013, options to purchase 5,347,500 and 5,030,000 shares of common stock, respectively, and
84,000 and 0 unvested Restricted Stock Units (“RSUs”), respectively, were not added to the diluted average shares because
inclusion of such shares would be antidilutive.
(6) Long-Term Debt
|
|
Outstanding Balance
|
|
|
|
|
|
|
|
|
March 31,
2014
|
|
|
December
31, 2013
|
|
|
Current
Interest Rate
|
|
|
Maturity
|
|
|
|
|
|
|
|
|
|
|
|
|
NTR line of credit (1)
|
|
$
|
2,303,359
|
|
|
$
|
2,383,359
|
|
|
|
2.0
|
%
|
|
August 1, 2015
|
Mortgage payable
|
|
|
1,813,190
|
|
|
|
1,843,061
|
|
|
|
6.7
|
%
|
|
August 1, 2016
|
Capital leases (2)
|
|
|
45,664
|
|
|
|
48,393
|
|
|
|
Various
|
|
|
Various
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Sub-Total
|
|
|
4,162,213
|
|
|
|
4,274,813
|
|
|
|
|
|
|
|
Less: Capital leases
|
|
|
11,209
|
|
|
|
11,091
|
|
|
|
|
|
|
|
Less: Current maturities
|
|
|
124,600
|
|
|
|
122,536
|
|
|
|
|
|
|
|
Long-term debt
|
|
|
4,026,404
|
|
|
|
4,141,186
|
|
|
|
|
|
|
|
Less: Line of credit (1)
|
|
|
2,303,359
|
|
|
|
2,383,359
|
|
|
|
|
|
|
|
Long term debt, less current maturities
|
|
$
|
1,723,045
|
|
|
$
|
1,757,827
|
|
|
|
|
|
|
|
|
(1)
|
On July 19, 2012, DGSE entered into a loan agreement with NTR Metals, LLC (“NTR”), an affiliate of DGSE’s
majority stockholder Elemetal, LLC (“Elemetal”), pursuant to which NTR, agreed to provide the Company a guidance line
of revolving credit in an amount up to $7,500,000 (the “Loan Agreement”). 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 Company receives 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, the Company
granted a security interest in the respective personal property of each of its 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 the Company pursuant
to the terms of the Loan Agreement were used for repayment of all outstanding financial obligations incurred in connection with
that certain Loan Agreement, dated as of December 22, 2005, between the Company and Texas Capital Bank, and additional proceeds
are expected to be used as working capital in the ordinary course of business. The Company 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 are being amortized to interest expense on a straight-line basis over two years. As of March 31, 2014 and December
31, 2013, we had outstanding balances of $2,303,359 and $2,383,359, respectively, drawn on the NTR credit facility. On February
25, 2014, the Company and NTR entered into a one-year extension of the Loan Agreement, extending the termination date to August
1, 2015. All other terms of the agreement remain the same.
|
|
(2)
|
On November 23, 2010, DGSE entered into a capital lease for $78,450 with Direct Capital Corporation
for a radio-frequency identification (“RFID”) inventory management solution. The non-cancelable lease agreement required
an advanced payment of $5,169 and monthly payments of $2,584 for 36 months at an interest rate of 11.5% beginning in January 2011.
At the end of the lease in December 2013, the equipment was purchased for $1. On April 3, 2013, DGSE entered into a capital lease
for $58,563 with Graybar Financial Services for phones at the new corporate headquarters. The non-cancelable lease agreement
required an advanced payment of $2,304 and monthly payments of $1,077 for 60 months at an interest rate of 4.2% beginning in May
2013. At the end of the lease in May 2018, the equipment can be purchased for $1.
|
(7) Stock-Based Compensation.
The Company accounts for share-based
compensation by measuring the cost of the employee services received in exchange for an award of equity instruments, including
grants of stock options, based on the fair value of the award at the date of grant. In addition, to the extent that the Company
receives an excess tax benefit upon exercise of an award, such benefit is reflected as cash flow from financing activities in the
consolidated statement of cash flows.
In January of 2014, DGSE’s
Board of Directors (the “Board”) granted 112,000 RSUs to our officers and certain key employees. Each RSU is convertible
into one share of Common Stock without additional payment pursuant to the terms of the Restricted Stock Unit Award Agreement, dated
January 23, 2014, between the Issuer and each recipient (the "RSU Award Agreement"). One-fourth (or 28,000) of the RSUs
vested and were exercisable as of the date of the grant, and an additional one-fourth of the RSUs (calculated using the total number
of RSUs at the time of grant) vest and will be exercisable on each subsequent anniversary of the date of grant until 100 percent
of the RSUs have vested, subject to the recipient’s continued status as an employee on each such date and other terms and
conditions of set forth in the RSU Award Agreement. Upon termination of service of the recipient to us, other than by reason of
death or disability, any RSUs that have not vested will be forfeited and the award of such units shall terminate.
Stock-based compensation expense
for the three months ended March 31, 2014 and 2013 was $60,200 and $0, respectively, relating to employee and director stock options
and RSUs, and included in selling, general and administrative expenses in the accompanying consolidated statements of operations.
(8) Related Party Transactions.
DGSE has a corporate policy
governing the identification, review, consideration and approval or ratification of transactions with related persons, as that
term is defined in the Instructions to Item 404(a) of Regulation S-K, promulgated under the Securities Act (“Related Party”).
Under this policy, all Related Party transactions are identified and approved prior to consummation of the transaction to ensure
they are consistent with DGSE’s best interests and the best interests of its stockholders. Among other factors, the Board
considers the size and duration of the transaction, the nature and interest of the Related Party in the transaction, whether the
transaction may involve a conflict of interest and if the transaction is on terms that are at least as favorable to DGSE as would
be available in a comparable transaction with an unaffiliated third party. DGSE’s Board reviews all Related Party transactions
at least annually to determine if it is in DGSE’s best interests and the best interests of our stockholders to continue,
modify, or terminate the Related Party transactions. DGSE’s Related Party Transaction Policy is available for review in its
entirety under the “Investor Relations” menu of our corporate website at www.DGSECompanies.com.
Elemetal is DGSE’s largest
stockholder. Elemetal, through its affiliates NTR and Elemetal Capital, is also DGSE’s primary refiner and bullion trading
partner. For the three months ended March 31, 2014, 28% of sales and 30% of purchases were transactions with Elemetal, and in the
same period in 2013 these transactions represented 32% of DGSE’s sales and 39% of our purchases. As of March 31, 2014 and
December 31, 2013, we were obligated to pay $3,727,916 and $3,332,858, respectively, to Elemetal as a trade payable. DGSE also
paid Elemetal and its affiliates $54,813 in interest for the three months ended March 31, 2014, including interest on DGSE’s
trade payable with Elemetal. In the same period in 2013 DGSE recognized $17,671 in interest related to Elemetal and its affiliates.
On July 19, 2012, the Company
entered into the Loan Agreement with NTR, pursuant to which NTR agreed to provide the Company with a guidance line of revolving
credit in an amount up to $7,500,000. The Loan Agreement provides that the Loan Agreement will terminate—and DGSE’s
Obligations will be due and payable– upon the earlier of (i) August 1, 2014, (ii) the date that is twelve months after DGSE
receives 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, DGSE granted a security interest in the respective personal property of each of its 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 DGSE pursuant to the terms of the Loan Agreement were used for repayment of all outstanding financial obligations incurred in
connection with that certain Loan Agreement, dated as of December 22, 2005, between DGSE and Texas Capital Bank, N.A., and any
additional proceeds are expected to be used as working capital in the ordinary course of business. As of March 31, 2014 and December
31, 2013, we had outstanding balances of $2,303,359 and $2,383,359, respectively, drawn on the NTR credit facility. On February
25, 2014, the Company and NTR entered into a one-year extension of the Loan Agreement, extending the termination date to August
1, 2015. All other terms of the agreement remain the same.
Estate Gold and Silver, LLC,
a Texas limited liability company (“Estate Gold”) was 25% owned by an entity owned by James Vierling, DGSE’s
former Chief Executive Officer and Chairman, and operated five stores in Oklahoma, primarily focused on buying gold, but also engaging
in retail sales of jewelry and bullion. In July of 2013, Estate Gold ceased all operations. The Company previously had an agreement
with Estate Gold to provide operations management services, consisting of: (i) the receipt, inventorying, and re-sale of Estate
Gold purchases; (ii) the management of Estate Gold’s payroll, insurance, accounts payable and receivable; (iii) the maintenance
of and updates to Estate Gold’s business software; maintenance of the Estate Gold website; and (iv) financial reporting of
Estate Gold to its owners. The Company also periodically engaged in the purchase or sale of jewelry, bullion and diamonds to Estate
Gold, from time to time in the normal course of business. DGSE had no transactions with Estate Gold in the three months ended March
31, 2014. During the three months ended March 31, 2013, the Company received $16,641 in fees for services, sold $8,214 in products,
and purchased $23,342 in products, in transactions with Estate Gold.
(9) Legal Proceedings.
On April 16, 2012, the Company
filed a Current Report on Form 8-K disclosing that DGSE’s Board had determined the existence of the certain accounting irregularities
beginning approximately during the second calendar quarter of 2007 and continuing in periods subsequent thereto (the “Accounting
Irregularities”), which could affect financial information reported since that time. On April 16, 2012, the Company also
announced that it had engaged forensic accountants to analyze the Accounting Irregularities, and that financial statements and
information reported since the inception of the Accounting Irregularities, believed to begin in the second calendar quarter of
2007, should not be relied upon. The Company brought the Accounting Irregularities to the attention of the SEC in a letter dated
April 16, 2012. On June 18, 2012, the Company received written notice that the SEC had initiated a private investigation into the
Accounting Irregularities, to determine whether any persons or entities had engaged in any possible violations of the federal securities
laws. The Company has cooperated fully, and continues to cooperate fully, with the SEC staff in the investigation. This investigation
is still pending as of the date of the filing of this Form 10-Q, and there can be no certainty as to the outcome of this investigation,
or to the findings of the SEC.
In connection with the Accounting
Irregularities, and the subsequent halt in trading of DGSE’s Common Stock on the Exchange, the Company settled two lawsuits
in Fiscal 2013. The first, Civil Action No. 3:12-cv-3664, was filed in the United States District Court for the Northern District
of Texas, on September 7, 2012, entitled Grant Barfuss, on behalf of himself and all others similarly situated vs. DGSE Companies,
Inc.; L.S. Smith, John Benson and William Oyster. This complaint alleged violations of the securities laws and sought unspecified
damages. Plaintiffs alleged that certain public filings in 2010 and 2011 were false and misleading. The second suit, Case No. 3:12-cv-03850
in the United States District Court for the Northern District of Texas, was filed on September 21, 2012, by Jason Farmer and entitled
Jason Farmer, Derivatively on Behalf of Nominal Defendant DGSE Companies, Inc., Plaintiff, v. William H. Oyster, James D. Clem,
William Cordeiro, Craig Alan-Lee, David Rector, L.S. Smith, and John Benson, Defendants, and DGSE Companies, Inc., Nominal Defendant.
This suit was filed against DGSE, as a nominal defendant, and against certain and former officers and directors. The plaintiff
asserted that certain statements made in DGSE’s proxy materials were false and misleading, that the defendants breached fiduciary
duties owed to DGSE, for abuse of control, and sought unspecified compensatory and exemplary damages, along with certain corporate
governance changes, for the benefit of DGSE.
The approved settlement resolved
all issues which were pending before the United States District Court for the Northern District of Texas in both cases. The defendants
agreed to pay $2 million to resolve all claims in both suits (including obligations to pay plaintiffs’ attorneys’ fees).
The Company also incurred its own attorneys’ fees and expenses associated with finalizing the settlement. While the majority
of the total settlement amount and related expenses were paid from insurance proceeds, the Company incurred approximately $314,000
in Fiscal 2013 in relation to these suits.
In the quarter ended March 31,
2014, the Company settled a civil suit filed in the County Court for Dallas County, Texas, Cause No. CC-13-02999-C entitled Joseph
C. Osterman, T.G. Herron, and, Jean K. Herron, Plaintiffs, vs. DGSE Companies, Inc. d/b/a Dallas Gold & Silver Exchange, Defendants.
The complaint alleged amounts owed and due to the plaintiffs by the defendant in relation to a variety of promissory notes allegedly
issued between 2001 and 2006 by the defendant. Pursuant to the confidential settlement agreement, which admits no liability on
the part of the defendant, the Company has resolved all claims with plaintiff Osterman to the parties’ mutual satisfaction.
Discussions with plaintiffs Heron are ongoing, and the final outcome of these discussions is uncertain, although any conclusion
to this suit is not expected to be material to the Company’s results in the year ended December 31, 2014 (“Fiscal 2014”).
The Texas Comptroller conducted
a sales and use tax audit of our operations in Texas with respect to the period March 1, 2006 through November 30, 2009 and subsequently
sent a Notification of Audit Results, by letter dated December 17, 2010, asserting that DGSE owes an amount of tax due, plus penalties
and interest. The Company submitted a request for redetermination to the Texas Comptroller by letter dated January 13, 2011. By
letter dated August 25, 2011, the Texas Comptroller stated that DGSE’s request for a redetermination hearing has been granted.
No hearing has taken place, but the Company has been actively engaged in discussions with the Texas Comptroller's office. The Company
has reached an informal agreement on certain issues with the attorney representing the Texas Comptroller in the administrative
hearing with respect to this liability, while other issues remain under discussion. Although no final determination has been reached,
based on the most recent communication from the Texas Comptroller in February of 2014, DGSE believes that it is likely that the
Company owes additional taxes, interest and penalty to the State of Texas, and accordingly reserved an additional $775,000 in Fiscal
2013 towards the payment of these amounts. The total reserve in this matter now is approximately $1.1 million, and is based on
the Company’s current best estimate, which may vary materially from any final assessment.
(10) Discontinued Operations
In January
of 2014, the Company elected to discontinue the operations of six of its Southern Bullion Coin and Jewelry (“Southern Bullion”)
locations due to the lack of profitability and management's belief that it was unlikely that profitability would be reached in
the foreseeable future. The Company officially discontinued these operations on February 3, 2014, and the operating results for
these six locations for the three months ended March 31, 2014 and 2013 have been reclassified as discontinued operations in the
consolidated statements of operations as detailed in the table below.
|
|
Three Months Ended March 31,
|
|
|
|
2014
|
|
|
2013
|
|
|
|
|
|
|
|
|
Revenue:
|
|
|
|
|
|
|
|
|
Sales
|
|
$
|
914,497
|
|
|
$
|
1,291,573
|
|
Cost of sales
|
|
|
819,731
|
|
|
|
980,445
|
|
Gross margin
|
|
|
94,766
|
|
|
|
311,128
|
|
|
|
|
|
|
|
|
|
|
Expenses:
|
|
|
|
|
|
|
|
|
S,G&A expense
|
|
|
132,406
|
|
|
|
348,493
|
|
Depreciation and amortization
|
|
|
-
|
|
|
|
-
|
|
Total Expenses
|
|
|
132,406
|
|
|
|
348,493
|
|
|
|
|
|
|
|
|
|
|
Operating loss
|
|
|
(37,640
|
)
|
|
|
(37,365
|
)
|
|
|
|
|
|
|
|
|
|
Other expense (income):
|
|
|
|
|
|
|
|
|
Other (expense)/income, net
|
|
|
-
|
|
|
|
-
|
|
Interest expense
|
|
|
-
|
|
|
|
-
|
|
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
Loss from discontinued operations before income taxes
|
|
|
(37,640
|
)
|
|
|
(37,365
|
)
|
|
|
|
|
|
|
|
|
|
Income tax expense
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
Loss from discontinued operations after income taxes
|
|
$
|
(37,640
|
)
|
|
$
|
(37,365
|
)
|
Subsequent
to the end of the first fiscal quarter of 2014, in April of 2014 the Company elected to discontinue the operations of all 17 remaining
Southern Bullion locations. During 2013, the Southern Bullion operations generated a net loss of approximately $1.9 million. These
operations represented approximately 20% the Company’s revenue, and approximately 70% of the Company’s operating loss
in Fiscal 2013. The significant change in the precious metal markets, including a 30% decline in the spot price of gold since the
acquisition of Southern Bullion in 2011, had a disproportionately negative impact on the customer traffic, transactional volume
and profitability of the Southern Bullion operations. The Company officially discontinued these operations on or about April 19,
2014. The operating results for all Southern Bullion locations are expected to be reclassified as discontinued operations in the
consolidated statements of operations beginning with the quarter ending June 30, 2014.
The Company
expects to report approximately $3.7 million in 2014 in non-recurring charges related to these closures. This includes approximately
$2.9 million in expected write-offs related to the Southern Bullion trade name, approximately $400,000 in expected fixed asset
write-downs, and approximately $500,000 in expected lease termination expenses, severance payments and other related costs.