DGSE Companies' CEO Discusses Q3 2013 Results - Earnings Call Transcript

Nov.13.13 | About: DGSE Companies, (DGSE)

DGSE Companies, Inc. (NYSEMKT:DGSE)

Q3 2013 Results Earnings Call

November 13, 2013, 04:30 AM ET

Executives

Brett Maas - Hayden IR, Investor Relations

James J. Vierling - Chairman, President, Chief Executive Officer and Principal Executive Officer

C. Brett Burford - Chief Financial Officer, Chief Accounting Officer, Principal Financial Officer and Secretary

James D. Clem - Chief Operating Officer

Analysts

Christopher Doucet - Doucet Asset Management

Operator

Good day, ladies and gentlemen. Welcome to the DGSE Companies' Inc. Third Quarter 2013 Financial Results Conference Call. At this time all participants are in a listen-only mode. Following the presentation instructions will be given for the question-and-answer session. (Operator Instructions). As a reminder this conference is being recorded today, November 13, 2013.

I would now like to turn the conference over to Brett Maas. Please go ahead.

Brett Maas

Thank you and good day. The call today will be hosted by Mr. Jim Vierling, Chairman and Chief Executive Officer, President of DGSE Companies. Joining Jim are Mr. Brett Burford, the company's Chief Financial Officer; and Mr. Dusty Clem, Chief Operating Officer. Following management's discussions there will be a formal Q&A session open to participants on the call.

Before we get started I'm going to review the Safe Harbor statement. Some of the information discussed in this call, particularly our revenue, store opening and operational target and our forward-looking business plans are based on information as of today, November 13, 2013 and contains forward-looking statements that involve risks and uncertainty. Actual results may differ materially from those set forth in such statements.

For a discussion of these risks and uncertainties you should review the forward-looking statements disclosure in the earnings press release we issued today, as well as DGSE's SEC filings.

With that out of the way I'd like to turn the call over to Jim Vierling, Chairman and CEO for opening comments. Jim, the floor is yours.

James J. Vierling

Thank you for participating in our call today. After our prepared remarks we look forward to answering your questions but to begin let’s go over the agenda for today’s call.

First I'll start by giving a brief summary of third quarter 2013. I'll also give you an update on the precious metals and jewelry market. Second, Brett Burford, our CFO will go over the financial results of the third quarter and year-to-date. Next I’ll give you an update on some additional initiatives we are pursuing going forward, and finally, Brett, Dusty and I will be glad to take your questions.

After a period of tremendous industry-wide challenges we feel like better days are at hand. During the third quarter of 2013 the markets in which we operate remained challenging and continue to demonstrate volatility as the price of gold remained depressed. The month of July was especially challenging. Things began to improve during August and September was a much better month for us.

That strength continued in the first part of October and I can report that assuming no further significant decreases in commodity prices we think the worst may be behind us. That is not to say I am happy with the current situation but it is considerably better than it was during the summer month and several of our initiatives to improve other areas of our business are gaining traction.

We’re now moving to the busiest season of the year, the holiday season with confidence and optimism. I think it’s important to look at the situation we face, including an unprecedented decline in gold price. The average price of gold during the three months ended September 30, 2013 was 19% lower than the same quarter in 2012. And the closing price on September 30, 2013 was 25% lower than on the same day in 2012.

Given our business model precious metal and diamond prices affect almost every aspect of our business and the dropping gold prices created a significant headwind against our efforts to properly operate the business. We have made great progress in our efforts to transition from a company primarily focused on scrap buying to a more diversified retail organization and we will continue to diversify our business going forward. However, even this diversification did not shield us from the effect of the drop in the gold prices.

The single biggest impact from the recent drop is that fewer customers are interested in selling their unused and unwanted gold and this has had a significant negative impact on the volume of our high margin scrap buying business. The impact to the industry has been profound.

For a long period of time any company that entered into the cash for gold business was successful and that has changed and the result is that many of these mom and pop gold buying businesses have closed and those that haven’t are looking somebody to buy their business. It is our opinion as we have been saying for several quarters now that stores that are exclusively gold buying operations cannot be successful in today’s environment.

We are a broad line company that offers much more than just cash for gold buying services, we are a full line exchange offering two way markets in bullion, fine watches, jewelry, diamonds, rare coins and collectibles. As the industry has rapidly evolved we have focused our marketing -- we have refocused our marketing strategy, enhanced our expertise outside of just scrap buying and are refocusing our M&A strategy.

As a result we are no longer focused on acquiring standalone gold buying locations. However we are now analyzing the profitability of acquiring jewelry stores and strong retail sales are more important than ever to our future success. We believe it’s much easier to add a scrap buying components to a jewelry store than it is to convert a gold buying operation into a full line retailer featuring our entire product line. And even within our existing portfolio of stores we have made the tough, the prudent decision to close locations that cannot support our broad line of merchandise.

We believe there is strong opportunity in this industry for companies like DGSE who have broad based expertise and diversified products. With this in mind it’s important to remind the shareholders that there are much more -- we are much more than a collection of brick and mortar stores. Much of the focus in recent quarters has been on growth through acquisition organically for opening additional new stores and as I just described the industry-wide changes have altered that strategy.

But the power of our business model is that we have revenue streams not just from retail but from wholesale and other sources of wealth. For instance I’ve identified e-commerce as an area where I think we can make significant improvements that will have a real impact on the bottom line. We are currently in the process of revamping our multiple websites and thus create our digital footprint so that we can better leverage our unique brands and drive going forward. In light of the volatility in the macroeconomic environment we believe this is a timely initiative on which to focus our operational and financial resources.

Market share for online jewelry sales is estimated about approximately 7% of the total U.S. jewelry sales for 2012 and has shown double-digit growth each year for the past three years. This is a powerful set up to increase and enhance our digital presence and we anticipate the new platform will lead to additional business in late 2014.

This new initiative will allow us to implement a fully integrated powerful e-commerce platform and a social customer relationship management system. This system will raise our visibility in the marketplace and show our products and capability and will allow us to capture customer data and marketing preferences, manage customer relationships and track customer transaction history. This will enhance our interaction with current and potential customers and this platform will allow us to effectively advertise, market, sell, track and to fill our comprehensive inventory to digital customers nationwide. Once launched we will finally be able to track ROI as a key metric to evaluate our success.

We look forward to communicating our process on this initiative over the next several quarters and we’ll announce the platform launch when it goes live. In concert with this enhanced e-commerce platform we’ve recently hired a strong marketing leader to help expand our digital advertising and social media presence. She’s also tasked at broadening our exposure beyond the traditional radio and TV advertising channels and we are targeting younger customers to make up the largest share of wedding jewelry sales.

Near term our focus has been on positioning the company to maximize holiday season and reducing our fixed cost. Let me elaborate on the first theory of focus. During the first three months of 2013 we’ve expanded our inventory as we normally do, buying items at favorable price points to sell during the fourth quarter. In addition we had a consignment of merchandise from several new vendors augmenting our existing inventory.

As the holiday season approaches we expect to see a strong sell through of this inventory. We also introduced a new financing program recently in all our stores. This third party credit source offers a variety of financing plans, including 90 day no interest and will make it easier for our customers to buy our products. These factors coupled with improved volumes during September and the first part of October bring increasing optimism about the fourth quarter which is traditionally our strongest quarter of the year.

While we cannot control macroeconomic conditions we are very effectively managing and significantly reducing our expenses. These cost reduction efforts have essentially cut enough fixed costs to more than offset the incremental cost related to opening six new stores in the last twelve months. As we’ve done in the past we remained focused on funding all new retail locations from internal cash flow. In addition we are taking specific step to increase store efficiencies at the time that we control expenses.

This would include putting all of our stores outside of Texas on a proprietary custom build point of sales system. This system enables improved tracking of inventory, more efficiencies in our accounting and back office functions and more automation. This initiative to integrate all the stores outside of Texas under this proprietary system has gone well and is now complete. Next we will introduce the system into our Texas locations in 2014. The improved efficiency should benefit us as we enter the holiday season and beyond. I’d also note that the POS system will help to expand and enhance the e-commerce platform I mentioned a few minutes ago.

We also put some of the inherited legal issues behind us. In late October a U.S. District Court granted final approval of the previously announced settlement to resolve the lingering shareholder losses related to the company’s previously disclosed accounting irregularity and subsequent restatement of financial results. In the coming months we expect to resolve the ongoing SEC investigations and our 2010 Texas sales tax audit.

As noted in today’s report we increased our accrued for this estimated sales act audit resolution by $650,000. I know that the original assessment was for more than $5 million and that after months of discussions with the authorities we have accrued less than $1 million based on our current best estimate of the final resolution. We don’t know the exact timing of the resolution nor do we know the exact amount but the accrual should provide you with an idea of our present thinking and our current expectations.

We look forward to resolving this matter as well as the SEC investigation. Putting these lingering legacy issues behind us will enable the company’s new management team to fully focus on executing the strategic initiatives that we developed for sustainable profitable growth from taking over leadership of the company. It's my expectations that the expenses related to these ongoing issues are essentially behind it and going forward we can look to deliver better operating results without the drain of these expenses.

With that update I now turn the call over to Brett for a more in-depth look at the third quarter financial results. Brett?

C. Brett Burford

Thanks Jim. I like to add my welcome and thanks to all the listeners on the call today as I review the third quarter of 2013 results and then the year-to-date results for the nine months ended September 30, 2013.

In the quarter ended September 30, 2013 revenues decreased by $5.2 million or 18$ to $23.8 million compared to $29 million in the quarter ended September 30, 2012. The primary decrease was in scrap sales which declined approximately 50% in the same period last year. This was driven by the deep drop in gold prices that Jim discussed earlier. Jewelry sales saw a slight decrease from the year-ago period while bullion sales were consistent even though gold prices were down significantly.

Gross profit decreased in the third quarter by $1.7 million to $4.5 million or 19.1% of revenue compared to $6.2 million or 21.4% of revenue in the prior year quarter due primarily to lower scrap sales, which carry high margins.

The third quarter of 2013 included $95,000 in non-recurring expenses related to the restatement and related legal matters and an additional accrual of $650,000 related to the estimated resolution of the 2010 Texas sales tax audit as Jim mentioned earlier. The third quarter of 2012 included $1.4 million -- the third quarter of 2012 included $1.4 million in non-recurring expenses related to the restatement and related legal matters.

Inclusive of these charges selling, general and administrative expenses decreased $906,000 or 14.1% to $5.5 million compared to $6.4 million in the prior year quarter. Again this was driven primarily by a reduction in non-recurring expenses from the restatement and related legal matters as well as cost reduction efforts across all areas. The reduction was partially offset by the opening of six new stores in the last 12 months which have added $468,000 of expense in the current quarter versus the same quarter last year. Excluding the non-recurring items SG&A for the third quarter of 2013 would have been $4.8 million compared to $5 million in the year-ago period.

On a sequential basis if you exclude the sales tax accrual our third quarter 2013 loss was reduced by 30% compared to the second quarter. Depreciation and amortization increased by approximately $35,000 or 23% in the quarter ended September 30, 2013 to $187,000 compared to $152,000 in the prior year quarter. This increase was driven primarily by assets related to new stores openings and to the -- and the move to our new corporate offices in April of 2013.

The company reported a loss from continued operations of $1.4 million in the quarter compared to a loss from continuing operations of $0.4 million in the prior year quarter, an increased loss of $1 million. The net loss was $1.4 million or $0.12 per diluted share inclusive of the non-recurring charges and the sales tax accrual compared to a net loss of $536,000 or $0.04 per share last year.

Turing to the year-to-date financials for the nine months ended September 30, 2013 revenues decreased by $6.6 million or 7.3% to $83.8 million compared to $90.4 million in the same period last year again due primarily to the aforementioned steep drop in gold prices which affected our scrap sales significantly. In addition revenue from discontinued operations for Superior Galleries was excluded in the amount of $3.2 million for the period ended September 30, 2012.

Gross profit decreased in the first nine months of 2013 by $2.6 million to $14.3 million or 17% of revenue compared to $16.9 million or 18.7% of revenue in the prior year period. The overall decrease in gross margin was primarily due to a higher mix of bullion sales which carries significantly lower margins and lower scrap sales which carry higher margins.

Selling, general and administrative expenses decreased by $2.3 million or 13% to $15.7 million compared to $17.9 million in the prior year period. This was driven again primarily by a reduction in the non-recurring expenses from the recent restatement and related legal matters as well as continuing cost reduction efforts across all areas of the business. This decrease was partially offset by the opening of six new stores in the last 12 months which have added $1.1 million in incremental expense during the period.

In addition the company incurred approximately $425,000 and $2.5 million during the nine months ended September 30, 2013 and 2012 respectively and professional fees and cost associated with the 2012 restatement and related legal matters. This amount includes $150,000 accrued in the second quarter of this year by the company in expectation of the shareholder litigation settlement as well as $650,000 accrued in the current quarter in expectation of the 2010 sales tax audit resolution.

Excluding the non-recurring items SG&A for the first nine months of 2013 would have been $14.6 million compared to $15.4 million in the year-ago period. I think it’s also important to note that we’ve cut normalized expenses by $1.9 million in the first nine months of 2013, excluding the onetime charges from the litigation and restatement and incremental operating costs from the six new stores.

Depreciation and amortization increased by $95,000 or 21% in the nine months ended September 30, 2013 to $0.5 million compared to $0.4 million in the prior year period. Again this increase was driven primarily by assets related to new store opening and the move to our new corporate facility in April.

The company reported a net loss from continuing operations of $2.3 million in nine months ended September 30, 2013 compared to a loss from continuing operations of $1.7 million in the year ago period, an increased loss of $0.6 million. The net loss was $2.3 million compared to $2.4 million in the year-ago period.

The year-ago period included a $0.7 million from discontinued operations. At September 30, 2013 we had cash and cash equivalents of $2.4 million compared to $4.9 million at December 31, 2012. During the same period inventories increased by $1.6 million or 13% as we expanded our inventory levels over the first three quarters. Much of this inventory should be turned during the fourth quarter and we are poised for a strong holiday season.

Stockholders equity decreased by 17% to $10.8 million at September 30, 2013 compared to $13.1 million at December 31, 2012. And the company’s current ratio was 1.3 to 1 compared to 2.4 to 1 at December 31, 2012 and working capital was $4.2 million at September 30, 2013 compared to $10.3 million at December 31, 2012.

As of the current quarter the outstanding balance of the company’s credit facility with NTR Metals Inc., has been reclassified as a current liability given its August 1, 2014 maturity date. The company is currently discussing the extension of this credit facility with NTR as well as various commercial lenders and we expect to extend or refinance this balance in the first half of 2014.

With that I’ll now turn it back over to Jim for some additional comments.

James J. Vierling

Thanks Brett. Before we conclude the call I want to reiterate our commitment to our shareholders. We’ve been working tirelessly to resolve the legacy issues we inherited and we are making great progress in this regard. We are focused on professionally and ethically managing this organization and are committed to being good stewards of shareholder capital. Our efforts to diversify our business, reduce expenses and pursue prudent M&A programs demonstrate our commitment in this area.

Finally shareholder communication is important to us as well. In order to improve our transparency we began conducting these conference calls which gives shareholders ample opportunity to ask questions in a public setting. We’ve also had some questions from the shareholders about the timing of our quiet period in regards to individual shareholder meeting. While shareholders may not have pointed questions about the current results on these individual calls we believe that the typical line of questioning can create uncertainty and an unfair playing field for other investors after the call has ended. Accordingly, our counsel has strongly advised us that the one-on-one conversations with shareholders during the weeks leading up to our quarterly reports is not advisable.

We also spend a great deal of time on these conversations even though SEC rules prevent us from saying much at all. To take a more proactive approach and protect all parties we will be enforcing a more structured quiet period in the weeks leading up to our conference call.

We expect to close the fourth quarter book on or about February 1 and will spend the reminder of February and March working with our auditors in completing the annual 10-K. From February 1st until the reports near the end of March we will not have one-off conversations with shareholders. Similarly we will begin a quiet period for the first quarter results on May 1st, lasting until we report in mid-May which we trust that you will understand the legal reasoning behind this decision.

In summary the first nine months of 2013 have been challenging on a macro-economic level and we’ve remained confident in our business and our strategic initiatives have shown progress. We have reduced our expenses continued to optimize our stores for greater efficiencies and finalized the lingering shareholder losses.

The holiday season is approaching and midway through this historically strongest quarter of the year we are extremely optimistic that our results will reflect the overall progress we are making.

That concludes my prepared remarks. We would now like to open the call up to take any questions you may have.

Question-and-Answer Session

Operator

Thank you. We’ll now begin the question-and-answer session. (Operator Instructions) Our first question comes from the line of Chris Doucet with Doucet Asset Management. Please go ahead.

Christopher Doucet - Doucet Asset Management

Hey, guys just a couple of questions, Brett, so let me make sure I get this right. So that the top line loss number was $1.4 million, you had about $100,000 in expenses related to the lawsuit which are one time in nature, about $700,000 in expenses due to the income tax restatement with -- or the sales audit with the State of Texas and about $0.5 million you spent from opening about six stores in the quarter, is that right?

C. Brett Burford

The $0.5 million Chris is not all from the quarter -- it’s not all from opening stores per se it is incremental expense that we have this quarter of this year versus -- that we wouldn’t have had this quarter last year because of new stores. So I wouldn’t classify it as one time but it is, if you’re looking at expenses on an incremental apples-to-apples basis versus last year that is incremental because of new stores not because of other expense growth if you will.

Christopher Doucet - Doucet Asset Management

Okay. So next quarter will look a lot better than I thought it did. And then Dusty I guess this question is for you but how many stores did you guys open this year, how many did you actually shutdown and how many stores do you have now total?

James D. Clem

Hi, Chris. We opened six new stores so far this year. We closed down -- within the last 12 months, the rolling 12 month period we’ve closed down two underperforming stores and have a total of 35 locations across the system.

Christopher Doucet - Doucet Asset Management

Okay. And in your comments Dusty may be you can answer this question for me. To my knowledge you guys have never broken down jewelry revenues in any quarter, including this quarter and yet that seems to be the direction that you guys want to go to. Does this portend that you guys plan on reporting jewelry revenue or breaking it out sometime in the future? And what makes you guys so confident that we should be going in this direction?

C. Brett Burford

This is Brett, Chris I’ll probably answer part of that question at least which is that -- and I think that you and other shareholders have asked the question about reporting individual kind of sales segments of our business and we haven’t done that so far. We continue to look at that. I think that we have said that we -- part of this relates to integrating our systems and how the stores have accounted for things traditionally, there is some money that’s there. But we are looking at that for 2014 so we think that we’ll at that point have a good history and be much more comfortable to produce that information for shareholders. So we’re looking at 2014 in terms of being able to report segment information.

As far as knowing is this the right direction to go we have two larger margin business, one scrap and one is jewelry and scrap is off in a significant manner. So the other opportunity to make that up is jewelry. So I don’t think it’s a matter of -- it’s the only choice we have. We have to build the jewelry side of things and make up for the scrap.

Christopher Doucet - Doucet Asset Management

Okay. Thanks guys I’ll step back in the queue.

Operator

(Operator Instructions). And we have a follow-up from Chris Doucet with Doucet Asset Management. Please go ahead.

Christopher Doucet - Doucet Asset Management

A couple of follow-up questions. Is the building still up for sale and do we still have a mortgage on that building, as the mortgage’s like still $1.8 million or something like that?

James J. Vierling

We are trying to sub lease out the portion of the building that we are no longer using. We actually have a lease in hand that we’re dong final negotiations on getting that leased.

Christopher Doucet - Doucet Asset Management

And the online initiative that you guys talked about early in the call do you plan to go out and buy an e-commerce site or do you plan to start one off from scratch?

James J. Vierling

We have hired a person that’s kind of spearheading that whole project and she has been actively going out -- there’s different phases of that, we will build the website and then the engine that runs that website, the e-commerce platform you buy. So it’s different companies out there like Magento and different ones that you can pick the best utilized e-commerce platform and we will probably buy that off the shelf, so that we’ll be able to customize out.

Christopher Doucet - Doucet Asset Management

Is this more of a munch and click kind of strategy where you buy online and you go to a particular store to pick up your gold or is this you buy it online and it’s shipped wherever you want in the world?

James J. Vierling

You can do both I mean and the situation is like that we do have these 35 locations. So if you see it online you can go pick it up. It’s a specific jewelry we can ship it directly to your home.

Christopher Doucet - Doucet Asset Management

Okay. And I think that was my other question. All right, thank you again.

James J. Vierling

Okay.

Operator

I will now like to turn back to management for closing remarks.

Christopher Doucet - Doucet Asset Management

Thanks everybody for your time and attendance today. We look forward to our next call when we’ll discuss the fourth quarter and the full year 2013 operating and financial results. Have a great day.

Operator

Ladies and gentlemen this does conclude the DGSE Companies Inc. third quarter 2013 financial results conference call. We like to thank you for your participation. You may now disconnect.

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