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DGSE Companies Inc. (NYSEMKT:DGSE)

Q2 2014 Results Earnings Conference Call

August 13, 2014 4:30 PM ET

Executives

Dusty Clem - Chairman and CEO

Brett Burford - Chief Financial Officer

Analysts

Chris Doucet - Doucet Asset Management

Operator

Ladies and gentlemen, thank you for standing by. And welcome to the DGSE Companies' Second Quarter Financial Results Conference Call. Today’s presentation, all participants will be in a listen-only mode. Following the presentation the conference will be open for your questions. (Operator Instructions)

This conference is being recorded today, August 13, 2014. I would now like to turn the conference over to Dusty Clem, Chairman and Chief Executive Officer of DGSE Companies Incorporated. Please go ahead, sir.

Dusty Clem

Thank you and good day. The call today will be hosted by myself; and Mr. Brett Burford, the company's Chief Financial Officer. Following management's discussions there will be a formal Q&A session open to the 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, operational target and our forward-looking business plan is based on information as of today, August 13, 2014, 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.

I’d like to begin by thanking everyone for joining us for our earnings call today. During the second quarter we finally and successfully resolve several of the legacy issues that have historically encumbered the company. During today's call, I want to give you an update on those issues. Brett will then give you a recap of our financial performance in the second quarter and finally, I’ll share my goals for the remainder of 2014 and beyond.

The first item on the agenda is the recap of the Southern Bullion Coin & Jewelry shutdown. As I told you during our last conference call, a significant change in the precious metals market including a 30% decline in the price of gold had a disproportionately negative impact on the customer traffic, transaction of volume and ultimately, the profitability of the Southern Bullion division.

One of my first decision after being named CEO is to close down all Southern Bullion branches, while it’s never time to celebrate the failure of our business, I would like give my sincere thanks to my staff who work tirelessly to wind down the operations of Southern Bullion over the last several months, while simultaneously executing their ongoing duties at DGSE.

This process has been cumbersome for our small staff, but their work ethic is tremendous and I am proud to report that this process has now being completely finished in line with our cost projections.

Southern Bullion has now been reclassified into discontinued operations. DGSE reported a total loss from these discontinued operations of $3.9 million for the quarter, which included losses associated with Southern Bullion operations of $700,000 and non-cash write-off, including the $2.9 million intangible assets related to the Southern Bullion trade name and $300,000 related to fixed assets previously used in Southern Bullion operations.

While these write-downs are painful to our balance sheet, it was a necessarily step to ensure the long-term viability and profitability of the company. These closures have allowed us to streamline every functional area of the company, including field operations, coin sell systems, accounting, IT, human resources, inventory management and more. This change allowed us to create a much leaner and more efficient operation with only one set of systems and processes, and significantly less corporate overhead.

While the second quarter has had its fair share of challenges, we’ve also had a number of very significant successes. During the second quarter we announced the final settlement of the previously disclosed SEC litigation, which resulted in no payment of civil damages by the company.

We also agreed to a series of corporate governance reforms, which I thought a reasonable addition to our internal control and many of which have already been implemented. This was a significant victory for DGSE and a testament to the remediation efforts our teams made over the last two years.

We also announced the final settlement with the Comptroller of the State of Texas surrounding the 2006 to 2009 sales tax audit. While this ultimately resulted in an amount due of $1.1 million to the State of Texas, it was substantially less than the original assessment of $4.4 million. Again, this is the result of the hard work of our staff.

We are also happy that our shareholders elected two new independent board members in the latest proxy vote. Bruce Quinnell and Dennis McGill both have substantial experience with the prominent national retailers and have already proven to be strong additions to DGSE’s Board of Directors.

Ultimately, our second quarter results fell well below my expectations. Our scrap and bullion businesses continue to lag substantially behind last year and were both down over 40% this quarter compared to 2013. While a portion of this is directly attributable to the 9% decline in average gold prices during the quarter, we have also seen a significant industry-wide slowdown in demand.

While this ultimately led to a decline in overall revenue more than $6 million or 26% compared to the second quarter of last year, I'm very pleased to note that our gross profit actually increased year-over-year by $100,000. This represents a 5.1% improvement in our gross margin as a percentage of sales, a direct result of our increased focus on jewelry.

While it’s disappointing to loose topline revenue, but we are able to continue to be successful growing our jewelry business will be able to create a much more consistent, sustainable and profitable company.

I'm now going to turn the call over to Brett for a more detailed look at the second quarter 2014 financial results. Brett?

Brett Burford

Thanks, Dusty. In the quarter ended June 30, 2014, revenues from continuing operations were $17.5 million, compared to $23.8 million in the quarter ended June 30, 2013. The decrease was a result of significant drops in pricing and volume in our bullion and scrap businesses, driven by declining gold prices, which were on average 9% lower than in second quarter 2013.

Gross profit from continue operations was $3 million or 17.2% of revenue, compared to $2.9 million or 12.1% of revenue in the prior year quarter. As Dusty said, despite significantly lower revenue for the quarter, gross profit dollars actually increased as gross margins percentage of revenue increased 5.1% due to a favorable sales mix shift as high-margin jewelry sales increased significantly while lower margin bullion sales decreased.

Selling, general, administrative expenses were $3.4 million, a slight decrease of $26,000, essentially flat compared to $3.4 million in the prior year quarter. Incremental operating expenses related to new stores not yet opened in the second quarter of 2013, those were offset by continued expense reductions in other areas.

Loss from continuing operations for the second quarter was approximately $539,000 or $0.04 per share, compared to a loss from continuing operations of approximately $525,000 or $0.04 per share last year. The loss from the continued operations for the three months ended June 30, 2014 was $3.9 million related to the Southern Bullion locations closed in February and April of 2014 compared to a net loss of $599,000 for these locations in the same quarter of 2013.

Discontinued operations for the current quarter includes the write-off of the $2.9 million intangible asset attributed to the Southern Bullion Coin & Jewelry trade name, as well as the write-off of approximately $300,000 in fixed assets, previously utilized in Southern Bullion operations.

The company reported a net loss in the second quarter of approximately $4.5 million or $0.36 per share, compared to a net loss of $1.1 million, or $0.09 per share last year.

Turning to the year-to-date financials, in the six months ended June 30, 2014, revenues decreased by $11.7 million, or 25% to $35.6 million compared to $47.3 million in the same period last year, again due to the drop in gold prices compared to the prior year which affected our scrap and bullion sales significantly.

Gross profit decreased in the first six months of 2014 by $240,000 to $6.2 million or 17.5% of revenue compared to $6.5 million, or 13.7% of revenue in the prior year period. The overall increase in gross margins as a percentage of sales was again primarily due to a higher mix of jewelry sales, which carry higher margins and lower bullion sales which carry lower margins.

SG&A expenses increased to $158,000 or 2.4% to $6.7 million, compared to $6.5 million in the prior year period. This slight increase was largely the result of the opening of two additional retail locations in the second half of 2013 and again largely offset by continued cost reduction efforts across all areas.

Loss from continuing operations for the six months ended June 30, 2013 was approximately $824,000 or $0.07 per share compared to loss from continuing operations approximately $333,000 or $0.03 per share last year. Loss from discontinued operations for the six months ended June 30, 2014 was $4.2 million related to the close of Southern Bullion locations compared to $489,000 for these locations in the first half of 2013.

As I stated earlier, discontinued operations for the current year includes the non-cash write-off of $3.2 million in Southern Bullion assets, which includes the intangible assets attributed to the trade name and fixed assets previously utilized in operations. The company reported a net loss in the six months ended June 30, 2014 of approximately $5 million or $0.41 per share, compared to a net loss of approximately $822,000 or $0.07 per share last year.

At June 30, 2014, we had cash and cash equivalents of $2.1 million compared to $2.6 million at December 31, 2013. Inventories for continuing operations increased $1.5 million to $11.5 million at June 30, 2014, compared to $10 million at December 31, 2013 due to transfers of inventory from discontinued operations.

Stockholders' equity decreased 46% to $5.5 million at June 30th, compared to $10.4 million at December 31, 2013, largely due to the Southern Bullion write-offs discussed previously. As of June 30, 2014, the outstanding balance on the company's credit facility with NTR metals was approximately $2.3 million compared to $2.4 million at year ended 2013.

As a reminder in February 2014, we entered into one-year extension of the loan agreement, which extended the term one year to August 1, 2015. All the terms of the agreement have remained the same.

With that, I'll turn back over to Dusty for some final comments.

Dusty Clem

Thank you, Brett. As we move into the last part of 2014, I want to make it clear that I’m not satisfied with our results. That being said, our recent jewelry, diamond and watch initiatives are showing early promise.

During the last quarter, we have refocused our advertising to be more centered on jewelry, diamonds and fine watches. We developed an entirely new jewelry sales training program including the creation of a dedicated, director of sales training positions, overall DGSE never had before.

We’ve named a new director of store operations who is squarely focused on improving our client in-store experience. And we've established several new vendor relationships, which expanded our jewelry, diamond and watch offerings.

While we’re a long way from arriving at my desired results, the early indications are positive. As a result of the focus, we’ve put on these initiatives, our jewelry sales are up over 25% compared to the second quarter of last year, a substantial improvement.

The bullion and scrap businesses are historically tied to a shifting gold market while these business signs will always be important components of our sales mix that have historically led to unpredictable profits. Our goal is to build a premiere jewelry retailer that is consistently profitable, the sourness of the ebb and flow in the precious metal markets but that has the potential to extraordinary profitability during favorable market conditions. We’re working everyday to achieve this goal.

That concludes my prepared remarks. And we now like to open the call to take your questions.

Question-and-Answer Session

Operator

Thank you, sir. (Operator Instructions) Our first question comes from Christ Doucet with Doucet Asset Management. Please proceed with your question.

Chris Doucet - Doucet Asset Management

Hey, Dusty. Congratulations on the progress in the quarter. A couple of quick questions for you. You talked in the last conference call about the consignment program, have you made any progress to that end?

Dusty Clem

We have, Chris. It’s -- we roll that program out last month and we’ve seen some frankly some early signs of success there, not enough but I think, I would trumpeted on a call like this. But I think something as we roll into the holiday season and into 2015 that will have some pretty not likes to it.

Chris Doucet - Doucet Asset Management

Okay. July 15th, there was a press release that came out and that spoke to the New York Stock Exchange Investigation of Trading in DGSE. What was the disposition of that investigation?

Dusty Clem

That was something the exchange had called and requested that we put out, basically, saying that there was no information that …

Brett Burford

I believe he is asking about the SEC investigation ramp up.

Dusty Clem

I apologize. I thought you’re asking about the press release, Chris. On a extraordinary training day -- trading day…

Chris Doucet - Doucet Asset Management

That’s what I was, actually I was.

Dusty Clem

Yes. Okay. Sorry. Miscommunication here with Brett and I. On that day, we traded close to 300,000 shares and since that is substantially higher than our average volume, the exchange simply wanted us to put out that we didn't put any information out there. There wasn't anything that was not said to the entirety of the market. And that’s true, it was just an extraordinary amount of volume for us to talk about DGSE. Really it was just a -- there is no news type of release.

Chris Doucet - Doucet Asset Management

Okay. And I guess, Brett, these last two questions are for you. I know that you paid the $1.1 million in the settlement with State of Texas in regards to the income tax issue or the sales tax issue? Where does that leave the cash balance now? Does -- is it close to $1.5 some like that, $1.4?

Brett Burford

No. Chris, at the end of the day we paid -- we got a good, in addition to wrapping up the sales tax agreement and again, I don’t know, we’re happy about, happy to $1.1 million but at the end of the settlement, I think, it was appropriate.

But we also got to stay to agree to a payment plan just to ease the pressure on cash flow. So what we’ve had to pay to-date is $325,000, which was kind of considered the down payment and then we’ll pay them $47,000 a month for 18 months.

So, I know at this point, all we’ve had to pay down is the $325,000, and we had sort of put that much aside if you will for that purpose. Our cash balance right now remains, I think, close to where it was at June 30th.

Chris Doucet - Doucet Asset Management

Okay. That’s good news. And you mentioned, last quarter and then again this quarter that the run rate for the existing business is around $3.4 million despite the fact that you guys actually added a couple new stores? Do you expect a similar run rate in the third quarter for SG&A?

Brett Burford

I think that in that $3.4, there is probably still a bit of kind of -- we all get tired calling it one-time when some of these things are going up for couple of years now. But as we wrapped up in the first half year, wrapped up the SEC investigation, wrapped up the Texas sales tax issue. There was still some what we call somewhat extraordinary expenses in there.

And so I think that on a run rate going forward we will do a bit better than that. We’ve worked really hard to cut out as much expenses we can and quite honestly, there’s always a few more dollars in there, but we are getting to part, we squeeze that bucket as much as we can.

So, I think, run rate may improve a bit on 3.4 but it won’t, its not going to -- at this point given the sort of business we have and interest we have that’s not going to change significantly.

Chris Doucet - Doucet Asset Management

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

Operator

(Operator Instructions) There are no further questions in the queue at this time. I would like to turn back over to management for closing comments.

Dusty Clem

Thank you for your time and attention today. We look forward to updating you during our next call when we discuss the operating and financial results of the third quarter of 2014. Have a great day.

Operator

Thank you. This does conclude today's teleconference. You may disconnect your lines at this time and have a great day.

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