| COLLECTORS UNIVERSE INC ITEM 1A RISK FACTORS Our business is subject to a number of risks and uncertainties that could prevent us from achieving our business objectives and that could hurt our future financial performance and the price performance of our common stock, and cause our future financial condition and future financial performance to differ significantly from our current expectations described in the forward-looking statements contained in this Annual Report |
| Those risks and uncertainties, many of which are outside of our control, include the following: A decline in the popularity of high-value collectibles and a resulting decrease in submissions for our services could adversely impact our business |
| The volume of collectibles submitted to us for authentication and grading is affected by the demand for and market value of those collectibles |
| As the demand for and value of collectibles increase, authentication and grading submissions, as well as requests by submitters for higher price, faster turn-around times, also increase |
| However, that also means that a decline in popularity and, therefore in the value, of the collectibles that we authenticate and grade would cause decreases in authentication and grading submissions and in requests for faster turn-around times and, therefore, also in our revenues and profitability |
| We have found, over the years, that the popularity of collectibles can vary due to a number of factors, most of which are outside of our control, including perceived scarcity of collectibles, general consumer confidence and trends and their impact on disposable income, precious metals prices, interest rates and other general economic conditions |
| For example, declines in gold prices or further increases in interest rates could lead to reductions in authentication and grading submissions and, therefore, could adversely affect our profitability and financial condition |
| 27 _________________________________________________________________ Declines in general economic conditions could result in decreased demand for our services, which could adversely affect our operating results |
| The availability of discretionary or disposable income is an important factor in the willingness and ability of collectors and consumers to purchase, and the prices that they are willing to pay for, high-value collectibles, diamonds and colored gemstones |
| Declines in purchases and sales, and in the value, of collectibles, diamonds or colored gemstones usually result in declines in the use of authentication and grading services, as such services are most often used by sellers and purchasers of collectibles in conjunction with and to facilitate sale and purchase transactions |
| As a result, economic uncertainties, downturns and recessions can and do adversely affect our operating results by (i) reducing the frequency with which collectibles dealers and collectors submit their coins, sportscards and other collectibles for authentication and grading; (ii) consumers purchasing fewer diamonds; thereby leading to a lower number of diamonds for grading by retailers; (iii) causing collectibles dealers and collectors to request longer authentication and grading turn-around times with respect to the collectibles they submit to us for grading, which would reduce our revenues and profitability, and (iv) reducing the ability of customers to pay outstanding accounts receivable |
| Temporary popularity of some collectibles may result in short-term increases, followed by decreases, in the volume of submissions for our services, which could cause our revenues to fluctuate |
| Temporary consumer popularity or “fads” among collectors may lead to short-term or temporary increases, followed by decreases, in the volume of collectibles that we authenticate and grade |
| These trends may result in significant period-to-period fluctuations in our operating results and could result in declines in our net revenues and profitability, not only because of a resulting decline in the volume of authenticating and grading submissions, but also because such trends could lead to increased price competition, which could require us to reduce our authentication and grading fees in order to maintain market share |
| In the last few years, for example, the popularity of sportscards has declined and, at the same time, we have experienced a decline in sportscard authentication and grading submissions |
| Our revenues and income depend significantly on revenues generated by our coin authentication and grading services |
| A decrease in the level of submissions for these services, which historically has been impacted by changes in economic conditions, could adversely affect our revenues and results of operations |
| Coin authentication and grading accounted for approximately 65prca, 69prca and 66prca of our net revenues in fiscal 2006, 2005 and 2004, respectively |
| Furthermore, in fiscal 2005, coin grading was the segment of our authentication and grading business that experienced the most significant increase in net revenues |
| We believe that this growth in coin grading submissions has been due, at least in part, to the volatility of and uncertainties regarding the performance of the stock markets, coupled with the decline in interest rates and in the value of the US Dollar, which have led investors to shift some of their investments from stocks and bonds to precious metals |
| The lack of diversity in our sources of revenues and our dependence on coin grading submissions for a majority of our net revenues make us more vulnerable to adverse changes in economic conditions |
| These adverse changes include declines in the value of precious metals or recessionary conditions that could result in declines in collectibles authentication and grading submissions generally or, more particularly, in collectible coin submissions that would, in turn, result in reductions in our total net revenues and income |
| Our top 5 customers, account for approximately 22prca of our total net revenues |
| During the year ended June 30, 2006, five of our coin authentication and grading customers accounted for approximately 22prca of our total net revenues |
| As a result, the loss of any of those customers, or a lower level of activity by any of those customers, may cause our net revenues to decline and, therefore, could harm our profitability |
| During the fourth quarter of fiscal 2005, the owner of the largest of these customers encountered an unexpected and serious medical problem, which led to a 55prca decrease in revenues earned from that customer in fiscal 2006, compared to fiscal 2005 |
| 28 _________________________________________________________________ Our stamp, currency and diamond authentication and grading businesses are in their start-up phases |
| There can be no assurance that these businesses will prove to be successful |
| We purchased our diamond grading business in November 2005, started our currency authentication and grading business in March 2005, and our stamp authentication and grading business in fiscal 2000 |
| These businesses have yet to make a material contribution to our net revenues |
| To date, our stamp, currency and diamond grading businesses have incurred operating losses and there is no assurance that these services will gain market acceptance or will ever make a material contribution to our net revenues or achieve profitability |
| If they do not, we may have to discontinue, and write off our investments in, those businesses |
| Future acquisitions and the commencement of new businesses present risks, and we may be unable to achieve the financial and strategic goals of any acquisition or commencement of any new business |
| One component of our growth strategy is to acquire existing or to start new businesses that serve other markets for other collectibles or high-value assets |
| In fiscal 2006, we acquired four businesses and, to-date in fiscal 2007, we have acquired two other businesses, a colored gemstone grading business and a trade show management company |
| These new businesses will face a number of risks and uncertainties, including: • difficulties in integrating newly acquired or newly started businesses into existing operations, as a result of which we may incur increased operating costs that would adversely affect our operating results; • the risk that our current and planned facilities, computer systems and personnel and controls will not be adequate to support our expanded operations; • diversion of management time and capital resources from our existing businesses, which could adversely affect their performance and our operating results; • dependence on key management personnel of acquired or newly started businesses and the risk that we will be unable to integrate or retain such personnel; • the risk that new services we may introduce or begin offering, whether as a result of internal expansion or business acquisitions, will not gain acceptance; • competition from established or larger competitors in new markets, such as (in our diamond grading business), which could adversely affect the financial performance of any of the businesses we may have acquired or started; and • the risk that the anticipated benefits of any acquisition or of the commencement of any new business may not be realized, in which event we will not be able to achieve an acceptable return on our investment |
| There are risks associated with new service offerings, including our dealer financing program, with which we have little experience |
| We are continually exploring new services that we might introduce and offer to our existing authentication and grading customers as a means of increasing our net revenues and profitability |
| Those new services, however, may prove to be unprofitable and negatively impact our operating results |
| One of those new services that we introduced in fiscal year 2005 is a Dealer Financing Program that involves our making short-term loans to collectibles dealers that are collateralized by the collectibles that they submit or have been submitted to us for authentication and grading |
| There is no assurance that we will be successful in achieving sustained profitability in our Dealer Financing Program |
| Additionally the lending business is subject to a number of risks and uncertainties, and we have limited loan underwriting and collection experience |
| In addition, the failure or inability of borrowers to repay their loans is an inherent risk in a lending business |
| Our ability to minimize loan losses will depend on several factors, including: • The loan underwriting policies and controls we continue to adopt and implement, which could prove to be inadequate to prevent loan losses from occurring; 29 _________________________________________________________________ • Our ability to sell collateral, when a borrower defaults in the payment of a loan, for amounts sufficient to offset loan losses, which can be affected by a number of factors outside of our control, including (i) changes in economic conditions, (ii) increases in market rates of interest and (iii) changes in the condition or value of the collateral that will secure the loans we make; and • The reserves we will need to establish for potential loan losses, which may prove to be inadequate, in which case we would have to incur additional charges, which would have the effect of reducing our net income and could negatively impact our financial condition |
| Additionally, the business of lending is subject to numerous state and certain federal laws and regulations, which may impose significant costs or limitations on the way we conduct or expand such a business |
| We currently have a dlra7 million bank line of credit, expiring in June 2007, that we can use to fund some of the eligible loans we make |
| To-date, we have not utilized this line of credit, as we have adequate cash resources to fund the Dealer Financing Program |
| However, in the event we make borrowings under this line of credit in the future, we cannot assure that our cash flow from the operations of our dealer finance program will be sufficient to enable us to repay any borrowings under the line of credit |
| Also, the loan agreements establishing the line of credit impose certain restrictive covenants on the Company which could operate to restrict our plans to grow our business |
| We are dependent on our key management personnel |
| Our performance is greatly dependent on the performance of our senior management and certain other key employees |
| As a result, the loss of the services of any of our executive officers or other key employees could harm our business |
| Some of our executive officers and key employees are experts in the collectibles markets and have industry-wide reputations for authentication and grading of collectibles |
| In particular, the loss of Michael R Haynes, our Chief Executive Officer, or David G Hall, our President, could have a negative effect on our reputation for expertise in the collectibles markets in which we operate and could lead to a reduction in authentication and grading submissions to us |
| We are dependent on our collectibles experts |
| In certain of our markets, there are a limited number of individuals who have the expertise to authenticate and grade collectibles, and competition for available collectibles experts is intense |
| Accordingly, our business and our growth initiatives are heavily dependent on our ability (i) to retain our existing collectibles experts, who have developed relatively unique skills and enjoy a reputation for being experts within the collectibles markets, and (ii) to implement personnel recruiting, succession and training programs that will enable us to add collectibles experts, as necessary, to grow our business and offset employee turnover that can occur from time to time |
| If we are not successful in retaining our existing collectibles experts or in hiring and training new collectibles experts, this could limit our ability to grow our business and adversely affect our operating results and financial condition |
| Moreover, some of our experts could leave our company to join a competitor or start a competing business |
| We could suffer losses on authentication and grading warranties |
| Certain of our grading service businesses offer customers service warranties |
| The warranties offered by our collectibles grading businesses provide that: • if any collectible we have authenticated and sealed in our tamper-evident plastic cases is later determined not to have been genuine, we would have to purchase the collectible at the price paid for it by its then owner; and • if any collectible that was graded by us and sealed in our tamper-evident plastic cases later receives a lower grade upon resubmission to us for grading, we would be obligated either to purchase the collectible at the price paid by its then owner or to pay the difference in its value at its original grade as compared to its value at the lower grade |
| 30 _________________________________________________________________ GCAL offers a grading warranty that provides that if a diamond graded by us is submitted for regrading within the succeeding year and, on regrading is assigned a color or clarity grade that is more than one grade lower than the original color or clarity grade it received, GCAL will become obligated to purchase the diamond at the price paid by its then owner or, if GCAL so chooses, to pay the difference in its value at its original grade as compared to its value at the lower grade |
| We have no insurance coverage for claims made under these warranties and, therefore, we maintain reserves to satisfy such warranty claims based on historical experience, which in the past have proven to be adequate |
| If warranty claims were to exceed these reserves, we would incur additional charges that would adversely affect our operating results and financial condition |
| Increased competition could adversely affect our financial performance |
| Although there are few major competitors in the collectibles authentication and grading markets in which we currently operate, competition in these markets is, nevertheless, intense |
| In addition, in the diamond market there are a number of grading services that are substantially larger, have been in business substantially longer and are better known than GCAL Increased competition in our collectibles markets could adversely affect our pricing and profit margins and our ability to achieve further growth, and we cannot assure that we will continue to be successful in competing against existing or future competitors in our collectibles markets |
| In our diamond business, which is just beginning to implement its growth strategy, we are likely to encounter intense competition from larger and more established competitors that have significant market shares |
| Also, our entry into new collectibles or high-value asset markets could lead other potential competitors to enter those markets as well |
| Such competition could adversely affect our ability to generate profits and could cause us to continue to incur losses in those markets and damage our financial condition |
| We depend on our ability to protect and enforce our intellectual property rights |
| We believe that our patents, trademarks and other proprietary rights are important to our success and competitive position |
| We rely on a combination of patents, trademarks, copyright and trade secret laws to establish and protect our proprietary rights |
| However, the actions we take to establish and protect our intellectual and other proprietary rights may prove to be inadequate to prevent imitation of our services or products or to prevent others from claiming violations of their intellectual and proprietary rights by us |
| In addition, others may develop similar trade secrets or other intellectual property independently or assert rights in our intellectual and other proprietary rights that could lead them to seek to block sales of our services based on allegations that use of some of our marks or other intellectual property constitutes a violation of their intellectual property rights |
| We have not conducted an exhaustive search of possible prior users of our unregistered trademarks, including Coin Universe, Collectors |
| com and PSE Therefore, it is possible that our use of some of these trademarks may conflict with others |
| As a result, we could face litigation or lose the use of some of these trademarks, which could have an adverse effect on our name recognition and result in a decrease in revenues and an increase in expenses |
| The imposition of government regulations could increase our costs of doing business |
| With the exception of state laws applicable to autograph authentication, the collectible coin and other high-value collectibles markets are not currently subject to direct federal, state or local regulation |
| However, from time to time government authorities discuss additional regulations which could impose restrictions on the collectibles industry, such as regulating collectibles as securities or requiring collectibles dealers to meet registration or reporting requirements, or regulating the conduct of auction businesses |
| Adoption of laws or regulations of this nature could lead to a decline in sales and purchases of collectibles and, therefore, also to a decline in the volume of coins, sportscards and other collectibles that are submitted to us for authentication and grading |
| 31 _________________________________________________________________ Our reliance on a single source for principally all of our “tamper-evident,” clear plastic coin and sportscard holders exposes us to potential supply and quality problems |
| We place all of the coins, sportscards and currency notes, and sometimes also the stamps that we authenticate and grade, in tamper-evident, clear plastic holders |
| In order to take advantage of volume pricing discounts, we have chosen to purchase substantially all of those holders, on a purchase order basis, from one principal supplier |
| Our reliance on a single supplier for a substantial portion of those plastic holders exposes us to the potential for delay in our ability to deliver timely authentication and grading services in the event that supplier were to terminate its services to us or to encounter financial or production problems |
| If, in such an event, we were unable to obtain replacement holders in a relatively short period of time, we could lose customer orders, or incur additional production costs |
| In addition, if the replacement holders were not of comparable quality to our existing supplier, we could expose ourselves to the potential for additional warranty claims in the event that tampering with our holders was not evident |
| These occurrences could cause a decline in our net revenues and have a material adverse effect on our results of operations |
| Our computer and network systems may be vulnerable to unforeseen problems and security risks, and we are vulnerable to system failure due to a lack of redundant systems at another location |
| Our operations are dependent on our ability to protect our computer systems that we use in our authentication and grading operations and to maintain our websites against damage from fire, power loss, telecommunications failure, earthquakes and similar catastrophic events |
| In this regard, Southern California, where we are primarily located, is particularly vulnerable to earthquakes and fires that could result in damage to our computer systems |
| In addition, our diamond operations are located in a New York City high-rise building that could be vulnerable to terrorist attacks or to fire or other disasters |
| We do not have redundant computer systems at a location that is remote from Southern California |
| Any damage to or failure of our computer systems could cause an interruption in our services that could harm our business, operating results and financial condition |
| In addition, our operations are dependent on our ability to protect our computer systems and network infrastructure from damage that could occur from physical break-ins, security breaches and other disruptive problems caused by the technology that we employ in our operations |
| Computer break-ins and security breaches also could jeopardize the security of information stored in and transmitted through our computer systems and network infrastructure, which could cause us to incur significant liability and possibly also damage our reputation |
| Other disruptions due to problems on the Internet or actions of Internet users could make it difficult for our customers to access our websites |
| In either case, problems of this nature could adversely affect our business and operating results, and security breaches that would adversely affect the privacy of customer information could lead existing customers to terminate their business relationships with us |
| Although we intend to continue to implement and upgrade sophisticated technology to prevent such disruptions and damage, there is no assurance that our security measures will prove to be successful |
| We rely on third parties for various Internet and processing services |
| Our operations depend on a number of third parties for Internet access and delivery services |
| We have limited control over these third parties and no long-term relationships with any of them |
| For example, we do not own a gateway onto the Internet, but, instead, rely on Internet service providers to connect our website to the Internet |
| Should the third parties that we rely on for Internet access or delivery services be unable to serve our needs for a sustained time period as a result of a strike, natural disaster or other reason, our revenues and business could be harmed |
| We are exposed to potential risks and we will continued to incur increased costs as a result of the internal control testing and evaluation process mandated by Section 404 of the Sarbanes-Oxley Act of 2002 |
| Although we continue to document and test the effectiveness of our internal controls over financial reporting, as required by Section 404 of the Sarbanes-Oxley Act of 2002, we expect we will continue to incur costs, including increased accounting fees, in order to maintain compliance with that Section of the Sarbanes-Oxley Act |
| Also, if our efforts to comply with new or changed laws, regulations and standards differ from the activities intended by regulatory or governing bodies due to ambiguities related to our practices, our reputation may be harmed or we may be subject to litigation |
| 32 _________________________________________________________________ If our quarterly results are below the expectations of securities market analysts and investors or we decide to suspend or discontinue the payment of dividends, the price of our common stock may decline |
| Many factors, including those described in this “Risk Factors” section, can affect our business, financial condition and results of operations, which makes the prediction of our future financial results difficult |
| These factors include: • increases or decreases in number of collectibles or diamonds graded from period to period; • changes in market conditions that can affect the demand for our authentication and grading services, such as a decline in the popularity of certain collectibles; • general economic conditions that affect the availability of disposable income among collectors and consumers; and • the actions of our competitors |
| If our quarterly operating results fall below expectations or we decide to suspend or discontinue the payment of dividends, securities market analysts may downgrade our common stock and some of our stockholders may sell their shares, which could adversely affect the trading prices of our common stock |
| Additionally, in the past, companies that have experienced declines in the trading price of their shares due to events of this nature have been the subject of securities class action litigation |
| If we become involved in a securities class action litigation in the future, it could result in substantial costs and diversion of our management’s attention and resources, thus harming our business |
| No assurance that we will continue to pay cash dividends |
| On May 31, 2006, the Company adopted a dividend policy that calls for the payment of an expected total annual cash dividend of dlra0dtta32 per common share, payable in the amount of dlra0dtta08 per share, per quarter and since then we have paid two consecutive cash dividends, each in the amount of dlra0dtta08 per share, in accordance with this dividend policy |
| The payment of cash dividends in the future, pursuant to the Company’s dividend policy, is subject to final determination each quarter by the Board of Directors based on a number of factors, including the Company’s financial performance and its available cash resources, its cash requirements and alternative uses of cash that the Board may conclude would represent an opportunity to generate a greater return on investment for the Company |
| For these reasons, as well as others, there can be no assurance that the amount of the Company’s current quarterly cash dividend will not be reduced or that the Board of Directors will not decide to suspend or discontinue the payment of cash dividends in the future |
| Provisions in our charter documents or in Delaware law may make an acquisition of us more difficult or delay a change in control, which may adversely affect the market price of our common stock |
| Our Amended and Restated Certificate of Incorporation and Bylaws contain anti-takeover provisions, including those listed below, that could make it more difficult for a third party to acquire control of us, even if that change of control would be beneficial to our stockholders: • our board of directors has the authority to issue common stock and preferred stock and to determine the price, rights and preferences of any new series of preferred stock without stockholder approval; • there are limitations on who can call special meetings of our stockholders; and • stockholders may not take action by written consent |
| In addition, provisions of Delaware law and our stock option plans may also discourage, delay or prevent a change in control of our company or unsolicited acquisition proposals |