10-K Year Ended June 30, 2005
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-K

(Mark
One)
 
ý
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the fiscal year ended June 30, 2005
   
 
OR
   
q
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
   
 
For the transition period from _______ to _____
   
Commission file number 0-27887
 
 
CU logo
COLLECTORS UNIVERSE, INC.
 
(Exact name of Registrant as specified in its charter)

Delaware
 
33-0846191
(State or other jurisdiction of
 
(I.R.S. Employer Identification No.)
Incorporation or organization)
   
1921 E. Alton Avenue, Santa Ana, California
 
92705
(Address of principal executive offices)
 
(Zip Code)
 
(949) 567-1234
(Registrant's telephone number, including area code)
 
Securities registered pursuant to Section 12(b) of the Act: None
 
Securities registered pursuant to Section 12(g) of the Act: Common Stock, par value $.001 per share
 
Indicate, by check mark, whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports); and (2) has been subject to such filing requirements for the past 90 days. YES [X] NO [ ]
 
Indicate, by check mark, if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x
 
Indicate by check mark whether the Registrant is an accelerated filer (as defined in Securities Exchange Act Rule 12b-2).
YES x NO [ ]
 
        Indicate by check mark whether the Registrant is a shell company (as defined in Securities Exchange Act Rule 12b-2).
YES [ ] NO x
 
As of December 31, 2004, the aggregate market value of the Common Stock held by non-affiliates was approximately $84,462,000, based on the per share closing price of $20.43 of Registrant’s Common Stock as of such date as reported by the Nasdaq Stock Market.
 
As of September 9, 2005, a total of 8,611,000 shares of Registrant's Common Stock were outstanding.
 
DOCUMENTS INCORPORATED BY REFERENCE
 
Except as otherwise stated therein, Items 10, 11, 12, 13 and 14 in Part III of the Form 10-K are incorporated by reference from Registrant's Definitive Proxy Statement, for its
Annual Meeting which is expected to be filed with the Securities and Exchange Commission on or before October 26, 2005, for its Annual Meeting of Stockholders to be
held on December 5, 2005.




COLLECTORS UNIVERSE, INC.
FORM 10-K
FOR THE FISCAL YEAR ENDED JUNE 30, 2005
 
TABLE OF CONTENTS



PART I
   
Page
       
 
Item 1.
1
 
Item 2.
26
 
Item 3.
26
 
Item 4.
26
   
27
PART II
     
 
Item 5.
28
 
Item 6.
28
 
Item 7.
30
 
Item 7A.
41
 
Item 8.
42
   
43
   
44
   
45
   
46
   
47
   
48
   
50
 
Item 9.
69
 
Item 9A
69
 
Item 9B
72
PART III
     
 
Item 10.
72
 
Item 11.
72
 
Item 12.
72
 
Item 13.
72
 
Item 14.
72
       
PART IV
Item 15.
73
   
S-1
E-1




(1)



FORWARD-LOOKING STATEMENTS
 
Statements contained in this Report that are not historical facts or that discuss our expectations or beliefs regarding our future operations or future financial performance, or financial or other trends in our business, constitute “forward-looking statements” as defined in the Private Securities Reform Act of 1995. Forward-looking statements can be identified by the fact that they do not relate strictly to historical or current facts. Often, such statements include the words “believe,”“expect,”“anticipate,”“intend,”“plan,”“estimate,”“project,” or words of similar meaning, or future or conditional verbs such as “will,”“would,”“should,”“could,” or “may”. Forward looking statements are estimates or predictions about the future that are based on current information and are subject to a number of risks and uncertainties that could cause our financial condition or operating results in the future to differ significantly from those expected at the current time, as described in the forward-looking statements that are contained in this Report. Those risks and uncertainties are described in Part I below under the caption “Factors that Could Affect Our Future Financial Performance” and in Part II under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” Accordingly, readers of this Report are urged to read the cautionary statements contained in those Sections of this Report.

Due to these uncertainties and risks, readers are cautioned not to place undue reliance on forward-looking statements contained in this Report, which speak only as of the date of this Annual Report and which are based on current information or factual assumptions that are subject to change for a number of reasons, including those set forth in the Section of this Report entitled “Certain Factors that Could Affect Our Future Financial Performance” and in “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” We undertake no obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.
 

 
PART I
ITEM 1. BUSINESS
 
Overview
 
We are a leading provider of value-added authentication, grading and information services to dealers and collectors of high-value coins, sportscards, autographs and stamps and vintage U.S. currency notes. These collectibles have market values generally ranging from $200 to over $1 million, due principally to their rarity, age or association with famous individuals or historical events. The authenticity and the state of preservation, or quality, of these collectibles are also important determinants of their value in the collectibles markets. For that reason, dealers and collectors submit their high-value collectibles to us for:
 
 
a certification by our independent experts of their authenticity; that is, confirmation that the collectibles are real and are what they have been represented to be; and
 
 
an evaluation of their physical condition and appearance and the assignment of a grade by our independent experts on the basis of uniform quality standards.
 
Once we have authenticated and assigned a grade to a collectible, we encapsulate it in a tamper-evident, clear plastic holder, or issue a certificate of authenticity, that (i) identifies the specific collectible, (ii) sets forth the quality grade we have assigned to it and (iii) bears one of our brand names and logos: “PCGS” for coins, “PSA” for sportscards, “PSA/DNA” for autographs, “PSE” for stamps and “PCGS Currency” for U.S. vintage currency notes1 . Additionally, we warrant our certification of authenticity and the grade that we assign to the coins and sportscards that we authenticate and grade, and we have recently begun offering warranties with respect to our determinations of authenticity and our assignment of quality grades to stamps.
 
We believe that our authentication and grading services increase the liquidity and marketability and, therefore, add to the value, of these collectibles. Our services provide dealers and collectors with (i) the confidence of knowing that the collectibles they are buying or selling are authentic, and (ii) information, in the form of objective
 

1    Collectors Universe, PCGS Professional Sports Authenticator and PSA/DNA, Set Registry, CU3000 and First Strike, and each of the logos associated with those names, are registered service or trade marks of the Company.

 
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and uniform measures of quality, that enable dealers and collectors to assess the value of those collectibles. Armed with this information, a prospective buyer who might otherwise be reluctant to purchase a high priced collectible is more confident and more willing to make the purchase, particularly “sight-unseen,” on internet auction sites such as those operated by eBay. We also believe that collectibles dealers who sell collectibles that have been authenticated and graded by us are more readily able to sell, and are more likely to obtain higher prices for those collectibles, than if the collectibles had not been authenticated and graded by us.
 
We originated the standards and methodologies we use for authenticating and grading coins, sportscards, autographs, stamps and currency. Those standards and methodologies have become generally accepted in the collectible coin, sportscards and autograph markets. Since we are the only company to have launched an independent third party stamp grading service, and the concept of stamp grading is relatively novel, our stamp grading standards have not yet become generally accepted; however, we believe that these standards have been gaining wider acceptance in that market.
 
We also have developed some of the leading brands in the collectibles markets in which we conduct our business:
 
 “PCGS” (Professional Coin Grading Service), which is the brand name for our independent coin authentication and grading service;
 
 “PSA” (Professional Sports Authenticator), which is the brand name for our independent sportscard authentication and grading service;
 
 “PSA/DNA” (PSA/DNA Authentication Services), which is the brand name for our independent authentication and grading service for vintage autographs;
 
 “PSE” (Professional Stamp Experts), which is the brand name for our independent stamp authentication and grading service; and
 
 “PCGS Currency” the brand name for our recently inaugurated currency authentication and grading service.
 
PCGS and PSA are among the leading independent authentication and grading services in the collectible coin and sportscard markets in the United States. PSA/DNA and PSE also are among the leading independent authentication services and, to our knowledge, provide the only independent grading services, in their respective markets. Currency authentication and grading are new to the currency market and PCGS Currency began offering its authentication and grading services in the third quarter of fiscal 2005 and began receiving authentication and grading submissions in the fourth quarter of fiscal 2005.
 
We began offering our PCGS coin authentication and grading services in 1986 and, from inception through the fiscal year ended June 30, 2005, we had authenticated and graded more than 11 million coins. In 1991, we launched our PSA sportscard authentication and grading service and, through June 30, 2005, had authenticated and graded over 8 million sportscards. In 1999, we launched our PSA/DNA vintage autograph authentication business and in June 2004 we extended that business by introducing vintage autograph grading services to dealers and collectors of autographed sports memorabilia. We started our PSE stamp authentication and grading service in 2000.
 

 
2


The following table provides information regarding the respective numbers of coins, sportscards, autographs and stamps that we authenticated or graded from 2003 to 2005 and the number of currency notes that we graded since the inception of our currency authentication and grading service in the third quarter of fiscal 2005.
 
   
Units Authenticated or Graded
 
   
Fiscal Year Ended June 30,
 
   
2005
 
2004
 
2003
 
 
Coins
   
1,670,000
   
58
%
 
1,241,000
   
53
%
 
917,000
   
46
%
Sportscards
   
1,084,000
   
38
%
 
998,000
   
43
%
 
1,058,000
   
53
%
Autographs
   
77,000
   
3
%
 
68,000
   
3
%
 
15,000
   
1
%
Stamps
   
26,000
   
1
%
 
16,000
   
1
%
 
12,000
   
0
%
Currency
   
3,000
   
-
   
-
   
-
   
-
   
-
 
Total
   
2,860,000
   
100
%
 
2,323,000
   
100
%
 
2,002,000
   
100
%

   
Declared Values (000)
 
   
Fiscal Year Ended June 30,
 
   
2005
 
2004
 
2003
 
 
Coins
 
$
1,191,000
   
91
%
$
993,000
   
90
%
$
769,000
   
90
%
Sportscards
   
66,000
   
5
%
 
67,000
   
6
%
 
72,000
   
8
%
Autographs
   
26,000
   
2
%
 
31,000
   
3
%
 
7,000
   
1
%
Stamps
   
17,000
   
1
%
 
10,000
   
1
%
 
8,000
   
1
%
Currency
   
8,000
   
1
%
 
-
   
-
   
-
   
-
 
Total
 
$
1,308,000
   
100
%
$
1,101,000
   
100
%
$
856,000
   
100
%
 
We generate revenues principally from our authentication and grading service fees. Those fees range from $6 to as much as $200 per collectible authenticated and graded, based primarily on the type of collectible authenticated or graded and the turn-around times selected by our customers, which range from 1 to approximately 60 days. In fiscal 2005, our authentication and grading fees averaged $11. As a general rule, collectibles dealers and, to a lesser extent, individual collectors, request faster turn-around times and, therefore, generally pay higher fees for more valuable, older or “vintage” collectibles, than they do for modern collectibles.
 
We also generate revenues, to a lesser extent, from sales of (i) advertising on our websites; (ii) our printed publications and price guides and advertising placed in such publications; and (iii) our rarity or “population” reports that contain data regarding the total number of coins and sportscards we have graded since our inception, categorized by item type and grade determination. We believe that our printed publications, price guides and reports make collectors better informed consumers and make collecting more interesting and exciting for them.
 
Industry Background
 
The primary determinants of the prices of, and the willingness of dealers and collectors to purchase, high-value or high priced collectibles or other high-value assets are their authenticity and quality. The authenticity of a collectible relates not only to the genuineness of the collectible, but also to the absence of any alterations or repairs that may have been made to hide damage or to restore the item. The quality of a collectible relates to its state of preservation relative to its original state of manufacture or creation. With regard to value, confirmation of authenticity generally is required before a buyer is willing to proceed with a purchase of a high priced collectible. Quality directly affects value and price, usually on an exponential basis, with higher quality collectibles generally attracting dramatically higher prices than lower quality collectibles. Even a relatively modest difference in quality can translate into a significant difference in perceived value and, therefore, in price. For example, a 1952 Mickey Mantle baseball card that received a PSA grade from us of 10 on our PSA grading scale of 1-to-10 was sold in 2001 for $275,000. By comparison, a similar 1952 Mickey Mantle baseball card that received a PSA grade of 8 was sold in 2004 for $62,338.
 
Until the advent of independent third party authentication and grading, most prospective buyers, including experienced collectibles dealers, insisted on physically examining high priced collectibles before consummating transactions. However, unlike professional dealers, most collectors lacked the experience and knowledge needed to determine, with confidence, the authenticity or the quality, and hence the value, of high priced collectibles, even when they had the opportunity to examine them physically. As a result, collectors had to rely on representations
 

 
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made by sellers regarding authenticity and quality. For these reasons, “buyer beware” characterized the high-value collectibles markets, and “sight-unseen” markets for rare coins and other high-value collectibles were practically non-existent.
 
Dealers and collectors traditionally marketed high-value collectibles by means of direct mail, catalogues, price lists and advertisements in trade publications, and sold and purchased them at collectibles shows, auction houses and local dealer shops. These markets were highly inefficient because:
 
 
they were fragmented and localized, which limited both the variety of available collectibles and the number of potential buyers;
 
 
transaction costs were often relatively high due to the number of intermediaries involved;
 
 
buyers usually lacked the information needed to determine the authenticity and quality and, hence the value, of the collectibles being sold; and
 
 
buyers and sellers were vulnerable to fraudulent practices because they had to rely on the dealers of high-value collectibles for opinions or representations as to authenticity and quality.
 
Coin Market. In an effort to overcome some of these inefficiencies, approximately 30 years ago, professional coin dealers began using a numerical grading scale for grading coins. That scale ranged from 1 to 70, with higher numbers denoting a higher quality. Previously, professional dealers used descriptive terms, such as “Fair,”“Fine” and “Uncirculated,” to characterize the quality of the coins they sold, a practice that continued after the development of the numeric grading system. However, whether using a numeric or a descriptive system, grading standards varied significantly from dealer to dealer, depending on a dealer’s subjective criteria of quality. Moreover, dealers were hardly disinterested or independent since, as the sellers or buyers of the coins they were grading, they stood to benefit financially from the assignment of a particular grade.
 
Sportscard Market. Misrepresentations of authenticity and quality also operated as a barrier to the liquidity and growth of the collectibles market for sportscards. Even experienced and knowledgeable dealers insisted on physically examining purportedly rare and higher priced sportscards. Most collectors lacked the knowledge needed to purchase collectible sportscards with confidence, even when they had physically examined them. Sportscard dealers eventually developed a rudimentary adjectival system to provide measures of quality, using descriptive terms such as “Poor,”“Very Good,”“Mint” and “Gem Mint.” These measures of quality were assigned on the basis of such characteristics as the centering of the image on the card and the presence or absence of bent or damaged corners, scratches and color imperfections. However, as was the case with coins, grading standards varied significantly from dealer to dealer, depending on a dealer’s subjective criteria of quality. Additionally, since the dealers who bought and sold sportscards were the ones that assigned these grades, collectors remained vulnerable to fraudulent practices.
 
Autographed Memorabilia Market. The market for autographed sports, entertainment and historical memorabilia has been plagued by a high incidence of forgeries and misrepresentations of authenticity. For example, Operation Bullpen, initiated by the FBI and other law enforcement agencies beginning in 1997, has uncovered a high volume of outright forgeries of signatures and widespread misrepresentations as to the genuineness of sports memorabilia. We believe that the high incidence of such fraudulent activities was due, in large part, to a dearth of independent third party memorabilia authentication services and an absence of systematic methodologies and specimen data needed for verification of authenticity.
 
Stamp Market. Stamp dealers developed an adjectival system, similar to the one developed for sportscards, by which they valued and priced stamps based primarily on the centering of the stamp image on the stamp paper background, ignoring other faults in the stamp. As a result, experienced and knowledgeable dealers insisted on physically examining purportedly rare and higher priced stamps before purchasing them. Additionally, most collectors lacked the knowledge and experience needed to purchase higher priced stamps with confidence. Consequently, as was the case with coins and sportscards, collectors were forced to depend on representations of authenticity and quality from the very dealers from whom they purchased or to whom they sold stamps.
 
Currency Market. While the market for third-party currency grading is not new, none of the entrants in the past have been particularly successful, and the currency market has not developed substantial demand for these services. The only established grading services with market presence prior to the beginning of 2005 were not
 

 
4


independent third-party grading services, as they are operated and owned by currency dealers who also buy and sell the currency that they grade, thereby creating potential conflicts of interest, much as we have seen in some of our other markets.
 
These conditions in our collectibles markets created a need and the demand for independent authentication and grading services from which dealers and collectors could obtain:
 determinations, from independent, third party experts, of the authenticity of the high-value collectibles that dealers and collectors purchased, particularly “
   sight-unseen”;
 representations of quality based on uniform standards applied by independent, third party experts; and
 authoritative information, compiled by a credible third party, to help collectors understand the factors that affect a collectible’s perceived value and price, including:
 
 its rarity;
 its quality or grade; and
 its historical and recent selling prices.
 
The Impact of eBay on the Collectibles Markets. The advent of the internet and, in particular, eBay’s development of an internet or “virtual” marketplace, have overcome many of the inefficiencies that had characterized the traditional collectibles markets. eBay’s online marketplace (i) offers enhanced interaction between and greater convenience for sellers and buyers of high-value collectibles; (ii) eliminates the involvement of dealers and other “middlemen;” (iii) reduces transaction costs; (iv) allows trading at all hours; and (v) provides continually updated information. However, internet commerce still raises, and has even heightened, concerns about the authenticity and quality of the collectibles that are listed for sale on the internet. Buyers have no ability to physically examine those collectibles and no means to confirm the identity or the credibility of the dealers or sellers who sell purportedly high-value collectibles on the internet. As a result, we believe that the growth of internet collectibles markets, such as eBay’s, has increased awareness of the importance of, and the demand for, independent third party authentication and grading services of the type we provide. Our services enable collectors to use the internet to purchase collectibles “sight-unseen,” with the confidence of knowing that those collectibles are authentic and are of the quality represented by sellers. The importance and value of our services to collectors, we believe, are demonstrated by eBay’s inclusion, on its collectibles websites, of information that identifies, and encourages visitors to use, our independent third party authentication and grading services, as well as similar services offered by some of our competitors.
 
Our Services
 
PCGS Coin Authentication and Grading Services. Recognizing the need for third party authentication and grading services, we launched Professional Coin Grading Service in 1986. PCGS employs expert coin graders, who are independent of coin buyers and sellers, to provide impartial authentication and grading services. Currently, we employ 16 experts who have an average of 27 years of experience in the collectible coin market, in most cases initially as dealers and later as authenticators and graders. We also established uniform standards of quality measured against an actual “benchmark” set of coins kept at our offices. We place each coin that we authenticate and grade in a tamper-evident, clear plastic holder that bears our logo, so that any prospective buyer will know that it is a PCGS authenticated and graded coin. We also provide a warranty as to the accuracy of our coin authentication and grading.
 
By providing an independent assessment by coin experts of the authenticity and quality of coins, we believe that PCGS has increased the liquidity of the trading market for collectible coins. Following the introduction of our independent, third party authentication and grading service, buyer confidence, even between dealers, increased to such a degree that coins authenticated and graded by PCGS were able to be traded “sight-unseen.” As a result, PCGS facilitated the development, in 1990, of a dealer market, known as the “Certified Coin Exchange,” on which coin dealers traded rare coins “sight-unseen,” over a private satellite network, which now operates on the internet. In addition, we began to provide a range of authoritative content on coin collecting to inform and communicate with the collector community, including guides and reports that track the trading prices and the rarity of PCGS-graded coins.
 

 
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More recently, our coin authentication and grading services have facilitated the development of a growing internet or “virtual” marketplace for collectible coins. A prospective buyer, who might otherwise be reluctant to purchase a high priced coin listed on the internet, is able to rely on a PCGS certification in deciding whether or not to bid and in determining the amount to offer for the coin. As a result, to enhance the marketability of higher priced coins, many sellers submit their coins to PCGS for authentication and grading. That enables the sellers to include, in their internet sales listings, digital images of the coins in their tamper-evident, clear plastic holders, which identify the coins as having been authenticated and graded by PCGS as well as their PCGS-assigned grades.
 
PSA Sportscard Authentication and Grading Services. Leveraging the credibility and using the methodologies that we had established with PCGS in the coin market, in 1991 we launched Professional Sports Authenticator (PSA), which instituted a similar authentication and grading system for sportscards. Our independent sportscard experts certify the authenticity of and assign a grade to sportscards using a numeric system with a scale from 1-to-10 that we developed, together with an adjectival system to describe their condition. Currently, we employ 13 experts who have an average of 21 years of experience in the collectible sportscard market. We believe that our authentication and grading services have removed barriers that were created by the historical seller-biased grading process and, thereby, have improved the overall marketability of and facilitated commerce in sportscards, including over the internet and at telephonic sports memorabilia auctions.
 
PSA/DNA Autograph Authentication and Grading Services. In 1999, we launched our vintage autograph authentication business, initially offering authentication services for “vintage” sports autographs and memorabilia that were autographed or signed prior to the time they were presented to us for authentication. The vintage autograph authentication business is distinctly different from the “signed-in-the-presence” authentication of autographs where the “authenticator” is present and witnesses the actual signing. Vintage autograph authentication involves the rendering of an opinion of authenticity by a handwriting expert based on (i) an analysis of the signed object, such as the signed document or autographed item of memorabilia, to confirm that its age and material composition are consistent with similar materials or items that existed during the signer’s lifetime; (ii) a comparison of the signature submitted for authentication with exemplars; and (iii) a handwriting analysis. We currently employ 2 autograph experts with an average of 19 years of experience in the autograph memorabilia market.
 
In June 2004, we also began offering grading services for vintage sports autographs and vintage signed sports memorabilia, beginning with baseballs containing a single signature or autograph. We use uniform grading standards that we have developed and a numeric scale of 1-to-10, with the highest number representing “Mint” condition or perfect quality. We assign two grades to the collectible: one based on the physical condition or state of preservation and legibility of the autograph and the other based on the physical condition of the autographed item of memorabilia. Autograph grading is in its infancy and we cannot predict whether it will gain market acceptance. However, if we find that there is a demand for such services, we intend to extend our grading services to include autographed historical and entertainment memorabilia.
 
PSE Stamp Authentication and Grading Services. In January 2000, we launched our Professional Stamp Experts (PSE) as an independent, third party stamp authentication and grading service. We use both an adjectival system and a numeric scale from 1-to-100 to grade stamps. We assign grades based on the centering of the stamp image on the stamp paper background and the absence or presence of other faults on the stamp. There have been viable third party stamp authentication services in operation for several decades, and stamp dealers and collectors had been using a subjective grading system based primarily on the centering of the stamp image on the stamp paper background, ignoring other faults. However, prior to our entry into the stamp market, independent third party stamp grading was non-existent. As a result, we have encountered some resistance to this concept in the stamp collectibles market, which is steeped in tradition and slow to change, as we did from coin dealers when we launched PCGS and from sportscard dealers when we launched PSA. We believe, however, that the grading of stamps can potentially gain, albeit gradually, increased market acceptance. Currently, we employ four stamp graders who have an average of 36 years of experience in the collectible stamp market.
 
Vintage U.S. Paper Currency Authentication and Grading. In the third quarter of fiscal 2005, we began marketing a U.S. paper currency authentication and grading service, which we decided to brand as “PCGS Currency” because many of the dealers of currency notes are familiar with and have used PCGS’ coin authentication and grading service. We have employed one currency expert and engaged the services of other currency grading experts for this business and began generating revenues in the fourth quarter of fiscal 2005.
 

 
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Publications and Advertising. We publish authoritative price guides, rarity reports and other collectibles data to provide collectors with information that makes them better informed consumers and makes collecting more interesting and exciting. Our publications also enable us to market our services, create increased brand awareness and to generate advertising revenues. Our publications include the Sports Market Report, which we publish on a monthly basis primarily for distribution to approximately 6,500 PSA Collectors Club members, and the Stamp Market Quarterly, which we publish for distribution to approximately 2,500 stamp dealers and collectors. We sell advertising to dealers and vendors for placement in our publications. In addition, we manage a Collectors Universe website and individual websites for four of our authentication and grading services. On those websites, we offer collectible content, some of which is available for a fee and some of which is available without charge. On a combined basis, our PCGS, PSA, PSA/DNA and PSE websites attracted, on average, approximately 167,000 and 154,000 unique visitors per week during the fiscal years ended June 30, 2005 and 2004, respectively. As a result of the increasing number of collectors visiting our websites, during the year ended June 30, 2005, we began selling advertising on our websites to dealers and other vendors that serve the collectibles markets. Such on-line advertising generated approximately $400,000 in revenues in 2005.
 
Our Mission
 
Our mission is to provide the finest available authentication and grading services to sellers and buyers of high-value collectibles and other high-value assets in order to:
 
 increase the values and liquidity of the high-value collectibles and other high-value assets;
 
 enable and facilitate transactions in high-value collectibles and other high-value assets;
 
 generally enhance interest, activity and trading in high-value collectibles and other high-value assets; and
 
 achieve profitable growth, build long-term value for our stockholders and provide rewarding opportunities for our employees.
 
Our Growth Strategy
 
Our growth strategies include:

•     Leveraging the strong brand awareness that we have achieved in our existing markets:
 
 
to increase the demand for and use of our services not only by dealers, but also by collectors, only a relatively small percentage of whom use independent authentication or grading services; and
 
 
to introduce new value-added services to customers in our existing collectibles markets.
 
 
Identifying and entering other high-value collectibles or high-value asset markets where we believe we can succeed in building and meeting the demand among dealers, sellers and buyers for independent, third party authentication and grading services.
 
     We are pursuing the following strategic initiatives in order to achieve these growth objectives:
 
Increasing the Demand for our Services. We have established leading brands in our existing collectibles markets, including PCGS, PSA, PSA/DNA and PSE. We intend to use those brands, as well as our new PCGS Currency brand, to promote Collectors Universe as the premier provider of authentication and grading services in the high-value collectibles markets in order (i) to increase our market share among existing users of authentication and grading services and (ii) to increase the use of our services by the numerous collectors that do not currently use any independent third party authentication or grading services.
 
Although we have authenticated and graded over 11 million coins since the inception of PCGS and over 8 million sportscards since the inception of PSA, we estimate that less than 10% of the vintage United States coins and vintage sportscards have been authenticated and graded. According to recent data available on eBay’s websites, the number of coins being sold at any one time on eBay generally ranges from approximately 150,000 to 180,000, of which only approximately 15% are authenticated and graded by a third party authentication and grading service, such as ours. Similarly, the number of sportscards being sold at any one time on eBay generally ranges from
 

 
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approximately 250,000 to 300,000, of which only about 10% are independently authenticated and graded. Additionally, we are not aware of any other companies that offer grading services for autographs or stamps and we estimate that we have authenticated and graded less than 1% of the potential market of autographs and stamps in the United States. Also, new collectibles are introduced each year into the markets in which we operate, some of which are authenticated and graded in the year of manufacture. Over time, these collectibles will increase the supply of vintage items that are sold by dealers and collectors and, therefore, that will be submitted for independent third party authentication and grading.
 
To take advantage of these market opportunities, we have:
                Introducing New Services in our Existing Markets. Using the brand recognition we have established in the markets we serve, we intend to create and promote new services and expand recently introduced services in our existing markets. These services include:
 
 
Collectors Universe Invitationals. Since 2001, we have been holding special “invitation-only” events for our authorized PCGS and PSA dealers. At those events, dealers have the opportunity to meet and engage in collectibles trading with other invited dealers. To facilitate collectibles trading at these events, we offer same day, on-site authentication and grading services, enabling the dealers to complete their transactions while at the invitationals. In fiscal 2005, we held nine dealer invitationals.
 
 
Sales of Website Advertising. During the quarter ended September 30, 2004, we began selling advertising on our websites to collectibles dealers and auctioneers in the markets in which we offer our branded authentication and grading services. Due to the increasing number of visitors to our websites, we are able to offer those dealers and auctioneers the opportunity to market their products and services to an increased number of prospective customers. In July 2005, the Company acquired substantially all the assets of Coinfacts.com, Inc., which operates an internet website on which it publishes detailed proprietary information and history on rare U.S. Coins. Integration of the Coinfacts website onto the Company’s PCGS website will add significantly to the number of advertising pages that will be contributing revenues in the very near term.
 
 
Dealer Financing Program. We initiated a dealer finance program beginning in the fourth quarter of 2005. Under that program, we offer short-term loans to established collectibles dealers that use our authentication and grading services. The loans, which are collateralized by collectibles that dealers submit to us for authentication and grading, are intended to provide those dealers with working capital during the authentication and grading process. We believe these loans will provide an incentive to dealers to submit additional collectibles to us for authentication and grading, and will generate interest income for us.
 

 
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Autograph Grading Services. In June 2004, we launched autograph grading services, beginning with single signed baseballs (patent pending). Our autograph grading service is intended to meet existing and create additional demand for differentiation in the quality, and thus in the value, of autographed memorabilia. Our grading is based primarily on sharpness, intensity, readability and clarity of autographs. It is our intention to expand this grading service to other autographed sports memorabilia and then to historical and entertainment autographs, if we find that there is a demand for our signed baseball grading services.
 
 
Expansion of Website Information Services. We have been expanding the information available on our websites, including the addition of: (i) historical coin auction prices; (ii) reproductions of historical reference books; and (iii) the contents of famous coin, sportscard and stamp collections. These services are designed to attract new collectors, increase the number of visitors to our websites and increase advertising revenues. During the year ended June 30, 2005, on a combined basis our five websites attracted, on average, over 167,000 visitors per week, as compared to 154,000 in the same period of the prior fiscal year.
 
 
Photography Services. We now offer digital photography for collectibles that are submitted to us for authentication and grading. The digital images can be used by dealers for recordkeeping purposes and by both dealers and collectors when listing collectibles on internet auction sites, such as eBay. We believe that we are able to offer digital photography services more efficiently than other service providers, because we will be able to easily incorporate this service as part of our authentication and grading processes.
 
 
eBay Promotional Programs. Leveraging our expertise and reputation as a leading independent third party authenticator and grader of high-value collectibles, we work with eBay to create programs designed to increase the marketability of collectibles on its auction websites and, at the same time, promote our authentication and grading services. We now offer a fee-based “Quick Opinion” autograph authentication service to visitors on eBay’s sports memorabilia auction website. Our autograph experts render an authenticity opinion based on an examination of the digital image of the autograph posted on eBay. We also have included, at eBay’s request, information about the benefits of our authentication and grading services on our websites, to which eBay has placed links on its collectibles websites in order to make that information readily accessible to its users.
 
          •
  
First Strikes™ Program. Every calendar year, the U.S. Mint produces new dies with the new year engraved on the die for minting the coins of that year, including the gold and silver bullion coins. In the third quarter of fiscal 2005, PCGS introduced a new program designed to generate submissions of these coins to us for authentication and grading with a special “First Strike” designation. This program was launched based on our belief that the marketplace would prefer coins struck early in the life of the die so that the details of the coin would be very sharp, provided that there was independent evidence of an early strike. To provide assurance to the marketplace of these early strikes, we required that coins for First Strike designation be submitted in January of the year as struck on the coin or otherwise be provided to us in their original, date-stamped, Mint-sealed containers. With such evidence, we would then encapsulate the coins in our tamper-evident, clear plastic holders with an imprint on the descriptive label designating the coins as First Strike coins. We inaugurated our First Strike program in January 2005 for U.S. Gold and Silver Eagle bullion coins.

          •
  
Set Registry Kiosk SM Program. The kiosk program places an attractive graphic and Internet link on a participating commercial dealer or auctioneer website that connects the customers to our popular and free Set Registry program. The Set Registry program provides for customers to register their partial or complete collection and compete on a worldwide basis for top ranking of the type of collection, while requiring that all items registered be certified for authenticity and quality by the appropriate division of our Company. (See Marketing- Pull Strategy- Set Registry Programs). Until the launch of the kiosk program, Set Registry participants must have registered on the PCGS website directly. We believe that by obtaining the participation, promotion and support of the commercial dealers and auctioneers through their respective websites, we will increase the exposure of Set Registry to the collecting community.
 
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          •
  
Certified Coin Exchange. In September 2005, the company acquired Certified Coin Exchange (CCE) www.certifiedcoinexchange.com, a dealer-to-dealer Internet-based, bid-ask system for certified coins. This system and its predecessors have been in continuous operation since the 1960’s. The CCE has approximately 400 dealer-members paying a fixed monthly fee with two access levels, the full access level supporting approximately 125 dealer-members paying $295 per month and allowed to post bid and ask prices for certified coins, including PCGS coins, and an associate access level supporting approximately 275 dealer-members paying $139 per month and allowed to view the pricing information. The CCE now supports approximately 100,000 bid-ask prices. In addition, there is an open segment of the website called “Collectors Corner” where dealer-members can post offerings at retail prices, with approximately 11,000 items now being listed. We believe that the CCE system will allow us to better take advantage of and monetize our data base of supply-demand information and to provide a platform for extending the CCE concept into other markets served by the Company.
 
Entering Other Collectibles and High-Value Asset Markets. There are additional high-value collectibles and high-value assets with respect to which marketability and value depend primarily on their authenticity and state of preservation or quality. We believe that the growth of some of these markets has been hampered by the absence or limited availability of independent authentication and grading services. It is our intention to expand our business into one or more of those markets. Markets that we are considering for possible expansion include:
 
Antique silver
Estate jewelry
Colored gemstones
Musical instruments
Comic books
Political memorabilia
Diamonds
Postcards
Entertainment memorabilia
Rare books
 
    We intend to consider the following criteria in selecting markets for future expansion:
The largest of these currently targeted markets are the diamond and colored gemstone markets. According to the Rapaport Group, an independent research firm to the diamond, gem and jewelry industry, in 2003 approximately 18 million carats of polished diamonds, valued in excess of $10 billion, were imported into the United States. Currently there are four companies of significant size that provide third party authentication and grading services in the diamond market, and two in the colored gemstone market, as well as a few smaller, mostly more recently established, companies that provide various authentication and grading services in those markets. Other large markets include estate and pre-owned jewelry and entertainment memorabilia, such as Hollywood props, scripts and wardrobes. According to data available from eBay, at any one time there are approximately 800,000 to 1,000,000 items of pre-owned jewelry, including watches, and from 300,000 to 500,000 items of entertainment memorabilia, listed on eBay. We are not aware of any significant third party authentication or grading services in either of these markets. Although the other targeted markets are much smaller than the diamond, pre-owned jewelry and entertainment memorabilia markets, we are not aware of any significant third party authentication or grading companies that operate in any of those markets.
 

 
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There is no assurance that we will succeed in expanding our business into any of these new markets or, even if we do succeed in doing so, that the authentication or grading services we will offer in those markets will gain market acceptance or become profitable.
 
Operations
 
We offer authentication and grading services for coins, sportscards, autographs and autographed memorabilia, stamps and currency. Our trained and experienced authentication and grading experts determine the authenticity of and, using uniform quality standards, assign a quality grade to these collectibles.
 
PCGS. Since our inception in 1986, we have graded approximately 11 million coins. We now authenticate and grade approximately 1,700,000 coins per year. We typically charge authentication and grading fees that range between $8 and $200 per coin, depending primarily on the turn-around time requested by the customer, which varies from one day for the highest level of service to approximately 60 days for the lowest level of service. In the fiscal year ended June 30, 2005, our fee per coin averaged approximately $13. We authenticate and grade coins in accordance with standards that we developed and which have become generally accepted in the industry. We use both an adjectival and numeric system, with a scale of 1-to-70, to rate the quality of the coins, with the highest number representing “gem” or perfect quality. We have authenticated and graded, either before or after sale, two of the three highest priced U.S. coins ever sold at public auction, including an 1804 Draped Bust Silver Dollar, that was sold by the owner at an auction in 1999 for approximately $4.1 million, and a U.S. 1913 Liberty Head Nickel, that was recently sold for $4.15 million, the second highest price paid for any coin.
 
Our grading of coins involves an exacting and standardized process. We receive coins from dealers and collectors and remove all packaging that identifies the submitter in any way. We then enter information regarding the coins into our proprietary computerized inventory system, which tracks the coins at every stage of our authentication and grading process. Generally, our process requires that two of our experts evaluate each coin independently, and no authenticity opinion is issued and no quality grade is assigned unless their opinions of authenticity and the grades independently assigned by each of them are the same. In some cases, depending on the type of coin being authenticated and graded or on the results of the initial review process, a third expert is involved to make the final determinations of authenticity and grade. The coin, the determination of authenticity and its grade are then verified by one of our senior experts, who has the authority to resubmit the coin for further review if deemed to be necessary. Only after this process is complete is the coin reunited with its invoice, thus keeping the authentication and grading process independent of the identity of the owner and the history of the coin. The coin is then sonically sealed in our specially-designed, tamper-evident, clear plastic holder, which also encases a label describing the coin, the quality grade that we have assigned to it, a unique certificate number and bar code, and the PCGS hologram and brand name.
 
PSA. We launched our PSA sportscard authentication and grading service in 1991 and, through June 30, 2005, had authenticated and graded over 8 million sportscards. Our sportscard grading system uses both an adjectival and a numeric system with a scale from 1-to-10, with the highest number representing “mint” condition or perfect quality. We employ sportscard authentication and grading procedures that are similar to our coin authentication and grading procedures. On receipt of sportscards from dealers and collectors, we remove all packaging that identifies the submitter in any way and enter information regarding the sportscards into our proprietary computerized inventory system that enables us to track the sportscards throughout our authentication and grading process. Only after the authentication and grading process is complete is the sportscard reunited with its invoice, thus keeping the authentication and grading process independent of the identity of the owner and the history of the sportscard. The sportscard is then sonically sealed in our specially-designed, tamper-evident, clear plastic holder, which also encases a label that identifies the sportscard, the quality grade that we have assigned to it and a unique certificate number and bar code, and the PSA hologram and brand name.
 
We primarily authenticate and grade baseball sportscards and, to a lesser extent, football, basketball and hockey sportscards, as well as entertainment and other collectible cards. We typically charge fees ranging between $6 and $100 per card, with an average fee of $6 per card in 2005. As is the case with coin authentication and grading, sportscard authentication and grading fees are based on the particular turn-around time requested by the submitter, ranging from one day’s turn-around for the highest level of service to approximately 60 days for the lowest level of service.
 

 
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The sportscards submitted to us for authentication and grading include primarily (i) older or vintage sportscards, particularly of memorable or historically famous players, such as Honus Wagner, Joe DiMaggio, Ted Williams and Mickey Mantle, and (ii) modern or newly produced sportscards of current or new athletes who have become popular with sports fans or have achieved new records or milestones, such as Nolan Ryan and Mark McGwire. These sportscards have, or are perceived to have, sufficient collectible value and are sold more frequently than are sportscards of less notable athletes, leading dealers and collectors to submit them for grading to enhance their marketability. Also, the production and sale of each new series of sportscards, which take place at the beginning and during the course of each new sports season, create new collectibles that provide a source of future additional authentication and grading submissions to us. Among the sportscards that we have authenticated and graded is a 1909 Honus Wagner baseball card, which received a PSA grade of 8 and was sold by the owner in 2000 for approximately $1.3 million.
 
PSA/DNA. In 1999, we began offering authentication services for vintage sports autographs. Because of the variability in the size of autographed memorabilia, the procedures we use necessarily differ from those used in authenticating and grading coins and sportscards. Customers may ship the memorabilia to us for authentication at our offices or, in the case of dealers or collectors that desire to have a large number of items authenticated, we will sometimes send an expert to the customer’s location for “on-site” examination and authentication. Generally, our procedures require at least two of our autograph experts to agree on either a positive or a negative opinion on authenticity for most items that are submitted for authentication. Our experts reference what we believe is one of the largest databases of known genuine examples of signatures for comparison to a submitted specimen and draw upon their training and experience in handwriting analysis. In most cases, we take a digital photograph of the autographs that we authenticate and store those photographs in a master database. Before shipping the item back to the customer, a tamper-evident holographic label is affixed to the collectible. The label contains our PSA/DNA name and logo and a unique certificate number. For additional security, in most cases we tag the items with synthetic DNA-laced ink, which is odorless, colorless and tasteless and visible only when exposed to a narrow band wavelength of laser light using a hand-held, battery-powered lamp. As a result, if the label is removed from the item, it is still possible to verify that the item was authenticated by us.
 
Memorabilia that have been authenticated by our vintage autograph service include Mark McGwire’s 70th home run baseball, which was sold at auction in 1999 for more than $3 million, a baseball bat autographed by Babe Ruth, which he used to hit the first home run ever hit in Yankee Stadium in 1923 that was sold by Sotheby’s for more than $1.2 million and a 1919 contract trading Babe Ruth from the Boston Red Sox to the New York Yankees, which was recently sold at auction for $996,000.
 
In June 2004, we also began offering grading services for vintage sports autographs, beginning with single signed baseballs. We use uniform grading standards that we have developed to assign two grades to the collectible, one based on the physical condition or state of preservation and legibility of the autograph, and the other based on the physical condition of the collectible, using a numeric scale of 1-to-10, the highest number representing “mint” condition or perfect quality. However, the grading standards that we apply for “game-used” baseballs, which by their very nature are not in “pristine” condition, are different than the grading standards for unused or souvenir autographed baseballs. Autograph grading is in its infancy and we cannot predict whether it will gain market acceptance. However, if we find that there is a demand for such services, it is our intention to offer grading services for autographed historical and entertainment memorabilia as well.
 
PSE. We commenced our PSE stamp authentication and grading service in January 2000. In rating the quality of stamps, we assign a numeric grade to each stamp that ranges from 1-to-100. The grade assigned to a stamp is based on several characteristics, including the centering of the image on the stamp and the absence or presence of various faults, such as creases, perforation problems and other imperfections that, if present, will reduce the value of the stamp. For a stamp to receive a grade of 100, which means that it is in “gem” condition, the image on the stamp must be perfectly centered and the stamp must be faultless. Stamps submitted to us for grading are independently examined and graded by two of our stamp experts, who must have independently arrived at the same grade before a final grade is assigned. After a stamp has been authenticated and graded, we generally issue a certificate of authentication that briefly describes the stamp and the grade assigned to it and has a digital image of the stamp attached. The certificate bears the PSE name and logo and a unique certification number that we assign to the stamp for record keeping purposes. We also offer our customers the option of having the stamp encapsulated in a tamper-evident, clear plastic holder with an encased label that, like the certificate, identifies the stamp and sets forth the grade assigned to it, its unique certification number and the PSE name and logo.
 

 
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Stamps that have been authenticated and graded by us include an 1868 1¢“Z” Grill U.S. postage stamp, which received a PSE grade of Extremely Fine (XF) 90 and was last sold at auction in 1989 for more than $900,000. The owner submitted the stamp to us shortly after we initiated our stamp authentication and grading service in 2000.
 
The volume of stamp authentication and grading submissions through fiscal 2005, relative to the number of coin and sportscard submissions, has not been material. Since stamp grading services are new to the market, we cannot predict when or even whether our services will gain the level of market acceptance needed for stamp grading to become a material contributor to our operating results.
 
Vintage U.S. Paper Currency. PCGS began marketing a vintage U.S. paper currency grading service, under the brand name “PCGS Currency” in the third fiscal quarter ended March 31, 2005. We have engaged a number of paper currency experts to grow this business and to authenticate and grade vintage paper currency. We use an adjectival and numeric grading system, with a scale of 1-to-70, which is similar to the system that we use for grading coins, largely because most vintage currency dealers are already familiar with that system. Currently, there are two relatively small vintage paper currency authentication and grading companies. Additionally, Numismatic Guaranty Corporation of America, our principal coin authentication and grading competitor, started a separate vintage paper currency authentication and grading service in the first calendar quarter of 2005. The rare currency market is smaller than our other collectibles markets and, although we began generating currency and authentication and grading revenues in the fourth quarter of fiscal 2005, there is no assurance that our currency authentication and grading service will gain market acceptance or that our entry into that market will generate material revenues for us or become profitable.
 
Publications and Content. We publish authoritative price guides and rarity reports for coins, sportscards, sports autographs and memorabilia and stamps. This information is available on our website and in our publications. These publications include:
 

 
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Marketing
 
We employ both “pull” and “push” strategies in marketing our services to dealers and collectors of high-value collectibles. Our “pull” strategies are designed to promote our brands and increase the preference among collectors for our authentication and grading services and to encourage collectors to communicate that preference to their collectibles dealers, because most authentication and grading submissions are made by dealers. In our experience, if a customer requests a particular service, the dealer ordinarily will comply with that request. On the other hand, if the customer expresses no preference, the dealer will make its own choice of authentication and grading service or may even decide not to submit the collectible to an independent service for authentication and grading. Therefore, our “pull” oriented marketing programs emphasize (i) the protections that collectors will have if they purchase collectibles that we have authenticated and graded, and (ii) the improved marketability and higher prices that they can realize if they use our independent third party authentication and grading services. Our “push” strategy, on the other hand, is designed to market our services directly to collectibles dealers and to encourage them to use and promote our services.
 
Our “Pull” Strategy. We have developed and implemented a number of marketing programs and initiatives designed to create consumer preference for collectibles that have been authenticated and graded by us. Those programs and initiatives include:
 
 
Direct Advertising. We directly address collectors by advertising our services in trade journals and periodicals in each of our markets. Those journals include Coin World, Linn’s Stamp News, Sports Collectors Digest and Autograph Collector Magazine. We make personal appearances at major, national-market trade shows around the United States that are attended by collectors, as well as dealers. We also participate in and support programs conducted by non-profit associations whose members are primarily collectors, such as the American Numismatic Association and the American Stamp Dealers Association.
 
 
Set Registry Programs. We provide collectors with the opportunity to participate in free internet “Set Registry SM  programs that we host on our collectibles websites. These programs encourage collectors to assemble full sets of related collectibles that have been authenticated and graded by us. Generally, each registered set is comprised of between 50 and 200 separate, but related, collectibles. Examples include particular issues of coins, such as Twenty Dollar Gold Double Eagles or Morgan Silver Dollars; particular sets of sportscards, such as all Hall of Fame pitchers or a particular team, like the 1961 Yankees; or sets of collectible stamps, such as Columbian Commemoratives or Graf Zeppelin Airmail stamps. Our Set Registry programs enable collectors:
 
 
to register their sets on our websites, which provides them with an off-site reference source for insurance and informational purposes;
 
 
to display on our websites, and compare the completeness and quality grades of, the collectibles making up their sets to those of other collectors who have registered similar sets on our websites, thereby creating a competitive aspect to collecting that adds to its excitement; and
 
 
to enter our annual company-sponsored Set Registry competitions and awards programs in which collectors can win awards for having collected the most complete and highest graded sets of particular series or issues of coins, sportscards or stamps.
 
The collectibles that may be registered on our Set Registries and included in our Set Registry competitions are limited to collectibles that have been authenticated and graded by us. To register the collectibles to be included in a particular set, a collector is required to enter the unique certificate number that we had assigned to each of the collectibles when last authenticated and graded by us. We use the certificate number to compare the information being submitted by the collector with our database of information to verify that the collectibles being registered by a participant for inclusion in a particular set qualify to be included in that set.
 

 
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We have found that our Set Registry competitions (i) create a preference and increase demand among collectors for our brands, and (ii) promote the trading of collectibles authenticated and graded by us by set registrants seeking to improve the completeness and overall quality of their sets, which generally results in additional authentication and grading submissions to us. Annual awards for set completeness and quality have been issued by PCGS and PSA each year since 2002 and by PSE beginning in 2004. As an indication of the popularity of our Set Registry programs, more than 30,000 sets were registered on our Set Registries as of June 30, 2005, which represents a 41% increase over the number registered as of June 30, 2004.
  • Collectors Clubs Subscription Program. We also have established “Collectors Clubs” for coin and sportscard collectors. For an annual membership fee, ranging from $100 to $200, collectors receive a number of benefits, including (i) the right to have, without any further charge, a specified number of collectibles authenticated and graded by us, a privilege that non-member collectors do not have; and (ii) access to certain proprietary data that we make available on our websites or in print. As of June 30, 2005, there were approximately 15,000 members in our Collectors Clubs.
    Our “Push” Strategy. We also market our services directly to collectibles dealers and auctioneers to promote their use of our authentication and grading services. Our marketing message is focused on the potential increase in marketability of the collectibles due to the increase in consumer confidence that is attributable to our authentication and grading of those collectibles. These marketing programs include:
 
 
Trade Publication Advertising and Direct Communications. We communicate to dealers and auctioneers by direct contact and through advertising in trade journals and publications in the respective markets. Those journals include Coin World, Linn’s Stamp News, Sports Collectors Digest and Autograph Collector Magazine. We also communicate with our dealers and with auctioneers by direct mail, email, and telephone.
 
 
Trade Shows and Conventions. There are numerous collectibles trade shows and conventions held annually in the United States, of which approximately 30 generally are considered to be the largest and most significant in the collectible coin, sportscard, autograph and stamp markets. At these shows and conventions, collectibles dealers gather on a trading floor or “bourse” to buy and sell collectibles. We offer same day, on-site authentication and grading services, which facilitate the trading and sales of collectibles at these shows and conventions. At the same time, we obtain additional brand exposure and generate increased revenues, because dealers and collectors generally are willing to pay higher fees for same day, on-site services.
 
 
Our Dealer Invitationals. We sponsor and host 8-to-10 “invitation-only” events per year for our larger dealers that provide them with forums for buying and selling their collectibles. We also offer same day, on-site authentication and grading services at these invitationals. Like the other trade shows and conventions we attend, these invitationals enable us to generate additional authentication and grading revenues. At the same time, because we host the invitationals, they provide additional brand exposure and build goodwill for us among the collectibles dealers.
 
 
Authorized Dealer Network. We have implemented authorized dealer programs for coin and sportscard collectibles dealers and auction companies. Authorized dealers are able to use our marketing materials which are designed to promote our services and those of our authorized dealers to collectors. Those materials include “point of sale” and “point of purchase” displays and brochures and direct mail pieces for insertion in customer mailings. In addition, authorized dealers may use our brand logotypes on their websites to attract buyers for coins and sportscards that have been authenticated and graded by us. We also conduct joint marketing programs with our authorized dealers in which we provide financial support for dealer marketing programs, approved by us, that promote both the dealer’s products and services and our authentication and grading services.
 
 
 
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eBay Promotional Programs. Since 1999, we have worked with eBay on programs to increase the volume of collectibles traded on eBay and, at the same time, to provide greater exposure for our authentication and grading services. Current programs include:
 
 
Informative and Educational Web Pages. We have created web pages for eBay specifically designed to inform and educate eBay buyers and sellers about the benefits of our authentication and grading services. eBay includes, on its collectibles web pages, links to our web pages and encourages its collectibles customers to use our services. eBay has similar programs with other collectibles authentication and grading services.
 
 
Quick Opinion Autograph Authentication Service. We have developed, for eBay’s customers that visit its sports memorabilia auction website, a fee-based “Quick Opinion” autograph authentication service. For a prescribed fee, currently approximately $7 per autograph, an eBay visitor that is interested in selling or buying an autographed item of memorabilia on the eBay auction website can obtain, from one of our autograph experts, a “quick” opinion as to the authenticity of the autograph, generally provided within a day of submission. The opinion is based on an examination of a digital image of the autograph posted on eBay and, due to the limitations inherent in this process, we do not warrant the accuracy of these opinions. The fees generated by this service are shared between us and eBay.
 
 
Other Initiatives. We have maintained an ongoing dialogue with eBay regarding other programs that will attract collectibles sellers and buyers and make it easier for them to complete collectibles transactions on eBay’s collectibles auction websites. For example, we recently authenticated and graded, for exclusive sale on eBay’s sports memorabilia auction website, a special issue of Boston Red Sox Poker Chips that commemorate the team’s World Series victory and we also graded promotional cards for the Star Wars Return of the Sith movie that were auctioned on eBay.
 
Patents and Intellectual Property
 
Our intellectual property consists primarily of trademarks, copyrights, proprietary software and trade secrets. As part of our confidentiality procedures, we generally enter into agreements with our employees and consultants and limit access to, and distribution of, our software, documentation and other proprietary information. The following table sets forth a list of our trademarks, both registered and unregistered, that are currently being used in the conduct of our business:
 
Registered Marks
 
Unregistered Marks
Collectors Universe
 
Cert & Sell
 
PSE
PCGS
 
World Series of Grading
 
Coin Universe
Professional Sports Authenticator
 
PCGS3000™
 
Collectors.com
PSA/DNA
 
History in Your Hands
 
Record Universe
Set Registry
 
First Strike
 
PCGS Currency
 
We have not conducted an exhaustive search of possible prior users of the unregistered trademarks listed above and, therefore, it is possible that our use of some of these trademarks may conflict with others.
 
In addition, the Company or its subsidiaries have been awarded two patents, one patent application is pending, and we have filed a provisional patent application in connection with grading and authentication of collectibles.
 
Collectibles Experts
 
As of June 30, 2005, we employed 36 collectibles experts in our authentication and grading operations, who have from 1 to 49 years, and an overall average of 25 years, of collectibles marketplace experience. Our experts include individuals that either (i) had previously been collectibles dealers or were recognized as experts in the markets we serve, or (ii) who we have trained in our authentication and grading methodologies and procedures. However, talented authentication and grading experts are in short supply and there is considerable competition among collectibles authentication and grading companies for their services. As a result, we have recently increased our focus on training young authenticators and graders who we believe have the skills or knowledge base to become collectibles experts. Such full-time graders and authenticators are prohibited from submitting items to us for grading or authentication. We also sometimes contract with outside experts on a consulting basis, who are usually collectibles dealers, to help grade and/or authenticate significant and/or very specialized items. These consultants can, and do, use our services. However, they are prohibited from grading and/or authenticating any item in which
 

 
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they have a financial interest. In addition, we may use outside consultants to enable us to address short-term increases in authentication and grading orders.
 
Service Warranties
 
We issue an authenticity or grading warranty with every coin and sportscard authenticated or graded by us. Under the terms of the warranty, if a coin or sportscard that was graded by us later receives a lower grade upon resubmission to us for grading, we are obligated either to purchase the coin or sportscard at the price paid by the then-owner of the coin or sportscard or, instead, if we so choose, to pay the difference in value of the item at its original grade as compared with its lower grade. Similarly, if a coin or sportscard that has been authenticated by us is later determined not to have been authentic, we are obligated under our warranty to purchase the coin or sportscard at the price that the then-owner paid for that collectible. We accrue for estimated warranty costs based on historical claims experience.
 
Before returning an authenticated or graded coin or sportscard to our customer, we place the coin or sportscard in a tamper-evident, clear plastic holder that encapsulates a label identifying the collectible as having been authenticated and graded by us. The warranty is voided in the event the plastic holder has been broken or damaged or shows signs of tampering.
 
We recently began offering a similar warranty for stamps and currency that we authenticate and grade. To obtain such a warranty, the customer must elect to have his or her stamp encapsulated in a tamper-evident, clear plastic holder that includes a label identifying the collectible as having been authenticated or graded by us. We do not offer such a warranty in those cases where the customer chooses, instead, to have us issue a certificate of authenticity and grade.
 
We do not provide a warranty with respect to our opinions regarding the authenticity or quality of autographs.
 
Customer Service and Support
 
We devote significant resources, including a 24 person staff, to providing personalized customer service and support in a timely manner. On our websites, customers are able to check the status of their collectibles submissions throughout the authentication and grading process and to confirm the authenticity of the over 15 million collectibles that we have graded. When customers need services or have any questions, they can telephone or e-mail our support staff, Monday through Friday between the hours of 7:00 A.M. and 6:00 P.M., Pacific Time. We also involve our collectibles experts in providing support services when necessary to address special issues.
 
Supplies
 
In order to obtain volume discounts, we have chosen to purchase most of the injection-molded plastic parts for our clear plastic holders principally from a single supplier. There are numerous suppliers for these items, however, and we believe that, if necessary, we could obtain those items from any of those other suppliers without significant cost to us. However, if it were to become necessary for us to obtain another supplier, we might have to arrange for the fabrication of a die for the new supplier. Fabrication of high precision dies can be a lengthy process. Therefore, it is our practice to maintain at least a one month supply of these molded plastic parts in inventory.
 
Competition
 
Coin Authentication and Grading. We have three primary competitors in the coin authentication and grading market: Numismatic Guaranty Corporation of America, Independent Coin Grading and ANACS.
 
Sportscard Authentication and Grading. We have two primary competitors in sportscard authentication and grading: Beckett Sportscard Grading Corporation and Global Authentication, Inc.
 
Autograph Authentication and Grading. In the vintage autograph authentication market, we compete with Global Authentication, Inc. and a few smaller competitors. By contrast, there are a number of competitors for “signed-in-the-presence” grading, including Tri-Star, Steiner Sports and Upper Deck Authentication. We have not encountered any competitors that offer autograph grading services.
 

 
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Stamp Authentication and Grading. In stamp authentication, our principal competitors are the Philatelic Foundation and the American Philatelic Society, both of which are non-profit organizations. On the other hand, we are not aware of any companies or other organizations that provide stamp grading services.
 
Currency Authentication and Grading. In the paper currency authentication and grading market, we compete against Numismatic Guaranty Corporation of America and two smaller competitors.
 
The principal competitive factors in our collectibles authentication and grading markets are (i) brand recognition and awareness, (ii) an established reputation for integrity, independence and consistency in the application of grading standards, and (iii) responsiveness of service. Price is much less of a factor in the case of vintage collectibles, but is a more important consideration with respect to modern coins and sportscards because of their significantly lower values. We believe that our PCGS, PSA, PSA/DNA, PSE and PCGS Currency brands compete favorably with respect to all of these factors and are among the leaders in each of their respective markets. Barriers to entry into the authentication and grading market are relatively low, especially in the sportscard authentication and grading market. However, brand name recognition and a reputation for integrity, independence and consistency in the application of grading standards can take several years to develop. The limited supply of collectibles experts also operates as a barrier to entry or expansion.
 
Information Technology
 
We have developed proprietary software systems that we use in our authentication and grading operations, principally for order tracking, processing and recordkeeping, and the operation and maintenance of our internet websites. These software systems include Grading Management and Production Systems, Set Registry, Population Reports, Price Guides, Market Indexes, Article Libraries QuickOpinion Systems and Featured Dealer Systems. These systems operate on software platforms in Microsoft Visual Basic.NET, Microsoft ASP.NET and Microsoft SQL Server. We also have legacy systems, which we are in process of replacing, in Cold Fusion and Visual Basic 6. We also maintain an integrated local area network that assists in and provides certain controls on production, product physical movement, accounting and financial functions, data warehousing and other tasks. During the fiscal year ended June 30, 2005, these systems tracked the authentication and grading process and generated records and data for over 2.9 million collectibles submitted to us for authentication and grading, without significant disruption or loss of service.
 
Although we do not primarily conduct our business on the internet, we do use the internet for information exchange and delivery of market-oriented content and for our Set Registry and certain of our other marketing programs. As a result, we have 25 Dell PowerEdge Servers with RAID, along with a fully redundant SQL Server 2000 with high-availability cluster supporting over two terabytes of clustered storage. The hardware resides at our headquarters in a server room that has 24/7 environmental monitoring and alerting through hardware sensors, 24/7 network availability and performance monitoring and alerting through network management software and 24/7 internet availability and performance monitoring and alerting through third party providers. The internet connectivity flows through multiple internet providers supporting up to approximately 47 megabit internet bandwidth with multiple layers of internet firewall protection, including three Cisco PIX firewalls and Microsoft ISA Server protection. We maintain a multi-tiered antivirus and anti-spam SMTP infrastructure scanning all incoming mail through four different AV engines. The system is backed up nightly with 1.6 terabyte capacity, expandable to over 3 terabytes under current configuration, and is managed by administrators certified by Microsoft, Cisco and Linux.
 
However, we do not have redundant computer systems at a location that is remote from Southern California, where our computer systems currently are located. As a result, any damage to or failure of our computer systems due to a catastrophic event in Southern California, such as an earthquake, could cause an interruption in our services.

Government Regulation

With the exception of laws in some states that require memorabilia authenticators to certify to the accuracy of their authentication opinions, there are no material government regulations specifically relating to the authentication and grading businesses that we conduct, other than regulations that apply generally to businesses operating in the markets where we maintain operations or conduct business. However, our dealer finance program is subject to numerous laws and regulations in those states in which we may make loans to dealers.

 
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Disposition of Collectibles Sales Businesses
 
During the period from 1999 through the latter part of fiscal 2004, we also were engaged in the business of marketing and selling collectible coins, sportscards, currency and sports entertainment and historical memorabilia. Most of those sales were made at multi-venue auctions that were conducted by our collectibles sales businesses, which were comprised of Bowers and Merena Galleries and Kingswood Coin Auctions for rare coins, Superior Sports Auctions for vintage sportscards and sports memorabilia, Lyn Knight Currency Auctions for currency and Odyssey Publications for entertainment and historical memorabilia. We also sold collectible coins by direct sales methods.
 
In December 2003, our Board of Directors authorized management to implement a plan to focus our financial and management resources, and collectibles expertise, on the operations and growth of our authentication and grading businesses, and to divest the collectibles auctions and direct sales businesses. This decision was based on a number of factors and considerations that included, among others, (i) the historical operating results of the collectibles auction and direct sales businesses, which had proven to be disappointing as compared to the operating results of our authentication and grading businesses; (ii) a lack of synergies between the collectibles sales businesses and our grading authentication businesses, which made it difficult to achieve a meaningful reduction in our operating expenses; and (iii) the additional capital that we believed would be required to grow our collectibles auction and direct sales businesses in comparison to the lower capital requirements of our authentication and grading businesses.
 
As a result of this decision, we sold our collectibles sales businesses during fiscal 2004, but retained the collectibles inventory and accounts receivable of those businesses, which we have substantially liquidated. We also terminated the licenses under which we operated our David Hall Rare Coins Division, which had been engaged in the business of selling collectible coins at retail. We generated cash of $10,435,000 in fiscal year ended June 30, 2004 and $2,332,000 in the year ended June 30, 2005, from the disposition of those businesses and the liquidation of their inventories and accounts receivable.
 
We believe that the divestiture of the collectibles sales businesses enables us to focus our financial and managerial resources on growing our existing authentication and grading revenues and to reduce our operating expenses, and, thereby, increase our overall profitability. Additionally, we intend to use the cash generated from the sales of the discontinued businesses, along with our other cash resources, to develop and implement new marketing programs, expand the value-added services that we are able to offer our existing customers and acquire or start new businesses that will enable us to offer authentication and grading services in other high-value collectibles or high-value asset markets.
 
Employees
 
As of June 30, 2005, we had 167 full-time employees and 19 part-time employees, of which 139 were employed in authentication and grading, including our 36 collectibles experts and 24 customer service and support personnel. The other employees included 8 in information services, 3 in marketing, and 36 in other business and administrative services. We have never had a work stoppage, and no employees are represented under collective bargaining agreements. We consider relations with our employees to be good.
 
Factors That Could Affect Our Future Financial Performance
 
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 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,
 

 
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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.
 
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 to purchase, and the prices that they are willing to pay for, high-value collectibles. Declines in purchases and sales, and in the value, of collectibles 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 collectibles 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 collectors submit their coins, sportscards and other collectibles for authentication and grading; (ii) causing customers to request longer authentication and grading turn-around times, which would reduce our revenues and profitability, and (iii) 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 69%, 66% and 60% of our net revenues in fiscal 2005, 2004 and 2003, 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 U.S. 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 27% of our total net revenues.
 
During the year ended June 30, 2005, five of our coin authentication and grading customers accounted for approximately 27% 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, would 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 45% decrease in revenues from that customer in the fourth
 

 
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quarter, compared to the third quarter of fiscal 2005. This reduction in revenues from that customer is expected to continue in fiscal 2006.
 
Our autograph grading, stamp and currency authentication and grading businesses are in their start-up phase. There can be no assurance that these businesses will prove to be successful.
 
We only commenced our autograph grading and currency authentication and grading businesses in fiscal 2005 and our stamp authentication and grading business, which we commenced in 2000, has yet to make a material contribution to our net revenues. There is no assurance that these services will gain market acceptance. To date, our stamp and currency grading businesses have incurred operating losses and our autograph grading business has been in operation for a short period of time. As a result, there is no assurance that any of these businesses will ever make a material contribution to our net revenues or achieve profitability. In that event, we may have to discontinue, and write off our investments in, those businesses.
 
There are risks associated with our decision to exit our collectibles auctions and direct sales businesses.
 
In December 2003, we adopted a new strategic plan that focuses our financial and management resources, and collectibles expertise, on the operations and growth of our authentication and grading businesses and that led us to dispose of our collectibles auctions and direct sales businesses. We adopted this strategic plan because we believed it would enable us to improve our profitability and the consistency and predictability of our operating results and cash flows. Although our operating results have improved since we initiated this strategy, there is no assurance that this strategy will prove to be successful over the longer term. Among other things, one consequence of our strategy is that there has been a significant reduction in our net revenues, because our discontinued auction and direct sale businesses had accounted for, on average, more than 60% of our net revenues from continuing operations in each of the fiscal years ended June 30, 2003, 2002 and 2001. Therefore, our future success will depend to a great extent on our ability to continue to increase our revenues by introducing and offering additional revenue generating services in our existing markets and entering into collectibles or high value asset markets in which we do not presently operate, either by acquisition of existing businesses or the commencement of new authentication and grading businesses.
 
There is no assurance that we will be successful in doing so, and if we are unable to achieve internal growth or acquire new authentication or grading businesses, this strategy could have a negative impact on our future financial performance.
 
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. Even if we succeed in acquiring or starting any such businesses, those 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 future 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 among dealers or collectors;
 

 
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the risk that we will face competition from established or larger competitors in the new markets we may enter, which could adversely affect the financial performance of any businesses we might acquire or start; 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 attractive 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 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 be unprofitable and harm our operating results.
 
One of those new services is a dealer financing program that involves our making short-term loans to collectibles dealers that would be collateralized by the collectibles they submit to us for authentication and grading. There is no assurance that we will succeed in achieving the objectives of our dealer finance program. Additionally the lending business is subject to a number of risks and uncertainties and we do not have loan underwriting or 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 adopt and implement, which could prove to be inadequate to prevent loan losses from occurring;
 
·          
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 income and could hurt 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 also have obtained a $7 million bank credit line that we will use to fund some of the dealer loans we make. We cannot assure that our cash flow from the operations of our dealer finance program will be sufficient to enable us to repay those borrowings. 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.
 
There are a limited number of individuals who have the expertise to authenticate and grade collectibles, and compete 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,
 

 
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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 adversely affect our growth initiatives and harm our business, 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.
 
We offer a warranty covering the coin, sportscard and stamps authentication and grading services that we provide. Under the terms of our warranty:
 
 
if any coin, sportscard or stamp that 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 coin or sportscard at the price paid for it by its then owner; and
 
 
if any coin, sportscard or stamp 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 coin, sportscard or stamp 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.
 
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. Increased competition could adversely affect our pricing and profit margins and our ability to achieve further growth. We cannot assure that we will continue to be successful in competing against existing or future competitors. Additionally, if we succeed in expanding our business into new collectibles markets in which there are companies that already provide authentication and grading services, we are likely to encounter intense competition from those companies. 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 incur losses and damage our financial condition.
 
We depend on our ability to protect and enforce our intellectual property rights.
 
We believe that our trademarks and other proprietary rights are important to our success and competitive position. We rely on a combination of trademark, copyright and trade secret laws to establish and protect our proprietary rights. However, the actions we take to establish and protect our trademarks 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 trademarks and proprietary rights by us. In addition, others may develop similar trade secrets or other intellectual property independently or assert rights in our trademarks 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.
 
Our unregistered trademarks could conflict with trademarks of others.
 
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.
 

 
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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.
 
Our reliance on a single source for principally all of our “tamper-evident,” clear plastic coin and sportscard holders exposes us to potential supply problems.
 
We place all of the coins and 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 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 replacements of comparable quality in a relatively short period of time, we could lose customer orders or incur additional costs, which 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 located, is particularly vulnerable to earthquakes and fires that could result in damage to our computer systems; however, 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 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.
 

 
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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 have now completed the documentation and testing of the effectiveness of our internal control over financial reporting, as required by Section 404 of the Sarbanes-Oxley Act of 2002, we expect we will have to incur continuing 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.
 
If our quarterly results are below the expectations of securities market analysts and investors, 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 financial results difficult. These factors include:
 
 
increases or decreases in number of collectibles 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
 
 
the actions of our competitors.
 
If our quarterly operating results fall below the expectations of securities market analysts and investors due to these or other risks, securities 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.
 
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.
 
Ownership of shares by our directors and executive officers.
 
As of June 30, 2005, our officers and directors and their affiliates owned approximately 12% of the outstanding shares of our common stock. By reason of that ownership and their positions with our Company, those stockholders continue to have the ability to exercise influence over our business. The interests of these stockholders may differ from the interests of other stockholders and their concentration of ownership also could discourage or prevent attempts to effect a change in control of our Company.
 

 
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We do not intend to pay dividends.   As a result, stockholders will benefit from an investment in our common stock only if it appreciates in value.
 
We have not declared or paid any cash dividends on our common stock since our initial public offering in 1999. Moreover, we currently intend to retain any future earnings to finance our operations and for the further expansion and growth of our business and, for that reason, do not expect to pay any cash dividends in the foreseeable future. As a result, the success of an investment in our common stock will depend upon any future appreciation in its value. We cannot guarantee that our common stock will appreciate in value or even maintain the price at which stockholders have purchased their shares.
 
ITEM 2. PROPERTIES
 
We lease approximately 59,000 square feet for our California-based headquarters under a nine-year lease that commenced in November 2000. We currently sublease 2,184 square feet of this office space to a sub-tenant with an expiration date that coincides with the expiration of the Company's nine-year lease. We believe that our leased offices are sufficient for our business requirements.
 
ITEM 3. LEGAL PROCEEDINGS
 
Bill Miller v. Collectors Universe, Inc. The Company has been named as a defendant in this action, which has been brought in the Superior Court of California, County of Orange, by Bill Miller, a former employee of the Company, who was president of one of the Company’s collectibles sales businesses that was sold in 2004 and an expert in the authentication of autographs and memorabilia. The complaint alleges that the Company had issued certificates of authentication bearing his name without his consent, in violation of a California statute prohibiting unauthorized appropriation of a person’s name, signature or likeness. The statute entitles the person whose name, signature or likeness has been misappropriated, in violation of the statute, to recover the greater of $750 or the actual damages suffered as a result of the unauthorized use, and any profits from the unauthorized use that are attributable to the use and are not taken into account in computing the actual damages. Although Plaintiff’s complaint does not state the amount of damages he is seeking, during the discovery phase of the action, plaintiff’s counsel has asserted that he is entitled to recover damages in excess of $10 million based on the assertion that the statue entitles plaintiff to $750 per issued certificate of authenticity. The Company has denied plaintiff’s allegations, including a denial that the use of the certificates was unauthorized and a denial that he has suffered damages, and the Company is vigorously defending against the lawsuit. The Company believes, moreover, that it has meritorious defenses to plaintiff’s claims and that it will not incur any material liability to plaintiff in this action. However, there is little interpretive history with respect to the statute, creating a number of relatively novel factual and legal issues, and for that reason, it is not possible to predict with certainty the ultimate outcome of the trial, which is scheduled to take place in October 2005.
 
The Company also is named, from time to time, as a defendant in lawsuits that arise in the ordinary course of its business. Management of the Company believes that none of such lawsuits that are currently pending against it is likely to have a material adverse effect on the Company.
 
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
 
None.
 

 
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EXECUTIVE OFFICERS OF REGISTRANT
 
Name
 
Age
 
Positions
Michael R. Haynes
 
54
 
Chief Executive Officer
David G. Hall
 
58
 
President
Michael J. Lewis
 
61
 
Senior Vice President - Finance and Chief Financial Officer(1)
Joseph J. Wallace
 
45
 
Vice President Finance and Chief Financial Officer(1)
 
 
(1)
Effective as of September 15, 2005, Mr. Lewis will become Senior Vice President of Finance and Mr. Wallace, who has been the Company’s Vice President of Finance since November 2004 and Controller since June 2004, will assume the position of Chief Financial Officer.
 
MICHAEL R. HAYNES has served as Chief Executive Officer and Director since January 1, 2003. He served as Chief Operating Officer, Chief Financial Officer and Director of Tangible Asset Galleries, Inc, a distributor of fine art, from 2000 to 2002. He has been President, Chief Operating Officer and/or Chief Financial Officer of eight collectibles, precious metals, specialty retail, distribution, e-commerce and manufacturing businesses. Overall, Mr. Haynes has more than 25 years of experience in managing the growth and development of growth companies, which includes over 19 years experience in managing both public and private companies engaged in the business of selling collectibles at auction, retail and wholesale. He was also one of the co-founding board members of the Industry Council for Tangible Assets, a Washington, D.C. trade association for dealers and auctioneers of tangible and collectible assets, where he served for nine years. Mr. Haynes holds a Master's degree in Business and a Bachelor of Science degree in mechanical engineering, both from Southern Methodist University. He is a Certified Public Accountant and a Certified Financial Planner.

DAVID G. HALL has served as President of Collectors Universe, Inc. since September 2001. From April 2000 to September 2001, Mr. Hall served as our Chairman of the Board and Chief Executive Officer. Mr. Hall also has served as Chairman of the Board and a Director of Professional Coin Grading Services, Inc., the Company’s predecessor, since it was founded in February 1986 and also served as its President and Chief Executive Officer until January 1999. Mr. Hall was honored in 1999 by COINage Magazine as Numismatist of the Century, along with 14 others. In 1990, Mr. Hall was named an Orange County Entrepreneur of the Year by INC. magazine. In addition, he has written A Mercenary’s Guide to the Rare Coin Market, a book dedicated to coin collecting. Mr. Hall is also a member of the Professional Numismatists Guild.

MICHAEL J. LEWIS has served as Chief Financial Officer of Collectors Universe, Inc. since October 2001. Effective September 15, 2005, Mr. Lewis will become Senior Vice President - Finance of the Company. At that time, his duties as Chief Financial Officer will be assumed by Joseph J. Wallace, the Company’s Vice President of Finance and Controller. From January 2000 to October 2001, Mr. Lewis was a private investor. In 1998, Mr. Lewis was Chief Financial Officer of the Young Presidents’ Organization. During 1999, Mr. Lewis was an associate with Eureka Financial Markets, a venture capital firm. From 1994 to 1997, Mr. Lewis served as Chief Executive Officer of National Case Management. Prior to that time, Mr. Lewis served as a Financial Consultant or as Chief Financial Officer in several companies, including Chief Financial Officer of Western Digital Corporation and Emulex Corporation.

JOSEPH J. WALLACE will become the Company’s Chief Financial Officer effective as of September 15, 2005. He has been the Company’s Vice President of Finance since November 2004 and its Controller since June 2004. From 1997 to 2003, Mr. Wallace was Vice President of Finance, Chief Financial Officer and Secretary of STM Wireless, Inc., a public traded company engaged in the business of developing, manufacturing and marketing satellite communications products and services, which filed for Chapter 11 protection under the Bankruptcy Code in February 2003. Mr. Wallace is a Fellow of the Institute of Chartered Accountants, a member of the Institute of Certified Public Accountants, in Ireland, and a CPA in the State of California.




 
27


PART II
 
ITEM 5.  MARKET FOR COMMON STOCK AND RELATED STOCKHOLDER MATTERS
 
Our common stock is listed on the Nasdaq National Market, trading under the symbol CLCT. The following table sets forth the high and low closing prices of our common stock, as reported by NASDAQ for each of the fiscal quarters in the fiscal years ended June 30, 2005 and 2004:
 
Fiscal 2005
 
High
 
Low
 
First Quarter
 
$
14.87
 
$
10.53
 
Second Quarter
   
20.43
   
14.50
 
Third Quarter
   
21.60
   
17.78
 
Fourth Quarter
   
19.34
   
14.82
 

Fiscal 2004
 
High
 
Low
 
First Quarter
 
$
3.80
 
$
3.35
 
Second Quarter
   
10.60
   
3.45
 
Third Quarter
   
12.44
   
7.45
 
Fourth Quarter
   
14.09
   
9.33
 
 
The Company had 111 holders of record of its common stock and approximately 2,184 beneficial owners on June 30, 2005.
 
Dividends and Share Repurchases
 
We do not intend to declare or pay cash dividends for the foreseeable future, as it is our current policy to retain all earnings to support future growth and expansion. In addition, there are restrictions on the payment of dividends arising from the Company’s new line of credit (see note 9 to the consolidated financial statements).
 
Pursuant to a program approved by the Board of Directors in 2000, the Company purchased 125,000 of its shares at an average price of $8.16 per share during the period from September 25, 2000 to December 28, 2000. Although we do not currently have plans to do so, depending on market conditions and the alternatives for the use of the Company’s cash that may be in excess of our current requirements, the Board of Directors may consider adopting additional stock repurchase programs in the future.
 
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
 
The selected operating data for the fiscal years ended June 30, 2005, 2004 and 2003, and the selected balance sheet data at June 30, 2005 and 2004, that are set forth below are derived from the Company’s audited consolidated financial statements included elsewhere in this Report. The selected operating data for the fiscal years ended June 30, 2002 and 2001 and the related balance sheet data at June 30, 2003, 2002 and 2001 were derived from audited consolidated financial statements that are not included in this Report. The following data should be read in conjunction with our consolidated financial statements and the related notes thereto and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included below in this Report.
 
As previously disclosed, in December 2003 the Company approved, and during the balance of fiscal 2004 implemented, a plan to dispose of its collectibles sales businesses. As a result, the consolidated selected financial data set out below for the five years ended June 30, 2005 have been restated to classify the assets and related liabilities of those businesses as held for sale and the related operating results as discontinued operations. Therefore, for fiscal years 2001 through 2003, the loss from discontinued operations reflects the after-tax results of operations of these businesses in those years. In fiscal 2004, the loss from discontinued operations reflects the after-tax results of operations for these businesses through the respective dates of their disposal, plus any gain or loss recognized on the disposal of those businesses. In fiscal 2005, the loss from discontinued operations reflects the after tax net loss incurred on the disposal of the remaining assets of those businesses, plus additional consideration recognized on the sale of the discontinued businesses that became determinable in the period.

 
28


In the third quarter of fiscal 2005, we completed a public offering in which we sold a total of 3,450,000 shares of our common stock at a public offering price of $17.50 per share, of which 2,195,856 shares were sold by the Company. The net proceeds to us, after payment of underwriting commissions and offering expenses, were approximately $35,657,000.
 
   
Years Ended June 30, (1)
 
   
(in thousands, except per share data)
 
   
2005
 
2004
 
2003
 
2002
 
2001
 
Consolidated Statement of Operations Data:
     
Net revenues
 
$
33,607
 
$
26,420
 
$
20,337
 
$
18,635
 
$
21,373
 
Cost of revenues
   
12,239
   
10,322
   
8,754
   
7,935
   
8,929
 
Gross profit
   
21,368
   
16,098
   
11,583
   
10,700
   
12,444
 
Selling, general and administrative expenses
   
13,901
   
11,829
   
11,486
   
11,884
   
11,044
 
Settlement of lawsuit
   
500
   
-
   
-
   
-
   
-
 
Amortization of goodwill
   
-
   
-
   
-
   
90
   
60
 
Impairment of goodwill
   
-
   
-
   
6
   
51
   
-
 
Operating income (loss)
   
6,967
   
4,269
   
91
   
(1,325
)
 
1,340
 
Interest income, net
   
906
   
135
   
94
   
191
   
855
 
Other income (expense), net
   
26
   
(25
)
 
(6
)
 
(20
)
 
(34
)
Income (loss) before provision (benefit) for income taxes
   
7,899
   
4,379
   
179
   
(1,154
)
 
2,161
 
Provision (benefit) for income taxes
   
3,141
   
1,581
   
(557
)
 
(502
)
 
949
 
Income (loss) from continuing operations
   
4,758
   
2,798
   
736
   
(652
)
 
1,212
 
Income (loss) from discontinued operations, net of gain
on sales of discontinued businesses (net of income  taxes)
   
60
   
(1,068
)
 
(2,202
)
 
(1,858
)
 
(1,861
)
Cumulative effect of accounting change (net of income taxes)
   
-
   
-
   
(8,973
)
 
-
   
-
 
Net income (loss)
   
4,818
 
$
1,730
 
$
(10,439
)
$
(2,510
)
$
(649
)
                                 
Net income (loss) per basic share:(2)
                               
Income (loss) from continuing operations
 
$
0.68
 
$
0.45
 
$
0.12
 
$
(0.10
)
$
0.19
 
Income (loss) from discontinued operations, net of gain on sales of 
  discontinued businesses (net of income taxes)
   
0.01
   
(0.17
)
 
(0.35
)
 
(0.30
)
 
(0.29
)
Cumulative effect of accounting change (net of income taxes)
   
-
   
-
   
(1.45
)
 
-
   
-
 
Net income (loss)
 
$
0.69
 
$
0.28
 
$
(1.68
)
$
(0.40
)
$
(0.10
)
                                 
Net income (loss) per diluted share: (2)
                               
Income (loss) from continuing operations
 
$
0.64
 
$
0.44
 
$
0.12
 
$
(0.10
)
$
0.19
 
Income (loss) from discontinued operations, net of gain  on sales of discontinued businesses (net of income taxes)
   
0.01
   
(0.17
)
 
(0.35
)
 
(0.30
)
 
(0.29
)
Cumulative effect of accounting change (net of income taxes)
   
-
   
-
   
(1.43
)
 
-
   
-
 
Net income (loss)
 
$
0.65
 
$
0.27
 
$
(1.66
)
$
(0.40
)
$
(0.10
)
                                 
Weighted average shares outstanding:(2)
                               
Basic
   
7,013
   
6,170
   
6,205
   
6,347
   
6,279
 
Diluted
   
7,452
   
6,463
   
6,294
   
6,347
   
6,408
 
                                 
Balance Sheet Data:
                               
Cash and cash equivalents
 
$
65,439
 
$
21,454
 
$
4,482
 
$
4,947
 
$
5,874
 
Working capital - continuing operations
   
68,576
   
22,308
   
4,566
   
5,621
   
7,943
 
Working capital - discontinued operations
   
338
   
991
   
13,803
   
13,732
   
12,682
 
Total assets - continuing operations
   
75,123
   
32,690
   
15,926
   
11,503
   
13,588
 
Total assets - discontinued operations
   
411
   
1,384
   
16,365
   
34,006
   
33,281
 
Stockholders' equity
   
70,566
   
29,366
   
26,319
   
37,128
   
39,550
 
 
(1)
Prior to fiscal 2003 the Company’s fiscal year ended on the Saturday closest to June 30 and, as a result, fiscal 2002 ended on June 29, 2002. Beginning with fiscal 2003 the Company changed its fiscal year end to June 30. For clarity of presentation, fiscal 2002 is reported as having ended on June 30.
 
(2)
Per share data and weighted average shares outstanding in fiscal 2002 and 2001 have been retroactively adjusted for a 1-for-4 reverse stock split of our outstanding shares, which was effectuated on December 9, 2002.
 
 
 


 
29


ITEM 7.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the “Selected Consolidated Financial Data” and our Consolidated Financial Statements and related notes, included elsewhere in Part II of this Report. This discussion also should be read in conjunction with the Section of this Report, entitled “Factors That Could Affect Our Future Financial Performance,” included in Part I of this Report, which contains information about certain risks and uncertainties that can affect our business and our financial performance in the future.  
 
Introduction and Overview
 
Our Business
 
We provide authentication and grading and other services to dealers and collectors of high-value collectible coins, sportscards, autographs and stamps that we believe add value to those collectibles by enhancing their marketability and, thereby, providing increased liquidity to the dealers and collectors that buy and sell these types of collectibles.
 
We principally generate revenues from the fees paid by dealers and collectors for our authentication and grading services. To a much lesser extent, we also generate revenues from the sale of advertising on our websites; the sale of printed publications and collectibles price guides and advertising in such publications; and the sale of historical data and information about the collectibles authenticated and graded by us.
 
Discontinued Operations
 
During the period from 1999 through the latter part of fiscal 2004, we also were engaged in the business of marketing and selling collectible coins, sportscards and sports entertainment and historical memorabilia. For the most part, those sales were made at multi-venue auctions that were conducted by our collectibles sales divisions, including Bowers and Merena Galleries and Kingswood Coin Auctions for rare coins, Superior Sports Auctions for vintage sportscards and sports memorabilia, Odyssey Publications for entertainment and historical memorabilia and Lynn Knight Currency Auctions for currency. We also sold collectible coins, at retail, by direct sales methods.
 
At the authorization of our Board of Directors, in December 2003, we adopted a plan to focus our financial and managerial resources, and collectibles expertise, on the operation and growth of our authentication and grading and other collectibles service businesses, and to divest our collectibles auctions and direct sales businesses. The decision to implement this plan was based on a number of factors and considerations that included, among others, the historical operating results of the collectibles sales and auction businesses, which had proved to be disappointing as compared to the operating results of our authentication and grading businesses; a lack of synergies between the collectibles sales and auction businesses and our authentication and grading businesses, which made it difficult to achieve operational efficiencies and cost savings; and the additional capital that we believed would be required to grow our auction and retail sales businesses in comparison to the lower capital requirements of our authentication and grading businesses.
 
Pursuant to that plan, during fiscal 2004 we sold our collectibles sales businesses. We also terminated the licenses under which we operated our David Hall Rare Coins Division, which had been engaged in the business of selling collectible coins at retail. However, we chose to retain and separately sell the collectibles inventories and collect the outstanding accounts receivables of those businesses. By June 30, 2005 we had substantially liquidated those retained assets.
 
In accordance with Statement of Financial Accounting Standard (SFAS) No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, the assets and related liabilities of the collectible sales businesses have been classified as held for sale, their related operating results have been classified as discontinued operations and prior period financial statements have been restated on that same basis. See “Selected Consolidated Financial Data” included in this Annual Report and our consolidated financial statements contained in Part II of this Report.
 
As a result of our divestiture of our collectibles sales businesses, the discussion that follows focuses almost entirely on our authentication and grading businesses, which comprise our continuing operations.
 

 
30


Factors That Can Affect our Financial Position and Operating Results
 
Factors that Can Affect our Revenues and Cash Flows. The provision of authentication and grading services has provided relatively stable and predictable cash flows for us, as the fees for a significant proportion of the authentication and grading submissions we receive are prepaid. In the years ended June 30, 2005, 2004 and 2003, respectively, we generated cash of $7,447,000, $6,068,000 and $838,000, respectively, from the operations of our continuing businesses.
 
During the year ended June 30, 2005 and 2004, we generated cash of $2,332,000 and $10,435,000 from the sales of our collectibles sales businesses and the liquidation of the retained inventories and accounts receivable of those businesses. As a result, at June 30, 2005, the remaining assets of those businesses, which we are in the process of liquidating, totaled $411,000, as compared to $1,384,000 at June 30, 2004. Therefore, it is not expected that the Company will generate any substantial cash flows from the sale of the remaining assets of the discontinued businesses in the future.
 
During the year ended June 30, 2005, five of our coin authentication and grading customers accounted for approximately 27% 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, would 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 45% decrease in revenues from that customer in the fourth quarter, compared to the third quarter of fiscal 2005. This reduction in revenues from that customer is expected to continue in fiscal 2006.
 
In addition, the Company’s cash flows from investing activities can be impacted by the extent to which the Company makes advances or receives repayments under the Dealer Financing Program that was initiated in fiscal 2005. Borrowings or repayments under the Company’s new line of credit, which will be classified as cash flows from financing activities, may offset the impact of such advances or repayment.
 
At June 30, 2005, we had cash and cash equivalents totaling $65,439,000, of which $35,657,000 represented the net proceeds from our sale, in a public offering, of 2,195,856 shares of our common stock in the third quarter of 2005.
 
We intend to use our cash resources to fund the growth of our authentication and grading businesses, including (i) the introduction of new services that we can offer our customers in our existing markets and (ii) the acquisition or start up of businesses that authenticate or grade other high-value collectibles or other high-value assets. A description of the new services we plan to introduce and the acquisition opportunities we are exploring is contained in the Section of this Report entitled “BUSINESS -- Our Growth Strategy” in Part I of this Report.
 
Factors Affecting our Gross Profit Margins. The gross profit margins on authentication and grading submissions are primarily affected by the mix of collectibles submitted to us for grading (i) between coins and sportscards and (ii) between vintage or “classic” coins and sportscards, on the one hand, and modern coins and sportscards, on the other hand. Generally, the prices for authentication and grading of collectible coins are higher than those charged for the grading of sportscards, autographs or stamps. In addition, our fees for authentication and grading of coins and sportscards vary depending on the “turn-around” time requested by our customers, because we charge higher fees for faster service times. Since, as a general rule, customers request faster turn-around times for vintage or classic coins and sportscards than they do for modern submissions, the mix of submissions between vintage and modern collectibles also affects our profit margin.
 
Impact of Economic Conditions on Financial Performance. We generate substantially all of our revenues from the high-value collectibles markets. Accordingly, our operating results are affected by the financial performance of those markets, which depends to a great extent on (i) discretionary consumer spending and, hence, on the availability of disposable income, (ii) other economic conditions, including prevailing interest and inflation rates, which can affect consumer confidence and the performance of the stock market and the precious metals markets, and (iii) the performance and volatility of the precious metals and stock markets. These conditions primarily affect the volume of purchases and sales of collectibles which, in turn, affects the volume of authentication and grading submissions to us, because our services facilitate commerce in collectibles. Accordingly, factors such as improving economic conditions which usually result in increases in disposable income and consumer confidence, and volatility in and declines in the prices of stocks and a weakening in the value of the U.S. Dollar, which lead
 

 
31


investors to increase their purchases of precious metals, such as gold bullion and other coins, and other collectibles, usually result in increases in submissions of collectibles for our services. By contrast, the volume of collectibles sales and purchases and, therefore, the volume of authentication and grading submissions, usually decline during periods characterized by recessionary economic conditions and by declines in disposable income and consumer confidence, and during periods characterized by increasing stock prices and relative stability in the stock markets. We believe that the strengthening of the economy in the United States, together with the weakening of the U.S. Dollar, coupled with some continuing uncertainties over the longer term direction of the stock markets, and the prospect of increased inflation and higher interest rates, have contributed to an increase in the demand for gold and other precious metals and, therefore, also to the increases in our authentication and grading revenues during the years ended June 30, 2005 and 2004, in each case as compared to the immediately preceding fiscal year.
 
The following table provides information regarding the respective numbers of coins, sportscards, autographs, stamps and currency that we graded or authenticated in the fiscal years ended June 30, 2005, 2004, and 2003 and their estimated values, which are the amounts at which those coins, sportscards, stamps and currency were insured by the dealers and collectors who submitted them to us for grading and authentication.
 
   
Units Processed
 
   
2005
 
 
2004
 
 
2003
 
Coins
   
1,670,000
   
58
%
 
1,241,000
   
53
%
 
917,000
   
46
%
Sportscards
   
1,084,000
   
38
%
 
998,000
   
43
%
 
1,058,000
   
53
%
Autographs
   
77,000
   
3
%
 
68,000
   
3
%
 
15,000
   
1
%
Stamps
   
26,000
   
1
%
 
16,000
   
1
%
 
12,000
   
-
 
Currency
   
3,000
   
-
   
-
   
-
   
-
   
-
 
Total
   
2,860,000
   
100
%
 
2,323,000
   
100
%
 
2,002,000
   
100
%

   
Declared Values (000)
 
   
 
2005
 
 
2004
 
 
2003
 
Coins
 
$
1,191,000
   
91
%
$
993,000
   
90
%
$
769,000
   
90
%
Sportscards
   
66,000
   
5
%
 
67,000
   
6
%
 
72,000
   
8
%
Autographs
   
26,000
   
2
%
 
31,000
   
3
%
 
7,000
   
1
%
Stamps
   
17,000
   
1
%
 
10,000
   
1
%
 
8,000
   
1
%
Currency
   
8,000
   
1
%
 
-
   
-
   
-
   
-
 
Total
 
$
1,308,000
   
100
%
$
1,101,000
   
100
%
$
856,000
   
100
%
 
Critical Accounting Policies and Estimates
 
General. In accordance with accounting principles generally accepted in the United States of America (“GAAP”), we record certain of our assets at the lower of cost or fair value. In determining the fair value of those assets, principally inventories and accounts receivable, we must make judgments, estimates and assumptions regarding circumstances or trends that could affect the value of those assets, such as economic conditions or trends that could impact our ability to realize the amounts at which our inventories are recorded, or to fully collect the accounts receivable shown, on our balance sheet. Those judgments, estimates and assumptions are made based on current information available to us at that time. Many of those conditions, trends and circumstances, however, are outside of our control and, if changes were to occur in economic conditions or trends on which our judgments or estimates were based, or unanticipated events were to occur, we may be required under GAAP to adjust our earlier estimates that are affected by those changes. Changes in such estimates may require that we reduce the carrying value of the affected assets on our balance sheet (which are commonly referred to as “write-downs” of the assets involved).
 
It is our practice to establish reserves or allowances to record such downward adjustments or “write-downs” in the carrying value of assets such as accounts receivable and inventory. Such write-downs are recorded as charges to income or increases in expense in our statement of operations in the periods when those reserves or allowances are established or increased to take account of changed conditions or events. As a result, our judgments, estimates and assumptions about future events, and changes in the conditions, events or trends upon which those
 

 
32


estimates and judgments were based, can and will affect not only the amounts at which we record those assets on our balance sheet, but also our results of operations.
 
The decisions as to the timing of adjustments or write-downs of this nature also require subjective evaluations or assessments about the effects and duration of events or changes in circumstances. For example, it is difficult to predict whether events, such as occurred on September 11, 2001, or increases in interest rates or economic slowdowns, will have short or longer term consequences for our business, and it is not uncommon for it to take some time after the occurrence of an event or the onset of changes in economic circumstances for their full effects to be measured. Therefore, management makes such estimates based upon the information available at that time and reevaluates and adjusts its reserves and allowances for potential write-downs on a quarterly basis.
 
Under GAAP, businesses also must make estimates or judgments regarding the periods during which, and also regarding the amounts at which, sales are recorded. Those estimates and judgments will depend on a number of factors, including whether customers are granted rights to return the products or reject or adjust the payment for the services provided to them (return rights).
 
In making our estimates and assumptions, we follow GAAP in order to enable us to make fair and consistent estimates of the fair value of assets and to establish adequate reserves or allowances for possible write-downs in their carrying values.
 
Set forth below is a summary of the accounting policies that we believe are material to an understanding of our financial condition and results of operations.
 
Revenue Recognition Policies. We record revenue at the time of shipment of the graded collectible to the customer. Our authentication and grading customers generally prepay our authentication and grading fees when they submit their collectibles to us for authentication and grading. We record those prepayments as deferred revenue until their graded collectibles are shipped back to them. At that time, we record the revenue from the authentication and grading services we have performed for the customer and deduct this amount from deferred revenue.
 
Accounts Receivable and the Allowance for Doubtful Accounts. In the normal course of business, we extend payment terms, usually of 30 days duration, to many of the larger, more creditworthy collectibles dealers who submit collectibles to us for authentication and grading on a recurring basis. We regularly review their accounts, estimate the amount of, and establish an allowance for, uncollectible amounts on a quarterly basis. The amount of that allowance is based on several factors, including the age and extent of significant past due accounts, and known conditions or trends that may affect the ability of account debtors to pay their accounts receivable balances. Estimates of uncollectible amounts are reviewed each quarter and, based on that review, are revised to reflect changed circumstances or conditions in the quarterly period they become known. For example, if the financial condition of certain dealers or economic conditions were to deteriorate, adversely affecting their ability to make payments on their accounts, increases in the allowance may be required. Since the allowance is created by a charge against income that is recorded in general and administrative expenses, an increase in the allowance will cause a decline in our operating results in the period when the increase is recorded.
 
Grading Warranty Costs. We offer a warranty covering the coins, sportscards and currency we authenticate and grade. We have recently begun offering a warranty covering the stamps that we authenticate and grade, if the dealer or collector requests that the stamp be returned to them in our tamper-evident clear plastic holders. Under the warranty, if any coin, sportscard, currency or stamp that was previously graded by us is later submitted to us for re-grading and either (i) receives a lower grade upon that resubmittal or (ii) is determined not to have been authentic, we will offer to purchase the coin, sportscard or stamp or, at our election, to pay the difference in value of the item at its original grade as compared with its lower grade. However, this warranty is voided if the coin, sportscard, currency or stamp, upon resubmittal to us, is not in the same tamper evident clear plastic holder in which it was placed at the time we last graded it, or shows signs of tampering. We accrue for estimated warranty costs based on historical trends and related experience. To date our reserves have proved to be adequate. However, if warranty claims were to increase in relation to historical trends and experience, we would be required to increase our warranty reserves and incur additional charges that would have the effect of reducing our income in those periods during which the warranty reserve is increased.
 

 
33


Inventory Valuation Reserve. Our remaining collectibles sales inventories, which totaled approximately $189,000 at June 30, 2005 and our coin and other collectibles inventories used in our continuing operations, are valued at the lower of cost or market and have been reduced by an inventory valuation allowance to provide for declines in the estimated value of those inventories. The amount of the allowance is determined on the basis of market knowledge, historical experience and estimates concerning future economic conditions that may impact the sales values of our collectibles inventories. Additionally, due to the relative uniqueness of some of the collectibles included in our collectibles inventory, their valuation often involves judgments that are more subjective than the judgments involved in valuing more standardized products sold by other businesses. If events or circumstances, such as changes in economic conditions, occur that we believe will make it more difficult, or will cause us to reduce the prices at which we will be able, to sell the collectibles, it may become necessary to increase the allowance. Increases in this allowance will cause a decline in operating results, because such increases are recorded by charges against income.

Results of Operations

The following table sets forth certain financial data, expressed as a percentage of net revenues, derived from our statements of operations for the respective periods indicated below:
   
Fiscal Years Ended June 30,
 
   
2005
 
2004
 
2003
 
Net revenues
   
100.0
%
 
100.0
%
 
100.0
%
Cost of revenues
   
36.4
%
 
39.1
%
 
43.0
%
Gross profit
   
63.6
%
 
60.9
%
 
57.0
%
Operating expenses:
                   
Selling and marketing expenses
   
10.5
%
 
12.0
%
 
13.0
%
General & administrative expenses
   
30.8
%
 
32.7
%
 
43.6
%
Settlement of lawsuit
   
1.5
%
 
-
   
-
 
Total operating expenses
   
42.8
%
 
44.7
%
 
56.6
%
Operating income
   
20.8
%
 
16.2
%
 
0.4
%
Interest income, net
   
2.7
%
 
0.5
%
 
0.5
%
Other, net
   
0.1
%
 
(0.1
%)
 
-
 
Income before provision (benefit) for income taxes
   
23.6
%
 
16.6
%
 
0.9
%
Provision (benefit) for income taxes
   
9.4
%
 
6.0
%
 
(2.7
%)
Income from continuing operations
   
14.2
%
 
10.6
%
 
3.6
%
Income (loss) from discontinued operations, net of gain on sales of
discontinued businesses (net of income taxes)
   
0.1
%
 
(4.1
%)
 
(10.8
%)
Cumulative effect of accounting change (net of income taxes)
   
-
   
-
   
(44.1
%)
Net income (loss)
   
14.3
%
 
6.5
%
 
(51.3
%)
 
Net Revenues. Net revenues consist primarily of fees generated from the grading and authentication of sportscards, coins and stamps and, to a much lesser extent, revenues from the sale of advertising and the publication of collectibles magazines. Net revenues are determined net of discounts and allowances.
 

 
34


The following tables sets forth certain information regarding the increases in net revenues and in the number of collectibles authenticated and graded in fiscal 2005, fiscal 2004 and fiscal 2003:
 
   
2005
 
2004
 
2005 vs. 2004
 
                   
Increase (Decrease)
 
       
 
% of Net
     
 
% of Net
 
 
Revenues
 
 
Units Processed
 
   
Amount
 
Revenues
 
Amount
 
Revenues
 
Amounts ($)
 
Percent
 
Number
 
Percent
 
   
(Dollars in thousands)
         
Coins
 
$
23,203
   
69.0
%
$
17,474
   
66.1
%
$
5,729
   
32.8
%
 
429,000
   
34.6
%
Sportscards
   
8,143
   
24.2
%
 
7,126
   
27.0
%
 
1,017
   
14.3
%
 
86,000
   
8.6
%
Other collectibles(1)
   
2,261
   
6.8
%
 
1,820
   
6.9
%
 
441
   
24.2
%
 
22,000
   
26.2
%
   
$
33,607
   
100.0
%
$
26,420
   
100.0
%
$
7,187
   
27.2
%
 
537,000
   
23.1
%

   
2004
 
2003
 
2004 vs. 2003
 
                   
Increase (Decrease)
 
       
 
% of Net
     
 
% of Net
 
 
Revenues
 
 
Units Processed
 
   
Amount
 
Revenues
 
Amount
 
Revenues
 
Amounts ($)
 
Percent
 
Number
 
Percent
 
   
(Dollars in thousands)
         
Coins
 
$
17,474
   
66.1
%
$
12,171
   
59.8
%
$
5,303
   
43.6
%
 
324,000
   
35.3
%
Sportscards
   
7,126
   
27.0
%
 
6,946
   
34.2
%
 
180
   
2.6
%
 
(60,000
)
 
(5.7
)%
Other collectibles(1)
   
1,820
   
6.9
%
 
1,220
   
6.0
%
 
600
   
49.2
%
 
57,000
   
211.1
%
   
$
26,420
   
100.0
%
$
20,337
   
100.0
%
$
6,083
   
29.9
%
 
321,000
   
16.0
%
 
(1)
Other collectibles consisted of autographs, stamps and currency in fiscal 2005 and autographs and stamps in 2004 and 2003.
 
Fiscal 2005 vs. 2004. The number of coins, sportcards and other collectibles (consisting of autographs, stamps and currency) authenticated or graded in 2005 increased by 34.6%, 8.6% and 26.2%, respectively, in 2005, as compared to 2004, resulting in a 23.1% increase in the number of units authenticated and graded and a 27.2% increase in net revenues. Also contributing to the increase in net revenues in 2005 were increases in sales of advertising and collectors club memberships totaling approximately $920,000 (which includes an approximate $319,000 increase in on-line advertising) in 2005, as compared to 2004. The average of the service fees earned for all collectibles was approximately the same in 2005 and 2004. However, modern coin revenues, for which the Company earns a lower average service fee than for vintage coin submissions, accounted for a higher proportion of the coins authenticated and graded in 2005, than in 2004. As a result, in 2005, the increase in the number of coins authenticated and graded was greater than the increase in the net revenues.
 
Fiscal 2004 vs. 2003. The 30% increase in net revenues in 2004, compared to 2003, was attributable to an overall increase of 16% in the number of collectibles authenticated and graded, including a 35.3% increase in the number of coins authenticated and graded, in 2004 as compared to 2003. The average fees paid for the grading of coins was higher in 2004 than in 2003, due primarily to customers requesting faster turnaround times in 2004, compared to 2003. Coins accounted for 53% of the total collectibles graded in fiscal 2004 as compared to 46% in fiscal 2003. Additionally, while the number of sportscards graded declined by 5.7% in fiscal 2004, as compared to 2003, sportscard grading revenues increased to $7,126,000 in fiscal 2004 from $6,946,000 in fiscal 2003, because 2003 included a large bulk order for the grading of newly manufactured sportscards, for which the average selling price was lower than for the grading of sportscards submitted by dealers and collectors.
 
We believe that the increases in the demand for our coin grading services, both in 2005 and in 2004, in each case as compared to the prior year, were largely attributable to two factors: (i) an increase in purchases and sales of collectible and gold bullion coins by investors, which we believe was due in large part to a shift by investors of some of their funds from marketable securities to tangible assets, primarily in response to the decline in the value of the U.S. dollar and uncertainties and volatility in the stock markets, and (ii) new marketing programs that we initiated in the second half of fiscal 2004. We believe that the increase in the number of other collectibles graded in 2005 versus 2004 was due largely to greater acceptance of and, therefore greater demand for, our grading services particularly among stamp dealers and collectors.
 

 
35


Gross Profit. Gross profit is calculated by subtracting the cost of revenues from net revenues. Cost of revenues consist primarily of labor to grade and authenticate coins, sportscards, autographs and stamps, production and printing costs, credit cards fees, warranty expense, and occupancy, security and insurance costs which directly relate to providing grading and authentication services. Gross profit margin is gross profit stated as a percent of net revenues.
 
   
Fiscal Year Ended June 30,
(Dollars in thousands)
 
   
2005
 
2004
 
2003
 
Gross profit
 
$
21,368
 
$
16,098
 
$
11,583
 
Gross profit margin
   
63.6
%
 
60.9
%
 
57.0
%
 
The increase in the gross profit margin in 2005, as compared to 2004, was primarily attributable to (i) increases of 30% in coin authentication and grading revenues, on which we realize higher margins than on authentication and grading submissions of sportscards and other collectibles; (ii) the increases in net revenues (described above), which caused the fixed elements of our costs of revenues to represent a lower percentage of total revenues than in 2004; and (iii) increases, as compared to 2004, in sales of website advertising, for which the cost of sales are minimal.
 
The increase in our gross profit margin in 2004, as compared to 2003, was due to a combination of factors, the most important of which consisted of (i) the increase in grading submissions of coins, on which we realize higher margins than on submissions of other collectibles for grading, and (ii) an overall increase in net revenues, which caused the fixed elements of our cost of revenues to represent a lower percentage of total revenues in 2004 as compared to 2003.
 
Selling and Marketing Expenses
 
Selling and marketing expenses are comprised primarily of advertising and promotions costs, trade-show related expenses, customer service personnel costs and third party consulting costs.
 
   
Fiscal Year Ended June 30,
(Dollars in thousands)
 
   
2005
 
2004
 
2003
 
Selling and marketing expenses
 
$
3,534
 
$
3,165
 
$
2,615
 
As a percentage of net revenues
   
10.5
%
 
12.0
%
 
12.9
%
 
The increase of $369,000 in selling and marketing expenses in 2005, compared to 2004, was primarily attributable to increases in general marketing expenses (customer service personnel, advertising and trade-show related costs) in 2005. Notwithstanding those increases, however, as a percentage of net revenues, selling and marketing expenses decreased from 12.0% of net revenues in 2004 to 10.5% in 2005, indicating that we were able to increase authentication and grading revenues and sales of advertising without having to make commensurate increases in our selling and marketing expenses. The increase in selling and marketing expenses of $550,000 in 2004, compared to 2003, was due primarily to an increase of $370,000 in trade-show related costs and other selling expenses in 2004, compared to 2003. However, notwithstanding that increase, as a percentage of net revenues, sales and marketing expenses decreased from 12.9% in 2003 to 12.0% in 2004.
 
General and Administrative. General and administrative (“G&A”) expenses primarily include wages and payroll-related expenses, advertising and promotional expenses, facility and security expenses, outside professional fees and service charges, travel-related expenses and other general administrative expenses.
 
   
Fiscal Year Ended June 30,
(Dollars in thousands)
 
   
2005
 
2004
 
2003
 
General & administrative expenses
 
$
10,367
 
$
8,664
 
$
8,871
 
As a percentage of net revenues
   
30.8
%
 
32.7.
%
 
43.6
%
 
Although, as indicated in the table above, G&A expenses increased by $1,703,000 in 2005, as compared to 2004, such expenses did not increase at the same rate as did net revenues, due primarily to improvements in
 

 
36


 
operating efficiencies and staff reductions we were able to make as a result of the disposition of our collectibles sales businesses. Therefore, as a percentage of net revenues, G&A expenses declined to 30.8% in 2005 from 32.7% for 2004.  In dollar terms, the larger value components of the increases in G&A expenses in 2005, compared to 2004, consisted primarily of (i) increases of approximately $320,000 in legal fees, including fees incurred on litigation matters, such as the Real Legends lawsuit (discussed below); (ii) approximately $185,000 of costs incurred in connection with the launch of our new currency grading service during 2005; (iii) consulting fees and audit costs of approximately $400,000 incurred in connection with the documentation and testing of our internal control over financial reporting, as required by Section 404 of the Sarbanes-Oxley Act 2002; (iv) new business development personnel and outside consulting costs of $263,000 incurred to develop and maintain our knowledge base in coins and to identify and analyze acquisition opportunities, and (v) general expenses and infrastructure costs incurred to support the increased volume of business that we conducted in 2005, as compared with 2004.
 
In 2004, G&A expenses decreased both in absolute dollars, by $207,000, and as a percentage of net revenues to 32.7% from 43.6%, as compared to 2003. The percentage decrease was primarily attributable to the 30% increase in our net revenues in 2004. The dollar decrease in 2004, as compared to 2003, was the result primarily of (i) a reduction in administrative personnel made possible by the disposition of the collectibles sales businesses and (ii) a reduction in consulting fees incurred for services rendered to us in connection with securing State Enterprise Zone Tax Credits in 2004, as compared to 2003, which more than offset increases in G&A expenses that were attributable to the increases in grading submissions in fiscal 2004, as compared to fiscal 2003.
 
Settlement of Lawsuit. In January 2005, without any admission of wrongdoing, we settled a legal action brought in the Superior Court of California for the County of San Diego, by Real Legends, Inc., a seller of sports cards (plaintiff) against When It Was a Game (“WIWAG”), a sports card dealer, and against us as a co-defendant. Pursuant to the settlement terms, all of the claims asserted against the Company by plaintiff were settled and plaintiff terminated the litigation, with prejudice, and we paid plaintiff $600,000, of which $100,000 was reimbursed to us by one of our insurers. As a result, the net cost to us of the settlement in 2005 was $500,000, or 1.5% of our net revenues.
 
Goodwill Impairment. In 2003, we recorded, as part of operating expenses, a non-cash goodwill impairment charge of $6,000 related to continuing operations.
 
Interest Income, Net. Interest income is generated on cash balances that we invest primarily in highly liquid money market accounts, short-term bank certificates of deposit and commercial paper instruments. Interest income, net was $906,000 in 2005, $135,000 in fiscal 2004, and $94,000 in fiscal 2003. The increase in interest income in 2005 compared to 2004 resulted primarily from increases in our cash, cash equivalent and short-term investment balances that were attributable to (i) the cash generated from the disposition of our collectibles sales businesses, (ii) the increases in income generated by our authentication and grading businesses, and (iii) the sale by us of 2,195,856 shares of our common stock in a public offering that we completed in the third quarter of 2005, which generated net proceeds to us of $35,657,000. Also contributing to the increase in interest income was an increase in the rates at which we earned interest on our cash and cash equivalent balances and the interest earned on the short-term advances that we made to one of our customers. The increase in interest income in 2004 as compared to 2003 was primarily attributable to interest earned on tax refunds that we received in fiscal 2004.
 
Provision (Benefit) for Income Taxes. The provision made for income taxes in fiscal 2005 and 2004 and the income tax benefits recorded in fiscal 2003 were calculated on the basis of our expected federal and state effective income tax rates for those years. Contributing to the income tax benefit in fiscal 2003 were $671,000 of California Enterprise Zone Hiring Tax Credits covering eligibility periods from 1999 to 2002, for which required governmental approvals were obtained in the second quarter of fiscal 2003.
 
Income (loss) from Discontinued Operations. As a result of our decision in fiscal 2004 to dispose of our collectibles sales businesses, in accordance with SFAS 144 the assets and related liabilities of those businesses have been classified as held for sale and their related operating results for fiscal years 2005, 2004 and 2003 have been classified as discontinued operations in the consolidated financial statements included in this Report. Therefore, in fiscal years 2003, the loss from discontinued operations (net of income taxes) related to the operations of those discontinued businesses for the entire fiscal year and included a goodwill impairment charge of $1,471,000. In fiscal 2005 and 2004, the income (loss) from discontinued operations includes (i) the losses from the operations of our discontinued collectibles sales businesses through the respective dates on which they were disposed of and
 

 
37


(ii) the losses or gains recognized on the sales of those businesses and the disposition of those assets (consisting primarily of inventories and accounts receivable) that we retained.
 
Cumulative Effect of Change in Accounting Principle, SFAS No. 142 required us to perform a transitional goodwill impairment test as of the beginning of fiscal 2003, the year of adoption of that new standard. Based on that test, it was determined that a substantial portion of our goodwill was impaired, and we recorded a non-cash after-tax charge of $8,973,000 or $1.43 per diluted share, as a cumulative effect of an accounting change, in fiscal 2003.
 
Quarterly Results of Operations and Seasonality
 
The following tables present unaudited quarterly financial information for each of the eight quarters beginning September 30, 2003 and ending on June 30, 2005. The information has been derived from our unaudited quarterly financial statements, which have been prepared by us on a basis consistent with our audited financial statements appearing elsewhere in this Form 10-K. The consolidated financial information set forth below includes all necessary adjustments, consisting only of normal recurring adjustments, that management considers necessary for a fair presentation of the unaudited quarterly results when read in conjunction with the consolidated financial statements and the notes thereto appearing elsewhere in this Form 10-K. These operating results, which reflect the reclassification of our results of operations between continuing operations and discontinued operations as a result of the disposition of our collectibles sales businesses, are not necessarily indicative of results that may be expected for any subsequent periods.
 
Generally, net revenues are lower during our second fiscal quarter that ends on December 31 than in other quarterly periods, which we believe is related primarily to the holidays that take place during that quarter. Additionally, while net revenues increased by 9% in the fourth quarter of fiscal 2005, compared to the fourth quarter of fiscal 2004, they declined by 5% compared to the third quarter of fiscal 2005, due primarily to the introduction of First Strike™ (see Introducing New Services in our existing markets) in the third quarter of fiscal 2005 that provided approximately $700,000 in revenue on approximately 75,000 graded units, which activity, by its nature, occurs only in the third fiscal quarter. Although there is no assurance as to the level of future activity, we anticipate that the third quarter of fiscal 2006 will also recognize First Strike revenue that, like fiscal 2005, will not continue into the fourth quarter of fiscal 2006.
 
In addition, although net revenues increased by 9% in the fourth quarter of fiscal 2005, as compared to the fourth quarter of fiscal 2005, that percentage increase was lower than the percentage increased in net revenues in each of the first three quarters of fiscal 2005, as compared to the respective corresponding quarters of fiscal 2004. We believe this slowing in the growth of net revenues was largely due to two unrelated factors. During the fourth quarter, we saw a slowing, which we believe is temporary, in the volume of gold trading, which impacts the volume of coins submitted to us for grading. Additionally, during the fourth quarter of fiscal 2005, the owner of our largest customer encountered an unexpected and serious medical problem, which led to a 45% decrease in revenues from that customer in the fourth quarter, compared with the third quarter of fiscal 2005. This reduction in revenues is expected to continue in fiscal 2006.
 
Our operating results also may fluctuate in the future due to a number of factors which are outside of our control. See “BUSINESS -- Factors That Could Affect Our Future Financial Performance” in Part I of this Report and “Factors That Can Affect our Financial Position and Operating Results” earlier in this Section of this Report for a discussion of those factors.
 

 
38



 
   
Quarters Ended
(In thousands, except per share data)
 
   
Sept. 30,
2003
 
Dec. 31,
2003
 
Mar. 31,
2004
 
June 30,
2004
 
Sept. 30,
2004
 
Dec. 31,
2004
 
Mar. 31
2005
 
June 30,
2005
 
Statement of Operations Data:
                                 
Net revenues
 
$
6,012
 
$
5,753
 
$
6,896
 
$
7,759
 
$
8,195
 
$
7,982
 
$
8,955
 
$
8,475
 
Cost of revenues
   
2,549
   
2,349
   
2,597
   
2,827
   
2,826
   
2,998
   
3,263
   
3,152
 
Gross profit
   
3,463
   
3,404
   
4,299
   
4,932
   
5,369
   
4,984
   
5,692
   
5,323
 
SG&A expenses
   
2,766
   
2,925
   
2,923
   
3,215
   
3,244
   
3,040
   
3,464
   
4,153
 
Settlement of lawsuit
   
-
   
-
   
-
   
-
   
-
   
500
   
-
   
-
 
Operating income
   
697
   
479
   
1,376
   
1,717
   
2,125
   
1,444
   
2,228
   
1,170
 
Interest and other income (expense), net
   
-
   
(5
)
 
7
   
108
   
64
   
112
   
225
   
531
 
Income before income taxes
   
697
   
474
   
1,383
   
1,825
   
2,189
   
1,556
   
2,453
   
1,701
 
Provision for income taxes
   
313
   
170
   
592
   
506
   
878
   
628
   
981
   
654
 
Income from continuing operations
   
384
   
304
   
791
   
1,319
   
1,311
   
928
   
1,472
   
1,047
 
Income (loss) from discontinued operations, net of gain
  on sales of discontinued businesses (net of income taxes)
   
47
   
(782
)
 
201
   
(534
)
 
(69
)
 
(7
)
 
(3
)
 
139
 
Net income (loss)
 
$
431
 
$
(478
)
$
992
 
$
785
 
$
1,242
 
$
921
 
$
1,469
 
$
1,186
 
Net income (loss) per basic share
                                                 
Income from continuing operations
 
$
0.06
 
$
0.05
 
$
0.13
 
$
0.21
 
$
0.21
 
$
0.15
 
$
0.21
 
$
0.12
 
Income (loss) from discontinued operations, net of 
  gain on sales of discontinued businesses
  (net of income taxes)
   
0.01
   
(0.13
)
 
0.03
   
(0.08
)
 
(0.01
)
 
-
   
-
   
0.02
 
Net income (loss)
 
$
0.07
 
$
(0.08
)
$
0.16
 
$
0.13
 
$
0.20
 
$
0.15
 
$
0.21
 
$
0.14
 
                                                   
Net income (loss) per diluted share:
                                                 
   Income from continuing operations
 
$
0.06
 
$
0.05
 
$
0.13
 
$
0.20
 
$
0.20
 
$
0.14
 
$
0.19
 
$
0.12
 
   Income (loss) from discontinued operations, net of
     gain on sales of discontinued businesses
     (net of income taxes)
   
0.01
   
(0.12
)
 
0.03
   
(0.08
)
 
(0.01
)
 
-
   
-
   
0.01
 
Net income (loss)
 
$
0.07
 
$
(0.07
)
$
0.16
 
$
0.12
 
$
0.19
 
$
0.14
 
$
0.19
 
$
0.13
 
                                                   
Weighted average shares outstanding
                                                 
Basic
   
6,172
   
6,167
   
6,135
   
6,201
   
6,214
   
6,242
   
7,113
   
8,479
 
Diluted
   
6,288
   
6,391
   
6,319
   
6,557
   
6,569
   
6,695
   
7,571
   
8,902
 

   
Quarters Ended
(In thousands)
 
   
Sept 30,
2003
 
Dec. 31,
2003
 
Mar. 31,
2004
 
June 30,
2004
 
Sept. 30,
2004
 
Dec. 31,
2004
 
Mar. 31,
2005
 
June 30,
2005
 
Selected Operating Data:
                                 
Units authenticated or graded
                                 
Coins
   
282
   
285
   
297
   
377
   
371
   
421
   
449
   
429
 
Sportscards
   
253
   
235
   
242
   
268
   
265
   
253
   
283
   
283
 
Autographs
   
9
   
14
   
25
   
20
   
22
   
17
   
15
   
23
 
Stamps
   
5
   
3
   
4
   
4
   
5
   
7
   
7
   
7
 
Currency
   
-
   
-
   
-
   
-
   
-
   
-
   
-
   
3
 
Total
   
549
   
537
   
568
   
669
   
663
   
698
   
754
   
745
 


Liquidity and Capital Resources
 
At June 30, 2005 , we had cash and cash equivalents of $65,439,000, as compared to $21,454,000 at June 30, 2004. Contributing to that increase were (i) net proceeds of $35,657,000 from our sale of 2,195,856 shares of common stock in a public offering that we completed in the third quarter of 2005; (ii) the receipt, in the year ended June 30, 2005, of cash consideration that became determinable in 2005, attributable to the sales of our collectibles sales businesses in fiscal 2004, together with cash from collections of accounts receivables and from sales of
 

 
39


collectibles inventories, which we chose to retain and liquidate ourselves, rather than sell to the buyers of those businesses; and (iii) increases in operating income that were primarily attributable to the increases in authentication and grading revenues.
 
Historically, we have relied on internally-generated funds, rather than borrowings, as our primary source of funds to support our grading operations. We expect our authentication and grading services to provide us with relatively stable and predictable cash flows, largely because (i) in many instances our customers prepay for those services at the time they submit their collectibles to us for authentication and grading, and (ii) in the event of a decline in authentication and grading submissions, we believe we would be able to reduce our variable operating costs to offset, at least partially, the impact on our cash flows of such a decline.
 
During the year ended June 30, 2005, operating activities of our continuing operations provided net cash of $7,447,000, which represented an increase of $1,379,000, from the $6,068,000 of net cash generated in fiscal 2004, that resulted primarily from an increase in income from continuing operations in fiscal 2005;
 
Investing activities used net cash of $257,000 during the year ended June 30, 2005, primarily to fund net short term advances to two of our established customers of $1,560,000 and capital expenditures of $256,000 substantially offset by $1,548,000 in cash received from the sales of our discontinued businesses; and
 
In the year ended June 30, 2005, financing activities provided net cash of $36 million, primarily from the sale of the shares in our public offering during the third quarter ended March 31, 2005 and, to a much lesser extent, exercises of employee stock options and sales of shares under our Employee Stock Purchase Plan.
 
Currently, we have the following outstanding obligations under operating leases, net of sublease income for years ending June 30:
 
2006 
 
$
1,092,000
 
2007 
   
1,164,000
 
2008 
   
1,150,000
 
2009 
   
1,157,000
 
2010 
   
414,000
 
   
$
4,977,000
 
 
In fiscal 2005 we organized Collectors Finance Corporation (“CFC”), as a wholly-owned subsidiary, to engage in the business of making short term loans primarily to coin dealers. All such loans are required to be collateralized by the delivery to us of collectibles coins for authentication and grading that have a fair market value of at least the amount of the loans. The loans are required to be repaid to us when those collectibles are returned to the dealers. To provide a source of funding for those short term loans, in June 2005 CFC obtained a revolving bank line of credit pursuant to a loan and security agreement that permits CFC to borrow, at any one time, up to the lesser of (i) $7,000,000 or (ii) an amount equal to 85% of the aggregate principal amount of those of its loan receivables that meet the bank’s eligibility criteria. Borrowings under that credit line, which has a term of two years, are secured by the loan receivables due CFC and a guarantee by the Company.
 
Other than (i) the obligation to repay any future borrowings under CFC’s revolving credit line, which we expect will be paid with the proceeds of repayments of the loans made by CFC to its borrowers or the sale of the items collateralizing those loans, and (ii) the cash requirements of our on-going operations, including the payment of rent obligations under operating leases, which we expect to be able to fund with internally generated funds, we do not have any material outstanding obligations.
 
We plan to use our cash resources, including the net proceeds from the sale of our shares in the public offering completed during the third quarter of 2005, to (i) expand existing and implement new marketing programs, (ii) introduce new services for our customers in our existing markets; (iii) acquire or start-up other high-value collectibles or high-value asset authentication and grading businesses, and (iv) fund working capital requirements, and for other general corporate purposes.
 

 
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Recent Accounting Pronouncements
 
In December 2004, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 123R, Share-Based Payment. SFAS No. 123R will eliminate the ability to account for share-based compensation transactions using Accounting Principles Board (“APB”) Opinion No. 25, Accounting for Stock Issued to Employees, and instead will require that such transactions be accounted for using a fair-value-based method with compensation costs related to share-based payments to be recognized in the financial statements. SFAS No. 123R also requires the tax benefit associated with these share-based payments to be classified as financing activities in the statement of cash flows rather than operating activities as currently required. SFAS No. 123R is effective as of the first annual period beginning after June 15, 2005. As a result, we have adopted SFAS No. 123R effective as of July 1, 2005. SFAS No. 123R offers alternative methods for determining the fair value of share based compensation. At the present time, we have not yet determined which alternative method we will use. Regardless of the method we choose to implement, SFAS No. 123R will result in increased compensation expenses in our reported consolidated results of operations. However, we are not able at this time to predict whether the increased compensation expense will be material as that will depend on, among other things, the number or amount of the share-based compensation we award and the prices of our common stock in the future.
 
In May 2005, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 154, Accounting Changes and Error Corrections. SFAS No. 154 replaces APB Opinion No. 20, Accounting Changes and FASB Statement No 3, Reporting Accounting Changes in Interim Financial Statements which required that most voluntary changes in accounting principle be recognized by including in net income of the period of the change the cumulative effect of changing to the new accounting principle. SFAS No. 154 will require retrospective application to prior periods’ financial statements of changes in accounting principle, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. This statement is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. We will adopt SFAS No. 154 for our fiscal year beginning July 1, 2005.
 
ITEM 7A.   QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
 
Market risk represents the risk of loss that may impact our financial position, results of operations or cash flows due to adverse changes in financial market prices, including interest rate risk, foreign currency exchange rate risk, commodity price risk and other relevant market rate or price risks.
 
Due to the cash and cash equivalent balances that we maintain, we are exposed to risk of changes in short-term interest rates. At June 30, 2005, we had $65,439,000 in cash and cash equivalents, primarily invested in a bank certificates of deposit, a money market fund and high grade commercial paper. Reductions in short-term interest rates could result in reductions in the amount of that income. However, the impact on our operating results of such changes is not expected to be material.
 
The Company has no activities that would expose it to foreign currency exchange rate risk or commodity price risks.
 


 
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ITEM 8.    FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

Index to Consolidated Financial Statements

 
Page
   
Report of Grant Thornton LLP, Independent Registered Public Accounting Firm
43
   
Report of Deloitte & Touche LLP, Independent Registered Public Accounting Firm
44
   
Consolidated Balance Sheets at June 30, 2005 and 2004
45
   
Consolidated Statements of Operations for the Years Ended June 30, 2005, 2004 and 2003
46
   
Consolidated Statements of Stockholders’ Equity For the Years Ended June 30, 2005, 2004 and 2003
47
   
Consolidated Statements of Cash Flows for the Years Ended June 30, 2005, 2004 and 2003
48
   
Notes to Consolidated Financial Statements For the Years Ended June 30, 2005, 2004 and 2003
50




 
42


REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM


Board of Directors and Stockholders
Collectors Universe, Inc. and Subsidiaries    


We have audited the accompanying consolidated balance sheet of Collectors Universe, Inc. and subsidiaries (the Company) as of June 30, 2005, and the related consolidated statements of operations, stockholders’ equity and cash flows for the year ended June 30, 2005. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audit.
 
We conducted our audit in accordance with standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
 
In our opinion, the consolidated financial statements referred to above, present fairly, in all material respects, the consolidated financial position of Collectors Universe, Inc. and subsidiaries as of June 30, 2005, and the results of their consolidated operations and their consolidated cash flows for the year ended June 30, 2005, in conformity with accounting principles generally accepted in the United States of America.
 
We have also audited Schedule II of Collectors Universe, Inc. and subsidiairies for the year ended June 30, 2005. In our opinion, this schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.
 
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of Collectors Universe, Inc. and subsidiaries’ internal control over financial reporting as of June 30, 2005, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated September 2, 2005, expressed an unqualified opinion thereon.

/s/ GRANT THORNTON LLP

Irvine, California
September 2, 2005



 
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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM