Business context and reporting period
This is DGSE Companies, Inc.’s unaudited Form 10-Q for the quarter and six months ended June 30, 2012. The filing identifies DGSE Companies, Inc. as the registrant, not Envela Corp. Results include its precious-metals, jewelry and collectibles operations; Superior Galleries is presented as discontinued operations. Southern Bullion Trading (SBT), acquired in September 2011, contributed to 2012 results.
The 2011 comparative figures are restated. The company said accounting irregularities dating from approximately the second quarter of 2007 could affect reported financial information, and that prior financial statements and information since then should not be relied upon. This 10-Q was filed concurrently with the delayed 2011 10-K and the first-quarter 2012 10-Q.
Key financial results
| Metric | Q2 2012 | Q2 2011, restated | Six months 2012 | Six months 2011, restated |
|---|---|---|---|---|
| Sales | $28.58 million | $30.64 million | $61.40 million | $53.61 million |
| Gross profit / margin | $4.01 million / 14.0% | $3.12 million / 10.2% | $10.74 million / 17.5% | $5.67 million / 10.6% |
| Operating income (loss) | $(2.12) million | $0.48 million | $(1.16) million | $0.90 million |
| Net income (loss), including discontinued operations | $(2.41) million | $0.24 million | $(1.91) million | $0.43 million |
| Net income (loss) per share | $(0.20) | $0.02 | $(0.16) | $0.04 |
For Q2, sales declined 7% year over year; for the first half, sales rose 15%. First-half operating cash flow from continuing operations was a use of $4.14 million, versus a source of $1.43 million in the prior-year period. Investing and financing used $0.86 million and $0.25 million, respectively. Cash fell to $1.73 million from $5.98 million at December 31, 2011; first-half net cash decline was $4.25 million.
At June 30, total assets were $24.36 million, total liabilities $10.88 million and stockholders’ equity $13.48 million. Current assets were $16.02 million and current liabilities $8.59 million. Reported debt and capital leases totaled approximately $5.73 million, including a $3.00 million line of credit. Inventories increased to $12.92 million from $10.72 million.
Material changes and management commentary
- SG&A rose 133% in Q2 to $5.99 million and 152% for the first half to $11.60 million. The company attributed increases to SBT, four new non-SBT stores, and professional fees related to the restatement and SEC investigation; first-half professional fees were $1.30 million.
- Management said gross margin improved, attributing the change primarily to higher margins in the acquired SBT business. SBT added $6.64 million of Q2 sales and $14.42 million of first-half sales.
- Superior Galleries was discontinued on June 8, 2012, after management concluded profitability was unlikely in the foreseeable future. It generated a first-half loss of $0.66 million, including a $0.16 million litigation settlement expense accrued in Q1 and a deferred-rent-liability write-off.
- Management expected approximately $1.00 million of capital expenditures over the next 12 months, largely for new store openings, to be funded from working capital. No capital expenditure commitments were outstanding at June 30.
- The Texas Capital Bank facility matured in June 2012 and was briefly extended. On July 19, 2012, majority shareholder NTR agreed to provide a secured revolving credit line of up to $7.50 million at 2% interest; proceeds repaid the bank facility, with additional funds intended for working capital. The facility’s repayment and termination provisions include demand-related triggers.
Risks, contingencies and unusual items
- Management concluded disclosure controls were ineffective. It identified a material weakness in account reconciliations and supporting documentation for inventory, depository accounts, payables, receivables, prepaid expenses and intercompany accounts.
- The SEC had initiated a private investigation into the accounting irregularities; the filing says the investigation was pending and its outcome uncertain. The company also disclosed two shareholder lawsuits seeking unspecified damages and other relief.
- A Texas sales-and-use-tax audit for March 2006 through November 2009 remained unresolved; a redetermination hearing had been granted but had not taken place. The filing does not provide a clear current amount due.
- Trading in the company’s shares had been halted, and the company was out of compliance with exchange listing requirements because of late filing. Its compliance plan had been approved with an extended deadline of October 31, 2012.
- Transactions with NTR were significant: during the first half, DGSE sold NTR approximately $25.0 million of precious metals and bullion and purchased approximately $12.0 million of products; $711,075 was payable to NTR at June 30. NTR was also the provider of the subsequent credit facility.
Important facts for investors to verify
- Confirm the scope, final adjustments and audit status of the restatement, including the periods affected by the accounting irregularities; the filing states prior financial information dating from approximately Q2 2007 should not be relied upon.
- Review the SEC investigation, shareholder litigation and sales-tax assessment for subsequent developments, potential exposure and any resulting financial impact.
- Verify current liquidity and borrowing availability under the NTR facility, its demand and collateral terms, and the company’s ability to fund operations and planned store investment.
- Assess whether sales growth, improved gross margins and inventory levels translate into sustainable profitability and operating cash flow, given the first-half cash outflow and rising SG&A.
- Confirm progress in correcting the material weakness and restoring effective disclosure controls, as well as the company’s exchange-listing status.