Envela Corp. (then DGSE Companies, Inc.) — Q3 2019 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2019; filed November 13, 2019. The filing reports DGSE Companies, Inc., which later changed its name to Envela Corporation. DGSE sells jewelry, bullion, coins and other valuables through retail, wholesale and online channels. Since May 20, 2019, the company has also operated the Echo Entities, which recycle and resell electronic components. The interim financial statements are unaudited.
Financial results and liquidity
| Metric | Q3 2019 | Q3 2018 | Nine months 2019 | Nine months 2018 |
|---|---|---|---|---|
| Revenue | $22.86 million | $13.66 million | $59.82 million | $40.45 million |
| Gross profit | $5.19 million | $2.48 million | $10.77 million | $7.17 million |
| Gross margin | 22.7% | 18.1% | 18.0% | 17.7% |
| Operating income (loss) | $1.22 million | ($0.48 million) | $2.23 million | $0.22 million |
| Net income (loss) | $1.04 million | ($0.49 million) | $1.98 million | $0.13 million |
| Basic and diluted EPS | $0.04 | ($0.02) | $0.08 | $0.00 |
- Revenue and margins: Q3 revenue rose about 67% year over year, including $6.21 million from Echo. DGSE retail revenue increased 22%, but its gross margin fell to 12.1% from 18.1%. Echo reported a 51.0% Q3 gross margin. For the nine-month period, DGSE’s margin was 12.7%, while Echo’s was about 49.8%; Echo was included only from its May acquisition.
- Expenses and interest: Q3 SG&A was $3.89 million, including $2.03 million for Echo; depreciation and amortization was $67,886. Interest expense was $148,720 for the quarter and $240,778 for the nine months.
- Cash flow: Nine-month operating cash flow was negative $2.73 million, compared with negative $0.61 million in 2018. Investing cash outflow was $6.02 million, primarily for Echo. Financing provided $9.86 million, principally through related-party borrowing for the acquisition and to pay off related-party trade payables. Cash increased by $1.10 million to $2.56 million.
- Balance sheet at September 30: Current assets were $16.21 million and current liabilities $4.02 million; inventories were $11.23 million. Total assets were $26.58 million, liabilities $16.19 million and stockholders’ equity $10.39 million.
- Debt and leases: Related-party notes payable totaled $9.71 million, including $276,861 current, at 6% interest and maturing May 2024. A $151,000 line of credit was also outstanding. Operating lease liabilities totaled about $3.90 million; the balance sheet records $3.78 million of related right-of-use assets.
Material changes and notable items
- The May 20 acquisition of the Echo Entities expanded the business into electronic-waste recycling and reuse. Q3 reported results include a full quarter of Echo operations; nine-month results include Echo only from the acquisition date.
- The $6.93 million Echo purchase was funded by a note from CEO and Chairman John Loftus, who had been a part-owner of the seller before the transaction and became the company’s largest beneficial shareholder on the same date. Loftus also lent $3.07 million to fund repayment of related-party trade payables. The company reported $9.71 million owed to him at quarter-end.
- The preliminary purchase-price allocation recorded $4.72 million of goodwill. A third-party valuation was in progress and expected by year-end, so the allocation could change. Goodwill is not amortized and is tested for impairment.
- Management attributed stronger retail sales partly to higher gold prices and a strategy to increase sales velocity, while acknowledging that the strategy reduced DGSE’s gross margins. The filing reports gold at $1,485 per ounce at September 30, 2019.
- The company adopted lease accounting standard ASC 842 on January 1, 2019, recognizing operating lease assets and liabilities. The acquisition added further lease balances.
- At the October 11, 2019 annual meeting, stockholders approved changing the corporate name to Envela Corporation and authorizing 5 million preferred shares.
Outlook, risks and contingencies
- Management estimated capital expenditures of approximately $85,000 over the next 12 months, mainly for point-of-sale system components and recycling equipment. It said additional borrowing could be sought if working capital is needed and inventory could be adjusted.
- Management cautioned that results are subject to forward-looking risks and that interim results are not necessarily indicative of full-year performance. Gold-price movements affect the retail business; management also identified ongoing efforts to improve recycling efficiency and find new uses for recycled electronic material.
- Four retail leases were due to expire in 2020; the Euless lease had an extension option management said it was reasonably certain to exercise. The filing gives no specific earnings or revenue guidance.
- The filing reported no legal proceedings, defaults upon senior securities or material off-balance-sheet arrangements. Management concluded disclosure controls were effective at a reasonable assurance level and reported no material change in internal control over financial reporting.
Important facts for investors to verify
- Whether the final independent valuation changes Echo’s preliminary purchase-price allocation, including the $4.72 million goodwill balance.
- Echo’s standalone performance and cash generation, and how results compare on a full-period basis. The filing’s pro forma nine-month figures show combined revenue of $65.72 million and net income of $1.13 million for 2019, versus $64.69 million and $1.63 million for 2018.
- The terms, repayment capacity and governance review of the $9.71 million CEO-related debt, and the related-party nature of the Echo acquisition and financing.
- Whether higher retail sales velocity can be sustained without further pressure on DGSE gross margins, particularly for bullion and jewelry.
- Working-capital and liquidity trends, given operating cash outflow, substantial inventory, and the company’s stated potential reliance on additional borrowing.