Business context and reporting period
DGSE Companies, Inc. (the registrant named in this filing; the request identifies Envela Corp) filed this unaudited Form 10-Q for the quarter and six months ended June 30, 2014. DGSE buys and sells jewelry, bullion and related products through retail, wholesale and online channels. Results reflect continuing operations separately from Southern Bullion, which the company discontinued in 2014.
Financial results and position
| Metric | Three months ended June 30 | Six months ended June 30 |
|---|---|---|
| Continuing-operations sales | $17.52 million, down 26% year over year | $35.58 million, down 25% |
| Gross margin | $3.01 million; 17.2% of sales, versus 12.1% | $6.22 million; 17.5% of sales, versus 13.7% |
| Operating loss, continuing operations | $438,000, versus $571,000 loss | $665,000, versus $267,000 loss |
| Loss from continuing operations | $539,000, versus $525,000 loss | $824,000, versus $333,000 loss |
| Loss from discontinued operations | $3.91 million, versus $599,000 loss | $4.15 million, versus $489,000 loss |
| Net loss / loss per share | $4.45 million / $0.36 | $4.98 million / $0.41 |
For the six months, continuing operating cash flow was negative $1.54 million, investing cash flow negative $110,000 and financing cash flow negative $146,000. Discontinued operations provided $1.30 million of cash, primarily from inventory liquidation. Cash declined from $2.64 million at year-end 2013 to $2.14 million at June 30, 2014.
At June 30, total assets were $18.86 million, current assets $14.20 million and current liabilities $9.32 million. Total liabilities were $13.31 million and stockholders’ equity $5.55 million. The NTR related-party credit line balance was $2.30 million; reported debt and capital leases totaled approximately $4.13 million, including that line. Inventory was $11.52 million. The company reported no material off-balance-sheet arrangements.
Material changes versus the prior comparable period
- Lower bullion and scrap sales drove the decline in continuing sales; stronger jewelry sales partly offset it. Product mix improved gross margin percentages, but six-month gross profit fell 4%.
- Southern Bullion’s six locations were discontinued in February and all remaining 17 locations in April. The 2014 discontinued-operations loss includes a $2.9 million write-off of the trade name, approximately $296,000 of fixed-asset write-offs, and closure and winding-down costs. Management said it believed all material closure costs had been recognized.
- Continuing SG&A was nearly flat year over year in Q2 and increased 2.4% for the first half. Interest expense rose 69% in Q2 and 63% for the first half, primarily because interest began accruing on trade payables to Elemetal Capital.
- The NTR credit line maturity was extended to August 1, 2015. Cash decreased despite cash proceeds from discontinued operations.
Outlook, risks, contingencies and unusual items
- No earnings or revenue guidance was provided. DGSE expected approximately $300,000 of fiscal 2014 capital expenditures for facility work, jewelry-repair equipment and a website relaunch; no commitments were outstanding at quarter-end.
- Management said gold prices had fallen 15% year over year in the first half of 2014 and 32% from the 2011 high. Price volatility hurt sales and profitability, especially scrap-gold buying and Southern Bullion; management expressed optimism that a more stable pricing environment would continue.
- Management said operations and working capital depend on negotiating extended vendor terms or refinancing debt, and expected to continue renewing, extending or replacing short-term debt. The NTR facility is from an affiliate of majority stockholder Elemetal and is secured by subsidiary personal property.
- Elemetal and its affiliates accounted for 26% of first-half sales and 27% of purchases. Amounts payable to Elemetal were $3.56 million at June 30. This related-party concentration and reliance on affiliated financing are material investor considerations.
- A Texas sales-tax audit settlement requires payment of tax, penalty and interest, totaling approximately $1.1 million as of May 29, 2014. The company accrued $1,129,958 and agreed to an 18-month payment schedule: $325,000 initially, then $47,000 monthly; interest continues to accrue.
- The SEC accounting-irregularities investigation concluded with an agreed final judgment. DGSE agreed to governance reforms, including two independent directors, a lead independent director, board term limits and an SEC-approved consultant; the judgment required no civil damages. Discussions with plaintiffs in a separate lawsuit remained ongoing; management did not expect its conclusion to be material to 2014 results.
- Management reported disclosure controls effective at June 30, 2014 and no material change in internal control over financial reporting during the quarter. The filing also notes adoption of the new revenue-recognition standard was under evaluation.
Important facts for investors to verify
- Whether the Southern Bullion closures and large impairment charges fully capture remaining exit costs, and what continuing-business results look like after the closures.
- Whether DGSE can fund operations and scheduled tax payments while continuing operations generate negative cash flow, and whether the NTR facility and vendor terms remain available.
- The effects of Elemetal-related sales, purchases, payables, interest and credit arrangements, including the terms and maturity of affiliated financing.
- Progress on SEC-required governance reforms and resolution of the remaining lawsuit discussions and Texas tax-payment obligations.