DGSE Companies, Inc. (identified in the request as Envela Corp) — Q2 2019 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2019. The filing is by DGSE Companies, Inc. and reports unaudited consolidated results. Its businesses were precious-metals, jewelry and collectibles retail, plus electronic-component recycling and resale following the May 20, 2019 Echo acquisition.
Financial results and liquidity
| Metric | Q2 2019 | Q2 2018 | Six months 2019 | Six months 2018 |
|---|---|---|---|---|
| Revenue | $20.94 million | $12.73 million | $36.96 million | $26.79 million |
| Gross profit | $3.37 million | $2.19 million | $5.58 million | $4.69 million |
| Gross margin | 16.1% | 17.2% | 15.1% | 17.5% |
| Operating income | $604,000 | $329,000 | $1.01 million | $701,000 |
| Net income | $590,000 | $274,000 | $944,000 | $620,000 |
| Diluted earnings per share | $0.02 | $0.01 | $0.04 | $0.02 |
- Q2 revenue increased about 64% and net income about 115% year over year. Six-month revenue rose about 38% and net income about 52%. 2019 includes Echo results only from May 20 onward; comparisons therefore are not like-for-like.
- Retail revenue grew, but retail gross margin contracted: 12.2% in Q2 versus 17.2% a year earlier, and 13.0% for the first half versus 17.5%. Management attributed higher sales partly to rising gold prices and a strategy emphasizing sales velocity, which it said reduced margins. Bullion/rare-coin sales grew substantially, while that category’s margin fell to 4.7% in Q2 from 12.8%.
- Echo contributed $2.36 million of revenue and $1.10 million gross profit from May 20 through June 30, a 46.4% gross margin; reported segment net income was $245,458. The filing’s unaudited Q2 pro forma presentation, as if the businesses had been combined for the full quarter, shows revenue of $23.17 million and net income of $69,197, versus $24.33 million and $1.59 million, respectively, for the prior-year pro forma quarter.
- Cash and cash equivalents were $1.67 million at June 30, up from $1.45 million at year-end. Current assets were $14.63 million and current liabilities $3.48 million; inventory accounted for $11.11 million of current assets.
- Operating cash flow was negative $3.66 million for the first half, compared with negative $227,000 in 2018. Investing cash outflow was $5.89 million, primarily for Echo. Financing cash inflow was $9.77 million, principally related-party borrowing; cash rose $220,000 overall.
- Related-party notes payable totaled $9.77 million at June 30, carry 6% interest and mature May 16, 2024. Current portion was $273,000. Operating lease liabilities totaled approximately $4.12 million. Total liabilities were $15.96 million and stockholders’ equity $9.36 million.
Material developments, outlook and risks
- DGSE acquired the Echo Environmental and ITAD USA assets for $6.93 million. The purchase-price allocation was preliminary and included $4.72 million of goodwill. The acquisition was funded by a $6.93 million loan from CEO and largest beneficial shareholder John Loftus; he also loaned $3.07 million to repay related-party trade payables. The filing notes that Loftus had owned about one-third of the seller’s parent before the transaction and no longer held that interest after the transaction.
- The filing says gold rose about 10% from the start of 2019 to $1,409 per ounce at June 30, and management linked increased sales velocity to higher gold prices. Management described efforts to improve recycling efficiency and identify uses for recycled electronic material.
- Management expected approximately $85,000 of capital expenditures over the next 12 months, mainly for point-of-sale system components and recycling equipment. It stated that additional working capital could be sought from individuals or commercial banks, or inventory could be adjusted. No revenue or earnings guidance was provided.
- The company adopted lease accounting standard ASC 842 on January 1, 2019, recognizing right-of-use assets and lease liabilities. It reported seven operating leases and four leases expiring in the following year. Management said disclosure controls were effective and reported no material change in internal control.
- The filing reports no legal proceedings, defaults upon senior securities, or off-balance-sheet arrangements. As a smaller reporting company, it omitted the specified risk-factor and market-risk disclosures; forward-looking statements remain subject to risks described in this and the prior annual report.
Important facts for investors to verify
- How the Echo business performs after the short period included in reported results, and how its pro forma results reconcile to the reported quarter.
- Whether retail sales growth can be sustained without further margin erosion, particularly in bullion and rare coins.
- The terms, repayment capacity and governance oversight of the $9.77 million of CEO-related-party debt, including the related-party acquisition and preliminary purchase-price allocation.
- Cash conversion and working-capital needs: first-half operating cash use was $3.66 million despite reported net income, while inventory was $11.11 million.
- Lease commitments, upcoming expirations and the company’s plans for locations whose leases lack renewal options.