Envela Corp (ELA) FY 2022 MD&A

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

CAUTIONARY STATEMENT REGARDING RISKS AND UNCERTAINTIES THAT MAY AFFECT FUTURE RESULTS

Please see the section of this Form 10-K entitled “Note About Forward-Looking Statements” on page 3.

The following discussion of our financial condition and results of operations should be read together with our financial statements and related notes and other financial information included in this Annual Report. The following discussion contains forward-looking statements that reflect our plans, estimates and beliefs. Our actual results could differ materially from those discussed in the forward-looking statements. Factors that could cause or contribute to these differences include those discussed below and elsewhere in this Annual Report, particularly in the section titled “Risk Factors.” Our historical results are not necessarily indicative of the results that may be expected for any period in the future.

Overview

We are enabling a better world through the circular economy; by empowering buyers and sellers to extend the useful lives of specialty and durable goods; and by seizing retail, recycling, and reverse-logistics supply-chain opportunities. Envela is a diverse re-commerce company that manages its business through two segments. Its commercial-services segment is led by subsidiary ECHG, and its direct-to-consumer segment is led by subsidiary DGSE. Envela reports its revenue and operating expenses based on these two operating segments, with revenue for each operating segment, being presented as resale and recycle. We also include segment information in the notes to our financial statements. For more information, see “Item 1. Business—Operating Segments” above. A list of the company’s significant subsidiaries is presented in Exhibit 21.1.

Key Economic Factors and Trends Affecting the Markets in Which We Operate

ECHG Business Drivers and Impacts

ECHG owns and operates Echo, ITAD USA, CEX, Avail and Teladvance, through which it primarily buys and resells or recycles consumer electronic components and IT equipment. Echo focuses on end-of-life electronics recycling and also offers disposal transportation and product tracking, ITAD USA provides IT equipment disposition including compliance and data sanitization services, and Teladvance, CEX and Avail operate as value-added resellers by providing offerings and services to companies looking to either upgrade capabilities or dispose of equipment. Like DGSE, ECHG also maintains relationships with refiners or recyclers to which it sells extracted valuable materials from electronics and IT equipment that are not appropriate for resale or reuse.

The electronic disposition and recycling industry is fragmented in the United States. Certain parts of ECHG’s business comes from a limited number of partners. The used electronics processing business is subject to cyclical fluctuations based upon product availability, promotions, seasonality, and supply chain constraints. In our ECHG segment, we compete primarily on price and on the services, we provide to clients. The price offered for devices is the principle competitive factor in acquiring material from generators. Generators of material may also consider factors other than price, such as logistics costs, timely removal, customized reports, the ability to service multiple locations, insurance coverage, and the buyer’s financial strength. For additional information regarding ECHG, see “Item 1. Business—Operating Segments—ECHG Segment” and See “Item 1A. Risk Factors—unable to maintain relationships with significant clients”.

DGSE Precious Metals Pricing and Business Impact

The Company is exposed to various market risks. Market risk is the potential loss arising from the adverse changes in market prices and rates. The nature of DGSE’s operations results in exposure to fluctuations in commodity prices, specifically diamonds, platinum, gold and silver. The Company does not currently use derivatives to hedge these risks. As a significant portion of our inventory and sales involve gold and jewelry, financial results can be influenced by the market price of gold and diamonds. The retail sales and gross margin could be materially impacted if prices of diamonds, platinum, gold, or silver rise so significantly that consumer behavior changes or if price increases cannot be passed onto customers. Because DGSE buys and resells precious metals, it is impacted by fluctuations and changes in precious-metal pricing which rises and falls based upon global supply and demand dynamics, with the greatest impact relating to gold as it represents a significant portion of the precious-metal in which DGSE trades. Such fluctuations, particularly with respect to gold, which accounts for a majority of DGSE’s merchandise costs, can have a significant impact on earnings and cash availability.

PART II

Items 7

Impact of COVID-19 and Macroeconomic Conditions on Our Business

The ongoing impact of the COVID-19 pandemic continues to affect our business and results of operations, although to a lesser extent than the prior years. Throughout the pandemic, our top priority has been to protect the health and safety of our employees and our customers. Macroeconomic uncertainty and inflationary pressure may drive lower demand for the end consumer and increase operating costs and costs of borrowing.

Critical Accounting Policies and Estimates

Our management’s discussion and analysis of our financial condition and results of operations is based on our financial statements, which have been prepared in accordance with United States generally accepted accounting (“U.S. GAAP”) principles. The preparation of these financial statements requires our management to make judgments and estimates that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements, as well as the reported revenue generated, and expenses incurred during the reporting periods. Our estimates are based on our historical experience and on various other factors that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these judgments and estimates under different assumptions or conditions and any such differences may be material.

While our significant accounting policies are more fully described in Note 1—Summary of Significant Accounting Policies, we believe that the accounting estimates discussed below relate to the more significant areas involving management’s judgments and estimates.

Inventories

DGSE inventory is valued at the lower of cost or net realizable value (“NRV”). We acquire a majority of our inventory from individual customers, including pre-owned jewelry, watches, bullion, rare coins and monetary collectibles. We acquire these items based on our own internal estimate of the fair value of the items at the time of purchase. We consider factors such as the current spot market price of precious metals and current market demand for the items being purchased. DGSE supplements these purchases from individual customers with inventory purchased from wholesale vendors. These wholesale purchases can take the form of full asset purchases, or consigned inventory. Consigned inventory is accounted for on our balance sheet with a fully offsetting contra account so that consigned inventory has a net zero balance. The majority of our inventory has some component of its value that is based on the spot market price of precious metals. Because the overall market value for precious metals regularly fluctuates, these fluctuations could have either a positive or negative impact on the value of our inventory and could positively or negatively impact our profitability. We monitor these fluctuations to evaluate any necessary impairment to inventory.

The Echo inventory principally includes processed and unprocessed electronic scrap materials. The value of the material is derived from recycling the precious and other scrap metals included in the scrap. The processed and unprocessed materials are carried at the lower of the average cost of the material during the month of purchase or NRV. The in-transit material is carried at lower of cost or NRV using the retail method. Under the retail method the valuation of the inventory at cost and the resulting gross margins are calculated by applying a cost to retail ratio to the retail value of the inventory.

For the year ended December 31, 2022, we have not identified critical accounting estimates that involve a significant level of estimation uncertainty and would have a material impact on our results. Refer to our significant accounting policies are more fully described in Note 1—Summary of Significant Accounting Policies.

Recent Accounting Pronouncements

See Note 1, “Accounting Policies and Nature of Operations” to our financial statements included this Annual Report on Form 10-K for recently issued accounting pronouncements not yet adopted as of the date of this Annual Report on Form 10-K.

PART II

Items 7

Use of Non-U.S. GAAP Financial Measures

In this management’s discussion and analysis, we use supplemental measures of our performance, which are derived from our consolidated financial information, but which are not presented in our consolidated financial statements prepared in accordance with U.S. GAAP. We believe that providing these Non-U.S. GAAP financial measures adds a meaningful presentation of our operating and financial performance. See the reconciliation of net income to EBITDA, in Non-U.S. GAAP Financial Measures below.

Non-U.S. GAAP Financial Measures

EBITDA is a key performance measure that our management uses to assess our operating performance. Because EBITDA facilitates internal comparisons of our historical operating performance on a more consistent basis, we use this measure as an overall assessment of our performance, to evaluate the effectiveness of our business strategies and for business planning purposes. EBITDA may not be comparable to similarly titled metrics of other companies. EBITDA means earnings before interest expense, other (income) expense, net, income tax expense, and depreciation and amortization. EBITDA is a non-U.S. GAAP measure and should not be considered as an alternative to the presentation of net income or any other measure of financial performance calculated and presented in accordance with U.S. GAAP. The following table provides a reconciliation of net income to EBITDA:

PART II

Items 7

Results of Operations

The results of operations presented below should be reviewed in conjunction with the financial statements and notes included elsewhere in the Annual Report. Prior year comparisons for 2022 and 2021, are included in “Part II, Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations” of our Annual Report on Form 10-K for the fiscal years ended December 31, 2022 and 2021. Year-over-year discussion and analysis of the line-item revenue and expenses within the consolidated income statement are included below for 2022 and 2021. The following tables set forth our results of operations and such data as a percentage of revenue and gross profit for the periods presented:

Comparison of 2022 and 2021

Resale Revenue

Resale revenue related to DGSE increased by $33,321,371, or 37% in Fiscal 2022 compared to Fiscal 2021. Resale revenue, such as bullion, jewelry, watches, and rare coins, increased primarily due to increased traction in DGSE’s new retail locations added to increased consumer demand with increased foot traffic from an increase in advertising. Resale revenue related to ECHG increased by $7,207,265, or 22%, in Fiscal 2022 compared to Fiscal 2021. Resale revenue increased primarily due to the economy beginning to stabilize during Fiscal 2022 from the COVID-19 pandemic.

PART II

Items 7

Recycled-Material Revenue

Recycled-material revenue related to DGSE increased by $1,066,803, or 14% in Fiscal 2022 compared to Fiscal 2021. The increase in recycled-material revenue is primarily due to DGSE’s retail locations purchasing additional inventory over the counter from increased foot traffic. Recycled-material revenue related to ECHG increased by $124,337, or 1% in Fiscal 2022 compared to Fiscal 2021. The increase in recycled-material revenue is primarily due to the increase of down-stream recycling activity beginning to come back from the COVID-19 pandemic.

Resale Gross Profit

Resale gross profit related to DGSE, increased by $3,218,633, or 29% in Fiscal 2022 compared to Fiscal 2021. The increase in resale gross profit is primarily due to the 37% increase in resale revenue even though the margin percentage decreased from 12.4% during Fiscal 2021 to 11.6% during Fiscal 2022. The resale gross profit related to ECHG, increased $7,549,761, or 52% in Fiscal 2022 compared to Fiscal 2021. The resale gross profit increase is primarily due to a 22% increase in resale revenue and the margin percentage increasing from 44.8% during Fiscal 2021 to 55.7% during Fiscal 2022.

Recycled-Material Gross Profit

Recycled-material gross profit related to DGSE, increased by $407,644, or 26% in Fiscal 2022 compared to Fiscal 2021. The recycled-material gross profit increase is primarily due to a 14% increase in recycled revenue and a margin percentage increase from 20.9% during Fiscal 2021 to 23.1% during Fiscal 2022. Recycled-material gross profit related to ECHG, increased by $2,429,889, or 60% in Fiscal 2022 compared to Fiscal 2021. The recycled-material gross profit increase is primarily due to a slight increase in recycled-material revenue and the margin percentage increasing from 34.5% during Fiscal 2021 to 54.7% during Fiscal 2022

PART II

Items 7

Selling, General and Administrative

Selling, general and administrative expenses for DGSE increased $1,134,055, or 15% in Fiscal 2022 compared to Fiscal 2021. The increase in SG&A was primarily due to an increase in advertising of approximately $312,000, and payroll and payroll related expenses of approximately $900,000. Selling, general and administrative expenses for ECHG increased by $7,498,574, or 57% in Fiscal 2022 compared to Fiscal 2021. The CExchange Transaction and the Avail Transaction closed in June and October 2021, respectively. The added companies are primarily the reason for the increase in selling, general and administrative expenses.

PART II

Items 7

Depreciation and Amortization

Depreciation and amortization for DGSE increased by $21,056, or 5% in Fiscal 2022 compared to Fiscal 2021. The increase is primarily due to the added depreciation from additional furniture and fixtures, new equipment and building improvements added during Fiscal 2022. Depreciation and Amortization expense for ECHG increased by $504,683, or 94% in Fiscal 2022 compared to Fiscal 2021. The CExchange Transaction and the Avail Transaction closed in June and October 2021, respectively. Added amortization expense from new intangible assets produced by the two transactions is primarily the increase in depreciation and amortization expense for ECHG.

Other Income from Loan Forgiveness

Other income from loan forgiveness, in Fiscal 2021, is due from the Federal Loan being forgiven and allocated to both segments in accordance with the use of the funds. The total amount forgiven of $1,668,200 was allocated to DGSE in the amount of $675,210, and $992,990 was allocated to ECHG.

Other Income/Expense

Other income for DGSE decreased by $176,899, or 74% in Fiscal 2022 compared to Fiscal 2021. During Fiscal 2022, other income consists of $48,000 of DGSE’s portion of the rental income generated from the Company’s corporate headquarters and approximately $13,700 of other miscellaneous income. During Fiscal 2021, other income of $238,585, consisted primarily of DGSE’s portion of the net rental income in excess of the SG&A expenses from space leased at the Company’s corporate headquarters of $230,364.

Other income for ECHG increased by $1,395,025 in Fiscal 2022, or 259%, to other income, net of $857,005, as compared to other expense, net of $538,020 during Fiscal 2021. Other income, net during Fiscal 2022, of $857,005 consists primarily of reducing the notes receivable reserve from $838,647 to $0, and bank account interest income of $11,720. Other expense during Fiscal 2021, of $538,020, consists primarily of interest income from notes receivables of $113,606, net rental income in excess of the SG&A expenses from the space leased at the Company’s corporate headquarters of $230,364, offset by the write-off of the CExchange notes receivable accrued interest of $49,174 and the reserve set for the CExchange notes receivable of $838,647.

PART II

Items 7

Interest Expense

Interest expense for DGSE decreased by $44,034 or 15%, in Fiscal 2022 compared to Fiscal 2021. The decrease is primarily due to Farmers State Banks of Oakley Kansas (“FSB”) refinancing of a DGSE loan on November 23, 2021. The refinancing reduced the interest rate from 6.0% to 3.1% annualized. The interest expense for ECHG decreased by $176,324 or 42%, in Fiscal 2022 compared to Fiscal 2021. The decrease is primarily due to FSB refinancing an ECHG loan on November 23, 2021. The refinancing reduced the interest rate from 6.0% to 3.1% annualized.

Income Tax Expense

Income tax benefit for Fiscal 2022 totaled $1,309,606 as compared to an income tax expense of $112,808 for Fiscal 2021. See Note 14 for Federal Income Taxes.

Net Income

The Company recorded an increase in net income of $5,640,258, or 56% in Fiscal 2022 compared to Fiscal 2021. The increase in net income is due primarily to an increase of revenue of approximately $41.7 million, the reduction of the reserve against the notes receivable of $838,647 during Fiscal 2022 and the valuation allowance reduction of $1,488,258 against the deferred tax benefit during Fiscal 2022.

PART II

Items 7, 7A

Earnings Per Share

Our net income per basic and diluted shares attributable to holders of our Common Stock increased by $0.21 per share, or 57% in Fiscal 2022 compared to Fiscal 2021. The increase is due primarily from the revenue increase of approximately $41.7 million from Fiscal 2021 to Fiscal 2022, the removal of the reserve against the notes receivable of $838,647 during Fiscal 2022 and the valuation allowance reduction of $1,488,258 against the deferred tax benefit, during Fiscal 2022.

Liquidity and Capital Resources

Cash Flows

The following table summarizes our cash flows for the periods indicated. Prior year comparisons are included in “Part II, Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations” of our Annual Report on Form 10-K for Fiscal 2022.

During Fiscal 2022, cash provided by operations totaled $10,019,885, which was primarily driven by net income of $15,689,133, reduction from non-cash charges, net of $801,653, the increase in accounts payable and accrued expenses of $1,367,713 and a decrease in other assets of $985,509. In addition, the foregoing was further offset by the increase of trade receivables of $856,660, the increase in inventories of $4,707,349, the increase in prepaid expenses of $792,778 and the reduction of customer deposits and other liabilities of $896,742.

During Fiscal 2022, cash used in investing totaled $229,339 which primarily consisted of the purchase of equipment and additional property build-out of $272,748 and the additional net cash payment concerning the Avail Transaction of $216,988, offset by the receipt of $260,397 from notes receivable.

During Fiscal 2022, cash used in financing totaled $2,758,725 which primarily consisted of principal payments made against the notes payable loans of $1,058,725 and payments made against the Company’s line of credit of $1,700,000.

On November 23, 2021, the Company secured a 36-month line of credit from FSB for $3,500,000 at 3.1% annual interest rate. A line of credit of up to $3,500,000 with Texas Bank and Trust was immediately closed with a $0 outstanding balance. Our line of credit with FSB is to fund any cash shortfalls that the Company may have from time-to-time during the life of the line of credit. Also, from time-to-time, inventory levels have been adjusted to meet seasonal demand or in order to meet working capital requirements. Management believes there are enough capital resources to meet working capital requirements. If additional working capital is required, additional loans can be obtained from individuals or from other commercial banks.

PART II

Items 7, 7A

Management expects our capital expenditures to total approximately $750,000 during the next 12 months. These expenditures will be largely driven by the purchase of equipment, the build-out of corporate office space in the Company headquarters and the potential purchase and build-out of any additional DGSE retail buildings. As of December 31, 2022, there were no commitments outstanding for capital expenditures.

In the event of significant growth in retail and wholesale jewelry sales and recycling demand, whether purchases or services, the demand for additional working capital will increase due to a related need to stock additional jewelry inventory, increases in wholesale accounts receivable and the purchasing of recycled material. Historically, operations has funded these activities.

The Company has historically renewed, extended, or replaced short-term debt as it matures, and management believes that we will be able to continue to do so in the near future.

The Company leases certain of its facilities under operating leases. The minimum rental commitments under non-cancellable operating leases as of December 31, 2022 are as follows:

Off-Balance Sheet Arrangements

There are no off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that is material to our shareholders.

STATEMENT OF MANAGEMENT’S RESPONSIBILITY FOR FINANCIAL STATEMENTS

Management is responsible for the preparation of the consolidated financial statements and related information that are presented in this report. The consolidated financial statements, which include amounts based on management’s estimates and judgments, have been prepared in conformity with accounting principles generally accepted in the United States of America.

The Company designs and maintains accounting and internal control systems to provide reasonable assurance at reasonable cost that assets are safeguarded against loss from unauthorized use or disposition, and that the financial records are reliable for preparing consolidated financial statements and maintaining accountability for assets. These systems are augmented by written policies, an organizational structure providing division of responsibilities and careful selection and training of qualified personnel.

The Company engaged Whitley Penn LLP, an independent registered public accounting firm, to audit and render an opinion on the consolidated financial statements in accordance with the standards of the Public Accounting Oversight Board (United States). Management’s report was not subject to attestation by our independent registered public accounting firm pursuant to rules of the SEC that permit the company to provide only management’s report in this annual report.

The Board, through its Audit Committee, consisting solely of independent directors of the Company, meets periodically with management and our independent registered public accounting firm to ensure that the Company is meeting its responsibilities and to discuss matters concerning internal controls and financial reporting. Whitley Penn LLP and our management team each have full and free access to the Audit Committee.

PART II

Items 7, 7A