Envela Corp (ELA) FY 2023 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, and its direct-to-consumer segment. 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 too 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 21.2.

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

Commercial Business Drivers and Impacts

The commercial segment includes 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 the consumer segment, the commercial segment 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 the commercial segment 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 commercial 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—Commercial Segment” and See “Item 1A. Risk Factors—Our revenues and profits may decline if we are unable to maintain relationships with significant clients or renew contracts with them on favorable terms”.

Consumer 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 the consumer segment 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 the consumer segment 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 it trades. Such fluctuations, particularly with respect to gold, which accounts for a majority of the merchandise costs, can have a significant impact on earnings and cash availability.

PART II

Items 7

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. Our significant accounting policies are fully described in Note 1 of the consolidated financial statements.  References to fiscal years below are denoted with the word “Fiscal” and the associated year.

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, 2023, 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.

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.

PART II

Items 7

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:

Starting December 31, 2023, the EBITDA Reconciliation presentation has been revised to align with the Company’s performance.

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 2023 and 2022, 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, 2023 and 2022. Year-over-year discussion and analysis of the line-item revenue and expenses within the consolidated income statement are included below for 2023 and 2022. 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 2023 and 2022

Resale Revenue

Resale revenue decreased by $12,681,956, or 8%, in Fiscal 2023 to $149,533,829, as compared to $162,215,785 during Fiscal 2022. The individual segments reported the following:

Resale revenue related to the consumer segment, decreased by $4,549,912, or 4% in Fiscal 2023 as compared to Fiscal 2022. Resale revenue, such as bullion, jewelry, watches and rare coins, decreased primarily due to a general volatility in precious metal commodity prices during 2023 as compared to 2022. Resale revenue related to the commercial segment, decreased by $8,132,044, or 20%, in Fiscal 2023 as compared to Fiscal 2022. Resale revenue decreased primarily due to the reduced demand of our hard drives.

PART II

Items 7

Recycled Revenue

Recycled revenue increased by $1,670,190 or 8%, in Fiscal 2023 to $22,140,259, as compared to $20,470,069 during Fiscal 2022. The individual segments reported the following:

Recycled revenue related to the consumer segment, increased by $2,856,148, or 33% in Fiscal 2023 as compared to Fiscal 2022. The increase in recycled revenue is primarily due to the volatility in commodity prices that forced the scaping of inventory that would have usually been sold in the retail stores. Recycled revenue related to the commercial segment, decreased by $1,185,958, or 10% in Fiscal 2023 as compared to Fiscal 2022. The decrease in recycled revenue is primarily due to a reduced level of inventory purchased.

Resale-Cost of Goods Sold

Starting December 31, 2023, the cost of goods sold, for both resale and recycled revenue, is added to our results of operations for comparison purposes.

Resale cost of goods sold decreased by $9,080,773, or 7%, in Fiscal 2023 to $116,774,364, as compared to $125,855,137 during Fiscal 2022. The individual segments reported the following:

Resale cost of goods sold related to the consumer segment, decreased by $3,000,426, or 3% in Fiscal 2023 as compared to Fiscal 2022. The decrease in the resale cost of goods sold is primarily due to the decrease in resale revenue of 3% in Fiscal 2023 as compared to Fiscal 2022. Resale cost of goods sold related to the commercial segment decreased by $6,080,347, or 34% in Fiscal 2023 as compared to Fiscal 2022. The decrease in the resale cost of goods sold is primarily due to the decrease in resale revenue of 20% in Fiscal 2023 as compared to Fiscal 2022.

PART II

Items 7

Recycled-Cost of Goods Sold

Recycled cost of goods sold increased by $1,239,563, or 10%, in Fiscal 2023 to13,243,194, as compared to $12,003,631 during Fiscal 2022. The individual segments reported the following:

Recycled cost of goods sold related to the consumer segment, increased by $1,892,543, or 28% in Fiscal 2023 as compared to Fiscal 2022. The increase in the recycled cost of goods sold is primarily due to the increase in recycled revenue of 33% in Fiscal 2023 as compared to Fiscal 2022. Recycled cost of goods sold related to the commercial segment decreased by $652,980, or 12% in Fiscal 2023 as compared to Fiscal 2022. The decrease in the recycled cost of goods sold is primarily due to the decrease in the recycled revenue of 10% in Fiscal 2023 as compared to Fiscal 2022.

Resale-Gross Profit

Resale gross profit decreased by $3,601,183, or 10%, in Fiscal 2023 to $32,759,465, as compared to $36,360,648 during Fiscal 2022. The individual segments reported the following:

Resale gross profit related to the consumer segment, decreased by $1,549,486, or 11% in Fiscal 2023 as compared to Fiscal 2022. The decrease in resale gross profit is primarily due to the decrease in resale revenue of 4% during Fiscal 2023 as compared to Fiscal 2022, added to the drop in gross profit margin from 11.6% during Fiscal 2022 as compared to 10.8% in Fiscal 2023. The resale gross profit related to the commercial segment, decreased $2,051,697, or 9% in Fiscal 2023 as compared to Fiscal 2022. The resale gross profit decreased is primarily due to a 20% decrease in resale revenue during Fiscal 2023 as compared to Fiscal 2022, offset by an increase in the margin percentage from 63.5% during Fiscal 2023 as compared to 55.7% during Fiscal 2022.

Recycled-Gross Profit

PART II

Items 7

Recycled gross profit increased by $430,627, or 5%, in Fiscal 2023 to $8,897,065, as compared to $8,466,438 during Fiscal 2022. The individual segments reported the following:

Recycled gross profit related to the consumer segment, increased by $963,605, or 48% in Fiscal 2023 as compared to Fiscal 2022. The recycled gross profit increase is primarily due to the 33% increase in recycled revenue and a margin percentage increase to 25.7% during Fiscal 2023 from 23.1% during Fiscal 2022. Recycled gross profit related to the commercial segment, decreased by $532,978, or 8% in Fiscal 2023 as compared to Fiscal 2022. The recycled gross profit for the commercial segment decrease is primarily due to a 10% decrease in recycled revenue for Fiscal 2023 as compared to Fiscal 2022.

Selling, General and Administrative

SG&A expenses increased by $2,106,953, or 7%, in Fiscal 2023 to $31,537,677, as compared to $29,430,724 during Fiscal 2022. The individual segments reported the following:

Selling, general and administrative expenses for the consumer segment, increased $1,878,408, or 21% in Fiscal 2023 as compared to Fiscal 2022. The increase in SG&A was primarily due to an increase in advertising of approximately $221,000 and payroll and payroll related expenses of approximately $1,700,000. Selling, general and administrative expenses for the commercial segment, increased by $228,545, or 1% in Fiscal 2023 compared to Fiscal 2022. The increase in SG&A was primarily due to an increase in payroll and payroll related expenses of approximately $217,000.

PART II

Items 7

Depreciation and Amortization

Depreciation and amortization expense decreased by $89,770, or 6%, in Fiscal 2023 to $1,362,064, as compared to $1,451,834 during Fiscal 2022. The individual segments reported the following:

Depreciation and amortization for the consumer segment, decreased by 85,532, or 21% in Fiscal 2023 as compared to Fiscal 2022. The decrease is primarily due to fixed and intangible assets being fully depreciated and amortized during Fiscal 2023 not yet fully depreciated or amortized during Fiscal 2022. Depreciation and Amortization expense for the Commercial segment decreased by $4,238, or less than 1% in Fiscal 2023 as compared to Fiscal 2022.

Other Income

Other income decreased by $190,909, or 21%, in Fiscal 2023 to $727,782, as compared to $918,691 during Fiscal 2022. The individual segments reported the following:

Other income for the consumer segment increased by $22,120, or 36% in Fiscal 2023 as compared to Fiscal 2022. During Fiscal 2023, other income consisted of approximately $78,000 and approximately $6,000 of other miscellaneous receipts. During Fiscal 2023, all of the corporate rental income was allocated to the commercial segment. During Fiscal 2022, other income consisted of $48,000 of the consumer’s portion of the rental income generated from the Company’s corporate headquarters and approximately $13,700 of other miscellaneous income.

Other income for the commercial segment decreased by $213,029 in Fiscal 2023, or 25%, to $643,976, as compared to $857,005 during Fiscal 2022. During Fiscal 2023, other income consisted of approximately $456,000 in bank account interest income, approximately $94,000 in written off notes receivable in prior years and $88,000 in the Company’s corporate headquarters being leased to a third party. During Fiscal 2022, other income of $857,005 was the result from reducing the notes receivable reserve from $838,647 to $0, and bank account interest income of $11,720.

PART II

Items 7

Interest Expense

Interest expense decreased by $20,492, or 4%, in Fiscal 2023 to $463,201, as compared to $483,693 during Fiscal 2022. The individual segments reported the following:

Interest expense for the consumer segment decreased by $51,809 or 21%, in Fiscal 2023 as compared to Fiscal 2022. The decrease is primarily due to the interest expense on the note for the corporate headquarters was fully allocated to the commercial segment during Fiscal 2023. The interest expense for the commercial segment increased by $31,317 or 13%, in Fiscal 2023 as compared to Fiscal 2022. The increase is primarily due to the interest expense on the note for the corporate headquarters was fully allocated to the commercial segment during Fiscal 2023.

Income Tax Expense

Income tax expense for the Company increased by $3,183,524 or 243%, to $1,873,918 in Fiscal 2023 as compared to a tax benefit of $1,309,606 in Fiscal 2022.  The income tax expense increase was partially due from the valuation allowance being reduced in the amount of $1,490,000 against the deferred tax benefit during Fiscal 2022. See Note 14 for Federal Income Taxes.

Net Income

The Company’s net income decreased by $8,541,681, or 54% in Fiscal 2023 as compared to Fiscal 2022. The decrease is due primarily from the revenue decrease of approximately $11,000,000 from Fiscal 2022 to Fiscal 2023, the increase of SG&A expenses of approximately $2,100,000 and the increase in income tax expense of approximately $3,200,000 during Fiscal 2023 as compared to Fiscal 2022. The income tax expense increase was partially due from the valuation allowance being released in the amount of $1,490,000 million against the deferred tax benefit during Fiscal 2022

PART II

Items 7

Earnings Per Share

Our net income per basic and diluted shares attributable to holders of our Common Stock decreased by $0.31 per share, or 53% in Fiscal 2023 compared to Fiscal 2022. The decrease is due primarily from the revenue decrease of approximately $11,000,000 from Fiscal 2022 to Fiscal 2023, the increase of SG&A expenses of approximately $2,100,000 and the increase in income tax expense of approximately $3,200,000 million during Fiscal 2023 as compared to Fiscal 2022. The income tax expense increase was partially due from the valuation allowance being released in the amount of $1,490.000 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 2023.

During Fiscal 2023, cash provided by operations totaled $5,842,708, which was primarily driven by net income of $7,147,452, adding in non-cash charges, net of $5,084,849. Offset by the increase of trade receivables of $161,815, the increase in inventories of $4,390,392, the decrease in operating leases of $1,899,365, and the decrease in accounts payable and accrued expenses of $32,310.

During Fiscal 2023, cash used in investing totaled $1,759,861 which consisted of the purchase of property and equipment of $2,238,111 and the acquisition of the Steven Kretchmer, Inc. stock of $100,000. Offset by the receipt of $578,250 from notes receivable.

During Fiscal 2023, cash used in financing totaled $3,398,963 which consisted of principal payments made against notes payable loans of $1,243,914 and the acquisition of Company treasury stock of $2,155,049.

Starting December 31, 2023, certain amounts within the Consolidated Cash Flow Statements have been reclassified for presentation purposes. The reclassification did not impact the overall operating activities.

PART II

Items 7

On November 23, 2021, the Company secured a 36-month line of credit from Farmers State Bank of Oakley Kansas (“FSB”) for $3,500,000 at 3.1% annual interest rate. 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.

Management expects our capital expenditures to total approximately $2,700,000 during the next 12 months. These expenditures will be largely driven by the build-out of six properties, included in this is the build-out of corporate office space in the Company headquarters and the potential purchase and build-out of an additional consumer segment retail building. As of December 31, 2023, there are commitments of approximately $150,000 to build-out space at the Company’s headquarters located at 1901 Gateway Dr., Irving, Texas 75038.

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, 2023 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