President and Chief Executive Officer of Charles & Colvard, Ltd.
We operate in a dynamic and rapidly changing business environment that involves substantial risk and uncertainty, and these risks may change over time. The following discussion addresses some of the risks and uncertainties that could cause, or contribute to causing, actual results to differ materially from expectations. In evaluating our business, you should pay particular attention to the descriptions of risks and uncertainties described below. If any of these risks actually occur, our business, financial condition, or results of operations could be materially and adversely affected.
In addition, consumer acceptance may be affected by retail jewelers’ and jewelry manufacturers’ acceptance of moissanite jewels and finished jewelry featuring moissanite. The quality, design, and workmanship of the jewelry settings, whether manufactured by us or other manufacturers, could affect both consumers’ perception and acceptance of our jewelsproducts and costs incurred by returns and markdowns. Additionally, as other competitors enter the market, the lower quality of competitors’ gemstones could negatively impact consumer perception of moissanite, and in turn, acceptance of our jewels.
| · | ourOur continued success in developing and promoting the Charles & Colvard brands, for our moissanite jewelssuch as Forever OneTM andMoissanite by Charles & Colvard®, which are used in finished jewelry featuring moissanite, resulting in increased interest and demand for moissanite jewelry at the consumer level; |
| ·• | Our ability to differentiate Charles & Colvard Created Moissanite® from competing products, including competitive moissanite and the rapidly-emerging lab-created diamond industry; |
The ability to operationally execute our digital marketing strategy for our Online Channels segment;
Our continued ability and the ability of manufacturers, designers, and retail jewelers to select jewelry settings that encourage consumer acceptance of and demand for our moissanite jewels and finished jewelry;
The ability to understand our consumer market segment and effectively market to them a compelling value proposition that leads to converted customers;
Our ability to continue our relationship with Cree in order to sustain our supply of high-quality SiC crystals;
| • | The continued willingness and ability of our jewelry distributors and other jewelry suppliers, manufacturers, and designers to market and promote Charles & Colvard Created Moissanite® to the retail jewelry trade; |
| ·• | theThe continued willingness of distributors, retailers, and others in the channel ofour distribution channels to purchase loose Charles & Colvard Created Moissanite®, and the continued willingness of manufacturers, designers, and retail jewelers to undertake setting of the loose jewels;
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| · | our continued ability and the ability of manufacturers, designers, and retail jewelers to select jewelry settings that encourage consumer acceptance of and demand for our moissanite jewels and finished jewelry; |
| · | our continued ability and the ability of jewelry manufacturers and retail jewelers to set loose moissanite jewels in finished jewelry with high-quality workmanship; |
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Our continued ability and the ability of Contents
jewelry manufacturers and retail jewelers to set loose moissanite jewels in finished jewelry with high-quality workmanship; and | · | our
Our continued ability and the ability of retail jewelers to effectively market and sell finished jewelry featuring moissanite to consumers; and |
| · | our ability to operationally execute our direct-to-consumer e-commerce business. |
We are currently substantially dependent on a limited number of distributors, jewelry manufacturers, and retailers for the sale of our products. The majority of the moissanite jewels and finished jewelry featuring moissanite that we sell are distributed through a limited number of distributors, manufacturers, and retailers and, therefore, we are substantially dependent upon these companies for distribution of our products. During 2016, our three largest customers, two of which are loose jewel and finished jewelry distributors and one of which is a television shopping network which carries loose jewel and finished jewelry, collectively accounted for 45% of net sales. As we continue to build our finished jewelry business, we anticipate in the near term that the majority of the moissanite jewels and finished jewelry featuring moissanite that we sell will continue to be to a limited number of manufacturers, distributors, and retailers.consumers.
The execution of our business plans could significantly impact our liquidity. The execution of our business plans to expand our direct-to-consumer distribution channelsOnline Channels segment and global market opportunities, as well as to create required inventory of our Forever OneTM and Moissanite by Charles & Colvard®jewels, requires significant investments,investment of our resources, which may reduce our cash position. Should we fail to execute on our business plans, we could see delays in the return of cash from our investments, resulting in a liquidity shortfall. Under the $10,000,000$5.00 million asset-based revolving credit facility, or the White Oak Credit Facility, that we obtained from Wells Fargo, National Association, or Wells Fargo, White Oak on June 25, 2014,July 13, 2018, failure to conductmeet one or more of the following covenants could restrict our business as conductedability to draw on the date we obtained theWhite Oak Credit Facility,Facility: (i) failure to provide White Oak with certain financial information; (ii) failure to make required payments to third parties, orparties; and (iii) failure to comply with the other covenants and defaults contained in the White Oak Credit Facility, including a financial covenant to maintain at least $1,000,000$500,000 in excess availability (as defined under the White Oak Credit Facility), could restrict our. Our ability to draw down from the White Oak Credit Facility is currently restricted as a result of our diminished borrowing base, which is tied to our accounts receivable. In addition, we currently have an effective shelf registration statement on Form S-3 on file with the Credit Facility.SEC that allows us to periodically offer and sell, individually or in any combination, shares of common stock, shares of preferred stock, warrants to purchase shares of common stock or preferred stock, and units consisting of any combination of the foregoing types of securities, up to a total of $25.00 million (approximately $13.99 million after giving effect to our June 2019 public offering, including the impact of the partial exercise of the underwriters’ over-allotment option). However, we may offer and sell no more than one-third of our public float (which is the aggregate market value of our outstanding common stock held by non-affiliates) in any 12-month period. If we are not able to take advances againstdraw on the White Oak Credit Facility, or if we are unable to access the capital markets when we need to or issue equity on terms that are acceptable to us or at all, our cash and cash equivalents and other working capital may be insufficient to meet our working capital and capital expenditure needs. In addition, theThe White Oak Credit Facility matures on June 25, 2017July 13, 2021, and there is no guarantee forof extension or renewal.
Our business and our results of operations could be materially adversely affected as a result of our inability to fulfill orders on a timely basis. As sales of our loose moissanite jewels increase, including our Forever Brilliant® and Forever OneTM jewels,and Moissanite by Charles & Colvard® gemstones, availability of certain shapes and sizes may be at risk. In addition, finished jewelry has a large variety of styles of which we maintain on-hand stock for such basiccore designs as stud earrings, solitaire and three-stone rings, pendants, and bracelets; and make-to-ordermade-to-order under strict deadlines for certain wholesale and direct-to-consumer e-commerce customers.outlets. We must adequately maintain relationships, forecast demand, and operate within the lead times of third parties that facet and/or enhance the jewels and manufacture the finished jewelry settingsettings to ensure adequate on-hand quantities and/or the shipment of customer orders in a timely manner as we transition certain customers from Forever Brilliant® and Forever ClassicTM to Forever OneTMor Moissanite by Charles & Colvard®. In addition, we are currently dependent on a limited number ofupon certain vendors for allmost of the faceting of our loose jewels. If any or all of these vendors were to cancel their arrangements with us, we could experience a disruption in our operations and incur additional costs to procure faceting services from a replacement vendor. The inability to fulfill orders on a timely basis and within promised customer deadlines could result in a cancellation of the orders and loss of customer goodwill that could materially and adversely affect our business, results of operations, and financial condition. In addition, the COVID-19 pandemic has caused, and may continue to cause, us or our distributors, vendors, and/or customers to temporarily suspend our or their respective operations and have an adverse impact on our ability to fulfill orders on a timely basis.
The financial difficulties or insolvency of one or more of our major customers or their lack of willingness and ability to market our products could adversely affect results. We are subject to a concentration of credit risk amongst our major customers (some of whom are distributors), and a default by any of these customers on their debtsamounts owed to us could have a material adverse effect on our financial position. Future sales and our ability to collect accounts receivable depend, in part, on the financial strength of our customers and our distributors’ willingness and ability to successfully market our products. We estimate an allowance for accounts for which collectability is at risk and this allowance adversely impacts profitability. In the event customers experience greater than anticipated financial difficulties, insolvency, or difficulty marketing products, we expect profitability to be further adversely impacted by our failure to collect accounts receivable in excess of the amount due, net of the estimated allowance. In these circumstances, we may demand the return of product sold to such customers, resulting in an increase in inventory and a reduction in accounts receivable. GivenUncertainty in the current economic environment, as a result of the COVID-19 pandemic, constrained access to capital, the impact of inflation on our currency, and general market contractions has heightened, and maycontinue to heighten, our exposure to customer default and generate lower than expected distributor sales.
We expect to remain dependent upon the Supply Agreement with Cree for the sole supply of our SiC crystals for the foreseeable future. If we are unable to obtain sufficient, high-quality SiC crystals from Cree and we have a significant increase in demand for our moissanite jewels, then we may not be able to meet that demand. Cree has certain proprietary rights relating to its process for growing large single crystals of SiC and its process for growing near-colorless SiC crystals. Under the Supply Agreement, subject to certain terms and conditions, we agreed to exclusively purchase from Cree, and Cree agreed to exclusively supply, 100% of our required SiC materials in quarterly installments that must equal or exceed a set minimum order quantity. The initial term of the Supply Agreement will expire on June 24, 2018, unless extended by the parties. We also have one option to unilaterally extend the term of the agreement for an additional two-year period, subject to certain conditions. Our total purchase commitment under the Supply Agreement until June 2018 is dependent upon the size of the SiC material and ranges between approximately $29.6 million and approximately $31.5 million. However, there can be no assurance that Cree will be able to continue to produce and supply us with SiC crystals of sufficient quality, sizes, and volumes that we desire or that we will successfully negotiate future purchase commitments at acceptable prices that enable us to manage our inventories and raw material costs effectively.
We face intense competition in the worldwide jewelry industry. The jewelry industry is highly competitive and we compete with numerous other jewelry products. In addition, we face competition from treatedmined diamonds, synthetic diamonds, lab-grownlab-created (synthetic) diamonds, other moissanite jewels,products, and companies developing other synthetic jewelry technologies.simulants. A substantial number of companies supply products to the jewelry industry, many of whichwhom we believe have greater financial resources than we do. Competitors could develop new or improved technologies, including those for lab-grown diamonds, that may render the price point for moissanite noncompetitive, which wouldcould have an adverse effect on our business, results of operations, and financial condition.
In addition, weWe have previously relied on our patent rights and other intellectual property rights to maintain our competitive position. Our current U.S. product and method patents for moissanite jewels expired in 2015 and most of our patents in foreign jurisdictions expired in 2016 with only one in Mexico remaining (which expires in 2021). As a result,However, we anticipatehave certain trademarks and pending trademark applications that support our moissanite branding strategy. Additionally, we have certain pending design patents that we believe, if approved, will differentiate our products in the gemstone and jewelry industry. Notwithstanding the foregoing, since the expiration of our patents we have noted new providers of moissanite will enterand competitive products entering the market. However, because the process of creating high-quality moissanite is challenging, we believe it will take emerging providers significant time and investment to bring meaningful and competitive products to market. Asas we experienced ourselves, we anticipate it will take these new providers significant time to evolve from producing low-end moissanite to delivering high-quality gemstones in the colorless or near-colorless range. Achievingachieving the capacity to consistently produce a high-quality moissanite product at mass scale requires a careful balance of silicon carbide-specificSiC-specific faceting skills and a well-tuned global supply chain. Therefore,As our pending patent rights and other pending intellectual property rights are approved, we do not anticipate direct moissanite competition in the colorless grade D-E-F or near-colorless grade G-H-I ranges for some timewill continue to come.rely on these patents and our carefully-executed brand awareness and digital marketing campaigns to build our consumer relationships and maintain our competitive position going forward. If, however, we are unable to successfully build strong brands for our moissanite jewels and finished jewelry featuring moissanite or competition grows faster than expected, we may not have commercially meaningful protection for our products or a commercial advantage against our competitors or their competitive products or processes, which may have a material adverse effect on our business, results of operations, and financial condition.
The resignationWe are subject to certain risks due to our international operations, distribution channels and vendors. We have continued to expand our direct international sales operations, with international net sales accounting for approximately 8% of total consolidated net sales during Fiscal 2020. We also currently have numerous international wholesale distributors and retail sales channels covering portions of Canada, the UK, Western Europe, Australia and New Zealand, Southeast Asia, the Middle East, and the Greater China Region. In addition, we use certain companies based outside the U.S. to facet our moissanite jewels and to manufacture finished jewelry. We plan to continue to increase marketing and sales efforts and anticipate expanding our direct international sales in addition to continuing to serve international distributors. Any international expansion plans we choose to undertake will increase the complexity of our Chief Financial Officerbusiness, require attention from management and other personnel and cause additional strain on our operations, financial resources and our internal financial control and reporting functions. Further, our expansion efforts may be unsuccessful as we have limited experience selling our products in certain international markets and in conforming to the local cultures, standards or policies necessary to successfully compete in those markets. In addition, we may have to compete with retailers that have more experience with local markets. Our ability to expand and succeed internationally may also be limited by the demand for our products, the ability to successfully transact in foreign currencies, the ability of our brand to resonate with consumers globally and the departureadoption of online or Internet commerce in these markets. Different privacy, censorship and liability standards and regulations, and different intellectual property laws in foreign countries may also prohibit expansion into such markets or cause our business and results of operations to suffer. Through our planned international expansion and our continued reliance on development of foreign markets and use of foreign vendors, we are subject to the risks of conducting business outside of the U.S.
These risks include the following:
the adverse effects on U.S.-based companies operating in foreign markets that might result from war; terrorism; changes in diplomatic, trade, or business relationships (including labor disputes); or other political, social, religious, or economic instability;
an outbreak of a contagious disease, such as COVID-19, which may cause us or our distributors, vendors, and/or customers to temporarily suspend our or their respective operations in the affected city or country;
the continuing adverse economic effects of any global financial crisis;
unexpected changes in, or impositions of, legislative or regulatory requirements;
delays resulting from difficulty in obtaining export licenses;
international regulatory requirements, tariffs and other trade barriers and restrictions, including the consequences of U.S. led tariff actions;
the burdens of complying with a variety of foreign laws and regulations, including foreign taxation and varying consumer and data protection laws, and other factors beyond our control, and the risks of non-compliance;
longer payment cycles and greater difficulty in collecting accounts receivable;
our reliance on third-party carriers for product shipments to our customers;
risk of theft of our Chief Revenue Officer create uncertaintiesproducts during shipment;
limited payment, shipping and insurance options for us and our customers;
difficulties in obtaining export, import or other business licensing requirements;
customs and import processes, costs or restrictions;
the potential difficulty of enforcing agreements with foreign customers and suppliers; and
the complications related to collecting accounts receivable through a foreign country’s legal or banking system.
In particular, there is currently significant uncertainty about the future relationship between the U.S. and various other countries, with respect to trade policies, treaties, government regulations, and tariffs. For example, the recent imposition of tariffs and/or increase in tariffs on various products by the U.S. and other countries, including China and Canada, have introduced greater uncertainty with respect to trade policies and government regulations affecting trade between the U.S. and other countries, and new and/or increased tariffs have subjected, and may in the future subject, us to additional costs and expenditure of resources. Major developments in trade relations, including the imposition of new or increased tariffs by the U.S. and/or other countries, and any emerging nationalist trends in specific countries could impactalter the trade environment and consumer purchasing behavior which, in turn, could have a material effect on our business. Effective December 2, 2016, Kyle S. Macemore resigned as our Senior Vice Presidentfinancial condition and Chief Financial Officer; Clint J. Pete, our current Corporate Controller, was appointedresults of operations. While the U.S. and China recently signed a “phase one” trade deal on January 15, 2020 to serve as our Interim Chief Financial Officer effective upon Mr. Macemore’s resignation.reduce planned increases to tariffs, concerns over the stability of bilateral trade relations remain. In addition, effectivethe UK’s exit from the European Union on January 10, 2017, Steve Larkin,31, 2020, known as Brexit, and the ongoing negotiations of the future trading relationship between the UK and the European Union during the transition period set to end December 31, 2020 have yet to provide clarity on what the outcome will be for the UK or Europe. Changes related to Brexit could subject us to heightened risks in that region, including disruptions to trade and free movement of goods, services and people to and from the UK, disruptions to the workforce of our Chief Revenue Officer, is no longerbusiness partners, increased foreign exchange volatility with respect to the Company. The Company’s ability to execute its business strategies may be adversely affected by the uncertainty associated withBritish pound and additional legal, political and economic uncertainty. If these transitions.
Leadership transitions can be inherently difficult to manageactions impacting our international distribution and may cause uncertainty and decreased productivity amongsales channels result in increased costs for us or our employees and increase the likelihood of turnover, whichinternational partners, such changes could result in significant disruptionshigher costs to us, adversely affecting our operations. We could be adversely affected ifoperations, particularly as we fail to adequately plan for the succession of membersexpand our international presence.
Additionally, while substantially all of our senior management team should we have additional departures. In addition, these management transitions inherently cause some lossforeign transactions are denominated in U.S. dollars, foreign currency fluctuations could impact demand for our products or the ability of institutional knowledge, which can negatively affect strategy and execution, and our results of operations and financial condition could suffer as a result. Finally, weforeign suppliers to continue to execute a number of significant business initiatives. Successfully managing these initiatives, including retention of key employees, is critical to our business success.
Salesperform. Further, some of our common stock by Mr. Larkin may cause the market price of our common stock to decrease. As previously noted, Steve Larkin, our Chief Revenue Officer, is no longer with our company, effective as of January 10, 2017. Upon Mr. Larkin’s departure, he held 279,957 shares of common stock and options exercisable for 150,000 shares of common stock. Mr. Larkin has the ability, subject to applicable securities laws, to sell all or a portion of his currently held common stock and any shares of common stock he obtains through the exercise of in- the-money stock options to provide liquidity or to diversify his investments. If he does sell his common stock into the market, these sales may cause the market price of our common stock to decrease.
Our failure to maintain compliance with NASDAQ’s continued listing requirements could result in the delisting of our common stock. Our common stock is currently listed on the NASDAQ Global Select Market. In order to maintain this listing, we must satisfy minimum financial and other requirements. In the past, we have received a notification letter from NASDAQ indicating that we were not in compliance with listing requirements because the minimum bid price of our common stock closed below $1.00 per share for 30 consecutive business days. However, NASDAQ subsequently notified us that we had regained compliance with the minimum bid price requirement. If we fail to satisfy NASDAQ’s listing requirements in the future, we expect to take actions to regain compliance, but we can provide no assurance that any such action would prevent our common stock from dropping below the NASDAQ minimum bid price requirement or prevent future non-compliance with NASDAQ’s listing requirements. If our common stock is delisted from NASDAQ, the delisting could substantially decrease trading in our common stock and adversely affect the market liquidity of our common stock; adversely affect our ability to obtain financing on acceptable terms, if at all;foreign distributors operate relatively small businesses and may resultnot have the financial stability to assure their continuing presence in the potential loss of confidence by investors, suppliers, customers, and employees and fewer business development opportunities. Additionally, the market price of our common stock may decline further and shareholders may lose some or all of their investment.
Our current wholesale customers may potentially perceive us as a competitor in the finished jewelry business. As described above, we are currently substantially dependent on a limited number of customers, including distributors and jewelry manufacturers, for the sale of our products. Our design, manufacture, and marketing of finished jewelry featuring moissanite under exclusive brands for sale to distributors and retailers may result in some of these current customers perceiving us as a competitor, despite our efforts to use primarily non-conflicting sales channels. In response, these customers may choose to reduce their orders for our products. This reduction in orders could occur faster than our sales growth in this business, which could materially and adversely affect our business, results of operations, and financial condition.
We may experience quality control challenges from time to time that can result in lost revenue and harm to our brands and reputation. Part of our strategy for success is to establish Charles & Colvard with reputable, high-quality, and sophisticated brands. The achievement of this goal depends in large part on our ability to provide customers with high-quality moissanite and finished jewelry featuring moissanite. Although we take measures to ensure that we sell only the best quality products, we may face quality control challenges, which could impact our competitive advantage.markets. There can be no assurance wethat the foregoing factors will be ablenot adversely affect our operations in the future or require us to detect and resolve all quality control issues prior to shipment of products tomodify our distributors, manufacturers, retailers, and end consumers. Failure to do so could result in lost revenue, lost customers, significant warranty and other expenses, and harm to our reputation.anticipated business practices.
Our business and our results of operations could be materially adversely affected as a result of general economic and market conditions. Our business, including our sales volumes and overall profitability, could be adversely impacted by disruptions in global financial markets, including severely diminished liquidity and credit availability, declines in consumer confidence, declines in economic growth, increased unemployment rates, and uncertainty about economic stability.stability including the increased risk of global trade tensions. We are unable to predict the likely duration and severity of the effects of these disruptions in the financial markets and the adverse global economic conditions, and if economic conditions deteriorate, our business and results of operations could be materially and adversely affected. The consequences of such adverse effects could include interruptions or delays in our suppliers’ performance of our contracts, reductions and delays in customer purchases, delays in or the inability of customers to obtain financing to purchase our products, and bankruptcy of customers and/or suppliers.
Luxury products, such as fine jewelry, are discretionary purchases for consumers. Recessionary economic cycles, higher interest rates, higher fuel and energy costs, inflation, levels of unemployment, conditions in the residential real estate and mortgage markets, access to credit, consumer debt levels, unsettled financial markets, and other economic factors that may affect consumer spending or buying habits could materially and adversely affect demand for our products. In addition, volatility in the financial markets has had and may continue to have a negative impact on consumer spending patterns. A reduction in consumer spending or disposable income may affect us more significantly than companies in other industries and could have a material adverse effect on our business, results of operations, and financial condition.
We are subject to certain risks due tocurrently dependent on a limited number of distributor and retail partners in our international distribution channels and vendors. We currently have over 20 international distributorsTraditional segment for
moissanite jewels covering portionsthe sale of
Western Europe, Australia, India, Southeast Asia, andour products. A significant portion of the
Middle East. In addition, we use certain companies based outside the U.S. to facet our moissanite jewels and
finished jewelry featuring moissanite that we sell are distributed through a limited number of distributors and retail partners in our Traditional segment, and therefore, we are dependent upon these companies for distribution of our products. Our three largest customers collectively accounted for approximately 33% and 30% of our net sales during the fiscal years ended June 30, 2020 and 2019, respectively. As we continue to
manufacturebuild our finished
jewelry. Duejewelry business, we anticipate in the near term that a significant portion of the moissanite jewels and finished jewelry featuring moissanite that we sell through our Traditional segment will continue to be to a limited number of distributors and retailers.
We rely on assumptions, estimates and data to calculate certain of our key metrics and real or perceived inaccuracies in such metrics may harm our reputation and negatively affect our business. We believe that certain metrics are key to our business, including but not limited to average order value, or AOV, average advertising spend per customer, and repeat customers. As both the industry in which we operate and our business continue to evolve, so too might the metrics by which we evaluate our business. While the calculation of these metrics is based on what we believe to be reasonable estimates, our internal tools are not independently verified by a third party and may have a number of limitations and, furthermore, our methodologies for tracking these metrics may change over time. Given the difficulty in tracking consumers online, calculations of our unique visitors may not accurately reflect the number of people actually visiting our platforms. We continue to improve upon our tools and methodologies to capture data and believe that our current metrics are accurate; however, the improvement of our tools and methodologies could cause inconsistency between current data and previously reported data, which could confuse investors or lead to questions about the integrity of our data. In addition, if the internal tools we use to track these metrics under-count or over-count performance or contain algorithm or other technical errors, the data we report may not be accurate. Accordingly, you should not place undue reliance on development of foreign markets and use of foreign vendors, we are subject to the risks of conducting business outside of the U.S. These risks include the following:these metrics.
| · | the adverse effects on U.S.-based companies operating in foreign markets that might result from war; terrorism; changes in diplomatic, trade, or business relationships; or other political, social, religious, or economic instability; |
Our failure to maintain compliance with Nasdaq’s continued listing requirements could result in the delisting of our common stock. Our common stock is currently listed on The Nasdaq Capital Market. In order to maintain this listing, we must satisfy minimum financial and other requirements. On March 24, 2020, we received a notification letter from Nasdaq’s Listing Qualifications Department indicating that we are not in compliance with Nasdaq Listing Rule 5550(a)(2), because the minimum bid price of our common stock on the Nasdaq Capital Market has closed below $1.00 per share for 30 consecutive business days. In accordance with Nasdaq Listing Rule 5810(c)(3)(A), we have 180 calendar days to regain compliance with the minimum bid requirement; however, due to the market disruption caused by the ongoing COVID-19 pandemic, Nasdaq tolled the requirement for meeting the minimum bid price until June 30, 2020. As such, we have until December 4, 2020, to achieve compliance with the minimum bid price requirement. To regain compliance, the closing bid price of our common stock must meet or exceed $1.00 per share for at least ten consecutive business days before December 4, 2020. If we do not regain compliance during this cure period, we expect that Nasdaq will provide written notification to us that our common stock will be delisted. At that time, we may appeal Nasdaq’s delisting determination to a Nasdaq hearing panel.
| · | unexpected changes in, or impositions of, legislative or regulatory requirements; |
| · | delays resulting from difficulty in obtaining export licenses; |
| · | tariffs and other trade barriers and restrictions; |
| · | the burdens of complying with a variety of foreign laws and other factors beyond our control; |
| · | the potential difficulty of enforcing agreements with foreign customers and suppliers; and |
| · | the complications related to collecting receivables through a foreign country’s legal system. |
Additionally, while all ofWhile we intend to engage in efforts to regain compliance, and thus maintain our foreign transactions are denominated in U.S. dollars, foreign currency fluctuations could impact demand for our products orlisting, there can be no assurance that we will be able to regain compliance during the ability of our foreign suppliersapplicable time periods set forth above. If we fail to continue to perform. Further, somemeet all applicable Nasdaq Capital Market requirements in the future and Nasdaq determines to delist our common stock, the delisting could substantially decrease trading in our common stock; adversely affect the market liquidity of our foreign distributors operate relatively small businessescommon stock as a result of the loss of market efficiencies associated with Nasdaq and the loss of federal preemption of state securities laws; adversely affect our ability to obtain financing on acceptable terms, if at all; and may not haveresult in the financial stabilitypotential loss of confidence by investors, suppliers, customers, and employees and fewer business development opportunities. Additionally, the market price of our common stock may decline further and shareholders may lose some or all of their investment.
We may experience quality control challenges from time to assure their continuing presencetime that can result in their markets.lost revenue and harm to our brands and reputation. Part of our strategy for success is to align Charles & Colvard with reputable, high-quality, and sophisticated strategic partners. The achievement of this goal depends in large part on our ability to provide customers with high-quality moissanite and finished jewelry featuring moissanite. Although we take measures to ensure that we sell only the best quality products, we may face quality control challenges, which could impact our competitive advantage. There can be no assurance that the foregoing factorswe will notbe able to detect and resolve all quality control issues prior to shipment of products to our distributors, manufacturers, retailers, and end consumers. Failure to do so could result in lost revenue, lost customers, significant warranty and other expenses, and harm to our reputation.
Seasonality of our business may adversely affect our net sales and operating income. Sales in the retail jewelry industry are typically seasonal due to increased consumer purchases during the calendar year-end holiday season. Because historically we have primarily sold our loose moissanite jewels and finished jewelry featuring moissanite at wholesale pricing to distributors, manufacturers, and retailers, our sales to support the holiday season have largely taken place during the third and beginning of the fourth calendar quarters, depending on the sales channel and the level of advance planning and production our customers undertook. As sales of our finished jewelry featuring moissanite to retailers and directly to consumers increase, both in dollars and as a percentage of total sales, our results for the three months in the calendar quarter ending December 31 of each year may depend upon the general level of retail sales during the holiday season as well as general economic conditions and other factors beyond our control. In anticipation of increased sales activities during the three months in the calendar quarter ending December 31 of each year, we may incur significant additional expenses in the second half of the calendar year.
In recent years, excluding one-time sales events, we have experienced a higher degree of seasonality in the three months ending December 31 than we have experienced in prior years primarily as a result of the calendar year-end holiday season sales to end consumers through our Online Channels segment and as a result of increased sales through our brick-and-mortar retailers within our Traditional segment. Our quarterly results of operations may continue to fluctuate as a result of a number of factors, including seasonal cycles, the timing of new product introductions, the timing of orders by our customers, and the mix of product sales demand, and these factors may significantly affect our results of operations in the future or require us to modify our anticipated business practices.a given quarter.
Our operations could be disrupted by natural disasters. We conduct substantially all of our activities, including executive management, manufacturing, packaging, and distribution activities, at one North Carolina location. Although we have taken precautions to safeguard our facility, including obtaining business interruption insurance, any future natural disaster, such as a hurricane, flood or fire, could significantly disrupt our operations and delay or prevent product shipment during the time required to repair, rebuild or replace our facility, which could be lengthy and result in significant expenses. Furthermore, the insurance coverage we maintain may not be adequate to cover our losses in any particular case or continue to be available at commercially reasonable rates and terms. In addition, the vendors that perform allsome of the faceting of our loose moissanite jewels are located in regions that are susceptible to tsunamis, flooding, and other natural disasters that may cause a disruption in our vendors’ operations for sustained periods and the loss or damage of our work-in-process inventories located at such vendors’ facilities. Damage or destruction that interrupts our ability to deliver our products could impair our relationships with our customers. Prolonged disruption of our services as a result of a natural disaster may result in product delivery delays, order cancellations, and loss of substantial revenue, which could materially and adversely affect our business, results of operations, and financial condition.
Our PPP Loan may not be forgiven or may subject us to challenges and investigations regarding qualification for the loan. We received a loan pursuant to the Paycheck Protection Program under the CARES Act, as administered by the SBA. The PPP Loan in the principal amount of moissanite jewelry$965,000 was disbursed by Newtek Small Business Finance, LLC, or the Lender, a nationally licensed lender under the SBA on June 18, 2020 pursuant to the Promissory Note issued by us on June 15, 2020. Pursuant to Section 1106 of the CARES Act, we may apply for and be granted forgiveness for all or a portion of the PPP Loan. Such forgiveness will be determined, subject to limitations, based on the use of the loan proceeds for qualifying expenses, which include payroll costs, rent, and utility costs. We cannot provide any assurance that we will be eligible for loan forgiveness, that we will ultimately apply for forgiveness, or that any amount of the PPP Loan will ultimately be forgiven by the SBA.
Additionally, the PPP Loan application required us to certify that the current economic uncertainty made the PPP Loan request necessary to support our ongoing operations. While we made this certification in good faith after analyzing, among other things, our financial situation and access to alternative forms of capital, and believe that we satisfied all eligibility criteria for the PPP Loan and that our anticipated receipt of the PPP Loan is consistent with the broad objectives of the Paycheck Protection Program of the CARES Act, the certification described above does not contain any objective criteria and is subject to interpretation. In addition, the SBA has stated that it is unlikely that a public company with substantial market value and access to capital markets will be able to make the required certification in good faith. The lack of clarity regarding loan eligibility under the program has resulted in significant media coverage and controversy with respect to public companies applying for and receiving loans. If, despite our good faith belief that we satisfied all eligibility requirements for the PPP Loan, we are found to have been ineligible to receive the PPP Loan or in violation of any of the laws or regulations that apply to us in connection with the PPP Loan, including the False Claims Act, we may be subject to penalties, including significant civil, criminal and administrative penalties and could be dependent uponrequired to repay the pricingPPP Loan. In the event that we seek forgiveness of precious metals, which is beyond our control. Any increases in the market price of precious metals (primarily gold) could affect the pricing and sales of jewelry incorporating moissanite jewels, including jewelry manufactured by us. The majority of price increases in precious metals are passed on to the end consumer in the form of higher prices for finished jewelry. These higher prices could haveall or a negative impact on the sell-through of moissanite jewelry at the retail level. From the beginning of 2006 through 2016, the price of gold has increased significantly (approximately 117%), resulting in higher retail price points for gold jewelry. This has had a negative impact on both sales of moissanite jewelry and the jewelry industry as a whole.
Seasonality of our business may adversely affect our net sales and operating income. Sales in the retail jewelry industry are typically seasonal due to increased consumer purchases during the holiday season. Because historically we have primarily sold our loose jewels and finished jewelry featuring moissanite at wholesale to distributors, manufacturers, and retailers, our sales to support the holiday season largely have taken place during the third and beginningportion of the fourth calendar quarters, depending on the sales channelanticipated PPP Loan, we will also be required to make certain certifications which will be subject to audit and the level of advance planningreview by governmental entities and productioncould subject us to significant penalties and liabilities if found to be inaccurate. In addition, our customers undertook. As sales of our finished jewelry featuring moissanite to retailers and directly to consumers increase, both in dollars and as a percentage of total sales, our fourth quarter results may depend upon the general level of retail sales during the holiday season as well as general economic conditions and other factors beyond our control. In anticipation of increased sales activities during the fourth quarter, we may incur significant additional expenses, including higher inventory of finished jewelry in the second halfanticipated receipt of the year. In recent years, excluding one-time salesPPP Loan may result in adverse publicity and damage to our reputation, and a review or audit by the SBA or other government entity or claims under the False Claims Act could consume significant financial and management resources. Any of these events we have experienced a higher degree of seasonality in the fourth quarter than we have experienced in prior years primarily as a result of the holiday season sales to end consumers throughcould harm our direct-to-consumer e-commerce website, charlesandcolvard.com and as a result of increased sales through televised home shopping networks within our wholesale distribution segment. Our quarterlybusiness, results of operations may continue to fluctuate as a result of a number of factors, including seasonal cycles, the timing of new product introductions, the timing of orders by our customers, and the mix of product sales demand, and these factors may significantly affect our results of operations in a given quarter.financial condition.
We may not be able to adequately protect our intellectual property, which could harm the value of our products and brands and adversely affect our business. We rely primarily on patent, copyright, trademark, and trade secret laws, as well as confidentiality procedures and contractual restrictions, to establish and protect our proprietary rights, all of which provide only limited protection. We hadheld U.S. product and method patents for moissanite jewels, which expired in August 2015, under which we believed that we had broad, exclusive rights to manufacture, use, and sell moissanite jewels in the U.S. We had these same patents in 25 foreign jurisdictions primarily across Asia and Europe that expired in the third quarter of 2016 and one that will expire in Mexico in 2021. However, our patent expirations could enablehave enabled competitors and other businesses to duplicate and market a similar product and enter the marketplace. Without patent protection, we must rely primarily on our branding strategy and the Supply Agreement under which Cree supplies SiC crystals exclusively to us, as well as confidentiality procedures, to protect our proprietary rights, which may or may not be sufficient. In addition, at the present time, we are primarily dependent on Cree’s technology for the production of SiC crystals. There can be no assurance that any patents issued to or licensed by or to us will provide any significant commercial protection, that we will have sufficient resources to protect our respective patents and proprietary rights, that any additional patents will be issued in the future, or that any existing or future patents will be upheld by a court should we seek to enforce our rights against an infringer. At this point, we cannot reasonably estimate the impact these patent expirations will have on our future results of operations.
The existence of valid patents does not prevent other companies from independently developing competing technologies. Existing producers of SiC crystals or others may refine existing processes for growing SiC crystals or develop new technologies for growing large single crystals of SiC or colorless SiC crystals in a manner that does not infringe any patents issued to or licensed by or to us. Accordingly, existing and potential competitors may behave been able to develop products that are competitive with or superior to certain of our products, and such competition could have a material adverse effect on our business, results of operations, and financial condition.
In addition, we have certain trademarks and pending trademark applications that support our moissanite branding strategy, and we use certain brand names for which we do not currently have proprietary rights.strategy. The success of our growth strategy may depend on our continued ability to use our existing brand names in order to increase consumer awareness and further develop strong brands around our moissanite jewels and finished jewelry collections. We cannot assure that any future trademark or other registrations will be issued for pending or future applications or that we will be able to obtain licenses or other contractual rights to use brand names that may infringe the proprietary rights of third parties. We also cannot assure that any registered or unregistered trademarks or other intellectual property or contractual rights will be enforceable or provide adequate protection of our proprietary rights. Our inability to secure proprietary protection with respect to our brands could have a material adverse effect on our business, results of operations, and financial condition.
We also cannot be certain that our products and brand names do not or will not infringe valid patents, trademarks, and other intellectual property rights held by third parties. We may be subject to legal proceedings and claims from time to time relating to the intellectual property of others in the ordinary course of our business. Litigation to determine the validity of any third party’s claims could result in significant expense and divert the efforts of our technical and management personnel, whether or not such litigation is determined in our favor. In the event of an adverse result of any such litigation, we could be required to expend significant resources to develop non-infringing technology or to obtain licenses for, and pay royalties on the use of, the technology subject to the litigation. We have no assurance that we would be successful in such development or that any such license would be available on commercially reasonable terms.
Negative or inaccurate information on social media could adversely affect our brand and reputation. We are actively using various forms of digital and social media outreach to accomplish greater awareness of our brand and the value proposition we offer. These social media platforms and other forms of Internet-based communications allow access not only by us, but by any individual, to a broad audience of consumers and other interested persons. Consumers value readily available information concerning goods that they have or plan to purchase; however, they may act on such information without further investigation or authentication. Many social media platforms, including those relating to recruiting and placement activities, immediately publish the content of their participants’ posts, often without filters or checks on accuracy of the content posted. While we actively monitor social media sites, we may be unable to quickly and effectively respond to or correct inaccurate and/or unfavorable information posted on social media platforms. Any such information may harm our reputation or brand, which could in turn materially and adversely affect our business, results of operations, and financial condition.
We depend on a single supplier for substantially all of our SiC crystals, the raw materials we use to produce moissanite jewels; if our supply of high-quality SiC crystals is interrupted, our business may be materially harmed.We are party to an exclusive supply agreement with Cree, which we depend on for the provision of substantially all of the SiC material we use to produce moissanite jewels. Under the terms and conditions of the Supply Agreement, we agreed to purchase from Cree, and Cree agreed to supply, all of our required SiC material, subject to terms and conditions that allow us to purchase certain amounts of SiC materials from third parties under limited conditions. The Supply Agreement is set to expire in 2025, but may be further extended upon mutual agreement of the parties to the Supply Agreement. If our supply of high-quality SiC crystals is interrupted, then we may not be able to meet demand for moissanite jewels and our business may be materially and adversely affected. Cree has certain proprietary rights relating to its process for growing large single crystals of SiC and its process for growing colorless and near-colorless SiC crystals. There is no guaranty that we would be able to obtain similar quality SiC crystals from another provider. There can be no assurance that Cree will be able to continue to produce and supply us with SiC crystals of sufficient quality, sizes, and volumes that we desire or that we will be able to continue to negotiate future purchase commitments at acceptable prices that enable us to manage our inventories and raw material costs effectively.
Sales of moissanite jewelry could be dependent upon the pricing of precious metals, which is beyond our control. Any increases in the market price of precious metals (primarily gold) could affect the pricing and sales of jewelry incorporating moissanite jewels. The majority of price increases in precious metals are passed on to the end consumer in the form of higher prices for finished jewelry. These higher prices could have a negative impact on the sell-through of moissanite jewelry at the retail level. From 2006 through 2020, the price of gold has increased significantly, resulting in higher retail price points for gold jewelry. Accordingly, higher gold prices could have an adverse impact on both sales of moissanite finished jewelry and the jewelry industry as a whole.
Our current customers may potentially perceive us as a competitor in the finished jewelry business. As described above, we are currently dependent on a limited number of customers, including distributors and retailers, for the sale of our products in the Traditional segment. Our design, manufacture, and marketing of finished jewelry featuring moissanite for sale to distributors and retailers may result in some of these current customers perceiving us as a competitor, despite our efforts to use primarily non-conflicting sales channels. In response, these customers may choose to reduce their orders for our products. This reduction in orders could occur faster than our sales growth in this business, which could materially and adversely affect our business, results of operations, and financial condition.
If the e-commerce opportunity changes dramatically or if e-commerce technology or providers change their models, our results of operations may be adversely affected. As e-commerce emerges as one of our primary selling channels, our business model becomes more reliant on third-party platforms to achieve success. Should our products, product listings, or business not meet the requirements of certain third-party transactional channels such as marketplaces, comparison shopping engines, or social commerce sites, it may affect our ability to meet our revenue targets. Additionally, Amazon, eBay, Walmart.com, Gemvara, or other desirable e-commerce platforms may decide to make significant changes to their respective business models, policies, systems, or plans, and those changes could impair or inhibit our ability to sell our products through those channels. Further, a significant change in consumer online behavior or the introduction of new or disruptive technology could adversely affect overall e-commerce trends and diminish the value of investments we have made in select online channels. Any of these results could cause a significant reduction in our revenue and have a material adverse effect on our results of operations.
A failure of our information technology, (IT)or IT, infrastructure or a failure to protect confidential information of our customers and our network against security breaches could adversely impact our business and operations. We rely upon the capacity, reliability, and security of our information technologyIT infrastructure and our ability to expand and continually update this infrastructure in response to the changing needs of our business.business related to the deployment, integration, and management of new technology. For example, we implementedregularly implement new IT systems and update payment gateways that support our wholesale and charlesandcolvard.com e-commerce businesses.Online Channels segment. As we implement and integrate new systems, oras well as retire and de-integrate existing systems, theythe IT operating environment following such changes may not perform as expected. We also face the challenge of supporting our older systems and implementing necessary upgrades. If we experience a problem with the functioning of an important IT system or a security breach of our IT systems, the resulting disruptions could have an adverse effect on our business.
In addition, we and certain of our third-party vendors receive and store personal information associated with our sales operations and other aspects of our business. In connection with our e-commerce business, we rely on encryption and authentication technology licensed from third parties to effect secure transmission of confidential information, including credit card numbers. Our disclosure controls and procedures address cybersecurity and include elements intended to ensure that there is an analysis of potential disclosure obligations arising from security breaches. We also maintain compliance programs to address the potential applicability of restrictions against trading while in possession of material, nonpublic information generally and in connection with a cybersecurity breach. The breakdown in existing controls and procedures around our cybersecurity environment may prevent us from detecting, reporting or responding to cyber incidents in a timely manner and could have a material adverse effect on our financial position and value of our Company’s stock. Despite our implementation of security measures, our IT systems and e-commerce business are vulnerable to damages from computer viruses, natural disasters, unauthorized access, cyber-attack, and other similar disruptions. An increasing number of websites and Internet companies have reported breaches of their security. Any such compromise of our security could damage our reputation, business, and brand and expose us to a risk of loss or litigation and possible liability, which could substantially harm our business and results of operations. In addition, anyone who is able to circumvent our security measures could misappropriate proprietary information or cause interruptions in our operations, damage our computers or those of our customers, or otherwise damage our reputation and business. These issues are likely to become more difficult as we expand the number of countries in which our e-commerce website operates. We may need to expend significant resources to protect against security breaches or to address problems caused by breaches.
IfFor example, in 2016, the e-commerce opportunityEuropean Union, or EU, Parliament approved the new EU data protection legal framework known as the General Data Protection Regulation, or GDPR. The GDPR, which became effective in May 2018, replaced previously existing regulations and thereby extended the scope of EU data protection law to all non-EU companies processing data of EU residents. The GDPR contains numerous requirements and changes dramaticallyfrom prior EU law, including more robust obligations on data processors, greater rights for data subjects, and heavier documentation requirements for data protection compliance programs. The GDPR also imposes strict rules on the transfer of personal data out of the EU, including to the U.S., and recent legal developments in Europe have created complexity and uncertainty regarding such transfers of personal data from the EU to the U.S. For example, in July 2020, the Court of Justice of the European Union, or if e-commerce technologythe CJEU, invalidated the EU-U.S. Privacy Shield framework, or providers change their models, our results of operations may be adversely affected. As we adopt e-commerce asPrivacy Shield, one of the mechanisms used to legitimize the transfer of personal data from the EU to the U.S. The CJEU decision also drew into question the long-term viability of an alternative means of data transfer, the standard contractual clauses, for transfers of personal data from the EU to the U.S. While we were not self-certified under the Privacy Shield, this CJEU decision may lead to increased scrutiny on data transfers from the EU to the U.S. generally and increase our primary selling channels, our business model becomes more reliant on third-party platforms to achieve success. Should our products, product listings, or business not meet the requirementscosts of certain third-party transactional channelscompliance with data privacy legislation. The costs of compliance with, and other burdens and any penalties imposed by, such as marketplaces, comparison shopping engines, or social commerce sites, it may affect our ability to meet our revenue targets. Additionally, Amazon, eBay, Jet, Walmart.com, Gemvara, or other desirable e-commerce platforms may decide to make significant changes to their respective business models,international and domestic laws, regulations and policies systems, or plans, and those changes could impair or inhibit our ability to sell our products through those channels. Further, a significant change in consumer online behavior or introduction of new or disruptive technology could adversely affect overall e-commerce trends and diminish the value of investments we have made in select online channels. Any of these results could cause a significant reduction in our revenue and have a material adverse effectimpact on our results of operations.
If we fail to evaluate, implement, and integrate strategic acquisition or disposition opportunities successfully, our business may suffer. From time to time we evaluate strategic opportunities available to us for product, technology, or business acquisitions or dispositions. If we choose to make acquisitions or dispositions, we face certain risks, such as failure of an acquired business to meet our performance expectations, failure to recognize cost savings from a disposition, diversion of management attention, retention of management and existing customers of our current and any acquired business, and difficulty in integrating or separating a business’s operations, personnel, and financial and operating systems. We may not be able to successfully address these risks or any other problems that arise from future acquisitions or dispositions. Any failure to successfully evaluate strategic opportunities and address risks or other problems that arise related to any acquisition or disposition could adversely affect our business, results of operations, and financial condition.
Governmental regulation and oversight might adversely impact our operations. We are subject to governmental regulations in the manufacture and sale of moissanite jewels and finished jewelry. In particular, in July 2018 the FTC has issued regulations andupdated guidelines governing the marketingdescription of synthetic gemstoneslab-grown diamonds and other gemstones similar to diamond that require such gemstones to be clearly identified as to the gemstone’s lab-grown origin in any promotional or marketing materials. In addition, the precious metal in our finished jewelry may be subject to requirements, which vary by country and by state, such as hallmarking and alloy content. We may be under close scrutiny both by governmental agencies and by competitors in the gemstone industry, any of which may challenge our promotion and marketing of our moissanite jewels and finished jewelry products. While we have a policy to ensure compliance with applicable regulations, if our production or marketing of moissanite jewels and/or finished jewelry is challenged by governmental agencies or competitors, or if regulations are issued that restrict our ability to market our products, our business, results of operations, and financial condition could be materially adversely affected.
Some anti-takeover provisions of our charter documents may delay or prevent a takeover of our company. A number of provisions of our articles of incorporation and bylaws impact matters of corporate governance and the rights of shareholders. Certain of these provisions have an anti-takeover effect and may delay or prevent takeover attempts not first approved by our Board of Directors (including takeovers that certain shareholders may deem to be in their best interests). These provisions also could delay or frustrate the removal of incumbent directors or the assumption of control by shareholders. We believe that these provisions are appropriate to protect our interests and the interests of all of our shareholders.
| Item 1B. | Unresolved Staff Comments |
Not applicable.
We currently lease approximately 36,350 square feet of office, storage, and light manufacturing space in the Research Triangle Park area of North Carolina from an unaffiliated third-party that is used by both of our current operating and reportable segments.
The majority of all U.S. personnel, including our executive offices, sales offices, administrative personnel, and production facilities are housed in the current space.
There are no material pending legal proceedings to which we are a party or to which any of our property is subject.
Not applicable.
PART II
| Item 5. | Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities |
Market for Registrant��sRegistrant’s Common Equity
Our common stock is traded on the NASDAQ Global SelectNasdaq Capital Market under the symbol “CTHR.” The following table presents, for the periods indicated, the high and low sales prices of our common stock, as reported by the NASDAQ Global Select Market. As of March 3, 2017August 28, 2020, there were 266223 shareholders of record of our common stock.
| | | High | | | Low | |
| Year Ended December 31, 2015: | | | | | | |
| First Quarter | | $ | 1.92 | | | $ | 1.11 | |
| Second Quarter | | $ | 1.68 | | | $ | 1.15 | |
| Third Quarter | | $ | 1.72 | | | $ | 1.14 | |
| Fourth Quarter | | $ | 1.45 | | | $ | 0.90 | |
| Year Ended December 31, 2016: | | | | | | | | |
| First Quarter | | $ | 1.49 | | | $ | 0.75 | |
| Second Quarter | | $ | 1.26 | | | $ | 0.93 | |
| Third Quarter | | $ | 1.33 | | | $ | 0.85 | |
| Fourth Quarter | | $ | 1.23 | | | $ | 0.83 | |
We did not pay any dividends on our common stock during 2016 or 2015.the fiscal years ended June 30, 2020 and 2019. We will regularly review and consider the best policies and practices for our company, including the dividend policy. The payment of future dividends will be dependent on the facts and circumstances at the time of that reviewreview.
Not applicable.
| Item 7. | Management’s Discussion and Analysis of Financial Condition and Results of Operations |
The following discussionManagement’s Discussion and Analysis of Financial Condition and Results of Operations, or MD&A, is intended to provide a better understanding of our consolidated financial statements, including a brief discussion of our business and products, key factors that impacted our performance, and a summary of our operating results. This information should be read in conjunction with Item 1A, “Risk Factors” and our consolidated financial statements and the notes thereto included in Item 8, “Financial Statements and Supplementary Data” of this Annual Report on Form 10-K. Historical results and percentage relationships among any amounts in the consolidated financial statements are not necessarily indicative of trends in operating results for future periods.
Business Overview
We manufacture, market,Our Mission
At Charles & Colvard, we believe that fine jewelry can be accessible, beautiful, and distributeconscientious. With innovative technology and sustainable practices, our goal is to lead a revolution in the jewelry industry – delivering a brilliant product at extraordinary value balanced with environmental and social responsibility.
About Charles & Colvard
Charles & Colvard, Ltd., a North Carolina corporation founded in 1995 (which may be referred to as Charles & Colvard, we, us, or our), manufactures, markets and distributes Charles & Colvard Created Moissanite® (which we refer to as moissanite or moissanite jewels) and finished jewelry featuring our proprietary moissanite gemstone for sale in the worldwide jewelry market. Moissanite, also knownOur unique differentiator, moissanite – The World’s Most Brilliant Gem® – is core to our ambition to create a movement around beautiful, environmentally and socially responsible fine jewelry and fashion jewelry. Charles & Colvard is the originator of lab-created moissanite, and we believe that we are leading the way in delivering the premium moissanite brand through technological advances in gemstone manufacturing, cutting, polishing, and setting. By coupling what we believe to be unprecedented lab-created gemstones with responsibly sourced precious metals, we are delivering a uniquely positioned product line for the conscientious consumer.
We sell loose moissanite jewels and finished jewelry through two operating segments: our Online Channels segment, which encompasses our digital properties components, comprises our charlesandcolvard.com website, e-commerce outlets, including marketplaces, drop-ship customers, and other pure-play, exclusively e-commerce customers; and our Traditional segment, which consists of domestic and international distributors and retail customers. We report segment information based on the “management” approach. This segment reporting approach designates the internal reporting used by its chemical name silicon carbide (SiC),management for making operating decisions and assessing performance as the source of our operating and reportable segments.
We operate in an environment characterized by both complexity in global markets and continuing economic pressures in the U.S. and internationally. Our strategy is to build a rare mineral first discovered inglobally revered and accessible brand of gemstones and finished jewelry that appeals to a meteorite crater. Because naturally occurring SiC crystals are too small for commercial use, larger crystals must be grown in a laboratory. Leveragingwide consumer audience and leverages our advantage of being the original and leading worldwide source of created moissanite jewels,moissanite. We believe a direct relationship with consumers is important to this strategy, which entails delivering tailored educational content, engaging in dialogue with our audience, and positioning our brand to meet the demands of today’s discerning consumer. A significant component of our strategy in this environment is to establishfocus on our core products, improving the quality and predictability of the delivery of our products and services, and placing those products quickly into the hands of our U.S. and international customers at affordable prices. Moreover, recognizing today that our customers and vendors are resource constrained, we are endeavoring to develop and extend our portfolio of products in a disciplined manner with a focus on domestic markets close to our core capabilities, as well as growing our global marketplace sales. We continue to focus on affordability initiatives. We also expect to continue to innovate and invest in technologies to fulfill product requirements for our customers and invest in our people so that we have the technical and production skills necessary to succeed without limiting our ability to build financial return to our investors.
Highlights of the Fiscal Year Ended June 30, 2020
COVID-19 Update
In March 2020, the novel strain of coronavirus, known as COVID-19, was declared a pandemic by the World Health Organization and declared a national emergency by the U.S. Government, and has negatively affected the U.S. and global economies. In response to this pandemic, federal, state, county, and local governments and public health organizations and authorities around the world have implemented a variety of measures intended to control the spread of the virus, including quarantines, “stay-at-home” orders, travel restrictions, school closures, business limitations and closures, social distancing, and hygiene requirements. These measures have adversely affected workforces, customers, economies, and global supply chains, and resulted in significant travel and transport restrictions – all of which have combined to lead to an economic downturn. It has also disrupted the normal operations of many businesses, including ours. In early 2020 in the Asia Pacific region and during our quarter ended March 31, 2020 globally, the pandemic and related governmental and business responses began to have an adverse effect on our operations, supply chains, distribution channels, and consumer buying behaviors. Cumulatively, these circumstances also impacted the net realizable value and marketability of our legacy inventory, which was subsequently written-off.
The overall impacts of the COVID-19 pandemic include the following:
Across our supply chain, we experienced instances of suppliers temporarily closing their operations, delaying order fulfillment, or limiting their production. Where applicable, we utilized alternative supply arrangements with strategic partners whose businesses were not under stay-at-home orders or whose production came back online. During the quarter ended June 30, 2020, many of our suppliers began returning to normal operating and production levels. However, we and our suppliers remain subject to ongoing changes to governmental closure requirements that may have a long-term impact on our supply chain and ability to produce gemstones and finished jewelry for sale.
In our Online Channels segment, our transactional website charlesandcolvard.com remained open under restricted fulfillment capabilities. However, a quickly rising unemployment rate combined with consumer uncertainty and lack of confidence began reducing website traffic and conversions in March 2020. Beginning in March 2020, we maintained limited shipping functions with support from third-party production and fulfillment partners. We were also able to support only a certain level of active products on marketplaces and drop-ship partner websites such as Macys.com, Helzberg.com, Overstock.com, ShopHQ.com, and more. This ongoing e-commerce presence was restricted to available stock and the limited production capacity of functioning suppliers. During the quarter ended June 30, 2020, we began seeing orders in our transactional website, along with orders in our marketplaces and drop-ship partner websites, increase as consumer confidence strengthened and our operating and shipping functions began to return to normal activity levels. However, until business resumes to pre-pandemic levels across our entire supply chain, our Online Channels segment is expected to continue to be adversely impacted by the pandemic.
In our Traditional segment, brick and mortar customers began closing their stores to foot traffic in March 2020, with tentative plans to re-open on a rolling schedule that may lead into the fall timeframe or later. We also experienced instances of distributors, whose businesses rely on sales into retail organizations, reducing or closing their operations. These adverse effects impacted our ability to maintain significant levels of sales through our wholesale customers. In addition, trade shows and industry events have been preemptively cancelled for the critical production season leading up to the calendar year-end 2020 holiday season. As a result, our selling activities in our Traditional segment were significantly modified, and our ability to convert those activities into sales have been adversely impacted by the pandemic. Consistent with the trends we are experiencing in our Online Channels segment, we have begun seeing business strengthen with our brick and mortar customers as these customers begin to move forward with their re-opening plans following their closures in March 2020, but until business resumes to pre-pandemic levels, our Traditional segment is expected to continue to be adversely impacted by the pandemic.
As global and U.S economic activity slowed in response to the COVID-19 pandemic, we experienced and anticipate ongoing constraints on our cash and working capital, including experiencing potential liquidity challenges. The impact of the pandemic has had – and is expected to continue having – an adverse effect on our operations and financial condition as revenues declined and, despite our cost-saving efforts, many business and operating expenses remained flat or continued to rise. Cash flow scrutiny will be crucial for our business in the months ahead as we anticipate seeing lower revenues resulting in less cash flow, along with delayed accounts receivable collections, as needs grow to step up payables to important suppliers. We continue to focus on being more nimble in managing our inventory levels given the uncertainty in the supply chain, which may also place further demands on working capital.
The COVID-19 pandemic has had a significant adverse impact on our business, results of operations, financial condition, and liquidity during Fiscal 2020. The full extent of the impact of the COVID-19 pandemic on our operational and financial performance is currently uncertain and will depend on many factors outside of our control, including, without limitation, the timing, extent, trajectory and duration of the pandemic, the development and availability of effective treatments and vaccines, the imposition of protective public safety measures, and the impact of the pandemic on the global economy and demand for consumer and wholesaler products.
We believe that our management has taken – and continues to take – swift and appropriate action designed to hedge against the overall impact that the pandemic may have on our business, to prepare for a potential recessionary environment, and to efficiently manage the business while maintaining adequate liquidity and maximum operating flexibility. We remain focused on three critical areas of wellbeing, including safeguarding the health and safety of our employees, implementing senior managerial changes and streamlining operations while ensuring support of our brand and customers, and maintaining our financial strength and stability. Notwithstanding these challenges, we believe that we further solidified the global Charles & Colvard brand during Fiscal 2020.
Since the onset of the pandemic domestically, we have implemented the following measures:
We deployed a work-from-home option for our employees on March 13, 2020, and effective March 27, 2020, instituted a mandatory work-from-home policy for all, but essential, employees due to mandated stay-at-home orders by the State of North Carolina and local governmental authorities;
We temporarily suspended all hiring of employees starting April 13, 2020 and we furloughed approximately 50% of our employee base at that time, principally within our operations area. While most of our operations employees returned to full-time status as we moved forward with reputable, high-quality,our phased reopening plans during May 2020, these actions materially impacted our productivity;
We extended new benefits to assist employees who participate in our 401(k) plan with additional distribution and sophisticated brands across multiple channels,new borrowing terms;
We implemented temporary salary and wage reductions for all employees, including a 25% reduction in salary for the President and Chief Executive Officer and a 15% reduction for each of the Chief Financial Officer and Chief Operating Officer. All employee salaries and wages were returned to pre-reduction levels in July 2020;
We reorganized our management and reduced our workforce. Effective June 1, 2020, Suzanne Miglucci, our former President and Chief Executive Officer, resigned and Don O’Connell was appointed as our new President and Chief Executive Officer. At the same time, we enacted a significant reduction-in-force, or RIF, that reduced our active workforce by approximately 25%. Included in the RIF were the elimination of senior-level sales, marketing, information technology, and operations personnel as well as executive-level sales and marketing positions. These RIF actions resulted in our recognition of severance-related expenses during the fourth quarter of Fiscal 2020 in the amount of approximately $427,000. The liability for the unpaid portion of our severance-related accrual in the amount of approximately $338,000 is included in accrued expenses and other liabilities in the accompanying consolidated balance sheet as of June 30, 2020;
We instituted a temporary 50% reduction in fees paid to our Board of Directors, which were also returned to pre-reduction levels in July 2020;
We successfully applied for and received a loan pursuant to the Paycheck Protection Program under the CARES Act, as administered by the SBA. The loan in the principal amount of $965,000 was disbursed by Newtek Small Business Finance, LLC, a nationally licensed lender under the SBA, on June 18, 2020 pursuant to a Promissory Note issued by us on June 15, 2020. As provided under the CARES Act, we intend to use the proceeds from this loan to enhance cash flow, to help maintain operations and fund current payroll requirements, and to position moissaniteassist us with the reopening phase of our business as an ethically-sourced, affordable,we navigate the COVID-19 pandemic recovery efforts. There can be no assurance that such PPP Loan will be forgiven; and
We reduced non-payroll operating expenses, including decreased digital marketing spend and luxurious alternativesignificantly reduced product development investments and travel expenditures.
We are continuing to other gemstones suchtake the following steps to further address the impact of the COVID-19 pandemic:
We are actively renegotiating contracts with vendors and suppliers to amend commitments to size our supply with current demand and delivery terms with others to reduce our cost of goods and services;
We are negotiating extended payment terms with select partners;
We are continuing to align variable expenses to match current sales trends as diamond.we continue to move forward with our phased reopening; and
We are currently continuing to offer the flexibility of a work-from-home option for our employees who are able to perform full-time duties effectively from home as the State of North Carolina continues to reopen through its predetermined phased reopening plan.
During the fiscal year ended June 30, 2020, we delivered on several key initiatives, which we believe leaves us well poised for future growth as we move forward into the fiscal year ending June 30, 2021. These accomplishments in fiscal year ended June 30, 2020, include the following:
Digital Marketing Refocus/Redirection. During June 2020, we ceased all top-of-funnel digital marketing campaigns and strictly refocused our digital marketing advertising strategy toward higher-converting, low marketing funnel activities. We believe that targeting consumers with whom we have already engaged and who have expressed interest in our products is a more effective use of our digital advertising spend. We believe this shift in our marketing strategy provides a more rapid financial return on our marketing investment, which is possiblecritical to our top line growth during the ongoing COVID-19 pandemic and going forward as we move into Fiscal 2021;
Enhanced Customer Experience. We developed and launched an improved technological e-commerce platform and offered user-friendly consumer services to support an enhanced customer experience. In June 2020 we launched our digital Charles & Colvard Virtual Bridal Ring Consultation program. This is a personal shopping concierge service where we are offering a customized virtual experience designed to simplify the ring buying process for our customers. This new customer support service offers deeper personalization and a more immersive shopping experience for our consumers. With our improved platform we believe that we are driving stronger customer engagement, encouraging repeat buyers, and growing our customer loyalty program, all of which we believe supports our ability to deliver an exemplary worldwide customer service personal shopping experience. We believe that offering this enhanced customer experience is an integral component of our overall marketing strategy. We believe that this enhanced customer interaction featuring a virtual personal shopping experience is important for our brand, but we also believe that it is even more relevant and important to our customers currently during these unprecedented times when social distancing practices remain in place throughout the U.S. and much of the world;
| • | E-Commerce Capabilities. In spite of the adverse impact that the COVID-19 pandemic has had on our Online Channels segment, we launched an online presence with the iconic Canadian department store Hudson’s Bay in May 2020. We believe this relationship gives us the ability to market our assortment of fine jewelry featuring Moissanite by Charles & Colvard® gemstones to this retailer’s robust digital audience on TheBay.com; |
Presence with Key Brick-and-Mortar Partners. Notwithstanding the adverse effect that the COVID-19 related closures had on our Traditional segment during the period these retailers were closed, in the months prior to the business interruption, we continued to broaden our relationship with Helzberg Diamonds stores with the addition of incremental product styles and expanded case line presence in nearly all doors during the early part of Fiscal 2020. We will continue to evolve our retail channel strategy as these stores reopen and businesses resume to pre-pandemic levels and when we are once again able to optimize our partnership arrangements; and
Corporate Social Responsibility. In these unprecedented times more than ever, we continue to believe that we have the responsibility to be a good corporate citizen, and in practice, to have a business model that helps us be socially accountable to our stakeholders. During Fiscal 2020, we elevated our use of responsible precious metals in substantially all the finished jewelry we sourced. We also want to positively impact the communities where we work and live and for the benefit of the world in general – which we intend to continue supporting through philanthropic programs that advocate positive social change. This is evidenced by our participation in a Coronavirus related giving-back program that contributes 40% of net proceeds from one of our top selling finished jewelry items to the Duke University Research Foundation’s Duke Health COVID-19 Research Fund that will help support the development of vaccines and treatments for COVID-19.
The continued spread of COVID-19 has led to ongoing disruption and volatility in the global and U.S. economies, and, depending on future developments, could continue to adversely impact our operations and financial position. Our focus as we move into Fiscal 2021 is centered on the health of our brand on a global scale. As lab-created gemstones are being embraced by emerging generations, we will continue our quest to establish moissanite and our jewelry brand directly with consumers. We will execute on our key strategies with a continued commitment to measured spending and generating sustainable earnings improvement.
As we manage through these challenging and unprecedented times, we plan to remain highly focused on prudently managing the reach of our brand – both domestically and internationally – through select digital marketing initiatives that align with consumer engagement and demand. However, in response to the global economic impact of the COVID-19 pandemic and its effect on consumer confidence and spending levels, we have narrowed our digital advertising spend toward higher-conversion marketing activities. We believe that our long-term mission will ultimately be accomplished through our ability to remain fluid and shift brand awareness strategies that are sensitive to these ever-changing times.
Our MD&A generally discusses Fiscal 2020 and Fiscal 2019 items and year-to-year comparisons between Fiscal 2020 and Fiscal 2019. Discussions of Fiscal 2019 items and year-to-year comparisons between Fiscal 2019 and the fiscal year ended June 30, 2018, or Fiscal 2018, that are not included in this Form 10-K can be found in “Management’s Discussion and Analysis of Financial Condition and Results or Operations” in our Annual Report on Form 10-K for the fiscal year ended June 30, 2019 filed with the SEC on September 6, 2019.
The following table sets forth certain consolidated statements of operations data for the fiscal years ended June 30, 2020 and 2019:
| | | Year Ended June 30, | |
| | | 2020 | | | 2019 | |
| Net sales | | $ | 29,189,020 | | | $ | 32,244,109 | |
| Costs and expenses: | | | | | | | | |
| Cost of goods sold | | | 21,200,207 | | | | 17,352,167 | |
| Sales and marketing | | | 9,443,244 | | | | 7,983,506 | |
| General and administrative | | | 4,861,297 | | | | 4,640,810 | |
| Research and development | | | - | | | | 2,069 | |
| Total costs and expenses | | | 35,504,748 | | | | 29,978,552 | |
| (Loss) Income from operations | | | (6,315,728 | ) | | | 2,265,557 | |
| Other income (expense): | | | | | | | | |
| Interest income | | | 158,091 | | | | 11,022 | |
| Interest expense | | | (884 | ) | | | (2,198 | ) |
| Loss on foreign currency exchange | | | (1,829 | ) | | | (344 | ) |
| Other expense | | | - | | | | (13 | ) |
| Total other income, net | | | 155,378 | | | | 8,467 | |
| (Loss) Income before income taxes | | | (6,160,350 | ) | | | 2,274,024 | |
| Income tax (expense) benefit | | | (1,733 | ) | | | 1,443 | |
| Net (loss) income | | $ | (6,162,083 | ) | | $ | 2,275,467 | |
Consolidated Net Sales
Consolidated net sales for the fiscal years ended June 30, 2020 and 2019 comprise the following:
| | | Year Ended June 30, | | | Change | |
| | | 2020 | | | 2019 | | | Dollars | | | Percent | |
| Finished jewelry | | $ | 16,777,628 | | | $ | 15,457,343 | | | $ | 1,320,285 | | | | 9 | % |
| Loose jewels | | | 12,411,392 | | | | 16,786,766 | | | | (4,375,374 | ) | | | -26 | % |
| Total consolidated net sales | | $ | 29,189,020 | | | $ | 32,244,109 | | | $ | (3,055,089 | ) | | | -9 | % |
Consolidated net sales were $29.19 million for the fiscal year ended June 30, 2020 compared to $32.24 million for the fiscal year ended June 30, 2019, a decrease of $3.06 million, or 9%. The decrease in consolidated net sales for the fiscal year ended June 30, 2020 compared with consolidated net sales for the prior fiscal year was primarily due to moissanite’s exceptional brilliance, fire, durability,the adverse impacts of the geopolitical unrest in Hong Kong in early 2020 which affected our international distributor market and rarity like nothe global outbreak of the COVID-19 pandemic. This pandemic has continued to negatively affect the U.S. and global economies and has had a significant adverse impact on our worldwide sales and results of operations. Notwithstanding the impact of the COVID-19 pandemic, during the fiscal year ended June 30, 2020, we saw increased seasonal sales for both the calendar year-end holiday and Valentine’s Day. We also witnessed increased consumer awareness for our moissanite products throughout these holiday periods. Our transactional website, charlesandcolvard.com, was flat compared with the prior fiscal year due to the strength of demand during the COVID-19 pandemic. Net sales through our cross-border trade, or CBT, platform increased 34% versus the prior fiscal year. Despite the sales pressures we have been experiencing during the COVID-19 pandemic, our results have provided evidence that we had strong finished jewelry product net sales during the fiscal year ended June 30, 2020 in both our Online Channels segment and Traditional segment.
Sales of finished jewelry represented 57% and 48% of total consolidated net sales for the fiscal years ended June 30, 2020 and 2019, respectively. For the fiscal year ended June 30, 2020, finished jewelry sales were $16.78 million compared to $15.46 million for the fiscal year ended June 30, 2019, an increase of $1.32 million, or 9%. This increase in finished jewelry sales was due primarily to higher finished jewelry retail sales in our Online Channels segment as well as increased sales of Forever One™ and Moissanite by Charles & Colvard® products in our Traditional segment during periods prior to the COVID-19 pandemic. Net sales of our Forever One™finished jewelry and loose jewels represented 81% of total net sales for the fiscal year ended June 30, 2020.
Sales of loose jewels represented 43% and 52% of total consolidated net sales for the fiscal years ended June 30, 2020 and 2019, respectively. For the fiscal year ended June 30, 2020, loose jewel sales were $12.41 million compared to $16.79 million for the fiscal year ended June 30, 2019, a decrease of $4.38 million, or 26%. The decrease for the fiscal year ended June 30, 2020 was primarily due to the adverse impact of the COVID-19 pandemic and the resulting impact on consumer confidence and spending. The decrease was also due to lower levels of loose jewel sales in our Online Channels segment and, in particular, lower levels of loose jewel sales through the international distribution network in our Traditional segment.
U.S. net sales accounted for approximately 92% and 87% of total consolidated net sales during the fiscal years ended June 30, 2020 and 2019, respectively. Notwithstanding the adverse impact of the COVID-19 pandemic, U.S. net sales increased during Fiscal 2020 as a percentage of net sales, principally resulting from the significant decrease in international sales as discussed below. The decrease in U.S. net sales during the fiscal year ended June 30, 2020 compared to the prior year was offset somewhat by increased sales to U.S. customers during periods prior to the impact of the COVID-19 pandemic in both our Online Channels segment and Traditional segment.
Our largest U.S. customer during the fiscal years ended June 30, 2020 and 2019 accounted for 13% and 14% of total consolidated net sales during each respective period. Our second largest U.S. customer during the fiscal years ended June 30, 2020 and 2019 accounted for 12% and 10% of total consolidated net sales during each respective period. We expect that we will remain dependent on our ability, and that of our largest U.S. customers, to maintain and enhance retail and domestic distributor programs. A change in or loss of any of these customer or retailer relationships could have a material adverse effect on our results of operations.
International net sales accounted for approximately 8% and 13% of total consolidated net sales during the fiscal years ended June 30, 2020 and 2019, respectively. International net sales decreased to $2.37 million, or 44%, during the fiscal year ended June 30, 2020 compared to $4.26 million in the fiscal year ended June 30, 2019. International sales decreased due to lower demand in our international distributor market resulting from the adverse impact of the geopolitical unrest in Hong Kong and the COVID-19 pandemic affecting the distributors we serve in the China and Hong Kong markets. Prior to the effects of the COVID-19 pandemic, the lower demand in our international distributor market was offset somewhat by growth in our direct-to-consumer presence internationally, along with an increase in the number of CBT transactions in these periods reflecting increased direct-to-consumer sales from our Online Channels segment in international markets. In light of the ongoing global economic conditions, we continue to evaluate these and other potential distributors in international markets to determine the best long-term partners. As a result, and in light of the ongoing worldwide pandemic and international trade challenges, we expect our sales in these markets to continue to fluctuate significantly each reporting period.
We did not have an international customer account for 10% or more of total consolidated sales during the fiscal years ended June 30, 2020 and 2019. A portion of our international consolidated sales represents jewels sold internationally that may be re-imported to U.S. retailers.
Costs and Expenses
Cost of Goods Sold
Cost of goods sold for the fiscal years ended June 30, 2020 and 2019 are as follows:
| | | Year Ended June 30, | | | Change | |
| | | 2020 | | | 2019 | | | Dollars | | | Percent | |
| Product line cost of goods sold: | | | | | | | | | | | | |
| Finished jewelry | | $ | 7,469,790 | | | $ | 6,859,112 | | | $ | 610,678 | | | | 9 | % |
| Loose jewels | | | 6,062,186 | | | | 8,242,830 | | | | (2,180,644 | ) | | | -26 | % |
| Total product line cost of goods sold | | | 13,531,976 | | | | 15,101,942 | | | | (1,569,966 | ) | | | -10 | % |
| Non-product line cost of goods sold | | | 7,668,231 | | | | 2,250,225 | | | | 5,418,006 | | | | 241 | % |
| Total cost of goods sold | | $ | 21,200,207 | | | $ | 17,352,167 | | | $ | 3,848,040 | | | | 22 | % |
Total cost of goods sold was $21.20 million for the fiscal year ended June 30, 2020 compared to $17.35 million for the fiscal year ended June 30, 2019, a net increase of approximately $3.85 million, or 22%. Product line cost of goods sold is defined as product cost of goods sold in each of our Online Channels segment and Traditional segment excluding non-capitalized expenses from our manufacturing and production control departments, comprising personnel costs, depreciation, rent, utilities, and corporate overhead allocations; freight out; inventory write-offs; and other inventory adjustments, comprising costs of quality issues, and damaged goods.
The increase in total cost of goods sold for the fiscal year ended June 30, 2020 as compared to the fiscal year ended June 30, 2019 was primarily driven by a write-off during the third quarter of Fiscal 2020 of approximately $5.26 million representing the carrying value of our legacy loose jewel available on the market. inventory and finished goods inventory set with these legacy gemstones. The legacy material inventory comprised lower grade raw materials, or boules,We sell work-in-process gemstones, loose moissanite jewelsfinished gemstones and finished jewelry at wholesaleset with these legacy gemstones in precious metals. The legacy inventory raw materials were purchased and finished gemstone products were produced through the period ended August 2015. These gemstone products and finished jewelry items are known and marketed as our older Forever ClassicTM, Forever Brilliant®, and lower-grade gemstones.
Our primary international gemstone distributors, which historically have been the principal customer base for our legacy gemstone products are located in the Asia Pacific region of the world, primarily in China and Hong Kong. As a result of the ongoing geopolitical unrest in Hong Kong, coupled with the global impact of the COVID-19 pandemic, consumer confidence and spending in this region plummeted throughout Fiscal 2020. As a consequence of this, our marketability of these products suffered a sudden and complete deterioration over this same period.
The net increase in non-product line cost of goods sold for the fiscal year ended June 30, 2020 comprises an unfavorable net change in inventory write-offs of approximately $5.47 million principally related to distributors, manufacturers, retailers, TV shopping networks,the write-off of the carrying cost of our legacy material inventory of $5.26 million as well as inventory valuation adjustments related to changes in obsolescence reserves in the fiscal year ended June 30, 2020. The net increase in non-product line cost of goods sold was also related to an approximate $14,000 change in production standard cost variances as compared to the fiscal year ended June 30, 2019 as well as an approximate $1,000 increase in non-capitalized manufacturing and designers,production control expenses principally due to the timing when work-in-process is received into inventory and at retailoverhead costs are allocated. These increases in non-product line cost of goods sold were offset in part by an approximate $68,000 decrease in freight out in the same period due to end consumers throughlower shipment costs during the fiscal year ended June 30, 2020.
For further discussion of non-product line cost of goods sold, see Note 3 to our wholly ownedconsolidated financial statements in Item 8, “Financial Statements and Supplementary Data”, of this Annual Report on Form 10-K.
Sales and Marketing
Sales and marketing expenses for the fiscal years ended June 30, 2020 and 2019 are as follows:
| | | Year Ended June 30, | | | Change | |
| | | 2020 | | | 2019 | | | Dollars | | | Percent | |
| | | | | | | | | | | | | |
| Sales and marketing | | $ | 9,443,244 | | | $ | 7,983,506 | | | $ | 1,459,738 | | | | 18 | % |
Sales and marketing expenses were $9.44 million for the fiscal year ended June 30, 2020 compared to $7.98 million for the fiscal year ended June 30, 2019, an increase of approximately $1.46 million, or 18%.
The increase in sales and marketing expenses for the fiscal year ended June 30, 2020 compared to the fiscal year ended June 30, 2019 was primarily due to a $1.15 million increase in advertising and digital marketing expenses reflecting the activation of funds from our June 2019 underwritten public offering that we deployed to expand brand awareness; a $217,000 increase in software-related costs principally in connection with maintenance agreements as well as other software-related agreements; a $58,000 increase in professional services fees principally comprising consulting services for cybersecurity and merchandise imaging; a $46,000 increase in compensation-related expenses; and a $41,000 increase in general office-related expenses, which is primarily related to increased sales and use taxes. These increases were partially offset by a $52,000 decrease in travel expenses as a result of COVID-19 cost control measures.
The increase in digital and social media marketing expenses for the fiscal year ended June 30, 2020 compared to the fiscal year ended June 30, 2019 was primarily due to a $623,000 increase in Internet marketing; a $524,000 increase in outside agency fees; a $110,000 increase in cooperative advertising; and a $9,000 increase in promotional expenses, primarily related to sponsorship of a local professional sports team. These increases were partially offset by an $89,000 reduction in trade show expenses resulting from the cancelation of the jewelry industry’s premier annual event as a result of the COVID-19 pandemic; and a $29,000 reduction in print media advertising. In response to the COVID-19 pandemic, management drastically reduced advertising and digital marketing expenditures beginning in mid-March 2020. In addition, as a result of its digital marketing redirection in June 2020, management further reduced advertising and digital marketing expenditures during the last month of Fiscal 2020.
Compensation expenses for the fiscal year ended June 30, 2020 compared to the fiscal year ended June 30, 2019 increased primarily as a result of a $201,000 increase in salaries, commissions, and related employee benefits in the aggregate; a $71,000 increase in severance accrual related to our June 2020 management reorganization and workforce reduction; and a $9,000 increase in employee stock-based compensation expense. These increases were partially offset by cost control measures implemented by management as a result of the COVID-19 pandemic and its effect on our operations that led to a $235,000 decrease in bonus expense.
General and Administrative
General and administrative expenses for the fiscal years ended June 30, 2020 and 2019 are as follows:
| | | Year Ended June 30, | | | Change | |
| | | 2020 | | | 2019 | | | Dollars | | | Percent | |
| | | | | | | | | | | | | |
| General and administrative | | $ | 4,861,297 | | | $ | 4,640,810 | | | $ | 220,487 | | | | 5 | % |
General and administrative expenses were $4.86 million for the fiscal year ended June 30, 2020 compared to $4.64 million for the fiscal year ended June 30, 2019, an increase of approximately $220,000, or 5%.
The increase in general and administrative expenses for the fiscal year ended June 30, 2020 compared to the fiscal year ended June 30, 2019 was primarily due to a $250,000 increase in compensation expenses; a $236,000 increase in professional services fees; and a $6,000 increase in equipment-related rental expense. These increases were partially offset by an $84,000 decrease in business franchise taxes and licenses; a $49,000 decrease in board retainer fees as a result of COVID-19 cost control measures; a $48,000 decrease in bank fees as a result of lower credit card sales transactions during the COVID-19 pandemic; a $31,000 decrease in travel expenses as a result of COVID-19 cost control measures; a $24,000 decrease in insurance expenses; an $18,000 decrease in bad debt expense associated with our allowance for doubtful accounts reserve policy reflecting lower customer accounts receivable balances during the COVID-19 pandemic; a $12,000 decrease in general office-related expenses, which is primarily related to lower software maintenance agreement-related expenses; and a $6,000 net decrease in all other general and administrative expenses.
Compensation expenses increased for the fiscal year ended June 30, 2020 compared to the fiscal year ended June 30, 2019 primarily due to a $282,000 increase in severance accrual related to our June 2020 management reorganization and workforce reduction; a $128,000 increase in salaries and related employee benefits in the aggregate; and a $33,000 increase in employee stock-based compensation expense. These increases were offset in part by cost control measures implemented as a result of the COVID-19 pandemic and its effect on our operations that led to a $193,000 decrease in bonus expense.
Professional services fees increased for the fiscal year ended June 30, 2020 compared to the fiscal year ended June 30, 2019 primarily due to a $158,000 increase in legal fees associated with corporate governance matters; a $38,000 increase in accounting services related to higher annual audit and tax fees, as well as fees associated with tax consulting services; a $30,000 increase in investor and public relations expenses; and a $10,000 increase in consulting and other professional services primarily in connection with nonrecurring accounting and financial reporting related consulting fees.
Loss on Foreign Currency Exchange
Loss on foreign currency exchange related to foreign sales transacted in functional currencies other than the U.S. dollar for the fiscal years ended June 30, 2020 and 2019 are as follows:
| | | Year Ended June 30, | | | Change | |
| | | 2020 | | | 2019 | | | Dollars | | | Percent | |
| Loss on foreign currency exchange | | $ | 1,829 | | | $ | 344 | | | $ | 1,485 | | | | 432 | % |
During the fiscal year ended June 30, 2020, we had international sales transactions denominated in currencies other than the U.S dollar that resulted in foreign currency exchange net losses. The increase in these losses for the fiscal years ended June 30, 2020, reflects changes in foreign currency fluctuation during the fiscal year ended June 30, 2020 compared with the prior fiscal year.
Interest Income
Interest income for the fiscal years ended June 30, 2020 and 2019 is as follows:
| | | Year Ended June 30, | | | Change | |
| | | 2020 | | | 2019 | | | Dollars | | | Percent | |
| Interest income | | $ | 158,091 | | | $ | 11,022 | | | $ | 147,069 | | | | 1,334 | % |
In June 2019, we completed an underwritten public offering of 6,250,000 shares of our common stock, which together with the partial exercise of the underwriters’ over-allotment option for an additional 630,500 shares in July 2019, resulted in net proceeds of approximately $9.99 million. The net proceeds from this offering have been deposited into an interest-bearing account with a federally insured commercial bank. Accordingly, during the full fiscal year ended June 30, 2020, we earned interest income from cash on deposit in this interest-bearing account.
Provision for Income Taxes
We recognized a net income tax expense of approximately $1,700 and a net income tax benefit of approximately $1,400 for the fiscal years ended June 30, 2020 and 2019, respectively. Our income tax provisions in these periods primarily relate to estimated tax, penalties, and interest associated with uncertain tax positions. During the fiscal year ended June 30, 2019 we recognized a federal income tax benefit in the amount of approximately $23,000 that related to the realization of the recoverable portion of the alternative minimum tax, or AMT, deferred tax credit carryforwards being reclassified from a deferred tax asset to that of an income tax receivable.
As of each reporting date, we consider new evidence, both positive and negative, that could impact our view with regard to future realization of deferred tax assets. Beginning in 2014, we determined that negative evidence outweighed the positive and established a full valuation allowance against our deferred tax assets. We maintained a full valuation allowance as of June 30, 2020 and June 30, 2019.
Our statutory tax rate as of the fiscal year ended June 30, 2020 is 22.11% and consists of the federal income tax rate of 21% and a blended state income tax rate of 1.11%, net of the federal benefit.
For discussion of the effects of the Tax Cuts and Jobs Act, or the Tax Act, the CARES Act, and the State of North Carolina General Assembly Senate Bill 704: COVID-19 Recovery Act, or the NC COVID-19 Relief Act, on our provision for income taxes and deferred tax assets, see Note 12 to our consolidated financial statements in Item 8, “Financial Statements and Supplementary Data”, of this Annual Report on Form 10-K.
Certain Operating Metrics
We believe that certain metrics are key to our business, including but not limited to average order value, or AOV, average advertising spend per customer, and repeat customers. The following operating subsidiaries,metrics, which we use to make strategic digital marketing related decisions and to monitor the performance and return on investment of our marketing activities, are based on financial results and customer-related data for charlesandcolvard.com, LLC, (formerly Moissanite.com, LLC) anda wholly-owned subsidiary of Charles & Colvard, Direct, LLC (until March 2016)Ltd., for the fiscal year ended June 30, 2020:
AOV is estimated to be approximately $1,000, based on charlesandcolvard.com revenue, net of returns, divided by the total number of customer orders.
Average ad spend per new customer is estimated to be approximately $275, based on the total advertising spend focused on charlesandcolvard.com traffic divided by the number of first-time customer orders.
Repeat customers represent approximately 17% of charlesandcolvard.com’s total customer orders, based on customer email addresses.
Our calculation for AOV is sensitive to volume and through third-party marketplaces. Asproduct mix. Therefore, we believe that our AOV may vary widely going forward as we respond to ever changing consumer demand and provide the products – that may have widely variable price points – our audiences are looking for. Likewise, as we continue to invest in our advertising and marketing communication channels and broaden the underlying content types, notwithstanding the effects of September 30, 2016,the COVID-19 pandemic, we changedexpect our average ad spend per customer to increase going forward. Finally, as our Loyalty Program is revived, we expect the namepercentage of people enrolled in our program to continue increasing over time.
The following operating metrics, which we use to manage operations and to also make strategic digital marketing related decisions and to monitor the performance and return on investment of our wholly owned subsidiary Moissanite.com,marketing activities, are based on financial results and customer-related data for charlesandcolvard.com, LLC, for the fiscal year ended June 30, 2020 compared to the fiscal year ended June 30, 2019:
1% year-over-year growth in charlesandcolvard.com LLC.revenue.
2.2% year-over-year growth in social media followers; 5% year-over-year growth in opt-in email subscribers.
For each of the fiscal years ended June 30, 2020 and 2019, gross margin (defined as net sales less product line cost of goods sold) for our Online Channels segment was 58% of Online Channels net sales.
Liquidity and Capital Resources
As the world continues to adapt to the COVID-19 pandemic and its effects on global economics and business operations, the outbreak of the coronavirus and the impact that the COVID-19 pandemic has had on the wider economy has placed unprecedented pressures on U.S. businesses including our own. The continued spread of COVID-19 has also led to disruption and volatility in the global capital markets, which, depending on future developments, could adversely impact our capital resources and liquidity in the future.
We remain increasingly focused on potential liquidity issues and debt incurrence capacity. Accordingly, faced with the prospect of significantly declining cash flows, we evaluated the possibility of raising additional capital through loans, debt or access to other capital transactions. In March 2020, the CARES Act was signed into law, which, along with earlier issued Internal Revenue Service, or IRS, guidelines, provides for deferral of certain taxes. The CARES Act, among other things, contains economic relief programs in the form of loans and grants for small businesses. In May 2020, the NC COVID-19 Relief Act was signed into law, which provides for a tax credit towards certain employer contributions to the North Carolina Unemployment Insurance Fund.
Capital Structure and Long-Term Debt
On June 18, 2020, we received the proceeds from the PPP Loan pursuant to the Paycheck Protection Program under the CARES Act, as administered by the SBA. The PPP Loan in the principal amount of $965,000 was disbursed by the Lender pursuant to a promissory note, or the Promissory Note, issued by us on June 15, 2020.
Under the CARES Act and the Promissory Note, loan forgiveness is available for the sum of documented payroll costs, covered rent payments, and covered utilities during the 24-week period beginning on the date of first disbursement of the PPP Loan. For purposes of the CARES Act, payroll costs exclude cash compensation of an individual employee in excess of $100,000, prorated annually. Not more than 40% of the forgiven amount can be attributable to non-payroll costs. Although we currently believe that our use of the PPP Loan will meet the conditions for forgiveness of the PPP Loan, we cannot assure our future adherence to the forgiveness criteria and that the PPP Loan will be forgiven, in whole or in part.
In April 2020, we also applied for capital relief pursuant to the Economic Injury Disaster Loan Program, or the EIDL Program, also under the CARES Act and administered by the SBA. In June we were notified by the SBA that our EIDL Program application was approved by the SBA. However, due to the limited amount of capital that would have been available to us under the EIDL Program, we did not further pursue those funds.
The CARES Act provides that existing AMT credit carryforwards are now eligible for acceleration and refundable AMT credits are to be completely refunded to companies for taxable years beginning in 2019, or by election, taxable years beginning in 2018. Accordingly, we have elected to have the AMT tax completely refunded and have filed a tentative refund claim for the remaining AMT tax credit. Consequently, the remaining balance of our AMT credit refund in the amount of approximately $270,000 is expected to be completely refundable. Accordingly, the full amount of our AMT credit refund has been classified as current as of June 30, 2020.
We also intend to take advantage of COVID-19 related tax credits for required paid leave provided by us. These eligible tax credits are determined by qualified emergency paid sick and expanded family and medical leave wages pursuant to the Families First Coronavirus Response Act, or FFCRA. Under FFCRA, we have provided employees with paid federal sick and expanded family and medical leave benefits for which we may be reimbursed by the government through payroll tax credits. Qualifying wages for tax credit purposes under FFCRA are those paid to an employee who takes leave under FFCRA for a qualifying reason, up to the applicable per diem and aggregate payment caps. Applicable tax credits also extend to the employer’s share of amounts paid or incurred to maintain a group health plan.
Finally, as permitted by the NC COVID-19 Relief Act, we will receive a tax credit towards our contributions to the North Carolina Unemployment Insurance Fund, which will also serve to further enhance future cash flow.
As a component of our liquidity and capital structure, we have an effective shelf registration statement on Form S-3 on file with the SEC which allows us to periodically offer and sell, individually or in any combination, shares of common stock, shares of preferred stock, warrants to purchase shares of common stock or preferred stock, and units consisting of any combination of the foregoing types of securities, up to a total of $25.00 million, of which approximately $13.99 million remains available after giving effect to our June 2019 public offering, including the impact of the partial exercise of the underwriters’ over-allotment option, described below. However, we may offer and sell no more than one-third of our public float (which is the aggregate market value of our outstanding common stock held by non-affiliates) in any 12-month period. Our ability to issue equity securities under the shelf registration statement is subject to market conditions, which are in turn, subject to the disruption and volatility being caused by the ongoing COVID-19 pandemic. Any capital raise is not assured and may not be at terms that would be acceptable to us.
Financing Activities
In February 2016, June 2019, we made completed an underwritten public offering of 6,250,000 newly issued shares of common stock, at a price to the strategic decisionpublic of $1.60 per share, pursuant to exploreour effective shelf registration statement on Form S-3. Net proceeds from the offering were approximately $9.06 million, net of the underwriting discount and fees and expenses. Pursuant to the terms of the underwriting agreement entered into in connection with this offering, the underwriters were granted a potential divestiture30-day option to buy up to an additional 937,500 shares of our direct-to-consumer home party business previously operated through our Charles & Colvard Direct, LLC (dba Lulu Avenue®) subsidiary. After careful analysiscommon stock to cover over-allotments. Pursuant to the partial exercise of the underwriters’ over-allotment option, in July 2019, we issued an additional 630,500 shares of our core competencies, go-to-market strategies,common stock at a price of $1.60 per share for net proceeds of approximately $932,000, net of the underwriting discount and intentfees and expenses of approximately $77,000. After giving effect to advance toward profitability, the partial exercise of the over-allotment option, we sold an aggregate of 6,880,500 shares of our common stock at a price of $1.60 per share with total gross proceeds of approximately $11.01 million, before deducting the underwriting discount and fees and expenses of approximately $1.02 million. During early Fiscal 2020, we began using the aggregate net proceeds of approximately $9.99 million from the offering for marketing and for general corporate and working capital purposes. However, in response to the COVID-19 pandemic and its impact on consumer confidence and spending, management teamdrastically reduced related advertising and Boarddigital marketing expenditures in mid-March 2020.
As discussed above, on June 18, 2020 we received a PPP Loan in the principal amount of Directors determined$965,000 from the Lender pursuant to a divestiturePromissory Note issued by us on June 15, 2020. The Promissory Note matures June 18, 2022 and may be extended with the consent of the Lender under the provisions of the CARES Act. The Promissory Note bears interest at a fixed rate of 1% per annum. Pursuant to the terms of the Promissory Note, monthly principal and interest payments in the amount of approximately $41,000 will commence on April 1, 2021. For financial reporting purposes as of June 30, 2020, the classification of the current maturity of this distribution channellong-term debt assumes there will be no principal forgiveness and principal repayment for the full outstanding principal amount of the PPP Loan will be spread in equal monthly installments over the period from April 1, 2021 through the maturity date of the Promissory Note.
We did not provide any collateral or guarantees for the PPP Loan, nor did we pay any facility charge to beobtain the PPP Loan. The Promissory Note provides for customary events of default, including, among others, those relating to failure to make payment and breaches of representations. We may prepay the principal of the PPP Loan at any time without incurring any prepayment charges.
Operating Activities and Cash Flows
We require cash to fund our operating expenses and working capital requirements, including outlays for capital expenditures. As of June 30, 2020, our principal sources of liquidity were cash, cash equivalents and restricted cash totaling $14.62 million, trade accounts receivable of $671,000, and net current inventory of $7.44 million, as compared to cash and cash equivalents totaling $13.00 million, trade accounts receivable of $1.96 million, and net current inventory of $11.91 million as of June 30, 2019. As described more fully herein, we also have long-term debt in the amount of $965,000, of which $193,000 is classified as its current maturity as of June 30, 2020, and a $5.00 million asset-based revolving credit facility with White Oak, or the White Oak Credit Facility.
During the fiscal year ended June 30, 2020, our working capital decreased by approximately $5.75 million to $17.42 million from $23.17 million at June 30, 2019. As described more fully below, the decrease in working capital at June 30, 2020 is primarily attributable to a decrease in our best interestallocation of inventory from long-term to short-term, a decrease in accounts receivable, an increase in short-term operating lease liabilities resulting from the adoption of the new lease accounting standard as of July 1, 2019, an increase in accrued expenses and our shareholders’ best interest. On March 4, 2016, weother liabilities, an increase in accounts payable, and Charles & Colvard Direct, LLC entered into an asset purchase agreement with Yanbal, under which Yanbal purchased certain assets related to our direct-to-consumer home party business for $500,000 and assumed certain liabilities related to such assets. A more detailed description of this transaction is included in Note 12, “Discontinued Operations”,increase in the Notescurrent maturity of our long-term debt. These factors were offset partially by an increase in our cash, cash equivalents, and restricted cash resulting from cash provided by operating and financing activities and an increase in prepaid expenses and other assets. During the fiscal year ended June 30, 2019, our working capital increased by approximately $10.91 million from $12.27 million at June 30, 2018. As described more fully below, the increase in working capital at June 30, 2019 is primarily attributable to an increase in our cash, cash equivalents and restricted cash resulting from cash provided by financing activities from our public offering described above and cash provided by our operations, increases in accounts receivable and in our allocation of inventory to short-term from long-term as well as in prepaid expenses and other assets. The increase in working capital is also attributable to decreases in accounts payable. These factors were offset partially by increases in accrued expenses and other liabilities.
During the fiscal year ended June 30, 2020, approximately $249,000 of cash was provided by our operations. The primary drivers underlying the cash provided by our operating activities were a decrease in accounts receivable of $1.32 million; a decrease in prepaid expenses and other assets of $490,000; an increase in accounts payable of $469,000; and an increase in accrued expenses and other liabilities of $109,000. In addition, non-cash items totaling $6.78 million also had a favorable impact on our cash flow from operations during the fiscal year ended June 30, 2020. These factors were offset partially by the unfavorable effect of our net loss in the amount of $6.16 million and an increase in inventory of approximately $2.76 million resulting from lower quantities of inventory items sold as a result of lower period sales stemming from the impact of the COVID-19 pandemic. During the fiscal year ended June 30, 2019, $917,000 of cash was provided by our operations. The primary drivers of the cash generated by our operations were net income of $2.28 million and an increase in accrued liabilities of $572,000. In addition, non-cash items totaling $1.51 million also had a favorable impact on our cash flow from operations during the fiscal year ended June 30, 2019. These factors were partially offset by an increase in inventory of $2.30 million; a decrease in accounts payable of $799,000; an increase in accounts receivable of $328,000; and an increase in prepaid expenses and other assets of $14,000. The inventory increases during the fiscal years ended June 30, 2020 and 2019 were, in part, due to the
Consolidated Financial Statements.purchase of new raw material SiC crystals during each fiscal year then ended pursuant to the Supply Agreement.
During the fiscal year ended June 30, 2020, accounts receivable decreased principally due to decreased sales during the third and fourth quarters, as a result of the effects that the COVID-19 pandemic and the impact that the global economy had on our Traditional segment customers. Cash collections on sales made during our first and second fiscal quarters, which reflect robust year-end holiday sales, remained strong. During the fiscal year ended June 30, 2019, accounts receivable increased principally as a result of the increased level of sales during our third and fourth fiscal quarters.
As a result of the divestitureCOVID-19 pandemic, we offered extended Traditional segment customer payment terms beyond 90 days to certain credit-worthy customers during the third and fourth quarters of Fiscal 2020. Because of the ongoing impact of the pandemic on the global economy, the extension of these terms may not immediately increase liquidity as a result of ongoing current-period sales, which we expect to continue to be pressured due to the effects of the ongoing COVID-19 pandemic. In addition, we believe our competitors and other vendors in the wholesale jewelry industry have expanded their use of extended payment terms and, in aggregate, we believe that, through our use of extended payment terms, we provide a competitive response in our market during the current global economic environment. We believe that we are unable to estimate the impact of these actions on our net sales, but if we ceased providing extended payment terms, we believe that we would not be competitive for some Traditional segment customers in the marketplace during this economic period and that our net sales and profits would likely be adversely impacted.
During the fiscal year ended June 30, 2020, prepaid expenses and other assets increased principally as a result of the timing of payments, principally for insurance-related expenses, in advance of goods or services received. During the fiscal year ended June 30, 2020, accounts payable increased primarily as a result of the timing of payment for costs associated with inventory-related purchases and professional services incurred and due under our vendors’ payment terms. Likewise, accrued expenses and other liabilities increased principally due to the severance accrual in connection with our June 2020 management reorganization and workforce reduction as well as increases in deferred revenue related to payments received prior to shipment of good from customers. During the fiscal year ended June 30, 2019, accrued expenses and other liabilities increased principally due to the timing of payments related to accrued compensation and related benefits, including year-end bonuses, as well as increased accrued sales and use taxes associated with higher current sales levels and additional liabilities for jurisdictions where we have reached sales tax nexus.
We manufactured approximately $10.64 million and $14.09 million in loose jewels and $7.82 million and $7.66 million in finished jewelry, which includes the cost of the loose jewels and the purchase of precious metals and labor in connection with jewelry production, during the fiscal years ended June 30, 2020 and 2019, respectively. We expect our purchases of precious metals and labor to fluctuate in conjunction with the levels of our
direct-to-consumer home party business operated throughfinished jewelry business. In addition, the price of gold has increased significantly over the past decade, resulting in higher retail price points for gold jewelry. Because the market price of gold and other precious metals is beyond our
control, the upward price trends could continue and have a negative impact on our operating cash flow as we manufacture finished jewelry.
Historically, our raw material inventories of SiC crystals had been purchased under exclusive supply agreements with a limited number of suppliers. Because the supply agreements restricted the sale of these crystals exclusively to us, the suppliers negotiated minimum purchase commitments with us that, when combined with reduced sales levels during prior periods in which the purchase commitments were in effect, have resulted in levels of inventories that are higher than we might otherwise maintain. As of June 30, 2020 and 2019, $23.19 million and $21.82 million, respectively, of our inventories were classified as long-term assets. Loose jewel sales and finished jewelry that we manufacture will utilize both the finished goods loose jewels currently on-hand and, as we deplete certain shapes and sizes, our on-hand raw material SiC crystals of $3.53 million and new raw material that we purchase pursuant to the Supply Agreement.
A more detailed description of our inventories is included in Note 5 to our consolidated financial statements in Item 8, “Financial Statements and Supplementary Data”, of this Annual Report on Form 10-K.
We made income tax payments of approximately $2,000 and $6,000 during the fiscal years ended June 30, 2020 and 2019, respectively. As of June 30, 2020 and 2019, we had approximately $309 and $102,000, respectively, of remaining federal income tax credits all of which expire in 2021 and can be carried forward to offset future income taxes. As of June 30, 2020 and 2019, we also had federal tax net operating loss carryforwards of approximately $23.72 million and $23.39 million, respectively, expiring between 2022 and 2037, which can be used to offset against future federal taxable income; North Carolina tax net operating loss carryforwards of approximately $20.12 million and $20.20 million, respectively, expiring between 2023 and 2033; and various other state tax net operating loss carryforwards expiring between 2021 and 2040, which can be used to offset against future state taxable income.
Contractual Commitment
On December 12, 2014, we entered into the Supply Agreement with Cree. Under the Supply Agreement, subject to certain terms and conditions, we agreed to exclusively purchase from Cree, and Cree agreed to exclusively supply, 100% of our required SiC materials in quarterly installments that must equal or exceed a set minimum order quantity. The initial term of the Supply Agreement was scheduled to expire on June 24, 2018, unless extended by the parties. Effective June 22, 2018, the Supply Agreement was amended to extend the expiration date to June 25, 2023. The Supply Agreement, as amended, also provides for the exclusive production of our premium moissanite product, Forever One™ and provided us with one option, subject to certain conditions, to unilaterally extend the term of the Supply Agreement for an additional two-year period following the expiration of the initial term. In addition, the amendment to the Supply Agreement established a process by which Cree may begin producing alternate SiC material based on our specifications that will give us the flexibility to use the materials in a broader variety of our products, as well as to permit us to purchase certain amounts of SiC materials from third parties under limited conditions. On August 26, 2020, the Supply Agreement was further amended, effective June 30, 2020, to extend the expiration date to June 29, 2025, which may be further extended by mutual agreement of the parties. The Supply Agreement was also amended to, among other things, (i) spread our total purchase commitment under the Supply Agreement in the amount of approximately $52.95 million over the term of the Supply Agreement, as amended; (ii) establish a process by which Cree has agreed to accept purchase orders in excess of the agreed-upon minimum purchase commitment, subject to certain conditions; and (iii) permit us to purchase revised amounts of SiC materials from third parties under limited conditions. Our total purchase commitment under the Supply Agreement, as amended, until June 2025 is approximately $52.95 million, of which approximately $36.60 million remains to be purchased as of June 30, 2020.
For more information regarding the second amendment to our Supply Agreement, executed on August 26, 2020, see Note 15 to our consolidated financial statements in Item 8, “Financial Statements and Supplementary Data”, of this Annual Report on Form 10-K.
During the fiscal years ended June 30, 2020 and 2019, we purchased approximately $7.47 million and $8.91 million, respectively, of SiC crystals from Cree. Going forward, we expect to use existing cash and cash equivalents and access to other working capital resources, including but not limited to the issuance of equity securities, together with future cash expected to be provided by operating activities and, if necessary, our White Oak Credit Facility, to finance our purchase commitment under the Supply Agreement, as amended.
Line of Credit
On July 13, 2018, we and our wholly owned subsidiary, charlesandcolvard.com, LLC, collectively referred to as the Borrowers, obtained the $5.00 million asset-based revolving White Oak Credit Facility. The White Oak Credit Facility may be used for general corporate and working capital purposes, including permitted acquisitions. The White Oak Credit Facility, which matures on July 13, 2021, is guaranteed by Charles & Colvard Direct, LLC, (dba Lulu Avenue®) subsidiary, during the three months ended March 31, 2016, we began managinganother of our business primarily through our two continuing distribution channels. Accordingly, for the years ended December 31, 2016 and 2015, our reportable segments are our wholesale distribution channel transacted through our parent entity, and our direct-to-consumer distribution channel transacted through the wholly owned operating subsidiary, charlesandcolvard.com, LLC. Wesubsidiaries. Under the terms of the White Oak Credit Facility, the Borrowers must maintain at least $500,000 in excess borrowing availability at all times. The White Oak Credit Facility contains no other financial covenants.
Advances under the White Oak Credit Facility may be either revolving or non-revolving. During the first year of the term of the White Oak Credit Facility, revolving advances accrued interest at a rate equal to one-month LIBOR (reset monthly, and subject to a 1.25% floor) plus 3.75%, and non-revolving advances accrued interest at such LIBOR rate plus 4.75%. Thereafter, the interest margins will reduce upon our achievement of a specified fixed charge coverage ratio. However, advances are now presentingin all cases subject to a minimum interest rate of 5.50%. Interest is calculated on an actual/360 basis and payable monthly in arrears. Principal outstanding during an event of default accrues interest at a rate 2% in excess of the operating results of Charles and Colvard Direct, LLC as a discontinued operation.rate otherwise applicable.
We sellhad not borrowed against the White Oak Credit Facility as of June 30, 2020. As a result of our loose moissanite jewels at wholesalediminished borrowing base, which is tied to someour accounts receivable, our ability to draw down funds from the White Oak Credit Facility is currently restricted.
A more detailed description of the largest distributorsWhite Oak Credit Facility is included in Note 10 to our consolidated financial statements in Item 8, “Financial Statements and jewelry manufacturers in the world, which mount them into fine jewelry to be sold at retail outlets and via the Internet. We also sell loose moissanite jewels and finished jewelry featuring moissanite at wholesale to retailers, TV shopping networks, and designers to be sold to consumers and directly to consumers through our e-commerce sales channel charlesandcolvard.com and third-party marketplaces. We believe our continued and expanding useSupplementary Data”, of multiple sales channels to the jewelry trade and the end consumer with branded finished jewelry featuring moissanite positions Charles & Colvard goods at the many touchpoints where consumers are when they are making their buying decisions – thereby creating greater exposure for our brand and increasing consumer demand.this Annual Report on Form 10-K.
2016 was a pivotal year for Charles & Colvard. Acting on our vision which is driven by an ethical promise: “create the world’s most brilliant gem, while leading the way for environmentally and socially responsible choices in the jewelry industry at a revolutionary value,” we embarked on a corporate re-branding initiative designed to position our brand as a premier, consumer-facing purveyor of jewels and fine jewelry. We believe this new brand presence positions Charles & Colvard with a platform that can support our multi-channel, global expansion strategy. Over the course of the year, we delivered key elements of our strategic plan in support of this new brand roll-out including:
| · | Expansion of Forever OneTM. Since its limited launch in September 2015, Charles & Colvard’s Forever One™ the world’s first colorless moissanite jewel (graded as D-E-F using the Gemological Institute of America’s color grading scale), has been met with great enthusiasm from channel partners and consumers. In response to this demand, we expanded our Forever OneTM product line by offering the jewel in an additional color grade (G-H-I), and in more shapes and sizes, including the innovative Asscher cut, which was released in June 2016. Forever OneTM represented more than 55% of all Charles & Colvard loose jewel and finished jewelry sales for the fourth quarter of 2016, and we believe Forever OneTM represents the future of premier moissanite to the market.
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Liquidity and Capital Trends
| · | A move up-market. With the advent of our colorless jewel, Forever OneTM, came an opportunity for Charles & Colvard to move up-market – competing directly with diamond for share of wallet. We believe the coupling of this amazing jewel with our new brand presence and jewelry line has elevated Charles & Colvard to the ranks of a premium brand. Market acceptance, as evidenced by our growth in the bridal sector, validates our move into what we believe is an underserved “white space” in the fine jewelry sector. To differentiate ourselves from emerging competition and to ensure our customers that they are receiving a reputable and high-quality jewel, each Charles & Colvard Created Moissanite® jewel is backed by a Limited Lifetime Warranty and Certificate of Authenticity – our commitment to our customers that their purchase is guaranteed to retain its fire and brilliance forever. With the launch of our new e-commerce website, we now offer expanded warranty coverage on our Forever OneTM jewels to include protection against usage damage to our moissanite gemstones.
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| · | Expansion of our jewelry line. Throughout 2016, Charles & Colvard carefully curated a collection of jewelry ranging from bridal to fashion and fine jewelry. While bridal continues to be a large and fast growing category, we believe the introduction of an expanded selection of everyday fashion and fine jewelry positions Charles & Colvard as a brand that appeal to consumers celebrating a multitude of commemorative moments – from birthdays to anniversaries and more – affording Charles & Colvard more opportunities to sell our wares. This broadened collection is now available to our retail and wholesale partners as well as promoted on Charles & Colvard’s e-commerce site and third-party transactional websites.
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| · | Growth within our traditional channels. Charles & Colvard has enjoyed 20 years of partnership with industry leaders in the wholesale and retail spaces. We believe these traditional channels continue to represent fertile ground for our move up-market. Sales efforts in 2016 delivered growth with existing partners and an expanded footprint into new retail and wholesale channels, supporting 21% overall growth in our wholesale sector.
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| · | Expansion of our direct-to-consumer e-commerce business. One of the primary channels that benefitted from our 2016 re-branding effort is our direct-to-consumer e-commerce website, charlesandcolvard.com. In October 2016, we announced the launch of our web presence with a new look and feel, an enhanced user experience, the introduction of our new jewelry line, and a singular and unified presence for our company and brand. We re-platformed our web presence on leading-edge technology that positions us to deliver the latest in consumer shopping experiences to our customers. This agile web platform enables us to iterate and refresh our website with new and innovate functionality as new e-commerce and direct-to-consumer strategies make their way to market. We coupled this new presence with an aggressive digital marketing and awareness strategy that drew interest to our new site, and conversions during the 2016 holiday season. Another critical element of our direct-to-consumer strategy is to provide our products for sale through third party e-commerce channels. We executed on this strategy with the release of Charles & Colvard products on marketplaces including Amazon, eBay, Jet and Walmart.com. Additionally, in August 2016, we announced our partnership with Gemvara, a leading online retailer of customizable fine jewelry, which showcases Charles & Colvard Forever One™ on its unique, world-class e-commerce platform.
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| · | A laser focus on millennials. Millennials are the largest age group in U.S. history, and they are moving into their prime spending years. Millennials proactively seek out goods and services that align with their core principles, and become devoted and vocal advocates of brands that embody ‘green’ practices. Our socially responsible and ethically-sourced products align directly with the principles and purchasing preferences of the millennial, and our quality and price point offer unprecedented value to the cost-conscious millennial. Throughout 2016, we proactively engaged this market through a multi-channel traditional and digital marketing strategy that we believe has meaningfully increased the awareness of our brand as evidenced through our increased social media following, multiple public relations postings and newfound interaction with this important customer segment.
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We believe that our existing cash and cash equivalents and access to other working capital resources, including but not limited to the access to federal government 22
As we execute our strategythe PPP Loan in whole or in part, access to buildavailable federal and reinvest in our businesses, significant expensesstate tax-related considerations, the issuance of equity securities, and investment offuture cash expected to be provided by operating activities combined will be required ahead ofsufficient to meet our working capital and capital expenditure needs over the revenue streams we expect in the future, and this resulted in some unprofitable reporting periods in 2015 and 2016. Despite this, we have maintained as one of our primary goals to generate positive cash flow from continuing operations to protect our cash position. We were successful in achieving this goal during 2015 and 2016 as we were able to reduce our inventories and aggressively collect on our trade accounts receivable balances. We will continue to monitor our cash burn rate and collection efforts as we grow the business.next twelve months.
Our total consolidated net sales for the year ended December 31, 2016 of $29.17 million were 14% greater than total consolidated net sales during the year ended December 31, 2015. Wholesale distribution segment net sales for the year ended December 31, 2016 of $24.53 million were 21% higher than wholesale distribution segment net sales during the year ended December 31, 2015. Direct-to-consumer e-commerce distribution segment net sales for the year ended December 31, 2016 of $4.64 million were 15% lower than direct-to-consumer e-commerce distribution segment net sales during the year ended December 31, 2015, primarily due to the reduction in discount salesfuture capital requirements and the migrationadequacy of available funds will depend on many factors, including the ongoing spread of COVID-19 that could lead to our new web presence on charlesandcolvard.com.
Loose jewel sales comprised 74% of our total consolidated net sales for the year ended December 31, 2016further disruption and increased 42% to $21.45 million, compared with $15.11 millionvolatility in the previous year. Finished jewelryglobal capital markets as well as its impact on our rate of sales comprised 26%growth; the expansion of our total consolidated net sales and decreased 27% to $7.72 million, compared with $10.58 million in the previous year.
Operating expenses from continuing operations increased by $889,000, or 7.5%, to $12.70 million in 2016 from $11.81 million in 2015. Of this increase, sales and marketing expenses increased $1.27 million, or 22%, to $7.04 million, primarily as a resultactivities; the timing and extent of costs associatedraw materials and labor purchases in connection with implementing our new sales and marketing strategies, including the launch of our new website. General and administrative expenses decreased $487,000, or 8%, to $5.54 million primarily as a result of decreased personnel expenses and temporary labor expenses partially offset by an increase in certain fees associated with our Credit Facility. Loss on abandonment of assets increased $118,000, or 100%, for the year ended December 31, 2016, compared to $0 in the previous year, as we abandoned costs of construction in progress related to website branding and design for our direct-to-consumer e-commerce business, charlesandcolvard.com, due to a change in our corporate strategy to consolidate our web properties.
We recorded a net loss of $4.53 million, or $0.22 per diluted share, for the year ended December 31, 2016, compared to a net loss of $9.57 million in the previous year. The decreased net loss was primarily due to the discontinuance of our direct-to-consumer home party business and an increased gross profit margin on greater net sales as we implement our new sales and marketing strategies. These improvements were partially offset by the increased operating expenses. We recorded a net loss from continuing operations of $3.95 million for the year ended December 31, 2016, compared to a net loss from continuing operations of $5.09 million in the previous year.
The execution of our strategy to grow our company, with the ultimate goal of increasing consumer awareness and clearly communicating the value proposition of moissanite, is challenging and not without risk. As such, there can be no assurance that future results for each reporting period will exceed past results in sales, operating cash flow, and/or net income due to the challenging business environment in which we operate and our investment in various initiativesloose jewel production to support our growth strategies. However, asmoissanite jewels business and precious metals and labor purchases in connection with jewelry production to support our finished jewelry business; the timing of capital expenditures; and the risk factors described in more detail in “Risk Factors” in Part I, Item 1A of this Annual Report on Form 10-K. Currently, we execute our growth strategy and messaging initiatives,have the White Oak Credit Facility through its expiration on July 13, 2021, that we remain committedbelieve would mitigate these risks to our current prioritiescash and liquidity position. Also, we may make investments in, or acquisitions of, generating positive cash flow and strengthening our financial position while both monetizing our existing inventory and manufacturing our created moissanite loose jewels and finished jewelry featuring moissanitecomplementary businesses, which could also require us to meet sales demand. We believe the results of these efforts will propel our revenue growth and profitability and further enhance shareholder value in coming years, but we fully recognize the business and economic challenges that we face.seek additional equity or debt financing.
Critical Accounting PoliciesResults of Operations