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Our continued ability and the ability of Contentsjewelry manufacturers and retail jewelers to set loose moissanite jewels in finished jewelry with high-quality workmanship; and
Our continued ability and the ability of retail jewelers to effectively market and sell finished jewelry featuring moissanite to consumers.
The execution of our business plans could significantly impact our liquidity. The execution of our business plans to expand our Online 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 $10.00$5.00 million asset-based revolving credit facility, or the White Oak Credit Facility, that we obtained from Wells Fargo Bank, National Association, or Wells Fargo, White Oak on June 25, 2014,July 13, 2018, failure to meet one or more of the following covenants could restrict our ability to draw or make further draws on the White Oak Credit Facility: (i)(i) failure to conduct our business as conducted on the date we obtained the Credit Facility; (ii)provide White Oak with certain financial information; (ii) failure to make required payments to third parties; and (iii)(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 $1.00 million$500,000 in excess availability (as defined under the White Oak Credit Facility) and. Our ability to draw down from the White Oak Credit Facility is currently restricted as a covenantresult 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 SEC that requiredallows us to maintainperiodically 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 specified minimum monthly EBITDA through December 2017 iftotal of $25.00 million (approximately $13.99 million after giving effect to our June 2019 public offering, including the cash position forimpact of the partial exercise of the underwriters’ over-allotment option). However, we may offer and sell no more than one-third of our demand deposit account maintained at Wells Fargo falls below $3.00 million or we draw uponpublic float (which is the Credit Facility.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, 2018,July 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 OneTM jewel,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 core designs as stud earrings, solitaire and three-stone rings, pendants, and bracelets; and made-to-order under strict deadlines for certain wholesale and direct-to-consumer e-commerce 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 upon 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. While general economic conditions have improved in recent periods, given uncertaintyUncertainty in the current economic environment, as a result of the COVID-19 pandemic, constrained access to capital, the impact of inflation on our currency, orand general market contractions has heightened, and maycontinue to heighten, our exposure to customer default and generate lower than expected distributor sales.
We are currently substantially dependent on a limited number of distributors, jewelry manufacturers, and retailers for the sale of our products. A significant portion 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 2017, our three largest customers, which are loose jewel and finished jewelry distributors, collectively accounted for approximately 38% of net sales. As we continue to build our finished jewelry business, we anticipate in the near term that a significant portion 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.
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 colorless and 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. Accordingly, we are reviewing various alternatives with respect to our purchase of SiC material, including whether to exercise our unilateral option, subject to certain conditions, to renew the Supply Agreement for an additional two-year period. Our total purchase commitment under the Supply Agreement until June 2018 is dependent upon the size of the SiC material and ranges between approximately $29.60 million and approximately $31.50 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 whom 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 could 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 SiC-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 inwill continue to rely on these patents and our superior quality gemstone ranges for the foreseeable future.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.
We 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 business, 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 failureability to maintain complianceexpand 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 Nasdaq’sconsumers globally and the adoption 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 listingreliance 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 products 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 alter the trade environment and consumer purchasing behavior which, in turn, could have a material effect on our financial condition and results of operations. While the U.S. and China recently signed a “phase one” trade deal on January 15, 2020 to reduce planned increases to tariffs, concerns over the stability of bilateral trade relations remain. In addition, the UK’s exit from the European Union on January 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 business partners, increased foreign exchange volatility with respect to the British pound and additional legal, political and economic uncertainty. If these actions impacting our international distribution and sales channels result in increased costs for us or our international partners, such changes could result in the delistinghigher costs to us, adversely affecting our operations, particularly as we expand our international presence.
Additionally, while substantially all 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. Inforeign transactions are denominated in U.S. dollars, foreign currency fluctuations could impact demand for our products or the past, we have received a notification letter from Nasdaq indicating that we were not in compliance with listing requirements because the minimum bid priceability 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 failforeign suppliers to satisfy Nasdaq’s listing requirements in the future, we expectcontinue 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 liquidityperform. Further, some 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 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, jewelry manufacturers, and retailers 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 currently dependent on a limited number of distributor and retail partners in our Traditional segment for the sale of our products. A significant portion of the 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 build our finished jewelry 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 these metrics.
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.
While we intend to engage in efforts to regain compliance, and thus maintain our listing, there can be no assurance that we will be able to regain compliance during the applicable time periods set forth above. If we fail to continue to meet 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 common 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 result 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.
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 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 we will be 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 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.
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, 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 have a negative impact on the sell-through of moissanite jewelry at the retail level. From the beginning of 2006 through 2017, the price of gold has increased significantly, 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 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 ending December 31 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 ending December 31, we may incur significant additional expenses, including higher inventory of finished jewelry in the second half of the calendar year.
2023
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 Contents
On January 30, 2018, our Board of Directors approved$965,000 was disbursed by Newtek Small Business Finance, LLC, or the Lender, a change in our fiscal year from a fiscal year beginning on January 1 and ending on December 31 of each year to a fiscal year beginning on July 1 and endingnationally licensed lender under the SBA on June 30 of each year. This change18, 2020 pursuant to the fiscal year reporting cycle will begin July 1, 2018. 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 resultPromissory Note issued by us on June 15, 2020. Pursuant to Section 1106 of the holiday season salesCARES 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 end consumers through our Online Channels segmentlimitations, based on the use of the loan proceeds for qualifying expenses, which include payroll costs, rent, and as a resultutility 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 increased sales through 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,PPP Loan will ultimately be forgiven by 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.SBA.
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.
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.
For example, in 2016, the European Union, or EU, Parliament approved the new EU data protection legal framework known as the General Data Protection Regulation, or GDPR. The GDPR, will replace existing regulations and will becomewhich became effective in May 2018, replaced previously existing regulations and thereby extendingextended the scope of EU data protection law to all non-EU companies processing data of EU residents. The GDPR contains numerous requirements and changes from existingprior EU law, including more robust obligations on data processors, greater rights for data subjects, and heavier documentation requirements for data protection compliance programs. 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 the CJEU, invalidated the EU-U.S. Privacy Shield framework, or Privacy 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 costs of compliance with data privacy legislation. The costs of compliance with, and other burdens and any penalties imposed by, such international and domestic laws, regulations and policies could have a material adverse impact on our results of operations.
| · | Expanded our finished jewelry line – We expanded our product line and introduced new jewelry options in fashion, fine, and bridal jewelry. This breadth is important as we expand our footprint beyond bridal and work toward building a relationship with our consumers that transcends a lifetime of commemorative moments.
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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.
| · | Invest in key retail and wholesale partnerships – We leveraged significant groundwork laid with existing partners whose brands and customers align with ours to amplify our reach into these established markets. A key accomplishment for 2017 was our expanded footprint with Helzberg Diamonds stores. Growing from our initial test of 50 stores in 2016, we celebrated a full year of brick-and-mortar success with Helzberg with an expansion into nearly all doors – a testament to the significant performance of our product in their stores. This is an important relationship for Charles & Colvard as we position ourselves in varied consumer-facing outlets to serve the consumer who wants to touch and see moissanite to validate their purchase.
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| · | Explore new traditional and non-traditional sales channels – We secured new inroads in previously unexplored channels as green field opportunities that we believe will open new and innovative inroads to the consumer.
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| · | Convey e-commerce learning to new channels – We leveraged our experience and significant underpinnings in e-commerce to expand our footprint into new channels and regions. We exemplified this goal with the launch of Charles & Colvard jewelry on Alibaba’s Tmall® marketplace in China. We will continue to explore optimal audiences and outlets for our products as we evolve this strategy in 2018.
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| · | Evolve our customer service function – We continually improved our customer service function throughout 2017, including a new 60-day return policy, and free shipping and returns. Coupled with substantial improvements in our charlesandcolvard.com shopping and mobile experiences, we made significant strides in our customer’s experience.
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| · | Amplify our global marketing efforts – We continue to carefully measure the return on our marketing investments, and focus our efforts on profitable endeavors that drive interest in the Charles & Colvard brand, pull consumers to our many sales and educational outlets, and drive conversions. Digital marketing is a complicated endeavor, and we believe it is imperative to leverage analytics and technology to support smart marketing investments. We will take our learnings and successes from 2017, and apply them to our 2018 organic and international growth plans.
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| · | Advance toward profitability – In 2017, we made calculated investments in our growth while continually striving to reach profitability, which culminated in profitable financial results for the fourth quarter of 2017. These efforts solidified the management team’s understanding of what it takes to make Charles & Colvard a profitable business, as well as set a baseline for the investments required to achieve sustainable top-line growth.
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As we continuemanage through these challenging and unprecedented times, we plan to executeremain highly focused on prudently managing the reach of our strategybrand – both domestically and internationally – through select digital marketing initiatives that align with consumer engagement and demand. However, in response to build and reinvest in our businesses, significant expenses and investment of cash will be required aheadthe global economic impact of the revenue streamsCOVID-19 pandemic and its effect on consumer confidence and spending levels, we expect in the future. While this has resulted in some unprofitable reporting periods during 2016 and 2017, we will continue to analyze each investment decision with the intent to growhave narrowed our business while maintaining our goal of achieving positive financial results and cash flows.digital advertising spend toward higher-conversion marketing activities. We believe that weour long-term mission will continueultimately be accomplished through our ability to generateremain 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 have access to sufficient working capital to fund operations as we executeFiscal 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 plans to expand and growAnnual Report on Form 10-K for the business.fiscal year ended June 30, 2019 filed with the SEC on September 6, 2019.
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Results of Contents
OperationsOur total
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 December 31, 2017 of $27.03June 30, 2020 compared to $32.24 million were 7% lower than total consolidated net sales duringfor the fiscal year ended December 31, 2016.June 30, 2019, a decrease of $3.06 million, or 9%. The decrease in consolidated net sales for the fiscal year ended December 31, 2017, was due principally to the sale, in a single transaction, during the first quarter of 2016 of approximately $6.77 million of legacy gemstone inventory, or the Legacy Inventory Sale, as a result of our efforts to reduce inventories. This decrease inJune 30, 2020 compared with consolidated net sales for the prior fiscal year was primarily due to the adverse impacts of the geopolitical unrest in Hong Kong in early 2020 which affected our international distributor market and the 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 December 31, 2017, was offset partially by June 30, 2020, we saw increased demandseasonal 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. Forever OneTM gemstones overOur transactional website, charlesandcolvard.com, was flat compared with the prior fiscal year and higherdue 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 2017.the fiscal year ended June 30, 2020 in both our Online Channels segment and Traditional segmentsegment.
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 December 31, 2017June 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 $15.95$1.32 million, were 21% lower thanor 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 December 31, 2016, primarily dueJune 30, 2020 compared to the Legacy Inventory Sale in the prior year. This decrease compared with the prior year was offset somewhat by strong finished jewelryincreased sales to U.S. customers during 2017.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 the year ended December 31, 201712% and 10% of $11.09 million were 25% greater than Online Channels segmenttotal 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 December 31, 2016,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 inventory and finished goods inventory set with these legacy gemstones. The legacy material inventory comprised lower grade raw materials, or boules, work-in-process gemstones, loose finished gemstones and finished jewelry set 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 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 production control expenses principally due to the timing when work-in-process is received into inventory and overhead 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 lower 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 consolidated 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 higher finished jewelrya $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 increased demand for our Forever OneTM gemstones during 2017 evidenced through our increased presence on e-commerce outlets, including charlesandcolvard.com.use taxes. These increases were partially offset by a $52,000 decrease in travel expenses as a result of COVID-19 cost control measures.
Loose jewel sales comprised 61% of our total consolidated net sales36
The increase in digital and social media marketing expenses for the fiscal year ended December 31, 2017June 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 decreased 23%a $9,000 increase in promotional expenses, primarily related to $16.58 million,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 with $21.45 million into the previous year. Finished jewelry sales comprised 39% of our total consolidated net sales andfiscal year ended June 30, 2019 increased 35% to $10.45 million, compared with $7.72 million in the previous year.
Operating expenses from continuing operations decreased by $533,000, or 4%, to $12.17 million in 2017 from $12.70 million in 2016. Of this decrease, general and administrative expenses decreased $855,000, or 15%, to $4.69 million primarily as a result of decreased compensation-relateda $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 partiallyin 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 bankfor 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 our Credit Facilitycorporate governance matters; a $38,000 increase in accounting services related to higher annual audit and credit card transaction processingtax fees, as well as fees associated with tax consulting services; a $30,000 increase in investor and bad debt expense. 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 abandonmentForeign 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 property6,250,000 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 equipment decreased $118,000,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 100%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 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, a wholly-owned subsidiary of Charles & Colvard, Ltd., for the fiscal year ended December 31, 2017,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 product 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 the COVID-19 pandemic, we expect our average ad spend per customer to increase going forward. Finally, as our Loyalty Program is revived, we expect the percentage 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 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 previous year. In 2016, we abandoned costsfiscal year ended June 30, 2019:
1% year-over-year growth in charlesandcolvard.com revenue.
2.2% year-over-year growth in social media followers; 5% year-over-year growth in opt-in email subscribers.
For each of construction in progress related to website brandingthe fiscal years ended June 30, 2020 and design2019, gross margin (defined as net sales less product line cost of goods sold) for our direct-to-consumer e-commerceOnline 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 charlesandcolvard.com,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 changetentative 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 June 2019, we completed an underwritten public offering of 6,250,000 newly issued shares of common stock, at a price to the public of $1.60 per share, pursuant to our 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 30-day option to buy up to an additional 937,500 shares of our common 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 common stock at a price of $1.60 per share for net proceeds of approximately $932,000, net of the underwriting discount and fees and expenses of approximately $77,000. After giving effect to 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 drastically reduced related advertising and digital marketing expenditures in mid-March 2020.
As discussed above, on June 18, 2020 we received a PPP Loan in the principal amount of $965,000 from the Lender pursuant to a Promissory 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 long-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 obtain 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 corporate strategyallocation of inventory from long-term to consolidateshort-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 other liabilities, an increase in accounts payable, and an increase in the current maturity of our web properties. We had no such abandonment of property and equipment in 2017.long-term debt. These decreasesfactors 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 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 COVID-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 marketingprofits would likely be adversely impacted.
During the fiscal year ended June 30, 2020, prepaid expenses and other assets increased principally as a result of $439,000,the timing of payments, principally for insurance-related expenses, in advance of goods or 6%, to $7.48 million,services received. During the fiscal year ended June 30, 2020, accounts payable increased primarily as a result of increased compensation-related expenses, an increase inthe 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 an increase in software-related expenses offset partially by a decrease in advertising expenses.
We recorded a net loss of $453,000, or $0.02 per diluted share, forother liabilities increased principally due to the year ended December 31, 2017, compared to a net loss of $4.53 million in the previous year. The decreased net loss was due primarily to an increase in Forever OneTM gemstone sales with a more favorable profit margin as we implement our new sales and marketing strategies and a gain on an insurance claim settlement related to excess recovery over costs previously written off associated with insured losses incurredseverance accrual in connection with aour June 2020 management reorganization and workforce reduction as well as increases in deferred revenue related to payments received prior to shipment of work-in-process materials. These improvements were partially offset bygood from customers. During the increased sales and marketing expenses. We recorded a net loss from continuing operations of $453,000 for thefiscal year ended December 31, 2017, compared to a net loss from continuing operations of $3.95 million in the previous year.
The execution of our strategy to grow our company, with the ultimate goal of increasing consumer awarenessJune 30, 2019, accrued expenses 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 initiatives to support our growth strategies. In addition, sales in the retail jewelry industry are typically seasonal due toother liabilities increased consumer purchasing patterns during the year-end holiday season. We can also see the effect of seasonalityprincipally due to the timing of orderspayments 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 receive to support new or expanded distributionhave 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
levelpurchase of
current inventory positions heldprecious 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 finished 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 customers. Accordingly,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 continue seeing these typesuse existing cash and cash equivalents and access to other working capital resources, including but not limited to the issuance of seasonal trends impactequity securities, together with future reporting periodcash 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, another of our wholly owned subsidiaries. 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 results.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 in 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 rate otherwise applicable.
We had not borrowed against the White Oak Credit Facility as we executeof June 30, 2020. As a result of our growth strategy and messaging initiatives, we remain committeddiminished borrowing base, which is tied to our current prioritiesaccounts receivable, our ability to draw down funds from the White Oak Credit Facility is currently restricted.
A more detailed description of generating positive cash flowthe White Oak Credit Facility is included in Note 10 to our consolidated financial statements in Item 8, “Financial Statements and strengthening our financial position while both monetizing our existing inventory and manufacturing our created moissanite loose jewels and finished jewelry featuring moissanite to meet sales demand. We believe the resultsSupplementary Data”, 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.this Annual Report on Form 10-K.
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Liquidity and Capital Trends
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 economic relief programs pursuant to the CARES Act, including our existing PPP Loan and the available conditional forgiveness of Contentsthe PPP Loan in whole or in part, access to available federal and state tax-related considerations, the issuance of equity securities, and future cash expected to be provided by operating activities combined will be sufficient to meet our working capital and capital expenditure needs over the next twelve months.
Our future capital requirements and the adequacy of available funds will depend on many factors, including the ongoing spread of COVID-19 that could lead to further disruption and volatility in the global capital markets as well as its impact on our rate of sales growth; the expansion of our sales and marketing activities; the timing and extent of raw materials and labor purchases in connection with loose jewel production to support our moissanite 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 have the White Oak Credit Facility through its expiration on July 13, 2021, that we believe would mitigate these risks to our cash and liquidity position. Also, we may make investments in, or acquisitions of, complementary businesses, which could also require us to seek additional equity or debt financing.
Critical Accounting PoliciesCosts and EstimatesExpenses
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 inventory and finished goods inventory set with these legacy gemstones. The legacy material inventory comprised lower grade raw materials, or boules, work-in-process gemstones, loose finished gemstones and finished jewelry set 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 discussionprimary 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 analysisHong 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 the write-off of the carrying cost of our financial conditionlegacy 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 resultsproduction control expenses principally due to the timing when work-in-process is received into inventory and overhead costs are allocated. These increases in non-product line cost of operations are based upongoods sold were offset in part by an approximate $68,000 decrease in freight out in the same period due to lower 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 consolidated 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 we preparedis primarily related to increased sales and use taxes. These increases were partially offset by a $52,000 decrease in accordance with accounting principles generally acceptedtravel 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 United States,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 U.S. GAAP. 5%.
The preparation of these consolidated financial statements requires us to make estimatesincrease in general and judgments that affectadministrative expenses for the reported amounts of assets, liabilities, revenues, and expenses and related disclosures of contingent assets and liabilities. “Critical accounting policies and estimates” are defined as those most importantfiscal year ended June 30, 2020 compared to the financial statement presentationfiscal 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 that requirea $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 most difficult, subjective, or complex judgments. We baseCOVID-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 estimates on historical experience and on various other factors that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Under different assumptions and/or conditions, actual results of operations may materially differ. The most significant estimates impacting our consolidated financial statements relate to valuation and classification of inventories, accounts receivable reserves, deferred tax assets, uncertain tax positions, and revenue recognition. We also have other policies that we consider key accounting policies, but these policies typically do not require us to make estimates or judgments that are difficult or subjective.
Valuation and Classification of Inventories - Inventories are stated at the lower of cost or net realizable value on an average cost basis. Inventory costs include direct material and labor, inbound freight, purchasing and receiving costs, inspection costs, and warehousing costs. Any inventory on hand at the measurement date in excess of our current requirements based on historical and anticipated levels of sales is classified as long-term on our consolidated balance sheets. Our classification of our inventory as either short- or long-term inventory requires us to estimate the portion of on-hand inventory that can be realized over the next 12 months and does not include precious metal, labor, and other inventory purchases expected to be both purchased and realized in cost of goods sold over the next 12 months.
Our work-in-process inventories include raw SiC crystals on which processing costs, such as labor and sawing, have been incurred and components, such as metal castings and finished good moissanite jewels, that have been issued to jobs in the manufacture of finished jewelry. Our moissanite jewel manufacturing process involves the production of intermediary shapes, called “preforms,” that vary depending upon the size and shape of the finished jewel. To maximize manufacturing efficiencies, preforms may be made in advance of current finished inventory needs but remain in work-in-process inventories. As of December 31, 2017 and December 31, 2016, work-in-process inventories issued to active production jobs approximated $2.99 million and $7.18 million, respectively.
The need for adjustments to inventory reserves is evaluated on a period-by-period basis.
Accounts Receivable Reserves - Estimates are used to determine the amount of two reserves against trade accounts receivable. The first reserve is an allowance for sales returns. At the time revenue is recognized, we estimate future returns using a historical return rate that is reviewed quarterly with consideration of any contractual return privileges granted to customers, and we reduce sales and trade accounts receivable by this estimated amount. The allowance for sales returns was $537,000 and $415,000 at December 31, 2017 and 2016, respectively.
The second reserve is an allowance for doubtful accounts for estimated losses resulting from the failure of our customers to make required payments. This allowance reduces tradereserve 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 an amount expected to be collected. Based on historical percentages of uncollectible accounts by aging category, changeslower software maintenance agreement-related expenses; and a $6,000 net decrease in payment history, and facts and circumstances regarding specific accounts that become known to management when evaluating the adequacy of the allowance for doubtful accounts, we determine a percentage based on the age of the receivable that we deem uncollectible. The allowance is then calculated by applying the appropriate percentage to each of our accounts receivable aging categories, with consideration given to individual customer account activity subsequent to the current period, including cash receipts, in determining the appropriate allowance for doubtful accounts in the current period. Any increases or decreases to this allowance are charged or credited, respectively, as a bad debt expense toall other general and administrative expenses. We generally use an internal collection effort, which may include
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 sales personnelJune 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 we deem appropriate. After all internal collection efforts have been exhausted, we generally write off the account receivable.
Any accounts with significant balances are reviewed separately to determine an appropriate allowance based on the facts and circumstancesa result of the specific account. DuringCOVID-19 pandemic and its effect on our operations that led to a $193,000 decrease in bonus expense.
Professional services fees increased for the quarterfiscal year ended SeptemberJune 30, 2016, we wrote off $815,0002020 compared to the fiscal year ended June 30, 2019 primarily due to a $158,000 increase in accounts receivablelegal fees associated with corporate governance matters; a $38,000 increase in accounting services related to one international customer that was past due on its payment arrangement,higher annual audit and tax fees, as we determined that the benefits of continued collections efforts did not outweigh the costs of legal proceedings.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.
Our allowance for doubtful accounts previously included an allowance for this accounts receivable, and therefore, this write-off did not have an impactLoss on net lossForeign 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 December 31, 2016.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 our review for 2017,the fiscal year ended June 30, 2019 we determined no additional reserves were necessary for specific accounts. Based on these criteria, management determinedrecognized a federal income tax benefit in the amount of approximately $23,000 that allowances for doubtful accounts receivablerelated to the realization of $254,000 and $226,000 at December 31, 2017 and 2016, respectively, were required.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.
Deferred Tax Assets -As of each reporting date, management considerswe consider new evidence, both positive and negative, that could impact itsour view with regard to future realization of deferred tax assets. Beginning in 2014, managementwe 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 December 31, 2017June 30, 2020 and 2016.June 30, 2019.
Our deferredstatutory tax assets in Hong Kong were fully reserved with a valuation allowance of $996,000rate as of December 31, 2017 and 2016 and had been fully reserved in all prior periods due to the uncertainty of future taxable income in this jurisdiction to utilize the deferred tax assets. Charles & Colvard (HK) Ltd., our Hong Kong subsidiary, which was re-activated in December 2017, but had no operating activity during thefiscal year ended December 31, 2017, previously ceased operations during 2008June 30, 2020 is 22.11% and becameconsists of the federal income tax rate of 21% and a dormant entity during 2009. If we use any portionblended state income tax rate of our deferred tax assets in future periods,1.11%, net of the valuation allowance would need to be reversed and may impact our future operating results.federal benefit.
On December 22, 2017,For discussion of the President signedeffects of the Tax Cuts and Jobs Act, or the “Tax Tax Act,” which among other things, lowered the U.S. corporateCARES 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 tax rate from 35% to 21% effective January 1, 2018. Consequently, we wrote down our nettaxes and deferred tax assets, as of December 31, 2017 by approximately $519,000 to reflect the estimated impact of the Tax Act. We also recorded a corresponding net adjustment to our valuation allowance related to the re-measurement of certain net deferred tax assets using the lower U.S. corporate income tax.
We have substantially completed our provisional analysis of the income tax effects of the Tax Act and recorded a reasonable estimate of such effects. However, the SEC staff issued guidance regarding application of Financial Accounting Standards Board income tax guidance in the reporting period that includes December 22, 2017 – the date on which the Tax Act was signed into law – to address situations when a company does not have the necessary information available, prepared, or analyzed (including computations) in reasonable detail to complete the accounting for certain income tax effects of the Tax Act. We have estimated the tax impacts related to the impact to deferred tax assets and liabilities and included these amounts in our consolidated financial statements for the year ended December 31, 2017, on a provisional basis. In this regard, the Tax Act repeals the corporate alternative minimum tax, or AMT, regime, including claiming a refund and full realization of remaining AMT credits. We have not been able to make a reasonable estimate with respect to the realization of existing AMT credit carryforwards, and accordingly, continue to apply the income tax-related accounting guidance that was in effect immediately prior to the enactment of the Tax Act. In order for us to complete the income tax effects of the Tax Act on the existing AMT deferred tax asset, we need to further analyze the nature, validity, and recoverability of the AMT-related deferred tax credit carryforwards prior to recording the underlying appropriate tax benefit. Accordingly, the ultimate impact related to the Tax Act may differ, possibly materially, due to, among other things, completing our analysis of the realization of available AMT credit refunds, further refinement of our calculations, changes in interpretations and assumptions that we made, additional guidance that may be issued by the U.S. Government, and actions and related accounting policy decisions that we may take as a result of the Tax Act. We expect this analysis to be complete when our 2017 U.S. corporate income tax return is filed in 2018.
Uncertain Tax Positions - Effective January 1, 2007, we adopted U.S. GAAP guidance regarding the de-recognition, classification, accounting in interim periods, and disclosure requirements for uncertain tax positions. Determining which tax positions qualify as uncertain positions and the subsequent accounting for these positions requires significant estimates and assumptions. Our net accrued income tax liability under the provisions of this guidance was $462,000 and $434,000 at December 31, 2017 and 2016, respectively. This liability is only resolved when we obtain an official ruling from the tax authority on the positions or when the statute of limitations expires. As of December 31, 2017, our liability has increased by $28,000 for accrued interest on these positions.
Revenue Recognition - Revenue is recognized when title transfers at the time of shipment from our facility or a third-party fulfillment company’s facility, excluding consignment shipments as discussed below; evidence of an arrangement exists; pricing is fixed or determinable; and collectability is reasonably assured. At the time revenue is recognized, an allowance for estimated returns is established. Any change in the allowance for returns is charged against net sales. Our return policy for certain customers in our Online Channels segment provides for the return of purchases for any reason generally within 60 days of shipment in accordance with our warranty policy as disclosed on the charlesandcolvard.com website. Our return policy for customers in our Online Channels segment (excluding those of charlesandcolvard.com) and those in our Traditional segment allows for the return of jewels and finished jewelry for credit generally within 30 days of shipment if returned for a valid reason. We have established an allowance for returns based on our historical return rate, which takes into account any contractual return privileges granted to our customers. Periodically, we ship loose jewel goods, finished jewelry goods, and finished goods inventory to Traditional segment customers on consignment terms. Under these terms, the customer assumes the risk of loss and has an absolute right of return for a specified period that typically ranges from six months to one year. Our Traditional segment customers are generally required to make payments on consignment shipments within 60 days upon the customer informing us that it will keep the inventory. Accordingly, we do not recognize revenue on these consignment transactions until the earlier of (i) the customer informing us that it will keep the inventory, (ii) the expiration of the right of return period, or (iii) the customer informing us that the inventory has been sold.
Recent Accounting Pronouncements - Seesee Note 212 to our consolidated financial statements in Item 8, “Financial Statements and Supplementary Data”, of this Annual Report on Form 10-K10-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 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, a descriptionwholly-owned subsidiary of recent accounting pronouncements, includingCharles & Colvard, Ltd., for the expected datesfiscal year ended June 30, 2020:
AOV is estimated to be approximately $1,000, based on charlesandcolvard.com revenue, net of adoptionreturns, 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 estimatedproduct 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 if any, onof the COVID-19 pandemic, we expect our consolidated financial statements.average ad spend per customer to increase going forward. Finally, as our Loyalty Program is revived, we expect the percentage of people enrolled in our program to continue increasing over time.
2017 Summary
The following is a summaryoperating 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 keyour marketing activities, are based on financial results and certain non-financial results achievedcustomer-related data for charlesandcolvard.com, LLC, for the fiscal year ended December 31, 2017:June 30, 2020 compared to the fiscal year ended June 30, 2019:
| · | Our total consolidated net sales decreased by $2.14 million, or 7%, to $27.03 million in 2017 from $29.17 million in 2016. The decrease in consolidated net sales was due primarily to the Legacy Inventory Sale in the first quarter of the prior year as a result of our efforts to reduce these legacy inventories in 2016. This decrease was partially offset by an increased demand for our Forever OneTM gemstones during 2017 over the prior year and higher finished jewelry net sales during 2017.
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| · | Operating expenses from continuing operations decreased by $533,000, or 4%, to $12.17 million in 2017 from $12.70 million in 2016. Of this decrease, general and administrative expenses decreased $855,000, or 15%, to $4.69 million primarily as a result of decreased compensation expenses and professional services expenses, partially offset by an increase in bank fees principally associated with the Credit Facility. Sales and marketing expenses increased $439,000, or 6%, to $7.48 million, primarily due to increased compensation expenses and professional services costs associated with implementing our new sales and marketing strategies, offset partially by a decrease in advertising expenses. We had no loss on abandonment of property and equipment for the year ended December 31, 2017 compared to approximately $118,000 for the year ended December 31, 2016, a decrease of $118,000, or 100% from the prior year. During the year ended December 31, 2016, 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.
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| · | Net loss from continuing operations decreased $3.50 million to a loss of $454,000 in 2017 from a net loss from continuing operations of $3.95 million in 2016. The reduction in net loss was due primarily to an increase in sales of our Forever OneTM gemstones, which have a more favorable gross profit margin, and lower general and administrative expenses. These improvements were offset in part by an increase in sales and marketing expenses.
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| · | Net loss decreased $4.07 million to a loss of $454,000 in 2017 from a net loss of $4.53 million in 2016. Net loss per share was $0.02 in 2017 compared to a net loss per share of $0.22 in 2016. The reduction in net loss was primarily due to an increase in sales of products with a more favorable profit margin and lower overall operating expenses. Our net loss in 2017 also reflected the $183,000 favorable impact of an insurance claim settlement and we incurred no losses from previously reported discontinued operations related to the discontinuance of our direct-to-consumer home party business in the prior year. In 2016, we also reported a $118,000 loss on the abandonment of property and equipment in connection with costs of construction in progress related to website branding and design for our direct-to-consumer e-commerce business.
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| · | We generated negative cash flows from continuing operations of $2.56 million in 2017 compared to positive cash flows of $3.33 million from continuing operations in 2016. The primary drivers of our negative cash flow in 2017 were a net loss of $454,000; an increase in accounts receivable of $733,000; an increase in inventory of $3.50 million; and an increase in prepaid expenses and other assets of $36,000. These factors were offset partially by an increase in accounts payable of $489,000 and an increase in accrued liabilities of $246,000. Non-cash items partially offsetting the impact of net loss totaled $1.43 million.
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311% year-over-year growth in charlesandcolvard.com revenue.
For each of Contents
| · | Cash and cash equivalents at December 31, 2017 were $4.59 million compared to $7.43 million at December 31, 2016. The primary reason for this decrease is the $2.56 million of cash used in operations.
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| · | Total inventory, including long-term and consignment inventory, was $30.97 million as of December 31, 2017, up from $28.13 million at December 31, 2016. This inventory increase was, in part, due to higher purchases of raw materials and higher levels of finished goods that were produced to meet increased product demand. Lower total inventory levels in the prior year reflected the Legacy Inventory Sale.
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| · | We continue to carry no long-term debt and believe we can fund our growth strategies for the foreseeable future from operating cash flows.
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Results of Operations
The following table sets forth certain consolidated statements of operations data for the fiscal years ended December 31, 2017June 30, 2020 and 2016.
| | | Year Ended December 31, | |
| | | 2017 | | | 2016 | |
| Net sales | | $ | 27,032,964 | | | $ | 29,168,128 | |
| Costs and expenses: | | | | | | | | |
| Cost of goods sold | | | 15,470,617 | | | | 20,401,439 | |
| Sales and marketing | | | 7,477,354 | | | | 7,038,277 | |
| General and administrative | | | 4,689,823 | | | | 5,544,452 | |
| Research and development | | | 3,714 | | | | 2,848 | |
| Loss on abandonment of property and | | | | | | | | |
| equipment | | | - | | | | 117,930 | |
| Total costs and expenses | | | 27,641,508 | | | | 33,104,946 | |
| Loss from operations | | | (608,544 | ) | | | (3,936,818 | ) |
| Other income (expense): | | | | | | | | |
| Interest expense | | | (541 | ) | | | (1,737 | ) |
| Gain on insurance claim settlement | | | 183,217 | | | | - | |
| Total other income (expense), net | | | 182,676 | | | | (1,737 | ) |
| Loss before income taxes from continuing operations | | | (425,868 | ) | | | (3,938,555 | ) |
| Income tax net expense from continuing operations | | | (27,609 | ) | | | (13,480 | ) |
| Net loss from continuing operations | | | (453,477 | ) | | | (3,952,035 | ) |
| | | | | | | | | |
| Discontinued operations: | | | | | | | | |
| Loss from discontinued operations | | | - | | | | (586,124 | ) |
| Gain on sale of assets from discontinued operations | | | - | | | | 12,398 | |
| Net loss from discontinued operations | | | - | | | | (573,726 | ) |
| Net loss | | $ | (453,477 | ) | | $ | (4,525,761 | ) |
Consolidated Net Sales
Consolidated2019, gross margin (defined as net sales for the years ended December 31, 2017 and 2016 comprise the following:
| | | Year Ended December 31, | | | Change | |
| | | 2017 | | | 2016 | | | Dollars | | | | Percent | |
| Loose jewels | | $ | 16,580,748 | | | $ | 21,451,728 | | | $ | (4,870,980 | ) | | | -23 | % |
| Finished jewelry | | | 10,452,216 | | | | 7,716,400 | | | | 2,735,816 | | | | 35 | % |
| Total consolidated net sales | | $ | 27,032,964 | | | $ | 29,168,128 | | | $ | (2,135,164 | ) | | | -7 | % |
Consolidated net sales were $27.03 milliongoods sold) for the year ended December 31, 2017 compared to $29.17 million for the year ended December 31, 2016, a decrease of $2.14 million, or 7%. The decrease in consolidated net sales for the year ended December 31, 2017 was due primarily to the Legacy Inventory Sale during the first quarter of the prior year. However, this decrease in 2017 was partially offset by increased demand for our Forever OneTM gemstones during 2017 over the prior year. In addition, we experienced higher finished jewelry net sales during 2017 in both our Online Channels segment was 58% of Online Channels net sales.
Liquidity and Traditional segment.Capital Resources
SalesAs the world continues to adapt to the COVID-19 pandemic and its effects on global economics and business operations, the outbreak of loose jewels represented 61%the coronavirus and 74%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 total consolidated net salesCOVID-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 years ended December 31, 2017sum of documented payroll costs, covered rent payments, and 2016, respectively.covered utilities during the 24-week period beginning on the date of first disbursement of the PPP Loan. For purposes of the year ended December 31, 2017, loose jewel salesCARES 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 $16.58 million compared to $21.45 million fornotified by the year ended December 31, 2016, a decrease of $4.87 million, or 23%. While this decreaseSBA that our EIDL Program application was primarilyapproved by the SBA. However, due to the Legacy Inventory Sale during 2016,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 Forever OneTM gemstone sales during 2017 increasedAMT credit refund in the amount of approximately 67%$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 June 2019, we completed an underwritten public offering of 6,250,000 newly issued shares of common stock, at a price to the public of $1.60 per share, pursuant to our 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 30-day option to buy up to an additional 937,500 shares of our common 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 common stock at a price of $1.60 per share for net proceeds of approximately $932,000, net of the underwriting discount and fees and expenses of approximately $77,000. After giving effect to 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 drastically reduced related advertising and digital marketing expenditures in mid-March 2020.
As discussed above, on June 18, 2020 we received a PPP Loan in the principal amount of $965,000 from the Lender pursuant to a Promissory 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 long-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 obtain 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 2016cash and cash equivalents totaling $13.00 million, trade accounts receivable of $1.96 million, and net current inventory of $11.91 million as demand for this product increased.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.
Sales of finished jewelry represented 39% and 26% of total consolidated net sales forDuring the years ended December 31, 2017 and 2016, respectively. For thefiscal year ended December 31, 2017, finished jewelry salesJune 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 allocation 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 other liabilities, an increase in accounts payable, and an increase in the current maturity of our long-term debt. These factors were $10.45 million compared to $7.72 million foroffset 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 December 31, 2016,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 of $2.74 million, or 35%. This increase was due primarily to strong finished jewelry sales in both our Online Channels segmentcash, cash equivalents and Traditional segment. Theserestricted cash resulting from cash provided by financing activities from our public offering described above and cash provided by our operations, increases in finished jewelry sales resulted from leveraging our strategy to drive sales in 2017 through multiple channels. This is reflectedaccounts receivable and in our expanded presenceallocation of inventory to short-term from long-term as well as in Helzberg Diamonds storesprepaid 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
Traditional segmentoperations. 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
promotionother 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
updated brand platformnet loss in the amount of $6.16 million and
increased presence within our e-commerce outlets, including charlesandcolvard.coman increase in
our Online Channels segment. U.S. net sales accounted forinventory of approximately 93% and 90%$2.76 million resulting from lower quantities of total consolidated net sales during the years ended December 31, 2017 and 2016, respectively. As a percentage of net sales, U.S. net sales increased during 2017inventory items sold as a result of increased demandlower 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 U.S. distributor marketfiscal 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 increasedan 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 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 from U.S. customers in bothduring 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 Online Channels segment. Whilesecond fiscal quarters, which reflect robust year-end holiday sales, remained strong. During the sharefiscal year ended June 30, 2019, accounts receivable increased principally as a result of the increased level of sales during our U.S.third and fourth fiscal quarters.
As a result of the COVID-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, increasedbut if we ceased providing extended payment terms, we believe that we would not be competitive for some Traditional segment customers in 2017, U.S.the marketplace during this economic period and that our net sales decreased to $25.18 million, or 4%, duringand profits would likely be adversely impacted.
During the fiscal year ended December 31, 2017 compared to $26.16 millionJune 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 priorfiscal year ended June 30, 2020, accounts payable increased primarily as a result of the Legacy Inventory Saletiming 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 finished 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 first quarteramount of 2016.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.
Our largest U.S. customer duringFor more information regarding the yearsecond 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 December 31, 2017 accountedJune 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 21%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, another of our total consolidated sales comparedwholly owned subsidiaries. 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 17%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 in 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 year ended December 31, 2016. A second U.S. customer accounted for 23%rate otherwise applicable.
We had not borrowed against the White Oak Credit Facility as of our total consolidated net sales during the year ended December 31, 2016, but did not have net sales that represented 10% or more of total net sales for the year ended December 31, 2017. No additional U.S. customers accounted for more than 10% of total consolidated sales in 2017 or 2016. We expect that we will remain dependent on our ability, and that of our largest customers, to maintain and enhance retail 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 7% and 10% of total consolidated net sales during the years ended December 31, 2017 and 2016, respectively. International net sales decreased 38% during 2017 as we serve distributors in the Hong Kong and India markets and demand for loose jewels in these markets was down compared to 2016. We continue to evaluate these and other potential distributors in these international markets to determine the best long-term partner. Additionally, we anticipate the need to develop a direct-to-consumer presence, which would require marketing and e-commerce investment to drive expected growth in these regions.June 30, 2020. As a result our sales in these markets may continue to fluctuate significantly each reporting period.
No international customers accounted for more than 10% of total consolidated sales in 2017 or 2016. A portion of our internationaldiminished borrowing base, which is tied to our accounts receivable, our ability to draw down funds from the White Oak Credit Facility is currently restricted.
A more detailed description of the White Oak Credit Facility is included in Note 10 to our consolidated sales represents jewels sold internationally that may be re-imported to U.S. retailers. Our top three international distributors by sales volume during the year ended December 31, 2017 were,financial statements in orderItem 8, “Financial Statements and Supplementary Data”, of sales volume, located in Hong Kong, Canada, and Hong Kong.this Annual Report on Form 10-K.
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Liquidity and Capital Trends
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 economic relief programs pursuant to the CARES Act, including our existing PPP Loan and the available conditional forgiveness of Contentsthe PPP Loan in whole or in part, access to available federal and state tax-related considerations, the issuance of equity securities, and future cash expected to be provided by operating activities combined will be sufficient to meet our working capital and capital expenditure needs over the next twelve months.
Our future capital requirements and the adequacy of available funds will depend on many factors, including the ongoing spread of COVID-19 that could lead to further disruption and volatility in the global capital markets as well as its impact on our rate of sales growth; the expansion of our sales and marketing activities; the timing and extent of raw materials and labor purchases in connection with loose jewel production to support our moissanite 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 have the White Oak Credit Facility through its expiration on July 13, 2021, that we believe would mitigate these risks to our cash and liquidity position. Also, we may make investments in, or acquisitions of, complementary businesses, which could also require us to seek additional equity or debt financing.
Costs and Expenses
Cost of Goods Sold
Cost of goods sold for the fiscal years ended December 31, 2017June 30, 2020 and 20162019 are as follows:
| | | Year Ended December 31, | | | Change | | | Year Ended June 30, | | | Change | |
| | | 2017 | | | 2016 | | | Dollars | | | Percent | | | 2020 | | | 2019 | | | Dollars | | | Percent | |
| Product line cost of goods sold | | | | | | | | | | | | | |
| Product line cost of goods sold: | | | | | | | | | | | | | |
| Finished jewelry | | | $ | 7,469,790 | | | $ | 6,859,112 | | | $ | 610,678 | | | 9 | % |
| Loose jewels | | $ | 8,524,843 | | | $ | 13,916,749 | | | $ | (5,391,906 | ) | | | -39 | % | | | 6,062,186 | | | | 8,242,830 | | | | (2,180,644 | ) | | -26 | % |
| Finished jewelry | | | 5,226,660 | | | | 4,148,788 | | | | 1,077,872 | | | | 26 | % | |
| Total product line cost of goods sold | | | 13,751,503 | | | | 18,065,537 | | | | (4,314,034 | ) | | | -24 | % | | 13,531,976 | | | 15,101,942 | | | (1,569,966 | ) | | -10 | % |
| Non-product line cost of goods sold | | | 1,719,114 | | | | 2,335,902 | | | | (616,788 | ) | | | -26 | % | | | 7,668,231 | | | | 2,250,225 | | | | 5,418,006 | | | 241 | % |
| Total cost of goods sold | | $ | 15,470,617 | | | $ | 20,401,439 | | | $ | (4,930,822 | ) | | | -24 | % | | $ | 21,200,207 | | | $ | 17,352,167 | | | $ | 3,848,040 | | | 22 | % |
Total cost of goods sold was $15.47$21.20 million for the fiscal year ended December 31, 2017June 30, 2020 compared to $20.40$17.35 million for the fiscal year ended December 31, 2016,June 30, 2019, a decreasenet increase of $4.93approximately $3.85 million, or 24%22%. Product line cost of goods sold is defined as product cost of goods sold in each of our TraditionalOnline Channels segment and Online ChannelsTraditional 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 valuation allowance adjustments;write-offs; and other inventory adjustments, comprising costs of quality issues, and damaged goods, and inventory write-downs.goods.
The decreaseincrease in total cost of goods sold for 2017the fiscal year ended June 30, 2020 as compared to the priorfiscal year ended June 30, 2019 was due primarily to the Legacy Inventory Saledriven by a write-off during the firstthird quarter of 2016. Fiscal 2020 of approximately $5.26 million representing the carrying value of our legacy loose jewel inventory and finished goods inventory set with these legacy gemstones. The legacy material inventory comprised lower grade raw materials, or boules, work-in-process gemstones, loose finished gemstones and finished jewelry set 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 decreaseincrease in non-product line cost of goods sold for the fiscal year ended June 30, 2020 comprises a $980,000 decreasean unfavorable net change in other inventory write-offs of approximately $5.47 million principally related to the write-off of the carrying cost of our legacy material inventory of $5.26 million as well as inventory valuation adjustments principally relatingrelated 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 and a $76,000 decreaseas compared to the fiscal year ended June 30, 2019 as well as an approximate $1,000 increase in non-capitalized manufacturing and production control expenses primarilyprincipally due to the timing of receivingwhen work-in-process is received into inventory and allocating overhead.overhead costs are allocated. These decreasesincreases in non-product line cost of goods sold were offset in part by a $398,000 increase in inventory valuation allowances, including inventory obsolescence, shrinkage, recuts, and repairs reserves, and a $40,000 increasean approximate $68,000 decrease in freight out as a result of an increase in sales transaction volume. the same period due to lower shipment costs during the fiscal year ended June 30, 2020.
For further discussion of non-product line cost of goods sold, see Note 3 “Segment Informationto our consolidated financial statements in Item 8, “Financial Statements and GeographicSupplementary Data”, in the Notes to Consolidated Financial Statements.of this Annual Report on Form 10-K.
Sales and Marketing
Sales and marketing expenses for the fiscal years ended December 31, 2017June 30, 2020 and 20162019 are as follows:
| | | Year Ended December 31, | | | Change | |
| | | 2017 | | | 2016 | | | Dollars | | | Percent | |
| Sales and marketing | | $ | 7,477,354 | | | $ | 7,038,277 | | | $ | 439,077 | | | | 6 | % |
| | | 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 $7.48$9.44 million for the fiscal year ended December 31, 2017June 30, 2020 compared to $7.04$7.98 million for the fiscal year ended December 31, 2016,June 30, 2019, an increase of approximately $439,000,$1.46 million, or 6%18%.
The increase in sales and marketing expenses for the fiscal year ended December 31, 2017June 30, 2020 compared to the fiscal year ended December 31, 2016June 30, 2019 was primarily due to a $531,000$1.15 million increase in compensation-related expense;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 $201,000 increase in professional services fees; a $145,000$217,000 increase in software-related costs principally in connection with maintenance agreements associated with our migration to a cloud-based data storage arrangement as well as other software-related agreements; a $90,000$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; a $24,000 increase in recruiting fees; a $12,000 increase in depreciation and amortization expense; and a $13,000 increase in miscellaneous otherexpenses, which is primarily related to increased sales and marketing expenses.use taxes. These increases were partially offset by a $596,000 decrease in advertising expenses; a $31,000$52,000 decrease in travel expense; andexpenses as a $13,000 decrease in market research expenses.result of COVID-19 cost control measures.
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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 Contentsa 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 December 31, 2017June 30, 2020 compared to the December 31, 2016fiscal year ended June 30, 2019 increased primarily as a result of a $362,000$201,000 increase in salaries, commissions, and related employee benefits in the aggregate; a $191,000$71,000 increase in severance expense primarilyaccrual related to the departure of our Chief Revenue Officer during the first quarter of 2017;June 2020 management reorganization and workforce reduction; and a $136,000$9,000 increase in bonus expense; and a $13,000 increase in relocationemployee stock-based compensation expense. These increases were partially offset by cost control measures implemented by management as a $171,000result of the COVID-19 pandemic and its effect on our operations that led to a $235,000 decrease in employee stock-based compensationbonus expense.
The decrease in advertising expenses for the year ended December 31, 2017 compared to the year ended December 31, 2016 comprises an $849,000 decrease in outside agency fees and a $33,000 decrease in print media expenses. These decreases were partially offset by a $159,000 increase in promotional expenses; an $84,000 increase in cooperative advertising; a $33,000 increase in Internet marketing; and a $10,000 increase in all other advertising expenses.
Sales and marketing expenses are allocated across our Traditional segment and Online Channels segment, which in 2016 included allocations to Charles & Colvard Direct, LLC, a segment we are reporting as discontinued operations. See Note 13, “Discontinued Operations”, in the Notes to the Consolidated Financial Statements for further discussion of discontinued operations. Approximately $61,000 of sales and marketing expenses for the year ended December 31, 2016, all of which were incurred during the first six months of 2016, are attributable to sales and marketing expenses that are now being allocated to our remaining two continuing operating segments that were previously allocated to Charles & Colvard Direct, LLC. We had no such sales and marketing expenses during the second half of 2016.
While our intent is to continue to invest in sales and marketing efforts to increase sales, we believe such expenses may also increase as part of our ongoing strategy to promote overall consumer awareness of moissanite and of our brands. However, this will be dependent on overall companywide marketing strategies and in which sales channels we may choose to make such further investments.
General and Administrative
General and administrative expenses for the fiscal years ended December 31, 2017June 30, 2020 and 20162019 are as follows:
| | | Year Ended December 31, | | | Change | |
| | | 2017 | | | 2016 | | | Dollars | | | Percent | |
| General and administrative | | $ | 4,689,823 | | | $ | 5,544,452 | | | $ | (854,629 | ) | | | -15 | % |
| | | 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 $4.69$4.86 million for the fiscal year ended December 31, 2017June 30, 2020 compared to $5.54$4.64 million for the fiscal year ended December 31, 2016, a decreaseJune 30, 2019, an increase of approximately $855,000,$220,000, or 15%5%.
The decreaseincrease in general and administrative expenses for the fiscal year ended December 31, 2017June 30, 2020 compared to the fiscal year ended December 31, 2016June 30, 2019 was primarily due to a $751,000 decrease$250,000 increase in compensation expenses; $300,000a $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 professional services;business franchise taxes and licenses; a $77,000$49,000 decrease in depreciation and amortization expense;board retainer fees as a $74,000result 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; a $16,000an $18,000 decrease in travel expenses; a $14,000 decrease in computer and software related expenses; and a $16,000 decrease in miscellaneous other general and administrative expenses. These decreases were partially offset by a $99,000 increase in bank fees, which includes fees associated with the Credit Facility and credit card clearing transactions; an $88,000 increase in bad debt expense associated with our allowance for doubtful accounts reserve policy; an $18,000 increasepolicy reflecting lower customer accounts receivable balances during the COVID-19 pandemic; a $12,000 decrease in equipment-related rental expense; an $8,000 increase in board retainer fees;general office-related expenses, which is primarily related to lower software maintenance agreement-related expenses; and a $5,000 increase$6,000 net decrease in business taxesall other general and licenses.administrative expenses.
Compensation expenses decreasedincreased for the fiscal year ended December 31, 2017June 30, 2020 compared to the fiscal year ended December 31, 2016June 30, 2019 primarily due to a $469,000 decrease$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 aggregateaggregate; and a $380,000 decrease$33,000 increase in employee stock-based compensation expense, principally due to changes in stock-based compensation performance measurements and the modification of restricted stock awards from wholly restricted stock awards to awards consisting of 70% restricted stock and 30% cash in lieu of restricted stock.expense. These decreasesincreases were offset in part by cost control measures implemented as a $56,000 increaseresult of the COVID-19 pandemic and its effect on our operations that led to a $193,000 decrease in bonus expense and an increase of $42,000 in severance expenses related to personnel changes.expense.
Professional services decreasedfees increased for the fiscal year ended December 31, 2017June 30, 2020 compared to the fiscal year ended December 31, 2016June 30, 2019 primarily due to a decrease of $230,000$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 decrease of $105,000$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 to human resources and sales and use tax projects in 2016; and a $1,000 decrease in investor and public relations expenses. These decreases were partially offset by an increase in legal fees of $36,000.consulting fees.
General and administrative expenses are allocated across our Traditional segment and Online Channels segment, which in 2016 included allocations to Charles & Colvard Direct, LLC, a segment we are reporting as discontinued operations. See Note 13, “Discontinued Operations”, in the Notes to the Consolidated Financial Statements for further discussion of discontinued operations. Approximately $175,000 of general and administrative expenses for the year ended December 31, 2016, all of which were incurred during the first six months of 2016, are attributable to general and administrative expenses that are now being allocated to our remaining two continuing operating segments that were previously allocated to Charles & Colvard Direct, LLC. We had no such general and administrative expenses during the second half of 2016.37
Loss on Abandonment of Property and EquipmentForeign Currency Exchange
Loss on abandonment of property and equipmentforeign currency exchange related to foreign sales transacted in functional currencies other than the U.S. dollar for the fiscal years ended December 31, 2017June 30, 2020 and 20162019 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 December 31, | | | Change | |
| | | 2017 | | | 2016 | | | Dollars | | | Percent | |
| Loss on abandonment of property and equipment | | $ | - | | | $ | 117,930 | | | $ | (117,930 | ) | | | -100 | % |
| | | Year Ended June 30, | | | Change | |
| | | 2020 | | | 2019 | | | Dollars | | | Percent | |
| Interest income | | $ | 158,091 | | | $ | 11,022 | | | $ | 147,069 | | | | 1,334 | % |
We had no loss on abandonmentIn June 2019, we completed an underwritten public offering of property and equipment6,250,000 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 December 31, 2017 compared to approximately $118,000 for the year ended December 31, 2016, a decrease of $118,000, or 100%. During the year ended December 31, 2016,June 30, 2020, we abandoned costs of constructionearned interest income from cash on deposit in progress related to website branding and design for our e-commerce business, charlesandcolvard.com, due to a change in our corporate strategy to consolidate our web properties.this interest-bearing account.
Gain on Insurance Claim Settlement
Gain on insurance claim settlement for the years ended December 31, 2017 and 2016 is as follows:
| | | Year Ended December 31, | | | Change | |
| | | 2017 | | | 2016 | | | Dollars | | | Percent | |
| Gain on insurance claim settlement | | $ | 183,217 | | | $ | - | | | $ | 183,217 | | | | 100 | % |
The gain on insurance claim settlement was approximately $183,000 for the year ended December 31, 2017, compared to $0 for the year ended December 31, 2016, an increase of $183,000, or 100%. In the fourth quarter of 2017, we settled an outstanding insurance claim related to recovery of costs previously expensed and written off during 2017 associated with insured losses incurred in connection with a shipment of work-in-process materials. The gain represents the excess recovery over amounts previously expensed and written off.
Provision for Income Taxes
We recognized ana net income tax net expense of approximately $28,000$1,700 and 13,000a net income tax benefit of approximately $1,400 for the fiscal years ended December 31, 2017June 30, 2020 and 2016,2019, respectively. IncomeOur income tax provisions in these yearsperiods 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, management considerswe consider new evidence, both positive and negative, that could impact itsour view with regard to future realization of deferred tax assets. Beginning in 2014, managementwe 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 December 31, 2017June 30, 2020 and 2016.June 30, 2019.
Our statutory tax rate as of the fiscal year ended June 30, 2020 is 23.25%22.11% and consists of the federal income tax rate of 21% and a blended state income tax rate of 2.25%1.11%, net of the federal benefit.
On December 22, 2017, the President signed the Tax Act that among other things lowered the U.S. corporate income tax rate from 35% to 21% effective January 1, 2018. For further 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 “Income Taxes”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 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, a wholly-owned subsidiary of Charles & Colvard, 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 product 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 Notesunderlying content types, notwithstanding the effects of the COVID-19 pandemic, we expect our average ad spend per customer to increase going forward. Finally, as our Loyalty Program is revived, we expect the percentage 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 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 Consolidated Financial Statements.fiscal year ended June 30, 2019:
1% year-over-year growth in charlesandcolvard.com 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 June 2019, we completed an underwritten public offering of 6,250,000 newly issued shares of common stock, at a price to the public of $1.60 per share, pursuant to our 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 30-day option to buy up to an additional 937,500 shares of our common 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 common stock at a price of $1.60 per share for net proceeds of approximately $932,000, net of the underwriting discount and fees and expenses of approximately $77,000. After giving effect to 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 drastically reduced related advertising and digital marketing expenditures in mid-March 2020.
As discussed above, on June 18, 2020 we received a PPP Loan in the principal amount of $965,000 from the Lender pursuant to a Promissory 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 long-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 obtain 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 December 31, 2017,June 30, 2020, our principal sources of liquidity were cash, and cash equivalents and restricted cash totaling $4.59$14.62 million, trade accounts receivable of $3.38 million,$671,000, and net current inventory of $11.21$7.44 million, as compared to cash and cash equivalents totaling $7.43$13.00 million, trade accounts receivable of $2.80$1.96 million, and net current inventory of $9.77$11.91 million as of December 31, 2016.June 30, 2019. As described more fully below,herein, we also have access to our $10.00long-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 December 31, 2017,June 30, 2020, our working capital decreased by approximately $1.37$5.75 million to $14.70$17.42 million from $16.07$23.17 million at December 31, 2016.June 30, 2019. As described more fully below, the decrease in working capital at December 31, 2017June 30, 2020 is primarily attributable to a decrease in our cash and cash equivalentsallocation of inventory from long-term to short-term, a decrease in accounts receivable, an increase in short-term operating lease liabilities resulting from cash usedthe adoption of the new lease accounting standard as of July 1, 2019, an increase in our operations and increases in accounts payable, accrued cooperative advertising, and accrued expenses and other liabilities.liabilities, an increase in accounts payable, and an increase in the current 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 and increasesas well as in accounts receivable, and 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
December 31, 2017, $2.56 millionJune 30, 2020, approximately $249,000 of cash was
usedprovided by our
continuingoperations. 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
useoperations 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
net lossdecrease in accounts payable of
$454,000;$799,000; an increase in accounts receivable of
$733,000; an increase in inventory of $3.50 million$328,000; and an increase in prepaid expenses and other assets of
$36,000. These factors were offset partially by an increase in accounts payable of $489,000 and an increase in accrued liabilities of $246,000. Non-cash items partially offsetting the impact of net loss totaled $1.43 million.$14,000. The inventory
increase was,increases during the fiscal years ended June 30, 2020 and 2019 were, in part, due to the purchase of new raw material SiC crystals during
the periodeach fiscal year then ended pursuant to the Supply
Agreement; production of moissanite jewels; and purchases of jewelry castings and other jewelry componentsAgreement.
During the fiscal year ended June 30, 2020, accounts receivable decreased principally due to increased demand in certain channelsdecreased sales during the third and preparation for market demand.
Accountsfourth 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 due toas a result of the increased level of sales during our third and fourth fiscal quarters.
As a result of the fourth quarter of 2017 as compared with the same period in the prior year, as well as an overall increase of sales in our Online Channels segment in 2017 compared with 2016. We did not offer anyCOVID-19 pandemic, we offered extended Traditional segment customer payment terms beyond 90 days to certain credit-worthy customers during the year ended December 31, 2017; however, we may offerthird and fourth quarters of Fiscal 2020. Because of the ongoing impact of the pandemic on the global economy, the extension of these terms from time to time, which may not immediately increase liquidity as a result of ongoing current-period sales. Wesales, 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 andduring the current global economic environment. We believe that our net sales have been favorably impacted. Wewe are unable to estimate the impact of this programthese actions on our net sales, but if we ceased providing extended payment terms, in select instances, 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 decrease. be adversely impacted.
During the fiscal year ended December 31, 2016, we wrote off $815,000 in accounts receivable related to one international customer that was past due on its payment arrangement as we determined that the benefits of continued collections efforts did not outweigh the costs of legal proceedings. We do not believe our commercial terms were a factor with this customer’s non-payment. Our allowance for doubtful accounts previously included an allowance for this customer’s accounts receivable balance, and therefore, this write-off did not have an impact on our net loss for the year ended December 31, 2016. We have not experienced any other significant accounts receivable write-offs related to revenue arrangements with extended payment terms.
PrepaidJune 30, 2020, prepaid expenses and other assets increased principally as a result of the timing of the receipt of an insurance claim settlement offset partially by the timing of payments, principally for insurance-related expenses, in advance of goods or services received. AccountsDuring the fiscal year ended June 30, 2020, accounts payable increased primarily as a result of the timing of payment for costs incurred but not yet paid as of December 31, 2017 associated with inventory-related purchases and professional services incurred but not yetand 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 travel-related expensespayments related to accrued compensation and services incurred but not yet due under our vendors’ payment terms.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 $15.26$10.64 million and $14.09 million in loose jewels and $7.61$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 yearfiscal years ended December 31, 2017.June 30, 2020 and 2019, respectively. We expect our purchases of precious metals and labor to increase as we increasefluctuate in conjunction with the levels of our finished jewelry business. In addition, from the beginning of 2006 through the year ended December 31, 2017, 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 our reduced sales levels during theprior periods whenin which the purchase commitments were in effect, have resulted in levels of inventories that are higher than we might otherwise maintain. As of December 31, 2017, $19.77June 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 $4.29$3.53 million and new raw material that we are purchasingpurchase pursuant to the Supply Agreement.
Our inventory principally comprises the following two types of materials: (i) new material that has been produced since September 2015 to the present, which is the raw materials for our Forever OneTM products with colorless and near colorless gemstones, or New Material; and (ii) legacy material that was produced through the period ended August 2015, which is the raw materials for our Forever ClassicTM, Forever Brilliant® and lower grade gemstones, or Legacy Material. Of our total inventory as of December 31, 2017, 64% of the total inventory was New Material, while 36% was Legacy Material, as compared to percentages of total inventory of 49% of New Material and 51% of Legacy Material at December 31, 2016. We are actively selling goods set with the Legacy Material gemstones through our omni-channel strategy in such outlets as marketplaces, drop-ship and pure-play retailers. A more detailed description of our inventories is included in Note 5 “Inventories,”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 Notesfiscal 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 Consolidated Financial Statements.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 willwas scheduled to expire on June 24, 2018, unless extended by the parties. Accordingly, we are reviewing various alternativesEffective 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 respect to our purchase of SiC material, including whether to exercise our unilateralone option, subject to certain conditions, to renewunilaterally extend the term of the Supply Agreement for an additional two-year period.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 20182025 is dependent uponapproximately $52.95 million, of which approximately $36.60 million remains to be purchased as of June 30, 2020.
For more information regarding the size of the SiC material and ranges between approximately $29.60 million and approximately $31.50 million. As of December 31, 2017,second amendment to our remaining purchase commitment through June 2018 under the Supply Agreement, ranges from approximately $5.15 millionexecuted on August 26, 2020, see Note 15 to approximately $7.05 million.our consolidated financial statements in Item 8, “Financial Statements and Supplementary Data”, of this Annual Report on Form 10-K.
During the yearfiscal years ended December 31, 2017,June 30, 2020 and 2019, we purchased approximately $9.39$7.47 million and $8.91 million, respectively, of SiC crystals from Cree. WeGoing 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.Agreement, as amended.
We made no income tax payments during the year ended December 31, 2017. AsLine of December 31, 2017, we had approximately $884,000 of remaining federal income tax credits, $533,000 of which expire between 2018 and 2021 and the balance without an expiration, which can be carried forward to offset future income taxes. As of December 31, 2017, we also had federal tax net operating loss carryforwards of approximately $24.59 million, expiring between 2020 and 2036, which can be used to offset against future federal taxable income; North Carolina tax net operating loss carryforwards of approximately $20.22 million expiring between 2023 and 2032; and various other state tax net operating loss carryforwards expiring between 2021 and 2036, which can be used to offset against future state taxable income.Credit
On June 25, 2014,July 13, 2018, we and our wholly owned subsidiaries, Charles & Colvard Direct,subsidiary, charlesandcolvard.com, LLC, and Moissanite.com, LLC (now charlesandcolvard.com, LLC), collectively referred to as the Borrowers, obtained the $5.00 million asset-based revolving White Oak Credit Facility from Wells Fargo.Facility. The White Oak Credit Facility may be used for general corporate and working capital purposes, including transaction fees and expenses incurred in connection therewith and the issuance of letters of credit up to a $1.00 million sublimit.permitted acquisitions. The White Oak Credit Facility, was scheduled to maturewhich matures on June 25, 2017.
Effective June 22, 2017,our wholly owned subsidiaries. Under the terms of the White Oak Credit Facility, was amended to extend the maturity date to June 25, 2018. The Credit Facility was also amended to reduce the interest rate payable on advances under the Credit Facility to a rate equal to Wells Fargo’s daily three-month LIBOR rate plus 2.00%, calculated on an actual/360 basis and payable monthly in arrears. In addition, the Credit Facility was amended further to include the addition of an EBITDA covenant, whereby the Borrowers were required to maintain a specified minimum monthly EBITDA through December 2017 if the cash position for the Borrowers’ demand deposit account maintained at Wells Fargo falls below $3.00 million or the Borrowers draw upon the Credit Facility.
The Credit Facility includes a $5.00 million sublimit for advances that are supported by a 90% guaranty provided by the U.S. Export-Import Bank. Advances under the Credit Facility are limited to a borrowing base, which is computed by applying specified advance rates to the value of the Borrowers’ eligible accounts and inventory, less reserves. Advances against inventory are further subject to an initial $3.00 million maximum. The Borrowers must maintain a minimum of $1.00 millionat least $500,000 in excess borrowing availability at all times. The White Oak Credit Facility contains no other financial covenants.
Each advance accruesAdvances 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 either (i) Wells Fargo’s three-monthone-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 2.00%, or (ii) Wells Fargo’s Prime Rate plus 1%, each4.75%. Thereafter, the interest margins will reduce upon our achievement of a specified fixed charge coverage ratio. However, advances are in 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 of 3%2% in excess of the above rate. Any advance may be prepaid in whole or in part at any time. There are no mandatory prepayments or line reductions.rate otherwise applicable.
The Credit Facility is secured by a lien on substantially all assets of the Borrowers, each of which is jointly and severally liable for all obligations thereunder. Wells Fargo’s security interest in certain SiC materials is subordinate to Cree’s security interest in such materials pursuant to the Supply Agreement and an Intercreditor Agreement with Wells Fargo.
The Credit Facility is evidenced by a Credit and Security Agreement, dated as of June 25, 2014, as amended, or the Credit Agreement, and customary ancillary documents. The Credit Agreement contains customary covenants, representations and cash dominion provisions, including a financial reporting covenant and limitations on dividends, distributions, debt, contingent obligations, liens, loans, investments, mergers, acquisitions, divestitures, subsidiaries, affiliate transactions, and changes in control.
Events of default under the Credit Facility include, without limitation, (i) any impairment of the Export-Import Bank guaranty, unless the guaranteed advances are repaid within two business days, (ii) an event of default under any other indebtedness of the Borrowers in excess of $200,000, and (iii) a material adverse change in the ability of the Borrowers to perform their obligations under the Credit Agreement or in the Borrowers’ assets, liabilities, businesses or prospects, or other circumstances that Wells Fargo believes may impair the prospect of repayment. If an event of default occurs, Wells Fargo is entitled to take enforcement action, including acceleration of amounts due under the Credit Agreement and foreclosure upon collateral.
The Credit Agreement contains other customary terms, including indemnity, expense reimbursement, yield protection, and confidentiality provisions. Wells Fargo is permitted to assign the Credit Facility.
Since the current amendment to the Credit Facility matures on June 25, 2018, we are currently reviewing various credit facility alternatives. Given the Company’s market growth and our improved financial strength over the past year, we believe that we may have access to additional sources of working capital that may provide more advantageous terms than the existing Credit Agreement.
As of December 31, 2017, weWe had not borrowed against the White Oak Credit Facility.Facility as of June 30, 2020. As a result of our diminished borrowing base, which is tied to our accounts receivable, our ability to draw down funds from the White Oak Credit Facility is currently restricted.
A more detailed description of the White Oak Credit Facility is included in Note 10 to our consolidated financial statements in Item 8, “Financial Statements and Supplementary Data”, of this Annual Report on Form 10-K.
Liquidity and Capital Trends
We believe that our existing cash and cash equivalents and access to other working capital together withresources, including but not limited to the access to federal government economic relief programs pursuant to the CARES Act, including our existing PPP Loan and the available conditional forgiveness of the PPP Loan in whole or in part, access to available federal and state tax-related considerations, the issuance of equity securities, and future cash expected to be provided by operating activities combined will be sufficient to meet our working capital and capital expenditure needs over the next 12twelve months.
Our future capital requirements and the adequacy of available funds will depend on many factors, includingthe ongoing spread of COVID-19 that could lead to further disruption and volatility in the global capital markets as well as its impact on our rate of sales growth; the expansion of our sales and marketing activities; the timing and extent of raw materials and labor purchases in connection with loose jewel production to support our moissanite 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. We obtainedCurrently, we have the White Oak Credit Facility tothrough its expiration on July 13, 2021, that we believe would mitigate these risks to our cash and liquidity position. Also, we may make investments in, or acquisitions of, complementary businesses, which could also require us to seek additional equity or debt financing.
Critical Accounting Policies and Estimates
39The discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which we prepared in accordance with accounting principles generally accepted in the United States of America, or U.S. GAAP. The future effects of the COVID-19 pandemic on our results of operations, cash flows, and financial position continue to remain unclear. The preparation of these consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues, and expenses and related disclosures of contingent assets and liabilities. “Critical accounting policies and estimates” are defined as those most important to the financial statement presentation and that require the most difficult, subjective, or complex judgments. We base our estimates on historical experience and on various other factors, including current economic conditions resulting from the COVID-19 pandemic, that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Under different assumptions and/or conditions, actual results of operations may materially differ. The most significant estimates impacting our consolidated financial statements relate to valuation and classification of inventories, accounts receivable reserves, deferred tax assets, uncertain tax positions, and revenue recognition. We also have other policies that we consider key accounting policies, but these policies typically do not require us to make estimates or judgments that are difficult or subjective.
Valuation and Classification of Inventories
Inventories are stated at the lower of cost or net realizable value on an average cost basis. Inventory costs include direct material and labor, inbound freight, purchasing and receiving costs, inspection costs, and warehousing costs.
Any inventory on hand at the measurement date in excess of our current requirements based on historical and anticipated levels of sales is classified as long-term on our Consolidated Balance Sheets. The classification of our inventory as either current or long-term inventory requires us to estimate the portion of on-hand inventory that can be realized over the next 12 months and does not include precious metal, labor, and other inventory purchases expected to be both purchased and realized in cost of sales over the next 12 months.
Our work-in-process inventories include raw SiC crystals on which processing costs, such as labor and sawing, have been incurred; and components, such as metal castings and finished good moissanite jewels, that have been issued to jobs in the manufacture of finished jewelry. Our moissanite jewel manufacturing process involves the production of intermediary shapes, called “preforms”, that vary depending upon the expected size and shape of the finished jewel. To maximize manufacturing efficiencies, preforms may be made in advance of current finished inventory needs but remain in work-in-process inventories. As of June 30, 2020 and 2019, work-in-process inventories issued to active production jobs approximated $1.34 million and $1.23 million, respectively.
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Each accounting period we evaluate the valuation and classification of inventories including the need for potential adjustments to inventory-related reserves, which also include significant estimates by management.
See Note 2 to our consolidated financial statements in Item 8, “Financial Statements and Supplementary Data,” of this Annual Report on Form 10-K under the Inventories caption for a further description of our inventories accounting policy and see Note 5 to our consolidated financial statements in Item 8, “Financial Statements and Supplementary Data,” of this Annual Report on Form 10-K for more detailed information relating to our accounting for inventory-related reserves.
Revenue Recognition
Revenue is recognized to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which we expect to be entitled in exchange for those goods or services. To achieve this principle, we perform the following five steps: (i) identification of a contract with a customer; (ii) identification of any separate performance obligations; (iii) determination of the transaction price; (iv) allocation of the transaction price to the performance obligations in the contract; and (v) recognition of revenue when we have satisfied the underlying performance obligations. We recognize substantially all of our revenue at a point in time when control of our goods has passed to the customer with the exception of consigned goods. We consider our performance obligation related to the shipment of goods satisfied at the time this control is transferred. We also have a variable consideration element related to most of our contracts in the form of product return rights. At the time revenue is recognized, an allowance for estimated returns is established and any change in the allowance for returns is charged against net sales in the current period. For our customers (excluding those of charlesandcolvard.com), the returns policy generally allows for the return of jewels and finished jewelry with a valid reason for credit within 30 days of shipment, except for returns during the COVID-19 pandemic during which we generally extended the return period for an additional 30 days. Our charlesandcolvard.com customers may return purchases for any reason within 60 days in accordance with our returns policy as disclosed on the charlesandcolvard.com website. Periodically, we ship loose jewel goods and finished goods to Traditional segment customers on consignment terms. Under these consignment terms, the customer assumes the risk of loss and has an absolute right of return for a specified period that typically ranges from six months to one year. Our Online Channels segment and Traditional segment customers are generally required to make payments on consignment shipments within 30 to 60 days upon the customer informing us that such inventory will be kept by the customer. Accordingly, we do not recognize revenue on these consignment transactions until the earlier of (i) the customer informing us that the inventory will be kept by the customer; (ii) the expiration of the right of returns period; or (iii) the customer informing us that the inventory has been sold.
See Note 2 to our consolidated financial statements in Item 8, “Financial Statements and Supplementary Data”, of this Annual Report on Form 10-K under the Revenue Recognition caption for additional information regarding the underlying required disclosures arising from contracts with customers as well as a more detailed description of our revenue recognition accounting policy.
Accounts Receivable Reserves
Estimates are used to determine the amount of two reserves against trade accounts receivable. The first reserve is an allowance for sales returns. At the time revenue is recognized, we estimate future returns using a historical return rate that is reviewed quarterly with consideration of any contractual return privileges granted to customers, including any current extenuating economic conditions resulting from the COVID-19 pandemic, and we reduce sales and trade accounts receivable by this estimated amount. Our allowance for sales returns was $704,000 and $746,000 at June 30, 2020 and 2019, respectively.
The second reserve is an allowance for doubtful accounts for estimated losses resulting from the failure of our customers to make required payments. This allowance reduces trade accounts receivable to an amount expected to be collected. Based on historical percentages of uncollectible accounts by aging category, changes in payment history, and facts and circumstances, including any current extenuating economic conditions resulting from the COVID-19 pandemic, regarding specific accounts that become known to management when evaluating the adequacy of the allowance for doubtful accounts, we determine a percentage based on the age of the receivable that we deem uncollectible. The allowance is then calculated by applying the appropriate percentage to each of our accounts receivable aging categories, with consideration given to individual customer account activity subsequent to the current period, including cash receipts, in determining the appropriate allowance for doubtful accounts in the current period. Any increases or decreases to this allowance are charged or credited, respectively, as a bad debt expense to general and administrative expenses. We generally use an internal collection effort, which may include our sales personnel as we deem appropriate. After all internal collection efforts have been exhausted, we generally write off the account receivable.
We do not use off-balance sheet arrangements with unconsolidated entities or related parties, nor do we use other forms of off-balance sheet arrangements. Accordingly, our liquidity and capital resources are not subject to off-balance sheet risks from unconsolidated entities. As of December 31, 2017,June 30, 2020 and 2019, we did not have any off-balance sheet arrangements, as defined in Item 303(a)(4)(ii)(ii) of Regulation S-K.
Not applicable.